NuVasive Inc (NUVA) 2014 Q2 法說會逐字稿

Greetings, and welcome to the NuVasive, Inc., second quarter 2014 earnings release conference call.

(Operator Instructions)

I would now like to turn the conference over to your host Carol Cox, Executive Vice President, Strategy and Corporate Communications. Thank you. You may now begin.

Thank you, Shea. Welcome to NuVasive's second quarter earnings call for the quarter ended June 30, 2014. Joining me on today's call are 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, our incoming Chief Financial Officer.

During our comments and responses to your questions today 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 and 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 our most recent 10-Q and 10-K forms filed with the Securities and Exchange Commission.

This call will also include a discussion in several financial measures that are not calculated in accordance with generally accepted accounting principles, or GAAP. 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 the supplementary financial information file, both of which are accessible from the Investor Relations section of the NuVasive website. With that, I would like to turn the call over to Alex.

Thank you, Carol. Good afternoon, and thank you, everyone, for joining us on today's call. We are extremely pleased to report second quarter results that exceeded our expectations on both the top and bottom line and demonstrated strong increased operational efficiency within NuVasive.

During the quarter, we continued to solidly execute our strategy to take market share, and according to reported results we can now claim the number three spot in the global spine market. Having achieved such a remarkable long-standing goal, I am confident that our mission to improve spine surgery with market-leading innovation will support our drive beyond $1 billion in revenue and toward the number two position in the spine market.

Now let's turn to results for the second quarter of 2014. We reported revenue of $191 million which represents year over year growth of 15% and non-GAAP earnings per share of $0.28 or EPS growth of 40%. Revenue growth was driven by stronger-than-expected performance in the US, especially lumbar and biologics, and continued strong growth in our international geographies. Revenue growth outperformed our expectations even excluding the benefit of a couple of less sustainable impacts in the quarter which Michael will cover in his remarks.

In addition to better-than-expected revenue growth, we made solid progress in our efforts to improve operating profitability resulting in a 200 basis point year over year expansion in our operating margin during the quarter. The expansion was driven primarily by ongoing efforts to bring manufacturing in-house, leverage of systems investments we have made over the last few years, and the operational initiatives that have been underway to drive efficiencies in all areas of the organization.

As a result of the outperformance in the second quarter and the sustainability of the momentum of our US lumbar products, we are updating and increasing full year guidance for revenue to approximately $745 million, up from $725 million previously, operating margin of approximately 16.5% up from 16% previously, and non-GAAP EPS to approximately $1.11 up from $1.06 previously.

Before I turn the call over to Michael to go through the results and discuss guidance in more detail, I will provide an overview of our longer-term growth goals and how we intend to achieve them. The goals include growing revenue to $1 billion and beyond, expanding our operating margin to at least 20%, and improving shareholder returns with initiatives to leverage earnings.

Let's begin with NuVasive's future revenue growth which we believe will be driven by the continued execution of our share taking strategy. Today, we have roughly 8% share of the global spine market. We believe that can be grown significantly by executing across three opportunities, first, driving the shift in spine toward minimally invasive, or MIS, and less invasive surgery; two, penetrating the traditional or open spine market with innovation that is converting that market toward less invasive surgery; and three, expanding our footprint globally and taking share of underpenetrated markets.

I'll spend a moment on each of these opportunities to provide a sense on how NuVa is currently position. First, the spine market is shifting increasingly towards less invasive solutions as better patient outcomes and a wealth of clinical and economic evidence are expanding surgeon adoption.

We estimate that MIS and less disruptive solutions will represent close to 30% of the global market in 2014, and we believe that within the next decade, less disruptive solutions will become the standard of care, approaching 80% of the global market. That shift will create over $5 billion of opportunity over the next decade. As an innovative leader in the US MIS market, we intend to continue to be a key beneficiary.

NuVasive established a leadership position within MIS by pioneering the lateral approach to spine surgery, but it hasn't stopped there. The manifestation of our core philosophy, innovating to improve surgical outcomes in spine has resulted in a constantly evolving, comprehensive portfolio of highly differentiated, less invasive solutions.

That is fostering our ability to not just sustain a leadership position within the fast growing market for less invasive solutions, but as demonstrated by our performance in recent quarters, to actually expand our market share within it. Our drive for continued leadership of the market for less invasive solutions will be a key tenet of revenue growth over the next several years.

Secondly, our core patient outcome driven philosophy is equally applicable to traditional techniques. Our ability to penetrate the traditional spine market and increasingly convert it to less invasive solutions will be another key driver of future revenue growth.

Our new solutions like Precept for posterior fixation, Armada and Bendini for deformity, ALIF for anterior column realignment, MAS PLIF, and MAS TLIF are blurring the line between traditional and MIS techniques. They leverage NuVa's experiences of pioneer of MIS and as the leading innovator in spine to make traditional techniques less invasive and to improve surgical outcomes.

Those solutions are opening new doors for NuVasive. For the first time in our history, we are establishing new surgeon relationships not just with XLIF, but also with recent product launches like Precept and MAS PLIF which are suitable for traditional techniques. As we penetrate the traditional space, our ultimate intention is to convert traditional surgeon customers to MIS and less disruptive solutions, and eventually toward MIS.

Another key driver of our future revenue growth will be international expansion. We have dedicated years to establishing an infrastructure to replicate our US achievements internationally. An international growth of 45% year-to-date is a testament to the rewards those investments have begun to reap.

In the EMEA, we implemented a more experienced leadership team early last year. Those efforts are driving better-than-expected performance in key markets like the UK and Italy.

In Asia-Pacific, our drive for share leadership in Australia and New Zealand is paying dividends. Also, our momentum in Japan is strong with surgeon interest and the adoption rates of not just XLIF, but also solutions like Precept and Armada continuing to be exceptional.

NuVa's penetration of the $2.2 billion international spine market is still in its infancy. We estimate that we have only 3% share internationally, but our share taking strategy is geared to drive that much higher, another key component of revenue growth going forward.

While revenue growth is a key priority improving operating profitability is critical as we strive to increasingly translate revenue growth to the bottom line. We are committed to expanding our operating margin from the 15% level reported last year to at least 20% as we approach $1 billion in revenue.

Our results this quarter and the corresponding ability to raise for full year operating margin guidance demonstrates excellent execution against that goal. We have multiple well identified drivers that we anticipate can get us to at least 20% operating margins over the next several years. The majority of the drivers are not reliant on revenue growth such as our vertical integration efforts, the majority of our asset efficiency initiatives, and the expiration of certain patent royalty accruals.

Going forward, the continued growth of our profitability should be driven primarily by increased international scale, as we lever years of investments; increased vertical integration, as we work to more than double the 20% of product that we currently manufacture internally; improved asset efficiency with initiatives underway to improved inventory turnover and distribution methods; rationalized real estate and lever IT investments; improved sales force effectiveness with mobility platforms and refocused sales teams; and finally, the February 2015 expiration of the patent behind the majority of our royalty expense accruals. I am confident in our ability to achieve our stated operating margin goals, and I hope to exceed them as we continue to work to identify additional opportunities to drive profit growth.

In addition to the strategies we have in place to drive top line growth and operating margin expansion over the next several years, we also have recently implemented new initiatives aimed at increasing earnings per share leverage. Our globalization initiative, for example, is designed to consolidate and standardized the management of our international business activities.

Over the next several years, it will drive multiple benefits including a gradual improvement toward a rate in the low to mid 30%s. Additionally, the intended share usage burn rate under the equity incentive plan recently approved by our stockholders is designed to reduce the amount of dilution, or new shares issued, from the historical annual range of 3% to 5% to about 2% of outstanding shares in future years.

In sum, the outlook for future earnings growth at NuVasive is strong. We have a proven strategy to drive revenue growth by expanding our market share beyond the 8% that it is today. In addition to revenue growth, we have numerous levers to improve shareholder value with the operating margin expansion and earnings leverage over the next several years.

Before I turn the call over to Michael, I did want to make a quick comment on the OIG subpoena which we are actively complying with. We have nothing new to report on that front, but will provide further up dates if and when they are needed. With that, I will turn the call over to Michael Lambert.

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 detail that will be covered on today's call, and to reconcile our non-GAAP items to their GAAP counterparts.

As Alex mentioned, revenue for the second quarter 2014 exceeded our expectations coming in at $190.7 million. As a result, we are increasing full year revenue guidance to approximately $745 million or 9% growth year over year, compared to the $725 million that we previously the expected.

Let's walk through the composition of revenue growth in the quarter, and our revised expectations for the full year 2014 which contemplate the more difficult growth comparisons that we face in the second half. Second quarter US lumbar growth of 10% exceeded our expectations on a continued trend of exceptional demand for our minimally invasive solutions, including Precept and MAS PLIF. This is momentum that we expect will continue through the second half of the year.

To flow-through the outperformance and slightly improved expectations for the second half, we now expect about 6% US lumbar growth for the full year, up from the 5% that we previously expected. US biologics growth of 18% greatly surpassed our expectations.

Procedural pull-through from our US lumbar solutions were strong, and the recent launch of Osteocel Pro is generating solid surgeon interest and trialing. We are encouraged by the positive impact of the trialing, but we need additional time to determine what portion, if any, is a more temporary type of impact. However, as a result of the Q2 outperformance we now anticipate full year 2014 US biologics growth of about 7%, up from the 2% growth with that we previously expected.

US cervical performance was below our expectations, decreasing by 1%. Softness was driven by a slower-than-expected ramp up of PCM device which I will address in a moment when I covered the intangibles impairment charge taken this quarter. Set availability issues in posterior cervical and a later than anticipated plating product launch also contributed to the underperformance.

With the plating product now set for launch late this year, and an initiative underway to improve the availability of sets in the field we are optimistic that we can reinvigorate the growth of the cervical category over time. That said, we now expect cervical to grow about 4% for the full year, compared to the 10% growth that we previously expected.

US monitoring service growth exceeded our expectations increasing almost 15% in the quarter. Similar to last year, we experienced an improvement in collections which drove the majority of growth in the quarter. While we are encouraged by that dynamic, it is related to historical volume so we cannot rely on the sustainability of its impact going forward.

Thus, our expectations for the second half of 2014 are unchanged and assume that strong volume growth will continue to be offset somewhat by pushback from insurers. As a result of the Q2 outperformance, we now expect US monitoring service growth of 2% for the full year, an improvement from our prior expectations for flat growth.

Our international business which includes Puerto Rico also exceeded our expectations, growing 56% in the second quarter on strong contributions from the Asia-Pacific and Latin American geography. During Q2, we saw some progress in Latin America after a period of sluggish growth, and this benefited our international growth rate.

However, given the continued economic turmoil in a couple of these countries Q2's progress is not something we necessarily expect to see systematically repeat itself in Q3 or Q4. Still in consideration of the strong organic results elsewhere, we now expect full year 2014 international growth of approximately 30%, up from 20% previously.

In sum, we were very pleased with Q2 revenue results. As you model the remainder of 2014 please note that our guidance does not assume continued benefits from the less predictable impacts I mentioned from Q2, both in our IOM monitoring services and in our Latin American market performance. Given our view on these items and considering that Q3's sequential growth has historically been flat compared to Q2, we currently anticipate Q3 revenue will be down sequentially.

Turning to the rest of the P&L, gross margin in the second quarter was 76.6%, up 120 basis points from 75.4% reported in Q2 2013. The gross margin expansion demonstrates very strong operational gains driven by our move to in-sourced manufacturing and improved inventory efficiencies. These items more than offset roughly 50 basis points of margin pressure, driven by revenue mix which measures the impact from the outsized growth of our lower margin biologics and international businesses.

Price was not a material factor in the quarter. In spite of the greater than originally anticipated revenue mix headwind that we expect will last through the end of 2014, we continue to expect a full year gross margin of approximately 76%.

Non-GAAP sales, marketing, and administrative, or SM&A, expenses totaled $106.8 million in Q2 2014 compared to $94.5 million in Q2 2013. SM&A expense was 56.1% of revenue for Q2 2014, representing nearly 100 basis points of improvement compared to the 57% reported in Q2 2013.

We achieved improved sales force productivity which more than offset both forecasted and opportunistic investment into our international infrastructure, and increased freight cost associated with managing greater than expected of surgery demand. We expect the freight pressure to ease some of the second half with the recent arrival of new sets. For the full year we continue to anticipate SM&A expense in the 54.5% range.

Non-GAAP research and development, or R&D, expenses totaled $8.6 million in Q2 2014, compared to $7.3 million in Q2 2013. R&D expense was 4.5% of revenue for Q2 2014 versus 4.4% in Q2 2013. This represents an increase in dollar spend of about 18% from prior year, driven by investments in talent and new product development projects.

Even as we invest, we are committed to increasing our efficiencies in R&D just as we are doing across the entire Company. With increased revenue expectations for the year, we don't expect to increase full-year R&D spend on an absolute dollar basis, and as a result we now anticipate a full year R&D expense of approximately 5% compared to the 5.5% that we previously expected.

Second quarter non-GAAP operating margin exceeded our expectations coming in at 16% which was up 200 basis points compared to the 14% we saw in Q2 2013. As a result of the Q2 outperformance and the slightly improved outlook for R&D spend as a percent of sales this year, we are raising full year 2014 non-GAAP operating margin guidance to 16.5%, up from the 16% that we previously expected.

Implied in my earlier commentary about revenue being down sequentially between Q2 and Q3 is an expectation that non-GAAP operating margin will display a similar cadence. In addition, our updated guidance anticipates non-GAAP operating profit dollar growth of about 20% this year or operating profit growth that is more than twice the expected rate of revenue growth.

Interest and other expense net on a GAAP basis totaled $7 million in the quarter, compared to $6.9 million in Q2 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.

Second quarter earnings were impacted by a $10.7 million non-cash impairment charge related to a lower valuation for the asset we acquired in the May 2009 Cervitech acquisition. This acquisition add a PCM device to our product pipeline.

The impairment was driven by an updated view of the landscape for cervical motion preservation devices, a market which has been considerably more difficult to penetrate than we originally anticipated. From a tax perspective, the impairment charge drove our Q2 earnings before tax into a GAAP loss position. Our quarterly tax expense is essentially a true-up to bring our year-to-date GAAP tax position into line.

Accordingly, even in spite of the $2.3 million pretax loss position, we recognized a Q2 GAAP tax expense of approximately $1.9 million or an effective tax rate in the low 80%s. With half of the year complete, we now expect a full year 2014 GAAP effective tax expense of about $6 million, down slightly from approximately $6.5 million previously. We continue to expect non-GAAP adjustments for the full year 2014 to be tax affected at approximately 40%.

Second quarter non-GAAP earnings were $13.6 million or $0.28 per share compared to $9.4 million or $0.20 per share in Q2 2013. With increased expectations for both revenue and non-GAAP operating margin, we now anticipate full year non-GAAP EPS of approximately $1.11, up from $1.06 previously. Please refer to the supplementary financial information file on our website in order to put the year over year EPS comparison into its proper context and to review all of the items that will be excluded for non-GAAP reporting purposes.

For the second quarter, cash flow from operating activities totaled just over $25 million, well ahead of the roughly $8 million we saw in Q2 2013, driven by top line growth and operating margin performance in the quarter. Free cash flow of about $6 million was impacted by about $19 million in capital expenditures in the quarter, most of which was product related. For the full year, we continue to expect free cash flow will be roughly flat with 2013 as a result, even in spite of our becoming a significant cash taxpayer this year.

Our cash and investments balance at the end of the second quarter was just over $350 million, up about $10 million from last year, and up $24 million year-to-date. The increase was driven by operating cash flow generation and proceeds from the exercise of stock options.

The Company's execution engine continues to deliver tangible progress that is increasingly evident in our reported result and in our guidance. We are simultaneously executing a share taking strategy and driving operational improvements to enable margin gains.

As you all know, last quarter we announced my eventual retirement from NuVasive. It's truly been a privilege to work with the most outstanding team and Company in spine, and I have no doubt about the Company's ability to achieve its next milestone of $1 billion in revenue concurrently with at least 20% operating margins. On July 31, I will be officially stepping down as NuVasive's CFO, and Quentin will step into this role. He and I will continue to work together on various projects through year end close in order to ensure a smooth transition.

My retirement marks the achievement of a long-standing personal objective for my family. I understand how lucky I am to have had the opportunity to play a role here at NuVa these last five years. Also, I am fortunate to be able to transition such an outstanding team to an exceptionally strong leader in Quentin.

Finally, I am especially thankful to our family of Cheetahs for all your incredibly hard work, dedication, outstanding results, and for the wonderful friendships we have developed here over the years. My alter ego, Captain Profit, will be handing off the Cheetah print cape and money belt to Quentin, who will be fielding your questions both on today's call and in the future.

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

In closing, I'd like to speak on behalf of the entire NuVa family in expressing gratitude to Michael for all of his contributions to NuVasive over the last five years. During his tenure, Michael has made a palpable difference within our organization, and I wish him and his family the best as he transitions into retirement.

I also look forward to working increasingly with Quentin. I have utmost confidence that Quentin, who has also been instrumental in implementing and driving the operating efficiency and earning leverage initiatives we have underway can take baton and advance our drive to increase shareholder value.

The second quarter was a clear demonstration of our aspirations for NuVasive. Our market share taking strategy delivered double-digit organic revenue growth which we achieved in conjunction with operating margin expansion of 200 basis points and earnings per share that exceeded our expectations. While we are proud of our Q2 performance, we are laser focused on executing to the full year 2014 guidance communicated today, and importantly, we have a strategy in place and initiatives underway intended to drive increased shareholder value and earnings growth this year and in the years to come.

NuVa is now the number three player in spine globally. That is a huge accomplishment. Now in true NuVa fashion, we are onward and upward to even bigger things. We will now take your questions.

Thank you.

(Operator Instructions)

Matthew O'Brien, William Blair.

Thanks for taking the question, and Michael, best of luck to you going forward.

I was hoping we could start off with the strength in the US lumbar business. Alex, the results from not too many larger competitors, but larger companies this quarter, has been pretty weak in our spine business whereas your performance here was quite good.

I'm hoping you can help us reconcile the performance, be it just the growth in the MIS market versus taking share with new reps, or going deeper with your existing customer base? How do you put up that type of performance in an environment where your competitors are talking about a pretty challenging environment?

Matt, I think it's been very clear that our strategy is working, and that is obviously that we're taking share. The strategy that's really working in the US is being able to convert much more of posterior business in the lumbar space and doing that through a combination of driving MIS more deeply, and then of course converting open surgeries more into our direction.

As I talked about in my comments, I hope that's really what you're seeing the big growth coming from NuVasive, and that's what's driving the US business. Of course biologics pulls through along with that into the lumbar as well as into the cervical space.

Okay. For the follow-up question, just a commentary about PCM and the inability to penetrate the cervical opportunity, is that more of a comment about the market not developing as fast as you guys had anticipated? That's something you've mentioned in the past.

Is it just a fairly competitive space where you just haven't had the success that you anticipated? How should we think about that product for you guys going forward?

I think it's a combination of all of those things, but largely it's the market. All of us anticipated that the motion preservation segment would grow at a very fast clip. That has not happened.

As you know, it's pretty well entrenched with the number of competitors. There's still a fair amount of insurance push back with regard to that, and so we have not seen the kind of uptake and conversion that we anticipated moving from the fusion business to the motion preservation market area. It's just the way that it's gone. Hopefully, someday that will take off, but there's a number of things that are really restricting that growth.

Got it. Thank you.

You bet.

Matt Miksic, Piper Jaffray.

The first question goes to Captain Profit whoever is donning the money belt at the moment. It had to do with some of the prepared remarks on international.

Could you maybe walk us through how much of this strength there, understanding there were some delays, and there was some success. How much of that was instruments or stocking or some kind of push to get into some of these additional channels that you've been pursuing? How much was just from what you can tell end user market volumes that are just difficult to predict going forward?

For the record, Michael will not release his cape, but Quentin in Captain Profit now. Quentin, please go ahead.

Hi, Matt. This is Quentin here. When you look at international, we're very pleased with the result that we saw coming out of that space. I wouldn't attribute any of it necessarily to large stocking orders. That wasn't the driver at all, but I do think that when you look at the prepared remarks, and Michael spoke to it a bit, we did see an impact coming out of the Latin America markets, and a couple of the different geographies there that historically have been a bit challenged from an economic perspective. We've talked about that in the past. Think of those markets like Brazil, Argentina, and Venezuela, those types of markets.

We did see the benefit play through in the current quarter as a result of some strength in those local markets. If you were going to quantify it, it was roughly $3 million in total. International growth still would've been sitting in the high 30% pushing up on 40% for the quarter, if you were to adjust for those items.

Okay. The follow-up, I guess, maybe along the lines of Matt's question on the market and your success there, Alex, you talked about taking more business in the posterior MIS area. I guess that could be posterior fixation for XLIF, or that could be MIS TLIF.

If you could maybe provide some color as to where you are in the cycle of those two product launches, maybe which one is out in front, and making a bigger impact? Then if you have characterized it before, I don't know if you've given us a number, but where you are in terms of capturing the share of the posterior fixation for your NuVa cases. I know that's part of the goal with the new posterior fixation system.

I don't think we've talked about the numbers with regard to that, Matt, but essentially what's happening is that if you look at this quarter and the first half of the year, we've had very strong performance from XLIF. We're extremely pleased with the success we've had in that area.

Concurrently has been all the pull-through business that we're getting as well as the door opening business with products like MAS PLIF, TLIF, Precept, and so forth. The strength is very balanced in posterior fixation, and it includes both ALIF, it includes PLIF, it includes all of our LIFs.

We're extremely pleased with the way that it's going for us. As I already mentioned, that also pulled biologics in a very serious way, as you can see from the performance we had in that area.

Super. Thanks.

Richard Newitter, Leerink Swann.

Thanks for taking the questions, and Michael, good luck in your retirement.

I was just hoping, it sounded like, correct me if I'm wrong, but I think this is now the second or third quarter where you've said that price was negligible. I would take that to mean that pricing was not negative nor positive, or was it just stable, and negative kind of way? Can you just elaborate on that?

Sure, Rich, what we mean by that it's been relatively consistent in the low, negative 1.5%, negative 2% range, which has been consistent for us over the last number of quarters now, spanning well over a couple of years. We have not seen any dramatic change in pricing trends with regard to our own specific business and continue to see it in the low-single digits.

Great. Thanks for that. I know that you guys have mentioned tax as a lever, and it's something where initiatives are likely going to kick in, in a more meaningful way particularly in 2015 and beyond. Maybe Quentin, can you give us a sense, maybe some targets as to where we can see that tax rate moving from the 85% today? Where could it realistically get to over the next two years, so to speak?

I think if you look at our current guidance today that Michael walked through, you actually see that tax rate sitting down in the 45% range, but a lot of that is being driven by these large items that we've had to record in the first half of the year, being the litigation liability in Q1 related to NeuroVision and the PCM impairment charge in Q2. If you were to normalize for those items though, you do get back into the 85% tax rate for the year that you're talking about.

As we think about where that goes into the future, we've spoken to the fact that we expect that to get down and the low 30%. Most of that's going to be contingent upon our ability to really grow that international business to roughly 20% of our overall revenue contribution. As we're able to do that, we're going to lever tax in a pretty significant way.

To help frame it up a bit for 2015, we've talked about the fact that we expect that to fall down into the mid-40%, and it will migrate from there into the low 30%, pretty pro rata-edly over the course of the next several years as revenue and the international business ramps up.

Thank you.

David Roman, Goldman Sachs.

I apologize for the background noise, but I'm on a cell phone. Hopefully, you can hear me okay.

I guess my first question would be, Alex, on this general trend within MIS surgery. In obviously all your analyst presentations and your prepared remarks, you've talked about this swap between MIS and conventional.

There's clearly been an acceleration the past several quarters. I think it took five years to get from a 15% mix to a 20%, and it just seems like the rate of penetration to MIS is picking up quite a bit. Can you maybe provide just some perspective on what's driving that acceleration, and how we should think about that going forward?

I think the growth rate is still somewhere in the 10% to 15%. It's difficult for us because we just largely have our own data, and most folks don't really talk about it very much.

I think what continues to drive MIS is that there's many more things you can do with it, from an application standpoint. That's, of course, what we've been evolving as pioneers in this space from scoliosis to what have you. I think that more and more surgeons are finding themselves comfortable in moving towards MIS and starting off with at least minimally disruptive approaches.

That's what's worked so well for us is moving surgeons down the pipe, where they began using our products on an open basis, eventually start to move more and more into less disruptive applications, and maybe not entirely MIS conversion, but moving closer and closer to that end point. I just think that there's a lot more open-mindedness on the part of surgeons, and then of course from a technological standpoint, I think we helped to bridge that by making it easier for surgeons to move down that pathway. I could probably talk about it some more but I think I've probably answered your question.

That's helpful. Maybe just a follow-up on the international side, (inaudible) business is going very well and maybe could provide a little bit more perspective on how much of the growth is coming from entering into new countries versus same-store growth in existing geographies, and then maybe further to that, what type of infrastructure you need to make that a very big business, and how we should think about that in terms of overall profitability?

Most of the growth that we're seen as coming from the existing markets where we have subsidiaries. That would be countries like Japan, Australia, New Zealand, the UK, Italy, Germany, and so forth. That's really where the bulk of our focus is. That's where the bulk of our resources have been expended over the last several years. We're now starting to see the fruit of that investment.

The other areas that we're in are largely smaller. They're more distributor based. We've set up as often as we can exclusive distributor relationships, but those are really not the major areas of focus.

The ones that I mentioned and really a couple of others are the main ones which would include China that we're especially interested in, but we're mostly interested in, and have already invested in, countries that have market opportunities anywhere between $50 million and $100 million in revenue today. That's been our focal point.

Okay. That's a helpful perspective. Thank you.

Chris Pasquale, JP Morgan.

Can you spend a minute on the cause of weakness in the cervical, and what drove the set availability issue there, which obviously it did not have any problems on the lumbar side? It seemed to have an impact with cervical.

The cervical weakness that we saw was really mostly had to do with PCM and the fact that PCM really hasn't moved forward. As I discussed having to do in part the market, and the fact that the product has just not taken off for us.

There was really less of a contribution to any kind of revenue shortfall with regard to posterior. Those are just some things that are running a little bit behind schedule, so those are launches and set builds that were plan, but they were behind.

We've either caught up or are catching up on those things. That's why we backed off our number from being around 10% growth originally for cervical, down to about 4%. That's already baked in with some of the lateness in the launches and the set builds.

Did PCM sales decline year over year? I'm trying to reconcile. It wasn't contributing a huge amount previously, and you have been growing very nicely in cervical. Did you see a step down there? Maybe you can just update what you're assuming now for full year PCM sales versus where you were at the beginning of the year?

Hi, Chris. This is Quentin. I wouldn't say that we saw a step down necessarily in PCM, but it's been relatively flat. We haven't seen incremental growth coming from it, and we continue to view it as running out the rest of the year in line with that same trend.

Okay. One other one, if you can quantify to any extent you can, the contribution from Osteocel Pro in biologics? I'm just trying to get at how much of the strength there we should think about is potentially being trialing related versus real underlying strength and the pull-through from the lumbar business.

We're clearly pleased with the results we saw in biologics with nearly an 18% growth rate in the quarter. It gets a bit difficult to try to quantify exactly what is trialing, as we have some of our existing surgeons both using the older product and the newer product to a greater extent than what they had in the past.

Certainly, you do have some new surgeons that are trying that as well, and how much of that sticks into the future quarters, it's hard to predict. If you look at the overall growth of 18%, far outpacing the lumbar growth the way we look at it at this point is that incremental growth potentially could have been trialing in the quarter, and we're just not sure how to quantify that yet from a go-forward basis.

Thanks.

Raj Denhoy, Jefferies.

I wonder if I can ask you a bit more about the strategy to move into less invasive as opposed to minimally invasive. You've made some comments about a number of surgeon customers that opens up to you, and is there anything you can offer in terms of how that's going? The number of new customers that are coming into being NuVasive customers at this point?

The strategy is to do both. It's something that we really embarked upon last year in earnest, as we started to introduce products like Precept that can be applied both in an open and in a closed fashion. We really don't talk about what it's netted for us in terms of added customers and things of that sort. Clearly it's been a real game changer for us.

What I'm trying to get at is it seems to have certainly been a big contributor to the acceleration in growth recently. I'm trying to understand how sustainable that could be in a sense. If you are targeting this much bigger part of the spine surgery market, and you're just now getting into that, it suggests that you could probably run in that space for a long time.

That's certainly how we look at it. As we talk about it in terms of the $5 billion that's out there, that's really what we're going after. As you well appreciate, we've really penetrated very deeply into the $2.2 billion, $2.3 billion MIS space. Now we're going after the $5 billion number, and I think we do have a lot of runway.

The follow-up question on that is as you do get a broader bag of products, not just minimally invasive but now less invasive, at what point do you get enough that you can move to having more of a consigned inventory in hospitals, and thus also reducing the cost it requires you to service your sets and the like?

We have a great deal of product that's already consigned. We're approaching 100 products this year. By the end of this year, we'll probably be north of 100 products. That's a big part of what we have.

I think that also because we're very known for service, very well known for service, we've also been very active on the loaner side. We move a lot of sets around, and we meet the demands of surgeries and pick off cases. In the more established accounts, you bet. Those are consigned sets, in those where we're still really going after the business and just getting some of the initial cases, that's where you see a lot of the loaner business being more prevalent.

Does that represent a significant opportunity for you though, as you get more into that bigger part of the market? I guess what I'm trying to get at is how big of a margin opportunity could that represent?

It's significant because it helps us a great deal freight. It helps us with other things. That's one of the levers that we're absolutely pushing on.

When you hear us talk about operating margin expansion opportunities and talk about the asset efficiencies, you're hitting on exactly those kinds of things that we're focused on. We've quantified that at roughly 150 basis points as we move to that 20% operating margin. You're down the right path of what we're looking at.

Okay. Helpful. Thank you.

Matthew Taylor, Barclays.

It's actually Dan in for Matt. I wanted to first ask was there a selling day difference in the 2Q?

Yes, there was, one less selling day in Q2.

Okay. Thanks. That's helpful. I just have a quick follow-up related to the monitoring business. Historically, or I'm really referring to most of last year, you talked about how the softness wasn't so much procedural. It was more reimbursement. As we look year-to-date and going forward, obviously the results are stronger. Is that really just a volume growth continuing, and then the collections, you talked about this quarter? Or have you actually seen any improvement in the reimbursement environment over there?

Not really seeing any improvement in the reimbursement environment necessarily. I think it's more stable from a volume growth perspective that's playing to the number, but we do still have some of the collection benefits that are impacting the number. That's part of the strength you saw in Q2. As we think about the future, next two quarters, we don't anticipate that's going to repeat itself.

That's helpful. Then just one last one if I could sneak it in, obviously good trends in the biologics business, I just wanted to ask, I know you've deemphasize (inaudible). Is that still some something that's a driver out into the future? Or is really the focus now Osteocel Pro and really the pull-through that you're seeing from lumbar?

Osteocel Pro is our primary focus.

Jeff Johnson, Robert W. Baird.

Quentin, maybe a couple of follow-up questions, clarifying questions, on the international side, on the Latin American comments you made, is end market demand, procedural demand, actually did you see a pickup in the quarter? Or is that maybe collecting on some of the past cases, some of the receivables that were due there? Then I didn't hear a comment on Japan. Maybe any kind of growth rates there, the push towards breakeven on profitability there, how do we think about that update?

From a procedural perspective in those markets primarily in Latin America where we see the economic challenges, the end user volumes remain solid. That's never been issue. The primary issue is the ability to get paid out of those markets, and the ability to recognize revenue.

We did see somewhat of a benefit related to that aspect in Q2. That's the aspect that's hard to predict in Q3 and Q4, and therefore we are not baking that into our guidance. Over time, we'll continue to build those markets, and you would expect some benefit from that. It's just hard to predict exactly when.

With regard to Japan, we couldn't be more excited about what we're seeing in that local market. I can tell you that it's been beyond expectations. When Michael talked about making some opportunistic investments in international that's really what he's speaking to there.

Most of the infrastructure is in place to support that business, but to the extent we can continues to train surgeons given the strong surge in demand, those are the kind of investments we're talking about making to continue to fuel the growth in those local markets. That's what we're seeing play out in the results right now.

The follow-up question, maybe two longer-term, bigger picture items. Any update on IGA, and still expecting a late 2015 launch there? Any change in how KOLs are thinking about that product line? Anything like that?

Then also an update maybe on the coverage rep model that I think you guys have been trialing, just how that's going, and updates there?

Let's just take one of those so we don't run out of time. With regard to IGA, we will address that really more fully as we move into next year which I talked about when we first disclosed that that was our strategy to move into a different way of correcting the spine. I can just give you a brief update and say that things are going well.

We're working our way through the alpha and beta clinical case experiences, and everything is on track. We have not fully vetted out exactly when we're going to launch things in 2015, but we will be launching in 2015. We'll talk about that as we get closer to that date.

Thank you.

William Plovanic, Canaccord Genuity.

Thanks for taking my questions. Just two of them, one, cervical obviously slowed down, beating a dead horse here, but when do you expect that business to turn around? Was it a function of sales focus, with lumbar doing so well?

It does have something to do with sales focus. Overall, we're certainly pleased with the contribution. It's around 10% of revenue. We're pleased with where cervical is.

The overall opportunity is only 20% of the market, so we're in a pretty solid position when it comes to cervical. We have been driving the sales force very hard when it comes to the lumbar opportunity. They've performed extremely well as you can see in the numbers.

That's really mostly what we're talking about. It's not that we don't care about the growth in our cervical side. I think if you have to prioritize things, it's really the lumbar business that makes or breaks the overall growth profile for the Company.

Nice segue into my other question which is, the lumbar has been driving everything. You talk about moving in this less invasive market, but as we look at Precept and the penetration into the existing XLIF cases, where are you on a percentage basis? If it was 10% or 20% a year or two ago, where do we stand today with that? That's all I have. Thank you.

I think we've historically said that we believe most cases, 75% of the time or so, you're going to back up with posterior fixation. In terms of the pathway we still have in front of us, I would still say we have a majority of that pathway left to go, still significant share to gain with respect to that opportunity.

Precept is not just about capturing that opportunity for us. When you look at the differentiation with it, and when you look at some of the opportunity we're seeing in the data, we have new surgeons trying that product with the Company, which is really differentiated for us from where we've been historically. Usually, that's through XLIF.

Now we're seeing that come through things like Precept, MAS PLIF, to a degree. If you look at the bigger posterior fixation market, that pushes up around $1.8 billion, that's the opportunity we look at as having the opportunity to get into. That's how we quantify the potential with regard to Precept. It's much bigger than just our own cases.

Great, that's very helpful. Thank you.

Bob Hopkins, Bank of America.

This is actually Travis [Dee] in for Bob. You're obviously taking share, but if you looked at your business over the course of the quarter, do you feel like there's an underlying improvement going on in spine surgical volumes?

That's a hard one for us to really get our arms around because we all probably have the same information, and based upon how other companies are performing in the US at least, it's looking like things are relatively flat in this particular quarter. How that plays out on the year, we're not really clear. I think that's why we've taken a pretty prudent approach when it comes to providing our guidance.

Sounds good. One quick question on the 20% operating margin guidance over the long term, is that a conservative hurdle, or is there a structural investment that will limit your upside?

It's a conservative hurdle.

Got it. Thanks.

Larry Biegelsen, Wells Fargo.

Hi, guys. It's actually Craig on for Larry. I just wanted to talk about the broader spine market in general, what kind of growth you're seeing there, what you expect for the second half compared to the first, and then maybe even preliminary thoughts moving into 2015?

We still look at the market as been relatively flat to maybe up a percent or two, but not much changing from that dynamic. Certainly some of the reported figures that we're seeing come out from our competitors would seem to indicate that it's probably still in that range.

With regard to how we think about the future, at this point still kind of status quo, right along the same lines that we're seeing today. There's certainly a bit more optimism out there with regard to what the (inaudible) potential could bring back into the market, if you ever saw it come back, or some relief on the reimbursement side of things. We aren't going to try to predict when that comes back into the market. At this point, we view it as relatively flat.

Just a follow-up on that, any changes in pay or pushback that you've seen recently?

I wouldn't say any changes that we're seeing here recently. The reality is it's still there though, but no changes.

Great. Thanks and congrats on a good quarter.

Josh Jennings, Cowen and Company.

Good evening. Thanks a lot. I just wanted to start off on your gross margin guidance for the year. With the uptick in your revenue guidance maintaining gross margins flat from your previous guidance, I just wanted to check in on whether there's a level of conservatism baked in there? What are some of the puts and takes to keeping it at that 76% level?

I wouldn't characterize it as conservative at this point, but certainly it's something we believe we can deliver on. You look at where we were at in Q2 at 76.6%, we did see some benefits of the in-sourcing initiative which was essentially our acquisition of our manufacturing capability back in May of last year.

It's really starting to play through, roughly a quarter earlier than what we had anticipated. Our guidance had already factored in some benefit from that in the back half of the year.

Similarly, some of the inventory efficiencies that Michael touched on with regard to other system investments that we made that are driving those are playing out also. What you're seeing in the back half of the year with the strengthen in biologics, with the strength in our international businesses, both which bring a lower gross margin profile with them, it creates a bit of incremental pressure from a mix perspective that we hadn't contemplated in the prior guidance. In the newer guidance we're trying to contemplate all those different moving pieces. That's why you don't see any improvement in gross margin for the year.

Thanks. Just one follow-up on your previous outlook for the spine market, you mentioned the potential for some of the POD share coming back in. Can you talk, Alex, about any updates in terms of your outlook for PODs? Any catalysts in the fall or early next year in terms of any Senate Finance Hearing or OIG issuance of any formal guidance, or recognition of PODs? Then how you're seeing the impact of the OIG special fraud alert impacting so far in Q2 and outlook in the back half of the year? Thanks a lot.

As you know, DOJ has been pretty aggressive with regard to PODs. We have seen the formulation of policy by a lot of the networks that have been anti-POD. That's been going on now for several months.

As far as what impact has it had, I would say it's not much different than the remarks I made in the last quarter which is that we're not seeing the formation of new PODs. We're hearing much less with regard to people trying to move towards PODs.

At the same time, there's a process underway right now with a number of the PODs that are out there, and physicians either changing their relationship and moving away from the POD, and trying to rekindle that better relationship with the hospital, or redefining their POD. It's in a little bit of a state of flux right now, I think, as Quentin mentioned. We're still hopeful about what that means in terms of the future and perhaps in 2015, or into the latter part of 2015 we start to see some more of those surgeons moving away from some of those models.

As best as we can tell, it's still somewhere in the 10% to 15% range. My guess, and this is entirely a guess, is that it's less than 15% but it's really impossible to quantify.

Another comment too on the PODs, I think it's important to note that there's still a number of surgeons that are in PODs doing traditional fusion surgeries with their POD contact or their POD investment. A lot of their less invasive, their lateral surgery, they're seeking different technology. There's still a relationship there, and that relationship fosters a greater long-term success together as they transition away from the POD.

Thanks, again.

Mike Matson, Needham and Company.

Thanks for fitting me. Just given the degree of success in the lumbar area, I'm wondering how much of that is coming from Precept versus some of the other products there that you mentioned, the less invasive LIF procedures?

As I mentioned, XLIF is really having record performance. We're seeing our base products perform exceptionally well. It's really across the board. It's interbody. It's all the new offerings, so the whole posterior fixation, let's call it LIF area, meaning all of it, is performing exceptionally well for us.

Also keep in mind, the aging population and the need for longer level constructs. It's not just Precept. There's good strength with our (inaudible) to really address a complete deformity correction, and doing that not only with interbody opportunities, but also doing it with posterior fusion. It's deeper than that.

Okay. Then in your biologics business, the strength there driven by Osteocel Pro, was that from volume, or price? Is Osteocel Pro priced at a premium to the prior version of the product?

Most of that strength there is being seen through volumes, although you do get a bit of the price premium on the Osteocel Pro product. What's interesting about it is you get a nice mix benefit on the top line from a gross margin perspective, they're relatively consistent between Osteocel Pro and Osteocel Plus. It doesn't necessarily flow all the way through the P&L with that same benefit.

That's all I have. Thanks a lot.

Jason Wittes, Brean Capital.

Thanks for taking the question. You've gotten a lot of questions about what's going on with lumbar. I think we're all impressed by basically the growth rate that you've been posting the last few quarters, this one in particular. I guess many of the questions are trying to figure out is this just expanding the basket within your surgeons or is it really pulling from other surgeons?

From the responses you've given, Alex, I get the sense that you've really starting to aggressively go after surgeons outside of your core. Is that the right way to think about it? That's what's happening here?

Absolutely. Yes, we are taking share, so it's deeper penetration with the existing base, and absolutely taking share.

You also mentioned that in terms of what's driving XLIF is the biggest underlying driver, whereas the new products are also kicking in, but XLIF is still the underlying driver here. Is that the right way to think about it?

XLIF is still the bigger part of the base because we've really moved into the direction of applying more fixation options over the last couple, three years.

We've talked about Precept before being one of our most successful ever launches. It continues to perform at a very high pace, but it's really across the board. Keith mentioned in Armada in deformities. We're very pleased to see the kind of uptake we're getting, both from a trialing standpoint with new surgeons, checking out our products, not necessarily beginning with XLIF, beginning with various other offerings, but the uptake is across the board.

Okay, great. One last question, now that you're basically number three in the market, are you competing as a full-service player with everybody at this point, meaning that you are looking to basically supply pretty much everything for the surgery? Or are you still focused on just being the MIS option for the surgeons?

I think that's really what got us here, is that we do have the complete offering. I think it's probably something that not everybody always appreciates and is clear on, but it's absolutely what has gotten us here. That's what's put us into a very strong position with the networks and with our national account business as well.

Great, thanks.

You're welcome.

At this time, we have no further questions. I would like to turn the call back over to Alex for closing comments.

Great. Thanks very much, everybody. Thank you for joining us, and we look forward to chatting with you in another three months, and again, all the best wishes to Michael and his family, and again, thanks for the many years of fantastic service. Thank you.

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