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NUVA > SEC Filings for NUVA > Form 10-Q on 1-May-2013All Recent SEC Filings

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Form 10-Q for NUVASIVE INC


1-May-2013

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

Forward-Looking Statements May Prove Inaccurate
You should read the following discussion and analysis of our financial condition and results of operations in conjunction with the unaudited condensed consolidated financial statements and the notes to those statements included in this report. This discussion and analysis may contain forward-looking statements that involve risks and uncertainties. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of certain factors, such as those set forth under heading "Risk Factors," and elsewhere in this report, and similar discussions in our other Securities and Exchange Commission filings, including our Annual Report on Form 10-K for the year ended December 31, 2012. We do not intend to update these forward looking statements to reflect future events or circumstances. Overview
We are a medical device company focused on developing minimally disruptive surgical products and procedurally integrated solutions for the spine. Our currently-marketed product portfolio is focused on applications for spine fusion surgery, including biologics, a combined market estimated to exceed $8.2 billion globally in 2013. Our principal product offering includes a minimally disruptive surgical platform called Maximum Access Surgery, or MAS®. The MAS platform combines three categories of solutions that collectively minimize soft tissue disruption during spine fusion surgery, provide maximum visualization and are designed to enable reproducible outcomes for the surgeon. The platform includes a proprietary software-driven nerve detection and avoidance systems, NVM5 and NVJJB, and Intra-Operative Monitoring (IOM) support; MaXcess®, a unique and integrated split-blade


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retractor system; and a wide variety of specialized implants. When the three elements of MAS are used together, they may significantly reduce surgery time and return patients to activities of daily living much faster than conventional approaches. The individual components of our MAS platform, and many of our products, can also be used in open or traditional spine surgery and may independently offer patient benefits to various surgical approaches dealing with a wide variety of pathologies. Our spine surgery product line offerings, which include products for the thoracolumbar and the cervical spine, are primarily used to enable access to the spine and to perform restorative and fusion procedures in a minimally disruptive fashion. Our biologic product line offerings include allograft (donated human tissue), FormaGraft®, a collagen synthetic product, Osteocel Plus®, an allograft cellular matrix containing viable mesenchymal stem cells, or MSCs, and AttraX®, a synthetic bone graft material, which is still in the process of U.S. regulatory clearance, all used to aid the spinal fusion process. Our subsidiary, Impulse Monitoring, Inc. (Impulse Monitoring) provides IOM services for insight into the nervous system during spine and other surgeries. We continue to focus significant research and development efforts to expand our MAS product platform and advance the applications of our unique technology into procedurally integrated surgical solutions. We dedicate significant resources toward training spine surgeons on our unique technology and products. We continue to train surgeons who are new to our MAS product platform as well as surgeons previously trained on our MAS product platform who are attending advanced training courses.
Our MAS platform, with the unique advantages provided by our nerve monitoring systems, enables an innovative lateral procedure known as eXtreme Lateral Interbody Fusion, or XLIF®, in which surgeons access the spine for a fusion procedure from the side of the patient's body, rather than from the front or back. Our MaXcess instruments provide access to the spine in a manner that affords direct visualization and our nerve monitoring systems assist surgeons in avoiding critical nerves.
At various times in the past, certain insurance providers have adopted policies of not providing reimbursement for the XLIF procedure or some of its components. We have worked with our surgeon customers and the North American Spine Society (NASS) who, in turn, have worked with these insurance providers to supply the information, explanation and clinical data they require to categorize the XLIF procedure as a procedure entitled to reimbursement under their policies. At present, the majority of insurance companies provide reimbursement for XLIF procedures. However, certain carriers, large and small, may have policies significantly limiting coverage of XLIF, Instrumented Lumbar Interlaminar Fusion (ILIF), Osteocel Plus, the PCM® Cervical Disc System, or other procedures or products we sell. We cannot offer definitive time frames or final outcomes regarding reversal of the coverage-limiting policies, as the process is dictated by the third-party insurance providers. To date, we have not experienced significant lack of payment for our procedures based on these policies. In addition, there is a downward pressure on reimbursement for the IOM services such as those provided by Impulse Monitoring. Significant coding changes for IOM services took effect in 2013. New Current Procedural Terminology (CPT) codes were introduced that may lead to reduced reimbursement by private payers for the professional remote oversight component of the service. Medicare patients will be subject to additional coding changes imposed by CMS which may restrict access to care and limit Impulse Monitoring's ability to cover, bill and collect for cases performed.
In recent years, we have significantly expanded our product offerings relating to procedures in the cervical spine as well as in the area of nerve monitoring. Our cervical product offerings now provide a full set of solutions for cervical fusion surgery, including both allograft tissue and CoRoent® implants, as well as cervical plating and posterior fixation products. In the fourth quarter of 2012, we received U.S. Food and Drug Administration (FDA) approval of the PCM Cervical Disc System, a motion preserving total disc replacement device, which further strengthens our cervical product offerings and enables us to continue our trend of increasing our market share. Our nerve monitoring offerings include both the NVM5 and NVJJB products based on our proprietary software-driven nerve monitoring systems and our IOM services business, Impulse Monitoring. To date, the majority of our revenues are derived from the sale of disposables and implants and we expect this trend to continue for the foreseeable future. We loan our proprietary software-driven nerve monitoring systems and surgical instrument sets at no cost to surgeons and hospitals that purchase disposables and implants for use in individual procedures. In addition, we place our proprietary software-driven nerve monitoring systems, MaXcess® and other MAS or cervical surgical instrument sets with hospitals for an extended period at no up-front cost to them. Our implants and disposables are currently sold and shipped from our primary distribution and warehousing operations facility located in Memphis, Tennessee. We generally recognize revenue for disposables or implants used upon receiving acknowledgement of a purchase order from the hospital indicating product use or implantation. In addition, we sell an immaterial number of MAS instrument sets, MaXcess devices, and our proprietary software-driven nerve monitoring systems. To date, we have derived less than 5% of our total revenues from these sales.
We expect monitoring service revenue from IOM services to remain consistent with the current year. Monitoring service revenue consists of hospital based revenues and net patient service revenues and is recorded in the period the service is provided. Hospital based revenues are recorded based upon contracted billing rates. Net patient services are billed to various payers, including Medicare, commercial insurance companies, other directly billed managed healthcare plans, employers, and individuals. We report revenues based on the amount expected to be collected.


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Substantially all of our operations are located in the United States and substantially all of our sales have been generated in the United States. We sell our products in the United States through a sales force comprised of exclusive independent sales agencies and directly-employed sales shareowners; both selling only NuVasive products. Our sales force provides a delivery and consultative service to our surgeon and hospital customers and is compensated based on sales and product placements in their territories. Sales force commissions are reflected in our statement of operations in the sales, marketing and administrative expense line. We expect to continue to expand our distribution channels. We are continuing our expansion of international sales efforts with the focus on European, Asian and Latin American markets. Our international sales force is comprised of directly-employed sales shareowners as well as exclusive distributors and independent sales agents.

Results of Operations
Revenue

                              March 31,
                          2013         2012       $ Change     % Change
                                    (Dollars in thousands)
Three months ended:
Spine Surgery Products $ 122,667    $ 114,858
Biologics                 27,156       27,397
Monitoring Service         9,681        9,436
Total revenue          $ 159,504    $ 151,691    $    7,813       5 %

Our Spine Surgery Product line offerings, which include products for the thoracolumbar spine, the cervical spine, and a set of motion preservation product offerings, are primarily used to enable access to the spine and to perform restorative and fusion procedures in a minimally disruptive fashion. Our Biologics product line offerings include allograft (donated human tissue), FormaGraft, a collagen synthetic product, Osteocel Plus, an allograft cellular matrix containing viable mesenchymal stem cells, or MSCs, and AttraX, a synthetic bone graft material, all used to aid the spinal fusion process. Our Monitoring Service line offering includes hospital-based revenues and net patient service revenues related to IOM services performed.
The continued adoption of minimally invasive procedures for spine has led to the continued expansion of our innovative lateral procedure known as XLIF, in which surgeons access the spine for a fusion procedure from the side of the patient's body, rather than from the front or back. In addition, increased market acceptance in our international markets contributed to the increase in revenues noted for the periods presented. We expect continued adoption of our XLIF procedure and deeper penetration into existing accounts and our newer international markets as our sales force executes on the strategy of selling the full mix of our products. However, recent changes in market dynamics, the public and private insurance markets and ongoing policy and legislative changes in the United States have created less predictability in the lumbar portion of the spine market and have substantially reduced the overall spine market's procedural growth rate. Accordingly, we believe that our growth in revenue in 2013 will come primarily from market share gains related to the market shift toward less invasive spinal surgery, both domestically and internationally. Our total revenues increased $7.8 million in the three months ended March 31, 2013 compared to the same period in 2012, representing total revenue growth of 5%.
Revenue from our Spine Surgery Products increased $7.8 million, or 7%, in the three months ended March 31, 2013 compared to the same period in 2012. This increase resulted from increases in volume of approximately 8% in the three months ended March 31, 2013 compared to the same period in 2012, offset by small unfavorable changes in price of approximately 1% in the three months ended March 31, 2013 compared to the same period in 2012.
Revenue from Biologics decreased $0.2 million, or 1%, in the three months ended March 31, 2013 compared to the same period in 2012. This decrease resulted from small unfavorable changes in price of approximately 1% in the three months ended March 31, 2013 compared to the same period in 2012.
Revenue from Monitoring Services increased $0.2 million, or 3% in the three months ended March 31, 2013 compared to the same period in 2012. This increase resulted primarily from increases in case volume in the three months ended March 31, 2013 compared to the same period in 2012.


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Cost of Goods Sold, excluding amortization of purchased technology

                          March 31,
                      2013         2012       $ Change     % Change
                                (Dollars in thousands)
Three months ended $ 39,096     $ 36,933     $    2,163       6 %
% of total revenue       25 %         24 %

Cost of goods sold consists of costs of purchased goods, inventory-related costs and royalty expense, as well as the cost of providing IOM service, which includes personnel and physician oversight costs.
Cost of goods sold as a percentage of revenue increased in the three months ended March 31, 2013 compared to the same period in 2012 primarily as a result of the medical device excise tax effective January 1, 2013.
We expect cost of goods sold, as a percentage of revenue, to approximate current levels. We are currently accruing royalties related to the Medtronic litigation at the rates stated in the judgment; however, ongoing royalty rates have not yet been determined. Accordingly, any increase to those rates will have a negative impact on cost of goods sold.
Operating Expenses
Sales, Marketing and Administrative

                          March 31,
                      2013         2012       $ Change     % Change
                                (Dollars in thousands)
Three months ended $ 99,886     $ 94,678     $    5,208       6 %
% of total revenue       63 %         62 %

Sales, marketing and administrative expenses consist primarily of compensation, commission and training costs for shareowners engaged in sales, marketing and customer support functions; distributor commissions; depreciation expense for surgical instrument sets; shipping costs; surgeon training costs; shareowner (employee) related expenses for our administrative functions; and third-party professional service fees.
As a percentage of revenue, sales, marketing and administrative expenses increased in the three months ended March 31, 2013 compared to the same period in 2012, primarily as a result of our continued expansion in our international operations.
Costs that tend to vary based on revenue, which include commissions, depreciation expense for loaned surgical instrument sets, worldwide sales force headcount, distribution and customer support headcount, and shipping, increased $2.6 million in the three months ended March 31, 2013 compared to the same period in 2012. This increase is materially consistent with our revenue growth during the three months ended March 31, 2013 compared to the same period in 2012.
Compensation and other shareowner related expenses for our marketing and administrative support functions decreased $0.7 million in the three months ended March 31, 2013 compared to the same period in 2012. This decrease is primarily a result of a decrease in performance-based compensation. We continue to make significant investments in our Japanese operations. This investment, along with depreciation expense associated with certain system software investments, increased $1.9 million in the three months ended March 31, 2013 compared to the same period in 2012.
In addition, legal expenses increased $1.6 million in the three months ended March 31, 2013 compared to the same period in 2012, $0.9 million of the increase relates to increased legal expenses incurred in connection with the Medtronic litigation.
For the remainder of 2013 and on a long-term basis, we expect total sales, marketing and administrative costs, as a percentage of revenue, to decrease moderately.


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Research and Development

                          March 31,
                      2013        2012       $ Change     % Change
                                (Dollars in thousands)
Three months ended: $ 9,694     $ 9,988     $    (294 )     (3 )%

% of total revenue 6 % 7 %

Research and development expense consists primarily of product research and development, clinical trial and study costs, regulatory and clinical functions, and shareowner related expenses.
In the last several years, we have introduced numerous new products and product enhancements that have significantly expanded our MAS platform, enhanced the applications of the XLIF procedure, expanded our offering of cervical products, and continued to invest to further enable our entry into the growing motion preservation market. We have also acquired complementary and strategic assets and technology, particularly in the area of biologics. We are developing total disc replacement devices for spine applications, which are currently in different phases of development, clinical trials and related studies. We anticipate continuing to incur costs associated with patient follow-up and advancing the products through the regulatory process related to these clinical trials and studies through at least the end of 2013.
Compensation and other shareowner related expenses, including performance-based and stock-based compensation, decreased $1.2 million in the three months ended March 31, 2013 compared to the same period in 2012, and relates to compensation-related savings.
Expenses incurred in connection with clinical trials and various studies, including outside professional services, decreased approximately $0.6 million in the three months ended March 31, 2013 compared to the same period in 2012, due to reduced costs as a result of the completion of enrollment in a clinical trial and ongoing study related activities.
Research and development facilities expenses, along with depreciation expense associated with certain system software investments, decreased $0.5 million in the three months ended March 31, 2013 compared to the same period in 2012, and is also attributable to compensation-related savings.
These decreases were offset by an increase of $2.4 million related to the acquisition of research and development intangible assets in the three months ended March 31, 2013 that were charged to expense in accordance with the authoritative accounting guidance.
For the remainder of 2013, as a percentage of revenue, we expect total research and development costs to remain consistent with current levels in support of our ongoing development and 510k product approval efforts. Amortization of Intangible Assets

                         March 31,
                     2013        2012       $ Change      % Change
                                (Dollars in thousands)
Three months ended $ 4,376     $ 2,846     $    1,530        54 %
% of total revenue       3 %         2 %

Amortization of intangible assets relates to the amortization of finite-lived intangible assets acquired. Amortization expense increased $1.5 million in the three months ended March 31, 2013 compared to the same period in 2012, primarily due to the acquisition of intangible assets acquired subsequent to March 31, 2012, and additional expense resulting from the approval of the PCM Cervical Disc System that occurred during the fourth quarter of 2012.
We expect expenses recorded in connection with the amortization of intangible assets to continue to increase in absolute dollars for the foreseeable future as amortization of acquired in-process research and development commences once acquired research and development projects reach technological feasibility.


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Interest and Other Expense, Net

                                              March 31,
                                         2013          2012        $ Change     % Change
                                                    (Dollars in thousands)
Three months ended
Interest income                       $    172      $    208
Interest expense                        (7,032 )      (6,825 )
Other income (expense), net                240           437
Total interest and other expense, net $ (6,620 )    $ (6,180 )    $    (440 )      7 %
% of total revenue                          (4 )%         (4 )%

Interest and other expense, net, consists principally of interest expense incurred on our Senior Convertible Notes, offset by income earned on marketable securities and other income (expense) items. Interest expense increased $0.2 million in the three months ended March 31, 2013 compared to the same period in 2012, as a result of additional non-cash interest expense recorded on the 2017 Notes following the effective interest method.
Other income (expense), net decreased $0.2 million in the three months ended March 31, 2013 compared to the same period in 2012, primarily as a result of a decrease in foreign currency gain of $0.2 million during the three months ended March 31, 2013 compared to the same period in 2012.
Interest and other expense, net, as a percentage of revenues, is expected to moderately decrease for the remainder of the year as a result of the maturity of the 2013 Notes on March 15, 2013.

Income Tax (Benefit) Expense

                                         March 31,
                                      2013       2012      $ Change    % Change
                                               (Dollars in thousands)
Three months ended                  $ (764 )    $ 597     $ (1,361 )     (228 )%
Effective income tax (Benefit) rate  (455)  %      56 %

We recorded an income tax benefit of $0.8 million and income tax expense of $0.6 million for the three months ended March 31, 2013 and 2012, respectively. The effective income tax benefit rate for the three months ended March 31, 2013 was 455% compared to the effective income tax expense rate of 56% for the three months ended March 31, 2012. The income tax provision for the three months ended March 31, 2013 also reflected a discrete tax benefit of $0.9 million, or 535% of pre-tax loss, related to the 2012 federal research and development (R&D) credit which was retrospectively reinstated in the three months ended March 31, 2013. No federal R&D credit benefit was recorded in the income tax provision for the three months ended March 31, 2012. We update our annual effective income tax rate each quarter and if the estimated effective income tax rate changes, a cumulative adjustment is made. Our annual effective income tax rate for 2013 is expected to be higher than the U.S. federal statutory rate of 35% primarily due to non-deductible expenses, state income taxes, net of federal benefit, and certain foreign losses expected to be incurred for which no benefit can be recorded.


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Stock-Based Compensation

                                        March 31,
                                    2013        2012       $ Change    % Change
                                              (Dollars in thousands)
Three months ended
Stock-Based Compensation
Sales, Marketing & Administrative $ 6,424     $ 6,142
Research & Development                342         465
Cost of Goods Sold                     21          14
Total Stock-Based Compensation    $ 6,787     $ 6,621     $     166       3 %
% of total revenue                      4 %         4 %

Stock-based compensation related to stock awards is recognized and amortized on an accelerated basis in accordance with authoritative guidance. The increase in stock-based compensation of approximately $0.2 million in the three months ended March 31, 2013 compared to the same period in 2012 primarily related to the increase in the weighted average grant date fair value of 2013 grants compared to 2012 grants, slightly offset by the timing of annual grants in the current year as compared to the prior year.
Liquidity, Cash Flows and Capital Resources Liquidity and Capital Resources
Our principal sources of liquidity are our existing cash, cash equivalents and marketable securities, cash generated from operations and proceeds from our convertible debt financing issued in June 2011.
In June 2011, we issued $402.5 million principal amount of the 2.75% Convertible Senior Notes due 2017 (the 2017 Notes). The net proceeds from the offering, after deducting initial purchasers' discounts and costs directly related to the offering, were approximately $359.2 million. We pay 2.75% interest per annum on the principal amount of the 2017 Notes. The 2017 Notes mature on July 1, 2017 and may be settled in cash, stock, or a combination thereof, solely at our election. Interest on the 2017 Notes began accruing in June 2010 and is payable semi-annually on January 1 and July 1 of each year.
In connection with the Medtronic litigation, a jury from the U.S. District Court, Southern District of California delivered an unfavorable verdict to us and awarded monetary damages of approximately $101.2 million to Medtronic. In May 2012, in accordance with an escrow arrangement, we transferred $113.3 million of cash into a restricted escrow account to secure the amount of the judgment, plus prejudgment interest, during pendency of our appeal of the judgment. These funds are included in restricted cash and investments in our March 31, 2013 consolidated balance sheet.
Cash, cash equivalents and marketable securities was $281.2 million and $346.1 million at March 31, 2013 and December 31, 2012, respectively, the decrease primarily relates to the maturity of the 2013 Notes on March 15, 2013. We believe that our existing cash, cash equivalents and short-term marketable securities will be sufficient to meet our anticipated cash needs for the next 12 months. Our future capital requirements will depend on many factors including our rate of revenue growth, the timing and extent of spending to support development efforts, the expansion of sales, marketing and administrative activities, the timing of introductions of new products and enhancements to existing products, the continuing market acceptance of our products, the expenditures associated with possible future acquisitions or other business combination transactions, and the outcome of current and future litigation. At March 31, 2013, we have cash and investments totaling $119.0 million in restricted accounts which are not available to us to meet any ongoing capital requirements if and when needed. This could negatively impact our liquidity and our ability to invest in and run our business on an ongoing basis. We expect that cash provided by operating activities may fluctuate in future periods as a result of a number of factors, including fluctuations in our operating results and working capital requirements. We have historically invested our cash primarily in U.S. treasuries and government agencies, corporate debt, and money market funds. Certain of these investments are subject . . .

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