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NuVasive, Inc. (NASDAQ:NUVA)

Q2 2008 Earnings Call Transcript

July 24, 2008 5:30 pm ET

Executives

Nick Laudico - The Ruth Group

Alex Lukianov - Chairman and CEO

Kevin O’Boyle - EVP and CFO

Keith Valentine - President and COO

Analysts

Bob Hopkins - Banc of America

Ben Andrew - William Blair

Raj Denhoy - Thomas Weisel Partners

David Roman - Morgan Stanley

Matt Miksic - Piper Jaffray

Joanne Wuensch - BMO Capital Markets

Steve Ogilvie - ThinkPanmure

Michael Matson - Wachovia Capital Markets

Ed Shenkan - Needham & Company

Operator

Greetings and welcome to the NuVasive Incorporated Second Quarter 2008 Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. (Operator Instructions). As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host Mr. Nick Laudico of The Ruth Group. Thank you Mr. Nick Laudico, you may begin.

Nick Laudico

Thanks operator. Welcome to the NuVasive second quarter earnings conference call. NuVasive senior management joining us on the call today will be Alex Lukianov, Chairman and Chief Executive Officer; Keith Valentine, President and Chief Operating Officer; and Kevin O’Boyle, Executive Vice President and Chief Financial Officer.

During our management comments and in our responses to your questions certain items may be discussed which are not based entirely on the 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-K, 10-Q rather and 10-K forms filed with the Securities and Exchange Commission.

With that I would like to turn the call over to Alex Lukianov.

Alex Lukianov

Thanks, Nick, and thank you everyone for joining us this afternoon for our second quarter 2008 call. Our strong second quarter performance was driven by the continued adoption of our XLIF procedure and deeper penetration into existing accounts as our sales force executes on the strategy of selling the full mix of our products.

We made substantial progress on a number of our strategic growth initiatives, including the expansion of our biologics offering through the acquisition of the Osteocel biologics business, which was closed and completed today, the upcoming completion of enrollment in our NeoDisc clinical trial and the continued building of our operations infrastructure through the recent go-live implementation of our SAP Enterprise software platform.

Our new product introductions and sales force initiatives coupled with building our corporate infrastructures are keys to achieving $500 million and beyond in revenues with sustainable GAAP profitability.

Before outlining our operational progress during the quarter, let me take a moment to briefly review our strong financial performance. Revenue in the quarter increased 61% year-over-year to $57.4 million. On a sequential basis this represents a 12% quarterly increase over the first quarter of 2008.

Accordingly, we are increasing our revenue guidance for the full year 2008 to $238 million to $240 million, which includes $15 million for the Osteocel biologics business. Although, global economic conditions have resulted in increased expenses relating to such items as shipping, distribution and travel, coupled with lower yields on cash investments, we remain committed to GAAP profitability and are increasing our GAAP earnings per share guidance for 2008 to $0.05 to $0.07.

Kevin will provide full details on our updated guidance, deal costs and our financial expectations for Osteocel during his prepared remarks.

The end of the second quarter marked the second full year of sales force exclusivity at NuVasive. Our original commitment to transition our sales force was based on our strategy that exclusivity would be a key driver of our ability to sell a full mix of spine products and leverage our unique lateral approach.

Our most experienced representatives those who have been with the company for at least 18 to 24 months are becoming expert in educating surgeons on the benefits of our products and driving deeper product penetration. These tenured representatives are focused on expanding relationships with existing accounts, increasing market awareness of our unique products, selling our complete product mix, and introducing advanced XLIF techniques that allow surgeons to further differentiate their practices by moving up to spine with our MAS platform.

Our recent transition from 5 to sales 11 regions has further sharpened our collective ability to play an integrated and comprehensive role in surgeons’ practices, while also focusing on the development of new business.

At the end of the second quarter our headcount stood at 269 sales professions. On average our commissioned representatives are currently producing more than $1 million in annual sales. Our most experienced representatives those located in regions, such as the west and southeast where we have had a longstanding presence are producing well above this average.

As a component of our exclusive sales force strategy and focus on deeper product penetration we expect this metric to continue to improve as our sales force solidifies and expands relationships with both current and new spine surgeon customers.

Our product development efforts center on our philosophy of continued innovation and [obsoleting] our own products to stay well ahead of the competitive curve. Our 2007 product introductions including the XLP Lateral Plate, SpheRx II, and Thoracic XLIF have increased the utility of our unique lateral approach and we continue to experience strong penetration of these products in 2008.

In the first half of this year we also expanded our cervical product offering through the full national launch of our Helix Anterior Cervical Plate, Helix Mini Plate and our VuePoint posterior fixation system to complement our existing line of cervical products. This has given our sales force a comprehensive selection of cervical fixation products with which to gain of a surgeons’ business.

We are pleased with the initial cervical business pull-through we have achieved and remain on-track to double our cervical revenue goal for the year to more than 10% of our overall revenue.

We also launched our Halo anterior plate to complement the CoRoent XLR interbody device to address the L5-S1 region. These products allow surgeons to perform either an ALIF or TLIF for pathology below L4-5. While surgeons have been able to access the L5-S1 level using evasive products in the past, Halo provides a fixation option design specifically for this level. In the second half of the year we will introduce further Korean products and line extensions along with XLIF revision instrumentation or failed TDRs or traditional fusions.

During the annual meeting of the North American Spine Society or NAS being held in Toronto in October of this year, we will introduce our next generation NeuroVision product line known as NeuroVision M5. This enhanced version will build upon our existing monitoring platform and will comprise a total of 5 monitoring modalities to cover the entire spine.

Tying into our current NeuroVision Platform, NeuroVision M5 will continue to offer one, stimulated EMG, two, free run EMG and three, MEP modalities. Two additional enhancements include SSEP mode broadening NeuroVision’s coverage for surgical procedures and navigated guidance a creative user-friendly approach to pedicle screw placement using precision trajectory feedback to the surgeon.

NeuroVision M5 offers complete monitoring coverage for the entire spinal cord along with the simplicity of M5 guidance. The next generation NeuroVision leverages NuVasive’s five years of system experience in more than 70,000 cases of surgeon directed neuromonitoring and will create even greater distance between us and our competitors.

We have also recently achieved two major milestones towards our goal of adding synergistic and unique products to our already comprehensive suite of spine surgery products. First, we just announced the completion of our acquisition of the Osteocel Biologics Business from Osiris Therapeutics. We closed the Osteocel acquisition today despite a last minute attempt by Orthofix to interfere. Some of you may have seen that Orthofix was seeking an injunction against Osiris to prevent the closing. Since, Orthofix has publicly stated that its rights to Osteocel terminate at the end of 2008 and has also stated that it is very prepared to replace the product we have no insight to offer on their motivation for trying to interfere. Nonetheless, our hearing was already held on this issue and the attempt to stop the closing was denied. The transaction has now fully closed and we are very excited about incorporating Osteocel into our product offering pursuing future development projects and educating our sales force and customers. As we have previously stated we intend to honor the existing distribution arrangements in place through the end of 2008.

As a reminder Osteocel provides what we believe to be one of the more powerful biologic platforms for use in spine applications on the market today. Osteocel is the only viable bone matrix product on the market that provides the three beneficial properties similar to autograph. One osteoconduction which provides a scaffold for bone growth, two, osteoinduction for bone formation stimulation and three, osteogenesis for bone production.

Osteocel allows us to participate in all segments of the $1.5 billion US Biologics market as we see it filling the product gap between DBM and InFUSE while complementing our Formagraft business. We will begin investments in infrastructure and studies this year in preparation of developing clinical data to further support the efficacy of Osteocel. We believe there are substantial opportunity to create an aggressive marketing program to achieve this products full potential. To that end we have created a Biologics business unit headed up by our new Senior Vice President, [Tyler Lipsop]. Tyler brings a solid record in driving new products to market in the Orthopedics area with such company is defused with the (inaudible). We welcome Tyler to our team and are enthused about his anticipated contributions to our results.

We are reiterating our incremental revenue guidance of $15 million in 2008 and $25 million in 2009 as we transition the product to our sales force. We believe Osteocel combined with our Formagraft product will provide the foundation for $100 Biologics business over the next several years. Secondly, we expect the complete enrolment of nearly 500 patients in our pivotal clinical trial for NeoDisc in August. NeoDisc is a next generation cervical device replacement device that is designed to maintain a patients natural spine motion. It’s (inaudible) offers a more forgiving placement while mimicking in natural motion of a human cervical disc. The procedure is very straightforward and the implant is fully immutable and easily revisable. We look forward to collect in-clinical data on this device during the follow-up period as we move toward a potential approval.

We will provide further clinical updates at NAS in October on our motion preservation platform progress. This will focus predominantly on NeoDisc as well as an introduction to the XLTDR, our lumbar TDR placed laterally versus through the abdomen which we anticipate to start enrolling in an ID Clinical study late 2008 or early 2009.

In Europe, we continued selling primarily into Germany, the UK and Greece. In the Far East we are focused on Australia with eventual penetration into Japan and China. We have also started limited distribution in parts of South America. Overall, we are in lined with our expectations to have international upwards of 3% to our overall revenue, and are pleased with the initial reception of our products as we continue infrastructure development and clinical education.

We believe this measured approach will ensure that we properly educate surgeons on the benefits and application of our unique XLIF procedure and innovative motion preservation products ahead of a ramping of our international sales activities in 2009 through 2011.

We are very pleased with our results through the first half of 2008. We remain focused on achieving GAAP profitability this year, while establishing strong corporate and IT infrastructure to support our drive for its $500 million in sales and beyond. In early July, we converted over to our SAP Enterprise software platform, which will allow us to efficiently grow our business both in the US and abroad.

This new unified platform is essential to meeting to them all of our high growth expectations. We also remain on schedule to complete the second and final phase of our relocation to our new campus style corporate headquarters in August. When the relocation is complete, all of our San Diego operations will be located in a single scalable complex allowing us to amplify our culture of absolute responsiveness across all areas of our business.

I would now like to turn the call over to Kevin O’Boyle for a detailed review of our financial results.

Kevin O’Boyle

Thank you, Alex. Our revenue for the second quarter 2008 was $57.4 million, a 61.2% increase over Q2, 2007 and a 12.2% increase over Q1, 2008. International revenue was $1.6 million, on target with our 2% to 3% revenue contribution that we guided to for 2008. Gross margin for the second quarter was 83.3%, compared to gross margin in Q2, 2007 of 81.2%, and gross margin in Q1, 2008 of 82.2%.

Our Q2, 2008 net loss was 495,000 or a loss per share of $0.01 on a GAAP basis. On a non-GAAP basis, the company reported net income of $5.1 million or $0.14 per share. Our non-GAAP net income calculation in the second quarter of 2008 excludes stock-based compensation of $5.1 million and amortization of intangible assets of $467,000.

Operating expenses for Q2, 2008 totaled $48.5 million. The decrease in operating expenses in the second quarter from the first quarter is a result of in-process research and development costs of $4.2 million incurred in the first quarter, related to the acquisition of new pedicle screw intellectual property.

Excluding the in-process research and development costs, first quarter operating expenses were $46.3 million. The increase in operating expenses primarily reflects increased selling costs, higher administrative expenses associated with infrastructure advancements and international startup costs.

Research and development expenses, excluding stock-based compensation for the quarter totaled $5.8 million versus $6.3 million in the first quarter. The decrease in R&D spend from Q1 was related to the timing of the expenses for new product development.

Excluding stock-based compensation, R&D as a percentage of revenues for Q2, 2008 came in at 10.1% versus Q1, 2008 at 12.4%. Sales, marketing and administrative expenses excluding stock-based compensation for the quarter totaled $37.6 million versus $34.8 million in the first quarter.

Excluding stock-based compensation sales, marketing and administrative as a percent of revenues for Q2, 2008 came in at 65.4% versus Q1, 2008 at 68%. The increase in spend from Q1 was related to typical selling expenses, related to higher revenue base, as well as a facility cost associated with the relocation of our corporate headquarters.

The interest and other income contribution for the quarter was 184,000. Interest and other income reflect reduced yields on our cash investments due to current market conditions. The stock-based compensation charge for the quarter was $5.1 million was recorded in our operating expenses and allocated as 610,000 in R&D with the balance of $4.5 million in sales, marketing and administrative expenses.

As of June 30th, we had $265 million in cash, cash equivalents, short and long-term investments. As previously announced in March, we raised net proceeds of approximately $208 million from an offering of convertible senior notes due 2013.

Our operating cash burn was $16.2 million for Q2, 2008, which broadly reflects the development of our MAS product pipeline, including motion preservation, the national launch of new products, and the build-out of inventory and instruments to support future growth.

Included in our cash burn were costs related to leasehold improvements for our new corporate facility, costs associating with moving into our new corporate headquarters and implementation costs for our ERP system. The total for these items was $4.5 million in the quarter. Our operating cash burn is the finest cash use for operating activities, plus additions to fixed assets.

Our inventory position was $52.2 million at the end of Q2 or 22.7% of annualized revenue. Inventory has increased each quarter in 2007 and through the first two quarters of 2008, principally because of our rapid revenue growth and the new products we have introduced. We expect our inventory-to-sales ratio to average about 20% to 25%, which may spike in a quarter depending on how many and what type of products are launched.

Additionally, a corresponding increase has occurred in our property and equipment costs for the same reasons. Day sales outstanding or DSOs were 50 days in Q2, 2008 compared to 53 days in Q1, 2008.

I would now like to turn to a review of our 2008 financial guidance, including our acquisition of the Osteocel biologics business. For the full year 2008, we are increasing our revenue guidance to a range of $238 million to $240 million, up from $210 million to 214 million, which includes the contribution from Osteocel of $15 million.

It’s important to note that for the balance of the year we anticipate flat sequential revenue in Q3 and robust Q4 growth. For Osteocel, the revenue should be $5 million in Q3 and $10 million in Q4 for Osteocel.

Our gross margins for the balance of 2008 should be in a range of 80% to 81%. The principal reason for the reduction from our current levels is the effective selling Osteocel to existing distribution agreements at a mid 30% gross margin, which should increase significantly in 2009.

For the full year 2008, we have increased our GAAP earnings per share guidance, excluding one-time charges to $0.05 to $0.07 from breakeven to $0.03 despite increased pressure from economic conditions resulting in higher expenses, relating to items such as shipping, distribution and travel, coupled with our expectation of continued lower yields on our cash investments.

The Osteocel acquisition is anticipated to be neutral to earnings in 2008 and 2009. We are, however, anticipating a one-time in-process R&D charge from the Osteocel acquisition in the range of $15 million to $20 million to be recorded in Q3.

For the full year 2009, we will transition Osteo sales to a direct channel model through our exclusive sales force and expect revenue up $25 million with gross margins above 60%. We expect the Osteocel revenue contribution in the first two quarters will reflect the transition to our sales force of next to no sales followed by a strong second half. Once again, excluding the one-time in-process R&D charge which should be in the $15 million to $20 million range in Q3, we anticipate an earnings neutral result in both 2008 and 2009.

The deal structure for Osteocel is as follows: A closing payment of $35 million in cash. Osiris will continue to supply Osteocel to NuVasive for a period of 18 months following the closing, and will be eligible to receive up to a total of $22.5 million in cash or stock in milestones related to product supply. NuVasive will also make a payment of $15 million in cash or stock upon achieving Osteo sales of $35 million.

Lastly, the dedicated processing facility for Osteocel will be transferred to NuVasive at the end or the 18-month supply period, and NuVasive will make a payment of up to $12.5 million in cash or stock at that time. The total maximum consideration is $85 million.

Our interest income in Q2 of $184,000 continues to reflect low yields on our invested cash due to current market conditions. We expect to earn similar interest income levels on a quarterly basis for the remainder of 2008 and only a marginal increase to these levels in 2009.

As Alex mentioned, we successfully converted to our Enterprise Software Platform, SAP in early July and we are on track to complete the transition to our new corporate headquarters in August.

I would now like to turn the call back to over Alex for closing commentary.

Alex Lukianov

Thank you, Kevin. Our second quarter results were driven by the continued improvement of our organization’s proficiency in selling the full mix of our innovative spine products and ability to attract new customers. Our comprehensive portfolio of products continues to gain momentum. While XLIF has experienced success, we have still only scratched the surface of its market penetration opportunity.

These successes combined with our infrastructure investments move us even closer to our goal of becoming a major competitive force in spine. All of our accomplishments during the quarter are a direct result of our dedicated shareowners and their commitment to our cultures output of absolute responsiveness at cheetah speed. We are extremely proud of the strong foundation we have built based on this culture, which has fostered a unique environment for A players to achieve outstanding results, be it our exclusive sales force, innovative product offering or our daily focus on making NuVasive the easiest spine company to do business with.

Overall, we believe we are very well positioned to leverage this foundation to reach our interim sales goal of $500 million in concert with growing profitability. We would now be pleased to answer any of your questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions). Our first question is from the line of Bob Hopkins with Banc of America. Please go ahead.

Bob Hopkins - Banc of America

Thanks and good afternoon, can you hear me?

Alex Lukianov

Yes, Bob we can hear you from Banc of America.

Bob Hopkins - Banc of America

That’s right. Congrats on your results today. Couple of questions, first just to ask a question on the Orthofix lawsuit, can you explain what’s the next step with that and also explain the positive ruling that you counted on your prepared remarks?

Alex Lukianov

Well, it's not a lawsuit, they filed for an injunction this morning and that was with Osiris.

Bob Hopkins - Banc of America

Right.

Alex Lukianov

The judge dismissed that. So there is no pending legal action.

Bob Hopkins - Banc of America

Okay, so that’s done?

Alex Lukianov

Correct, and we closed the deal as I know.

Bob Hopkins - Banc of America

Right, okay that’s clear. And then on the Osteocel guidance I assume it's pretty similar commentary to what you made before in terms of really projecting no growth for the product out for next 18 months primarily because of the change that you should be making in the handover for manufacturing and that’s why you are offering up the conservative guidance as you have done?

Alex Lukianov

The reason for the forecast or the guidance of $25 million for next year is because our sales force will effectively be starting from zero in January. We do not expect a transition of sales of any substance coming from Orthofix over to us. So we will be building it from the ground level. That’s the reason we are projecting for a $25 million. I don’t think it is conservative as I think it is just a realistic projection, and I believe that as we give guidance into 2010, we will be able to accelerate the growth rate.

Bob Hopkins - Banc of America

Okay, and then one question I had for Kevin. Kevin, can you just give me a sense as you look at your business longer-term, what kind of revenue base do you guys need to have in order to be able to drive something close to a 20% GAAP operating margin?

Kevin O’Boyle

Something north of in and around 500 million.

Bob Hopkins - Banc of America

Okay, so that’s kind of the magic number for roughly 20%.

Kevin O’Boyle

That’s before stock-based compensation. It’s a non-GAAP operating income of 20% on 500 million is the sweet spot. We have been system independent.

Bob Hopkins - Banc of America

Yes. Okay. Thanks, that’s all I have for today.

Kevin O’Boyle

You’re welcome.

Alex Lukianov

Thank you, Bob.

Operator

Thank you. Our next question comes from the line of Ben Andrew with William Blair. Please go ahead.

Ben Andrew - William Blair

Good afternoon, guys.

Alex Lukianov

Hi, Ben.

Ben Andrew - William Blair

I guess following on Bob’s question about Osteocel, maybe you talk a little bit about the mechanics of the transfer of Osteocel and how you see, weighted into capacity and kind of the milestone of 35 million, but the transfer, so the idea is basically is that Orthofix has these relationships and you don’t think you have material overlap with the same surgeons and you are going to have to start selling it again or mechanically what’s going to be going on in the ground?

Alex Lukianov

Well, we don’t have knowledge and we don’t anticipate having any knowledge of where they are selling, and so we will be starting from the ground level introducing the product as our very own next year. So, that’s why we believe that there is no hassle, or if you will, from one company to another in this transition process.

Ben Andrew - William Blair

So, there may well be sales in Q1, Q2, but do you think, since you are starting from scratch, you don’t want the assumptions to be very conservative and (inaudible)?

Alex Lukianov

Well, I want them to be, exactly want them to be reasonable because we don’t know exactly where we are going to be, and how long it’s going to take for our sales force to learn about the biologics arena and to be effective. So, that’s going to take some time.

Ben Andrew - William Blair

Okay, and the balance of, since from the closing here today until the end of the year, what do you think the behavior pattern Orthofix is going to be, I mean, if they suit the block, they obviously want the product, will they sell it, do you think, do you think that they will try to load up inventory and prevent you from selling it separately. I mean, do you have in -- and finally do you have any direct sales of the product by your sales force between now and the first of January?

Alex Lukianov

We are not planning for any sale of our products between now and January 1. We anticipate that Orthofix will conduct business in a reasonable and prudent fashion over the course of the next six months in particular or through the end of the year. So, we anticipate transferring the product to them in exchange for the purchase orders that should be coming our way and we expect it to be a smooth process.

Ben Andrew - William Blair

Do you have rights under the contract, let’s say they never give you another order for Osteocel, do you have the right to terminate that distribution deal at a certain point?

Alex Lukianov

That would be considered a breach and we would be able to take appropriate action.

Ben Andrew - William Blair

Okay. And then the 35 million, Kevin, total, is that including Orthofix end-user sales and then kind of running through your 35 million, if you take it over or is it only starting when you get the product?

Kevin O’Boyle

No, if I understand the question, the guidance was 15 million this year, 25 next year, but...

Ben Andrew - William Blair

I mean the milestone came in at 35?

Kevin O’Boyle

The total of 35 is the aggregate number of sales from day 1 to the point we get to 35, and that’s the sales that we would record over. And we think it should probably take somewhere in the 18-month timeframe, or maybe a little longer?

Ben Andrew - William Blair

Okay. So when Orthofix was selling Osteocel from here to the end of year, you will book that as 100% revenue or the transfer price?

Kevin O’Boyle

No, the 100% revenue because effectively we are stepping in Osiris’ shoes and selling the product to Orthofix.

Ben Andrew - William Blair

Okay. But is that the end user price or the transfer price of your gross margin?

Kevin O’Boyle

Transfer price.

Ben Andrew - William Blair

Okay, and then finally, looking at the capacity and the ability to ramp manufacturing, I think, it has been more of a challenge with Osteocel along the way, where is your confidence now with a few more months under your belt, looking at that business in terms of the ability to deliver on that and drive to that 25 million next year?

Kevin O’Boyle

Our confidence and the reason that we pull the trigger on doing this deal ultimately is that we can obtain $100 million worth of product over the next several years, and that’s why we have been forecasting our biologics business to arrive at that sort of a milestone we anticipate over the next few years. So, we feel very positive about the supply.

Ben Andrew - William Blair

Great, thank you.

Kevin O’Boyle

You’re welcome.

Operator

Thank you. Our next question comes from the line of Raj Denhoy with Thomas Weisel Partners. Please go ahead.

Raj Denhoy - Thomas Weisel Partners

Hi. Good afternoon guys.

Alex Lukianov

Hey, Raj.

Kevin O’Boyle

Hey, Raj.

Raj Denhoy - Thomas Weisel Partners

I have an Osteocel question as well, but I want to first ask you about the results in the quarter, I mean, obviously very strong, after all it was very strong first quarter. I am curious if you could, maybe portion where that’s coming from. There was the expansion in geographic territories, which is growing out this year. Is the growth coming from new areas, existing areas, maybe you can just give us a little bit more color on that?

Alex Lukianov

It’s coming from both. It’s coming throughout the United States. We are seeing a little bit more coming out of the more established areas that I talked about the west and the southeast, which as you know as how the company has progressed with its distribution. So, that’s what we are seeing and that’s where we have the most tenured representatives. And as a result, we are getting bigger contributions from them on a pro-representative contribution basis. So, they are as I talked about our sales force doing about $1 million for our representative overall, we see results more like in the neighborhood of $2 million and even plus $2 million in those other areas.

Raj Denhoy - Thomas Weisel Partners

Well, then I guess the other questions, the new territories, which you have established, I guess, the six new territories. What is the pace of business building there? I mean are they training surgeons, or is it really just, is it still early days there or maybe if you could just give us some insights?

Alex Lukianov

It is still early days there and I think we are making very good headway, but it is just, it is still in the process of hiring representatives, and we have just talked about increasing to 269 sales professionals. Those people need to be trained; they need to build relationships. So we are still in the process of making hay in those areas, but we are very pleased with how that’s going.

Raj Denhoy - Thomas Weisel Partners

So, it is fair to say that most of growth is coming from existing areas. So the growth story that comes from expansion is yet to really kick in?

Alex Lukianov

That is right.

Raj Denhoy - Thomas Weisel Partners

Okay. As far as Osteocel, you mentioned that you will start collecting data there and that has always been one of the pushbacks, what sort of timeline do you envision that you could actually start to produce data, where you could go to surgeons with white papers or just some data that the material is actually doing something?

Alex Lukianov

Well, we certainly anticipate having some data in 2009. I think, as far as, anything hugely significant, it’s going to be closer to the end of next year and really into 10. So, that’s really when we expect to see more longer term data with regard to Osteocel.

Raj Denhoy - Thomas Weisel Partners

But, I guess, I imagine that since the product, it’s the tissue product, the data you collect, it can come in a lot of different forms, so it does not need to be in the form of clinical trials. It can really be white papers, anecdotal reports, case reports and those sorts of things?

Alex Lukianov

Yes. That’s correct.

Raj Denhoy - Thomas Weisel Partners

Okay. Great. Thank you.

Alex Lukianov

Thank you.

Operator

Thank you. Our next question comes from David Roman with Morgan Stanley. Please go ahead.

David Roman - Morgan Stanley

Good evening, everyone. Thank you for taking the question. Two just a couple quick ones, just on the gross margin, 83% gross margin this quarter that is considerably higher than what we have seen in the past couple of quarters. Can you maybe just sort of walk us through some of the components there, both as a sequential and year-over-year increase?

Alex Lukianov

Yes. The margin increase is more of an answer that is based on product mix. XLIF continues to lead the charge. Our biologics and Formagraft continues to do very well which carry some very nice margins compared to some of the other products in the portfolio. In the ongoing penetration of those products in the markets has what’s really pushed that margin to the 83% range.

David Roman - Morgan Stanley

Okay. Then on the earning guidance for the full year, can you give us some sense to the progression for the next two quarters, I assume the vast majority that is going to come in Q4?

Alex Lukianov

That is right.

David Roman - Morgan Stanley

Okay. And then lastly on the number of sales reps, it looks like growth this quarter year-over-year was about 22%, is that the type of growth rate we should consider for the next two quarters or should we expect to see more than 15% range that you have talked about previously.

Alex Lukianov

It should be about the 15% range, perhaps as high as 20. It’s just a question of how quickly we can find qualified representatives. So, it’s not going to greatly exceed 20% rate as far as we have visibility.

David Roman - Morgan Stanley

Okay. And then lastly and now as you referenced that you have some data on NeoDisc, but anything on XLIF or where you see maybe two year follow-up data on the conventional procedure as well?

Alex Lukianov

Well, there is a book that has just been published that’s dedicated to XLIF and that is being released. So, certainly that will be featured, and there are a lot of very positive articles, chapters rather in that book. So additionally, we’ll be talking at NAS in October at our analyst meeting. We will be talking about XL TDR and talking about our plans for that study and for beginning enrollment.

David Roman - Morgan Stanley

Okay. Great. Thank you very much.

Alex Lukianov

You bet.

Operator

Thank you. Our next question comes from Matt Miksic with Piper Jaffray. Please go ahead.

Matt Miksic - Piper Jaffray

Hi, everybody.

Alex Lukianov

Hi, Matt. It’s Piper Jaffray, is that right?

Matt Miksic - Piper Jaffray

Yes, yes. A lot of things moving around here, it’s up to keep track and we are going to get…

Alex Lukianov

It is, it is.

Matt Miksic - Piper Jaffray

…are going to get to little (inaudible), may be.

Alex Lukianov

We have got a whiteboard that we keep moving all this time.

Matt Miksic - Piper Jaffray

So, a couple of questions, I think a lot of them have been asked here. But I have a couple of maybe just on Osteocel. I think the Raj talked about the kinds of data that you could pull together. I mean is the strategy to do kind of post-marketing studies or really to get something published in a previewed journal?

Alex Lukianov

It’s a combination of all those things. We’re going to invest significant dollars into doing a variety of things that are preclinical, mechanical. So, we are going to be investing in the number of different areas, where we’re finalizing our plans to do so. And as I mentioned [Tyler Lipsop] has come on board and is driving effort for us.

Matt Miksic - Piper Jaffray

And when you talk filling the gap between InFUSE and DBM, I assume you are thinking primarily of using the lumbar spine or is that something that’s also safe, you think, to be using in the cervical spine?

Alex Lukianov

Well, it’s both, but I am going to let Keith jump in here and give some additional color.

Keith Valentine

Yeah, this is a great opportunity also for the cervical spine. I think we’re all aware of some cautions that have been put out there by the FDA in the cervical spine. And certainly, as Alex described in the commentary earlier that this is the only product that offers the three basics for bone growth and that plays very well into what the demand is out there is cervical space.

Matt Miksic - Piper Jaffray

Okay. And then just one, again just to make sure I understand how you’re coming at this market opportunity. I am trying to understand the kind of folks who would be interested in using this. Clearly, there are people who are very comfortable to use it all the time. I suppose there are some folks who are price-sensitive, there is [only across] bone Graft users out there still. Who do you think is the right target audience initially to start using the product?

Keith Valentine

I think both. The unique part about this product is that you’re really functioning around a more natural alternative to bone growth. And we have seen both excitement not only on BMP users who may have cost conscious constraints imposed by the hospital, who are interested in this alternative, but there is also a great deal of people who want a more supercharge product from the existing DBMs that are out there or even the synthetic products. So, it does bridge a gap between both, and it participates in a very large wide space that really nothing participates in right now.

Matt Miksic - Piper Jaffray

Great. Thank you for taking my questions.

Alex Lukianov

Okay. Thank you.

Kevin O’Boyle

Thank you.

Operator

Thank you. Our next question is from the line of Joanne Wuensch with BMO Capital Markets. Please go ahead.

Joanne Wuensch - BMO Capital Markets

Thank you very much for taking my question. Did you give the percentage of revenue that’s being generated outside the United States?

Alex Lukianov

Yes. We said it was approximately 3% and that’s our guidance for the year.

Joanne Wuensch - BMO Capital Markets

Okay. And when you talk about the cost differentials say between InFUSE and Osteocel, could you walk us through what Osteocel charges cost?

Alex Lukianov

Well, we see it is having a lower price point. And as far as setting the exact price, we can give you a range and I’ll ask Keith to comment further about that versus the InFUSE price point.

Keith Valentine

Yes. The ASP that’s been in the marketplace by a number two distributors right now in the marketplace is lower on a per [CC] basis or quantity basis than BMP, somewhere between 15% to 20% lower for similar volumes or similar applications. So, it does participate nicely as I mentioned in that particular wide space. On average we are looking at around $500,000 a level for most InFUSE that’s being used, and sometimes that’s extended over multiple levels. But that’s the advantage of this product as well that can be extended and has been extended in surgical hands as we understand for quite a while now.

Joanne Wuensch - BMO Capital Markets

When I think about growth, not necessarily this year or next year as you go through this transition, what do you think this growth can be and what was it growing under the product Osteocel under its previous owner.

Kevin O’Boyle

Well, it was our projection and I guess it’s probably what most important thing that we have talked about achieving $100 million over the next several years. So, I think that that’s really what key is. The run rate has approximately been $15 million to $30 million. We don’t know the specifics of exactly where the product has gone and nor do we expect to learn that information. So, we don’t know what’s inventory, we don’t know what were. We simply what’s been purchased from Osiris by Orthofix.

Joanne Wuensch - BMO Capital Markets

Do we need to worry about excess inventory being out there and then I feel this can take you while to eat through once you launce the product on your own?

Alex Lukianov

Well, we don’t think it’s going to affect the results in terms of what we are forecasting for next year regarding the revenue line. We think there is lots of opportunity for uptake with this product. So, even if there is a dwindling supply that remains in the field next year with Orthofix, we don’t see that having an impact on what we are going to do.

Joanne Wuensch - BMO Capital Markets

Many thanks. Have a good evening.

Alex Lukianov

Bet you.

Operator

Thank you. Our next question comes from the line of Steve Ogilvie with ThinkPanmure. Please go ahead.

Steve Ogilvie - ThinkPanmure

Hi, guys. The Osteocel is the best here. I am just wondering did Osiris ship it to Orthofix or do they ship direct to their customers.

Alex Lukianov

Does Osiris ship to Orthofix? It ship directly to Orthofix not to customers.

Steve Ogilvie - ThinkPanmure

Do you guys don’t even have access to the customer information.

Alex Lukianov

Yes, that’s correct.

Steve Ogilvie - ThinkPanmure

Okay. And then on the supply side how involved are you going to be starting tomorrow in terms of could ever acquisition building up to manufacturing and how is that going to over time.

Alex Lukianov

We are going to be extremely involved, it’s now our business and we are going to take the care of it in terms of ensuring that we have the supply that we are accounting on as well as making arrangements for continuing that supply beyond the $100 million that we are expecting over the next few years.

Steve Ogilvie - ThinkPanmure

Okay. And then if I understand Orthofix contract, they have a certain percentage which they can sale up to, so are used in a way kind of disincentivize to make a lot this year. Are you really going to be focusing on next year, or do you not think of it that way?

Alex Lukianov

We don’t think of it at that way. We are looking at meeting our obligation to Orthofix and planning for scaling up for 2009.

Steve Ogilvie - ThinkPanmure

Okay. And then last question not Osteocel related, the NeoDisc enrollment hasn’t gone exactly as you previously said. I am wondering if there is anything you can shed light on.

Alex Lukianov

Well, I have said that we would be completed with the study in the summer. It's still summer and it will be completed in August. And so, we thought it would be done by the end of the first half of the year. But we’re effectively within four to six weeks of being done versus right smack in the middle of the year.

Steve Ogilvie - ThinkPanmure

Any discussion with the FDA yet on that and what it will look like, are you still at kind of the same timeframe at your follow-up and then a year of [bureaucracy] before approval?

Alex Lukianov

A total of two year of follow-up on each patient, so we are still looking at 2011 and nothing has changed from that standpoint. And our closing up the study in August keeps us right on track with that original timeline that we offered.

Steve Ogilvie - ThinkPanmure

Okay, great. Thanks guys.

Alex Lukianov

Thank you.

Operator

Thank you. Our next question comes from the line of Michael Matson with Wachovia Capital Markets. Please go head.

Michael Matson - Wachovia Capital Markets

Hi. Thanks for taking my question. I guess just with regard to the new NeuroVision system that you are going to be launching. I was just curious how that would potentially affect your P&L, if at all. How exactly do you count for these systems, because I guess I understand you are not typically selling them to the hospitals, do you capitalize that or something?

Kevin O’Boyle

Yes, what we do that's an asset that is on NuVasive’s books, and we traditionally depreciate that asset over three years through cost to sales category, very similar matter of fact identical to what we do with NeuroVision today.

Michael Matson - Wachovia Capital Markets

Okay. And so, that really wouldn’t. Would you be upgrading the existing customers or just gradually rolling it out over time?

Alex Lukianov

We will be rolling this out over time. The current NeuroVision have usages overseas as well as other applications within the U.S. So, we will gradually move into the M5 line and build it out throughout 2009.

Michael Matson - Wachovia Capital Markets

Okay. And then I was wondering if you could – again I have another Osteocel question. I was wondering if you could compare the Osteocel-XC product to the Osteocel product. I realize you just bought the Osteocel product not the XC product yet. But you may think you have right of first refusal there, if I am correct. Just your thoughts on how those compare and so forth?

Keith Valentine

Yes. The XC describes the culture product, and the culture product has a number of benefits most significantly is a greater control of supply, and theoretically limit this amount of supply, because the way XC is cultured. So, that gives a great deal of advantage. The XC product too has a lot of similarities, functionally to some of the projects that Osiris is already working on. This is in a different area of course the XC that we will be interested in is for bone growth. So, there is a strong history and success of what Osiris is working on right now that could help parlay to that XC.

So, from that perspective it would be a more consistent production product and would also give you ability potentially. And clinical studies would have to prove that out of how much more efficacious it would be to have that sort of controlled environment for our product line instead of it coming from donors.

Michael Matson - Wachovia Capital Markets

Okay. And then finally, I know there has been concern among investors about the economic impact on procedure volumes, and I realize that for NuVasive you are such as small portion of the market you are probably not as sensitive to the overall market trends. But I was just wondering if you were getting any feedback from any of our customers about any delays in surgery or anything like that. What I have seen so far from some of the other spine companies that does look like the market may have slowed a little bit, I don’t know if that’s due to procedures or not but…?

Alex Lukianov

We have certainly not seen that, and I think that’s reflected in our results. So that’s not how we’re seeing the market and I don’t think our ability to gain share has been adversely effected whatsoever.

Michael Matson - Wachovia Capital Markets

Alright. That’s all I got, thanks.

Alex Lukianov

Thank you.

Operator

Thank you. Our next question comes from the line of Ed Shenkan with Needham & Company. Please go ahead.

Ed Shenkan - Needham & Company

I have two financial questions, for the tax rate guidance and the share count guidance where would you direct us?

Kevin O’Boyle

Tax rate, I don’t think we have to worry about tax rate at the moment. We have NOL that exceeds 150 million, so we don’t have an issue with the tax rate anytime soon. And in terms of in our shared guidance as we start turning gap profitable you know the actual share number is in our tables to our press release, which is 37, little over 37 million shares which should certainly be used in the fourth quarter.

Ed Shenkan - Needham & Company

And when you are reporting at least profitability in your income statement even though have the NOL what would be 40% tax rate in the income statements?

Alex Lukianov

Yeah probably 34 to 40 somewhere in that range but it's going to be a while before we start recording any provisions for income taxes.

Ed Shenkan - Needham & Company

And for the SAP update what amount this capitalize, what should we think about for amortization expense going forward associated with that?

Kevin O’Boyle

We have capitalized the IBM group who are software implementers plus the purchase of the system and so on in that number is $10 million.

Ed Shenkan - Needham & Company

And your written off over what five to seven or..?

Kevin O’Boyle

Seven years.

Ed Shenkan - Needham & Company

Seven years. Okay, thank you.

Operator

Thank you. Our final question is a follow-up from Bob Hopkins with Banc of America. Please go ahead.

Bob Hopkins - Banc of America

Hi, thanks just one more on our favorite subject of the day. I just want to be clear about a comment you made earlier, did you really say that you don’t know what percentage of your doctors are using Osteocel currently today?

Alex Lukianov

I said that we do not know where Osteocel is being used. Very few of our doctors have used the product.

Bob Hopkins - Banc of America

Very few of your doctors, okay. So and then in terms of your due-diligence process, I assume you reached out to your network and talk to a fair number of physicians as a result of that process, what I am trying to get out here is what sort of cross-selling opportunity might there be in terms of introducing NuVasive products to Osteocel users who don’t use new NuVasive core products today?

Alex Lukianov

Well I think it's not so much as driven out of the acquisition of Osteocel. I think Osteocel becomes a strong adjunct for us with regard to our portfolio. So, we see ourselves being able to primarily sell the product into our existing customer base and then just along with our efforts of expansion with XLIP MAS cervical that gives us the opportunity to obviously bring our new biologic products into the full there. And I think the fact that we are focused on adding more products to the cervical arena is really a plus and an opportunity for us as Keith outlined to take advantage of the situation with regard to InFUSE been largely now focused on the lumbar spine.

Bob Hopkins - Banc of America

And in term of percentage of your doctors currently using Osteocel, where would you put that 5%, 10%?

Alex Lukianov

5% or less.

Bob Hopkins - Banc of America

Okay, thanks very much.

Alex Lukianov

You’re welcome.

Operator

We wish to have a second follow-up from Matt Miksic with Piper Jaffrey. Please go ahead.

Matt Miksic - Piper Jaffray

Hi, just one quick follow-up on, I am sorry to say it’s also kind of on Osteocel and Orthobiologics, but I am thinking about what then may InFUSE so successful and part of it obviously is the powerful effectiveness of the product, but the data and I think the ability of the company to kind of detail in sort of a specialty sales force way. And I am wondering you’re focused on data which is part of that and I think that’s important going out a year or two, can we expect to see some of the same kind of focus on specialized Orthobiologics sales force that just to detail the product a little bit more like the way you detail pharmaceutical products to these surgeons?

Alex Lukianov

No.

Matt Miksic - Piper Jaffray

Nothing like that.

Alex Lukianov

No, we are going to continue to ensure that our sales force can sell mix and to be able to speak about all of our products.

Matt Miksic - Piper Jaffray

So you just put the totals in hands of the regular reps, put the data on their hands and let them sale the product?

Alex Lukianov

Yes, they have been very effective with selling Formagraft. They have been very effective in moving allograft, especially into the cervical spine. So, I think that this is being an allograft of product that our sales force is going to embrace it and understand it quickly.

Matt Miksic - Piper Jaffray

Great, that’s all I got, thanks.

Alex Lukianov

Thank you, sir.

Operator

Thank you. We have no further questions in the queue at this time. Let me turn the floor back over to management for any closing comments.

Alex Lukianov

Thank you everybody and we will speak to you next quarter. Bye-bye.

Operator

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

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Source: NuVasive, Inc., Q2 2008 Earnings Call Transcript
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