NuVasive Inc (NUVA) 2014 Q1 法說會逐字稿

Greetings and welcome to the NuVasive first-quarter 2014 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 will now turn the conference over to Ms Tina Jacobsen, Director of Investor Relations. Thank you, Ms Jacobsen, you may begin.

Thank you. Welcome to NuVasive's first-quarter 2014 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; 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 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 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 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 release and in the supplementary financial information file, 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.

NuVasive solidly executed against our full-year strategy to take market share in the first quarter of 2014. Revenue was in line with our expectations, growing 11% to $177 million on strong contributions from each of our major product categories. Operating profit translation also met our expectations. We generated a non-GAAP operating margin of approximately 13.2% and a non-GAAP EPS of $0.29.

First-quarter results place us on track to achieve the full-year expectations outlined at the start of the year. We continue to anticipate full-year revenue of approximately $725 million. We also expect to demonstrate excellent progress against our commitment to improve operating profitability. We continue to anticipate a full-year non-GAAP operating margin of approximately 16% and non-GAAP EPS of $1.06.

This afternoon I will provide an update on our views of the US spine market. Then I'll walk through the key drivers of our future earnings growth. Following my comments, Michael will walk through first-quarter financial results.

So let's begin with an update on the US spine market. Gradual progress continues to be made with respect to both insurer pushback and physician owned distributorships, or PODs, two forces that have negatively impacted market growth for the last few years. With respect to insurer pushback, we are encouraged that the North American Spine Society, or NASS, is becoming increasingly active on the advocacy front. The Society intends to more proactively recommend credible and reasonable, clinically supported positions to help drive consensus on spine patient coverage before it becomes a matter of controversy.

NASS is also more actively working to settle controversies that already exist. Their efforts have been impactful with the recent obtainment of a new Category 1 code for two-level total disc arthroplasty. Soon the Society expects to publish clinically-based coverage recommendations for multiple techniques, including cervical and lumbar artificial disc replacement, lumbar fusion, and the use of BMP. We are pleased to see the surgical community collaborating to more assertively ensure spine patients access to the care that they really need.

Progress is also being made against PODs as adoption continues to decline. Numerous hospital networks have increased disclosure requirements for physicians and device companies. Some of those networks are not just refusing to work with PODs, but more broadly refusing to work with any structure in which physicians are financially incented. We continue to believe that the prevalence of PODs has peaked, but we do not expect the progress made thus far to materially impact US growth in 2014.

With that market backdrop let's zero in on NuVa. In 2014 we are celebrating a decade as a public Company and a decade of industry leading growth. All that we have achieved thus far has been driven by a differentiated culture, focused on the crisp execution of our strategy to take market share. We have a Company-wide commitment to change spine surgery in order to improve patient outcomes. In our next decade as a public Company that core philosophy will not change.

That said, we are actively evolving NuVasive so that even as a much larger, more profitable global organization, innovation continues to be the foundation of all that we do, both technologically and operationally. This year you will hear us talk about NuVa 2.0, a shift in focus for our organization with three points of emphasis: increasing market share in a profitable way, driving innovation in our products and in our business, and making culture and people our competitive advantage.

NuVa 2.0 will focus the entire organization on achieving growth in a profitable way and on driving innovation throughout every single area of our business. A critical first initiative will involve collaborating with our sales team to change and improve our operations, supply chain, customer service, and distribution flow. That change management process is underway with an objective to provide the best customer service and fulfillment in conjunction with the greatest financial efficiency.

Beyond that we are focusing on identifying other opportunities and deploying innovative solutions. The process will unfold over the next few years and will fortify our cultural foundation as we evolve into a $1 billion startup with improved profitability.

With a differentiated culture as a strong backbone, we have our sights set on continued industry leading growth as we enter our second decade as a public Company. The growth will be multi-faceted and importantly, we can now speak to drivers of not just revenue growth, but also operating profitability growth and EPS growth.

Let's walk through each of these. First with respect to revenue growth, our progression toward $1 billion in revenue and beyond will be driven by continued market share taking. At the close of 2013 we estimate NuVasive had 8% share of the global spine market. The drivers of our expansion beyond 8% will be: the shift in spine toward minimally invasive surgery, or MIS, our penetration of the traditional or open spine market, and the continued launch of our share taking strategy internationally.

Most of you have heard me speak about these, but let me touch on them very briefly. As a market share leader within the $2.2 billion MIS market, NuVasive is championing the shift toward less invasive surgery which continues to unfold in spine. We estimate that MIS solutions represented about 27% of the global market at the close of 2013. Better patient outcomes, superior economic evidence, and the growth in the number of institutions teaching MIS in fellowship programs continue to drive adoption of MIS. We believe that as MIS becomes a standard of care in spine, NuVasive will be a key beneficiary.

Our mission to change spine surgery and improve patient outcomes isn't limited to MIS. Our core patient outcome-centered philosophy, which drove growth throughout our first decade, is equally applicable to traditional or open techniques. Gradual penetration of the $6.5 billion traditional market where we historically haven't participated in a meaningful way will be another key driver of our future market share expansion and revenue growth.

To penetrate that space we are leveraging the experience gained as a pioneer of MIS to make traditional procedures less invasive for patients and more reproducible for surgeons. It has been an immensely successful strategy considering the sales achievements and the continued strong momentum behind recent product launches like Precept, MAS PLIF, MAS TLIF, and VuePoint II.

New solutions like Bendini, our anterior column realignment techniques, and the global spinal column realignment solutions under clinical evaluation in our pipeline are all intended to further our ability to provide patient-specific, procedurally-integrated care. Each is capable of addressing both MIS and traditional techniques, and over time can advance our penetration of the traditional market.

Another key driver of our market share expansion and revenue growth will be international expansion. As we drive toward $1 billion, we expect the revenue we generate internationally to almost triple from where it is today and approach $200 million.

Let me update you on some progress made this year. In the EMEA, the leadership changes affected last year have begun to reap rewards, resulting in strong results in Q1. In Asia-Pacific we continue to ramp aggressively. Australia and New Zealand are performing to plan and gaining share.

The momentum in Japan is also solid. We trained more Japanese surgeons during the first quarter than in any quarter last year. Adoption rates also remained strong. Altogether it has been an exceptional start to a strong future in the world's second largest spine market in Japan. The excitement in our overseas markets is absolutely palpable, and our international NuVa family is eager and well positioned to take market share on a global scale.

In addition to industry leading revenue growth, we are also targeting operating margin expansion from the 15% level reported last year to at least 20% as we approach $1 billion. Profitability improvements will be driven primarily by: increased international scale, as we lever several years of investment; increased vertical integration, as we work to more than double the 20% of total implants that we currently manufacture internally; improved asset efficiency with initiatives to improve inventory positions and distribution methods, rationalize our real estate footprint, and lever IT investments; improved salesforce effectiveness through mobility platforms and revamped sales teams; and finally, the February 2015 expiration of the patent behind the majority of our royalty expense accruals.

Lastly, we are implementing a globalization initiative that will provide a long term P&L lever for us. The initiative is designed to consolidate and standardize the management of our international business activities. Over the next several years its various benefits will materialize, including streamlined operations and a steady improvement in our GAAP tax rate from its high point in 2014, down to an eventual rate in the low to mid-30%s.

In sum, NuVasive's future growth outlook has never been more exciting. We have a proven strategy to drive revenue growth by expanding our market share beyond the 8% that it is today. And in addition to revenue growth, we have numerous drivers of operating profitability and earnings leverage expected to unfold over the next several years.

Briefly turning to the legal front, as we've previously disclosed we received an unfavorable jury verdict this month relating to our use of the trade name NeuroVision in the amount of $30 million, despite being the trademark owners. We strongly disagree with the verdict and will promptly petition the US District Court with post trial motions in an attempt to have it overturned. If necessary, we plan to appeal the verdict.

As we described in 2011, when we first dealt with this issue, the case is merely about the name NeuroVision and has no impact on our products, procedures, or ability to supply and service the surgeries that are at the heart of our business. We also are actively complying with the OIG's document request. We have no further report on that front, but will provide updates if and when they are required.

With regard to our ongoing patent litigation with Medtronic, the appellate process related to Phase 1 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 a 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 with the financials 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 details that will be covered on today's call, and to reconcile our non-GAAP items to their GAAP counterparts.

Revenue for the first quarter 2014 was in line with our expectations at $177.5 million, an 11% increase over the first quarter of 2013. We continue to anticipate full-year 2014 revenue of approximately $725 million or 6% growth year over year.

Let me walk through the composition of revenue growth in the quarter and for the full year 2014. US lumbar growth grew about 8% in the first quarter. We continue to expect about 5% growth for the full year, driven by the continued strong momentum of our new procedural solution, albeit within the context of a still stabilizing US spine market, and increasingly difficult year-over-year comparisons as the year progresses.

US biologics growth of about 9% exceeded our expectations. As a result of the first-quarter strength, we now expect growth of about 2% for the full year 2014, up slightly from the 1% growth we previously expected. Pull-through from our US lumbar solutions continues to be strong, and the recent launch of Osteocel Pro with improved handling characteristics is driving increased surgeon interest. That said, we are again mindful of increasingly difficult year-over-year comparisons.

US cervical growth of about 9% was below our expectations on slower than expected penetration of the cervical market. In consideration of the first-quarter result, we now expect cervical to grow about 10% in 2014, compared to the 12% growth that we previously expected, still much faster than the growth rate of the cervical market in aggregate.

US monitoring service exceeded our expectations, increasing nearly 11% in the quarter. We are encouraged by the improvement in collections we have achieved over the last several months, but we don't yet feel fully confident in the sustainability of that dynamic. As a result of the Q1 out-performance, we now expect US monitoring service will be flattish for the full year, an improvement from our prior expectations of down 4%. That assumes that strong volume growth will continue to be offset by pushback and collections impacts from insurers.

Our international business, which includes Puerto Rico, grew over 30% in the first quarter. We continue to expect it to grow just over 20% for the full year, as solid results in Europe and Asia-Pacific continue to be offset to a degree by economic turmoil in several Latin American markets.

Non-GAAP gross margin in the first quarter was 75.7%, up fractionally from the 75.5% reported in Q1 2013. The fact that gross margin expanded slightly is especially favorable in light of about 20 basis points of mix pressure related to the out-performance of lower margin product categories like biologics and IOM, and about 60 basis points of pressure from the incremental royalty expense, which we will begin to anniversary during Q2. We more than offset those negative impacts with operational improvements, including cost efficiencies from NuVa manufacturing. Price was not a material factor in the quarter.

With the increased growth expectations for biologics revenue and IOM service revenue that I mentioned earlier, the mix pressure experienced in the first quarter could persist for the remainder of the year. In spite of that mix headwind, we continue to anticipate a full-year 2014 gross margin of approximately 76%.

Non-GAAP sales, marketing, and administrative, or SM&A, expenses totaled $102.4 million in Q1 2014, compared to $92 million in Q1 2013. SM&A expense was 57.7% of revenue for Q1 2014, in line with the 57.7% reported in Q1 2013. Relative to last year, SM&A reflects increased investment in our international infrastructure and about 40 basis points of spending related to the OIG request, which we will begin to anniversary during Q2.

Those sources of pressure were offset by gains in sales rep productivity on the domestic side and by an approximate 40 basis point benefit from the change in the estimated useful life, or EUL, for the instrument sets used in our international operations. The change brings the depreciation cycle for our international business in line with our domestic business. Over the course of this year we currently expect the EUL's slight positive contribution will be partially absorbed by incremental spend related to the NeuroVision trademark litigation. As a result, we continue to anticipate a full-year SM&A expense of roughly 54.5%.

Before I move on to the rest of the P&L I want to point out that included in Q1 GAAP SM&A expense is a litigation liability of $30 million related to the trademark case that Alex mentioned earlier. That $30 million may ultimately be set aside on the balance sheet as restricted cash pending the outcome of post trial motions and the likely appellate process.

Also included in GAAP SM&A is a leasehold termination charge of $6.4 million which we signaled last quarter. This item is related to our ongoing effort to rationalize our domestic real estate footprint and drive enhanced asset efficiency.

Non-GAAP research and development, or R&D, expenses totaled $8.5 million in Q1 2014, compared to $7 million in Q1 2013. R&D expense was 4.8% of revenue for Q1 2014, versus 4.4% in Q1 2013. Relative to last year, the increase in R&D was driven by investments to support several significant projects in our pipeline. We continue to anticipate a full-year R&D expense of approximately 5.5%.

First-quarter non-GAAP operating margin was roughly in line with our expectations, totaling 13.2%, compared to 13.5% in Q1 2013. As a reminder, Q1 operating margin has typically been the annual low point given the front end loaded nature of our normal spending pattern and the quarterly spread of revenues across the year. In addition, I mentioned earlier several of the moving parts that were unique to Q1 2014, including the incremental royalty expense, spend related to the OIG's request, and the benefit from the EUL change, which if they were all neutralized would have driven a Q1 operating margin of approximately 13.8%.

Considering our Q1 results, our proactive management of unanticipated variances, and our current outlook for the remainder of the year, we feel comfortable in our ability to demonstrate the roughly 100 basis points of improvement we've targeted for the full year. Accordingly, we continue to expect a full-year non-GAAP operating margin of approximately 16%.

That expectation now contemplates the offsetting incremental impacts that I mentioned earlier, including the potential mix pressure related to higher expectations for lower-margin product categories like biologics and IOM, the incremental spend related to the NeuroVision trademark litigation, and the EUL benefit. Importantly, still implied in our 2014 guidance is non-GAAP operating profit dollar growth of about 14%, or operating profit growth that is roughly double the expected rate of revenue growth.

Interest and other expense net on a GAAP basis totaled $6.3 million in the quarter, compared to $6.6 million in Q1 2013. We continue to anticipate full-year 2014 interest and other expense to be approximately $27.5 million, including roughly $14.7 million in non-cash interest expense.

Our Q1 GAAP effective tax rate, or ETR, was affected by the recognition of a litigation liability. On an absolute basis we recognized a Q1 GAAP tax benefit of approximately $15.1 million, which equates to a GAAP tax benefit rate of roughly 45%. As a result, we now expect a full-year 2014 GAAP effective tax expense of approximately $6.5 million, compared to the estimated $19 million that we previously expected. We continue to expect non-GAAP adjustments for the full year 2014 to be tax affected at approximately 40%.

First-quarter non-GAAP earnings were $14.3 million or $0.29 per share, compared to $11.9 million or $0.26 per share in Q1 2013. In the move from a tax expense rate to a tax benefit rate in the quarter, we saw this shift contribute about $0.04 to EPS. That benefit is timing related and will be offset over the course of this year, so we continue to anticipate full-year non-GAAP EPS of approximately $1.06. Please refer to the supplementary financial information file on our website in order to put the year-over-year EPS comparison in its proper context, and to review all of the items including any updates that will be excluded for non-GAAP reporting purposes.

For the first quarter, cash flow from operating activities totaled about $23.3 million, down slightly from our roughly $24 million total last year, driven by higher investment in inventory. Free cash flow totaled $9.9 million, down from last year's total of just under $15 million, driven by higher capital expenditures. For the full year, we continue to expect free cash flow will be roughly flat with 2013's result.

Our cash and investment balance at the end of the first quarter was just under $340 million, up about $14 million from $326 million at the end of 2013. The increase was driven by operating cash flow generation and proceeds from the issuance of common stock.

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

Our strategy to take market share is alive and well, and while staying true to NuVasive's core philosophy, innovating to achieve better patient outcomes, we are evolving our organization to maintain our startup mentality and to lead spine innovation as a much larger and increasingly profitable global organization. From my comments today my hope is for you to better appreciate our numerous future earnings growth drivers. We are simultaneously driving revenue growth through market share expansion while making profitability improvements and generating EPS leverage, and we are very excited about our future prospects.

Before we take questions I would like to express my sincere gratitude to Michael, or Captain Profit as he is affectionately known at NuVa, for his numerous contributions to our continued evolution as a Company. Michael has made a real difference in his tenure with us, and we are far better off as a result of his active engagement.

I would also like to express my confidence in Quentin Blackford, whom all of you have had the opportunity to meet over the last few years. During Quentin's tenure at the Company he has excelled in every role Michael and I have challenged him with. As many of you know, we added investor relations to Quentin's responsibilities almost two years ago, and more recently he has also assumed responsibility for the accounting team and joined our Executive Committee. Through his increasing responsibility, Quentin has helped drive the strategy for our expanding profitability as we have been identifying areas for increased efficiency in our business. I have every confidence that Quentin will continue and expand this effort in the years to come.

As Quentin assumes the CFO role in August following our future earnings call, he and Michael will continue to work closely together into the spring of next year to ensure an exceptionally smooth transition of the many CFO responsibilities. I look forward to working with Quentin and the rest of our Executive team to drive NuVasive toward $1 billion in revenue and beyond with improved profitability. We will now take your questions.

(Operator Instructions)

Matt Miksic, Piper Jaffray.

Thanks for taking our questions First I had a question for you, Alex. You mentioned this has come up a few times in the past, this idea of the Society is getting more involved and sort of helping drive some of the evidence and policy and coverage guidelines for the industry. When do you think -- I know it's a tough question, but when do you think we'll start to see some of the fruits of those efforts?

Well, Matt, I think we've already seen some of that. They pushed back on the cervical issues with pretty good success. They haven't fully resolved the issue.

They did get the two-level approval for cervical arthroplasty. That's in the works. And they're working hard on the various other areas that I mentioned from lumbar fusion to broader utilization for arthroplasty.

So they're making I think pretty good headway. I also don't think it's going to be over once they do address these things.

This is the new way things are done in the healthcare environment. So this will be an ongoing process for them, and I'm very happy to see them as well as ISASS and other organizations take it seriously, and really get together, collaborate, and move forward with the right recommendations.

I just ask because of the -- we were pretty impressed with the systematic review that was published last year, that whatever it was, 70%, 75% efficacy, which was surprising for those DDD patients in those trials. And it's been a year, just love to get a sense of when and if we are able to start to move the needle on that, but apparently not just yet.

My sense, Matt, is that it's going to take a lot longer to move the needle on DDD. That's probably the biggest area of pushback by the insurers, and that's probably the hardest one to make a change in. So I think that's going to take a while despite as you say the very strong prevalence of excellent data.

Fair enough. Then on the guidance and on some of the results in the quarter, which obviously better than our expectations, a couple points I wanted to ask. This is maybe where you nudged around your expectations a little, and biologics came up a touch and cervical came down a touch.

I'm wondering, A, was there anything that you see sort of driving some of the strength in biologics other than just the pull-through in lumbar fusion? And then B, on the cervical side anything to be concerned about there?

No, nothing to be concerned with on the cervical side. We're still growing at a very healthy double-digit pace. I think that you've coined it appropriately, which is we continue to see more and more pull-through into our procedures of biologics.

Somewhat anecdotally, one of the pushback points on cervical has been the utilization of PEEK devices. And so it's hard to say for sure and with a lot of certainty, but just anecdotally I think we may see some additional uptake of biologics versus let's say some additional uptake of PEEK-type products like [are form]. So it's not a big change at this point in time. Either way I think we have the product covered regardless of which way they choose, but I think that has something potentially to do with some of the change in those numbers.

Could I ask just one follow-up to that?

You've gone full circle already. All right. Go ahead.

I'm sorry. I'm just curious on that issue of PEEK versus titanium or biologics, I'm wondering if you have anything that we can expect to see as maybe an answer to the sort of bone-friendly products other folks are rolling out in fusion as opposed to PEEK?

Well, we certainly have that with our allograft line and also with Osteocel. I think that people really like our allograft and it's been very popular, so I think we're in very good shape on that.

Okay, fair enough. Thank you, Alex.

You're welcome.

Matthew O'Brien, William Blair.

Hi guys. This is Kayla in for Matt. Just had a couple quick ones for you. So with respect to the lumbar strength in the quarter, can you just provide an update on the competitive landscape there? Specifically just given the recent merger between two sizable players, and then taking into account the integration issues that we've seen in other larger companies, are you foreseeing any changes in the competitive dynamic that may allow NuVasive to potentially capture new accounts in the coming quarter?

Gosh, that's a hard one to answer. Clearly based upon the results that we've seen, we're taking share. We're taking share obviously from a number of different players, and a lot of the larger players have pretty flat results, if not negative. So one would assume that it's really not so much the strength of market growth obviously that's fueling results for us, but our ability to take share and we've been doing that effectively for some time.

And then internationally, growth was again better than we anticipated, and particularly in Japan, and so the 20% guidance appears quite achievable. Can you just help us understand the risk there that may result in that deceleration from the 30% to 40% growth that we've seen in recent quarters?

So we think 20% is a good way to start. I think that we are a bit conservative on international simply because of the pressure we see in Latin America. That has more to do with the economic environment certainly than the spine industry per se, but we do expect international to perform better than 20%, and I think as we've stated, at least 20%. So we do expect to see some pretty strong performance out of international this year somewhere north of 20%.

Great. Thank you.

And I would just add on that, the second half comparisons are very, very tough for us internationally. Low 30%s, low 40% growth rates Q3, Q4 year over year by comparison.

Great. Thanks.

Bob Hopkins, Bank of America, Merrill Lynch.

Hi, thanks and congrats to Quentin and Michael on their moves. So a couple quick things here. Alex, first on your 2.0 commentary I appreciate all the detail you laid out. I was just curious.

Is there anything new with the programs that you were talking about in your introductory comments relative to things that you've talked about in the past that you really want to highlight here in this call? I'm just trying to understand exactly what's new here and is anything changing with commissions or anything like that?

Sure. Really what I'm talking about, Bob, is that we've always been very good at innovating with regard to products and services, that's been our strength. What I'm trying to do now is to drive innovation into the entire fiber of the organization and keep coming up with more and more ways for us to achieve profitability, efficiency, right down to every single person.

So I think as a company is approaching our size, it's rather easy to become complacent about some of those thing. We refuse to do so. And so we're driving a series of innovation programs that we're calling 2.0 over the next few years, and starting off with really tackling operations to make that a more profitable area.

So this has nothing to do with commissions.

Has nothing to do with commissions per se. That's an ongoing process of what we'll do on driving down commissions over a longer period of time, which we're doing anyway.

And then I just wanted to ask you a longer term question because obviously your results the last couple quarters have sort of spoken for themselves. I'm just curious again with all the merger activity you're seeing in orthopedics, if you think about the world in terms of three to four year chunks of time, do you ever envision a time when spine will be bundled more aggressively with other orthopedic products, or do you just not see that happening? Just curious as to your thoughts.

I don't see that happening over the next five years, Bob. I think that we've been very effective at winning some bigger and bigger accounts lately, but we are bundling in terms or moving towards bundling spine products with other services, and I think that is the change that clearly has been moving in our direction.

But we -- I think what's important for us is to continue to have a very differentiating offering of products and services. And so that's what we're focused on and we have a number of things in the works that we've referenced from global spinal balance to what have you that we believe will drive that growth for the next four or five years easily.

The services that you're talking about like neuromonitoring and other thing or are you referring to something else?

Neuromonitoring, Bendini, things that we're doing to resolve the simplicity or create the simplicity of rod bending. Pre-operative planning is a big area of focus. That's part of a service that we'll be providing in the future.

Great. Thank you.

Yes.

Bill Plovanic, Canaccord.

So a couple questions. Really it all stems from one is you talk about the five levers that you can pull on margin improvement over the next couple of years, but I was wondering if you could just detail exactly the five levers and the timing, the cadence, when we'll start to see this in the P&L.

So, Bill, this is Quentin here. We've laid out those five levers really speaking of those as international scale. So we've talked about this for several quarters now. As we continue to grow into that international business into the investment that we've made over time, we expect that to become much more profitable, at some point exceeding the overall corporate average.

So that's just going to be a matter of time in terms of how the growth translates out across different regions. So we'll see that over the course of the next several years as we grow it to roughly 20% of overall revenues.

The in-house manufacturing, bringing production in-house, we've talked that we're nearly around 20% of the implants today, trying to double that over the course of the next couple years. So again I think you're looking at something that's going to be in the time frame of the next year or so to continue to see those benefits playing out.

And then you look at salesforce leverage, asset efficiencies, Alex talked a bit about that in terms of the whole new 2.0. Those are things that are front and center in terms of where we're trying to drive efficiencies, and I think that's a matter of probably playing out over the next year to two years as well.

So not going to get specific with regards to how it plays out in the 16% by category but, certainly the big part of how we get into 16% and then onto the greater 20%. And then probably the easiest one is the Medtronic royalty which we all know is going to expire in February of 2015, and that's going to be somewhere around 150 basis points or so that's going to fall out of the P&L pretty quickly.

Okay. The reason I ask is I was looking at this. I think your -- on a sales and marketing line or SG&A line, I mean you've been at like non-GAAP at the same amount for the last two years if I look at Q1 2014, Q1 2013, Q1 2012, I believe they're all the same on a non-GAAP basis. So that's really what I'm getting at. Can we expect in 2015 we're actually outside of the manufacturing and the Medtronic royalty that we'll actually see it on the operating expense line?

Yes, yes. Absolutely we expect you will. I think in Q1 you've got a bit of an anomaly playing through the quarter. Keep in mind we have OIG spend this year that we didn't have last year in the first quarter, roughly 40 basis points.

We also spoke to a bit of the investment in the international footprint, which is more along the lines of the global initiative. So there was another roughly 40 basis points in the quarter that we didn't have last year at the same time that gives a bit of a difficult compare on the SM&A line specifically.

We'll anniversary those over the middle part of the year and into the back half of the year. So you'll start to see leverage in SM&A over the course of this year and certainly into the future.

Okay, great. Those are my questions. Thank you very much, and congratulations on a good quarter.

Thank you.

Rich Newitter, Leerink Partners.

Thanks for taking the questions, and congratulations Quentin and Michael. I was just wondering if there were any distortions for the 1Q growth rates to be called out, either on selling days or was there any impact from weather, or what you saw from kind of 4Q to 1Q seasonality?

It definitely wasn't weather, but I know Michael wants to talk about selling days.

All right. So Rich, there was one extra day in the quarter. So if you adjust for the math a little bit under $3 million or so in terms of revenue and takes the low 11%, 11.3% down to 9.5% from a growth perspective.

Rich, this is Quentin. In term of anything outside the norm in the quarter, the only thing that I would point to is in the services business we saw some strength there growing roughly 11%. A bit of that continues to be our ability to collect on some of the historic procedures that hit more one time in nature and not necessarily sustainable into the future. That's playing into the guidance of a full-year expectation of somewhere around flat.

The other thing to keep in mind is Q2, when you look at Q2 versus Q1, in 2013 there was roughly a three selling day increase quarter two versus quarter one. This year we don't have that same phenomenon. The seasonality will be a bit different for us. We're only going to see a one day increase.

Okay. That's helpful and then maybe, Alex or Michael, can you just talk a little bit about you kept your full-year guidance unchanged despite some nice upside in the first quarter. Just could you help us think about the puts and the takes there? What was a little bit better than expected, and where do you perhaps try to temper your expectations most in the back half to not want to let that flow through?

Rich, a revenue statement or an op margin statement?

On the revenue side.

Yes, okay. So on the revenue side, and it's sort of an extension or continuation of the Q1 result, right? Biologics and IOM certainly outperformed and cervical in the overall scheme of things came in a little bit light.

So we have updated our forward guidance to try and reflect that over the course of the remainder of the year. And still looking for continued momentum on the lumbar side, still looking for some progress in cervical, and we've got new product coming out on the anterior plate side in the latter half of the year, which will help.

But I do think the really primary message about this is when we think about how Q1 looks relative to the full-year guidance is that the second-half comparisons are extremely difficult for us this year. Lumbar last year, Q3, Q4 we were 12% growth each quarter. Biologics last year 11% and 12% growth each quarter, Q3, Q4; international as I mentioned earlier 31% growth Q3, 41% growth Q4, and what that means is from a comparison standpoint it's a high bar to jump over.

Rich, last thought I'll leave you with on it and we've said this time and time again. I hope the last couple years it's registering. We aren't really focused to executing to a full year at this stage, not on any given quarter, and of course, if performance dictates, we'll update guidance later in the year.

Thanks a lot. Keep it up.

Mike Matson, Needham & Company.

Hi. Thanks for taking my question. I guess I just wanted to start with the cervical business. I'm just wondering if you could provide a little bit more commentary around the slower growth there and maybe what you're seeing there, and why it's not living up to kind of what you thought it would be earlier in the year.

Mike, this is Quentin. As we get into the cervical and certainly spend some time really trying to dig into the details there, what I can tell you is there's nothing from a product perspective, surgeon customer perspective that really jumps out at you.

We got off to a bit of a slow start over the course of January, February. March was a very strong month for us on the cervical side, and I can tell you that the leadership team here is very excited about what we have going for us on the cervical side of things with regard to new products that are going to come out later in the year, particularly the Archon Plate that gives us another offering in the anterior the portion of the cervical spinal.

For us the change to the full-year guidance is more or less going through what we saw in the first quarter, but our growth expectation in terms of accelerating that over the remainder of the year remain intact, and we feel very good about it. Nothing of significant concern that we've seen.

Okay. And then just with regard to the latest litigation, patent litigation with Medtronic, I was wondering if you could maybe sort of frame out the range of possible outcomes there. I mean I would assume it wouldn't possibly be as bad as kind of the first round in term of the amount of royalties that you had to pay, but I know it's kind of up in the air, but just in terms of the percent of your sales that these products account for and so forth, maybe any metrics you could give us there would be helpful.

You're talking about Medtronic?

Yes, sorry, Medtronic, the patent litigation with Medtronic.

Sure. So as you know, with regard to Phase 1 we don't even see ourselves getting an answer from the appellate court until sometime in 2015. So I think that that's been a sort of -- we'll see where that ends up and then we'll prepare for in all likelihood a new trial.

Phase III is in the very early stages and it basically looks like it's going to be effectively just a couple of patents in dispute, one on the biologics side for Medtronic, and one on dilator design for us. So it's a pretty straightforward process versus the very convoluted one that was part of Phase I, but that also has a bit of runway to it, and wouldn't see anything until sometime in mid- to late 2015.

All right. And then just one final question on the patent situation. So with the spacer patent that you were paying the bulk of the royalties on that's going to expire, there's no risk that Medtronic could somehow extend the life of that patent, is there?

Not without changing the law.

All right, thanks.

I'm not saying they wouldn't do that. I'm just saying it's unlikely. They do have a lot of attorneys, you know. No, obviously there's nothing they can do.

All right. Thanks a lot.

Yes.

Jeff Johnson, Robert W Baird.

Thank you. Good evening, guys, and, Michael, best of luck. Quentin, congratulations.

Alex, was hoping I could maybe start with you on new products. The computerized spinal alignment system that you've been talking about for next year, any update there? And I would assume still plan on beta testing and maybe moving into the deformity next year but just want to make sure that's still on track as well.

That's correct. That is on track and we've actually started with alpha, so beta will scale up over the second half of this year. And if all continues to move forward, which so far it looks like it will, then we'll be able to launch probably in the first or second quarter of next year.

All right. Great. And then Quentin, you had made some comments on OIG spending as we start lapping those, at least the incremental impact of those and some other comments you made, but I know you guys can't predict what happens with the OIG. I wouldn't ask you to do that, but I guess if it would go on to a formal investigation, would it be your assumption that your OIG investigation costs, that line item would go up then over a year or two period as maybe that process played out, or is your spending at a level now where you think due to that issue alone it may stay stable here?

At this point I think it's just too early to try to even assess what would take place in that situation. We have no idea what the go forward requirement would be to support anything that might come out of that. So it's too early to say.

Okay. Fair enough. Quentin, can you give us just selling days, or Michael either one, selling days over the balance of the year on a year over year basis?

Yes. We talked to this earlier. In Q1 we had one extra selling day. Q2 was one less, and the remainder of the year will be equal each quarter. So full year comes in line year over year, no change.

All right, great. Thanks, guys.

Chris Pasquale, JPMorgan.

Just wanted to understand the issues in the IOM business a little bit better. There's two quarters in a row that that's been stronger than it was expected.

It sound like this is a case where you've been doing more procedures historically than you've actually been getting paid for, and now that's changing. Just tell me if I have that right and why that yield so to speak has changed now and what drives your conservatism over the balance of the year.

Yes, so when you look at the fourth quarter, and really Q1 as well, we took upon ourselves the effort to go back and essentially get after some of the historic cases that we were having trouble collecting on, and we found some success in that both in the fourth quarter and the first quarter. A good chunk of that has now been collected on, so those cases are no longer there to go back and then try to clean up. So you're not going to see that same issue repeat itself throughout Q2, 3 and 4.

We've always had good growth volume-wise in the business itself. The issue has been from a rate or reimbursement perspective.

We see that stepping down year over year at least for the last two years. So we continue to expect that we're going to see those same rate challenges into the future offsetting any volume growth that we have.

Okay. That makes sense. And then one kind of broader picture on the US hardware business, any sense what percentage of your business today posterior fixation represents, how that compares to the broader market, and then maybe how that's changed for you from maybe a year or two ago?

It would be -- it's certainly been less than let's say some of -- most of the other companies that are out there that do carry the bulk of that area. Really probably wouldn't make sense to get into a percentage analysis of it per se, but I think it's fair to say that posterior fixation is what really drove lumbar growth for us in 2013, and we are certainly hopeful that it will do so again in 2014 and it's off to a good start.

I guess part of my question is to trying to understand what kind of runway there could be left given how important it's been for the last several quarters.

I think there's a huge amount of runway. We're just getting started and I think with the things we're doing on global balance in 2015, hopefully that's where we're going to be able to pick up the pace is in 2015.

I think, too, when you look at procedural solutions and you look at how we're advancing small incremental advances in our XLIF platform with new styles, new devices, that drives longer constructs sometimes, those longer constructs then lead to posterior fixation, rod and screw fixation, also, that leads to a just a bigger case overall. So the whole strategy as you look at a procedural solution, you look at the global balance of the entire spine. That's important for all of the systems that compose our posterior procedural offering.

Thanks, guys.

You bet.

(Operator Instructions)

David Roman, Goldman Sachs.

Hi there, guys. It's Chris in for David. First of all, congratulations to Michael and Quentin on their new paths. But my first question, Alex, you touched on this a little bit on the tax side of things, but I was hoping that you could walk through a little more detail on the initiatives that you're taking in order to reduce the costs in the outer years, and maybe a little bit on the cadence of when we should start seeing some of these benefits.

Sure. We'll have the finance guy answer that. There's a lot going on in that area.

So you think about it on the tax side you need to understand this multi-year implementation which essentially we got started on end of last year and through this year. So we would expect to see benefits start to emerge, real tangible benefits start to emerge, meaning read that as GAAP tax rate below sort of standard statutory levels in the 40% range out in 2016, 2017, and beyond.

What we expect in the medium-term period is from the high of this year in the mid-80%s or so, that tax rate will start to come down over the course of the next couple years and approach statutory and then as I said, eventually go below statutory. Part of what's driving that is really the mix in the growth of our OUS business. The faster that OUS business grows, the faster the tax rate will lever down from a magnitude perspective.

And as I mentioned before, we think that ends up in the low- to mid-30%s range once you get out medium to long term. And we're working actively still today as Quentin mentioned earlier, putting in place the groundwork on that globalization initiative, because we understand as you suggest what a lever it's going to provide in the out years.

Great. That's very helpful. And if I could, Michael, one quick followup, if I could pick off -- pick up where Rich's question left off, on the full-year guidance asked differently, if I were basically to flatline the sales for call it the first three quarters and then assume only a modest acceleration in the fourth quarter, it seems like these numbers would be fairly easy to get to. And I understand the issue with the more difficult comps, but asked differently what really has to go wrong in order for you not to get to that $725 million?

I guess I would articulate it this way and Alex and Quentin can jump in. We talk a lot about our aspirations, and last year we saw our aspirations to be a double-digit grower, and we turned around and guided to the streets mid-single digits essentially at the start and for the vast majority of the year. We executed well and delivered above that.

I would emphasize again the difficult comps in the second half of this year, and I ran through those numbers earlier. If you look at them, they are very aggressive comps to drive growth off of when we think about the year over year compares for this year.

But Q1 came, results came in aggregate in line with where we expected to be. So it's current course and speed and we hope we will meet our aspirational objectives.

Our full-year guidance is prudent and it's what we've set at the start of this year, and what we've reiterated today is our confidence in being able to achieve that guidance. So we're staying with the full-year objective. We don't intend to change that.

Great. Thanks a lot, guys.

You're welcome.

Matt Taylor, Barclays.

Hi. Thanks for taking my question. I guess first question that I had was you moved away the past couple years from giving us the reps and those kind of metrics by quarter, but I wonder if there's anything qualitatively you can talk to in terms of your productivity for rep and how that's been tracking. And I guess how important is rep growth versus productivity growth to your goals over the next couple years?

They're equally important as you know. And we've actually had a very nice net increase in the number of sales representatives, both in the United States and in other key international markets in the first quarter.

So I'd say it's a substantial increase over prior year. So we find ourselves in a very good position there, and we are driving into getting much deeper penetration in every one of our territories.

Thanks. And just a followup on your litigation strategy, so I know that you're pursuing a number of interparties' reviews of electronics patents. Could you talk about how that plays in or coincides with your district court litigation strategy?

I'm not going to comment on that at this point in time. I will be happy to give an update next quarter, but at this point in time probably not going to get in that deep with regard to the legal strategy.

All right. Thanks a lot.

You're very welcome.

Joanne Wuensch, BMO Capital Markets.

Good evening. Thank you for taking the question. Congratulations both to Michael and to Quentin. That's really great for both of you.

Thank you, Joanne.

Quick question, spine robotics, are you seeing any impact from that and what's your current view on it?

What do you mean? Oh, you means in terms there's really one company doing it? No.

Any interest in the area or is just something -- not so much?

Not so much.

Okay. And then just as a follow-up question, is there any update on the launch of your biologics in the US, AttraX? We sort of moved that off to the side for quite some time now.

Sure. So the update on AttraX is that we anticipate -- we hope that we will have a favorable answer from FDA hopefully at the end of this year. We've done some additional work as they requested. So we hope to have an answer by sometime by the end of the fourth quarter.

Can you tell us what kind of work that is? Was it clinical or was it paper?

It was additional pre-clinical work.

Pre-clinical work, okay.

Yes.

As you may have heard from the message earlier there was a nice -- Osteocel Pro was launched, and has been going well. So it has new handling characteristics and more moldable, formable, and so that is a nice addition to the biologics offering.

Thank you.

You bet.

Larry Beigelsen, Wells Fargo.

Good afternoon. Thanks for taking my question, and my congratulations to Quentin and Michael. On the last call you guys talked about normal seasonality, first quarter representing 23.5% to 24.5%. Is that still valid, guys?

Yes. I think you would see the Q1 result would certainly put you right in that range that we talked about.

Okay. Because that would get you to Quentin, $725 million to $755 million, that would be the math on that.

We gave you the range of 23.5% to 24.5%. We came in towards the upper end of that, 24.4%, 24.5%, so in line with expectations.

Okay. And then last question from me guys. SI joint fusion got a positive coding recommendation earlier this year. Alex, how attractive is that market to you and what's your plan for that? Thanks.

We don't really have anything that directly competes with that per se. So it's not an area that we've participated in.

We've been watching it for several years and really waiting to see if it flourishes or not. It's done fairly well, but it also hasn't taken off and really run in a big way.

I would say I would categorize it that we are keeping close tabs on it, especially trying to see how the reimbursement finally plays out. There has been some I think nice in-roads on the reimbursement side, but still not clear what's been finalized for surgeon and hospital payment.

Great. Thanks for taking the question.

Jason Wittes, Brean Capital.

Hi. Thanks for getting me in. Just real quick on PODs, I think you've mentioned on the last few calls that the regulatory landscape is certainly becoming less favorable, we've noticed that as well. But you've also at least on the last call mentioned that the number of PODs hasn't really changed materially. From your comments in the beginning is that starting to change, and what is your outlook for the rest of the year in terms of how many PODs will remain standing?

As you know, that's a really tough number to measure and it's entirely anecdotal. So what we hear really is the chatter among surgeons, talking about it a lot more, and then of course, the position that the hospitals have taken.

I think if we were to absolutely guess, the high of 15% maybe has dropped down to the 10%, 12% range. That's just a complete guess. There's no way for us to really quantify that number with any degree of accuracy.

Astonishingly to me I spent a fair amount of time in the field. Astonishing to me is the fact that I've heard of three surgeon groups recently joined PODs despite all of the fervor over this issue. So there's still some people out there that just want to keep pushing the envelope, but generally speaking, it's on the decline.

Okay. And then perhaps you could help us out just on sort of product cadence for this year if we think about launches that you guys have planned for this year, which one should we be paying attention to and what quarters will they hit roughly speaking?

So we'll be launching a total of 10 products over the course of this year. We're just in the process right now of rolling out Osteocel Pro. We're also increasing the availability of Bendini. We have a series of cervical plates. Most of our product launches coincide with the third quarter because we like to time it around NASS.

So that will be pretty consistent, although Osteocel Pro is already out. So almost everything else from us outside of just line extensions and straight forward additions of that sort, you'll see at NASS.

So we hope to get somewhere around the fourth-quarter benefit of those launches. And usually it's not that much because we just ramp it end of fourth quarter, and then look to do a full national and then international launch more the following quarter, the first quarter of 2015.

So 10 new product launches roughly speaking, at least three that you mentioned are the ones to focus on.

Yes. As well as we're doing additional things in posterior fixation. We're doing some additional plating options with the anterior spine. We'll be talking about all of that stuff around NASS time.

Great. Thank you very much.

Thank you. We have no further questions at this time. I would like to turn the call back over to Mr. Lukianov for any closing remarks.

Thanks everybody for joining us. We look forward to chatting with you the next quarter, which will be Michael's last as CFO and look forward to him passing the mantle to Quentin, and we will certainly spend a little bit more time remembering some of his contributions. So until then, 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.