NuVasive, Inc.
Q1 2015 Earnings Call Transcript

Published: 5 May 2015

[Operator:]

Greetings and welcome to the NuVasive, Inc. First Quarter 2015 Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. 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, Corporate Affairs and Human Resources. Thank you. You may begin.

[Carol A. Cox:]

Thank you, Roya, and welcome, everyone, to our first quarter 2015 earnings call. Joining me on today's call are Greg Lucier, our Chairman and Interim Chief Executive Officer; Pat Miles, our President and Chief Operating Officer; and Quentin Blackford, our CFO. 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 to be correct, could cause NuVasive's results to differ materially from those expressed or implied by such forward-looking statements. These and other risks and uncertainties are more completely described in today's press release, and in our most recent 10-Q and 10-K forms, which have been filed with the Securities and Exchange Commission. We assume no obligation to update any further statements or information, which speak as of their respective dates. This call will also include a discussion of several financial measures that are not calculated in accordance with Generally Accepted Accounting Principles, or GAAP. We generally refer to these as non-GAAP financial measures. These measures include our cost of goods sold, gross margin, sales, marketing and administrative expenses, research and development expenses, operating margin, non-GAAP earnings per share, free cash flow and EBITDA. We believe this information is useful to investors because it provides information regarding earnings generation at NuVasive and is helpful for measuring our progress. We use these non-GAAP financial measures along with the most directly comparable GAAP financial measures in evaluating our actual and forecasted operating performance, capital resources and cash flow. The most directly comparable GAAP financial measures and information reconciling these non-GAAP financial measures to our financial results prepared in accordance with GAAP are included in the news release and the Supplementary Financial Information, which are accessible from the Investor Relations section of the NuVasive website. With that, I would like to turn the call over to Greg.

[Gregory T. Lucier:]

Thank you, Carol, and good afternoon, everyone. I'm pleased to be here today to talk about NuVasive's results for the first quarter of 2015 and our strong momentum in the marketplace. Before jumping into our results, I want to touch briefly on where I've been focused since being appointed the Interim CEO. In particular, over the past few weeks, I have conducted a number of meetings with extended management team and the majority of our sales force as well as an increasing number of our surgeon customers, and the feedback I'm getting is very affirming. I've been listening and learning and my early impressions are overwhelmingly positive. Our sales force is incredibly energetic about NuVasive's ability to grow, particularly given our competitive, procedurally integrated offerings and undeniable position as the leading innovator in spine. With our continued commitment to the space and ongoing R&D investment, our surgeon customers also believe the future is bright. In business, it's all about having great people and building a culture and environment where talented people can come and thrive. We've got that in spades at NuVasive. Our culture is a competitive advantage and while it will naturally evolve as the company matures, our Cheetah culture will remain ingrained in all we do. Moving forward, we will preserve the tenets that have made NuVasive so successful, including our reliance on Speed of Innovation and Absolute Responsiveness and our focus on enabling the very best spine surgery outcomes for patients. In addition to our strong culture, we also benefit from strong customer relationships and innovative products and procedures. Our focus to ensure that we best capitalize on these strengths and our competitive market opportunities remains. My time as Interim CEO, talking directly with our shareowners and our surgeon customers, has enabled me to learn more about the opportunities in front of us. Clearly, we do a lot of things well. We are the number three player in the global spine market and now aspiring for the number two position. Our shareowners are dedicated, passionate and committed to innovation that changes patient lives. Our innovation efforts continued to produce game-changers. The upcoming launch of our Integrated Global Alignment platform, or iGA, is indicative of what we are all about at NuVasive, specifically, breaking down traditional barriers and thinking disruptively about the future of spine surgery. Pat will speak further to the launch of the new iGA platform in just a moment. I also want to be clear that the strategy that NuVasive management team has previously communicated has not changed. We continue to be focused on

[Patrick Miles:]

Thanks, Greg. I appreciate it. I'm pleased to share the exciting news around our new Integrated Global Alignment, or what we call iGA. I've been at NuVasive since just about the beginning, and I couldn't be more energized about what we have going on, and what we are going to do to change spine surgery. As you know, NuVasive has a strong history of driving innovation in the spine market. We have truly been an industry disrupter. More than 10 years ago, we redefined minimally disruptive spine surgery with the introduction of XLIF. Since then, we haven't stopped leading the charge of improving patient outcomes and changing spine surgery. Through our collective technological expertise, we have moved minimally disruptive spine surgery forward. Now we are taking that experience to the next level by applying new tools and technology to spinal alignment. Alignment is the most correlative element to achieving successful long-term patient outcomes. Historically, alignment has been the primary focus of surgeons, taking a backseat, however, to decompression and stabilization. For us to improve upon alignment predictability clearly serves an unmet clinical need. Further, alignment today is not reconciled to the preoperative plan, but relies solely on surgeon gestalt or experience. You've heard us talk about the importance of alignment for quite some time. The first phase of our hard work and that of our surgeon partners will come to fruition with today's launch of our Integrated Global Alignment platform at the American Association of Neurological Surgeons Meeting here in Washington. As XLIF did more than 10 years ago, iGA is set to significantly shift how spine surgery is performed. And just as we defined the premier approach to MIS surgery over the past decade, we are now positioned to help enable proper alignment in the very same way. So, what specifically is iGA? Integrated Global Alignment is a procedurally integrative assembly of products designed to enhance predictable spinal column alignment. Enabled by our industry-leading NVM5 technology, iGA is more than a single product; it is a complete procedural platform that centers on the critical importance of proper alignment. The launch of the iGA platform also includes a suite of alignment-focused offerings including the introduction of next-generation fixation, which is named Reline, anterior and posterior inner body implants focused around our XLIF and ALIF ACR, updated neuromonitoring, computer assisted, and surgical planning technology in NuvaMap, NuvaMap O.R., Nuvaline and Bendini. It is the combination of procedurally based technologies that is unique to NuVasive and designed to enhance clinical outcomes by increasing the predictability of achieving global alignment in spine procedures. These elements and their integration across the surgical workflow are designed to help the surgeon to competently and reproducibly first calculate alignment parameters with preoperative planning tools via NuvaMap and Nuvaline, interoperatively correct the anterior and posterior columns with comprehensive procedural implants with real-time intraoperative assessment via NuvaMap O.R., and confirm the restoration and preservation of global sagittal alignment postoperatively, again with NuvaMap and Nuvaline. Our implant suite builds on the success we have experienced with our ALIF and XLIF ACR products. Anterior column surgery has been one of the cornerstones to NuVasive's success. Now we are leveraging that success with a premier posterior fixation system. The Reline pedicle screw system is an evolution of posterior fixation technology within the iGA platform, providing integrated open and minimally disruptive procedural solutions. Whether preserving or restoring spinal alignment, the seamless and versatile system provides one system to address and either to refine or reconstruct even the most difficult pathologies. Reline essentially brings together all of our previous experience in the most comprehensive pedicle screw system for maximum versatility. Additionally, our propriety Bendini rod bending system provides the surgeon with the ability to customize rods in real-time at any point during surgery with computer-driven rod-bending capability right in the O.R., tailoring rods to specific patient needs against a pre-surgical plan. The next generation of Bendini fully integrates into all of our planning software in a NuvaMap, Nuvaline, and NuvaMap O.R. to enable corrective alignment. Bendini will address the entire spine, from enabling the restoration of a mal-aligned spine against a pre-surgical plan, to assuring the preservation for an aligned spine with customized rods bent to implant location. Taken together, these products and features form NuVasive's game-changing procedurally iGA platform. This is not solely a product development effort, but also part of a sales and surgeon education approach. We have assembled a team of both ortho and neurosurgeons to assist in assembling technology to drive predictability and really one of the core tenets of spine care, which is alignment. During the evaluation process, the enthusiasm around creating predictability and alignment has validated the excitement behind the unmet clinical need. We are blazing new trails by addressing unmet clinical needs with Integrated Global Alignment. We saw a missing element critical to bettering patient outcomes, and now we're working to raise awareness and focus a spotlight on alignment. The timing couldn't be better. The clinical evidence supporting the importance and value around proper alignment is overwhelming. So by applying our procedural expertise to increase predictability in spine's greatest challenge, we are set to bring a truly new and unique value to the market, to once again change spine surgery. We can't be more excited. With that, I'll turn the call over to our CFO, Quentin Blackford.

[Quentin Blackford:]

Thanks, Pat, and good afternoon, everyone. Before we get started with the financials, let me remind you that many of the financial measures covered today will be on a non-GAAP basis. Please refer to the Supplementary Financial Information file on our website in the Investor Relations section for all of the detail covered on today's call and to reconcile our non-GAAP items to their GAAP counterparts. As Greg noted, we had a very strong start to the year, driving top-line growth ahead of expectations at $192.4 million or 10% growth on a constant currency basis. We also continued to deliver on our commitment to improved profitability with 450 basis points of operating margin expansion for the first quarter 2015. We reiterated our guidance for the full year, with revenue growth expected in the mid-to-high single-digit range, despite stronger currency headwinds. We also expect to continue to drive increased operating efficiencies and deliver at least 300 basis points of operating margin expansion for the full year. Now beginning with our revenue performance. Revenue for the first quarter 2015 exceeded our expectations at $192.4 million or 8.4% growth year-over-year, including approximately $2.8 million of currency headwinds. On a constant currency basis, revenue for the quarter would have been $195.2 million, or 10% growth year-over-year. Our performance for Q1 was driven by strength in both our U.S. and o-U.S. businesses. We continue to expect revenue of approximately $810 million for 2015, which now includes an estimate of approximately $12 million of currency headwinds versus our prior guidance of approximately $10 million of currency headwinds for the year, with the second quarter expected to realize the greatest impact of those currency headwinds. For the full year, this represents approximately 6% growth year-over-year, or 7.8% growth on a constant currency basis. As a reminder, beginning this quarter, we changed the company's revenue categories to better align with the key growth areas of our business, consolidating our business revenue reporting to, one, U.S. Implants and Services; two, U.S. Biologics; and three, International. With that in mind, let's walk through the composition of revenue in the quarter as we continue to deliver on our guidance to drive mid-to-high single-digit growth on the top-line. Sales for U.S. Implants and Services, which includes the lumbar, cervical, NVM5 and services businesses grew 5.9% for the first quarter driven by continued momentum of our minimally invasive solutions and somewhat tempered by a more difficult year-over-year comparison in our U.S. business. The performance of both our lateral and posterior product portfolios continues to fuel solid growth in some of the most proprietary portions of our business. Additionally, we are seeing a resurgence in our cervical portfolio, which is performing well ahead of expectations. During the quarter, we experienced growth of more than 9%, driven primarily by the continued strong momentum from ACDF on the heels of the successful Archon product launch. We continue to expect that U.S. Implants and Services will grow by approximately 5% for 2015. We are also excited about the launch of the iGA platform, announced this morning, as it provides even greater confidence in our ability to deliver on our full-year revenue expectations. U.S. Biologics sales drove very strong results during the quarter, growing 13.4%. We continue to experience increased procedural pull-through in line with the strong demand for our U.S. lumbar solutions with Osteocel Pro continuing to generate solid surgeon interest. We estimate the U.S. Biologics business to grow approximately 7% in 2015, up slightly from the previous guidance of an estimated 6%. Our International business, which includes Puerto Rico, grew 17% in the quarter or 30.5% on a constant currency basis. We continue to drive significant growth from this area of the business where we have tremendous runway ahead of us with currently only having an estimated 4% share of that total market. Asia-Pacific continued to drive our performance, growing more than 50% on a constant currency basis led by both Japan and Australia. In addition, we realized solid growth from EMEA and Latin America. As a result of the increased currency headwinds, we now expect our International business to grow by approximately 9% on a reported basis, and remains unchanged on a constant currency basis, growing more than 20% for the full year. In summary, we are very pleased with our revenue results for the first quarter of 2015, as we have continued to execute our proven share-taking strategy. Also, as a reminder, beginning this quarter, we updated our non-GAAP definition to include the impact of non-cash share based compensation and certain IP-related litigation expenses. To assist in the understanding of this change, there is a Supplementary Financial Information file on our IR website that outlines this change, as well as a presentation that illustrates our longer-term profitability goals under updated non-GAAP definition for both operating and EBITDA margins. Turning to the rest of the P&L and results, non-GAAP gross margin in the first quarter was 76.3%, up 70 basis points from the 75.6% reported in Q1 2014. Included in the quarter was a 70-basis point benefit related to the Medtronic royalty accruals primarily as a result of the 973-patent expiring at the end of February. We also realized on-going benefits from our continued efforts to increase in-source manufacturing and achieving better asset efficiencies, which resulted in approximately 70 basis points of improvements. These were offset by a non-recurring inventory-related charge and the strong performance in our lower margin International and U.S. Biologics product offerings, which carried lower margins than the corporate average. Price continued to be consistent with prior periods declining approximately 1% and was not a material factor in the quarter. We estimate non-GAAP gross margins for 2015 to improve from the prior year to approximately 77.3%, a slight reduction versus the prior guidance of 77.6% as a result of the incremental mix headwinds from the strength of our U.S. Biologics and International businesses. Non-GAAP sales, marketing and administrative, or SM&A expenses, totaled $113.2 million in Q1 2015 compared to $111 million in Q1 2014. SM&A expense was 58.8% of revenue for Q1 2015, representing 370 basis points of improvement compared to the 62.5% reported in Q1 2014. Included in the quarter was a benefit of approximately 50 basis points related to the settlement of a legal dispute. Excluding this non-recurring benefit, SM&A expense as a percent of revenue improved by 320 basis points versus the prior year. During the quarter, we realized more than 200 basis points of benefits from our efforts to drive sales force and asset efficiencies. We are making significant progress in these areas as we focus on better utilization of the assets we deploy. As we become more efficient, we're driving initiatives designed to address our fixed cost expense base, renegotiating vendor agreements, reducing the need to deploy unnecessary assets for surgeries, and reducing the loss associated with our loaner instrument model. In addition, in the quarter, we realized a 100-basis-point benefit related to non-cash share based compensation, which we intend to lever over the course of the year. On the heels of the strong start to the year, we estimate non-GAAP SM&A expense to be approximately 57.9% for 2015, an improvement from the previously provided guidance of 58.2%. Non-GAAP research and development, or R&D, expenses totaled $9.3 million in Q1 2015 compared to $9 million in Q1 2014. R&D expense was 4.8% of revenue for Q1 2015 versus 5% in Q1 2014. The planned increase in dollar spending continued to be driven by our investments and game-changing procedural solutions including the build-out of the iGA platform. We remain committed to investing in innovation in 2015 and continue to anticipate a full year of non-GAAP R&D expense to be approximately 5% of revenues. We are very pleased to report that first quarter non-GAAP operating margin increased to 12.6% resulting in an exceptional 450 basis points of operating margin expansion, compared to the 8.1% we reported last year. We are making very good progress in our goal to improve profitability across the board. Adjusting for the previously mentioned benefits from the expiration of the Medtronic royalty and the one-time benefit from the legal settlement, we drove 320 basis points of underlying operational improvements in our operating margins for the quarter. We are very pleased with the start to the year and with where we are positioned relative to our stated goal of 150 basis points of underlying core operating margin improvement for the year. Consistent with the prior year, we will continue our drive to exceed our original profitability guidance. However, at this time we continue to estimate a non-GAAP operating margin of approximately 14.4% for 2015. On a GAAP reporting basis, we realized a one-time benefit of reducing our Medtronic accruals related to the recent court decision, which determine that the prior damages award had included lost profits and royalties on convoyed sales, which should have been disallowed. As a result, we reduced our royalty accruals and litigation liability by $56.4 million in the quarter. In addition as Greg mentioned, we reached a preliminary settlement agreement with the DOJ in connection with the outstanding OIG investigation. As a result, we realized the one-time charge of $13.8 million in Q1 related to the settlement and do not expect entering into a corporate integrity agreement. In addition, in the quarter, on a GAAP-only basis, we incurred costs associated with the transition of our CEO, which resulted in a charge of $3.4 million, as well as charges of $2.9 million, primarily related to the closure of our New Jersey facility and $2 million related to the management restructuring charges, both of which we had guided to and discussed last quarter. Interest and other expense, net, on a GAAP basis totaled $6.3 million in Q1 2015, consistent with what it was in Q1 2014. We continue to anticipate full year 2015 interest and other expense to be approximately $29.5 million, including roughly $16 million of non-cash interest expense. Income tax expense on a GAAP basis for the first quarter of 2015 was $17.9 million compared to a $15.1 million tax benefit in the first quarter of 2014. This resulted in a GAAP tax expense rate of 36.3% for the quarter, below our full-year expectations for a GAAP effective tax rate. The lower tax rate was primarily due to a difference in the mix of earnings as a result of the gain we realized upon the reversal of a portion of the Medtronic royalty accrual. This placed a large portion of earnings into the U.S., which has a lower tax rate than the expected corporate average effective tax rate. We now estimate a GAAP effective tax expense rate of approximately 46% for the full-year of 2015 versus our prior guidance of 49%. Our non-GAAP effective tax expense rate guidance for 2015 of approximately 46% remains unchanged. First quarter non-GAAP earnings were $15.1 million or $0.30 per share compared to $8.9 million or $0.18 per share in Q1 2014. We continue to estimate non-GAAP earnings per share of approximately $1.10 for 2015, unchanged from prior guidance. However, on a GAAP basis, we now estimate GAAP EPS to be approximately $1.12 versus our prior guidance of an estimated $0.67 for 2015 as a result of a net benefit realized from the reduced Medtronic royalty accrual, offset by the OIG liability and leadership transition-related cost. In addition, adjusted EBITDA margin, which excludes the impact of non-cash share-based compensation was 23% for Q1 2015, compared to 19.2% in Q1 2014, reflecting a 380-basis-point improvement in the business. We continue to expect an adjusted EBITDA margin of approximately 24.6% for 2015. Our cash and investments balance at the end of the first quarter was $316.8 million, down about $89 million from last quarter, driven by several factors including the placement of $33 million into escrow related to the NeuroVision litigation from last year, $31 million associated with the net settlement of equity awards, $30 million related to the purchase of intangible assets associated with our minimally invasive product portfolio and $12 million of tax payments as we transitioned to a cash tax payer. In closing, we are off to a very strong start for the year. In the first quarter, we grew operating profit dollars by approximately 70% with earnings per share up more than 60% year-over-year. We remain dedicated to executing on our stated goals of driving profitability improvements in our business and creating incremental shareholder value. We have a solid operating plan for 2015 as we look to deliver 300 basis points of improved non-GAAP operating margins, adjusted EBITDA margin approaching 25% and a greater than 60% improvement in non-GAAP EPS for the year. With that, I'll turn the call over to Roya, who will open it up for Q&A.

[Operator:]

Thank you. We will now be conducting a question-and-answer session. Thank you. Our first question comes from the line of Matthew O'Brien with Piper Jaffray. Please proceed.

[Matt O'Brien:]

Good afternoon. Thanks for taking these questions. I was hoping to start with Greg on his commentary about the focus that he has for business going forward. Is it fair to say that your key focus for the next 6 months to 12 months will be on key operating profitability of the company, and in your time there, I know it's relatively short, can you just give us a sense for what you've identified as some of the low-hanging fruits as far as taking the costs out? And is there any possibility of accelerating some of the profitability metrics that Quentin played out over the last couple of years?

[Gregory T. Lucier:]

Yeah, good set of questions. The first we'd say that, as I've said to the group inside the company, I've been very impressed with the sophistication of our sales force here in the United States, with the sophistication and adeptness of our R&D and development teams. What's not equal to that in terms of the maturity that you would see at this point of a company of NuVasive's size is, our manufacturing capabilities. I've had a chance to meet our team. I've had a chance to go to Dayton to see our facilities, and we have an opportunity there to vertically integrate to a greater extent, improve our margins considerably over the next couple of years and just become a much more sophisticated, adept manufacturer of our products. So that's number one. And that's something Pat Miles and I have been talking about a lot. We think we're putting together good plans, and you're going to see us very, kind of disciplined and executing this manufacturing strategy. The second one would be, as you look at our business, as I said in my comments, I think the international markets represent just that much more of an opportunity for us. I recognize our teams have done a really nice job over the last couple of years building that international business, but the opportunity is again just that much more. And so you're going to see us get much more focused in key countries. This is a country-by-country game. You're going to see us put more resources into those countries, and very selectively, move into a couple more new ones here in the next two years. So we think there's a lot of growth there on the international side. Finally, with respect to your comment, can we accelerate the roadmap we've given for improving the operating margins of the company; I think, it's too soon for me to comment on that. I would just simply say we're completely committed to the guidance we've given so far, and we know how to get that done.

[Matt O'Brien:]

Okay. And then as my follow-up, just talking about the international business here again, very strong in Q1, can you just give us a sense for why 30% growth in Q1 would translate into 20% for the full year? Is there something in Latin America that you're concerned about? Quentin, I think you mentioned some conservatism on your collections, expectations there, et cetera? Just any kind of color there would be helpful.

[Gregory T. Lucier:]

Yeah, let me give that one to Quentin to answer.

[Quentin Blackford:]

Yeah, Matt, you've hit the nail on the head. It's common to what we've been talking about over the last quarter or so from when we set those expectations, and it really does come down to that Latin America market, and the lack of predictability and visibility we have to some of the payments that come from what are key markets for us in that region. So we've chosen to be a bit prudent with respect to how we think about it. As those payments come in, and we have opportunity to recognize that revenue, we'll talk about the results at that time. But we're trying to be thoughtful about how we set the expectations in that market.

[Matt O'Brien:]

Fair enough. Thank you.

[Operator:]

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

[David Harrison Roman:]

Thank you for taking the questions. Good afternoon, Greg. I'm looking forward to getting to know you and working with you on a go-forward basis.

[Gregory T. Lucier:]

Me, as well. Thank you.

[David Harrison Roman:]

So I just wanted to start with one of the key concerns that I've been getting in the transition here; I'd hope you could address this directly to whatever extent you can, which is on sales force turnover. Can you maybe talk to us about since the announcement of the CEO transition, what's been going on with the sales-facing organization? And have you taken any specific measures to ensure that those representatives stay in place given the importance of the customer-facing relationship here?

[Gregory T. Lucier:]

Great question. So when I came into this role, suddenly, I had several constituent groups that I wanted to make sure I touched. First was our surgeon customers, and Pat and Matt Link and Russell Powers, head of our International group, have been great introducing me to our key partners in the surgical space, and I've done a number of dinners and lunches and phone calls. And I'd say our group of collaborators feels they understand the transition. They're still very committed to the company because of the technology and the people behind the company. Now, this company is more than one or two people, and I think that's just really a testimony to those one or two people actually. Second group I've been touching is the sales force. And I made a commitment, it's a rather audacious commitment, to our domestic sales force that I'd call each and every one of them, and that number is just under 400 people or so. And I have been making phone calls; I'm getting trained for my future political run. That's a joke. But I have made a lot of phone calls, I've touched a lot of people, and I would tell you that we haven't seen any change in the turnover profile since these personnel transitions have been announced. People are excited about NuVasive. They're committed to this company. They see that the culture that has been created is beyond a couple of people, and I think you as an investor should rest assured that the future here is solid, stable and bright. One other group I haven't spoken to a lot, yet, and I'm just now beginning to is people like yourself; the folks on Wall Street, our share owners, and I'm going to start ramping that up now that this conference call has been underway.

[David Harrison Roman:]

Okay, that's great. And then for my follow-up, I was hoping to come back to iGA because I haven't heard that type of enthusiasm around a new product launch in quite some time at NuVasive, and I think in the prepared remarks you describe that as potentially as significant as XLIF and maybe you could just go into a little bit more detail about how we should think about the rollout of that product and any financial parameters you could help us put around it and maybe in the context of whatever is in the guidance or the forward outlook here?

[Patrick Miles:]

David, this is Pat Miles. I'll let Quentin speak to the forward outlook, but I'll speak to the enthusiasm behind iGA. If you look at what – if you look at the three tenets of spine surgery, it's truly – it's decompression, stabilization and alignment, and nobody has really taken a shot at how to create a level of predictability around alignment and if the spine is not aligned, then what happens is that patient compensates, and if a patient compensates, the likelihood of a good outcome is somewhat limited. And so if we're selling good outcomes, the whole iGA just makes absolute total sense. And so what we've done is we've assembled a number of different technologies to further the predictability associated with alignment. And so when a patient goes in the operating room, the surgeon has a plan of exactly how they should try to align the patient, and the great part is interoperatively, there's technology to reconcile against the original plan. And so it's really the same type of thing. When we came out with XLIF we assembled a access system, we assembled nerve physiology and we assembled an implant. With this, what we're doing is just assembling more elements to fully configure a procedure. And so what we found is creating predictability in a surgery with a multitude of variables is good business, and so that is truly what we've approached.

[Quentin Blackford:]

Yeah, David, this is Quentin. We talked about iGA and Reline coming online later this year. As we said, expectations back at the end of 2014, I guess in the February timeframe, so we've had expectations already around the launch of Reline. We're a bit ahead of where we thought we would be with respect to launching iGA. We're excited about that, but at this point we're not going to increase expectations. If anything it creates more confidence in our ability to get into the number that we've already put out there.

[David Harrison Roman:]

Got it. Thank you very much.

[Operator:]

Thank you. Our next question comes from the line of Rich Newitter with Leerink. Please proceed.

[Rich S. Newitter:]

Hi. Thank you for taking the questions. Maybe I'll start off, the first one for Quentin. You've talked in the past about Biologic, the success you've had with Osteocel Pro, and there's been some initial trialing benefit and obviously the comps begin to getting a little tougher in the back half of the year, or actually starting next quarter. So I was wondering if you could update us. Do you have any more visibility there, or when do you think you'll have visibility as to how sticky usage of that product is?

[Quentin Blackford:]

Yeah. I think, we've always said let's get 12 months under our belt, so a full year of launch, that's going to come about at the end of Q2, really. So, to your point, we did launch it in the second quarter of last year. We're going to be up against a pretty tough comp. Biologics grew roughly 18% last year in the second quarter. So, we will have the more difficult comp. But what we're seeing in the underlying business is very encouraging. The procedural integration continues to hover right around the 70% rank in terms of our own procedures that we're penetrating. Historically we had seen that closer to 60%, so the penetration is sticking. I'd like to see another quarter, a full quarter of launch before we get out in front of ourselves with trying to reset those expectations in any significant way. But to your point, we are going to anniversary that launch and be up against some more difficult comps for the remainder of the year, so we need to keep that in mind as well.

[Rich S. Newitter:]

Okay. That's helpful commentary. Thank you. And then maybe again, Quentin, or Greg, as we think about your guidance, you've had a track record now of kind of guiding conservatively and then exceeding expectations, and I'm just wondering as you kind of look at the guidance with one quarter under your belt of outperformance, where do you see the biggest potential if you were to drive upside, where you're being most conservative? What are maybe the three key things that you think could drive upside to your number?

[Gregory T. Lucier:]

This is Greg. I'm not going to let Quentin answer that question. I think, we're very secure in reaffirming the guidance. One quarter down, done well, and I think, it's just we don't want to get ahead of ourselves here on 2015. So, Quentin, if you want to say anything more to the question, but I think we feel good where we are right now.

[Quentin Blackford:]

Yes. There's no question. We feel good about it, and Rich hit the same things that we've commented on coming out of the last call. We've been thoughtful about how we think about International. We talked about that already on the call here this afternoon. Same with Biologics and trying to be thoughtful about those kind of things, but we couldn't be more excited about where the year's gotten itself started off at, and that's really both from a top line and bottom line perspective.

[Rich S. Newitter:]

Got it. And then just maybe one follow-up, Quentin; on the U.S. Implants and Services business, that drove a bit of upside versus our thinking. I was just wondering what – can you comment whether it was more on the lumbar fusion side or the services side that drove that?

[Quentin Blackford:]

Yeah. That would have been more on the lumbar side. The whole transition of the services into lumbar is something that will play out over the remainder of the year. Hasn't really taken a big impact in Q1.

[Rich S. Newitter:]

Thank you.

[Operator:]

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

[Jeffrey D. Johnson:]

Thank you. Good evening, guys. Greg, I wanted to start with you, and welcome and looking forward to getting to meet you and work with you going forward. But wanted to ask, you couched some of your prepared remarks kind of as opportunities where you could maybe do more, and that was on the globalization efforts, the manufacturing scale, the disruptive innovation, things like that. I don't think too dissimilar from what has been said in the past, but it almost had a tint to me as maybe something where you would consider investing more aggressively in the near term and I wonder how that might impact kind of that 100 basis points a year of operating margin expansion that has been the long-standing goal? Obviously, you're going to exceed that by quite a bit this year, but the 100 basis points a year. Would you be willing to put that at risk to drive the top line faster? I'm just trying to read what your comments were getting at there.

[Gregory T. Lucier:]

Yeah. So, we are fully committed to becoming more profitable, fully committed to the guidance that Quentin and the team have provided. And everything I've said in my prepared comments, we're going to be able to do with the available resources against that guidance. So no change to what you have heard before. Just we're going to do more with what we have.

[Jeffrey D. Johnson:]

All right. That's helpful. Thank you. And then, Quentin, was there a deal at all? I'm looking at the cash flow statement of $27 million purchase of intangibles. That was in the K as well. I just can't remember what that was?

[Quentin Blackford:]

Yeah. That was related to some ongoing IP associated with our minimally invasive product portfolio. That's IP that would have run out through 2023 or so, so quite a few years ahead of it. We essentially took the opportunity to purchase that, or buy that down, and that's essentially what we did with the $30 million that went out the door. So that has the opportunity to help us lever the P&L in a better way going forward, but took an opportunity to bring that down.

[Jeffrey D. Johnson:]

Any way you would quantify what the P&L impact this quarter or this year, I'm sorry, would be at the operating line?

[Quentin Blackford:]

Yeah. There's really not much of a benefit this year associated with it. The benefit really starts to play into the incremental years out beyond 2015.

[Jeffrey D. Johnson:]

All right. Helpful. Thanks.

[Operator:]

Thank you. Our next question comes from the line of Ben Andrew with William Blair. Please proceed with your questions.

[Benjamin Andrew:]

Great. And Pat, thank you for being on the call to talk about iGA. So maybe a question for you first. Can you talk about the revenue model and how this might specifically impact the company? Obviously, you don't really break out the differences between implants and services anymore. But is there a specific revenue opportunity with the iGA sale, number one? Second, what procedures will this particularly enable pretty well? Does it strengthen your hand in deformity, et cetera, or just in your traditional strength? And then, finally within that, what chunk of your customers are actually already ready to hear about this and are asking about it, and shouldn't the ramp be quicker, obviously, than XLIF versus where you are in the organization today versus then?

[Patrick Miles:]

Hey, Ben. It's good questions, and appreciate your interest. The – it's a heck of an opportunity. I guess, I'm going to invert the question – or the answers to the questions. First one, I think is, if you look at the deformity market traditionally, and then you look at what parameters matter. And obviously alignment has been a focal point of the deformity market previously and we have had a relatively small footprint in that market, so it's exciting to be able to have something that really creates meaningful impact to a again significant growth area of the marketplace. Additionally, so often what you find is those parameters that are meaningful in deformity are also applied to the degenerative spine. So, a lot of short segment surgery is likely affected by alignment and it's been pretty widely published on that in the international or European clinical press. So it just gives you a perspective of the relevance of alignment in surgery in general. If you start to look at what it's going to affect, I think what's going to happen is you're going to see surgeons really take a look at all the different things that they do. If they have to refine alignment, they could do that. If they have to completely reconstruct, they can do that. And one of the great things is we've made a significant impression on the market with regard to all we've done in the front of the spine, or the anterior part of the spine. And so with all of our ACR inner body products and then refining it in the back with Reline, those will be the ultimate reflection of our success as it relates to the adoption of the products. I think, I hit both those.

[Benjamin Andrew:]

Yeah. And then the other was, is there a specific revenue item with the sale or use of the system?

[Patrick Miles:]

Not really. I think, it's like we've done with XLIF, it's really in the assembly of all the stuff that ultimately is going to be – reflect success or not.

[Benjamin Andrew:]

Okay. And then for my follow-up. Greg, I mean, when the transition occurred, I think it was little over 30 days ago, there's been some chatter about it being maybe 30 days to 40 days until we'd know whether you were going to take the job. Your comments on the call suggest you're fully embedded and looking forward to meeting investors and all that. Can we assume that you're going to take the job? Or when might we understand your intentions?

[Gregory T. Lucier:]

So the last three weeks to four weeks, I've been very immersed in the company, as I've said in my comments and been trying to add value in terms of what's going on and where we can go next in terms of opportunity. But the realm of the full-time CEO is with the board. We have a very thoughtful, independent board and we'll be talking about this very question here at our May board meeting. So, no news to report yet, but just know it's a discussion at the board level and we'll be able to communicate something I think more forcefully and determining here in the next couple weeks.

[Benjamin Andrew:]

Thank you.

[Operator:]

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

[Chris T. Pasquale:]

Thanks. Greg, you talked about international expansion as one of your areas of focus. That's been a big part of the NuVasive growth story the last couple of years. As you come in and look at the business with some fresh eyes, are there things that you think the company should be doing differently with regard to the international business, are you advocating a more aggressive build-out, or really just a continuation of what we've seen.

[Gregory T. Lucier:]

A couple thoughts I'd add, again, first, we have done a very nice job in the outside U.S. business growth. This last quarter is a great example of that. Where we can go farther and faster, though, is to enter more directly a couple new countries, China, perhaps Brazil, so that would be one new area of expansion for the company. The second would be more philosophical. Where we have done very well, we have basically replicated the strategy we had here in the United States which is that we enter a market using XLIF and then we radiate from there. When we have tried to actually enter countries and be, for example another Medtronic, it doesn't work as well. And so being true to who we are when we enter into these countries is the learning, and so you're going to see us be more focused, be more intense in terms of our supportive resources in the countries we select, and I think you'll see us grow even faster. Those are two elements I'd add in terms of what we can do more in terms of our international expansion.

[Chris T. Pasquale:]

That's helpful, thanks. And then can you talk a little bit more about the strength in the cervical business this quarter. 9% is a pretty good number coming off of somewhat challenging 2014. How are you thinking about that piece of the business going forward?

[Quentin Blackford:]

Yeah, so this is Quentin here. Look, Q1 was a good quarter for us and really Archon, which was a product launched in Q4 gave us a great product offering in the anterior fusion segment of that market. That's seen great results, so – now we're still early in that launch. Obviously 9% in the quarter was a bit ahead of where we thought we would be. We're excited about what we're seeing there, but we'll let that play out for a while before we start to predict anything significantly different than where we're at currently.

[Chris T. Pasquale:]

Thanks.

[Operator:]

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

[Larry Biegelsen:]

Good afternoon. Thanks for taking the questions, and Greg, also looking forward to working with you. So let me start with the guidance. I think you grew the operating margin by 450 basis points in Q1, but you're guiding to I think a 300-basis point improvement, despite a late Q1 expiration of the Medtronic royalty and the settlement with the OIG, which I think should reduce your expenses. So why can't the operating margin improvement be better in 2015 than you're guiding to?

[Quentin Blackford:]

Yeah, Larry, this is Quentin here. Obviously, we're only one quarter into the year. Now, with respect to your comment around some of the legal clarity, the OIG specifically, you did see us bring the SM&A guidance down by about 30 basis points. That really is reflective of the greater clarity we have around some of those matters. The mix with the strength of the U.S. Biologics and international and the gross margin is essentially consuming that 30 basis points. So that's what you're seeing played through in kind of the tweaking of the numbers on the full-year basis. Clearly we're only one quarter into this. So we're very pleased with how we started the year, but we'll wait to come back and refine those expectations as we get further into it.

[Larry Biegelsen:]

Thanks. And let me, for my follow-up, switchgears to the international expansion. Greg, could you give us your thoughts on M&A in general and how you think about dilution? And I thought in your prepared remarks you talked about entering China. If that were through an acquisition, is that – how would you think about dilution there? Thanks.

[Gregory T. Lucier:]

So China is a good growth market for NuVasive. We should be there. We haven't made any decisions whether it would be organically or inorganically. So let me just take your question more broadly, which is that if this company were to make acquisitions, we would do so in a very responsible way in terms of return on invested capital. If it's a smaller acquisition, you'd want to be able to get your return on invested capital above your weighted average cost of capital within the next 36 months. If it's a larger thing, then my rule of thumb is it can't be outside of five years. But again that's just more general principles. We haven't made any decisions, as I said, about acquisitions. Our main goal is to grow organically and I think you can see by our results we're pretty darn good at that.

[Larry Biegelsen:]

Thanks for taking the questions, guys.

[Operator:]

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

[Raj S. Denhoy:]

Hi. Thanks for taking the question. Just really want to ask around your comments about the culture. At NuVasive it's been such a key aspect to the company over the years and with the departure of Alex and Keith Valentine before that, I'm curious how that doesn't change. And maybe that's not such a bad thing and I'd love to get you just general view on how you expect to preserve it and if not, areas where it might need or have to change.

[Gregory T. Lucier:]

Let me tag-team and answer to your question with Pat. The first I would say is one of the great decisions Alex made was to promote Pat to be the President. As I said in my prepared remarks, this is a great leader. He is the visionary behind the company, and putting him in a position of greater responsibility I think was a very smart move. And so you have an individual like Pat, like Quentin, others that are real collectors of a culture and perpetuators of a culture. And so you should rest assured that this management team is broader than a couple people and that reservoir of who we are and where we are and what we want to do is pretty deep. That said, one of the things that I've said to the group as I've done my travels and I've met my fair share of people is a great culture is also one that has great curiosity and doesn't get too, too caught up in itself. And I think that's where NuVasive can further evolve its culture for the better where not only can we be proud of what we've done, and there's a lot to be proud of, but curious about how we can be even better, and I think you're going to see that type of hunger for whether it's profitability improvement, whether it's growing even faster internationally, that type of culture of striving for a better way will be even more ingrained I think going forward. But Pat, maybe you can add a few things.

[Patrick Miles:]

Yes. I think it's a reasonable question. I think the issue is you have to see the inside of the company. And I will say the heart of the company has never beaten stronger. I look at what we're doing from an innovation perspective, and there is authentic buy-in. And I think that it's a reflection of really the culture that was created years ago, but it's required to evolve, and it will perpetually evolve based upon what the requirements of the business are. And so, I've been here before commercialization. I've never seen people more enthusiastic about what we're trying to accomplish.

[Raj S. Denhoy:]

Okay. Maybe just for my follow-up I can ask about something you raised this idea of profitability or operational excellence. And I'm curious how you – or if you view revenue growth and profitability as kind of mutually exclusive in a sense, and whether company has perhaps tilted over the last several years too much in one direction, and now you need to go in the other direction and how those two pieces really play out in your mind?

[Gregory T. Lucier:]

Well, as I said in my prepared comments, I think we can continue to grow very fast organically and yet become more adept on the operation side. And as we become more adept on the operation side, we can drive that profitability higher. Look, the information systems in the company are good, but not great. It requires then a lot of duplication. Processes can be refined, and savings can be extracted. As I said, the manufacturing is not to the maturity level that we would want for a company that over the next 24 months will punch through a $1 billion in sales. All of that adds up to very nice margin improvements that some of them we deliver to shareowners, as we've talked about in terms of becoming more profitable, and some of it we put back into the business to continue that very fast organic growth rate.

[Raj S. Denhoy:]

Okay. That's helpful. Thank you.

[Gregory T. Lucier:]

You bet.

[Operator:]

Thank you. Our next question comes from the line of Bob Hopkins with Bank of America Merrill Lynch. Please proceed.

[Robert Adam Hopkins:]

Hi. Thanks for taking the questions. Just two quick ones. Quen, first, just to follow up on some of the earlier questions, you guys are on a $1.20 run rate, and you're sticking to the $1.10 guidance. Is there something that you're seeing besides the 30 basis points on the SG&A, or is that really just the bulk of it, just conservatism and it's early in the year?

[Quentin Blackford:]

No. I think to Greg's point earlier, we're going to make sure we're making the proper investments to ensure that we can grow this company as quickly as we can. And certainly the guidance is going to continue to enable us to make those necessary investments over the coming quarters. To the extent we get further into the year and have greater clarity on what the full year might look like, we'll take that opportunity to update it. But at this point we want to make sure we've got the opportunity to make the critical investments that are necessary.

[Robert Adam Hopkins:]

And then, Greg, just for you, it may be too early to ask you this, but I'd love your take on the outlook for pricing generally at NuVasive, separate from mix, because it's one of the things that really stands out at the company currently relative to the overwhelming majority of your peers. And again, I realize it might be a little early to ask you that kind of a question, but it is a price-pressured industry. Just your confidence as you look at the business in terms of maintaining that very low-single digit price pressure that separates you from the pack.

[Gregory T. Lucier:]

Very good question. One of the benefits NuVasive has compared to its competitors is it is incredibly focused. We are a category killer, if you will, and because of that you have very strong leadership focused on these things like price, like mix, that you would probably not see in a much bigger enterprise, quite frankly, because it wouldn't be as focused. And so from my former life I can tell you I know a lot about pricing, and as I've walked into NuVasive I think this company is very good at pricing, and I think you're seeing it demonstrated in the results.

[Robert Adam Hopkins:]

Thanks for the time.

[Operator:]

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

[Matt C. Taylor:]

Hi. Thanks for taking the question. So just wanted to ask one about iGA. You had a lot of enthusiastic comments about the launch year. I think last time we touched base you said you really didn't expect a lot of revenue contribution this year and didn't want to get too far ahead of yourselves. Could you just talk about what you expect in terms of revenue this year or maybe from a high level over the medium term from that?

[Quentin Blackford:]

Yes. Matt, this is Quentin. We're not going to get into disclosing revenue expectations down at the product level. The reality is iGA, we announced the launch of it this morning. It's something that will ramp up over the course of the year. So it's not as if we've got a full launch out the door this afternoon. It's going to take time to get sucked (1

[Matt C. Taylor:]

Great. And I think you've sort of wrapped up the transition issues pretty well here in terms of discussing the impact or lack of impact that it's had on NUVA, but I guess could you just address in terms of the CEO transition whether NuVasive loses or gains anything with Alex leaving? And what is his role going to be over the next 18 months as he serves as a consultant?

[Gregory T. Lucier:]

So we have a consulting agreement with Alex. He is on call to be a resource for the company, whether it's questions we have inside the company or potentially helping with certain relationships. So that's in place with Alex right now.

[Matt C. Taylor:]

Okay. I guess you're basically saying that you don't think there's going to be any negative impact from the transition.

[Gregory T. Lucier:]

I think we've tried to answer those questions very thoughtfully, and I hope you can hear from our voice, from our answers that the company is in a very good position. The company is beyond one person, and it's a real tribute to that person that the culture they have is sustained and couldn't be stronger.

[Matt C. Taylor:]

All right. Well said. Thanks for the answer.

[Gregory T. Lucier:]

You bet.

[Operator:]

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

[William J. Plovanic:]

Great. Thanks. Good evening. Can you hear me okay?

[Gregory T. Lucier:]

Yes, we can.

[William J. Plovanic:]

Good. Thank you for taking my questions. First of all, just Quen, on the acquisition of the IP, you have an upfront charge. You said it'll start impacting the P&L in 2016. Just what type of impact to the P&L does that have?

[Quentin Blackford:]

Yes. Bill, this is something that's been running through the P&L for a while now. We've licensed the rights to this. What we did was took the opportunity to acquire the exclusivity around it and essentially get it at a discount, which means that future periods, as the international business really starts to grow, becomes a benefit to us. There will be savings realized at that point in time. So the real savings are going to come out in 2016, 2017, and all the way up through 2023 when the patents would expire. So it's not a whole lot of a benefit in 2015 relative to any of the expectations that we've already set, but it will be something that will benefit us in the future periods.

[William J. Plovanic:]

Great. Sounds like this is something that will benefit the gross margin, so it will help drive gross margin because I would assume a royalty would flow through there?

[Quentin Blackford:]

That's accurate, yes.

[William J. Plovanic:]

And is this 50 bps, 100 bps, I mean how do we think about that?

[Quentin Blackford:]

Yes, we'll talk about that as we get into 2016 and start setting those expectations.

[William J. Plovanic:]

Okay. And then my next question is with the Medtronic, with that ruling coming back, does that change the amount that you accrue for royalties in 2015 and 2016?

[Quentin Blackford:]

Yes. Theoretically, Bill, it would. The issue is you've got to consider the fact that the royalty on the key products there expired at the end of February this year, 2015. So there's not much of an ongoing royalty that will continue to accrue, especially with Medtronic and certainly you're not going to see much of any benefit either.

[William J. Plovanic:]

Okay, so basically it would have been historical. It's not really going to benefit going forward is what you're telling me?

[Quentin Blackford:]

Yes, that's accurate.

[William J. Plovanic:]

Okay. And then on your CapEx, that was a lot of CapEx, especially since the iGA is a concept, a strategy than a specific product. And I'm just curious what should we expect for CapEx this year? What exactly is that going to and then the same question for 2016?

[Quentin Blackford:]

There's no question that CapEx was heavily loaded in the first quarter of this year relative to what you've seen in historic periods. So you do see a bit of a timing difference and a lot of what you see driven by that is Reline, trying to get the assets in the door, start to build out those sets and be in a position to roll those out over the course of the year. So we've tried to bring those in as early as we could in the year and take as much of an advantage of it as we possibly could. In terms of full-year expectations, I'd say we'd be slightly ahead of where we were last year, or slightly more in terms of CapEx and that's really because of the large Reline launch. But you'll see that number start to come down over the remaining quarters.

[William J. Plovanic:]

But if I look at CapEx for last year, I think – I'm just trying to flip it up real quick...

[Quentin Blackford:]

It should've been in the mid-to-high $50s million.

[William J. Plovanic:]

Okay.

[Quentin Blackford:]

We were about $30 million in Q1. So I would expect us to get back similar to that full-year number of last year just a little bit more than what you see there.

[William J. Plovanic:]

Okay, great. That's all I had. Thanks.

[Quentin Blackford:]

Yes.

[Operator:]

Thank you. That is all the time we have allocated for questions. I would like to turn the call back over to Mr. Lucier for closing remarks.

[Gregory T. Lucier:]

Thank you, everyone, for calling in. We appreciate your interest in NuVasive. This concludes the call.

[Operator:]

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