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NuVasive (NASDAQ:NUVA)

Q2 2012 Earnings Call

July 25, 2012 5:30 pm ET

Executives

Patrick F. Williams - Vice President of Finance & Investor Relations

Alexis V. Lukianov - Chairman and Chief Executive Officer

Michael J. Lambert - Chief Financial Officer, Principal Accounting Officer and Executive Vice President

Keith C. Valentine - President and Chief Operating Officer

Analysts

Matthew S. Miksic - Piper Jaffray Companies, Research Division

Raj Denhoy - Jefferies & Company, Inc., Research Division

William J. Plovanic - Canaccord Genuity, Research Division

Richard Newitter - Leerink Swann LLC, Research Division

Robert A. Hopkins - BofA Merrill Lynch, Research Division

Lawrence Biegelsen - Wells Fargo Securities, LLC, Research Division

John M. Putnam - Capstone Investments, Research Division

Christopher T. Pasquale - JP Morgan Chase & Co, Research Division

Glenn J. Novarro - RBC Capital Markets, LLC, Research Division

Matthew Taylor - Barclays Capital, Research Division

David H. Roman - Goldman Sachs Group Inc., Research Division

Denis Kelleher

Matthew O'Brien - William Blair & Company L.L.C., Research Division

Jacob Messina

Michael Matson - Mizuho Securities USA Inc., Research Division

Spencer Nam - ThinkEquity LLC, Research Division

Jeffrey D. Johnson - Robert W. Baird & Co. Incorporated, Research Division

Operator

Greetings, and welcome to the NuVasive Inc. Second Quarter 2012 Earnings Release Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Patrick Williams, Vice President of Strategy and Investor Relations for NuVasive. Thank you, Mr. Williams, you may begin.

Patrick F. Williams

Thanks, operator. Welcome to NuVasive's Second Quarter 2012 Earnings Conference Call. NuVasive's senior management on the call today will be Alex Lukianov, Chairman and Chief Executive Officer; Keith Valentine, President and Chief Operating Officer; and Michael Lambert, Executive Vice President and Chief Financial Officer.

During our management comments and our responses to your questions, certain items may be discussed which are not based entirely on historical facts. Any such items should be considered forward-looking statements that involve risks, 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 NuVasive's most recent 10-Q and 10-K forms filed with the Securities and Exchange Commission.

Finally, to keep the conference call to a manageable time, we will be limiting the Q&A to approximately 30 minutes.

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

Alexis V. Lukianov

NUVA continues its market share taking execution. We are now halfway through 2012 with a very solid foundation to build on for the balance of the year. Revenue for the second quarter grew 16% year-over-year and 19% for the first half. We also saw a very strong sequential profitability leverage, reporting a 16.3% non-GAAP operating margin for the quarter, and 14% for the first half. This translated to a $0.27 non-GAAP EPS this quarter.

Our cash generation in the quarter was also outstanding, resulting in our highest free cash flow of all time. I am really pleased with the global execution of our market share taking strategy and with the strong operating margin and earnings translation.

As I mentioned in our first quarter earnings call, we continue to focus on executing to annual expectations, and our first half performance gives us confidence to increase both our revenue and profitability guidance for the full year. We are raising full year revenue guidance by $10 million to approximately $625 million, which implies year-over-year growth of over 15%.

We are also raising our non-GAAP operating margin guidance by 50 basis points, and now expect approximately 14.5% for the full year. Accordingly, we are raising our non-GAAP EPS to $0.97. Execution against these objectives in 2012 will serve as a stepping stone on our path toward becoming the #3 global spine player and driving toward $1 billion in revenue with continuously improving profitability.

The global spine market though continues to be challenged, but we believe it is showing signs of stability. International markets are showing modest growth rates, while the U.S. market continues to see pressure from insurance payer pushback, position on distributorships and general uncertainty in the health care environment. Our market share taking strategy remains unchanged, and our execution in the first half speaks to this despite the industry challenges.

Our unparalleled focus on products with complete procedural solutions to drive better patient outcomes and reduce health care costs will continue to deliver growth at multiples to the market. We also continually balance the required investments to further drive market share gains while delivering on our profitability objectives. Our decisions have fueled industry-leading growth since NuVasive went public over 8 years ago.

Similar to the prior earnings calls, I will provide an update on the key investment decisions that will sustain NuVasive's differentiation for years to come, and optimize the increasing value of our enterprise.

First of all, products and services. NuVasive's role as a leader of innovation in spine is mission-critical to the continued success of our share taking strategy. By the end of the year, we expect our portfolio to boast over 80 innovative spine products which address both minimally-invasive and traditional procedures. Our commitment to reinvent our portfolio by developing game-changing products also remains unchanged and will position NuVasive ahead of the competition.

In the first half of this year, we launched additional indication-specific implants for XLIF sagittal alignment, new lateral fixation options, extension of MAS TLIF and the new MaXcess C-retractor for the cervical spine. Soon, we will launch a new posterior approach known as our MAS CLIF. This will redefine the traditional posterior approach into a less invasive, medialized procedure for posterior pathology that requires direct decompression. With our sights set on becoming a $1 billion company with increasing profitability, you can expect that we will continue to have a solid MIS development pipeline.

With regard to our cervical TDR device known as PCM, we continue to plan for an eventual approval later this year. However, we still do not know exactly when FDA will give us approval. Launch of this device would mark our foray into motion preservation of the cervical spine.

As we mentioned on our last call, protracted FDA delays and a less-developed reimbursement landscape for the PCM and similar motion preservation products, have severely impacted the addressable size of the market. Nonetheless, it is a very exciting segment of minimally-invasive surgery with excellent outcomes. We have not included, however, any 2012 revenue for this product in our newly raised guidance. We plan to provide updates and general forecasts once we gain clarity on the timing of this launch.

As well, we continue to work toward U.S. clearance of our synthetic biologic AttraX, but we have no further updates at this point in time. As a reminder, AttraX augments our existing portfolio of biologics solutions, which we believe can compete head-to-head with the industry leader at a more economical price point.

On the monitoring front, we are only 3 quarters into our acquisition of Impulse Monitoring, which enables NuVasive to offer the most comprehensive neuromonitoring solutions available to hospitals and surgeons. The clinical prowess of the Impulse team continues to demonstrate to surgeons the power of integrated neuromonitoring and the technical superiority of our monitoring solutions. Offering a complete procedural solution to a surgeon is a unique advantage, and we are beginning to see the results as monitoring case volumes continue to grow to record levels.

We are also starting to see early signs of leverage as the Impulse neurophysiologists learn the NeuroVision M5 platform and the NuVasive hardware sales force leverages our in-house service capability. Strategically, the acquisition is rolling out as we hoped, and we remain on track with our expansion plans to add 40 neurophysiologists by the end of this year, many of whom were hired late in the second quarter.

The Impulse sales cycle is similar to the adoption of XLIF and NeuroVision, whereby the introduction to NuVasive through monitoring can eventually develop into a deeper relationship across other lines. As the strategic rationale behind the combination plays out, we expect to drive surgeon conversion and accelerate the penetration of both our monitoring service and hardware products.

Our case volumes are growing as planned, while we have also seen a tightening of monitoring reimbursement by some payers, which has led us to slightly trim our U.S. monitoring service revenue estimate by $3 million to around $42 million for the year. Clinical execution by Impulse has been outstanding for the first half of the year, and we look forward to continued growth in our integrated monitoring platform.

Clinical research is another crucial element of our share taking strategy, and we remain committed to fostering the development of the body of evidence in support of spine fusion. Our efforts continued in Q2 with steady progress on multiple postmarket studies covering not only XLIF, but also the differentiation and utility of NeuroVision M5 in various procedures and studies such as MAS TLIF.

As well, we saw an additional publication demonstrating a 10%-plus savings in perioperative charges when comparing XLIF versus ALIF. Our support of the surgical societies in developing the Health Technology Assessment or HTA, is also making great strides. The HTA is now complete, and we anticipate it will be published within 6 months. This collection of clinical data will provide evidence in support of spine fusion that surgeons and societies can use in dialogue with insurers.

NuVasive is the leader in its dedication to support the clinical community to publish peer-reviewed data, demonstrating the positive change that our procedures can have on patients' lives. This quarter, over 175 surgeons attended our annual meeting for the Society of Lateral Access Surgery or SOLAS. SOLAS is clearly delivering on the society's mandate to advance the knowledge and science of lateral surgery and to facilitate greater surgeon education and collaboration. It is programs like this, along with supporting scientific societies, registries and clinical databases, that will further raise the clinical bar and help advance the best surgical modalities for spine patients.

Our commitment to being absolutely responsive to surgeon customers is another critical differentiator for NuVasive, and another major element of our share taking strategy. This strategy is being replicated internationally and will be a key part of our revenue growth. Our vision is to replicate the success and adoption curve that we have demonstrated in the U.S. This has required tremendous investment into the development of an absolutely response in this culture and dynamic infrastructure in international markets. And it means finding the right top performers to spearhead our new market entries with our vast product portfolio and introducing to surgeons and hospitals overseas to NuVasive's results and high-performance culture.

It also means offering those surgeons the same best-in-class customer service that U.S. surgeons enjoy. We call it Cheetah Speed and that means having the equipment and inventory on-site to meet demand and cultivate long-term relationships with customers.

Commitment and execution have driven outstanding international results for the first half, and we are now preparing to enter the Japanese market. This is the second largest market in the world. Our infrastructure ramp is in the works, and we remain hopeful for a Q4 2012 launch on select products as they clear registration. We'll provide further details as we approach commercialization. Our guidance revision today does not assume any incremental revenue from Japan.

Our international expansion will be a critical driver of future growth, and after several years of investment, we have reached an exciting inflection point as the scale of our international efforts will finally begin to contribute to profitability.

Before I turn the call over to Michael, I'll provide a quick update on our ongoing patent litigation case. The district court still has not yet determined the royalty rates that will apply during the period of time from the verdict through the appeal. We now anticipate that this may not happen until the fourth quarter or even later.

As we reported earlier, the federal appellate process for Phase 1 has formally begun, and we are eager for justice to be served in the long run. As a reminder, the 973 patents pertaining to the lateral implant in dispute expires in 2.5 years. Phase 2 of the case in the District Court is beginning, and we expect to start claim construction in Q1 of 2013. This will involve a single patent asserted against us related to our cervical plate line which comprises only about 3% of the total revenue. The remaining patents in the case are also cervical, and in various stages of administrative review with the U.S. Patent Office and will not be part of this Phase 2.

Finally, the oral arguments in the appeal of the NeuroVision trademark case occurred in June. This is the last substantive step of the federal appeals process, and we now await a decision hopefully later this year. We remain confident in our ability for a more favorable resolution.

For all of these stated legal issues, we have taken the steps necessary of securing cash and incorporating the anticipated final financial impacts into our guidance.

Now I'm going to turn it over to Michael.

Michael J. Lambert

Thank you, Alex, and good afternoon, everyone. Our revenue for the second quarter of 2012 was $154.4 million, a 16% increase over the second quarter of 2011 and an approximately 9% increase excluding our IOM service revenue. The strength of revenue results in the quarter was broad-based and demonstrates excellent execution within a challenging global spine environment. This brings our results in the first half to an overall growth rate of 19%.

Year-over-year revenue in the second quarter for U.S. lumbar grew about 5%, with year-to-date growth of 8%. U.S. Biologics also grew around 5% and year-to-date was approximately 11%. Global Biologics revenue grew roughly 8.5% to well over $26 million in the quarter. On a year-to-date basis, growth here was nearly 14%. U.S. cervical revenue grew just over 17% and is up over 19% year-to-date. The services revenue portion of the Impulse Monitoring business was $10.2 million.

Finally, International revenue, including its Biologics component, grew over 40% to just over $14 million, with year-to-date growth just a bit under 40%. All of this detail is provided for your reference in the supplementary financial information posted on our website in the Investor Relations section.

Overall, we were pleased with our revenue performance in the quarter and for the first half. Our Q2 2012 GAAP net income was $2.9 million or earnings per share of $0.06.

Excluding an aggregate adjustment of approximately $9.2 million, net of tax, for the adjustments detailed in our press release, second quarter non-GAAP earnings were approximately $12 million or $0.27 per share. Gross margin in the second quarter was 76.3% compared to 80.8% in Q2 2011 and 75.7% in Q1 2012.

Year-over-year, gross margin was primarily impacted by patent litigation royalty expense, which drove roughly 180 basis points of impact and by the acquisition of Impulse Monitoring, which drove about 310 basis points of impact. Hospital pricing pressure was immaterial in the quarter.

Research and development or R&D expenses adjusted to exclude stock-based compensation and acquisition-related items totaled $8.7 million in Q2 2012 compared to $9.2 million in Q2 2011 and $9.9 million in Q1 2012. R&D expense as adjusted was 5.6% of revenue for Q2 2012 versus 6.9% in Q2 2011 and 6.5% in Q1 2012. Relative to last year, the decrease in R&D as a percent of revenue was caused by the addition of Impulse revenue, which comes without a heavy R&D component to it, and by the lower spending on clinical trials, FDA approvals and studies.

PMA-related expenses are notably down as we take a wait-and-see strategy with the FDA approval process on such devices. However, we continue to invest in our product pipeline through 510(k) applicable products.

Sales, marketing and administrative or SM&A expenses adjusted to exclude stock-based compensation, certain intellectual property litigation expenses and acquisition-related items totaled $84.1 million for Q2 2012 compared to $75.3 million in Q2 2011 and $87.2 million from Q1 2012. SM&A expense as a percent of revenue was 54.5% in Q2 2012 versus 56.6% in Q2 2011 and 57.5% in Q1 2012. The year-over-year decrease in SM&A as a percent of revenue is mostly attributable to the addition of Impulse, which has a less intensive SM&A structure than the rest of NuVasive, with the remainder being improved operational efficiency in our distribution area.

On an absolute dollar basis, the year-over-year growth in SM&A expense is primarily attributable to higher spending on variable costs, including additions to headcount and related compensation, continued international expansion, higher set depreciation to fuel growth in our loaner model and the addition of Impulse.

As a result of the above-mentioned gross margin, R&D and SM&A results, our second quarter non-GAAP operating margin was 16.3% compared to 17.3% in Q2 2011 and 11.7% in Q1 2012. Compared to Q2 last year, Q2 2012 results include the impact of both patent litigation royalty expense and the Impulse acquisition. Normalizing for the impact of these 2 items, Q2 2012 non-GAAP operating margin would have been 18.9% or 160 basis points of year-over-year improvement, which demonstrates progress on the operating margin front. On a sequential standpoint, the strong Q2 non-GAAP operating margin was a result of operational efficiencies, timing of certain expenses and active management of operating expenses.

Interest and other expense net totaled $7.3 million in the quarter compared to $1.7 million in Q2 2011 and $6.2 million in Q1 2012. Included in this total is about $6.8 million of interest expense related to both our old and new convertible notes with $3.1 million representing the noncash portion of the new notes and $3.7 million representing the remainder, the vast majority of which is cash.

For the second quarter, cash provided by operating activities came in at roughly $26 million, leaving us at nearly $66 million year-to-date. Excluding the refund received from an overpayment made to a taxing authority in Q4 2011, the year-to-date number is almost $55 million. When you adjust that $55 million to exclude capital expenditure so far this year, we have generated nearly $31 million in free cash flow in the first half of 2012. That first half total already significantly exceeds last year's total for the full year.

We are pleased to see this strong performance given our team's continued focus on improving our cash generation capabilities. We are clearly making progress.

Our cash and investments balance at the end of the second quarter was approximately $266 million, which is net of the approximately $113 million which we recently escrowed for the patent litigation. Normalized for this escrow, our ending cash total would have been approximately $379 million, which compares to 2011's ending balance of approximately $342 million and to last quarter's ending balance of $364 million. We are pleased with the progress in our cash generation relative to both operating and free cash flow.

At the end of Q2 2012, our inventory position was roughly 21% of annualized second quarter revenue compared to about 22% at the end of Q2 2011 and roughly 20% at the end of Q1 2012. Days Sales Outstanding or DSO, when run off of our net AR balance, was 50 days in the quarter compared to 53 days for last year's Q2 and 50 days at the end of Q1 2012. The AR team posted another solid quarter of cash collections, which helped us improve DSO year-over-year, even in spite of a day's worth of upward DSO pressure due to the outsized growth of our international revenues that generally have longer collection cycles.

Now let me turn to our updated guidance for the full year 2012. Please reference the tables in today's press release for additional detail. And as I mentioned earlier, we have posted supplementary financial information on our website in the Investor Relations section. The file should be a substantial aid to those of you building models, as it has a bridge from GAAP to non-GAAP EPS for quarterly results in 2011, the first and second quarter of 2012 and a view for full year 2012 guidance.

We are increasing full year 2012 revenue guidance to approximately $625 million, up from approximately $615 million. As well with half of the year completed, we are updating the growth rates for our various revenue components. We now expect U.S. lumbar growth year-over-year to be approximately 7%, up from 6%, and we expect U.S. Biologics growth to be approximately 5%, up from flat growth previously.

Our expectation for U.S. cervical growth remains unchanged at approximately 15%, and we now expect international growth to be about 40%, up from 35%. As Alex mentioned, we have seen a decrease in reimbursement rates in the U.S. monitoring service component compared to last year. Despite some rate improvements in the second quarter, we now expect to be around $42 million versus our prior expectation of approximately $45 million. The year-over-year quarterly growth rates in each of these areas may vary a bit as we move through the balance of the year, and as a result, the final revenue contribution of each may also vary. But this is the best estimate we have at this time, and we remain focused on delivering to our revised full year numbers.

Turning to the rest of the P&L. We are increasing our full year non-GAAP operating margin to approximately 14.5%, up from approximately 14%. We now expect full year 2012 gross margin to be approximately 75.5% versus our prior guidance of 76%, driven primarily by product mix issues even on a higher revenue.

Non-GAAP operating expenses are now expected to be lower at approximately 61% of revenue versus our prior guidance of 62%. As we think longer term, we expect R&D expense to eventually increase back toward historical levels, which of course suggests that the main driver of our future profitability improvement will be further SM&A leverage.

In terms of the remaining quarters of 2012, consistent with our history, we anticipate revenue results to be flattish sequentially from Q2 to Q3 with a material ramp up in revenue and corresponding profitability at the end of the year. Accordingly, we expect our non-GAAP operating margin in the third quarter to be noticeably below the approximately 14% result from the first half of 2012 as we see gross margins come off their Q2 level and as we increase spending in Japan to finish the regulatory process and to build out infrastructure and create an initial sales and marketing capability in that geography.

As a reminder, non-GAAP operating margin guidance excludes stock-based compensation, certain intellectual property and litigation expenses, amortization of intangible assets and acquisition-related items. Full year 2012 other income expense is unchanged at approximately $27 million, which will include about $12.5 million in noncash interest expense.

We now anticipate a full year 2012 GAAP effective tax rate of approximately 55%, down from 60%. While we generally expect our effective tax rate to improve some each year as we move forward, significant progress will be dependent on international revenues and earnings, becoming a more meaningful percentage of our total mix.

Non-GAAP adjustments continue to be tax effective from approximately 40% for the full year 2012. Diluted shares outstanding for the full year 2012 remain unchanged at approximately 45 million. And finally, we now estimate full year 2012 non-GAAP EPS to be approximately $0.16 and non-GAAP EPS to be approximately $0.97.

Non-GAAP EPS guidance for 2012 excludes the full year impacts of noncash stock-based compensation of approximately $32 million, down from $34.5 million, certain intellectual property litigation expenses of $2.5 million, amortization of intangible assets of approximately $12 million, acquisition-related items of $1.5 million and as-incurred additional items and noncash interest expense associated with the convertible notes of approximately $12.5 million.

We feel this non-GAAP EPS measure, generally speaking, most accurately portrays the operating earnings power of NuVasive and should be the basis for measuring our progress. The second quarter of 2012 marks another quarter of industry-leading growth, combined with measured improvement in our operating margins, profitability and cash flow.

Now I'll turn the call back over to Alex for closing comments.

Alexis V. Lukianov

Thank you, Michael. 2012 is off to an excellent start for NuVasive. Our first half results give us increased confidence to raise and achieve our full year revenue and profitability guidance for 2012. We continue to make the necessary investments into the sources of NuVasive's differentiation and share taking strategy, which will culminate in sustainable growth and steady improvements in profitability.

Our commitment to maintain NuVasive's innovative prowess to drive superior clinical outcomes and to merge our Absolute Responsiveness culture, are the drivers of our success to date and will carry us well beyond $1 billion in revenue.

Importantly, we saw not only great top line growth year-to-date but also strong improvements in our profitability profile and record-breaking cash generation. As efforts to reduce our cost of goods sold and streamline our business model continue, and as the scale and scope of our business naturally levers operating cost, we believe we can continue to show strong profitability expansion while still making the necessary investments to expand, diversify and fuel our market share taking strategy.

I am very, very proud of the entire NuVasive family. We have established NuVasive as one of the top 4 spine companies in the world, with innovative and integrated procedural solutions that address the entire spine. We are in a unique position as the spine market continues its shift toward minimally-invasive solutions, and we intend to fully capitalize upon it. Our runway has never been longer. As we like to say at NUVA, Onward and Upward! We're now ready to take your questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from the line of Matt Miksic from Piper Jaffray.

Matthew S. Miksic - Piper Jaffray Companies, Research Division

Wanted to ask you if you could expand a little bit about on how some of the new products, you talked about cervical, you talked a little bit about IOM. Just maybe some of the other products, any color you have on things like Precept, your products that are just getting out into the field, products that are out there, any forthcoming products that you see as drivers over the next couple of quarters, and I have one follow-up.

Michael J. Lambert

Hey Matt, it's Michael also. Before we start responding there, Patrick pointed out to me that I said non-GAAP EPS for the GAAP numbers. So just to clarify for everybody, for new guidance, full year 2012 GAAP EPS, we expect to be approximately $0.16 and non-GAAP EPS to be approximately $0.97.

Alexis V. Lukianov

So Matt, really, as you know, new products are key to our success. So what we've seen is, and you know this from our guidance that, that just changed, which is that we anticipate Biologics performing much stronger for the entire year, same with U.S. lumbar, U.S. cervical about the same, and o U.S. performing even more strongly. So I think just as far as color is concerned, we talked about how Impulse is doing. It's hitting record levels as far as the number of cases, so that's going well. The overall integration process has gone extremely well so we expect that to continue to accelerate over time. Overall, our lumbar business is very healthy. The same with really all of our major segments. So I -- we don't really call out a particular product, per se. We don't get into the specifics of one product versus another, and that's because we really think about things in terms of procedural totality and what's involved in conducting an entire case versus one part of it.

Matthew S. Miksic - Piper Jaffray Companies, Research Division

Okay. So but just to be clear, Precept is fully rolled out, is that correct? It's not still in rollout or is that fully launched?

Alexis V. Lukianov

No, Precept is still in a limited release mode and probably will be for at least the next couple of months as we continue to scale inventory and so forth.

Matthew S. Miksic - Piper Jaffray Companies, Research Division

Got it. And then one follow-up, just on -- I'd love to get your perspective on -- you heard your comment on the spine market generally. Maybe if you could talk a little bit about the growth dynamics, penetration dynamics related to MIS or lateral access, how you think you're doing within that market, holding share, gaining share in that segment, any kind of color there would be helpful.

Alexis V. Lukianov

So overall, we see the market in the U.S. as being basically around minus 2%, roughly. And so what we are looking at is a market that seems to be bottoming out as far as we're concerned. We continue to see good performance with regard to our lateral uptake. I talked about SOLAS. What I didn't mention in terms of my prepared remarks is that at our SOLAS meeting, we were expecting about 100 surgeons. Instead, we had 175 surgeons come with their nurses and assistants, it was well over 200 people that came to the SOLAS meeting. I think that speaks very well for the demand of XLIF, as well as the demand for advanced training. So I think overall for us, we feel like the market is really sustaining things pretty well, and we expect further stabilization. And we haven't really seen a lot of price pressure. So that has not impacted us, I think, over the first half of this year. Obviously, that can be a factor in the second half, but we see a lot of stability.

Matthew S. Miksic - Piper Jaffray Companies, Research Division

And just to be clear, the general market for spine, down 2% in the U.S., but stabilizing. Do you have -- you had given some numbers at the beginning of the year around what you think to the MIS segment is growing, given it's growing faster, it's penetrating the overall market. Any sense of where those numbers are now?

Alexis V. Lukianov

We still think it's somewhere in the, I don't know, call it 10% to 15% range. It's hard for us to measure that without having anybody else's data.

Operator

Our next question comes from the line of Raj Denhoy from Jefferies.

Raj Denhoy - Jefferies & Company, Inc., Research Division

Wonder if I could just ask a little bit of clarity on the growth rates you guys posted. First quarter, I think most of us were pretty surprised at how strong the growth was. I think you posted 12% lumbar growth. I know there was an extra day there. But this quarter, it was 5%, and I know that's still well in excess of the market, but I'm curious if you have any explanation as to why it would've slowed that dramatically.

Alexis V. Lukianov

Well, this is honestly what I'm not going to do, which is to go into a quarter-by-quarter dissection. It is not how we look at our business. So I said we weren't going to do this, and I think it's really not the way that we look at things. So we try to annualize our guidance. We look at things in terms of there's obvious fluctuations up and down. And as you know, we've increased guidance pretty dramatically, so we feel like things are very much intact, and our thesis is working when it comes to our market share taking strategies. So I'm not going to get into a sort of quarter-by-quarter dissection of what happened. I'd rather focus on the full year. Happy to talk about the first half of the year. First half of the year saw on the saw [ph], very strong growth, 19% growth for the first half of the year. That's how I look at our business.

Raj Denhoy - Jefferies & Company, Inc., Research Division

No, that's very fair. Maybe I could just segue a bit and take perhaps to the margins. I think the commentary was that in the next quarter, we'd see margins drop fairly significantly. I just want to make sure I heard that correctly, below the 14% or so from the first half. But then I guess you would need a pretty big pickup in the fourth quarter. I'm just curious about the dynamics around what's going to drive those -- that margin progression over the back half of the year. And again, I know its quarterly detail, but perhaps you could just help us out.

Michael J. Lambert

Yes. So you'd have to do roughly high 14s, 15-ish to get to the full year number. You'd have to do that off margin in the second half. When you look at the moving parts on the Q3, we do expect gross margin to be lower. There's a couple of things going on there. We've got the new Impulse hires rolling onto COGS for the first time. And as we've talked about, we also have some challenges on the mix, so while revenue growth is still strong, International and Biologics, which are lower margin areas for us, create some pressure there. I would suggest on the margin side, similar to Alex's prior comments a minute ago, we don't overreact to any of the quarterly swings because we're managing this thing to an annual full year number. On the OpEx side, like last year in some respects, we're trying to invest a little bit to help enable a strong Q1, so those second half investments hopefully helping us get off to a strong start at the beginning of 2013. The drivers there are things like the Japan ramp to finish out the regulatory process. And as we mentioned, trying to build a -- initially build a sales and marketing capability and the infrastructure you need there to start off. We're also going to try and make a few investments in sales headcount like we did last year. We probably have a little bit higher legal spending, too.

Operator

Our next question comes from the line of Bill Plovanic from Canaccord.

William J. Plovanic - Canaccord Genuity, Research Division

Just -- the only question I have, you kind of touched on it, but just on the leverage as we go forward in the free cash flow, I mean, this is a big change of years past. Is this pretty much -- would you expect the path forward? Can we double the cash flow from the front half of the year? And think in terms of we'll start to see these types of improvements going forward? Or should we not extrapolate off of this?

Michael J. Lambert

Yes. Just Bill, remember, there's lumpiness always to the cash flow profile based on quarters you make interest payments on the debt, quarters where variable comp gets paid, all that sort of stuff. We're not going to get into specifics at some point out in the future we will probably end up providing guidance that way, but we're not ready to do that just yet. I would not take the first half and necessarily multiply it by 2 though.

William J. Plovanic - Canaccord Genuity, Research Division

Okay. And then just with Japan, as you look at the cost and all this and the investment being made, you probably don't want to quantify that. But when can you say that at least you feel that Japan would start becoming a breakeven proposition for you?

Alexis V. Lukianov

As far as breakeven, it is going to be really towards the latter part of next year. And as we clear the various product registration requirements that are still in front of us, that hopefully we'll be clearing most of them within the next few months here, then we'll be able to provide some additional color on what the Japan ramp will look like. But until we've completed all of that, we're just not going to get into that. But I can give you some -- a general overview that says probably in somewhere in the range of 4 to 6 quarters, we'd certainly be where we see a breakeven in Japan.

William J. Plovanic - Canaccord Genuity, Research Division

And when you mentioned that you're launching certain products at year end, are those the most important products at the end of this year? Or how do we think about them ? When do you expect to kind of have the full entourage product set available?

Alexis V. Lukianov

So essentially where we are right now is we have NeuroVision has been cleared, and so that's a big positive for us. We're in the process of, looks like we have a cervical clearance underway so we have a cervical plate. We have our retractor cleared. We're still waiting to clear out some of our interbody components, some of our other pedicle screw systems like Armada and so forth. So those are the things that we're waiting for in order to be able to ramp. As you know, you don't want to show up at an account with a spoon when everybody else is using a knife and a fork, so we want to make sure that we've got everything we need in order to be able to effectively compete in that market. But we do expect all of that to happen here in the very near future. And when that happens, we'll provide some additional color on what it looks like over the next couple of years.

Operator

Our next question comes from the line of Richard Newitter from Leerink Swann.

Richard Newitter - Leerink Swann LLC, Research Division

I was hoping we could just drill down a little bit more on the kind of some of the top line growth changes to your guidance. On the neuromonitoring side -- I'm sorry on Impulse Monitoring, if you could just talk a little bit more about what reimbursement issues you were seeing. I think you said that they resolved in 2Q. Kind of what exactly is that? And how is that impacting the business? And then on your o U.S. increase to growth, if that doesn't include Japan, just curious what's giving you more confidence there? Is something happening in Europe? Is it just sales reps starting to get -- gain traction?

Alexis V. Lukianov

So we've had very strong o U.S. performance in all of our markets. Europe has actually fared pretty well. Same with Asia Pacific and Latin America. So I think that's unlike what we saw last year. We're still cautious when it comes to Europe, but it's done well. So I think overall, things have gone very well and, as a result, we've increased our guidance. With regard to Impulse in the first quarter, as we were working through that, what we saw was a bit of a payer pushback. And it was not all the payers, it was just really -- it varies quite widely from state to state. But we saw a little bit of a downtick in some of the reimbursement. We saw a recovery of that in the second quarter, and I think it had to do with also just having a broader swath of business and more payers, which kind of offset a little bit of that softness. So we feel like we're in good shape, and we've done the kind of hiring that we want to get done. So most of that is on track. And so we'll finish the year with somewhere around 200 neurophysiologists, and that will also drive the revenue in the second half and well into '13.

Richard Newitter - Leerink Swann LLC, Research Division

And if I could just ask on biologics, what's changed there? I know heading into the year, you were much more cautious on Osteocel. Last quarter, you did better than expected, and now you're increasing your guidance. Can you talk about what's happening in that part of the business?

Alexis V. Lukianov

Sure. We've -- one of the things that we've talked about for quite a while is that there's really been a requirement of more clinical data, and we started to see now parts of that clinical data make it into the marketplace. So there have been several studies that are favorable to Osteocel, one in the general orthopedic application, which is not one that we're pursuing but nonetheless speaks well to bone fusion, and another one in a spine application with very strong results. So I think that's part of it. But we've gone from effectively 0% to 5% guidance on biologics and feel very good about our ability to continue to leverage and grow that.

Operator

Our next question comes from the line of Robert Hopkins from Bank of America Merrill Lynch.

Robert A. Hopkins - BofA Merrill Lynch, Research Division

So I actually realize you want to get away from the quarterly stuff, which I appreciate. But just generally on the market, in terms of the tone and things you're seeing in the market Q1 to Q2, is there -- any different, do you think, in terms of what's -- anything going on in the U.S. spine market that's worth calling out?

Alexis V. Lukianov

No, we really don't see a difference. It's very, very consistent.

Robert A. Hopkins - BofA Merrill Lynch, Research Division

Okay. And then as far as your business is concerned, anything in the quarter that you think was onetime in nature, good or bad, in the quarter in terms of a difference between Q2 and Q1?

Alexis V. Lukianov

Well, just -- we talked about Impulse and some of the pushback there. Outside of that, that's really it. I mean, we're taking all of our numbers up with the exception of Impulse, which is just slightly taking it down by $3 million.

Michael J. Lambert

And Bob, if your question was around stocking orders or capital equipment orders or anything like that, of course we monitor those things. And if you look back at the horizon quarterly for the last couple of years, no difference really as a percentage of revenue on that side either.

Robert A. Hopkins - BofA Merrill Lynch, Research Division

Okay. And then just lastly real quickly, I just want to ask you a question about the Medical Device Tax and get your updated thoughts on the magnitude of the tax and your ability to offset it. Obviously, this year, you're talking about underlying operating margin expansion of roughly 100 basis points. And so I'm just curious, as we look forward, just any comments updating us on the medical device tax and your ability to offset would be helpful.

Alexis V. Lukianov

Yes, I think at this point, we don't have really much to offer with regard to how we see ourselves offsetting it. We know that it's going to be anticipated as something roughly in the order of $14 million next year. So we're still working through that, trying to understand what we can do in terms of filling out service, meaning Monitoring and Impulse from that. We believe that, that will be -- that that's feasible and likely. So we're still working through that and what we're going to do to mitigate it. We obviously have a number of things that we're planning to do that you can see, for example, in our improved profitability for next year. So we're going to be levering down SM&A even harder as we continue to go forward. So we're going to do other things that will help us to improve our bottom line. I can't really quantify it for you at this point in time, and I'm still really, really hopeful that things will happen in such a way that, that will go away. But we won't know that until, I think, it's November 6.

Michael J. Lambert

And Bob, it's Michael. The final regs on that thing are still not going to be published really until the fall sometime. And I know there's a little bit of jockeying and horse trading, at least from what we heard, about how the -- definitionally about how it all still may fall out. And that definitional question may or may not help or hurt people like ourselves avoid some of the tax or potentially end up paying more. Still a TBD.

Operator

Our next question comes from the line of Larry Biegelsen from Wells Fargo.

Lawrence Biegelsen - Wells Fargo Securities, LLC, Research Division

Alex, should we read anything into the ruling on the ongoing royalties being pushed out or why have they been pushed out?

Alexis V. Lukianov

Yes, it's at the judge's discretion. So it's just kind of her workflow and what she's chosen to focus on and how she's going to go about it. So it's not something that we can really control as far as the calendar.

Lawrence Biegelsen - Wells Fargo Securities, LLC, Research Division

On Osteocel, I mean, I think Orthofix is saying that Trinity is growing a lot faster. Any reason why you think one is growing so much faster than the other? And then I just have one follow-up.

Alexis V. Lukianov

Because they apply it beyond spine. I mean, so certainly, there -- whatever -- I don't know exactly how they're doing in spine other than what you guys publish. So -- but clearly, they have an orthopedic business and a trauma business. And so they apply it in those applications. We don't do that. That's a very small, very tiny part of the utilization of Osteocel for us.

Lawrence Biegelsen - Wells Fargo Securities, LLC, Research Division

Okay. And I realize -- I understand you want to get away from kind of the quarterly guidance, but...

Alexis V. Lukianov

That would be correct, yes.

Lawrence Biegelsen - Wells Fargo Securities, LLC, Research Division

The growth rate decelerated organically to about 9% this quarter from 14% last quarter. And the full year guidance assumes it's about 9% organic in the third and fourth quarter. I guess I'm trying to ask, what gives you confidence that we won't see a further deceleration in the second half of the year?

Alexis V. Lukianov

We expect to execute to what we've guided towards based upon all of the resources that we put to play. So, I mean, I think it's tied to a strong first half for us in terms of our growth prospects. And so we feel it's very attainable. We don't have any doubts or trepidation about our ability to achieve guidance.

Operator

Our next question comes from the line of John Putnam from Capstone Investments.

John M. Putnam - Capstone Investments, Research Division

And Alex, I wanted to ask about the tax as well, but I think you've handled that. And I thought that the editorial that you wrote in the San Diego paper was excellent, and I applaud you for that. And I'll let someone else ask a question.

Alexis V. Lukianov

Thanks very much. I appreciate that. We're going to keep fighting it, too. So it's far from over.

Operator

Our next question comes from Chris Pasquale from JPMorgan.

Christopher T. Pasquale - JP Morgan Chase & Co, Research Division

I just want to -- I have one quick follow-up on the tax subject. Is it your expectation that your neuromonitoring sales will be subject to tax? I would have thought there was at least a chance that those could be exempt.

Alexis V. Lukianov

No. No, that's what I said. I said that we thought that monitoring would be excluded.

Christopher T. Pasquale - JP Morgan Chase & Co, Research Division

Okay, all right. And then one, I guess, more of a strategy question for international. How transferable do you think the absolute response in this approach really is, Alex, as you move into international markets? This may not as apply as much to Japan but in a lot of those o U.S. markets, particularly the emerging ones, we see companies operating under less intensive service models to make up for lower ASPs, things like that.

Alexis V. Lukianov

Yes, and that's always a challenge when you're working with distributors. Clearly, the markets that we've chosen to go direct in, they bleed purple and they run like cheetahs. And so we've been very pleased to see how they're going about cultivating the business in those markets. Australia is a great example, same as the U.K., same as Germany, Puerto Rico, Singapore, Malaysia and soon to come Japan. So the main markets outside the United States are the ones that we chose to go direct in, and that's really where we will stake our reputation for service and responsiveness. I have to say, though, we also have quite a few distributors, though, that really enjoy the culture and buy into the culture and practice the culture. So yes, it's more challenging, but I have to tell you that they are on board and we make sure that we hire the kind of folks that remain on board with the way that we do things.

Keith C. Valentine

I think one comment to add to that. We have sales meetings throughout the year, and the international distributors often do not invest in sending people to those meetings because of the cost and we don't see that. We see their participation. We see them wanting to invest in the training, wanting to invest in what the new products are. And that's something unlike what we have seen in our past lives. And so I think that's a testament not only to Absolute Responsiveness but also those distributors embracing the culture and wanting to expand it.

Alexis V. Lukianov

That's a great point that Keith made. And in fact, what comes to mind is our distributor in Brazil who has really been rapidly increasing market share and doing it through the utilization of our culture, exactly to Keith's point.

Operator

Our next question comes from the line of Glenn Novarro from RBC Capital Markets.

Glenn J. Novarro - RBC Capital Markets, LLC, Research Division

First question, just wanted to clarify on pricing. You said that pricing was not material. In the past, you said pricing was down low single digits. So are you seeing pricing a year ago was down low single digits and this year down low single digits, so nothing, no material change?

Michael J. Lambert

That's right, Glenn.

Glenn J. Novarro - RBC Capital Markets, LLC, Research Division

Okay. And then just on the payer pushback dynamic. In the past, you said that it's still happening but seems to be leveling off or at least not as bad. Any update or color that you can provide?

Michael J. Lambert

I think that's accurate, Glenn. I think it's the surgeons are adjusting to that. It certainly is still out there. And I think that the surgeons have really figured out which tools to use in order to be able to repeal and to be able to be successful with regard to getting our case on. So as I've talked about before, I think what we've seen are longer lead times in many cases, but it's really factored into the market now. So it takes longer in a lot of situations to get a case on, but I think we're really beyond that lag time now.

Glenn J. Novarro - RBC Capital Markets, LLC, Research Division

So just one other follow-up. If the payer pushback is starting to stabilize, not get much worse, what drives the spine market to start getting better? Is it more of the macro, in your opinion, the economy?

Alexis V. Lukianov

I think the economy plays a role. I think, though, there's going to be -- I think a lot of this has to do with what happens to what's known as Obamacare, right, and what continues to be implemented over the next couple of years. But clearly, we believe that that's connected to payer pushback. So whether if that continues to go, which, of course, is what we all anticipate will happen outside of a change in Congress, then I guess that that's probably going to be much more of an issue. If not, there may be some significant changes coming relative to reimbursement. But clearly, it's going to be still be focused more on outcomes, it's going to be focused on the need for data. So there's going to be an ongoing process of pushback no matter what happens over the next several years and a reliance on more and more clinical effectiveness data. That's why we have put so much in the way of resources to work here and have made sure that we have everything we need in terms of faster, better, cheaper. And that's obviously the big play with minimally invasive surgery.

Operator

Our next question comes from the line of Matthew Taylor from Barclays Capital.

Matthew Taylor - Barclays Capital, Research Division

I just wanted to ask one on the trademark litigation. You talked about expectations for a more favorable result, and you're not reserving for it. Can you elaborate on that at all without giving away your strategy, I guess?

Alexis V. Lukianov

What do you mean we're not reserving for it? We've put the cash. There's -- we've basically gone through that process. So I guess we can clarify that for you, but the cash has been restricted now for quite some time since that happened.

Michael J. Lambert

Yes. We just haven't taken an income statement or a P&L hit for it. And the reason is, we think the odds of reversal are probable.

Matthew Taylor - Barclays Capital, Research Division

That's what I was referring to. And then I just wanted to ask about the publication, the HTA. Where can we expect that to be published? And can you give us some color as to how you and the societies are going to use that and promote that one to get published?

Alexis V. Lukianov

Yes, I really want to be able to tell you who and where, but I can't simply because I'm not at liberty to. It's still in the process of making its way into the literature. So I am aware of the status of it, but I am not allowed to disclose it. What I think it's going to do, though, is I think it's going to provide a very important paper, which will really be then put together in the form of an HTA. So this is really a paper that is a definitive overview of the outcomes of fusion in the lumbar spine. And it's a very exhaustive review of the literature. And so what that facilitates then is the preparation of what we're calling the HTA, and the HTA is really a format that is then taken into the payers and allows societies and total surgeons individually, companies for that matter, to be able to come in and deal with payers directly and say, "Here's the data. You're not in a position to pushback and here's why." So this has really not been done heretofore in spine. There are certainly many literature reviews that have been done, and there's all sorts of data that's been out there. And I think that's one of the reasons why we're not seeing the entire payer pushback continue to gain more legs than it has, and that's because the outcomes are so good in so many of the -- in all of the procedures. But I think that's how it's going to be utilized, and we hope to see this thing in print here within 6 months. Certainly, as soon as it can be -- if we can formally tell you what it is, we will. We're just are not in a position to do so.

Operator

Our next question comes from the line of David Roman from Goldman Sachs.

David H. Roman - Goldman Sachs Group Inc., Research Division

Alex, I was hoping you could talk a little bit about how some of the integration efforts are going on Impulse. And I guess specifically, what I'm asking is, I believe at the time of the transaction, one of the benefits you touched on, though, was potential to sort of cross-pollinate the service business with your lateral approach business, and that many of the hospitals where Impulse had a presence, you did not have an excellent presence and vice versa. I mean, how is it sort of tracking relative to your initial expectations? And then any impact the reimbursement dialogue that you brought up has had on that?

Alexis V. Lukianov

So that's still very much in its infancy. We've seen the beginnings of that, and I believe I mentioned that in my prepared remarks. So that's really what we expect to see start to happen over the course of the next 6 to 12 months, is that integration process to take root. That would really be more on the eastern or on the eastern half of the United States, and that's really where Impulse is right now until we continue to get the footprint to be larger. We obviously are having that impact in various pockets outside of the East Coast. But that's really what's driving it at this point in time, is just really the increase of the footprint, and then we'll start to see a lot more of the integration.

David H. Roman - Goldman Sachs Group Inc., Research Division

Okay. And then I think in the response to a previous question, you indicated that you thought MIS penetration was in the 10% to 15% range. And you have a slide that you use in showing the...

Alexis V. Lukianov

Growth, growth.

David H. Roman - Goldman Sachs Group Inc., Research Division

Growth. Oh, sorry. So I think you said that it's really in the 15% range in recent investor presentations in that. Over -- and's that's sort of up -- that's up from like 10% 5 years ago or so, and you sort of expected to go, I think, to -- in a vast majority of the market over time. It sort of seems like we've been stalled in this 15% range. What's sort of the next catalyst to get it moving much higher because the clinical argument seems sort of straightforward? Why haven't we seen more of a commercial uptake? And what gets it moving higher again?

Alexis V. Lukianov

Well, so it's hard for us to gauge, outside of our own performance, really what's happening out there in terms of our competitors. So we can only estimate exactly where things are at. We believe that somewhere around probably 22%, maybe it's a little bit higher now, 23% of the market is minimally invasive. And so we said before that it was 20%. We think that's starting to increase. I think what you're seeing, with all the noise in lateral, is I think we are starting to see certainly much more of an uptick and a focus. And we saw that with our own SOLAS meeting. We're seeing that with more and more advanced applications. So these things, fortunately or unfortunately, I guess, Dave, they take time before they really penetrate into the teaching centers. And still, most of the folks that are coming out of fellowships are being taught to do big, open procedures. And so they've got to come to places like NuVasive in order to be trained and then to go forward from there. So we feel like things are going pretty well. They'd probably be going even faster if it wasn't for the overall environment that we're in economically and some of the pushback that's happening on a broad level. I think if it wasn't for that, it'd probably be picking up even more steam. But what's confounding to us, and I'm sure to you, is that the value proposition is so strong that you think the hospitals would be all over it. In many cases, they are. I do think probably the silver lining of what's happening with health care reform is that hospitals are going to be pushing even more for outstanding results faster, better, cheaper. And so I think that kind of works right into the sweet spot of what they're going to be looking for. So I think over time, we'll continue to see it grow, and I think it's going to be still in that 10% to 15% range. There's no reason to change the forecast for that for the really conceivable future.

Operator

Our next question comes from the line of Josh Jennings from Cowen & Company.

Denis Kelleher

This is Denis Kelleher in for Josh. Just a question on the lumbar fusion reimbursement front. The American Association of Neurological Surgeons responded in June to the Blue Cross Blue Shield of Illinois regarding the restrictiveness of its lumbar fusion reimbursement proposal. Have you heard any updates on whether or not the proposal will be modified? And have you heard of other proposed revisions in the works that you're aware of? And I just have one follow-up question.

Alexis V. Lukianov

No, we've not heard anything with regard to whether or not it's going to go into effect. Our suspicion is that it -- there's not going to be a major change. So that's the latest that we know.

Denis Kelleher

And then the second question is just kind of along the same lines, prepayment audit programs for spinal fusion. T or G Codes have been put in place in Florida by First Coast, in the Midwest by Trailblazer. Are some of these programs impacting your customers at all?

Michael J. Lambert

No, we haven't heard from 2 areas.

Alexis V. Lukianov

Yes, we have not. We have not.

Operator

Our next question comes from the line of Matt O'Brien from William Blair.

Matthew O'Brien - William Blair & Company L.L.C., Research Division

Just on the R&D side, and Michael, I understand that Impulse doesn't necessarily have the level of R&D spending as the other parts of the business. But when you net out Impulse for the quarter, R&D as a percentage of revenue was about a little under 6.5%. That metric's been trending lower in recent years. Now I'm just curious, your thoughts on the opportunity for more revolutionary-type products within the spine industry going forward. Is this -- is that metric indicative of your outlook there? Or I guess how vehemently do you disagree with that statement?

Michael J. Lambert

Well, as I mentioned, I think, in my prepared remarks, we do expect that R&D percentage to tick back up towards historical levels over time. I mean, I think you got a couple of things going on. You got some clinical trials ended, NeoDisc slowing down or ending, XL TDR. And then as we talked about, our PMA-related spend is down as we continue to take a bit of a wait-and-see attitude towards what is happening at the FDA. But we're continuing to fund the 510(k)-related products, and that's still continuing to feed certainly a strong pipeline if you look at some of their recent announcements. I mean, Alex, you want to add anything or Keith?

Alexis V. Lukianov

Yes, I think there's a couple of things to bear in mind, is that I think what Michael just talked about certainly has slowed down our burn with regard to R&D and the lack of certainly PMAs. And I can tell you that as a company right now, we're relatively risk averse when it comes to starting PMAs in the FDA environment that we see today. There's a number of changes in the works, and so, hopefully, as those come through, I think we probably might consider going down that path again. But it's been a very protracted process for us with PCM, for example, for the last 3 years. And we believe we're going to get through that, but we want to get one under our belts so that we can surely move forward. As far as game changers are concerned, I do want to point out that a lot of game changers can still come to market through the 510(k) process. It's no different than how XLIF came to the market. It's all done through a 510(k). Same with the various products that we're talking about for posterior fixation, whether it's MAS TLIF, which is about to be launched, MAS TLIF. The same thing with Precept, which we think is a real game-changing type of product. So we think that there's a lot of things that can still happen through that process. And I think, as Michael pointed out, we do expect to see R&D spending increase as we move into subsequent time frames and especially as we move into '13.

Keith C. Valentine

Yes, I think you need to focus, too, that the new product introductions that Alex just mentioned are all around a procedure. And so it's not just a pedicle screw system. We're also making significant investments and R&D work being done for retraction systems, for example, that are focused on a particular technique and really drive the entire procedure. So the fact that we're moving away from the PMA process because of the uncertainty, and not to mention you get certain devices even into those studies, it's tough sometimes to figure out what the reimbursement pathway is afterwards as well, whereas what we're spending R&D dollars on are very clear reimbursed procedures, and those reimbursed procedures are driven to a procedural level.

Matthew O'Brien - William Blair & Company L.L.C., Research Division

I appreciate the color. I apologize. I've been hopping between calls and I missed that in the prepared comments. Alex, if I could, just one more big picture question for you. The game plan that you've had in terms of taking market share within the spine market has worked out quite well. It's a large market. I'm just curious, how sustainable do you think it is not only as you get larger but just in terms of when you may see some sort of aggressive competitor responses? Or is it something you've seen in the past from a pricing perspective, maybe in a couple of markets here or there, who really try to slow down you taking share within this market? And then is it more on just the traditional side of the market in terms of more penetration of existing accounts? Or is it more new product flow that helps you continue to take the market share?

Alexis V. Lukianov

I think our strategy is clearly sustainable. We believe that it'll take us to well over $1 billion in revenue. I think that we've put together what we believe are the right ingredients and the right way to go about building things. We also do react to what's happening in the marketplace, and we do make adjustments. But honestly, we spend most of our time leading versus following. So we don't really sit there and think about what everybody else is going to do. That's why we're completely redoing posterior fixation. We're really coming up with new ways of doing things, and I think that the surgeons know that our products really are game changing. When you combine that with a robust culture, with a big focus on execution and results, there's no reason to believe that we won't continue to take share and to do that for as long as we continue to employ that strategy, which is what we're running with for many years to come. So obviously, there's people that will try to undercut. And I think if you go back even 1.5 years ago, there were probably what, 8 or 10 companies that went out there with lateral solutions. And there was a lot of discussion amongst analysts about trialing and what was going on, and clearly, that was taking place. And I think here we are with a 19% top line start to 2012 in what is still a very challenged environment. And I think that speaks to the strength of our products and the strength of our programs. And surgeons see that. They tend to stick with that, and they tend to migrate towards that. So I'm very confident in our strategy and the way that we're doing things and its sustainability.

Operator

Our next question comes from the line of Joanne Wuensch from BMO Capital Markets.

Jacob Messina

This is Jake Messina in for Joanne Wuensch. I just had a question on the sales force expansion. I think in the fourth quarter, you said you were just over 300 or so. And I was really wondering if the expansion has had any impact, the new flow of hires, on growth over the last couple of quarters.

Alexis V. Lukianov

The expansion, most of it, took place, as we talked about, in the fourth quarter. We continue to hire on a very typical rate. So no, it's not -- we have not accelerated the hiring process. So we're running to our sort of normal hiring process for 2012.

Jacob Messina

And on IOM, I believe you said there were a few regions that cut reimbursement. Was that correct?

Alexis V. Lukianov

Payers. There was just really -- it was more payer specific versus across-the-board.

Jacob Messina

And is that sort of a reversion to the mean? Or is it something where you might see continued pressure?

Alexis V. Lukianov

I think we're going to see some ongoing pressure. But it's -- it varies quite a bit from payer to payer and from state to state. And I think as we've increased our footprint, it's allowed us to mitigate really that impact. So I think that we've been able to deal with that effectively, and we'll see how things look when we get to '13 and what our forecast looks like towards the latter part of this year really as we give guidance for next year.

Jacob Messina

And lastly, if I could very quickly, I think it was 400,000 in the first quarter for IOM that you called out. Is that about the same thing in the second quarter '11?

Michael J. Lambert

Repeat the question. I'm not sure what you're asking.

Jacob Messina

Oh, I'm sorry. For the -- last year for IOM sales, you called out about 400,000 in the first quarter of '11, and I was wondering if it's about the same amount in the second quarter of '11. When you filed the 10-Q, it had the detail for IOM sales.

Michael J. Lambert

Oh, yes, yes. That...

Jacob Messina

That's where [indiscernible], of course.

Michael J. Lambert

That's -- so that would have related to a small acquisition we made, Sandia. We've now rolled in Impulse and Sandia together, which is why you can't -- you sort of can't separate them easily. So that's all that related to. It didn't relate to Impulse per se, but it related to the Sandia acquisition.

Jacob Messina

Right. Sorry, so I was just trying to clarify if that was the correct amount for the Sandia in the last year.

Michael J. Lambert

And that's all it would be. And those numbers will show up in the 10-Q. We'll have visibility, too.

Operator

Our next question comes from the line of Michael Matson from Mizuho Securities.

Michael Matson - Mizuho Securities USA Inc., Research Division

I guess I just was wondering with regard to the physician and distributors. Do you think that those -- obviously, they're growing rapidly. Do you think that that's hurt your growth rate at all? Or is it really more of an issue for the legacy companies like Medtronic? And to the degree that those were to kind of go away, would that help you guys out at all?

Alexis V. Lukianov

And I apologize, I missed the very part first part of your question. What...

Michael Matson - Mizuho Securities USA Inc., Research Division

Sorry, the -- and so...

Michael J. Lambert

PODs.

Michael Matson - Mizuho Securities USA Inc., Research Division

Yes, PODs, yes.

Alexis V. Lukianov

And sorry, would you just repeat the question? That would probably be easier.

Michael Matson - Mizuho Securities USA Inc., Research Division

Yes. So with regard to the PODs, do you think that the PODs have affected your growth rate? Or is it more of an issue for the bigger legacy companies like Medtronic? And I guess conversely, if the pods were to go away, would that then help you guys in terms of your growth rate?

Alexis V. Lukianov

Yes and yes. I think it's affected the entire market. They've proliferated like mushrooms around the United States. So I think there's no question it's affecting everybody's growth rate.

Michael J. Lambert

Yes, I would say also that the companies that have the larger market share in traditional products are impacted higher. We're all impacted, but those with the most traditional business are the ones that I think we’re seeing the highest impact.

Michael Matson - Mizuho Securities USA Inc., Research Division

Okay. Then my second question would just be on the XL TDR. I know you mentioned it in an earlier question, but I just wanted a quick update on that. Is that something where -- it sounds like the study is completed. And you are still planning to go to the FDA with that or not?

Alexis V. Lukianov

The enrollment is effectively done, so there is still a lot of work to be done in terms of getting that ready for a PMA and putting everything else together. So we don't have any other updates on that, as I'm sure you're aware. By the time you go from enrollment to your follow-up to putting together a PMA, it's still several years away.

Michael Matson - Mizuho Securities USA Inc., Research Division

But at this point, I mean, your comments around PMAs and FDA, I mean, that wouldn't apply to this product assuming that it met the end point, et cetera, and the data is good, right?

Alexis V. Lukianov

Right.

Operator

Our next question comes from the line of Spencer Nam from ThinkEquity.

Spencer Nam - ThinkEquity LLC, Research Division

Just I'll have a couple of quick questions here. Maybe start with guidance just quickly. I know you guys last quarter, you were a little hesitant to make any definitive statements about the outlook. You guys were feeling confident, but you wanted to kind of wait and see how things played out. I was wondering whether, as part of your planning process, you actually had the trajectory that resulted in current -- the new guidance versus the previous guidance or that over the last 3 months-plus that you guys started seeing some improvements in fundamentals that compelled you guys to raise outlook for the rest of the year.

Alexis V. Lukianov

So you want to know exactly how we think about this, huh?

Spencer Nam - ThinkEquity LLC, Research Division

Well, I'm just -- I'm trying to figure out that -- whether you guys [indiscernible] the points that -- near term that made you guys feel [indiscernible].

Alexis V. Lukianov

I understand. I'm just teasing. I understand. I think as we look at the way things have gone, clearly we were hoping for the trajectory that we're seeing now. But our position has been to be conservative as we started the year in particular and to make sure that we guided to annual performance. We did not feel it was appropriate after one quarter to make an adjustment to our guidance. I would not anticipate that we would make an adjustment to our guidance after the third quarter necessarily either. And this may be our only adjustment to guidance for the year, and I think that has a lot to do with how we posture relative to an annual look at our business. So I think your insight is probably correct in terms of how you think about this, but I hope you appreciate that what I'm trying to do is to get away from the quarterly knee-jerk analysis of what happens in spine when you really have to take a broader view of how things really play out.

Spencer Nam - ThinkEquity LLC, Research Division

That's very helpful. I appreciate that. And then just a quick follow-up on competitive front. Do you guys have a specific sort of players or group of players that you are taking share away from? Or is it just across-the-board against all your competitors in the space? I recognize it's getting a little bit crowded right now, but I was wondering if you guys have particular sort of set of competition that you feel very comfortable with versus, say, a couple of years ago when things were a little more challenging at times.

Alexis V. Lukianov

There's companies that we most enjoy taking market share from, but I think it happens across-the-board. So clearly, we compete with the top -- we're a top 4 spine company, and so I think we're going after the lion's share of what's out there. And so we're very effectively gaining market share from all the players.

Operator

Our next question comes from the line of Jeff Johnson from Robert W. Baird.

Jeffrey D. Johnson - Robert W. Baird & Co. Incorporated, Research Division

Two quick ones just at the end here. But -- so Alex, as I look at your guidance, and Larry kind of brought this up before, but 9% constant currency organic growth this quarter. It seems like your second half guidance implies 9%. Is that how we should be thinking kind of about your base business at this point, and then if you get Japan or PCM or anything, maybe hire some new sales reps in fourth quarter as you're talking about maybe getting acceleration off that 9% but the base kind of 9% at this point?

Alexis V. Lukianov

Yes, I think that's about right.

Jeffrey D. Johnson - Robert W. Baird & Co. Incorporated, Research Division

Okay. And then just on the self-manufacturing front, I know you've had some success. I'm blanking on the name of the manufacturer you acquired in Ohio, but feedback on that sounds like it's been pretty good here over the last couple of quarters. How do you think about that opportunity as you go forward over the next maybe 6 to 12 months versus a couple of years?

Alexis V. Lukianov

Yes, and that's something that we're still in the process of really acquiring. So we have rights to that, and we've got a very strong position there. So we've not formally concluded that process. What we've talked about is a transition towards doing more manufacturing in Ohio. So that's still in the works. That would be formalized by the latter part of the year and really for '13. But it's allowing us to reduce COGS. We expect to get more leverage out of it in '13, '14 and beyond, and we're going to continue to look at additional manufacturing sources and additional ways of decreasing our COGS.

Jeffrey D. Johnson - Robert W. Baird & Co. Incorporated, Research Division

Can you remind us what -- yes.

Michael J. Lambert

You should think about it as an investment. It's not, as Alex mentioned just to be clear, not outright ownership at this stage. And the thinking on it at the time was we wanted to sort of put our foot in the water and start to learn the process. And we've been working with that company now for the better part of 12 going on 18 months, and it's been a good thing for the Nuva side to actually pick up and learn how do we run a manufacturing business from the ground up.

Jeffrey D. Johnson - Robert W. Baird & Co. Incorporated, Research Division

Yes, Michael, can you remind us kind of what percentage maybe of products today are self-manufactured or where you think that might go over the next few years?

Michael J. Lambert

It's a small amount today. I don't have the exact percentage, Jeff.

Operator

There are no further questions. I'd like to turn the call back over to management for closing comments.

Alexis V. Lukianov

Thank you, everybody. It's been fun chatting with you and sharing with you our first half perspective. And we look forward to talking to you again in a quarter. Thanks for your time. Bye.

Operator

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

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