NuVasive Inc (NUVA) 2010 Q3 法說會逐字稿

Greetings and welcome to the NuVasive Incorporated third 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, Mr. Patrick Williams, Vice President of Finance and Investor Relations for NuVasive. Thank you, Mr. Williams, you may begin.

Thank you, operator. Welcome to NuVasive's third 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 section, so that we can accommodate the large number of requests, and keep the conference call to a manageable time. With that, I would like to turn the call over to Alex.

Third quarter 2010 was challenging for the spine industry. Our results speak volumes to our continued execution of our strategy to take market share and improve profitability. They also indicate that the difficult conditions pressuring the spine market have negatively impacted our growth and visibility. Highlights of the third quarter included revenue growth of 27% year-over-year to over $120 million, an achievement of non-GAAP earnings per share of $0.46. We also demonstrated significant progress on our profitability, reporting a non-GAAP operating margin of approximately 17% in the quarter.

So let me begin by addressing what happened during the quarter. As many of you know midway through September, we hosted an Analyst Day, and embarked on several trips to meet with investors. During the planning process for these meetings, competitive commentary and results suggested to us that the spine market growth had slowed considerably from the high single-digit rate we observed during early 2010, to the low single-digit rate that materialized in the second quarter.

We turned to our weekly surveys of visiting spine surgeons, and studied what our own sales force was experiencing in the field, and chose to adjust expectations for 2011 lower, while we took time to evaluate the disparity between the challenges that our peers were experiencing, and the generally healthy outcomes that our own internal analysis continued to support. As the curtain closed on our third quarter, however, it became apparent that achieving the revenue guidance that we issued mid-September which at that time we believed was reasonable, was actually a challenge.

So while we were able to generate impressive growth and revenue results within the range we provided late in the quarter, we were surprised by how the last week unfolded. Surgery cancellations lead to lower than expected results. We believe spine market growth has slowed considerably from a positive high single-digit rate earlier in the year, to a negative low single-digit to flat pace at present. Thanks to positive mix, we continued to mitigate the well-documented pressure on pricing, which is responsible for at least 2% to 3% negative impact on industry growth.

The more predominant factor in the decline in industry growth and the one that admittedly took us by surprise is the market deceleration in procedural volumes which appears to be impacting legacy and MIS spine market growth. According to conversations with surgeons and our sales force, the major driver of that deceleration is heightened push back from insurers.

Specifically insurers have done two things, first they have increased the criteria necessary to preauthorize lumbar spine fusion surgery, and second, they have increased the level of scrutiny for preauthorization. The increased criteria leads insurers to deny coverage for fusion surgery if patients present without meeting each condition in the list of stringent requirements, including such things as instability, neural compression or stenosis, and radicular leg pain.

Each of these conditions must now be well documented, and the patient must also typically fail at least three months of conservative care. Chronic patients undergo conservative treatment modalities for much longer than three months, yet rarely does a fusion patient meet all of these requirements. In fact prior to being the recipient of an XLIF procedure myself two years ago, following five years of chronic pain, I was suffering severe leg and back pain, and was unable to stand for longer than five minutes, yet I would not have met all of the new requirements for fusion, since I had some but little instability.

Most of the heightened guidelines relate to eliminating degenerative disc disease indications, however, with the stringent criteria, insurance companies are making the most of the opportunity, by putting more resources behind the review of the preauthorization process. In many cases this results in patients who meet the criteria being denied coverage, because the doctor's offices are unaccustomed to the higher scrutiny. For example, many doctor's offices are not in the habit of sending X-rays to document instability since it has never been previously mandated.

Today the insurance companies will use the resulting long-standing lapses in paperwork to deny coverage. Sometimes resubmission is straightforward, but many times it can take months, and the patients are often responsible for driving the process. The result of the payers' behavior has been confusion and uncertainty in the marketplace, creating a significant overcorrection. Patients are still suffering from back pain, and fusion is still the clinically proven remedy as was shown in the sport trial, and in scores of peer-reviewed articles.

As you know, spine surgery tied to pain and pathologic compromise is not elective in nature, and fusions simply cannot be postponed indefinitely, so we are hopeful that the impact of this increased back and forth between surgeons and insurers will be transitory.

That said our check suggests that roughly 10% to 20% of procedures are being canceled outright, when degenerative disc disease is an indication. This has a carryover effect on all fusions. As a result, our visibility is very limited right now, and we cannot be sure when procedural growth will return to the industry. Insurer behavior is the predominant dynamic impacting our growth. However, to a much lesser extent, we believe our volumes may be temporarily impacted by surgeon trialing of the host of new lateral products, which add to the confusion.

We are truly at the tipping point of the shift from open to minimally disruptive spine surgery, and we are optimistic that expanded offerings in the category will only help to validate the market. We look forward to the comparison that our several-year head start will afford, because our MAS platform is truly differentiated. There is simply no substitute for the safety and reproducibility that NeuroVision, our patent protected, fully integrated neuromonitoring capability makes possible.

It is the only surgeon directed neuromonitoring solution that applies stimulation in a patented automated non-linear fashion that provides real-time feedback and allows spine surgeons to direct instrumentation as they access the spine, and to make adjustments as necessary to avoid neural injury throughout the surgical procedure.

As well, NeuroVision M5 offers 5 different modalities, which makes it capable of monitoring the entire spinal cord and improving outcomes not only in the lumbar spine, but also in the thoracic and cervical spines. Many of the new lateral market entrants have incorporated the use of third-party monitoring in their first generation solutions, a feature that is unlikely to compare favorably to the time-tested safety profile and predictability that the XLIF procedure has achieved. Ultimately it will be superior outcomes and reproducibility, not novelty or inferior imitations that drive surgeons to truly adopt MIS technology.

So to summarize, primarily push back from insurers to surgeons is having a temporary impact on our volume growth and visibility. These dynamics led to lower than expected revenue in the third quarter, and continue to challenge growth in the current quarter. As a result, we now expect full year 2010 revenue in the $470 million to $475 million range, down from the $485 million to $495 million range we expected previously.

Lower volumes, coupled with strategic investments into the growth drivers of our business, will also result in lower than previously expected profitability. We now expect to manage the business to a full-year operating margin of approximately 15.5%, down from 17% previously, but still showing nearly 300 basis points of improvement from last year.

Looking to 2011, the market is exceptionally unpredictable right now, and our 2011 expectations are 10% to 20% growth, which assumes that US volume growth is in the process of bottoming. We have good visibility to growing our business at a baseline of 10%, largely attributable to the more predictable growth of our biologics, cervical and international revenue. Upside to 10% growth will come from our US lumbar product platforms as the market re-stabilizes. This impact on revenue growth will likely require us to revisit our prior operating margin commitment of 20%. We will provide detailed revenue and earnings guidance for 2011 when we report our fourth quarter in February.

This is a difficult time for NuVasive and the entire spine industry. But we view the current conditions as an opportunity to advance our position in the market, expand our technological leadership, and garner more surgeon respect. We plan to lead the charge to improve coverage of spinal fusion, through data from our extensive pipeline of clinical trials, as well as by marshalling the surgeon community to rally behind their patients, and fight for coverage of spinal fusion and better patient care.

Sadly there is a lack of industry leadership in the spine market right now, but we will gladly fill that void going forward. We are addressing insurer push back head-on, much like we successfully did when XLIF was deemed by some payers as experimental. It is our belief that the stringent list of requirements being demanded for fusion procedures is ill informed. We are at the beginning stages of driving an advocacy effort that will better educate the payer and surgeon communities, to the essential nature and improved outcomes made possible with fusion procedures, as well as to the proper preparation of documentation to obtain preauthorization.

In the meantime we will aggressively pursue our growth and product differentiation strategies, to drive continued market share gains. We firmly believe that being absolutely responsive to customers, and spearheading the innovation that consistently improves our technology and patient outcomes will lead to greater adoption, payer engagement, and above-market growth.

Fundamental to our long-term share-taking strategy is improving spine care through innovation, and nowhere is NuVasive's speed of innovation more apparent than at NASS each year. The NUVA booth at NASS a few weeks ago was no exception, our ability to expand XLIF into new applications and to continually improve upon existing solutions, drew more surgeon interest and excitement than any other booth at the conference, and our momentum coming out of NASS is very strong.

We showcased unique solutions for deformity, TLIF, tumor, and trauma, laminoplasty, and for the thoracic spine, all of which are just beginning to build traction with surgeons. We launched several new products including the Helix, our cervical plate, and specialized instruments that integrate the delivery of implants and biologics in our less disruptive procedures. We continued to stay years ahead of the competition by introducing four additional XLIF implants and instruments, to address various advanced applications. We also added upgrades to our NeuroVision software platform.

Looking to 2011, we are on track to launch multiple new products and product line extensions, and though dependent on timelines at the FDA, we continue to look forward to the potential commercialization of the PCM motion preservation device for the cervical spine, and of our synthetic biologic, Progentix.

Our mission to promote superior clinical outcomes was also palpable at NASS this year, where clinical evidence in support of our solutions was widespread. NuVasive solutions for the lumbar, thoracic, and cervical spine were the subject of ten podium presentations, three oral posters, and three E-posters. The ten podium presentations at this year's NASS compares to only two last year, and none the year prior, demonstrating the massive effort our clinical team and the surgeon community has made in building the body of evidence for our solutions; presentations highlighting the breadth of pathologies that our solutions address with increasing emphasis on long-term data.

A highlight was a peer-reviewed published XLIF study showing a nearly 10% hospital cost reduction using minimally disruptive spine surgery, compared to open surgery in the perioperative period. As well, NuVasive was a major topic of conversation in a first-ever four-hour pre-NASS session dedicated entirely to minimal access to the lumbar spine, as well as a symposium titled, Minimally Invasive Spine Surgery, Simple to Complex applications, which focused on both new and existing MIS techniques. Our product offering backed by clinical data has positioned NuVasive as the market leader in the high-growth segment of less invasive spine surgery.

Absolute responsiveness is another key element of our competitive advantage, and we took major strides in enhancing our ability to serve customers with the opening of NUVA East this summer, NUVA East will serve as the face of NuVasive for our East Coast and internationally based surgeon customers, and will enable us to recreate our best-in-class personalized training experience, and to offer unmatched clinical training opportunities, as we drive deeper penetration in newer markets.

Since NUVA East opened a few months ago, regional excitement has been building, and demand for training has been excellent. In fact the facility is currently fully booked through 2010, and to date, over 40 surgeons have already been trained at NUVA East.

The majority of surgeons being trained at NUVA East are participating in NUVA training for the second or third time in advanced training courses that will enable them to address new pathologies, perform new techniques, or treat additional levels of the spine with our technology. We also enhanced the clinical education experience by responding to surgeon requests for a one-on-one cadaver experience in all of our training sessions. We are currently adding more resources to NUVA East to train both new and returning surgeons this year and next.

Our sales force is also central to our ability to be absolutely responsive, and we continue to strategically invest to expand NuVasive's presence in both new and existing markets. During the quarter we wrapped up a new initiative to recertify our sales force, and increase their clinical expertise. The XLIF recertification program is designed to advance the clinical proficiency of each of our representatives, and so they are heads and shoulders above the competitors. As we work toward the achievement of $1 billion in revenues, we expect to grow toward roughly 500 quota-carrying representatives, producing $2 million in average annualized sales.

Our efforts in the US to take market share at cheetah speed are being mirrored overseas, where we continue to expand our international organization. We are very pleased with our progress this year, and our performance in Europe, the Far East, Australia, Latin America, and Singapore has been excellent, and has exceeded expectations. We look forward to laying the ground work to enter Japan and China in 2011, and we are on track to execute to a long-term goal of generating at least 10% of total revenue outside of the United States.

Before I turn the call over to Michael, I would like to offer a brief update on IP litigation. We take immense pride in our unique technology, and the intellectual product rights that protect it. You can expect that we will aggressively use all offensive and defensive measures available to preserve the investments we have made to become the most creative spine technology company in the world.

A few weeks ago, we initiated a patent infringement lawsuit against Globus Medical, which contends that Globus Medical's, whatever it is --LLIF lateral fusion offering infringes NuVasive's XLIF intellectual property.

We also initiated a dispute against Orthofix earlier in the year, in defense of patents acquired in the Osteocel transaction. Both suits are in the very early stages of litigation, so I have little else to report.

This week, however, we received word of an unfavorable verdict delivered against us, for use of the NeuroVision name, which awarded damages to the plaintiff of $60 million. We plan to immediately appeal the decision, as we believe strongly that we are the proper owners of the NeuroVision name. We, accompanied by outside counsel, are confident that this will be resolved through the appellate process, so accounting practice does not require us to report any accruals related to the verdict. It is important to note that the matter solely relates to the brand name NeuroVision and has no bearing on our proprietary technology, or product platform, or our ability to drive revenue. We will provide updates as the appellate process progresses.

Regarding the Medtronic dispute, we continue to expect $5 million in IP litigation expense in 2010, and year-to-date we have spent approximately $3.6 million. We continue to assert that we will not seek a settlement with Medtronic, and the trial has now been scheduled for mid-year 2011. We will 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, or meeting with customers.

With that I will turn the call over to Michael.

Thanks, Alex. Good afternoon, everyone. Our revenue for the third quarter 2010 was $120.3 million. That represents a 27% increase over Q3 2009, and a nominal increase over Q2 2010. The strong year-over-year revenue growth demonstrates our continued ability to take market share, and outgrow the overall spine market. Our Q3 2010 GAAP net income was $8.5 million, or earnings per share of $0.21.

Excluding intellectual property litigation costs, acquisition-related items, stock-based compensation, and amortization of intangible assets, our third quarter non-GAAP earnings were approximately $18.4 million, or $0.46 per share.

Gross margin in the third quarter was 82.1%, compared to 83.3% in Q3 2009, and 82.4% in Q2 2010. Year-over-year gross margin was primarily impacted by increased contribution from our lower margin biologics and international businesses. Operating expenses in aggregate for Q3 2010 totaled $89.1 million, compared to $73 million in Q3 2009, and $90.3 million in Q2 2010.

Research and development expenses, excluding stock-based compensation and acquisition-related items, totaled $9 million for Q3 2010. This expense was 7.5% of revenue for Q3 2010, versus 9.5% in Q3 2009, and 8.3% in Q2 2010. The flat absolute expense year-over-year was driven by several moving parts, first we saw higher net spending on studies in clinical trials designed to demonstrate the value of our emerging and existing technologies. In particular, XL TDR, and we invested in headcount across most groups to support growth. Second, these increases were offset by lower consumption of R&D materials, and lower estimates for full-year variable compensation.

Sales, marketing, and administrative expense for Q3 2010, excluding stock-based compensation, intellectual property, litigation expenses, and acquisition-related items totaled $69.7 million. Excluding the adjustments mentioned, SM&A expense as a percent of revenue was 57.9%, versus 61.2% in Q3 2009, which also excluded a $2 million reversal of a lease abandonment charge, and 58.3% last quarter.

The year-over-year decrease in SM&A as a percent of revenue, shows some of the leverage and productivity progress that we have guided to, as we continue to grow our top line, and as well, shows the consideration of lower estimates for full-year variable composition. In total, the more variable components of SM&A expense, like freight, commissions, loaned instrument set depreciation, and direct sales headcount, grew roughly in line with revenue growth.

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 growth. We also encouraged significantly higher expenses on the legal and litigation front year-over-year, due to a variety of legal actions, both offensive and defensive, including the recently-announced actions taken to protect our intellectual property rights.

Third quarter non-GAAP operating margin was 16.6% versus 15.8% last quarter. Non-GAAP operating margin excludes stock-based compensation, intellectual property litigation expenses, acquisition-related items, and amortization of intangible assets. Stock-based compensation expense for the third quarter totaling $7.3 million was recorded in our operating expenses, and compares to $5.2 million recognized in Q3 2009, and $7.5 million in Q2 2009.

Sales, marketing, and administrative expense includes $6.5 million of stock-based compensation, with the balance in research and development expense. For the third quarter, intellectual property litigation expense related to the Medtronic dispute was $1.2 million recorded in SM&A. Acquisition-related items totaled $0.6 million, and was recorded approximately 60% in SM&A with the balance in R&D. Amortization of intangible assets was $1.3 million.

Other expense for the third quarter was about $1.5 million versus $1.2 million last year and $1.5 million last quarter. Cash provided by operating activities came in at approximately $18.5 million for the quarter, furthering an excellent trend in cash flow this year. Through nine months, we have generated almost $45 million from operations, up 35% from this point last year.

Our cash and investments balance at the end of the third quarter was $216.8 million, up from the 2009 year-end balance of approximately $204.7 million, and Q2's ending number of $213.2 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 Q3 2010, our inventory position was 20.5% of annualized third quarter revenue, compared to 19.5% last quarter. The increase is attributable to driving the business to support a higher revenue outcome. We are focused on long-term progress here, instead of on any given quarter's fluctuation, so it is possible that this ratio will rise on occasion as it did this quarter. We continue to work on improving our operational systems through investments and logistics, distribution, and related reporting functionality.

Days sales outstanding, or DSOs, when run off of our net AR balance was 54 days in the quarter, compared to 51 days at the end of Q2 2010. In this tight economic environment we are seeing customer attempts to stretch payments, thereby contributing to longer collection cycles, even as we work to continuously improve the productivity of our collections team.

Now I will address guidance for the full year 2010. As Alex mentioned, due to challenging spine market conditions, we now expect full-year revenue of approximately $470 million to $475 million, down from the prior expected range of $485 million to $495 million. Due to the lower revenue expectations for this year and our continued commitment to preserve investments and the key drivers of our growth, we now expect to manage the business to a full-year non-GAAP operating margin of approximately 15.5%, assuming that our Q4 non-GAAP operating margin will approximate 19% at the high end of our revenue range.

As we continue to refine our tax modeling, we now anticipate our 2010 full-year tax rate to approximate 12%, down from 15%, and the one-time reversal of the remaining valuation allowance to be in the range of $45 million. We now anticipate revised full-year GAAP EPS of $1.61 to $1.64, down from $1.77 to $1.87 previously. As well we anticipate non-GAAP EPS to approximate $1.42 to $1.45, compared to $1.50 to $1.60 previously.

Non-GAAP EPS guidance correlates to our non-GAAP operating margin guidance, and excludes stock-based compensation, intellectual property litigation expenses, acquisition-related items, amortization of intangible assets, and the revised estimated $45 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 non-GAAP to GAAP EPS guidance. Relative to our non-GAAP expectations regarding the P&L, we expect full-year gross margin to approximate 82%, down slightly from the 82.5% previously expected. The slight reduction is due primarily to product mix shift toward our lower-margin biologics and international businesses.

We now expect research and development expense, excluding stock-based composition and acquisition-related items, to approximate 8% of revenue for the full year, down from 8.5% previously, based on the associated spending patterns, related to our motion preservation platform. We remain committed to advancing our product portfolio, and further arming our sales force with clinical evidence.

Sales, marketing, and administrative expense, excluding stock-based compensation, intellectual property, litigation expenses, and acquisition-related items, will approximate 58.5% of revenue for the full year, improving in the fourth quarter as higher revenue levels enable further cost leverage.

For the full year, we now expect stock-based compensation of approximately $28 million to $29 million in 2010, slightly lower than the $30 million expected previously due to a lower assumption for stock price. Stock-based compensation will be spread roughly 85% towards sales, marketing, and administrative expense, with the remainder landing in research and development.

We continue to expect the intellectual property litigation expenses related to the Medtronic dispute to approximate $5 million. Expenses related to all other litigation including the recent NeuroVision trademark case have been contemplated in our revised estimates for guidance.

Amortization of intangible assets will approximate $6 million, and other expense will approximate $5 million for the year. Acquisition-related items have been contemplated in our guidance as they have been incurred year-to-date. As we close the books on my fourth quarter at NuVasive, I am pleased with our considerable improvement on year-to-date non-GAAP operating margin relative to 2009, and I look forward to participating in NuVasive's march toward $1 billion in revenue with increasing profitability.

Now I will turn the call back over to Alex for closing comments.

Thank you, Michael. For those of you who are familiar with the 6.5 year track record of meeting or exceeding expectations that our management team has achieved, you can understand that it is disappointing that revenue came in on the low end of our guidance. You can rest assured, however, that we always strive to exceed expectations, and we are already implementing strategies that will enable us to come out of this market downturn stronger than ever.

We are very well-positioned with our industry-leading MIS platform, supported by a large and growing body of clinical outcomes. Our biologics business continues to see more penetration, and we are in the early stages of building out a comprehensive portfolio in this market segment to challenge BMP.

Finally, we expect our international business to double year-over-year, and we stay keenly focused on opportunities to even further ramp our revenue growth in this area. In spite of this being the most challenging year that the spine market has ever seen, NuVasive will post annual revenue growth of nearly 30%, and an operating margin expansion of over 300 basis points. We have a very clear vision on how to reach $1 billion in sales, and our results continue to be testimony to our ability to grow at multiples of the spine market.

Our success is the result of a competitive advantage that is the very foundation of NuVasive, and that will be sustained through continued dedication to innovation at cheetah speed, superior clinical outcomes, and a culture of absolute responsiveness.

Over the next several years, we are convinced that the standard of spine surgery will shift toward minimally disruptive approaches, and NuVasive will be a key beneficiary as the Company at the very forefront of that shift. We expect to achieve outstanding revenue growth, increasing profitability, and cash generation, as we drive the minimally disruptive market today to 80% of the total spine market over the next decade.

As we like to say at NUVA, onward and upward. We will now take your questions.

Thank you. Ladies and gentlemen, we will now be conducting a question-and-answer session. (Operator Instructions) Our first question is coming from the line of Mr. Bob Hopkins with Bank of America. Your line is now open. You may proceed with your question.

Thanks, can you hear me okay?

Yes.

So I just want to make sure I understand the message. The message is basically that things slowed down meaningfully just in the last two weeks of the quarter, and into the early part of October?

Yes, that is correct.

Okay. And I guess my question is, what percentage of that do you think is Company-specific issues, such as you mentioned some of the competitive trialing of the new lateral fusion technologies, and the reason I asked for that percentage, or any sense you can give, is that J&J has reported their spine numbers, Stryker has reported, Synthes has reported, and they have all actually shown pretty stable results for the third quarter. So I am just kind of curious what percentage of this that you are seeing in the marketplace you think is kind of a NuVasive Company specific trialing issue, versus incremental slowdown in the market?

I think it is incremental slowdown in the market. I think it is because of canceled surgeries. I don't think the third quarter was as much because of trying out other lateral systems. We think it did certainly play into that. We don't think that was the main reason, but we just saw a lot of cancellations. We still see cancellations happening right now at a very unprecedented rate.

So the majority of the issue was not competitive trialing. You threw that out there as something that was just a bit incremental? Again, I just want to make sure I understand the core reason for the slowdown.

That is correct. And I think certainly it is out there right now and adds to the confusion. So I think it is a factor. I don't think it is the main factor.

Okay. Alex, could you also tell us what you are seeing on pricing on the margin? Has pricing gotten worse as well in your view?

Well, pricing from our perspective has been pretty much the same as we have talked about all year, so price is not a big factor, so from our perspective I think that is what I talked about on the call, it is probably somewhere between 2%, 3% or so of the downward pressure on it, but with mix we are able to offset that, so we have been able to mitigate that consistently. I think, Bob, as we talk about sort of what is happening with the competitors. The competitors, what does stable mean? It means that they are flat or negative. That is pretty much what they are reporting, is flat or negative.

Right, but you are talking about something getting worse on the margin, whereas they are talking about things staying the same and stabilizing. So I am just trying to jux those two different comments.

Right. And they are talking about performance over prior year, and we are just basically saying that it is flat. We are up 20-some odd percent over prior year. They are talking about being flat or stable over prior year. Sequentially, I'll bet you that they are down.

Well, no actually that is what I am referring to. Sequentially all of those companies are showing the same kind of growth rates in Q3 that they are showing in Q2. So that is why I am asking the question.

Yes, so ours is obviously is looking, it is basically an uptick over the prior quarter, but we are suggesting that it is going to remain flat into the fourth.

Okay. Thanks very much.

Thank you.

Thank you. Our next question is coming from the line of Mike Weinstein, JPMorgan Chase & Co. Your line is now open. You may proceed with your question.

Thank you for taking the question. First question the comment that 10% to 20% of a procedure submitted for degenerative disc disease are now being rejected; that comment is for what time period? You are seeing that in the month of September? That has been true the last few months? Give me some characterization of that.

I feel like we are seeing that more in September -- I mean we heard inklings of it coming out of the summer. We are hearing a lot more of it throughout October, and again, what I am talking about is really, specifically back pain alone without radicular symptoms. I think that is the primary issue. Our concern is that that part of the spine market may be gone right now, and we are not sure exactly when that is going to come back. We don't know what happens to those patients that have just isolated back pain. Do they go on to a discectomy, do they go on to a laminectomy, do they end up having a fusion in six months or a year? We just don't know.

We are trying to start tracking what is happening much more in the industry right now, and getting a handle on when they say that there is a cancellation or denial, what exactly does that mean? We are trying to actually run those down and find out if it is just a matter of resubmitting paperwork, or is the patient being denied outright. We have a large effort underway that we just started recently that we are trying to get to the bottom of. But that is what our suspicion is that is happening with regard to the back pain aspect of it.

Okay. And then let me just touch on the initial thoughts you gave about 2011, the 10% to 20% growth range, and it seemed like you were indicating that at 10% growth, you were assuming no growth in lumbar, is that what you were suggesting? Or were you suggesting that --?

That is right.

Okay. So your lumbar business could be flat year-over-year, and you would still grow 10%?

That is correct. And that 10% would come from half international, and the rest would be cervical and biologics. And then what we are suggesting is that we have another 10% which is upside, and that upside is tied to the market starting to reenergize.

Help me just one last question, I am still struggling with that math, given how big your lumbar business is relative to the rest of the Company, that if lumbar doesn't grow, there is enough growth in the rest of the Company to get you to 10%? Maybe just help me with that.

Sure. Well, lumbar is basically not an easy number to give you, because if you look at our business, we have got 5% coming outside of the United States, and that includes all products. If you look at MAS, MAS is roughly about 80% or so of our business, and of course, that is almost all lumbar, but then there is some crossover with biologics, biologics covers both lumbar as well as cervical. But I think if you call it basically somewhere around 80%, I think that is a reasonable round number as an estimate. But don't forget that our O-US business doubles year-over-year, is what I am suggesting and that of course would include lumbar.

Thank you. Our next question is coming from the line of Mr. Ben Andrew with William Blair. Your line is now open. You may proceed with your question.

Maybe just following up on that line of questioning in lumbar. Can you talk about what the performance is in lumbar, if you can, throughout the quarter? Did it actually go negative? Because if your growth accelerated that significantly at the end of the quarter and into October, it implies a material change in the underlying dynamic.

Lumbar obviously was performing much lower than we anticipated. If you take a look at our results quarter-over-quarter, it is not a huge sequential growth increase, so there was an increase in our overall growth, so it wasn't negative by any means going from Q2 to Q3, but it was modest.

Okay. And then Alex or maybe Keith, when do you think you might have some visibility in to the extent of the trialing, and how long that can persist, such that you would start to gain some visibility about when perhaps you could gain some of those customers back? Thank you.

I think right now, and I'll ask Keith to jump on as appropriate, but right now what we are not saying is that, we don't think that we have lost a bunch of customers. I think clearly some of our early adopters over the years have moved towards some competitive products as champions, but that is a number you can count pretty much on one hand. That in and of itself does not change the numbers, it does not affect our results per se. That has been sort of dwindling over a longer period of time.

Right now what we are saying is that if a surgeon comes out and trains with NuVasive, and is using competitive products routinely, goes back to his or her institution to the hospital, it is much more difficult for them to jump on and start doing XLIF, because now the competitor rep is saying, why don't you try our lateral stuff, and based upon that relationship there is an opportunity for them to at least delay the process of moving to XLIF, or to even hamper it. And so that is what we are seeing. We are seeing a little bit of churn taking place in the market right now, and I think it is just because of the fact that there are so many more things out there.

As I said in my remarks, I am that convinced that over time this plays out in a very favorable way, because the differences are so dramatic. Our big concern and fear is that people are going to have, surgeons are going to have inferior outcomes with other systems, and are going to have poor training because that standard is nowhere near the standard at NuVasive. So I think we play out very well in the long run, so there is some churn as I was telling Mike I believe it was, or Bob, I am not exactly sure that we can point to that and say this is why we were off in the quarter. But I think it is what we are pointing to that we think will cause us in part to have some flatness going into the fourth quarter.

Thank you. Our next question is coming from the line of Matt Miksic with Piper Jaffray. Your line is now open. You may proceed with your question.

Hi, Alex, Michael. We are all focusing here on the same issue, obviously. But there were a couple of things you said, first I want to make sure that we heard correctly. You said something like, as much as 20% of the cases were being canceled. Is that 20% of cases? Or is that 20% of the back pain, no leg pain, DDD patients?

Our estimate is that if you look at, and this is really just our best guess.

Sure.

We don't have any data to point to. So if you ask us, what do we think is the percentage right now of patients that have isolated back pain, and are receiving fusions, our guess is that number is somewhere in the 10% to 20% range. We think it could be between 15%, probably no less than 15%, but again, it is somewhere in that range.

What we are hearing consistently when we talk to surgeons is those patients are being outright denied. Absolutely that -- so I am explaining that that part of the market, because that has been there for some time, right? Whatever you want to call it, whether it is 10% or 20%. That has been there in terms of the lumbar fusions being done every year. Right now that is absolutely out of the equation. Those patients are not likely to get a fusion and what that is doing is causing a spillover effect into other fusions, and again more and more stringent indications are being sought. So that is what we were explaining.

Okay. And I guess, so now backing up to what you had talked about in September at your meeting.

Yes.

Some of the things that you, and this is very much kind of on the same issue, but you had talked about push-outs, and those push-outs being transitory, it sounds like you are still saying that today, only saying that you just don't know how much, it has become much harder to predict, you don't know how long it is going to be pushed out. But it sounded like you had your, you felt like you had your arms around the impact of this deferral and push-out and denial and delays on the part of payers in the middle of September, but then what, did it just, it was a target in motion and just got a lot worse than you expected in the back half, and continues to get worse or --?

That is correct. It has been accelerating. We have seen it accelerating in October as well. And that we just didn't expect that. And certainly didn't expect it to move so quickly. We started to see signs of it in the Northeast, more so than in other parts of the country. But now we are seeing it everywhere. It's just -- I cannot think of any particular market that is insulated from this. I think to some degree it is every single market in the US, and we just didn't see that coming to that level as it is happening now.

And again, this is coming from our own, from our sales force as they are speaking to surgeons and to their offices, so the data so to -- call it data -- is very real time, and again, we are just trying to understand what that means as I mentioned to Mike, we are putting forward an effort to get our arms around it, and to find out exactly what is happening to those patients.

So, given it is a moving target, I guess then the question naturally is the guidance that you have given for this year, the 10% to 20% for next year, I guess how -- what kind of confidence can you really have that that has captured the potential size of this if it is still in motion? I guess what have you done to try to maybe hammer that down to a worst case?

Sure, and I believe that is the worst case, and that is our assumption. Our belief is that worst case we are flat, and we don't see any kind of an uptick as we normally do, and we don't see the seasonality normally associated with the end of Q4. December is usually the strongest, not usually, it has consistently been the strongest month of the year for years in the orthopedic business, whether it is spine or otherwise.

So as we look out right now, sitting here preparing for the call and looking at our numbers and our trends, it is hard to sit here and say, December is going to be equally aggressive as it has been before in terms of volume and sales. So what I am telling you is that we believe that our, the best way to look at our business right now is the lumbar business can be flat, and it could be flat into the fourth quarter, and it would continue to be flat into next year without something changing to give it an uplift, and the other parts of our business that I have already gone through will continue to grow at a much faster pace.

And just clarification on Ben's question, and I just want to make sure I heard this correctly.

Sure.

Initially the trialing element is a factor. I think normally we would think of, okay, trialing like your users are trialing other people's products to see whether they want to switch away from NuVasive. I guess, and then I heard you describe it again, and it sounded like new prospective --

That is right.

-- folks are trying, say, DePuy's system, because the DePuy rep says, hey, before you go to San Diego for training, why don't you try ours at least. And that is what is slowing down the share gains. Which one of those two things is it?

So it would be the latter, and it is consistent with what we have talked about before, right, which is that 75% of our business comes from our current accounts. We are not seeing much of an erosion in that whatsoever. It is the 25% new that right now we are concerned about, just because of all the lateral systems that are out there, but we don't believe it is an erosion in our base business. And that is why again we have confidence in saying that if the market remains flat then we could be flat into next year, and that is predicated upon us keeping our base business, which we believe is intact.

Got it. Thanks.

You bet.

Thank you. Our next question is coming from the line of Doug Schenkel with Cowen and Company. Your line is now open. You may proceed with your question.

Hi, good afternoon.

Hey, Doug.

Alex, in your prepared remarks, as we talked about a lot in the Q&A, you talked about this increased payer scrutiny issue that intensified late in the quarter. Many of your peers had talked about this dynamic earlier in the year, any reason why you think this might have impacted you specifically so much later than some of the others in the group? It's specifically so late in the quarter. There was nothing in the way of policy changes or something really specific to NuVasive that would have driven this change for you later than others? Anything you can say on that front?

Yes, nothing specific to NuVasive. I know Keith has got a very clear opinion on this that he would like to share.

I think some of the other competitors had talked about some of this, and largely it was centered around some of the legacy products that also are part of, if you will, some of the bread and butter open fusion opportunities for the lumbar spine. And I think that what has happened is the insurance providers have now grabbed onto also less invasive and MIS approaches as well, especially the multi-level approaches.

So we have catered the product line largely for MIS to expand beyond just one level surgery and into multi-level surgery, so I think we saw the delay, and we saw the delay because I think the insurance providers also had a delay to what their strategy was for causing concern.

Now some of the good news out of this though is I think the doctor's offices, and some of the doctor's offices we have talked to as well, are better prepared now for this push back. The push back surprised them. They didn't have the right staff in place, they didn't have the right mechanisms in place for the volume, and now they do, or they are at least preparing.

So in some areas, especially the MIS areas, we are seeing some positive signs of offices that had been prepared, but I think the delay is largely just the differences amongst the product mix between our competitors, and what we do every day.

All right. That is helpful, and maybe if I could just sneak in one more and then I will get back in --

Sure, go ahead.

Back on the 14th of September, you talked about your outlook for growth for I guess classic open procedures versus MIS.

Right.

Are you -- based on what you are talking about in terms of the outlook for lateral, or the worst case for lateral in your view, is it fair to say that you are expecting that MIS growth also is going to moderate down to low single-digit levels, or do you still believe that MIS will grow materially better than classic open cases?

I think it is going to grow much faster. I am not prepared to abandon our thesis that it is still going to grow at less than 20% overall over time. What happens short-term right now is just very difficult for us to predict. I think largely that is still going to be the pace, but we have to get through this transitory period of cases being canceled and things being pushed off, and I think when we get past that, I think we are right back to 20% again.

Okay. Thanks a lot.

Sure.

Thank you. Our next question is coming from the line of Rick Wise with Leerink Swann. Your line is now open. You may proceed with your question.

Good afternoon. First, Alex, back on the insurance push back thing, if I remember correctly, I may not, that you thought that it would take two or three months to work through that.

Right.

Back at the analyst meeting. Keith was also sort of commenting on it, the doctors are better prepared. Sort of two questions. Do you think that is the right timeframe now? Wouldn't that suggest that as we start 2011 that things get, quote, a little more back to normal, and last, how do you incorporate the insurer's part of the slowdown into that 10% to 20%?

I think right now, Rick, it is very hard for us to say how long it is going to last. As we saw this in September without a rapid downturn, we thought that was a reasonable time period for doctors to regroup and to move forward, but it is going to take them time to figure out exactly what they need to do. I think a lot of them will come to the conclusion fairly soon, if a large part of their business is eroded. They are obviously going to take steps to figure out how to resolve that. It shouldn't take more than a few months, but it could. So I think for us, again, we are just concerned about getting too far out ahead.

And I think that overall if you take a look at what has been happening for us, it is not an XLIF issue, it is not specific to a particular implant, or specific to a technique. There is just an overall overcorrection that seems to be taking place right now.

So, for example, if you were to come in and say, and I think this is what Keith was alluding to, if you were to come in and say, you know what, I want to do a four-level fusion right now, the climate is such that they are going to just push back on the surgeon. It is not even an issue of improper indications. All of the indications are correct. They just say no, no, absolutely not, and put them through the ringer. Is that going to take three months or six months, I don't know.

We are very comfortable, though, with a 10% to 20% outlook for next year, again, for the reasons we talked about, which is our ability to drive the biologics business, the cervical business, and O-US, and so I think we have a lot of upside in that area, and once we start to see some clear visibility with regard to, is the back pain component totally gone, and are the surgeons starting to lessen the number of rejections? I think that is going to paint a different picture, and that should -- we expect to know that, certainly by February, and be able to provide an update at that point in time, if not earlier? Did I answer your question satisfactorily?

Yes. Sure. Coming back to again, the 2011, you talked, Alex, about the market and marketing leadership initiatives.

Yes.

Could that pressure SG&A? How do we think about just the potential for positive operating leverage, again, looking ahead to 2011? And maybe at the same time addressing that issue, talk about the environment clearly has changed in your mind. Do you step up your investment on the sales and marketing side, do you slow it down? Just again whatever color you can give us?

Sure. Overall what it means is we are going to step up our expenses in those areas. We are going to do a number of different initiatives that are underway right now, to help clarify the situation with payers, to better arm the surgeons. So it is a big educational process. So we will be doing a lot of different things.

I mentioned several on the call, for example, we are applying more resources to NUVA East, as well as in San Diego, so our overall cost of doing MVPs is rising. We are planning to do more touches with surgeons next year, so that is going to be a little bit higher than we potentially anticipated, so I think as we look at our operating margin, we think that it may come off a little bit. I don't think it is going to come off dramatically, but it may come off of what we were talking about.

So right now what we have out there is still roughly a 20% or so operating margin, which was discussed back in September. And we may need to back off of that, but we are not going to back off of that dramatically, but we may need to back off of that, and we will talk about that some more on the next call. Michael, I don't know if you want to add anything.

Yes, Alex, let me jump in for a second. Couple of thoughts on it too, Rick. Alex mentioned that there are some areas where of course in order to continue to sort of double down and drive the growth, we feel like we will have to invest more around the edges, collecting some of that data and information in the G2 and the things that Alex mentioned. But I think you can rest assured that even as that is happening, right, we are off actively driving vendor management, renegotiations where we can, to lower the expense profile.

We have got a great focus going on on asset utilization within the Company so that we use inventory in a more efficient manner, so that we can try and lower some of the expensive freight that we bear, and some of the things we have talked about before, sort of rethinking some of the old spending patterns, and questioning why have we spent that historically. All of those things we are doing, which will help, we believe start to free up cash and spend to allocate to some of these other areas.

Okay. And one last one for me on the competitive environment, we are hearing the trialing of the large companies. Can you talk a little bit more about the small guys. When I was at NASS, just talking to some of the smaller competitors, they seemed to be signaling that September was a lot stronger than August and July had been, and talked about record months. Obviously I didn't talk to everybody --

They say that every month, Rick. They say that every month because it is true. If you are only growing $100 to $200, it is true.

Okay, so not in your mind, apparently, a worrisome trend that is part of this changed guidance?

No.

Thank you very much.

You are welcome.

Thank you. Our next question is coming from the line of Raj Denhoy with Jefferies and Company. Your line is now open. You may proceed with your question.

Hi, guys. Your commentary around how the industry responds to this insurance push back issue that is taking place right now, my understanding is that one of the reasons, or the main reason insurance companies are pushing back on the 20% of cases of low back pain without radicular symptoms, is that the data to support that is just not very good, and I am curious how the industry responds in a short period of time to that push back, without the data to support it, and what could play out potentially is that maybe the just industry compresses or contracts by 20%. Is that a possibility here?

I think it is a very real possibility, and just to be clear though, we are not trying to go out there and defend back pain in and of itself. That is not our focus at all. And in fact, I think if you take a look at XLIF procedures, and most of the fusion procedures, that is obviously not what they are done for. They are done when you have the variety of indications, and so that is what we are going to do, we are going out there to make sure that this overspill that is taking place, and overflow into other fusion areas is not effecting us as well as other surgeons, that is what I am talking about. I mean if that whatever that number is, as much as 20% goes away, it goes away. That does not fundamentally change our outlook, our thesis, because we don't think we are getting, we are getting next to none of that business today.

Okay. Just that is an interesting point. I mean, and I am curious how do you track that? Are you 100% sure that no XLIF cases out there are being done for patients that after a clinician really after treating them for a number of months or even years, with this non-specific low back pain, doesn't know what else to do, so they do surgery. You hear that happens occasionally. How sure are you there are no XLIF cases being done in those situations?

I can't provide assurance to 100% because we don't know, what I can tell you though, is because of SOLAS, which is the Society for Lateral Access that is specific to XLIF, with over 430 members, there are various registries, and so we can tell from the way that the indications are spelled out from the discussions that take place at those meetings, that those surgeons are not operating on back pain. I will tell you honestly, I can't even think of a surgeon that I know that consistently simply operates on back pain. That is not a good indication. That is not to say that there aren't patients that have back pain with a lot of complexity, and they don't necessarily need a fusion. That is not our call, but what we are saying, as I tried to explain in my own surgery, I met two of the three criteria. I could tell you that my spine was a mess. And I went through five years. You know my story, I am not going to repeat it. But after going through five years of injections, I potentially would have been denied today. And that is absurd. That is part of the Milliman guidelines that surgeons will tell you they really contend with, and don't think it makes sense. But there are things right now like just telling the surgeon, show us on X-ray that there is an unstability. They don't submit X-rays for preauthorizations for instability. That is kind of a jaundiced view of whether or not you need fusion. That is not the sole indication, right? So that is really what we are trying to help ferret out as we go forward, but yes, I think it is certainly possible that a big part of the market could absolutely, when I say it disappears, if somebody has legitimate back pain, the chances of them entering the downward cascade that leads to fusion may just be postponed. It is very unlikely that they would absolutely be able to avoid it. It just may mean that now they are two years away, or five years away, or just because they have a discectomy or a laminectomy instead, or they have nothing and deal with the pain.

Very helpful. Thank you.

You bet.

Thank you. Our next question is coming from the line of Vivian Cervantes with Maxim Group. Your line is now open.

Thank you for taking my question. Given where visibility is right now, and some worries out there of death by thousand cuts. I just wanted to gauge your comfort that the 10% is indeed the bottom of the 10% to 20% guidance that, or growth outlook like you are looking into in 2011?

That is exactly what we believe, and we feel comfortable with that. So I think looking at Q4, I think the guidance that we have given for that, as well as the total on the year are numbers that we feel comfortable with. We can't predict whether or not this market could further downturn beyond our expectations, but as far as we can read it, we have spent a lot of time trying to read it, those numbers look very solid to us.

Okay. And then second question, coming out of NASS when all of those big and small players were coming up with their own lateral solutions, again and again the point that was being raised was NeuroVision and some premiums derived out of the disposables. Given where the market seems to be going, and I know you have commented even at NASS that there is a possibility for some wiggle room there, do you think the additional 10% upside from the 10% floor, will come from maybe rejiggering that strategy a little bit? And if so, what should we think of the impact to margins at that point?

No, that is already factored in, and so I don't see that as having any kind of a negative impact. That is already contemplated with regard to our NeuroVision models, and we anticipate an ongoing sort of downward pressure on the disposables. We have a three to five-year modeling process that takes that into account, so that is all there. We don't see that as either upside or downside.

Great. Thank you that is helpful.

You are welcome.

Thank you. Our next question is coming from the line of David Roman with Goldman Sachs. Your line is now open. You may proceed with your question.

Good evening everyone. Thank you for taking the question. Alex I was hoping that you could talk a little bit about what you are seeing from the smaller competitors? I think it was a few years ago that when Medtronic started to see their spine business deteriorate, they referenced smaller players as ankle biters, and at that point, you may have fit into that category. You are now at a point where your share is big enough where some of those smaller players, even if in your example, where they are going from $100 to $200 month to month, that is still coming from somebody. Are you seeing the majority of the change or at least impact in your business from larger players or smaller players?

Well, the majority of the change, when you say in terms of competition?

Yes.

What we are seeing is we are just seeing a lot of churning. We are not seeing an impact on our base business. That is what I just explained. What we are seeing is there is just a lot more churning going on out there. There is a lot of, and here is what happens.

A lot of these smaller players, they are not actually making their living on lateral solutions. They are making their living on legacy products, and that is entirely how their strategy works. So if you go through the entire list of them, without naming anybody in particular, they are doing plays on scoliosis, they are doing plays on degenerative, but these are largely all big open procedures, so they are the ones that have been taking down the share of the bigger companies that have that. On the lateral side I thought I explained it pretty well in terms of what we think is happening there.

And maybe it's --

Does that make sense? Is that clear or no?

Yes. That is clear. And I think you referenced in your commentary that the Northeast in particular was an area where you were seeing some churning?

Yes, cancellations.

Cancellations, sorry.

Yes.

From a share perspective, is that not correct, the churning, was it more predominant in the Northeast than elsewhere?

I think it started to be, it came out of the Northeast faster than we thought. Northeast is still being pretty hard hit, and now it is spreading around the country or has spread around the country.

Your two largest competitors have talked about is that while obviously you can offer a full range of product in spine, Medtronic and J&J both have been more aggressive in bundling across all of their therapeutic categories. Have you seen any push back from your customers, saying we are just buying everything from Medtronic, so we are going to try their lateral approach out now, or J&J?

No, I can't even think of, I don't think there's an account in the United States anywhere that buys all products from one vendor. And I think what has changed over the years is that a lot of the hospitals are switching from having, gosh, 20 vendors in spine now, I am just talking about spine, from 20 down to 10, and then from 10 down to 7, and from seven to five, and so on and so forth. So we have never seen anything, and I think Keith could comment about this as he handles this area directly, but we never see a situation where a hospital is reduced to anything less than three or four vendors.

Agreed, and there are a few examples even over the past quarter, that were traditionally one major supplier with a secondary supplier, that have now moved to three or four, and we have been part of that bidding process into those hospitals, so it is becoming very unusual to see only one. Mostly it is even more unusual now to see two, it is expanding now to three to four as a minimum.

And David that would also include the national account networks. It is the same thing for national account networks. There is no such thing as a one-company exclusive.

And Keith maybe a follow-up to your comments, what impact is that having on the pricing dynamic, and are you still able to get sufficient volumes to offset any type of price compression to sustain your gross margin?

Exactly. There is to participate in some of these larger accounts, there is a sacrifice that needs to be made across product lines for your legacy products, but we have also been very successful in demonstrating premiums to be put on the MIS side of the business, so it is really up to our sales force and up so us to make sure we are leveraging and getting the new surgeons that come along with those hospitals trained and excited about some new techniques and new implants.

Thank you very much.

Thank you. Our next question is coming from the line of John Putnam with Capstone Investments. Your line is now open. You may proceed with your question.

Yes, thanks very much. I was just wondering if you see anything in terms of the economy that is affecting you, as opposed to just the insurance companies pushing back. I am thinking of maybe lost healthcare insurance? And also I wonder if in the first quarter you face the challenge of deductibles being reset, and that is having a negative impact?

I think those all affect the spine industry in general. I don't think you can point to them as really having a huge impact. Yes, I think all of that is going on, just like the issue with COBRA, and everything else is having an effect overall. It is just hard to put a number of points on that when you deduct it from the market, but I think that is there.

Thanks a lot.

You bet.

Thank you. Our next question is coming from the line of Glenn Novarro with RBC Capital Markets. Your line is now open. You may proceed with your question.

Thanks. Alex, I believe you said that for 2011, you could grow the top line 10% if the base business doesn't grow because biologics and international will be strong. So by our math it looks like biologics next year, assuming the base business doesn't grow, biologics would have to grow at least 30%, and international would have to grow to at least 70%, at least do 10% revenue growth. One, is our math in the ballpark, and then secondly, is there any risk to those growth rates? Thanks.

I think you are thinking about it correctly, and in fact, I think O-US, we expect that to actually grow 100%, and we believe that is very doable. It has very strong momentum. There are some additional markets opening up for us. I think those numbers are very good. What was the second part of the question, Glenn, sorry?

The question was is there any risk, so obviously you don't believe there is risk with strong growth in O-US, what about biologics?.

No, we do not. No, we do not, and the same on the biologics front, we believe we have upside on biologics with the Progentix product, even if for some reason that were delayed due to FDA, or what have you, we have tons of momentum going through right now with Osteocel Plus. It is going very, very well.

And just one follow-up.

Yes.

What will be the ski growth markets for you outside of the US next year? Thanks.

So a lot of opportunity for us in Central and Latin America. That is really opening up very well right now. Obviously Europe is still a very small component, and we see a lot of upside there. So Germany has been growing well. UK has been growing well. Again those are large markets. We see that really taking off.

Next year we start to get our first footstep into China. We start to see some early revenue coming out of Japan next year. Those won't be big numbers next year, but they really set the ground for 2012. Japan is the second biggest market compared to the US, as you know second only to the US, and then the same thing with Germany being very large, and then Australia, New Zealand, we are having tremendous success there, so all of our O-US groups are performing well.

Okay. Thank you Alex.

You are welcome.

Thank you. Our next question is coming from the line of Joanne Wuensch with BMO Capital Markets. Your line is now open. You may proceed with your question.

Thank you very much. Did you mention what you thought operating margins would look like in 2011?

We did not, Joanne, we are going to update guidance as we exit the year.

Okay.

Hey, Joanne we didn't change the outlook, it is still 20%, but we said that we would be looking to revisit that, and that there may be some pressure on it, but we haven't changed the 20% outlook at this point, but I think as Michael rightfully points out, I think we have to take a look and see where we are at by the time we get to February. But we don't see it being a huge shift either.

Okay. Was there any change at the hospital inventory management level?

No, I don't think there has been any significance. We still see life in certain areas of the country that still do set sales and want to have opportunities for different kind of pricing, because they actually own equity in the sets. So I don't think there is a huge shift there. There are still opportunities for placing sets for the right individuals who need it, the right hospitals that need it. So I don't see a real shift from second to third quarter on that front.

Okay. I am just wondering if part of the slowdown you saw was the hospital saying I have enough XLIF, I need to try LLIF, or something else LIF, so I am not going to buy any more at this stage?

No we don't think that is it. I think the only thing that I alluded to is that in Q4 we just don't if we are going to see the kind of lift that we would normally expect, in terms of revenue in December, because December is strong for a number of reasons, but one of the main reasons has to do with some capital pull through, yearend deals that the hospitals like to make, and we just don't know if that is going to be as strong as it has been in prior years.

When we met with you in September, the approach was, or the sense was you were lowering guidance at the time, not because you were seeing anything, but because people had expected you to. Now you are seeing something. Do you think you are seeing it all?

As best we can tell, Joanne, yes. We are doing so many channel checks right now, and trying to understand what is happening with the surgeons, so as I think I have spent a lot of time, I know you haven't been on this call that much today, but I have spent a lot of time trying to work through all of the things that are happening, and the fact that the back pain component, which could be degenerative disc disease could be as much as 20%. That seems to be gone right now from the market completely.

We don't know what else is happening as far as the overflow effect, but we do know that there is an overflow effect into all fusions right now, and we are seeing things getting canceled or perhaps postponed, not for good reasons just for a lack of some paperwork. Can I tell you that is three months or six months? I can't say. I don't know how it is going to shake out. I know we will being very aggressive about making sure that the surgeons are properly educated about the best ways to maximize their interface with the insurance companies.

We are taking that on. We are trying to be the industry leaders as far as helping the surgeons, and making sure that for the right cases that they are going to be able to get those put on, but I feel very comfortable with the guidance that we are giving. I feel very comfortable from where we sit on the annual number, and to what we are projecting for next year.

Terrific. Thank you very much.

Okay.

Thank you. Our next question is coming from the line of Sameer Harish with Needham and Company. Your line is now open. You may proceed with your question.

Hi, good afternoon.

Hi there.

Hi. I wonder if I can just sum up what we have heard so far, and follow it with a question. The difference in what you are seeing from insurance, it is a procedure mix, perhaps more the multi-level or more the MIS than you have seen with the competitors, and therefore, you are seeing an impact from the insurance companies later than the rest of them have. Can you talk about how the product is being differentiated in terms of coding or labeling, so that this would make an impact to the insurance companies?

It is a none of those things at all, Keith.

Yes, what we were referring to in the question previous that was asked, that some of the competitors have been talking about this maybe for a quarter or a quarter or two before us, and the comment behind that was they have broad legacy systems, and those legacy systems are largely for one and two-level cases, in that many MIS procedures now with our expanded product line do address single, multiple level, and really even really extended levels into the thoracic spine. We don't see the sort of push back in some of those advanced thoracic opportunities, nor have we.

But the point was is that those lumbar opportunities that were largely being driven quite successfully by our MIS surgeons, they are now seeing some of the standard push back that some of the other legacy products we are seeing. And their staffs and their entire operations weren't prepared for it. And so these things are getting rescheduled, it just that timing thing. They lost that opportunity in the OR, and so what they are doing now is jumping on it so they don't lose that time slot in the OR by having to cancel the case. And the point to be made was, those other companies are doing many, many more cases with those legacy products, so of course they were seeing it first. They were seeing it first because their volume was so much higher.

So in terms of your outlook for fourth quarter, are you expecting procedure volumes to be flat sequentially? Or the net impact on revenues to be flat because you are not expecting some of the traditional yearend ordering that you would normally see?

Both. Flat as well as we are not sure that we will see the year-end ordering.

And last question. Margins internationally can you help us think about how gross margins are impacted internationally?

What was the latter part, how gross margins what?

How they are impacted in international versus domestic.

Yes. Yes. And we have talked about this, I think numerous times, O-US does fall below the average gross margin for NuVasive overall. People, I think the last time we talked about it on the order of 70%, low-70s to mid-70s kind of thing.

Thank you.

You are welcome.

Thank you. Our next question of Mr. Bill Plovanic, Cannacord Adams. Your line is now open. You may proceed with your question.

Great. Thanks. A lot has been asked but on the push back is it DDD only, or are they pushing back on the adult deformity as well? I was wondering if you could give us a little color on that first off?

Well the push back on DDD I think is more than push back. I think that they are absolutely not allowing those cases to move forward. I think on all other spine procedures, it is not just deformity. It is on all other spine procedures, that is where there is a lot of push back, and things are not necessarily going through on the first round of preauthorization.

And I think something to make sure you are aware, when you start getting into adult deformity, it is a very common over 65 condition. So you are not seeing this phenomenon in that CMS patient.

Okay. So you are not seeing it in the adult deformity patient is what you are saying?

There is some adult deformity that is not CMS basis, private pay, but, no, those usually involve stability, they usually involve more advanced criteria, you can show instability, you can show what that degenerative condition is. Typically no. I can't say across the board none. But typically no.

Okay. And like you said that is the CMS patient. So they wouldn't fall under what the private pay has been pushing back on?

CMS is not, yes, this is not a phenomenon with CMS. That is right.

Okay. And people have danced around the question just on, what were O-US as a percentage of revenues in the quarter? And then same question for biologics?

I don't know. We will have to ask the financial folks here.

Yes, on the order of 5% give or take on O-US.

Okay --

Yes, biologics, somewhere in the 15% to 20% realm.

Okay. That is all I had. Thanks.

Sure.

Thank you. Ladies and gentlemen, due to time constraints we will have time for just two final questions. Our first question is coming from the line of Charles Chon with Stifel Nicolaus. Your line is now open. You may proceed with your question.

Great. Thank you. You spoke to how the quarter end disruption was driven in large part by procedures being cancelled, I don't know if you addressed this already and I missed it, but did you also speak at all about bulking patterns going into quarter end, did that dynamic change in any way?

No, that did not. So it is really just procedures falling off.

Okay. That is very helpful. The second question just a big part of NuVasive's growth has been about penetrating the market and driving adoption, has anyone changed strategically there on that front, because you have talked in the past about NuVasive has been actively seeking new business even at the national level, I am just wondering if there are maybe any large account wins or contracts that you can speak to?

Well so again we grew 27%, I mean the Company is performing extremely well. We continue to make nice inroads on national accounts. I think I have talked before about the fact that we have a very strong HCA account now, and we are making inroads on several others, so fundamentally there is nothing changing about how we are doing business. In fact we are trying to go deeper and deeper with surgeons as you might note from our comments in talking about guidance, a big emphasis for us is to make sure that we hold on to our business face. We are doing that through formalized programs. We have been doing that for quite some time. So we are very confident about that.

And we also think we have upside for growth, but we don't see the same upside for growth when the market is as flat or negative as it is today. And we want to make sure that as we move in to the fourth quarter, that we are properly looking at it, and we think we are, relative to our forecasts.

Terrific. Just one last question, of the lumbar fusion number that we were discussing earlier, would you be able to share some granularity on how much of that is TLIF versus XLIF? Thank you.

No we don't get into those specifics per se. Okay.

Thank you. Ladies and gentlemen, our final question is coming from the line of Mr. Douglas Tsao with Barclays Capital. Your line is now open. You may proceed with your question.

Thanks a lot for letting me get in. You referred to strategic options that the Company was considered. I was just wondering if you could provide a little bit of a framework, what sorts of buckets is that pricing, types of accounts you are targeting, product cadence, in terms of introductions, exactly what you are thinking about in broad brush, I know for competitive reasons you don't want to give us everything but if you could just give us a little bit more detail that would be fantastic?

Sure. So the things that we are doing and that we have started doing earlier in the year, is we are beefing up our sales force, we are making sure that the training for the sales force allows them to be heads and shoulders above everyone else. We have put more money into the MVP program, with regard to having a cadaver dedicated to every surgeon versus five or six surgeons sharing one cadaver. That is a bigger expense, and that is something that we have taken on. We are pushing more people through the facilities, both in New York as well as out here. On the O-US side we continue to look at opportunities to be able to grow that, and those are some of the things.

I think the bigger thing that we are doing is really trying to drive through some solutions with the payers, and what we did with regard to XLIF, when we went through that entire process, and were able to unite all of the different players, from surgeons, to associations to payers to resolve that. We are looking to do the exact same thing right now again. And that is a very big strategic undertaking, and it is one that we have already started, and moving in that direction, I think that is the one that we are probably most focused on, other than the things that we are doing normally to keep expanding our customer service, and so forth.

But I think overall if you take a look at where we are, we obviously drove to 27% in terms of our results, Yes, we came in a couple million dollars less than where we wanted to. And right now what we are doing is saying as a result of the conditions in the spine market, which we have largely been insulated from for quite some time, we are now in the same situation as everyone else, and it is difficult for us to forecast more than just flat to a slight increase as we move into Q4.

We feel very comfortable with our visibility for next year in the areas that we talked about, and we definitely want to make sure that we have addressed everybody's questions, and people feel comfortable in terms of our transparency and giving people a lot of visibility to how we see things.

Okay. That is great. And just one question, I was sort of interested in your comment that you model the pricing of the NeuroVision disposables to go down over the next few years, I was just curious as to what the thinking was, you make the case, a differentiated product, and so that would make me believe that you have confidence in terms of the sort of differentiation and the ability to set the price on that product, I am just curious as to why you would want to pursue or model in a decline in the price there?

Because all of our competitors they have a very simple strategy which is to make that a commodity, and they don't really understand what they are telling the hospital when they say, you know something you do it our way it is going to cost you less. What they are not understanding is that the hospital is going to pay a professional fee. That professional fee will be anywhere between $1,000 and $2,000 for somebody to monitor. That is what actually takes place.

We instead of trying to fight that battle for the next several years, believe that we are better off having a strategy that reduces the cost of the disposable to the hospital, yet provides a far superior product obviously in terms of NeuroVision, and allows us to move forward and garner much more on the way of implant sales, and that is where we have the highest margin products, and what is what we are always trying to accomplish with regard to going deeper in the account.

NeuroVision facilitates a highly safe and reproducible procedure in XLIF, and that is what is accomplishes, but it is also if you look at our entire strategy from when the Company started was around access, and from access it went to the bread and butter, and the bread and butter is selling implants. And that is what we want to do more and more of.

Great. Thank you very much.

Okay. And on that note, we will talk to you in a few months, and be happy to answer questions along the way. Please feel free to contact us. Thanks for your time today. Good bye.

Ladies and gentlemen this does conclude today's teleconference, you may disconnect your lines at this time, thank you very much for your participation, and have a wonderful evening.