NuVasive Inc

F:NK8

Earnings Call Transcript 2019-Q2

[Operator]

Greetings and welcome to the NuVasive, Inc.'s Second Quarter 2019 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.

I would now like to turn the conference over to your host, Suzanne Hatcher, Vice President of Internal and External Affairs. Thank you. You may now begin.

[Suzanne Hatcher, Vice President, Internal and External Affairs]

Thank you, Sherry. Welcome to NuVasive second quarter 2019 earnings call. The company's earnings release, which we issued early this afternoon, is posted on the website and has been filed on Form 8-K with the Securities and Exchange Commission. We've also posted supplemental financial information on the IR website to accompany our discussion.

Before we begin, I'd like to remind you that the discussions during today's call will include forward-looking statements which are based on current expectations and involve risks and uncertainties, assumptions, and other factors which, if they do not materialize or prove to be correct, could cause NuVasive's results to differ materially from those expressed or implied by such forward-looking statements.

Additional risks and uncertainties that may affect future results are described in NuVasive's news releases and periodic filings with the Securities and Exchange Commission. NuVasive assumes no obligation to update any forward-looking statements or information which speak as of their respective dates.

This call will also include a discussion of several financial measures that are not calculated in accordance with Generally Accepted Accounting Principles or GAAP. We generally refer to these as non-GAAP financial measures. These measures include our cost of goods sold, gross margin, sales, marketing and administrative expenses, research and development expenses, operating margin, non-GAAP earnings per share, free cash flow, and EBITDA.

Reconciliations to the most likely comparable GAAP financial measures may be found in today's news release and the supplementary financial information which are accessible from the Investor Relations section of NuVasive's website.

Joining me on today's call are Chris Barry, Chief Executive Officer; Raj Asarpota, Chief Financial Officer; and Matt Link, President.

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

[Chris Barry, Chief Executive Officer]

Thank you, Suzanne. Earlier this afternoon, we reported second quarter 2019 revenue results of $292.1 million, representing 3.7% reported growth or 4.7% constant currency growth over prior year. These results are primarily driven by a solid performance from US spinal hardware and NuVasive clinical services business, offset by anticipated slower growth in the international business.

Overall, we delivered a strong performance for the first half of the year and I'm pleased with how the business is executing on the objectives we set out against – at the beginning of this year.

Based on year-to-date performance, we are raising our full-year guidance for non-GAAP operating margin and earnings per share. Raj will share more about the updated full-year guidance as well provide additional commentary on how we believe the rest of the year will play out.

Now, let me elaborate on second quarter revenue results. US spinal hardware revenue increased approximately 6% year-over-year, highlighted the quarter with strong increase in case volume, plus tangible growth in both the XLIF and ALIF franchises, driven by continued adoption of NuVasive's X360 system.

We have trained more surgeons year-over-year on NuVasive surgical procedures including X360 through our world-class clinical professional develop program and we are confident we'll continue to see further ramp in the second half of the year.

US surgical support was generally flat over prior year. However, we saw continued momentum in the NuVasive clinical services business, primarily driven by another strong quarter of strong billings and collections and solid growth in volume.

These positive drivers are associated with the focus over the last six months of disciplined business execution to drive account profitability.

Biologics performed in line with expectations at about a 1% decline year-over-year.

Revenue from the international business grew approximately 2% on a reported basis and approximately 7% constant currency. Sequentially, this growth was lower than Q1 2019 as expected and reflects first half international revenue growth of 11%.

In Q2, we saw continued strength in the EMEA region, carrying over from the first quarter, offset by slower growth rates in Asia Pac and LatAm. We continue to hone in our globalization efforts and I remain confident in our ability to take share across key international markets in the near and long-term.

Turning to profitability. Non-GAAP operating margin came in at 16.3% for the second quarter of 2019, flat year-over-year but higher than expectations. We're balancing profitability. We're strategically investing in key areas for future growth. I'm encouraged by the disciplined execution throughout the organization, with manufacturing in the West Carrollton performing well.

I'd like to give you an update on innovation. At its core, NuVasive is a med-tech company, committed to leading the spine industry by delivering new technologies to enable better clinical and economic outcomes that are more predictable and reproducible.

Our focus remains on technologies that drive the complete procedure, enhancing the entire surgical experience and expanding current offerings in key market segments.

We're on track to launch more than a dozen new products this year, spanning from solutions in core implant and fixation product lines to enabling technologies to support the further adoption of minimally invasive surgery.

This past quarter, we further built out advanced material science, or AMS, portfolio. NuVasive continues to pioneer design and manufacturing methods that focus on combining the inherent benefits of porosity, with the advantageous material properties of PEEK and titanium.

This provide surgeons with a portfolio of advanced material implant options that best fit their patient's needs. This includes Modulus TLIF-O, a coarse titanium spine implant engineered for TLIF, the most commonly performed surgical procedure in the spine industry. We also had first case use of Cohere XLIF, the first of its kind lateral Porous PEEK implant for XLIF in lateral single position surgery.

It's also important to understand, as the AMS portfolio is built out, we're also investing in clinical studies to further substantiate implant technology that leads to better, more predictable and reproducible outcomes.

Last quarter, a study was published in the Journal of Spine and Neurosurgery of 167 patients presenting with degenerative cervical disc disease who underwent an ACDF using Cohere Porous PEEK structural allograft with smooth PEEK interbody implants.

The study concluded that patients receiving Cohere coarse PEEK exhibited significant clinical improvements relative to preoperative scores, better outcomes than alternative treatment as early as six weeks and sustained improvements relative to other treatments through the 12-month post-op.

NuVasive's key product launch of the Pulse platform occurred earlier this month signifying an important milestone on our journey to transform surgery, advanced care and change lives through enabling technology.

Pulse is the first single platform to include multiple technologies designed to help surgeons adopt more efficient, less disruptive surgical approaches in all spine procedures.

I'm proud of our team of engineers, developers, product marketing teams and support functions who work tirelessly to bring Pulse to market and excited about how Pulse positions NuVasive for the future.

Pulse addresses many of the challenges facing spine surgery by combining neuromonitoring, surgical planning, rod bending, radiation reduction, imaging and navigation functions, with extensible capabilities to enable increased surgical efficiencies in the OR.

This technology can be used in a 100% of spine cases, giving NuVasive immense potential to shift the standard of care in spine surgery as we work to accelerate the adoption of less invasive surgery.

With Pulse commercially launched in the US, alpha and beta trials in international markets are now underway with hospital sites already identified in Europe, New Zealand and Australia. We anticipate gaining CE Mark later this year which is a milestone to launch the system globally.

Pulse is the foundational element of our innovation roadmap to make spine surgery more reproducible, less invasive and more driven by patient specific insights. The platform will continue to evolve within the OR, with the flexibility to add additional applications including robotics, smart tools and more.

We will share more details of how the Pulse system will be further built out at our investor day in early August. And as previously indicated, we plan to unveil the Pulse robotic application at NASS at the end of September.

Finally, it's great to see the excitement surrounding NuVasive X360 system. The enthusiasm of our surgeons and our sales force is quite tangible. Spine surgeon, access surgeons and hospital systems are clearly seeing the benefits of the X360 system to the care they can deliver.

By eliminating the need to reposition the patient during surgery, the X360 drives shorter surgery times in the OR, which means the patient spends less time under anesthesia and hospitals and surgeons gain efficiencies and increased productivity.

We continue to see great adoption of this procedure, not only among traditional NuVasive XLIF surgeons, but also with converted surgeons who may have less experience with lateral procedures.

These are just a few examples of the innovations we're bringing to market. Overall, this is just beginning and the next phase of NuVasive future growth. And I hope you share in my excitement for the opportunities in front of us.

Before turning over the call to Raj to discuss our financial performance in more detail, I want to take a minute to discuss our progress relative to the three priorities I laid out to shareholders when I joined NuVasive.

Hopefully, what you heard and seen through our actions over the last two quarters are driving confidence in our ability to do what we say we're going to do and execute on the financial commitments we communicate to you.

In January, I outlined three priorities to enable NuVasive to continue to grow at multiples of market and be an attractive investment. Number one, create a disruptive technology and continue to be the leader in spine innovation. Number two, focus on operational excellence and deliver world-class execution across all aspects of our business. And number three, drive profitable growth through renewed rigor and discipline on operating leverage.

In terms of the scorecard, for innovation and profitability, we're making clear headway in these categories. We continue to outpace others in technology that truly aligns with the more predictable and reproducible spine surgery, focused on improving patient lives.

With the Pulse commercial launch in the US, in combination with our robotics application well underway, the current and future product portfolio has never been stronger.

In terms of profitability, the team's focused execution on balancing top line revenue growth, while driving operational leverage is progressing and can be seen in the financial results so far this year.

Governance mechanisms, along with clear alignment across the organization on business priorities, is driving accountability and find execution. Operational excellence continues to be ingrained within our internal teams on how we do business.

Improved supply chain and logistics is a work in progress and there's a fair amount of process improvement to drive further efficiencies. The day-to-day execution by the organization is key to making these three priorities a competitive advantage for NuVasive.

I will continue to operate the business in a focused manner and look for opportunities to accelerate our growth.

With that, I'd like to turn over to Raj to further discuss our Q2 financial financial performance. Raj?

[Rajesh Asarpota]

Thanks, Chris. And good afternoon, everyone. Before we get started with the financials, let me remind you that many of the financial measures covered in today's call are on a non-GAAP unless noted otherwise. Please refer to today's earnings news release as well as the supplemental financial information at nuvasive.com for further information regarding non-GAAP reconciliations.

For the second quarter 2019, we reported revenue of $292.1 million, reflecting 3.7% reported growth year-over-year and 4.7% growth on a constant currency basis. These solid quarterly results were driven by above-market growth in US spinal hardware, largely due to strong case volumes as well as the US surgical support and international performing in line with expectations.

Now, let me discuss some of the specific drivers that supported these results. US spinal hardware revenue was $160.2 million for the quarter, growing 6.3% over the prior-year.

Performance continues to be driven by strong commercial execution, new product and procedure introductions and robust case volume growth.

The further ramp up of surgeon training and adoption of the X360 system continues to make a meaningful impact on adoption rates, leading to double-digit growth in lateral and anterior procedures this quarter. Offsetting topline growth was pricing pressure of negative 2%.

As I mentioned last quarter, when NuVasive's price pressure continues to be lower than our competitors, we're now seeing a consistently more aggressive hospital pricing environment.

We believe driving further innovation in the spine market from both new technology and a continued focus in proceduralization will continue to help offset industry pricing trends. We expect to balance pricing with volume trade-offs to help capture further market share.

Revenue from US surgical support was $73.9 million, generally flat compared to prior year. NuVasive clinical services performance was up 6% and that's attributed to steady volumes and continued strength in billing and collections.

Partially offsetting NPS growth was a decline in IOM products, driven primarily by the competitive pricing landscape. Biologics revenue for the second quarter was down 1% over the prior year, which is in line with expectations.

We're still on track to achieve flat to modest growth in this franchise by the end of the year, especially as volumes continue to increase from last year's new production introductions and the deployment of strategies to benefit new accounts.

International revenue was $57.9 million, growing 2.1% as reported and 6.6% on a constant currency basis. As anticipated, the international business growth rates slowed in the quarter, resulting in a blended growth rate of approximately 11% constant currency for the first half of the year.

For the quarter, EMEA revenue growth was driven by solid execution, particularly in Italy, Spain and the DACH region, with continued wins in new accounts and execution of tenders secured last year.

This was offset by limited set availability in Asia Pac and Latin America as well as slower-than-expected growth in newly entered markets.

Moving to profitability, non-GAAP gross margin for the second quarter was 73.4%, an increase of 60 basis points compared to 72.8% in the second quarter of 2018.

The variance to the prior-year was driven by savings realized from manufacturing efficiencies, while partially being offset by price erosion. Manufacturing efforts are progressing as expected to slight ahead for the year.

Further integration of additional processes started this past quarter, including the in-source of additional SKUs, new product introduction prototyping and further implementation of Lean Six Sigma practices.

Our focus will remain on ensuring that investment in the factory continues to deliver the supply-chain benefits for the balance of the year and beyond.

Non-GAAP SM&A expenses for the quarter were $149.7 million compared to $144.1 million for the prior-year period, both representing 51.2% of revenue.

We continue to be disciplined and rigorous in spend to drive efficiencies across the organization in order to fund strategic investments.

Within the quarter, supply-chain investments were made as planned for MDR and sterile packaging initiatives, as well as the boundary models.

SM&A spend in total was favorable to our internal expectations, primarily driven by the impact of stock-based compensation.

Non-GAAP research and development, or R&D, expenses totaled $17.3 million in the quarter or 5.9% of revenue, an increase of 60 basis points compared to second quarter of 2018. R&D expense remains in line with expectations, with a focus of investing in surgical intelligence, robotics and the core hardware business.

Second quarter 2019 non-GAAP operating profit margin was 16.3%, flat compared to the prior-year and above expectations. This year-over-year performance was driven by manufacturing and SM&A efficiencies, offset by planned R&D investment.

We continue to make steady progress in managing operating expenses and reinvesting into the business. The unexpected benefit as previously mentioned between gross margin and SM&A equated to about 100 basis points of favorability within the quarter.

Based on two quarters of solid execution, I will discuss updated full year non-GAAP operating margin guidance shortly.

Moving further down the P&L, interest and other expense net on a non-GAAP basis was $4.9 million in the second quarter, down from $8.1 million in Q2 of 2018. The reduction is due primarily to higher unrealized foreign currency losses in the prior-year.

Now turning to tax. Non-GAAP tax expense in the quarter was $9.8 million, resulting in a non-GAAP effective tax rate of 23%, an increase of 300 basis points over prior-year. This was due to reduced windfall tax benefits and inclusion of global intangible low tax income within the current year.

Second quarter non-GAAP net income was $32.8 million or non-GAAP diluted earnings per share of $0.63 compared to non-GAAP net income of $30.3 million or non-GAAP diluted earnings per share of $0.58 in the same period last year, an increase of $0.05 or 8.6% over prior-year.

Turning to GAAP results, GAAP net income for the second quarter of 2019 was $15 million or diluted earnings per share of $0.29 compared to $11.5 million or $0.22 per share in the same period last year.

Adjusted EBITDA margin, which includes the impact of non-cash stock-based compensation and other non-GAAP adjustments, was 25.9% for the quarter compared to 24.8% in the same period last year. This increase was primarily due to the impact of higher operating profit in the [Technical Difficulty] period and unrealized foreign currency losses recognized in the prior-year period.

Finally, free cash flow for the quarter was $37.5 million compared to $16.6 million in the same period last year. The increase was driven by improved net income and a one-time litigation settlement payment in the second quarter of last year. The increase was offset in part by additional investments in surgical instrumentation this past quarter.

Moving into guidance, based on first half results and outlook for the remainder of the year, we're updating full-year guidance for 2019. We maintained full-year revenue guidance of $1.14 to $1.16 billion, which now incorporates currency headwind expectations of approximately $5 million compared to prior guidance of $4 million.

This is reflected in the adjusted full year reported revenue growth range of 3.4% to 5.4% compared to prior guidance of 2.5% to 5.5%. Full year constant currency revenue growth remains in the range of 3.8% to 5.8%.

We're raising our full year non-GAAP operating margin guidance range to 15.3% to 15.7% compared to a prior range of 15% to 15.5%. We're also updating non-GAAP earnings per share guidance range to $2.25 to $2.35 compared to previous guidance of $2.25 to $2.30.

Let me give you some additional context around the increased financials and remind you of the few puts and takes that we discussed at the beginning of the year.

US spinal hardware business is now expected to grow between 3% to 5% for the year compared to prior guidance of 2% to 4%. This increase is driven by performance in the first half of the year, while still reflecting the expected lower growth rates in the back half of the year, primarily due to harder comparisons.

US surgical support full-year guidance remains in the range of 1% to 3% growth. We anticipate the strength in the NCS business to continue, but remain prudent with the performance expectations from billings and collections in the first half of the year will slow down in the second half of the year, along with continued pricing pressure in our IOM product line.

In regards to the international business, it grew as expected at approximately 11% in the first half of the year on a constant currency basis. As we look to the second half of the year, we're lowering full year revenue guidance to a range of 12% to 14% growth on a constant currency basis compared to prior guidance of 14% to 16%.

This updated guidance reflects the revised outlook based on the market dynamics we have seen, particularly in Asia-Pac and Latin America compared to the beginning of the year.

On operating expenses, as expected, we saw increased spend in the second quarter towards planning and execution on key business priority investments, including EU MDR and sterile packaging as well as investments in surgical intelligence and integration of robotic capabilities into Pulse.

Spend on these investments will further accelerate in the back half of the year and will partially be offset by gains in operational efficiencies. We expect the cadence of operating margin in the back half of the year to be similar to the cadence we saw in the first half of the year with the third quarter below our second quarter results based on typical seasonality and improving in the fourth quarter with incremental volumes.

With two solid quarters behind us and confidence in raising full-year guidance midway through the year, we remain optimistic on delivering on our financial commitments for 2019.

With that, I'd like to open up the call for Q&A.

[Operator]

Thank you. [Operator Instructions]. Our first question is from Matt Miksic with Credit Suisse. Please proceed.

[Matt Miksic, Credit Suisse]

Hi. Thanks for taking the question. So, congrats on a really solid quarter. I just wanted to maybe ask you to talk a little bit more about some of the dynamics in the US volume business and how, if any, impact you're seeing from some of the competitors out there on the robotic surgery side in terms of contracting or pricing or how that's affecting you at all? Doesn't seem to be affecting you too much at the moment, but any color on that front?

And then, on the component of Pulse that we hear an awful lot about in the marketplace, which is LessRay. I know now it's kind of built into the platform, but maybe where that's finding traction, how it's affecting the uptake of Pulse? Those two elements, it'd be super to hear a little more about.

[Matt Link, President]

Thanks, Matt. Appreciate the comments. When you talk about the spine market in general, clearly, we continue to have a good success in the US market. I think that a direct reflection on our continued focus on proceduralization, X360, most recently the advanced materials science portfolio that's rolling out that we've talked about.

I do believe that our competitors, with some of the key commercial tactics they're driving with robotics, I don't know itf it's having a direct impact on our ability to grow, but it is challenging. US market is a very competitive market. I do believe some of the competitors that were maybe not as competitive over the last several years have renewed their focus through robotics and some other key technologies. So, I think we're competing well and I think our focus on proceduralization has paid off in dividends.

And, clearly, I think as represented by what we've posted over the last couple of quarters, we continue to see the ability to take share. But, very clearly, the entrance of Pulse and ultimately our pursuit of robotics gives us better competitive footing against other competitors that have parts of the portfolio we simply don't have today.

So, we're laser focused on continuing to drive the adoption of X360 and lateral surgery, minimally invasive surgery in the short-term, but are very excited to come to market with competitive alternatives to some of those systems in the midterm.

So, no direct impact on our business today, but I would say that the competitiveness of the market has increased over the last 24 months. Matt Link is sitting here beside me. I'll have him comment and also he can comment on the LessRay question.

[Matt Link, President]

So, I think as Chris characterized it accurately, we're seeing a general movement to consolidation of the market. I think when we think about consolidation, critical factors include having a comprehensive offering of procedural solutions and technologies, and so the work we've done to really build out the portfolio comprehensively, to really participate in the market as a full-line spine provider has been critical. And then, obviously, the role enabling technologies play is important as well.

But with respect to LessRay, it's a critical component of the Pulse platform, but ultimately would come back to and reference that the value proposition of Pulse is really around an integrated platform of enabling technologies of which LessRay is a critical one.

When we think about significant barriers to adoption with respect to advanced technologies and procedures, like minimally invasive procedures, radiation exposure and imaging integration is a key component, and that's obviously an area where LessRay shines.

When we think about integration of enabling technologies in the workflow integration to make those technologies actually improve, interoperative efficiency that then support great patient outcomes, LessRay again is a platform technology that is critical to that. So, we've had the benefit obviously of having some experience with LessRay as a standalone technology in the OR over the last several months, but at the same time we see it as a valuable addition to a comprehensive integrated solution that includes really a suite of imaging technologies to advanced spine surgery.

[Matt Miksic, Credit Suisse]

[technical difficulty] international business. Maybe Chris or Matt, if you could talk about your confidence and your sort of visibility into some of the factors that you expect to kind of improve growth in Asia-Pac and Latin America and timing of some of those events.

[Chris Barry, Chief Executive Officer]

Let me kind of back up. I think the globalization efforts that we've taken on over the last couple of years have been really impactful to drive growth for NuVasive and also diversify geographical diversification of where our revenue has been concentrated, which has primarily been in the US market. So, over the last 6, 8, 12 months, what I think we've started really looking at was what is our longer-term globalization strategy, and echoes from everything for how do we ensure that we've got sustainable growth built in some of the larger markets, Western European markets, Japan, Australia, New Zealand; how do we thoughtfully move into markets, so that we don't overcommit/underdeliver; how do we ensure that we have the robust NuVasive technology, but also the clinical education and support; how do we ensure we have the assets to fully support. So, just getting more thoughtful on how we enter markets. So, all of those things honestly are working well. The diversification that we see within EMEA is offsetting some weakness we saw recently in Asia-Pac.

I say Japan – you were referencing Japan and some of the key markets, listen, Japan is still going very well for us, double-digit growth, yet we just are not growing as much as we thought we were going to grow in the first half. We're ramping up through new product innovation and new product introduction in that market. So, I feel we'll see good results in the back half.

We've got competitive pressures we're dealing with in Australia/New Zealand. We're working through those as we speak. But generally speaking, some softness compared to expectation in Japan, but relatively very good results versus market. Some challenges we're facing in this Australia/New Zealand and really good strength we're seeing in EMEA. So, kind of a pathway to how do we ensure that we continue to diversify, how do we continue to make sure that we're focused with a clear understanding of how we're going to win in these specific markets. And I feel like we're making good progress there.

[Operator]

[Operator Instructions]. Our next question is from Josh Jennings with Cowen and Company. Please proceed.

[Josh Jennings, Cowen and Company]

Hi. Thanks for taking the questions. And congrats on a solid quarter. I was hoping that you might be able to help us just with expectations for next week's investor day. Primarily, on the guidance side, we just received 2019 guidance update. Thanks for that. And should we be expecting targets out three years, five years. And then also, maybe just what we should be expecting with kind of the Pulse update with – you guys have been clear that most of that will happen at NASS, but maybe you could start with that.

And then, secondarily, just if we could just understand the dynamic of lower guidance in the international side and higher guidance for US spinal hardware, whether that's been the biggest driver of the operating margin target revision. Thanks for taking the questions.

[Chris Barry, Chief Executive Officer]

I'll take the first one, Josh, and I'll let Ross take the second one. The expectation, yeah, next week, we're excited. Really, a few things we want to do. We want to really reframe and reestablish some of the key priorities we talked about and the key drivers that we're looking to execute on over the next five years. We'll give you a much more in-depth, hands-on perspective of the innovation and the innovation pipeline that we're both currently launching and then a future look at some of the things that we're looking to focus on as we forward. And we will give that five-year range of where we expect to be. Now, that won't be specific guidance for 2020, 2021 or 2022. But, clearly, we'll give a range of where we want take the company both from a topline and bottom line perspective and, hopefully, give you some confidence that we've got clear line of sight in order to make sure that we do that in a competent way, so that, as we said before, the company priorities of delivering our commitments and ensuring that we meet our both internal and external commitments are very important.

So, we're going to have myself, Matt will have some surgeons there to talk, we'll have a demo or a hands-on workshop. So, hopefully, you'll walk away with a much better understanding of where we're going, how we're going to get there and a better sense of a longer-term financial strategy.

So, hopefully, that answers your question, Josh. I'll turn it over to Raj to hit on the question on the guidance.

[Rajesh Asarpota]

Yeah, Josh. So, I think the question you asked on international, of course, which is what's going on there in terms of lowering the guidance. So, first and foremost, if you think about the first half of the year, that was in line with our expectations, the results in Q2, like Chris said, was driven by strong performing in EMEA and that was offset a little bit with growth in Asia-Pac and Latin America.

So, the update in guidance really was driven by our current outlook of the growth factors that played out in the first half and then Q2 in particular. So, we expect that the deceleration that we saw a little bit in Latin America in Q2 will continue into the second half. We had some surgeon relocation there, but that's just moving from one geography to the other, so there's no big deal there.

Chris also talked about the expectation of newly entered markets. We're being very thoughtful into making sure that the markets that we've – like, the markets that we enter are providing sustainable growth rather than turning on markets for the sake of growth.

And then, the last thing that Chris mentioned again, which was – look, we are seeing some competitive pressure in Asia-Pac and that's also been taken into account as we think about the guidance for the international to the rest of the year, which is why we updated the range there.

[Operator]

Our next question is from David Lewis with Morgan Stanley. Please proceed.

[David Lewis, Morgan Stanley]

Good afternoon. Just real quickly for me, Raj. You did over 100 basis points margin expansion first half. Second half guidance implies more flattish margins. I know you talked about reinvestment. But is it the right way to think about it? It looks like there's some durable improvement now for several quarters in some of the internal initiatives. So, is the right way to think about it, you expect all that improvement to be fully offset by increased investments into the back half of the year? Thanks so much.

[Rajesh Asarpota]

So, yeah. I think if can think about sort of the puts and takes into operating margin guidance, first and foremost, of West Carrollton and our manufacturing facility is continuing to deliver the expectations that we had and maybe even slightly ahead of plan. So, we're pleased with what's happening there.

And then, just on the SM&A, R&D and gross margin line, we expect to continue ramping up our investments in robotics, on the MDR side, sterile packaging and boundary models. So, these investments will kind of offset margin improvements from Ohio and some of the other workforce efficiencies that we started work through last year. So, those are sort of the puts and takes. But, really, gross margin certainly being helped by West Carrollton and we've got some investments that we need to finish playing through the rest of the year.

[Matt Link, President]

David, this is – I would say you're dead on. There is durability growing within our business, what I said before, both the performance of some of the initiatives around West Carrollton, but also just disciplined execution and a much more conscious focus on spending and expense controls inside the company.

There are some very clear initiatives that we had to deliver on, including some work in MDR initiative and sterile pack. Obviously, standing out the Pulse platform and ultimately investing in robotics. I don't think those are one-timers per se, but clearly they are headwinds that offset some of the underlying durable games that we're feeling. So, still committed to expanding margins, but some of the things that we have to ensure that we deliver on are acute to the next several quarters. So, that's the way you should think about that.

[Operator]

Our next question is from Kyle Rose with Canaccord Genuity. Please proceed.

[Kyle Rose, Canaccord Genuity]

Great. Thank you for taking the question. Can you hear me all right?

[Chris Barry, Chief Executive Officer]

Loud and clear.

[Kyle Rose, Canaccord Genuity]

Chris, I just wanted to touch on two questions. One, Raj, you talked a little bit about –you've seen some pricing pressures accelerate. It sounds like maybe some of that's coming from some of the consolidation of vendors. But I just wondered if you could really talk about that a little bit more. Is it in specific areas from a technology standpoint? Is it blanket across the board? Just help understand that.

And then, secondly, where are you in the rollout of the boundary model? And how long do you expect that rollout to take? And then, kind of how long until you expect to see some of the leverage come off of that as far as you make an upfront fixed costs in the investments and then over what time period should we start to see the leverage roll off that boundary model? And I'll hop back in the queue. Thank you.

[Chris Barry, Chief Executive Officer]

I'll let Matt take that one. He's closest to both those conversations on that.

[Matt Link, President]

Yes. So, first on the pricing side, I think that we've obviously seen a consistent compression or headwind based on pricing in the market for a number of years now. As you would probably expect, that pressure is largest in areas where there is greater commoditization, so think about things like conventional fixation products, open pedicle screws, cervical plates and the like.

One of the other areas we tend to say an increased pressure on prices is for disposables and that's reflected in some of the results that Raj referenced in his comments earlier as it relates to the IOM and product under surgical intelligence.

What we do continue to see is the benefit of our new product – our cadence of new product introduction in each of the areas that I've described. We have a project pipeline related to new technology or line additions to our existing portfolio. Also, as you think about conventional fixation areas like pedicle screw fixation, our investment in the complex spine and deformity segments, the larger constructs, brings with it benefit of higher ASP per case even though we may see some compression on component pricing. So, the puts and takes kind of flow across the portfolio in that manner.

As it relates to the boundary model, I'd say we're still somewhat in the early days in the rollout of the boundary. As you've heard us reference in the past, we are further along in certain markets, Chicago being one, and we're being judicious in our measurement and the performance not just financially, but the performance of the asset. So, turn rates associated with set utilization, sales force efficiencies, so we can really understand the mix of the deployment model as we continue to move forward into other geographic areas. We don't anticipate moving away from a central learner model completely, but we certainly want to understand where we can gain efficiencies with the regionalization asset to better serve our customers and as well as our sales force. So, still working through that, but so far the results have been good.

[Chris Barry, Chief Executive Officer]

Thanks for the question.

[Operator]

Our next question is from Joanne Wuensch with BMO Capital Markets. Please proceed.

[Joanne Wuensch, BMO Capital Markets]

Good afternoon. And very nice [technical difficulty]. When we entered this year, I was thinking of 2019 as sort of an investment year and a restructuring year. Some of that, you're starting to see the benefits of already on the operating margin, for example. But could you sort of give us a state of the union on how you're thinking of the year?

[Chris Barry, Chief Executive Officer]

Yeah. You know that. I honestly come in, new CEO, a lot of this year I wanted to really get an assessment of where we were and kind of those three areas we talked about. I wanted to really understand our innovation and I wanted to understand the regions, some of the structural elements I changed early on to get a real good sense of what's happening in the region, what are the key needs. I wanted to get a better sense of how we operated the company and, ultimately, get a better sense of how or what were the challenges we're facing on consistently delivering our commitments.

The good news is the key element of all of those things that actually exceeded my expectations was innovation. And so, the innovation pipeline is driving a lot of growth that is actually helping me get to some of the other areas faster than what I probably expected. We've established a new strategic framework that we'll unveil at the investor day. I think we've made tremendous strides in establishing strategic priorities, installing governance mechanisms and starting to get much better at discipline and rigor around financial forecasting and things that I think were potentially areas of opportunity.

So, we're actually ahead of where I had hoped to be. Nowhere near where I want to be. But all of those things together, I think, allows us to both deliver on our commitments and start to transition the company for sustainable longer-term growth. We're just getting started, but the organization seems to be responding well. And like I said, the hardest thing for us to do, I think the company does really well, which is innovate and lead in really driving better clinical outcomes. The things I think we're challenged with, we're working diligently on is driving operational discipline and ensuring that we hold ourselves accountable delivering on our commitments both internally and externally. And the prioritization that comes with the planning, communication and coordination of our resources is something we continue to work on.

So, I'm happy with where we are and I'm thrilled to deliver two solid quarters, but we are working through – muscle building the organization and that's the way I look at this year.

Thanks for the question.

[Operator]

Our next question is from Larry Biegelson with Wells Fargo. Please proceed.

[Larry Biegelson, Wells Fargo Securities]

Good afternoon. Thanks for taking the question. Raj, just two quick ones for you. Maybe if you could elaborate on the comments you made about making pricing and volume tradeoffs to capture share. Does that seem to be incremental with pricing pressure?

And just secondly, Raj – and I apologize for the background noise – first half was at [indiscernible] about 5.5% [indiscernible] about 4% in the second half. Is it just the comps are tougher in the second half? And how should we think about the cadence of growth in Q3 versus Q4, given that, I think, you have one extra day in Q3, but the comp is clearly is tougher. Thanks for taking the questions, guys.

[Matt Link, President]

So, Larry, this is Matt. I apologize, with the background noise, difficult to hear. I'm going to try to distill the first part, which I think was around price and price to volume trade-offs. So, in line with expectations, like I said, I highlighted through some earlier comments certain segments of the portfolio where we're seeing perhaps greater pricing pressure than other segments. But, currently, we're comfortable with the current pricing environment and our ability to continue to perform in line with expectations and have volume growth to offset that pricing impact as reflected in the guidance.

With respect to the second part, it was a little more of a challenge understanding the question…

[Rajesh Asarpota]

I think, Larry, what you were alluding to was sort of the comparables in the second half. And if I can maybe talk you through a little bit on both international and on the US side. So, like we said, we had some really strong growth on the US side last year, which made comps a little bit hotter as get into the second half of the year. On the international side, it's the other way around where we have a lot more tailwind as we get into the second half. So, it's really a tale of two cities over here. So, with that kind of in mind, and given the usual seasonality factor and just good in terms of the risks and opportunities, we've got it pretty well balanced. And we still think that the guidance and the expectation we've given enables us to hit in both those geographies. Hope that answers your question, but if not I can further clarify.

[Operator]

Our next question is from Richard Newitter with SVB Leerink. Please proceed.

[Richard Newitter, SVB Leerink]

Hi. Just two questions here. First is, I think, Raj, you provided a growth rate for your lateral portfolio. I think you said it was mid-teens. If you can just provide what that trend has been over the last few quarters, I'd be curious to see the extent to which its accelerating?

And then, the second question, maybe Chris, I just want to make sure I'm keeping straight. You've got Pulse which is an ecosystem. What exactly is launching and commercial and where and when? And then, when can we expect to start seeing revenues being booked for it? I remember you launched Pulse, I think, late last year and you said you weren't going to start booking revenue until mid-2019. So, where are we on that? And, I guess, you're looking for CE Mark. Is that the official go-to-launch of the Pulse?

And then, when do you think – even though you're showing the robot, let's just say at NASS, when do you think you start actually commercializing and booking the robotic portion of Pulse revenue-wise? Should we think of that about mid-to-late 2020? Thank you.

[Chris Barry, Chief Executive Officer]

Right. I'm going to take a shot at this. There was a lot of questions in that question. Let me just hit on the lateral side. We really look at the lateral as a part of what we consider to be the minimally-invasive side. It's a little tough sometimes because you have lateral ALIF, you have lateral XLIF surgery. Obviously, you've got X360 which is a combination of those. So, we look at that entire MIS side of our portfolio and we think that's growing around the 6% to 10%, not necessarily teens, but 6% to 10%. And that basically reflects what we've seen over the last several months and quarters. So, that's that. Compared to, for instance, open spine surgery which we think is more in the 0 to 1%, 0 to 2% range. So, clearly, winning in the MIS side of the portfolio is very important to our growth story and what we're doing to really innovate.

As far as Pulse goes, Pulse is launched. We are in the process of going through the final initial launch phases and we expect to recognize revenue over the next two quarters. We're not recognizing revenue today, but we will in very short order. We're going through the final process of launch.

What's available are the elements that we've talked about. We're in the process of continuing to enhance the system through a roadmap of technology. We will show robotics at NASS. I'm not going to talk yet about launch dates or revenue recognition in relation to that application of Pulse. But we'll be more than happy to continue to really articulate our vision for Pulse and Pulse robotics as we move forward.

So, there may be other questions in there. I think that got the gist of it, but if you have additional questions, you can follow-up with us or talk to us at Investor Day.

Thanks for the question.

[Operator]

Our next question is from Raj Denhoy with Jefferies. Please proceed.

[Raj Denhoy, Jefferies & Company, Inc.]

Hi. Good afternoon. I want to ask a little about the single position lateral system, the X360 you've talked about. I think you made some comments about the pace of surgeon training and the like with that system. And I'm curious if that's competitive surgeon wins you're seeing with that system or is it really you're seeing more traction with your current users and really anything you could offer just in terms of how that's driving your results?

[Chris Barry, Chief Executive Officer]

Yeah. Thanks for the question. I'm going to let Matt hit it, but I will just tell you that, just backing up on X36, one of the key things I think that we do here at NuVasive is really look for innovative procedural approaches, and this is a great example of that and has very clear clinical and economic benefit. But I'll let Matt kind of hit the high notes. He's been involved from day one.

[Matt Link, President]

Yeah. So, I think one of the more exciting elements of X360 is we're seeing wins sort of across all segments of customers. So, new lateral customers, so think of it existing NuVasive customers that may be new lateral customers; expansion of the application of lateral procedures within an existing lateral user; as well as conversion of competitive users. So, that's really driving, I think, a lot of the enthusiasm internally that we're seeing the innovation be well-received. We're seeing the clinical validation of what we believe is not just a more efficient procedure in the operating room, but one that supports our goal of driving better patient outcomes. So, with that, we'll continue to apply the resources across the surgeon training functions as well as inventory, so we continue to scale this globally.

[Raj Denhoy, Jefferies & Company, Inc.]

Maybe just a follow-up to that, there's a lot of lateral systems. This is, obviously, very different. Can you speak a bit about the intellectual property, the protection of that system relative to competitors?

[Matt Link, President]

So, one of the key elements of the lateral portfolio for NuVasive has been the intellectual property around the integration of the procedure. So, certainly, there is protections around specific elements of the procedure, but really the integration of technologies across the procedure. So, the integration of neurophysiology, the retractor system as well as some of the interbody designs as we've looked to scale not just in X360, but across our entire interbody portfolio, the MS technology portfolio which includes modules and the Cohere platform have unique intellectual property components as well. So, again, it's a relatively comprehensive approach to the complete procedural solution.

[Operator]

Our next question is from Robbie Marcus with JP Morgan. Please proceed.

[Robbie Marcus, JP Morgan]

Thanks a lot for taking the question. Chris or Raj, I just wanted to focus on the guidance, specifically the US hardware and the international. And I appreciate the desire to be conservative here at this point in the year. Still got halfway to go. But I wanted to focus on the US where you said that the comps are getting tougher. But it actually looks on a two-year basis like comps are getting a little easier. And to get to the midpoint of the range, it looks like you have to do something like 2% growth versus 6% growth in the first half of the year. So, as you think about all that, what are the puts and takes that we should be focusing and how are you thinking holistically about guidance here?

[Chris Barry, Chief Executive Officer]

It comes down to a couple of things. You hit a couple. We have some tough comps. We talk about that. One of the other questions referenced the fact that we do have renewed competitors that are investing in this market through things like – we're seeing with some of our key competitors. We are launching Pulse. That is a – in itself – it's not isolated to a Pulse team. We're using some capital specialists, but also using our existing organization. Now, I don't know if that will be a headwind. That should be a tailwind for us in the future. But all those things coinciding in Q3 and Q4 just gives me some pause to get overly aggressive in taking revenue guidance up.

So, that's what's driving my thinking. There's a lot going on. We're learning a lot. We're in the process of launching an evolutionary product within our organization. And I can tell you that there's a lot of learning that happens every day around that. That, coupled with, like I said, tougher comps and ultimately some – it is a competitive market.

From an international perspective, it's really just the puts and the takes of – I'm seeing strengthening, yay. I'm seeing some things that I don't necessarily like in other key markets. I feel like we're on those, but I need to see those turnaround. And so, I'm going to make sure that I see the improvements that I'm hoping to see in Japan and the initiatives we put in place actually deliver better than what we've seen in the first half, although, as I said before, Japan still growing nicely, just not to the extent we thought it would two quarters ago.

So, the thinking there, I wouldn't say I was being overly conservative. I think I'm being realistic. I am optimistic that we'll continue to see success. But the fact is those are the contributing factors that give me pause to do anything. I feel good about the progress we're making in our margin and I feel those are well within our control. That's why I feel very confident and comfortable taking that guidance up. But on the revenue side, I want to continue to be cautiously optimistic, but ensure that we're doing what we need to deliver our commitments.

[Rajesh Asarpota]

Hey, Robbie. If I could just also add to what Chris said. Just primarily on the US hardware side again, in 2018, primarily in the third quarter, we saw like an increased case volume growth. I think part of that was pent up from the prior year impact from the hurricanes, et cetera. So, we're just being, at this point, given everything that's on the plate, being a little bit prudent in terms of what we're seeing. So, I think the business is very strong. The hardware growth is tracking nicely, but we're cautiously optimistic on that front.

[Operator]

Our next question is from Ryan Zimmerman with BTIG. Please proceed.

[Ryan Zimmerman, BTIG Research]

Thanks for taking the questions. So, just want to turn to biologics for a minute here. You've lapped now, I think, the easiest comps in the biologics line. When does that turn positive? And what we're seeing this quarter, maybe if you could parse out volume versus price and what you're seeing on the pricing line relative to your volume gains or losses in biologics? And then I have a follow-up. Thank you.

[Rajesh Asarpota]

I'll start, then, Matt, if you want you can jump in too. But, Ryan, we saw biologics was down a little over 1% this quarter or 5% in the prior quarter. So, in terms of answering your questions, when does it turn positive, it turns positive in the second half. So, like we said, we're expecting our guidance to be – for the total year, to be at slight to kind of modest growth. So, Ryan, to your question, straight on, we expect positive uplift in the second half of the year.

We've talked about several new product lines that we've introduced on the biologics side over the last nine months. Those are all kind of taking traction and there is still volume-price trade-offs going on as we trade out Osteocel, which is a more expensive product for some of the DBM and synthetics. So, we're continuing to make those price-volume trade-offs. Matt, anything…

[Matt Link, President]

Yeah. To just echo Raj's comments, there is a little bit of a mix shift in the portfolio, but we continue to manage, to ensure that we're offering a complete line of biologics solutions and that we're also continuing to integrate it into a complete procedural solution consistent with what our philosophy as a company has been. Much like other products in the portfolio, we monitor and measure attachment rates, to see where we're creating that complete solution. So, under the leadership of the biologics team, it's been a good sort of correction in the business and we're in line with expectations for the balance of the year.

[Operator]

Our next question is from Matt O'Brien with Piper Jaffray. Please proceed.

[Kevin Farshchi, Piper Jaffray]

Hi, everyone. It's Kevin Farshchi on for Matt O'Brien today. Thanks for squeezing me in and congrats on the results. My question is putting a finer point on international. I know it's been asked there. You've got some favorable comps going into the second half of the year. But even with these, we need more than acceleration against the full year number. I know you mentioned EMEA strength things in there, but if you can dig in a little bit more on the issues in APAC, are they going to resolve? I think you mentioned it was on sets in the prepared remarks.

And then, last quarter, it sounded like Lat Am was growing nicely or at least in line with your thinking. Has anything changed there in Q2 or for the rest of the year or something more one time in nature? Any color there would be helpful? Thank you.

[Chris Barry, Chief Executive Officer]

Yeah. I'll hit a quick market overview. Feel very good about what we're seeing in EMEA as we talked about. Strong growth there. If you turn to Asia-Pac, it's really a tale of two major markets, Japan and Australia/New Zealand. Japan, we saw double-digit growth. We forecasted something higher than that. We did have some assets that we didn't get to Japan in the timeframe that we thought we would. Caused some slowdown. We expect to resolve most of that in the back, but we've sort of missed some of our ramp. So, I do think there'll be some challenge to hit our original expectation in Japan. Again, I'll stress the fact that that's still well ahead of market as they grow today.

Australia/New Zealand, we just have some competitive pressure. We're digging into what exactly is – what our recovery and what our remediation plans are there? But the fact is we've hit some competitive pressure. And outside of that, I'll leave it there for now. But I do feel like that will continue into the back half and create some level of risk in Asia Pac. From a Lat Am perspective, we had a couple of key elements, primarily set asset opportunity in Brazil. We've continued to be challenged with some of the customers related issues over the past several months. We think we're getting some of those resolved and we need to continue to get more sets into Brazil to grow that market. So, we think that will continue to improve over the next two quarters. But, again, some of these things are – getting through the customers' challenges can be difficult.

So, those things together, I continue to think we'll see good strength in US and EMEA. I feel like we'll see decent recovery in Japan with some challenges in A/NZ and expect to see some level of recovery in Brazil. But all things considered, in line with what we've guided to.

[Operator]

We have reached the end of our question-and-answer session. I would like to turn the call back over to Chris Barry for closing remarks.

[Chris Barry, Chief Executive Officer]

Thank you. Just in closing, just thank everyone for being on the call today. I look forward to seeing all of you or as many of you as I can at our Investor Day, August 8, which is next week, in New York City and sharing with you our long-term growth and financial outlook. So, with that, I'll end the call. Thank you.

[Operator]

This concludes today's conference. You may disconnect your lines at this time. And have a great day.