NuVasive Inc (NUVA) 2012 Q1 法說會逐字稿

Greetings, and welcome to the NuVasive Incorporated first quarter 2012 earnings release conference call. At this time, all participants are in a listen-only mode. A brief question and answer session will follow the formal presentation. (Operator Instructions).As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Mr. Patrick Williams, Vice President of Strategy and Investor Relations for NuVasive. Thank you, Mr. Williams, you may begin.

Thank you, operator. Welcome to NuVasive's first quarter 2012 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's comments and our responses to your questions, certain items may be discussed, which are not based entirely on historical facts. Any such items should be considered Forward-looking statements 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 in NuVasive's most recent 10-Q and 10-K forms filed with the Securities and Exchange Commission.

Finally, to keep the conference call to a manageable time, we will limiting the Q&A to approximately 30 minutes. With that, I would like to turn the call over to Alex.

Nuva is growing fast. We've started 2012 with a very solid quarter, to build on for the year. We achieved revenue of $152 million, which represents 22% growth year-over-year, or 15% excluding our IOM service revenue, and we reported a non-GAAP operating margin of 11.7% for the first quarter, in line with our expectations. All in all, I am very pleased with the global execution of our market share-taking strategy in the quarter.

As I mentioned in our February earnings call, we are keenly focused on executing to the annual expectations that we have previously outlined. Our performance in the first quarter gives us increased confidence in our ability to achieve both our revenue and profitability guidance for the full-year. We continued to anticipate full-year revenue of approximately $615 million, which implies year-over-year growth of about 14%. We also continue to anticipate, that non-GAAP operating margin will demonstrate the seasonality that it has in prior years, ramping in the second half of 2012 and approximating 14% for the full-year. Finally, we continued to expect non-GAAP EPS of $0.93. Execution against these objectives in 2012 will serve as a stepping stone on our path toward becoming the global number three spine player, and driving toward $1 billion in revenue, with continuously improving profitability. Our strategy balances the long-term goal to take market share, and to become a much larger, yet nimble Company with our need to show progress against shorter term objectives. Our decisions have fueled industry-leading growth since NuVasive's inception, and have propelled us from a start-up, to a top five global spine Company.

Today I will provide an update on the investment decisions that will sustain NuVasive's differentiation, and will continue to fuel growth. They are intended not simply to meet short-term expectations, but more importantly to enable NuVasive to become the dominant player in spine that we envision within the next several years. We believe that the value of our enterprise will be optimized by focusing on a long-term vision for growth, by sustaining our share-taking strategy. Our reputation as a leader of innovation in spine is mission critical to the continued success of our share-taking strategy. And few aspects of our business better demonstrate the delicate balance between executing to short-term expectations, and investing in our future than does surgeon training and research and development. By the end of the year, we expect the NuVasive portfolio to boast over 80 innovative products for spine. But just as spine surgery is continually evolving, it is crucial for us to reinvent our portfolio by developing game-changing ideas that will continue to set NuVasive years ahead of the competition.

The strength of our pipeline today is the direct result of strategic investments and development years ago. As prior year investments come to fruition in 2012, for example, we will launch additional indications specific implants for XLIF, new lateral fixation options, expansion of MAS TLIF, a MAS PLIF solution, extensions to our ALIF portfolio, and new access and fixation options for the cervical spine. With our sights set on becoming a $1 billion Company with improved profitability, you can expect that we will continue to have a solid development pipeline. As we strategise about the direction of the industry and about how spine surgery is advancing, we are also making strategic investments that will enable NuVasive to exploit that evolution. We executed transactions years ago, which upon FDA approval, will materialize into opportunities to further penetrate both the biologic's and the cervical markets. ATTRAX is a synthetic biologic that will augment our existing portfolio of biologic solutions, and which we believe can compete head-to-head with the industry leader at a more economical price point. Our PCM cervical TDR device will mark our foray into motion preservation for the cervical spine, a very exciting segment of the MIS market that is still in it's infancy.

As you know, we only recently closed on the acquisition of Impulse Monitoring, which will enable NuVasive to offer the most comprehensive Neuro monitoring solution available to hospitals and surgeons. We expect to reap the rewards of that investment in the years to come, as our new team of Neuro Physiologists help surgeons fundamentally appreciate the power of integrated Neuro monitoring, and the technical superiority of our monitoring products, and all of our surgical products. As the strategic rationale behind the combination plays out, we can drive surgeon conversion, and accelerate the penetration of our products. And as we expand our overall monitoring solutions, IOM will also begin to contribute to profitability. Clinical research is another crucial element of our share-taking strategy. As a result, we are committed to fostering the development of the body of evidence, in support of MIS procedural solutions. In the first quarter of 2012, we made excellent progress against that effort.

At an annual conference held in March, by the International Society for the Advancement of Spine Surgery or ISASS, there were 45 scientific posters and 25 podium presentations on MIS. Importantly, close to half of those MIS presentations featured XLIF, and showcased the procedural sophistication that our years of experience in lateral have achieved. In addition, to the numerous presentations that covered the general safety and efficacy of XLIF, attendees also learned the benefits of XLIF for adult deformity, XLIF for [perpectomy], and XLIF overweight and obese patients. As well, the results of the IDE trial for our PCM device, which awaits FDA approval were presented. In that trial, the device met or exceeded all of it's clinical endpoints.

Another highlight of the first quarter was the publication of a peer-reviewed manuscript summarizing the radiograph results of Osteocel in lumbar inter-body fusion procedures. In a retrospective, single center review of 52 patients using Osteocel, the authors noted a high fusion rate, despite what was characterized as a challenging patient population, and concluded that the use of Osteocel is both safe and effective. NuVasive is a leader in it's dedication to support the clinical community to publish peer-reviewed data, that demonstrates the positive change that our products can have on patients lives. We also strive to raise the clinical bar for spine surgery, through clinical research, support of scientific societies, and our increased support for registries and clinical databases to help identify the best therapies for spine care patients. This focus is not only beneficial for showing the value and differentiation of NuVasive's suite of products, but also helps contribute to the overall body of clinical data, as clinicians show doctors, patients, hospitals and payers, the benefits of spine surgery.

Our commitment to being absolutely responsive to surgeon's customers globally is another critical differentiator for NuVasive, and another element of our share-taking strategy, that is a fantastic example of investments being made today, that will foster sustainable growth. Our mission to be the best, and the most absolutely responsive Company means never missing an opportunity to partner with a surgeon for a case. We hear countless stories from our sales team of surgeons preparing to use the competition solutions for a surgery, only to discover that the competition cannot meet a tight time constraint, or does not have the inventory to support the demand for the product. It is in those situations, where our reputation as the most responsive Company in spine opens the door for NuVasive. We convert those cases into NuVasive cases, and quite often convert those surgeons into more dedicated NuVasive customers. While the premise sounds simple, it takes an incredible level of thoughtful investment to position ourselves to respond to any and all customer requests, which we take great pride in doing.

The gradual expansion of our sales team, and our team of Neuro Physiologist's is also a critical driver of our ability to be responsive. But it is far more complex, than simply having feet on the street. We dedicate high caliber resources to insure that we get the right people on the NuVasive team in the first place, and our rigorous training programs, and OR training venues are second to none. We also invest in the infrastructure, and the tools that will help our sales team win in the field. We build and maintain the instruments, the sets and the inventory levels that will enable us to meet surgeon demand 100% of the time. We strategically located our Memphis global distribution center next to FedEx, to respond to demand as quickly and as efficiently as possible. As well, we have increased the responsiveness of our logistics model by regional distribution in both San Diego and our Nuva East office. We continually invest in the infrastructure and the resources that insure NuVasive surgeon training program will demonstrate surgeons the value of our comprehensive unique technology and products as they treat their patients.

The surgeons that proctor our training's are leaders in their field, and the typical one-to-one ratio of surgeon to cadaver fully maximizes each surgeon's training experience. Both San Diego and Nuva East continued to support these efforts, and we have experienced great success in providing excellent service to our customers from around the globe. Our vision for NuVasive overseas is to replicate the success and the adoption curve that we have demonstrated in the US. This has required tremendous investment into the development of an absolutely responsive culture and infrastructure in international markets. It means finding the right people to spearhead our new market entries, and introduce new surgeons and hospitals overseas to NuVasive's culture and vast portfolio of products. It also means offering those surgeons, the same best-in-class customer service that US surgeons enjoy. And it means having the equipment and inventory on hand to meet demand, so that we can cultivate a long-standing relationship with a true believer in NuVasive's differentiated MIS and traditional products and customer service.

Our international expansion will be a critical driver of future growth. And after several years of investments, we have reached an exciting inflection point, as the scale of our international efforts is beginning to contribute to profitability. Our absolute responsiveness rings as true as ever, in our reaction to challenges facing the spine industry as well. When insurers began to enforce a more rigid set of restrictions for spine fusion procedures, generally we didn't sit back and complain about the impact. We listened to the frustration of our surgeon customers, and responded by taking a leadership role in marshalling the surgeon community to affect change on behalf of patients, who in some cases were being denied access to needed surgical care. We supported the surgical societies, in crafting letters of response to the insurers, and in the development of a health technology assessment or HTA, which is a collection of evidence in support of spine fusion that surgeons can use in the dialogue with insurers. And we are supporting the surgical community, in a collective aim, to push insurers nationwide to adopt consistent clinically supported guidelines for spine fusion. We helped the industry develop a hot line for spine patients, who have exhausted the appellate process for medically indicated spine surgery. NuVasive uniquely responded to the challenge head on, eagerly dedicating resources to an effort that will ultimately benefit the entire industry, because we recognize the need for leadership, and because we have a reputation of responsiveness to uphold, to our customers and to our patients.

Before I turn the call over to Michael, I would like to provide a quick update on our ongoing patent litigation case with Medtronic. There are various procedural issues still being resolved, but we have now agreed on how the damages award will be secured, pending the appeal. Rather than posting a bond, we will be placing approximately $113 million into an interest-bearing escrow account to secure the jury verdict and associated interest, in the event it is required to be paid. The court has not yet determined the royalty rates that will apply during the period of time, from the verdict through the appeal. When that is determined, which we expect over the next two to three months, we will accrue and escrow the appropriate amounts. As we reported earlier, the appellate process has formerly begun, and we are eager for justice to be served in the long run. As a reminder, the 973 patent pertaining to the lateral implant expires in February 2015, or less than three years from now.

Michael?

Thank you, Alex, and good afternoon, everyone. Our revenue for the first quarter 2012 was $151.7 million, a 22% increase over the first quarter of 2011. The strength of revenue results in the quarter was broad-based, and demonstrates excellent execution within a challenging global spine environment. In the first quarter, we saw strong performance across our US lumbar, US biologic's, US cervical and international offerings. US lumbar revenue in the first quarter grew almost 12%. US biologic's revenue grew roughly 15%, and global biologic's revenue grew just over 19% to approximately $27 million. US cervical revenue grew just over 20%. IOM service revenue, which on an ongoing basis will combine Impulse Monitoring and Sandia was $9.4 million. Finally, international revenue, including it's biologic's component, grew nearly 35% to just under $11 million. All of this detail is provided for your reference in the supplementary financial information posted on our website in the Investor Relations section.

Overall, we were pleased with our revenue performance in the quarter. Our Q1 2012 GAAP net income was $673,000, or earnings per share of $0.02. Excluding an aggregate adjustment of approximately $8.1 million net of tax, for the adjustments detailed in our Press Release, first quarter non-GAAP earnings were approximately $8.8 million or $0.20 per share. Gross margin in the first quarter was 75.7%, compared to 81.1% in Q1 2011, and 75.3% in Q4 2011. Year-over-year, gross margin was primarily impacted by patent litigation royalty expense, which drove roughly 190 basis points of impact, and by the acquisition of Impulse Monitoring which drove about 300 basis points of impact. Hospital pricing pressure was immaterial.

Research and Development or R&D expenses adjusted to exclude stock-based compensation, acquisition-related items, and an asset impairment charge in Q4 2011 totaled $9.9 million in Q1 2012, compared to $10.2 million in Q1 2011, and $8.9 million in Q4 2011. R&D expense as adjusted, was 6.5% of revenue in Q1 2012, versus 8.2% in Q1 2011, and 5.9% in Q4 2011. Relative to last year, the decrease in R&D as a percent of revenue, was caused by the addition of Impulse revenue which comes without a heavy R&D component to it, and by lower spending on clinical trials, FDA approvals and studies. Sales, marketing and administrative or SM&A expenses adjusted to exclude stock-based compensation, certain intellectual property litigation expenses, and acquisition-related items totaled $87.2 million for Q1 2012, compared to $74.2 million in Q1 2011, and $82.4 million in Q4 2011. SM&A expense as a percent of revenue was 57.5% in Q1 2012, versus 59.6% in Q1 2011, and 54.9% in Q4 2011. The year-over-year decrease in SM&A as a percent of revenue is attributable to the addition of Impulse, which has a less intensive SM&A structure than the rest of NuVasive.

On an absolute dollar basis, the year-over-year growth in SM&A expense is primarily attributable to higher spending on variable costs which tend to grow roughly in proportion with revenue growth. These costs include additions to sales headcount and related compensation, continued international expansion, and higher set depreciation to fuel growth in our [loaner] model. We also invested in mobility tools and solutions to enhance the efficiency of both our sales and operations teams. As a result of the above mentioned, gross margin, R&D and SM&A results, our first quarter non-GAAP operating margin was 11.7%, compared to 13.3% in Q1 2011, and 14.5% in Q4 2011. Compared to Q1 last year, Q1 2012 results include the impact of both patent litigation royalty expense and the Impulse acquisition. Normalizing for the impact of these two items, Q1 2012 non-GAAP operating margin would have been 14.1% or an 80 basis point improvement year-over-year operationally, which demonstrates good progress towards our profitability targets.

Interest and other expense net totaled $6.2 million in the quarter, compared to $1.1 million in Q1 2011, and $7 million in Q4 2011. Included in this total is about $6.7 million of interest expense related to both our old and new convertible notes, with $3.1 million representing the non-cash portion of the new notes, and $3.6 million representing the remainder, the vast majority of which is cash.

For the first quarter, cash provided by operating activities came in at roughly $39.7 million. Excluding the refund received from an overpayment made to a taxing authority in Q4 2011, this number was $28.5 million, which still represents strong performance. When we adjust that $28.5 million to exclude capital expenditures, we generated about $14 million in free cash flow in Q1 2012. That is more than triple the amount generated in Q1 2011, and marks one of our strongest quarters of free cash flow generation to date. Our cash and investment balance at the end of the first quarter was approximately $364 million, which compares to 2011's ending balance of approximately $342 million.

Relative to the post trial motions in our ongoing patent dispute, we will place in escrow approximately $113 million to secure the $101 million patent litigation verdict, as well as associated interest. In addition, we are earmarking roughly $74 million to repurchase the balance of the convertible notes maturing in March 2013, and $50 million to $60 million for potential future milestone payments related to prior M&A. Net of all these assumptions, we would still have more than $100 million in cash, which we currently believe provides sufficient resources to run the business and execute on our strategic plans. As a reminder, remember that our guidance assumes patent litigation royalty expense consistent with the jury award, which is still subject to change in the post-verdict period. Going forward, we understand that we will need to apply a nominal interest rate to the jury award, and to the non-cash royalty expense accruals. We currently expect all this post-judgment interest expense to be immaterial from a cash planning perspective, and to be absorbed without impacting EPS guidance.

At the end of Q1 2012, our inventory position was roughly 20% of annualized first quarter revenue, compared to about 23% at the end of Q1 2011, and roughly 20% at the end of Q4 2011. Day sales outstanding or DSO, when run off of our net AR balance was 51 days in the quarter, compared to 55 days for last year's Q1, and 53 days at the end of Q4 2011. Our AR team posted another stellar quarter of cash collections.

Now let me turn to guidance for the full-year 2012. As a reminder, we are focused on executing to annual expectations in 2012, which implies a reduced emphasis on quarterly expectations in our public commentary. For our annual guidance, please reference the tables in today's Press Release, which provide additional detail. And as I mentioned earlier, we have posted supplementary financial information on our website in the Investor Relations section. The file should be a substantial aid to those of you building models, as it has a bridge from GAAP to non-GAAP EPS for quarterly results in 2011, the first quarter of 2012, and a view for full-year 2012 guidance.

As Alex already mentioned, we are reiterating revenue guidance for the full-year 2012 of approximately $615 million. Last quarter, we outlined a rough -- the rough growth rates, that we anticipate for each of our major product areas. We have included these numbers for your reference in the supplementary financial information posted on our website. The year-over-year quarterly growth rates in each of these areas may vary as we move through the year, and the final revenue contribution of each may also vary. As we gain more visibility into each area's relative performance, we will adjust the components as necessary.

Turning to the rest of the P&L, there are no changes to the guidance we gave during our February earnings call. We continue to anticipate full-year 2012 gross margin to be approximately 76%, and full-year 2012 non-GAAP operating margin to be approximately 14%. First quarter margins were fundamentally in line with our expectations, and give us increased confidence in our ability to achieve our profitability guidance for the year. Similar to prior years, we expect non-GAAP operating margin will exhibit seasonality in 2012, with Q1 being the low point, and ramping up in the back half of the year, particularly in Q4. Non-GAAP operating margin guidance excludes stock-based compensation, certain intellectual property litigation expenses, amortization of intangible assets and acquisition-related items. We continue to anticipate full-year 2012 non-GAAP operating expenses, as a percent of revenue to approximate 62%. We will continue to structure longer-term profitability improvements, while maintaining important investments behind the critical drivers of our share-taking strategy.

Full-year 2012 other income and expense is unchanged at approximately $27 million, which will include about $12.5 million in non-cash interest expense. We continue to anticipate a full-year 2012 GAAP effective tax rate of approximately 60%. While we generally expect our effective tax rate to improve some each year, as we move forward, significant progress will be dependent on international revenues becoming a more meaningful percentage of our total revenue mix. Non-GAAP adjustments continue to be tax effected at approximately 40% for the full-year 2012. Diluted shares outstanding for the full-year 2012 remain unchanged at approximately $45 million. And finally, we continue to estimate full-year 2012 GAAP EPS to be approximately $0.09 and non-GAAP EPS to be approximately $0.93. Non-GAAP EPS guidance for 2012 excludes the full-year impacts of non-cash stock-based compensation of $34.5 million, certain intellectual property litigation expenses of $2.5 million, amortization of intangible assets of approximately $12 million, acquisition-related items of $1.3 million and as incurred additional items, and non-cash interest expense associated with the convertible notes of approximately $12.5 million.

We feel this non-GAAP EPS measure generally speaking, most accurately portrays the operating earnings power of NuVasive, and should be the basis for measuring our progress. The first quarter of 2012 marks an excellent start to the year. I look forward to another year of industry-leading growth, combined with steady improvement in profitability.

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

Thank you, Michael. Well, 2012 is off to a very good start for NuVasive. First quarter results give us increased confidence in our ability to achieve our full-year revenue and profitability guidance for 2012. We continue to make the necessary investments to the sources of NuVasive's differentiation and share-taking strategy, culminating in sustainable growth with steady improvements in profitability. Our commitment to maintain NuVasive's innovative prowess, to drive superior clinical outcomes and to nurture our absolute responsiveness culture are the drivers of our success to date, and well beyond $1 billion in revenue. Importantly, our top line will grow in tandem with an improving profitability profile, as our efforts to reduce cost of goods sold, together with streamlining our business model continue, and as the scale and scope of our business naturally levers operating costs. The expansion of operating profitability, coupled with our dedication to increased asset efficiency will also drive continual improvements in free cash flow. We are laying the ground work today to become the number three spine company in the world.

I am very proud of the entire NuVasive family, and all of our accomplishments so far. We have established NuVasive as one of the top spine companies in the world, with innovative and integrated procedural solutions that address the entire spine. We are in a very unique position, as the spine market continues it's shift toward minimally invasive solutions, and we intend to fully capitalize upon it. Our runway has never been longer. As we like to say at Nuva, onward and upward.

We will now take your questions.

(Operator Instructions) Our first question is from the line of Bob Hopkins with Bank of America. Please go ahead.

Hi, thanks. Can you hear me okay?

Yes.

Great. Good afternoon. So Alex, I'm sure you probably anticipated this question. You put up 15% growth or a little bit greater in your spine business ex monitoring, and yet you didn't change your guidance which is for 7%, so you grew over twice what your guidance is. Is there something in the next nine months that you think will slow the growth rate that you're seeing in spine or are you just being conservative?

Being conservative, Bob.

Okay. So there's nothing incremental we need to know about, that would have an impact on the business over the next nine months, that is a one-off or something that would cause you to lower those numbers?

No, that's exactly right. Look, this is how we're looking at it. As we described and I described in my prepared remarks a few months ago, that we're looking at our year as an annualized process. The same as we look at our business, and the same as I look at it strategically for the next several years. So we're not prepared at this point in time after three months, to start readjusting our numbers after one quarter of very strong success.

We'll come back and revisit it the middle of the year as appropriate. But I also want to get through a couple of other things, to see whether or not we'll be adding things like PCM and like ATTRAX, and so on and so forth. So there's still a couple of moving parts that could even improve our outlook for 2012, but it would be premature for us to start contemplating those in guidance at this point in time.

Okay. Then just as a quick follow-up on the royalty rate to Medtronic. I know you said you'll hopefully have a final ruling on that in the next couple of months. But since we last talked is there anything that you've learned that might have given you incremental confidence about what that royalty rate might ultimately be? Or is the best guess still just what we're already assuming?

Nothing has really changed. Our best guess is the same. We think it's going to be the same as was outlined by the jury.

Okay. Then on ATTRAX, can you remind us what you think your best estimate timing is there?

Honestly I've been trying to do that for two years, and without any success whatsoever. So we're just literally waiting week in, week out, for answers from the FDA. We certainly hope to have an indication in the second quarter whether it's a go, or a no go, meaning they are going to want something else. So, I honestly can't say until a little bit further into the quarter. I can't say it's going to happen in the second quarter for that matter again either. The same with PCM. We think we're very close on PCM, but our time lines are not at all consistent with what FDA has been doing.

Great. I'll get back in queue. Thanks.

Thank you, Bob.

Thank you. Our next question is from the line of Matt Taylor with Barclays. Please go ahead.

Hi, thanks for taking my questions. Just wanted to touch on Biologics. Your growth there was pretty strong versus guidance for flat growth from the year. Just wondering what you're seeing there, and if some of that is pick up from InFuse.

Hard to say whether it is or it isn't. Again, it's one quarter. We're not going to really postulate on what a segment is doing on the year. So, I think at this point in time, we'll just leave it, as where it is. I agree with you very strong first quarter growth.

Great, and thanks for the update on the litigation. I guess at this point, you're just waiting for some procedural issues to work it's way through the courts. And you should get resolution on that royalty rate, you said, in the next two to three months? Is that what we should be looking for?

Yes, we were hoping it would happen by the end of the first quarter. It continues to take longer. There has been a new judge assigned to the case. That probably has something to do with some of the delay. That judge has a background in IP. We think that, that's potentially a positive, certainly no less than a neutral, but that's probably slowed things down a little bit.

Okay. All right. Thank you very much.

You bet.

Thank you. Our next question is from the line of Rich Newitter with Leerink Swann.

Thanks for taking the question. I just wanted to ask about your core US Lumbar fusion. You did 12% in this quarter, which was a very strong number. Better than I think most of us were looking for, and your comps, they do get easier throughout the year. Alex I appreciate your comments, that you're not ready to take a quarter and go crazy with your guidance. I just was wondering, can you comment more broadly on anything specifically, either you're seeing in the market, did you benefit from a potential lift in volumes? You said there was pricing that was immaterial. Is that something that improved at the margin?

So, if you take a look at the last quarter and this quarter, there's no change per se, that we're seeing with regard to pricing. It's still in the low negative single-digits, so that's the same. I think what you're seeing from us at least, is obviously our ability to take market share continue. We obviously, are pleased with the start of the year. I think what you're seeing among some of the other larger companies ahead of us, is losing some market share. So there's a fair amount of churn taking place, I think in the spine industry right now. ¶ That's among the really -- the whatever you want to call it 25% to 35% of the market share that's owned by the smaller companies, taking it from the larger players. I think that's the piece that's not being talked about very often, is the fact that most of the larger players are losing market share in the US to smaller entities. Of course that includes us, as a number five Company.

Just one follow-up, quickly on Biologics. We saw a pretty nice sequential uptick. And I believe the comments last quarter were aimed at the Osteocel line where, while you continue to have strong results, it's tough to get incremental revenue. Did the paper or the publication that you referenced have an impact this quarter? Was it Osteocel to begin with, that caused the uptick?

No, I think what it is, is that, what we're seeing overall and we talked about this on our last call, is that because of the pressure on InFuse, there's an increased reliance upon the utilization of DBM and similar type of products. So I think that, that just opens the pathway, not only for us, but for I think all companies to really utilize their DBM versus their -- utilize their DBM products versus really seeing more traction or utilization by InFuse. I think that's just a general industry shift that's taking place right now. I think we're obviously, one of the benefactors as are probably some of the other companies as well.

Thank you.

Thank you. Our next question is from the line of Matthew O'Brien with William Blair. Please go ahead.

Good afternoon. Thanks for taking the questions. Alex, I'm just curious, or Keith, you were talking about all of this infrastructure building. Clearly you have some things to do internationally and with Impulse. But at what point do you think the US business, the infrastructure there is fully built out, and you'll start to harvest some of the profitability potential of that business?

In subsequent quarters.

Okay, okay, so --

No, I'm not -- I think in all sincerity, look that's something we're very focused on. We expect to see incremental translation taking place throughout the course of this year and well into next year. As we continued to ramp our business, we expect to see that continue to flow nicely.

Okay. But as you get up to--

Sorry, it's Michael jumping in. Also remember, we've been talking about some of those trade-off decisions in investments we've been making for a while. We've been in a multi-year investment strategy OUS, particularly last year or two in Japan, to get through the regulatory process. So while all that spending is occurring, the domestic business has obviously, continued to improve because overall, op margins have been improving.

Sure, I understand that. That's helpful. I was just -- I'm just a little more curious on this talk about getting up to 80 products by the end of this year. I mean there is a ton of instrument sets, to go along with having all of those products --

Sure.

-- available. Is that the point where we can start to see the curve of spending bending in your favor?

Yes, I think that's what we talked about. We'll start to see that towards the latter part of this year, and we'll expect to see more and more translation next year, and the following year, without question.

Okay. Then, just one quick follow-up. Again, getting back to the organic growth in the quarter, quite strong. How much of that was more -- just getting back to growth rates similar to what you're seeing in the MIS segment of the market, versus getting some market share on the traditional side?

It was across the board. So it wasn't -- as you know from Michael's comments, it wasn't just one particular area. So, we saw it across-the-board. I think clearly, our MIS story is far superior to those of our competitors. But again, I don't want to take extra credit for this quarter, relative to what we did versus our competitors. We started off very strong. We've been building out our sales force. We added to our sales force on a net basis last year. So, we are expecting fruit from our sales force, and it's delivering.

Okay, thank you.

Thank you. Our next question is from the line of Matt Miksic with Piper Jaffrey. Please go ahead.

Thanks, good evening. Just wanted to follow-up on, maybe the tone of the market, Alex. If you could talk a little bit about what we've seen, I guess across some other sectors, is some improving utilization sequentially. Some of the sequential dip that we had seen or expected in your numbers from Q4 to Q1 seasonality, we didn't see much really. Wondering if you could provide some color on what you're seeing? Maybe what some of your reps or surgeons are seeing, particularly as they look out at surgical calendars going forward? Then I have a follow-up.

Sure. Matt, I think it's the same as we talked about last quarter, is that we do not see things getting worse. Again, is that -- does that imply that we're at the bottom, and we have bottomed out? It's hard to say for sure. It feels like it. It seems like it, certainly based upon how it's been well over a year now. So that's our sense of it. And that's probably the best answer I can give you, honestly.

Okay. Then on the integration and synergies, how things are coming together with Impulse Monitoring and your core business, implant business? Could you talk a little bit about, maybe the kind -- how is that changing, if at all? Either the results that you're starting to get out of your sales force in regions that you have been targeting? Or perhaps in the way that you're looking at growing your core sales force in this intermediate period here, to bring the two businesses together?

It's still very much in its infancy. So I can't sit here, and tell you that its had a huge impact on the quarter. It has not. We did not expect it to. We expect that to come, the first signs of it, towards the latter part of this year. So we're very pleased with it, but this is still an integration process for us. We're entirely focused on making sure that our monitoring business grows and continues to do so. So we've added quite a few neurophysiologists over the course of the first quarter, which was inside of our plans. So that's on track.

We're not really in a position at this point in time, to start making adjustments to the larger sales force. I think we'll contemplate that as we move into '13, and ways to really start to further lever the relationship between the two groups. Right now, we're not looking for that to happen very much as I've said, until perhaps the latter part of the year.

Great.

Matt, it's Michael. We're taking the integration piece by piece. This quarter's completion from our point of view, is getting Sandia and Impulse rolled together. So, we've got those -- all those neurophysiologists, the technologists, sitting essentially in one entity. The good news of that is, it's all consolidated and managed that way. The other side of that news, is we lose a little bit of the visibility between the two. But I think it's the right answer.

Thanks so much.

You bet.

Thank you. Our next question is from the line of Raj Denhoy with Jefferies. Please go ahead.

Maybe I can start with your share of the lateral market. I think in quarters past, you have commented that you were close to 50% of that. Are you still running close to that, or do you think you might have improved a bit?

It's hard to know after a quarter, because nobody else reports that. So our best guesses we are at least there, perhaps even a little bit improved.

Okay. Maybe I could ask a bit more of a structural question. Now we saw the filing of an S1 from one of your competitors this last quarter. Globus has put out their S1. Their operating margins, which you probably take notice of, are close to 30% or at least the high 20% range. I have just been curious, why you're so much below that? Perhaps is that an aspirational target, in the sense. Do you think that there is anything structural keeping you from improving your margins from the low teens now, to perhaps that high 20% range over the next couple of years?

So I can't fully comment on Globus, and am not prepared too. As you realize, perhaps a lot of the most important information is not in the S1, that would help us to figure things out. But I can tell you that we obviously, invest a great deal in our business and our profitability will continue to increase. If you're sitting somewhere in the 30% range, your profitability is probably not going to increase over the next several years. Then you have to ask yourself what's the normal resting point that companies are trying to get to?

My belief is that number is somewhere in the low, to maybe as high as mid 20%, in terms of an operating margin. So call it somewhere in the low 20% to 25%, is probably about where companies can get to. Provided that they are also not investing as fast as we are, in all the things that we're doing. As you know, from watching us for many years, we don't invest in things just to get a pop in revenue. I'm certainly not implying that somebody else is either. But we do things in such a way that takes years to cultivate.

We could have been in Japan a long time ago. We could have been in other markets a long time ago. We've chosen to build them in a way that's sustainable, and that we'll produce for us. Not only revenue but profitability that we can count on year-in, year-out, but to do so for decades. So, that means building out entirely different organizations. The same thing with our inventory focus, what we do from a surgeon training standpoint, and so forth.

So I don't think it would be a fair apples-to-apples comparison, unless you load in all of the spending. Really consider obviously, for any Company, this has nothing to do with Globus. Any Company that is in their pre-IPO phase, has utilized I'm sure it's equity, in order to offset the typical expenses that it would have otherwise have to absorb over the course of many years. Whether that's in services and relationships with various sales forces and what have you. So that's not unusual, and so that doesn't surprise me. As those things all start to catch up, then I think you have to figure out what is that point of modulation. I think that's what I have already espoused, in terms of my own personal view.

Well, just a bit of follow-up to that, because you have mentioned the absolute responsiveness several times on the call. It's clearly been an asset for you, as you have built your business, and an expensive one obviously. But is that a scalable or leveragable asset, in the sense that, is that something that's going to continue to keep your profitability, perhaps lower than it could be?

I think our profitability increases the way that we have been outlining. I think it gets us into the 20% range over the next several years. So yes, it is scalable.

Okay, perfect. Thank you.

You're welcome.

Thank you. Our next question is from the line of Bill Plovanic with Canaccord. Please go ahead.

Great, thanks. Just on the free cash flow in the quarter, it was about $14 million. I mean, can we annualize that? Just look at this and say, that you'll do at least $60 million in free cash flow or is that too simplistic? Then I have a follow-up.

Yes, Bill, I mean, I wouldn't necessarily annualize it. We're obviously pretty pleased with where it landed in Q1, but we have not formally put out that annual guidance. Certainly, we're on a good trajectory. We want to continue to drive improvement off that where we can.

Okay. Then just with the ATTRAX and the PCM and the FDA approvals. Are there any specific questions that the FDA is getting hung up, on either of those products? Or something that we can look to, to get clarity or comfort that those will get or gain FDA clearance at some point this year? Thanks.

I don't think that we can give you anything that would give you more comfort, that anything is going to happen in 2012. As you know, many of the delays are across all industries, relative to med tech. So it's hard to say. No, there is not specific things we are hung up on. We're working through a whole series of issues that have taken place over the last several years, of additional information requests, and so on and so forth.

We believe that with both of those products, we are in the final stages. Whether or not again, as I said before, does that mean it's going to be Q2? Or it's going to be '13 or who knows? I wish I could tell you more. We're as frustrated as anyone.

Thanks.

You're welcome.

Thank you. Our next question is from the line of Michael Matson with Mizuho. Please go ahead.

Yes, so I was wondering, did you have an extra selling day in the quarter? Obviously, you would have beaten, probably beyond that, but I was just curious --

No, we were closed -- we were on February 29. No, I'm kidding. (Laughter) We did. We did.

Okay. So it probably added 1.5 points or --?

Yes, sure, I think it did for everybody.

All right. Then, just in terms of the PCM product. When that's initially approved, how quickly do you think that can ramp? And is that something where you're going to -- the gating factor will need to go out and train surgeons? Or is there enough surgeons out there that have already been trained on cervical discs, that you can just -- let them start using it?

It's going to take time. I want to get Keith involved here, to talk about it more specifically.

Yes, I think you should look on the ramp to this, as being very controlled, in the sense that we want to make sure, whether they've had experience or not, with other motion preservations devices. This particular cervical device requires it's own training, it's own understanding, and the philosophy behind it. It needs to be understood how the results went for the clinical trial. So, that we're sure we're selecting the right patients. The tips and tricks and pearls that were learned throughout the clinical trial process, and the usage of the product internationally is being accepted and understood by each of those surgeons. So we are going to have a training requirement component to this.

All right. That's all I have. Thank you.

Okay.

Thank you. Our next question is from the line of Larry Biegelsen with Wells Fargo. Please go ahead.

Good evening. Thanks for taking the question. Two questions. First on volume. Alex, there are some surveys and some data points that suggest that the volume did improve in the first quarter? And you said earlier, you don't think it got worse. Maybe do you think it actually got a little bit better?

It's hard to say. I think that, the way that we judge things in the field is, when we don't hear about bad news. So meaning that surgeons are not being as prolific, as perhaps they normally would be. So we're certainly not hearing that. We're not hearing much, with regard to significant pushback. I'm not saying, it's not happening. It certainly is, from market segment to market segment. But I'm reading the same reports that you are, and it's hard to know I think, just given three months into the year.

Okay. Let me ask you about PODs. I mean, how do you see things playing out over the next, let's say, 6 to12 months? Do you see PODs eventually being made illegal, or severely restricted? Or do you see additional clarification around PODs, which would make them legal under certain conditions? And if Alex, if the latter were to occur, would NuVasive be willing and able to sell to PODs, without undermining your current distribution model? Thanks.

I think the entire PODs model undermines really, innovation. I think that it is not good for the industry, and I don't think it's really a wise way to go. Our hope is that there will be a legal change that takes place, and that, that has the impact on PODs that we think is appropriate. We are certainly not modeling or contemplating selling into PODs. We realize some of our competitors have done so. It's not part of our strategy. Certainly sitting here in 2012, and looking at 2013, it's not something that we're contemplating.

Thank you.

You're welcome.

Thank you. Our next question is from the line of David Roman with Goldman Sachs. Please go ahead.

Good evening, everyone. Alex, I was hoping you could expand a little bit more or your comments regarding market share gains. I know this has been a pretty consistent theme, but did you see the pace of share gains pick up in the quarter? Just looking at the results that you put up in your US core fusion, versus where some of the peers shook out?

The only way that we can postulate, with regard to market share gains, is what happens on a territory basis. So, in order to put up the numbers that we did in the first quarter, we generally have to increase our market share on a territory, basis. There's no way for us to correlate that into a national trend, or to correlate that up against all of our competitors. As I mentioned, we do see a lot of churn. We do see a lot of other companies taking market share from the larger players, and that's been the ongoing trend that's been out there, I think for quite some time.

Okay. Then on Impulse. I think I have the number is correct on neuromonitoring. Was the business down sequentially versus Q4? I think in the supplemental materials it said, $10 million for last year, and then $9.5 million for this quarter.

It was essentially flat, compared to last year when you normalize it out. There was a few days that didn't count in the quarter. So effectively, when you normalize it out, it's about flat.

Is that the result of seasonality, because there is a capital component in that business? So you see a big bolt in Q4? Or is it anything else going on in that business?

No, I think it's that, that's -- put it to you this way. At this point in time, we still are on track with regard to what we're forecasting. We're not changing our guidance with regard to IOM. And that's where we are, after one quarter.

Okay. That's helpful. Thank you very much.

You bet.

Thank you. Our next question is from the line of Glenn Novarro with RBC Capital Markets. Please go ahead.

Thanks, good evening. Two questions on international. First, international performed well in the quarter. It seems like it was pretty broad-based. But were there any specific drivers that you can call out? And then as a follow-up, I know Japan is going to be -- will be a big driver down the road. Can you give us any update on Japan? I know in the past you said, you hope to start selling product end of 2012. Any update would be great, thanks.

So international performance was really strong across the board, all areas performed well. I think Europe had an easy comp though. To be fair, I think overall internal comp, compared to the other areas. But nonetheless, Europe met our internal expectations. So overall, looked very good for us. As far as Japan is concerned, we still believe that's going to happen in the fourth quarter. We're not exactly sure of how much revenue we're going to get from that just yet. So as we get closer at the mid year point, we'll be able to start talking about that in greater earnest. But at this point in time, we do expect to see revenue in the fourth quarter. To what level, we aren't 100% sure, just yet.

Just as a follow-up on Japan, Alex, is the infrastructure is in place right now. I guess the launch into Japan will be more lateral based. Is that correct?

There is some infrastructure in place right now in Japan. That infrastructure ramps up, as we get closer to the fourth quarter. But that's also predicated upon certain regulatory approvals. We think that those are all going to happen, and we think we'll be able to start selling product in the fourth quarter. So they really start to happen more in the third. And that's pretty much when we're going to have some greater visibility, to what happens in the second half of the year.

Okay. Thanks for taking my question.

You bet.

Thank you. Our next question is from the line of Chris Pasquale with JPMorgan. Please go ahead.

Thanks. Alex, you spoke in your opening remarks about the desire to maintain a strong pipeline. But R&D expense has been flat to down now, for about five straight quarters. That was really what drove a lot of the upside versus our numbers, for adjusted operating margin this quarter. Has that been a timing issue? Has it been the result of certain key programs rolling off or being terminated? When should we expect to see spending pick back up again?

That's largely as a result of fewer clinical trials right now, that are ongoing. In this regulatory environment, I think we're probably a little gun shy, with regard to launching a whole series of them. So right now we don't have any major clinical trials that are running up big numbers. We certainly have our XL TDR, that is still in the process of recruiting patients. So we're looking to maintain our growth investments overall in these areas, but we're focused more on 510(k)s right now. But I think you'll start to see R&D spending come back up in 2013 for sure.

This seems like you are stuck in between a rock and a hard place. The regulatory requirements have ramped up, less products are categorized as 510(k)s, and yet the lack of visibility is making you hesitant to launch PMA trials. I mean, is that something you think will change as you get more comfortable with the new regulatory structure, or is that the new landscape?

It's the new landscape for now. I mean potentially, political change could have some effect, hard to say. That's probably the only thing that, that as far as we can see would have an impact in Washington going into the fourth quarter. So, it is the new normal. And because things really take so much longer now, you're spending a lot more time, just waiting for approvals.

We also were up $1 million sequentially in R&D, and so from Q4 to Q1. The biggest chunks of that were some new product development efforts starting up.

I think another comment, just to be aware of, is exactly how you're seeing it play out here from a PMA IDE process you are seeing also, in new technology companies. So if you look at over the past two years specifically, very light investments from a venture capital perspective into start-up companies, that have anything to do with longer regulatory process.

Uncertainty, not only with the regulatory process itself, but then post regulatory, how you're going to get reimbursement, and what the consistency is, of understanding that reimbursement process. So most are pushing towards -- if it's not a 510(k), they aren't willing to take that uncertainty in the US, and looking more to global expansion if anything.

Thanks.

Just with regard to R&D spending, I think you have to take into account the impact of Impulse revenue. So, obviously the spend would be a little bit higher, than it would with Impulse revenue being factored in, just as a point of consideration there for you. Okay. Next question?

Thank you. The next question comes from the line of Joanne Wuensch with BMO Capital Markets.

Thank you for taking my question. You noted that you have a new judge. What is his name?

He's a she.

What is her name, excuse me.

Bencivengo.

Okay.

It's B-e-n-c-i-v-e-n-g-o. Her e-mail address is -- sorry. (Laughter).

That's okay. It makes Wuensch look easy to spell. (Laughter). Second up, if I take a look at my numbers, and I pull out about $27 million in total Biologics, it looks like your OUS revenue ex Biologics is about $8 million in the quarter, which has been consistent quarter after quarter for some time now. So I am just curious if my math is right? If so, if we should start -- should be staying at that level on a go forward basis?

Joanne, I don't think that math is exactly right. I mean, think we were about -- I think it was about a $1 million or so in OUS Biologics. So the non OUS -- non-Biologics OUS revenue number is higher than your number.

All right. We will have to go through that afterwards. Then finally, could you give us an update on where your sales force is, versus a year ago? Thank you.

Our sales force is larger than it was a year ago. We have really stopped giving that number Joanne, other than just to say it's well over 300 globally, and its been growing very dramatically over the US. But the sales force increased net last year, I don't remember exactly by how much, but it increased net last year. We are actively adding more folks this year. So I can -- on average, we're probably adding about 10% or so a year, is a good way to look at it.

Thank you.

You're welcome.

Thank you. Your next question is from the line of John Putnam with Capstone Investments.

Thanks. Just a point of clarification, Alex. Is most of that overseas, the increase -- and I guess how far are you in building your infrastructure in Europe?

So as far as Europe is concerned, we're direct in two markets. We may go direct in one other one, but those are the two major ones that we're focused on. So, all of our other relationships in Europe will be with distributors. We still have, gosh, at least half a dozen countries to set up more formal relationships with, in terms of a distribution arrangement. As well as a host of countries in which we want to see better distribution arrangements. So I think Europe has pretty good upside over the next several years. But most of those countries are small, and don't contribute greatly to top line performance. So the major one is really, Germany. Then the second one is the UK, and we're in those markets and the infrastructure set up.

Great. Thanks very much.

You're welcome.

Thank you. Our next question is from the line of Jason Wittes with Caris. Please go ahead.

Hi. Thank you for taking the question. Just wanted to ask -- several new products are expected this year. I just want to make sure I understand which ones are actually going to be incremental for the year. I know you've got -- you just mentioned Japan is going to have a small incremental impact in the fourth quarter I think we should assume. But what about ATTRAX, and what about cervical disc, because I assume that's not in the numbers at all?

That's right. So those numbers are not in guidance. So, we have not provided any guidance with regard to those products. So once and when they are approved, then we will certainly come back and talk about them. That's what I mentioned in my prior remarks, that I really want to wait to get through some of these potential approvals in the second quarter if they come, start of the third. Be able to factor that into our guidance. If we indeed, need to make those changes in a three-month period.

So just to be clear, neither the revenue profile, nor the expense burden associated with building and starting those product ramps on the rev side are in guidance today.

Should we assume they are initially somewhat dilutive then, when they get launched, in terms of the way the ramps generally work?

Yes, I mean, you typically invest a little bit ahead of the curve, to build some of the sales and marketing capability. In this case, probably more the marketing.

Okay. I guess in relation to that, I mean it sounds like for most of these, with the exception of Japan, which you are obviously building -- you are not really set out to -- you're waiting to get the approval, before you pull the trigger on those expenses?

Right. That's correct.

Also, let me just ask about the sales force build. I mean, you're basically saying you're adding about 10% a year, which is a little bit below your revenue growth rate. Is that how you target it at this point? You just want a little bit of operating leverage, but not too much until, I guess you reach your, I believe it is a 500 sales person target?

Correct.

Okay.

Our productivity per rep has actually been increasing, and so we're pleased with that.

I guess you don't disclose that, at this point?

You guessed right. (Laughter)

Fair enough. Thank you very much.

Thank you. Our next question is from the line of Jeff Johnson with Robert W. Baird. Please go ahead.

Thank you, good evening. Most of my questions have been answered at this point. But Alex, were there any outside contract wins or distributer sell ins, anything else in the quarter, besides the one extra selling day you alluded to?

No, nothing exceptional --

Okay.

Or unusual.

Okay, great. Last question, just on guidance. Understanding, you are not changing revenue guidance, you put out -- some organic growth by segment guidance last quarter. Is it fair to think that still stands, or should we assume that could move around within those numbers you gave last quarter?

So Jeff, I'll take it. First off, we're focused on the full-year results. We absolutely did see strong performance across the product portfolio, relative to the full-year growth rates expectations, that we had talked about. The drivers there, Lumbar -- US Lumbar and US Biologics. So, absolutely increased confidence in our ability to deliver the full-year revs guidance and the profitability guidance.

As I said in my script, the year-over-year quarterly growth rates in each of these areas, it may vary some as we move through the year. And the -- and because of that the final revenue contribution may also vary. So we'll sort out what we do over the next 90 days to 180 days, as we get a little bit better visibility.

Fair enough. Thanks.

Sure.

Thank you. We have no further questions in queue at this time. I would like to turn the floor back over to Management for closing remarks.

So I think that wraps it up for us, a very strong first quarter. We're excited about our prospects for this year. We certainly hope to be able meet or even exceed for 2012. So we'll be talking to you again in a quarter. Bye-bye.

Thank you. Ladies and gentlemen, this concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.