NuVasive Inc (NUVA) 2015 Q2 法說會逐字稿

Greetings, and welcome to the NuVasive second-quarter 2015 conference call.

(Operator Instructions)

As a reminder, this conference is being recorded.

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

Great. Thank you, Manny, and welcome to NuVasive's second-quarter 2015 earnings call. Joining me on today's call are Greg Lucier, our Chairman and Chief Executive Officer; Pat Miles, our President and Chief Operating Officer; and Quentin Blackford, our 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, including, without limitation, the anticipated growth rates and trends in our Business; our beliefs and expectations regarding our market penetration and expansion efforts; our expectations and beliefs regarding the impact of investigations; claims and litigation; risks associated with the acceptance of the Company's surgical products and procedures by spine surgeons; development and acceptance of new products or product enhancements; those regarding revenues, gross margins, operating expense, other income and expense, taxes, future products, and capital allocation plans.

Our actual results or trends could differ materially from our forecast. 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 to be 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-K and 10-Q forms filed with the Securities and Exchange Commission. We assume no obligation to update our forward-looking statements or information, which speak as of their respective dates.

This call will also include a discussion of 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 cost of goods sold; gross margin; sales, marketing and administrative expenses; research and development expenses; operating margin; non-GAAP earnings per share; free cash flow; and EBITDA. We believe this information is useful to our investors because it provides 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 news release and the supplementary financial information, which is accessible from the Investor Relations section of the NuVasive corporate website.

With that, I'd like to turn the call over to Greg.

Thank you, Carol, and good afternoon, everyone. I'm pleased to be here today to talk about NuVasive's results for the second quarter of 2015, and our continued marketplace momentum as the innovation pioneer in spine.

We delivered solid results for the quarter, as we continue to take market share and gain momentum in all our efforts to improve operational efficiencies. We drove revenue growth in line with our commitment to drive mid- to high-single-digit growth, expanded our non-GAAP operating margins by an impressive 460 basis points, and reported non-GAAP earnings per share of $0.31, an increase of more than 100%.

Our sales force continues to be highly engaged, and is laser-focused on expanding our leadership in spine with increased penetration of minimally invasive surgeries, conversion of traditional surgical procedures, and accelerating our international expansion. We remain very optimistic as NuVasive looks to accelerate our market share-taking strategies.

I'll provide an overview of our results for the second quarter, and Quentin is going to provide more detail in his section. We reported revenue growth of $203 million, which represents 6.4% growth year over year, or 8.5% on a constant-currency basis. Our revenue performance for the quarter was driven primarily by strength in lumbar, cervical, and monitoring in the US. US Biologics was flat to prior year, as a result of the very difficult year-over-year comparison related to the launch of Osteocel Pro in the same quarter last year.

International revenue increased 7% as reported, or up 23% on a constant-currency basis for the quarter. Our international results were led once again by strong growth in Asia Pacific and European regions, where Japan, Australia and Italy continue to outperform our expectations. In these geographies, our team has been able to deliver growth that outpaces the market by leading with what NuVasive does best. We first penetrate with our XLIF procedure, then radiate throughout the market training surgeons in our lateral approach to revolutionize spine surgery in these regions. We're going to look to use this same penetrate-and-radiate strategy in existing geographies, and evaluate opportunities to be acquisitive in key growth markets.

We also continued to execute strongly against our profitability goals during the quarter, delivering non-GAAP operating margins of 15.3%, which represents an impressive 460-basis-points improvement compared to last year. This increase reflects improved supply chain efficiencies, international expansion, as well as the benefit of the Medtronic royalty expiration in the first quarter. Based on our progress to date, and overperformance in the first half of 2015, we are increasing our non-GAAP operating margin expectations for the full year from 14.4% to an even 15%, or an increase of approximately 360 basis points over 2014 results.

As we mature as an organization, increasing our profitability is a key priority for us, both this year and the next several years. We have a tremendous amount of runway in front of us to leverage our scalability, while maximizing processes and efficiencies to deliver meaningful profit improvement towards our goal of achieving 20% operating margins as we reach the $1-billion mark in revenue. This will allow us to further invest in R&D, and in programs designed to accelerate our market share-taking strategies, both of which we expect will drive that further revenue growth.

More recently, we announced changes in our executive leadership team that will create greater alignment, and allow us to focus on our most important strategic goals. Our executive leadership team reflects that deep bench of talent and expertise within NuVasive, and the addition of new individuals who bring complementary experience and proven records of execution. With the team in place, and the new roles and responsibilities it finds, we can now move even faster to drive NuVasive's next phase of growth and success.

We will scale our operations and drive efficiencies, and integrate our sales, service and specialized customer marketing programs. We believe that these efforts will turn NuVasive into a commercial powerhouse. This is going to allow us to successfully expand our global footprint so that, over time, we can grow 2 to 3 times the size we are today.

Additionally, we made moves to further diversify the depth of Board experience, and enhance the governance of NuVasive with the recent appointment of Vickie Capps and Dan Wolterman. Vickie brings extensive financial expertise and executive leadership experience as the former Chief Financial Officer of DJO Global. Dan, who currently leads and serves as the President and CEO of Memorial Hermann Health Systems, one of America's top health systems, brings a relentless focus on quality, patient safety, and a commitment to redefining healthcare economics.

With our leadership team largely in place, we are laser-focused on transforming spine surgery to drive us to that number-one position. I came to NuVasive because I saw incredible promise in the people, the products, and the possibility to completely redefine the spine business. Together, I have no doubt that in a few years time we will further transform outcomes in spine surgery, both clinically and economically.

One of the first things I did when I came on board was to reach out to our field sales teams to understand customer satisfaction. I was also interested in how the market was responding to the launch of our integrated global alignment platform, or iGA, and to learn what challenges our sales representatives might face. The feedback from those many phone calls, and I've spoken to well over 150 sales professionals, have been incredibly enlightening and encouraging, and I've corroborated their feedback with visiting over 80 key spine surgeon customers.

I also have had the opportunity to visit our manufacturing facility in Ohio and our distribution center in Memphis, in addition to visiting some of our international markets, and meeting one on one with those leaders to build a complete picture of this Company. These first-hand experiences and insights gathered are shaping my thinking to the approach we're going to take commercially and operationally, and I've learned a few things I want to share with you.

First, we're on the right track with the launch of the iGA platform. The feedback we've received from the field team has been tremendously positive. The utilization of our pre-case planning software, Nuvaline, as well as our intra-operative reconciliation capability, NuvaMap OR, has been very strong, as has the initial experience with our ReLine comprehensive posterior fixation system.

The market is properly understanding the value of surgical planning to achieve sagittal balance, and the iGA technologies we are integrating are creating genuine enthusiasm. While we understand that broader adoption of iGA will take time as we continue to educate and shift surgeon mindsets, there is no doubt that iGA has become a competitive door-opener for NuVasive. It is giving our sales force an important tool to call on new accounts and get access to surgeons with whom we have not previously done business.

We have also connected with more than 100 surgeons through our peer-to-peer engagement programs in iGA, and will continue to focus on surgeon education, marketing and sales training to drive further awareness and adoption of iGA. Beyond the push around iGA, we also remain committed to increasing investments in R&D as we fortify our position as the industry's innovation pioneer, and continue to differentiate NuVasive from the competition. It is this commitment to innovation and the regular introduction of new products that allow us to have much less price erosion than our peer group, because we bring clear value to the marketplace.

Second, it's critical that we both fix and revolutionize the way we supply tools and implants for surgery. We have committed to our sales team that meaningful progress would be made in the eight months, and normalcy will be achieved in 24 months. Beyond that two-year mark, we will run towards world-class performance. The new operating mechanisms we have put in place consistently reviewing our supply chain progress are just the start.

More strategically, we intend to radically increase the percentage of implants and fixation products we self-manufacture. Today, we manufacture approximately 30%. With our current resources, we can increase that up to 60%. With some investment, we can push the self-manufacturing goal to nearly 100%, which has the potential to nearly double the benefit over the next several years than what we currently anticipated from our in-sourcing initiatives.

We can move farther and faster with this type of targeted investment, and the return will be profound. This planned overhaul of our operations capability will become an example of how we transform our Company to deliver the best customer experience, and provide incredible support to the sales process team.

Third, to accelerate growth and continue to take market share in the global spine market, our international efforts are also expanding. With Jason Hannon now leading our highly capable international team, we look to capitalize on the strong foundation we have built across Latin America, Europe and Asia Pacific markets. Our immediate focus will be centered on globalizing our Business, including accelerating investment for rapid growth in very targeted ways, as well as aggressively pursuing inorganic growth options to supplement NuVasive's already strong organic expansion. We'll continue to build out the infrastructure needed to more rapidly expand this global footprint.

Additionally, we're undertaking a comprehensive evaluation of our international business, and actively building plans to accelerate momentum in each of these international markets, particular Europe, Middle East and Africa. Our plan is to replicate the incredible success we've had in markets like Japan, Australia and Italy, where we've led with our excellent technology, garnered immediate attention around our differentiated offering, and been able to use this as the tip of the spear to get even further success.

Finally, we're pleased to announce that we've reached a definitive settlement with the US Department of Justice related to the Company's investigation by the Office of Inspector General of the Department of Health and Human Services, or OIG. Under the terms of the settlement agreement, we will pay $13.5 million, plus fees and accrued interest. Importantly, the settlement is neither an admission of liability or wrongdoing by NuVasive, and the Company was not required to enter into a corporate integrity agreement by the OIG as part of the settlement. We are happy to have this matter finalized.

In all, we have immense opportunities ahead. Our teams are focused, they understand their priorities, and they are totally energized to go after the number-one position.

With that, let me turn it over to Quentin.

Thanks, Greg, 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 filed 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 Greg noted, we delivered solid revenue growth for the quarter, up 6.4% as reported, or 8.5% growth on a constant-currency basis. We also continued to deliver on our commitment to improve profitability, with 460 basis points of expansion in our non-GAAP operating margin for the second quarter of 2015, the majority of which came from our focused efforts to reduce our selling, marketing and administrative expenses.

We are reiterating our revenue guidance for the full year, with growth expected in the mid- to high-single-digit range, despite increased currency headwinds. At the same time, we are very happy with our progress on focused efforts to increase operating efficiencies, and are increasing our expectation for non-GAAP operating margin to 15%, resulting in at least 360 basis points of operating margin expansion for the full year, up from our previous expectations of a 300-basis-points improvement.

Now, beginning with our revenue performance, revenue for the second-quarter 2015 came in at $202.9 million or 6.4% growth year over year, including approximately $4 million of currency headwinds. On a constant-currency basis, revenue for the quarter was $206.9 million, or 8.5% growth year over year.

As a reminder, we were up against our toughest comp from the prior year, where we grew 15% in the second-quarter 2014 due to the launch of Osteocel Pro and some benefits in our Latin America markets that were not expected to repeat. Adjusting for this comparison, our growth in the quarter was approximately 11% on a constant-currency basis. Our performance for Q2 was driven by strength in our US lumbar and cervical businesses.

Turning to the composition of revenue in the quarter, as we continued to deliver on our guidance to drive mid- to high-single-digit growth on the top line, sales for US implants and services, which includes the lumbar, cervical, NVM5 and services business, performed ahead of expectations, growing 7.8% for the second quarter. We continued to experience strong results in our lumbar and cervical product portfolios, where products like our Precept posterior fixation system, ALIF ACR, VuePoint II posterior cervical fusion system, and Archon anterior cervical plating system continue to be growth drivers.

For the quarter, our cervical portfolio grew 11.9%. We continue to expect that US implants and services will grow by approximately 5% for 2015, which includes approximately 5% growth expected in cervical, up from our previous expectations of 4%, given the strength we have experienced in cervical during the first half of the year. As a reminder, ReLine, our comprehensive posterior fixation system, which is part of the iGA platform, is expected to be more of a significant revenue contributor into 2016 as we drive awareness and adoption of this exciting new platform.

US Biologics sales were essentially flat to prior year, primarily due to the difficult comparisons created by the launch of Osteocel Pro in the second quarter of last year, where we realized growth of more than 18%. Within the quarter, the penetration of our existing procedures continued to increase, moving beyond 70%, and getting closer to our longer-term goal of 80%. We continue to expect the US biologics business to grow approximately 7% in 2015.

Our international business, which includes Puerto Rico, grew 7.4% in the quarter, or 22.6% on a constant-currency basis. We continue to expect significant growth from this area of the Business, where we have tremendous runway ahead of us, and currently only an estimated 4% share of that total market. We continue to experience significant growth in markets like Japan, Australia and Italy, where we focus our efforts on leading with the differentiation of XLIF and our lateral solutions.

As Greg mentioned, with our recent leadership change in international, we are incorporating those learnings and optimizing our market approach in other countries, which will include greater direct engagement with customers to create focus on our differentiated solutions and capitalize on our market-leading surgeon education programs. As a result, we expect some near-term disruption in Q3 2015 from these changes; however, we remain confident in our full year performance outlook for international. As such, we continue to expect our international business to grow by approximately 9% on a reported basis, or more than 20% for the full year in constant currency.

In summary, we are pleased with our revenue results for the second quarter of 2015, as we have continued to execute our share-taking strategy. We continue to expect revenue of approximately $810 million for 2015, which now includes a $13-million impact from currency headwinds, or a $1-million increase from prior guidance. For the full year, this represents approximately 6.2% growth year over year, or 7.9% on a constant-currency basis.

Turning to the rest of the P&L and results, non-GAAP gross margin in the second quarter was 76.1%, down 40 basis points from the 76.5% reported in Q2 2014. The expiration of the royalty associated with the Medtronic 973 patent resulted in a benefit of 160 basis points to prior year, as expected. But this benefit was more than offset by one-time incremental charges related to new products and inventory management, specifically 130 basis points was attributable to new product launches ahead of schedule, and approximately 70 basis points related to inventory efficiencies realized last year in the second quarter that did not repeat.

The impact of price continued to be consistent with prior periods, declining approximately 1%, and was not a material factor in the quarter. We now expect non-GAAP gross margins for 2015 will improve from the prior year to approximately 76.7%.

Non-GAAP sales, marketing and administrative, or SM&A expenses, totaled $114.7 million in Q2 2015, down from $116.3 million in Q2 2014. SM&A expense was 56.5% of revenue for Q2 2015, representing 450 basis points of improvement compared to the 61% reported in Q2 2014, as we continue to leverage our operating expenses. During the quarter, we realized more than 280 basis points of benefit from our efforts to drive sales force and asset efficiencies, as well as an additional 160 basis points of improvement in share-based compensation-related charges.

While happy with the progress, we see additional opportunity to drive leverage within our SM&A expense profile over the longer term. The opportunities are numerous, and as we mentioned last quarter, we're driving initiatives designed to address our fixed cost expense base, renegotiating vendor agreements, better understanding the true cost of serving our customers, reducing the need to deploy unnecessary assets for surgeries, and reducing the loss associated with our loaner instrument model. As a result of the progress made through the first six months of the year, we are now improving our outlook for SM&A expense to be approximately 56.9% for 2015, an improvement of 100 basis points from the previous estimate of 57.9%, and now 300 basis points better than prior year.

Non-GAAP research and development, or R&D expenses, totaled $8.8 million in Q2 2015, compared to $9.1 million in Q2 2014. R&D expense was 4.3% of revenue for Q2 2015, versus 4.8% in Q2 2014. This decrease follows higher levels of spending earlier in the year to support the launch of our iGA platform in May 2015, and reflects continued investment in our game-changing procedural solutions, as we plan to introduce additional new products and line extensions throughout the year. We remain committed to investing in innovation in 2015, and now anticipate our full-year non-GAAP R&D expense to be approximately 4.8% of revenues.

We are very pleased to report that second-quarter non-GAAP operating margin increased to 15.3%, resulting in an exceptional 460 basis points of operating margin expansion compared to the 10.7% we reported last year. We continue to make significant progress in our goal to improve profitability across the board, delivering roughly 500 basis points of improvements from leveraging our operating expense profile.

We are very pleased with our performance for the first half of the year, and with where we are positioned relative to our underlying core operating margin improvement for the year. To that end, we are increasing our profitability guidance, and now expect a non-GAAP operating margin of approximately 15% for 2015, an improvement of 60 basis points from our previous estimate of 14.4% for the year, now resulting in non-GAAP operating profit dollar growth of 40% for the year.

Our non-GAAP results for the second quarter excluded the following charges, as follows: $3 million related to the amortization of intangible assets; $1.4 million for one-time and acquisition-related costs; and a net charge of $0.6 million related to litigation liabilities. In addition, to be consistent with prior practice, we realized a charge of $0.2 million of leasehold-related charges, and $0.1 million related to our CEO transition.

The net charge of the $0.6 million related to litigation liabilities reflected a $3.3-million charge associated with an unfavorable verdict in a general litigation matter, which was partially offset by a gain of $2.8 million related to the settlement of the NeuroVision trademark dispute. You may recall that we had accrued $30 million for NeuroVision litigation in the first quarter of 2014, which we ultimately settled for $27.2 million.

Interest and other expense net on a GAAP basis totaled $7.2 million in Q2 2015, relatively consistent with what it was in Q2 2014. Included in the quarter was $3.9 million of non-cash interest expense related to our convertible notes. We continue to anticipate full-year 2015 interest and other expense to be approximately $29.5 million, including roughly $16 million of non-cash interest expense.

Income tax expense on a GAAP basis for the second quarter of 2015 was $8.6 million compared to $1.9 million of expense in the second quarter of 2014. This resulted in a GAAP tax expense rate of 46.3% for the quarter. As a result of our improved profitability outlook, we now expect both our GAAP and non-GAAP effective tax expense rate to be approximately 45% for the full year of 2015.

Second-quarter non-GAAP earnings were $15.7 million or $0.31 per share, more than double when compared to $7.6 million or $0.15 per share in Q2 2014. We now expect non-GAAP earnings per share of approximately $1.17 for 2015, versus a prior expectation of $1.10. Additionally, we now expect GAAP EPS to be approximately $1.18 versus our prior guidance of $1.12 for 2015.

In addition, adjusted EBITDA margin, which excludes the impact of non-cash, share-based compensation, was 24.9% for Q2 2015, compared to 21.5% in Q2 2014, reflecting a 340-basis-point improvement in the Business. We now expect an adjusted EBITDA margin of approximately 25.2% versus our prior guidance of 24.6% for 2015.

Our cash and investments balance at the end of the second quarter was $306.6 million, down about $10 million from last quarter, as a result of an incremental $23 million of tax payments made in the quarter, as we transitioned to a cash tax payer.

In closing, we have finished the first half of the year with a very strong performance. On a year-to-date basis, revenue growth is 9.2% on a constant-currency basis, and non-GAAP operating expenses are essentially flat with prior year, resulting in non-GAAP operating margin expansion of 460 basis points, and non-GAAP operating profit dollars growing nearly 60%. In addition, non-GAAP earnings per share are up more than 80% year to date, as our strong leverage story continues to play out.

As we came into the year, we laid out a multi-year path that would have us driving our non-GAAP operating margins to 20%, with adjusted EBITDA margins growing to 30%. Six months into the year, we are well on our way to achieving those goals, and have direct line of sight to how we will execute on those longer-term stated expectations. We remain committed to delivering on those plans and creating incremental shareholder value. We are excited as we head into the back half of the year to deliver on our full-year commitment of driving mid- to high-single-digit revenue growth, while delivering 360 basis points of improved non-GAAP operating margins, and adjusted EBITDA margins surpassing 25%, and improvement in non-GAAP earnings per share of nearly 75% for the year.

With that, I'll turn the call back over to Greg for closing comments.

Thanks, Quentin. As we look ahead, we are committed to capitalizing on the strong fundamentals in NuVasive's business and the market as a whole, to attract the very best talent, drive value for our shareholders, and make a difference for our customers. We are energized by what our future holds, and are confident in our ability to execute to continue NuVasive's positive momentum in 2015 and beyond.

Before I open the call for your questions, I want to make you aware of our intention to hold an Investor Day at our headquarters in San Diego on December 10. We hope you'll save the date. I promise it will be [something].

With that, operator, we would be pleased to answer any questions.

(Operator Instructions)

The first question comes from Matthew O'Brien of Piper Jaffrey.

Afternoon. Thanks for taking the questions. Was hoping to start with the US implant business, and the strength that we saw there this quarter. Quentin or Greg, can you just provide a little bit of a sense in terms of where the components of that strength came from? Be it the market or the position of distributors shift away from those entities, share-taking or deeper penetration within your existing accounts? And then as you look forward, just some of those levers that you have among those areas, to keep generating that type of performance going forward.

Yes, Matt, this is Quentin here. I think there's several areas we can point to and we have question we believe we continue to take share in the marketplace. And I think you can point to where we continue to grow at a rate that far out paces our overall growth, certainly a contributor there and really the focus around alignment we're gaining traction with that product line which highlights the fact that the marketplace is starting to appreciate the importance of alignment which is something critical to iGA and the success that we believe will come with that over time as well. And certainly you get into the cervical portfolio, where we're seeing nice results around Archon. We've launched the anterior cervical plating system in the fourth quarter and got some nice adoption there as well as 2.2, which is our posterior fixation system for the cervical spine, and we're seeing nice results come from that as well. So there's certainly new product launches that are fueling the growth, continue to gain traction, and we would believe that into the future have the potential to continue to demonstrate those kind of results as well.

So it seems like it's a combination of going deeper in your existing accounts, plus taking some share throughout the market as well, is that fair?

Absolutely, without a question.

Okay and then I know we're supposed to keep it to one, but if I could sneak in one more. Greg, I just was interested the commentary you had on the insourcing opportunity you see going forward, going from 60% to 100% potentially. How much of that is internal investment versus external investment, and can you give any sense for time frame and potential improvements to gross margin from doing that? Thank you.

So right now we have a modest size factory in Dayton, Ohio. With that set of capabilities, we can go from about the 30% that we are today towards the 60% I mentioned in the script. What's new is that we're going to move beyond that facility, and open up a much larger manufacturing capability somewhere here in the United States. We'll be announcing that probably in the next few months. And with that increased capability, we'll be able to take our potential for self-manufacture up to 100%. In terms of its impact on our trajectory to becoming a 20% operating margin company, or greater, as I referenced, we think that it will accelerate that, and potentially move us beyond 20%, but we haven't fully quantified that yet for investors.

Great, thank you.

Thank you. The next question is from Rich Newitter of Leerink Partners.

I don't know, either Greg or Quentin, just in light of some of the leadership transitions that are taking place, I think I might have missed it, but Greg, I think you mentioned this might have caused a little bit of transient disruption. I was just wondering if you could maybe give a little more color on that, and what we should expect going forward? And then as you answer that question, you mentioned some inorganic activity. I'm guessing some of that is probably going to be focused OUS. Can you elaborate on what your ambitions and initiatives are, as you look forward through M&A?

You bet. So just to be hopefully very clear, the Company executed, I think, extremely well in the second quarter. Perhaps the narrative that there would be disruption in the sales force was in the end not true. The sales force is very stable, very focused, and as you can see by the results, very successful. On your second point, in terms of inorganic growth, I am indicating to investors that we will begin to be more acquisitive, very, I think, responsible in what capital we would deploy, and the focus would be to continue to build on our strength in international markets, and so further expanding where we can open up new geographies, potentially by using our balance sheet.

Great. And just maybe to follow-up on that, Greg. How should we think about your willingness, or as you look at opportunities, what's your view on how M&A impacts the P&L, or what criteria are you more focused on or do you provide, have greater weighting on? Should we expect deals to be accretive first and foremost, or can you give us anything there?

Well the first filter for any M&A is that it has to support and enhance the strategy, and it has to do it in a way that we couldn't do it on our own. And as an example, this Company is incredibly innovative. A lot of implant technology sits out there, a lot of it is of no interest to us, because we're so innovative on our own, so it has to fit in with our strategy.

The second would be that we can get a proper return on invested capital, because we all know in these low interest environments today, getting accretion is not the challenge, getting the return is. And so we would have expectations to get a return on our invested capital in a smaller deal within three years. If it was a larger deal, certainly within five. The last would simply be the capacity of the organization to absorb the particular acquisition at that moment in time, and so that's the filter, if you will, by which we'll consider deploying our balance sheet at the right opportunity, at the right time.

Thanks, congrats.

Thank you, the next question is from Ben Andrew of William Blair.

Hi, guys. So this is Kaila in for Ben. Just to follow-up on the M&A comments, Greg, can you just elaborate on your comment to be more acquisitive? I know you mentioned that NuVasive does have a lot of innovation across segments, so I can imagine it would be difficult to pinpoint a specific area, but can you just touch on maybe a potential few segments that you are interested in getting into?

Well, I'm cautious about doing just that. I apologize, but let me try to be at least responsive to your question, perhaps in more generalities. As I said in the previous question, we're growing very fast internationally. We like what we're doing, and so the question we ask ourselves, can we grow even faster by moving into new countries inorganically? And I'll leave it at that for you to consider how that could be done. We do look at a lot of technologies, and we're going to ramp up that surveillance, and think about other things that may accelerate the overall building out of a portfolio. But as I said, we're cautioned because we are quite innovative on our own.

The third area would be to think about data, data systems. It's very clear as you go out a few more years that there's going to be the need for capitation around these bigger surgeries, and we want to be in a position to understand the economics of spine surgery better than anybody. And so perhaps an inorganic move might be in order at the right time there. So there's generalities for you just what we're thinking about to become number one in this marketplace.

Okay, that's helpful. That makes sense. And then just given the improvements that we've seen in operating margin in the quarter, and the lift in guidance, just looking at the out years beyond 2015, do you think, do you still think of 100 basis points as a multi-year expansion goal, again beyond 2015, or is that more of a baseline case?

It's a good question, and what I've been very cautious to do here is to not change the fundamental longer term, or maybe medium term guidance that Quentin and the team have provided so far. Which as we said before is 100 basis points improvement a year, as we get to $1 billion we get to the 20%, and I think that's good guidance you should still build into your models. All that said, when you visit us on December 10 on that sunny day, we'll give you a lot more medium term guidance about where we are taking the Company.

Great, thank you.

Thank you. The next question is from Chris Pasquale of JPMorgan.

Thanks. Greg, I just want to follow-up first on your comment about opening up a second manufacturing site in the US, and I'm curious why you view that as the right approach, versus maybe filling out your footprint with OUS manufacturing in a cost advantaged location?

Very good question. And our answer is that we want to continue to execute flawlessly, and our worry not being historically, I would say, awesome at operations, is to then immediately take a higher-risk approach of building a plant in Singapore or somewhere else like that. And so we believe the more prudent approach is to build a plant somewhere in the United States that leverages the expertise we do have, and allows us to get a much bigger economic improvement from our current path, get that done, and get that done where it doesn't cause us any problems, but only causes us pure upside, and then toward the 2020 time frame, probably looking at a second plant, given our volume growth, overseas, just like you described.

Okay, that's helpful. And one for Quentin. Can you just walk through some of the puts and takes on gross margin in the quarter, and the slightly lower full-year forecast? I would have expected with the royalty winding down, that we would have seen a bigger improvement, and I know you mentioned a couple items that were weighing on that.

Yes, sure so within the quarter, gross margin was down year-over-year by 40 basis points. We did see the benefit year-over-year of the Medtronic royalty falling off. That benefited us by about 160 basis points, but we also had some one-time product-related costs with new product launches and transitioning different product lines of about 130 basis points. And then we had benefits last year of 70 basis points that just simply didn't repeat this year. And if you'll recall, going back into that second quarter we talked about some inventory efficiencies around the loaner model or filled inventory that had benefited us at that point in time. So you had a bit of a tough comp there, but if you would normalize for the one-time items, gross margins would have been up for the quarter, there's no question.

For the course of the full year, it's not that there's a product transition-related item that's impacting us. We had contemplated that on a full year basis, that just came in a little bit different from a timing perspective, but the challenge here is really two things: One, we've got some mix in our international business, Japan is doing incredibly well for us, but we're seeing Precept be a bit stronger in that local market, which has a little bit of a higher cost profile associated with it, so it's just putting pressure on us.

The other thing is NML. We didn't generate as much of the savings in the second quarter that we anticipated, and the reason being is really aligned to what Greg has talked about, which is how we take our manufacturing capability from the 60% we once talked about to 100%. And what that means is that we've got to spend time building out the capability and the processes around bringing more products into that facility, not just focusing on the few that we were producing, but expanding that out to where we can produce all products.

So we're working through design engineering, manufacturing engineering, setting up the manufacturing processes. It's not going to have those machines running at full efficient capacity here in the next couple of months, but it's going to put us in a position to drive significant better efficiencies over the longer term. So we're going to feel a bit of that in the near term over the remainder of the year, which puts a bit of pressure on the gross margin, but ultimately will put us in a much better position long term.

Thanks.

Thank you. The next question is from Larry Biegelsen of Wells Fargo.

It's Craig on for Larry. I don't believe, Greg, that you, in your international comments, or your comments on the international business, in the script, that you mentioned China. And I just wanted to touch on that and see what the strategy is there. I know at the Analyst meeting, obviously different management, but last year, it was a key focus for 2015. So just wanted to know, is the focus on China maybe pushed to 2016? So just strategy and timing on China?

We remain committed to expanding in China, in some ways, some of the disruption at the top of NuVasive may have worked to our advantage given the disruption going on in China now, and so my hope is that we'll be able to bring something to shareholders here in the next six to eight months regarding China.

I guess just from a market, or the Chinese market perspective, there's no, is that, is it specifically something that's happening in the market environment there that maybe pushed you a little further out?

No, it's just simply, maybe I was being too opaque. Simply, with the change in the management, with Alex to me, we've just had to reorient some priorities, and in parallel with that, we know the devaluation has taken place in the China Stock Market as well as potentially sellers' expectations, regularly so. And I'm simply saying that timing may not work to our advantage, because our ambition to move into China has not changed. It's just moved out a few months. So we remain very interested in trying to enter China, and as I said, our hope would be to try to bring news to shareholders in the next six to eight months.

Great, thanks.

Thank you. The next question is from Glenn Novarro of RBC Capital Markets.

Two questions. First with respect to the revenue guide for 2015. You didn't change the guide, but if you look at the first half, up very strong, 7%. By keeping the guide, it implies the second half is going to be up more like 5%, and the comps do get easier.

And Quentin, I know you mentioned FX is going to be a little bit worse, but I'm just curious as to maintaining the guide. Is it just conservatism? Is there something that makes you a little bit nervous? Thank you.

Yes, Glenn, this is Quentin here. I would not point to anything that gets us nervous, with respect to the back half of the year. I think the fact is, we're six months into this. There's no need at this point to come out and really change expectations for the full year. Let's get another quarter under our belt and see how we're performing, and at that point, we'll be back here talking with you with better clarity around where we think the full year is going to finish. But at this point, nothing in the business specifically that we would point to that gives us significant concern.

The one thing I would highlight is just in Q3, with some of the leadership transition, and the bit of a different approach in the international market, with respect to how we start to lead with XLIF and the learnings around my role in some of those markets, I do think there's a bit of an opportunity for some disruption in that Q3 result. I want to make sure people are thinking about that appropriately. But for the full year, we feel good about where we're at. So that's why we chose not to change anything on a full-year basis, but certainly be mindful of the Q3 potential there.

Okay, and then, just for Greg, you mentioned the stability of the sales force. Greg, maybe can you comment on the stability of maybe we should call it the middle management? The reason I'm asking is I saw a C-Spine press release that some of the leadership team went over to C-Spine. I know they aren't part of the senior leadership team, but maybe talk about the stability of the organization right above the direct sales folks, and right below the very senior leadership of the Company? Thank you.

Yes, you bet. Actually, we'll do a two-pronged answer. Pat, why don't you take the first shot, given you managed the bulk of the organization, and just give a view of the sentiment inside the place?

It's an interesting question. It's one that, candidly, to live in here, I think you'd appreciate the enthusiasm that's going on with regard to -- we just had the largest launch in the Company's history, with regard to the whole iGA platform. I think the reflected enthusiasm from the field has done nothing but inspire the inside. And so I think if you look across the engine of Company, I would tell you that it's extraordinarily healthy.

And again, coming in on the outside or maybe just on the Board to the inside, I have to tell you, I'm just completely energized personally, because I interact with just the most innovative, creative set of people, and it's just a lot of fun to see what's going on now. But also knowing what I do about our pipeline, it's just very encouraging about where we will be over the next couple of years.

Okay, thank you.

Thank you. The next question is from of Lin Yu of Cowen and Company.

Thanks for taking the question again. Thanks, congratulations on a good quarter. I just want to know if you disclosed a little bit more on the iGA rollout plan. What kind of accounts you are targeting, and do you have a specific target or number in mind? Just want to get some additional color on it. Thanks.

Yes, happy to talk iGA. The great part about this strategy is one that it doesn't require a hurdle, meaning if somebody approaches the spine in one way or another, it's not inhibiting through our capacity to enable them to do the procedure. And so it's really been one of those things where we've really approached the short segment surgeons, or the guys who do short segment surgery, and those are the guys who are often least knowledgeable about the value of alignment. And so, there's great opportunity to educate a group of surgeons who have candidly have not implemented this knowledge base before. And so it hasn't pushed us in any other direction other than really the wide degenerative audience, which is really consistent with regard to the demographics of our base.

Great.

Maybe Pat, just further talk about the launch of iGA being square in where we're strong today, and we can broaden our base, but also maybe talk about deformity as well, in a bigger way?

I think, without question, the opportunity to start to take morbidity or make for a more minimally invasive approach to longer constructs has been the foundation of the Company, and the ability to continue to do that in the deformity realm is high. I think if you look toward where we're going right now, we really focus on what will be considered degenerative deformity, which is mostly older folks who have degenerated over time into deformity. Our capacity continues to expand that footprint into that customer base, as well as look toward more earlier stage deformity, is clearly an opportunity for us.

Great, thanks, just kind of follow-up question. Do you have any plans to build clinical evidence, or are you aware of any surgeon-sponsor studies that will demonstrate, educate the surgeon about the benefits of alignment, sagittal to surgical outcomes? Just want to know if there's any particular studies we should keep our eyes on?

Yes, there is and matter of fact, it was phenomenal, we were able to launch a book, or a book was launched with the whole iGA, strategy settling a compendium of clinical rationale around the alignment. So the acceptance in the ledger is voluminous, which is fantastic. What you're seeing now is in the relevance in more of a -- what would be deemed a degenerative surgery, so you're seeing that in papers published out of Europe. You're seeing it -- [John Charles Laweck] is a name that has published several papers talking about how the deformity parameters are now being sought in degenerative surgery based upon creating a more durable long term outcome. And so there's a lot of literature out there, Schwab is very well published in this room, and we will continue to invest in post market research to continue to affirm the value that we're creating clinically and economically.

Great, thanks. Congrats on a really good quarter.

Thank you. The next question is from David Roman of Goldman Sachs.

This is actually Kyle filling in for David. Good afternoon and thanks for taking the questions. Greg, as you continue to reach out to the sales force, could you provide us with some of the feedback from those conversations? For example, what has surprised you the on upside and have you fielded any concerns?

The three areas maybe I could comment on are first, the operational support to the sales force. As we've alluded to both in this call and I'm sure earlier calls, the supply chain approach the Company had historically taken was not fully serving the sales force, and we have brought on a new team under Pat, a team that has substantial experience in realigning supply chain and building factories and running them and just in the last 90 days, we've made nice progress increasing and creating predictability of when they will get their trade sets. Less anxiety. More time selling. It's been a huge win, we've got a long way to go, but we're on the right path.

Second is our best people, as you know, are really great, because not only do they sell, but they support the surgeon in the operating theatre. We're going to continue that but we're going augment the capability with increased hiring of clinical associates, to allow them to be more productive on the sales side. This will allow us to continue to take market share, and as I say, the sales force has really received that with great enthusiasm. Now, the last that I've been personally impressed by, and the sales force has commented back to me, don't change it and keep going with it, is just the very high investment the Company makes in training. I think it's recognized, and maybe this is just me repeating what I've heard, but it's certainly what they told me, is they feel they are the best trained sales force in the industry. They are best trained clinically, and increasingly they are starting to hear from us economically on how best to talk to the C suite of hospitals, to become a spine partner of choice. That's a whole new arena for us. As we've gotten bigger we can become bolder in our ability to partner, and you'll see that unfold over the next couple of quarters. So that's a bit of the context with the dialogue and sales force.

Thanks very much for that detail. It's helpful. Switching gears, one question quickly on the US biologics business. I know that this quarter represented a difficult comparison with the Osteocel launch annualizing, but I think the number came in a bit below where we were expecting, with sales declining quarter-over-quarter. Can you perhaps briefly walk us through the drivers of this quarter's performance relative to first quarter?

Yes, this is Quentin here. For the most part, it really wasn't a tough comp issue in the quarter itself. One way to look at it is to go back to last year and normalize the second quarter, and just assume that we grew that second quarter in line with what we grew the entire year for, which is about 10.5%, 11%. If you were to do that, you'd come into about 7% growth in biologics this year in Q2, on a normalized basis, which is essentially right in line with the way we've guided to it. So as we start to parse apart the business and try to understand the true impact of that tough comp and then pay attention to things like penetration in our own existing cases, which we saw move north of 70% this quarter, we're still very bullish on the potential in that product line. So normalizing for all of that, and still growing roughly 70%, right in line with full year guidance, has us feeling pretty good with where we're at.

Great. Thanks very much.

Thank you. The next question is from Bob Hopkins of Bank of America.

Great, good afternoon. Thanks for taking the questions. So just two quick questions. First on, back on the topic of M&A. That's gotten a little bit of attention this call. Can you give us the sense for the size of the deal that you might consider? Are we talking about deals in the tens of millions to maybe low hundreds of millions, or we should consider a larger transaction?

Good question. I don't think that we have talked about the size of acquisitions at this point, more around the question earlier, around the economic return of them, so that's really more where we would be focused on, making sure that whatever money we invest, we get the right return on it.

So does that mean, should we take from that, that you would consider larger deals?

Look, if a larger deal allowed us to create the tremendous shareholder value, we're going to take a look at it. But you're asking a question that's hypothetical, and I'm trying to give you a more principled answer of, I think that it's important that the Company remains grounded on a return on its invested capital.

Just trying to get a sense for what to expect. And then lastly, just really quickly on the Q3 OUS growth. Given full year guidance, and you explained what's going on in Q3, but just in terms of expectations for Q3 specifically, I would assume we're still talking about double digit growth in third quarter OUS, is that fair?

Yes, Bob I think the thing that you've got to keep in mind is last year we also had a one-time benefit coming out of that Latin America market. Those things are hard for us to predict when they recur, and we've said that we aren't going to try to do that on a quarterly basis. But I think if you go back and look at the remarks we made, it was about $3.5 million of benefit last year in the third quarter alone. So if you don't see that coming out, I think growth in the double digit territory is going to be hard to produce in the third quarter, but for the full year, we have every bit of confidence that we're going to be able to achieve the 20% constant currency growth that we laid out.

Perfect, thanks very much. Appreciate the color.

Thank you. The next question is from Matt Taylor of Barclays.

Thank you for taking the question. I wanted to ask one follow-up on the insourcing initiative, which is an interesting one. I guess, can you provide us, number one, with any context in terms of what the timing of that might be, both in terms of when you break ground and when it would benefit the P&L? And then on the insourcing initiative that you outlined last year, did you ever actually quantify that? I know there's a little chart with like the bar of contribution towards 20% growth, but did you give a number?

We did. So as we talked about moving towards the 20% operating margin goal, we had laid out insourcing as being a primary driver of that, and we said it was about 200 basis points of improvement that would come from insourcing, and that was if we could get ourselves to 60% of the product coming in house. And you listened to Greg talk earlier, our goal now was really to take that 60% and move it to close to 100%, which over time, we think is going to have the opportunity to nearly double that 200 basis points. And I think the way to think about that is, an incremental 200 basis points of improvement, on say $1 billion Company is $20 million of improvement in any given year, so there's a substantial return that comes with that investment that we're looking to make.

In terms of timing, I think we realize the opportunity there to create the leverage, and realize that benefit. We want to move quickly in this area, so we're focused on it. It's a high priority for us, and it's one of those that we believe has relatively low risk. The manufacturing capability here is not significant in terms of know-how. We're doing some of it already. We just need to accelerate the efforts around it.

Great and in addition to iGA, are there any other products or line extensions that we should watch out for that are coming, or either -- or keep an eye on that, that are driving some of the momentum?

Yes, I think at this point, we've launched the foundation of the iGA platform, and what you're going to see is a backfill of a lot of technique-related devices that will ultimately continue to support whatever the approach preference is to the surgeon. So you will see a lot of smaller type of launches through the end of this year that will ultimately reflect in continued elegance.

Great, thank you.

Thank you, and our next question is from William Plovanic of Canaccord Genuity.

Great, thank you. So just two questions. One, I think Quentin, on the last quarter, you said that you expected some major disruption in the impulse monitoring services business this year, and what degree of that impact are you seeing from the changes that were made?

Bill, that disruption was really contemplated in the back half of the year, so as we talked about the disruption there, it was really focused around ensuring that we're strategically aligned with our service business and the hardware business, and so we've taken the opportunity in the course of 2014, and even the beginning of 2015 to trial that with some incremental hires of clinical associates in the targeted locations. What we've contemplated in the back half is potentially walking away from some those territories where the hardware is not in line with service, and making those more aligned in the future, where we think we can drive even greater growth. So we haven't seen an impact in Q2 or Q1 as a result of that. That was more focused in the back half of the year.

Great, and secondly, just on OUS and a lot of people have asked about it, but just clarify your comments on the OUS impact of leadership changes for the second half of the year. Are there specific geographies? Is this going to be significant impacts, are you changing distributors, what exactly, just more granularity would be helpful, thank you.

Yes, the focus is primarily around Europe, Bill. We're doing very well throughout the Asia-Pac region, we've taken very specific targeted approach with leading with XLIF in our lateral solutions in both Japan and Australia, and have seen significant results. We've seen the same in Italy.

What we want to do is take that know-how and take that experience and to really double down in some of these other European markets that we have been in for a period of time, but haven't experienced the same kind of growth. So in the near term what you end up with is a focused effort that historically might have been more around the traditional spine surgery products, and now you've pulled back from that just a bit to get more focus on XLIF, spend some time training the surgeons and sales force, which is going to create some near term disruption, but ultimately, we believe in greater growth opportunities for us, so that's what we highlighted as the Q3 disruption, but still feel very good about the full year expectation that we laid out.

And is that changing distributors out or what exactly, going direct, what exactly does that mean?

So we're direct in most all of the major markets there in Europe. We talked about this historically, right? We're direct in the UK, we're direct in Germany, we're direct in Italy. We've just gone direct in Spain. Looking to go direct in Benelux. There are a couple smaller markets where we may look at those opportunities to be direct as well, and that could potentially be looking at distributors from time to time, but right now, it's about how we can grow in some of these bigger markets in a much more meaningful way.

That's helpful. Thank you very much.

Thank you. I would now like to turn the conference back over to Mr. Lucier for any closing remarks.

No, that concludes our second-quarter earnings conference call. Thank you very much for your interest in NuVasive, and we look forward to talking to you in 90 days.

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