Apr 23, 2009
Executives
Alexis Lukianof – Chairman and Chief Executive Officer Keith Valentine – President and Chief Operating Officer Kevin O’Boyle – Executive Vice President and Chief Financial Officer Patrick Williams – Vice President of Finance and Investor Relations
Analysts
Ben Andrew - William Blair Raj Denhoy - Thomas Weisel Partners Matt Miksic - Piper Jaffray Michael Matson – Wachovia Capital Markets Rick Wise – Leerink Joanne Wuensch – BMO Capital Markets Taylor Harris - JP Morgan Chase & Co. Bob Hopkins – Bank of America Securities Bill Plovanic – Canaccord Adams
Operator
Welcome to the NuVasive, Inc., first quarter 2009 earnings conference call. (Operator Instructions).
It is now my pleasure to introduce your host, Mr. Patrick Williams, Vice President of Finance and Investor Relations for NuVasive.
Patrick Williams
Welcome to NuVasive's first quarter 2009 earnings conference call. NuVasive senior management on the call today will be Alexis Lukianof, Chairman and Chief Executive Officer; Keith Valentine, President and Chief Operating Officer; and Kevin O’Boyle, Executive Vice President and Chief Financial Officer.
During our management comments and our responses to your questions, certain items may be discussed which are not based entirely on historical facts. Any such items should be considered 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 those expressed or implied by such forward-looking statements.
These and other risks and uncertainties are more completely described in today’s press release and NuVasive’s more recent 10-Q and 10-K forms filed with the Securities and Exchange Commission. With that, I’d like to turn the call over to Alex.
Alex Lukianof
Thank you for joining us this afternoon on our first quarter 2009 conference call. Our first quarter profitability and revenue growth demonstrates that our strategy to build market share is performing well.
Our XLIF approach to spine fusion has improved patient outcomes as evidenced by the growing number of surgeons performing the procedure. The superiority of XLIF outcomes gives our exclusive sales force a considerable advantage and enables us to grow faster than our competitors.
Today, we are laying the groundwork for an innovative and best in class spine franchise designed to cover all areas of spine surgery, including cervical, biologics, and motion preservation with highly differentiated products to support our goal of $500 million and onto $1 billion in revenue while increasing profitability as we drive towards becoming the number four spine company in the world over the next several years. Revenue in the first quarter increased well over 50% year over year to $80 million and was up sequentially over 7% from fourth quarter 2008.
Turning to guidance, we are increasing both revenue and earnings guidance for the full year thanks to strong results across our entire business in the first quarter as well as higher expectations for the balance of the year. For 2009, we now expect $355 to $360 million in revenue, up from prior guidance of $345 to $350, representing over 40% growth compared to 2008 results.
This assumes $30 million in revenues from Osteocel Plus, up from prior guidance of $28 million. For 2009, we are increasing our earnings guidance despite dilution from the Cervitech acquisition announced today demonstrating that our business is able to achieve our strategic goals without compromising profitability.
Kevin will give a more detailed review of our financial results and full year guidance later in the call. We are excited about major strategic initiative with our acquisition of Cervitech and its PCM device.
The cervical disk replacement market holds real promise, and it will be one of the fastest growing segments of the spine market over the next several years, potentially replacing up to 40% of the traditional anterior cervical fusion market. The PCM is an innovative mechanical cervical disk which we believe will greatly speed NuVasive’s entry into the US cervical disk market.
There are significant advantages in making an early entry into the cervical disk market, and the PCM has the potential to receive US approval before most competitive devices reaching the market much faster than our current motion preservation product pipeline. Cerpass, our ceramic on ceramic mechanical cervical disk, has an approved IDE, but has not begun enrollment.
PCM is at least 3 to 4 years ahead of Cerpass on the regulatory pathway. NeoDisc, our embroidery technology with a nucleus-like core, has significant potential because of the opportunity for use earlier in the degenerative process.
However, the NeoDisc design is unprecedented. We may experience a protracted timeline for NeoDisc approval because of the novel nature of the device and the lack of an established regulatory pathway.
Currently NeoDisc is viewed as a total disk replacement at the FDA, but it may well be scrutinized as a nucleus replacement in the future. We expect to have more insight into the NeoDisc approval process once we collect and compile our 2-year data which should be complete in late 2010.
At that point, we’ll have greater insight into the approval pathway for PMA submission. In contrast, the PCM device is a mechanical TDR and has a more conventional regulatory pathway which we believe could save valuable time to market.
We plan to submit the PMA in the first quarter of 2010 and depending on whether or not a panel is deemed necessary by FDA, we anticipate possible PCM commercialization in 2011. In consideration, we’ll approximately $47 million upfront for the acquisition of Cervitech followed by $33 million contingent upon FDA approval.
In order to maintain our strong cash position, up to half of the payments may be made in stock. We expect that Cervitech will have a minimal benefit on international revenues in the near term as we transition their product into our growing global sales network.
We anticipate PCM revenue of $100 million annually within 3 years of US commercialization. Although this acquisition will be dilutive to EPS until US launch, it does not change our ability to reach our previously stated profitability goals for 2009, and we remain on track to reach our longstanding goal of 20% non-GAAP operating margins at $500 million in revenue.
Our decision to purchase Cervitech eliminates the need to proceed with the Cerpass PDR project. The knowledge we gained from the development of Cerpass will serve us well as we establish our innovative suite of TDR products.
Eliminating the Cerpass trial will save us up to $20 million in clinical trial costs over the next several years, which further helps diminish the dilutive impact of Cervitech. Additional information about the Cervitech transaction can be found on our corporate web site in our 8-K filing.
We have concluded a series of M&A transactions over the last year that have a cash and stock components. We are committee to maintaining a strong cash position as we leverage our topline growth and expect to finish the year with a cash balance of greater than $150 million.
Next, I’d like to discuss the thoracolumbar market segment which includes our revolutionary XLIF procedure that continues to transform the fusion market by providing better outcomes and shorter recovery. We’re currently advancing XLIF products for multilevel spine fusions such as degenerative scoliosis and trauma.
In 2009, we plan to launch a new scoliosis system, more foreign implants, and the next generation of our XLP lateral plate. We also have line extensions for MaxCess thoracic product to better equip surgeons to move into the thoracic spine.
We continue to roll out our next generation NeuroVision platform, the M5, which provides additional monitoring and guidance capabilities. Most importantly, the sophisticated capabilities of M5 further solidify our place as the leading lateral access company by further locking in our proprietary strong hold on safety and reproducibility.
Lastly, I would like to touch on the biologics space. Our acquisitions over the past several years have provided NuVasive with an offering to suit any surgeon preference, and we’re extremely pleased with our positioning in this $1.5 billion market.
With Osteocel Plus officially in the hands of our exclusive sales force, we’re seeing positive early acceptance of this unique stem cell based technology, and we believe that it is firmly on track to generate $30 million in revenue in 2009. We will provide additional insight on NuVasive’s new product launches at the web-casted investor morning we’re hosting on May 12th in New York City which will include hands-on demonstrations of our products.
There will also be a surgeon panel to answer your questions, provide additional color on the market for spine fusions, and provide data from NuVasive-sponsored surgeon surveys which objectively assess the health of the spine market. It is an opportunity not to be missed, and we hope that you will join us in New York.
I’d like to address the overall spine market and our growth trajectory. In our view, spine fusion surgery has not seen signs of the slowdown as contemplated for other orthopedic markets which are more elective in nature.
In fact, in the eyes of most spine fusion patients, spine surgery is not elective at all. Our ongoing dialogue with existing and potential surgeons who come to our headquarters for training has reinforced our belief that the spine fusion market continues to grow at a rate greater than 10%, with well-established reimbursement.
Although our sales have more than doubled over the past couple of years, we still only have modest market share in the US and much less internationally. We feel strongly that we have a long global runway of growth ahead of us.
A major factor in our confidence is our exclusive sales force. During first quarter of 2009, we grew our US quota carrying sales representative count to 235 from 225.
We are on track to reach $1.4 to $1.5 million in revenues per representative by the end of the year, up from $1.3 million at the end of 2008. We are on track to achieve $13 to $15 million in international sales in 2009.
While still small, we continue to add new share owners in new countries. In 2009, we expect to make our first sales in Australia, and recently we began the process of regulatory approvals in Asia.
We are optimistic about NuVasive’s potential in international markets with new offices opening in London, Berlin, Germany, and Melbourne. Before I turn it over to Kevin, I’d like to give a brief update on a few miscellaneous items.
The Medtronic litigation is still in the preliminary phases. We will continue to vigorously defend ourselves using all defensive and offensive measures available to us.
We have no intention whatsoever to seek settlement and expect to have our day in court in late 2010 or 2011. In the first quarter of 2009, we spent $1.6 million and continue to expect $5 million in litigation expenses for 2009.
On the compliance front, we expect the government and medical societies to adopt stricter policy related to disclosure of surgeon relationships which will provide increasing details on remuneration. We will continue to acquire innovative product ideas and intellectual property from surgeons, and we’ll continue to work closely with surgeons to proctor and teach our innovative techniques, all within the bounds that have been determined by the government and industry groups.
We believe surgeons are crucial for driving innovation in the spine market and helping companies like NuVasive to develop products that deliver outstanding patient outcomes. To place our efforts in context, royalty payments for technology transfer and product development collaboration comprise approximately 3% of total revenue and approximately 0.5% of revenue is related to surgeon proctoring and initial product evaluations.
Now I’d like to turn it over to Kevin O’Boyle for a detailed review of our financial results and updated guidance.
Kevin O’Boyle
Our revenue for the first quarter of 2009 of $80.0 million represents a 56.3% increase over Q1 2008 and a 7.3% increase over Q4 2008. The strong revenue demonstrates the company’s continued ability to take market share.
Gross margin for the first quarter was 81.5%, compared to 82.2% in Q1 ’08 and 82% in Q4 2008. The gross margin in the first quarter is consistent with our guidance of 81-82% and primarily reflects our product mix and international revenue contribution.
Our Q1 2009 GAAP net loss was $4.3 million or a loss per share of $0.12. Excluding intellectual property litigation expenses of $1.6 million and costs related to our acquisitions of $1.9 million, our first quarter loss was approximately $800,000, or a loss per share of $0.02, which improved from our previous guidance of a loss per share of $0.19 to $0.21.
Please reference the table in the press release for more detail. The strong financial results demonstrate our ability to leverage our revenue growth into improved profitability.
A portion of the loss per share improvement is due to the timing of operating expenses and is reflected in our updated full year guidance. Operating expenses for Q1 2009 totaled $68.7 million, compared to $50.5 million in Q1 2008 and $57 million in Q4 2008.
The increase in operating expenses in Q1 2009 from Q4 2008 is primarily due to costs associated with increased revenue volume, stock-based compensation, and acquisition related costs. As a reminder, with the new accounting rules, acquisition costs are now expensed in the period they are incurred.
Our legal expense related to the Medtronic lawsuit in the first quarter was $1.6 million and will remain on track with the previous guidance of $5 million. R&D expenses for the first quarter excluding stock-based compensation and intellectual property expenses totaled $7.1 million versus $5.2 million in Q4 2008.
R&D as a percent of revenues for Q1 2009 was 8.9% versus Q4 2008 at 7%. The increase in R&D spend was principally due to investments related to clinical data to support our biologics portfolio and the initiation of new development projects.
Sales, marketing, and administrative expenses for the first quarter excluding stock-based comp, amortization of intangible assets, acquisition-related costs totaled $50 million versus $43.9 million in Q4 2008. The increase in sales, marketing, and administrative expenses was commensurate with commissions on higher revenues as well as increased training and marketing activities in the quarter.
Excluding stock-based comp in the aforementioned adjustments, the percent to revenue was 62.5%, versus Q4 2008 at 59%. The stock-based compensation expense for the quarter of $6.7 million was recorded in our operating expenses and allocated as $1.4 million in research and development, with the balance of $5.3 million in sales, marketing and administrative expenses.
The interest and other expense for the quarter was $900,000. This reflects a continued trend of low yields on our cash investments due to market conditions.
With $203 million in cash and investments, our primary focus has been and will be going forward safety of principal. As a result, the majority of our invested cash is in securities backed by the U.S.
Government. We anticipate that we’ll close the year with a solid cash position of between $150 to $170 million, taking into account expected milestone payments to Osiris, the investment in Progentix, and the acquisition of Cervitech.
In our P&L included in the other expense total is a new item titled net loss attributable to noncontrolling interest. As a result of our investment in Progentix, we must now consolidate the entire expense in R&D.
However, the net loss representing the 60% we do not own is backed out in the line titled net loss attributable to non-controlling interests. Our full year inventory target remains at 20% to 25% inventory to sales ratio.
At the end of the first quarter of 2009, our inventory position was $82.2 million, or 25.7% of annualized first quarter revenue. We expect that by year end we will be back in our target range.
Days sales outstanding or DSOs were 59 days in quarter, down from 63 days in Q4 2008. I would now like to turn to a review of our updated 2009 financial guidance.
For the full year 2009, we are increasing our revenue guidance range to $355 million to $360 million, from $345 to $350 million, or approximately 43% growth over 2008. This updated revenue guidance includes an increase in our Osteocel Plus sales from $28 to $30 million.
We are improving our full year GAAP guidance to a loss per share of $0.05 to $0.07 from previous guidance of a loss of $0.12 to $0.14. Excluding IP litigation expenses and acquisition-related costs, we are also raising our EPS guidance to $0.11 to $0.13 from $0.02 to $0.04.
Gross margin guidance for the year has not changed from 81% to 82%. R&D expenses excluding stock-based compensation and intellectual property expense adjustments as a percent of revenues will increase from our previous guidance of 11% to 11-12% for the full year attributable to the Cervitech acquisition.
Sales, marketing, and administrative expenses excluding stock-based compensation, amortization of intangible assets, and acquisition-related costs will show a progressive leverage from Q1, and therefore we expect to see cost as a percent of sales at the lower end of the 58-59% guidance range. As previously mentioned, stock-based compensation remains unchanged for the full year at an estimated $27 million, with 20% allocated to R&D and 80% allocated to sales, marketing, and administrative expenses.
Amortization of intangible assets and interest and other expense both remain unchanged at $5 million each. I’d now like to give some insight into the trend of our operating expenses and impact of the recent Cervitech acquisition.
Our updated EPS guidance takes into the account the dilutive impact of the Cervitech acquisition which includes expenses to complete the clinical trial and work through the regulatory approval process. Our expected strong financial performance will enable us to absorb the dilutive impact of the Cervitech acquisition.
Consistent with prior years, we expect revenue to increase progressively throughout the year while fixed expenses should be more consistent from quarter to quarter. As a result, we expect to have higher earnings in the second half of the year.
We will continue to maintain a strategic approach to the industry as we drive to achieve $500 million and then on to $1 billion in revenues. For more than two years, we have publicly stated a goal of hitting 20% non-GAAP operating margin in conjunction with $500 million in revenues.
Today, we’re more confident than ever in our ability to achieve this goal. I now would like to turn the call back over to Alex for closing commentary.
Alex Lukianov
Overall, we are very pleased with our financial performance in the first quarter of 2009 in revenue and earnings. We have consistently met or exceeded all 20 quarters as a public company.
Our XLIF approach to spine fusion continues to be an extraordinary competitive advantage that offers better reproducible outcomes for both patients and surgeons. With this year’s launches, we will have over 50 differentiated products for fusion, biologics, and motion, a strategy that we expect will enable us to both take increasing share of today’s spine market and to expand that addressable market.
In summary, we have the strategy and the foundation in place to drive toward our goal of being the number four spine company in the world, and we plan to get there by adhering to our core values of absolute responsiveness, outstanding customer service, and cheetah speed. We will now take your questions.
Operator
(Operator Instructions) Our first question is from the line of Ben Andrew - William Blair.
Ben Andrew - William Blair
I wanted to talk a little bit about Cervitech and NeoDisc. I think that’s the newest piece of information in this quarter.
Maybe go through the thought process, other than timing which is obviously great to move that forward by three years and discuss, if you would, a bit more the regulatory path on NeoDisc. That just seems like a new development there.
Alexis Lukianof
Let me explain it in the same context that we discussed it in the script. If you take a look at Cerpass and where we are with that, we’ve obviously decided to not move forward on Cerpass and instead to purchase the PCM product, because that allows us to move into the market much more quickly as we discussed, and we think that that could be as soon as 2011.
With NeoDisc what we’re contemplating is that it may be treated more as a nucleus type of device, meaning that it could take us longer to get in front of a panel. The whole process may be protracted, and so as a result, we’re not certain of exactly how quickly we can get the device approved.
So, if you start to just do the basic math on the approval process and you take a look at what that looks like, submitting let’s say a PMA sometime in 2011, being able to get that completed into panel in 2012 is probably reasonable assuming that’s where we are 2011, and then by the time you complete the labeling process, by the time you go through all of the normal back and forth with FDA, it pushes it out to 2013. So that’s the reality of simply doing the math of how long it takes to go through the FDA process.
Our feeling is it was much better with what we believe is a sure thing relative to coming to the market quickly with a mechanical device that we are not sure if it will require help, but our guess is that it may not, and it should bring us to the market a heck of a lot faster.
Ben Andrew - William Blair
How much insight do you have at this point, Alex, in terms of the data on NeoDisc, obviously the European experience, but also the data on Cervitech? Is there a shorter term followup available that gave you the confidence to do this transaction?
Alexis Lukianof
There are a couple of papers now that are being published. There are 6000 cases now that have been done with Cervitech, so we feel very comfortable with regard to the data.
We’ve done extensive diligence in speaking to the surgeons that have implanted the device, so we feel that it’s a very solid device. It will be well accepted by the market.
Give us an opportunity to start to market it to our direct sales force in select countries throughout the world and then move it into the US with hopefully what will be a much earlier approval time from the FDA, as I said hopefully sometime in 2011.
Ben Andrew - William Blair
A couple of quick questions for Kevin. Can you give us the Osteocel sales number in the quarter, so we can get a look at the underlying implant numbers, and then talk a little bit about inventories, why they are staying high and why it takes towards the end of the year to bring those back down to normal, if you would?
Kevin O’Boyle
The Osteocel number in Q1 was $5 million, so the underlying business was obviously growing, and if you take out the number from Q4, it was growing a little more than 8% sequentially, so that’s all great news as it relates to the underlying business. As it relates to the inventory of $82 million, as part of the transition, we took on additional inventory around the Osteocel product to make sure that we have the inventory for the upcoming ramp of revenues going to $30 million.
That inflated, if you will, the first quarter inventory number.
Ben Andrew - William Blair
If you look at inventory on the core business, can you look at it that way and say the days are a bit more normal or is that possible?
Kevin O’Boyle
Instead of looking at it in the number of days, we look at it as a percent of sales of 20-25%. We’re just a little bit above 25%, and I think as we continue with our sales ramp and the things that we have, once the initial inventories are out in the international markets, we can get back into the guidance range of 20-25%, and that’s where we’re comfortable.
Operator
Your next question comes from the line of Raj Denhoy - Thomas Weisel Partners.
Raj Denhoy - Thomas Weisel Partners
When I look at your guidance for the year, obviously you’re baking a little bit of dilution from the Cervitech deal, but you’ve also raised your guidance for the year particularly on the earnings side by quite a bit, and I am curious what the difference is from just a month and a half ago. Is it that you found less places you need to spend, or is there just more leverage in the model than you thought?
What has really changed over the last 6 weeks or so?
Alexis Lukianof
Part of it is certainly leverage based on the revenue, Raj. That’s certainly there.
Part of it is some timing of expenses that we thought would hit in the first quarter that will hit in the subsequent quarters, so there’s a combination of both of that, and we’re getting some increased leverage out of the SMA line, and we’ll continue to see some leverage out of that as we go to the end of the year. So you throw all that together, and that gives us the confidence to increase our guidance.
Raj Denhoy - Thomas Weisel Partners
But when we consider through that’s still pretty heavy spending load you’re guidance towards for this year. Is that a worst case scenario?
Is that maximum spending? Again what I’m trying to get at is whether that’s very conservative guidance still at this point, because you guys beat by pretty handily amount here in the first quarter.
Alexis Lukianof
It’s called reasonable spending to achieve superior results, and that’s what it takes to put up the kind of growth that we’re talking about, so I think the numbers are reasonable relative to what we’re putting forward. We’ll see how the rest of the year goes, but we’re very bullish on our prospects.
Raj Denhoy - Thomas Weisel Partners
Obviously, there’s been a lot of interesting stories circulating around about your stock over the last couple of weeks and months, and maybe you can just address some of the ongoing concerns about potential reimbursement changes and competitive pressure that some are expecting will develop over the course of this year.
Alexis Lukianof
First of all, we do not believe that there is a reimbursement issue. We have not been apprised of such, and we have done extensive research because of some of the nonsense and rumors that we’ve seen developed by the shorts, to put it in blunt terms, and there’s nothing brewing.
There’s absolutely nothing that has changed. Our reimbursement prospects have not changed.
There is nothing being done differently by surgeons. We’re following the exact same coding process that we’ve following since 2006, as was established by NAS.
So absolutely nothing has changed, and frankly it’s bologna, and there’s absolutely no truth to it. That’s pretty clear, right?
Raj Denhoy - Thomas Weisel Partners
That’s crystal clear. I’ll leave the competition for someone else maybe to ask, but just maybe if I ask about international.
Did you give an OUS number in the quarter?
Alexis Lukianof
No, not in the quarter. We just simply said that we’re on track for in the range of $13 to $15 million on the year.
So that’s puts somewhere in the 3-4% range in terms of percent of revenue.
Raj Denhoy - Thomas Weisel Partners
There’s obviously a lot of potential on that number if you do expand internationally, and it sounds like you’re doing some things there, but why the decision not to go faster there? Overall spine market is maybe 40% internationally, still a small percentage of your business.
You could obviously ramp that a lot faster if you chose to, and I’m curious why you’re not doing that.
Alexis Lukianof
We could do that, but we don’t that that’s a solid way to build the long-term business. The way that you would do that is you would engage distributors, they would be non-exclusive.
You’d get a rise in sales, but it would not be ultimately sustainable for the levels that we would expect in terms of our growth expectations, so we feel it’s much more prudent to build an appropriate sales force that’s exclusive, so we’re going exclusive as a result. We’ve started now exclusively in Germany and Australia, have been in the United Kingdom, are making plans to do so in Japan, and our entire process entails hiring very seasoned individuals.
You have to wait for those individuals at times, and get the right people in place, but I think that when you take a slightly slower approach, get the right people, hire the right people, then you end up making it up on the backend, and so I see us being able to grow quickly as we move. I think next year will be a strong year for international.
I think as we continue to move forward, we’ll expect that to grow commensurate with the kind of pace that we’re seeing in the US and then some.
Operator
Your next question comes from the line of Matt Miksic - Piper Jaffray.
Matt Miksic - Piper Jaffray
You’re obviously taking share here and have been for a while, but some of the larger players in the space are not growing as fast as you are, but making comments that they’re seeing some deferrals. What are you seeing in your business?
What gives you the confidence that that hasn’t changed, which is what I read through in your 10 percentish kind of growth number you gave in your prepared remarks?
Alexis Lukianof
There are a number of things. Obviously it has to do with our product portfolio, our exclusive sales force, and our ability to take market share, so clearly XLIF is doing exceptionally well.
We’re moving up the spine. We’re doing obviously degenerative scoliosis applications, so it has broad utility.
The same thing with moving into the thoracic spine, and I think that’s critical point relative to our success. We also as you know train a large group of surgeons on an ongoing basis here in San Diego, and so we decided that who better to survey the surgeons than us since we see them on a routine basis, and so when we talk to them about their business what it looks like relative to the future, what we’re understanding from 90% of them is that they expect their lumbar spine fusion procedures in ’09 to increase or to be the same as last year.
I think that probably with regard to our space, and we don’t know this for a fact, but we believe that there’s probably going to be some downward force more on diskectomy, laminectomy-type of procedures, but certainly not fusions, and we’ve not seen a downward trend. We talk to surgeons constantly, and the same thing with our sales force, and so I think it’s all of those things together being driven by our unique lateral approach and the confidence that we’re hearing from our surgeons who are using XLIF as well as prospective customers that we also survey when they come through here.
Matt Miksic - Piper Jaffray
A followup also on inventory, as I think about the growth in the sales force and I’m thinking that some of the products are rolling out and moving up into thoracic, how much of the build has been around Osteocel, how much of the build maybe has been around facets, has there been an effect of stretching some of your inventory across these new geographies? Maybe some color on what the fourth and first quarter build has been and anticipation of for the rest of the year.
Alexis Lukianof
Before Kevin answers that, I just want to mention one thing. We’ve taken, and we’ve done this now for several years, an approach of zero backorders when it comes to our products, and we feel that if we’re going to be out there taking market share, and we’ve done this before, and we know that the way to fail at taking market share is to not be able to deliver on the product, so we tend to perhaps run a little bit higher on inventory as a result than perhaps other companies, in that 20-25%.
We think that’s totally acceptable, and over the course of the year, bringing it down to something below 25% is how we’ve established our target. We did beef up on some additional inventory on Osteocel.
I’m not sure that we’ve the numbers to run through with you in particular, but I think Kevin can provide some additional color, but I wanted to explain just how we support our sales force, and we do run to a higher number with regard to that when we move forward on our top line, so that’s a normal way that we set things up with our sales force. Our sales force obviously has a quota that is higher than our guidance.
That’s the way every single company in the world does it, and so we have a tendency to build to a higher number that will support our sales efforts. Those numbers will then tend to intersect and then ultimately meet as we have a successful year, which we certainly would hope to have this year again.
Kevin O’Boyle
On the Osteocel inventory in terms of the first quarter, $7 was that number as it relates to Osteocel, Mike. That certainly gets us over the 25% range, and as we move throughout the year, we have a number of initiatives and things that we’re looking to make sure that we hit the 20-25% range appropriately so, because that’s our internal target, and that’s the one that we’ve related to the street.
We’re confident in that, and it’s going to take a couple of quarters to get it back into that range, but there are a couple of reasons as Alex just mentioned as to why we’re at the high end of that range at the moment, but we don’t consider that to be a significant problem.
Matt Miksic - Piper Jaffray
Just to make sure I heard your comments right on on Cerpass and the PCM acquisition, is it discontinuing your progression of Cerpass? In other words, does that program go away in favor of PCM?
Alexis Lukianof
That’s exactly right, and we’ve not started enrolment. We have been kind of hedging to see if we could put some things together, so that simply will be supplanted by PCM.
Operator
Your next question comes from the line of Michael Matson – Wachovia Capital Markets.
Michael Matson – Wachovia Capital Markets
I just wanted to go back to the percentages that you gave of your sales that you’re paying to physicians, either as royalties or as consulting payments. I appreciate the visibility there, and I think that’ll help alleviate investor concerns, but I was just wondering do you give stock options at all any physicians and if so, would that be included in that number as well?
Alexis Lukianof
We give zero stock options, and there are no stock options included.
Michael Matson – Wachovia Capital Markets
With regard to the cervical disk market, it seems like you’re pretty bullish on that market segment, and as best we can tell, it seems like the products that are out there are struggling, and I guess we’re more optimistic about it than the lumbar disk market, but I was just wondering if you could give us your perspective on why it hasn’t yet really taken off.
Alexis Lukianof
We think actually the products are doing better than perhaps the companies are talking about, because we have our ear to the street. Our belief is that they’re doing quite well, both of the cervical PDRs that are out there.
We kind of see that as a very robust opportunity for us, and we’ve also seen on the reimbursement side them able to gain additional states, and they’re kind of going on a local approach with a state by state approach to their reimbursement strategy, but being able to gain more and more traction, so our belief is that this is going to really take off over the next couple of years, and I think the one thing that perhaps is most important is the clinical relevance of the product. It’s one of those things where good medicine ultimately prevails.
I think it’s like the XLIF story in that regard, but motion preservation makes a lot of sense in the neck. In the lumbar spine, it certainly has a place and a space, but it’s more limited in application, but in the neck, clearly as you know adjacent segment disease is much more easily documented and has been in the literature, so I think you’ll see and we’ve seen this with surgeons and with our own diligence that the surgeons are very bullish on the need for motions preservation in the neck especially as that disease progress and patients move down that cascade process.
If you start off with a fusion, you’re simply accelerating them to another level of fusion. We believe that that’s also going to prevail over the next couple or three years in particular as this product becomes more available in the US.
Michael Matson – Wachovia Capital Markets
The Asian launch that you’re planning, what countries are you entering, and does that involve Japan, and if not, what are your plans with Japan, and how long would it take you to get your products on the market there?
Alexis Lukianof
Japan is our primary focal point, and so we anticipate essentially being able to have some significant revenue in ’11. The beginnings of that will come in ’10 as we’ll start scaling up, but we’ll see it in ’11, so we’re going through that regulatory process.
We’re interested in China as well. We’re looking at the Singapore markets, but we’re largely focused on making sure we get into Japan.
It’s the largest market, but the Chinese market is also coming around very quickly as well.
Operator
Your next question comes from the line of Rick Wise – Leerink.
Rick Wise – Leerink
Alex, could I ask you for a little more color on the revenue. It came in $5 million better than our numbers anyway.
Maybe just color and you may have some other ideas other than what I’m going to suggest. Was this new reps getting more productive faster than you thought, is it the more experienced guys penetrating accounts faster than you thought, opening new accounts faster than you thought, more thoracic spine than lumbar spine than you thought?
I’m just trying to understand where the incremental better than you’d have expected came from?
Alexis Lukianof
We had a very strong performance across the board, and our sales force is measured on mix, so in terms of how it does on XLIF, cervical, biologics, NeuroVision, and so forth, and so we came across the board very strongly in every category. That’s unusual for any company to have such a strong performance across all categories of mix, but that was the case for us.
We also had a stronger number on the Osteocel side than we originally thought we might have. As you know, we transferred that product from the fourth quarter to the first quarter into the hands of our own sales force.
That’s gone very well. As a result, we’ve increased our guidance to $30 million on the year there, but that certainly contributed very nicely also.
Rick Wise – Leerink
When we look at the doctor training commitments and planning, do you have a sense that in terms of folks making reservations to come and get trained, has that changed at all in the last month or so, and how far out are you booked for those trainings at this point?
Alexis Lukianof
It’s been consistent as last year. That time is anywhere from 6 weeks to 8 weeks, and our courses are filled, so we’ve not seen any drop whatsoever in those numbers.
The training rate is the same. It’s about 125-150 a quarter.
We just recently had our SOLAS meeting which is our Society of Lateral Access Surgeons. We had about 100 surgeons come in for that, so the surgeons I think are very excited about what we’re doing, and we’re seeing absolutely no change whatsoever in our traffic, nor in our forecast that way.
Rick Wise – Leerink
Raj was kind enough to leave the competitive question to somebody else. I’ll pick that up.
Maybe any update in your thoughts about new competing lateral approach products that we’ve got coming. That’s another recurring concern that we all have to address.
Alexis Lukianof
For us it’s been 20 quarters of success in terms of being a public company. I think it’s just as many quarters of companies trying to copy what we’re doing with XLIF, without success.
The reason for that is because NeuroVision being very proprietary is so far ahead of everybody else, and I think as you talk to surgeons, you can do a lateral surgery without NeuroVision. It’s just not safe and reproducible, so if somebody wanted to subject themselves to potential nerve damage, then I’m sure that they can move towards a competitor product, but from our perspective and from what we hear from surgeons on a routine basis, and we’ve had quite a few surgeons that obviously have been targeted by companies that use the XLIF procedure to try a competitive offering, and we’ve gotten the same consistent remarks, that there’s absolutely no comparison between XLIF, the suite of products, and instrumentation, the approach, the sophistication, our ability to move up into the thoracic spine, so we believe that we’re firmly several years ahead of the competition.
We’ll continue to evolve our products and stay in that lead position. I know you speak with surgeons, but if you talk to any surgeon that’s done comparisons, they’ll tell you it’s night and day, and they would not move towards subjecting their patients to what I think they’ve described to us as clearly inferior technology.
Rick Wise – Leerink
Kevin, on the R&D front, I understand that Cerpass is going away, Cervitech is coming in, no massive shift in R&D spending, but as we look at our models and we think about R&D as a percentage of sales, should we assume whatever we’ve assumed as reasonable to continue assuming, or is it likely to be higher or lower? How do we think about that, maybe more this year than we might have thought because of the starting of the trial?
Kevin O’Boyle
We talked about 11-12%. Our prior guidance 11% for the year, so between 11-12% because of Cervitech as it relates to the R&D line, and for sales, marketing, and administrative, we had originally guided 58-59%, and we’re now guiding for the low end of that, so right around 58% for sales, marketing, and administrative.
When you add in the increased revenue guidance, you start dialing into our guidance on an EPS basis.
Rick Wise – Leerink
I may have just missed it because it went too quickly. I understand your $1.4 to $1.5 million annualized sales per rep by the end of the year.
Did you say what you thought it was in the current quarter?
Kevin O’Boyle
We gave the rep number of I think $235. You can do the math, but I think it’s about $1.3 and change.
Operator
Your next question comes from the line of Joanne Wuensch – BMO Capital Markets.
Joanne Wuensch – BMO Capital Markets
The 235 reps stat, I assume that’s in the US?
Kevin O’Boyle
Yes, that’s all US.
Joanne Wuensch – BMO Capital Markets
What about outside of the US?
Alexis Lukianof
It’s approximately 20 at this point, and that’ll increase obviously dramatically as we move into the year.
Joanne Wuensch – BMO Capital Markets
Is Cervitech CE marked approved at this stage?
Alexis Lukianof
Yes.
Joanne Wuensch – BMO Capital Markets
What is its revenue run rate at this stage?
Alexis Lukianof
It really doesn’t have a revenue run rate per se. Historically they did a couple of million dollars in revenue on a global basis with a broach range of different distributors, so we’re starting effectively from zero with Cervitech because we’re going to move it into our direct sales force and then move it into select countries, so we have worked with Cervitech to cancel the vast majority of those agreements, and so we are just down to a couple of countries that are remaining that we’re still working through, and we may use the distributors that are in place, but we’re starting all over.
Joanne Wuensch – BMO Capital Markets
You said something which sounded like you were with the M&A environment. I think you specifically said we have a concluded a series of M&A transactions.
Is that a pause for now, or how are you thinking about M&A?
Alexis Lukianof
I didn’t say that. I’m not sure if somebody else said that, but the way that we’re looking at it is that we’ve certainly completed the major transactions that we wanted to get done on the biologics side as well as on the motion side, so we’re not working towards any particular transactions at this point in time, but we’ll do in the future as we’ve done now for years.
We’ll certainly continue to evaluate technology, technology transfers, but those are smaller ticket items.
Joanne Wuensch – BMO Capital Markets
Everyone keeps talking about a slowing spine market, and you’re clearly not seeing that, so I’m thinking you’re taking share, a fair amount. Do you have an updated estimate of what that may be?
Alexis Lukianof
We don’t. It’s a hard one because it’s a moving target relative to the performance of other companies, so we know the same things that you do about how they’re growing.
We can simply sort of rehash what we’ve already talked about, and how well we’re doing with XLIF and how well we’re doing across the board and really the strength of our exclusive sales force.
Operator
Your next question comes from the line of Taylor Harris - JP Morgan Chase & Co.
Taylor Harris - JP Morgan Chase & Co.
Alex, just curious as to what you’re seeing in your business. Obviously XLIF for you has been the driver for a number of years, but you’re more penetrated in terms of what XLIF can do than perhaps your overall spine market share, and so I’m wondering in some of the applications were XLIF perhaps can’t be used, are you starting to take share there as well, and how meaningful can that be for you?
Alexis Lukianof
,
Taylor Harris - JP Morgan Chase & Co.
As you incentivize your sales force, how much emphasis is put on new account acquisitions versus existing account penetration?
Alexis Lukianof
It depends on the territories. The way that we focus them is again relative to mix, but we have their territories well defined, and we concentrically grow out our territories, so there are areas where we continue to increase the number of reps because we only have a small number in a particular city even though they are deeply penetrated, so we’ll add reps in those particular areas, and they’ll start from zero, and obviously in that case, they are out there getting new accounts and moving into those territories, but for the most part, what we’re trying to do and our strategy is I would say 75% of our efforts are about pulling through and pulling through on our existing accounts and then 25% keeping a reasonable pace, and again these are just estimates of moving towards new accounts.
Taylor Harris - JP Morgan Chase & Co.
These are tough times especially for some of the larger companies that you compete against, and my assumption is that some of these large organizations are cutting back in terms of expense whether it’s a sales force or R&D or otherwise. Are you seeing that play out in the marketplace or just sort of a thought at this point?
Alexis Lukianof
I have not seen that play out in the marketplace, certainly not at this point.
Operator
Bob Hopkins – Bank of America Securities
Alex, I just wanted to get your opinion on the spine market again. Just looking forward, obviously right now it’s extraordinarily healthy and just wanted to see what you thought about looking forward over the next 12 to 24 months from a pricing perspective, from a unit perspective, do you expect this to continue to be a 10% growth marker?
Do you expect any impact from the economy at all, and then I have a followup as to how that might affect you guys, and if it affects you guys.
Alexis Lukianof
,
Bob Hopkins – Bank of America Securities
I’m not sure how you build up your internal models, but is there a sensitivity that you’ve done because it strikes me that if the market is growing 10 or if the market is growing 7 or 8, it probably doesn’t make a huge amount of difference to your ability to grow the topline within the range that you’ve articulated, but I’m just curious as to is there a threshold that you thought about if the market is below 5 or something below that that it starts to get difficult for you to meet your projections or is that just not the way you’ve built up the model?
Alexis Lukianof
We have not built up the model that way. We still have such a small market share in the United States so no matter how you slice this thing up, and then now throw in the biologics piece that we have talked about, throw in OUS, which are still very small numbers for us as a company.
Our ability to take share, I think, is relatively unprecedented compared to other companies, so we continue to invest aggressively, and I think a lot of that, and I can just tell you from having been in the industry for years, it’s because we are a standalone spine company. We don’t do anything else, and we don’t focus our energies on other areas, and we can make decisions quickly, and we can move into new product offerings quickly, and so that is very effective.
I think sometimes that’s lost on people relative to how we are able to do business versus perhaps some of the other companies.
Bob Hopkins – Bank of America Securities
The last question is on the cervical disk market. Two things I’m curious about.
One is what’s your sense as to when this market will really start to happen? Is broad-based commercial insurance the major issue here, and when do you see that happening and loosening up this market place because there are obviously products out there right now, and they are not doing spectacularly well, and then I was just wondering if you can comment a little bit more on this strategic fit of this deal with the cervical program that you already have.
Alexis Lukianof
What I would like to do is turn it over to Keith to give you a little bit more color on what we think the market is in the US today based on our reconnaissance and talk about that, and he has got to answer a question or he is going to get mad at me for prepping all this time.
Keith Valentine
Bob, I think you are going to see a lot of freedom in 2009 right now, and we are seeing it already. We’re seeing the payer community more receptive, and I think that the pent-up market share predications that were put on TDR for both lumbar and cervical made both of them very difficult to live up to, but the good news is if you compare this to the lumbar experience, you are seeing cervical free up on the payer communities a lot quicker and you are seeing it free up in a very consistent manner, and we see 2009 as freedom for that space for two players that are there, and then we see nice expansion for 2010 and beyond, and it will be well over $100 million market in 2009, and I would expect if this continues with the payer and what we are seeing with some of the payer freedom that it’s going to be on a ramp closer to $200 million for next year, and so I think that it’s just been under high expectations, and I think some of the clearances have taken a little bit longer than anticipated, but now that you have two very good players with very good options and great clinical results now, you are getting clinical results out past three years, and they are starting to show some superiority with some certain outcomes, and those are the kind of things that really create a nice momentum shift with the payer community.
Bob Hopkins – Bank of America Securities
So you think that market might double in 2010 is what you are saying?
Keith Valentine
Yes. We think it has clear ability if this momentum continues with the payers.
Bob Hopkins – Bank of America Securities
Could you talk about the strategic fit? How this fits with NeoDisc and just some comments there?
Keith Valentine
The real opportunity here is that this gets us to into that market place as the number three player, and in that, it also gives a great opportunity for our sales force to get on the ground to be driving a motion preservation platform, which only helps the continued driving as we bring new products, such as NeoDisc after that, and so this really is a great process for us to make sure that we’re getting our sales force up to speed in the process and we’re also delivering new technology after this particularly technology, this particular motion technology, is approved by the FDA.
Bob Hopkins – Bank of America Securities
When do you expect approval of this device in the US?
Alexis Lukianof
2011.
Bob Hopkins – Banc of America Securities
What’s the soonest that we see some good data from it?
Alexis Lukianof
There are actually two papers that are out. They will be referenced on our website, and so we will make sure that they are available shortly to everyone, but we will do that very quickly, but there are already two very strong published papers out.
Operator
Bill Plovanic – Canaccord Adams
First just on the Osteocel, was there an impact on your Formagraft sales or do you feel like you are replacing more competitive products that were being used in those procedures?
Alexis Lukianof
No impact on Formagraft, all incremental.
Bill Plovanic – Canaccord Adams
What was cervical as a percentage of revenues in the quarter in the US?
Alexis Lukianof
We will have to look it up, but it should be consistent with what it has been. It would be in the 10% to 11% range.
Bill Plovanic – Canaccord Adams
As you bring in the PCM product, would you expect it post approval event, you might come out with a ceramic on ceramic version of that product? Are you able to do that with the PCM design?
Alexis Lukianof
I think what we are going to be looking at are other ways to expand our cervical portfolio. Our number one priority is to get PCM out into the OUS market and to get it into the United States, so we are spending a substantial amount of money in purchasing it, and we certainly want to make good on that transition and get the revenue that we are looking for, but we think that there is probably going to be other opportunities to look at other ways for us to inject further development components either directly to PCM or do things that are related to that.
Bill Plovanic – Canaccord Adams
That’s all I had. Thank you.
Alexis Lukianof
That’s it for questions. We appreciate everybody being on the call today, and we look forward to speaking with you in another quarter.