NuVasive Inc (NUVA) 2013 Q4 法說會逐字稿

Greetings and welcome to NuVasive's fourth-quarter 2013 earnings release conference call. At this time, all participants are in a listen-only mode. A question and answer session will follow the formal presentation.

(Operator Instructions)

As a reminder, this conference is being recorded. I would now like to turn the conference over to Miss Tina Jacobson, Director of Investor Relations. Thank you, Miss Jacobson, you may begin.

Welcome to NuVasive's fourth-quarter 2013 earnings conference call. NuVasive Senior Management on the call today will be Alex Lukianov, Chairman and Chief Executive Officer; Keith Valentine, President and Chief Operating Officer; Michael Lambert, Executive Vice President and Chief Financial Officer; and Quentin Blackford, Executive Vice President of Finance and Investor Relations.

During our 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 are based on current expectations and involve risks, uncertainties, assumptions, and other factors which if they do not materialize or prove correct could cause NuVasive's results to different 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 SEC.

This call will also include a discussion of several financial measures that are not calculated in accordance with generally accepted accounting principles. We generally refer to these as non-GAAP financial measures. These measures include our gross margin, sales, marketing, and administrative expenses, research and development expenses, operating margin, and non-GAAP earnings per share. We believe this information is useful to investors because it provides important financial information regarding earnings generation at NuVasive and is helpful for measuring our progress.

We use these non-GAAP financial measures along with the most directly comparable GAAP financial measures in evaluating our actual and forecasted operating performance, capital resources, and cash flow. The most directly comparable GAAP financial measures and information reconciling these non-GAAP financial measures to our financial results prepared in accordance with GAAP are included in the press releases and in the supplementary financial information files, both of which are accessible from the Investor Relations section of our website. With that I would like to turn the call over to Alex.

Thank you, Tina. The fourth quarter of 2013 marked a fantastic close to a year of solid execution. NuVa is on a mission to change spine surgery and our market share taking strategy clearly continues to fuel industry-leading growth.

Revenue in the fourth quarter exceeded our expectations, growing 15% to $191 million. The strength was broad-based, each major product group outperformed their targets. Operating profit translation was also strong. We generated a non-GAAP operating margin of 16.3% and non-GAAP EPS of $0.37. For the full year 2013 revenue grew 10% to $685 million, and we generated a non-GAAP operating margin of 15% and non-GAAP EPS of $1.23.

With a strong 2013 in the rearview, I will focus my comments this afternoon on NuVasive's future. First I will update you on our outlook for the US spine market, then I will detail the key pillars of our strategy to continue to take market share, which we believe will drive revenue to well beyond $1 billion. I will also address our commitment to improve profitability. Following my comments, Michael will walk through fourth-quarter results and provide detailed guidance for the full year 2014.

So let's start with an update of the US spine market. As you know, both insurer pushback and physician owned distributorships, or PODs, are forces that have negatively impacted market growth for the last few years. However, progress is being made; with respect to insurer pushback, the Health Technology Assessment, or HTA, was published in a peer-reviewed journal. This collection of clinical evidence in support of spine fusion for degenerative disc disease also demonstrated that lumbar surgery outcomes are consistent with outcomes for hip and knee replacements, and is being used by surgical societies to develop consistent clinically-supported guidelines for spine fusion.

Progress was also made against PODs. In a report that summarized their investigation, the OIG did not ban POD models. It did underscore that they have a propensity to drive higher procedure volume without less cost to the hospital. Overall scrutiny of PODs continues to grow. Adoption is decreasing and hospital networks are increasingly refusing to work with PODs.

As well, we just learned of the first enforcement action taken by the Department of Justice in an application filed for a civil investigation of a surgeon involved in a POD model. Clearly the prevalence of PODs should decline. That said, we do not expect the progress to materially benefit US growth in 2014.

Regarding Obamacare, we do not expect its implementation will be an incremental positive for spine. While purely anecdotal, our conversations in the field suggest that fourth-quarter volumes did not benefit from the ongoing uncertainty and challenged implementation of Obamacare. With respect to 2014 we have seen research that speaks to spine patient volume growth. However, we do not see market evidence of that being the case.

In consideration of all of these factors we expect the market will continue to stabilize. In 2014, we anticipate US market growth will be flat to up about 2%, similar to 2013. And regardless of US market growth, we intend to continue to outgrow the industry by executing our strategy to take market share.

Let me now turn to a discussion of our share taking strategy and the drivers of NuVa's continued industry-leading growth. We are focused on executing to the full-year expectations that Michael will outline in a moment, but our vision extends well beyond 2014.

NuVasive is evolving into an increasingly profitable spine powerhouse, capable of generating well over $1 billion in revenue. And we are doing that with a commitment to change spine surgery. We talk a lot about culture at NuVasive. At our sales meeting a month ago our focus was on developing ways to evolve our culture to expand our dominance of innovation in spine in the decades to come. To achieve that, we are incenting share owners at every level of the organization to rethink processes and team architecture in order to best achieve our mission.

We didn't get to where we are with today with replication, so we are challenging the entire organization to inject innovation on a major scale and drive strategic execution by being champions of change, thinking creatively, and being inventive in everything that we do in operations, manufacturing, IT, marketing, and development. With a backbone of our truly differentiated culture we have our 1,600 NuVa family members focused on one mission -- to change spine surgery and take market share.

This mission will be driven by three key pillars. First, we are driving the shift in spine toward minimally invasive surgery. Secondly, we are introducing innovation to the traditional or open spine market. And third, we are launching our market share taking strategy internationally. So now let's walk through each one of these.

NuVasive is at the forefront of the shift toward minimally invasive solutions, or MIS, which continues to unfold in spine. We estimate that less invasive solutions represented about 27% of the global market at the close of 2013. As better patient outcomes, superior economic evidence, and the growth in the number of key institutions teaching MIS in fellowship programs continue to drive adoption, we believe MIS solutions will become the standard of care in spine.

So how is NuVasive championing that shift? First, with economic evidence. We are a market share leader within the $2 billion MIS market. We have an unrivaled 10 years of experience pioneering the lateral solution for spine fusion. That market leadership and that experience give us a unique ability to educate decision-makers on the cost effectiveness of our MIS solutions.

We have evidence that asserts 10% to 14% reductions in overall cost to the hospital when a surgeon performs an XLIF instead of a traditional open fusion procedure, and we have evidence that MIS surgeries result in lower complication rates and readmissions, which can otherwise erode hospital profit margins by as much as 23%. These are incredibly powerful arguments in an increasingly cost-focused environment.

We are also championing the shift toward MIS by expanding internationally, introducing new surgeons to the superior clinical outcomes and procedural reproducibility of our MIS platform. The US market is over 30% MIS today, but international markets are still under 10%. NuVasive is building new markets for MIS overseas much as we began to do here in the US a decade ago based on our development mantra of providing technology to make spine procedures faster, better, and cheaper.

Lastly, we are driving the shift toward MIS with constant innovation. Our experience and research afford us an unrivaled understanding of the unmet clinical needs in MIS and where NuVasive can create additional value in the operating room. For example, we are rolling out Bendini, I love that name, rod-bending software designed to minimize the most time-consuming, most difficult, and least reproducible step in long posterior constructs. Bendini can dramatically reduce the amount of time in OR, resulting in less exposure to fluoroscopy and less anesthesia time.

We also launching the Decade Lateral Plate, which enables single approach lateral surgery. Surgeons can work through their original incision to achieve nearly the same degree of stability without needing to reposition the patient; this can save a great deal of time in the OR and reduce the risk of complications.

And we are launching XLIF for anterior column realignment, or ACR, an MIS technique that can restore lumbar lordosis. Compared to the traditional treatment, XLIF ACR is designed to further reduce time in the OR, the length of hospital stay, and the amount of blood loss.

Innovation is at the heart of our continued ability to take share and drive spine market conversion toward MIS. And importantly, I am more excited about the direction of our current pipeline than I have been at any point in our past. We are making more R&D investments to bring innovation to fruition over the next few years, developing solutions that will expand MIS surgical capabilities. We have a new systems plan for clinical evaluation this year that will change the way spine surgery is being done. We will tell you more about that platform in 2015.

Our focus on innovation is a great segue into the second major driver of our path toward $1 billion in revenue. We are introducing more innovation in the traditional or open spine market, which is over $6 billion globally, nearly three times the size of the global MIS market. As we continue to introduce innovative ways to perform traditional open procedures, we are not just capturing share of the traditional market, we are also establishing relationships with new surgeons who will gradually convert to MIS.

Surgeon demand for our recent product launches that address traditional procedures like Precept, MAS PLIF, MAS TLIF, and all of the innovation we've done within our surgical portfolio validate that there is definitely a place for NuVasive in the traditional market. Precept, our posterior fixation solution that can be used both in MIS and in open procedures, rolled out over the course of 2013 and became our all-time fastest growing product. The second generation of VuePoint, a posterior cervical solution, achieved $1 million in sales more quickly than any product in our history.

These successes demonstrate that our drive to change spine surgery really isn't about MIS or open. Our success comes from architecting both new and better procedures to achieve improved patient outcomes in reproducible way. Again, faster, better, cheaper. NuVasive has a unique ability to deliver on that development mantra.

Looking forward, the momentum behind our procedurally integrated innovations will enable us to marshal the market shift toward MIS and to increase our penetration of the $6 billion traditional market by modernizing traditional posterior procedures. We had strong success driving that in 2013, and we expect to expand upon it with our robust new product line.

The third major driver of our long-term revenue growth will be launching our market share taking strategy internationally. We estimate the international spine market to be over $2.5 billion and growing at about a mid-single digit pace. In 2013 we generated over $70 million in revenue internationally, just a 3% share. Compare that to the roughly 10% share we have achieved in the US and you can appreciate the long runway for growth in front of us. As we drive toward $1 billion, we expect the revenue we generate internationally to almost triple, approaching $200 million.

Let me update you on our strategy for expansion. We are increasing penetration across the EMEA, a $1.1 billion market. We built upon the executive leadership changes of last year with additional highly experienced country leaders to effectively drive share gains in the most important markets, Germany, the UK, Italy, and Spain. And to develop new and emerging market opportunities.

In the $1.2 billion Asia-Pacific market, we are ramping aggressively. We have strong momentum in Japan where the demands for surgeon training and the adoption rates in our inaugural year have been fantastic. We also are cultivating our leadership position in Australia and growing strategically in China.

In the $350 million Latin America market, efforts are underway to further develop our position in Brazil and in Mexico. We also just appointed a new exclusive distributor in Argentina, which will improve our ability to service customers across the region. We have exceptional, seasoned international leadership and subsidiaries in eight key market countries, plus 20 dedicated distributors in 20 countries. The members of our international NuVa family are extremely excited and well-positioned to replicate our share taking strategy globally.

So assuming consistent market dynamics, we believe that those three pillars of growth can support mid-single digit revenue growth for the foreseeable future. In addition to that topline growth, we are also committed to operating margin expansion from the 15% level reported for the full year 2013 to at least 20% as we approach $1 billion. That is a growth opportunity of over 500 basis points that we have a clear line of sight to achieve.

Profitability improvements will be driven primarily by increased international scale as we lever years of investment, increased vertical integration as we work to triple the 15% of total implants that we currently produce internally, improved asset efficiency with operational initiatives to improve inventory positions and distribution methods while levering IT investments, improved sales force effectiveness through our new mobility platforms, and revamped sales teams to drive deeper geographic penetration, and finally, the February 2015 expiration of the patents behind the majority of our royalty expense accruals.

Our vision for growth and the differentiated Company culture at NuVasive position us exceptionally well to continue to take market share. We are laser focused on continuing to drive both top and bottom line growth as we move toward the next milestone of $1 billion in revenue.

Lastly, turning to the legal front, we are actively complying with the OIG's document request. We have nothing new to report on that front, but we'll provide further updates if and when they are needed. With regard to our ongoing patent litigation with Medtronic, the appellate process related to Phase I of the litigation is moving forward. Initial briefs have been filed by both sides and additional briefs will be filed in the coming months. We expect the appeals court to then schedule a hearing with the potential decision by midway through 2015. With that, I will turn the call over to Michael.

Thank you, Alex and good afternoon, everyone. Before we get started, let me remind you that when we cover gross margin, SM&A expenses, R&D expenses, operating margin, and EPS numbers today, we will be speaking to non-GAAP results. Please refer to the supplementary financial information file on our website in the Investor Relations section for all of the detail that will be covered on today's call to reconcile our non-GAAP items to their GAAP counterparts and to put the 2013 to 2014 EPS comparison into context.

Our revenue for the fourth quarter 2013 was $190.8 million, a 15% increase over the fourth quarter of 2012. Year over year, revenue growth in the fourth quarter for both US lumbar and US biologics was about 12%. US cervical revenue grew approximately 17% in the quarter, and services revenue from our impulse monitoring business grew about 15%. International revenue, which includes Puerto Rico grew over 40% in the quarter.

Non-GAAP gross margin in the fourth quarter was 74.2%, down fractionally compared to 74.6% in Q4 2012 and 74.4% in Q3 2013. Year over year, gross margin was pressured by 130 basis points from the combination of incremental royalty expense and med device tax impacts. We offset most of that pressure with 90 basis points of benefits from operational and other improvements.

Non-GAAP sales, marketing, and administrative, or SM&A, expenses totaled $103.3 million in Q4 2013, compared to $90.8 million in Q4 2012 and $93 million in Q3 2012. SM&A expense was 54.1% of revenue for Q4 2013, versus 54.8% in Q4 2012 and 55% in Q3 2013. The year-over-year improvement in SM&A expense came in spite of about 60 basis points of spend in the fourth quarter related to the OIG request. Excluding that, the magnitude of SM&A leverage demonstrated in Q4 would have been more significant at approximately 130 basis points.

Non-GAAP research and development, or R&D, expenses totaled $7.1 million in Q4 2013, compared to $7.9 million in Q4 2012 and $6.8 million in Q3 2013. R&D expense was 3.7% of revenue for Q4 2013, versus 4.8% in Q4 2012 and 4% in Q3 2013. Relative to last year, the decrease in R&D as a percent of revenue was primarily driven by the prioritization of R&D investments and a timing related decrease in clinical spending.

Fourth-quarter non-GAAP operating margin exceeded our expectations, totaling 16.3%, compared to 15% in Q4 2012 and 15.4% in Q3 2013. Interest and other expense net totaled $6.4 million in the quarter, compared to $5.9 million in Q4 2012 and $3.4 million in Q3 2013. Fourth-quarter non-GAAP earnings were $17.8 million or $0.37 per share, which includes an approximately $0.05 tax benefit related to the reversal of foreign tax valuation allowance.

Full-year 2013 cash flow performance met our expectations. For the full year cash flow from operating activities approached $98 million, compared to an adjusted total about $119 million last year. Free cash flow approached $50 million versus last year's adjusted total of about $78 million. While both of these numbers are below the 2012 totals, we did not anticipate repeating the magnitude of the working capital progress that we made in 2012. As well, in 2013 we absorbed the med device tax hit and the cervical litigation settlement, and we also spent more capital expenditures.

Our cash and investments balance at the end of the fourth quarter was approximately $326 million, down about $20 million from $346 million at the end of 2012. The decrease was primarily driven by our repayment of the remaining $74 million associated with our March 2013 convertible debt, and by significant capital expenditures, both of which were partly offset by strong operating cash flow generation.

Now let's turn to detailed guidance for the full year 2014. As I mentioned earlier, please reference the tables in today's press release and the supplementary financial information posted on our website for additional guidance details.

We continue to anticipate full-year 2014 revenue of approximately $725 million, or 6% year over year. This view anticipates our continued ability to take share within a still stabilizing spine market. Similar to 2013, our focus will be on achieving full-year expectations, not on results in any given quarter.

Let me walk through the expected composition of the various elements of our 2014 revenue growth profile. US lumbar grew about 8% in 2013. We expect it to grow about 5% for the full year 2014, driven most heavily by continued progress from some of our new solutions like Precept and MAS PLIF, within the context again of a still stabilizing US market.

US biologics grew about 5% in 2013. We expect it will grow 1% for the full year 2014. Growth will continue to benefit somewhat from the pullthrough of our US lumbar solutions, but Osteocel Plus has likely reached its potential level of penetration.

US cervical grew about 21% for the full year 2013. We expect it to grow about 12% in 2014 in consideration of the larger revenue base and as we anniversary a few major product rollouts.

US monitoring service was flat for the full year 2013. We expect it to be down about 4% for the full year 2014 as strong volume growth continues to be offset by pushback from insurers.

Our International business grew over 30% in 2013. We expect it to grow just over 20% for the full year 2014 as our expansion into new geographies and our drive for leadership in existing markets continues to be offset to some degree by economic turmoil in various regions.

Turning to the rest of the P&L, we expect full-year 2014 gross margin to be approximately 76%, compared to the 74.8% reported for full year 2013. The significant year-over-year improvement primarily reflects the initial impacts of our vertical integration efforts. We expect full-year 2014 non-GAAP SM&A expense to approximate 54.5% compared to nearly 56% in 2013. SM&A leverage is a major focus for us with the numerous initiatives that Alex detailed in his remarks. The improvement in SM&A expense that we anticipate in 2014 reflects strong progress across many of those areas.

We expect full-year 2014 non-GAAP R&D expense to be approximately 5.5%, compared to about 4% in 2013. The increase will be driven by support of several large projects in our pipeline, including procedurally integrated computerized solutions being designed to enable surgeons to more precisely achieve spinal column realignment. The increase also contemplates accelerated efforts to design products for manufacturing as well as for distribution, also to achieve product approvals in overseas markets and to accommodate sterile packaging requirements.

To summarize, we expect to drive close to 250 basis points of efficiencies out of the combination of cost of goods sold and SM&A over the course of 2014. That progress will be balanced against about 140 basis points of greater R&D investments to maintain our innovative prowess and cultivate the future growth drivers of our business. As a result, we will translate over 100 basis points of operating margin expansion in 2014, resulting in an expected full-year non-GAAP operating margin of approximately 16%, compared to the 14.9% reported for the full year 2013.

Implied in our guidance is growth in non-GAAP operating profit dollars of about 14% in 2014. That represents operating profit growth that is roughly double the expected rate of revenue growth in 2014, a clear demonstration of our commitment to improve the operating profitability of our business.

In thinking about the progression of non-GAAP operating margin from quarter to quarter, please make sure that you are mindful of the historical seasonality it has demonstrated. The front end loaded nature of our normal spending pattern has led Q1 operating margin to be far and away, a low point for the last few years. In addition unlike Q1 2013, the first quarter of 2014 will also bear the impact of the incremental royalty expense and the incremental spend on the OIG request. As a result, Q1 2014 operating margin will likely be down compared to Q1 2013.

Continuing with the rest of the P&L. We anticipate full-year 2014 other income and expense to be approximately $27.5 million, including roughly $14.7 million in non-cash interest expense. We anticipate a full-year 2014 GAAP effective tax rate of approximately 80%, compared to the roughly 29% reported in 2013. A portion of this increase can be attributed to the fact that 2013 benefited from several discrete items unique to that year, including the reversal of our foreign tax valuation allowance as well as the one-time double up of the R&D tax credit.

The rest of the increase in our expected 2014 effective tax rate will be driven primarily by the impact of our globalization initiative, which is designed to consolidate and standardize the management of our international business activities. Over the longer term, we expect the initiative to drive operational, asset utilization, compliance, and cost and tax oriented benefits. As a result of its implementation, we expect to see a spike up in US tax expense and in the corresponding tax rate this year, 2014.

We expect our GAAP tax expense will be approximately $19 million, which includes more than $9 million of impacts associated with implementing the initiative. Over the next several years depending on the rate of growth of our international business compared to current expectations, as well as other factors, we anticipate that the various benefits of the initiative will materialize.

On the tax side, over the next several years it should enable a steady improvement in our GAAP tax rate from its high point in 2014, down to a rate in the low to mid 30%s. Under our new structure once we reach the low to mid 30%s, we expect our effective tax rate to remain at or around that level over the longer term. We expect non-GAAP adjustments for the full year 2014 will continue to be tax affected at approximately 40%.

As we transition to becoming a cash taxpayer and as we implement our globalization initiative, we anticipate a significant impact on free cash flow in 2014. However, even with these impacts we expect to manage free cash flow to be roughly flat with 2013's results.

Diluted shares outstanding for the full year 2014 will be approximately 50 million. We expect full-year 2014 GAAP EPS to be approximately $0.11, and non-GAAP EPS to be approximately $1.06, down $0.17. In order to put the year-over-year EPS comparison in its proper context, normalize for the discrete 2013 items, including the tax benefits and the legal settlement benefit in other income and expense, as well as for the 2014 tax rate impact of our globalization initiative. Those adjustments result in an expected 2014 non-GAAP EPS growth rate of about 14%, roughly twice the rate of revenue growth.

Non-GAAP operating margin and EPS guidance for 2014 excludes full-year impacts of non-cash stock-based compensation expense of approximately $36 million, certain intellectual property litigation expenses of approximately $5.5 million, amortization of intangible assets of approximately $16 million, one-time and acquisition related items of approximately $7.5 million, which includes a real estate rationalization item and as-incurred additional items, and non-cash interest expense associated with the 2017 convertible notes of approximately $14.7 million.

I am really looking forward to what 2014 will bring. We are simultaneously executing a share taking strategy and driving operational improvements. Now I'll turn the call back over to Alex for closing comments.

Thank you. 2013 results clearly demonstrate that our market share taking strategy is thriving. And importantly, we are cultivating the drivers that will support top and bottom line growth for many years to come.

In May of 2014 we will notch 10 years for NuVa as a public Company. Over our first decade we've pioneered the lateral approach to spine fusion surgery. We developed an idea into a Company because we engaged early adopter surgeons, drove broad penetration, and amassed the clinical evidence to build that idea into a procedural platform. In just 10 years we launched over 90 products, establishing a comprehensive portfolio that addresses every level and pathology of the spine achieving better patient outcomes, surgical reproducibility, and cost savings. We were able to do all of that by fostering a vibrant corporate culture with a collective will to succeed in changing spine surgery. And we did just that.

Some companies would be content to simply celebrate those achievements. But our deep desire and commitment to improve patients' lives by continuously evolving and changing spine surgery through speed of innovation means NuVa is just getting started. We are systematically converting the global market to MIS solutions, and our dedication to innovation has conceived a pipeline that might even dwarf what we achieved in our first 10 years. Onward and upward indeed. We will now take your questions.

Thank you. (Operator Instructions)

Matt Miksic, Piper Jaffray.

Couple quick questions here. Bigger picture question is just because we just learned a great deal in the preannouncement, but I apologize to the background noise in advance. But thinking about how your positioning the product portfolio Alex, you talked about extending it to traditional spine and broadening the offering that you have not just into MIS but beyond MIS, what experience have you had so far, or how soon do you expect us to see more often in some of these larger centers where NuVasive is able to take the leadership position with the breath at your back, able to knock out some of the more traditional suppliers and give the surgeons and hospitals confidence that you have everything that you need? Is that a '14 event, is it happening already, is it a '15 event? And then I have one additional question. Thanks.

That already started to happen in '13, Matt. And I think that's what you really saw in terms of driving our lumbar growth, was the success that we had with posterior fixation, products like Precept performed exceptionally well as I discussed in my prepared remarks. Same with MAS PLIF and TLIF and so forth, so that's where we are now.

We will be adding more products to the fold to give us more tools in the posterior fixation market over the course of this and next year. And we're just in the process of rolling out the products that I also mentioned like Bendini, ACR, and so forth. So we believe that that will give us more opportunities to come at both the open and the MIS market this year, so we're in a very strong position and already there.

Excellent. And then just one follow-up on what we're seeing, is growth in the device market and to some degree in spine, the use of greater technology in the OR, whether it's guidance or robotics or planning software, it sounds like you're working on extending your technology offering in the OR from what has been the market leading neuromonitoring technology to more planning alignment. Just your thoughts on how you see greater use of technology in the OR going forward. Does robotics make sense? Do we expect this to be greater part of the market in the next two, three, five years? Thanks.

So our approach is to really help the surgeons to plan the procedure earlier on in the process. And so we're putting forward a series of different products and software options over the course of this year and into next as we continue to move down that pathway. So our approach it is exactly as you described, providing a more comprehensive approach to being able to do a procedure.

It's not especially reliant on robotics in terms of our thinking right now. I do believe there is ultimately perhaps a place for robotics down the road. But that's not what we're relying on at this point in time. We will continue to expand our neurophysiology monitoring capabilities and that will be a big part of how we get there, together with some of the things we're doing on the software side for planning.

Thanks, Alex.

(Operator Instructions)

Matthew O'Brien, William Blair.

Was hoping to dig in a little bit more on the lumbar side of things. Alex, what you're saying about share taking and looking at growth in '14 versus '13, you saw already a little bit again off a little bit stronger comp, are you saying something specifically about the opportunity with Precept or MAS TLIF, or is there something else going on competitively that would cause that spiked slowdown in lumbar given all the momentum that you're seeing?

So what we've done is really considered the current state of the US market in providing our guidance and forecast for 2014. We are certainly pleased with the success that we had last year in achieving double-digit growth overall as a Company. And we certainly expect to have very strong performance over the course of '14.

But as we've considered still some of the pushback issues relative to insurance, the fact that PODs still are in the way of growth, we've actually opted to go with the guidance that we've put forward as a result. So we'll see how the year progresses. We'll see where we end up. But we think we're forecasting appropriately for this point in time.

Okay. And then my follow-up is on Japan. You discussed a lot of momentum in that country. Can you just be a little bit more specific as far as what is that has you so optimistic there? Is it number of surgeons that you're training? Number of accounts that you've opened, or going deeper within those accounts? And then I figured I'd give it a shot anyway, can give us the revenue run rate coming out of Q4 from Japan alone? Thanks.

I just heard the first part of your question. And as far as Japan is concerned, I think what we've really seen is that the uptake for XLIF in particular as well as utilization of some of our products, has been very robust, and I think what has been especially pleasing to us is seeing the surgeons continue to utilize the products and look for more and more applications. So I think the success and the stickiness so to speak of our penetration has been excellent.

So we expect very strong growth in Japan this year. I'm sure it will be higher than our overall average growth for international given the strong platform we already set up in '13.

Great. Thank you.

Bill Plovanic, Canaccord.

Just curious on if you could provide more color on the globalization initiative and what exactly that entails?

I'll try and give you an overview. So the globalization initiative for us is essentially as I mentioned, trying to secure the benefits of consolidation. Read that as scale. And standardization, read that as commonality and repeatability in the management of our OUS business activities and that includes our assets.

As I mentioned, we think the benefits of that are operational in nature. We'll get some asset utilization benefits out of it too, compliance oriented and cost and tax oriented. What it involves for us is essentially setting up an operational hub, in this case in Ireland. They've got a great workforce there. They've got operational logistics and even manufacturing skills. And as a country they've also got some attractive incentives. They've also as you know got one of the lowest corporate income tax rates in the world, so those are the key structural items underneath it.

And what's the timing and costs associated with this?

The timing -- it will take multiple years to get through it, but I think the way to think about it from a tax rate standpoint is that we'll go from the high that you'll see in 2014, that 80% or so we have in our guidance, steadily down to the low to mid-30%s over the course of several years. And the other thing to keep in mind about it is essentially after 2014, it should become a future EPS lever for us off of the 2014's result.

Okay.

Just to be clear, Bill, this is underway and this was started in the fourth quarter, and it's fully in effect now in terms of our offices and what we're doing internationally.

Okay. And then just on that same kind of topic, the cadence of the gross margin improvements, what should we expect in 2014?

In the guidance, this is Quentin here, Bill, you can expect roughly 100 basis points of improvement in gross margin in the guidance that we set forward, which is really the benefits of the manufacturing facility that we acquired back in 2013 starting to play through, so about 100 basis points.

Richard Newitter, Leerink Partners.

I just wanted to ask one, Alex, in your opening remarks you specifically talked about 4Q trends and 1Q trends at the market level, and you mentioned ACA. I was just wondering said you're not seeing anything particularly strong fourth quarter. Is there anything that was unique to the fourth quarter that we shouldn't think about as coming through? And then also what about weather related impact in the first quarter of '14? Anything there?

So for us, I think the fourth quarter and really '13 is an execution story and our ability to take share. I mean, it's essentially that. We did not expect or see a lot of help coming from Obamacare in any way, so there were -- I guess there's a fair amount of chatter about that, but we didn't actually see that take place in the marketplace.

As far as weather is concerned, we expected this to be winter and we thought it would snow, so there's nothing really in particular that has happened that's offset our planning or expectations.

Okay. Thanks. That's helpful. And then just what I was hoping to get a better understanding of with respect to your -- sounds like you're not just a minimally invasive Company. Your broadening the breadth of your product offering, you're pulling through a more traditional portfolio. Can you talk about some of the benefits of the product like Precept or MAS TLIF for example, in offering relative to traditional types of instrumentation? Like why is your solution in penetrating the traditional market different than competitors' solutions in traditional markets?

There's a couple things -- this is Keith -- a couple things I think you have to consider is one, the open instrumentation often works seamless with the less invasive instrumentation. So as you're learning particular technique, you're also able to do both open and less invasive.

And I think Alex mentioned nicely in the comments when we started, that as you build a relationship with some of these key institutions and those surgeons, you're able to then change and move them towards less invasive solutions. And so you're able to build a deeper relationship with them and really guide them to that less invasive course. And the good news is the instrumentation that they're using has lots of similarities as they move to the MIS, MAS platform. So it really is a simple transition process for them because of the way they're designed.

I think what we've really tried to do is for example to make PLIF better, to make TLIF better, to address how to do these traditional procedures in ways that surgeons are actually excited and they get some of the benefits like Keith just said of minimally invasive spine surgery actually immediately. So what starts to happen is they start reducing the length of incisions, just even big open surgeons are now thinking about how do I do this in another way? Even though they're still doing a large incision, I think it's starting to shrink. And so it gives us a very strong position to be able to keep improving our position in [the kallens] as Keith outlined.

Bob Hopkins, Bank of America Merrill Lynch.

First, Michael, just one for you on the tax rate to make sure I understand the moving parts here, if you look at your non-GAAP EPS guidance versus where consensus is, it looks like the main difference is really tax rate and share count.

And on the tax rate could you just in simple terms why is the tax rate going up in 2014? I know you've run through it a little bit, but I just wanted to make sure I understand that. And then more importantly you gave some longer-term guidance on tax rate. How much progress can you make towards that in 2015? How long is it going to take to get down to those kinds of levels?

Bob, so if you think about that 80% GAAP tax rate, which equates I think as I mentioned to about $19 million in GAAP tax expense, that includes within it, Bob, about it's actually over $9 million of unfavorable 2014 impacts as a result of implementing the globalization initiative. So while it benefits future years, it certainly has its impact on 2014.

If you exclude out those roughly greater than $9 million of unfavorable impacts, our actual GAAP tax rate in 2014 would have been in the 40% to 45% range, and it would have looked probably quite a bit more normal in that sense.

If you think about how long it takes to get there, I mentioned it's over -- it will take over several years. That's really a function of how fast our OUS business continues to grow, obviously, as well as a host of other factors. But we expect to be back at or around that statutory federally state rate of about 40%, probably by 2016 and then underneath that, post.

Okay. And then Alex, as a follow-up, your comment on PODs and things starting to loosen a bit there, but then you guys aren't guiding to any real benefit from that in 2014. Is that just you being conservative as you wait and see how you want to see how it might play out?

It would seem to me that there's some growing momentum here and that NuVasive may be better positioned than others to benefit given that you have higher market share in some of the areas where PODs are concentrated, so I'm just wondering is this conservatism on your part or is there some sort of structural reason why this is going to go so slowly?

Bob, I think we are very well-positioned to benefit from that. What we haven't seen, though, is just surgeons immediately jumping away from PODs. So I think that as this evolves over the course of '14 and hopefully they go away or for a large -- at least large part of it goes away, then I think we can start to factor that into our guidance. Right now, it simply hasn't happened. And if whatever has happened has been pretty minor in terms of impact, so as we start to see that accelerate then we can talk about that further. But right now, in terms of our crystal ball, it hasn't happened yet.

Chris Pasquale, JPMorgan.

Start off with just a quick one on the intraoperative monitoring business. That segment has been struggling. Your guidance for '14 reflects a modest decline, but this quarter's result was obviously quite good. What happened there?

So we caught up on some of the collections, but largely it continues for us to be a headwind with regard to reimbursement. And so if you look at last year versus prior year, relatively flat. This year I think as we look at the year, it could be flat, but we've actually forecasted it's probably going to be down a little bit. If things go better than we expect then hopefully we'll get back to being flat, but we don't see that at the moment.

Okay. So --

Just a quick follow-on to that, as Alex mentioned reimbursement he's talking about insurer pushback, not the coding challenges that we negotiated at the beginning of last year.

Okay. So the growth this quarter was driven by collections, a catch-up in collections from prior periods?

The volume has been strong as well. And so overall the volume has been good the last couple of years, and it's been increasing. But we've not been able to really get a pullthrough with regard to revenue from that.

Raj Denhoy, Jefferies.

Wonder if I could ask a little bit about the sales force, with the strong results the last couple quarters, have there been any changes to the complexion of the sales organization?

Well we made a couple of number of changes going into '13 with regard to leadership. We also make changes with regard to the Vice Presidents running things, and we've been adding with regard to new sales directors and so forth. Everything else is effectively the same. Even though we've put together as I think we talked about over a year ago, we put together some very strong incentive packages for our sales reps to outperform. Those are in place this year as well.

But in terms of the actual number of sales reps in the US market this year, the fourth quarter versus a year ago, has it changed dramatically?

No. Not dramatically. It's up a bit but not dramatically.

Okay. And maybe I could just ask a follow-up in terms of the margin expansion potential, particularly on the gross margin line, I know you're citing the move to internal manufacturing, mentioned 15% now but growing over time. Do you have any rough gauges in terms of how much you save on a product when you start to manufacture internally in order to gait the magnitude at which you can see the gross margin expand from that over time?

Hi Raj, this is Quentin. Certainly not going to give color with respect to the cost difference down at a product level, but I think if you go back to our analyst day and kind of roll that forward to today, we've talked about the opportunity being the 250 basis point range, so as we come into 2014, we see roughly 100 basis points of improvement in the gross margin coming primarily from the opportunity in the manufacturing space. And 250 being the longer term gives you a sense of the opportunity that's still out there.

David Roman, Goldman Sachs.

Michael, wanted to just go back to your comments regarding operating leverage where you've made a tremendous amount of progress, and if I look at the fourth quarter 2013 as an example, looks like you're dropping through about 25% of every incremental $1 of sales, and that's with the headwinds of the medical device tax and OIG year over year. If I normalized for those two factors, is it fair to think about your business as a 35% plus incremental operating margin business over time?

David, we will never really put out there our translational flow-through statistics to be tracked and reported and monitored. The reason for that is we make investment decisions and choices around those things all the time. We actually made some of those even here in Q4. And so it would have translated even stronger had we not invested a bit more in domestic sales, OUS sales, Japan, and insurgent training.

But I do understand your comment. And I guess I've thought about it more from a full-year perspective. If you look at 2013 on a full-year basis, we came in at 14.9%, but if you exclude those items med device tax, the new royalty, and the OIG, we actually would have been up in the mid 16%, 16.6% or so, which essentially is 210 basis points of year-over-year improvement from 2012's 14.5%. So we view that as very strong execution on the leverage story.

Okay. That's helpful perspective. And maybe just a follow-up on the sales and marketing side. I think one of the topics that a lot of us have been monitoring is the disruption from consolidation at some of the larger players, and it actually seems not to have come up as of late. But maybe you could just talk a little bit about what benefits you might be seeing out there as it relates to the J&J Synthes integration, and now that we're I think 16 to 18 months post the closing of that transaction, whether there are even more opportunities there as some of the non-competes start to roll off?

I guess the best way to think about it is what's happening with regard to market share. And most of the companies that are larger than us really are not taking any share and so they're losing share. They are not necessarily investing much as far as we can tell into R&D and new product rollouts, so that's not a great environment for sales reps who are really incented to put forward new products and to go deeper into accounts.

So I think the best way to summarize it is that over the course of the last really year and a half, we've continued to attract and be able to secure some of the top reps in the business coming really from the major players. And so that's been very consistent. Keeps taking place on just about a daily basis. So I think we have benefited really by the lack of those companies being able to take any significant market share, if any at all.

Mike Matson, Needham and Company.

I know you probably can't say whole lot about the new products that you're planning for the 2015 time frame, but I was just wondering if you could give us some sense of whether this is some sort of a new MIS procedure or just new instruments and implants used with existing procedures. Anything you can say about those products would be helpful.

Sure. We can't go into a lot of detail at this point. We'd like to get through our clinicals just to exactly see where we are, but effectively what it is, it's new implant systems and it's a different way of approaching the spine. And I'll leave it at that and we will be delighted to provide more color after we get through our round of clinical evaluations later this year.

All right. Thanks. And I was just wondering with regard to acquisitions, are you still out there looking for acquisitions? And if so, do you see opportunities? And would these be more for scale and/or technology? It just doesn't seem like there's a lot of new technologies out there right now in the spine market. And you're already pretty big and pretty broad from a scale perspective.

So I think what you have to factor in is that we have a very strong organic growth machine. And we have the ability to produce products at a very robust clip, and we can do it faster, better, cheaper than anybody else can. And so I think that we've been really leveraging that as much as possible.

We are always on the lookout for things that would make sense. I would hope that we can do some things internationally over the course of the next couple of years. Things that would really be positive for us and allow us to either increase distribution or to do things more in that general direction. But at the same time we'd be looking for things to be accretive.

Matt Taylor, Barclays.

Firstly, I wanted to just ask if you could help parse out your expectation in terms of the lumbar growth and how much of that is going to come from let's call it new products versus legacy products or some of the ones that you launched last year versus the legacy products? I guess I'm trying to figure out how much of the growth here is going to be affected by some of the comps next year.

So I guess we don't give that level of detail with regard to how things are really rolling out and the impact. I think the products that we showed in the fourth quarter of last year and at NASS, those are just ramping, so those will have a very positive impact on this year overall. But typically new products for us have had an impact of adding a substantial amount of additional fuel and providing anywhere from 25% to even 30% pick up on the revenue side.

Okay. Thanks. And just to follow-up on the comments on the insurance pushback, so I guess you said in the earlier prepared comments that you are I guess maybe more optimistic around the health technology assessment, but you aren't really forecasting any change. Do you think this is just going to take a long time to evolve in terms of something that could be more positive?

So we know that the societies are working on it. We don't know when they're going to complete their work and put something out there. We're just -- can't give you any more information than that to be honest with you with regard to timeline.

I would certainly expect that something would happen over the course of this year. I believe they've been working on it long enough for that to be a reasonable expectation. And they have I think done a good job at NASS and ISASS in particular, of taking on some of the more individual issues and fighting some of the insurance companies head on for various things that have come up that frankly just don't make very much sense, whether it's on a surgical site or on the biologic side.

Glenn Novarro, RBC Capital.

On the 2014, just on the revenue ramp, you gave us some guidance regarding operating margin, how that's going to play out in 2014. Can you give us any help with respect to the revenue ramp for example? Are there any extra selling days we should be thinking about in 2014? With your 2013 I didn't see much seasonality throughout 2013, but is there any seasonality we should be thinking out? Just any help with how we model 2014 in the revenue ramp? Then I had a follow-up on the pipeline.

This is Quentin here. I think as you think about modeling 2014, I don't expect seasonality would be any different than what we've really seen over the last couple of years. I think seasonality is going to be in line with what we've experienced. In terms of selling days, there is an extra selling day in Q1 offset by one less selling day in Q2, so for the full-year selling days are even.

Okay. And then in years past you would give us an update or your outlook for PCM. Any update on PCM revenues for 2014, and your outlook for the cervical disc space? And any update on AttraX?

Certainly. On the PCM side, the motion preservation market continues to be a difficult market to navigate through with some of the reimbursement challenges. We gave some color on PCM in 2013 as it was in its first year of launch, but came in line with those revised expectations. And at this point, we won't give further color with regard to that product specifically in 2014. With regard to AttraX, it continues to sit with the FDA. We've worked through that process with them in terms of some of the additional testing that's been required, I anticipate not hearing anything more until the fourth quarter of this year.

Jeff Johnson, Robert W Baird.

Alex, one more question on the 2015 pipeline. I know you're not going to talk about it a whole lot at this point. But I think at one point you mentioned potentially getting into the deformity market, that's about a $400 million opportunity I believe in the US market anyway that you don't have a big exposure to it at this point. Is that still something you'd be looking to beta test in 2014 as a move in to more formally into 2015?

Yes. That's definitely part of the plan.

Okay. Thank you. And Michael, maybe I'm just slow on the uptake here. I've been accused of that in the past many times, but that $9 million 2014 impact on the tax side from the global initiative, what exactly is that $9 million? I know you've used that number, you've explained a couple times. I still don't see what the $9 million in expense is at the tax line --

Let me take a shot take a shot at it, Glenn. Let me see if I can help. The $9 million is essentially an increase in US tax expense that will happen in 2014 on higher tax taxable pretax US income, and it is essentially generated out of two things. The transfer of intellectual property rights outside the United States so they can be exploited by our Irish and related subsidiaries, and then also in the structures you also allocate out a fair share of US costs that are there in support of the OUS operation. Both of those factors essentially raise our US taxable income in 2014 and generate that $9 million in higher tax expense.

Makes sense now. Thank you.

Sure. Glad it helped.

Larry Biegelsen, Wells Fargo.

Back to the 2014 guidance, I'm just trying to reconcile here the comment in the release to note the historical seasonality for quarter-over-quarter modeling, and I'm trying to understand does that apply to Q1 2014 over Q4 of 2013? Because that would imply about $183 million or so in revenue in the first quarter or down 4% sequentially like the first quarter of '13. Or does it imply like the 23% or so that you typically see for the first quarter, which would apply a very big step down in Q1? I'm trying to understand those two things.

So when we speak to seasonality we're speaking to it more in line with Q1 in the last couple years has been between 23.5%, 24.5% of the full-year revenue contribution, so that's the way we speak to seasonality.

The sequential drop from Q4 into Q1 certainly in a situation where the growth is a bit slower, you're going to feel the impacts of that seasonality sequentially to a higher degree, and that's what you're seeing reflected in the number.

Understood. And then my follow-up question, on the OIG I know you said there was no update on this call, but in the past I think you said you expected an update in April or so of this year. Is that still the case and can you just refresh us on what you're expecting to hear next on the OIG? Thanks.

So I'm not sure of what the timing will be when we do hear back from them. I think it's fair to say that it should be somewhere by the middle of the year, but we have no way to control what that's going to look like.

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

Thanks everybody for being on the call. We're very excited about our progress and success in 2013. And equally enthused about 2014 and our ability to take share and drive more profitability. So we'll talk to you in a couple months. Thanks, everybody.

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