NuVasive Inc (NUVA) 2018 Q1 法說會逐字稿

Ladies and gentlemen, greetings, and welcome to the NuVasive, Inc. First Quarter 2018 Conference Call. (Operator Instructions) As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Carol Cox, Executive Vice President, External Affairs. Thank you, you may begin.

Great. Thank you, Adam, and welcome, everyone, to NuVasive's first quarter 2018 earnings call. The company's earnings release, which we issued earlier this afternoon, is posted on our website, as is an investor presentation, both of which have been filed on Form 8-K with the Securities and Exchange Commission. We've also posted supplemental financial information on the IR website to accompany our discussion.

On today's 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 also follow along.

Before we begin, I would like to remind you that in the discussions today, we may 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 release and periodic filings with the Securities and Exchange Commission. We assume 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 all 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'll turn the call over to Greg.

Thank you, Carol. Earlier this afternoon, we reported first quarter 2018 revenue results of approximately $261 million, representing year-over-year growth of about 5% on a reported basis and in line with the guidance range we provided you in February.

Results were driven primarily by strong international growth of approximately 20% on a constant currency basis, U.S. hardware case volume growth of 5% and a sequential improvement in the biologics business. As we anticipated at the start of 2018, these results are against the backdrop of a stable but flat U.S. spine market today.

Now let me elaborate on the first quarter U.S. revenue results. U.S. core hardware revenue increased 1%, driven by strong case volume growth, partially offset by pricing headwinds of 2% and a product mix of 2%. In particular, we saw solid contributions from the XLIF and TLIF franchises and continued penetration of our ReLine posterior fixation system.

Raj will get into more detail on the mix we saw in U.S. spinal hardware in a moment. However, overall, we are pleased with how the quarter came together in this area. New product introductions from late last year are taking hold in the market, helping us validate that continued investments in R&D are addressing the needs of surgeon customers. In particular, our TLIF expandable cage, RELINE Small Stature, XLIF Modulus and COHERE, the porous PEEK implant we acquired through the Vertera acquisition last year, contributed to our growth. We are seeing good early adoption of our lateral single-position surgery platform, along with the surgeon training program for this procedure being very well-received, followed by adoption pull-through after the training.

We also continue to gain share on our NuVasive Specialized Orthopedics portfolio, including our precise technology for limb lengthening as well as ReLine trauma, product pull-through and advancing new users in the adolescent idiopathic space.

In the surgical support business, revenue was essentially flat year-over-year. As we expected, declines in the biologics business were offset by growth in our NuVasive Clinical Services business, which includes contributions from SafePassage as of mid-January 2018, when the acquisition closed, and sales of our LessRay technology platform for radiation reduction.

As I mentioned, our biologics business performed better than expected, down 10% versus the hardest comparison quarter we will see this year and better than the results we had guided to.

I'm cautiously optimistic we are starting to see renewed traction with surgeons and health care systems as we implement new strategies to regain share and increase volume. While not a full recovery, I'm confident we have the right team in place working strategically with a sense of urgency to drive sustainable improvement in this area.

Turning to the Services business. During the quarter, NCS results were impacted by lower U.S. case volumes related to our focus on the integration of SafePassage and a strategic decision to exit certain accounts that didn't meet our profitability target. As you know, an integral part of our ongoing strategy in the Services business is an active and robust business development process. While we are seeing success with this strategy, the timing of lost accounts this quarter didn't outweigh the new business coming in from the legacy service business, which we expect to ramp up for the balance of the year.

The fundamentals of the Service business remain intact though. We are seeing -- still seeing solid adoption of our M5 units, which delivers revenue through the pull-through of our disposables products and spinal hardware technologies. Moreover, given this business does not require the same level of capital as our core business but just as profitable, we like its mix in our portfolio. Now we just have to get the revenue growth to where it matches the rest of our business and our expectations.

Turning to international results for Q1. Revenue increased 28% on a reported basis, up 20% on a constant currency basis. This is in line with our forecast and driven by strength across all geographies. This consistently strong performance from our international business is the result of an intense focus over the last few years in developing the infrastructure, hiring strong regional management teams and consistently executing a strategy of leading with our lateral offering and expanding the surgeon relationship from there.

With this momentum, we remain confident in our ability to take share across key international markets, from the roughly 4.5% share we hold today, to doubling that over the next few years. Raj will share more detail on how each region performed in his remarks.

Profitability. As you know, margin expansion is a key element in our efforts to deliver value creation for our shareholders. While we have made considerable progress in reducing our operating expenses, our strategy to radically improve gross margins through self-manufacturing continues to lag our expectations due to a delay in hitting factory absorption rate targets.

Now I'm going to be the first one to admit, we set out to tackle this project in an aggressive way, but I knew when I came on as CEO 3 years ago, we had to completely reimagine how we manufacture our technology in order to handle price pressures that have become an inevitable element of the health care industry.

The foundation of that thesis is still very sound. On a per unit basis, in our Ohio plant, we are efficiently and effectively driving unit costs down. The hurdle in our results is a total throughput of the Ohio plant in relation to fixed costs. As we are unable to ramp up the production output to the levels we need, we ultimately are not getting the gross margins we require, and so our challenge ahead of us is to get this right, get the outputs higher and ultimately drive the gross margins to the benefits that we projected when we built this plant. Now it's time to deliver, and we will do so in the second half of 2018.

Innovation remains at the heart of what NuVasive does best, and we continue to lead the industry by delivering the technologies and innovations that surgeons want and need. Our commercial launch plans for 2018 include more than a dozen new product introductions, spanning from implant systems to the introduction of our Surgical Intelligence platform as well as the next-generation MAGEC rods for early onset scoliosis. These technologies will help us meet our commitment to enable a complete procedure, enhancing the entire surgical experience and expanding current offerings in key markets.

This past quarter, we made solid headway in our efforts in key areas that, when combined, differentiate and place NuVasive in a strong position to compete for both a clinical and economic perspective and will support the growth in 2018 and beyond. These areas include further adoption of minimally invasive lateral surgery, like I mentioned, the buildup of our Surgical Intelligence platform and service organization that we believe will deliver a highly competitive integrated offering over time.

As an example, at the recent American Association of Neurological Surgeons scientific meeting, we hosted a hands-on workshop with several top surgeons featuring the latest advances in lateral single-position surgery, technology to reduce the OR radiation and development in 3D-printed implants. This forum demonstrated our commitment to safer, faster and smarter surgery. We believe strongly in the merit of the lateral single-position surgery platform, and the response from the early adopters has been nothing but positive.

Reducing the number of times the patient has to be repositioned during surgery improves the OR efficiency, and surgeons are seeing this as a true benefit to both patients and their practices.

In addition, from an internal R&D standpoint this past quarter, we have continued to make good headway on how we will redefine the experience for surgeon partners and patients with our Surgical Intelligence platform, spine's only the integrated surgical platform, connecting technology and tools to align the right patient with the right surgery for the right outcome.

As I mentioned on last quarter's call, we plan to unveil the Surgical Intelligence platform in September at NASS, which will be a connected system and phased in to bring together radiation reduction, monitoring, planning, imaging, 2D and 3D navigation, automation and insights to help deliver an optimized OR and quality patient outcomes. It is a significant step in our evolution from a product-focused company, to a systems-based company focused on delivering end-to-end solutions that not only enable predictable clinical and economic outcomes, but also pull through the implants and create stickiness in the market.

So in closing, our international business continues to execute on all cylinders and delivers results well above the market growth. Last year's new technology introductions continued to ramp up, and I'm encouraged by the progress of our biologics team. We have more work to do with our internal manufacturing capabilities in West Carrollton to achieve the desired impact on our income statement, not only getting us to the 20% operating margins, but even higher. Those benefits will start to flow in the second half of 2018.

As for the market, it has not materially changed since the second half of 2017, but with that being said, we continue to be a share-taker and applying additional focus on new product introductions and increased rigor on day-to-day execution by our sales leaders.

Now let me turn it over to Raj for his comments.

Thanks, Greg, and good afternoon, everyone. 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 the supplemental financial information on nuvasive.com for further information regarding our non-GAAP reconciliations.

For the first quarter of 2018, we reported revenue of $261 million, which reflects approximately 5% reported growth performance year-over-year and 3% growth performance on a constant currency basis. Excluding the impact of our SafePassage acquisition, which closed in mid-January of 2018, revenue grew approximately 2% on an organic basis, excluding the impact of currency.

Our results were primarily driven by strong international growth of 20% on a constant currency basis and essentially flat revenue performance in the U.S., where case volume growth in our core hardware business and the impact of new product introductions was offset by the expected decline in the biologics business and weaker case volume in our legacy NuVasive Clinical Services business.

Our U.S. spinal hardware revenue was $141.5 million for the first quarter, which represents approximately 1% growth over the prior year revenue of $140.6 million. The primary drivers of this performance were growth in case volume of approximately 5%, contribution from product launches like XLIF Modulus, TLX, ReLine Small Stature and COHERE and continued growth in our ReLine posterior fixation systems. Offsetting these gains was pricing pressure of approximately 2% and some mix challenges primarily in the area of cervical and centered around the timing of new product introductions that we expect to see in the back half of 2018.

Additionally, we are pleased with our ongoing efforts to convert new surgeons to NuVasive, which was strong in the first quarter of 2018 and will contribute to growth throughout the year.

Revenue from U.S. surgical support performed at $69.6 million for the first quarter, which was flat compared to the same period in the prior year. Revenue growth of $4.5 million from our acquisition of SafePassage was offset by lower U.S. case volume experienced within our current existing Services business and the expected weakness in our biologics product line.

Early in the first quarter, we acquired SafePassage, which is a fast-growing market leader in the Services business and demonstrates the kind of growth we see available in the services space. As we onboarded the business, our focus on integration was a contributing factor that led to weaker case volume in our existing U.S. Services business. As a management team, we are balancing maintaining a key focus on tending to the existing customer base and in some cases, expanding our footprint concurrently while moving thoughtfully through the integration process.

Another driver in the Services business revenue results was a select group of strategically identified accounts that we chose to exit as the profitability in those accounts did not meet our internal threshold for margin. In turn, we're utilizing our resources to go deeper into existing accounts and to be more aggressive in winning new accounts for the balance of the year.

In our biologics business, we have seen positive momentum from the back half of 2017, moving into the first quarter of 2018, and expect to see this momentum stem losses going forward. As Greg mentioned, under new leadership for that business, we have adjusted efforts to be more competitive and recaptured 7 lost accounts with offerings across the entire portfolio. This reengagement, combined with sales force-wide retraining on biologics at our global sales meeting earlier this year, have yielded positive results for the franchise.

As it pertains to LessRay, we continue to see growing interest in the platform. We are slightly behind the revenue targets, which we believe is more of a timing issue as we drive to convert trials to form partnership commitments as the year progresses.

Our international revenue was $49.5 million, growing approximately 28% on a reported basis and 20% on a constant currency basis. This marks the sixth consecutive quarter with at least 20% growth rate, and we are very pleased to see the strong performance spread across all key regions.

On a constant currency basis, EMEA grew 21% year-over-year, driven by solid performances across Western Europe and growth in key emerging markets like South Africa and Saudi Arabia. In the U.K., we experienced difficult market conditions due to limited bed availability as hospital beds were reallocated away from elective procedures, resulting from the unusually bad flu season.

This was seen as a temporal dynamic for the quarter, and we expect the U.K. business to improve in the second quarter.

On a constant currency basis, Asia-Pac grew 23%, primarily driven by strong results in Japan following the reintroduction of XLIF into that market in the first quarter of 2017 and continued market share gains in the region. On a constant currency basis, Latin America grew 6% and delivered its sixth consecutive quarter of growth, driven by strong performance in Brazil, where the business has more than doubled over prior year.

The revenue in Puerto Rico has still been challenged by the lingering infrastructure impact of the hurricanes. That said, we are very pleased that the strength in Brazil has offset much of that softness and continues to deliver strong growth.

Profitability. Moving to profitability. Our non-GAAP gross margin for the first quarter was 71.8%, a decline of 350 basis points below prior year of 75.3%. We experienced a higher-than-expected decline in gross margin and what ultimately led to operating margin erosion in the quarter as a result of slower production throughput at our West Carrollton facility. Approximately 120 basis points of the decline was attributable to that facility and the primary driver of the year-over-year decline.

As it pertains to West Carrollton, we have been disappointed at the level of production throughput performance in the first quarter after fully migrating from our facility in Fairborn at the end of 2017. What we found once volumes had ramped up early in the quarter, the back end of the manufacturing process had bottlenecks which impacted total output and therefore absorption rates. We have since worked to fix these issues and normalized the plant ramp-up.

In the second quarter, we have experienced increased throughput from the first quarter levels, and that acceleration will continue through the year. Our efforts around in-sourcing manufacturing and the significant contribution it will make to our margin improvement thesis remains intact. And while we are a bit behind on our progress, we believe getting this right represents a tremendous margin opportunity for the future.

When we get to full capacity, the manufacturing plant will deliver 400 basis points of improved profitability while allowing us to control our source of inventory. We will continue to focus on ensuring our investments in the factory will deliver the supply chain benefits through the balance of the year and beyond.

Other drivers of gross margin variance in the quarter include a 70 basis points decline, resulting from the acquisition of SafePassage, which, as a reminder, is offset in operating margin. Our mix of revenue related to the operating plant yielded approximately 70 basis points of decline as a result of being heavily weighted towards international revenue, which have lower margins. And lastly, pricing pressure on revenue generated around 30 basis points of decline over the prior year.

Non-GAAP SM&A expenses as a percent of revenue decreased 240 basis points from prior year to 54% in the first quarter or $140.7 million. With the growth in our international business, we are continuing to leverage our expanding scale with fixed overhead costs. Domestically, we have seen the benefit of productivity and efficient cost containment.

We continue to manage our operating expenses in a very disciplined manner. Non-GAAP research and development or R&D expenses totaled approximately $14.5 million in the first quarter or 5.6% of revenue, which was an increase of 60 basis points compared to the first quarter in 2017. As we have declared in the past, our increased R&D spend reflects continued commitment to supporting internal R&D efforts and investing in strategic assets that we acquired to drive innovation.

A clear demonstration of that is apparent through our investments in Surgical Intelligence and Advanced Materials platforms. We believe the most recent and upcoming product launches related to these platforms will drive material results.

First quarter non-GAAP operating profit margin was 12.3%, down 170 basis points compared to 14% we reported in the first quarter of 2017. For the quarter, the primary issue impacting our profitability was related to our manufacturing facility. We saw gross margin pressures from the slower production throughput at West Carrollton, which flowed through to the operating margin line.

Year-over-year, we made progress in reducing our operating spend as a percentage of revenue, with operating expenses down 180 basis points over prior year, but not enough to offset the headwinds created by our gross margin challenge.

While we are disappointed in our operating margin performance in Q1, we remain committed to delivering 100 basis points of expansion for the year. We will continue to invest in the business with a prudent and balanced approach, while driving for both gross margin and operating margin improvements to deliver increased profitability in future periods.

Moving further down the P&L. Interest and other expense, net on a non-GAAP basis, was $5.9 million in the first quarter, up from $5.1 million in the same period last year. This increase is primarily a result of certain equity investments we made in 2017.

Now turning to tax. Our non-GAAP tax expense in the quarter was $5.9 million, resulting in a non-GAAP effective tax rate of 22.5%, which we are very pleased to say is an improvement of more than 1,200 basis points from the prior year. This significantly lower rate is the combination of the newly enacted tax reform in the United States, of which NuVasive is a large benefactor, as well as the continued shift to international profitability, which helps reduce the overall tax rate.

As you may recall, years ago, we had set up our tax structure to benefit from the shift to more international revenue, and we continue to see benefits associated with those efforts.

First quarter non-GAAP net income was $20.2 million or earnings per share of $0.39 compared to non-GAAP net income of $19.7 million or earnings per share of $0.37 in the same period last year, an increase of $0.02 or 5% over prior year. This performance was below our expectations, stemming from the margin challenge I previously discussed. We expect to grow non-GAAP EPS in the double digits over time and look to get back into that growth trajectory and operating margin as well.

Turning to our GAAP results. GAAP net loss for the first quarter of 2018 was $27.1 million or $0.53 per share compared to net income of $12.4 million or $0.22 per share in the same period last year. Please refer to our earnings press release or the supplemental financial information file posted on nuvasive.com for further information related to our GAAP versus non-GAAP adjustments.

Adjusted EBITDA margin, which excludes the impact of noncash stock-based compensation and other non-GAAP adjustments, was 21.1% for the first quarter 2018 compared to 23.9% in the same period last year. This decrease was largely in line with the decrease in operating margin in the year, combined with some favorability in the share-based compensation in the current year.

Finally, free cash flow for the quarter was a positive $7 million compared to a negative $6 million in the same period in 2017. The increase over prior year was driven primarily by working capital improvements.

During the quarter, we recorded an accrual for a litigation liability of approximately $29 million related to a previously disclosed lawsuit with a former sales agent. It is important to note that this is an accrual only and our appeal of the judgment is still pending. More information can be found in our SEC filings.

For the quarter, we're also announcing a tax ruling with the Tennessee State Government, which entails the consideration for NuVasive to be viewed as a locally based entity no longer subject to property, sales and use taxes specific to the state. With our primary distribution facility based in Memphis, we expect this will yield in excess of $100 million in tax savings over the next 15 years.

As it pertains to the cost of this structure, we have recorded a nonrecurring success-based specialized tax consulting fee for $6.1 million in our financials during the quarter. We are pleased about the savings this ruling brings over the upcoming years in delivering enormous value back to our shareholders.

Now turning to the topic of guidance. Based on our first quarter results and our outlook for the remainder of the year, we are reiterating full year revenue guidance of -- for 2018 to be in the range of $1,095,000,000 to $1,105,000,000. We have updated exchange rate assumptions and expect currency to have a positive impact in 2018 of approximately $10 million, which is up $5 million from our prior assumption. While this is a modest improvement in potential contribution from currency, it is too early in the year to update revenue expectations based on currency alone.

As a result of the profitability challenge in our manufacturing facility, we are adjusting down our gross margin guidance from 74% to 73.5% for the year and recovering that profitability erosion to effective operating expense leverage. We are reiterating our operating margin goal and guidance for the year at 17.6%.

Our world could be singularly focused on accelerating the output from our manufacturing facility and optimizing our operating cost structure through the initiatives that have been in place to achieve our internal path to 25% operating margin plan.

In closing, we are encouraged by the achievement of our revenue guidance for the first quarter, driven by momentum in our international business, growth in our hardware case volume and better-than-expected performance in our biologics portfolio. As we look ahead to the balance of the year, we remain confident and committed to continuing on delivering both our revenue plan and operating margin target of 100 basis points improvement for the year.

Thank you. And with that, we'll open the call for Q&A.

(Operator Instructions) Our first question comes from the line of Matthew O'Brien from Piper Jaffray.

I'm going to break the rules and ask 2 here together. But I would love to hear a little bit more on the mix commentary that you had on the U.S. hardware business. Is that specifically reimbursed? Are payers telling you to move from lower-profile cervical products to the more traditional plates and screws, which have a lower margin, and that's where that mix impact comes from? Because as I look at that, if you exclude that, I think you're still taking your U.S. hardware outlook up a little bit, and I'm not sure if you had anticipated that kind of mix headwind so you're actually taking up a little bit higher than maybe than you had been expecting or we have been expecting.

And then the second question is on the U.S. surgical support business. You took that down in your guidance. Is that entirely because of exiting those accounts? And is that the entire reason for the modest organic reduction to the sales outlook for the business?

Matt, so let me start with your first question here on mix, and I think you made a good observation. Really, the -- it's nothing to do with reimbursement. What I'm seeing and what we're seeing here is really a mix of the result of timing on some product launches, which we expect to see as a result of continued ramp in the NPIs that we launched at the end of 2017. And as -- so we had a bit of a gap in the first quarter as our cervical NPI comes in the second half of the year. So that's the mix issue we were struggling with this quarter. But again, as we release -- we bring new products in online in the second half, we expect to recover that. So it's really a question of making sure that we have the right product mix, primarily as it relates to the cervical piece of the business, part of the business.

Okay. And the U.S. surgical business?

Matt, I'm sorry, can you repeat the question on the surgical business.

Sure. Your organic guidance for the year came down, I think, 30 to 40 basis points. And I think that's entirely because the U.S. surgical business, the outlook there is down, I think, a couple hundred basis points. Is that entirely from the accounts you're expecting to exit? And was that something you had anticipated when you were guiding for the year?

No. We're not taking our guidance down, so I'm not sure I'm connecting with your question here, Matt.

Our next question comes from the line of Josh Jennings from Cowen and Company.

I was hoping to focus on the U.S. spinal hardware business. Thanks for the metrics on case volumes and the 5% and the mix and pricing commentary, but I was hoping to get some color on the NuVasive revenue per case, if we could think about that sequentially and whether there's any improvement there and then whether or not we should be thinking about improvement in some NuVasive revenue per case going forward this year with the new product introductions, particularly interbody spacer segment and with some of the biologics improvement.

So we are seeing a slight uptick in the per-case volume, like per-case revenue growth. So as we look at versus prior year, we are seeing some revenue lift from improved procedure revenue per case.

Okay. And just a follow-up on the U.S. spinal hardware business. There have been some concerns about sales rep attrition and potential surgeon defection. And I was just hoping to get -- to check the box about what -- did you see any outside sales rep attrition in 1Q or any surgeon defection? And what are the plans for sales rep adds and were you net adders of new surgeon customers in the quarter?

Yes, you bet. This is Greg. Just to further add some color on the last question. The dollar per procedure continues to notch up slightly. But if you maybe take your question and go to medium term, I think there's an opportunity for it to go nicely up just as we continue to mix more towards deformity, and we continue to put more electronic systems into the operating room. So the overall dollar for procedure will begin -- flow upwards over the next couple years.

In terms of attrition of sales reps, actually our sales rep attrition is at its lowest rate since I've gotten here. I think the sales force is very stable. So that's good. And then surgeon attrition, really not anything different than what we've had in the past. So pretty standard in terms of the quarter.

Our next question comes from the line of Kaila Krum from William Blair.

So first on biologics, second on the Surgical Intelligence platform. So first on biologics, and you mentioned you are seeing a sequential improvement there. Can you talk about specifically what you are seeing? Because I think you're still expecting about 6% growth in the surgical support business for the full year. So that is a reasonably sizable acceleration from this quarter's levels. So again, just any color about what gives you confidence in that improvement and what's implied as it relates to biologics within there would be helpful.

Yes, I got you. So the biologics business, as we said in the prepared remarks, performed better than expected. We think we're at a trough, at the low point of the growth rates or negative growth rate. And if you just track the retraction in that business over the last couple of quarters, you would see that we're coming -- the deceleration is now slowing, and the goal here is to get to positive growth over the next couple of quarters. So we're, as I said, encouraged by what took place in the first quarter and onward and upward for the balance of the year there. Your second question was outside of biologics and pertains to surgical support. Is that right?

Yes. Just as it relates to the initial launch of the platform. I know you'd been a little elusive about your efforts there, and you've said that you'd give us more color out at NASH. But just perhaps, if you could walk through sort of what you viewed perhaps to be some of the shortfalls of existing robotics technology today that perhaps your system could address. And then do you think you'll have more of an edge breaking into the ASC segments of the market versus the OR?

You bet. So as we have been consistent in our opinion, in the world of health care, the last thing the OR needs in the world of spine is the addition of a $1 million piece of hardware that basically only does one thing, and that is help place pedicle screws. And when you actually look what's needed in the operating room, we think it's more sophisticated navigation, radiation reduction and what we would just call smart automation. And smart automation is the right tasks at the right economics. At NASH, we're going to launch our platform that will embody all of those elements in a way that's very economical. And so it takes a little bit of a steady hand to get through the kind of enthusiasm that people have for "robotics" right now because it's a shiny new object. But I think we're focused here on the right solution that we'll launch at NASH. And your point is dead right, that most of the growth of spine procedures will happen outside of hospitals, and that's where the economics are going to be really important. And I think you're seeing that we are designing systems for where a surgery has to be a couple of years from now, not where it is today, and that's what we'll talk more about at NASH.

Our next question comes from the line of Robbie Marcus from JPMorgan.

I was hoping -- you gave some good color that you thought NuVasive volumes were 5% in the U.S. in the quarter. We've gotten different data points from some of your competitors that it seems like the market in general, both in the U.S. and globally, remained flat in the first quarter. So it would be great to get your take on where you think the market is -- was in the first quarter and where you think it's stabilizing in the second quarter.

You bet. So internationally, we saw consistent demand that we've seen in the last few years. And as you can see, we continue to execute against those customer demands at a very robust pace, 20% constant currency growth. And as Raj guided, we don't see any reason why we won't continue to do that for the balance of the year. In the first quarter in the U.S., case volumes were 5%, price deflation was 2% and our particular mix issue in the first quarter also gave us about a 2% headwind.

As Raj also said, we don't see that mix issue repeating itself in subsequent quarters. So, knock on wood, we'll actually see higher hardware growth rates from NuVasive in the U.S. which means we are definitely taking share. So that's what we would tell you is our view of the world is that the international markets remain about the same. The U.S. market is flat but stable, not getting worse, not getting better, but we're executing better and we think we'll show that even in the next couple quarters and a better extent in the U.S.

Okay. So if I look at your guidance for U.S. spinal hardware, and it's 0.6% to 2.4% growth, should I interpret that as something around 5% volume growth offset by 3% to 4% price?

No. I think you should presume 5% case volume growth, 2% is your price, and then you've got our guidance.

Okay. There's still a little bit of a delta there. Is there anything specific to point to?

I'm going to let you do the final math. Our guidance is our guidance.

Okay. And just one quick follow-up on SG&A. You lowered that to offset the lower gross margin. Where exactly do you think you'll be able to pull back on SG&A?

Look, we have -- if you look at our operating expense budget for the year, it's over $600 million and to find like less than 1% here, which was the mix on operating profit, we think we easily get that by just a little bit of belt-tightening. We have some back-office efficiencies and spend elsewhere in the business that's discretionary that we can pull back on. So clawing back that $4 million to $5 million is no big deal.

The other thing I want to emphasize, although we didn't get a question on it yet, is our Ohio manufacturing plant. I do want to make sure the investor understands what we believe will happen. So those of you that have visited this plant, this is the most advanced spine manufacturing plant on the planet. It's highly automated. It's all digital, it's big. And our issue isn't that the unit costs aren't going to be competitive, they are. We can make parts now 20% to 25% lower than anything possible on the outside. Our issue now is getting all of the throughput out of the plant to absorb the fixed cost. We will be there in the second half of the year. And when you look at margins, it will have a demonstrable impact on the gross margins, which will flow to the operating margin.

And our next question comes from the line of Mike Matson from Needham and Company.

I guess, first, just wanted to ask about LessRay. I think you commented it was running below your expectations. So you mentioned the shiny new object of robotics. Is this just kind of losing out just to robotics at this point?

Look, the LessRay product is selling. We're not going to break out the numbers. We like its traction in the marketplace. We like how we're unfolding the story that this is the entryway to our Surgical Intelligence platform, and it will be a nice net positive for the 2018 results. And I would just contrast to a robot, it's far less expensive and it gets to one of the top items when surgeons are really reflective of what they want. And what they want for sure is radiation reduction if they're going to do minimally invasive surgery.

Okay. And then just on the margins. The -- what sort of trajectory should we expect there? I mean is it going to be more of a ramp over the next few quarters? Or is it going to be more of a step change in the second half of the year in terms of, I guess, gross margins you [set there] with the Manufacturing [plant] and everything?

Yes. So let's talk about gross margins and primarily focus on the NML contribution. So we talked about 130 basis points for the year. And like we mentioned in our prepared remarks, we were down in the first quarter. So as we look towards the balance of the year, nothing's changed in terms of the trajectory there. So we see an increased accretion in the back half of the year. While we won't be able to claw back everything that we missed in the first quarter, we still expect to deliver 80-plus basis points of improvement on that line. So what you're going to see in Q2 is pretty much a bit of neutral factor than significantly accretive in Q3 and Q4.

Our next question comes from the line of Joanne Wuensch from BMO.

Can we flesh out a couple of the things that happened this quarter? Number one, you had a selective departure of certain accounts that you chose to do. Number two, you have the impact of flu. And then number three, West Carrollton. Is there a way to exactly say how much of that is maybe slowing down, either gross margins or maybe just in general, some of your sales cycle?

So let me work with Skip, who's here on the commercial side, Raj and myself to give you some quantification. The flu impacted us certainly in our European results. However, we still delivered 20% constant currency growth internationally. So think of that as going away in the second, third, fourth quarter and international results should actually go up from here. Skip, maybe just a few words on international?

Yes, absolutely, Greg. Joanne, I think the key takeaway from international is we continue to scale this business and focus our efforts on 8 to 10 key markets and the U.K. being one of those markets hence the reason we highlighted the push relative to the bed exposure and the flu. Obviously, we're feeling great around where that International business is going. There's a strong focus on better commercial execution. We're hiring great talent, and we're building out brand awareness. We have 4.5% to 5% market share across that International business, and there's plenty of headroom by us showing up in a meaningful way in certain accounts and certain markets. So we're getting excited about where we're going with international.

So again, the flu will have been a temporal item in the first quarter. Raj, maybe NCS, just say a few words about that, about the case volumes and where we go from here?

Yes, yes. So in the first quarter, we saw NCS case volumes down roughly in the 7% range. But having said that, like I said in my prepared remarks, some of that was due to accounts that we purposely chose not to -- we exited those accounts for internal sort of margin thresholds. Having said that, we are now going into the second quarter with a little bit more of an aggressive approach in terms of getting new accounts and making sure that we put this back on track in terms of growth. So we expect that -- the core services business to turn around.

And the other thing like I also mentioned was a little bit of a sort of balance between integration and executing on our core business. So I think they're going to be a little bit thoughtful in terms of making sure that we have resources more committed to executing on our core business and a lesser focus on integration like we initially aggressively tried to go after. So that's the color on NCS.

And then maybe you and I, Raj can just answer on West Carrollton. I can give the medium term impact, you could talk to 2018. But just to remind the investor, the West Carrollton investment was to deliver 400 basis points of gross margin improvement. Interestingly enough, in the first quarter, we took a step backward, as we said, because the output (technical difficulty) [fixed] cost yet. We're still very committed to the full 400 plus the 100 improvement in gross margins, which will take this business to the high 70% range gross margins in the medium term. In terms of 2018?

Yes. So in the first quarter, we already quantified the impact of NML through our gross margin. So 120 basis points of the 350 basis points of erosion came from the NML side. And like I said, as we move forward into Q2, you will not see that 120 basis points of erosion. It will be more a little bit neutral. And then you'll see significant accretion in the second half of the year so that, overall for the year, we will deliver 80 basis points of improvement versus the 130 that we committed to. That's how I see 2018 playing out.

Our next question comes from the line of Richard Newitter from Leerink Partners.

I just wanted to clarify the -- what the organic constant currency was in the quarter and then what your guidance organic constant currency is and what it compared to as of your last call? Can you just run through those? Because I know you gave organic guidance, but I think that includes currency, and currency assumptions change. Can you just remind us those 3 metrics?

Sure. So including SafePassage, actually let me take that back into excluding SafePassage here. So organic growth. We've basically guided to a range of 4.7% growth for the year and ex currency, that growth rate would be 3.7%.

Okay. So for the quarter, your constant currency organic rate was -- is somewhere between 1.5% and 2%, right? Is that, right? Just...

Yes. If you look at ex currency growth, organic was about 2%.

Okay. And for the year?

Versus the reported growth of 4.6%. And for the year, this growth would be 3.7% for the total year, organic ex SafePassage.

Inclusive of currency?

Ex currency.

Or is that excluding currency?

Excluding currency.

Okay, got it. So 3.7%. So is that a slight -- so that's very, very -- a couple of tens of basis points below what it was. Am I -- is that correct?

No. I mean, it's noise.

Okay. And just one housekeeping item. It looks like you restated for the ASC 606 accounting that all companies are doing. I had thought that you guys had already restated for that. Can you just, one, am I getting that incorrect? And if so, I apologize. But if not, can you just tell us what were the additional restatements related to today?

We did and it's on our website, and the impact is on there. I mean, we filed that clearly. So the impact that you'd see for the year was $2.8 million on top line. And you'll see that in our reporting.

Our next question comes from the line of Isaac Ro from Goldman Sachs.

I wanted to spend a little bit of time on the Carrollton update you guys gave us and just -- I'm not an operations person by training. I'd certainly appreciate if you could maybe break down a couple of the key operational goals you need to hit to realize the 400 basis points margin improvement. And you can break that down however you want, but I appreciate just a little bit of detail under the hood in terms of what's happening there to realize the improvement.

You bet. So just to remind everybody, we shut down the old factory at the end of last year, December. We put everybody into the new plant starting in January. And so we're talking about the first 3 months of full operation of this plant. The plant is producing obviously the output we need in addition to items that we outsourced continues -- that we still outsource to meet the overall sales demand for the company. On those units we're producing out of West Carrollton, the unit costs that is, think of a widget and how much it actually costs, is meeting our expectations. It's 20% below what you could buy it on the outside. And so that's good.

The issue for us is we're not producing enough of them yet. So the key measurement you would want to know is output per day and getting that to a level that absorbs the fixed cost of all of that factory. So the output per day is going up. It's got to go up faster, but it's going up. There's no invention required here. It's just work to continue to scale the plant. And as it gets past the threshold of the cost of the fixed operations, it starts to produce accretive gross margin to the company. That will happen in the mid-part of this year, and gross margins will start to escalate in the second half per the guidance.

Okay, that's helpful. And so I think last quarter, you had given the forward quarter guidance. This quarter, you're just updating for the year. Is that because there's some swing factors between 2Q and 3Q as it relates to the items that you just touched on? Or was there another consideration that makes it difficult to kind of provide us a forward quarter outlook?

Our crystal ball isn't that perfect, we're still [thinking] second half of the year and so you shouldn't read into anything we're saying here.

Our next question comes from the line of Kyle Rose from Canaccord Genuity.

Great. Just wanted to circle back to your LessRay and then the broader -- your Surgical Intelligence push in the NASH in September. Just I guess maybe what has the first 6 to 9 months of LessRay, as far as that sales process and the capital sales process, really helped teach you when you think about starting to roll out the broader initiative of Surgical Intelligence in the year end? I mean I guess what makes you more confident that, that will have a bigger push this time versus how we thought about LessRay maybe this time last year impacting 2018?

So LessRay was our first piece of capital equipment that the company had to sell. It is allowing us to develop the kind of muscle memory, the ability to [sell] capital in addition to spinal implants, and we're getting better and better at it. We're building out a capital selling force. We're creating the models in our CRM system. We're learning how to deal with the value committee, the hospitals, something we've never had to do before. I'd further remind the investors that LessRay is the first element of now what we believe is a long trend of systems going into the operating room.

A few years from now, I just don't see a company being in spine business unless it's integrated like we are going to be and I'm sure some of our larger competitors. So come NASH, you're going to see the launch of a much bigger set of operating room technologies. And by the October time frame, our capital selling force will be bigger, we'll have sold more LessRays. All of this is just stepwise -- stepping towards becoming this totally integrated spine company.

Great. That's very helpful. And then just one quick follow-up. Obviously, biologics came in a little bit better than I think you were expecting. Maybe just talk about were there any changes to how you think about your sales force incentives in order to maybe drive a better attachment rate there as well as some of the underlying hardware strength we saw in the Q1?

Yes, good question. So what we did in the first quarter with biologics was we adjusted our prices to meet the market price. That was long overdue. We started to actually work with our salespeople to make it integrated into their selling where, candidly, we had probably let that discipline lapse last year. So we're doing that. And both of those things have combined to produce in the first quarter a little bit better results. As we said, we think we're at the nadir, we're at the trough of where the biologics business will be, and we think we'll continue to get a little bit better every quarter now.

What you could expect from us in the subsequent quarters in biologics is broader product offerings, a more complete book so that we can be a more formidable biologics player in and of itself. And we think that's what you got to do today to be in the biologics business.

Ladies and gentlemen, that is all the time we have for Q&A today. Mr. Lucier, I would like to turn the call back over to you for closing comments.

You bet. So as we conclude today's call, I'd like to announce that Carol Cox, our Executive Vice President of External Affairs, is going to be transitioning to a strategic advisory role and will remain with the company through early 2019. Carol's decision to move to an advisory capacity is something we have been discussing together for a few months. And I'm in full support of her desire to move to this new role.

As many of you know, Carol and I have worked together many years. She is a true IR and communications professional. Over the past 4 years at NuVasive, she has achieved a lot, including building out our Investor Relations function and ensuring our investor community understand the value of NuVasive and where we are headed. She has also led other functions during her tenure, including public and government relations as well as the NuVasive Spine Foundation. She's had a direct hand in many accomplishments that have made this company better. I've learned a great deal from Carol, appreciated her mentoring others in the organization and can't thank her enough for her leadership and counsel to me personally and for the good of the overall company.

As Carol transitions, Raj and Suzanne Hatcher will work together, managing the Investor Relations function. Many of you know Suzanne and interact with her frequently already. You're in good hands with her, along with Raj and the NuVasive finance team.

Carol, I turn it over to you now to say a few words.

Thanks, Greg and everyone. First and foremost, thanks for the kind words, for the support that you and the board have shown to me at my tenure at NuVasive. I'm very grateful for the opportunities I've had here to broaden my skill set, build out several kinds of teams and help mentor our next level of leadership. I'm proud to have been part of this vibrant culture that heroically puts patients first and strongly values innovation, and really the (inaudible) of giving back.

As Greg said, we've been discussing my plan to transition from my current role and while finding that optimal time is really not possible at all, I'm confident we have a strong team in place now with Raj and Suzanne and a very robust finance team to continue to support the Investor Relations efforts really at the highest levels here at NuVasive.

So more than anything, I want to ensure a smooth transition. And to do that, as Greg said, I'll remain as a strategic consultant to NuVasive through the early part of 2009 (sic) [2019]. For me, it's really been an honor to be part of the NuVasive leadership team for 4 years and as we've evolved and further built out our strategy to lead in spine. Again, as we end this call, I'd like to thank Greg and the Board of Directors and really all the talented and dedicated colleagues here at NuVasive for your support and friendship over the years. And I look forward to catching up with everyone individually.

Carol, again, thank you very much. We wish you all the very best. And with that, thank you all of those who called in on the call today. We look forward to speaking to you next quarter. All the best.

Thank you, ladies and gentlemen. This does conclude our teleconference for today. You may now disconnect your lines at this time. Thank you for your participation, and have a wonderful day.