NuVasive Inc (NUVA) 2011 Q1 法說會逐字稿

Greetings, and welcome to the NuVasive, Inc. first quarter 2011 earnings conference call. At this time, all participants are in a listen-only mode. A 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 Industry and Investor Relations for NuVasive. Thank you, Mr. Williams. You may begin.

Thank you. Welcome to NuVasive's first quarter 2011 earnings conference call. NuVasive's 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 by discussed which are not based entirely on historical facts. Any such items should be considered forward-looking statements that involve risks, uncertainties, assumptions, and other factors which, if they do not materialize or prove correct, could cause NuVasive's results to differ materially from 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'd like to turn the call over to Alex.

We are pleased with our first quarter 2011 results, which attest to continued strong execution in a challenging environment. Revenue in the first quarter increased over 14% year-over-year to almost $125 million, and we delivered better than expected operating margin improvement, demonstrating further progress toward our goal of steadily increasing profitability.

I'd like to open today with an update on the state of the spine market. The surgical community and our sales force continued to face pay or pushback for lumbar spine fusion procedures because various private payors have increased the level of scrutiny and the enforcement of criteria necessary to preauthorize lumbar surgery. This dynamic began to impact our US lumbar volumes late in the third quarter of 2010 and continues to be a challenge today. That said, our financial results in both the fourth quarter of 2010 and the first quarter of 2011 suggest that we are appropriately forecasting the impact that both pay or pushback and the considerable pressure on the DDD procedure volumes will have our on business. And our experience in the field year to date suggests that while the situation continues to limit spine market volumes, the landscape is stabilizing.

Last month, we hosted over 150 top XLIF surgeons at the annual meeting for SOLAS, the NuVasive-supported Society of Lateral Access Surgeons. We conducted a live voting survey to better understand what our top surgeons were experiencing in terms of insurance pushback for all lumbar procedures. With regard to the fusion cases that are being denied by insurance, the SOLAS surgeons polled believe that the majority of the cases actually meet insurance policy guidelines. We learned that roughly 60% of the respondents successfully overturned preauthorization denials on first appeal, and the rest take anywhere from weeks to months. And we also learned that when faced with a preauthorization denial for fusion surgery, approximately 10% of surgeons have been forced into performing a nonfusion procedure, such as a discectomy or laminectomy. The results of our survey support our belief that the market has been compressed by 10% to 20% due to reduction of lumbar fusions for DDD. However, we are optimistic about the future.

As the surgeon community works through reimbursement difficulties on a case-by case-basis, they are gradually becoming more effective at dealing with the insurers and are learning how best to navigate in this difficult environment, and as a result, we believe that the market is stabilizing. That, coupled with slightly improved expectations for our ability to take US market share and the excitement that is building in our product pipeline, renders us comfortable with a marginally improved outlook for our US lumbar business in the second half of the year. We are raising revenue guidance for 2011 to $530 million to $540 million, up from $525 million to $535 million, which now reflects low, single-digit growth for our US lumbar portfolio and continues to anticipate strong contribution from our international biologics and cervical offerings.

NuVasive continues to lead the charge in support of the surgical community and the various spine societies in an effort that we hope will ultimately result in a set of surgeon-formulated guidelines for spine fusion. As you know, the surgeon community was able to effect change within the policy of Blue Cross Blue Shield of North Carolina back in January. That was a very symbolic first step toward resolution of the disconnect between spine fusion patient needs and insurance coverage, and it is definitely building confidence within the surgical community as they organize to coordinate a similar result on a much grander scale. We believe that surgeons, not actuarial consultants, should determine what care is appropriate for patients. NuVasive is working closely to help bring together the surgical societies and the clinical research community to draft thoughtful and clinically-supported guidelines for spine fusion. This work was a key topic at the recent SAS conference in Las Vegas, where the entire afternoon of the meeting's opening day featured a session on coding and reimbursement, as well as a call to action for the surgeon members to once again come together as a unified spine surgeon community in support of new proposed guidelines that are being finalized as we speak.

From a technology perspective, our focus is to advance spine surgery by developing new products and procedures that provide superior surgical outcomes through shorter operations and hospital stays with faster return to normal activity. NuVasive has had tremendous impact on changing patient lives with superior clinical outcomes that are faster, better and cheaper. However, a slower FDA approval process, healthcare reform with increased tax burdens and administrative requirements, along with unpredictable private insurance payment practices that retard patient care, are having a direct impact on the ability of innovative companies to develop new technologies that improve health and quality of life. We recognize the need for assertive leadership in our industry and have teamed up with trade organizations MDMA, BIOCOM, and CHI to actively address these topics directly with the legislative community. NuVasive has presented physician statements and testimony on these issues for the House Energy and Commerce Committee, as well as the Committee on Oversight and Government Reform. Rest assured we will lead the charge in addressing those federal policies affecting innovation for NuVasive and the med tech industry.

Superior clinical outcomes continue to drive a massive shift within the spine market toward less disruptive approaches. We estimate that in 2011, the market for minimally disruptive solutions, which includes the lateral and MAS TLIF approaches to spine fusion, motion preserving devices, and the biologics associated with less disruptive procedures, will be an approximately $1.8 billion market segment, correlating with just over 20% share of today's global spine market. We continue to believe that over the course of the next decade, minimally disruptive solutions will become the standard of care in spine and will comprise close to 80% of the global spine market. As the pioneer of the lateral approach to fusion, NuVasive continues to drive the shift toward minimally disruptive solutions and boasts the largest share of this segment.

Moving forward, our portfolio is exceptionally well positioned to drive continued market share gains. Years of experience in lateral have afforded us the best in class, most comprehensive lateral solution for spine fusion. Also, the launch of our game-changing new approach for MAS TLIF continues to gain traction in the market. We also look forward to the launch of our PCM motion preserving device for the cervical spine and Progentix, our synthetic biologic. As surgeons seek better outcomes for their patients and as the body of clinical evidence in support of MAS builds, surgeons and hospitals will increasingly partner with NuVasive, due to our differentiated solutions and service.

Nothing attracts competition like success, and as you know, the lateral market has been privy to a host of new products recently. While we continue to anticipate surgeon trialing of the new products near term, our experience in the field year-to-date suggests that we are still taking market share, which is a component of our ability to raise revenue guidance today. Longer term, the new market entrants will serve to even further validate the lateral approach to fusion and encourage surgeons who once believed that XLIF was a niche product to consider how it can dramatically affect their practice. Any surgeon who adopted a competitive lateral approach to fusion will eventually see the superior product comparison, due to our sales team's ability to drive new customer sales based on technology and functionality.

NuVasive offers unmatched integrated neuromonitoring that provides surgeons self-directed real-time feedback with both nerve proximity and directionality, resulting in a safer and reproducible approach which reduces complications. Surgeons also have access to an unmatched number of implants that are capable of treating various indications laterally. And while our retractor is already best in class with a customizable exposure designed specifically for the lateral approach, we are very excited about the launch of MaXcess 4 late this quarter, which is the culmination of our years of XLIF experience. The retractor has been redesigned for strength, precision, fluorovisibility, and seamlessly integrated neuromonitoring, which will make the XLIF procedure even more reproducible and easier to learn. As we look toward our evolution into a $1 billion start-up, we will continue to invest in the levers of our market share taking strategy that will propel growth for NuVasive at multiples of the industry for years to come.

Our global sales force number is over 300 today, and as we look forward to the $1 billion revenue milestone, we envision a sales force at least 500 representatives strong facilitating NuVasive's presence in new territories and depth in existing territories. As our sales force continues to mature, efficiency is improving at a measured, consistent pace, driving operating margin leverage. Our evolution into a $1 billion start-up also mandates continued investment in the surgeon training that is driving adoption of the lateral approach to fusion, not only for basic, single-level lumbar cases, but also for multi-level procedures, tumor and trauma procedures, thoracic procedures, and the treatment of scoliosis. We opened the Nuva East training facility in July 2010, and demand for the training at the facility has been exceptional. As a result, we now anticipate over 550 surgeon training sessions this year in the US and expect our penetration in both in the Northeast and overseas to increase as a result. SOLAS is now over 500 members strong and will continue to grow as surgeons increase the use of NuVasive products and drive the market toward more minimally disruptive approaches to spine surgery.

Another major growth lever for NuVasive is the industry-leading innovation and product stream that we are known for. We have over 65 products in the NuVasive portfolio and continually update our offering with new products or line extensions that set us years ahead of the industry in terms of even greater functionality and consistently give our sales representatives unique products to show their surgeon customers. Late this year or early next, depending on FDA time lines, we look forward to the commercialization of two solutions in our pipeline that have the capacity to be game-changers. The PCM device for the cervical spine will be the third motion preservation device to the US market, marking NuVasive's foray into an very exciting field that we continue to believe could ultimately displace most cervical fusions. Our synthetic biologic Progentix is a novel orthobiologic with a synthetic bone substitute technology that we expect to be able -- to be capable of competing head-to-head with the leading biologic solution on the market. The surgeon community has come to big ideas from NuVasive, and as we drive toward $1 billion in revenues, we will continue to deliver.

We have also been investing into our expansion outside of the US for the last several years and are only beginning to see the fruits of that effort. We just opened a fully operational office in Puerto Rico, and despite the recent tragedy, we are on track to enter Japan, the second largest market for spine fusion, with a Tokyo office later this year. We anticipate that our international operations will represent about 8% of revenue in 2011 and will add to profitability in 2012.

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 property rights that protect it. You can continue to expect that we will aggressively use all offensive and defensive measures available to preserve the investments we have made to be the most innovative spine technology company in the world. During the quarter, we successfully added another licensing agreement for our stem cell biologic, which further validates the strength of our intellectual property in this area. Late last year, we initiated a patent infringement lawsuit against Globus Medical, which contends that Globus Medical's LLIF lateral fusion offering infringes NuVasive's XLIF intellectual property. That suit is still in the early stages of litigation, so I have little else to report.

Regarding the Medtronic dispute, we recognized $2.1 ' in IP litigation expenses in the first quarter of 2011 and continue to expect approximately $6 million in expenses for the full year. We continue to assert that we will not seek a settlement with Medtronic and expect a trial this fall. We'll 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 will turn the call over to Michael.

Thank you, Alex, and good afternoon, everyone.

Our revenue for the first quarter 2011 was $124.5 million. This represents a 14% increase over Q4 2010, and as we anticipated, about a 4% decrease compared to last quarter. Biologics revenue, which you will see reported in our 10-Q, was $22.6 million or about 18% of revenues, and OUS revenue, including its biologics component, was approximately 6.5% of total revenue in the quarter. Revenue results this quarter demonstrate excellent execution, even though we continue to operate in a difficult environment within spine.

Before I walk through our results from the first quarter, I would like to discuss the accounting estimate change detailed in today's press release. Specifically, for certain loaned instrument sets placed into service before January 1, 2011, we changed the depreciable life estimate from three years to four years. Let me briefly explain what that means. For the majority of spine cases that employ NuVasive solutions, we ship out instrument sets from our Memphis facility to be used by the surgeons to perform the procedures. The instrument sets are fixed assets of NuVasive which, like all fixed assets, are depreciated over their estimated useful lives for accounting purposes. After a thorough view of our available history, we concluded that four years is a better estimate of the economic life of these assets.

Our choice here will significantly impact our operating expenses and, consequently, our operating margin and earnings per share. I will detail the impact on each line item as we walk through the P&L today, but generally speaking, the change in accounting estimate reduced depreciation, which is a sales, marketing, and administrative expense, by about $1.7 million. Under existing accounting literature, this type of change is referred to as a change in accounting estimate and therefore is only adjusted prospectively in the financial statements. As it is not an error, it does not require the restatement of prior financial statements and will not be applied retroactively.

Now I will turn to our results in the first quarter. Our Q1 2011 GAAP net income was $2.4 million or earnings per share of $0.06, which includes a benefit for the change in accounting estimate of approximately $0.02 per share. Excluding an aggregate adjustment of approximately $7.2 million for stock-based compensation, certain intellectual property litigation expenses, amortization of intangible assets, and acquisition-related items, first quarter non-GAAP earnings were approximately $9.5 million or $0.24 per share, which also includes the benefit for the change in accounting estimate of approximately $0.02 per share. For more detail on the GAAP to non-GAAP bridge, please reference the reconciliation table in today's press release.

Gross margin in the first quarter was 81.1%, compared to 82.2% in Q1 2010 and 82.1% in Q4 2010. Year-over-year gross margin was impacted primarily by a shift in product mix within the US business, with smaller secondary impacts from a geography mix shift towards our international business and price. The price impact is consistent with the low single-digit impact we've been experiencing for some time. Operating expenses as reported for Q1 2011 totaled $96.3 million. Excluding the benefit from the previously discussed change in accounting estimate, operating expenses in aggregate for Q1 2011 totaled $98.1 million, which compares to $86.7 million in Q1 2010 and $94.9 million in Q4 2010.

Research and development expenses, adjusted to exclude stock-based compensation and acquisition-related items, totaled $10.2 million for Q1 2011, compared to $9.6 million for Q1 2010 and $9.7 million for Q4 2010. R&D expense as adjusted was 8.2% of revenue for Q1 2011, versus 8.8% in Q1 2010 and 7.5% in Q4 2010. The increase in the absolute dollar expense year-over-year was driven by the incremental investment we made in staff and related expenses across most groups to support growth. As reported, sales, marketing and administrative expenses for the first quarter, excluding stock-based compensation, intellectual property litigation expenses, and acquisition-related items, totaled $74.2 million. Excluding the adjustments mentioned and the benefit from the previously discussed change in accounting estimate, SM&A expenses for the first quarter totaled $76 million, which compares to $67.7 million in Q1 2010 and $73.9 million in Q4 2010.

On an apples-to-apples basis which excludes the adjustments mentioned and the benefit from the previously discussed change in accounting estimate, SM&A expense as a percent of revenue was 61%, versus 62.1% in Q1 2010 and 57.2% last quarter. A 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 topline and manage operating expenses prudently. On an absolute basis, the year-over-year increase in the more variable components, SM&A expense, including commissions, freight, set depreciation, and sales force personnel, was less than the corresponding increase in revenue. In addition to the variable components relative to last year, we invested significantly in continued international expansion, increased surgeon training, and in adding share owners and infrastructure along with their related costs to support growth.

First quarter non-GAAP operating margin as reported was 13.3%. Excluding the benefit from the change in accounting estimate, first quarter non-GAAP operating margin was 11.9%, which compares to 11.3% in Q1 2010 and 17.5% last quarter. Non-GAAP operating margin excludes stock-based compensation, certain intellectual property litigation expenses, amortization of intangible assets, and acquisition-related items. Stock-based compensation expense for the first quarter of $7.9 million was recorded in our operating expenses, which compares to $6.4 million recognized in Q4 2010 and $6.9 million recognized in Q4 2010. Stock-based compensation was allocated at $7.3 million to sales, marketing, and administrative expenses, with the balance in research and development.

Acquisition-related items for the first quarter totaled $571,000, which compares to $335,000 recognized in Q1 2010 and $1.4 million in Q4 2010. The acquisition-related items were allocated entirely to sales, marketing, and administrative this quarter. Other expense for the first quarter was about $1.1 million, versus $1.4 million last year and $1.8 million last quarter. Cash provided by operating activities continued to show progress in the first quarter, coming in at approximately $14.5 million.

Looking forward, we will continue to focus on identifying efficiencies in our cash generation cycle. Our cash and investment balance at the end of the first quarter was approximately $226 million, down slightly from 2010's ending balance of approximately $230 million. Reduction from year-end 2010 was driven by a payment made during the first quarter in connection with the ongoing renegotiation of a supply agreement. During the second quarter, the renegotiation was completed, resulting in a return of a portion of those monies. 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.

One other item to mention. We continue to believe that the Neurovision trademark dispute will be resolved in our favor, despite the jury verdict. That said, we will likely be required placed to place in escrow up to $63 million in cash or investments for the 18 to 24 month duration of the appeals process. We do not currently foresee that this escrow requirement will impact our 2011 cash needs, given our improving operating cash flow and the portion of our cash balance that will remain available for use.

At the end of Q1 2011, our inventory position was about 23% of annualized first quarter revenue, up from about 21% at year-end 2010. We are aligning inventory to ensure we avoid missed revenue opportunities in this dynamic environment, and we wanted additional flexibility as we plan for some new product announcements and as we manage through reconfiguration of our sets in an attempt to improve future efficiency. So we expect some of the Q1 increase will work its way through our inventory over the remainder of 2011. 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, so it is possible that the ratio will rise on occasion, as it did this quarter. In the meantime, we continue to work on evolving our operational systems through significant investments in logistics, distribution, and related reporting functionality.

Days sales outstanding, or DSOs, when run off of our net AR balance, was 55 days in the quarter, compared to 51 days for last year's Q1 and 53 days at the end of Q4 2010. In this tight economic environment, we are seeing customer attempts to stretch payments, thereby contributing to longer collection cycles, even as we continue to focus on improving the timeliness of our collection efforts. In addition, roughly two days of the year-over-year variance is related to the outsized growth in the OUS business, where payment terms are much longer than on the US side.

Now I will turn to guidance for the full year 2011. Please reference the table in today's press release which further details our guidance changes as well as the expected benefit from the change in accounting estimate for the useful life of loaned instrument sets. As Alex mentioned, we are raising revenue guidance for the full year to growth of 11% to 13% or $530 million to $540 million, up from $525 million to $535 million. We expect that revenue in the current quarter will approximate $130 million to $132 million, and given Alex's comments, we also anticipate that revenue growth will accelerate in the second half of the year.

Moving through the rest of the P&L, we continue to anticipate a full-year gross margin of approximately 81%. As a result of the change in accounting estimate, we now expect full-year 2011 non-GAAP operating margin to be approximately 17.5%, up from the roughly 16.5% that we previously guided. Non-GAAP operating margin will ramp up throughout the year, much like it did in 2010, and should approximate 16% in the second quarter, which already includes the benefit of the previously discussed change in accounting estimate. Our guidance for all non-GAAP measurements will continue to exclude stock-based compensation, certain intellectual property, litigation expenses, amortization of intangible assets, and acquisition-related items. Research and development expense, excluding stock-based compensation and as-incurred acquisition-related items, will approximate 8% of revenue for the full year as we remain committed to reinventing our product portfolio and further arming our sales force.

As I mentioned, sales, marketing, and administrative expense will be impacted by the change in accounting estimate. We now expect SM&A expense, excluding stock-based compensation, certain intellectual property litigation expenses, and acquisition-related items, to approximate 55.5% of revenue for the full year, compared to our previous guidance of approximately 56.5%. For the full year 2011, we expect the amortization of intangible assets to approximate $8 million, spread roughly evenly throughout the year, and acquisition-related items to be approximately $1.7 million. Other expense is anticipated to be just over $6 million and will also be spread roughly equally throughout the year. We expect intellectual property litigation expenses related to the Medtronic dispute to approximate $6 million, slightly front-end loaded this year, as we now anticipate a trial date in the late summer or early fall.

We continue to anticipate stock-based compensation of approximately $33 million, which we now expect will be allocated as roughly 90% toward sales, marketing, and administrative expense and 10% towards research and development. We now anticipate our 2011 full-year GAAP tax rate to be roughly 45% and our non-GAAP adjustments to be tax effected at approximately 40%. The lower 2011 GAAP tax rate is due to higher pre-tax net income as a result of the previously discussed change in accounting estimate, as well as a better estimate of non-deductible stock-based compensation expense, due to our 2011 annual stock awards being granted in Q1.

Finally, we now anticipate full-year GAAP EPS of $0.52 to $0.55, up from $0.39 to $0.42 previously, and we expect non-GAAP EPS to approximate $1.20 to $1.23, up from $1.07 to $1.10 previously. Higher non-GAAP EPS expectations are driven primarily by the benefit from the previously discussed change in accounting estimate, which drives about $0.08 of the increase. Our expectations for a lower full-year tax rate drove approximately $0.04 of the increase, with the remaining $0.01 driven by higher revenue expectations. Please reference the table in today's press release for further details.

Non-GAAP EPS guidance correlates to our non-GAAP operating margin guidance and excludes stock-based compensation, certain intellectual property litigation expenses, amortization of intangible assets, and acquisition-related items. We feel this non-GAAP EPS measure most accurately portrays the operating earnings power of NuVasive and should be the basis for measuring our progress. Please refer to the tables in today's press release for the reconciliation of non-GAAP to GAAP EPS guidance. We continue to expect 2011 fully diluted weighted average shares outstanding to be approximately 42 million shares.

The first quarter of 2011 marked a solid start to what we expect will be another year of industry-leading growth for NuVasive. Despite a highly fluid market backdrop, results this quarter and our ability to raise guidance today suggests that we are executing very well in a difficult market. NuVasive's evolution into a $1 billion start-up continues to unfold, and I look forward to contributing to steady, predictable progress in levering operating expense structure and the asset base.

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

Wow, you're on fire, Michael. Okay.

I am exceptionally pleased with our first quarter results and with our ability to raise guidance today. We again generated industry-leading revenue growth and made consistent progress toward our profitability goals. We continue to expand the foundation that will sustain growth and market share gains for NuVasive for years to come, and in true NUVA fashion, we have assumed a leadership role in addressing head-on the issues that are impacting industry growth. As we move toward the next milestone, which is the evolution of NuVasive into a $1 billion start-up company, we are laser focused on maintaining the start-up mentality that is the very source of NuVasive's success. Our market share taking ability, together with speed of innovation, will drive continued industry-leading, less invasive treatments for the spine with improved surgeon and patient outcomes. As we like to say at NUVA, onward and upward.

We will now take your questions.

Thank you. Ladies and gentlemen, at this time we will be conducting a question-and-answer session. (Operator Instructions).

The first question comes from the line of Matt Miksic from Piper Jaffray. Please proceed with your question.

Hi, good afternoon. Thanks for taking our questions.

Happy to do it.

I've got one for Alex and then I have a follow-up. Maybe also for you, Alex.

So you described the market development efforts of the new competitors and the scrips kind of validating lateral and driving some interest there. Of course this is offset by some trialing or training on these competitive products. Can you describe whether you think the net impact of these two dynamics is positive, or is that negative now or neutral, and where do you think that goes over time?

I think that the net of it right now is positive. I believe it took for us some time to adjust to all of the noise in the marketplace from NAS of last year. I think our sales force has recalibrated and readjusted to dealing with the plethora of competitors, so we welcome the opportunity to do side-by-side comparisons, and we also appreciate the fact that everybody is talking about lateral. And we certainly know that we have the safest and most reproducible way of doing it, so we know that we will differentiate ourselves, so it's a positive.

That's helpful. And maybe --

You're welcome to ask me a follow-up if you'd like, and then we'll have another question for Michael.

Well, thanks so much. I would like to --

I'm in a very good mood today.

That's great to hear. I just want to make sure I understand your answer, because it is probably counter to what most people would think. Boy, competition is positive, if the math goes something like three or four or five competitors promoting to their surgeons instead of 10 surgeons knocking on your door for training, maybe now there is more, even though each one of those competitors is capturing some of those, temporarily, maybe permanently, as their own lateral business. Is that a fair way to characterize the math?

I think that's reasonable. I think what you have to remember, though, is what they are doing is they are expanding the market for us. So when the larger players are participating, they're cannibalizing surgeons into MIS, into MAS, and those are surgeons that would not necessarily look at our platform until they had some exposure to lateral. That's why I see it as a positive, because it's an expansion process coming through the various competitors for us.

Okay.

And then I think this follow-up probably is for you too. Thoughts on the potential impact of this change since this deal, either in the spine market or on any potential opportunities it might present. In particular, are you still looking at expansion of your distribution towards the East Coast?

Yes, I think that it's likely to be disruptive, obviously, to the two companies as they go through their consolidation process. And as we know from prior deals, there is a fair amount of nervous energy on the part of the sales force between now and that day. So I think that for us, it's going to probably open up more opportunities of people that may want to come on board with NuVasive instead of that combined entity. So we see it as a positive for us and believe that it expands the size of the pool of representatives that could make their way over in our direction. And I do not think it's just representatives. I think it's other positions as well on the admin, R&D side, marketing, and throughout the organization.

Got it. Thank you.

You're welcome.

Our next question comes from the line of Bob Hopkins from Bank of America. Please proceed with your question.

Hi, thanks. Can you hear me okay?

Yes.

Great.

So first a question for Michael, and then a question for Alex or Kevin. So Michael, on the guidance, could you tell us without the --

Kevin who?

I'm sorry.

That's okay.

First question on the income statement and the guidance. Without the accounting change, what would the non-GAAP operating margin guidance have been? Would it have been the same as the previous guidance of about 16.5%?

Yes, Bob, that's right. It's about 100 basis point delta, and that combines the effect of the EUL and a small adjustment for the revs change.

Okay. But in the first quarter, the operating margin -- non-GAAP operating margin, excluding the accounting change, was up about 100 basis points. Are you planning on spending a little bit more money in the Q2, 3, and 4? Is that the way to look at it?

No, if you remember, we gave that original view at around 11%, and we certainly came in above. But always implied in our guidance is some range around the OI number. And for us, the timing aspect of how we're layering in the expenses of the year is not dramatically different from what we communicated last year, too, which is sort of that step up as you go across the course of the year. Also, we do have a table in the back that shows the EPS bridge broken down into the useful life piece for the accounting change, the revs, and the tax, and out of that $0.13 is $0.08 EUL, $0.04 tax, and about a penny on revs.

Thank you.

And then for Alex, back on the topic of J&J/Synthese, I was just wondering if you could give us your opinion on, is it easier to integrate two indirect sales forces together, or do you think it's easier to ingrate an indirect and a direct sales force together? Which one do you think is more disruptive, and why? Thank you.

I think both are difficult because of the overlaps that take place. And I think that what the representatives tend to worry about is being cut back with regard to revenue, because of the territories being reduced. And I think that's really always in the forefront of their minds.

I think in this particular case, if you look at Synthese, which has an entirely direct sales force, I believe that most of those folks are not going to be terribly interested in being a member of a distributor organization. I think that that's going to be hard to convince them to come on board a distributor organization. I think they're slightly different cats when it comes to direct versus indirect. They can obviously do a comparable job, but they do tend to be a little bit different in either one and some of the aspects that go along with security associated with being direct, versus a fiercer independence associated with being part of a distributor organization. So I think it's going to be cumbersome and challenging for them to put it together. I also think that -- I don't want to sound like a naysayer, I can understand the move, I think it's a good move for them to have made, for J&J to have made. But it's going to be challenging on the distribution front, and I'm sure they'll get through it one way or another, but it will be a challenging move.

Any thoughts from Keith on that subject?

Keith or -- we're trying to get Kevin. We don't know where the hell he is.

Bob, come on, we're just teasing.

Yes, I would agree. On your question, obviously, I think the biggest struggle that goes on is a lot of their overlap for their other orthopedic categories seem to be relatively straightforward. Spine is going to be their biggest challenge by far, product overlap and sales force overlap. I think the real challenge is, if there is any group of employees that can get very nervous very quickly, it's the sales force when there is nothing that is put out there clearly on what is going on. And so with that, I think there is going to be a great opportunity for a number of organizations to be able to grab some good salespeople in that point of flux. And I think J&J will absolutely digest it. They've done it before, but in that process, there will be great opportunity for some organizations to build out their sales teams.

Great. Thanks so much.

You're welcome.

Our next question comes from the line of Sameer Harish from Thinkequity. Please proceed with your question.

Hi. Thanks, guys. Good afternoon.

Good afternoon.

Wanted to ask about sort of the longer-term operating margin targets for the Company. Obviously, you guys have an improved outlook in the near term. What is the sort of implication there on the longer-term outlook for spine growth and hence NuVasive's growth than maybe you expected a year ago? And what does that do for your operating margin targets long-term?

I think right now what we're seeing -- what we're talking about and projecting is a marginal improvement. What we need to do is get through this year and see how this plays out. I'm also optimistic that there will be progress made on the payor front, and as that progress really is made, then I think we can come back and recalibrate on the growth. We believe that once the payor pushback is resolved, that we move into high single-digit growth as an industry, and I think that NuVasive would certainly take the lion's share when it comes to faster growth in that.

Operating margin overall, our target is to get to 20% operating margin, and then to continue to grow from there to be somewhere in the low 20s over the next several years.

And are you expecting that 20% around the time you reach $1 billion, or is that more of just kind of a general target?

We expect that to happen sooner, but we're not giving specific guidance on when.

Okay, great.

And if I could squeeze another one in, more on the near side. International revenues, as you layer on territories, geographies, there, are you expecting straight line growth for the year or some more variability around that?

It's actually pretty smooth on the international front, so there is your answer.

Great. Thank you.

You're welcome.

Our next question comes from the line of Ben Andrew from William Blair. Please proceed with your question.

Good afternoon. It's actually Matt in for Ben.

I wanted to talk a little bit about the core XLIF products. You've been adding a number of products, MIS TLIF, traditional fusion products, but when you look at the performance of just the core XLIF products, how has that been trending in recent quarters, and what is contemplated in your guidance for 2011 for that segment of the business? Put another way, are some of these new products really helping to kind of steady the lumbar segment of your business?

Yes, they are helping. And I think that, as we talked about, we're getting good growth from all of the different segments, from cervical to biologics and so forth. So all areas are contributing very well. Our XLIF business is growing in pace with the market, and that's basically the reality of where we are. And we're taking share through XLIF and through some of our other products.

Okay. And when you say in pace with the market, you're talking about the less invasive segment of the market, correct?

Yes.

And then the other question. As far as your interactions with FDA go with Progentix and with PCM, is there anything in terms of the question or correspondence you're having with them that is outside of what you have been planning at this point?

Well, I think -- that all depends on how -- there is a number of ways to answer that, because there have been significant delays now for quite some time. So if we're talking about 2011, it's pretty much within the scope of what we were planning. If you talk about a year ago, it's taken a lot longer than we anticipated. So we're hopeful that there are not additional delays, and we hope to see both of those products to market either by the very end of this year or the start of '12. But that's still up in the air. We do not have that big end to our numbers at this point.

Okay, great. Thank you.

You're welcome.

Our next question comes from the line of Chris Pasquale from JPMorgan Chase. Please proceed with your question.

Thanks.

Alex, you mentioned the effort to generate surgeon-formulated guidelines. Do you have any visibility at this point on when and how those will be presented?

Yes. At SAS, they presented essentially clinical guideline -- a clinical guideline policy, and that's been put out there for comment, and they are seeking comments from all of the different spine surgeons that are members of that society. So I don't know exactly when that will close in terms of that period. But I think that what it's looking like right now is that I'm hopeful that sometime by somewhere in the third quarter, that we should have things pretty well settled out in terms of having guidelines. And then having something to be able to take in to meet with payors and be able to start to resolve the pushback that we've been seeing, somewhere in the fourth quarter.

Okay.

And you've talked in the past about being interested in doing deals to buy and distributors internationally to help you get more scale there. So first, have you executed any of those transactions thus far, and then is that still something that you still think you're likely to do in the near term?

Well, we haven't so far. I think we've been very pleased with the growth that we're getting from our subsidiaries, so if anything, we've tended this year to invest more in international. And it's part of our break-even approach for international so I think that that's serving us very well. But we are interested in those sort of deals. We're interested in looking at deals like that, even in the US now, especially given the Synthese and Depuy combination, I think that's going to open up more opportunities globally.

Great, thanks.

Yes.

Our next question comes from the line of Raj Denhoy from Jefferies. Please proceed with your question.

Hi. Good afternoon, guys.

Hi.

You were probably asked just kind of a clarification question. I appreciate your renewed enthusiasm for the market, and you raised your guidance, obviously. And I'm curious what in particular you are more excited about. Is it that you are seeing better growth out of the lumbar market, is competition not as bad as you thought it was going be? You're seeing better performance out of the cervical and biologics area. Generally, what's doing better that's now caused you to come back and raise your numbers a little bit?

It's kind of a yes to everything that you just said. But I think what we're really seeing is that the surgeons are more accustomed and more able to deal with the various rejections that they get. And so I think that wherever their volume is adjusted to, and we know that for a number of surgeons, their volume is down. That seems to be the new normal. And that's what I think we're comfortable with, is that we're not seeing a deterioration in the volume.

So as we look out for the rest of this year, we also see our ability to take share, as we did in the past, being enhanced, really, by the fact that the surgeons, I think, are stable. I think the offerings that we have that are new that are coming out -- for example, I talked about MaXcess 4. I think that's a big deal. MaXcess 4 is going to have a real impact, and so it's not going to have an impact on Q2 revenue, but we think it's going to help us out in the second half of the year. And we believe that it will thwart some of the competitive efforts that are out there.

And there is still a potential for some additional upside from Progentix and from PCM. On the Progentix front, the one thing that we haven't really talked very much about is that we are rolling out that product. It's not a lot of revenue, but we are starting to roll it out outside of the United States, and so that will give us a little bit of upside, overall, to the Company's revenue profile.

So you do think then that -- you had talked about lumbar potentially being flat here in 2011 and 0% growth for you in that market. You're expecting now to see something positive out of the lumbar segment for you, domestically?

Yes. We see it as being a 1% to 4% growth opportunity right now.

Okay. Fair enough. And then broadly on the market, it was really this summer, mid-year 2010 that the market really kind of started to slow fairly dramatically. And I appreciate your sort of looking out in the second half of 2011 before you think the market will kind of pick up again. But what I'm trying to get a sense of is how that plays out, because it probably wasn't that every insurance company suddenly in the middle of last summer stopped paying for (inaudible) back pain. And so maybe there is this thought that perhaps we see the tail be a bit longer and the softness in the market, and maybe you could comment about kind of the complexion on what the recovery looks like.

That's certainly possible, and that's why we're being guardedly optimistic. I think what we see is our ability to take share. We see strong performance outside of the United States, as we had projected. Cervical is performing very well. Biologics is contributing appropriately. And if you take a look at everything that we said was going to happen as we formulated our guidance for this year, it's all come together. I think that, as I just talked about with MaXcess 4, it's going to have a very, very big impact. And I do not think -- we didn't have the visibility on MaXcess 4 as we set the year in motion. But we did a lot of alpha beta trialing with that product, and it's been just, across the board, received in a very big way.

So if you just take a look at -- I think where all of the players are right now, everybody is pushing back. Is it likely to get worse? I don't think so. Do not forget, one other thing that is going on here is that this pushback that's taking place is really catching the ire of patients, as well as surgeons. And there is a lot -- there is a lot of people that are very disgruntled right now and are making noise, and I think that when they do that, you're going to start to see more things potentially get in front of state insurance boards, and those things will be turned around.

But as you very well know, what has been happening in our space is that they've been pushing out guidelines that really are inappropriate guidelines, or I guess more specifically, the Milliman guidelines. And so I think that that's being better and better understood now by a larger audience, and I'm also optimistic that we'll have some progress made sometime in Q4 on the payor front. To what level? I'm not exactly sure. It will just be the beginning of that process.

So I think all of that just bodes well for how we see the year. But again, guardedly optimistic.

Since you're in a good mood, can I ask a third question?

Absolutely. You can even do four if you want to.

I'll keep it to three.

But on pricing, I think you said low single-digit, if I'm not mistaken, which is I think a little bit better than some of your peers have commented on the pricing environment. Maybe you could just comment on maybe the different pricing you're seeing and what is happening out there.

Yes, I'm going to turn it over to Keith.

Yes, I think it's been very similar the past couple of quarters. There is still a number of larger accounts that are opening up their doors, I think, to more and more competitive influence by offering what they call RFPs for a process. So that does open up the opportunity for us to participate, but that participation is at a more constrained pricing arrangement. But I wouldn't say that it's significantly different than what we've been seeing over the past couple of quarters. But there is certainly still pressure out there. There is a pressure out there for pricing, and there's a pressure out there for larger institutions to rethink how they are giving exclusive agreements and move away from those exclusive agreements to bring in greater competition within the hospital.

But on your core XLIF, are you still seeing relatively good pricing there in a sense, because I think that's one area that you've been able to maintain pricing a bit better than in some of the more commodity kind of constructs?

It is. I think it is two fold. I think the part to XLIF that it has a benefit is you had traditionally, years ago, just a single- or double-level procedure, and those procedures are under more and more cost containment. But as you move into deformity and trauma procedures, those have less. And they especially have less because you are using less implants with some of the newer, less invasive techniques. So it really comes down to taking a look at it from a procedure perspective, and the benefit that's going on with XLIF is how it's advancing into more complicated procedures.

Great. Thank you.

Our next question will come from the line of Rick Wise from Leerink Swann. Please proceed with your question.

Hi, guys. This is Rich in for Rick. Thanks for taking the questions.

I just wanted to start off on that last point that you made about kind of the more complex spine surgeries. In the wake of the decreased volume that we did see in the spine market, have you noticed any kind of greater magnitude of impact on those more complex procedures, versus kind of the single level, and how has that impacted your mix?

From a complexity perspective, specifically, deformity and trauma, and even adult degenerative conditions, you're seeing -- you're not seeing the kind of concern with pushback. It's the traditional lumbar procedures, the bread and butter procedures that we've long talked about, which is the one- or two-level procedures that may or may not have the instability levels that certain insurance carriers are requiring or that the surgeons have the ability to provide justification for. When you get into trauma and longer deformities, and specifically, even adult longer degenerative deformities, you have a great deal of instability, or you have enough, justification-wise, way beyond the traditional DDD requirement, so to speak. So you're not seeing the pushback on those longer constructs.

And to the best of your knowledge, with respect to what competitor products are able to accomplish, are you really the only lateral fusion technique that can address these more complex cases?

Yes. Right now, when you take a look at the product offering, it comes down to a number of different opportunities. It's not just the implant that provided. When you start looking at what we're going forward with, with newer retraction systems in MaXcess 4, it also gives greater ability to cater to these more complicated cases. And then on top of that, you need to keep in mind that the Neurovision product line still has the ability to monitor in the thoracic spine and do SSEPs and MEPs, which creates a different level of safety profile. So it's the whole suite of products, it's not just simply a competitor saying, well, we can do a deformity case because we have this new-shaped implant. It's much more complicated, what you need in the procedure as you start getting into complex cases.

And if I could just ask one more on the payor issue. So just help me understand. Once you -- let's say in the fourth quarter, get these proposals moving into discussions with insurers, what then? What is the discussion timeline? When do you think, realistically, we might actually see some of these things take effect?

So I think what we're hoping is going to happen is that in the fourth quarter, discussions will start to take place between surgeons, some of the societies, and so forth, sitting down and really pointing to the overwhelming evidence that exists in support of fusion. And there is a lot of it. And what they're doing right now is they're putting together all of that data in mass form and really correlating that with the guidelines, such that I think that it becomes essentially a template that the insurance company cannot turn their back on. They can't turn around and say, well gosh, there is not enough evidence. There is a lot of evidence, and there's been a lot of evidence for quite some time.

It hasn't been all rolled up in a way that I think makes the most sense to the insurance companies. That's what is going to take place. How quickly will they respond? That's hard to say. I think that they'll be in a difficult position not to respond favorably, but we won't know until we get closer to the fourth quarter and see what their immediate reactions are like. But I also am counting on the fact that there is more and more noise coming from patients about their conditions and being forced to stay on narcotics and not be able to get surgery in certain situations. And that's untenable long-term as well.

Thanks.

Our next question comes from the line of Joanne Wuensch from BMO Capital Markets. Please proceed with your question.

Thank you very much for taking my question.

Forgive me if you've already given this. I've been moving between calls, but have you given us an update on the Big Apple training session -- center out in New Jersey?

We just talked about how well it's doing. We didn't talk specifically about any numbers. We just said that overall, we expect to see about 550 surgeons train this year. But that's both facilities, obviously, and we are seeing just a very good impact and effect from that facility. So it's going very well for us.

Let me ask the question a different way then. OUS sales went up nicely this quarter, and you're on track to double it for the year. What percentage of the doctors that you are training there are from OUS?

I would still say that -- I don't know if we know an exact percentage, but a majority of the surgeons coming from OUS are still coming to the San Diego facility. But the Big Apple facility has been responsible for a number of very strong visits as well. But it's really -- it's really -- we leave a lot of it up to the surgeon as well, and their schedule and everything else. We are not pushing them one way or another, necessarily.

We've certainly seen follow-up visits come out there for advanced training from Europe, so I don't have the exact number in front of us.

Without the exact number, Joanne, I think the rough consideration on it is, a lot of the stuff flowing in and out of New Jersey is up and down the East Coast, right, and primarily the Northeast.

Okay. And when do you expect your OUS business to be break-even?

It is break-even.

It is. Excellent.

Profitable next year.

Break-even, profitable next year.

It is break-even this year. It will be profitable next year.

Even better. Thank you.

Yes.

Our next question comes from the line of John Putnam from Capstone Investments. Please proceed with your questions.

Thanks very much.

First of all, is MaXcess 4, is that FDA approved?

Yes. Yes, it is.

And was that under a 510k?

Yes.

Okay. What I was wondering is, a lot of companies in the medical device industry that used to get products approved first in the United States are now looking overseas to try to get those products approved first, I think to generate some revenues. Are you giving any stronger consideration to doing that or adopting that kind of a strategy?

We are considering it. We haven't really done it in earnest at this point in time. We're very seriously looking at manufacturing outside of the United States because of the regulatory and economic environment that is unfavorable for us doing it here. I think it's going to become more and more of a reality for us to start to do certain things outside of the US, unless things start to pick up with FDA. But we've seen a very significant decrease in our approval time, so we've seen things slow down by as much as 50% over the last year or so between '10 and '11. So we're not very happy with the overall approval time process right now.

A good example of what you're referring to is how we're going to go forward with ATTRAX. Obviously, ATTRAX is under CE style mark -- what Alex was talking about, the Progentix product line, going forward with using that in Europe and launching that in Europe. And it's not a significant amount of revenue, but it certainly is a great way to make sure that we're ready for the US launch as far as handling properties and how it's packaged and just the formalities of how it's being presented to the customer.

Right. It also does give you some revenues that otherwise wouldn't be there.

Right. That's correct.

Thanks very much.

Yes, there is nothing really significant, though, in the way of revenues. In line with your questions, nothing really significant this year, maybe next year, but nothing that we're really contemplating at the moment.

Our next question comes from the line of Doug Schenkel from Cowen and Company. Please proceed with your question.

Hi, guys. Thanks for taking the questions.

Sure.

Beyond picking up market share, an important component of your growth strategy is obviously driving more revenue growth per procedure. Given your year-over-year growth in a tough market, it seems like this must be an important factor in driving growth this quarter. Are there any notable trends along these lines that you would be able to share with us?

Of driving more revenue per procedure?

Yes. Basically moving up the spine, getting biologics used in a higher percentage of procedures, anything notable there this quarter?

No, I would say it's pretty consistent. Not a big change, overall. I mean, certainly we do see more cervical business that comes from some of our existing customer base and so forth. Those are the pull-through products. So I think as far as just getting more for a procedure, no, not necessarily. It's really more procedures that come from some of that existing base. But that trend has been intact since last year.

Okay. So really a continuation of what you've seen in the past few quarters?

Yes.

Okay.

And then, again in your prepared remarks, you talked about the 10% to 20% of the market that is susceptible to, really, the enforcement of the Milliman guidelines. You're now talking about the lumbar market growing 1% to 4%. Is some of this a function of you thinking that the exposure is maybe closer to 10% than 20%, or is this more a function of the successful appeals dynamics that you mentioned in your prepared remarks?

I think it's a combination of the two. It seems to us that it's probably -- you know, I think the impact on us, we've talked about DDD being roughly 5% overall in terms of our customer base. I think that probably, as we're seeing the market right now, there is definitely 10% gone from the market. So we've got that pretty well understood at this point in time.

And sorry, I forgot the second part of your question.

No, it was really just how much of it is more successful appeals versus (inaudible).

On the successful appeals front, I think that that is kind of baked into where we are right now, because what is happening is that in some cases -- we talked about this just through our own small survey that we did. But 40% of the surgeons are spending much longer on the appeals process for a particular patient, and so that can go on for months. And I was in the operating room last week, and a surgeon told me about somebody that really had taken months to get through the process and who was in severe pain, whereas 90% of his patients are just flying right through, and nothing particularly unusual about that particular patient. So we think it's around -- we think 10% is a pretty good number, overall.

A good number. Okay. Thanks very much.

You're welcome.

Our next question comes from the line of Glenn Novarro from RBC Capital Markets. Please proceed with your question.

Thanks. Good afternoon, guys.

I have a question on the competitive landscape for lateral. Most of the knockoffs were unveiled at last year's NAS, which was October, if not before that. Generally, a trialing period for a device procedure is usually six months. So my question is two-fold.

One, on previous calls you said that you lost very few surgeons to the competition. I'm wondering if that's still the case. And then second, I'm wondering if you're feeling better about your outlook, because we're coming toward the end of this trialing period, and you've lost very little surgeons, and you just believe that the risk of losing any more surgeons is now pretty minimal.

Any thoughts there? Thanks.

We've not lost very many surgeons, so I think it's consistent with our prior remarks. And again, as I talked about in some of the Q&A here, I think that what we've seen in terms of trialing are a lot of surgeons that would not necessarily be involved in lateral technology. So not to pick on any particular competitor, but if you look at some of those that have the most prehistoric offerings, that you'd actually have to sit there and wonder, why is a surgeon even thinking about doing this? Well, it's because of the relationship of what they have, and it's because of their version of trying to expose them to some form of lateral surgery.

And what we've found is that there are some surgeons out there that don't know very much at all about XLIF, and that's consistent with our overall footprint and market share and the size of our sales force compared to some of the larger companies. So I do not think that there is a magic number of six months trialing. I think what we're seeing is just a lot more surgeons being exposed to lateral, and that's helpful to us.

But is it fair to say, Alex, that you're just feeling a lot more confident about your competitive positioning today and going forward?

Sure. I think what we've seen is that as we've been kind of running through the storm here of the market and of our competitors, what we're seeing is just the fact that our surgeons are staying with us. And they're not staying with us just because they feel so good about the Company, they're staying with us because of our offering, because of all of the programs that we have, everything we do on education, and so forth. So, yes, we feel a lot more confident, I think, as we look at the rest of this year.

And since you're allowing one more follow-up, just a real quick one. Your cervical disc, do you think that needs an FDA panel, or are yes just going to get an approval at some point via a press release?

Yes, we do not think it's going to be an FDA panel, and so we've been informed of such, and so we believe that that's going to stick. So it's just a matter of kind of working through the process.

Okay. Great. Thank you.

You're welcome.

Our next question comes from the line of David Roman from Goldman Sachs. Please proceed with your question.

Good evening, and thank you for taking the question. I apologize for the background noise. I'm on a cell phone.

But I was hoping, Alex -- you talked a little bit about insurance being one of the key drivers of the slowing in the growth rate last year, but have you guys built up a model or quantified to what extent insurance, the economy, and new competition contributed to the slowing of the growth rate?

No. I don't think so.

I guess why I'm asking is while I've been thinking about the recovery you've talked about in the second half of the year and sort of quantify what was lost in the back half of last year and whether we should look at the second half of the year as a normalization period whereby you have a hockey stick-type growth effect where a lot of these patients who might have been deferring procedures for more economic reasons come back, or is this just kind of things are slowly stabilizing, and as the comps get easier, the growth rate accelerates?

I think what we've gotten used to is the change in the flow of patients, and we've seen a decrease in terms of the overall volume of surgeons, and I'm talking about this as a market. And I think that that's what we've all gotten accustomed to. And what we're seeing from the surgeons and what we're hearing and -- both anecdotally and through our own form of surveys, is that it has stabilized. So I don't know that it's -- I don't think it's necessarily a particular type of patient. It's just that their overall flow has decreased, and now we're all pretty comfortable with what that flow is, and it seems to be a lot more predictable.

Okay.

And then maybe for Michael, if I look at -- you did raise revenue guidance. But more than the upside in the quarter, I think to the tune of about $5 million, I was wondering why we do not see that flow-through to the operating margin side, where I think you said underlying operating margins are about the same as the previous guidance, excluding the impact of the change in depreciation. If we're thinking that $5 million would add sort of anywhere from 30 to 50 basis points to that number, is that --

David, there was an increment add for the revs upside guidance, and we do have it reconciled roughly -- I think pretty clearly in the tables. I think some of it is in the rounding. We're going from 16.5% with the old guidance to 17.5% or so. So it's in that 1% increase you've got a couple of impacts. You've got the EUL, you've got the revs change, you've got the tax piece. It's mostly in the rounding. There is upside built in on the topline, $5 million increment.

And lastly, on international, the growth rate you're putting up is obviously very strong. How is it parsed out on existing geographies where you can see it last year versus new geographies that you've entered?

It's, for the most part, the existing geographies from last year. There is a few new ones in Latin America, but most of it is coming from Asia-Pacific and from Europe and in the Latin American markets that we were in last year.

Okay. Thank you very much.

You're welcome.

Our next question comes from the line of Charles Chon from Stifel Nicolaus. Please proceed with your question.

Great. Thank you.

Alex, when I take your numbers and back into how much NuVasive's US lumbar business growth was during the quarter, I think it was 10%. Does that sound right to you?

That's approximately correct, yes.

Okay. Thanks.

And then, second question is on just the SM&A spending for 2011, the guidance there. If SM&A on a non-GAAP basis was roughly 62% during the quarter and I take into account the higher revenue guidance of the year, back out the positive impact from the accounting change, in order for SM&A to come in line with the guidance from before, which was 56.5%, I think underlying SM&A spend has to stay roughly flat on an absolute basis, if not actually decline from first quarter levels at some point going forward. Is this correct? Is the first quarter SM&A spend on an absolute dollar basis? This is a high water mark for the year, and is this something that the Company can do, or maybe is my math off here?

Charley, I haven't mapped it out exactly the way you're describing, but remember the EUL piece is a chunk in there. We have looked at it and we know from the old view we were looking at, 56.5, we're comfortable we can execute to the 55.5. Sorry, I used EOL, Patrick is reminding me, the change in accounting estimate.

But is it possible to actually reduce SM&A spending on an absolute dollar basis here going forward, the underlying SM&A spending? Because I think that's what you're guidance is implying. My math might be off here but that would be very impressive kind of operating leverage if that were to be the case.

I don't think that's exactly what it's implying.

Okay. Maybe we can take this conversation offline.

Okay.

Thank you.

Okay, sure.

Our next question comes from the line of Jason Wittes from Caris & Company. Please proceed with your question.

Thank you. First off, I understand that there is really no definitive end of trialing, but it sounds to me like you've reached at least an inflection point, where the trialing has at least slowed down. A, is that the case? And B, you also have mentioned in the past that there is an extended sales period of roughly nine months, I believe. Is that still in place in terms of you think about gaining new accounts, etcetera?

Yes. I think it can be as long as nine months, and I think that it's in that six- to nine-month range. And I think the whole idea of trialing is that it's not going to end because it's a market expansion process. So there is always going to be competitors out there showing something lateral. Lateral is obviously here to stay. We've changed the spine surgery market very dramatically with it. So I think what starts to happen is that everybody starts to kind of filling their own little niche of whatever customers they have, and then over time, they get exposed to what they believe is the best offering.

And along those lines, basically, it sounds like you're saying it's a net-net win, because they're basically looking at these inferior products and eventually just going with you, it just takes a little longer. Is that the way to be thinking about it?

That's how we look at it.

And is that showing up in the numbers this quarter? I think the math is about 10%.

We're clearly taking share, and I think that that's what we've been talking about, and that gives us confidence on the second half of the year to increase our guidance.

And the last follow up on that is, so that's part of your confidence in the numbers, but also I think you talked about MAS 4 also kicking in the second half, being part of your guidance, and less so any change in specific macro and specific spine macro environment, or is there some of that incorporated into that thought?

I think, again, it's just flat. And so, I think that that's really what has changed. If there was concern, and I think we all had concern from third quarter of last year, whether or not that this would -- this market would decelerate for a longer period of time, we're not seeing that right now. We're seeing it flatten out, and we're seeing our ability to take market share significantly enhanced.

Okay, thank you.

You're welcome.

Our next question comes from the line of Michael Matson from Mizuho Securities USA. Please proceed with your question.

Yes, thanks.

I guess a question for Michael, just about the tax rate. I know it's come down, your guidance, it's at 45% versus 49%, but even at 45%, it's well above what I've seen for any other med tech companies I've looked at. And just wondering if there is some further conservatism built into that, or if you really think it's going to end up being that high.

We're just trying to help socialism, that's all. Sorry, go ahead, Michael.

Well, 45% is the current view for the full-year outlook, and you've got to forecast the tax rate that way on an annual basis. And we're in a zone where it's highly sensitive to the pre-tax book income. At the start of the year, working off of a very low GAAP pre-tax book income, we saw a significant increase in the forecast up to the 49%, because it was so -- it was because the pre-tax book income was so low. The reason you saw Q2 come down quite a bit is the accounting estimate change actually helped -- sorry, the accounting estimate change actually reduced the impact, and so you see leverage off of the tax rate from 49% down to 45%. So you've got a small amount of fixed dollars in the rate that get leveraged as the pre-tax book income goes up.

Okay.

And then a question for Keith or Alex. I know that, just regarding cervical discs, I know I had asked the question back at one of your investor days about reimbursement -- physician reimbursement for cervical discs being lower than it was for cervical fusions. And I think the response you guys gave was that you expected that to kind of come into line, basically, with the fusion coming down, essentially, to where discs were. So has that happened yet, and if not, is that something that you still expect to happen?

Yes. No, it hasn't happened, but it certainly looks like that will be the ultimate direction. At the SAS meeting, there appears to be additional coverage decisions that are positive for cervical TDR, and I think as that sweeps across and becomes consistent across the nation, you'll start seeing that become more and more in line. And certainly, it's also a phenomenon that will be driven ultimately -- obviously by decisions with CMS.

We still think that that's going to invariably happen over the next few years.

And then just one quick question on the patent trial. With Medtronic, can you just tell us how many patents at this point are involved from either side of the case?

Yes, we are faced with -- we are faced with one that we're in with them. And there are four on their part. But it goes to speak to families, so there's three families that are being discussed from a product perspective.

So you're suing them over one patent, and they're suing you over four? Am I hearing you correctly, or am I getting that backwards?

Yes. Three.

Four total.

All right. Thanks a lot.

I'm sorry, too, you're probably looking back a few years when this first started. And there were others that were in that suit that are put aside, if you will. And this was the streamlining of getting this particular case down a pathway. So the others are still there and could come after this.

Okay, thanks.

Did you understand that, Michael? Because I think it's a good point.

So I think there was nine or ten patents originally, right? And so it's been really knocked down to the ones that I think are the greatest conflict, I guess is the best way to put it, and those are the ones that we're really litigating over right now. It's our defense on, we're suing them with regard to XLIF, and so it's being reduced down really to the XLIF litigation at this point. And then, as Keith said, there could be some additional things down the road. We cannot really speculate about that. But this trial will focus more narrowly on the smaller number of patents.

Also let me take a better shot. I lost my train of thought on the tax response a couple of minutes ago.

So from 49% moving down to 45% in the quarter, lower than the prior guidance of the 49, really due to the higher pre-tax book income on the accounting change and estimate, and we also had better estimates of non-deductible expenses associated with stock-based comp because we made the Q1 grant. That higher pre-tax book income really allows us to leverage the permanent differences, those fixed dollars that sit in our tax rate, resulting in the benefit that you saw. We do think about this year as now a 45%. We think about next year as probably 45 -- mid 40s, 45-ish, hopefully getting down the following year to below that.

And then last comment I'll make is, we're just starting some of the long-term tax planning this year to try and get that rate down to a more effective level of sub-40. A lot of our competitors you see down in the mid- to high 20s and mid-30s range. And we think over the long term, once we put in place long-term tax planning, we can get down towards those levels.

All right. That's all I have. That was very helpful. Thank you.

Michael, just so we close clearly on your question on the patents, it's three for Medtronic, it's one for us. The core for us is around the neurophysiology, and the core for them really is around the lateral implant. So that's really the way it's coming down. So the tranches out in the future, as Alex said, you can't speculate as to whether those will even be an issue still, later on. This is really what we've faced, and it's taken, what, almost four years to get to this place.

Okay.

All right.

Our last question in queue comes from the line of Douglas Tsao from Barclays Capital. Please proceed with your question.

Thanks for sneaking me in here.

Just, Alex, on the triple D reimbursement front, I guess you're sort of now sensing that it's going it be down 10% or is going to go away. Is that sort of a sense -- what is leading you to think that it's not maybe as severe as the 10% to 20% range that I think you had suggested before? Is that there are sort of particular aspects of triple D disease or sort of sub-segments of it that are being allowed through, or is it just the effectiveness of surgeons in terms of navigating the reimbursement process?

I think it's a combination of both the things that you mentioned. I think that there is a part of triple D that has gone away. I think basically permanently. And that would be doing a three- or four-level fusion, for example. I just don't know how that's really going to get approved. And that's not the majority of cases by any means. But I think that those are going to be very difficult to get through.

But I think if you look at somebody that has DDD and potentially some other mitigating circumstances, it's possible that they're going to get through. So -- and we're seeing that. We're seeing people that have maybe a one-level or a two-level situation, and they're going through, because they're just -- there is enough severe pain involved, there is enough problems with regard to disability and so forth, that I think the insurance company is realizing that -- because nobody ever said that you shouldn't be operated on for DDD. I think you should be operated on very selectively. And the insurance companies, I think, and the surgeons generally agree on that. But you just cannot make a blanket policy that excludes people on the basis of actuarial tables.

So in coming full circle on it, I think 10% is probably a pretty reasonable number, but again, a lot of this is the contraction of the market which is there, but it's that slowing down of the queue that has just -- and I don't think there is ever going to be a hockey stick that comes out of that. That I think that that's a permanent slowdown in the queue, because there will always be heightened scrutiny of these cases, regardless of the success with the guidelines.

Okay.

And then just one follow-up question for Michael. Not to belabor the point, but in terms of the operating margin guidance, it's going from 16.5 to 17.5, but we're getting 140 basis points from the change in the accounting treatment for the instrument sets. So is there a negative headwind, sort of as an offset to that, or are we just thinking about rounding here?

Yes, I mean I've said part of it is rounding, but the 140 basis points was actually the Q1 impact. It's actually -- the way the math works it's not that full impact over the rest of the course of the year. It's about 100 -- it's a little over 100 basis points on the full year. That's the point to take away. And by the way, that's really a function of a growing revenue stream, right?

And so when we think about just sort of straightforward though, this accounting change does represent the lion's share or the increase to the operating margin right now?

It represents the majority of it. I think that's right. If you remember, we've talked about running the business in this range of revenue to within a certain revs range to a certain OI margin. And so we're putting in place the cost profiles to try and deliver the growth that will also deliver the margin. So you're right. The last observation was correct.

Okay, great. Thank you very much. Have a good night, guys.

Thank you.

There are no more questions. I would like to hand the call back over to management for closing comments.

Okay, well, thanks everybody for your time today, and we look forward to speaking with you in another quarter. See you until then.

Ladies and gentlemen, this does conclude today's teleconference. Thank you for your participation. You may disconnect your lines at this time, and have a wonderful day.