NuVasive, Inc.
Q3 2014 Earnings Call Transcript

Published: 31 Oct 2014

[Operator:]

Greetings and welcome to the NuVasive, Inc. Third Quarter 2014 Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. (Operator Instructions) As a reminder, this conference is being recorded. I would now like to turn the conference over to your host Carol Cox, Executive Vice President of Strategy and Corporate Communications. Thank you, you may begin.

[Carol Cox:]

Thank you. Good afternoon, everyone and welcome to NuVasive’s third quarter earnings call for the period ended September 30, 2014. Joining me on today’s call are Alex Lukianov, our Chairman and Chief Executive Officer; Keith Valentine, our Chief Operating Officer; and Quentin Blackford, the company’s Chief Financial Officer. During our comments and responses to your questions today, certain items may be discussed which are not based entirely on historical facts including without limitation those regarding revenues, gross margins, operating expenses, other income and expense, taxes, future products and capital allocation plans. Actual results or trends could differ materially from our 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 correct, could cause NuVasive’s results to differ materially from those expressed or implied by such forward-looking statements. These and other risks and uncertainties are more completely described in today’s press release and in our most recent 10-Q and 10-K filings with the Securities and Exchange Commission. NuVasive wished no obligation to update any forward-looking or information which speak as of the respective date. This call will also include a discussion in several financial measures that are not calculated in accordance with Generally Accepted Accounting Principles or GAAP. We generally refer to these as non-GAAP financial measures. These measures including our gross margin, sales, marketing and administrative expenses, research and development expenses, operating margin, and non-GAAP earnings per share. We believe this information is useful to investors because it provides important information regarding earnings generation at NuVasive and is helpful for measuring our progress. We use these non-GAAP financial measures along with the most directly comparable GAAP financial measures in evaluating our actual and forecasted operating performance, capital resources and cash flow. The most directly comparable GAAP financial measures and information reconciling these non-GAAP financial measures to our financial results prepared in accordance with GAAP are included in today’s press release and the supplementary financial information file, both of which have been posted on the Company’s Investor Relations section of our website. With that, I would like to turn the call over to Alex.

[Alex Lukianov:]

Thank you, Carol. Good afternoon and thank you everyone for joining us on today’s call. We are extremely pleased to report third quarter result that exceeded our expectation on the top-line generated strong free cash flow and again demonstrated strong increased operational efficiency across our global operations. We’ve reported revenue of 190 million, which represents year-over-year growth of 12% and non-GAAP earnings of $0.19. Revenue growth was driven by stronger than expected performance in the U.S. especially in lumbar and biologics and continued strong growth in our international geographies. In addition to better than expected revenue growth, we made solid progress in our efforts to improve operating profitability, resulting in a non-GAAP operating margin of 16.7% in the quarter, which is a 130 basis point expansion over year-over-year. The expansion was driven primarily by ongoing efforts to bring manufacturing in-house, driving asset and sales force efficiencies and the operational initiatives that we have underway in all areas of the organization. In the quarter, we also made solid progress on reducing discretionary SM&A spend as a percentage of revenue both year-over-year and sequentially. As a result of our strong operating performance, we generated a quarterly record for free cash flow at 35 million. As a result of the outperformance in the third quarter and with the majority of 2014 behind us, we are updating and increasing full year revenue guidance to approximately 755 million implying growth of approximately 10% over 2013 performance. While we are pacing ahead of our operating margin improvement plan for 2014, we are maintaining guidance of 16.5% for the year which takes into accounts strategically reinvesting a portion of our increased profitability back into the business to drive future growth. This guidance represents a 150 basis points improvement over 2013 and is well ahead of our commitment to deliver at least 100 basis points of improvement per year. For non-GAAP EPS, we’re increasing full year guidance to a $1.12. As a reminder, we’ll be hosting our Investor Morning on November 13th in San Francisco. Based on this timing, I intend to keep my comments much shorter on today’s call. Members of our senior team will participate in the Investor Morning where we intent cover several topics. Our market share taking strategies by market segments and geography, efforts around significantly increasing profitability and leveraging earnings per share, improving our operational efficiencies and scaling the company to 1billion in revenues and beyond. While executing on these value driving priorities we will stay true to our culture of innovation that will continue deliver best in class surgical solution resulting in better outcomes, faster recoveries and increased efficiencies for the healthcare system, in other words faster, better and cheaper. We it’s be (indiscernible) in San Francisco where you also be able to learn more about the less disruptive procedural solutions and products, we are showcasing at the NAS Conference. On the macro level, we continue to see stability in the global spine market with growth in the very low single digits. While we continue to see pricing pressure of less than 2%, this is right in line with what we expected and consistent with what we’ve experienced all of this year and last. As demonstrated by our results, we continue to outpace the market as we execute against our market share taking strategy, which focuses on three main drivers. First, by further driving the shift for MIS unless disrupt a solution. Second, penetrating and converting the traditional spine market with less invasive solutions. And third, expanding our international footprint. I’m very pleased that our results for the third quarter demonstrated solid progress across all three of these drivers. In the MIS market, our flagship XLIF surgical procedure and the decade plate provided solid growth, which is particularly exciting because these solutions are laying the foundation for greater utility of single position surgery. As the spine market continues to shift less invasive solutions and as better patient outcomes and clinical and economical evidence are driving surgeon adoption, we remained committed to spending our leadership in this market. We fully believe that our procedural offerings will allow us to further penetrate with this estimated to become a $5 billion MIS market opportunity over the next decade. Increasingly we have invested in procedural offerings to enter the traditional spine market and convert it to less invasive solutions with improved surgical outcomes. These new solutions like Precept for posterior fixation, ALIF ACR to correct sagittal alignment, Armada and Bendini for deformity and MAS PLIF support our patient outcome philosophy both Precept and Armada continue to grow at an aggressive clip during the quarter and (indiscernible) between traditional and MIS techniques. Several years ago, we made the decision to expand our geographical footprint by strategically and methodically entering the $2.2 billion international spine market. Today we have commercial operations across EMEA, Asia Pacific and Latin America. During the third quarter, we continue to benefit from investments with strong results in Australia, Japan, UK and Italy driving 45% growth. Our approach focuses on entering large and rapidly developing spine surgery market and then thoughtfully buildup our infrastructure to match the market dynamics and opportunity. I am very proud of the leadership teams we have built across our international markets and I am confident that the opportunity to replicate the success, we’ve been able to achieve in the U.S. will be a significant driver of revenue growth moving forward. Our market share taking strategy is working well and while revenue growth in a key priority, I’ll show you that the entire management team and shareholder base is also keenly focused on improving operating profitability. For a couple of quarters now I’ve been speaking about NUVA 2.0 our process innovation mindset that we’re applying across the company. We’ve made that the cornerstone of our culture as we approach one billion in revenue and undertake the work that will allow us to simplify operations and skill NUVA as a world class. Culture has been and continues be a differentiating factor and competitive advantage for NuVasive. Our vision of changing spine surgery and improving patient outcomes is the foundation from while we drive our internal focus as we apply NUVA 2.0 mindset to achieving greater efficiencies, streamlining our processes and strategically reinvesting in game changing innovation to improve even more patient lives. We are also committed to driving great shareholder value and one of the ways we intent to do is, is to do enhance profitability. Our goal is to expand our operation market from the 15% level we reported last year to more than 20% as we approach one billion in annual revenue. We have articulated and sized several clearly defined drivers that we anticipating get us to this goal. These include international scale, vertical integration as we scale our in-house manufacturing capabilities asset efficiency, improved sales force effectiveness and the February 2015 expiration of the patent for which we accrue the majority of Medtronic related royalties. We are working hard to execute against these drivers and our results again this quarter demonstrate XLIF execution against that goal. I am confident and our ability to achieve a stated operating margin goals and I hope to exceed them as we continue to identify additional opportunities to drive profit growth. Before I turn over to Quentin, we have nothing new to report on the OIG subpoena, but we’ll provide further update this and when they are need. In sum, our execution in the third quarter and year-to-date has been very strong and I believe that our current portfolio and pipeline position invasive very well as we finished 2014 and head into 2014. With that I’ll turn the call over to Quentin.

[Quentin Blackford:]

Thank you Alex and good afternoon everyone. Before we get started with the financials, let me remind you that many of financial measures cover today will be on a non-GAAP basis. Please refer to the supplementary financial information file on our website in the Investor Relations sector for all the detail covered on today’s call and to reconcile our non-GAAP to their GAAP counterparts. As Alex mentioned, we’re very happy with our underlying operational performance in the quarter, exceeding operating margin expectations and generating a record $35 million of free cash flow. Revenue for the third quarter 2014 exceeded our expectations at a 189.9 million. As a result, we are increasing full year revenue guidance to approximately 755 million, which includes nearly $2 million of the incremental FX headwinds versus prior guidance. This translates to just over 10% growth year-over-year and as a $10 million increase from the 745 million that we previously expected. Let’s walk through the compensation of revenue growth in the quarter and a revised expectation for the full year 2014. Third quarter U.S. lumbar growth of 8% was solid on the continued momentum of a minimally invasive solutions particularly Precept, ALIF ACR and MAS PLIF. Based on the strength we are seeing, we now expect to about 7% U.S. lumbar growth for the full year, up from the 6% growth that we previously expected. U.S. biologics growth of about 13% exceeded our expectation. The strength of demand for our U.S. lumbar solutions continues to drive XLIF procedural view. And the recent launch (indiscernible) continues to generate solid surgeon interest in trailing. Stocking orders were about 1 million higher than the prior quarter. We’re very encouraged by the positive momentum being built in this business, but also additional time to determine what portion of the impact between trailing and stocking orders if any will prove to be temporary. As a result of the Q3 outperformance, we now anticipate full year U.S. biologics growth of about 11%, up from the 7% growth that we previously expected. U.S. Cervical sales decreased 2% versus prior year, primarily driven by soft performance from our motion preservation devise. With our new plating products launch at the upcoming NAS Conference and our initiative in place to improve the availability of sets in the field, we continue to be optimistic that we can revive growth within our Cervical category overtime. We are now modifying our Cervical growth expectation to about 1% for the full year, down slightly from the previously forecasted 4%. U.S. monitoring service growth also exceeded our expectation, increasing almost 14% in the quarter. Unlike the last couple of quarters, case volume growth drove the outperformance in the third quarter, while the impact from focus collection efforts moderated in the quarter and were nominal. We continue to expect strong volume growth will be offset somewhat by pushback from insurers. As a result of the Q3 outperformance, we now expect U.S. monitoring service of 6% for the full year and improvement from our prior expectation for 2%. On the international business which included Puerto Rico, we also exceeded our expectations. International growth was 45% in the quarter with strong contributions from each key geographies. During Q3, we continue to make progress in Latin America including collections in Brazil despite economic turmoil in several countries. We expect that progress may fluctuate from quarter-to-quarter. Still in consideration of the strong results, we now expect full year 2014 international growth of approximately 35% up from the previously forecasted 30% annual growth. As noted before, updated full year guidance contemplates an incremental currency headwind of about $2 million versus our prior guidance in the category. In sum, we’re very pleased with the year-to-date revenue results. As you model the fourth quarter and begin to project 2015, please note that we do not to continue to benefit from some of the temporary impact we’ve discussed over the course of the year. Turning to the rest of the P&L, gross market in the third quarter was 74.9%, up 50 basis points from the 74.4% reported in Q3 2013. The expansion demonstrates continued strong operational gains driven by our moved in source manufacturing and improved asset efficiencies. Included in the quarter was a 100 basis point negative impact related to a non-recurring product royalty charge and continued mix pressure of approximately 40 basis points from the strength of our biologics performance. This was more than offset by nearly 200 basis points of improvement related to our focused efforts to in source manufacturing and to drive asset efficiencies. Price was consistent with prior period unless the negative 2% and not material factor in the quarter. We continue to expect a fully year gross margin of approximately 76%. Non-GAAP sales, marketing and administrative or SM&A expenses totaled 102 million in Q3 2014 compared to 93 million in Q3 2013. SM&A expense was 53.7% of revenue for Q3 2014 representing a 130 basis points of improvement compared to the 55% we reported in Q3 2013. Further progress with our focused efforts to drive both sales force and asset efficiencies continue to more than offset both planned and opportunistic investments into our international business. For the full year, we continue to anticipate SM&A expense of approximately 54.5%. Non-GAAP research and development or R&D expenses totally 8.6 million in Q3 2014 compared to 6.8 million in Q3 2013. R&D expense was 4.5% of revenue for Q3 2014 versus 4% in Q3 2013. The planned increase in spending continue to be driven by investment in talent and new product development projects, we continue to anticipate a full year R&D expense of approximately 5%. Third quarter non-GAAP operating margin was strong coming in at 16.7%. We demonstrated an exceptional 130 basis points of operating margin expansion compared to the 15.4% we reported last year, while absorbing approximately 100 basis points of a non-recurring charge related to the product royalties. We continue to balance the translation of operational improvements, while opportunistically investing to unable the acceleration of a market share gains. As a result, we continue to expect a full year operating margin of approximately 16.5% and impressive non-GAAP operating profit dollar growth of greater than 20% this year, more than two times the expected rate of revenue growth. Interest and other expense net on a GAAP basis totaled $9.2 million in the quarter, which included a $2.5 million FX loss or a negative impact of $0.03 per share net of tax related to the currency swings we saw late in the quarter. This compared to a $3.4 million expense in Q3 2013 which included the favorable impact of a legal settlement. We now anticipate full year 2014 interest and other expense to be approximately 29.3 million including roughly 14.7 million of non-cash interest expense. We’ve recorded an income tax expense of $9.1 in the quarter compared to the $900,000 in the third quarter of 2013. This resulted in a tax expense rate of 128% for the quarter, which was higher than we had anticipated as a result of a greater amount of pretax loses residing a low tax jurisdictions which provide nominal tax benefits and a greater portion of pretax profits residing in a highest tax jurisdictions resulting in great tax expense. The higher than anticipated tax rate negatively impact the results by approximately $0.08 per share, all of which we expect to recover in the fourth quarter and is reflected in the revised increase to our full year EPS guidance. We now anticipate a full year GAAP tax expense of approximately $7 million and we continue to expect non-GAAP adjustments for the full year 2014 to be tax affected at approximately 40%. With the higher than expected tax expense in the third quarter non-GAAP earnings were $9.6 million or $0.19 per share compared to the 18.3 million or $0.39 per share in Q3 2013. As a result of increased full year revenue expectations and recovery of the tax impacts that I mentioned previously, we now anticipate full year non-GAAP EPS of approximately $1.12, up from previously forecasted $1.11. Please refer to the supplementary financial information filed on our website in order to put the year-over-year EPS comparison into proper context review all of the items that will excluded for non-GAAP reported purposes. For the third quarter, we generated record operating and free cash flow. Cash flow from operating activities totally just over $48 million well ahead of roughly $38 million that we saw in Q3 or 2013 driven by strong top line and operating margin performance in the quarter. Free cash of $35 million reflected $30 million capital expenditure investment in the quarter most of which was product related. Our cash and investment balance at the end of the third quarter was 384 million up about 34 million from last quarter and up 58 million year-to-date primarily driven by approximately 51 million in year-to-date free cash flow. I am exceptionally proud of the tangible progress that is increasingly evidence both in our reported results and forward-looking guidance. For the quarter, we continue to make solid progress and increasing our operating profitability as we not only improved our operating margin year-over-year but sequentially by roughly 70 basis points from the second quarter despite revenues being relatively equal. Our performance reflects our ability to observe margin impact well at the same time enabling margin expansion. In fact we are now positioned to achieve a fourth quarter operating margin of nearly 20% illustrating our ability the reach the longer terms sustainable 20% or greater operating margin objective that we have spoken to previously. With this strong operating performance combined with continued execution of a market share taking strategy, we expect in 2014 on a strong note and after 2015 with meaningful momentum. I look forward to seeing you at the Investor Morning in a few weeks. And now I’ll turn the call back over to Alex for closing comments.

[Alex Lukianov:]

The third quarter was a clear demonstration of our aspirations for NuVasive. Our market share taking strategy delivered double digit organic revenue growth which we achieved in conjunction with operation market expansion of 130 basis points and record quarterly free cash flow of 35 million. Last quarter, we announced that we could clearly claim to be the number spine player in the world. This was an incredible accomplishment for the NUVA family and we are proud that we were able to continue our strong market share gains in the third quarter. Our dynamic share taking strategy combined with well-defined levers to improve profitability will drive revenue growth and improve shareholder value over the next several years onward and upward. We will not take your questions.

[Operator:]

Thank you. We will now be conducting a question-and-answer session. (Operator Instructions) Thank you. Our first question comes from the line of Matthew O’Brien with William Blair. Please proceed with your question.

[Unidentified Analyst:]

Hi guys, this is Kela (ph) in for Matt. So you listed full your expectation of lumbar segment but (indiscernible) in the fourth quarter. Can you just comment on the momentum and opportunity that still exist with products in that segments that is Precept and what sort of runway of growth you see?

[Quentin Blackford:]

Sure, this is Quentin. In terms of the runway that’s head of us, I think we’re incredibly excited about what we see with Precept in particular, that’s a product that you compete in the entire 1.8 space that’s out there which leaves for us incredible runway. So there is kind of opportunity that’s there. When you think about the Q4 performance, last year we had incredibly tough cost that we’re up again, so we had a very strong performance last year. And as a result of that I do expect the growth is going to slow a bit. When you look at it, I think we are kind of to look at that from a prudent perspective, we certainly don’t want to get ahead ourselves, but if you look at momentum that we’ve seen in Q4 in Precept, MAS PLIF, ALIF ACR all new products that have come to market here within the last 18 months or so, incredibly excited and a lot of runway to those.

[Unidentified Analyst:]

Okay, great. And then you did lower sort of expectation for the full year and you mentioned that the cervical and motion preservation, does performance remain flat, can you just elaborate on what you are seeing competitively there and what else to happen in order to really accelerate performance in those segment?

[Quentin Blackford:]

So I would say that overall we’re pretty disappointed in the performance of PCM, the main reason for that is that it’s designed for single level applications, we’re simply not seeing the uptick of that particular application, it seems the market more interested in two level application. We don’t have the FDA clearance for that. So we’ve just simply are overall disappointed in that area Cervical otherwise it’s performing well, the procedural volume has been up. But really the downside for us has been on motion preservation.

[Unidentified Analyst:]

Okay, great, thank you.

[Quentin Blackford:]

You bet.

[Operator:]

Thank you. Our next question comes from on Matt Miksic with Piper Jaffray. Please proceed with your question. Matt Miksic you line is live for question, please proceed with your question.

[Matt Miksic:]

I went mute there for a moment, sorry about that. Can you hear me okay?

[Alex Lukianov:]

Yeah.

[Matt Miksic:]

Thanks so much for taking my question. So one, on the environment, its question that we get a lot, so I want to focus that too much, but I love to get your sense of where sort of pricing trends sound like they were heading in the quarter sort of sequential, using the pricing slightly others are seem kind of steady, so maybe pricing and just what you saw out of the strength here in the seasonal quarter, just maybe couple of market question, then I have one follow up.

[Alex Lukianov:]

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

[Matt Miksic:]

And then in the seasonality, we would typically expect a little bit of following off here in the third quarter and I think you and a number of other folks have reported some pretty strong and seasonally strong growth either takes on that?

[Alex Lukianov:]

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

[Matt Miksic:]

And then just a follow-up if I could on Precept and where you are seeing the uptick here, is there any area the strength in sort of types of procedures where you are seeing particular uptick is it in – is it in one or two level cases, is it in should it view it as a good system for most complex cases or is it sort of across the board uptick that you are seeing?

[Alex Lukianov:]

It’s across the board and Precept has been out there now for pretty close to two years not in full lunch but pretty close to that. It started of largely because we’re able to start to backup XLIF procedures and I think that’s how we began moving into that space and then overtime it’s been applied more, there is also more for everything across the entire spine. I think as I’ve talked about after the last couple of quarters, we’ll be continue to see is surgeons that are used to doing big open procedures being able to apply a product like Precept and utilize it in that fashion and then obviously it’s designed for both open and close procedures and then slowly move that into less and less disruptive applications of the technology. So it’s exactly as we’ve been talking about and it’s very broad.

[Matt Miksic:]

If I could Alex just one clarification. You are like open and –

[Alex Lukianov:]

Yeah, this is like your number four question.

[Matt Miksic:]

Just to clarify, I am sorry. When you say open (indiscernible) you picking up share in – we think you maybe you are picking up your fair share of your posterior fixation or XLIF cases or you also just picking up XLIF cases that are necessarily wouldn’t put you any case with that?

[Alex Lukianov:]

Correct, and that’s really been the posterior fixation success that we’ve had on an Armada, with Precept, with other systems Bendini which is the largest to get into to deformative cases. So we’re seeing good strength from XLIF from lateral plating and also from all of our posterior fixation business.

[Matt Miksic:]

Great, thank you and sorry for that.

[Alex Lukianov:]

Okay, don’t do it again.

[Operator:]

Thank you. Our next question comes from line of Bill Plovanic with Canaccord Genuity. Please proceed with your question.

[Bill Plovanic:]

Great, thanks, good evening. Can you hear me okay.

[Alex Lukianov:]

Yes, you can ask three questions Bill.

[Bill Plovanic:]

I’ll keep it two, so other people can ask question. Quentin, on the Medtronic royalty when that goes away in mid-February what looking at that today not that you have pretty clear path on the run rate, what is the – how many bps of operating margin benefit will you pick off of that?

[Quentin Blackford:]

Yeah, that’s – we’re going to see right around the 150 basis points, that’s why we’ve been talking to you for some time now it’s going to come right into to be in right around that number.

[Bill Plovanic:]

And as we think about 2015, if you’ve got a 150 bps of Medtronic rolling off, should we expect continue leverage from the core business and sales of marketing, what have you so that you’re shifting towards a 200 to 250 bps or 300 bps improvement for next year, how should we think about 2015?

[Quentin Blackford:]

Well, you are thinking about it appropriately. From our perspective our goal is to drive roughly 100 basis points of underlying operational improvement in the business and certainly we kind of look at the 150 basis point improvement from Medtronic outside of that. So you are think about it appropriately you side up to that 200-250 basis point improvement.

[Bill Plovanic:]

I’ll stop there, thank you.

[Quentin Blackford:]

Thank Bill.

[Operator:]

Thank you. Our next question comes from line Chris Pasquale with JPMorgan. Please proceed with your question.

[Chris Pasquale:]

Thanks. Where you guys now with the OPRO launch, how much more of your count base, you still have to upgrade before we could see these big stocking order stand to wind down.

[Alex Lukianov:]

Yeah, I did (indiscernible) and part of having that product available for sweet spot penetration in our own case is somewhere around 60% and we historically said we thought to be hard to penetrate the Armada without another innovative product in this space. OPRO certainly allowed us to have that opportunity. I think what you are seeing now is that we’re closer to 70% in terms of penetration of our own case, still into the extent we can go even further where we like to do that. But I think the growth that you are seeing there has the potential to sustain itself into the future now really two quarters into that launch, so we need a bit of time to see that’s going stick and it’s not just trailing. But like I look at it, it seems like there is an opportunity to cash more of their procedural opportunity with our surgeon base. So it has the potential to stick.

[Chris Pasquale:]

Quentin, you have mentioned a track some that allow, any update there and is the OPRO success kind of taking away you urgency of having a product like AttraX.

[Keith Valentine:]

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

[Chris Pasquale:]

And if I could just one of the IOM segment, have five straight double digit growth quarters there, and what point do we start to think about that as the sustainable growth business that maybe you’d expected to be when you first did that acquisition and not just a temporary phenomenon?

[Keith Valentine:]

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

[Chris Pasquale:]

Thanks.

[Keith Valentine:]

You’re welcome.

[Operator:]

Thank you. Our next question comes from the line of Richard Newitter with Leerink Partners. Please proceed with your questions.

[Richard Newitter:]

Hi thanks for taking the questions. I just wanted to start off, Quentin you went to a bunch of the gross margin drivers in the quarter and what doesn’t – can you just quickly give us the high levels summary of those again?

[Quentin Blackford:]

Yeah sure, so if you look at gross margin, we’re up 50 basis points year-over-year but you start to peal it back a little bit and we would have been up 200 basis points year-over-year just from the in sourcing and the inventory efficiency that we’ve driving through that business. Now we’ve lost a bit of room with the non-recurring one time product royalty related charge that came through in the quarter and then a big of mix just related to the strength in our biologics portfolio, but net-net 200 basis points of improvement offset roughly 100 basis point then one time item in 40 basis point s of mix.

[Richard Newitter:]

Okay, and then that gives you the confidence that you’ll put also that and that’s keeps you on track for 76%.

[Quentin Blackford:]

Yes, absolutely, the 74.9% is not going to be a sustainable margin level, you are going to see that go back to the 76% that we’ve been operating at excluding the item in the quarter, we would have been sitting right on 76% again in our guidance implies that will see in around 76% also. We feel confident in what we’re seeing to there to be able to get into that number for the year end.

[Richard Newitter:]

Thanks, and then just quickly tax rate is something that you guys said you’ve been planning for you think you can bring and that number down. Can you just give us a sense of where you think that can go down to in 15 or I guess 50 were cannot be in the next right two year, how far down can that go?

[Quentin Blackford:]

When we started to go through making a tax position where the company much more efficient, the go we had in mind was to get that down in below 30s over the next three to five years. So I think we’re still aligning to being able to achieve that, you’ll see the rate come down next year somewhere in the mid-40% range and them from that as revenue continues to increase and the U.S. markets will likely see that rate move down in the low 30s.

[Richard Newitter:]

Thank you.

[Operator:]

Thank you. Our next question comes from line of Raj Denhoy with Jefferies. Please proceed with your question.

[Raj Denhoy:]

Hi good afternoon. I am wondering I could just ask a question, it seems to be the last several quarters is kind of this economy between the numbers you guys keep putting up and you in the terminal you used to sort of talk about any sort of sustainable trends, and one can you also little bit is the how these new products in line penetrating to less in procedures. I am curious that you can offer anything in terms of whether you are – how quickly you are expanding the customer base, number of surgeons you are bring in and you actually fold and how more room you think you have to continue to add new customer in for these products?

[Alex Lukianov:]

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

[Raj Denhoy:]

Let me ask in a different way, in terms of the step up in growth we’ve seen over the last kind of four, five quarters, how of that can be tied to new completely new customers that are come into – completely new surgeons versus you’re taking these new products whether it’s Armada or Precept or some of these new ones and simply penetrating into your establish base?

[Alex Lukianov:]

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

[Raj Denhoy:]

Okay, and if I’m just telling it correctly it sounds like again you’re not seeing any sort of limits in what you can do here simply just your conservatives on your part in terms of the sustainability?

[Alex Lukianov:]

Yeah, I think that’s fair.

[Raj Denhoy:]

Okay, thank you.

[Operator:]

Thank you. Our next question comes from the line of Matt Taylor with Barclays. Please proceed with your question.

[Matt Taylor:]

Thanks. I have one question of the surgical business, you mentioned in your comments that you see that as being able to turn around over the longer term, how is longer term and what do you think will turn that around?

[Alex Lukianov:]

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

[Matt Taylor:]

And just a follow-up, are there any areas that your portfolio now that you feel like you really need to add and what should we expect in terms of the new system the emerging system that you’ve talking about, we might peak out and that?

[Alex Lukianov:]

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

[Matt Taylor:]

Great, thanks a lot.

[Alex Lukianov:]

Yeah.

[Operator:]

Thank you. Our next question comes of line of David Roman with Goldman Sachs. Please proceed with your question.

[David Roman:]

Thank you, good afternoon, everybody. Can you hear me okay?

[Alex Lukianov:]

Yeah, David.

[David Roman:]

Thanks Alex. First maybe just starting with the revenue picture, Quentin you wrapped up discussion around revenue indicating that there was a number of onetime factors that benefited the growth rate, that would not recur next year. Can you maybe just go into that in a little bit more detail and at this point last year, you did provide some context on for you revenue growth, so are you willing to blast the 6.5% to 7% growth number that’s in consensus right now for ‘15?

[Quentin Blackford:]

Yeah I think you’re certainly thinking about forward looking estimates in the mid – of a single digit range is fine from that perspective at this in time. We’ll talk more about that as we get to Analyst Day here in a couple of weeks and then start to think about 2015 a bit more as we exit the year. But when you think about kind of the onetime items that we’ve brought up over the course of the year, I think they really come back to the service business, we did have some impacts of collection benefits that came through and really the first two quarters of the year, now we did see strong volume growth in Q3, which was really the first time that became the significant driver in the business, part of that it is the collection growth and we certainly don’t expect that we’re going to continue to see that into next. As a matter of fact that’s going to set up for relative tough comp in that business in the first part of next year. Yeah, we get into the international business, so we’ve talked about this. In Latin America the underlying business procedurally is performing very well, but the ability to get paid in those markets is highly unpredictable, so to the extent that we put that into our forward-looking guidance, it’s get difficult to do that because you can never really predict exactly when you going to get paid. So certainly in the international business just around Latin America bit of concern there with regard to how you think about and how you plan for it. And then the last one just in biologics, you know we’ve strength in the last two quarters, certainly we’re excited about what we’re seeing but to some extend within the couple of quarters yet to go to really determine whether or not that just trailing of the new product and whether it sticks or whether it doesn’t and those are the kind of things that I am referring to in the prepared remarks.

[David Roman:]

Okay and that’s helpful. And then Alex maybe it’s a follow-up on your comment. I think you’ve made a reference earlier to people feeling better about spine surgery I mean some of your competitors have reference spine is a potential area a better fit from expanding coverage around, are you willing to sort of give us anymore perspective on what it is that’s making we will feel better, is it expanded coverage, is that just a seasonal boost that we normally see in the end of the year or there are something about their perception of the surgery that sort of sustainably change from the concerns that exit in several years ago.

[Alex Lukianov:]

We haven’t seen much of a boost from ACA, I mean obviously there are more patients available but we haven’t really seen much of a positive impact from that. I think there is just – that there is a more positive tone as you know NAS has put forward quite a few guidelines to address the various issues that been out there with regard to pushback. So I think that’s why the surgeons pretty dramatically and made them feeling – fell a lot more positive about the tools they to push back when the insurance companies are not approving procedure. So generally speaking, there is a small uptick with regard to the number of procedures that are being done versus those that are being slowdown by insurance companies. We don’t have an exact number, it’s more through dialog with our customers.

[David Roman:]

Okay, that’s helpful, I’ll drop. Thank you.

[Alex Lukianov:]

Okay.

[Operator:]

Thank you. Our next question comes from the line of Jeff Johnson with Robert W. Baird. Please proceed with your question.

[Jeff Johnson:]

Thank you. Good evening guys. Most of my questions have been answered but Alex, I guess I’ll just ask you inventory question on PODs, you talked about the fair pushback there in the last answer, but anything you can say on the PODs?

[Alex Lukianov:]

So I think that they are diminishing but every still slowly, they still out there. So despite the actions taken by the government which you would think have had more positive impact or at least diminishing them faster, we haven’t really seen that what we have seen of course is the hospital networks pushing back, a lot of them have implemented policy, so we’re certainly not seeing the growth, but it’s hard for us to assess the level of shrinkage at this point in time.

[Jeff Johnson:]

And sense that’s helping your numbers if at least that rate of growth is slowing or anything maybe shrinking that growth?

[Alex Lukianov:]

Yeah, we don’t believe, so I think we’ll have to see how that plays out next year, maybe there will be some impact next year, we’re not forecasting that to happen just yet.

[Jeff Johnson:]

Yeah, it’s helpful. And then Quentin, just a modeling question, I was wondering if you could do kind of an EPS crosswalk here, you full year guidance going up by a penny. I think the ETR in the GAAP I know was this quarter was impacted by I think there was a non-GAAP ETR impact, is that right as well at this quarter?

[Quentin Blackford:]

That’s right it would have impacted both GAAP and non-GAAP.

[Jeff Johnson:]

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

[Quentin Blackford:]

No, I would think for the most part the FX that you seeing come through the revenue is primarily offset by the same changing coming through the operating expense profile. We have essentially a nature hedge backed into the P&L just from a small operating margin with the international business. The FX loss that I spoke to you another income and expense was really driven by revaluing the balance sheet at the end of the period, which unfortunately it realizes the significant change in the rates that came at the end of September. So that FX loss will flow through on the full year, that’s going to be $0.03 more than offset that’s when the incremental revenue that were increasing for your expectation guide. So FX will be offset. Then the tax rate tier points going to come back on the full year basis, we’re not changing full year expectations from a tax perspective, really we did increase full year expense by $1 million but that’s due to the $10 million increase on the top line and the profit associated with that. Outside of that we never been changing our tax.

[Jeff Johnson:]

Okay, got it. Thank you.

[Operator:]

Thank you. Our next question comes from the line of Glenn Navarro with RBC Capital Markets. Please proceed with your question. Glenn Navarro, your line is live. Please proceed with your questions. Are you perhaps on mute, sir?

[Glenn Navarro:]

Right, can you guys hear me okay.

[Operator:]

Yes, sir.

[Alex Lukianov:]

You there? Why don’t we go on to the next caller and then give Glenn chance to get back in the queue.

[Operator:]

Certainly. Our next question comes from the Bob Hopkins with Bank of America. Please proceed with your questions.

[Bob Hopkins:]

Thanks and good afternoon everybody. I just really had one question, it was a fallow-up on to some of your comments NAS, and I realize you kind of highlighted which you are going to be talking about there a little bit. But I was wondering if I could ask a specifically on the product side, just kind of the relative important of the things that you’ll be talking about and highlighting at NAS in terms of thinking about potential impact in terms of 15 and 16 annual revenue growth. What are the key new product launches at NAS and how impact those be as we think about the next 12 to 18 months?

[Alex Lukianov:]

So I think the, what we’ll be talking about at Investor Morning really has to do with what we’re calling IGA Integrated Global Alignment and we’re just started to discussing that because we’re starting to get pretty follow one now in our beta trial and that’s going very well. So we’re going to start laying out in the foundation but how this changes all of our fixation systems over the next few years. So we think it’s a very significant change again just fine surgery in terms of what we’re doing. And as I’ve alluded, it’s really taking the principals of scoliosis surgery and applying them just to the scoliosis not just the thoracic spine but also to the lumbar spine. So those are really the – I would that that’s the biggest shift that we’re working towards. We’re going to continue to drive our XLIF ACR at the meeting, that’s really gaining a lot of support. I think we’re going to be obviously putting forward a series of other products including Archon, Archon was just release. So that’s rolling out as you know biologics with OPRO and with (indiscernible) that really pushing those out further at NAS and then gaining additional traction with the posterior system that we’ve been talking about.

[Bob Hopkins:]

And then on this scoliosis side, is there way help us think about quantifying that opportunity if you are successful?

[Alex Lukianov:]

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

[Bob Hopkins:]

Great, thanks for the color.

[Alex Lukianov:]

Okay.

[Operator:]

(Operator Instructions) Thank you. Our next question comes from the line (indiscernible) with BMO Capital Markets. Please proceed with your questions.

[Unidentified Analyst:]

Thanks for taking our question. This Andrew in for (indiscernible). I wanted to start out with the international business that continues to deliver healthy growth and wanted to get some color on some of the puts and takes and specifically the progress in Japan.

[Quentin Blackford:]

Sure, what we said our business grow roughly 45% in the quarter and I would stop to really the key markets that were driving that growth which continue to be in Japan, Australia is well up over that 45% growth clip as well which again we have probably the second largest market share in that local market, so to continue to see that kind of growth coming from and is encouraging Italy, UK both very well also. When you look at international, we’ve got roughly 3% of the total international market share, so the runway is still incredible for us. And I think for the most part in most of the major markets would maybe just an exception of one of two countries. But I think that speaks to the runway that’s in front of us, we’re just having that small market share and just getting into the key market that will enable us to take more of that over the next several years.

[Unidentified Analyst:]

Great, thanks. And then just one last question from us which is any distributor changes in last six months? Thanks for taking the questions.

[Quentin Blackford:]

No.

[Operator:]

Thank you. Our next question comes from line of Larry Biegelsen with Wells Fargo. Please proceed with your question.

[Larry Biegelsen:]

Hey guys, thanks for taking my question. Actually just one question from me. Alex, maybe if you could give us a little bit of color on how you are thinking about business development M&A at this point? Thanks.

[Alex Lukianov:]

So we’re really focused on Asia Pacific and EMEA and looking for opportunities to drive both revenue and our margin. We’re also at ways to expand our manufacturing process which is obviously not M&A but we are looking at other ways to support the manufacturing that we’ve already taken on. We’re absolutely thrilled with the progress that we’ve made in that area, it’s been very substantial effecting the gross margin and really helping aside with. So we’re looking to expand more in that area and other than that we’re focused on just other ways to think our revenue footprint and are working on a number of things. Nothing really big and nothing that we would anticipate to be certainly hugely. So our process is still built around looking for deals that would accretive, we are certainly looking for a accretive deals.

[Larry Biegelsen:]

Thank you taking the question.

[Operator:]

Thank you. Our next question comes from like Mike Matson – Needham & Co. Please proceed with your question.

[Mike Matson:]

Alex, obviously the move towards the internal manufacturing helping out your gross margins quite a bit. So I was wondering if you could give us some perspective on where your add with that process, another words as of right now, how much of your manufacturing is being done, are you on plan, I think it’s on a high over, so it’s being outsourced and then how much more that do you think you can move in inside over the next few years?

[Keith Valentine:]

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

[Mike Matson:]

Okay, and then just a question on the decade play, I think Alex mentioned that in some of his prepared remarks it sounds like he is doing well, but wondering if you tell us what portion of procedure you think that’s been used in and how many those are have moved toward the one position I guess procedure basically.

[Quentin Blackford:]

This is Quentin here. Decade play just being now here little over you know, there is still a tremendous amount of runway in more of our own procedures and I think still on the early stages (indiscernible) that’s out there.

[Alex Lukianov:]

One thing great about the decade play and it comes from years and years of learning right, we’ve been in this lateral space as far as long we have we’ve also had single position surgery with plating but it is – without a doubt this plate really does have a much better combination of the bodies and it is great opportunity for a single position surgery and that’s why we’re seeing nice uptick.

[Mike Matson:]

Alright, thanks a lot.

[Alex Lukianov:]

Okay.

[Operator:]

Thank you. Our next question comes from line of (indiscernible). Please proceed with your question.

[Unidentified Analyst:]

Hi thanks, just two quick follow-ups here. Once your PCM you mentioned labeling is probably good the major issue which is still holding it back. Are you guys looking at way of potentially expanding the label and what would be involved in doing that?

[Alex Lukianov:]

We are not at this point because it would go beyond a PMA supplement and we have to essentially probably start however with the new device. Frankly we’re not very excited about doing in this regulatory environment, we’ve been through several PMAs and I’ve been frustrated with the regulatory process. So our focus is on 5-10-K products we’ll continue to be not suggesting, we never do a PMI but that’s not within the scope what we’re thinking about. So that’s what here. I have to say that I am probably less excite about the cervical motion preservation market then we probably were few years ago, I shouldn’t believe that there is opportunities for two level applications but we’re probably a little more hesitant right now with regard to how much of fusions will it convert. If you go back several years ago, we were all forecasting it could be anywhere between 30% to 50% of that market, from what we’ve seen from combination of insurance pushback surgeon uptick, our guess is that it’s going significantly less than that and I don’t have an exact number for you. But fair to say that’s it’s really going to be much less than 30%. So I guess that really mitigates our interest in making a big investment in that area now. If that changes well maybe we’ll be a little behind but then we’ll potentially chase it, but right now we’re not think about anything.

[Unidentified Analyst:]

Okay, very helpful. Thanks for that color Alex. The second just follow-up would be, I appreciate the pricing has been quite stable for the last multiple quarters, if I could just push you on a little more color, I love to get a sense of how new product or pricing versus sort older product at this point, is there the economy there and could you give us a little color help us see how this market is moving.

[Quentin Blackford:]

Yeah, sure, when we talk about price, we are talking about it on a same store, same product, so it’s true product price in a period over period, what we don’t mix into that is the mix benefits that we do get from our premium price innovation in a bit of technology that were bringing to the market place and we do see a positive mix benefit and now it’s alluded to that a bit earlier. Certainly on the more space and where you don’t have a much differentiation, you do feel a bit more of the pricing pressure in those areas and we see some of that just like – better I all comment on this well but where we make that up is just innovation that we are bring back to market and see the premium and the pricing that we are getting.

[Unidentified Analyst:]

Great, thank you.

[Operator:]

Thank you. Mr. Lukianov I wound now turn the call back over to you for closing comments.

[Alex Lukianov:]

Okay, well thanks everybody for joining us, we hope to most of you if not of you in San Francisco and those of you listening on today’s call. We are excited about the progress that we’ve made especially on the bottom line as well our top line. So we’ll talk soon. Thank you

[Operator:]

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