NuVasive Inc (NUVA) 2007 Q2 法說會逐字稿

Greetings ladies and gentlemen and welcome to the NuVasive, Inc. second quarter 2007 earnings. (Operator instructions)

It is now my pleasure to introduce your host, Mr. Zach Kubow of The Ruth Group. Thank you, Mr. Kubow. You may begin.

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

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

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

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

With that I would like to turn the call over to Alex Lukianov.

Thank you. And thank you everyone for joining us on our second quarter conference call. We are very pleased with our operating and financial performance during the second quarter. We continue to experience increased sales force effectiveness, driving our innovative products deeper into hospitals. We added new accounts to our sales base and we continued training spine surgeons on our MAS platform at our anticipated rate.

Before outlining our operational progress for the quarter, let me summarize our strong financial performance. Revenue for the second quarter increased 56.7% year over year to $35.6 million. On a sequential basis, this represents a 7.2% increase. Our gross margin for the second quarter was 81.2%, in line with our expectations. Accordingly, we are increasing our revenue and GAAP guidance for the full year 2007, which Kevin will discuss in detail shortly.

Most importantly, our sales force has been making substantial progress and further cultivating existing surgeon relationships, as well as generating new relationships across the U.S. Our sales team remains focused on selling the entire mix of NuVasive products and concurrently expanding its geographical reach by continually adding new accounts. As these representatives move toward their revenue productivity goals, we expect to simultaneously grow our account base and realize greater leverage in the second half of 2007 and beyond.

Our traditional metric of vertical integration stood at 47% at the end of the second quarter, a good result with the 50 accounts that we've added. With the progress our sales force has made cultivating new accounts in the first half of this year, we have concluded that our efforts to achieve product integration in our accounts is not meaningfully reflected by the existing vertical integration metric. With a rapidly growing sales force, many of whom are new to our product line, we had forecasted that sales efforts would initially focus on penetrating existing accounts which would have lead to a rapid rise in our traditional measure of vertical integration.

Although the majority of our sales force is still gaining product knowledge and building relationships in their territories, many of our seasoned sales professionals are generating new account activity faster than anticipated. This rapid account growth is being produced while maintaining the strength of our vertical integration measure, but that metric has now become obsolete for reflecting the progress of the sales force.

Rather than continue reporting this metric, we are analyzing more meaningful ways to demonstrate our successful efforts by driving deeper into accounts, including providing more information regarding the success of the sales force by geographic region and we will be prepared to discuss these topics on future calls. For these reasons, we will no longer report on our traditional, and now obsolete, vertical integration metric.

Our sales force continues to grow at our guidance rate of about 20% to 25% per year. Our total sales force currently stands at approximately 220, up from 207 the previous quarter. With the growth of the sales force we see substantial opportunities for incremental market share gains throughout the U.S., especially in places where our presence is still relatively limited, such as the Northeast, parts of the Midwest, and Mid-Atlantic areas, where we are quickly generating sales momentum.

Working in tandem with our elite sales force, we are putting forth significant effort to brand and expand our lateral approach to spine surgery. As the acceptance of minimally invasive spine surgery, or MAS as we call it, continues to proliferate in the surgeon community, XLIF is becoming an integral part of a surgeon's armamentarium. Broadening the use of XLIF and leveraging that innovation into other spinal indications such as adult degenerative scoliosis and thoracic indications is another important component to our growth strategy.

We also continue to make progress on expanding and enhancing what we believe to be the most innovative product suite in the spine industry. A major focus of the second quarter was building a complete inventory for our three newest implant products, SpheRx II pedicle screw system, XLP/XLIF lateral plate, and Formagraft biologic.

We have completed this full inventory build on schedule in order to meet what we expect to be a robust demand in the second half of 2007. We have received very positive surgeon feedback, as well as strong demand for each, allowing us to develop deeper relationships with spine surgeons. We remain excited about their expanded utilization in the second half of the year.

Our major component of our innovative technology is our NeuroVision nerve avoidance platform. We recently launched significant new features of NeuroVision in the form of [MAP] monitoring capability and remote monitoring, as well as a new generation I-PAS needle, which has further enhanced our technological leadership. All of these advancements have contributed to a NeuroVision product family that is meeting all of our expectations, strengthening the foundation for the future.

Our remaining product launches, scheduled for the third and fourth quarter of the year, remain as planned. These innovative product launches collectively cover all areas of the spine. Many of our upcoming products are part of a strategy of advancing our proprietary XLIF procedure deeper into other areas of the spine, such as adult degenerative scoliosis and thoracic indications.

Our product releases focused on thoracic indications are on track for launches in late third quarter of this year, and include our MaXcess thoracic retractor system specifically designed to allow surgical access to the thoracic spine in a minimally disruptive manner; our CoRoent XLT implants for thoracic indications; and all related specialized and precise instruments that are key to ease of use for the general population of spine surgeons.

Also, as previously announced, we will be conducting launches of two new cervical plates in the fourth quarter, both of which will be premiered at the NASS meeting event in October. These include our [Helix] ACP cervical plate and the limited release of our Helix mini-plate to meet the multiple preferences of surgeons for cervical fixation.

Lastly, we also plan to debut our SpheRx DR, dynamic rod, system in the fourth quarter with a full product launch to follow in 2008.

These recent and planned product launches will strengthen our position as a leading innovator in the spine market. We are focused on continually developing and introducing products that meet the needs of the spine community. In true MAS fashion, our innovative products deliver superior results to patients in a minimally disruptive manner while providing surgeons with surgical options that are safe and reproducible.

I would now like to turn the call over to Kevin O'Boyle who will review our second quarter financial results and key performance indicators.

Thank you, Alex. Our revenue for the second quarter 2007 was $35.6 million, a 56.7% increase over Q2 2006 and a 7.2% increase over Q1 2007. Our strong sequential revenue growth was driven by continued adoption of our MAS platform, including our XLIF procedure, as well as early success from our launch of SpheRx II, XLP/XLIF lateral plate, and Formagraft biologics.

Gross margin for the second quarter was 81.2%, compared to a gross margin in Q2 2006 of 77.6% and a gross margin in Q1 2007 of 82.8%.

Our Q2 2007 net loss was $3.4 million, or a loss per share of $0.10 on a GAAP basis. On a non-GAAP basis, the company reported net income of $450,000, or $0.01 per share. The non-GAAP income per share is due to the realization of sales force efficiencies and the continued strength of our product line. Our non-GAAP net income calculation in the second quarter of 2007 excludes stock-based compensation of $3.5 million and amortization of intangible assets of $400,000.

Operating expenses for Q2 2007 totaled $34 million, flat in comparison to the first quarter of 2007.

R&D costs were $5.4 million in the second quarter, excluding stock-based compensation, versus $5.2 million in the first quarter. The marginal increase in R&D spend from Q1 was related to the enrollment of subjects in the NeoDisc clinical trial and development efforts related to our product pipeline.

Sales, marketing, and administrative expenses totaled $25.1 million, excluding stock-based compensation, which is essentially flat to Q1 levels. Excluding stock-based compensation, sales, marketing, and administrative expenses as a percent of revenues for Q2 2007 came in at 70.5%, versus Q1 2007 at 76.5%.

The interest and other income for the quarter of $1.6 million is comprised of $1.3 million in interest income and $275,000 for an insurance settlement.

The stock-based compensation charge for the quarter of $3.5 million was recorded in operating expenses and allocated as $575,000 in research and development, with a balance of $2.9 million in sales, marketing, and administrative.

Our key performance indicators, or KPIs, for Q2 2007 are as follows, percent of vertically integrated hospitals, Q1 '07 45%, Q2 '07, 47%; total sales force in Q1 '07 207, and in Q2 '07 220. As a reminder, our definition of a vertically integrated hospital is a hospital that purchases products from each of our three MAS product lines of NeuroVision, MaXcess, and specialized implants.

As Alex mentioned in his prepared remarks, we'll be introducing new metrics to help put into greater perspective the impact that our vertical integration strategy is having on revenue growth. Our vertically integrated hospitals metric that we have given to date served as a proxy for measuring the success of our product penetration strategy. However, it does not reflect our account growth or the deepening product penetration into existing hospital accounts, since those accounts we have already considered vertically integrated.

As of June 30, 2007 we had $96.7 million in cash, cash equivalents, and short and long term investments. Our operating cash burn was $9.9 million for Q2 2007, which partly reflects the development of our MAS product line, including motion preservation; the launch of SpheRx II and XLT/XLIF lateral plate; and the buildout of inventory and instruments to support future growth. Our operating cash burn is defined as cash used for operating activities, plus additions to fixed assets.

Days sales outstanding, or DSOs, were 60 days in Q2 '07, compared to 58 days in Q1 2007.

As it relates to 2007 guidance, we anticipate our mid-year product launches and the increasing effectiveness of our exclusive sales force will provide for a strong second half. Therefore, we are increasing our full year 2007 revenue guidance to a range of $143 million to $146 million from our previous range of $139 million to $143 million, more heavily weighted towards our fourth quarter, which is consistent with our traditional trends.

Our R&D operating expenses for the balance of the year will increase due to the expected spike in enrollment in the NeoDisc trial over the first half levels, and for the advancement of the next generation NeuroVision platform. The increase in R&D should be evenly allocated to both Q3 and Q4. It is for these two principal reasons that our non-GAAP earnings per share remains at a range of $0.05 to $0.09 per share.

Our GAAP loss per share guidance has improved to a range of between $0.38 to $0.31 per share, principally because our stock-based compensation range for 2007 has decreased to a range of $13 million to $14 million. The stock-based compensation costs should be consistent between the remaining quarters.

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

Thanks, Kevin. In summary, we continue to make substantial progress on the strategic initiatives that we believe will ultimately lead to NuVasive becoming a major force in spine. Our exclusive sales force is acutely focused on furthering product penetration, strengthening surgeon relationships, and broadening our reach across the U.S. hospital base.

In Q2 we completed major inventory builds and full launches of three products, SpheRx II, XLP/XLIF lateral plate, and Formagraft, which we believe will make significant contributions to our revenue growth in the second half of the year. SpheRx II allowed us to participate in multi-level fusion surgeries. XLP has received very positive surgeon feedback from those who typically rely on implants alone without posterior fixation, but now opt for additional fixation because it can be delivered through the same access portal as the implant.

Our newest product, and initial entry into the biologic market with a unique graft extender, Formagraft, has contributed to increased revenue per procedure and now, with the appropriate level of inventory, we anticipate stronger momentum.

We also remain on track with our motion preservation initiatives in both the U.S. and O.U.S. Our NeoDisc clinical trial enrollment is progressing as expected and we remain excited about the prospects of the device. We are currently over 40% through the enrollment process and we expect to complete trial enrollment in the first half of 2008.

Additionally, we are on track with our international strategy to seed our differentiated motion preservation suite of NeoDisc; Cerpass, also for the cervical spine; and XL-TDR, a total disc replacement via lateral approach in the lumbar spine. Additionally, we are on track for [ID] filings for Cerpass in late 2007 and XL-TDR in early 2008. This initial O.U.S. market strategy will consist of introducing motion preservation and XLIF products into select European countries in late 2007 and early 2008 as planned.

Lastly, I want to address what we see as a strategic opportunity. In the second half of this year we intend to increase our investment into two key projects that would help ensure our position as the leading innovator in the spine industry.

The first of these projects is our NeoDisc clinical study. This unique device has the potential to be the first of its kind to market and we are eager to generate clinical results from the study. The device represents the potential for early treatment of the cervical spine in a manner that preserves range of motion and does not limit future surgical options. For these reasons we will increase our investment in the study to accommodate patient enrollment at a rate in excess of what we had seen in the first half of 2007.

In addition, in line with our focus of being a technological leader focused on obsoleting our own products, we have for some time been working on the next generation of our NeuroVision nerve avoidance technology. We plan to accelerate development of this technology and deliver a fully redesigned interface and operating system in 2008. This redesign will significantly increase expanded capabilities and ease of use of NeuroVision on a new operating platform, securing its dominant market position for years to come.

These investments, as with everything we do, are being made with a keen eye on increasing our operational efficiencies and growing profitability. An example of this is our overall reduction in selling expenses as a percentage of revenue, which will increase our profitability over the short and long term.

We continue to work diligently to remain at the top of the spine industry's innovation curve. Our culture of absolute responsiveness continues to permeate across the entire organization, allowing the sales and marketing and R&D teams to work surgeon feedback into product development in real time.

We have a number of exciting products in development across both fusion and motion preservation platforms that we believe will fuel our sales growth to $500 million and beyond over the next several years and generate increasing profitability. And last, but not least, we plan to do so with absolute responsiveness at cheetah speed, while continuously striving to be the easiest spine company to do business with.

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

(operator instructions) Our first question comes from Bob Hopkins with Lehman Brothers.

Thanks very much and good afternoon.

Hello, Bob.

Hello, Bob.

Couple questions here, after obviously a good quarter. First, Alex, could you talk a little bit more about the adult degenerative scoliosis opportunity? Where are you now in that opportunity and is there any way to quantify it?

Well, I think we've tried to describe that before is that it's a lumbar opportunity when we talk about adult degenerative scoliosis, and that means moving further up and doing several levels in the lumbar spine. So, as we've described before, XLIF is approximately 20% to 25% of lumbar procedures as an opportunity, and then of course, by adding this incrementally, we think that that moves it to 30%, potentially even a little bit higher.

Moving into the thoracic spine takes us up further, and especially on the revenue side, because what happens on the thoracic side is they tend to do even more levels in a lot of instances as we move into scoliosis; and even though -- and we're talking about two different things when we talk about lumbar degenerative scoliosis and scoliosis in the thoracic spine. So in the thoracic spine, we'll tend to see higher levels of revenue, more implants being utilized, but a smaller market and not as many procedures being done.

So 25% to 30%, and then with thoracic would get you up to -- what percentage did you say? Sorry.

I didn't say. I was just saying that I think we can get to as high as 35% without thoracic. I think with thoracic, you just add -- it's really a few points from a market share percentage; but from a dollar standpoint, it's substantial.

Okay. And then on the sales force adds, can you just give a quick description of this quarter and last quarter, where these guys are coming from, guys and gals? Are these experienced people mostly that you're hiring, or is it a range of people? Just a little bit of color there.

Well, as I reported, we went from 207 to 220. The vast majority of the sales force that we're hiring are new and are moving into pretty much brand new territories. So in cases where there are non-competes, there are unavoidable solutions to those non-competes, we have been forced to hire people without spine experience, and those are folks that have a very strong selling background, so we expect them to do well. But of course, it'll take a little bit longer for them to get up to speed in those markets. But they're coming from a variety of the key spine companies.

And typically the non-competes run about a year; is that right?

They vary; but yes, that's about right. They go anywhere from six months to even as long as two years in some cases. But yeah, it's usually about a year; but they're specific in most cases. For sales representatives, they're specific to territories, so that allows us to hire a sales representative, for example, from Michigan, and allow that person to work somewhere in New England or what have you.

And then the last question; at the end of the call, you talked about the two key projects that you're going to be spending a little more money on; NeoDisc was the first. Could you just -- does the incremental spending have any incremental impact on the timing of the completion of the enrollment in those trials or anything like that, or just allow them to be a little bit bigger trials? Could you just give a little more color there?

The focus is on enrollment, and so we believe that we have an opportunity to finish the trial a little bit earlier. We're saying that we'll finish it in the first half of 2008, and we are taking steps to accelerate that the best we can. So I can't sit here and tell you we'll get it done by the end of 2007. We're trying hard to do so and taking steps in that direction.

And did you quantify the incremental spend on these two new initiatives, or two incremental initiatives?

No, we did not.

Thanks very much.

You're welcome.

Our next question comes from Steven Lichtman with Banc of America Securities.

Thanks, guys. Just in terms of the new product launches -- the three product launches in 2Q, can you give us a little bit more granularity in terms of when exactly did they launch? Is it really literally at the end of the quarter, or is it throughout 2Q?

In terms of the 2Q ones?

Yes.

Literally at the end of the quarter.

Okay. So they're really just ramping now.

Yeah. They're really -- they're all pretty much June sort of timeframe in terms of getting it out nationally, so we're expecting to see them begin penetration in the third quarter, and ramping up heavily towards the fourth quarter along with our other products.

Okay. And you've spoken before about the dynamic rod; it sounds like a little bit more definitiveness now. Can you perhaps describe the product a little bit and how it may differ from others on the market or in development?

What I'd like to do is to hold off until NASS, and I'll personally show it to you then. How's that?

Sounds good. And so it'll be a limited launch post-NASS and then full in '08?

That's correct.

Okay. And then, Kevin, on gross margin, what are we thinking these days in terms of sort of comfort level as we look forward?

No, we're still in the 81%, 82% guidance range. We're comfortable in there, Steve, and remain comfortable at those levels.

Okay. And we've built some inventory in 2Q, obviously, so that'll settle back here. You're going to now burn through that inventory that was built for these product launches, correct?

Right, because we had big national launches on those as well as Formagraft, and you can see that on our balance sheet as it related to inventory and fixed assets.

Okay. And on sales force, are you anticipating adding more people this year than originally thought? I think originally you were thinking 220 to 240 by the end of the year; you're at 220 now, or is it just you've done it a little quicker than expected?

I think we're going to be somewhere in the 240 range. I'm not sure if we'll exceed that or not. It depends on the quality of the folks that we come across and how we continue to realign some of our territories. I think 240's reasonable, and I think there is a chance of being slightly north of that.

Okay, great. Okay, thanks guys.

You're welcome.

Our next question comes from Matt Miksic with Morgan Stanley.

Hi. Thanks for taking the question.

Yeah. Hey, Matt.

So I don't know if you give a number or if you're talking about the -- it sounds like Formagraft, you have the inventory at the right level by the end of this quarter, right? So you're teed up for the second half. Is that a little bit earlier than you were expecting? I guess I'm wondering whether we're going to see a bigger contribution in the second half from Formagraft than I was looking for; and maybe, if you could give us an idea of what an annual number looks like on that business.

That is on schedule. That's what we anticipated in terms of inventory delivery; and that number will not change in relation to what we've talked about before, which is $4 to $5 million for 2007 on the year.

Okay, and that's a good way to think about an annualized number, or is that sort of a base?

I think that's a base, and that takes us -- on an annualized basis, I think for next year, what we're looking at is for that to double.

Okay. All right. Also was wondering about the sales force. We had been looking at sort of productivity ramping, and on the one hand, this is good news, right, that you're at 220 already and on-track maybe to hit that 240 number in terms of total reps. But as we model this out, as you're adding more people, some of them have non-competes, should we think about maybe the productivity per rep taking either flat or maybe even sort of a temporary pause here; because you are adding new people and they've got to come up to speed?

I would say -- generally speaking, I would say that it doesn't really change what we've talked about before. It still comes down to building a relationship and having a very strong relationship with both the hospital as well as the surgeons in the community. So we see reps being most effective after 12 months, and I think that seems to be the point where they start to really excel, and that's kind of what we've been trying to talk through is that we see them excelling not only in terms of vertical integration, but in their ability to add new accounts.

So I think that number's going to hold, and I think that timeframe could also be as long as 18 months in very tough markets, like New York City; like Boston, even though we've had earlier success than 18 months in those places right now and are starting to ramp.

Okay, so we should be thinking about -- this time next year through the end of next year really, you're still going to be ramping what that sales force can do; so it'll be kind of on an upward curve.

Yeah. I think that we're going to have a largely mature sales force to start 2008, and of course, 25% of it, approximately -- and we'll talk about it some more at the start of next year, how we think it will continue to grow, but I think that's going to be relatively constant. But 25% of it is always lagging behind because it's new.

Okay. There's one question -- you had talked about the percentage of -- you say the good uptake on the lateral plate from surgeons who rely on implant for stabilization and not so much on pedicle screws. Any sense of what percentage of your business or what percentage of the surgeons out there are kind of comfortable with that?

Well, we think that that opportunity is approximately one-third of the surgeons that are doing XLIF. So that's -- so in other words, two-thirds to three-quarters; but let's just say it's -- I think two-thirds is a good way to look at it. Two-thirds of the surgeons are doing it with posterior fixation. So our primary target is the one-third that are not doing it that way.

And then finally, just some color on your business. I guess we had -- we don't typically look at it this way, but I'm assuming that you are still predominantly a lumbar business; any sense of where you are in cervical? Give us some color maybe on where that is versus a year ago as a business for you, since that has been part of the whole bag that these folks are selling.

Yeah. Cervical is still a very small part of our business. I see cervical ramping considerably in 2008. As we launch, and you'll see it at NASS, as we launch the Helix plates, I think that that in combination with Gradient allows us to really move our cervical business up in a positive way. We haven't talked about this in detail, but in 2008, we will be launching a posterior cervical system as well; and as we have specific launch dates, we'll announce that, but that will probably be at the start of next year.

So I think that what you'll see from us next year is a formidable cervical offering that will allow us to go head-to-head with our competitors, many of whom have anywhere between 6 and 12 plate offerings. So we don't need to have quite that many; but we feel that having 3 plate offerings and having a posterior system, and then potentially developing a fourth will allow us to really move the dial on the cervical side of our business next year.

Good. Good stuff. Thanks very much for taking the questions.

Thanks, Matt.

Our next question comes from Vincent Ritchie with Wachovia.

Hi, thanks for taking my question. Most of my questions have been taken. One thing I was just curious about; it sounds like most of your sales force additions were kind of young and most of the products that you launched were directly at the end of Q2; so what was really the impetus for the sequential growth in the quarter? Was it getting into new territories, or just your sales force getting better at what they're doing?

I think what we've tried to make clear -- number one, we're getting more revenue from vertical integration. So as that's moved up, that's driven the numbers substantially. What we've also seen is that our senior sales force has become adept at concurrently adding accounts, and that's what really drove the revenue. And so what we've seen is that they're able to get in front of surgeons and talk about these three new products that we've just launched and get them to use those products -- really, try those products. And so that is why we believe that surgeons that try our products and are satisfied with them will allow us to catapult into stronger sales in the second half of the year. Again, we'll certainly see an increase in the third quarter; but as I said earlier, we expect to see a very strong and robust fourth quarter.

Great. And can you just remind us with the Formagraft now, what's the average ASP for a case?

It's approximately $1500 to $1700 per case.

Great. Thanks for taking my questions.

Our next question comes from Steve Ogilvie with ThinkEquity.

Hey, guys. I wanted to ask you a question on your product life cycle. You guys seem to innovate and keep it fresher than anyone, which means you're cannibalizing your own things really fast. I'm wondering if that's a long-term thing as you think of it, or do you think you can get more life out of each product life cycle and maybe save a little money that way; or do you feel the need to keep iterating at this pace?

Well, I think we're getting a lot of life out of our products. I think what we're doing is we're making sure that we're meeting the varying needs of surgeons. So MaXcess I is being sold along with MaXcess II and MaXcess III, so when we talk about that as a philosophy, that is an internal business philosophy that makes it very clear to engineering and marketing that they do need to come out with the next version.

For example, III is extremely -- MaXcess III is very different from MaXcess II; the thoracic MaXcess, again, a very different product. Those are things that we classify philosophically as obsoleting ourselves. SpheRx I, we don't anticipate that product going away. SpheRx I will always be around to some degree or another, but SpheRx II allows us to do more multi-level cases.

But for a very simple, straightforward, MAS-type of one level fusion, SpheRx I is a terrific way to go. So I think there's really -- at the moment, there's nothing -- I'm sitting here trying to think about it -- but there really is nothing that we have obsoleted with the exception of our allograft sales, as we've talked about over the last several years, have continued to decrease; and they have been supplanted by CoRoent sales. That's the only product line that we really see continuing to move downward and there being just less and less demand for it.

Perfect. And then, a question on the dynamic stabilization product. I guess we'll see it at NASS. There's a lot of products out there, whether it's a jointed rod or different materials. The jury still seems to be out in terms of what's going to work best and what doctors are going to adopt. Assuming that it -- maybe your launch isn't -- two years from now isn't the perfect technology where the market's heading; would you look externally, or do you think that you have the internal capacity to keep up to speed with the technology that seems to be changing so quickly?

We always look at both. I think we've come up with some pretty clever ideas. I think what you'll see at NASS is very well thought out. So we believe -- and again, just like you said, the indications are moving. So based upon the collective wisdom as we understand it today from surgeons, we think it addresses their concerns; whether or not that means that that product has to go through multiple iterations or have a series of line extensions, we really don't know that until we get into full launch in '08 and we see what's happening with regard to competitive offerings.

And then just a quick question on the -- just to clarify. The 220; are they all quota-carrying reps, or is that total sales support staff?

That's total. So that includes some sales management; that will include some associates as well; so no, not every single of them is quota-carrying, but every single one of them is quota-linked.

Okay, great. And congratulations on the quarter.

Thank you very much. We appreciate that.

Our next question comes from John Putnam with Dawson James Securities.

Thanks. Alex, I wondered if we could revisit the timing of NeoDisc. I'm a little unclear as to what's really going on. Did you say that about 40% of the patients have been enrolled?

Yes, and that goes back to September, starting in September.

Okay. And that's out of what, a potential enrollment of 500 patients?

That's right.

Okay. And so you're going to try to accelerate a piece of that enrollment such that you can finish hopefully by the end of this year or the beginning of next year?

Yes. The guidance that we've given on that is to finish in the first half of '08. We believe that it's prudent for us to accelerate that. We think that we have a real blockbuster product and we want to get it to market as fast as we possibly can. So we think that if it's possible to shave a quarter or even two -- but if we can shave a quarter off, that's a prudent investment.

I would agree with that. But that would be followed by a filing of an IDE; is that correct?

It's already under IDE. We are in the clinical trial under an IDE for NeoDisc. So that means that we'd be filing for a PMA once we have two-year data. That's when you file for the PMA, and potentially go through a panel process; although I don't believe that would be necessary, given the fact that there are devices that would be on the market ahead of us that are mechanical; although ours is different because it's more of a nucleus-like total disc replacement.

John Putnam. Right. Okay, so you need two-year data on the entire 500 patients, or just some portion of it? Yes. It's a little less than 500. It's about 480, but yes, you have to have two-year data. Everybody does when they go to -- to get their PMA.

Thanks very much. Appreciate it.

You're welcome.

Our next question comes from Brian Wong with First Albany Capital.

Good afternoon. Thanks for taking my questions. I just had two things. First, I was wondering if Kevin could quantify what your revenues were from acquired products versus organic products.

The only product this year that's in the mix on the acquired products, if you will, is the Formagraft biologic. And we mentioned that the contribution this year would be $4 to $5 million. The first half was limited because of the amount of inventory we had, so it would be more weighted in the second half of the year, but we don't give out specific product revenue numbers.

Okay. So basically all the 56% was internally generated, then.

Yes.

Okay. And then I was wondering if you guys could comment perhaps on pricing, whether or not you're seeing any sort of pressure. Obviously you've had a couple of big companies out there who have stumbled; a couple of big companies and other companies that have done really well, yourself included. How much of that is due to pricing increases versus volume and mix?

Well we have not done a price increase, and it's been a couple of years since we did any sort -- in fact, two and a half years since we've done a price increase. None of our revenue is coming from that aspect. We do see, certainly, some downward pressure on price, and especially as we move into the larger accounts that are well infiltrated by the Medtronics and J&J type of implant companies. So in those situations, we need to get more aggressive, and we certainly do, and we've been successful.

So most of our battles, if you want to call them that, with our competitors, do take place with the larger companies, and we are just now in the process of getting into larger accounts. However, if you take a look at our gross margin, it continues to be very strong and we anticipate it staying in the low 80s this year and I think for the foreseeable future.

Okay, great. Thanks, and nice quarter.

Thank you very much.

Our next question comes from Ben Andrew with William Blair.

Just a couple questions on kind of the approach to the market. As the sales force grows and as the saturation grows, are you seeing a difference in the way that surgeons start with NuVasive products, maybe moving away from NeuroVision and MaXcess as the principal to more of the implants, or is it the same?

Generally speaking, what we see is that with our exclusive sales force and that changing, we're seeing surgeons, when they come in for training, having more product experience versus very little to none. What that means is they are, in fact, following that crawl-walk-run strategy that we've talked about for quite some time. But we still have the surgeons that really want to come out here and start by learning XLIF. But largely speaking, it's the crawl-walk-run of NeuroVision, implants, and XLIF.

I guess what I'm also asking is with the vertical integration holding in the mid to high 40s, it probably doesn't sound like it's going to go up a lot in the balance of this year. Is that partly a function that more of your accounts are not using NeuroVision and MaXcess and just implants, or is it really the other way around and you're just not getting the implant penetration you (multiple speakers)?

No, the vertical integration number is moving up. The problem with the vertical integration number is that our denominator is increasing.

Right, so as it's increasing, it's --

So we've got more and more accounts and we're adding more and more accounts quicker. So as we continue to measure vertical integration, it's being diluted by the brand new accounts.

What I'm really asking is do you have any accounts that are not using NeuroVision or MaXcess, and are only really using your implants? Because that would not be a vertically integrated account by your definition.

That would not be a vertically integrated account. We certainly do have some accounts that are at that stage, as we have accounts in all stages of the selling process, and we get in with whatever makes the most sense to that surgeon. But generally speaking, the vertical integration strategy is working well.

Okay. And on the new NeuroVision product, do you anticipate meaningful changes in terms of the economics of that, whether it's cost or pricing to you all?

To us?

To you, or to the customer, ultimately.

I think what it is going to be is it's going to be a blockbuster product in terms of addition. So we're very excited about all the features that it will have, and I think it clearly moves us forward several years. We're right now several years ahead of any competitor, and I think this takes it forward several years again. Our cost basis in terms of our NeuroVision system and the platform will be approximately the same as it is today.

Okay. And you've talked before about doc training, and I think we've been looking for something in the range of 400 surgeons being either trained or retrained, with a certain percentage being retrained. Is that what you mean, 400 for the year, when you say you're on track?

That's correct, and it's been very consistent. For the first two quarters, we're actually -- we're even perhaps slightly north of that. So it's just as we anticipated.

Thank you for that. Kevin, a quick question for you. You mentioned an insurance settlement. Can you tell us any more about that?

Yeah, that was some instrument sets that got lost and damaged in the field, and we made a claim for the product and effectively got reimbursed for the replacement cost.

Okay. And I guess finally, any comments relative to where you'd like to go next on the biologic side, whether it's internal capabilities or an external opportunity?

Well, I think that clearly there's a number of things that we're looking at doing there, so it's both; and we're looking at how to change the -- the configuration of the products. We're certainly looking at additional applications, and we will be more seriously getting into additional applications in the second half of this year in really planning our strategy for 2008 and beyond.

Okay. Thank you.

You're welcome.

Next, we have a follow-up question from Bob Hopkins with Lehman Brothers.

Thanks. Alex, I was just wondering if I could just ask you a couple of macro questions; just especially now that you're gaining some critical mass here and obviously becoming a bigger thorn in the side of some of the larger players; are you seeing any competitive response from those larger players that's different recently than you've seen in the past?

And then I was also wondering if you could just comment on the general state of the spine market, what you're seeing out in the marketplace, again, now that you have a better vantage point for what's going on from a 30,000-foot perspective, that'd be great.

Sure. We're not really seeing much in the way of direct responses. What we're seeing are every company trying to get into minimally invasive spine surgery. As you know, as you read through and as you see the various outputs, everybody's trying to have that as part of their armamentarium. We have not seen anything that we believe is truly competitive with our offering. I think NeuroVision is so far beyond and our MaXcess system is so much better than anything else that's out there; uniqueness of implants, and I won't go into all of that.

So the short answer to that is no. What we continue to see is I think the market has picked up in terms of the pace recently, so the market seems to be growing a little bit faster. I think it's growing faster than the low teens; I think it's back up into the mid to -- even slightly higher, 16%, 17% range. I think what we continue to see, though, is a large number of companies being out there, a lot of capital chasing spine, and it's a little confounding in terms of why that is happening, to be frank.

And then of course as you know, there's a number now that are in queue for trying to get their public offerings done. So I think if those companies can be true innovators and achieve long-term forecasts, God bless them. That's good for them. But I think largely what we're seeing in terms of the market is just more growth. I think we've seen very effective and successful competition on our part against the big players. That continues to work well for us. We continue to see, though, these companies budding, and we continue to see companies moving towards IPO, which as I say, if they can deliver on the things that are required to be successful long-term, that's great. But I would have concerns about any company that isn't sure of its prospects.

Thanks, Alex. Appreciate it.

Okay. You're welcome.

(operator instructions)

Okay, sounds like we're done. All right, well thank you very much for joining us, and we will look forward to speaking to you in another quarter. Bye-bye.

Ladies and gentlemen, this does conclude today's teleconference. Thank you for your participation.