NuVasive Inc (NUVA) 2017 Q3 法說會逐字稿

Greetings, and welcome to the NuVasive, Inc. Third Quarter 2017 Conference Call. (Operator Instructions) As a reminder, this conference is being recorded.

I would now like to turn the conference over to our host, Carol Cox, Executive Vice President, External Affairs. Thank you. You may begin.

Thank you, Dan, and welcome everyone to NuVasive's Third Quarter 2017 Earnings Call. The company's earnings release, which we issued earlier this afternoon, is now posted on our website, as is Investor Presentation, both of which have been filed on Form 8-K and with the Securities and Exchange Commission. We've also posted supplemental financial information on the Investor Relations website to accompany our today -- our discussion today.

On the call, we will be covering information that is included in the investor presentation, and I encourage you to access these materials, so that you may follow along.

Before we begin, I would like to remind you that the discussions during today's call will include forward-looking statements, which are based on current expectations and involve risks and uncertainties, assumptions and other factors, which if they do not materialize or prove to be correct, could cause NuVasive's results to differ materially from those expressed or implied by such forward-looking statements. Additional risks and uncertainties that may affect future results are described in NuVasive's news releases and periodic filings with the Securities and Exchange Commission. NuVasive assumes no obligation to update any forward-looking statements or information, which speak as of their respective dates.

This call will also include a discussion of several financial measures that are not calculated in accordance with generally accepted accounting principles or GAAP. We generally refer to these as non-GAAP financial measures. These measures include our cost of goods sold, gross margin, sales, marketing and administrative expenses, research and development expenses, operating margin, non-GAAP earnings per share, free cash flow and EBITDA. Reconciliations to the most directly comparable GAAP financial measures may be found in today's news release and the supplementary financial information, which are accessible from the Investor Relations section of the NuVasive website.

Joining me on today's call are Greg Lucier, our Chairman and Chief Executive Officer; and Raj Asarpota, our Chief Financial Officer. With that, I'd like to turn the call over to Greg.

Thank you, Carol, and good afternoon, everyone. On today's call, we will be covering our results for the third quarter, providing an update to our 2017 guidance and providing some initial thoughts on 2018.

I want to welcome Raj to his first earnings call with NuVasive as our Chief Financial Officer. He brings over 25 years of experience and a proven track record of driving operational improvements and supporting market expansion at medical device and life sciences companies. I'm pleased to have his skills and guidance on our leadership team.

Now earlier this afternoon, we reported third quarter results, including revenue of $247.4 million, representing a year-over-year growth of approximately 3% on an organic basis. We also reported non-GAAP operating profit margin of 17.6%, 150 basis points increase over prior year; and non-GAAP earnings per share of $0.52, representing year-over-year growth of approximately 30%.

Revenue growth in the quarter was primarily driven by our international sales, which grew approximately 46% on a constant-currency basis. This was the fourth consecutive quarter in which we achieved sales growth in excess of 20% in our international market. This consistent double-digit growth demonstrates the continued strong demand of our spine technology outside the United States from the buildout of our operations and sales capabilities, resulting in strong demand in all of our international markets, including key markets, such as Italy, Germany and Japan. Further, as we've scaled these international sales, our profitability grows due to fixed cost leverage and, in turn, that profitability will accelerate the reduction in our effective corporate tax rate.

In the U.S., our revenue declined 3.5% due to some uncontrollable dynamics in the quarter, including the negative impact from Hurricanes Harvey and Irma, and 1 less selling day versus the prior year. U.S. sales reflected greater penetration in the deformity market with our ReLine posterior fixation portfolio and our NSO portfolio, along with new product introductions, including BASE Interfixated ALIF system, TLX expandable cage, RELINE Small Stature and the early rollout of our XLIF Modulus, all driving growth in our spinal hardware business.

This growth was more than offset by continued softness in our biologics business. A new leader has been named over that franchise who is going to dig in and put all options on the table. Our longer-term goal remains lowering the need for biologics to advance material engineering of the implant, but in the meanwhile, we're going to do a better job stemming this revenue erosion.

Putting that all together, excluding the impact of hurricanes Harvey and Irma on U.S. results and hurricane Maria on international results, which we estimate to be approximately $5 million in total, and 1 less selling day, revenue growth for the company would have been approximately 6%.

Now I also get asked questions about the U.S. market and the trends we're seeing. Like others across the industry, we saw softer volumes than expected during the quarter. Procedural volumes grew approximately 1% year-over-year, lower than anticipated. In fact, we had expected incremental sequential uptick in volumes in the second half of the year, as patients met premiums in their high deductible plans and moved forward with elective spine procedures. While we did not see volumes step up in September, the acceleration was not as steep as we expected. The hurricane, which came late in the quarter, had some impact on volumes, as I mentioned, but we do not believe this alone could be the primary driver of the differential.

We talk regularly to our surgeon customers, hospital systems and insurance executives as part of our work to assess the market. While these conversations and our analysis have provided various data points, we do not have a definitive view on what is causing the underlying softness in the U.S. spine market. But here's what I can tell you so far, based on the first 9 months of the year, the U.S. spine market is stable but largely flat overall. Through our services business, we participate in nearly 90,000 spine procedures a year, giving us a unique insight into procedural volumes across the U.S. And what we are seeing is that volumes are down about 2% on the quarter, including the impact of the hurricane. We believe some of the softness is likely due to the timing of when patients are getting procedures done. Additionally, we know hospital admissions and surgical volumes continue to be down, and the reasons for this include commentary around the impact of high deductible plans and changes in insurance and payer mix. Pricing has been relatively in line with our expectations, down roughly 2%. We have pocket where pricing is better, particularly new products, and products -- and pockets where it is worse, but overall in line with our expectation. This is largely a patient volume issue.

We continue to monitor the data and stay close to our customers, but without a clear line of sight to the timing of the rebound of the U.S. market, we are taking a more conservative stand for the remainder of 2017 and reducing our full year revenue expectations to $1,030,000,000 from $1,065,000,000 to reflect these dynamics.

Let me provide some color on these numbers. When we reiterated guidance on the July call, we believed there was a pathway to our full year revenue guidance of $1.065 billion. That pathway assumed an uptick in volumes in the back half of the year based on the combination of historical trends, customer conversations and the impact of high deductible plans. However, the uptick has not materialized as I discussed. Our July guidance also did not anticipate the recent hurricanes and their continued impact in Q4 as it relates to particularly our business in Puerto Rico. We believe the fourth quarter numbers we have provided today are achievable, and we are optimistic about 2018 given the many opportunities ahead of us as you will hear.

Underscoring our confidence in the growth ahead for NuVasive, today, we announced our Board of Directors approved a share repurchase program, authorizing the purchase of up to 100 million of the company's common stock over a 3-year period. The board strongly believes in our strategic road map, our ability to execute against our strategic initiatives and to deliver long-term organic growth and improved operating profitability while staying committed to disciplined capital deployment and driving value for our shareholders. While it's too early for us to provide specific metrics for our expectations of 2018, I do want to provide a base framework for how we are thinking about the next year. Based on where we expect to finish in 2017, folding in new product launches, continued execution on our operating initiatives, we feel good about revenue growth in the mid-single-digit range, at least 100 basis points of operating margin expansion and EBITDA of approximately $300 million in 2018. We will provide specific guidance for 2018 when we report fourth quarter results.

Let me turn now to factors underpinning the buyback and our confidence in NuVasive and our value creation capabilities. NuVasive is the absolute industry leader in spine with state-of-the-art technology and deep surgeon and hospital relationships. I'm proud of the excellent and talented leadership team we have built, not only at the senior level but deeper into the organization. Today, we have senior leaders like Matt Link, Steve Rozow and Skip Kiil who brings decades of spine and orthopedic experience to their role of leading strategy and technology, operations and global commercial, respectively. Matt is a long-tenured NuVasive executive with more than 15 years of industry experience, including extensive knowledge of the U.S. spine market as well as surgeon and hospital dynamics. Steve spent over 20 years in Zimmer at various manufacturing and operational leadership roles. And Skip has led complex and global commercial enterprises internationally and in the U.S. He spent over 12 years in Stryker where he was responsible for commercial operations for 6 strategic businesses, including their Neuro Spine/ENT group.

At the next level of management, we have a strong bench of leaders who have spent their careers at NuVasive, driving the development of our new technologies for products, procedures and systems. As in years past, we have leaders who understand the spine market and have strong legacy relationships in the industry. When you partner this up with the deep operational excellence and broad med tech experience the rest of the leadership team brings to bear, we are the right team in place to grow this company responsibly and continue to take market share.

I'll tell you something else. These leaders are dedicated to teamwork and supporting our "we" culture. A great company is about teamwork, not 1, 2 or 3 people. It's about shared consciousness across many, many individuals and having every person empowered to deliver exceptional result. Our future at NuVasive is shared leadership to drive sustainable growth and value creation.

As you know, we have a strong history of delivering disruptive spine technology, and this week at NASS, we will host surgical innovation workshops, in-booth demonstrations and scientific sessions focused on lateral procedural solutions and Advanced Materials Science, among other technologies and procedures. For 15 years, we have been the global leader in lateral spine surgery with the XLIF procedure, and over the last year, we have doubled down our investments in this flagship surgical approach. At this year's NASS, we will showcase the expansion of our lateral procedure solutions portfolio to enable single-position surgery from -- for laterals from T6-S1 through the launch of our XLIF Crestline and Lateral Alif. XLIF Crestline is an additive procedural solution to XLIF, providing increased access to the sometimes challenging anatomy of L4-L5. And Lateral ALIF will provide additional access at L5 through S1, while delivering OR efficiency to enable lateral single-position surgery.

We are also introducing our proprietary Advanced Materials Science, or AMS, technology portfolio of premium spine interbodies at NASS. We will be highlighting both our porous PEEK and Modulus titanium interbodies. Through AMS, we will enhance the structure and service of our surgical materials to deliver interbody implants with superior osseointegration and biomechanics and fund research, which hopefully demonstrates the need for much less biologic material than surgery.

In early September, we -- when we acquired Vertera Spine, a privately held medical device company developing and commercializing highly innovative interbody implants for spinal fusion using patent porous PEEK technology. As a result of this acquisition, NuVasive is now the only medical device company to offer porous interbody technology across the PEEK and titanium materials, thereby addressing the spectrum of surgeon needs and preference -- preferences for interbody implant. The technology developed by Vertera provides a unique 3-dimensional porous PEEK architecture to help elicit and encourage bone ingrowth based on preclinical studies while maintaining biomechanical and imaging properties of PEEK, in general. The technology will be adapted to existing NuVasive product lines as porous PEEK, and we believe porous PEEK will become the new gold standard in PEEK technology.

Additionally, we will highlight our Modulus titanium, which integrates endplate porosity with an optimized body lattice structure, providing a fully forced architecture and an ideal environment for bone growth while enhancing visualization of traditional titanium interbody implant. We have recently launched our first Modulus titanium interbody for XLIF and have plans to expand to additional procedures.

Before I turn the call over to Raj, I would like to give an update on the commercial launch of our industry-disrupting, radiation-reducing Lessray software technology system that was launched late in third quarter, following robust alpha and beta testing in more than a dozen hospitals that perform spine surgeries. Interest in Lessray is extremely high, demonstrating a critical need for a solution like Lessray to address a major safety issue related to radiation-facing surgeons and hospital administrators. Our team is busy conducting trials in many places, and we are at various stages of the capital purchasing process.

A few weeks into the launch, a couple of dynamics have become clear. Early customer interest is biased to the 24-month lease option, and hospital capital budget cycles are allocated annually and can take up to 6 to 9 months on average to complete and are somewhat unpredictable given budget cycles that are hospital customers. As a result, the exact timing of each transaction is too early to predict. Based on these dynamics, we are tweaking our expected revenue associated with Lessray in the fourth quarter to approximately $1 million, down slightly from the $2 million to $3 million we have previously guided to. We are pleased with our customer interest and pipeline and believe that as we work through the capital sales process over the next few quarters, this demand will translate in the revenue levels we had anticipated.

In closing, we continue to be encouraged by our current portfolio, our robust technology pipeline and the opportunities we have working as a team to continue to bring differentiated solutions to market. While the slowing U.S. market presents a challenge, it does not diminish our objective and resolve to grow market share as we invest in growing our global franchise. We expect international revenue growth greater than 20% for the foreseeable future, and that we will benefit from the leverage this scale provides. From a profitability standpoint, we have multiple opportunities to continue to execute on the targets we have laid out and fully expect to drive double-digit growth for both non-GAAP EPS and EBITDA.

NuVasive's prospects remain strong.

Now I'd like to turn the call over to my colleague, Raj.

Thanks, Greg, and good afternoon, everyone. I'm pleased to be participating in my first earnings call at NuVasive today and look forward to meeting many of our investors and analysts later this week at NASS.

Before we get started with the financials, let me remind you that many of the financial measures covered in today's call are on a non-GAAP basis unless noted otherwise. Please refer to today's earnings news release as well as other supplemental financial information on nuvasive.com for further information regarding our non-GAAP reconciliation. Given that we are past the 1-year anniversary for the Biotronic acquisition, all results are organic and will be discussed on a reported basis.

For the third quarter of 2017, we reported revenue of $247.4 million, which reflects growth of approximately 3% on both a reported and constant-currency basis. Revenue growth in the quarter was primarily driven by strong international growth of approximately 46% on a constant-currency basis with above market growth across all geographies. In the U.S., revenue was down 3.5% driven by growth in our core hardware business, which is offset by continued declines in our biologics business, lower-than-expected procedural volumes in our NuVasive clinical services business and increased reserves against the remaining billing and collections backlog we first discussed in Q2. Both the international and U.S. businesses were impacted by headwinds resulting from hurricanes Harvey, Irma and Maria, estimated to be approximately $5 million and by 1 less selling day in the quarter compared to Q3 of 2016, which is approximately $3 million. Adjusting for these items, worldwide growth would have been approximately 6%.

Our U.S. spinal hardware revenue grew at or above the U.S. market at about 2% per year -- year-over-year to $235.2 million. The increase was driven by new product introductions in the U.S., including BASE, TLX, RELINE Small Stature and the early rollout of XLIF Modulus. Adjusting for the impact of the hurricanes and offsetting the impact of 1 less selling day year-over-year, the U.S. spinal hardware business would have grown approximately 5% over the prior year period.

Revenue from U.S. surgical support came in at $63.7 million for the quarter, down 12.7%, primarily related to continued softness in our biologics business. We continue to face challenges in this area as new competitive product offerings enter the market, and we experience some procedural sell-through issues that are affecting revenue volume. This is an area where we must make inroads, and we are attacking it through multiple approaches, including the hiring of a new biologics leader and executing on different partnerships to further penetrate the spine market in adjacent areas. We will continue to explore additional avenues as appropriate.

NuVasive clinical services and IOS revenues are down year-over-year driven by the decline in procedural volume. During Q3, the conversion of NVM5 increased 63% year-over-year. As you may recall, we had some billing and collection challenges over the course of the first half of the year. Over the third quarter, we made significant improvements, and by the end of the quarter, the entire backlog of billings was processed and submitted for reimbursement. Given the timing of the improvements, some of which were implemented late in the quarter, most of the billings were submitted, but collections lagged due to the reimbursement cycle, and as a result, our revenue was impacted by $2 million for the quarter. We don't expect this process to impact revenue in future periods, and while we may have, even from the (inaudible) in the fourth quarter, we're not building that into our 2017 revenue expectation.

The delayed billing has also increased our days sales outstanding, or DSOs, to 68 for the quarter compared to approximately 66 days in Q2 of '17. While overall accounts receivable had decreased by approximately $3 million over the prior quarter, DSOs were approximately 2 days higher given the sales level. The primary driver remains the NCS accounts receivables, which are approximately $2.5 million despite the sequential decrease in sales, driving the change. The driver, as I've just discussed, is due to reduction of the backlog, getting billings out but not having the opportunity to collect cash prior to quarter end. Excluding the impact of NCS, the overall organizational DSO would have been approximately flat despite the impact of slower cash collections and hurricane-impacted areas such as Florida, Houston and Puerto Rico, and strong international sales that generally come with longer DSOs. We expect a significant reduction in DSOs into the fourth quarter as cash collections in the NCS business increase significantly as a result of clearing the backlog.

In the third quarter, international revenue grew approximately 46% on a constant-currency basis to $48.5 million. This is the fourth consecutive quarter where our international business has posted above 20% growth, and we feel confident this type of growth will continue well into the future. The EMEA region has continued to perform well, delivering approximately 41% growth on a constant-currency basis. All key Western EU markets saw more than 26% -- 20% growth driven by strength in the U.K. Italy, Germany and Benelux.

Our Asia Pacific business also had a solid quarter, reporting very strong growth of approximately 47% on a constant-currency basis. Specifically in Japan, XLIF continues to see good momentum as well as our posterior fixation business. Latin America grew approximately 57% on a constant-currency basis, driven by very strong performance in Brazil. These results are particularly strong as we absorbed approximately $1 million impact in Puerto Rico due to Hurricane Maria. We anticipate the Puerto Rico business will continue to be impacted in the fourth quarter of '17 as the government struggles to get electricity back up and running. And as a result, we are removing $3 million from our forecast. We're uncertain at this time what surgeries that were postponed in Q3 will return in Q4 or what percent of electric procedures will return altogether.

Now let's turn to the rest of the P&L. Non-GAAP gross margin for the third quarter was 73.5%, down 280 basis points from the prior year. The primary drivers include 90 basis points due to a higher mix of revenue and lower margin businesses. Pricing pressure continues to be consistent from past quarters, remaining in the low single digits at approximately negative 2%. Gross margin was also impacted by the timing of operational efficiencies of approximately 60 basis points.

As we continue to build out our West Carrollton facility, we faced a 70 basis point headwind due to a slower-than-expected ramp-up in our in-source manufacturing. As we work through that transition, we anticipate these headwinds will turn into tailwinds by the first quarter of 2018.

Our efforts to our self-manufacturing continues as the team in West Carrollton further ramped up production in the third quarter. All interior and exterior construction on the facility have been completed, and all the equipment is on-site at this point.

The new production facility machine hundreds of thousands of pieces in Q3, with nearly a 70% increase over Q2. Also, during the third quarter, the transition from the Fairborn facility began with employee shareowners and equipment starting to move over to the West Carrollton facility with a focus on completing all this activity by the end of the year.

While there has been some short-term pressure on our gross margins as we get the West Carrollton facility up and running, these challenges are quite normal when starting up a new factory. In October, we hit our internal targets related to absorption for the first time and now expect to be on track for the remainder of the year. As a reminder, we believe the benefits of controlling our cost structure, including our supply chain, will pay dividends over the next several years, contributing an approximate 400 basis points to gross margins.

Inventory levels in the quarter were up from the prior quarter from $237 million in the second quarter to $249 million in the third quarter. The increase in inventory was attributable to increased raw materials and work-in process at our West Carrollton facility as well as inventory builds associated with new product launches.

The company has traditionally had a cycle in which inventory builds throughout the year in anticipation of product launches while ramping down towards the end of the year. In the fourth quarter, we expect inventory levels to decrease dramatically as we have launched nearly half a dozen new product throughout the second half of the year.

Non-GAAP SM&A expenses as a percent of revenue decreased 420 basis points from the prior year to 50.8% in the quarter or $125.8 million. This meaningful progress was primarily driven by greater asset efficiencies related to freight, workforce productivity and related equity-based awards that were canceled in connections -- connection with recent departures. With the growth in our international business, we were also able to take advantage of our expanding scale and accelerate some of this leverage.

Non-GAAP research and development, or R&D, expenses totaled $12.7 million in Q3 of 2017 compared to $12.5 million in Q3 of 2016. R&D expense was 5.1% of revenue for Q3 of 2017 versus 5.2% in the same period last year. Sequentially, we continue to ramp up our R&D spend and as a percent of revenue to increase over the long term, with the goal of investing approximately 7% of revenue on these efforts.

Our path has not changed. We continue to make investments in key areas, including the NSO technology and efforts on imaging, navigation and surgical automation as well as our push into Advanced Materials Sciences, our interbodies.

Third quarter non-GAAP operating profit margin was 17.6%. This represents 150 basis points of favorability to prior year as a result of performance compensation and international scale, partially offset by the decrease in overall gross margin for the company. Approximately 100 basis points of operating margin improvement is related to the reversal of share-based compensation expense associated with the departure of our former vice chairman.

Third quarter adjusted EBITDA margin, which excludes the impact of noncash stock-based compensation, was 24.9%, a decrease of 100 basis points compared to 25.9% in the same period last year.

Moving further down the P&L, interest and other expense net on a non-GAAP basis was $5.3 million in the -- in Q3, down from $5.8 million in the same period last year.

Now turning to tax. Our non-GAAP tax expense in the quarter was $11.9 million, resulting in a non-GAAP effective tax rate of 31.1%, an improvement with expectations primarily due to higher international revenue and continued tax planning efficiencies. We're now expecting our full year tax rate to be 34%, an improvement from previous guidance of 35%. As I have reviewed the plan for tax planning initiatives designed to lower our tax rate, I'm comfortable with the work the team is doing to drive further improvements. As previously discussed, we are committed to bringing our corporate tax rate down into the mid- to high-20s over time, and we continue to make nice progress in that direction. If the U.S. government puts into place further tax reform as has been discussed recently, NuVasive would be a significant beneficiary of these changes.

Third quarter 2017 non-GAAP net income was $26.7 million, and non-GAAP earnings per share was $0.52 compared to non-GAAP net income of $21.1 million and non-GAAP earnings per share of $0.40 in the same period last year.

Turning to our GAAP results. GAAP net earnings for the third quarter of 2017 was $33.6 million or $0.64 per share compared to $3.9 million or $0.07 per share in the same period last year. Please refer to our earnings press release or the supplemental financial information filed -- posted on nuvasive.com for further information related to our GAAP versus non-GAAP adjustments for our third quarter of 2017 performance.

With the third quarter of 2017 now behind us and several dynamics playing out in the third quarter and continuing into the fourth quarter, we are taking a conservative stance through the remainder of the year as we update our full year 2017 guidance. As we go forward, I want to ensure we are setting realistic goals for the company, and that you feel confident we can achieve these goals. Based on the results for the third quarter and our revised outlook for the fourth quarter, we're now guiding to full year 2000 (sic) [2017] revenue of $1,030,000,000 versus prior guidance of $1,065,000,000. This new outlook includes the following assumptions for the fourth quarter: our international business continues to grow over 20%; minimum spine surgeries occurring in Puerto Rico for the full quarter; anticipated lower procedural volumes in the U.S. due to the strength of our hardware business as we take share in deformity and benefit from new product launches in our degenerative portfolio; and continued softness in our Biologics business.

Based on our lower revenue expectations for the full year, we are also updating our non-GAAP operating margin guidance to 16.6% and our non-GAAP EPS expectations to $1.91. While we are disappointed to have to reduce these expectations, we continue to make solid strides in our profitability efforts and, in fact, are not lowering these estimates to the same extent we're reducing the top line.

Going forward, we continue to be committed to delivering at least 100 basis points of improvement in non-GAAP operating margin each year.

Please refer to our supplemental information filed on our website for greater details of the updated revenue guidance.

Finally, I'd like to share a few thoughts with you about my first 50 days at NuVasive. What I have seen so far is a company that has a ton of runway ahead of it, and that's why I was excited to join NuVasive in the first place. I continue to spend time delving into the financials of the company and learning the business side. In areas that I'm specifically excited about is operating margin improvement opportunities, and I want to reaffirm the company's commitment to profitability, including its goal to ultimately achieve a non-GAAP operating margin of 25%. There are a lot of levers to make that happen, and I've already seen the finance team working collaboratively with the department functions and sales force to execute on those levers. In addition, I'm working through some of the headwinds we saw in the last quarter to ensure that for things within our control, we turn them around to tighter execution. I'm laser-focused on closing the year strong and meeting our revised commitments to you.

With that, I'd like to open up the lines for Q&A.

(Operator Instructions) Our first question is from Josh Jennings from Cowen & Company.

Josh, you may be on mute.

I'm sorry. Can you hear me?

Yes, we can hear you now.

Okay. I apologize. I just wanted to start off -- thanks for all the details on the quarter and the guidance revision, but just to be clear, that the assumption in terms of the U.S. spine market in the fourth quarter is that it remains constant at Q3 levels. And do you have any update in terms of the trends you're seeing thus far, though it's early days, in October?

Your assumption is correct. And I'd say early October has been good, but we're not going to give any other guidance other than what we've already given you.

Understood. If I could, just one follow-up. I just wanted to touch base on the sales force, and then, productivity. Was NuVasive still a net-adder in the quarter? And then, you've talked about sales people coming off non-competes, can you give us any details to help us attempt to quantify the impact of the productivity ramp of those reps as we move into '18?

Josh, it's Carol. Yes. Thanks a lot for the question. I'd say, we've had a group or a bolus of the sales reps coming off of those non-competes. I would say they're coming off at various times. And we've seen some really good highlights in some specific geographic areas where they performed very well. We've seen a couple of other areas where we probably need to ramp up a little bit better, and those areas, I'd say, overall, is relatively in line with what we expected. Of course, it's mashed up with a little slightly slower U.S. market, but relatively in line with what we saw.

Our next question is from Matthew O'Brien from Piper Jaffray.

I'm going to sneak in a couple here. So just as far as the guidance for '17 goes, the lowering, I think, was largely expected, the amount in Q4 is a little bit eye-popping and it's not that -- it's not that, that's overly surprising, but what I'm trying to illuminate here, I think, for most people on the call is whether or not that guidance is really conservative similar to what you've been talking about, Greg, versus something really coming off the rails of the company, i.e., you're losing customers or the biologics business is really starting to fold into itself or something along those lines. So any kind of color you can provide around the reduction that you made. I think, when you net out everything, it's about $20 million in Q4 to the guidance. Any kind of color you can provide there, I think, will be helpful.

Thanks for the question. So qualitatively, you have assessed it right. We have brought the guidance down to a number that we feel is very conservative, very achievable and allow investors to come in potentially if they'd like to and make some money. It is not reflective of any external dynamics, any competitive repositioning of the company accordingly. Raj, maybe you want to say a few other words?

Yes, Matt, I think, like Greg said, so if I look at the $20 million-ish of Q4 call down, more than 50% or like half of it is really coming from hurricanes and biologics, right? So we said the impacts from the hurricanes will be about $4 million and we continue to see a little bit of softness on the biologics side. The rest of it really is procedural volume decline in the U.S. that's going to be partially offset by some goodness on the international side. So that's kind of how we see it right now. And like Greg said, we are calling it conservatively. And that's the walk, essentially.

Okay. And then, just a quick follow-up on LessRay. I think that may get some attention as well. But you're thinking 2 to 3 in Q4. If people are shifting over to an operating lease-type arrangement, but you're still sticking with about $1 million given that ASP is, I don't know, 150, 200, something in that range. That would imply, actually, that the number of systems you're going to place would be a lot higher than you would have thought had it just been an outright sale. So is the demand even stronger than you had thought here in Q4, but this nuance as far as the lease versus the outright purchase, just different than you anticipated? So we shouldn't over read a lack of interest in the system.

No. Actually, I think you also have articulated that one right. There is a ton of interest in that system. It's going to be more of a lease. So revenue recognition will be different, but we feel very strongly about the potential of the system. And heading into a full year of 2018, we're going to be able to capture the revenue we had anticipated early on. We're just giving you the first 60-, 90-days outlook here, which is awfully kind of fresh.

Yes. I'd add 2, Matt. I think it's really important to think about. I think, there are, of course, piece of capital equipment that we're launching. What we're finding is, the interest is higher, higher than we thought it was going to be, but we've got a time frame that we're running into some of these -- the capital lease reviews are about a year out. And so some of the folks are having interest, but they've got to get into the queue and get that approved. So I think you'll see that really play out as we're in 2018.

Yes. Those budget cycles take 6 to 9 months, on average, to complete. So it's still a little bit unpredictable.

Our next question is from Richard Newitter from Leerink Partners.

I was hoping to start off, Greg, maybe on biologics, and within the context of some of the items that both you and Raj indicated were under your control and not under your control. Is biologics one of those items that you feel like is under your control? And do you feel like you've hit a floor now for the year-over-year declines in biologics? Or do you feel like it's a bit of a wildcard and it could continue to get worse? And what's embedded in that 2018 mid-single-digit kind of initial outlook, with respect to how biologics performs relative to the back half of this year?

Let me take your question and put it more into historical context. So a few years back, NuVasive launched a very popular biological product based on stem cell technology, and it had a very fast growth rate. Whether or not you need biologics to drive fusion is a larger question now that we're starting to have inside the company. So I would just say, from here forward technologically, our goal is to greatly limit the amount of biologics required by better advanced material science on the implants. Now let me just come back to biologics. I think you've seen the worst of it at this point in 2017. I think we can do a much better job of stemming the erosion, of making it more bundled into the procedure than we have in the past, and that's basically the focal point of our efforts. What we tried to have investors understand is that the implant business in the U.S., obviously, relative to patient volumes is doing good. We're having to focus now on the Biologics and getting it included, and that's where the new leader is going to spend a lot of their time.

Okay, got it. And then, my second question is just on the margin. Are you guys -- you committed to 100 -- your long-term outlook of at least 100 basis points of margin expansion per year. For 2018, is that inclusive of the reinstatement of the med tech tax? And how should we be thinking about that comment with respect to that?

No. Right now, our assumptions do not include any -- we expect that med tech -- the tax will be repealed. So that's in our assumptions right now.

Okay. And then, maybe just one follow-up on the gross margin. Raj, you said you're committed, still, to the 400 basis points, once the U.S. Carrollton facility is fully up and running and inventories migrated there. Should we be thinking about any dynamics into the first half of '18 versus the second half, with respect to gross margin? Just, it feels like the gross margin benefit is pushed out one or 2 quarters. So should we be thinking about that? Or does it start really hitting right off the bat in the first quarter of '18?

Yes. So right off the bat, we expect the headwinds that you're seeing right now to turn into tailwinds. As the factory is up and running, and we start to increase our absorption. I think it will be fully optimized, and that's what we're baking into our plans right now.

Our next question is from Matt Miksic from UBS.

So you may have been bouncing back and forth, and, Greg, I apologize if you've gotten some flavor of this type of question, but I'd love to understand. First, if we just -- and this may be a question for Raj, also, just sort of pick through the 2% growth. U.S. would have been 5% was what I think I heard you say, x some items. And I think 1.5%, it sounds like, would have been from the selling day. What made up that other 1.5%?

Yes. So if you look at the U.S. spinal growth, right, so we are, on a reported basis, it said 2%, and what we said is the impact from the hurricanes was -- add a couple of points to that. And then, you have the selling day in there as well. So that's what migrates you from 2% to 5%.

Got it. Okay. And then, just sort of the broader question I wanted to ask is, perception heading into this quarter was, obviously, some discounting and expectations of a shortfall and softness in the spine market. I don't think that, that is much of a surprise and some expectation that you would trim. I guess, if we're talking about taking, I guess, in the neighborhood of -- what does it work out to be? $15 million to $20 million or so out of Q4. Given the environment in spine or lack of visibility in this market, what gives you the confidence? Because that is sort of what investors, I think, are looking for, is some confidence that this Q4 number is doable.

Thanks for that question. As I tried to convey, we went back through all of the numbers, all of the assumptions, have done a -- from the bottoms-up view across all the different geographies of the world, and has now created guidance that we have labeled very conservative, so that an investor can have confidence that those are the numbers that will be achieved, if not exceeded.

Okay. All right. And you feel like you're controlling for what has been kind of a variable in terms of the market growth just coming in. I guess assuming that it remains 100 basis points or flattish-type of growth in the U.S. market?

That's what the guidance is based off. No big recoveries. Kind of business as usual. And those are the numbers that we're guiding to now.

Okay. And no seasonal step up? I think that some people are also thinking we might get sort of deductible year end push, is not something you're baking into these numbers?

We're anticipating the normal seasonality, not the super seasonality we were originally expecting, due to the push out of elective procedures into the fourth quarter. We're just not counting on that now, and that's what the new guidance reflects.

Great. And if I could just -- one more clarification, Greg, on your discussion of the results and relative to the market. It sounds like the softness in the market, this kind of slowness that we've seen in the first 9 months of the year. You had described that as kind of across the board and not a competitive -- some new competitive dynamic that is emerging into U.S. degenerative MIS space.

We certainly do not see that. If you look at results that have been reported so far, based on what we know and our competitive intelligence of others are doing, we think we're continuing to hold in there, if not gain. And I think we'll just let the next 2 or 3 weeks play out. And I'm pretty confident that you'll see that NuVasive is doing quite well competitively.

Our next question is from Matt Taylor with Barclays.

So I just wanted to follow-up on the U.S. market discussion. I mean, you characterized the issue of being really a patient volume one. Do you have any further thoughts on that? Early in the year, you pointed to some payer friction, you talked about high-deductible plans. What does your field intelligence telling you that may be happening out other in the market deposit side?

Thanks for that question. Let me give a little more qualitative commentary. When we went in 2017, I think, we were like most companies. We expected the market to be as it was in 2016. We anticipated pretty robust growth for us in the U.S. market, and I think we were caught a little surprised, like the entire industry has now been, by the softness we were seeing. And like good competitors we were or are, we did a lot of self-examination, wondering if it was ourselves, wondering if we were missing something, but as the year has unfolded, it's become clear, this market in the U.S. has become softer. And I suspect it's a combination of a lot of things, high-deductible plans, spine is an area of healthcare where the doctor continues to make virtually all the decisions, and payers are wanting to push back a little bit more than they have in the past. A variety of circumstances have cause the market to essentially go flat. Now for us, we're spinally, it's the island we live on, and we're going to make this thing work, and we're making it work internationally so we know we have the right formula. We think we have the right formula in the U.S. too. We're just going to tighten it up a bit more. And that's what our guidance into 2018 anticipates, is that we can grow this franchise mid-single digits, increase profitability, and make it a pretty darn good business no matter what the kind of U.S. market looks like and, we're counting on it to be basically as it is today.

And just a follow-up, you had a separate press release today about $100 million buyback authorization. Could you talk about how you're thinking about executing that? Is that going to be opportunistic? Do you want to consistently buy back shares? What's the philosophy there?

So we are believers in the company. We're believers in the strategy. We wanted to signal that we're buyers of the stock. We have not signaled yet what the exact strategy will be to implement that, but I can say for sure, we will definitely be opportunistic if the stock becomes too undervalued, and we wanted to have that in place to be able to take immediate action accordingly.

Our next question is from Kaila Krum from William Blair.

You've done several (inaudible) technology and services deals over the last 18 months. It looks like you did invest quite a bit in Vertera, just looking at the cash outlay in the quarter. So I guess, can you talk a little bit about how you plan to prioritize organic growth and internal product developments relative to continued inorganic tuck-ins into 2018.

Our #1 preference to grow is organically. We believe you have to be all about innovation in this market, and we want to obsolete ourselves and everyone else accordingly. The only reason we do acquisitions is because we have a humble view that sometimes not all the right ideas or the best ideas fit in our 4 walls. And so, with that humility, we look around the world, and we very, very selectively, and in a disciplined way, we'll buy things. Vertera Spine is just one example. Look, the porous PEEK technology is amazing in its ability to drive bony growth. That, coupled with our titanium development, which we think is, by far, the industry-leading technology, creates an incredible set of choices for surgeons that, we think, hopefully, supports the premium strategy that NuVasive has in the marketplace. So again, it's all about organic growth. It is all about internal innovation, and quite frankly, we only do M&A if we can see ideas that we think we can bring to market faster than doing them inside the 4 walls of our place.

Okay. That's helpful. And then, I guess, as far as internal product development, I mean, what would be the process if you wanted to evolve the LessRay platform to include not only neuromonitoring and Bendini, but potentially, also a robotic arm longer term?

Well, good question. Right question. We're not going to get into pipeline conversations, but as Carol rightly pointed out, this is our first capital light that we're starting to sell. And as we have guided investors, in 3 to 5 years, this company will become a systems company as much as it is an implants company today. We believe spine has to become much more proceduralized, integrated with implants and systems all working together, and that's what NuVasive is going to do over the next couple of years.

Our next question is from Andrew Hanover with JPMorgan.

I wanted to start by just talking about utilization trends, as I know a bunch of these questions have been around. But looking through the lens of the services business, Greg, for the third quarter and how the third quarter panned out, I mean, looking at it in the second quarter, and then giving guidance for the third quarter, how did that look versus where it played out? And how are you seeing that now for the fourth quarter? And can you remind us what your line of sight is with the Services business?

So in the second quarter earnings call, our thesis was that we would see super seasonality start to kick in, in the final months of the third quarter, and then, big time in the fourth quarter. What we've tried to convey to investors now is we're not seeing that super seasonality like we thought at that second quarter earnings call. We have a very good view into the industry because, as you rightly point out the Services business, we do more spine cases than probably any other company in the world, certainly in the United States. And our viewpoint is typically a couple of weeks ahead as spine surgeries are scheduled. So I wouldn't say that our outlook is incredibly long term, but at least it provides a moving snapshot a couple of weeks ahead of time. And based on that, we're saying now is that the industry in 2017 is definitely down. There will be seasonality in the fourth quarter. So count on that. It's just not being pushed into the fourth quarter like we originally thought when we sat down and talked to you at the end of the second quarter.

Got it. And then, just to tease out some of your commentary around the market. I mean, do you feel as though this is your -- we're near the bottom? We're plateauing at the bottom? Or the bottom is still -- there's a little bit more room to go? I mean, how would you characterize that? Because it does sound as though you're -- we're more at the bottom than we are on the way to the bottom.

Look, we don't think this is a market that is going down further, it is not tanking. It's modulating. It was a kind of low single-digit growth market before. It's gone a little flattish now in 2017. I don't want anyone jumping out of the windows. We can get through this, and the business is going to do just fine. So steady hands, steady arms, steady mind, and we'll get through this. And we're going to continue to take share. We know, very conservatively as we look forward, we can grow mid-single digits. That's just kind of an initial outlook, and we'll give more confirmed guidance as we move into January of next year.

And then, my last one is just on the business as a whole. I mean, their nuance is here where there's a -- there are positives. I mean 2% to 5% without the -- excluding the hurricane and the selling day. So can you just give us some more clarity in terms of how do you feel like the business did in terms of penetrating the deformity market and taking advantage of that, and improving the comp structure issue that we had in the second quarter, in terms of sales rep productivity and the positives that you're seeing despite some of the weakness in utilization?

Thank you for the question. So there's a lot to click off that went well. As you say, the deformity penetration continues. Historically, this is a degenerative surgery business. We've moved it towards deformity and we're starting to make inroads and that's good. We have largely cleaned up all of the billing issues that we had in our clinical services business. As Raj pointed out, there's a couple of million bucks that will finish out here in Q4, but all those systems, and that was a big systems integration, is all done, and that is a platform for growth for us now going forward. You will see us continue to do M&A in that category. If you do the adjustment, as Raj did the walk, we continue to gain share in our implant business in the United States. Actually, quite robustly. Our issue is we try to focus investors' kind of minds and thoughts here is, we've got to work on the biologics business. It is a medium-term issue. The business for us is not kind of long-term strategic because we think, actually, the science is moving towards the implants. So we're going to fix that. We're going to put our energies into that, and if we can continue to do kind of better things there, you're going to see some pretty darn nice results in the U.S. business.

Our next question is from Kyle Rose with Canaccord.

So I just had one quick question, on the biologics follow-up there. I think you've been -- when we talked on the last call, we talked about the Q2 being down somewhere 7% to 8%, and that was in addition to Q1 being down around 6%. I was just wondering how we should think about how that trended into Q3? Did we see another step down relative to what we saw in the first half of the year? And then, the second question is just, how do you think about the cadence and the setup for 2018, relative to how we've seen 2017 play out year-to-date? Do you expect it to be continued slower start to the year with increased seasonality as we move through the year? Or do you think that some of the hurricanes that have impacted the Q3 and Q4 may actually serve as a bit of a tailwind in catch-up procedures as we think about the first half of '18?

Let me jump on the last part of your question first, and then Raj can get into that other part. Look, I think what we're seeing right now is that 2018 will have the traditional seasonality like the business has had. Until we see some external factors change, I don't want to be calling some super seasonality in the fourth quarter of 2018. So when you model, you should model to the normal seasonalities that we've been seeing in '16 and '17. So that's how you should think about going forward.

So back to your question, biologics, right? So in Q2, we saw about 7% decline year-over-year. And in this quarter, that erosion rate doubled to about 15%. So what we're thinking in Q4 is assuming that, that erosion rate will be approximately 14% to 15% as we kind of manage through any further erosion, and then, kind of helping turn around the biologics business as we move into 2018, based on the focused initiatives and as the new leader kind of gets their arms around the business.

Great. And then, one additional question on LessRay. I mean, I know it's still early, but you did give some early comments as far as field demand and some of the purchasing timelines. Just wondering what you could give us as far as when LessRay is being evaluated, what it's being valuated against? Is it just getting in the capital budget process? Or is it -- are people evaluating LessRay versus some of the more expensive robotic technologies? And just -- and how that value proposition conversation is going with the accounts?

Yes. Good question. So LessRay is a completely different price point than any of these robotic solutions being sold. So it's got a lot of advantages from just an economic standpoint. What we do on these trials is we put it into the surgery. They perform 3 or 4 days of surgeries with it. They get accustomed to the workflow, and we are seeing just rave reviews on the workflow for those people giving it a trial. As we've said, though, there are capital budget cycles here in these hospitals, and so we've got to navigate through those. In the meanwhile, there's an opportunity to do leases to get these systems out there and get them used. And so that's why we just, in the fourth quarter, have modulated the amount of revenue. The enthusiasm for the product remains extremely high, and I think the investors should be encouraged by what we'll see in terms of results in 2018.

This concludes today's question-and-answer session. I would now like to turn the conference over to Mr. Lucier, for closing comments.

Thanks for participating today, everybody, and we look forward to speaking with you at the next quarter. All the best.