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Edited Transcript of NUVA earnings conference call or presentation 1-May-19 8:30pm GMT

Q1 2019 NuVasive Inc Earnings Call

SAN DIEGO May 28, 2019 (Thomson StreetEvents) -- Edited Transcript of NuVasive Inc earnings conference call or presentation Wednesday, May 1, 2019 at 8:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* J. Christopher Barry

NuVasive, Inc. - CEO & Director

* Matthew W. Link

NuVasive, Inc. - President

* Rajesh J. Asarpota

NuVasive, Inc. - Executive VP & CFO

* Suzanne Hatcher

NuVasive, Inc. - VP of Internal & External Affairs

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Conference Call Participants

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* Jonathan Lee Demchick

Morgan Stanley, Research Division - Equity Analyst

* Joshua Thomas Jennings

Cowen and Company, LLC, Research Division - MD and Senior Research Analyst

* Kevin Michael Farshchi

Piper Jaffray Companies, Research Division - Research Analyst

* Lawrence H. Biegelsen

Wells Fargo Securities, LLC, Research Division - Senior Analyst

* Matthew Stephan Miksic

Crédit Suisse AG, Research Division - Senior Research Analyst

* Richard S. Newitter

SVB Leerink LLC, Research Division - MD, Medical Supplies & Devices and Senior Analyst

* Robert Justin Marcus

JP Morgan Chase & Co, Research Division - Analyst

* Ryan Benjamin Zimmerman

BTIG, LLC, Research Division - Research Analyst

* Steven Plachtyna

BMO Capital Markets Equity Research - Senior Associate

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Presentation

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Operator [1]

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Greetings, and welcome to the NuVasive First Quarter 2019 Earnings Conference Call. (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 Internal and External Affairs. Thank you. You may now begin.

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Suzanne Hatcher, NuVasive, Inc. - VP of Internal & External Affairs [2]

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Thank you, Rob. Welcome to NuVasive's First Quarter 2019 Earnings Call. The company's earnings release, which we issued earlier this afternoon, is posted on our website and has been filed on Form 8-K with the Securities and Exchange Commission. We have also posted supplemental financial information on the IR website to accompany our discussion.

Before we begin, I'd like to remind you 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 directly 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.

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J. Christopher Barry, NuVasive, Inc. - CEO & Director [3]

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Thank you, Suzanne. Earlier this afternoon, we reported first quarter 2019 revenue results of $274.8 million, representing 5.5% reported growth or 6.4% constant currency growth over prior year. These results were attributable to a solid performance from U.S. Spinal Hardware, improved billings and collections within our NuVasive Clinical Services, or NCS business, and our double-digit year-over-year growth in the international business. Overall, I'm pleased with the start of the year.

Now let me elaborate on first quarter revenue results. U.S. Spinal Hardware revenue increased 4.5% year-over-year. In particular, we saw a healthy uptick in our XLIF and ALIF franchises from the momentum gained in our Lateral Single-Position Surgery solution now branded as the X360 System. With this growing demand, the clinical and professional development team has increased the velocity of training to meet surgeon demand and accelerate the adoption of this procedure to continue driving minimally invasive surgery. New product introductions from late last year also contributed nicely to the top and bottom line in Q1.

In particular, the Advanced Materials Science portfolio, with the COHERE cervical and TLIF porous peek interbodies are up nearly 70% year-over-year, along with the high interest for COHERE XLIF cage that is currently in alpha testing. The expandable interbody cages and RELINE fixation system continue to perform well. I am pleased with the growth globally of PRECICE product line from NuVasive, especially orthopedics or NSO business. With strong revenue growth from NSO in Q1, the business is looking forward to expanding the PRECICE technology line through 2 commercial launches, the STRYDE nail launching this month and the Bone Transport System, which will be introduced into the market later this year.

In the U.S. Surgical Support businesses, revenue grew approximately 4% over prior year, primarily driven by 15% improvement in our core service business, with improved billings and collections. Over the past 3 to 6 months, the service business strategy has been focused on 3 primary objectives; #1, complete the integration of SafePassage, which we wrapped up at the end of the first quarter; #2, refine business development processes with additional rigor around account profitability; and #3, continued enhancement of the billings and collections functions through high-performance work teams and a more focused collection strategy. Turning to biologics, revenue was in line with internal expectations at approximately negative 6% for the quarter. Investment through a pilot and a couple of biologic-only sales force team members in key geographic areas at the beginning of the year has demonstrated good progress.

Revenue from the international business increased approximately 11% on a reported basis, and approximately 16% on a constant-currency basis. This reflects a few region-specific trends that played out in the quarter. In the EMEA region, the U.K. demonstrated accelerated growth from strong sales force execution as well as several tenders in the region that were awarded last year, producing revenue in the quarter. Lat Am was in line with expectations, offset by lower growth rates in the Asia-Pacific region. We'll continue to hone in our globalization efforts and I remain confident in our ability to take share across key international markets and achieve full year guidance of 14% to 16% growth, excluding the impact of foreign currency.

Turning to profitability, non-GAAP operating margin came in at 14.9% for the first quarter of 2019, an improvement of 240 basis points year-over-year. The entire management team is operating the business with rigor and discipline to drive profitability, while strategically investing in key areas of future growth. West Carrollton insource manufacturing is stable and performed as expected, with the majority of the over performance in the operating margin tied to timing of investment spend. For example, investment in the European medical device regulation and sterile packaging initiative did not ramp as fast as expected in the first quarter and drove favorability in our spend. Raj will give you a bit more color on how you should think about the margin outlook for the rest of the year in his remarks.

Let's turn to innovation. At NuVasive, we are committed to leading the 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 a complete procedure, enhancing the entire surgical experience and expanding current offerings in key market segments. 2018 saw the launch of more than 2 dozen new products, spanning from solutions in core implant and fixation product lines to support the further adoption of minimally invasive surgery, the fastest growing subsegment in spine. The strong utilization of these new products are reflected in our U.S. Spinal Hardware growth rates and represent a shift to more sophisticated implants through expandables and different surface structures.

At the American Association of Neurological Surgeons scientific meeting held a few weeks ago here in San Diego, the company launched the X360 System, the evolution of our Lateral Single-Position Surgery procedure. NuVasive's flagship XALIF procedure is supported by hundreds of clinical studies, validating clinical efficacy and patient outcomes. The X360 System builds upon the XALIF procedure and widens the addressable market by enabling surgeons to access L5-S1 in addition to providing posterior instrumentation to support this minimally invasive technique.

As mentioned earlier, we're seeing great adoption in this procedure, not only among traditional and invasive lateral surgeons but also with converted surgeons who may have less experience with lateral procedures. We have validated certain clinical and economic value propositions associated with this innovative procedure. First and foremost, the X360 System is beneficial to the patient because there is no repositioning, which equates to less time under anesthesia. This procedure is also beneficial to the surgeon and hospital, as it drives gained efficiencies and productivity through reduced OR time and associated hospital stay costs.

Commercialization progress of the Pulse platform continues as we near the launch of the technology at the end of Q2. After completing focused alpha testing for the past 6 months, clinical trials began in April, with positive feedback from surgeons. In addition, Pulse preorder selling is underway. In parallel, work continues internally on the robotic application to be added to the Pulse system, which will be unveiled at NASS in late September this year. All these critical milestones will enable the company's Surgical Intelligence, vision of connecting technology and tools to align the right patient with the right surgery for the right outcome. It is a significant step in the evolution from a procedurally integrated company to a systems-based technology company focused on delivering end-to-end solutions that enable predictable clinical and economic outcomes.

Now let me turn to discussing updates on how we're managing the business. I'm excited about the progress we've made since stepping into the CEO role about 6 months ago. Clear priorities have been set and communicated to my team to drive focused execution as we balance top line revenue growth while driving operational leverage. We have instituted key governance mechanisms to measure our progress and ensure accountability and alignment on our priorities. A disciplined product planning and staged process is now implemented to ensure we deliver a strong innovation pipeline to the market.

The management team also continues to focus on operational excellence from in-sourcing manufacturing efforts to supply chain and logistics to overall improvements in our business systems. This focus has resulted in a good start to the year. We remain optimistic, yet cautious, especially as the U.S. and global spine markets have not changed much from the end of 2018. With the mindset of continued share taking, the organization is applying additional focus on increased rigor around the day-to-day execution by management and our commercial sales teams globally.

Finally, as I announced in early April, we'll be hosting an Investor Day in New York City on Thursday, August 8. This will be a great opportunity to engage with analysts and investors face-to-face, and to hear from our management about NuVasive short- to long-term business and financial strategy, along with an opportunity to better understand the product roadmap to support both the current and future state of spine and specialized orthopedics. I am extremely excited about this opportunity and look forward to seeing many of you in attendance.

With that, I'd like to turn over to Raj to further discuss our Q1 financial performance.

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Rajesh J. Asarpota, NuVasive, Inc. - Executive VP & CFO [4]

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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 basis unless noted otherwise. Please refer to today's earnings news release as well as the supplemental financial information on nuvasive.com for further information regarding non-GAAP reconciliations.

For the first quarter 2019, we recorded revenue of $274.8 million, which reflects 5.5% reported growth year-over-year and 6.4% growth on a constant-currency basis. As Chris described, results were achieved across U.S. Spinal Hardware, U.S. Surgical Support and international, all performing above-market growth.

Now let me share some of the specific drivers that supported the business results. U.S. Spinal Hardware revenue was $147.8 million for the first quarter, representing 4.5% growth over prior year. The solid performance spanned across several sales regions and contributions from traction of new product introductions launched last year, coupled with new surgeon conversions. We see continued adoption of NuVasive expandable cages to TLX 20 degrees, our proprietary Porous PEEK implants and the X360 system. Performing Lateral Single-Position Surgery with NuVasive technologies has gained momentum over the last 6 months and is translating into benefits in our XLIF and ALIF franchises.

Offsetting this top line growth was pricing pressure of negative 2.4% for U.S. Spinal Hardware. Although this is low compared to competitors, it's higher than usual for NuVasive in the first quarter. We continue to drive innovation in the space to help offset the industry pricing trends, balanced with price volume trade-offs to gain and drive further market share capture.

Revenue from U.S. Surgical Support was $72.2 million for the quarter, a 3.7% increase compared to prior year. This was driven by NuVasive Clinical Services revenue, which is approximately 15%, and driven primarily by continued strength in billing and collections as volumes were steady and in line with market growth.

Biologics revenue for the first quarter was down approximately 6% over prior year, which was in line with internal expectations. This franchise continues to see increased volume, offset by declining average selling price as a result of ship from Osteocel to lower cost osteobiologics. Selling traction outside of Osteocel with DBMs and AttraX products has been positive since the launch last year. With a well-rounded portfolio in place, we continue to track towards achieving flat to modest growth for the full year 2019.

International revenue was $54.8 million, growing approximately 11% on a reported basis, and 16% on a constant-currency basis. This business performed to our growth targets with some regional puts and takes. EMEA growth was driven by solid performances in the U.K., Southern Europe and Benelux. The execution in the U.K. was driven by wins across several new key accounts and tenders secured last year in Germany and Benelux, which produced revenue in the quarter.

Additional dynamics that played out in the quarter related to the occurrence of 2 extra billing days and timing of a favorable distributor order. Overall, the results provide validation for the turnaround in EMEA and the normalization of these dynamics for the balance of the year have been contemplated in our full year guidance. Asia Pac experienced growth primarily from Japan and Australia and New Zealand through strong RELINE sales with sales force investments made last year and partially offset by a onetime distributor transition in the region. Latin America performed in line with expectations with Puerto Rico, Brazil and other countries remaining stable.

Moving now to profitability. Non-GAAP gross margin for the first quarter was 72.9%, an increase of 110 basis points compared to 71.8% in first quarter of 2018. The improvement in gross margin was led by the achievement of stable and consistent production throughput and planned queue insourcing at the West Carrollton manufacturing facility. Insource manufacturing efforts are progressing as expected, with 6-plus months of stable operations, further integration of additional processes has now been initiated. Our focus will remain on ensuring that investment in the factory will continue to deliver the supply chain benefit through the balance of the year. The realization of strong billing and collections from NCS was also a factor in driving gross margin improvement within the quarter. The positive margin expansion from both West Carrollton and NCS was partially offset by the impact of price erosion and business mix as international and NCS businesses grew at a faster pace than the core U.S. hardware.

Non-GAAP SM&A expenses as a percent of revenue decreased 210 basis points from the prior year of 51.7% in the quarter, or $142 million. With the growth in the international business, there continues to be leverage of expanding scale with fixed overhead costs. Domestically, the management of operating expenses in a disciplined manner has produced the benefit of productivity and efficient resource management.

SM&A spend in total was below our internal expectations in the quarter. The execution organizational design changes early in the quarter provided savings that have freed up resources to redeploying through investments for the balance of the year. These investments include the boundary model, EU MDR and sterile packaging that were slow to ramp in the first quarter, but will accelerate through the remainder of the year in a disciplined manner.

We have discussed our hub and spoke asset management model, or the boundary model over the last few quarters. This initiative was piloted last year in certain high density regions of the U.S. to enable forward deployment of sets for surgery that are allocated to a certain geography. As a result of this initiative, we see significant decreases in courier costs and productivity for our sales teams with more freed up selling time.

This year, we are slated to add 4 additional geographies to the boundary model. EU MDR and sterile packaging are table stakes to continue conducting business in certain markets and increase our competitiveness in other international geographies. Non-GAAP research and development, or R&D expenses, totaled $17.2 million in the quarter or 6.3% of revenue, which was an increase of 70 basis points compared to first quarter of 2018. The increased R&D spend reflects continued investments in Surgical Intelligence, robotics and the core business.

We believe both recent and upcoming product launches related to these technologies will help drive further future revenue growth.

First quarter 2019 non-GAAP operating profit margin was 14.9%, up 240 basis points compared to 12.5% for the first quarter of 2018. The primary driver of improved profitability was related to the West Carrollton manufacturing facility. Year-over-year, progress in reducing operating expenses as a percent of revenue drove down 140 basis points over the prior year. This management team is continuing to run the business with discipline and rigor and intends to invest in opportunities to drive top line growth with profitability to deliver on our commitments.

Moving further down the P&L, interest and other expense net on a non-GAAP basis was $5.2 million in the first quarter, down from 5.9% in the same period last year.

Now turning to tax. Non-GAAP tax expense for the quarter was $8.2 million, resulting in a non-GAAP effective tax rate of approximately 23% for both the current and prior year. First quarter non-GAAP net income was $27.6 million or diluted earnings per share of $0.53, compared to non-GAAP net income of $20.6 million or diluted earnings per share of $0.40 in the same period last year, an increase of $0.13 or 33% over prior year. This performance stems from improved non-GAAP margins.

Turning to GAAP results, GAAP net income for the first quarter of 2019 was $9.4 million or diluted earnings per share of $0.18, compared to net loss of $27.1 million or a loss of $0.53 per share in the same period last year.

Prior year results included a litigation accrual for the [Mapton] case, which was resolved in the second quarter of 2018.

Adjusted EBITDA margin, which excludes the impact of noncash, stock-based compensation and other non-GAAP adjustments, was 24.3% for the quarter compared to 21.4% in the same period last year. This increase was primarily due to improved operating margins.

Finally, free cash flow for the quarter was negative $9.5 million compared to a positive $7.3 million over last year as expected. The reduction was primarily driven by investment in inventory of surgical instrumentation as well as a difficult comparable due to strong non-NCF collections in the prior year period.

Moving into guidance, based on first quarter results and the outlook for the remainder of the year, we are reiterating full year guidance for 2019, including revenue in the range of $1.14 billion to $1.16 billion, and non-GAAP operating margin guidance for the year at 15% to 15.5%.

Some additional color on guidance starting with revenue. While the year is off to a strong start across the board, there are several items to note. First, I expect U.S. Surgical Support to be more in line with market growth for the remainder of the year as our billing and collections align with the volume growth we are seeing. Second, as we enter the second quarter, we expect growth in EMEA to perform in line with overall international growth rates normalizing for the Q1 favorability, as I pointed out earlier. Third, there is a harder comparable period in Q2 over prior year, which should translate into total company year-over-year growth rates that are lower than those observed in Q1.

On margins, we expect a larger ramp in spend starting in the second quarter on key business priority investments, including Surgical Intelligence and the integration of robotic capabilities into Pulse, MDR and sterile packaging. Offsetting the increased spend will be ongoing benefit from insourced manufacturing, disciplined spending within our non-customer facing areas, where we'll continue to identify opportunities to drive efficiencies.

So as we look ahead to the balance of the year, we remain optimistic and dedicated to delivering on our commitments. Thank you. And with that, we'll now open up the call for Q&A.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from the line of Josh Jennings with Cowen and Company.

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Joshua Thomas Jennings, Cowen and Company, LLC, Research Division - MD and Senior Research Analyst [2]

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Congratulations to a strong start to the year. I was hoping just to start off, I think Raj commented about the 6.4% organic constant currency growth. I think if you add back on a constant billing day basis, that's probably closer in the high 7%s. I think from a high level, you said new projects and new surgeon conversions were the drivers of that performance. You also called out a lot of -- you've had a lot of commentary in Q4 and Q1 around interbody strength, and I was just wondering if you could hone in there and help us understand if NuVasive is seeing higher revenue per surgery growth in the last couple of quarters? And how you see that trending over the course of 2019 and into 2020?

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J. Christopher Barry, NuVasive, Inc. - CEO & Director [3]

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Sure, Josh.

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Matthew W. Link, NuVasive, Inc. - President [4]

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Hi, Josh, this is Matt. As you noted, we have seen a strong uptick of interbody, but historically, we've seen very strong interbody performance by virtue of being [seasonally] based company. So what we're seeing is continued adoption of our interbody, continued strong growth in our fixation business as well, as referenced during the script with RELINE, and continue to see some benefit in price related to those new interbody offerings again as referenced in the pricing spectrum from Raj. So I'd say, in line with what we've seen in prior periods and continuing to support our surgery conversion rate through the balance of 2019, consistent with expectations.

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Joshua Thomas Jennings, Cowen and Company, LLC, Research Division - MD and Senior Research Analyst [5]

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And just a quick follow if I could. I mean just on RELINE, you had strong 4Q -- strong 1Q you've been calling it out as a driver and one of the 4 technological focus areas is complex spine. That's a large market opportunity within the overall spine industry. And I was hoping you could just help us understand where you feel like your share position is in complex spine? We tag it as a kind of $1.2 billion to $1.4 billion opportunity. And if you think you can make strides to get to a share position in complex spine to where you are in degen? Maybe what the trajectory there is? And can you penetrate adolescent scoli effectively?

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J. Christopher Barry, NuVasive, Inc. - CEO & Director [6]

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Yes, no problem. So I'll try to break this up into maybe 2 sections, adult complex and then maybe pediatrics. So I think as you appreciate and as your question referenced, we have participated more largely in the adult degenerative segment since we introduced RELINE in 2015 as well as historically. A lot of that is by virtue of being focused more in minimally disruptive procedural segments. Since the introduction of RELINE, we've seen steady growth into the complex segment and we expect that to continue. It's an area where proportionally we have underparticipated relative to our degenerative market share.

As you shift gears into the pediatrics segment, I think you need to take into consideration 2 critical components. One was the Ellipse Technologies and MAGEC rod acquisition, which has continued to support our market growth in that segment as well as the introduction last year of the RELINE Small Stature system also geared towards that acute pediatric patient population. So we are continuing to see strong growth from RELINE, largely supported through the complex and deformity segment, although, I'll acknowledge, as the market would also acknowledge, those conversions typically are a longer cycle than the degenerative segment based on the complexity of the pathologies, and so we are comfortable with the rate of conversion to date and expect it to continue.

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Operator [7]

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The next question comes from the line of Matthew O'Brien from Piper Jaffray.

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Kevin Michael Farshchi, Piper Jaffray Companies, Research Division - Research Analyst [8]

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This is Kevin Farshchi on for Matt today. Congratulations on the nice quarter. I wanted to follow up on the first question that was just asked. I think you mentioned in the past 1 to 2 points of growth impact coming from 1 less billing day in the quarter. Can you confirm what that growth impact was? And then on the guidance, there's been that strong growth in Q1. Can you break out why stick with that range? Why not, at least, bring the low end a bit higher? I understand the commentary on surgical support and the other 2 factors coming more in line, but is this to really keep things risk-adjusted? Or do you anticipate some market dynamics, price erosion or any other disruption you had not accounted for previously?

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Rajesh J. Asarpota, NuVasive, Inc. - Executive VP & CFO [9]

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Yes. So I think, your first part of the question was what is the extra -- or like 1 billing day in the U.S. entail? So in Q1, we did have one less billing day which equates to about 1.4% growth in the U.S. And the second part of your question, I think, you mentioned price. We did talk about price as being a little higher in the first quarter this year than we've seen historically at about 2.4% compared to our 2%. And normally the way we think about this, and we've always said this in the past, we are going to remain -- while our NPI enables us to command premium pricing, to some degree, we continue to make price volume trade-offs. And as long as it entails in driving growth momentum on top line, we are okay to sacrifice a little bit of price.

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J. Christopher Barry, NuVasive, Inc. - CEO & Director [10]

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I'll speak to the last part, which was the guidance question. When it comes down to it, we're excited about how we started the year, but there were some one-timers that we experienced all in our favor this quarter. One of the things I committed to you guys last time was, I want to make sure we deliver on our commitments. I don't think we're being risk-averse. I just think we need to see the trend continue in a couple of key areas of the business, I feel very good about how we drove U.S. hardware, the NCS business as we discussed, I believe that was more of a onetime event. We are going to make improvements in the way that we collect, but the fact is, we were able to catch up in some areas that really benefited us in that business in the first quarter. We also saw some strong bounce back in certain key markets that Raj discussed. I need to see that trend out over another 2 to 3 months to really ensure that we've got the underlying strength and we're not just dealing with volatility coming off of a very, in many cases, subpar year in certain key countries to really rebounding into a very phenomenal quarter.

So I think it's prudent for us to maintain the guidance that we've given at this particular moment. As we move through the second quarter and into the back half of the year, I'll readdress guidance at that time.

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Rajesh J. Asarpota, NuVasive, Inc. - Executive VP & CFO [11]

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And just 1 additional point. We talked a little bit about this being a first half, second half story. As you guys know, on the international side, we have favorable or easier comps going into the second half of the year and on the flipside, on the U.S. side on the hardware business, we've got harder comps from 2018 given we had like a really strong Q3 last year and Q4 on the strength of what case volumes coming back after the hurricane impact in '17. So it's a little bit of a first half second half story. And we've got a great start this quarter, but we have to be like Chris said, a little bit cautiously optimistic as we go into the second quarter and the balance of the year.

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Kevin Michael Farshchi, Piper Jaffray Companies, Research Division - Research Analyst [12]

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That makes a ton of sense. Wanted to ask a quick question on Pulse. As you're building the indications for the robotics add on, I know you showed it at NASS and you are beginning to recognize some revenue for Pulse without robot this year, can you talk a little bit about how that launch may progress, either from a revenue perspective or just from the customers that you've showed the product to? And then on the robotics side, could you talk a little bit about what the prototype at NASS may look like? And will the same indications that you're going to be presenting to clinicians in September be present in the robotics add on when you inevitably launch it? If you can provide some color there.

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J. Christopher Barry, NuVasive, Inc. - CEO & Director [13]

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Yes, I'll give it a shot. Thanks for the question. We're super excited about the new entry into this new phase of our company, as I mentioned, really moving from a procedurally integrated company to really a technology and a broader systems company to support, I think, a much more predictable and reproducible surgery. The way we're thinking about our launch coming into the back half of this year, to be very honest, is we're going to be -- we're going to run before -- we're going to walk before we can run. We're going to be deliberate in how we drive the first sales. Clearly, we have seen very good customer reaction to our alpha tests and into the trials that we're into now. As I mentioned earlier, we're in the preselling process. And I think demand is showing very strong -- showing very strong demand as we speak but I want to make sure that we don't -- we need to, as a company, learn how to manage these types of products and that's something that we are doing as we speak, we'll do into the third quarter and into the fourth quarter to that end.

I don't look for a ton of material revenue this year. I do look for us to learn a lot as an organization and implement the technology. Moving over to robotics, as we've talked about, I'm not going to speak to any kind of features or benefits of robotics. What I will say is, the system of Pulse integrating multiple modalities, multiple technologies, I think, is a very architecture or software-rich environment to then build a robotic application into. We are focused on and to -- simplistically, on broader utilization of our technology. We want our Pulse system, and ultimately going into the future, our Pulse system with robotics to be utilized in every spine case, whether that be navigation, 2D-3D imaging, reducing exposure to radiation through our LessRay technology or, in future cases, having a robotic application that supports the surgery.

So we think about it -- I don't necessarily think about Pulse and then robotics, I think about Pulse and then Pulse with robotics. So we are entering into this phase of our growth, launching the Pulse system. We're excited about the reaction and the support we're seeing from customers that have been exposed to this technology. As an organization, we are going to resist the temptation to move faster than what we can support. We have to learn and build organizational capability, and we're very excited to unveil our robotic application and an enhancement to our Pulse system at NASS in September. So hopefully that provides the level of insight. I know people are anxious to see and hear about what we're going to say about robotics, but I'm going to be disciplined and hold that until we see you guys in September.

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Kevin Michael Farshchi, Piper Jaffray Companies, Research Division - Research Analyst [14]

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Congrats again.

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Operator [15]

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(Operator Instructions) Next question will be coming from the line of Jonathan Demchick with Morgan Stanley.

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Jonathan Lee Demchick, Morgan Stanley, Research Division - Equity Analyst [16]

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I wanted to follow-up on the Pulse conversation. I guess, both without and with robotics going into the future, but what's the strategy for selling there? From customers you've talked with so far, are they looking for outright sales, leases, usage-based models? Just trying to figure out any color of how you plan on selling this and recognizing the revenue? And then secondly, also with Pulse, just wanted to think about guidance this year. Is any revenue from Pulse needed to hit guidance this year? Or is that more upside?

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J. Christopher Barry, NuVasive, Inc. - CEO & Director [17]

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We've reflected what we believe is in our guidance, so I don't -- we don't need any additional sales of the capital to deliver on our commitments, kind of back to your first question. I think the thing that -- as I mentioned earlier, we're focused on utilization. I'm not taking anything off the table and I think we're being open-minded to our customer needs on how we sell the system, how we place the system, how we recognize revenue in the system. I will tell you, being focused on utilization, really directly would represent that I'm not necessarily focused on trying to sell capital as a means to an end. I want to become a systems-based company, tying in our current hardware technology with the system and the architecture that we see with Pulse with the multiple knowledge that we have to offer in today's Pulse, inclusive of where we take robotics.

And in order to do that, I don't want to be limited by hurdles that we inherently would install. So I think we're being very open-minded. We're having, I think, very strategic conversations with our customers around the best way for them to acquire technology. And as I mentioned before, we are learning how to support this technology and as we do that, I think, it will further define the different ways to place the technologies, sell the technology or other innovative ways that we get this product with our customers so that we can as we said, drive the proper utilization in advanced spine surgery.

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Operator [18]

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

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Lawrence H. Biegelsen, Wells Fargo Securities, LLC, Research Division - Senior Analyst [19]

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Chris, congrats on a good start to the year and everyone at NuVasive. First question is just on X360. Could you help us understand kind of the commercial opportunity there? Are you getting a price premium? And then I have one follow-up.

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J. Christopher Barry, NuVasive, Inc. - CEO & Director [20]

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I'm going to let Matt -- Matt's our expert here on 360. He's been working on this for a long time, so I'll let Matt take this one.

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Matthew W. Link, NuVasive, Inc. - President [21]

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Larry, good afternoon. There's a relatively well defined interbody space, and one of the things we've learned over the history of XLIF is that in certain procedural applications and for certain pathologies there becomes a limitation to XLIF, in particular, the ability to address the L5-S1 interbody segment. And whether there's a requirement for posterior fixation that may require repositioning of the patient in both instances. And so we still believe in lateral surgery, particularly lateral transpsoas XLIF as being the premier minimally invasive interbody technique, providing other technologies to expand the utility of it in an efficient manner has been our goal, and in doing so, see the opportunity to capture a broader segment of the interbody market that makes it -- and other interbody techniques today such as TLIF and PLIF in particular from a posterior approach.

And so we see it as primarily share shifting with respect to interbody techniques, based on the ability to offer a better solution to the patient and a single position approach that then also offers greater efficiency and cost savings in the healthcare setting. So that's really where we think about the market opportunity around X360, shifting other interbody opportunities to lateral surgery where we remain the market leader.

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Lawrence H. Biegelsen, Wells Fargo Securities, LLC, Research Division - Senior Analyst [22]

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That's very helpful. And Chris, just a big picture question. It seems with -- NuVasive's been focused on top line growth. Margins have suffered and vice versa. So my question for you, Chris, is what's your priority, top line growth or margin expansion? And is it possible to do both?

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J. Christopher Barry, NuVasive, Inc. - CEO & Director [23]

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Thanks, Larry. Simple answer is, it is possible to do both. I, clearly, we're focused on top line growth first and foremost as a #1 priority because I think that's a direct reflection of innovation and technology and how our customers actually value innovation technology. And at the end of the day, we want to continue to be a technology company that's truly innovative in the spine space. So that is my #1 priority.

Having said that, I do believe it is possible to drive some level of operational leverage, which is, to me, a function of discipline. Clearly, there are some trade-offs along the way, but I believe at our company now is a little over $1 billion, $1.1 billion, there is -- as we've grown, there is naturally, I think, a way for us to continue to drive efficiencies across the enterprise, take full advantage of a growing footprint in our international markets. And as we -- earlier as we said, move from procedural integration to a systems-based company, become more with our customers particularly drive efficiencies across our channels.

So I 100% believe that it is not only possible but is required. I believe the organization is galvanized in rally to accomplish this objective. The one thing I would say, which I said to you back in San Francisco a few weeks ago, the pace of how we drive operating margin expansion, that's the question I have. What I don't want to do is trade innovative opportunities to drive arbitrary margin improvement. So I will strive and continue to drive margin improvement across the business, but I will also be disciplined and diligent on ensuring that we continue to innovate and drive our technology forward.

So a long-winded way of saying that we are going to do both. The rate of our margin expansion is something that we're assessing as we speak, but we will continue to really lead the market from an innovation perspective and that is our #1 priority.

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Rajesh J. Asarpota, NuVasive, Inc. - Executive VP & CFO [24]

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If I could add just a little bit more color to emphasize on what Chris said. So we've been seeing over the last couple of years we talked about the path to '25 and the opportunities that exist for margin expansion. Those levers have not changed, so whether it's sales force efficiencies, it's our factory investment that's going to pay dividends on gross margin, it's our international leverage, which continues to move along quite nicely and other operational leverage that we have.

Having said that, again, to Chris's point, as this company continues to scale, there are opportunities to drive top line, and those will be balanced as we think about how the profit margin rolls through the P&L.

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Operator [25]

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Our next question is from the line of Richard Newitter with SVB Leerink.

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Richard S. Newitter, SVB Leerink LLC, Research Division - MD, Medical Supplies & Devices and Senior Analyst [26]

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Raj, just wanted to get a better understanding of the margin out performance in the first quarter but the reiterated full year margin guide. And I appreciate that there are some -- there are some items that maybe were a little stronger on the top line and some investment that got pushed out, but on the gross margins specifically, you still came in above where the consensus was certainly where we were thinking by about 100 basis points, and The Street I think has you modeled moving right up to about where you started off the year in 1Q, in 2Q, 3Q or 4Q. So I guess the question is just was The Street maybe mismodeling kind of the cadence there? And we should be thinking that it came in line with where your internal plan was? Or was there out performance relative to the gross margin improvement that we saw? And that's the -- I'm trying to get at what the explanation is for no carryforward through a guidance increase given this out performance?

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Rajesh J. Asarpota, NuVasive, Inc. - Executive VP & CFO [27]

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Yes, sure. Yes, let me try and unpack that, right? So gross margin performance was good. And if you think about -- if you do the walk from where we ended last year at 71.8% to 110 basis points of expansion that we saw. So West Carrollton had great performance. I think we said we have now seen 6 months of really stable growth there. The throughput there is turning our quite nicely. Our insourcing plan's working, so we saw 130 basis points of expansion through West Carrollton. We saw a little bit of goodness from -- and I'll say about 50 basis points that came through expired royalty, expense on a couple of products.

The NCS margin, so you saw we had good services performance in the quarter. And as you know, that's a fixed cost business and as you get more top line, there's leverage that translates from that. And then to offset that, we had mix and price. So price erosion was about 50 basis points and then the rest of it falls through in mix. So the international and the NCS growth was above U.S. core growth. So that's kind of what drove the gross margin performance.

And then as you think about operating margin then, so outside of the GM, the gross margin fallout, we saw a lot from efficiencies that have continued from streamlining efforts that we've worked through, starting in mid-last year, so those efficiencies and back office have been working out. And then I think we also mentioned in the script that we have some investments that have kind of ramped up a little bit slower. So the MDR, the sterile packaging was a little bit slower in the first quarter and will start to catch up as we go through the rest of the year.

So I guess, it's a long-winded way of saying that we are maintaining our operating margin guidance at this point, and should that change, we will continue to keep you updated.

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Richard S. Newitter, SVB Leerink LLC, Research Division - MD, Medical Supplies & Devices and Senior Analyst [28]

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Okay. And maybe just 1 other one. I hear you guys talking a little bit about this transition from a procedural-focused company to a systems-focused company. I just want to make sure I'm understanding exactly what that means because I always thought that NuVasive focused on the procedure, that in and of itself was the holistic approach to making sure you service your customers on their actual clinical needs. What do you mean when you talk about the systems -- kind of a systems-focused versus a procedural, or moving away from a procedural focus?

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J. Christopher Barry, NuVasive, Inc. - CEO & Director [29]

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Let me be clear. We're not moving away from procedural approach. We're actually enhancing our procedural approach by becoming more to the overall operating room infrastructure. So we've been procedurally integrated by providing the interbodies, the fixation systems, the hardware and the training and support associated, the monitoring for the patient. We're now entering into a realm where we'll now start to integrate that procedural solution and enhance it by now offering what we're going to be offering in Pulse, which will now start to incorporate the navigation aspect of our procedures, 2D and 3D imaging. Having that hub that we talked about within Pulse, integrating LessRay and your monitoring capabilities into the system, and ultimately, participating and fully equipping that system to have a robotic capability.

So much more inclusive of other technologies that, in our past, have operated outside of what we've considered to be our focus on the procedure. Clearly, still, inherently a part or could be and should be, in many cases, a part of the procedural solution we just haven't participated. By moving into this next evolution of a systems-based company, we're not only focused on the procedure, but what is technology surrounding the patient, engaging with the clinical staff, not just the surgeon, but the staff, in many cases, to ensure that we are inclusive of the entire operating room theater to ensure that we are participating in driving the best possible solutions for the safest possible procedure in the safest possible operating room environment, providing ultimately the best possible outcomes for the patient. Does that make sense? Is that good?

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Operator [30]

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This question comes from the line of Matt Miksic with Crédit Suisse.

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Matthew Stephan Miksic, Crédit Suisse AG, Research Division - Senior Research Analyst [31]

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So I wanted to make sure like a lot of folks I guess given some of the variability and, Raj, as you talked about early in the call, just the timing of some of these expenses you mentioned for Q1. And normally there is a pretty substantial, historically, step down from Q4 to Q1 in terms of operating margins. This time, it was a little less substantial. And wanted to get a sense of how much of that was timing of expenses? Should we maybe expect the cadence going forward to be slightly different just on the operating margin sort of cadence? And then I had 1 quick follow-up just on the robotics.

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Rajesh J. Asarpota, NuVasive, Inc. - Executive VP & CFO [32]

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Yes. So the operating margin cadence, you're right in that we did have a little bit of -- we are going to see a ramp-up of SM&A as we go through the back half of the year. And Q4 operating margin will be typically higher than the rest of the year, but I think what you'll see over the next couple of quarters is a slight ramp in operating expenses, so your operating margin will align accordingly.

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Matthew Stephan Miksic, Crédit Suisse AG, Research Division - Senior Research Analyst [33]

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Okay. So whereas we might see like a substantial step Q1 to Q2, maybe less substantial and then kind of a similar pattern, less significant step up in Q4 just based on the spending ramp that you're talking about?

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Rajesh J. Asarpota, NuVasive, Inc. - Executive VP & CFO [34]

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That's about right.

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J. Christopher Barry, NuVasive, Inc. - CEO & Director [35]

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Yes, save for some of the one-timers in Q1 you would've seen a much more sharp drop from Q4 to Q1. So yes.

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Matthew Stephan Miksic, Crédit Suisse AG, Research Division - Senior Research Analyst [36]

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And I'm sorry if I missed it, but did you quantify those at all in terms of basis points or anything like that, that could help us understand that?

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Rajesh J. Asarpota, NuVasive, Inc. - Executive VP & CFO [37]

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In terms of?

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Matthew Stephan Miksic, Crédit Suisse AG, Research Division - Senior Research Analyst [38]

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Like in other words, it would have been, I don't know, 50 basis points or 100 basis points of additional -- margins would have been 100 basis points to 150 basis point different, say, if without the one-timers?

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Rajesh J. Asarpota, NuVasive, Inc. - Executive VP & CFO [39]

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It's right -- if you think about it, it's going to be around 100 to 200 basis points, basically. So again, in Q1, some of the one-timers that Chris alluded to, we had the billings and collections that continued to pick up from where last year left off. There was a top line beat on the Europe side. There were a couple of extra billing days there from the timing on how the Easter holiday fell. We also had a distributor order that came in sooner than we expected, and then to offset that, we also had some of the MDR and sterile packaging expenses that are being pushed out. So the ballpark is around 100 basis points, 200 basis points.

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Matthew Stephan Miksic, Crédit Suisse AG, Research Division - Senior Research Analyst [40]

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And then just on the robot, I know, Matt and Chris and team, don't really want to tip your hand too much at this point, but maybe I would ask, what have you learned? What -- from your observations and speaking with folks in the field interested in robotics that you may not -- we might not expect you to chase down the path that the other 2 major players have gone down? Or given that you're a lateral company, to what degree should we be expecting something that's -- you're not a lateral company, that's not fair, but you do an awful lot of lateral surgery, something that has a bit more capability in that approach? Just anything you could tell us that might be unique and different, perhaps as a teaser here ahead of NASS?

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Matthew W. Link, NuVasive, Inc. - President [41]

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[We're getting] lateral is actually a great reference point. We take pride in that being a foundational component of who we are as a company in our portfolio of technology. I think Chris did an excellent job talking about the clinical utility and the application based environment of Pulse. And what we see with respect to technology in the OR is, it needs to provide value. And largely, that value is by integrating seamlessly to a workflow that supports ease of adoption and actually drives incremental improvement in surgery. And so I think that's really the best way to think about what we're trying to do in the robotics space. It's building off this application-rich environment of Pulse, providing a form of mechanical automation that will support broad clinical applications that we don't believe is represented as completely in the market today.

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Operator [42]

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The next question is from the line of Joanne Wuensch with BMO Capital Markets.

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Steven Plachtyna, BMO Capital Markets Equity Research - Senior Associate [43]

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This is Steve on for Joanne. You guys launched a number of new products in 2018 and you have even more coming online this year with Pulse. I guess the question is, outside of robotics, what areas in spine do you feel you have the biggest portfolio gaps? If any, what areas from the portfolio standpoint would you like to see improved?

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J. Christopher Barry, NuVasive, Inc. - CEO & Director [44]

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Let me just use this to kind of restate the way we look at the market and where we're looking to grow. As we talked a lot about, we lead in what we consider to be the minimally invasive side or the minimally invasive approaches to spine surgery, primarily focused on lateral surgery, enhancing now Lateral Single-Position Surgery, and we need to continue to drive and keep our growth and leadership position strong there that drives a lot of our innovation, drives a lot of the way that we think about innovation across the enterprise.

But another growth vector outside of continuing to lead in minimally invasive surgery is, I think, we're misrepresented in areas like cervical, in areas like deformity and complex spine where, I think, just because of our focus in developing lateral surgery over the last decade or so, we just haven't focused in this area. It's something that we've looked at over the last 12 to 18 months. We've got technology coming out including a cervical plate this year. So I think it starts to reposition us as a broader, more comprehensive spine player.

One of the key drivers that we're talking about internally is, how do we take full advantage of the breadth and depth of spine procedures where we should at least get our fair share. And obviously, I'm not going to be settled for that, but just getting our fair share provides a tremendous opportunity for us. And then obviously we think about globalization. And we're just really starting down the pathway to really globalizing NuVasive's business and very excited about where we are, building strong businesses across the globe, but just starting -- just really starting in our efforts there.

And then lastly, I don't want to underscore this, but -- too much, but moving into this realm where we're going to start providing more in the cervical procedure to really become more in the eyes of our customers and ultimately better support to the patients. There's the way we look at it. So most underrepresented I would say we've got room to grow outside of really the minimally invasive approach. We've got room to grow and we're excited about the opportunity.

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Steven Plachtyna, BMO Capital Markets Equity Research - Senior Associate [45]

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And just a quick follow-up on Pulse. I mean I know it's just getting off the ground here in the U.S., but how should we think about Pulse maybe rolling out in the international markets? Is that a 2019 event? Or you expect more of the fully automated system for a global launch?

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Matthew W. Link, NuVasive, Inc. - President [46]

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This is Matt. So we're actually running, concurrently, our alpha in clinical testing as well as second half launches in select countries in Europe as well as Australia and New Zealand. But as we stated earlier, when we think about timing of introduction, typical capital sales cycle, all that's really been accounted for in full year 2019, but we do absolutely believe the ability to consistently commercialize our entire portfolio in a global manner is important and so that was certainly a consideration as we bring Pulse to market as well.

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Operator [47]

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The next question comes from the line of Ryan Zimmerman with BTIG.

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Ryan Benjamin Zimmerman, BTIG, LLC, Research Division - Research Analyst [48]

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I want to ask first about the stability of your biologics franchise. You called out a couple sales specialists that you hired that have been more effective recently. And I'm just wondering what the impact has been in those markets? And whether you intend to accelerate that or slow that down? And really more broadly speaking, where are we at in the end market? It sounds like the stem cell market is either going away or is gone at this point as you downshift to lower-cost DBM. So help us understand what the status is of the biologics business? And then I have a follow-up, just a quick one, on the status of the Premier contract. And what impact that you're factoring into guidance? And how should we be thinking about the benefit of that contract this year?

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J. Christopher Barry, NuVasive, Inc. - CEO & Director [49]

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I'll take the first one and maybe I'll let Matt take the second one as he's close to the in sales business. And so on the biologics, just as you think about it, we were a high-end player with Osteocel. Since broadening the portfolio, driving a more favorable, a broader portfolio, we've gone through a cycle now where, although we've seen increasing volumes, we're being -- also being offset by price or mix. For example, we were negative 6% growth this quarter, but compared to Q1 of 2018, that's about a 350 basis point improvement, which is in line with where we think we should go.

We have -- first and foremost, we put strong leadership over that franchise. We broadened the portfolio. We're now going through an exhaustive process to gain better attention from our primary sales force and then more recently, have added sales specialists to accelerate our focus and our organizational capability around biologics. So as we think about the rest of this year, we'll continue to annualize some of the mix headwinds that we took on really over the course of the last 12 to 18 months. As we annualize those headwinds, we get back to a more normalized growth, which is in line with market of flat to slight growth. So we're on track. Second question was on the Premier contract, so let me turn it over to Matt.

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Matthew W. Link, NuVasive, Inc. - President [50]

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Just real quick, so we entered into the Premier contract with our services organization, NCS second half of last year. It's factored into our growth plans for this year. We're really focused on the continuing integration of the services businesses that we've acquired and really optimizing the growth and utilization of our [MP] -- services organization in the field. So Premier is a part of that. It continues to be a part of our growth strategy and we have seen opportunities come online through our pipeline, consistent with our expectations.

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Operator [51]

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The next question is from line of Robbie Marcus with JPMorgan.

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Robert Justin Marcus, JP Morgan Chase & Co, Research Division - Analyst [52]

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Just 2 quick ones for you, Raj. First, it sounded like there was 1 fewer billing day in the U.S., but 2 extra billing days outside the U.S. Do you know how much those were worth outside the U.S.? And what the total impact to the company on billing days was? And then I'll just throw out my second question here on free cash flow. It was down year-over-year. You said there was some investment in instrumentation inventory. How do we think about what that's for? How much will be needed for the year? How do we think about cash flow over the following 3 quarters and then just throw in what you're planning to do with your cash flow this year?

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Rajesh J. Asarpota, NuVasive, Inc. - Executive VP & CFO [53]

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Yes, so let me start with the second question first. So you're right in pointing out that we had an inventory build associated with new product introductions. But the bigger factor along with that was last year, we had -- outside of our NCS business, we had a huge collections quarter in 2018, which impacted the quarter, the growth -- the comparable over prior year. Having said that, as we go through the rest of the year they'll tend to normalize and we do intend on hitting our free cash flow targets for the balance of the year. So there was a bit of an anomaly in the first quarter, but I think we'll be jumping right back into it.

And can you remind me your first question or the first part of your question? Was regarding the Europe billing days? So yes, I mean, the Europe, it was about 2% to 2.5% growth impact for the international business when it came to the impact from the 2 extra billing days. So I mean these aren't huge numbers within the regions, but nonetheless, they did have an impact. So -- but all over the company level, it's not material.

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Operator [54]

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Mr. Barry, there are no further questions at this time. I would like to turn the call back to you for closing comments.

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J. Christopher Barry, NuVasive, Inc. - CEO & Director [55]

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Thank you. And with that, thank you to those on the call today and we look forward to speaking with you in the next quarter. Thanks.

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Operator [56]

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Thank you. This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.