NuVasive Inc (NUVA) 2015 Q3 法說會逐字稿

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

(Operator Instructions)

As a reminder, this conference is being recorded. I would now like to turn the conference over to our host, Carol Cox, Executive Vice President, Strategy, Corporate Development and External Affairs. Thank you, Ms. Cox. You may begin.

Great. Thank you, Kevin, and welcome everyone to NuVasive's third-quarter 2015 earnings call. Joining me on today's call are our Chairman and Chief Executive Officer, Greg Lucier; Pat Miles, our President and Chief Operating Officer; and Quentin Blackford, our Chief Financial Officer.

Before we begin today, I would like to remind you that the discussions during today's call will include forward-looking statements, which 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. For a discussion of these risks and uncertainties, please see today's press release and our periodic 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 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. Reconciliations to the most directly comparable GAAP financial measures can be found in the press release and the supplementary financial information, which are accessible from the Investor Relations section of the NuVasive corporate web site. With that, I will turn the call over to Greg.

Thank you, Carol, and good afternoon, everyone. I'm happy to be here today to talk about NuVasive's results for the third quarter of 2015. First, I'll provide an overview of our results for the quarter. Then Pat and Quentin will delve into more details on the phenomenal innovation and exceptional margin expansion driving our performance.

We are very pleased to report revenue growth in line with our mid to high single digit growth expectations, and profitability that once again outperformed our plan, with incredibly strong year-over-year and sequential growth in non-GAAP operating profit margin and EPS, as well as adjusted EBITDA during the quarter. We delivered revenue growth of approximately 8% on a constant currency basis, and continued to make significant improvement in our non-GAAP operating profit margin, which we expanded by an impressive 460 basis points. Non-GAAP EPS came in at $0.35, increasing nearly 3.5 times over the same quarter last year, while adjusted EBITDA grew a notable 540 basis points.

Revenue for the third quarter was approximately $200.5 million, up approximately 5.6% as reported, or approximately 7.8% on a constant currency basis, driven primarily by strong US sales, somewhat offset by softer growth in certain international markets, as we expected. Our revenue performance for the quarter was driven primarily by the continued acceleration of growth in our US lumbar and cervical sales. Clearly, NuVasive continues down the share taking path, benefiting from both a strengthening US marketplace, as well as an unmatched, innovative and highly competitive portfolio of integrated procedural spine solutions.

We continued to drive sequential growth in lumbar results. Growth in our posterior fixation category accelerated, hitting a double-digit increase for the first quarter, as ReLine posterior fixation system is starting to gain traction, in addition to continued momentum in our ALIF and TLIF business. We expect this strong lumbar performance to continue and end 2015 on a strong note.

Our cervical offerings also performed well, driven by our Archon anterior cervical plating system, which provides additional stabilization to cervical fusion procedures, and our posterior cervical fixation offering, VuePoint-II. The story around our US biologicals performance, which was flat to prior year, is primarily cyclical in nature. As you know, we had an exceptionally strong launch of Osteocel Pro last year.

This year, we had an incremental product innovation on the biologics side of the business, including the launch of Propel DBM, a highly moldable demineralized bone matrix putty. As such, the timing and cadence of our R&D efforts and product introductions can and will impact our quarter-to-quarter performance. Additionally, we saw new competitive entrants on the biologics front, as emerging performance factored during the quarter as well. Looking ahead, we are very pleased to announce that we recently received FDA clearance on our synthetic biologics product, AttraX putty, which we already sell outside the US. Our US biologics team is currently in the market launch planning phase, as we ready the product for a US introduction in 2016.

Our international results were particularly robust in geographies of historical strength, including Japan and Italy, where we continued to experience strong year-over-year growth. As expected and guided to on our Q2 call, we experienced some softness and disruption in our international business, primarily in Western Europe, as our international team refocuses market penetration efforts around our leading XLIF technology, and seeks to regain momentum in key markets. Additionally, Latin America experienced difficult year-over-year comparisons as expected, due to the timing of collections which occurred in the prior year, but did not repeat to the same degree this quarter. Adjusting for these factors, international growth in the quarter would have been in the mid-20s on a constant currency basis.

While we experienced more pressure than anticipated in Western Europe during the third quarter, we are making steady progress on our recovery strategy to replicate the success we've had in markets like Japan, Australia, and Italy, where we led with NuVasive's competitive XLIF technology and differentiated offerings. With this said, we are expecting the change of play disruption to continue through the remainder of this year, for the strategic initiatives we are implementing to provide positive momentum, starting in the first quarter of 2016. We view this disruption as temporary and limited in scope and timing.

We are confident we have the right strategy in place, and that as we work through these plans, we will see a real acceleration of our international results. Additionally, we expect to launch our game-changing integrated global alignment platform in several countries internationally throughout 2016, which we expect will fuel the same opportunity to attract competitive surgeons that we are currently enjoying in the US. Profitability was strong during the Q3 period, with non-GAAP operating profit margin for the quarter coming in at approximately 16.3%, a significant improvement of 460 basis points from the prior year, driven by our strong operating expense control.

We experienced exceptional expense improvement from increased operating leverage, delivered by increasing inventory and instrument-related efficiencies, lower facility costs, sales force efficiencies, and a lower total cost of our workforce. These results demonstrate the substantial strides we are making to optimize our operating model, and achieve a whole new level of efficiency for the organization. Pat will provide more details in his commentary.

With our accelerated strength in the US expected to more than offset the softness we are experiencing in these certain international markets for the remainder of the year, we continue to expect revenue of approximately $810 million for 2015, which includes an approximate $13 million impact from currency headwinds. For the full year, this represents approximately 6.2% growth year over year, or approximately 8% on a constant currency basis, consistent with our mid to high single digit growth goals on the top line.

Based on our progress to date, we are increasing our non-GAAP operating profit margin expectations for the full year from 15% to 15.2%, or an increase of approximately 380 basis points over our 2014 results. Increasing our profitability highlights a key value creator for our shareholders, both this year, and over the next several years. We are laser focused on our goal of delivering at least 100 basis points of improvement annually, as we look to achieve 20% non-GAAP operating profit margins, as we grow beyond $1 billion in revenue.

But we're not going to stop there. We'll look to set new long-term profitability targets that reflect the benefits of our increased scale as we continue to drive growth, while also balancing further investments in R&D and in programs designed to accelerate our market share taking strategies.

Now after being they the business for nearly six months and recognizing that a great deal of progress has been made regarding the focus and future of NuVasive, I thought it an opportune time to share my thoughts on our path forward. When I came on board in April, I made a commitment to the organization to meet teams, employees, share owners, surgeon customers who have helped make us a spine powerhouse. It was critically important to learn and absorb as much as I could about the people at the heart of our success. Now, a few months later I have met with our San Diego, Memphis, Dayton, Italian, German, Japanese, UK teams and have visited well over 100 of our top surgeon customers.

I've also been an active participant and attendee in key internal product and services meetings, US commercial meetings, that are driving our share taking strategies. All this upfront engagement has been incredibly helpful to better appreciate the current NuVasive trajectory, the areas where we are shining, and the areas where we know we can improve. Beyond these interactions, to understand our customer and employee share owner views, I've been thinking a great deal about the spine industry and its future, given the many forces of change impacting it: reimbursement, regulation, demographics, or competition. We have an incredible opportunity to not just adapt to these pressures, but actually get ahead of them and lead. It is with this attitude we are now reshaping the strategic action plan to position the Company for growth and success.

We've implemented new operating mechanisms to ensure a line of sight into the business for our leaders, to understand what's going on across the organization, so we can make good business decisions and proactively make any needed corrections. It also gives us the ability to capitalize on areas of opportunity across a functional level that didn't exist previously. We've also begun to think differently about sales force compensation, with enhanced plans that reward new surgeon conversion, and introduce equity participation to support retention.

Just as we say about iGA, our strategies are all about alignment. We know how critically important alignment is for the patient, it's also critically important for us as a Company. It will ensure that we are communicating to be coordinated, efficient, and super successful. Companies that have achieved the level of success that we have at NuVasive need to maintain their insurgency, in order to continue to scale and grow.

Our culture will continue to honor these aspects of a startup, the insurgent mindset, while continuing our cultural evolution in breaking down barriers, rapidly adapting to change, embracing challenges, and remaining that much more competitive. We will deploy our ever-increasing expertise in resources and innovation into the market, so that surgeon customers and patients want and ask for the NuVasive procedural solutions. More on that, I'd like to turn the call over to President and COO, Pat Miles. Pat?

Thanks, Greg. Good afternoon, everyone. Very pleased to be here today to discuss the competitive strengths of NuVasive's ongoing cycle of innovation, and significant advances we are making from an operational excellence perspective.

First, a quick update on our unwavering commitment to continue to improve spine surgery. There is no better example than our integrated global alignment platform, or iGA. Our strategy remains focused on procedurally-integrated spine solutions. We are continually met with positive feedback from key opinion leaders and surgeon customers that this focus is unique to NuVasive and continues to further our market position.

Our recent participation in the Scoliosis Research Society and NAS meetings served to broaden awareness of our iGA platform and its capabilities. iGA represents a fundamental shift in the traditional approach to spine surgery, bringing together the best of our technology, tools and software into one procedurally-integrated platform to help address the most correlated element of successful long-term surgical outcome, which is proper spinal alignment. The iGA platform includes pre-operative planning and interoperative reconciliation to the original surgical plan.

Acceptance of this platform continues to expand, but will take time as we are changing habits, just as we did with XLIF. We have a comprehensive and integrated plan to accelerate this acceptance, including surgeon education and sales force incentives. We have successfully had dozens of iGA forum dinners featuring key opinion leaders in targeted geographies around the country. Additional during the quarter, we also received FDA clearance for AttraX putty, as Greg mentioned, as well as an expanded clearances for our X-Core Mini Cervical VBR.

The X-Core Mini Cervical VBR Corpectomy System is an expandable titanium vertebral body replacement device, designed to provide enhanced stability following a corpectomy procedure. This first of its kind clearance further showcases NuVasive's commitment to investing in innovative technology to improve patient outcomes. After an extended process of working with the FDA to gain clearance for AttraX putty we are very pleased to add this sophisticated synthetic biologic to our offering.

AttraX putty's unique engineered micro structure does robust bone formation, while maintaining superb handling characteristics. We have significant experience with AttraX putty outside the United States, and expect it will be well-received when we begin marketing the product in 2016. These accomplishments are tremendous examples of the power of teamwork, and the inherent strength of our R&D and regulatory capabilities, as we continue to expand our leadership position in spine.

This year alone, we have launched more than 12 products or line extensions, as we remain committed to driving industry-leading innovation. The iGA platform alone included four entirely new products in ReLine, NuvaMap, Nuvaline and NuvaMap OR, as well as the integration of a next generation Bendini into the iGA work flow. This is in addition to bringing to market multiple TLIF, XLIF and ACDF interbody devices, as well as additions to our IOS and biologics platform.

In addition to remaining focused on innovating spine surgery, we're also making tremendous progress in elevating the operating performance of our Company. Our dedication to translating this is clearly reflected in the quarter, with a 460 basis points of operating margin improvements. The focus of our organization is to operate at a world-class level. This includes tackling some of the basics, as well as providing a more robust, scalable operating infrastructure, to better support our growth.

Several key initiatives are currently underway, some of which are already moving the needle in 2015. First and foremost, we are laser focused on increasing the asset utilization of our tray sets. Together, our operations and sales team are working to infuse a higher level of efficiency to more effectively manage our inventory, to meet customer needs. This is a part of our broader commitment to improve the servicing of our sales force and surgeons, by ensuring that they have the required implants and instruments they need on time. We're also increasing the robustness of how we assess performance of our fulfillment efforts, by implementing a perfect order approach into our supply chain efforts, in essence, getting the right stuff to the right place at the right time.

Additionally, we are working diligently to refine and enhance our sales and operations planning function, which is aimed at improving our position in manufacturing alignment. This will enable significant reductions in the amount of cash consumed by our instrument and implant inventory levels, resulting in future free cash flow benefits. From a self manufacturing perspective, we are increasing utilization of NML, our existing manufacturing facility in Dayton, Ohio.

We have also made good strides in optimizing our current manufacturing -- we have also made good strides in optimizing our current manufacturing capabilities as we bring new equipment online and continue to prepare to enable our ability to significantly expand what we manufacture. This is huge for us. It will give us significantly more control over our supply chain, while increasing profitability. As we identify where we build or buy, economic incentives are being negotiated in key states, and we remain on track to finalize the location by year end. In these ways, we are delivering on the promise of further integrating NuVasive's spine procedure strategy with operational activities that we detailed at the beginning of the year.

My focus remains to ensure that our operational performance functions under the same rigor of consistency and reproducibility that we put into our procedural solutions. This alignment will enable us to flawlessly fulfill the requirements of the surgeries we support. At this stage in our growth cycle, we cannot emphasize the importance more of operational excellence. It is an absolutely essential element of becoming number one in spine. It will not only play a large role in helping us achieve our long-term target of 20% operating margin, but more importantly, enable us to drive growth. To that end, we have a lot of initiatives in place, and we are making solid progress across all of them in 2015, with additional plans to gain further efficiencies in 2016 and beyond, as we remain focused on our operational excellence. With that, I'd like to turn the call over to CFO, Quentin Blackford.

Thanks, Pat. 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 Greg noted, we delivered solid revenue growth for the quarter, up 5.6% as reported, or 7.8% growth on a constant currency basis. We also continued to execute on our efforts to improve profitability, and delivered a stronger than anticipated performance, with 460 basis points of expansion in our non-GAAP operating profit margin for the third quarter 2015, the majority of which came from our focused efforts to reduce our selling, marketing, and administrative expenses. Based on our results for the year so far, today we are reiterating our full-year 2015 revenue guidance of approximately $810 million, and increasing our expectation for non-GAAP operating profit margin to 15.2%, resulting in at least 380 basis points of operating margin expansion compared to 2014, up from our previous expectations of a 360 basis point improvement, and well above our stated annual goal of 100 basis points of improvement per year.

Beginning with our revenue performance, revenue for the third quarter of 2015 came in at $200.5 million, or 5.6% growth year-over-year, including approximately $4.2 million of currency headwinds. On a constant currency basis, revenue for the quarter was $204.7 million, or 7.8% growth year-over-year. Our revenue growth was driven primarily by accelerating procedural volume growth in our US lumbar and cervical sales as a result of new product introductions, somewhat offset by softer than anticipated growth in certain of our international markets. Additionally, and as expected, the benefits in our Latin America markets that occurred in Q3 of last year did not repeat and impacted year-over-year comparisons for the quarter. Adjusting for these items, our growth in the quarter was approximately 10% on a constant currency basis.

Turning to the composition of revenue in the quarter, sales for US implants and services, which includes the lumbar, cervical, NVM5 and service businesses performed ahead of expectations, growing 8.7% for the third quarter, accelerating for the third quarter in a row. We continue to experience strong results in our lumbar and cervical product portfolios.

Overall, procedural volumes and mix remain strong, up more than 10% during the quarter. Growth in our posterior fixation category continues to generate strong results, at the ReLine posterior fixation system starts to gain traction, in addition to continued momentum in our ALIF and TLIF business. Our cervical portfolio also showed robust growth during Q3, up 12.8% due the strength of our Archon anterior cervical plate, following its Q4 2014 launch, along with the ongoing utilization of our VuePoint II posterior cervical fusion system.

We now expect US implants and services will grow by approximately 7% for 2015, up from prior expectations of 5%. This reflects a continuation of the sequential strengthening of our core lumbar business, which we have experienced throughout the year, as well as cervical's growth reaching double-digit levels, or approximately 10% for the full year. As a reminder, ReLine, our comprehensive posterior fixation system that 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, below our expectations. As we've now anniversaried the launch of the Osteocel Pro product launch, it appears that some of the strength may have been cyclical or trialing by surgeon users. We'll continue to monitor this closely, but as a result of these factors, we now expect our US biologics business to grow approximately 2% in 2015. We look forward to the US launch of AttraX putty next year as we broaden our portfolio with the synthetic biologic and continue to expand our competitive offering.

Our international business, which includes Puerto Rico, increased 13.1% on a constant currency basis, and declined 2.5% in the quarter on an as-reported basis. We continue to experience significant growth in markets like Japan and Italy, where we focus our efforts on leading with the differentiation of XLIF and our minimally innovative solutions. We have tremendous runway ahead of us and currently only an estimated 4% share of the international market, and we expect significant growth from this area of the business well into the future.

While we expect that some related sales disruption will continue into the fourth quarter, we remain confident that refocusing our market penetration efforts will place us in a significantly stronger position to grow our international market share over the long term, and expect to see positive momentum from these efforts starting in the first quarter of 2016. For 2015, we now expect our international business to grow by approximately 6% on a reported basis, or roughly 19% for the full year in constant currency.

In summary, we are pleased with the revenue results for the third quarter of 2015, as we successfully execute our share taking strategy. We remain on track to deliver revenue of approximately $810 million for 2015, which includes a $13 million impact from currency headwinds. For the full year, this represents approximately 6% growth year-over-year, or 8% on a constant currency basis.

Turning to the rest of the P&L and results, non-GAAP gross margin in the third quarter was 75.5%, up 60 basis points from the 74.9% reported in Q3 2014. The expiration of the royalty associated with the Medtronic 973 patent resulted in a benefit of 150 basis points to prior year, as expected. This benefit was partially offset by favorable impacts in the prior year that did not repeat, as well as some excess inventory charges offset by favorable mix benefits. We did not realize any benefits from our efforts to in-source products in the quarter, as we worked to enable the ability to produce 100% of the product opportunity available to us over time, which will generate significant margin expansion opportunity into the future.

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 to improve slightly from the prior year to approximately 76.3%, as we continue to transition manufacturing capabilities at our Dayton facility. Non-GAAP sales, marketing and administrative, or SM&A expenses totaled $110.6 million in Q3 2015, down from $110.9 million in Q3 2014. SM&A expense was 55.1% of revenue for Q3 2015, representing 330 basis points of improvement, compared to the 58.4% reported in Q3 2014, as we continue to leverage our operating expenses.

During the quarter, we realized more than 260 basis points of benefit from our efforts to drive asset and sales force efficiencies, as well as an additional 70 basis points of improvement in share based compensation. While very happy with the progress, we see additional opportunity to drive leverage within our SM&A expense profile over the longer term. We now expect our outlook for SM&A expense to be approximately 56.6% for 2015, or 330 basis points better than the prior year.

Non-GAAP research and development or R&D expenses totaled $8.2 million in Q3 2015, compared to $9.1 million in Q3 2014. R&D expense was 4.1% of revenue for Q3 2015, versus 4.8% in Q3 2014. The lighter spend in R&D is primarily related to the timing of products in development, and is expected longer term to increase moderately as we plan to invest in our game-changing procedural solutions, as we build an R&D pipeline capable of introducing 10 to 12 new products and line extensions each year. As such, we now anticipate full-year 2015 non-GAAP R&D expense to be approximately 4.5% of revenues.

We are very pleased to report that third-quarter non-GAAP operating profit margin increased to 16.3%, resulting in an exceptional 460 basis points of operating margin expansion, compared to the 11.7% we reported last year. We continue to make significant progress in our goal to improve profitability across the board, delivering 400 basis points of improvements from leveraging our operating expense profile. Through nine months, operating expense dollars are now below the prior year, demonstrating our commitment to driving significant improvements in our underlying core operating margin profile. To that end, we are increasing our full-year profitability guidance, and now expect a non-GAAP operating profit margin of approximately 15.2% for 2015, an improvement of 20 basis points from our previous estimate of 15% for the year, now resulting in non-GAAP operating profit dollar growth of more than 40% for the year.

Our non-GAAP operating profit results for the third quarter excluded the following charges: $3.1 million related to the amortization of intangibles, $1.9 million for one-time and acquisition related cost, and a net gain of $0.5 million related to litigation liabilities. In addition, to be consistent with prior practice, we realized a charge of $100,000 related to our CEO transition. Interest and other expense net on a GAAP basis totaled $6.6 million in Q3 2015, down approximately 29% compared to $9.2 million in the prior year, primarily due to the benefits of our hedging program introduced in late 2014.

Included in the quarter was $4 million of non-cash interest expense related to our convertible notes. We now anticipate full-year 2015 interest and other expense to be approximately $28 million, including roughly $16 million of non-cash interest expense. Income tax expense on a GAAP basis for the third quarter of 2015 was $8.8 million, compared to a $9.1 million expense in the third quarter of 2014. This resulted in a GAAP tax expense rate of 40.8% 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 both be approximately 43% for the full year of 2015.

Third-quarter non-GAAP earnings were $18.1 million, or $0.35 per share, increasing nearly 3.5 times over prior-year levels when compared to $3.9 million or $0.08 per share in Q3 2014. We are now raising non-GAAP earnings per share guidance to approximately $1.25 for 2015, versus a prior expectation of $1.17. Additionally, we now expect GAAP EPS to be approximately $1.24 versus our prior guidance of $1.18 for 2015.

In addition, adjusted EBITDA margin, which excludes the impact of non-cash share based compensation was 26.7% for Q3 2015, compared to 21.3% in Q3 2014, reflecting a 540 basis point improvement in the business. We now expect an adjusted EBITDA margin of approximately 25.4% for the year, versus our prior guidance of 25.2% for 2015.

Our cash and investments balance at the end of the third quarter was $451.2 million, up significantly from $306.6 million last quarter, as a result of the release of restricted cash related to favorable ruling early in the year regarding our Medtronic litigation, which determined that the prior damages award had included lost profits and royalties on convoyed sales, which should have been disallowed. In addition, all restricted funds for the Neurovision trademark litigation were released in the quarter, in connection with our payment of the settlement.

While free cash flow for the quarter was negative, it reflected certain one-time litigation payments relating to the previous settlements of the Neurovision trademark case and the US Department of Justice, amounting to approximately $40 million combined. Excluding those events, free cash flow would have been a record quarter for NuVasive at $41 million for Q3 2015.

In closing, we have finished the first three quarters of the year with a very strong performance. On a year-to-date basis, revenue growth is nearly 9% on a constant currency basis, and non-GAAP operating expenses are down from the prior year, resulting in non-GAAP operating profit margin expansion of 460 basis points and non-GAAP operating profit dollars growing nearly 55%.

In addition, year-to-date non-GAAP earnings per share are up more than 130%, 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 profit margins to 20%, with adjusted EBITDA margins growing to 30%. We are executing exceptionally well against these goals, as we remain laser focused on delivering on those plans, and creating incremental shareholder value.

We are confident that we will end 2015 in line with the expectations we've laid out today, with our full-year commitment of driving mid to high single digit revenue growth, while delivering 380 basis points of improved non-GAAP operating profit margins, and adjusted EBITDA margin improving beyond 25%, and an improvement in non-GAAP earnings per share of nearly 90%. With that, I'll turn the call back over to Greg for closing comments.

Thanks, Quentin. We remain confident in our ability to execute against our priorities to end 2015 on a strong note, and continue to drive positive momentum going into 2016 and beyond. With an unrelenting focus on transforming spine surgery with minimally disruptive and procedurally integrated solutions, NuVasive is at an inflection point where we are pursuing the reimagination and reshaping of a great Company into a world-class phenomenon. We remain optimistic about our ability to evolve from a spine Company selling parts and pieces today, to the leading spine solutions Company in the years ahead.

In the coming months, we will share with you our progress, including fixing and then revolutionizing the distribution of our in-plant steps to the operating room, building a significant service component to our customer offering, and opening up new geographies for growth, among just a few of the category-shifting moves that will enable NuVasive on its path to become number one in spine. These are just some of the topics we plan to cover at our upcoming Investor Day in San Diego on December 9 and 10. We hope you can make plans to join us, or listen to our webcast of the event. With that, operator, we would be pleased to answer any questions.

(Operator Instructions)

Our first question today is coming from Matthew O'Brien from Piper Jaffray. Please proceed with your question.

Good afternoon. I'll stick with the one, as instructed. On the international side of things, was hoping you could quantify in some way the impact of Brazil and Europe in the quarter, and the confidence that you have that these pressures will ease by year end, and then if they don't, what should we think about for the growth profile of international, as we get into 2016? Can you get to 20% growth if those pressures are still lingering out there, and would you need China to kick in for you to get to that 20% growth rate?

Matt, it's Quentin here. With respect to Brazil, if you recall back last year, we quantified that impact as somewhere around $3.5 million in the quarter. And I can tell you we made good progress this year in trying to recapture a good part of it, but we were $1.5 million short where we shout we would be in Brazil in terms of it getting it all the way back, so we didn't close the gap all the way, and we were short there.

With respect to Europe, it was a couple million bucks in the quarter, and again, that was primarily self inflected with respect to our approach to some of the Western European markets that we absolutely believe is the right near-term decision. We're already seeing some of the underlying benefits in the business. For example, in some of those countries, we've got more XLIF users exiting Q3, than what we've had in history. So we're seeing the right results, but it's going to take time for that to come back.

You get through Q4 and as we start to head into next year, it's going to set us up really well for a strong year internationally in 2016. So, feel good about it. I don't think we have to have China on board to get to your 20%. I think there's tremendous opportunity there, regardless. Keep in mind, we've got what is close to a 4% market opportunity in a big market space that we just haven't penetrated that dramatically yet, and it's growing mid to high single digits. We're still excited very much about what international has for us.

Thank you.

Thank you. Our next question today is coming from Richard Newitter from Leerink Partners. Please proceed with your question.

Thanks for the question. Maybe just on AttraX, that's one we haven't heard about in a while, and biologics obviously had some interesting dynamics in the quarter. I think you had mentioned that it's product cycle related. Can you talk about, one, the transition as we move from Osteocel Pro as a growth driver and AttraX, what procedures is AttraX going to target? Is this something that requires that much preparation to launch, and maybe you could give us a sense for whether or not AttraX will be cannibalistic at all to Osteocel? Thanks.

This is Pat. I don't believe it's going to be cannibalistic. In the grand scheme of things, oftentimes these synthetics are used as adjunctive to allograft or to extend the Osteocel Pro. The way that we look at these things is that they are very complementary, and so really the interest becomes in making sure that they're utilized in that way. The indications are for posterior lateral fusion, and so that's where it will be promoted, but as it relates to the effect it will have, it will be utilized in the very way I described.

Thank you. Our next question today is coming from Ben Andrew from William Blair. Please proceed with your question.

Good afternoon. Pat, since we've got you on the call, can you discuss how the iGA rollout is going compared to how challenging XLIF was, when you initially undertook that? I know you've been there for the duration, and you do detail the surgeons on it, how do they the typically respond in terms of case volume, over a three or six month window, and when should that product be a material contributor to revenue?

Great question, Ben. I'll tell you, having been here for the full 15, it's one of those things where turning a patient from the front or the back to their side, I would tell you was a harder thing to overcome. The great thing about iGA is what we're doing is providing technology for them to better, in essence, calculate the alignment that they're trying to achieve, and they can apply it through the very procedures that they're doing today, if they're operating from the back or from the front or from the side. They don't have to change the way that they operate.

What they have to change is the technology that we're applying to the activity. And so getting surgeons to adopt or apply new things to their practice is always hard, but it's not as fundamental a shift as it was to get the XLIF thing done. I'll tell you, the great part is that we're getting significant feedback from the field of just the enthusiasm associated with -- as opposed to doing maybe a four-level case, they get to do a three-level case because they're accommodating their alignment goals with less levels, or at times, more levels. Ultimately, what they're doing is they're achieving their goals. I think that's the tremendous run in front of us, is just bringing about a precision that doesn't exist today.

Is it changing behavior already?

It's changing behavior already. We've seen several significant pockets really adopt the technology to a point of not doing cases without it. So I'm as inspired as I was the day we launched it, probably more so, just based upon really, you get something out in the marketplace and the type of feedback that you get back that this is really making a foundational change in the way they approach an operation, I think just speaks to the innovation strategy that we've created from the onset of the Company. When Greg and Quentin talk about the continued fueling of these efforts, that foundation is reflective of what we're trying to accomplish, but I'm extremely bullish and remain bullish on the uptake of the iGA strategy, but it's going to take time and going to need patience.

Thank you. Our next question today is coming from Bill Plovanic from Canaccord. Please proceed with your question.

Great. Thanks. This is actually Kyle on for Bill. Just wondered if we could get a little more color on gross margins in the quarter, came in a bit light relative to what we were expecting, and brought guidance down for the full year. Quentin, you mentioned that there was no benefit from the insourcing of the manufacturing. Just wonder if you could walk us through the puts and the takes of the gross margins in this quarter, and any expectations for insourcing into Q4?

So you look at year-over-year, gross margins were 60 basis points favorable. Folks probably expected that to be a bit higher than that given the Medtronic royalty falling off, and we did see a benefit of 150 basis points as a result of that particular item, but a couple things to note. Last year, we had about 60 basis points of favorable items related to some inventory efficiencies that we had that didn't repeat, so those were a headwind. And then beyond that, we had some mix challenges within our international business. Japan continues to do incredibly well for us, but has a margin profile right now below the corporate average. Over time, that will come up, as we take product that they manufacture there locally, we'll bring it into our own manufacturing capability in Dayton, and we'll see the efficiencies from that. So that becomes an opportunity into the future, but certainly drug on the margins in the quarter.

With respect to our own insourced manufacturing capability, what we're doing right now is trying to build out that capability to produce 100% of all product opportunity available to us. If you go back and look at the strategy that we had initially started with, the goal was to take that to 60%, and we had focused on a few product lines initially, and then we would expand it over time. I think, you look with Greg coming on board, we quickly changed direction there, and said, why aren't we going after 100% as quickly as we possibly can? It's going to create a significant benefit for us into the future. We've quantified that as much as 400 basis points of gross margin opportunity for us, and the reality is, we haven't started to experience any of that 400 basis points yet. That's going to become an opportunity as we head into 2016 and into 2017. For Q4, your specific question on Q4, we haven't factored in really any benefits in Q4 either. You'll start to see that come back next year.

Thank you. Our next question today is coming from Jeff Johnson from Robert W. Baird. Please proceed with your question.

Thank you. Quentin, wondering if I could just ask a follow-up on Europe and Latin America. You talked about being $1.5 million short in Latin America, $2 million short in Europe. Can you talk about the end markets there? Has there been an end market slowing, or what are you seeing in the end markets there versus for example in Europe was the shortfall just because you more aggressively started to move and reposition some of that business? So just trying to break out the stuff you chose to do in the quarter versus end market demand.

I think what you're seeing there is specific to NuVasive. The end markets, in our view continue to be very opportunistic. We have 4% share, so regardless of what the overall market's doing, the opportunity there is tremendous for us. I would call it NUVA specific at this point, and we couldn't be more bullish about international.

Thank you.

Our next question today is coming from the line of Larry Biegelsen from Wells Fargo. Please proceed with your question.

Thanks for taking the questions. Just two from me. Greg, so M&A, obviously got a lot of air time on the last call, and intra quarter at investor conferences. So if you could give us your latest thoughts on M&A. I think on the second-quarter call you said to expect something in six to nine months. What's the status? Is the focus still China and new technology? And I had one follow-up.

The focus of our M&A efforts continue to be new technologies, continue to be geographic expansion. We now have our Corporate Development team fully staffed, it's operational. We're getting the processes going inside the Company, and have evaluated a number of deals over the past few months.

My earlier comments should be reiterated, though. We're going to be extremely disciplined about our deployment of capital, because we have the great luxury of a franchise here that's growing nicely organically. We've got enormous runway to expand the bottom-line margins, and so anything we acquire has to be very nicely additive to, I think what will be a great couple year run from here. So all you're seeing right now is processes being running, targets being evaluated, and then we'll be judicious when we actually pull the trigger on one of them.

That's very helpful. For my follow-up, Greg, you've done a remarkable job improving the operating margin. But NuVasive has not delivered less than double-digit growth in any year in the existence of this Company, so my question, and I know the guidance is about 8% constant currency for this year. Is double-digit top line growth still realistic, given the size of the Company today? And do you think the focus on profitability has impacted your ability to hit double-digit top line growth? Thanks for taking the question.

I'm glad you asked the question. So whenever a new CEO comes in, you can expect some changes, and I think one of the changes you're seeing is hitting a little bit of the pause button, reset button on our international efforts. That organization has grown very fast over the last couple of years, but we are now taking a couple of quarters here to reset the foundation in a couple of very important countries, and I think what you're seeing us is taking a more long-term approach to get us back to 20%-plus growth internationally into 2016. So that's all the investors should look at, is we're doing a little bit of a hockey line change here, and we will be right back to where we wanted to be, if not even stronger in a set of countries.

In terms of the operating margins, all the credit goes to the team that was here, not to me. They have had extremely good discipline in the course of 2015, and I would just simply say to all investors, we are well on our way to becoming at norm profitable, like you should be as a med device Company. It's a shared goal. We have a good path to get there, and you'll see that unfold in the quarters to come.

Thanks for taking the questions.

Our next question today is coming from Raj Denhoy from Jefferies. Please proceed with your question.

Thanks for taking the question. I wonder if I could ask a little about the margin progression, as you think about it, it's a bit of a follow-on to the last question. You continue to reiterate this guidance of 20% margins at $1 billion. At the pace you're going, you'll probably get there in three to four years maybe, and that would imply though that you'll get more margin quicker. You'll realize that 500 basis points over a shorter period of time. So the question is really how you think about the progression of margin expansion, and whether it will be linear, whether you could realize it faster even, given that a lot of it's under your control, just any thoughts around that would be helpful.

It's a good question. As we've said in response to a question like that in other settings, we feel that we have a really good control over our ability to improve margins to this 20%. I don't think it's any big secret, we could move it a lot faster, but we're going to balance that pace against putting more money to work, to fuel faster growth. The much bigger opportunity for us is growing our share in this marketplace, and so we're going to be deliberate on the path to 20% and determined on putting money to work on share growth and revenue growth. So you should see us grow nicely over the next several years, and be very deliberate on that march to 20%-plus operating margins.

Helpful. Thank you.

Thank you. Our next question today is coming from Joanne Wuensch from BMO Capital Markets. Please proceed with your question.

Good afternoon and thank you for taking the question. I actually have two. You mentioned that you're sort of -- I'm going to use the word hunting, towards an at-norm profitable Company. What's your definition of an at-norm profitable Company? Who are you comparing yourself to?

What we would want to acquire is a Company that in a fairly shorter, medium period of time could be restored if it doesn't have it already, to margins that are the same or in line with ours, as they are today, or one that has our margins today, and we could make even more profitable. We're not looking for big turnarounds. I don't think we're in the position quite yet to do that. So we're looking for things that are running well, but we could make them run a bit better and just, again, enhance our position in this global spine industry.

Okay. And then my second question has to do with your sales force. Somewhere intra-quarter, people started to get concerned about sales force turnover or departures. Can we put that concern to rest?

You can put that concern to rest. Just to put it in an overall kind of narrative, there was a narrative when we had the change with Alex at the top that there would be a max exodus. It has been anything but that. I think the field is more energized than ever, that the headquarters team is listening, we're going to be even more responsive, both in terms of our time and our actions to support them, and we head into 2016 with extremely good plans to, I think, increase our share-taking, increase our revenue growth, in line with what you expect NuVasive to do.

Thank you.

Thank you. Our next question today is coming from Matt Miksic from UBS. Please proceed with your question.

Good evening. Thanks for taking our questions. I had one on, I think you mentioned you were looking to start to roll iGA into some of your international markets, and I'd love to get your perspective as to how you think your approach is going to be different there, how the pathway or the uptake or the culture or what those centers are like, and how that might be different. Then I have one follow-up, if I may.

Okay. Matt, this is Pat. I'll tell you, one thing that we've done is, we've learned a lot of lessons from the XLIF experience, and I think that if you look at how we've gone into Japan with XLIF, we're going to do the same as we go into really the entire international market space, which is be highly deliberate, be extremely focused, and really make sure that the clinical experience is reflective of the same things that we're seeing here in the States.

And so it's going to be a methodical walk into those things, but I think the point that was made earlier in the call is, you look at where we've been successful internationally, and it's been where we've been extraordinarily disciplined, extraordinarily focused. The clinical experience was very consistent with what we've had in the States. And where we haven't done that, and we've in essence obviated to more of a local flair, we've not done as well. And so I think that's the commonality associated with how we're going to march into the marketplaces, based upon the lessons we learned on the XLIF front.

That's great, and the follow-up is on -- there's been great progress with leverage, and plans to continue that is outstanding. I think folks have been very pleased with the way that's been going. Wondering if you could talk about to what degree this expansion into a greater pedicle screw share as part of your business has provided you the ability to do that, and whether you feel like that gives you any tailwind at all, or any color you could provide on the relative importance, I guess. The strength, the ability that gives you to drive more leverage across your field force now that you're participating in what's essentially a bigger part of the market.

This is Quentin here. I think the opportunity in front us with posterior fixation is significant, both from a top line perspective, I don't think we have any more than 6% to 7% of that overall market, currently. I think the opportunity to bring that in line with the overall share that the Company enjoys of 10% in the US is certainly realistic, and no reason we can't take it to the 10% and even elevate beyond that when you start to look at the differentiation that iGA brings, and pulls posterior fixation in with it. I think the opportunity on the top line is significant.

When you look at it from a margin perspective, the reality is that posterior fixation has a better gross margin profile to it than what our overall business does today. As we drive more mix towards that, we're going to see a benefit of the gross margin as well, which ends up benefiting profitability for the Company. At times, people will ask about the price pressure in that space. Even with incremental price pressure there, the gross margin profile still is well above the corporate average, that we'll be able to offset that, and see a nice mix benefit for us. I think it helps us all the way around, both top and bottom.

Thanks so much.

Thank you. Our next question today is coming from Glenn Navarro from RBC Capital. Please proceed with your question.

Thanks. Good afternoon. Your US implant business came in stronger than we had expected, and if you look at the competition in the quarter, J&J did a little bit better, so did Stryker. I'm curious, Quentin, Greg, or Pat, as you're out in the field, I know our survey work is telling us that the spine market in the US is doing better, but are you feeling that as you travel the country, or are you hearing surgeon backlogs growing?

Are you hearing less payer pushback? And is that what is contributing to your strong growth that we see here in this quarter? Or are you just continuing to take share against the biggest player, or maybe it's both? So just some color in terms of the market, and how you think you're performing relative to the competition. Thanks.

Glenn, this is Quentin here. I think when you look at the results that we've put together over the last three quarters in our implant business, you're seeing sequential improvements in traction being gained. My view is the overall market continues to be relatively steady, so I think that leads directly to the fact that we continue to take share. I don't know if Pat has anything he'll add, with respect to being out in the marketplace, but my own checks have indicated the market's flat, and we continue to execute on the share taking strategy.

I was just going to add really as much of a follow-on to Quentin's last point about posterior fixation. As I'm out in the marketplace, the one thing that I see is the fact that we're making more and more progress on what would be called the anterior column or the front of the spine, and if you look at the harder one to earn, oftentimes it's spine-approach related. What happens is you pull through the posterior fixation. So generally, you're seeing stability in the marketplace, but I've been very pleased with regard to the type of movement that we're making from a competitive perspective, because we're earning the harder part of the surgery, which ultimately becomes the approach-related segments. Hopefully that makes sense.

Yes, it does. Thanks.

Thank you. Our next question today is coming from Josh Jennings from Cowen and Company. Please proceed with your question.

I just wanted to also ask about the US implant service business. Obviously, you're seeing sequential acceleration there, and nice -- you downloaded us another nice quarter in the cervical implant unit, but can you talk about lumbar a little bit more, and parse out, I think you've called out a headwind to that line item on the services side for 2015. It doesn't seem like we've been seeing that. Is that contributing to any offset in Q4, excuse me. And are we just seeing such strength in the implant business it's offsetting the service side, or has that headwind not actually come into play?

One, we're seeing strength certainly in the lumbar side of the business that's offsetting any of the decisions we're making around the services business. At the same time, we've been pretty effective in that services area of really increasing the utilization and driving the productivity out of that business, that's resulted in some nice results. So the headwinds that we had spoken to early in the year are not materializing like we thought they would, and I think the opportunity to pull through the hardware business and really capitalize on that opportunity has been more significant than anticipated. That's what you see reflected in the revised expectations for the year today, and the new guidance we put out.

Great. Just one follow-up. Just on the market. Physician distributors, it's hard to track them, but do you have any insights in terms of how hospitals are either refusing to contract with them, or whether or not pods are giving up share this year in the US marketplace? Thanks a lot.

Go ahead, Pat.

I was just going to say, this is Pat, Mike. My channel checks, or when I'm in the field, I'm hearing less and less about them. If anything, flat to going away is my experience.

Same as mine, Pat.

Thank you. Our next question to days coming from Jonathan Demchick from Morgan Stanley. Please proceed with your question.

Good afternoon. Thank you for taking the questions. Wanted to follow up on the recent questions about the US business. There was a decision obviously made to hold the top line guidance constant, and while we can certainly understand that, international and biologics probably came in a little below expectation, as we discussed. US business seems to be maintaining a lot of solid momentum. As we have heard some of the reports and that sounds like the market seems relatively healthy, is there any reason -- is it more just conservatism thinking about the guidance at the end of the year, that we should see some real, I guess deceleration in the business? How should we kind of be thinking about that, as we try to think about into 2016?

I think more than anything we're just trying to be thoughtful about the headwinds that are out there, and to the extent we continue to execute well against those, we hope to be able to over achieve those expectations. The one thing I would point to specifically is cervical. We're three quarters into the launch of Archon, it does incredibly well. We're growing at a double-digit pace, and right now, Q4 is dialed in somewhere around a mid single digit pace. We'll continue to watch that play out without getting out ahead of ourselves at this point in time, but certainly excited about what we see in that US business.

Thank you. Our next question today is coming from Chris Pasquale from JPMorgan. Please proceed with your question.

Thanks. Two questions. First, what's a reasonable expectation for a revenue contribution from AttraX next year? Can this be as much of a needle mover for the biologics business as Osteocel Pro was in 2014?

We're not going to get into quantifying 2016 revenue drivers at this point in time. When we come out and talk about 2016 guidance, we'll be sure to contribute, build in the contributions from it, but at that point, we'll speak to it and not before.

Fair enough. And then it certainly sounds like the ReLine launch is going well. What's next? As you kind of move beyond this initial posterior approach and incorporate iGA into the rest of your product portfolio, are you planning other launches for 2016, or is that really longer term and 2016 is just going to be about going deeper with ReLine?

This is Pat again. We're going to further enhance ReLine. We're going to move -- excuse me, iGA, we're going to move up the spine to cervical. There's the same type of reasons that you want to align the thoracolumbar spine, you want to make sure alignment becomes a meaningful element in the cervical spine. So those things are foundationally important.

The other elements that will continue to evolve are making sure that, from an implant portfolio perspective, what we're reflecting is all of the requirements associated with a TLIF and a PLIF and all of the other types of procedures that will ultimately integrate the whole integrated global alignment strategy. So it's continuing to round out the entire portfolio, one, but it's also moving up to the cervical spine, and make sure that we're reflecting the iGA strategy there, as well.

Thank you. We've reached the end of our question-and-answer session. I'd like to turn the floor back over to Mr. Lucier for any further or closing comments.

Thank you, operator, and thank all of you for joining us today. As always, we appreciate your interest in NuVasive, and we look forward to talking to you next quarter. All the best.

Thank you. That does conclude today's teleconference. You may disconnect your lines at this time, and have a wonderful day. We thank you for your participation today.