Integra Lifesciences Holdings Corp (IART) 2016 Q4 法說會逐字稿

Good day, everyone, and welcome to the Integra fourth-quarter 2016 financial results call.

As a reminder, today's call is being recorded.

At this time, I would like to turn the call over to Angela Steinway, Global Head of Strategic Initiatives and Investor Relations. Please go ahead, ma'am.

Thank you, Jessica. Good morning and thank you for joining the Integra LifeSciences fourth-quarter 2016 earnings results conference call. Joining me today are Peter Arduini, President and Chief Executive Officer; and Glenn Coleman, Chief Financial Officer and Corporate Vice President of International. Earlier this morning, we issued a press release announcing our fourth-quarter and full-year 2016 financial results and providing 2017 full-year guidance.

We also posted a presentation on our website which we will reference during the call today. You can find this presentation at integralife.com under investors, events and presentations, in the file named Fourth-Quarter and Full-Year 2016 Earnings Call Presentation. If you would open that file up to slide 2, please reference our Safe Harbor Statement covering the forward-looking statements.

Also, please turn to slide 3 to find an explanation of non-GAAP financial measures that we will refer to on today's call and reference to reconciliations of non-GAAP financial measures at the end of the presentation beginning on slide 15. We held a conference call last week announcing the planned acquisition of Codman Neurosurgery. The presentation is available on our website.

As a reminder, this transaction is expected to close in the fourth-quarter of 2017 and we're not including the impact of this acquisition in our financial guidance. That said, our guidance will include the financial impact for the Derma Sciences acquisition announced in January and the charges associated with pre-closing costs for the Codman Neurosurgery acquisition. And now I will turn the call over Pete.

Thank you, Angela, and good morning, everyone. Our fourth-quarter results closed out a strong performance in 2016. And we're seeing the results of the investments that we've made in our business over the past few years. If you'll turn to slide 4, I'll walk through some of our recent accomplishments. Organic sales increased 9% for the full year and 7% for the fourth quarter. Growth in our Dural Repair franchise and our regenerative portfolio once again drove these results.

Full-year adjusted gross margins reached 69.5%, while adjusted gross margin for the fourth quarter was a record high of 70.2%. We're pleased with the progress that we've made and believe that it is directly attributable to the growth of our differentiated high-margin products. Sales in our specialty surgical solutions segment increased 7% in the fourth quarter and over 7.5% organically for the full year, exceeding the 6% to 7% guidance we provided in October last year.

In addition to continued strengthen in our Dural Repair and Precision Tools and Instruments franchises, we were also pleased to see our global capital businesses in Tissue Ablation and Neuro Critical Care finish the year with strong results. For the full-year 2016, we generated nearly $160 million in cash flow from operations and approximately $50 million in the fourth quarter, excluding the payment of accreted interest associated with the maturity of our convertible notes in December.

Free cash flow conversion outpaced our October guidance by nearly 83% on a trailing 12-month basis. Improvements in working capital and increased GAAP profitability drove this result. Finally, in December, we announced the expansion of our credit agreement to $1.5 billion and its extension through 2021. This balance sheet flexibility provided us with the means to refinance our convertible notes, will fund the Derma Sciences acquisition, and will partially fund the acquisition of Codman Neurosurgery.

Before turning the call over to Glenn, I'd like to make a few comments about our recently announced and pending acquisitions. On January 10, we signed a definitive agreement to acquire Derma Sciences through an all-cash tender offer. Last night, the tender offer expired and we're pleased to report that the majority of the shares were tendered and we expect to close the transaction in the next few days.

The addition of Derma's regenerative technology capabilities, amniotic tissue-based technology, and Advance Wound Care products accelerates our three-by-three strategy and further enables us to drive scale in the Advance Wound Care market. Separately, last week, we agreed to acquire the Codman Neurosurgery business from Johnson & Johnson, which will enhance our global position in neurosurgery by adding a complementary product portfolio and the world recognized Codman brand.

This purchase will help build relevant scale, accelerate international growth and expand the neurosurgery sales channel. This acquisition also will accelerate our strategy to achieve our aspirational targets of $2 billion in revenue and 30% adjusted EBITDA margin. This deal is expected to close in the fourth-quarter of 2017. And now, I'd like to turn the call over to Glenn, who is going to provide a more detailed review of our financial results. Glenn?

Thanks, Pete. Good morning, everyone. Please turn to slide 5. Our fourth-quarter financial performance was in line with our January 10 pre-announcement. Fourth-quarter reported sales in Specialty Surgical Solutions were $163.8 million, an increase of 7.2% over the prior year on an organic basis.

Sales in Dural Repair increased in the high single-digit range, resulting in record sales. As we expected, growth began to temper in the fourth quarter from the double-digit growth that we had achieved for most of the year, but was more in line with the above-market growth that we believe is sustainable.

Precision Tools and Instruments sales increased low single digits compared to the prior-year quarter. Our MAYFIELD 2 sales combined with lighting and surgical instruments drove the growth. Together, Tissue Ablation and Neuro Critical Care sales grew double digits over the same quarter last year. Strong global capital sales, especially in Europe, helped drive the performance and resulted in double-digit growth across all regions in the fourth quarter.

For 2017, we expect sales in the segment to increase in the range of 3.5% to 5.5% on a reported basis and a point faster on an organic basis. Compared to the 7% performance in 2016, this deceleration reflects tempered expectations for growth in Dural Repair and Precision Tools and Instruments, consistent with our prior messaging. Please keep in mind that Specialty Surgical Solutions has a larger foreign currency impact than our Orthopedics and Tissue Technology segment.

The Codman Neurosurgery acquisition is expected to close in the fourth quarter of 2017. It will be integrated into our Specialty Surgical Solutions segment at that time. As this acquisition has not closed, it is not included in today's financial outlook. We plan to provide more details, including financial guidance for the Codman Neurosurgery acquisition when we get closer to the fourth quarter.

Turning to slide 6, fourth-quarter sales in the Orthopedics and Tissue Technology segment were $91.9 million, representing an increase of 6.6% on an organic basis. Sales of our regenerative technologies increased high single digits in the fourth quarter. That said, this franchise grew double digits excluding the PriMatrix and SurgiMend brands. We gained new PriMatrix and SurgiMend customers during the fourth quarter, which resulted in a sequential sales increased in the US.

The addition of new customers coupled with several upcoming product launches will enable these product lines to return to growth during 2017. We closed 2016 with sales of our Advance Wound Care product lines of approximately $11 million, in line with our January 10 pre-announcement.

Moving to our extremities franchise, sales of our Salto Talaris and Cadence ankles together with Titan shoulder product lines increased double digits in the quarter, but were more than offset by declines in our legacy extremities products and the discontinuation of our Hintegra ankle in Europe. We are early in our launch of the Cadence ankle in Europe and expect that overtime we will be able to recapture a solid portion of the lost sales.

The Derma Sciences acquisition is expected to close in the next few days and, once complete, will be integrated into this segment. For 2017, we will be providing directional commentary on our Advance Wound Care product lines, sold by the roughly 90 sales person sales force focused on the outpatient wound care channel. The products in this category will include Omnigraft, PriMatrix and VolTAC, now combined with Derma Sciences' Advance Wound Care portfolio.

Some of the Derma Sciences brands sold by this channel include the Total Contact Cast, Medihoney, and AMNIOEXCEL as well as other antimicrobial wound dressings. To [redefine] what we're now calling Advance Wound Care, total pro forma 2016 sales of these products were approximately $50 million. For 2017, we expect at least 20% growth to $60 million in pro forma sales in our Advance Wound Care franchise, including the full year of Derma Sciences.

Given the integration work and cross training of the sales teams, we expect growth to be greater during the second half of the year. With respect to the Orthopedics and Tissue Technology segment as a whole, we expect 2017 sales to grow in a range of 27% to 32% on a reported basis and 9% to 14% on an organic basis. This includes a total acquired sales impact of approximately $70 million for the Derma Sciences acquisition.

Turning to slide 7, I'll walk through the components of our full-year 2017 revenue guidance. We ended 2016 with reported sales of $992 million and based on the segment guidance I just provided, we expect consolidated full-year 2017 revenues to be in the range of $1.12 billion to $1.14 billion, representing reported growth of between 12.5% and 15.5%. Included in this range, we expect organic sales to grow between 7% and 8.5%.

Derma Sciences is expected to add about 7 points of growth revenue in 2017. Foreign currency is expected to produce a headwind of approximately 1% at current exchange rates. For the first quarter of 2017, we expect revenue to be in the range of $252 million to $256 million representing 5% to 6% organic growth.

Now, if you please turn to slide 8, I will review our fourth-quarter and full-year P&L performance and provide guidance for the full year 2017. In the fourth quarter, GAAP gross margin of 66.6% increased 390 basis points from the prior year. Adjusted gross margin reached a record high at 70.2%, an increase of 190 basis points over the prior year as we continued to benefit from a favorable product mix. For 2017, we expect GAAP gross margin to be in a range of 65% to 66% and adjusted gross margin to be between 69% and 70%.

As we indicated on our January 11 preliminary results call, the addition of Derma Sciences is dilutive to our adjusted gross margin by about 100 basis points for the full year. Excluding the Derma Sciences acquisition, we expect an improvement of roughly 100 basis points in the underlying gross margin during 2017.

Turning to operating expenses, R&D as a percentage of revenue in the fourth quarter was 5.4%. For 2017, we expect both our GAAP and adjusted R&D to be approximately 6%. SG&A expense in the fourth quarter was 43.9% of revenue, a decrease of 160 basis points over the prior year's fourth quarter. Adjusted SG&A decreased 50 basis points to 41.9% year over year. In 2017, we expect GAAP SG&A to be in the range of 51% to 52% and adjusted SG&A to be 43% to 44%, reflecting the additional investments in channel expansion.

The increasing GAAP SG&A for 2017 is primarily related to the integration costs we will incur associated with the Derma Sciences and Codman Neurosurgery acquisitions. Our fourth-quarter 2016 adjusted EBITDA margin was a record 26%, an increase of 250 basis points over the prior year. On a full-year basis, our adjusted EBITDA margin increased 120 basis points to 23.4%. For 2017, we expect our adjusted EBITDA margin to be in a range of 23% to 24%, which includes about 100 basis points of dilution from the Derma Sciences acquisition.

Moving to slide 9, based on our full-year 2017 outlook and the guidance for revenue and expenses that I just provided, we expect GAAP earnings per share to be in the range of $0.49 to $0.55 and adjusted earnings per share to be in the range of $1.88 to $1.94. This represents growth of between 7% and 10% in our adjusted earnings per share and it includes a foreign currency headwind and dilution from the Derma Sciences acquisition.

We also faced a headwind from the higher share count associated with warrants that are tied to our convertible bond. It is worth noting that our 2017 adjusted net income growth is 10% to 13%, inclusive of the dilution from the currency and Derma Sciences. For the first quarter of 2017, we expect adjusted earnings per share to be flat with the prior-year first quarter.

Turning to slide 10, we close the fourth-quarter and full-year operating cash flows on a positive note and exceeded the high end of our guidance range. This enabled us to continue to advance our investments in automating our collagen manufacturing plant in Plainsboro. For 2017, we expect cash flow from operations and free cash flows to be negatively impacted by the integration costs associated with both acquisitions. Including these integration impacts, we estimate our operating cash flows to be in the range of $115 million to $145 million and free cash flow conversion in the range of 40% to 60%.

Please turn to slide 11 for a quick update on our capital structure as of December 31, 2016. We ended the year with a cash balance of approximately $102 million and a net debt of $563 million. This translates to a bank leverage ratio of approximately 2.4 times. In December, we expanded our credit facility from $1.1 billion to $1.5 billion and used a portion of the proceeds to pay off the 2016 convertible Senior Notes. The credit facility was also extended two years to 2021.

Turning to slide 12, let me now provide a preliminary pro forma look at our capital structure, taking into account both recent acquisitions. We will be using approximate $200 million of cash from our credit facility to pay for the Derma Sciences acquisition in the next few days. We plan to finance the Codman Neurosurgery acquisition through a combination of cash held outside the US, our existing credit facility and a new term loan, which we expect to finalize between now and the closing of the acquisition.

Based on our anticipated borrowings, our bank leverage ratio is expected to increase to slightly under 5 times net debt to adjusted EBITDA in late 2017. However, as we've indicated, the Codman Neurosurgery acquisition is accretive to our adjusted EBITDA and we will immediately focus on using cash generated in the near-term to pay down our outstanding debt.

It is our plan to operate with a net debt to adjusted EBITDA ratio as calculated in accordance with our credit agreement at or below 3.5 times, which we believe we can achieve by the end of year three based on the projected cash flows of the new combined business. And with that, I'll turn the call back over to Pete. Pete.

Thanks, Glenn. We achieved the many goals that we set for ourselves in 2016 and on slide 13, we outline our key focus areas for 2017. Glenn just walked through our detailed 2017 guidance and we look forward to delivering organic growth of 7% to 8.5% and adjusted EPS of $1.88 to $1.94 with double-digit adjusted net income growth.

The addition of Derma Sciences broadens our portfolio of Advance Wound Care products and expands our regenerative technology capabilities with an amniotic tissue based platform. This acquisition caps off 2016 as a transformative year for our Advance Wound Care strategy and sets us up for accelerated growth in the second half of 2017 after we integrate the channels.

We received PMA approval for Omnigraft, which was launched in 2016. Omnigraft has unmatched clinical data supporting its wound healing characteristics and it is the only product with a label for regenerating tissue. We also [enlicensed] VolTAC, a unique antimicrobial wound dressing which is used earlier in the wound care treatment process. We're excited to begin 2017 with an outpatient focused channel of roughly 90 representatives who can offer a comprehensive set of Advance Wound Care solutions.

In our commercial channel, along with the Derma Sciences products, we are excited about the long-term value we can create for patients as well as shareholders in this fast-growing market.

Shifting to Specialty Surgical Solutions, last week, we announced an agreement to acquire the Codman Neurosurgery business from Johnson & Johnson. This acquisition hits on many key strategic tenants while moving us towards our aspirational financial targets of $2 billion in revenue and 30% adjusted EBITDA margin. While providing needed international scale, Codman Neurosurgery and its globally recognized brand provide a broad and complementary product offering, which will enable Integra to extend its position in the United States and become a leader in the global neurosurgery market.

The scope and scale of this acquisition will support increased investments in R&D that will result in innovative products and solutions for neurosurgeons and we look forward to new product introductions from both our internal R&D program as well as the Codman pipeline. Neurosurgery is our core expertise within Specialty Surgical Solutions. With future investments, the Codman acquisition provides the global reach that will contribute to growth for years to come and we look forward to closing this transaction in the fourth-quarter of 2017.

The combination of successful integrations of Derma Sciences and Codman Neurosurgery along with execution of our core growth strategy will make 2017 an important year for Integra. We've assembled separate, dedicated teams made up of executive leaders, internal functional specialists, and external advisors with carve-out acquisition expertise to drive these integrations. And we're confident in our ability to complete these acquisitions, while at the same time, driving growth in our core business.

We will also advance our Regenerative Technology strategy this year. Many of you attended our Regenerative Technology Day in December and saw the breadth of our product portfolio and the market opportunities that exist. We will continue to make investments in this channel and the necessary health economic programs to prepare the market for the new product introductions that we expect later this year.

In 2017, we expect to launch five new regenerative products, which in conjunction with other launches within our hardware and electro-mechanical franchises, will contribute to organic growth across the Company. Finally, we will expand our extremity efforts in 2017. In the first half, we will add additional sales reps to build capacity in our extremities reconstructive channel.

This added capacity will support both the new regenerative launches as well as the planned growth in ankle arthroplasty. Currently, we're in the process of a global full-market release of the Cadence ankle and, in combination with the Salto Talaris, we are well positioned to capture share in this fast-growing ankle market.

If you turn to slide 14, we want to reiterate some of the commentary that we made on the Codman Neurosurgery announcement call last week. We expect to sustain 6% to 8% organic growth through 2018 and beyond and even though both acquisitions are expected to be slightly dilutive to our overall top-line growth, post integration and with additional scale and commercial focus, we believe we can accelerate growth for both of these businesses.

I just mentioned that we will have five new regenerative products launching in 2017 within our OTT segment. Specialty Surgical Solutions has a similar strong pipeline of new products and the international markets will benefit from many of these product launches. Our adjusted gross margin will be reduced by roughly 2 points when we factor in the impact of these acquisitions without cost synergies.

That said, the faster growth of higher margin products such as AMNIOEXCEL and operational improvements should enable us to achieve our adjusted gross margin targets, albeit slightly longer than initially planned. The combined scale and profitability from these deals gives us the confidence that we will be ahead of our 25% adjusted EBITDA margin target in 2018.

With that greater profitability will come faster growth in adjusted EPS and as you recall from last week's announcement, the Codman Neurosurgery acquisition is expected to be at least $0.22 accretive in the first year after closing and increasing thereafter. If our profitability metrics are on target of 2018, we expect to incur significant cash expenses and one-time charges related to the two integrations that will have a negative impact on our cash flow metrics.

We expect this impact to be temporary and look forward to updating our long-term strategy and financial targets later in the year. To wrap up our prepared remarks, the Derma Sciences and Codman Neurosurgery acquisitions together will transform the Company and significantly advance our scale, global reach, and profitability. Coupled with organic growth driven by new product introductions and commercial investments, 2017 is taking shape as a transformative year for Integra.

With that, operator, would you please open up our line for questions?

Certainly.

(Operator Instructions)

Matt Miksic.

Thanks so much for taking our questions. Nice job on the organic growth, we thought. But maybe just to take that topic as we head into 2017 here, it would be helpful if we could get a sense of what some of the headwinds against your the reported numbers will be, just so we can think about the right math, whether it's discontinued products, I think we can figure out the contribution or approximate contribution from new businesses, but just maybe just some of the puts and takes if we think about first-half organic growth and then I had one follow-up.

Yes, Matt. Let me -- it's Pete. Let me open up and I'll comment on it and then maybe I'll have Glenn give a few more details on some of the puts and takes on how the ramp takes through the year. Obviously, we have a steeper ramp in the second half than we do in the first half, but why we feel confident in 7% to 8.5% and starting out with a 5% to 6% is this. First of all, we're going to be adding about 125 total new sales representatives this year.

There's about 75 reps that led organically through the organization. Many of those will be in a combination of our OTT business as well as international, some select editions within SSS and then on top of that, there's 50 coming in, obviously, from Derma Sciences, which will be plan on beginning the integration here within second quarter. We plan to obviously keep all those reps and to be able to grow that channel. However, when you're bringing those together, we don't expect to have a significant amount of upside growth. In fact, some disruption as we're bringing those together.

So that's channel. If you go to new products, we really have a really nice basket of new products coming out. More of the launches take place in later Q2 into Q3, but we're pretty excited about it. We've got about five, as I mentioned, regenerative products. Keep in mind, all of those products have higher margins on them. They also are products that we think address some of our challenges we've had in the areas of say SurgiMend.

They bring out another version, I'd say size-wise, in the Omnigraft area, as well as some other unique components there that I don't want to necessarily give an update on at this point in time until we launch. But all of those products, just within OTT, are, for the most part, Q2 to Q3 launch. And then in Specialty Surgical, we have a similar situation with about three products and we have a larger launch that we've been working on for some time that we think is going to be quite a continual growth driver for the Company and we will talk more about that on our next call when we're ready to launch that.

All of those are the products and then I think about markets and momentum. We'd clearly had a stronger first half in 2016, so there is some comps in the first half that are a little bit stronger. But if I look at our skin and reconstructive wound business, our classic Integra business, it continues to be strong. The outpatient Advance Wound Care area, we believe that we're going to have strong growth there.

But again, we will probably have a little bit of some disruption in the first half and then as we get this channel integrated together, all 90 of those sales reps are going to be selling both sides of the product. Dural Repair continues on, but again, Dural Repair has some much more challenging comps. If you remember, in some areas, we were growing in the high teens to close to 20% last year.

And then also we're making very good progress with Ankle. I'm very optimistic about the ankle market, both what we can do domestically, but globally as well. And that will be ramping up throughout the year.

And then I think last, but not least, is private label, which we've talked about. We started working on some deals last year. Some of those are going to come through and more of those, I'll say, will have an impact on volume in Q3 to Q4 just based on how those agreements go. So that's kind of the broader laundry list channel additions, new products and market momentum. Glenn, I don't know if you want to add any details around that.

Sure. So, Matt, I think one of your questions was year over year as well. We did over 9% organic growth in 2016. Our guidance is 7%, 8.5%. Pete talked about our confidence in the 7% to 8.5%. But year over year, our specialty surgical business is going to be a point or two slower. We've been messaging this now for a while, that Dural Repair is going to be a nice grower for us, high single-digit range. And that's what we did in the fourth quarter here, but not going to see the double-digit growth rates that we had in the first three quarters.

So that's one of the year-over-year decelerators, but still, very strong growth overall. And also the same thing with our Precision Tools and Instruments business. So year over year, those are the areas that we're not going to probably see the same level of organic growth. And then relative to some of the other moving parts that you had referenced, I would say discontinued products is about 50 basis points of a headwind for us and FX is about full point based upon current exchange rates.

That's super. Thank you for the color. And, Glenn, while I have you, if I could ask you one follow-up on gross margin. I think we understand after the call on Codman the expectations for this year, underlying improvement in gross margin and impacted negatively in the near term by Codman.

But looking out, and I know we're not talking about 2018 and 2019 per se, but does that gross margin -- what puts it back on track if that's the right way to say it? Or what are some of the intermediate long-term positives that can start driving that back up again in terms of leverage?

Yes, let me just put a couple of parameters around what you said. I would say first, relative to our base business in 2017, continuing to expect good mix in our overall portfolio. So, our base business, we're expecting to see about 100 basis point improvement. But it's being offset by the dilution from Derma Sciences. So relative to our guidance, 69% to 70% reflects those two moving parts.

To your point on Codman, it probably adds another 100 basis points of dilution in the short term after we close the acquisition. But again, as we look past 2018, we expect to see an improvement in our overall gross margins bringing us back to 70% or even higher than that once we've moved past the integration. So I would say the targets the we had laid out for 2018 are still very valid for gross margins. It's just going to take us longer to get there given these two acquisitions, but we're still believing we can get to at least 70% beyond 2018.

Great. I'll leave it there. Thanks so much.

Thanks, Matt.

Travis Steed.

Thanks for taking the questions. I have a big feature question on Codman. Now that the deal has been announced for a few days, can you share some of the early feedback from your employees, Codman's employees, and also any early feedback from the FTC?

Yes, I would say, Travis, look, the overall feedback has been extremely positive. The interactions that we've had with the Codman employees, which has been minimal at this point, as you can imagine. We're obviously still competitors. We've had some dialogue that we have been able to communicate to them in a video form and letters and things and I would say in the next few months, we will have opportunities to actually go to some of their locations and meet people and have discussions.

But I would say, at this point, overall excitement from the standpoint of what we can create together and that's what's really important here that, in many ways, this is a merger bringing two great companies and groups together to create a neurosurgery business that can really innovate and bring new innovations to the market.

This is a space that has probably been a slower innovation area for a lot of reasons, but our intent is, and that's a lot of the excitement around this, is to be able to bring back more clinical innovation within the space and the size and scope of this with the complementary nature of the products is going to enable us to be able to do that. And on the Integra side, across the board, same things. People really excited about it, see it as a great opportunity. Glenn can comment on it as the Head of International.

Our International Team, broadly, not just in Specialty Surgical, but for the whole Company, really see this as a big win because it makes international that much more relevant to the Company when you go from $200 million of revenue to $400 million of revenue, you become somebody and you set up a capability that allows us to focus on realistically the biggest long-term growth.

As far as the FTC, we've just commenced our filing, as you can imagine. So, really, no feedback at this point in time and, as I've commented before, it's a very highly competitive industry within this. Yes, there are about four larger players overall, but in each of these segments, in many cases there's eight to 10 different players that throughout the world play in all these segments.

And so, we will obviously engage the FTC and we plan on working with them to work this through and our goals are to obviously layout our overall strategy here and interact with them over the next few months. But so far, across the board, everything is coming off as we drew it out on the chalkboard and we feel quite good about the initial week's amount of feedback.

Great. Thank you. And then you've kept the 7% to 8.5% revenue guidance even after announcing Codman. Is there any potential for disruption in your Neuro business before the deal closing? Just how are you considering that in your guidance? And also, in CapEx, the step up in 2017, is that all Derma coming in or is there some extra investments on the Integra side as well?

I'll hit the growth piece and then maybe, Glenn, you can hit the question on, the CapEx question. We've looked at the component here of potential disruption. I would say this, from a standpoint of any of the work that we need to do to stand up the business, the carve-out acquisition, keeping our commercial teams completely separated from this event, even including up into Senior Commercial Leaders, is a big part of what we talk about setting up these dedicated teams with dedicated resources. That's why we're doing it.

We don't want your Head of Sales on meetings half the week talking about integration when they should be worried about selling and we've been thoughtful about doing that in a very productive way. That being said, we think, I mentioned about Derma Sciences, we are going to be integrating here as we're closing this deal in the next few days. Do we think the end of Q1 into Q2 we have a little bit of disynergies as we actually align the territory to do some of that work? Yes. And we factored some of that into the run rate.

We called it $70 million for the year, but there's probably about $5 million of a little bit of disynergies here in the first half with Derma. We will get that behind us and then we will leave Q4 with a run rate that is a growth above the base of the 2016 growth that Derma put up.

So we factored that in and then, again, when you add 125 reps, you've got over 10 new products, you've got some healthy markets, that's what gives us confidence that we can see that 7% to 8.5% organic growth coming through, even with integrating these deals. Glenn, you want to hit the other point?

Yes, Travis, on your question relative to CapEx, certainly we've got some CapEx planned for the Derma Sciences acquisition and integration. What I would say, though, is we view CapEx, on a normal run rate, to be about 4% to 5% of our sales, so if you think of sales being quote $1.1 billion, it fits into the range that we provided for CapEx for this year of $50 million to $55 million or so.

I would say the big parts of the CapEx, though, are going towards growth initiatives, so automating our new collagen manufacturing plant. Spent some money in 2016. We have more to do in 2017. We're also investing more in the instrument sets to do the launches of several of our orthopedic implants, like Cadence, as an example, and Salto and so forth.

The nice thing about our CapEx is a lot of it's going to support the growth initiatives across the Company and automating our facilities. Very little going towards facility maintenance and so forth. But going forward, you should think of a normalized CapEx run rate to be about 4% to 5% of sales. And as we grow as a Company, that absolute dollar number will continue to grow.

Great. Thanks for taking the questions.

Sure.

Jonathon Demchick.

Hello. Thanks for taking the question.

Sure, John.

Pete and Glenn, not sure which one of you wanted to tackle this one, but I wanted to start off on the Codman deal and the financing associated with it. I had a handful of questions from investors over the past week about the possibility of an equity financing considering the higher leverage ratio and the strategy used for the Confluent deal a few years back.

Given commentary from financing and debt pay-down strategy, it sounds like you're committed to only using financing, but can you comment on this and your comfort level of operating at near five times leverage and also your willingness to use equity deals in the future if the opportunity comes up?

Jon, I'll take a crack at this one. Pete can add in any comments. At this point in time, we don't have any intentions of doing an equity raise. We'll use a small amount of cash OUS as part of funding the Codman acquisition. We've got a lot of capacity still under our senior credit facility. We will still leave ourselves some room to do the general day-to-day operations and then we're going to do a new term loan B.

That is our plan relative to how we're going to finance the transaction. And that's what's been baked into all of our conversations and guidance so far. Would we ever do an equity raise the future? Sure. I mean, we continue to look at our capital structure, if we do more deals down the road and so forth. We've done a couple of equity raises in the past. You mentioned DuraSeal being one. After the TEI deal, we also did an equity raise. But right now, our plans are to fund the Codman acquisition through debt.

Very clear and, Pete, I had a quick follow-up on the Advance Wound Care side. Appreciate the additional color on the channel and then the $60 million in pro forma sales expected in 2017, 90 reps in the field. This yields I guess just under about $700,000 of sales per rep. With the continual rep adds, it's likely a little lower than that. In this sales tenor, I would general think of rep productivity at closer to the $1 million per rep range. Is that a fair target overtime? And do you need additional products to get there?

No, Jon, your math is pretty close. If you think about, again, our pro forma number, Glenn went through it, is, when you take our regenerative products plus the Derma, the pro forma number for 2016 is about $50 million. The comparable number, as we talked about, is $60 million for 2017, about 20% growth. It's obviously significantly less per rep in the first half than your number we quoted and we get on to that level of about $700,000 right at the end of the year.

So, I would agree with you. A rep that carries those events products, but also carries a broader spectrum of products to prepare the wound as well as things like protected offloading with boot, you might ultimately be able to handle a little bit over $1 million at some point.

Our hope is to channel around 100 reps, clearly at say $700,000 a rep, there is clearly more capacity and the question is definitely up to $1 million per rep, maybe a little bit better. And we will test out that theory and see how we go, but our, obviously, channel we're starting out with will have some more upside capacity.

And the growth is going to come from more so on the fact of being able to advance the three-by-three strategy, more PriMatrix, more Omnigraft, more AMNIOEXCEL, in the same accounts where they may use these products on different patients at different times as opposed to more customers that burn more time covering more geography. So the concentration of the bag makes a pretty big difference in developing more sales per rep.

Thank you very much.

Young Li.

Thanks for taking our questions. Can you hear me okay?

Yes, we can.

Okay, great. Maybe just a product question to start. It seems like the Salto Ankle is performing well. Can you talk about exercising the international rights and just the timing and expectations around that? And you also mentioned an ankle revision product at an earlier conference. Was that in reference to a new product?

Yes, it's a good question. Again, just broader ankle market in general, we feel quite good about US and as we made in our comments, the Integra, which was a three-piece ankle that we had in the past, discontinued and so the Cadence is our only product outside the United States as we're launching now.

We do have the rights to pick up the Salto and those rights can be initiated as far as working on it as early as April through the second half the year. But I would caution that initiating them doesn't mean selling it right away. So the fact is we're going to make some decisions on when we exercise the right and how the timing of that will play out. The earliest of that playing out and having any type of effect on a sales rep getting it and selling it is later in the second half of the year. But we're quite interested in bringing that in to have the complete portfolio.

On your question relative to revision, we've been working on a revision product and that product, before the end of the year is out, we will speak more to that in more details on it, be in a position to be able to get it into the clinic this year. But most likely from a standpoint of commercial sales, it won't have really any relative impact until next year.

But what is important between the Cadence, which has very distinct capabilities, Salto, longest track record in history, Salto International and a revision, we're going to be quite a strong player within the ankle space and hence why we're adding additional resources as well as to support it.

Okay, great. Thanks for that color. Very helpful. And just the Ortho and Tissue Tech business came in a little bit slower than our expectations and the overall extremities business declined this quarter while the market is growing. Maybe can you talk about the additions in ankle or extremity rep adds in terms of number or timing or contribution?

So let me make a quick comment and then, Glenn, you can add some color to it. If you think about how we came out of Q4, we actually had a little bit more of a slowdown relative to some of the TEI products and then we had little bit of lightness on the outpatient. Those are plans that we think between reps and such that we will be in good shape. We actually ended up in double-digit growth with our Shoulder and our Ankle coming out of the end of the year and have good momentum with Ankle coming into the quarter.

We think that the ramp up on that obviously is going to be linear over the year because we're just bringing that out and it takes time to get new sets out, it takes time to get it into more countries around the world. If you think first half, second half, obviously, there's going to be a stronger ramp up in the second half relative to the hardware and the Ankle lineup.

I would also say there's some complementary products like an external fixation product that we just launched, again, that is used for ankle fusion or cold trauma. Our PANTA nail product, which has been a leading product we've had is internal fixation. That will be continually sold within that and so as we bring more reps on, particularly with more of a focus on the ankle or lower foot issues, there's a pretty good basket that we've assembled now that they can sell against.

And on the regenerative side, we've got some interesting things going on, and, Glenn, you may want to comment on that. That helps fill out some of the portfolio, and again, I emphasize the fact that these are new products that are coming out of our latest acquisition and will be incremental this year.

The only other thing I would add, first on the extremities, the decline that we saw was really outside the US and we're working through a transition right now, as Pete mentioned, the Integra Ankle and so forth. The US actually had growth so just to highlight why extremities was down, it was really a transition that we're going through outside the US.

Relative to the regenerative portfolio, we've got a lot of new products for launching, we've got a couple different sizes coming out, smaller sizes of PriMatrix, of Omnigraft, we've got various forms of SurgiMend being rolled out, including a macro-porous product. So we've got a very interesting lineup of new product introductions that are coming out here that should drive some good growth for us in 2017.

Great. Thank you for taking the questions.

Sure, thank you.

Raj Denhoy.

Good morning.

Morning, Raj.

Wondering if I could just follow up on that last question. You did comment, in the prepared remarks, that your legacy extremity products continued to be a little weaker and I know the question has come up at various points over the last couple of years, but have you given broader thoughts to your strategy in extremities and if it's still an area where you think you want to be broadly focused and I know you've made a lot of comments around the ankle space, but what about beyond that?

Yes, look, it's a great question, Raj, and, in short, we're very much committed to the extremities space. And here's some of the things that have changed. We've obviously had different levels of performance. We've had some fits and starts relative to new products and we've made some pretty good changes in the last year to concentrate really the whole team now in our Austin facility, which goes a long way with being able to get new products out faster, alignment with our marketing organization.

The addition of Bob Davis within that team is going to really make a big difference relative to their ability to get new products out, be able to focus on differentiation and marketing. So that's all part of the operational things that's, what's different that's going to help us be able to get the kind of growth we expect. The other side is that when you take a look at, in particularly, lower extremities, there are still some very good synergies with the regenerative pipeline and how we've exploited those has probably not been maximized.

Whether it be our nerve technology and how that's tied in with hand and reconstruction surgery and upper, but in lower, everything from with podiatric surgeons to orthopods on tissue, on tendon, on ligament repair. We actually have a pretty nice portfolio of products that we're spending more time integrating those into the strategy and we've talked about that, but our effectiveness of doing, I would say, hasn't been what we had hoped. And we've got the right people in place to be able to do that.

The breadth of our overall channels, upper, lower, we're going to spend some time to make sure that we're focusing on those areas within extremities where we can have the biggest impact and win.

But over the next two years, there's going to be a real critical window for us to be able to demonstrate that with the changes we made, we can get the growth that we need and to the fact, be one of the top four players in the chosen submarkets in extremities. But right now, we're very much committed to it, we're investing appropriately, and I'm pretty excited to what we can do here in 2017 relative to extremities.

Just to put a finer point on, are you're equally as committed to the upper extremity, the shoulder market? Because a lot of focus, it seems, is on the ankles and what you can do in terms of leveraging the regenerative portfolio in the lower extremities. But do you think you have got an equally strong chance to be a competitive in the shoulder market long term?

We do, but it's really tied as much to how our pyrocarbon technology and the evolution of that plays out. And what do I mean by that? Look, in the short term, we've got everything from different gelnoid solutions and work that we're doing relative to instrumentation to make us very competitive. But to be competitive versus the big guys that play in this market, us coming up with tweaks within the metal portfolio for shoulder probably isn't going to do it.

What's going to do it is having a technology that differentiates us and we think pyrocarbon can be it. We'll see how that ultimately plays out here in the clinical work and, if it does, we can be a substantial player. If it doesn't, we probably have to make different decisions about how we think about the overall portfolio. But at this point in time, it looks extremely promising.

Really changing how you think about shoulder arthroplasty that you could do a hemi procedure and there really isn't any other technologies or capabilities on the horizon that look like they could compete with a product that would play in that space. So that's really how we think about that, and again, that take multiple years of clinical study to come to market. In the meantime, it's focused on tweaks and line extensions into the product family of the Titan shoulder.

Okay, great. Thank you.

Thanks, Raj.

Robbie Marcus.

Morning, Robbie.

Good morning. You made it all the way through a call without anybody asking about DFU, so I'm going to go ahead. I know you had some, a shortfall in the fourth quarter. I didn't hear any guidance for 2017 as it's being lumped into the Advance Wound Care. Maybe you could just give a sense of what you saw in the fourth quarter that led to the shortfall. Maybe your thoughts on some numbers for 2017 and how the addition of the Derma product helps you maybe sell better into that channel.

Robbie, we're glad you asked that question on DFU and Advance Wound because it is a big and exciting area for us.

Again, I would say, I will let Glenn, maybe on some of the numbers and the breakouts how we think about it, but look, we know we've got a winner within Omnigraft and now having this three-by-three strategy where you can go to a clinician, if they want amniotic, they want a different product that has unbelievable strength and shearing capabilities such as PriMatrix, they want a product that actually can heal in one application and has the best data out there, has a regeneration claim to it, we now have that full portfolio.

And when you add in all the preparation products on how to take care of a wound bed, things such as Medihoney, every patient that has a DFU needs some time of offloading. We know have the best offloading boot in the Total Contact Cast. Yes, it's a big deal when you can now day one see a doctor be able to actually sell them something as opposed to waiting for four to six weeks until they can use one of your advanced products. So we have more of a continuum sale.

The other side I'll mention just before Glenn comments a little bit is about reimbursement. Our insights and capabilities have grown quite a bit from the standpoint of how we think about reimbursement with different, in areas, be it, Medicaid, Medicare, the private payer world and how we think about office-based wound care or inpatient. And so our sophistication has grown in that area which is important on how you think about where you put priorities and where you don't.

And so I remain very optimistic and quite excited now that we've got the Derma family of products within the fold. Glenn, you may want to comment just on how we thought about the guidance and how we think about the numbers.

Yes, Robbie, we're not going to specifically break out the specific revenues for each of the product lines within our Advance Wound Care business for competitive reasons, but we felt that it was important to give some context about how that part of our business is doing year over year and what we're including in our 2017 guidance.

So, when we look at 2016 pro forma, including Derma Sciences for a full year, it's about $50 million of pro forma revenues. We're expecting 20% growth in 2017, so the $50 million becoming, call it, $60 million. What I would say is the vast majority of that growth is expected to come from the legacy Integra portfolio, including Omnigraft. But we're not breaking out separately. That's the way we think about the growth for 2017, 20% and a lot of that coming from the legacy Integra portfolio.

Okay. That's helpful. And, Glenn, if I could sneak in two quick ones for you. One is, with organic growth where it is for the first quarter, it implies organic growth for the rest of the year closer to 9%.

Maybe you could just help with the cadence and some of the puts and takes that get you confident in getting up to that higher end and then also the free cash flow conversion was a bit lower than I was thinking coming into the year. Maybe you could just comment on some of the drivers there and what we should be thinking in 2018 once Codman comes on board. Thanks.

Sure. Relative to the organic growth and how we see the year laying out, 5% to 6% Q1, I would expect it to sequential improvement for each of the quarters during 2017. We're not going to give specific guidance on each of the quarters, but going up sequentially from a growth-rate perspective throughout 2017 is where we think about it, and again, the main reason behind that is the new product launches we talked about earlier on in the call, especially around the regenerative portfolio along with three product launches we're going to be doing in our Specialty Surgical business.

We're going to be adding over 75 commercial resources, it's going to take time to get salesforce effectiveness from those sales reps. So, those are the key drivers in my mind that drive the sequential improvement in our organic growth rates. Relative to free cash flow conversion, 2017 is going to have a lot of one time cash outlays associated with the integration of these two acquisitions. The guidance that we gave contemplates some pretty significant one time cash outlays here in 2017.

We're not ready to give guidance yet on 2018. When we get closer to the close of the Codman acquisition, we can provide that, but once we've moved past the one-time costs over the next couple years, clearly we would like to see ourselves getting back towards the targets we had laid out, which is 95% free cash flow conversion. But again, it's going to take us longer to get there now with those two acquisitions and a lot of the integration costs.

Thanks.

Matthew O'Brien.

Thanks so much. Good morning, everybody. Just talking a little bit about your commentary about PriMatrix and SurgiMend and the sequential improvement that you saw, would love to hear a little bit more about some of the drivers that you saw there and specifically on the new accounts side. That transition that you were able to generate as far as getting some new accounts on board, how has that gone and what are some of the pull-through opportunity you see out of those accounts going forward?

Matt, look, in a word, it's focus. I had mentioned on some previous calls that the OTT sales organization that had the inpatient PriMatrix, they also had ankle product, they had a lot of the orthopedics, they had a lot of new products and we were kind of bumping up on capacity.

Some of the ads that we started in the fourth quarter that are going to take place in the first part of the year are a combination of, I'll say, beginning reps that can help actually on orthopedics cases they can free up our senior guys to sell into tissue areas as well as expanding some of our tissue capacity selling resources, so that's one.

They just didn't have the focus on it. We increased focus within Q4 and had double-digit increases in the US salesforce within those areas. And it takes time to open up some of these accounts, particularly if you're using larger size product in reconstructive areas. You're talking about not routine stuff.

Give you a contrast, a diabetic foot ulcer, there's a pretty defined protocol of what someone does, how they do it. Someone comes into your hospital and has a really nasty motorcycle accident, everyone is different relative to the de-gloving, the issues associated with it.

And so to adopt a product to use in those types of cases, it takes time. You need to spend multiple weeks with that doctor, within that account, while they're using it. And starting out, we weren't giving that type of attention that was needed. That's increasing and that's what's going to drive more adoption over time, that coupled with new things to talk about.

So in this space, we were missing some sizes. We were actually missing some other areas within the SurgiMend side that were pretty critical within the hernia space that we think we will talk about that are going to address some challenges that clinicians have and also bridge some of the clinical difference of why a biologic is much better than a synthetic, but there could be challenges to the total cost and we think we've got some interesting opportunities within that.

Again, it's a combination of channel increase and focus and then new products to address specific needs and, again, 2017 will be the year where we start getting some traction within this area.

Helpful, and then as a follow up on the extremities side, it seems like you are focusing on the foot and ankle side going forward and maybe it's my own ignorance here, but the portfolio that you have on the Total Ankle side is pretty good. I don't know if you'd have a fuller bag elsewhere among other ankle procedures, so do you have the bag that you need right now to sell effectively into that market as you're building out the sales reps?

Are you going to be adding quite a few sales reps this year and maybe next year as well specifically on the foot and ankle side? And then are you going to back that up as well with a lot of medical education because that tends to get pretty expensive.

Yes, we've got medical education factored into this. And you're right. So that's part of the investment dollars that we have within the spend this year, within SG&A, and some of the clinical work that needs to be done tied with R&D. But, look, to your question, clearly, we've got a winning portfolio within the ankle area, so either in fixation or when it comes to ankle arthroplasty, we've got a world-class portfolio.

And we also have a very strong shoulder product, we also have some strong upper areas, whether it be a leading wrist replacement, all the digit components, the nerve replacement, but when you have a market as hot as Ankle with two of the best products out there, the associated fixation, are you going to put a little bit more focus on that because of the timing of the market? And the answer is yes.

So you're kind of hearing us correctly. It doesn't mean the areas aren't as important. It just means that where we are in the market with competition and actually how much conversion is taking place in the market, it will tend to be an area that we're going to put more focus on because of the opportunity at hand.

Very helpful. Thank you.

Stephen Whitman.

Thank you. Hello, guys. Pete, you alluded to private label maybe starting to accelerate in the back half of the year now with the new capacity in New Jersey. Can you take a step back and talk a little bit more about the opportunity ahead, how much of a growth driver you see that being? And I believe it is operating margin accretive as well, correct?

It is. Steve, I will comment and maybe if Glenn could jump in on a few comments. As you well know, we've talked about with our new facility, and still running our previous facility until we get all of those products shifted over that we're going to be in a position where through the next few years, we're going to still have our older facility as we move everything into new area. A lot of that is tied to registration, timing, and conversion.

What that means is, over the last few years, we've opened up a lot of capacity that we can utilize for our own products, but where it really fits into our platforms, we can do private-label deals. Within the Orthopedics and Tissue business, we've got a team focused on that.

And the short of it is they've made some progress, whether it be in near-neighbor products that are used in the dental space, to products that are used in animal health, to products that are used with some of our biggest existing private label customers that are actually adding additional lines or accelerating their geographical presence. And I would say the pick-up that we see in the second half is associated with a little bit of all of those.

And, relative to overall impact, in the year, it is starting to actually have an effect, but it's bigger effect will be if we add more this year as it moved into 2018 and, to your point, about high-level numbers, it's still a smaller portion of our business. It goes up and down. At one point in time, it will significantly bigger. Over the last few years, it decreased quite a bit. And now we're back on the climb. Could it be a business that generates $50 million, $70 million of capacity business over time? Yes, it has the potential to do that.

But the point here is that it really helps us two ways. When we fill that in, it actually helps fill capacity, which drives lower cost for everything in that facility, and to your point, has operating margins, EBITDA margins that are significantly above the Company average, mainly because you really have no investments in SG&A and mainly minimal if any investments in R&D. Glenn, I don't know if you want to add some other comments.

Yes, Pete hit the main highlights. But what I would say is we would expect our private label business to grow at least in line with the overall regenerative portfolio, so think of it as a double digit growing part of our business as we look out over the next few years. And again, it's a combination of growth we're seeing with existing customers, so very healthy underlying growth, plus new customers we are adding given the increased capacity that we have.

So that's the way I look at the business and Pete mentioned the profitability. It's a little bit dilutive to our gross margins, but certainly from the EBITDA margin perspective, very accretive and so we love this business.

Great. Thanks. And then, Glenn, I appreciate the added color during the Q&A on extremities. The US was up broadly and, you had mentioned, internationally down. That international component, what is going out in terms of, you mentioned, a transition and when do you kind of anniversary that?

So, it's going to take us some time. Keep in mind, we're just now rolling out the Cadence Ankle in a controlled market release in Europe, as well as Canada. As we move to a full market release later this year, that will start to help get some of the growth back, if you will, and replace the Integra Ankle. And with that, obviously, we expect some pull-through effect with our lower extremities portfolio.

But I wouldn't expect much growth in 2017 and we're probably talking about 2018, which is when we'll have the full-market release of Cadence and then potentially the Salto Ankle as well coupled with some other lower extremity products. But for 2017, not expecting much of a recovery outside of the US.

Got it. Great. Thanks, guys.

Jayson Bedford.

Good morning guys. Thanks for squeezing me in. I apologize if I missed this, but it looked like you bumped up your expectation for Derma by about $5 million to $70 million and I'm just wondering does that reflect the timing of close or is there anything specific on the bump there?

Jayson, that is a function of the timing of the close. We didn't have an exact date relative when the deal was going to close. We figured it was going to close closer to the end of the first quarter and again, we're expecting it to close here in the next few days. It's more reflective of just the timing of the close.

Okay. And, Glenn, what is the expected contribution from Derma in the first quarter?

We're not going to give specific guidance relative to Derma relative to Q1, but what I would say is, for the full year, it's going to be about $0.03 dilutive on a full-year basis. If you model the first quarter one month, you could probably figure a penny or so rough order of magnitude.

And on revenue, you're not going to, you're just going to keep to that $70 million for the year?

Yes.

Okay. In the $50 million pro forma of Advance Wound Care revenue in 2016, how much of that bucket was Derma?

The Integra legacy portfolio ended at about $11 million. The rest of it would be Derma.

And the growth, you think, to get to that $60 million is largely the legacy Integra business?

That's correct. Omnigraft, PriMatrix.

Okay. That's helpful. Thanks, guys.

We have no further questions. I'll turn the call back over to your speakers.

Thank you, operator, and thanks for all your questions today. Just to reiterate a couple points from the call, first, we're very much focused on driving our 2017 financial targets, committed to the 7% to 8.5% growth and hopefully you had a good feel for, with the core business, the new products in the channel expansions, how we get there.

Second, we're look at forward to welcoming the Derma Sciences and Codman Neurosurgery into the Integra organization and these are unique long-term opportunities and we're committing the resources to ensure the integrations are done successfully for the Company. Third, we're committed to our long term organic growth targets of 6% to 8% and our aspirational 30% adjusted EBITDA margins, while making all the necessary investments to sustain the long-term value.

Again, thanks for everyone listening and we will be speaking with you all here in the near future. Thank you.

This does conclude today's program. Thank you for your participation. You may disconnect at any time.