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NUVA > SEC Filings for NUVA > Form 10-Q on 30-Apr-2014All Recent SEC Filings

Show all filings for NUVASIVE INC

Form 10-Q for NUVASIVE INC


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, 2013. 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 $8.7 billion globally in 2014. 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 safe and reproducible outcomes for the surgeon and the patient. The platform includes our proprietary software-driven nerve detection and avoidance systems, NVM5 and NVJJB, and Intra-Operative Monitoring ("IOM") support; MaXcess®, an integrated split-blade retractor system; and a wide variety of specialized implants. The individual components of our MAS platform, and many of our products, can also be used in open or traditional spine surgery. 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 used to aid the spinal fusion process or bone healing include allograft (donated human tissue), Osteocel Plus®, an allograft cellular matrix containing viable mesenchymal stem cells, or "MSCs", FormaGraft®, a collagen synthetic product, and AttraX®, a synthetic bone graft material, currently available commercially only in select markets outside of the U.S. 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 have dedicated and continue to dedicate significant resources toward training spine 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, and/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 recent years, we have significantly expanded our product offerings relating to procedures in the cervical spine. Our cervical product offering now provides a full set of solutions for cervical fusion surgery, including both allograft 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 (the "FDA") approval of the PCM® device, a motion-preserving total disc replacement device, further strengthening our cervical product offering and our continued trend of increasing our market share.
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

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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, biologics 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.
IOM 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.
The majority of our operations are located in the United States and the majority 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 engaged to sell 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 to invest in 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.
During the three months ended June 30, 2013, we received a federal administrative subpoena from the Office of the Inspector General of the U.S. Department of Health and Human Services ("OIG") in connection with an investigation into possible false or otherwise improper claims submitted to Medicare and Medicaid. The subpoena seeks discovery of documents for the period January 2007 through April 2013. We are working with the OIG to understand the scope of the subpoena and to provide the requested documents. We intend to fully cooperate with the OIG's request and will provide periodic updates as information becomes available. Responding to the subpoena requires Management's attention and results in significant legal expense. Any adverse findings related to this investigation could result in significant financial penalties against the Company.

Results of Operations
                              March 31,
                          2014         2013       $ Change     % Change
                                    (Dollars in thousands)
Three months ended:
Spine Surgery Products $ 137,308    $ 122,667
Biologics                 29,489       27,156
Monitoring Service        10,699        9,681
Total revenue          $ 177,496    $ 159,504    $  17,992        11 %

The continued adoption of minimally invasive procedures for spine has led to the expansion of our innovative procedures. 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 innovative minimally invasive procedures and deeper penetration into existing accounts and our newer international markets as our sales force executes on our strategy of selling the full mix of our products. However, the continued consolidation and increased purchasing power of our hospital customers and group purchasing organizations, the proliferation of physician-owned distributorships, recent changes in the public and private insurance markets regarding reimbursement, and ongoing policy and legislative changes in the United States have created less predictability in the lumbar portion of the spine market and have limited the spine market's procedural growth rate. Accordingly, we believe that our growth in revenue in 2014 will come primarily from share gains in the shift toward less invasive spinal surgery and international growth.
Our total revenues increased $18.0 million in the three months ended March 31, 2014, representing total revenue growth of 11% for the three months ended March 31, 2014 compared to the same periods in 2013.
Revenue from our Spine Surgery Products increased $14.6 million, or 12% in the three months ended March 31, 2014 compared to the same period in 2013. This increase resulted from an increase in volume of approximately 14% offset by small unfavorable changes in price of approximately 2% in the three months ended March 31, 2014 compared to the same period in 2013.

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Revenue from Biologics increased $2.3 million, or 9%, in the three months ended March 31, 2014 compared to the same period in 2013, which was due to an increase in volume.
Revenue from Monitoring Services increased $1.0 million, or 11% in the three months ended March 31, 2014 compared to the same period in 2013. This increase resulted primarily from increases in case volume and collections in the three months ended March 31, 2014 compared to the same period in 2013. Cost of Goods Sold, excluding amortization of purchased technology

                          March 31,
                      2014         2013       $ Change      % Change
                                 (Dollars in thousands)
Three months ended $ 43,294     $ 39,096     $    4,198        11 %
% of total revenue       24 %         25 %

Cost of goods sold consists primarily of raw materials, labor and overhead associated with product manufacturing, purchased goods, inventory-related costs and royalty expense, as well as the cost of providing IOM services, which includes personnel and physician oversight costs.
Cost of goods sold as a percentage of revenue decreased in the three months ended March 31, 2014 compared to the same period in 2013. The factors that contributed to this decrease were margin improvements resulting from our acquisition of the spine implant manufacturer ANC, LLC (now named NuVasive Manufacturing Limited, or "NML"), which occurred in May 2013, increased margins from IOM services as a result of increases in collections, a lower inventory reserve trend in the three months ended March 31, 2014 compared to the same period in 2013, and a lower margin impact from the medical device tax due to favorable revenue mix in the three months ended March 31, 2014 compared to the same period in 2013. These margin improvements were partially offset by lower international margins due to revenue mix as well as an increased Medtronic royalty accrual during the three months ended March 31, 2014 as compared with 2013. The increased royalty accrual accounts for the difference in using the royalty rates stated in the September 2011 verdict versus those in the June 2013 ruling (see Note 10 of Notes to Unaudited Condensed Consolidated Financial Statements).
We expect cost of goods sold, as a percentage of revenue, to approximate 24% for the remainder of 2014.
Operating Expenses
Sales, Marketing and Administrative

                          March 31,
                      2014          2013       $ Change     % Change
                                 (Dollars in thousands)
Three months ended $ 118,104     $ 99,886     $  18,218        18 %
% of total revenue        67 %         63 %

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 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, 2014 compared to the same period in 2013. Of this increase, $6.4 million relates to a charge taken during the three months ended March 31, 2014 as a result of exiting the majority of our New Jersey lease prior to the end of the lease term.
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, freight expenses, and continued investment in our international market, increased $8.0 million in the three months ended March 31, 2014 compared to the same period in 2013. This increase is primarily a result of our revenue growth during the three months ended March 31, 2014 compared to the same period in 2013.

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Compensation and other shareowner related expenses for our marketing and administrative support functions increased $1.6 million in the three months ended March 31, 2014 compared to the same period in 2013. This increase is primarily the result of an increase in headcount.
In addition, legal expenses increased $0.8 million in the three months ended March 31, 2014 compared to the same period in 2013. This increase is primarily related to costs incurred in response to the OIG subpoena received during the second quarter of 2013 as well as increases in certain intellectual property related legal matters. Expenses incurred in relation to the Medtronic litigation remained consistent in the three months ended March 31, 2014 compared to the same period in 2013.
For the remainder of 2014 and on a long-term basis, we expect total sales, marketing and administrative costs, as a percentage of revenue, to decrease moderately.
Research and Development

                         March 31,
                     2014        2013       $ Change     % Change
                               (Dollars in thousands)
Three months ended $ 9,455     $ 9,694     $    (239 )     (2 )%
% of total revenue       5 %         6 %

Research and development expense consists primarily of product research and development, clinical trial and study costs, regulatory and clinical functions, and compensation and other 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.
Research and development facilities expenses and compensation and other shareowner related expenses, including performance-based and stock-based compensation, increased $1.6 million in the three months ended March 31, 2014 compared to the same period in 2013, and relates to increased headcount and investments in capital equipment.
Expenses incurred related to the acquisition of research and development intangible assets charged to expense in accordance with the authoritative accounting guidance decreased $1.9 million in the three months ended March 31, 2014 compared to the same period in 2013.
For the remainder of 2014, as a percentage of revenue, we expect total research and development costs to moderately increase over current levels in support of our ongoing development and 510k product approval efforts. Amortization of Intangible Assets

                         March 31,
                     2014        2013       $ Change     % Change
                               (Dollars in thousands)
Three months ended $ 3,998     $ 4,376     $    (378 )     (9 )%
% of total revenue       2 %         3 %

Amortization of intangible assets relates to the amortization of finite-lived intangible assets acquired. Amortization expense decreased $0.4 million in the three months ended March 31, 2014 compared to the same period in 2013, primarily due to certain intangible assets reaching the end of their useful lives subsequent to March 31, 2013.

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Litigation Liability
                        March 31,
                      2014       2013     $ Change    % Change
                              (Dollars in thousands)
Three months ended $ 30,000     $  -     $  30,000       100 %
% of total revenue       17 %      - %

Litigation liability relates to the unfavorable jury verdict that was delivered against us relating to the Company's use of the trade name "NeuroVision" in the amount of $30 million. The amount of the jury verdict represents a probable loss that can be reasonably estimated. Accordingly, we recorded a liability of $30 million as of March 31, 2014 for this anticipated cost.

Interest and Other Expense, Net
                                              March 31,
                                         2014          2013        $ Change    % Change
                                                    (Dollars in thousands)
Three months ended:
Interest income                       $    217      $    172
Interest expense                        (6,865 )      (7,032 )
Other income, net                          375           240
Total interest and other expense, net $ (6,273 )    $ (6,620 )    $     347      (5 )%
% of total revenue                          (4 )%         (4 )%

Interest and other expense, net, consists principally of interest expense incurred on our 2013 and 2017 Senior Convertible Notes, offset by income earned on marketable securities and other income (expense) items. Interest and other expense, net decreased $0.3 million in the three months ended March 31, 2014 compared to the same period in 2013 primarily as a result of having paid off the 2013 Senior Convertible Notes on March 15, 2013.
Interest and other expense, net, as a percentage of revenues, is expected to remain consistent for the remainder of the year.

Income Tax Expense (Benefit)
                                           March 31,
                                        2014         2013       $ Change     % Change
                                                  (Dollars in thousands)
Three months ended                  $ (15,095 )    $ (764 )    $ (14,331 )     1,876 %
Effective income tax (benefit) rate      (45)  %     (455 )%

We recorded an income tax benefit of $15.1 million and $0.8 million for the three months ended March 31, 2014 and 2013, respectively. The effective income tax benefit rate for the three months ended March 31, 2014 was 45% compared to an income tax benefit rate of 455% for the three months ended March 31, 2013. We update our annual effective income tax rate each quarter and if the estimated effective income tax rate changes, a cumulative adjustment is made. For the three months ended March 31, 2014, our expected statutory tax benefit associated with the Trademark Infringement litigation accrual has been reduced by US permanent tax items primarily relating to stock-based compensation and non-deductible expenses. The income tax provision for the three months ended March 31, 2013 reflected a discrete tax benefit of $0.9 million, or 536% of pre-tax loss, related to the 2012 federal research and development credit which was retrospectively reinstated in the three months ended March 31, 2013. The Company implemented its Globalization Initiative in January 2014, which involved establishing new international operations and entering into new intercompany transfer pricing arrangements, including the licensing of intangibles. The Company intends to continue to streamline its international operations over time, including procurement, logistics and customer service functions, with the expectation of achieving overall operational efficiencies, including asset utilization, cost and expense savings

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and standardization and compliance benefits. We expect a detrimental impact on our effective tax rate over the next few years as a result of this initiative. 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. A substantial portion of our operations are located in the United States, and the majority of our sales since inception have been made in U.S. dollars. Accordingly, we do not have any material exposure to foreign currency rate fluctuations. However, as our business in markets outside of the United States continues to increase, we will be exposed to foreign currency exchange risk related to our foreign operations. Fluctuations in the rate of exchange between the U.S. dollar and foreign currencies, primarily the euro, the Australian dollar and the yen, could adversely affect our financial results, including our revenues, revenue growth rates, gross margins, income and losses as well as assets and liabilities. The 2017 Notes were issued in June 2011 with a $402.5 million principal amount and an interest rate of 2.75%. 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 2011 and is payable semi-annually on January 1st and July 1st 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, 2014 consolidated balance sheet. Further, as a result of the June 2013 District Court ruling on the ongoing royalty rates, we will be required to escrow funds to secure accrued royalties, estimated at $23 million to date, and ongoing royalties.
On April 3, 2014, an unfavorable jury verdict was delivered against us relating to our use of the trade name "NeuroVision". Accordingly, we established a liability of $30 million as of March 31, 2014. The $30 million verdict amount may require funding a trust which would be classified as restricted cash, pending the outcome of post-trial motions and the likely appellate process. In the event that we are unable to prevail in future legal action, we could be required to have a significant cash outlay.
Cash, cash equivalents and marketable securities was $339.6 million and $326.1 million at March 31, 2014 and December 31, 2013, respectively. The increase primarily relates to $23.3 million in cash from operations and proceeds from the issuance of common stock of $8.7 million, offset by $13.4 million in capital expenditures during the three months ended March 31, 2014. 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, the outcome of current and future litigation, and the evolution of our Globalization Initiative. At March 31, 2014, we have cash and investments totaling $123.1 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 believe our current cash and cash equivalents, investments and cash provided by operations will satisfy our working capital requirements, debt obligations and capital expenditures for the foreseeable future. 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 to general credit, liquidity and other market risks. The general condition of the financial markets and the economy has exacerbated those risks and may affect the value of our current investments and restrict our ability to access the capital markets or even our own funds. . . .

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