NuVasive Inc (NUVA) 2014 Q3 法說會逐字稿

Greetings, and welcome to the NuVasive Inc. third-quarter 2014 conference call.

(Operator Instructions)

As a reminder, this conference is being recorded. 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 begin.

Thank you, Roy, and good afternoon, everyone. Welcome to NuVasive third-quarter earnings call for the period ended September 30, 2014. Joining me on today's call are Alex Lukianov, our Chairman and Chief Executive Officer; Keith Valentine, our Chief Operating Officer; and Quentin Blackford, the Company's Chief Financial Officer.

During our comments and in responses to your questions today, certain items may be discussed which are not based entirely on historical facts, including without limitation, those regarding revenues, gross margins, operating expenses, other income and expense, taxes, future products and capital allocation plans. Actual results or trends could differ materially from our forecasts. These 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 filings with the Securities and Exchange Commission. NuVasive assumes no obligation to update any forward-looking statements or information, which speak as of their respective dates.

This call will also include a discussion and 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, including 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 today's press release, and the supplementary financial information file, both of which have been posted on the Company's investor relations section of our 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 third-quarter results that exceeded our expectations on the top line, generated strong free cash flow, and again demonstrated strong increased operational efficiency across our global operations.

We reported revenue of $190 million, which represents year-over-year growth of 12%, and non-GAAP earnings per share of $0.19. Revenue growth was driven by stronger-than-expected performance in the US, especially in lumbar and biologics, and continued strong growth in our international geographies. In addition to better-than-expected revenue growth, we made solid progress in our efforts to improve operating profitability, resulting in a non-GAAP operating margin of 16.7% in the quarter, which is a 130 basis point expansion over year over year. The expansion was driven primarily by ongoing efforts to bring manufacturing in-house, driving asset and sales force efficiencies, and the operational initiatives that we have underway in all areas of the organization.

In the quarter, we also made solid progress on reducing discretionary SM&A spend as a percentage of revenue both year over year and sequentially. As a result of our strong operating performance, we generated a quarterly record for free cash flow at $35 million. As a result of the outperformance in the third quarter, and with the majority of 2014 behind us, we are updating and increasing full-year revenue guidance to approximately $755 million, implying growth of approximately 10% over 2013 performance.

While we are pacing ahead of our operating margin and improvement plan for 2014, we are maintaining guidance of 16.5% for the year, which takes into account strategically reinvesting a portion of our increased profitability back into the business to drive future growth. This guidance represents 150 basis points improvement over 2013, and is well ahead of our commitment to deliver at least 100 basis points of improvement per year. For non-GAAP EPS, we are increasing full-year guidance to $1.12.

As a reminder, we will be hosting our investor morning on November 13 in San Francisco. Based on this timing, I intend to keep my comments somewhat shorter on today's call. Members of our senior team will participate in the investor morning, where we intend to cover several topics:

Our market share taking strategies by market segments and geography, efforts around significantly increasing profitability and leveraging earnings per share, improving our operational efficiencies, and scaling the Company to $1 billion in revenues and beyond. While executing on these value-driving priorities, we will stay true to our culture of innovation that will continue to deliver best-in-class surgical solutions resulting in better outcomes, faster recoveries, and increased efficiencies for the healthcare system. In other words, faster, better and cheaper. We hope that you can join us in San Francisco, where you will also be able to learn more about the less disruptive procedural solutions and products we are showcasing at the NASS conference.

On the macro level we continued to see stability in the global spine market, with growth in the very low single digits. While we continue to see pricing pressure of less than 2%, this is right in line with what we expected, and consistent with what we have experienced all of this year and last. As demonstrated by our results, we continue to outpace the market as we execute against our market share taking strategy, which focuses on three main drivers: First by further driving the shift toward MIS and less disruptive solutions; second, penetrating and converting the traditional spine market with less invasive solutions; and third, expanding our international footprint.

I am very pleased that our results for the third quarter demonstrated solid progress across all three of these drivers. In the MIS market, our flagship XLIF surgical procedure and the Decade plate provided solid growth, which is particularly exciting, because these solutions are laying the foundation for greater utility of single position surgery. As the spine market continues to shift toward less invasive solutions, and as better patient outcomes and clinical and economical evidence are driving surgeon adoption, we remain committed to expanding our leadership in this market.

We fully believe that our procedural offerings will allow us to further penetrate what is estimated to become a $5 billion MIS market opportunity over the next decade. Increasingly, we have invested in new procedural offerings to enter the traditional spine market, and convert it to less invasive solutions, with improved surgical outcomes. These new solutions like Precept for posterior fixation, ALIF ACR to correct sagittal alignment, Armada and Bendini for deformity, and MAS PLIF support our patient outcome and philosophy. Both Precept and Armada continue to grow at an aggressive clip during the quarter, and are blurring the line between traditional and MIS techniques.

Several years ago, we made the decision to expand our geographical footprint by strategically and methodically entering the $2.2 billion international spine market. Today we have commercial operations across EMA, Asia-Pacific and Latin America. During the third quarter, we continued to benefit from investments with strong results in Australia, Japan, the UK and Italy, driving 45% growth. Our approach focuses on entering large and rapidly-developing spine surgery markets, and then to thoughtfully build up our infrastructure to match the market dynamics and opportunity. I am very proud of the leadership teams we have built across our international markets, and I am confident that the opportunity to replicate the success we've been able to achieve in the US will be a significant driver of revenue growth moving forward.

Our market share taking strategy is working well, and while revenue growth is a key priority, I want to assure you that the entire management team and shareowner base is also keenly focused on improving operating profitability. For a couple of quarters now, I've been speaking about NuVa 2.0, our process innovation mindset, that we are applying across the company. We have made it the cornerstone of our culture as we approach $1 billion in revenue, and undertake the work that will allow to us simplify operations and scale NuVa's world class organization.

The culture has been and continues to be a differentiating factor and competitive advantage for NuVasive. Our vision of changing spine surgery and improving patient outcomes is the foundation from which we drive our internal focus, as we apply our NuVa 2.0 mindset to achieving greater efficiencies, streamlining our processes, and strategically reinvesting in game-changing innovation, to improve even more patient lives.

We are also committed to driving greater shareholder value, and one of the ways we intend to do this is through enhanced profitability. Our goal is to expand our operating margin from the 15% level we reported last year to more than 20%, as we approach $1 billion in annual revenue. We have articulated and sized several clearly-defined drivers that we anticipate can get to us this goal: These include international scale, vertical integration as we scale our in-house manufacturing capabilities, asset efficiency, improved sales force effectiveness, and the February 2015 expiration of the patent for which we accrue the majority of our Medtronic-related royalties.

We are working hard to work against these drivers, and our results again this quarter demonstrate excellent execution against that goal. I am confident in our ability to achieve our stated operating margin goals, and I hope to exceed them, as we continue to identify additional opportunities to drive profit growth. Before I turn the call over to Quentin, we have nothing new to report on the OIG subpoena, but will provide further updates if and when they are needed.

In sum, our execution in the third quarter and year to date has been very strong, and I believe that our current portfolio and pipeline position NuVasive very well, as we finish 2014 and head into 2015. With that, I'll turn the call over to Quentin.

Thank you, Alex, and good afternoon, everyone. Before we get started with the financials, let me remind you that many of the financial measures covered today will be on a non-GAAP basis. Please refer to the supplementary financial information file on our website, in the investor relations section, for all of the detail covered on today's call, and to reconcile our non-GAAP items to their GAAP counterparts.

As Alex mentioned, we were very happy with our underlying operational performance in the quarter, exceeding operating margin expectations and generating a record $35 million of free cash flow. Revenue for the third quarter of 2014 exceeded our expectations, at $189.9 million. As a result, we are increasing full-year revenue guidance to approximately $755 million, which includes nearly $2 million of incremental FX headwinds versus prior guidance. This translates to just over 10% growth year over year, and is a $10 million increase from the $745 million that we previously expected.

Let's walk through the composition of revenue growth in the quarter, and our revised expectations for the full year 2014. Third-quarter US lumbar growth of 8% was solid on the continued momentum of our minimally invasive solutions, particularly Precept, ALIF ACR, and MAS PLIF. Based on the strength we are seeing, we now expect about 7% US lumbar growth for the full year, up from the 6% growth that we previously expected.

US biologics growth of about 13% exceeded our expectations. The strength of demand for our US lumbar solutions continues to drive excellent procedural pull-through and the recent launch of Osteocel Pro continues to generate solid surgeon interest in trialing. Stocking orders were about $1 million higher than the prior quarter.

We are very encouraged by the positive momentum being built in this business, but also need additional time to determine what portion of the impact between trialing and stocking orders, if any, will prove to be temporary. As a result of the Q3 outperformance, we now anticipate full-year US biologics growth of about 11%, up from the 7% growth that we previously expected.

US cervical sales decreased 2% versus prior year, primarily driven by soft performance from our motion preservation device. With our new plating product set for launch at the upcoming NASS conference and an initiative in place to improve the availability of sets in the field, we continue to be optimistic that we can revive growth within our cervical category over time. We are now modifying our cervical growth expectations to about 1% for the full year, down slightly from the previously forecasted 4%.

US monitoring service growth also exceeded our expectations, increasing almost 14% in the quarter. Unlike the last couple of quarters, case volume growth drove the outperformance in the third quarter, while the impact from focused collection efforts moderated in the quarter, and were nominal. We continue to expect strong volume growth will be offset somewhat by pushback from insurers. As a result of the Q3 outperformance, we now expect US monitoring service growth of 6% for the full year, an improvement from our prior expectations for 2% growth.

On the international business, which includes Puerto Rico, we also exceeded our expectations. International growth was 45% in the quarter, with strong contributions from each of our key geographies. During Q3, we continued to make progress in Latin America including collections in Brazil, despite economic turmoil in several countries.

We expect that progress may fluctuate from quarter to quarter. Still, in consideration of the strong results, we now expect full-year 2014 international growth of approximately 35%, up from the previously forecasted 30% annual growth. As noted before, updated full-year guidance contemplates an incremental currency headwind of about $2 million versus our prior guidance in this category.

In sum, we are very pleased with year-to-date revenue results. As you model the fourth quarter and begin to project 2015, please note that we do not expect to continue to benefit from some of the temporary impacts we've discussed over the course of the year.

Turning to the rest of the P&L, gross margin in the third quarter was 74.9%, up 50 basis points from the 74.4% reported in Q3 2013. The expansion demonstrates continued strong operational gains, driven by our move to insourced manufacturing and improved asset efficiencies. Included in the quarter was 100 basis points negative impact related to a non-recurring product royalties charge, and continued mix pressure of approximately 40 basis points from the strength of our biologics performance.

This was more than offset by nearly 200 basis points of improvement, related to our focused efforts to insource manufacturing and to drive asset efficiencies. Price was consistent with prior periods, at less than negative 2%, and not a material factor in the quarter. We continue to expect a full year gross margin of approximately 76%.

Non-GAAP sales, marketing and administrative, or SM&A, expenses totaled $102 million in Q3 2014, compared to $93 million in Q3 2013. SM&A expense was 53.7% of revenue for Q3 2014, representing 130 basis points of improvement compared to the 55% we reported in Q3 2013. Further progress with our focused efforts to drive both sales force and asset efficiencies continue to more than offset both planned and opportunistic investments into our international business. For the full year, we continue to anticipate SM&A expense of approximately 54.5%.

Non-GAAP research and development, or R&D, expenses totaled $8.6 million in Q3 2014, compared to $6.8 million in Q3 2013. R&D expense was 4.5% of revenue for Q3 2014, versus 4% in Q3 2013. The planned increase in spending continued to be driven by investments in talent, and new product development projects. We continue to anticipate a full year R&D expense of approximately 5%.

Third-quarter non-GAAP operating margin was strong, coming in at 16.7%. We demonstrated an exceptional 130 basis points of operating margin expansion, compared to the 15.4% we reported last year, while absorbing approximately 100 basis points of a non-recurring charge related to the product royalties. We continue to balance the translation of operational improvements, while opportunistically investing to enable the acceleration of our market share gains. As a result, we continue to expect a full-year operating margin of approximately 16.5%, and impressive non-GAAP operating profit dollar growth of greater than 20% this year, more than two times the expected rate of revenue growth.

Interest and other expense net on a GAAP basis totaled $9.2 million in the quarter, which included a $2.5 million FX loss, or a negative impact of $0.03 per share net of tax, related to the currency swings we saw late in the quarter. This compared to a $3.4 million expense in Q3 2013, which included the favorable impact of a legal settlement. We now anticipate full-year 2014 interest and other expense to be approximately $29.3 million, including roughly $14.7 million of non-cash interest expense.

We recorded an income tax expense of $9.1 million in the quarter, compared to the $900,000 in the third quarter of 2013. This resulted in a tax expense rate of 128% for the quarter, which was higher than we had anticipated, as a result of a greater amount of pre-tax losses residing in low tax jurisdictions, which provide nominal tax benefits, and a greater portion of pre-tax profits residing in our highest-tax jurisdictions, resulting in greater tax expense. The higher than anticipated tax rate negatively impacted results by approximately $0.08 per share, all which of we expect to recover in the fourth quarter, and is reflected in the revised increase to our full-year EPS guidance.

We now anticipate a full year GAAP tax expense of approximately $7 million, and we continue to expect non-GAAP adjustments for the full year 2014 to be tax effected at approximately 40%. With the higher than expected tax expense in the third quarter, non-GAAP earnings were $9.6 million or $0.19 per share, compared to the $18.3 million or $0.39 per share in Q3 2013. As a result of increased full-year revenue expectations and recovery of the tax impacts that I mentioned previously, we now anticipate full-year non-GAAP EPS of approximately $1.12, up from the previously forecasted $1.11. Please refer to the supplementary financial information file on our website, in order to put the year-over-year EPS comparison into proper context, and to review all of the items that will be excluded for non-GAAP reporting purposes.

For the third quarter, we generated record operating and free cash flow. Cash flow from operating activities totaled just over $48 million, well ahead of the roughly $38 million that we saw in Q3 of 2013, driven by strong top line growth and operating margin performance in the quarter. Free cash flow of $35 million reflected a $13 million capital expenditure investment in the quarter, most of which was product related. Our cash and investment balance at the end of the third quarter was $384 million, up about $34 million from last quarter, and up $58 million year to date, primarily driven by approximately $51 million in year-to-date free cash flow.

I'm exceptionally proud of the tangible progress that is increasingly evidenced, both in our reported results and forward-looking guidance. For the quarter, we continue to make solid progress in increasing our operating profitability, as we not only improved our operating margin year-over-year, but also sequentially by roughly 70 basis points from the second quarter, despite revenues being relatively equal. Our performance reflects our ability to absorb margin impacts, while at the same time enabling margin expansion.

In fact, we are now positioned to achieve a fourth-quarter operating margin of nearly 20%, illustrating our ability to reach the longer-term sustainable 20% or greater operating margin objective that we have spoken to previously. With this strong operating performance, combined with continued execution of our market share taking strategy, we expect to end 2014 on a strong note, and enter 2015 with meaningful momentum. I look forward to seeing you at the investor morning in a few weeks, and now I'll turn the call back over to Alex for closing comments.

The third 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 130 basis points, and record quarterly free cash flow of $35 million. Last quarter, we announced that we could clearly claim to be the number-three spine player in the world. This was an incredible accomplishment for the NuVa family, and we are proud that we were able to continue our market share gains in the third quarter. Our dynamic share taking strategy, combined with well defined levers to improve profitability will drive revenue growth and improve shareholder values over the next several years. Onward and upward. We will now take your questions.

(Operator Instructions)

Matthew O'Brien, William Blair.

This is Kaila in for Matt. You listed full-year expectations for the lumbar segment, but does there still seem to be a deceleration in the fourth quarter? Can you just comment on the momentum and opportunity that still exists with product in that segment such as Precept, and what runway of growth you see ahead?

Sure. This is Quentin here. In terms of the runway that's ahead of us, I think we're incredibly excited about what we see with Precept in particular. That's a product that can compete in the entire 1.8 posterior fixation space that's out there, which leaves for us incredible runway. There's a ton of opportunity that's there.

When you think about the Q4 performance, last year, we had an incredibly tough comp that we're up against. So we had a very strong performance last year, and as a result of that, I do expect the growth is going to slow a bit. When you look at it though, I think we're trying to look at it from a prudent perspective. We certainly don't want to get ahead of ourselves, but if you look at the momentum from Q3 and Precept, MAS PLIF, ALIF ACR, all new products that have come to market here within the last 18 months or so, incredibly excited and a lot of runway left in front of those.

You did lower cervical expectations for the full year, and you mentioned that the cervical motion preservation disc performance remained soft. Can you just elaborate on what you're seeing competitively there, and what has to happen in order to really accelerate performance in that segment?

I would say that overall we're pretty disappointed in the performance of PCM. The main reason for that is that it's a device that's designed for single level applications. We're simply not seeing the uptake of that particular application. It seems the market is more interested in two-level applications. We don't have FDA clearance for that.

So we just simply are overall disappointed in that area. Cervical otherwise is performing well. The procedural volume has been up, but really the downside for us has been on motion preservation.

Thank you.

You bet.

Matt Miksic, Piper Jaffray.

So one on just the environment, it's a question that we get a lot. Don't want to focus on it too much, but I'd love to get your sense of where pricing trends felt like they were heading in the quarter. Some folks have seen sequential easing of pricing, slightly. Others have seen steady. So maybe pricing, and just what you thought of the strength here in the seasonal quarter, just maybe a couple of market questions. And then I have one follow-up.

So as I mentioned in my prepared comments, what we're seeing is about 2% negative on price. It's very consistent with last year, and I think as you know, because of all the products that we launch, it's offset by mix for the most part of new products. So that is consistent. We're not seeing a trend that's any different than what we've been reporting.

And then in the seasonality we would typically expect a little bit of falling off here in the third quarter, and yet, I think you and a number of other folks have reported some pretty strong --unseasonably strong growth. Your thoughts on that?

I think that's really reflected in the fact that the market overall is just more stable. I think that there's a more positive sentiment in general right now, with regard to spine surgery, and the volumes are slowly picking up. It's, as you say, typically we'd expect it to be down a little bit more, but it outperformed our expectations, and we're certainly pleased with that.

The follow-up, if I could, on Precept, and where you're seeing the uptick here, is there any areas of strength in types of procedures, where you're seeing particular uptick? Is it in TLIFs? Is it in one or two level cases? Is it viewed as a good system for more complex cases, or is it across the board uptake that you're seeing?

It's across the board. Precept has been out there now for pretty close to two years, not in full launch, but pretty close to that. It started off largely because we were able to back up XLIF procedures, and I think that's how we began moving into that space, and over time it's been applied more for scoliosis, more for everything across the entire spine.

I think as I've talked about now for the last couple of quarters, what we continue to see is surgeons that are used to doing big open procedures being able to apply a product like Precept, and utilize it in that fashion, and obviously it's designed for both open and closed procedures, and then slowly move that into less and less disruptive applications of the technology. So it's exactly as we've been talking about, and it's very broad.

If I could, Alex, just one clarification, with open and minimally invasive --

This is like your number four question.

Just to clarify, I'm sorry, when you say open and minimally invasive, are you picking up share in -- we think of you maybe as picking up your fair share of your posterior fixation on XLIF cases, but are you also just picking up open cases that aren't necessarily-- wouldn't have put you in a case with XLIF?

Correct. That's really been the posterior fixation success that we've had with Armada, with Precept, with other systems. Bendini, which has allowed us to get into more deformity cases, so we're seeing good strength from XLIF, from lateral plating, and also from all of our posterior fixation business.

Thank you. I'm sorry for that.

Okay. Don't do it again.

Bill Plovanic, Canaccord.

You can have three questions, Bill, just to be fair.

I'll keep it to two so other people can ask my questions. For Quentin, it's on the Medtronic royalty, when that goes away in mid-February, looking at that today, now that you have pretty clear path on the run rate, what is the -- how many BPs of operating margin benefit will you pick off of it?

We're going to see right around 150 basis points. That's what we've been talking to, for some time now. It's going to come right into being right around that number.

As we think about 2015, if you've got 150 BPs of Medtronic rolling off, should we expect continued leverage from the core business in sales and marketing, what have you, so you're shifting towards a 200 to 250 BP or 300 BP improvement for next year, or how should we think about 2015?

You're thinking about it appropriately. From our perspective, our goal is to drive roughly 100 basis points of underlying operational improvement in the business, and certainly we look at the 150 basis point improvement for Medtronic outside of that. So you're thinking about it appropriately. You size it up to that 200, 250 basis point improvement.

I'll stop there. Thank you.

Chris Pasquale, JPMorgan.

Where are you now with the Osteocel Pro launch? How much more of your account base do you still have to upgrade before we could see these big stocking orders start to wind down?

Yes. You look at Osteocel Pro and prior to having that product available for us, we saw penetration in our own cases somewhere around 60%, and we historically said we thought it would be hard to penetrate beyond that, without another innovative product in the space. O Pro has certainly allowed us to have that opportunity.

I think what you're seeing now is that has moved closer to 70% in terms of penetration of our own case, so to the extent we can go even further, we'd like to do that, but I think the growth that you're seeing there has the potential to sustain itself into the future. Now we're only two quarters into that launch, so we need a bit of time to see that's going to stick and it's not just trialing, but when you look at it, it seems like there's an opportunity to capture more of our own procedural opportunity with our surgeon base, so it has the potential to stick.

Corollary to that, you haven't mentioned AttraX in a little while. Any update there, and is the Osteocel Pro success taking away the urgency of having a product like AttraX?

It's not a lack of urgency, it's more the ongoing delays we've had with FDA. At this point in time we're hopeful to have clarity on whether or not we'll be able to launch in the US by the middle of next year, but we've continued to have delays in that area. And as Quentin has pointed out, we're certainly very pleased with the biologics segment progress that we've had so far.

If I could, just one on the IOM segment, there's now been five straight double-digit growth quarters there. At what point do we start to think about that as the sustainable growth business that maybe it was expected to be when you first did that acquisition, and not just a temporary phenomenon?

I think what it's doing for us strategically is exactly what we had envisioned, which is, it's allowing us to go deeper into accounts where we provide both monitoring, and get more implant business on a pull-through basis. That's really where we're seeing more of that success. We're pleased with that. I don't think we're prepared to say it's going to continue growing at this pace, as we're seeing this year, but we're certainly having a banner year, having caught up on collections and now moving towards an increase, a significant increase, in procedural volume.

Richard Newitter, Leerink Partners.

I just wanted to start off, Quentin, you went through a bunch of the gross margin drivers in the quarter and what does and doesn't repeat. Can you just quickly give us the high-level summary of those again?

Yes, sure. We look at gross margin, we were up 50 basis points year over year, but you start to peel it back a little bit, and we would have been up 200 basis points year over year, just from the insourcing and the inventory efficiencies that we've been driving through that business. Now we lost a bit of room with the nonrecurring one-time product royalty related charge that came through in the quarter, and then a bit of mix just related to strength in our biologics portfolio, but that net 200 basis points of improvement offset by roughly 100 basis points of that one-time item and 40 basis points of mix.

Then that gives you the confidence that you'll recoup most of that, and that keeps you on track for 76%?

Absolutely. The 74.9% is not going to be a sustainable margin level. You're going to see that go back to the 76% that we've been operating at. Excluding the item in the quarter, we would have been sitting right on 76% again, and our guidance implies that we'll see Q4 come in around 76% also. We feel confident in what we're seeing there, to be able to get into that number for the year-end.

Thanks, and then just quickly, tax rate is go that you said you've been planning for, you think you can bring in and ratchet that number down. Can you just give us a sense of where you think that can go down to in 2015, or if you don't want to give 2015, where can that be in the next two years? How far down can that go?

Sure. When we started to look through making the tax position of the Company much more efficient, the goal we had in mind was to get that down into the low 30s over the next three to five years. So I think we're still aligned to being able to achieve that. You'll see the rate come down next year somewhere in the mid-40% range, and then from that, as revenue continues to increase in the OUS markets, we will likely see that rate move down into the low 30s.

Thank you.

Raj Denhoy, Jefferies.

Wonder if I could just ask a question. There seems to be this, the last several quarters, this dichotomy between the numbers you keep putting up, and yet your unwillingness to talk about any sustainable trends. And one thing you've also alluded to a little bit is how these new products are allowing you to penetrate into less invasive procedures. And I'm curious if you can offer anything in terms of whether you're -- how quickly you're expanding the customer base, the number of surgeons who you're bringing into the NuVasive fold, and how much more room you think you have to continue to add new customers in with these products?

Well, I think that we're just scratching the surface when it comes to adding customers. That's really been through the advent of posterior fixation systems, and that's really what -- I think as I've been talking about for a while, our fate is very much linked to how well we do in the lumbar growth rates, right? And so that's afforded us double-digit growth rates for the last two years, and we're pretty excited. Actually longer than that but the last two years in particular, and we're certainly excited about that. We think there's huge upside for us to continue to move in that direction. At the same time, there is a fair amount of pressure when it comes to reimbursement, as you very well appreciate, and won't go and list all of the things that are pushing back on growth, but that's the reason that we remain prudent with regard to our guidance, and want to really continue the effective trend that we've had heretofore.

Let me ask it a different way. In term of the step-up in growth we've seen in the last four or five quarters, how much of that can be tied to completely new customers that have come into NuVasive, completely new surgeons, versus you taking these new products, whether it's Armada or Precept or some of these new ones, and simply penetrating them into your established base?

I don't have a mix distribution to share with you. I can tell you that we certainly continue to go much deeper with our existing customer base, and we add accounts at a pretty fast basis. We haven't been talking much about our sales force, but this year, we've got a net add of about 35 heads. So we're pretty pleased with how that's moving forward, and I think that reflects the number of accounts that we need to address, beyond what we've typically been able to cover.

If I'm just hearing you correctly, it sounds like again, you're not seeing any limits in what you can do here. It's simply just still conservatism on your part in terms of sustainability.

Yes. I think that's fair.

Okay, thank you.

Matt Taylor, Barclays.

I had one question on the cervical business. You mentioned in your comments that you see that as being able to be turned around over the longer term. Now long is longer term, and what do you think will turn that around?

So it's increasing the volume beyond where we're at, right now. We have some reconstructive systems that we've already started to launch, with the Archon plate and additional things that we're doing. So we would certainly expect to see some better growth over the next year or two, but we're not expecting to see that really jump up dramatically. We'll talk further about guidance at a subsequent time, but at this point in time, what we're really seeing is a drag coming out of cervical, because of PCM.

And just a follow-up, are there any areas of your portfolio now that you feel like you really need to add? What should we expect in terms of the new system, the imaging system you've been talking about we might get a peek of at NASS?

We'll talk about that a little bit during our analyst morning, and that's really moving us in a broader direction of addressing deformity and being able to do that with what we're, in simple terms, calling more of a three dimensional correction, with preoperative planning, processes, and the same all the way through to outcomes. So we'll talk about that some more next month, and certainly a lot more next year.

David Roman, Goldman Sachs.

First, maybe just starting with the revenue picture, Quentin, you wrapped up your discussion around revenue indicating that there were a number of one-time factors that benefited the growth rate this year, that would not recur next year. Can you maybe go into that in a little more detail, and at this point last year, you did provide some context on forward year revenue growth. Are you willing to bless the 6.5% to 7% growth number that's in consensus right now for 2015?

I think you're certainly thinking about forward-looking estimates in the mid- to upper single digit range is fine from that perspective at this point in time. We'll talk a lot about that as we get to Analyst Day here in a couple weeks and start to think about 2015 a bit more as we exit the year, but when you think about the one-time items that we brought up during the course of the year, I think they really come back to the service business. We did have some impacts of collection benefits that came through, and really the first two quarters of the year.

Now we did see strong volume growth of Q3, which was really the first time that became the significant driver in the business. Prior to that it was the collection growth, and we certainly don't expect that we're going to continue to see that into next year. As a matter of fact, it's going to set up for a relatively tough comp in that business in the first part of next year.

Beyond that you get into the international business, and we have talked about this. In Latin America, the underlying business procedurally is performing very well, but the ability to get paid in those markets is highly unpredictable, so to the extent we put that into our forward-looking guidance, it gets difficult to do that, because you can never predict exactly when you're going to get paid. So certainly in the international business just around Latin America, a bit of concern there with regard to how you think about it and how you plan for it.

And the last would be in biologics. We've seen strength in the last two quarters. Certainly we're excited about what we're seeing but to some extent we need a couple quarters yet to go to really determine whether or not it's just trialing of the new product and whether it sticks or whether it doesn't, and those are the kind of things I'm referring to in the prepared remarks.

That's helpful, and Alex, maybe as a follow-up on your comment, I think you made a reference earlier to people feeling better about spine surgery. I mean, some of your competitors have referenced spine as a potential area of benefit from expanded coverage around ACA. Are you willing to give us any more perspective on what it is that's making people feel better? Is it expanded coverage? Is it just a seasonal boost that we normally see in the end of the year, or is there something about the perception of the surgery that's sustainably changed from the concerns that existed several years ago?

We haven't seen much of a boost from ACA. I mean, obviously, there are more patients available, but we haven't really seen much of a positive impact from that. I think there's just a more positive tone. As you know, NASS has put forward quite a few guidelines to address the various issues that have been out there with regard to push back.

So I think that's buoyed the surgeons pretty dramatically, and made them feel a lot more positive about the tools they have to push back, when the insurance companies are not approving procedures. So I'd say generally speaking, there's a small uptick with regard to the number of procedures that are being done, versus those that are being slowed down by insurance companies. We don't have an exact number. It's more through dialogue with our customers.

Okay. That's helpful. I'll drop. Thank you.

Jeff Johnson, Robert W. Baird.

Most of my questions have been answered, but Alex, I guess I'll just ask you an obligatory question on PODs. you talked about the payor push back there in the last answer, but anything you can say on the POD front?

I think that they are diminishing but ever so slowly. They're still out there. Despite the actions taken by the government, which you would think would have a more positive impact, o at least diminishing them faster, we haven't really seen that.

What we have seen, of course is the hospital networks pushing back. A lot of them have implemented policies. We're certainly not seeing the growth, but it's hard for us to assess the level of shrinkage at this point in time.

Any sense yet that's helping your numbers, if at least that rate of growth is slowing or maybe not shrinking, but not growth?

We don't believe so. We'll have to see how that plays out next year. Maybe there will be some impact last year. We're not forecasting that to happen just yet.

All right, helpful. Quentin, just a modeling question. I was wondering if we could do an EPS crosswalk, your full year guidance going up by $0.01. The ERR in the GAAP I know this quarter was affected by $0.08. I think that was a non-GAAP $0.08 impact. Is that right as well this quarter?

That's right. It would have impacted both GAAP and non-GAAP by roughly $0.08

And so that reverses in fourth quarter, so that really doesn't impact your full-year, but the FX loss of $0.03 in the third quarter does impact the year, the negative $2 million in the top line probably is a $0.01 or $0.02 flow through to the bottom line. Is it fair to think of you absorbing maybe $0.05 in FX-related headwinds for the year, as far as the raise of $0.01 plus the $0.05 absorption?

I would think, for the most part the FX that you're seeing come through the revenue is primarily offset by the same change coming through the operating expense profile. We have essentially a natural hedge baked into the P&L just from a small operating margin within the international business. The FX loss that I spoke to in other income and expense was really driven by revaluing the balance sheet at the end of the period, which unfortunately, it realizes a significant change in the rate that all came at the end of September.

So that FX loss will flow through on the full year. it's going to be a $0.03 impact, but will more than offset that from the incremental revenue that we're increasing the full-year expectation by. FX will be offset. The tax rate to your point is going to come back on the full year basis. we're not changing full-year expectations from a tax perspective really. we did increase full-year tax expense by $1 million, but that's due to the $10 million increase on the top line and the profit associated with that. Outside of that, we wouldn't have been changing our tax guidance at all.

Got it, thank you.

Glenn Navarro, RBC Capital Markets.

Something is wrong with my phone.

Why don't we go on to the next caller, and then give Glenn a chance to get back in queue.

Bob Hopkins, Bank of America.

I just really had one question, and it was a follow-up to some of your comments on NASS and I realized you have highlighted what you're going to be talking about there a little bit, but I was wondering if I could ask specifically on the product side, just the relative importance of the things that you'll be talking about and highlighting at NASS in terms of thinking about potential impact, in terms of 2015 and 2016 on overall revenue growth. What are the key new product launches at NASS, and how impactful could those be as we think about the next 12 to 18 months?

So think I what we'll be talking about at investor morning really has to do with what we're calling IGA, integrated global alignment, and we'll just start discussing that, because we're starting to get pretty far along now in our beta trial, and that's going very well. So we're going to start laying out the foundation for how this changes all of our fixation systems over the next few years. So we think it's a very significant change, again, to spine surgery, in terms of what we're doing.

And as I've alluded, it's really taking the principles of scoliosis surgery and applying them not just to the thoracic spine, but also the lumbar spine, also. So those are really, I would say that's the biggest shift that we're working towards. We're going to continue to drive out XLIF ACR at the meeting. That's really gaining a lot of support.

I think we'll be putting forward a series of other products including Archon. Archon was just in limited release, so that's rolling out. As you know, biologics with Pro, and with Plus both, but really pushing those out further at NASS, and gaining additional traction with the posterior systems that we've been talking about.

On the scoliosis side, is there a way to help to think quantifying that opportunity if you're successful?

Well, we'll talk about that some more in a couple weeks, Bob. We'll get into some specifics on that, in terms of how we're viewing the market, but what we think it does, is it really is transformational, as far as what we can do in the thoracic spine, and starts to also move us into adolescent idiopathic applications, which right now, we're really not focused on that at all, just very little. So I think it just broadens for us the whole field over the next couple of years. But as I said earlier, the real application is not just in what you can do in the thoracic spine but changing how you treat the lumbar spine, and that fundamentally is going to shift, I think, our business applications dramatically over the next three, four years.

Great. Thanks for the color.

(Operator Instructions)

Joanne Wuensch, BMO Capital Markets.

This is Andrew Hanover in for Joanne. Wanted to start out with the international business. It continues to deliver healthy growth, and wanted to get some color on some of the puts and takes, and specifically the progress in Japan.

Sure. We saw that business grow roughly 45% in the quarter, and Alex talked to really the key markets that were driving that growth, which continue to be Japan, Australia is well up over that 45% growth clip, as well. Again we have probably the second largest market share position in that local market, so to continue see that growth coming from it is encouraging. Italy, UK both doing very well, also.

When you look at international, we've got roughly 3% of the total international market share, so the runway is still incredible for us. And I think we're for the most part in most of the major markets, with maybe just an exception of one or two countries. But I think that speaks to the runway that's in front of us, with just having that small market share, and just getting into the key markets that will enable us to take more of that, over the next several years.

Just one last question from us which is, any distributor changes in the last six months? Thanks for taking the questions.

No.

Larry Biegelsen, Wells Fargo.

Actually just one question for me. Alex, maybe if you could give us a little bit of color on how you're thinking about business development M&A at this point? Thanks.

We're really focused on Asia-Pacific and EMEA, and looking for opportunities to drive both revenue and op margin. We're also looking at ways to expand our manufacturing process, which is obviously not M&A, but we are looking at other ways to support the manufacturing that we've already taken on. We're absolutely thrilled with the progress that we've made in that area.

It's been very substantial, affecting the gross margin and really helping us out with COGS. So we're looking to expand more in that area, and other than that, we're focused on just other ways to increase our revenue footprint, and are working on a number of things. Nothing really big and nothing that we would anticipate to be certainly hugely dilutive. Our process is still built around looking for deals that would be accretive, worst case neutral, but certainly looking for accretive deals.

Thanks for taking the question.

Mike Matson, Needham & Company.

Obviously the move toward the internal manufacturing is helping out your gross margins quite a bit, so I was wondering if you could give us some perspective on where you're at with that process? In other words, as of right now, how much of your manufacturing is being done at your own plant, and I think it's in Ohio, versus being outsourced, and how much more of that do you think you can move inside over the next few years?

Sure. this is Keith. We're going to give some color on that too, in a couple of weeks. Essentially, when you look at the entire product range, obviously everything in the product range can't be manufactured, but when you look at just the implants, you're looking at 20%, 25% can be done and is being done in Dayton, and so a real opportunity for us over the next five years is seeing that expansion get up over 50%, and then how do we really leverage that, not only in Dayton, but is there other opportunities elsewhere, to really get even greater ability to bring more in-house? So we view it right now as it's an exercise of efficiency, maximizing what we have in Dayton right now from a machines perspective, and then we look at the next steps of growth and expansion. So there's a lot of runway ahead for us.

Just a question on the Decade plate. I think Alex, he mentioned that in some of his prepared remarks, it sounds like it's doing well, but wondering if you'd tell us what portion of procedures you think that's being used in, and how many of these are -- have moved toward the one position, I guess, procedure basically?

This is Quentin here. Decade plate just being out here a little over a year now, still a tremendous amount of runway and capturing more of our own procedures. I think still in the early stages of opportunity that's out there.

One thing great about the Decade plate, and it comes from years and years of learning, right? We've been in this space for as long as we have. We've also had single position surgery with plating, but it is -- without a doubt, this plate really does have a much better accommodation of the vertebral bodies, and it is a great opportunity for single position surgery, and that's why we're seeing nice uptake.

Jason Wittes, Brean Capital.

Just two quick follow-ups here, one for PCM. You mentioned labeling is the probably the major issue which is holding it back. Are you looking at a way of potentially expanding the label, and what would be involved in doing that?

We're not at this point because it would go beyond a PMA supplement. We'd have to essentially probably start all over with a new device. Frankly, we're not very excited about doing that in this regulatory environment.

We've been through several PMAs, and have been pretty frustrated with the regulatory process. So our focus is on 510(k) products and will continue to be. Not suggesting we'll never do a PMA, but that's not within the scope of what we're thinking about. So that's what it would entail.

I have to say that I am probably less excited about the cervical motion preservation market than we probably were a few years ago. I certainly believe that there's opportunities for two-level applications, but we're probably a little more hesitant right now with regard to how much of fusions will it convert. If you go back several years ago, we were all forecasting it could be anywhere between 30% to 50% of that market.

From what we've seen from the combination of insurance push back, surgeon uptake, our guess is that it's going to be significantly less than that, and I don't have an exact number for you, but fair to say that it's certainly going to be much less than 30%. So I guess that really mitigates our interest in making a big investment in that area right now. If that changes, well, maybe we'll be a little behind, but then we'll potentially chase it, but right now, we're not thinking about anything different.

Very helpful. Thanks for the color on that, Alex. Second just follow-up would be, I appreciate that pricing has been quite stable for the last multiple quarters. If I could just push you on a little more color, I'd love to get a sense of how new products are pricing versus the older products at this point? Is there a dichotomy there, and could you give us a little color to help us see how this market is moving?

Sure. When we talk about price, we're really talking about it on a same-store, same-product basis. So it's true product price, period over period. What we don't mix into that is the mix benefits that we do get from our premium price innovative, innovative technologies that we're bringing to the marketplace. We do see a positive mix benefit, and Alex alluded to that a bit earlier. Certainly on the more commoditized space, and where you don't have as much differentiation, you do feel a bit more of the pricing pressure in those areas, and we see some of that, just like our competitors comment on as well. Where we make that up is through the innovation that we're bringing back to the market, and see the premium and the pricing that we're getting.

Great. Thank you.

Mr. Lukianov, I would now like to turn the call back over to you for closing comments.

Thanks, everybody, for joining us. we hope to see most of you if not all of you in San Francisco, and those of you listening on today's call. We're very excited about the progress that we've made, especially on the bottom line as well as on our top line, so we'll talk to you real soon. Thank you.

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