NuVasive Inc (NUVA) 2010 Q2 法說會逐字稿

Greetings and welcome to the NuVasive Inc second quarter 2010 earnings conference call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. (Operator Instructions) As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Patrick Williams, Vice President of Financial and Investor Relations with NuVasive. Thank you Mr Williams, you may now begin.

Welcome to NuVasive second quarter 2010 earnings conference call. NuVasive senior management on the call today will be Alex Lukianov, Chairman and Chief Executive Officer, Keith Valentine, President and Chief Operating Officer, and Michael Lambert, Executive Vice President and Chief Financial Officer.

During our management comments and our responses to your questions, certain items may be discussed which are not based entirely on historical facts. Any such items should be considered forward-looking statements and involve risks, uncertainties, assumptions and other factors, which if they do not materialize or prove correct, could cause NuVasive's results to differ materially from those expressed or implied by such forward looking statements. These and other risks and uncertainties are more completely described in today's press release and NuVasive's most recent 10-Q and 10-K forms filed with the Securities and Exchange Commission. Finally, as a courtesy to all, we will be limiting each person to two questions during the Q&A session so that we can accommodate the large number requests and keep the conference call to a manageable time. With that, I'd like to turn the call over to Alex.

We are pleased with our Q2 results which attest to our ability to drive market share gains with differentiated solutions for spine surgery, while concurrently expanding profitability. Our focus on improving clinical outcomes for spine surgeons and their patients, while spearheading more rapid innovations than competitors through our true to speed culture of [Ford's] NuVasive, a competitive advantage that is the basis of our goal to grow to $1 billion in revenue. Revenue in the second quarter increased 35% year-over-year to nearly $120 million and we achieved non-GAAP earnings per share of $0.42. We are pleased with our profitability performance for the quarter with a non-GAAP operating margin of almost 16% versus 11% in Q1, which puts us soundly on track for exiting the year at approximately 20%.

Our growth prospects remain strong. We viewed the global spine market as growing 8% annually in concert with procedural growth rates. This reflects higher growth in more differentiated products like NuVasive's, which are off set by low single digit pricing pressure on legacy and traditional open surgery products from bigger players and startups. NuVasive is growing 4X the market because of both our differentiated solutions and the pace of innovation which drives procedural volume growth and protects our margins through favorable mix. Here's how we see the market.

We believe that minimally disruptive solutions make up 20% of the spine fusion market today. This segment includes enabling technologies that drive cost efficiencies through faster patient recovery, such as our XLIF and MAS platforms, as well as percutaneous fixation systems. Additive to this is 20% of the $1.7 billion global biologics segment, as well as about $200 million from the growing motion preservation area. We believe these collective minimally disruptive products currently comprise a $1.5 billion market. We expect this $1.5 billion market to grow 20% to 25% for the foreseeable future as patient demand and clinical efficacy drive innovation of the next generation of spine treatments. This paradigm shift should drive the high growth MAS, biologics and motion segments to over $4 billion in the next five years and to over $10 billion in the next 10 years. NuVasive has strategically the product portfolio necessary to compete in this arena and as the market leader, our innovation and superior technology will fuel continued growth rate above the competition. Let me now address guidance.

Based on our year to date results, we are raising the lower end of our revenue guidance range by $5 million from $480 million to $485 million, with the top end remaining at $500 million. For 2011, tied to favorable long term market dynamics which I just outlines, we still see 25% to 30% revenue growth. Innovation related catalysts in motion preservation and biologics beyond accelerate growth in 2011 beyond the 25% to 30% range. As far as EPS is concerned, Michael will detail the positive impact on 2010 earnings.

Turning to R&D, our new product development continues at a rigorous pace unmatched in the spine industry as we lead the shift toward minimally disruptive solutions. As many of you know, we showcased several key products at our investor event during the quarter where members of a surgeon panel highlighted some of the new products that are gaining traction in the marketplace such as MAS PLIF and XLIF Corpectomy. At NAS in the Fall, our marketing and development team will launch several new products in line extensions including the next generation of our MaXcess refractor and specialized instruments to integrate the delivery of biologics in our less disruptive procedures.

We will soon have a clearer view of launch plans for our synthetic biologics, called Progentix, which we anticipate will launch in early 2011. On the motion preservation front, our commercialization efforts are focused on a clear strategy to advance our disc replacement technologies taking into account the lengthening timelines associated with achieving FDA approval. Our primary effort is dedicated to achieving PMA approval of the PCM cervical disc replacement device in 2011. Beyond that, we are focused on driving enrollment in our XLTDR clinical trial for the lumbar spine, which we anticipate completing in mid-2011. Finally, we will begin compiling the two year clinical data related to our neo disc cervical motion preservation device in 2011 and will formulate our regulatory strategy once that is completed.

The body of clinical research, which is advancing the adoption of the minimally disruptive market, continues to expand. The surgeon panel at our investor event detailed some of the most recent clinical evidence for the XLIF procedure and highlighted details of three previously referenced studies demonstrating long term fusion rates for nearly 250 XLIF patients. We are happy to announce that all three studies have now been published. One of these published studies analyzed hospital costs which compared over 100 minimally disruptive XLIF patients to over 100 legacy or traditional posterior, or PLIF patients, and noted a roughly 10% savings in perioperative costs in the first 45 days. We continue to anticipate publication of additional studies, which will include economic indicators that we believe will continue to demonstrate cost savings to the overall healthcare system. This mounting body of clinical evidence and future publications further validate the growing acceptance and efficacy of the XLIF procedure for the lumbar and thoracic spine.

Innovative products and clinical data are not the only ways that we differentiate ourselves in the marketplace. Our strategy and cultural commitment to absolute responsiveness and cheetah speed set us apart in the eyes of surgeons as we respond to our customer needs at a level that is unmatched in the industry. We continually focus on advanced product development and seek input from the surgeon community to create innovative products at a pace much faster than the competition, advancing spine surgery for the benefit of patients. One example of our dedication to furthering the science of spine surgery is SOLAS, or the Society of Lateral Access Surgeons, where we provide a forum for surgeons to collaborate and improve surgery. Revolutionary advancements in lateral surgeries have emerged from SOLAS, such as XLIF corepectomy, just to name one, that keeps us well ahead of the competition.

Also we have nationally launched our patient education platform known as the better way back program with hall of fame basketball star Bill Walton and UFC fighter Nate Quarry as two of our ambassadors, having themselves undergone very successful XLIFs. The program serves to heighten awareness of solutions to spine disorders through education and insight to those suffering from chronic back or leg pain. The better way back helps patients to further understand the risks and rewards of technologically advanced spine surgery.

Our success in penetrating the US is being mirrored overseas where we are building on last year's efforts to drive deeper penetration and expansion of our International organization. We are very pleased with the progress we have made in 2010 and are on track to double revenue over 2009. Longer term, we expect that at least 10% of revenue will be derived outside the United States.

A critical element of NuVasive's growth has always been thoughtful investments into infrastructure to support our evolution into a larger, yet responsive company and 2010 is no exception. During the quarter, we completed the expansion of our Memphis distribution facility to house our growing team dedicated to providing absolute responsiveness to our surgeon customers. Our east coast, or NUVA east office, has also just opened this month and is already training our sales force. Surgeons will begin advance training in New York next month.

Before I turn the call over to Michael, I'd like to offer a brief update on IP litigation. We continue to expect $5 million in IP litigation expenses related to the Medtronic dispute in 2010, and year to date we have spent approximately $2.4 million. We will not seek a settlement with Medtronic and plan to aggressively use all defensive and offensive measures available to us. Additionally, we initiated a dispute against Orthofix in defense of patents acquired in the Osteocel transaction. We plan to provide updates on litigation progress as necessary, but you can continue to expect that we will not conduct internal meetings during normal business hours concerning these matters, which would otherwise distract us from executing our plans. With that I would like to turn the call over to Michael.

Good afternoon everyone. Our revenue for the second quarter 2010 was $119.6 million. That represents a 35.2% increase over Q2 2009 and a 9.6% increase over Q1 2010. The strong year-over-year revenue growth demonstrates the Company's continued ability to take market share.

Our Q2 2010 GAAP net income was $6.7 million, or earnings per share of $0.17. Excluding intellectual property litigation costs, acquisition related items, stock based compensation, and amortization of intangible assets, our second quarter non-GAAP earnings was approximately $17 million, or $0.42 a share. For the second quarter earnings per share reflect a change in the expected full year effective tax rate equating to an impact of $0.04 on a GAAP basis and $0.13 on a non-GAAP basis.

Gross margin in the second quarter was 82.4%, compared to 83.9% in Q2 2009 and 82.2% in Q1 2010. Year-over-year gross margin was impacted by increased revenue contribution from our lower margin biologics and International businesses. Gross margin for the full year will approximate our Q2 results due to these dynamics combined with previously recorded inventory obsolescence reserves from Q1 2010.

Operating expenses in aggregate for Q2 2010 totaled $90.3 million, compared to $69.8 million in Q2 2009 and $86.7 million in Q1 2010. Research and development expenses, excluding stock based compensation and acquisition related items, totaled $10 million for Q2 2010. This expense was 8.3% as a percent of revenue for Q2 2010, versus 8% in Q2 2009 and 8.8% in Q1 2010. On an absolute dollar basis we invested in head count across most groups to support continued growth and we continued to ramp investment in the various clinical trials and studies designed to demonstrate the value of our emerging and existing technologies.

Sales, marketing, and administrative expense for Q2 2010, excluding stock based compensation and intellectual property, litigation expenses, and acquisition related items totaled $69.8 million. Excluding the adjustments mentioned, SM&A expense as a percent of revenue was 58.3% versus 60.4% in Q2 2009 and 62.1% last quarter. The year-over-year decrease in SM&A as a percent of sales shows some of the leverage and productivity progress that we have guided to as we continue to ramp the top line. In total, the more variable components of SM&A expense like freight, commissions, and loaned instrument set depreciation grew reasonably consistent relative to the corresponding growth in revenue.

In addition to the variable components on a year-over-year basis, we invested significantly in continued International expansion and in adding share owners and infrastructure to support growing volume with the heaviest weighting of this head count growth coming on the sales and International sides. We also incurred higher expenses on the legal and litigation front due to recently announced lawsuit to protect our Osteocel intellectual property and other ongoing items, partially offset by the full collection of a significant International receivable in the quarter which had been previously reserved for.

Stock based compensation expense for the second quarter totaling $7.5 million was recorded in our operating expenses and compares to $6.3 million recognized in Q2 2009 and $6.4 million in Q1 2010. Sales, marketing and administrative expense includes $6.7 million of stock based compensation with the balance in research and development expense. Other expense for the quarter was about $1.5 million verse $1.6 million last year and $1.4 million last quarter.

Cash provided by operating activities came in at $16.3 million for the quarter furthering a positive cash flow start to 2010. Our cash and investments balance at the end of the second quarter was just over $213.2 million, up from the comparable 2009 year-old balance of $204.7 million. Our primary investment focus for cash balances will continue to be safety of principal. As a result, the majority of our invested cash is in securities of US government sponsored entities.

At the end of Q2 2010 our inventory position was 19.5% of annualized second quarter revenue. Down from 20.8% last quarter reflecting continued progress on this important metric. As we have communicated in the past, we are focused on the long term trend line here instead of on any given quarter's fluctuation and it is possible that the ratio will rise on occasion, particularly in conjunction with new product launches. Days sales outstanding, or DSOs, when run off of our net ARO balance was 51 days in the quarter which is flat with the results at the end of Q1 2010. We continue to work on improving our operational systems through investments in logistics, distribution, and related reporting functionality. Now I will turn to guidance for the full year 2010.

We have raised the low end of our revenue guidance to $485 million with the high end still at $500 million. As I mentioned in the last earnings call, regardless of where we fall within the revenue guidance range for 2010, we expect to manage the business to a full year non-GAAP operating margin of approximately 17%, expanding to approximately 20% as we exit the year. As a reminder, second quarter non-GAAP operating margin was 15.8%, versus 11.3% last quarter. Non-GAAP operating margin guidance excludes intellectual property litigation expenses, acquisition related items, stock based compensation, and amortization of intangible assets.

For 2010 we anticipate GAAP EPS of $1.77 to $1.91 and non-GAAP EPS of $1.50 to $1.64. Approximately $0.02 of our EPS guidance increase is attributable to the higher revenue guidance and the balance is due to the new lower effective tax rate guidance. Non-GAAP EPS guidance correlates to non-GAAP operating margin and excludes intellectual property litigation expenses, acquisition related items, stock based compensation, amortization of intangible assets and the estimated $47 million one time reversal of the remaining valuation allowance, which we still currently expect to impact Q4 2010 and the full year. We feel this non-GAAP EPS measure most accurately portrays the operating earnings power of NuVasive and should be the basis of measuring our progress. Please refer to the tables in today's press release for a reconciliation of the non-GAAP to GAAP EPS guidance.

Relative to our non-GAAP expectations regarding the P&L, we expect full year gross margin to approximate our Q2 results at roughly 82.5%. Research and development expense, excluding stock based comp and acquisition related items should now approximate 8.5% of revenue for the full year based on the associated spending patterns related to the prioritization of our motion preservation platform. We remain committed to advancing our product portfolio and further arming our sales force.

Sales marketing and administrative expense, excluding stock based compensation, intellectual property litigation expenses and acquisition related items will approximate 56% to 58% of revenue for the full year. Improving over the course of the year as higher revenue levels continue to enable further cost leverage. For the full year, we continue to expect the intellectual property litigation expenses related to the Medtronic dispute to approximate $5 million and the amortization of intangible assets to approximate $6 million. Both spread roughly evenly throughout the year. Other expense will approximate $5 million and will also be consistently spread throughout the year.

We expect stock based compensation of approximately $30 million in 2010, which will be spread roughly 85% towards sales, marketing, and administrative expense with the remainder landing in R&D. Finally, at present, we are lowering our full year effective tax rate guidance from 35% to 15%. The decrease in guidance is the result of improved visibility and active work to affirmatively secure utilization of some tax attributes from the CerviTech acquisition. As we close the books on my third quarter at NuVasive, I look forward to participating in NuVasive's march towards $1 billion in revenue with increasing profitability. Now I'll turn the call back over to Alex for closing comments.

Thank you, Michael. Our Q2 results clearly demonstrate our continued ability to translate revenue into improved profitability. Spring boarding from 25 consecutive public quarters of meeting or exceeding expectations, we are focused on being the most creative spine technology company in the world and achieving outstanding results through speed of innovation, absolute responsiveness and superior clinical outcomes. Our strategy will continue to differentiate NuVasive and drive market expansion of the robust minimally disruptive market.

Over the next several years we are convinced that the standard of spine surgery will shift toward minimally disruptive approaches. Currently this $1.5 billion market will grow at 20% to 25% to over $4 billion in the next five years and to over $10 billion in 10 years. Our MAS platform, biologics, and forth coming motion preservation offerings comprise 90% of NuVasive's product portfolio and position us to fully leverage these opportunities. We expect to achieve outstanding revenue growth, increasing profitability and cash generation as we drive the minimally disruptive market from 20% to 80% of the global spine market over the next decade. As we like to say at NUVA, onward and upward. We will now take your questions.

Thank you. We'll now be conducting a question and answer session. (Operator Instructions) One moment please while we poll for questions. Our first question comes Joanne Wuensch BMO Capital Markets.

Thank you very much for taking my question. It's interesting as I've talked to investors throughout the last couple of weeks, their level of concern towards your market and your ability to deliver revenue, not just this year, but going into next year is so high and you see that in your stock price. And I look at the quarter you just delivered and the guidance that you gave in 2010. I have two questions, one, can you comment on 2011? And two, where do you see the difference between the walls of worry that Wall Street has going on and what you see down at home base?

As far as next year is concerned, as I mentioned in my remarks, we see growth opportunities of 25% to 30% for the top line. What I tried to do on today's call was to really explain our growth prospects as they relate to the minimally disruptive arena of the spine market. And I think that's exactly what is taking place. There are legacy products and companies that have been out there for a long period of time. And they're under pressure now to do something with their portfolios to move towards either lateral solutions or other percutaneous opportunities, and they're having a hard time with that overall conversion. Our entire portfolio is based off of the products that I mentioned. We're very bullish on the opportunities that face us. And as you know, what really helps us dramatically is an output of products at a very fast pace, which effects mix.

I think we see the market growing at a fast clip. The same we see for non-GAAP operating margin as we go to next year. We anticipate that being around 22%. We further will drive profitability into 2011. We're sitting here feeling very bullish. And I might add, at the start of last year or even the prior year, end of 2008, I think there was a lot of clouds over the spine arena in terms of where was it going to go in terms of the economic downturn. And at that time we said that we were going to grow at a very fast pace regardless of what took place and that's exactly what we did last year. And this year we see much of the same. And again, because our portfolio is so different and what we're doing is so different from everyone else.

Just to be clear, you're not experiencing the mid single digit price pressures that some of your competitors are? Thanks.

That's correct. So what we're seeing is that happens in the legacy area, but it's not happening in other areas where, again, because we drive out 10 products per year where we have very favorable mix. That's the main reason.

Thanks.

You're welcome.

Thank you. Our next question comes from Mike Weinstein from JPMorgan Chase.

Thanks. I'll start just by taking issue with one of your statements earlier on in your prepared remarks. I think you said that NuVasive is growing at four times the market rate and this quarter NuVasive was growing at 35 times the market rate. And.

I stand corrected.

And I think that's the crux of people's concerns. We've seen this very significant deceleration of the spine market mostly driven by price and the underlying question for people is how can NuVasive continue to sustain such out performance relative to its underlying market and at some point doesn't this price pressure on the base spine market and some of that you could argue is being created by -- not updated companies like NuVasive and how does NuVasive sustain such growth in the face of that market. And I know we're hearing a response that the minimally invasive segment going from 20 to 80 and you're obviously the company that's driving that. Any more color you want to provide in terms of where this pricing is really showing up in the marketplace and your ability to grow it in the face of that.

Well, the whole 80/20 shift that I talked about is taking place in part because of cannibalization, mostly because of cannibalization of the legacy products that are out there. And I think that's what you're not hearing from others that are talking about the spine market is what's actually taking place in the field. If you take a look at what's happening on price, it's the same thing I just mentioned to Joanne. It's no different. We do see some downward pressure with regard to legacy products and that's been the case now for several years. That's really not new news. But the up side for us is coming from XLIF and from related procedures and the same thing we expect will happen with motion preservation.

Can you -- well, I appreciate that. Can you give us your view on the FDA's receptivity to new products right now in spine. It's been awhile since we've seen PMA type devices make their way through the agency. If you have any view on that, that would be appreciated.

Sure. We had our 100 day meeting with FDA for PCM. That went favorably well. We're still waiting to get some clear direction as to what that will mean for 2011. We still hope that we can commercialize or have approval of our PMA by some point in 2011. What we've seen so far is that overall on the five 10-K side, things are taking longer. There are probably more questions than there had been in prior submissions. On the PMA side, so far we're seeing it's moving along pretty well. We've certainly spent a lot of time crossing the T's and dotting the I's to make sure that the submission was extremely thorough. At this point, we're not seeing any huge delays or kind of signaling that concerns us from FDA on the PMA front.

Okay. I'll let others jump in.

Thank you.

Our next question comes from Bob Hopkins from Banc of America.

Can you hear me okay?

Yes.

Okay, great. Thanks, Alex. A couple things, curious, talking about two different spine markets here. What percentage of your growth would you say come from the minimally invasive versus the traditional market?

So it's in the 80% range of MAS. 80% is about MAS. And then we have cervical and I think I'm getting some re-verve from your speaker. And we have cervical and then we have the OUS piece. So generally it's about 80%. It could be even as high as 90% depending on how we count biologics.

And I apologize if it's a bad reception here. I just wanted to be clear on your other comments. You're saying that there's really no change to your 2011 guidance and you still consider the global overall spine market to be high single digit market?

Yes. Approximately 8% growth overall, which we think is procedure growth.

Just to be clear on a couple points. Some other companies have talked about some pushback from insurance companies in terms of tougher precertifications. Are you not seeing that in your business?

We hear that periodically about insurance companies being very specific about the indications for procedures. But we're not seeing pushback and there have been no rejections of XLIF this year since, I think we talked about the one or two that took place very early on.

And from a pricing perspective for the market overall, are you seeing that on the overall market you do see pricing down mid-single digit, but just in your niche where you are primary playing it's a lot less. Or is your message on pricing for the global market kind of different from what the other guys are saying, which again for most players has been down mid-single digits. I'm just wondering if you have a different view on what's going on at the overall market.

Sure. The way that we see it is that we see pricing being about, let's say minus 2%. Procedure growth being a positive, a plus 8%. And mix being a positive 2%. And that's how we arrive at 8%.

For the overall market?

You've asked as many questions as we've grown over the market. You're at 34 I think. 34 questions now, Bob.

We'll leave it at that. Thanks so much.

Thank you. Our next question comes from Matt Miksic from Piper Jaffray.

Hi, thanks for taking my questions. Alex, just to step through this with the way that you're framing the market, I just want to confirm fight that I'm looking at this the right way or hearing the right way. The 20% minimally disruptive surgery by my math I guess we're looking at about a billion dollars.

1.5 because we're counting biologics and we're counting cervical motion of about $200 million.

Right, so 1.5 all together. Approximately a billion of the core minimally disruptive, $200 million of motion and I guess whatever is left is biologics. And that biologics represents what you would characterize as the more advanced segment of that market. Could you be a little more specific?

No it's just a straight same 20%. So 20% biologics contribution and 20% is the contribution from thoracic lumbar fusions from instrumentation.

Okay that's helpful and so one thing I wasn't sure that you're still getting or comfortable talking about. But maybe any color you could provide just around how your sales force is growing in terms of heads or where you are in terms of tracking against your long term metrics in sales force productivity just to kind of get us something we can triangulate your growth here again.

Sure. We've stopped doing that simply because it was very helpful to our competitors the way we were mapping our sales force for them. So we've stopped doing that. I can just tell you that we've consistently added heads. Our average has increased past the 1.6 or so million dollars that we talked about last year on a per salesperson basis. So we're very happy with our progress towards $2 million per sales head rep. And we've simply leave it that we've got a sales force of several hundred now.

And finally --

Whoa. This is what three or four?

I thought that was a clarification and one question. Maybe a quick question on amplify. Curious to hear what your thoughts are. It looks like the panel is going ahead with a recommendation. Would love to hear how you're positioned around that product or maybe some of the data that will help you position better around the infuse and amplify portfolio.

We'll get Keith to jump in on this one.

Yes. I think there's a number of things that are interesting in that space, Matt. There's also some items out there of concern from a CMS perspective too on some of the more potent biologics. From our perspective we feel very strongly that the allograft offering that we have in having a stem cell product line offering still is going to be the best event as as far as what you're seeing the concerns out there with usage. And I think that portfolio combined with some of the new biologics that will be coming in 2011 for us will be the best of both worlds to drive forward. Especially in this less invasive space that we're talking about and how that market is growing and the critical nature biologics play with those success rates.

And the data?

The data is moving along nicely. And you're going to be seeing much more data on our entire biologic portfolio as we unwind over the next 18 months.

Thanks so much.

Thank you. Our next question comes from Rick Wise, Leerink Swann and Company.

Good afternoon, Alex. Let me start with NeuroVision. One of the questions I get most frequently these days tends to run something like are NeuroVision revenues at risk? Are they at risk because competitors are now coming either improving or cutting costs for remote monitoring? Are they at risk because of the higher cost of NeuroVision? The $1500. And there's another theory that they are sort of like training wheels, you use it for a while and you get comfortable and you don't need it, docs don't need it after that. I'm sort of confused because I would say three quarters of the docs I speak to seem to use it in high volumes all the time. Can you just update us on your thoughts? Should we be more concerned about the outlook and your competitive advantage and the price of NeuroVision?

I think that that's a very straight forward to answer. As far as the NeuroVision is concerned, it is essential to the success of XLIF and it is essential to the success of all procedures related to lateral. And I think that what we've seen our competitors doing is obviously trying to sell against it and saying it's not needed and you can use any monitoring system. And it's simply not the case. I think if you look at Dr Pimenta, for example, who helped us to develop the entire XLIF procedure, was doing lateral surgery before NeuroVision and had a complication rate that was not acceptable to him. Dr Pimenta wouldn't do a case without NeuroVision today and he is probably the most experienced surgeon in the world. I think it clearly underscores the importance of NeuroVision.

As far as price is concerned, we've discounted on price regularly for years now, tied to volume, tied to the needs of certain hospitals. So price is something that we're always willing to work with an account on and the most important thing for us is to bundle up and get NeuroVision, as well as our implants and other systems into the hospital. So that's how we approach it.

Rick, and just to finish on this point, the IP around NeuroVision is extremely strong and so, as I've mentioned before, we've had this dispute now with Medtronic for some time and NeuroVision is not a part of that. There is a very good reason why it is not a part of that, because it is the strongest IP position that we probably have of all the products that we have. And it's, again, a game changer in terms of the ability to do XLIFs safely and reproducibility. Can you do an XLIF without it? You can. You wouldn't do it on me, I can tell you that much and you probably wouldn't do it on anybody on this call because it wouldn't be safe and reproducible in the hands of all surgeons and that's a big problem.

Just bottom line, you feel like NeuroVision revenues and sort of average pricing are not any more at risk today than they've been at any time in the past?

No. It's been very consistent what we have done in that area now for years.

Second question if I could follow up. Slightly awkward to ask, but one of your larger competitors said on their earnings call that sort of implied that the larger companies are losing share to smaller companies because of the larger companies, quote compliant approach to selling in this market. I hardly know what the question is. But what do you think their saying? Is there anything to be worried about? You've explained this in the past and talked about it. I just felt like it would be good to hear your answer.

They obviously think we're a very large company. We're number four in the US so I guess we are. We passed Stryker in the United States now and are number five globally. I have addressed this many times before and we are extremely compliant and have ensured that we have everything in order. As I've also talked about, if you take a look at the percentage that goes out in royalty and on consulting costs and so on and so forth, the number is very low. It is the order of about 3%. We're very comfortable with where we are and we're very comfortable with how we've handled everything related to that area for years. And we've spent a lot of money ensuring that we've learned from those around us and watched what they've had to do with regard to compliance. And that we have the same, if not better systems.

Thank you so much.

Our next question comes from Ben Andrew from William Blair and Company.

Good afternoon. Thanks for taking the questions.

You can have two and a half because it wouldn't be fair otherwise.

I'll stop the third question halfway through. How about that?

Please. That would be perfect.

Keith, maybe a question for you, but if you look at newly launched lateral products out there and we hear a lot of chatter about that. Can you give us some sense of your market share for a given surgeon and how your growth is broken down between new surgeons that you continue to train and existing guys. What's going on with same store growth effectively? And I'll try to think of a half a question follow up.

We look at it a little bit differently, Ben. I think the key to think about is how long we've been pursuing the XLIF platform and obviously a lot of surgeons started off just understanding and learning and coming to the lab to understand the degenerative opportunity. And that has advanced over the years to now creating many different pathologies that are being treated. A lot of them now in deformity going up into thoracic for the trauma opportunity and trauma and tumor opportunities.

So the point is when you take a look at the competitive landscape, the competitive landscape is talking to surgeons about what we were doing four or five years ago. And they're talking to them about just trying to have an implant to address the degenerative market and they really have no solution that climbs up the spine of the thoracic region and talks about the more advanced techniques. I think that -- we're looking at it in a much different perspective. Our perspective is how do we make sure this is part of the surgeons practice and that they are taking it deeper into the practice for greater and greater solutions for less invasive surgery. And that's the focus.

The focus is driving deeper and helping more patients with really complicated pathologies. And you get into thoracic spine and you avoid what they call a big shark bite procedure and you now do it in a less invasive way between the ribs, and still give the patient the same kind of stability up their spine, but they get out of the hospital in a couple of days instead of weeks. You're now talking about completely changing, not only the surgeon's practice, but really changing the way a patient looks at spine surgery. And that plays very well into how we're getting patients back with surgeons and the better way back so to speak.

I guess my follow-up question is if you think about your market share within lateral lumbar, is that tracking your expectations? Is it approximating your overall growth, or can you give us some insights there?

It is. It's on track and I think we obviously feel that we have the lion's share of that $1.5 billion in terms of the excellent component of it.

Thank you.

Thank you. Our next question comes from Michael Matson from Wells Fargo Securities.

Hi. I guess my first question is just wondering if you could give us a percent of your sales that were from biologics and then from outside the US?

The biologics overall, we're not giving out that number dollar wise. But the biologics overall were well over 10%.

And OUS percentage?

Roughly five on OUS.

And I guess just on the Progentix product that you're going to be launching next year, I know several of your other biologics projects have lower gross margins, but will that be the case with Progentix or will it have higher margin -- I guess where is it at relative to your metal hardwares?

We anticipate that it will be higher -- at least the same as the corporate average, potentially higher.

All right. Thanks.

You're welcome.

Thank you. Our next question comes from Vivian Cervantes from Maxim Group.

Thanks for taking the question. Wanted to drill down a little bit on your comments about gaining market share, particularly given the flow of new lateral devices out there. How does your sales force deal with the multiple players that are coming in, particularly when it comes to having conversations with surgeons and hospitals? How do you position yourself versus what the competitive lateral devices are?

I think Keith covered that pretty well a few minutes ago in just talking about where they are in the learning curve and where we are with actual product offering. What they're doing is really very simple and straight forward. It goes back several years to our very formative years of XLIF. As I think as we move forward with either competitive surgeons or just in general expanding, what we may clear is the huge arsenal of products that we have, and as Keith talked about, from what we can do in the thoracic spine to all the things we can do in the lumbar spine.

I will tell you that I had, not long ago, a lengthy conversation with a surgeon who was a big DLIF surgeon and he kept on chronicling to me all these things that he was hoping he could see from the DLIF side and how he'd like to apply it. We showed him all the things that we're doing and he went at great length to say he couldn't believe -- he didn't know that these things were on the market. It had been basically shielded from him. And that has subsequently changed. He just went on talking about he wished he could do a corepectomy the way it is being done now on a thoracic spine, he wished he could do a lot of other things.

I think that's the reality of where we are. We're able -- and when we go head to head and all the things that we provide in terms of SOLAS and better way back. It's an overwhelming proposition in terms of choosing NuVasive versus our competitors. And I think our sales force does that effectively.

It doesn't sound like there's heavy risk of share cannibalization from new competition with or without NeuroVision as part of the package.

I think that what's happening is that the market is expanding and that's why we chose to spend so much time talking about it today. What our competitors are doing is they are essentially giving it a heck of a lot more attention, they are giving a lot of credence to lateral. They're coming up with albeit primitive solutions to it. It is moving people into that directions, so that's helpful to us. And that allows us to come in and detail all the offerings that we have. We see the market as expanding in that area. And that's why I think it's very important to look at the market, not just grossly with all the legacy products that are there, but to look at what's actually happening inside the spine market. And I think from that you can have a very clear picture of what's happening amongst al the major players in spine.

Great. Terrific. Thank you.

Thank you. Our next question comes from Doug Schenkel from Cowen and Company.

Hi. It's [Greg O'Mide] in for Doug. Thanks for taking the questions. Just wanted to touch on gross margin briefly. You have talked about one of the growth areas for you as you've become a bigger player with a more complete bag of products. Getting into major hospitals, may have had preferred vendor lists in the past. Presumably, considering hospital environment, this may be where you're seeing pricing pressure. Can you talk about how that being a new growth area (Inaudible) and how that drags down to the gross margin, which I think you reduced slightly for the year today.

I think that if you take a look at how we're able to deal with that effectively. We do have to go in and match price in terms of any kind of legacy type products or how the hospital perceives them as legacy type products. It does not have a big drag on our gross margin per se. I think it's something you see as a very small impact. And then, of course, for us, it's all incremental business and so it allows us to participate in ways that we can drive our higher mixed products in. And so that's the key for us. We can go in with some legacy offerings and we can provide a discount in those areas as needed. And this is not different than the strategy we've employed forever in this base and allows us to maintain reasonable premium pricing on the products that only we have, and that are truly premium products.

One other support comment. We do expect the full year I think as we said to be in that range of about 82.5%. And I think the point to make, which we tried to in the earlier discussion, is that that really is reflecting a bit higher mix of International and biologics combined with the Q1 excess and obsolete number that we talked to last quarter. As we flow through all the drivers and elements of the gross margin deterioration or the gross margin adjustments, price today, price pressure, while there, is very, very small.

Okay. And quick to follow on that. You said Europe was kind of a negative pressure there. OUS, I'll call it. What is the margin of that business? I don't know if you've broken that out before. Is 5% kind of a pickup there and how are we proceeding on that front?

We've described those as being well below the average. So if your call an average low 80s give or take, both the International business overall where we're in investment mode there, certainly today, and the biologics business are running quite a bit under. It's also partial to the earlier question about the Progentix gross margin and what opportunities are there with the new synthetic, getting that gross margin back up.

And Alex with regards to OUS. Given that you have another competitor in J&J now there with the lateral. I think there's three lateral products in Europe and the difference is in the use of access surgeons over there, you have just set up the East Coast facility. Any further thoughts on acquisitions in that realm or how you're approaching entering that market?

No updates from what we've talked about before. The East Coast will facilitate training from Germany and from the UK and particular as we focus on Europe and we're really pleased with the uptick we're seeing from XLIF this year coming out of Europe. It's very, very strong. And I think the surgeons, especially the German surgeons, they really do appreciate technology like Americans do. And really enjoy the broad applicability that our systems offer. I think, again, on a head to head comparison, we always emerge favorability in that context.

Our next question comes from Raj Denhoy from Jefferies and Company.

Hi. Good afternoon. Wonder if I could ask about a specific product. The MAS TLIF product seems to be getting quite a bit of interest out there. I'm curious if you could give us some detail around the receptivity you're seeing. Are you starting to see a lot of surgeons adopting that using XLIF L45 and MAS TLIF below that. Just some thoughts around that would be helpful.

We think it's a very clever approach that our engineers came up with in terms of how it's applied. And it solves a problem which is clear exposure for the surgeons. We're very pleased with how that's going. The demand for courses has been very strong. I'm going to let Keith jump in with any other color that he might have. We are ramping it up, so it's pretty early in the process. We're very pleased with what we're seeing.

We see some of the ramp has parallels to how we got started can XLIF. I think it's important that you provide the right kind of training environment to make sure there's a full understanding of how the instrumentation is used, the philosophy behind it. There's a good peer to peer review meaning surgeons talking and training with surgeons. And what we've seen is that that is what really creates the momentum and uptake with it. As with any new technique, there is a part that has a learning curve to it and time to get used to the implants and get used to the instrumentation. And we're seeing the progress very similar to the way the progress went with XLIF training and later XLIF expansion. And we're pursuing it in that same fashion.

Overtime, do you think it has a significant possibility of increasing the revenue you could derive from multilevel cases that involve L5S1?

I think any time you have an opportunity to address certain pathologies all posteriorly and be able do them in a less invasive approach, you have a double win. Certain anatomical conditions you have to go posterior. And this offers a way to do it, but do it in a way that gets faster recovery by having less tissue trauma.

Just one broad follow-up question, it does seem like the pace of your share gains is accelerating here for a variety of reasons whether it's MAS getting more receptivity, perhaps the pricing environment is allowing more surgeons to take a look at you. Last year you gained a little less than two points of share. Do you have any thoughts to where you could exit this year, where you'll be next year and how quickly you can capture share in this market now given some of the dynamics we're seeing out there?

We think we're going to get to double digits here pretty fast. I can't speculate as to the exact numbers because finance accounting and legal won't let me.

In a sense do you think the market is getting more receptive in a sense because of these --

I do. And I think it's because of all the noise being made by our competitors. I think, as you say, places that we've been locked out of for years are now open. Hospitals are very willing to look at alternatives. And I think at the same time our sales force is much larger. We have a lot more products that we offer. The timing for us is, I think, terrific. And we're in a bit of a sweet spot in terms of the size of our Company and our ability to double over the next several years.

Maybe just on the pricing side, doesn't sound like you've had to give up too much pricing on XLIF in a sense because there simply aren't competitive products that a hospital could substitute it for. Are you seeing -- maybe you have answered this, but what level of pricing are you seeing on that, is it low single digits? No pricing on XLIF? What is the dynamic there?

It's low single digit. It's about the same as it is. As it has been rather.

That's fair enough. Thank you.

Okay.

Thank you, our next question comes from John Putnam from Capstone Investments.

Yes, thanks a lot. Alex, the last time the stock got beaten up, it was because of reimbursement. I was wondering if you could give us any kind of an update with respect to any of the insurance companies that have changed their status of XLIF.

I don't think anything has changed since our last update. So it's still the same group that took us off of their sites and the same couple still have us on their sites. We think that we're going to come off now just in their normal cycle as they review things. Most of them were on an annual cycle, whether it be year end or whatever fiscal year that they're on. We think that's what is going to happen next. There have been literally zero rejections over the course of this year outside of, I think in January we talked about one or two that were delayed and ultimately got done. So we don't -- it's certainly not an issue for us at all.

So it was a tempest in a teapot then?

Yes.

My other question is, I wonder if you might talk about the uptake in adult scoliosis and how that's going.

That's really just being used by more of the advanced surgeons, so it's going very well. Armada is very successful. We're doing more and more things with thoracic XLIF. It's also something that we're not trying to roll out to the masses. It has to be done in the hands of very experienced scoliosis and XLIF surgeons. So that's a fairly small group. We never anticipated that this would be very broadly applied. But it does solve some difficult indications. And it really provides some terrific alternatives for the patients, as well as the surgeons.

Thanks, thanks a lot.

You're welcome. We're just going to take a couple more questions.

Our next question comes from Glenn Novarro from RBC Capital Markets.

Keith or Alex, we've discussed a little bit about the new competition coming into the marketplace. Specifically, J&J, most of us on the call were at a big J&J meeting about six or eight weeks ago where they talked about the cougar system. There were no pictures, there was no demos. I'm wondering, Keith or Alex, have you actually seen this system out there? Just thoughts -- any thoughts if you have on this new system from J&J is one? And then from Mike you said gross -- you said R&D was going down to 8.5. I think 9% was where you were last call. Any commentary about the R&D ratio. Thanks.

On the first one, we've had really good intel and we've talked to a couple surgeons who have been part of the process. And I think if you want to categorize it from a -- they're level of how they're getting there from a retraction perspective, but there's really nothing different than what we've been talking about for the past five years on graft. And I think that's a critical thing to talk about. What they're doing is really just duplicating a large graft into the inner body space and doing it from a lateral perspective. They're not looking at the fact that there's different shapes and sizes because you're addressing a particular pathology a very specific way. And the reality is a lot of a you are cases are multilevel. And so different shapes and sizes, not configurations, are used at those different levels because of the a real need and a real strategy. And that's where those systems lack.

And of course the other thing that we've seen caution in the marketplace already with that particular system is they're really driving the surgeon to find a neurophysiologist that will help them on the case, which is quite different than a true neurophysiologic system that ensures safety and ensures reproducibility. I would view that particular system in specific as being one that has not really taken advantage of the safety and reproducibility that you can tie into an XLIF style approach.

Glenn, on the R&D side you did see the 8.5%. You can see that essentially trades off a little bit with the gross margin and the overall financial model. And that really, for us, is just about actively managing all the moving parts. For specifics on the piece -- and I think we talked about it a little bit -- that really is related to re-prioritization of some of the spending patterns associated with the motion preservation platforms, and I think Alex talked about that. PCM device as the top priority, XLTDR number two and neo disc third.

Thanks, guys.

You bet. One last couple of questions here.

Our last question comes from Sameer Harish from Needham & Company.

Hi, under the wire.

Yes. Just made it.

Wondering if you could talk a little bit about physician productivity. I know you kind of gave a little bit of clarity and don't want to talk too much in terms of the revenues per rep. Maybe if you could just talk about the top tier docs, we kind of assume there's a 20% or 15% of doctors at the tier at the top. Where are they in terms of utilization? Are they still continuing to grow? Is there more training that they can continue to do? And how do you sort of translate the successes you have there into the bigger middle group of docs that are still just getting around?

As far as productivity is concerned, I think we see a surgeon over the course of a fairly long period of time. Clearly a couple of years, kind of moving up in terms of their sophistication and the things they tend to do. As I said in my prior remarks, we really want to make sure that the very advanced applications are done by a small group of surgeons. And I think what we've seen is that because there are some very well known surgeons now that are applying XLIF in the thoracic spine and other areas, I think it's made others take note of the kinds of successes that they're seeing. It does have a big impact on the surgeons in the middle. What we see is surgeons start off with relatively narrow indications and then they eventually start to spread out. And I think that happens through various forums and publications driven by SOLAS, driven by the surgeons on their own, it's hard for us to quantify that into numbers. It's not quite that straight forward.

But as we've talked about before in the past, 25% of the surgeons coming in here were coming in for a second or third time. And it's changed now to about 50% coming in for additional training. 50% is new and 50% is coming in for additional training. And our intention, especially with the New York office and having both east coast and west coast is to have as many touches as we possibly can with the surgeons on an ongoing basis where they are exposed to all the newest technologies on an ongoing basis.

As a follow up, do you view the SOLAS society group of physicians as the target next year to get to the active advanced applications?

Yes, and that group has grown dramatically. That group will be -- it's expected to be about 500 surgeons at the end of this year. So that's what is really driving the advanced applications.

Great. And anything anecdotally you can add in terms of the new facility, types of procedures that are being trained there or anything to add?

We've started with the sales force and we'll begin advanced training next month. So we will be doing a variety of different things. Mostly for the east coast based docs, one of the things that will be focused on is XLIF corepectomy and making sure they are comfortable with that. We will be doing MAS TLIF as well and offering some of those things. We'll keep going up the ladder of different applications for them to try.

Thank you.

Thank you. I guess that concludes it for today. We'll talk to everybody next quarter. Thanks for your time. Bye, bye.

Thank you. This does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation.