NuVasive (NUVA) recently announced its third-quarter earnings, and despite the OIG, subpoena related to Medicare/Medicaid false claims, it was able to surpass Wall Street's earnings expectations. Solid execution, the end of physician owned devices or PODs, and a maturing spine market allowed NuVasive to beat analysts' third quarter revenue expectations. Furthermore, the accelerating U.S. implant market and sales force stability are boosting NuVasive's stock price to gain further upside.
I expect the combination of NuVasive's lateral offering, robust development pipeline, physician/patient advocacy programs, and strong recent history of market share gains to facilitate the company to maintain its market-leading position and above-market growth rates. Furthermore, the fraud-alert issued by the OIG related to the business practices of PODs marks the end for this business model, and traditional manufacturers and/or distributors like NuVasive stand to gain from this. NuVasive's shares are up 138% over the past twelve months making it one of the best-performing stocks in the global spine market. I believe the company will dominate in the minimally invasive fusion market, which is expected to double over the next five years.
Strength of NuVasive
Spine surgery market
The spine market is the largest segment within the global orthopedic market. The global spinal implant market, including the US, Europe, and Asia Pacific, was valued at over $5 billion in 2008 and grew to more than $7 billion in 2013. The U.S. is the biggest market for spinal surgeries, and it will achieve momentous growth due to the aging population, growing number of younger patients, changing lifestyles, and product innovations. The spine surgery market is experiencing accelerated demand for implants and MI alternatives.
The global spine surgery market is expected to reach $9.07 billion by 2019, boosted by an increase in patients with chronic back pain and overall awareness. According to the U.S. National Center for Health Statistics, back pain is the principal cause of disability in Americans under 45 years old. Each year 13 million people visit physicians for chronic back pain, and about 14.3% of new patient visits to primary care physicians are for lower back pain treatment. The condition leaves about 2.4 million Americans chronically disabled and another 2.4 million temporarily disabled. Low back pain is one of the most prevalent problems people have. About 60 - 80% of adults in the U.S. have low back pain, and it is the second most common reason people visit doctors. Low back pain affects the spine's flexibility, stability, and strength, which can cause pain, discomfort, and stiffness. The global spinal surgery devices market is expected to grow at a compounded annual growth rate of 4% from $6.5 billion in 2011 to $8.7 billion in 2018. Earlier, this market was mainly dominated by DePuy Spine, Medtronic Spinal and Biologics, Stryker Spine, Synthes Spine, and Zimmer Spine, which collectively owned 78% of the global market (in 2008), but this group is now continuously losing market share to small companies like NuVasive and Globus Medical (GMED).
NuVasive develops and sells products used in spine surgeries. It is gaining a solid footprint in the U.S. lumbar and cervical business units. In the recent quarter, its U.S. lumbar revenue grew 12% against the same period last year. The reasons for this growth were strong sales of NuVasive's innovative Precept system, which is a multilevel percutaneous posterior minimally invasive spinal, or MIS, solution, MAS lumbar interbody fusion, or PLIF, products, and sales of the Armada spinal system.
Although the spine market in the U.S. witnessed slowdown in 2012, the introduction of motion preserving technologies like artificial disc replacement, interspinous spacers, and dynamic stabilization technologies in the recent past have provided moderate rhythm to the spine market. As a result, the U.S. market for MI spine technologies will grow significantly, reaching around $2 billion by 2017. The majority of the growth will come from expansion of the largest segment, the MI spinal fusion market. NuVasive is also conducting a study that compares traditional open posterior PLIF with NuVasive's MI MAS PLIF variant. The study is expected to be complete by 2014 and may change the environment for MI spine technology. Positive outcomes in this study will favor the volume of MI procedures involving spinal technologies.
NuVasive is also enjoying the benefits of Precept and MAS PLIF, which should carry through into 2014 and contribute meaningfully to revenue growth. In the U.S. cervical segment, the company experienced 27% growth in the quarter. In the past few years, the spine surgery device market has witnessed the emergence of a new segment, the Motion Preservation technique, which involves the use of artificial discs developed specifically for degenerative disc diseases of the spine. The technique offers the advantage of less invasive, less traumatic procedures, faster recovery, and timely return to normal activity. Thus, the motion preservation devices represent a potential opportunity within the spine surgery device market. Management anticipates to continue delivering meaningful growth in this business segment. On the motion preservation disc side, management's expectation for revenue will be $2 million-$3 million due to the difficult reimbursement landscape. This reimbursement dynamic is nothing new, but I feel that as more clinical data surfaces to confirm the reimbursement costs, the cervical motion preservation market will be one of the most attractive growth areas within the spine business.
OIG Inquiry- No drastic impact on NuVasive
In the recent quarter, NuVasive didn't provide any updates on the OIG inquiry into possible false/improper Medicare and Medicaid claims. I think these issues are common in the orthopedics and medical technology, and are typically resolved within one or two years, after a small fine is paid. Seeing the history of False Claim Acts investigations suits and settlements, I think the resolution is likely to be less severe than feared. Also, if the subpoena is related to a false claim act investigation, then the final resolution could be less than $10 million.
Broad product portfolio
NuVasive has a diversified product portfolio that allows the company to serve a diversified customer base, which in turn reduces the various risks associated with the overdependence on a particular product segment. It also protects the company from fall in demand for any particular product line, thereby giving it a balanced revenue platform. Its product line consists of a minimally disruptive surgical platform, known as MAS, and a growing offering of biologics, cervical, and motion preservation products.
MAS allows the surgeon to perform minimally invasive surgery on the spine while minimizing tissue disruption and enabling safe navigation of the body's nerve anatomy. The MAS platform combines three categories of its product offerings:
· NeuroVision, a software-driven nerve avoidance system
· MaXcess, a split-blade design retraction system providing surgical access to the spine
- Specialized implants, like its SpheRx pedicle screw system and CoRoent suite of implants
NuVasive also created speedy recovery spine surgery, known as eXtreme Lateral Interbody Fusion, or XLIF. It works by joining tissue-sparing access instruments, neuromonitoring technology, and a unique implant the surgeon applies from the side of the patient's body.
The company provides NuVasive Helix and Gradient Plus plating systems, its cervical implants and instruments, for both anterior and posterior fixation, or Anterior Cervical Discectomy and Fusion, or ACDF. The devices accommodate both primary and reconstructive cervical surgery, and its precision-machined allograft offers outstanding strength and ease of use. For posterior cervical fusion, VuePoint OCT spine system provides the surgeon a range of options while addressing the occipito-cervicothoracic region.
NuVasive's Biologic products include allograft (donated human tissue), FormaGraft, a collagen synthetic product used to support the fusion process, and Osteocel Plus, an allograft cellular matrix containing viable mesenchymal stem cells to support in spinal fusion.
Strong product pipeline
NuVasive also has robust pipeline products and successful development could generate significant revenue for the company. Some of its significant pipeline products are:
Product Pipeline | Usage |
AttraX | a synthetic bone graft material to aid in the healing and regeneration of human bone |
NeoDisc | an artificial cervical intervertebral disc to replace a degenerative cervical disc while maintaining range of motion and leaving the natural vertebral endplates |
Osteocel XC | an allograft stem cell-based bone matrix product containing stem cells to aid in spinal fusion by stimulating bone regeneration |
XL Total Disc Replacement | a total disc replacement system for the treatment of degenerative disc disease |
Apart from these pipeline products, in October 2012 NuVasive received Premarket Approval from the U.S. FDA for Porous Coated Motion, or PCM, Artificial Cervical Disc, a motion preserving total disc replacement device to copy the function of the disc. Commercialization of these products could help the company boost its top-line.
Improving financial position
Fiscal Year 2011 | Fiscal Year 2012 | |
Revenue | $540.5 million | $620.26 million |
Operating Profit/Loss | $85.04 million (Loss) | $37 million (Profit) |
Net Profit/Loss | $69.85 million (Loss) | $3.14 million (Profit) |
NuVasive's operating margin increased from (15.7%) in 2011 to 5.97% in 2012. This represents an increase of 2170 basis points over 2011, which signifies management's focus on improving profitability. NuVasive also reported an increase in its profitability ratios. Like return on equity, return on capital employed, return on assets, return on fixed assets, and return on working capital employed increased from (14.1%), (9.3%), (6.2%), (16%), and (22.1%) in 2011 to 0.6%, 3.7%, 0.3%, 5.7%, and 10.6% respectively in 2012. Increasing profitability ratios indicate the company's robust performance and its ability to deliver the returns expected by its shareholders.
Benefit from potential PODs backlash
On March 26, the U.S. Department of HHS and OIG issued a special fraud alert aimed at throttling PODs, which it describes as "shell" companies that use kickback-like schemes involving surgeons and hospitals to divert about $800 million in spinal implant device sales to privately held manufacturers and profits to the physician-owned shell companies. Medtronic (MDT) was found to be biggest culprit in this fraud-alert.
According to Jordan T. Cohen, an attorney with the Roseland, N.J. law firm Brach Eichler LLC,
the "royalty payments" made by Medtronic to spine surgeons are "staggering." Medtronic is careful not to pay royalties to surgeons for specific surgeries in which Medtronic products are used. Instead, the company pays royalties to surgeons in a more general way for recommending its devices and/or helping to design them, which skirts anti-kickback laws. Physician-owned devices distributorships cross that legal line when they pay surgeons for implanting POD-supplied devices in specific cases, in an overtly quid pro quo scheme.
The biggest beneficiaries of federal enforcement actions at Medtronic are NuVasive and Globus Medical. I believe the OIG Fraud Alert related to the business practices of PODs could provide a tailwind for spine companies as POD revenue is transitioned back to the manufacturers. As the practices of PODs receive more attention, NuVasive reported the start of pushback from hospitals and care networks. NuVasive is well positioned to benefit from the potential redistribution of POD shares back into the spine market, as hospitals and networks choose to shift purchasing to non-POD manufacturers.
International revenue expansion
NuVasive's international growth, which wasn't impacted by account churn issues last year, grew to 30% in the recent quarter against a tough 45% comp from last year, suggesting that at least some of this quarter's improvement is likely coming from the growing appeal of the company's broadening product portfolio. For the fourth quarter last year, management guided the revenue to solid 6-7% year over year growth.
Several potential new products and geographic catalysts exist for NuVasive, especially the company's growing presence in Japan. In April, NuVasive opened its Japan office in Tokyo, which will fortify its ability to bring new products, procedures, and services to the fourth largest spine market in the world. Around $8 million, contribution from Japan is expected in 2013 in comparison to $2 million in 2012. This expectation is because Precept continues to grow, representing NuVasive's best new product launch in company history. Additionally, Bendini and several other products launched at NASS a month ago, received solid positive feedback from the surgeons. The company is set to debut its new Precept posterior fixation system in Japan, in hopes to use the device to break into the Japan's spinal market. The Precept Posterior Fixation System provides surgeons with exceptional ability to treat a wide range of pathologies, all while offering an unparalleled ease of use.
Potential risks
NuVasive also possess some potential downside risks that may bother investors' sentiments. Any signs of slowing sales growth or profitability could cause NuVasive's shares to come under tremendous pressure. Some of the key risks include:
1. Unfavorable court decisions related to ongoing trial vs. Medtronic: Potential negative financial impact should the current OIG investigation end in increased compliance-related expenses and/or cash settlements/payments, or disruption to the company's selling practices.
2. Market share losses for NuVasive in the MIS segment as more competitors launch lateral systems.
Conclusion
NuVasive is a rising star in the spine surgery market and is well positioned to capitalize from any improvement in the spine market dynamics. The number of treatments for cervical and lumbar spine pathologies are expected to have continuous growth in the future. While the matter of OIG subpoena is something to monitor, and likely somewhat alarming to some investors, I believe that investors should focus on the strength in the fundamentals of NuVasive's business, which continue to improve, and I don't expect a disruption to this momentum. I believe the combination of a modestly better spine market, solid international growth, and increased sales of new products will cause NuVasive's overall revenue to accelerate next year.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. (More...)
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