NuVasive Inc (NUVA) 2011 Q3 法說會逐字稿

Greetings, and welcome to the NuVasive third-quarter 2011 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). It is now my pleasure to introduce your host, Patrick Williams, Vice President, Industry and Investor Relations for NuVasive. Thank you, Mr. Williams. You may now begin.

Welcome to NuVasive's third-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 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 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 filings filed with the Securities and Exchange Commission. Finally, as a courtesy to all, we ask that you limit your questions during the Q & A section so that we 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.

NuVa outpaces the market once again. Third quarter 2011 was both eventful and demanding. Revenue grew nearly 11% percent year-over-year, despite a challenging spine market with flat to negative growth. We are very pleased with our industry-leading execution and we remain on-track growing our business within our range of annual guidance.

I will begin today by recounting some highlights of the strategic move we made to acquire Impulse Monitoring. We look forward to expanding the Impulse platform nationwide and applying the lessons learned from our own neuromonitoring business as we integrate Impulse into our operations. Our own experience in neuromonitoring gives us confidence to accelerate our market share gains in spine implants and biologics, NeuroVision and XLIF, and intraoperative monitoring, which I will refer to as IOM.

NeuroVision is, and will remain, the gold standard for neuromonitoring when performing any lateral approach to spine fusion. The Impulse Monitoring acquisition enhances us to take share in the spine market by building upon NuVasive's unique reputation of offering complete procedural solutions in both lateral and across all areas of spine surgery. NeuroVision's real-time, surgeon self-directed, discrete and directional neuromonitoring is what we believe makes our solution to lateral surgery safe and reproducible.

The acquisition of Impulse opens new doors to revenue and deeper market penetration. We will benefit from extensive cross-selling opportunities, as our team of over 300 spine specialists has little overlap with the hospital relationships fostered by Impulse's team of 150 neurophysiologists. Our Impulse team has contracts with approximately 200 hospitals. Currently, our spine specialists have business in 20 of the 200, a huge opportunity.

In our IOM experience, we have learned that few can advocate the technical superiority of NeuroVision better than a neurophysiologist. The wealth of clinical expertise that neurophysiologists bring to an operating room will be a key strategic advantage to expanding our surgeon relationships, providing unmatched patient outcomes, and convincing surgeons that our fully integrated platform is the best lateral solution available. We can also capture the additional IOM revenue opportunity in the growing number of non-lateral procedures already utilizing neuromonitoring.

Equally as important to opening new doors and expanding our IOM platform are the efficiencies we expect to create in the field. NuVasive continues to lead the evolution of complete procedural integration in the operating room. By bringing Impulse's accredited neurophysiologists into the NuVasive offering, they can focus on patient care and monitoring in the OR, while the NuVa spine specialist manages the surgical flow of implants and instruments. This allows the NuVa specialist to dedicate more time to product sales. Our neurophysiologist network and expertise, coupled with our top-notch sales force, will be an unparalleled force in driving market share gains and elevating the standard of spine surgery and patient care. Our competition is going to be left behind.

Adding IOM to NuVasive's product offering puts us in the driver's sheet. As neuromonitoring increasingly becomes the standard of care in both lateral and non-lateral spine procedures, not only can we offer the market-leading solution in NeuroVision, we can also offer the most comprehensive, safe, and reproducible platform complete with certified neurophysiologists. This adds value to every single case.

Now, let me turn to the jury verdict in phase 1 of our trial with Medtronic. There have not been any meaningful, subsequent events since the date of the verdict. We are now in the post-trial motions portion of the case. And over the next few months, the original presiding judge will hear motions on both sides over the size of the damages award, ongoing royalty rates, what those rates should apply to, and the amount of the judgment that needs to be secured and numerous other issues. At this time, we anticipate post-trial motions will wrap up sometime in Q1 of 2012. To date, neither side has asked for an injunction. While it is possible that either side can move for an injunction, history shows injunctions are rarely granted as they require proof of irreparable harm, which is typically very difficult to prove. Depending on the outcome of the post-trial motions, the case will move to the appellate court in Washington DC before a panel of 3 judges with expertise in patent law. This process typically takes about a year to conclude, so we are unlikely to have a final decision on the first phase of the trial until sometime in 2013.

Please note that we are finished with the jury portion of the trial, as all post-trial motions and the appellate case will be decided by judges. While we are confident in the appellate process, we are mindful of the need to prepare for any outcome. We continue to develop a strategic plan that contemplates royalty payments as the future cost of doing business, and a potential product development plan that designs around the limitations set forth by the outcomes of the trial. At this point, we find it prudent to reflect the financial impact of the trial outcomes and our ongoing results. Michael will go into more detail on this.

Let me assure you of 2 things. First NuVasive is a growth business. We will continue to invest in the levers of our growth, be it overseas expansion, surgeon training, development, and sales force expansion. We recognize that these investments are the very foundations of our market share taking ability. Second, we are looking at ways to prioritize investments into our growth. There are numerous levers to pull within G&A, COGS and company-wide projects that are being prioritized, should royalty payments be a new cost of doing business. From a tax perspective, after reserving for all outstanding items, we feel we still have sufficient cash of over $100 million to execute on our business and strategic plans. Michael will provide more detail in just a moment.

I also would like to be clear that the attitude of our sales force remains overwhelmingly positive. Our sales force and surgeon customers recognize that the entire litigation is Medtronic's sour grapes over losing the battle in the field. NuVa spine specialists are emboldened to take market share by standing true to what got us here, superior patient outcomes and a culture of innovation driving a pipeline of new products, all coupled with absolute responsiveness. When I shared the news of the verdict with the NuVasive team, I also issued a call-to-arms across our team. It was met with resounding commitments around the globe.

Simply put, today's NuVa family of 1,300 is in. And, I mean really in. Like never before. We take it personally. In the face of this adversity, we are sending a clear message to the market. Surgeons and the entire industry recognize that NuVasive developed XLIF and its advanced applications with Dr. Pimenta and many gifted surgeons. We pioneered the lateral approach. We are only getting started, and we intend to continue to take market share in spine for many years to come, especially from Medtronic.

I will now offer an update on the US spine market and the progress being made to ensure patient access to spine procedures. Progress is being made. About a year ago, various private payers increased the level of scrutiny and the enforcement of criteria necessary to preauthorize lumbar fusion surgery. This is a dynamic that continues to depress US spine procedure volumes, as evidenced by flat to even slightly negative US spine market growth throughout 2011. We are encouraged by our experience in the field, which continues to indicate that the landscape is stabilizing, as surgeons learn to navigate the new environment and slower cues.

As I have said in the past, we expect to return to mid-single digit volume industry growth longer-term, but organic growth is unlikely to materialize until the surgical community is able to affect change with the private payers. To that end, I am happy to report that there was progress made during the quarter with the Medicare administrative contractor for the state of Florida. Just a few months ago, the contractor proposed a restrictive new policy for lumbar spinal fusion, which would have negatively impacted patient access to fusion procedures. NuVasive immediately engaged the surgeon community and our Better Way Back patient ambassadors, resulting in almost 200 submitted letters, including 1 from Senator Marco Rubio, which requested a reversal of the restrictive coverage headlines.

As well, AANS, one of the major surgical societies in spine, reacted very quickly with a well-crafted response, asserting that a surgeon's clinical judgment and the individual patient needs should take precedence over strict and rigid criteria that mostly serves the payers' interests. I am pleased to report that the changes AANS suggested were, for the most part, accepted and resolved in the final policy that was put place this month. We are also grateful to Senator Rubio for ensuring patient access to spine surgery.

I think this is an outstanding example of the coordinated effort underway behind the scenes throughout the country, as NuVasive actively works to support the surgeons and the spine societies in advocacy for their patients. We have a good understanding of what it takes to affect change on a grander scale, what the process entails, and who the key stakeholders are. We will continue to forge ahead in this mission on behalf of the entire spine industry.

We also continue to work closely with the surgical societies and the clinical research community to facilitate thoughtful, clinically supported, consistent guidelines for spine fusion, which are on track to be completed over a few months. At that point, the guidelines will be coupled with a wealth of peer-reviewed clinical evidence, and submitted to the payers as a more uniform set of standards for lumbar fusion surgery. A set of standards that should altogether replace the myopic and absurd (inaudible) guidelines. It is our collective goal that surgeons, not actuarial consultants hired by the payers, will determine the appropriate care for patients and that good medicine and good outcomes will prevail. Today's technologically advanced spine surgery is indeed good medicine.

So now I will turn further outline of our results in the quarter. And first of all, obviously revenue in the third quarter increased nearly 11% year-over-year to approximately $133 million. This was slightly below our expectations because of challenging conditions in several European markets, where current economic conditions are impacting surgery volumes. European revenues were about $2 million light of our expectations in the third quarter. However, our US lumbar business is exceeding expectations.

With that, I will focus on updated revenue guidance for the full year 2011. Based on a good Q1 result and anticipated continued penetration in both Europe and in biologics for the second half of the year, we raised our original full-year guidance of $525 million to $535 million by $5 million on both the low and high end. Now with only 1 quarter remaining in the year, it has become clear that we cannot offset increasing weakness in key European markets, and that we cannot achieve the penetration that we anticipated with our US biologics business in this environment. As a result, we now anticipate our core business to come in at a lower end of our current revenue guidance of $530 million to $540 million. Including an approximate $8 million contribution for the newly acquired Impulse IOM service, we now anticipate full-year 2011 revenue of $538 million to $540 million.

Let me walk you through our expectations for each of the major components of our revenue. I will begin with our expectations for our US lumbar business, which represents about 65% of our overall business. As I mentioned, while insurance payer pressure continues to negatively impact the market, we continue to observe evidence that the market is stabilizing. Our results over the last year imply that our expectations about the trend impact on NuVasive's US lumbar growth were appropriate, and in fact, a bit conservative. Despite the host of me too lateral solutions introduced to the market within the last year, our results point to continued solid market share gains. Driven by our XLIF and NeuroVision penetration, we now anticipate US lumbar growth of approximately 6% to 7% for the full year, up from the 3% to 6% rate we previously expected.

Next I'll turn to our international business and expand on what is happening in each area. We continue to see strong growth in our Asian market led by Australia, New Zealand and Singapore. The Latin America markets also continue to outperform expectations. However, European markets comprised about half of our international revenues at this point in time. The economic turmoil there began to impact our revenue in the second quarter, which we offset, but had a more significant impact in the third quarter. While surgeon adoption and market share increases are as solid as ever, European turbulence is impacting surgery volumes. We also are experiencing reluctance among European distributors to make investments in growth.

Europe remains a sizable market for us. Our key growth plans for that region will focus on direct distribution; however, revenues from the region were about $2 million light of our expectations in the third quarter, as I said earlier. And we expect the turmoil will continue to pressure results for the time being. As a result of the European slowdown, we now anticipate full-year 2011 international revenue growth of about 60% to 70%, compared to the doubling of revenues that we expected previously.

Biologics results in the quarter suggests a full-year growth rate closer to 10%, compared to the 15% rate we were expecting previously. As I mentioned last quarter, delays at the FDA have forced us to shift out the expected contribution from AttraX into 2012. As well, we are not seeing the pull-through we anticipated for Osteocel Plus in this environment of heightened, infused scrutiny. Deeper account penetration of our biologics portfolio to contribute up to 15% to 20% of our overall revenue at $1 billion in revenue, will require the approval of AttraX and additional clinical data of our Osteocel Plus product, which we now expect in the first half of 2012. Finally, our cervical offering remains strong and on track to grow at a roughly 20% rate for the full year, despite continuing FDA delays of our PCM disc replacement.

Michael will detail guidance for the rest of the P&L in a moment, but before I turn it over to him, please note that our investor luncheon, which we are hosting in connection with NASS next week, takes place on Thursday, November 4. We have a very comprehensive investor event planned, which will feature a progress report on our long-term growth drivers. And like years past, we will have an interactive surgeon panel comprised of some of the nations' leading spine surgeons, including a focus on our recent Impulse Monitoring acquisition, and the importance of intraoperative monitoring and spine procedures. There will be time allocated for Q&A, and our intention is for the audience to walk away with a deeper understanding of our long-term vision for NuVasive. It is an opportunity not to be missed, and we hope to see you in Chicago. Please reach out to our IR team if you plan to attend, or with any questions.

Speaking of NASS, we continue to leverage unrivaled years of experience in XLIF to afford NuVasive the best-in-class, most comprehensive lateral solution for spine fusion, and our showing at the conference next week will be a testament to our prowess and superior position. We will proudly feature the next-generation MaXcess 4 Retractor, which is now widely available in the field. We will also showcase an enhanced user-interface functionality for our NeuroVision M5 system, and a recently FDA-cleared NeuroVision M5-enabled electrode, which is now integrated into MaXcess 4. There is nothing else like it on the market. It is a big differentiator for NuVa once again.

We have had great success the last few years as a result of our recently developed ability to treat every level of the spine and to offer a comprehensive platform capable of addressing the spine surgeon's every need. In keeping with that progression and with the innovation that surgeons have come to expect from NuVasive, our booth at NASS this year will also feature our new IOM offering, a new MAS posterior fixation system, and a new CoRoent XL implant that will be the widest implant available. Our advocacy efforts to ensure patient access to life-improving spine surgery will be prominently displayed as well. Our Better Way Back program patient ambassadors, like Bill Walton, will also be involved in various events. And our [Solis] numbers will be active in various panels. We encourage you to stop by the NuVasive booth to gain an appreciation for the full suite of innovative solutions that we continue to offer. With that, I'll turn the call over to Michael.

Thank you, Alex, and good afternoon, everyone. Our revenue for the third quarter 2011 was $132.9 million. This represents a 10.5% increase over Q3 2010. Revenue results this quarter demonstrate continued strong execution within a very difficult spine environment. Biologics revenue was $25.5 million, and OUS revenue including its biologics component, was just under $10 million, or about 7.5% of total revenue in the quarter.

In our first quarter press release, we detailed an accounting estimate change, which went into effect this year. As a reminder, for certain loaned instrument sets placed into service before January 1, 2011, we changed the depreciable life estimate from 3 years to 4 years. This change in historical accounting estimate reduced depreciation expense, which is a sales, marketing, and administrative expense in the third quarter by $1.2 million, and year-to-date by $5 million. When comparing to prior year only, this increased both GAAP and non-GAAP earnings per share in the quarter by $0.02 and year-to-date by $0.09. Each quarter of actuals in 2011, as well as full-year 2011 guidance already takes into consideration this impact. So all numbers I'll reference below will be on an as-reported basis.

Now let me turn to our results in the third quarter. Our Q3 2011 GAAP net loss was $67.6 million, or a loss per share of $1.69. Excluding an aggregate adjustment of approximately $78.2 million, net of tax for stock-based compensation, certain intellectual property litigation and related expenses, the amortization of intangible assets, acquisition-related items, non cash interest expense associated with the new convertible notes, certain transactions associated with convertible notes activity, and certain discrete tax items, third quarter non-GAAP earnings were approximately $10.6 million, or $0.26 per share.

Gross margin in the third quarter was 80.4% compared to 82.1% in Q3 2010 and 80.8% in Q2 2011. Year-over-year gross margin was primarily impacted by higher excess in obsolete inventory reserves. Second order impacts on gross margin were caused by continued shifts in geographic mix and by estimated royalty expense accruals associated with the Medtronic litigation outcome, which by itself, drove more than 40 basis points of gross margin impact.

Operating expenses for Q3 2011 totaled $198.3 million, compared to an $89.1 million in Q3 2010, and $96 million in Q2 2011. Research and development, or R&D, expenses, adjusted to exclude stock-based compensation and acquisition-related items, totaled $9.2 million in Q3 2011, compared $9 million in Q3 2010, and $9.2 million in Q2 2011. R&D expense, as adjusted, was 6.9% of revenue for Q3 2011, versus 7.5% in Q3 2010, and 6.9% in Q2 2011.

Sales, marketing, and administrative, or SM&A expenses adjusted to exclude stock-based compensation, certain intellectual property litigation expenses and acquisition-related items totaled $75.3 million for Q3 2011, compared to $69.7 million in Q3 2010, and $75.3 million in Q2 2011. SM&A expense as a percent of revenue was 56.6% in Q3 2011 versus 57.9% in Q3 2010, and 56.6% in Q2 2011. The year-over-year decrease in SM&A is primarily attributable to the previously discussed change in accounting estimate. On an absolute basis the year-over-year increase in the more variable components of SM&A expense, including commissions, freight, international investment, and sales force personnel, was similar to the corresponding increase in revenue. In addition to the variable components, relative to last year, we invested significantly in adding (technical difficulty) and infrastructure, especially at our new East Coast training facility to support growth.

Third-quarter non-GAAP operating margin was 16.8%, compared to 16.6% in Q3 2010, and 17.3% in Q2 2011. Our non-GAAP operating margin in the quarter was impacted by more than 40 basis points, due to the effect of the estimated ongoing royalty expense accruals associated with the Medtronic litigation outcome. Non-GAAP operating margin excludes stock-based compensation, certain intellectual property litigation expenses, amortization of intangible assets, and acquisition-related items.

Stock-based compensation totaled $8.1 million in the quarter, compared to $7.3 million in Q3 2010, and $7.7 million in Q2 2011. Stock-based compensation was allocated as $7.5 million to SM&A expenses with the balance in R&D. Certain intellectual property litigation expenses were $103.7 million in the quarter, compared to $1.2 million in Q3 2010, and $1.1 million in Q2 2011.

This quarter, we recognized the full amount of the Medtronic litigation liability charge, which totaled $101.2 million. Although we are aggressively appealing this outcome, we recognize the full amount of the verdict in the third quarter. As Alex mentioned, post-trial motions that are underway will determine how much cash we are required to post bond for or restrict for the duration of the appeals process.

Amortization of intangible assets totaled $1.5 million in the quarter, compared to $1.3 million in Q3 2010, and $1.4 million in Q2 2011. Acquisition-related items totaled $441,000 in the quarter, compared to $629,000 in Q3 2010, and $1.3 million in Q2 2011. This quarter, acquisition-related items were allocated as 168,000 to SM&A, with the balance in R&D.

Interest and other expense net totaled $5.3 million in the quarter, compared to $1.5 million in Q3 2010, and $1.7 million in Q2 2011. Included in this total is $7.3 million in interest expense, with $3.7 million being cash, and $3 million representing the non-cash portion associated with the new convert. The remainder reflects issuance costs from the 2 notes. We also had a $2.4 million favorable mark-to-market impact in the quarter, associated with the accounting for the convertible conversion option and bond hedge related to our new convert. The mark-to-market treatment should be a 1 quarter issue for us, as we received shareholder approval within the quarter for the higher authorized share count we were seeking to support our new convertible debt structure. Interest and other expense net total also includes a one-time net P&L impact for the repurchase of $119 million of our March 2013 convertible notes.

In early August we repurchased approximately $119 million of the $230 million of convertible notes at a price equal to 99.4% of par value. This created a small one-time gain, which was more than offset by the write off of a pro rata share of the remaining deferred financing costs from the original debt issuance. On a net basis, the transaction resulted in a loss of $721,000 on the GAAP income statement, but it was certainly a favorable transaction from a cash standpoint. We expect to maintain a disciplined financial approach to dealing with the remaining $111 million balance as we head toward its eventual maturity in March 2013.

As a result of the $101.2 million expense recorded in the quarter from the Medtronic litigation liability charge, we concluded that, under GAAP, we would be unable to realize our California deferred tax assets, or DTAs. This caused us to establish a valuation allowance on those DTAs, resulting in a discrete tax impact of $4.8 million, which affected our tax expense line in Q3. Additionally, in connection with the repurchase of our March 2013 notes, we recorded tax expense of $1.5 million for future tax deductions, which we will no longer have access to.

On a year-to-date basis, cash provided by operating activities continued to demonstrate progress with Q3 coming in at approximately $25.7 million, and year-to-date coming in at $53.4 million. Looking forward, we continue to focus attention on identifying efficiencies in our cash-generation cycle.

Our cash and investments balance at the end of the third quarter, which does not include any of our restricted cash items, was approximately $419 million, which compares to $524 million at the end of Q2 2011, and 2010's ending balance of approximately $230 million. The major drivers of the change in cash sequentially were the $119 million repurchase of a portion of our March 2013 convertible notes and just under $15 million in positive free cash flow. Our primary investment focus for cash balances will continue to be safety of principal.

As Alex mentioned, from an ongoing cash position, we feel that we currently have ample resources to run the business and execute our strategic plans. Roughly $111 million remains earmarked to repurchase the balance of the convertible notes maturing in March 2013. Approximately $40 million was used to close the purchase of Impulse Monitoring in the first week of the fourth quarter, and there remains roughly $50 million related to future anticipated milestone payments for CerviTech and AttraX. Including those investments and setting aside $101 million for the Medtronic verdict award, we still have over $100 million in cash.

At the end of Q3 2011, our inventory position was just over 23% of annualized third quarter revenue, compared to over 20% at the end of Q3 2010, and just over 22% at the end of the second quarter. The slight sequential uptick was attributable to an increase in NeuroVision stock levels, as we prepare to expand our neuromonitoring footprint into product launch deferrals, which relate most directly to delays at the FDA. 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 this ratio will rise on occasion.

Day sales outstanding, or DSOs, when run off of our net AR balance was 53 days in the quarter, compared to 54 days for Q3 2010, and 55 days at the end of Q2 2011. On a year-over-year basis, we achieved a one-day reduction in DSO, even though the impacts from our increasing OUS revenue mix actually cost us a full day on the DSO front. Our collections team had a fantastic quarter in Q3, blasting well past the $125 million barrier in collections for the first time. My compliments out to this team.

Now let me expand on guidance for the full-year 2011. Please reference the tables in today's press release, which further detail the changes. The guidance update issued today, in addition to the normal items we include contemplates the impacts related to the acquisition of Impulse Monitoring, $101.2 million Medtronic litigation liability charge, and ongoing royalty rate assumptions, certain transactions associated with convertible notes activity, and certain discrete tax items. Our revised guidance does not contemplate any additional convertible note repurchases in 2011.

So, as Alex mentioned, we are updating revenue guidance for the full year 2011 to $538 million to $540 million. Moving through the rest of the P&L, we now anticipate a full-year gross margin of approximately 79.5%, compared to the approximately 81% that we previously anticipated. Relative to our prior guidance ranges, our acquisition of Impulse Monitoring has a roughly 70-basis-point negative impact on the full-year gross margin, while the estimated ongoing royalty expense accruals from Medtronic litigation outcome have a roughly 70-basis-point negative impact.

We now expect full-year 2011 non-GAAP operating margin to be 15.5% or higher, compared to the approximately 17.5% that we previously expected. Relative to our prior guidance ranges, approximately 30 basis points of this decrease is related to our acquisition of Impulse Monitoring, while approximately 70 basis points is related to the estimated ongoing royalty payment from the Medtronic litigation outcome. The balance of today's change is being driven by the lower view for full-year revenue and by our decision to maintain investments behind our market share-taking strategies.

We continue to expect R&D expense, excluding stock-based compensation and acquisition-related items to approximate 7% of revenue for the full year. We now expect SM&A expense to be approximately 57% of full-year revenue, compared to the 56.5% that we previously expected. We now anticipate stock-based compensation of approximately $32 million, compared to the $33 million that we previously expected, which will be allocated as roughly 90% towards SM&A expense, with the remainder towards R&D expense.

Excluding the $101.2 million liability charge, we now expect intellectual property litigation expenses related to the Medtronic patent dispute to come in a bit above the $6 million that we had previously guided to for the full year. We have spent approximately $5.7 million year-to-date, with a significant actuals expense number in Q3 in conjunction with the Medtronic litigation outcome decided in late September. For the full year 2011, we now expect the amortization of intangible assets to be approximately $6.5 million, compared to the $8 million that we previously expected.

Interest and other expense net is now anticipated to be just under $15 million for the full year 2011, down from the approximately $18.5 million we previously expected, due to the Q3 repurchase of approximately $119 million of our March 2013 convertible notes. For purposes of computing our non-GAAP earnings, we will exclude the non-cash interest expense associated with our new convertible notes, which we expect to be about $3 million in the fourth quarter.

Due primarily to the accrual of the Medtronic litigation award, our 2011 forecast of pre-tax book income has changed significantly from an income position to a significant loss position. As a result, we now anticipate a 2011 full-year GAAP effective tax benefit rate of approximately 27%, compared to the 50% tax expense rate that we previously expected. We now expect our non-GAAP adjustments will be tax affected at approximately 38% for the full year, down from the 40% rate that we previously expected. Our total tax liability on an absolute cash dollar basis for the full year is also expected to decrease.

Finally we now anticipate a full-year GAAP loss of $1.43 to $1.42, compared to $0.33 to $0.36 previously. We now expect non-GAAP EPS of $1.01 to $1.02, compared to $1.09 to $1.12 previously. Non-GAAP EPS excludes non-cash stock-based compensation, certain intellectual property litigation expenses, amortization of intangible assets, acquisition-related items, non-cash interest expense associated with the convertible notes, certain transactions associated with convertible notes activity, and certain discrete tax 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 a reconciliation of GAAP to non-GAAP EPS guidance.

We now expect 2011 fully diluted weighted average shares outstanding to be approximately 42.6 million for non-GAAP EPS purposes, up from the 42 million shares that we previously expected as a result of the acquisition of Impulse Monitoring.

The third quarter 2011 marks solid performance through continued industry turmoil, in what we will be another year of industry-leading growth for NuVasive. As Alex mentioned, we will give detailed guidance for 2012 when we report fourth-quarter and 2011 results in February. Now I'll turn the call back over to Alex for closing comments.

Thank you, Michael. And I appreciate your enthusiasm over cash collections. As I reflect on the third quarter, I am pleased with the outstanding execution by the NuVasive family. In the face of a most challenging spine market and the short-term distraction of a disappointing jury verdict, we delivered industry-leading growth and executed a strategic transaction that will increase the penetration of excellent for years to come. Financial results cannot do justice to the spirit of service and innovation at NuVasive that is not only alive and well, but also revived, as we look to win this battle for spine market share among certain surgeons who will see the breadth and importance of our differentiation to their practice and to their patients.

We will continue to position ourselves for strong growth and a challenging market as we drive toward our next milestone, which is the evolution of NuVasive into a $1 billion start-up Company. With only an 8% US market share and 6% global market share, we believe we have a lot of room to grow and take share. We believe the greatest ongoing value will be created by making targeted surgeons in those areas -- targeted investments, excuse me, in those areas which drive revenue growth and market penetration.

However, we also recognize that our industry is changing, and we need to restructure our approach to support strong top line growth in conjunction with solid operating margins improvements. Over the next few months as we finalize our budgets and strategic plans, we will be making the hard decisions necessary to more closely align our spending patterns with the current revenue growth we are delivering. We believe these choices will properly structure the organization to support robust long-term revenue growth and associated operating market translation. To that end, we will provide 2012 guidance during our Q4 earnings call in February.

With respect to our growth catalysts for 2012 and beyond, we remain very excited about our core growth opportunity and further fuel from our PCM cervical motion preservation device, our synthetic biologic AttraX, and entry into the Japan market, the number 2 market in the world behind the United States. As well, we will have better visibility into our Impulse Monitoring integration and growth plans, and could be closer to getting some resolution on the first phase of the Medtronic patent verdict.

To say the least, the spine market continues to face challenges. But the conversion to MIS and our ability to take market share and grow in multiples of the industry remains completely unchanged. We are well-positioned with key upcoming products and expansion of both our IOM and international markets to drive strong top-line growth for years to come, which should deliver increased profitability and cash generation. We hope that you will join us next week in Chicago. As we like to say at NuVa, onward and upward.

We will now take your questions.

Thank you. We will now be conducting a question-and-answer session. (Operator Instructions). Our first question comes from Bob Hopkins from Banc of America.

Hi, can you hear me okay?

Sure can.

So, just a couple of things, I want to try to get my arms around the guidance. Michael, for your guidance for non-GAAP operating margin for 2011 excluding the deal and excluding Medtronic has come in by 100 basis points. It is now 16.5% versus 17.5% previously. Is that right?

That's right, Bob.

Can you just talk quickly about why that is coming in?

You are talking about the remaining delta?

No, not the remaining delta, the 100 basis point decline. That is -- what is that exactly? Is that a function of revenues being a little lighter? Why the 16.5% versus 17.5% previously?

Yes, I got it. So, It is 100 basis point delta, 16.5% up to 17.5%. The split on that is really due to two things, Bob, lower view of full-year revs, call that roughly $5 million give or take, and then really maintaining some investments that we have been talking about behind the share taking strategy. A bit more than half of that, 100 basis points, is related to the revs delta and change on guidance.

Okay. And then Alex, in the past you have given thoughts on longer-term guidance. You're on record as giving some longer-term guidance previously. Has the slowdown in Europe that you're seeing and the general toughness of the market, should we anticipate that, that longer-term guidance from a revenue growth perspective will come in? Because I believe the math suggests that Q4 estimates are about 9% growth, which is a little bit less than what you are doing this quarter. I'm just wondering about your confidence in 2012 in light being at 10.5% this quarter, and maybe guiding to something like 9% next quarter on a core basis.

Our confidence is very high, Bob. We feel good about top-line revenue growth. And as I said, we're in the process right now of effectively regrouping and going over what our budgets are going to look like for next year and for the following years. And we want to make sure that we continue to grow at a very robust pace. We are not going to be making any comments with regard to 2012 until February, but certainly are very confident in our ability to grow share.

And as I mentioned in our remarks, very enthused about what we are seeing in terms of an uptick in the lumbar business, in particular, in the United States. We think that bodes very well for us, as well as what we are seeing in the way of strength across all the other sectors of the globe outside of Europe. So very strong performances in Asia-Pac, Latin America, and the United States, for that matter.

And then just lastly for me, Alex, you reiterated your guidance late in September. And now you're suggesting it's coming in at the lower end of the range. I'm wondering on the timing of the European slowdown and did that -- is that something that manifested late in the quarter again, and did things really deteriorate late in the quarter? Or can you just give some color around that, that would be great. And then I will jump off.

Sure. As I mentioned, Europe was light as we started the year. We thought that first quarter was pretty good, but after that, it started to lighten up. And we were able to offset it with strong growth in other parts of the globe. As we got into the third quarter, it has continued to be even lighter than we anticipated. So, we thought we were going to come in closer to a 135 number or so on the quarter. And that just didn't materialize in terms of Europe.

What we felt very strongly about during our road shows and during all of our discussions with investors and analysts is where we end up on the total year versus one quarter or being $1 million shy of consensus in this particular case. And that is what we are enthused about is that we are still coming in at the low end of guidance. We think there is a little bit upside to that. And then obviously, we have our Impulse acquisition on top of that. So we feel very bullish with regard to where we are on the year, and as well as our prospects for next year, which we are not prepared to detail with regard to any numbers, but feel very good about and we'll talk about as we get closer to February.

Okay.

Thank you. Our next question comes from Matt Taylor from Barclays Capital.

Hi. Thanks for taking the question. I wanted to ask you to go into some more depth on your comments on biologics. You mentioned some penetration issues. Is that having to do with the environment and scrutiny around Infuse, or is it something else. Was it a general macro comment?

Yes, I think the entire biologic's market right now is very soft, obviously driven by the fact that Infuse, as far as we can understand is dropping precipitously with regard to revenue contribution. So what we are seeing is, we are seeing very good uptake in our current accounts. We've seen that now for quite some time. And Osteocel does extremely well.

What we haven't seen is really an ability to go outside of our base business, and go into new accounts and get biologics business. So, we thought we might get some of that from Infuse, but we just have not seen that transfer. So, I think what is happening is that whatever -- wherever Infuse usage is going, in other words, wherever that revenue shortfall is being transferred, it's not coming to us. I think it is being spread out pretty evenly across the various companies that are out there, but we are not seeing a direct translation over to us as a result of Infuse. We thought we might see some of that as we got into the year.

Just a follow-up, you mentioned earlier in your comments that you continued to see some nice share gains despite competitive launches this year. There was just another launch recently from a big competitor. I was wondering if you're seeing any trialing or any disruption from that?

We are not.

Okay, thank you very much.

You're welcome.

Thank you. Our next question comes from Matt Hewitt from Craig Hallum.

Good afternoon. I realize it is very early, but with Impulse Monitoring, have you had a chance to speak with some of the customers that do overlap with your existing customer base? And what is the feedback you're getting there? Or from new potential customers, what are you hearing from the Street?

I think is still very early. Everybody is enthused; everything is positive. We expect things to go through as I outlined in my prepared remarks. So, I think it is moving along very well. I will tell you that anecdotally, there is a very good conversation taking place between our sales force and between the neurophysiologists. As we have accounts now that we are not in, and these guys are all talking to each other, guys and gals. They are all talking to each other, and really contemplating what is the way to get NuVasive in there, in terms of our core products, and conversely, I think, in areas where we don't have a monitoring presence outside of what we are doing laterally, Opportunities to bring Impulse into those accounts. So the chatter is very positive. The integration is still early, but it is going along as well as I think it can, and we are pleased with the progress.

Good, and then shifting gears, and I realize that you are not providing 2012 guidance. You mentioned roughly a 70-basis-point hit to margins because of the royalties. Is that how we should think about it as we are looking at our models for 2012?

Yes. That's right.

Okay. Thank you.

Our next question comes from Raj Denhoy from Jefferies & Co.

Good afternoon, good evening. Maybe just following up on the IMI question, I think you had previously talked about a run rate of $40 million and potentially doing $8 million here in the fourth quarter. When you look at that $40 million number though, have you contemplated much of this idea of additional pull-through for your other hardware? Is that potentially upside here in 2012, or how should we think about that at this point?

That is all up side in 2012. So as we think about our opportunities right now, and again we haven't given guidance, we do think that there is an upside to our core business and to the $40 million, with-pull through as well.

Following that last question, I know you haven't had this for long, but you have had another monitoring business in the past, or you still have that other monitoring business. Perhaps you could talk about some of the potentials. How quickly do you think this pull-through could materialize? Is it something that even early next year we could start to see some of this happening?

Yes, I think it is going to take a good 12 months to have the full impact that we are talking about. We don't want to be overzealous with regard to forecasting that positive uptick. But I do think it starts to happen rather soon. I think we will start to see it in as soon as a quarter. So I'm hoping that first part of next year, we start to see some of that pull through. But I don't really expect it to be material until about a year from now.

Also, it's Michael again. Just a quick clarification, I thought the last caller was asking about 2011 results on the basis points impact. It was 70 bps in 2011, but that of course is partial year. So if you think about next year, you really need to be thinking about roughly 180 basis points of impact, full year, all in.

Okay. Just a second question, just on the other things we should be looking for in 2012. I know you're not giving guidance on 2012 yet, but we have the AttraX approval and PCM, they're still sitting with the FDA. I'm curious if there has been any updates or any change in your confidence, your discussions with the FDA on the approval of those products? Do you think it is just a matter of timing? Is there potential for more data being required, or really just an update would be very helpful.

This has taken so long that it can't take much longer. I'll put it to you that way. So, I think the timing is realistic for, hopefully, the middle of next year for PCM. We don't have a fixed date; we don't know for sure. But we're hopeful that it's going to be resolved by the middle of next year. I would say that we have some visibility to that potential. AttraX, we're hopeful that we can get AttraX sorted out somewhere also in the first half of the year. Right now, and we're not going to be baking this into our numbers, but I guess as you guys are thinking about 2012 in particular, we don't have that contemplated. So whatever would be in the numbers would certainly be second half of the year, and that would include Japan too. Japan would be a second-half impact.

Okay, see that was just my last question. So Japan is still now contemplated for next year. For 2012 you expect to get there?

Yes, and I think the reality is it's going to be more to the end of the year. Again, it is just regulatory approvals. We are ready to fire up the infrastructure, and all of that is ready to go. And we have a lot of base infrastructure already in place. It is a 3Q or 4Q event for us, and it is just a matter of getting through the final hurdles.

Great, thank you.

Okay.

Thank you. Our next question comes from Ben Andrew from William Blair.

Good afternoon, everyone.

Hi, Ben.

Hi, Ben.

Alex, you talked about expanding the IOM business to add up to a few hundred people in total to that organization. Can you give us a sense of the time frame, if you have an update to that, as well as how you would finance that, or how you would attract those people to the organization?

Sure. What I last spoke about is that we are going to do things from an organic standpoint. It's not to say that we wouldn't consider acquisitions, but for the most part, we are going to be doing this with organic growth. So, outside of doing an acquisition of similar size or perhaps smaller than the one that we just did, I would guess that we would be adding in the neighborhood of 75 to 100 neurophysiologists as we grow it organically per year. So I think that if -- right now we have 150. Our desire would be to be at around 250 by the end of next year, and then probably adding about the same number the following year, and then being very close to the same size as our sales force.

What I want to have is a one-to-one ratio of neurophysiologists to NuVa spine specialists. We get there in about two years or so. We are continuing to look at different opportunities out there and see what could make sense. We are very mindful of our cash constraints right now, relative to the restrictions that we've placed on ourselves largely, and how we have looked at cash. We're looking at things that we might be able to do, and if we find some creative ways to do them, then perhaps we will execute them. But we don't have anything at the moment that we are looking to get done, and our focus is on organic development.

Hi, Ben, it is Michael. Also in support of that to your question on the financing side of it, even the organic growth requires some view on financing. So, as Alex mentioned earlier, that is part of what we are circling on as part of our budget closure process in the next month or so. The idea is to make sure we understand as you bring on that type of person, how fast does it take them to ramp up and scale? How quickly can they get to capacity utilization, or at least normalized capacity utilization that we expect, which gets them to revenue-producing and profitable producing -- profitable production.

The good thing about scaling the neurophysiologists is that you can get them up to speed in about three months. And then the key is to secure the contract for that particular hospital. If we are able to secure the contract and then essentially backfill in with neurophysiologists, we are online in about three months. So, as Michael said, there is some cash, there's some OpEx hit involved in doing so, but it's not very big, and it's very short-lived. It's an opportunity to translate that into revenue pretty fast.

Okay my other question, if I might, is as you think about the prioritization of revenue growth versus operating market pension next year, directionally, you have talked in the past about a goal over the course of a few years of something in the low to mid 20%s, maybe 22%, 23% op margin. Understanding the puts and takes, is that still a reasonable goal for a one or two-year time frame?

Not one or two years, that's a reasonable goal for the longer term. I think our primary focus is to continue to increase our top-line opportunities. And so, our objective is we want to get the Company growing to north of 15%, and that is what we are working on. We want to continue to improve our operating margin, and we're working on that in concert. I think our thesis of getting to $1 billion and getting to a very strong operating margin is very much intact. We are unable right now to really give you the exact letter of how we do that year-over-year. But I think we are very much intact with regard to $1 billion. And we will give color on that in February.

Thanks.

You're welcome.

Thank you. Our next question comes from Jason Wittes from Caris & Company.

Hi, thank you. First question in terms of the Q1 decision from the judge. I assume he is able to potentially lower the royalty rate that was decided on by the jury, because it seemed like a relatively high rate.

Very high rate, ridiculous rate. 10% is absurd. And I say that because we all know what industry standard is; that's 4% to 5%. And we know that we were awarded 5.5% on NeuroVision.

I did notice that. Secondly, if I look at lumbar, first, could you give us the growth rate this quarter. And secondly, you mentioned there was indications that the market was stabilizing. I guess if you could help us out to explain what some of those inputs were to make you feel that way?

Yes, so the growth numbers is 6% for US lumbar. Right now, overall, it is about 8%. I think what we are seeing is that there is not -- there has been I think, an overall suppression in the market that goes back to last year where DDD came out. We estimate that to be about 15% of the market that went away. The market since that has gone away, in our view, has been very stable. We don't see what we saw last year and going into the start of this year, where surgeons were telling us, My volume is just drying up, and I used to be booked for two months, and now I'm booked for two weeks. We are not hearing surgeons being booked back out necessarily to two months but we are not hearing them complaining about the fact that their queue is way too short. I think they have readjusted to that. And so anecdotally, a surgeon that used to be booked out two months and then was booked out two weeks is probably now closer to back to four to six weeks again, so that is very stable.

We also know that anytime that there has been a rejection with regard to a particular surgery, and there has not that many of them, they get overturned. Just like the case that I described, a broader case on First Coast in Florida and talked about that. So, the pushback is very effective when it's done. And I think we are seeing huge success in any surgeon that really goes through and pushes back and the same thing with all of our efforts.

Just a follow-up on that really quick. You had described the compression process within spine as something that probably takes at least a year. Is that still your feeling, or are we -- are you incrementally more positive about the way things are trending at this point, especially with the backlog increasing with your surgeons and seeing the success with the pushback?

The compression meaning DDD? Yes, I don't think that DDD is going to be coming back, per se. I don't see the 15% recovering anytime soon, shy of massive changes on the payor front. What I do believe is going to happen is that as we do resolve these payor issues, and through the various steps that are being undertaken by us, by societies, but individual surgeons, I think we will start to see an uptick once again, such that we get into stronger single-digit growth. And I think we are already seeing that, like I said, in the lumbar business. It is positive. We don't want to get over exuberant about it. But it is positive uptick, and we believe that that can get stronger over the next several quarters.

Okay, great. Thank you.

You bet.

Thank you. Our next question comes from Chris Pasquale from JPMorgan Chase.

Thanks, can you hear me okay?

Yes.

Alex, I want to start off and circle back on the issues in Europe. If I take your estimate that Europe came in about $2 million light this quarter, that implies that the international business would've been closer to $12 million. And you are saying that Europe is about half of your international business, normally or about $6 million. That implies that you lost about one-third of your sales from that region in the quarter. Is that right? And if so, how is that big a shortfall possible?

Yes, that is about right. That is possible simply because there's collapse of certain markets. So we had a substantial book of business in Greece; that went away. Same thing in Turkey. And we've had really a slowdown amongst a lot of our distributors and their willingness to invest in the business. So we just haven't seen the uptick. So there's a number of countries that have been challenged overall. I think it has been very, very clear that, that's really been the situation.

Okay, so it wasn't due to a key account loss that impacted you guys disproportionately? You really think that it was market-related?

Correct. It's across the European market. And Keith might want to chime in too, as he has spent a lot of time over there this year.

Yes. It really comes down to we have a combination of direct and distributor sales in Europe. And the distributor base is really challenged because of their access to cash and their access to be able to further invest in their business. So what we are doing is we're working with them to help them through their inventory needs, and at the same time, be able to provide the minimum to get surgeries done. And so it's a little bit of a hybrid model how we have to support some of these distributors now.

I was just over there last week, in Italy as well as in the UK. I can tell you that we are taking market share; we continue to gain. But the market is extremely soft over there right now. And it's not even just spine; it is just everything. I'm sure -- we've heard that on the reports from other companies, and you're hearing the same thing, obviously. So there's just a lot of weakness in Europe right now, and we're seeing the same thing. But we're not seeing that in other sectors of the globe.

Okay. You talked about the positive Florida Medicare decision as being a good example of the success of your advocacy efforts. But the original proposal was still pretty draconian. When do you think we get to the point where the two sides are a little bit closer to being on the same page, and you guys don't need to do these urgent interventions every time a new coverage decision is proposed?

I don't know that the battle is going to end anytime soon, but I think we start to see some real significant upticks taking place as we go through the process of getting the HTA's and everything else in front of the payors. So that is going to start as soon as the end of this quarter. There's key papers now that are working their way through the press. There is a lot coming together, the society guidelines are in next-to-final stages; they have all been drafted out. So, there is a lot taking place, and I think that we could start to see, as early as December, a lot of this being pushed forward.

I think as that starts to happen, what that does, as I said in my remarks, it completely negates the silliness and the absurdness of the Milliman guidelines, where were not predicated on clinical evidence or science or the literature. So this really is the mother of all literature reviews when it comes to spine fusion, and I think shows a very clear picture from what I have seen of it, relative to how much technology has changed, spine fusion surgery over the last decade in particular, and the kind of positive results that are out there.

I believe it is going to have a real impact as we move into first quarter. As far as really turning it around and putting out all the fires, we are going to still see gaminess from the payors, because they are all trying to play around with ways to pad their bottom line, is my personal view. So that's not going to stop. Just like we see this taking place around the country where they put forward nonsensical positions, that once you challenge them on it, they admit that they're nonsensical and they start to fold on it.

Thanks, Alex.

You're welcome.

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

Hi, good evening. A couple of follow-ups. One on just something you were touching on just now in the last couple of questions on trends in the US. Just stepping back and looking at this, I guess I want to make sure I've got it right. Is that, you're talking about Europe at the beginning of the year, we're looking for something much stronger. Biologics, we're looking for something much stronger. On the other end, I guess you were looking for something much closer to flat in your core business. We see where the weaknesses is; you are making up a good deal of that here with the core business, including lumbar. Is that fair?

Yes. That's right.

On cervical you mentioned it, but I did not get a sense of maybe how well it that growing relative to where you thought in the beginning of the year? Anything you can share with us in terms of the percent of your business now, or whether that's -- how that's tracking relative to what you thought it would be?

Yes, cervical is right on track. So it's growing at about 20%, which is what we thought was going to happen. And we also thought we were going to have the benefit of some additional revenue from PCM this year. That didn't come in, obviously. So we are especially pleased with cervical.

Okay, and then I guess one of the other things I'm trying to get a handle on is in the past, in the past few weeks, you talked about adding to the IOM opportunity in terms of resources. You talked about the $40 million opportunity. Can you talk about if there is pull-through, I think you mentioned on the conference call that you felt like these folks are doing -- if you do the math a little over a case, what a case -- is it a case a day, roughly, or something like that? And you have some opportunity for increasing the productivity. Maybe give us a sense of where you think your productivity of this workforce could go on the current base. So just organically without adding another 75 people.

I think if you take a look at what they are doing right now, the relative increase is not that great. It's probably more in the 10% to 25% range; I would estimate something like that. That would have to take place over time. So there is the ability for them to add more revenue in terms of case volume. But it's not a huge opportunity. I think the biggest opportunity for us are the cross-selling opportunities, are the ability to get the NuVasive sales specialists into the accounts. It's all of the things that I talked about. Those are the bigger opportunities. IOM, as you know, is going to grow based on just market 15%. We expect 15% percent growth from IOM no matter what. Can, that grow more like 25%. Yes, it probably can.

I guess what I'm trying to get at is what -- so it could go 25% and get some leverage out of that business. I know the pull-through on the implant side is what everybody's looking for. I'm trying to get a sense of -- it sounds like there is some leverage on the service side. Then finally, just if you could help with a couple of numbers. I'm trying to get -- you talked a little bit about Europe sequentially. Could you give us a sense where Osteocel is sequentially?

First of all, with regard to IOM and leveraging that, I think that what we have now is we have a very strong infrastructure that we acquired. I think our ability to leverage that is going to really be through the organic growth. It is really going to be adding on additional neurophysiologists and so forth. That is going to come over the next 12 months to 18 months in particular.

As far as bologics is concerned, as far as where we are, we are generally, basically looking at about 10%. So, it's pretty flat.

Okay. Thanks so much.

You're welcome.

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

Thanks, guys. Alex, I've got a couple questions on your lumbar commentary. I think you're saying lumbar for you is up 6% to 7%. Is that correct?

Yes, that's right.

What is the overall market growing at right now?

Based upon what everybody else has done? I don't know, minus something. Minus low single digits, right?

Okay, so you are clearly gaining share. And are the share gains a function of pure technology wins, or are you having to give price up to pick up business?

I think price is the same issue that everybody else has, right. So, I think for us, we're not gaining share because we give up price. We are gaining share, in part, because we are going through the process of cannibalizing the business that Medtronic's and DePuy and then the larger players have as it shifts more and more towards lateral and more and more towards minimally invasive surgery.

And most companies that we have talked to during this reporting season, they've said price for them in spine has been down in the mid-single digits. Is that the same for you?

That is probably about right.

I'd say, Glenn, I'd say low single digits. And to Alex's earlier point, too, it's not really price as a driver. But, just remember, we are talking about tactical strategic investments we are making, Nuva East, surgeon training, continued OUS expansion, albeit, probably not so much, not as much in Europe. Those things we are investing in to continue to drive the gains on the share side

Okay. Then, one last question on Impulse. I remember when you announced the deal, I think you said that it would be neutral to your operating margins in 2012, is that the case?

If you look at actually the reconciling schedules, you'll see that it's $0.01 dilutive, and that $0.01 dilutive is really based on the share count.

Right. I know it's for this quarter, but I think for next year you had said on the call that you don't expect to have any dilutions that operate -- to operating mrgin.

That's right. We believe -- not to operating margin, to EPS, we believe it will be accretive, certainly in 2012.

Okay what does it do to the operating margin? That is my last question.

To our overall operating margin, it certainly has an impact. If you think about this year's impact, which is a partial year, Glenn, it is probably 30 bps on the full year, but almost 80 bps in the quarter. And so it's a significant impact, a reasonably significant impact at an Op margin level. The thing to understand about it though is it does drive certainly higher operating profit dollars, which is going to be contributing, which is why we think it will be accretive down on the EPS line.

Okay, great. Thanks, guys.

Thank you. Our next question comes from Sameer Harish from ThinkEquity.

I wanted to ask about your targets for physician training. I know you outlined some of that at the beginning of the year. Can you give an update on NuVasive East, the traction there, or are you seeing a slowdown in physicians coming through as well?

We are actually going to see about 600 this year, and that will be up from 400 to 500, years prior. NuVa East is doing very well, as is San Diego.

In terms of the composition of that training, has there been any shift in terms of portion of new physicians trained or cervical or any other component there?

No, not cervical, we do very little in the way of cervical. We are going to reserve that for when we go ahead and launch PCM. We will start to scale that up next year. But we do see, I think an ongoing influx of surgeons coming in here wanting to learn more advanced techniques, and so that's very positive. As well as we get the newcomers, so it's along the lines of what we had originally projected. It's working the same way.

Okay, great. I wanted to follow up also, just in terms of some of the questions asked before and the composition as you grow your revenue. With the slow down that you are seeing today in international biologic, how does that change your long-term trajectory. And it's certainly not guidance, but in terms of when you do get to a $1 billion, is there a similar composition of biologic and international you see there. Or is it going to be a different mix at this point?

At this point I don't that think it is going to be different from what we saw before, because the Osteocel product is not ideally suited for international, and is impossible to move into many of the markets. Because in effect, it falls under -- it's tissue. It falls under a different classification. That is why it's important for us to get AttraX on the market. We think, in fact, with AttraX going on the market, we actually do have some biologics sales that began this year for us in some of the global markets with AttraX and have gone extremely well. So, we feel very positive about bringing AttraX on and AttraX being a very key driver of biologics revenue for us for the next several years, both US and outside the US.

Great, thank you.

You're welcome.

Thank you. Our next question comes from John Putnam from Capstone Investments.

Thanks, very much. Alex, I was just wondering on the litigation front, do the other patents, the litigation on that, is that put on hold until after the appeal is heard?

It is effectively. At this point in time, that is how we are viewing it, yes.

Okay, so it could be several years before we see the next tranche actually go to trial?

Yes, I think until we realy get through all of the post-motion items relative to the verdict, which as I said, hopefully, will be resolved by end of first quarter or start of the second, but probably the end of the first quarter. That will give us line of sight to the appeals process, which should take about a year. And I think during that time period, we will start to contemplate what happens with the next phase. But the most important thing for us is to get through the appellate process and to win that.

And I think you need to remember that the balance of the patents are largely cervical, right? So, we've talked before on the call with regards to how much of our business that entails. That's about 3% of revenue in terms of interior cervical plates. So I think we are -- that is something that we're certainly going to take seriously, but it's not a major priority right now, where we sit.

Right, and when you enter Japan, what will the competition be like? Will it be the same players you are up against now, or is there endemic competition there?

There will be fewer competitors for us in Japan, but obviously, the larger companies are all there. I honestly don't know enough about where they are with their offering right now. I think we are going to be very much in a position to be first in, for example, on lateral and XLIF. So we are going to have some have unique opportunities, because they have to go through the same registration processes that we are going through. And we believe that we are going to get there first. That's good news for us in terms of being able to seed those markets.

Thanks very much.

Thank you. Our next question comes from Rick Weiss from Leerink Swann.

Good afternoon, Alex. Impulse, I spoke to a doctor recently, in trying to understand this market a little better, who suggested that one of the reasons you might have considered the acquisition is that it's for use in procedures, complex procedures beyond lateral, and suggested trauma as one example. Are there -- I can appreciate you might not want to share all your cards at this point. But are there, in fact, other uses that if we understood this market better, or the technology better, we would appreciate what's going on?

I would say that certainly trauma is an area, but probably the biggest one along the lines of what you're talking about is in scoliosis. If you look at major scoliosis treatments, surgical treatment in kids, that entails a great deal of monitoring. That is not the kind of monitoring we are doing. So there's a big opportunity there for revenue from IOM. Obviously, there's a big opportunity for us in that sector to move our implants into the treatment of scoliosis. Because right now, that's about the small piece of our revenue. And those are very attractive pieces, because there is a lot of implants used over a great deal of levels. So they are attractive to us from that perspective alone.

A different topic for you, Alex or Michael. Gross margins, obviously, were pressured by a couple of things. Volumes obviously, complex answer about improving Impulse dynamics, mix is different, Medtronic royalty, et. cetera. But the question is, what can you do? Are there any levers or buttons to push, as you were alluding to earlier, on the gross margin side that we are not thinking about? Are some of these new products you talked about that we will see at NASS, will that help? Is there a manufacturing or sourcing initiative you can take that could give us a little more optimism as we think about 2012?

A couple of things, Rick. We started to invest this year, really for the first time in a vendor-vendor management program, and to start to look at our manufacturing costs and try and drive them down with some work on the design side. So that's actually something that just got rolling in the last 12 months. As you think about -- and we have talked about some of these things, as you think about the future opportunities, you think about margin-positive items being things like Progentix. As a synthetic, it's got a higher gross margin profile than the other biologics in the portfolio for us. You also think about Japan, as Alex talked about, the number two spine market in the world. We think the margin economics there look a lot more like our corporate average than they do the rest of our OUS business. So, there are reasons for positive things to look at, things to look at as positive.

The other thing to keep in mind too is we also did this year, for the first time, dipped our toe in on the manufacturing side, and invested in an entity just so we could learn that business. And that really, hopefully, will translate longer-term into something more fully fledged for us on the manufacturing side as we grow it over the next few years.

Okay. Last, just to make sure I'm understanding your perspective on the US market on the lumbar side, Alex. In some of our position checks in recent months, it was clear that July and August procedure surgeries were down as we talked to individual doctors on a random basis. But these same folks were saying things stabilized in September, and were much stronger in October. And these doctors felt, to your point about waiting lists and schedules, seemed much more optimistic about the fourth quarter. Is that a reasonable description of the trends you are seeing in the US, or is that not sound appropriate?

I think the summer has the usual seasonality associated with it that we saw. I think that's pretty much across the industry. But we do see the fourth quarter starting off very well. We do see very strong uptick with regard to procedures, with regard to surgeons' business. So, I think very consistent with what you just described is what we are seeing as well in our world.

Okay. But, maybe a little more of a recovery as opposed to just normal seasonal move into the fourth quarter? Is that too much to ask?

It is hard to answer that question exactly right because of just where we sit in a challenging market. But it's encouraging and it's positive, just like we've seen some very positive signs in our lumbar business in the US. We are not going to be over exuberant about it, but we certainly feel good about the trends and what we are hearing.

Thank you.

You bet.

Thank you. Our next question comes from Joanne Wuensch from BMO Capital Markets.

Thank you very much for taking my question. Two. One, was there a foreign exchange contribution in the quarter?

Nothing significant, Joanne.

Number two, what will it take for you to launch into Japan? Are we going to see a first half of the year SG&A increase or something as we head into that market in the second half of the year?

We would not expect to see a first-half increase. We would expect to see some of the investments in the second half of the year as we start to build sales force.

But what will it build to take? Are we talking hundreds of people? Could you just--?

No. We are talking dozens, as opposed to hundreds.

Okay, and are those distributors or are they going to end up being direct hires?

We are going direct.

Going direct. Okay, thank you very much.

Thank you. Our next question comes from Charles Chon from Stifel Nicolaus

Great. Thank you. Alex, I may have missed this in your prepared comments, did could you speak to pricing trends from NuVasive throughout the quarter. And are you still seeing year-over-year declines there?

I did not talk about it, but Michael is coming out of his seat to answer your question.

Hi, Charlie. Really be thinking about the pricing impact still as low single digits for us.

Okay. Because I'm just trying to think through the selling process as you utilize this established Impulse Monitoring channel, and how that works. I'm just wondering how NuVasive and Impulse become one Company. Is NuVasive going to be in a position to protect the combined revenue opportunity for the monitoring and the implants? I'm just wondering how pricing holds up in a bundled approach like this going forward? Thank you.

It's not bundled, per se, to the hospital. It's two separate invoices. And I think it's important to appreciate that. It won't be bundled up per se. And that's -- we feel there's protection, if you want to look at it that way. That does not concern us. I think there's more all the pull-through opportunities that come with it. I want to make sure I answered your question. You do understand what I mean, right?

I do. Thank you.

Okay good.

Thank you. Our next question comes from Michael Matson from Mizuho Securities.

Thanks. Another question on Impulse, I guess. I'm just trying to understand how NeuroVision fits in with Impulse. If you have physicians where they are doing XLIF procedures, and they are using Impulse's services, then they would have to use the NeuroVision system, or could they use the Impulse service with the hospital neuromonitoring system?

We are going to get into this at Analyst Day, and we're going to have some surgeons talking about this. But essentially this can be done any way that the surgeon and the hospital want to do it, and it's really their choice. So, we can provide NeuroVision for lateral, which of course, NeuroVision would be used no matter what. If on top of that, a surgeon wants or the hospital wants to have a neurophysiologist in the room as well, that could be provided also. It is really up to the surgeon how that is done.

As you know, our technology stands on its own relative to NeuroVision. And what we're really looking to do is to be able to keep building with the neurophysiologists and expanding our monitoring revenue overall, outside of lateral and further into the spine, and having them help us on the NuVasive sales -- the typical NuVasive sales channel to further XLIF.

Okay. Then, you made some comments around -- it sounded like you were alluding to a restructuring program or something along those lines. I'm just wondering, do you expect actual headcount reductions, or do you just plan to put in some type of program to try to lower some of your fixed costs and things like that, without actually reducing headcount?

Yes, we do not anticipate reducing headcount at all, and that is not our intention. Our intention is to reduce as many fixed costs as we can. And that is why we are not giving 2012 guidance right now, because there's a lot of moving parts on top line and earnings for next year. There's also a lot of very positive things coming our way, as I mentioned PCM, AttraX, Japan. On our IOM expansion, there's a lot of good things going on. But we want to make sure we are able to structure our profitability in line with our growth projections. So that is what we are working on, and we will have very clear focus and very clear visibility to that in February.

Okay. Then the biologics growth slowed down, and you mentioned that you have got the data coming on Osteocel in the first quarter, it sounds like. Has the Infuse situation--?

First half.

First half, sorry. So is the Infuse, actually, I don't want to say backfired, but maybe worked against you a little bit from the standpoint that maybe it's actually causing the doctors to look at what they are using, and actually ask for more data on everything? So that they don't have to worry about using a product and then finding out later on that there's all these risks that they didn't really know about earlier on?

Yes. I think that you are right, but I probably wouldn't frame it the same way that you did. I think what it means is that they're less willing to try different products. So what happens is, if a surgeon has been doing a lot of Infuse, then all of a sudden, they may go with whatever else Medtronic is going to offer with regard to DBM, with regard to other products and be more comfortable with that versus trialing our products or perhaps other competitive products. I think that's what we are seeing, is just a general reluctance to go out a limb, given the very strong backlash with Infuse.

Okay, thank you. That's all I have.

One other comment, Michael. I think the other thing you're seeing too is keep in mind the timing of when all of the backlash happened with the BMP. There was already a significant movement in the marketplace that hospitals and surgeons, specifically surgeons, were using BMP, but augmenting it with other fusion products. That was already being done. If you talked to most surgeons, they don't really necessarily believe it's unsafe. And they especially believe that they've already limited and improved the safety profile by adding other biologics into it, meaning extending the BMP usage with the use of allograft extenders. I think that had already been taking place, and all you're seeing is a continuation of that. So I think there is less of a backlash that many had thought would happen.

Okay thanks.

Thank you. Our next question comes from Bill Plovanic from Canaccord.

Hi. My questions have been answered, thanks.

You're welcome.

Thank you. Our next question comes from Jeff Johnson from Robert W. Baird.

Thanks, guys. Good evening. Two quick ones on my end. Alex, I know you were talking about the other Medtronic patents maybe not being litigated here over the next year. Can you just remind me though, there were two patents that you had also brought against Medtronic that haven't been litigated yet. But I thought the 949 maybe was ruled invalid. I have since heard maybe it hasn't been. Would you still, in the next phase, have patents to litigate against Medtronic?

We have quite a few patents to litigate against Medtronic. We've got lots of surprises for those guys.

There was no invalidity. I'm not sure what you are referring to on that, but there is no invalidity on the 949.

So the 949 and the 058 could still be litigated against Medtronic at this point?

Exactly.

Okay. And Alex, just trying to reconcile one other thing. I hear on market it seems to be stable on the lumbar side. Push back really seemed to spike last year in the third quarter. You do 6% lumbar growth this quarter. That's down, versus 10% in the first half of the year. In the context of a stable market pushback having spiked last year the third quarter, what is the delta between 10% first half and 6% this quarter?

What is the delta?

Why would you have slowed it in the context of a stable market, and the pushback having increased third quarter of last year. So where we are starting to anniversary through that. Why would lumbar revenue growth this quarter have slowed to 6% versus 10% in the first half of this year?

I think it just a continued pressure, but we are seeing an uptick.

All right. Fair enough. Thanks, guys.

Thank you. At this time, we have no further questions. I would like to turn the call back over to management.

Okay, thanks very much, and that's it for us. We'll talk to you real soon here in February. Goodbye.

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