Integra Lifesciences Holdings Corp (IART) 2017 Q3 法說會逐字稿

Good day, everyone, and welcome to the Integra LifeSciences' Third Quarter 2017 Financial Results Call. As a reminder, today's call is being recorded. At this time, I would like to turn the conference over to Mike Beaulieu, Director of Investor Relations. Please go ahead.

Thank you, Bettina.

Good morning, and thank you for joining the Integra LifeSciences' Third Quarter 2017 Earnings Conference Call. Joining me on the call are Peter Arduini, our President and Chief Executive Officer; and Glenn Coleman, our Chief Financial Officer and Corporate Vice President of International.

Earlier this morning, we issued a press release announcing our third quarter 2017 financial results. The release and corresponding earnings presentation, which we will reference during the call, are available at integralife.com under Investors, Events & Presentations in the file named Third Quarter 2017 Earnings Call Presentation.

Before we begin, I'd like to remind you that many of the statements made during this call may be considered forward-looking statements. Factors that could cause actual results to differ materially are discussed in the company's most recent filings with the SEC. Also, the discussions will include certain non-GAAP financial measures. Reconciliations of the -- any non-GAAP financial measures can be found in today's press release, which is an exhibit to Integra's current report on Form 8-K filed today with the SEC. I will now turn the call over to Pete.

Thank you, Mike, and good morning, everyone. If you'll turn to Slide 4, I'll begin by sharing some take-aways from the third quarter. I'll also provide an update on the Codman integration and our near and long-term financial outlooks.

Total sales in the third quarter were $279 million, resulting in organic growth of 1.5%. While this was a disappointing result, we managed to deliver significant accomplishments in the quarter while dealing with adversity in Puerto Rico.

We closed the Codman acquisition, the largest transaction in the company's history, which included a multi-product divestiture and aggressive closing date, which was achieved. We also implemented action plans to address underperforming areas in our business and launched 3 new products. And finally, we managed through 3 separate major hurricanes, which impacted both sales and manufacturing results in the quarter.

We responded by mitigating a large portion of the financial impact. We estimate the storm-related disruptions had an impact of roughly $7 million, including lost procedures and shipments that we were not able to get out of Puerto Rico before the close of the quarter. Excluding this impact, total revenues and adjusted EPS for the quarter would have been within the guidance range that we provided in July. Third quarter organic growth, excluding the storm-related disruptions, would have been 4.4%, about 1.5 points below our July guidance, mainly due to underperformance in our dural repair and SurgiMend product lines.

Cash flow from operations was $45 million, exceeding our expectations, largely because of the lower spending and improvements in working capital. This performance demonstrates our ability to generate cash flow, which should increase with the addition of the Codman products in our portfolio.

Turning to performance in Orthopedics and Tissue Technologies in the quarter, we delivered strong performance in our core regenerative products and Advanced Wound Care business, including Derma Sciences, and our ankle and shoulder portfolios. We launched several new regenerative products into the surgical reconstruction market that addressed critical gaps in our portfolio.

Moving to Specialty Surgical Solutions. Sales in dural repair increased about 2%, below the 4% we expected when we provided guidance in July. Based on our analysis of market data, the programs that we put in place last quarter to address competitive pressures in dural sealant have been successful in maintaining market share. That said, the majority of the shortfall versus our guidance resulted from price concessions, tied to additional contracting in the quarter. With the addition of Codman's commercial resources, we believe we're well positioned to accelerate growth in dural repair in 2018.

Sales in our tissue ablation franchise increased double digits, both inside and outside of the U.S, driven by the success of CUSA Clarity, which was launched only a few months ago.

Turning to Codman Neurosurgery, we announced the closing of the acquisition on October 2. And as you can imagine, this is a busy time for us as we're working hard to effect a smooth transition in all functions. The year-to-date pre-closed results of the Codman business have performed in line with our expectations and since closing, the transition is on track globally. As a result, we are increasing our 2018 accretion estimate to $0.25 from our prior guidance of at least $0.22.

The acquisition of Codman will effectively double our international business and a key to our integration plan is making sure that we have strong leadership in place to guide our global business.

I'd like to announce an important addition to our leadership team. Mike McBreen, who joins us from Johnson & Johnson, has been appointed President of International and will have full commercial responsibility for our international business reporting to Glenn Coleman.

Mike is an accomplished executive who had served in key leadership roles while at Codman, and has 27 years of experience in the medical device industry, specifically in neurosurgery and orthopedics. We're excited to have Mike join us and to leverage his broad experience as we strengthen our global infrastructure to support our expanding international business.

Let me now provide a brief update on our Puerto Rico manufacturing facility.

First and foremost, we've been in contact with all of our employees. The damage to the island has been significant and unprecedented and I'm both humbled and proud at the resilience of our colleagues and to the many who've returned to work so quickly in the face of such a devastating event.

As many of you are aware, we manufacture regenerative products, neurosurgery products such as DuraGen as well as certain private-label products at our Añasco, Puerto Rico, facility. This facility supports roughly $200 million of the company's annual revenues. As we reported in September, the facility experienced minor structural damage and we've completed all repairs and have re-established manufacturing capabilities utilizing our backup generators. But we are running at less than full capacity. And we're working with local authorities, suppliers and infrastructure providers to re-establish basic services required for long-term operations.

Our current manufacturing capabilities, coupled with inventory on hand, should enable us to minimize significant disruptions to sales. That said, operating at less than full capacity will have an impact on the fourth quarter for certain neuro products as well as nonstocked private-label products. We estimate at this point in time, an impact on revenues similar to that of the third quarter -- about $8 million. Based on our third quarter result and our expectations for the fourth quarter, we are revising our outlook for full year 2017 consolidated organic growth to be about 4% and reported growth to be roughly 18%.

Before turning the call over to Glenn, I'd like to provide a few comments related to 2018 and our longer-term revenue targets.

With the addition of the Codman products to our portfolio and the new mix of our business, we are revising our target for long-term organic growth to a new range of 5% to 7%, down 1 percentage point from our prior range.

During much of the first half of 2018, we will be heavily engaged in Codman integration activities particularly with the alignment of sales territories. And as a result, expect 2018 organic growth to be at the low end of this range at around 5%. That being said, we're still committed to long-term double-digit adjusted earnings per share growth, including 2018 EPS growth of 25%. As we exit 2018, we expect that our organic growth will accelerate in 2019 and beyond, and as we leverage our increased scale, infrastructure and R&D capabilities.

With that, I'll turn the call over to Glenn to review our quarter in detail and provide more information on our 2017 guidance and long-term outlook. Glenn?

Thanks, Pete, and good morning, everyone. Since Pete just covered the overall company revenue and adjusted EPS for the quarter, I'll move right into our segment performance discussion starting on Slide 5 with Specialty Surgical Solutions.

Third quarter reported sales grew 3.4% to $165 million, with organic sales increasing 2.7%. Tissue ablation sales increased double digits over the prior year driven by strong capital sales of CUSA Clarity. The global launch of CUSA Clarity is going well in the U.S. and abroad, and we expect the momentum of this product launch to continue to drive growth in our tissue ablation franchise.

Earlier this month, we attended the CNS Annual Meeting and the European Neurosurgery Society meeting where CUSA Clarity was a featured product. We continue to receive positive feedback from our global customer base on Clarity's ergonomic design, streamlined operating room setup and enhanced surgical performance, which can provide a fibrous tissue removal rate of greater than 50%.

Moving to Dural Repair. Sales increased about 2% in the quarter, which was 2 points lower than our July projections. Although we gave up some price within the quarter, we maintained unit share and have received encouraging feedback about the health economic study we published in August. We anticipate that the economic significance of this study, combined with strong clinical data and the expansion of our commercial organization, will drive unit growth in our Dural Repair franchise.

Sales in Precision Tools and Instruments increased low single digits compared to the prior year quarter, in line with our expectations. Strong growth in cranial stabilization and specialty neuro products were partially offset by lower sales of dental instruments. International sales within the segment increased high single digits driven by strength in our Dural Repair and Tissue Ablation franchises in both Asia Pacific and Europe.

Moving to our full year outlook for Specialty Surgical. We are revising our expectations for fourth quarter Dural Repair growth to be in line with the third quarter run rate at about 2%. This translates to full year organic sales guidance for the segment to be in the range of 2% to 3%, down about 1 percentage point from our prior guidance. Our reported growth rate, including Codman, is now expected to be between 11% and 12%.

Turning to Slide 6. I'll now cover the revenue performance in Orthopedics and Tissue Technologies.

Third quarter sales in this segment were $114 million, representing an increase of 26% from the prior year's quarter, largely due to the addition of Derma Sciences. Organic sales in this segment declined about 1% in the quarter. The impact of the hurricanes resulted in lost wound care and orthopedic procedures mainly in Florida. In addition, we are unable to fulfill certain private-label orders, because of the disruptions to operations in Puerto Rico, leading to a double-digit decrease in private-label sales in the third quarter.

Organic sales, excluding the effect of storm-related disruption, increased by 6%, which was about 3% to 4% below our expectations. Regenerative Technologies increased mid-single digits in the quarter, led by growth in our inpatient skin portfolio, but it was tempered by lower-than-expected performance in our SurgiMend product line.

We introduced several new products late in the third quarter that expand our portfolio of solutions in the U.S. hernia repair market and the breast -- and the European breast reconstruction market, which should spur growth in 2018.

Sales in Derma Sciences were approximately $24 million in the quarter and were higher than expected, putting us on track to exceed $80 million for the full year.

Our total Extremities business increased low single digits during the third quarter. Strong growth in our extremity arthroplasty business, which includes both ankle and shoulder, helped drive growth in the quarter. Together our Cadence and Salto Ankle portfolio grew 40% over the prior year. The growth has come from the addition of new users and an increase in procedures from our existing surgeon base.

Shoulder sales increased almost 20% as we continue to make progress on channel expansion with the addition of distributors. International sales in this segment increased about 30% largely due to the incremental revenues from Derma Sciences.

For the full year 2017, we are adjusting our reported sales growth range for Orthopedics and Tissue Technologies to be between 28% and 30%. We are revising our organic growth rate in the segment to a new range of 5% to 8%, down from our previous range, largely because of storm-related disruptions in the third and fourth quarters and lower expectations for our SurgiMend product line.

Please turn to Slide 7 for our consolidated revenue guidance. For the full year 2017, we are adjusting our revenue guidance to a new range with the midpoint of $1.17 billion. This guidance range reflects an impact of roughly $15 million from storm disruptions, a reduction of about $10 million to the base business and the expected fourth quarter revenue contribution for Codman in the range of $60 million to $65 million net of divestitures, which is consistent with our previous comments. These changes result in an increase to our reported revenue growth rate of approximately 18%.

Organic growth for the full year is now expected to be about 4% compared to the midpoint of our prior range of 6.5%. This represents a decrease of about 2.5 percentage points from our previous guidance, consisting of about 1.5 points related to hurricane disruptions and 1 point from base business declines.

As a reporting note, we previously communicated the expected Codman revenue contribution to be net of all divestitures. Going forward, we will be reporting Codman revenues, excluding the divested Integra products as these will be reduced from our base business, which is where they were previously reported. This results in a higher revenue contribution from Codman and lower base business revenue, but there's no change to the overall numbers. We've broken out these numbers in the revenue bridge for your reference.

Turning to Slide 8, I'll review the key components of our third quarter and full year P&L performance.

Third quarter GAAP gross margin decreased 80 basis points over the prior year to 63.5%, while adjusted gross margin was 68.7%, a decrease of 60 basis points, and was slightly better than we'd indicated in July. For the fourth quarter, we expect adjusted gross margins to be in line with the third quarter, including the impact of Codman. For the full year 2017, we are reiterating guidance for an adjusted gross margin of about 69%.

Our third quarter 2017 adjusted EBITDA margin was 22.6%, a decrease of 80 basis points from the prior year's third quarter, attributed to Derma Sciences which carries lower gross margins. For the full year 2017, we expect our adjusted EBITDA margin to be about 22.5%, which has now been adjusted to reflect our lower sales guidance.

GAAP net income and earnings per share were both lower compared to the prior year quarter, largely because of acquisition-related costs. Third quarter adjusted net income was flat compared to the prior year quarter.

Please turn to Slide 9 for an overview of the changes to our full year 2017 adjusted earnings per share guidance. We are revising our 2017 full year adjusted EPS guidance to a new range of $1.83 to $1.87, a $0.06 decline from our July guidance. This guidance reflects the following changes: a $0.07 impact from storm disruptions, a $0.05 reduction due to lower organic sales in our base business, largely offset by about $0.04 of operational savings and finally $0.02 of accretion from Codman.

For the full year, we are revising our GAAP earnings per share to a new range of $0.24 to $0.30, down from the prior guidance range, which includes the impact of the changes I just mentioned plus the inclusion of purchase accounting adjustments and onetime costs associated with the Codman acquisition.

Since we have recently closed Codman, I would like to now provide you with some preliminary thoughts with respect to how we're looking at 2018 adjusted earnings per share. If you please turn to Slide 10.

The information on this chart assumes a 5% organic revenue growth rate in 2018, the continued suspension of the medical device tax, and does not contemplate any U.S. corporate tax reform. Starting with the midpoint of our revised 2017 guidance, we assume 12% adjusted EPS growth on our base business consistent with our long-term goals. We assume a full recovery in our Puerto Rico facility, which will enable us to meet commercial demand generating an additional $0.05 of adjusted earnings per share.

We are increasing our expectations for the accretion from Codman by $0.03 and now expect it to contribute $0.25 to earnings per share in 2018. With the Codman integration well underway, we also have plans for significant channel investments in Orthopedics and Tissue Technologies worth about $0.07, which are required to enhance long-term revenue growth. We'll provide additional details on our December Investor Day, but these investments are expected to expand both our Orthopedics and Tissue channels. Inclusive of these investments, we expect adjusted earnings per share to grow nearly 25% in 2018.

Over the long term, with the addition of Codman into our portfolio, we see opportunities to increase our profitability as we gain more scale or leverage across our business, which we expect will drive significant operating and EBITDA margin expansion.

Turning to Slide 11. Our operating cash flow in the third quarter of 2017 was $45 million with capital expenditures of $8 million. On a trailing 12-month basis, our adjusted free cash flow conversion ratio was 71% compared to 76% in the prior year.

Operating cash flows in the fourth quarter are expected to decline sequentially because of additional cash outlays associated with the acquisition and integration of Codman. That said, we expect full year cash flow metrics to be at the high end of our guidance ranges given the outperformance we've seen through the first 9 months of the year.

Please turn to Slide 12 for an update on our capital structure as of September 30, 2017, and our pro forma December 31, 2017, capital structure, inclusive of the Codman acquisition.

Our cash balance at the end of the third quarter was approximately $482 million with total debt of $1.17 billion. Our cash balance as of September 30, reflects the initial draw from our loan facility, in anticipation of the October 2 close of the Codman acquisition. Our bank leverage ratio at September 30 was approximately 2.5x.

In the fourth quarter, our total debt will reflect the additional $700 million of borrowings associated with closing on the Codman acquisition. Our year-end 2017 pro forma bank leverage ratio is expected to be less than 4.5x, unchanged from our prior guidance. This represents a full turn below the 5.5x maximum leverage ratio allowed in our credit agreement that went into effect in the fourth quarter. As we've previously stated, we are committed to lowering this leverage ratio by about half a turn in each of the first 2 years post-closing and a full turn thereafter.

And with that, I'll turn the call back over to Pete.

Thanks, Glenn. If you now turn to Slide 13, I'll provide an update on our key focus areas for the rest of 2017.

While the third quarter was challenging on several fronts, we accomplished a number of milestones and positioned the company for long-term growth. Through the first 3 quarters of 2017, most of our portfolio was meeting or exceeding our plans, including our core regenerative tissue products, our total ankle and shoulder portfolios and CUSA Clarity. In those areas, we have not expectations, we have plans in place to improve our performance, including new product introductions, channel enhancements, and clinical and marketing programs.

We've revised our organic growth for the year based, partially, on underperformance of 2 product families, but largely because of the unprecedented storm activity that occurred in the third quarter. We minimized the impact to our adjusted earnings per share for the year through cost reductions and great work by our operations team bringing our Puerto Rico facility back online.

We closed the Codman acquisition on October 2 and are implementing the integration plan that we meticulously prepared over the last 6 months. And the more we look at Codman, the more encouraged we are in our ability to accelerate growth and profitability in the back half of 2018 and beyond.

The Codman deal enables significant channel expansion worldwide and a complementary product portfolio and pipeline, which positions us to achieve critical scale in many markets around the world. As part of a branding strategy, we're taking advantage of the globally recognized Codman name by rebranding our Specialty Surgical segment to Codman Specialty Surgical. This new identity will enable us to utilize the Codman Specialty Surgical brand in neurosurgery as well as other franchises such as Instruments to enhance our global competitive position.

Derma Sciences is now fully integrated into our operations; both Derma Sciences and our Advanced Wound Care businesses are on pace to exceed our 2017 targets. The Derma Sciences integration was executed as planned and is positioned for success.

We launched a number of new products this year in both our segments. We expect many of these products such as CUSA Clarity to drive the growth in 2017 and beyond. And finally, today we provided early look into 2018. The addition of Codman Neurosurgery is transformational for the entire company, but will require time for us to integrate it and then execute on our plans for faster growth. We've adjusted our expectations for long-term organic growth to a new range 5% to 7% and expect to grow 5% organically in 2018. And this takes into account the new mix of business and disruptions expected as we enlarge channels and integrate product lines in the first half of 2018.

As Glenn discussed, our preliminary adjusted earnings per share growth target for 2018 is 25%. This growth includes a contribution of $0.25 from Codman and an investment of $0.07 to fund the expansion of our OTT commercial channel. This significant OTT investment is intended to address the channel constraints that we have experienced in orthopedic extremities and also our legacy inpatient wound business, both of which provide large growth expansion opportunities. This investment will result in a more focused and larger commercial capability to drive growth. That being said, focused on improved profitability will also be a key part of our long-term strategy going forward.

I'm proud of our team and how they dealt with the 3 challenging storms, closed the largest deal in our history and managed expenses to offset a major portion of the impact on adjusted earnings per share in the third quarter.

We remain very optimistic about our future as the #1 neuro company worldwide and a global leader in regenerative medicine. It's a new day at Integra and we plan to demonstrate our confidence with improved results. I'd also like to announce today that we'll be hosting an Investor Day on Monday, December 11, in New York City, where we will provide additional details to our long-term growth strategies, in both Codman Specialty Surgical and Orthopedics and Tissue Technologies. And we hope to see many of you in New York.

That concludes our prepared remarks. Operator, would you please open up the lines for questions?

(Operator Instructions) Our first question today comes from Robbie Marcus of JPMorgan.

Maybe, Glenn, a question for you. The 5% organic growth guidance in 2018 is fairly below where the street was modeling kind of in that 6.5% to 7% organic range. So you bridge 3Q to 4Q, but maybe you could help us bridge -- what's going to happen between 2017 and 2018 that will lower it so much versus expectations?

Sure. So when we look at 2018, we're going to be somewhat limited on the remarks we are going to make. But I would say when you look at the 5% organic growth, we would obviously expect Orthopedics and Tissue business to be growing much faster than that, and our Codman Specialty Surgical business to be growing slower than the overall average.

And as we look at that, keep in mind, we're going to be integrating the largest acquisition in our company's history in the first half of 2018, and we're expecting that to have some disruption on our base business, including our organic business. And so we would expect that to be more limited in terms of organic growth especially in the first half of the year versus second half of 2018. And if you look at the mix between the two, we expect 5% organic growth as a reasonable assumption right now given we still have a few months to go to close out 2017.

Yes Robert, the only thing I would add, it's Peter, just to emphasize that Glenn's point here is that fundamentally every territory in the United States in neurosurgery is going to have some changes done to it, and so we've factored that in. And we want to make sure that we factored effectively what we think that could be. If we do a little better than that as Glenn said, we have opportunities for upside beyond that, but we think it's quite prudent just based on the scale of the integration where we have a #2 and #3 coming together from a channel's standpoint.

All right. Maybe in the third quarter, the things that stood out were Dural Repair softer, regenerative, SurgiMend was a bit lower even excluding the hurricane and then CUSA did better than expectation. So maybe can you touch on each of those and what you're seeing in the markets and then how you expect those to play out over the next few quarters?

Yes, Robbie, so with the Dural Repair, we were, I think, probably a little optimistic that we could keep the price and the socket simultaneously from Q3 to Q4. And, as I mentioned, what was good through the quarter and we saw our market share data, we held on to share and in many cases in Dural Repair, particularly in the online market and the sealant market, we've gone in many cases without integrated contracts for those products and what we have been doing, and this has been part of our strategy, is to have more integrated products strategies in that area.

We -- as we felt more pressure in that area, we actually signed up more contracts really within the last 2 quarters. And so I would say, in Q3 the biggest part of the price component was signing up to some longer-term agreements that I think will give us stability on our market shares, on the price side and also have us be in a position that we can focus on growth from this point forward. So I think it was a smart move ultimately to be able to tie the contracts that resulted in some price; that was the Dural Repair side.

On SurgiMend, it's a new business for us that came in from TEI. I'll just kind of broadly say the TI acquisition, 2 major products areas, PriMatrix and SurgiMend. PriMatrix is growing at double digits and we continue to see that expand. And we think that SurgiMend is going to be a contributor.

What we've been struggling with is getting the right products in the right markets. And I would say the U.S. it's been about hernia and having the right regenerative product that can compete price wise with a bio-absorbable. We think we have the product out in this MP product we launched a few months ago. But it takes some time to get that established, get it through facts, get going. And that was part of the slower uptake, probably about the half of it was there.

The other area is in breast reconstruction outside the United States. There is a change within procedures to do what's called a prepectoral procedure. You need a different approach and style of the product, we think we have it. Glenn referenced, we just launched it at the end of the quarter and we think that's going to bring back growth. But when we take a look at third quarter, those are really the 2 negative factors and we think those trends just because of the time to ramp up is still going to exist into Q4.

Glenn, you may want to comment on that before we go to CUSA?

Yes. No I'll just say with CUSA, we had a really strong quarter, double-digit growth, both in the U.S. and outside of the U.S. So the global launch is going quite well.

I'd just temper some expectations over the longer-term horizon, next couple of years. We see this franchise growing in the high single-digit range, but clearly off to a really strong start.

I would also just point out relative to our third quarter results, if you exclude the storm, we actually would have met or hit our revenue guidance, the midpoint of our guidance, and actually been above our adjusted EPS. So while we were sure on organic growth, even when you remove the storm, we would've been within our guidance ranges for both revenue and probably higher on EPS without the storm impact.

Our next question today comes from Jonathan Demchick of Morgan Stanley.

So on -- I wanted to follow up on the hurricane impact actually. You gave a lot of detail and that was really helpful. But when you look at the OTT business, it seems like maybe 7 points of growth was perhaps impacted from the hurricane. Can you, perhaps, give a little more context there as it just seems a lot larger than we would've expected? I mean, is a good chunk of this just the private label business? Is that the main thing to be thinking about here? And then also heading into the fourth quarter, I was wondering if you're expecting any catch ups from that heading in?

Yes, Jon. Let's -- I have Glenn walk you through some and then I'll provide some comments. I think you're right, the private label is quite unique in how we actually make it and what we do or don't with stocking. But, Glenn why don't you walk through some of those numbers and we will...

Sure. So the hurricane impact for us in the third quarter was about $7 million; almost all of it was OTT related. And if we look at the components of what happened in the third quarter, $2 million or so was associated with product and private label that did not get off Puerto Rico, in the island. So that was product that we were making progress to shipping out, but just did not get off in the third quarter.

The other $4 million to $5 million is really related to Florida predominantly and the fact we had lost procedures in Orthopedics and Wound Care. And so the $7 million impact in the third quarter is almost entirely OTT related.

Relative to the fourth quarter, the big impact is really going to be on the private label business. If we look at the $8 million or so of revenue there, probably $2 million of it is related to Specialty Surgical and some Specialty Neuro products we make in Puerto Rico, where we have some codes that we're getting low on inventory on. But $6 million or so is really private label and keep in mind, we don't keep inventory of private label products, right? So our private-label partners obviously have safety stock, but we have no inventory -- it's made to order -- and so as we gradually ramp up here in Puerto Rico, it's going to take us time to recover some of the manufacturing relative to the private label part of the business.

Yes, so just to add some more color to that. I mean, private label has been growing nicely as you guys know and we've been focusing in multiple locations, New Jersey as well as Puerto Rico where we have capacity as we've moved products between those 2 locations. And Glenn correctly characterized it, and we've been in contact with our top private label customers. They have all the adequate inventory in their channels to support their customer needs, so we don't see out of stocks for them or patient issues.

But relative to -- they'll be burning down some of their safety stock. So we get an order, we make it, we ship it immediately to them. We don't put it in one of our DCs, that's the point. Hence from a recovery standpoint, we believe the majority of all this private label business will recover in the first half of 2018 as we'll be able to make it and replenish their safety stock.

Relative to the other products, particularly the Florida scenario and Orthopedics, we may get fortunate to pick up some of the cases, but at this point in time we're not counting that those are all going to come back, depending on how things get rescheduled the patients move on to, delay the procedure, all those kind of things. So quite confident in private label and not counting really much of the Florida impact to come back.

Very helpful. And just one quick follow up, I guess, expectations for Codman accretion in '18. Looks like the $0.22 number was moved to $0.25, but I guess, now we're also seeing a channel investments part being broken out. I guess, my sense on prior guidance was that accretion was already digging in some amount of the build out needed. Is it possible to provide a little bit of context there?

So just to be clear, the channel investment we're talking about isn't to do with Specialty Surgical. It's that we're using some of the accretion to actually really address a chronic issue we've had for the last few years, which was to be able to expand our OTT channel and address some of the issues we've had. It's no secret that we've struggled in our lower extremities franchise, ex ankle, to be able to get to the kind of growth that we think we need. This is a move to fund that channel to be able to expand it based on really positive experience we've had in pilot so to speak on our ankle and our shoulder. So that's part of it.

The other side of it then is our inpatient products, which we continue to do quite well on, are all Integra line or PriMatrix line. I would tell you I believe we're still channel constrained on our ability to expand. And so the $0.07 that Glenn referenced is about applying that towards the Orthopedics and the Tissue business to expand it and to drive future growth.

Our next question comes from Matt O'Brien from Piper Jaffray.

This is JP on for Matt. To go back to the dural side. When we left Q2, it seemed the competitor had more inventory, it was competing on price and it was going to be more of a temporary type scenario. But now it sounds like you're signing longer-term contracts. So was it more that you found that the competitor was just that competition on price is here to stay so that kind of forced you into doing some longer-term contracts? So what changed, I guess?

Well, I just think, again, it's a very competitive healthcare market, no matter if it's Dural Repair, or if it's other types of devices. And if you're having a discussion with the customer, two products seem relatively equivalent. We've done some, I think, very good work to show that they're not in some of the studies that we have out there. But we made some decisions to say that, if we have an opportunity to do contracting, give up a little bit of price, still very profitable product for the company and reduce that volatility going forward, it just makes sense. And so that's what we did within the quarter and that resulted in a lower growth rate than we initially projected. But, again, I think to the future, it's going to provide more stability and consistency in that number.

Got it. And then can you just help me reconcile the additional OTT spend? Why wouldn't that for 2018 -- why wouldn't that just be counted in kind of your organic EPS growth? And then just reconciling that with -- you normally when you make a good investment layout -- high investment like that you should expect an acceleration and growth. But you lowered the longer-term growth targets. So can you help kind of fish those 2 out? Is it more of your investing in '18, you're going to see acceleration in '19 and '20 on the OTT side? Or how should we think about that?

Yes, let me -- I'll talk about the broader picture then maybe Glenn, you could tell about how we layout the accretion and then using some of that spend.

Yes, look, first of all, we think about our original 6% to 8% to 5% to 7%, that primarily is aligned with reflecting of the addition of Derma Sciences, the addition of Codman and what that does to the broader mix of the growth. And there is about a point shift that brings us down from an overall growth standpoint. Clearly, within '18, we're adjusting and recommending a 5% for modeling purposes, because in the first half of the year, we're going to be integrating all of the channel. Again, as we've closed Codman for the fourth quarter, we're still running the channel separately, which is a higher SG&A burden and then will be doing some integration in the first quarter and the second quarters of 2018, as well as expanding the OTT channel.

So as I mentioned in the second half of '18, we expect the growth to start to pick up for sure. We hope that way. And then as we go into '19 and '20, we think it definitely sets us up for accelerating growth, most likely into the higher end of that range. So -- but we felt it was prudent just based on the major change with adding Codman into the portfolio, that we adjust how we see our long-term guidance ranges in 5 to 7 points. So Glenn, if you want to add any comments?

Yes, JP, the other thing I would say is relative to the $0.07, this is incremental above and beyond the normal investments we would make within OTT. So it's not just year-over-year up 7, it's incrementally above what we would normally have as an increase for Orthopedics and Tissue. And to your point, we would expect that growth to really start to accelerate into 2019.

Keep in mind for 2018, we still expect to see growth like we put up in the past in the high single, low double-digit range for this part of our business. But if you think about these investments we're going to make in areas where we struggled recently, like lower extremities outside of ankle and the opportunities we see with inpatient skin and continuing to grow that even faster, we think it's necessary to make these types of investments to really position ourselves for long-term growth beyond 2018. But the $0.07 is clearly incremental to the normal investments we would make within this part of our business.

Yes, I would just (encourage) you, I mean, at our Investor Conference on -- in December, we'll plan on giving some more color around how we think about some of the channel investments in both of these businesses.

Our next question today comes from Raj Denhoy of Jefferies.

Wonder if I could come back again, I know it's been hit on a few times, but this change in your outlook for the longer-term growth of the business. If I'm hearing you, it sounds like it's primarily in the Orthopedic Tissue business, the OTT business. I mean, obviously, that's the requirement now for the investment next year to support the growth there. So I'm curious if you could may be give us a bit more in terms of what you're seeing in that business? Is it just that it's harder to get traction? Is it turning more -- out to be more competitive than you thought? Why the sort of a reduced outlook in that business, in particular?

So Raj, it's not at all to do with OTT, it's really to do with plus $300 million of revenue coming in from Codman that's growing in low single digits, that we're going to integrate into our Neuro business and then move those into mid-single-digit growers. And it takes time to that.

We expect OTT to be putting up low double-digit numbers, high single-digit numbers within that area and this investment really assures that we can't, because it's supplementing areas that have not contributed at the level we think they could at the last few years. Inpatient, wounds, still growing very well, in many cases, high single/low double, we think could even do better with more resources. And in the case of lower, where we've actually been down or clearly not to market share, to be able to get our fair share of that market. So it actually is not OTT, it's the triple [SSS] effect and then we're bolstering, so to speak, OTT to be able to outperform in areas that we have not in the past.

Right. So I guess -- so it really as you look at that longer-term -- long-term growth rate, it's just the mix of Codman and other -- it's the Codman revenue coming in. That's how we should think about that.

That's clearly the change of why we're representing 6% to 8% to 5% to 7% is the percentage of revenue now that we have that's growing at low single digits. And we believe over the long run, we'll be able to increase that. But we think that 5% to 7% range is more realistic about how you should think it for modeling over the next few years.

Okay. Fair enough. And then maybe just -- then over the short-term, right, on the Orthopedics and Tissue Technologies business, you didn't give us any updates on Omnigraft, how that's doing. I think you may have just eluded to it with what you're seeing at inpatient wound side. But any updates on Omnigraft and the adoption there?

And then on the SurgiMend products, what is the issue there? Is it again competitive or what is holding up the adoption of that product?

Yes, so Raj, look on the outpatient wound care side, we continue to do well, which is a combination of Omnigraft and also PriMatrix small sizes, as well as the Derma Sciences products that we brought in. And if you remember just a few months ago, we integrated the channels. We have a charnel of about 80 reps, which is still small versus many of our competitors, but we think it's adequate right now and we're on track to over-perform against what we had communicated earlier.

Specifically, about Omnigraft, since we've adjusted our expectations here in the second quarter about how we see it to grow, it's on track to that level of growth; we are picking up new users. We're actually being able to build that out, but more methodically, as we talked about. I would tell you and then we'll talk a little bit more about this in December, our reimbursement strategies are coming along, which is going to be a really important part for Omnigraft to continue to grow.

But now that we have this 3x3 strategy where we have an amniotic and we have 2 other technologies, PriMatrix and Omnigraft, all 3 of them are contributing right now to our overall growth.

And relative to SurgiMend, look, on the hernia side it definitely is competitive, it's the bioabsorbables in the United States. And, again, with our macro porous product that we just recently launched, there's a lot of interest in it because we can hit the price point, but it doesn't have some of the side effects or some of the related issues that you have with synthetics or bioabsorbables. And so we think that's going to take a little bit of time, but in '18 , we're going to see some positive growth coming out of that market.

And on -- in Europe, for the breast market, it's less competitive, it's more of a procedure change that we think we're actually on the front end of and so we're going to start seeing some pickups in this meshed product that is designed to actually help in this new procedure, which is a prepectoral procedure related to breast reconstruction.

Our next question comes from Matt Taylor of Barclays.

This is Ian Mahmud on for Matt. I just had one question for you. I wanted to focus on Derma Sciences, specifically for a bit. I mean, you noted that revenue outperformed your expectations during the quarter; I was just hoping you could maybe dig into that a little bit and provide some more detail on what drove that out-performance? And maybe explain kind of how this is going to factor in as a driver going forward into 4Q in 2018?

Yes, I'll take a crack at this one. So Derma Sciences in the quarter did about $24 million of revenue, which actually was a couple of million dollars better than we thought. Keeping in mind that in the mid-July time frame, we had the entire outpatient team out in the field training the combined portfolio. So the team did quite well in terms of driving both year-over-year growth on a pro forma basis as well as sequential growth, especially when you consider the fact they were out of the field for a week.

And really, what we're seeing is growth in the MEDIHONEY product as well as the amniotic tissue product. And those products are key drivers for us as we look out at Q4 as well as into 2018.

When you look at the overall Derma portfolio, I would say, I'd expect it to grow pretty much in line with the overall corporate average, so whatever your organic growth rates are on the 5% to 7% range is where we would see Derma growing over the long term as we cross sell their products with this channel, now that's got 80 reps and hopefully we'll see that channel go up over time in 2018 and 2019.

The traditional wound care part of the business is a slower growing part of the business. And obviously that's a bit of a drag on growth, but clearly we're looking at that as an area that we could actually do better in as well. But I would say the key growth area is really Advanced Wound Care and MEDIHONEY along with the boot, the total contact cast boot which is doing quite well, as well.

We will now take a question from Jayson Bedford of Raymond James.

Just a few questions. So I'd like to talk about end-market growth and, obviously, I don't want to preempt the investor event. But, I guess, the way we're thinking of your market kind of 4 percentage -- 4%, 5% neurosurgery growth, regenerative medicine kind of 8% to 10%, extremity kind of 8% to 10%, which I think supports maybe a 5% to 7% end-market growth rate. Can you just, one, comment if those numbers are in the ballpark?

I think what you quoted, maybe, that's definitely in the ballpark and to your point, I mean, these are some of the areas that we'll give more detail on in December.

Okay. The 5% organic growth expectation for next year, just to be clear, does that reflect some Puerto Rico spillover?

Yes. It assumes $10 million coming into 2018 for Puerto Rico -- positive.

Puerto Rico recovery that we pick up some in that point in time, which is just the private label shipments that we referenced.

Okay. And then lastly, there was no change to the gross margin target. Given that the Puerto Rico disruption, what's allowing you to hold gross margin in the fourth quarter here? And then should we expect some kind of spillover softness in the first half of '18?

So we ended up doing, I would say, a little bit better on gross margins in the third quarter. When we look at the fourth quarter, we're basically saying, it should be pretty much in line with the third quarter, which basically assumes some improvement in our base business offset by some dilution from Codman, right? So Codman has slightly lower gross margins than our base business.

We think the effects for Puerto Rico will be minimal on gross margins and we have called out about $1 million impact in our special charges in the third quarter associated with that.

As we look out to next year, I would just say my expectation, without giving guidance yet is, we will be down slightly on gross margins just because of the Codman dilution. So having Codman in for the full year will be somewhat dilutive to our gross margins and that would be offset somewhat by improvements in our base business, but looking at 2018, I would just say at a high level probably slightly lower gross margins given the Codman dilution. Having said that, we do expect pretty meaningful EBITDA margin expansion because Codman is accretive to EBITDA margins. And as we look at 2018, that's kind of -- at a high level how we framed out our EPS guidance.

Yes, Jays, what I want to add that some of this is going to be determined on how well our launch is that we are coming out with, have come out, continue to grow. The great part about our base business is most of our recent launches in our core growth products are all accretive to our gross margins. If you think of our ankle being accretive by 5 to 6 points, shoulder same case, Clarity even more than that. And also made in a low-tax jurisdiction in Ireland.

Our inpatient tissue business, the PriMatrix business is growing quite well. And as we get SurgiMend turned around, that will be a very high contributor from a gross margin standpoint. So, again, that's why a lot of focus on those areas. But to Glenn's point, with as much integration as we have going on in the first half '18 for the whole company, we're tempering what we actually think our performance can be in that first half.

(Operator Instructions) We will now take a question from Steven Lichtman of Oppenheimer & Co.

Just as -- the first question relative to International. Can you give us your latest thoughts on the infrastructure that Codman brings and how that could potentially positively impact the core Integra International franchise?. I know in Japan you've highlighted that and how do you factor that into your thinking on growth in '18 and in the long term?

Yes, so good question. I'll comment on the infrastructure first as it relates to kind of the core functions to support the business, meaning customer service, distribution, logistics, warehouse and IT.

We get very little from Codman because it's a carve-out from J&J, right? So we have to set all of that infrastructure up ourselves as it relates to running the business, taking orders, customer service, all those areas. So that's all work we have to do over the next couple of years. As we go through that set up of the infrastructure, we have transition services agreements in place with J&J to help ensure a smooth transition.

When I think about the sales infrastructure, this is the really exciting part of this merger. And I look at the amount of resources we're going to get in Europe as an example, increase our footprint by 50%, but really when I look at Asia Pacific, we more than double the resources there, and if I specifically maybe look at Japan as one specific market, if you look at our resources today in Japan, it's about 11 people. Codman brings in more than 60. Now we can take this combined organization of 70-plus commercial reps directly in Japan, a very large market, and we'll be launching meaningful new product launches in the end of the 2018. So DuraGen, CUSA Clarity and we can put those new product launches through this very large channel and go direct.

That's really where the infrastructure's going to benefit us on the commercial side as an example. But outside of the selling commercial resources areas, Steve, we get very little infrastructure in the other areas that I mentioned.

Yes, Steve, the only thing I would add, I think Glenn hit it all, just I mean, again, this is why we're so excited about Codman. Just on neurosurgery, 40% to 50% more reps worldwide now all selling Dural Repair, now all selling CUSA, now all selling Mayfield, now all selling Hydrocephalus. So big impact potential once integrated and what that means for growth over the next 3 years.

And then for OTT, there will be markets such as a Japan and really in Western Europe where we couldn't contemplate taking some of our legacy products in our tissue side and going direct, or really being able to support them because we didn't have the right structure, we'd outrun our supply lines. And that will change because of the structure we are putting in place with Codman.

And just a last point on our infrastructure, Steve. So once we actually build out the infrastructure needed to support this business, keep in mind, we can leverage that infrastructure across the other part of our business in Orthopedics and Tissue. So that same infrastructure can be a leveraged down the road and we see a lot of benefits in that as well.

And then just on Dural Repair, you had talked about in the second quarter that perhaps contracting would be one way to kind of fight back on some of the pricing pressure and you executed on some of that. Is there -- as part of these new contracts are there more volume tied with that over time or is really the benefit, just sort of the line of sight visibility that you get?

Well, ultimately it's more volume, Steve, and the way some of these work is they're multiproduct and if they're multiproduct, they're about volumes, discounts based on an aggregate buy. So if you only bought 70% of these, you only get certain price. If you bought 95%, you get more, that's pretty typical. That's the majority of them.

And in some cases, we haven't had those included in the contracts, which allowed us to have a little more flexibility on how we may think about price or SKUs. And so in this case, we've opted to bring more those in. And again, it takes price away in the near term and actually gives you more consistency and actually even some potential price over the long run if you're locked in. So that's how we've looked at it and again, we obviously, would have likely been able to kind of hit the number but I think being able to actually take the hit now and be able to lock some of these contracts in was the smart move for us to do.

Thank you. So thanks, operator, and everyone, thanks for all of your time and attention. I know it's been a busy week and month. And we hopefully will see many of you in December in New York City. We'll be putting out some more details on that, but that will be December 11 in New York, and we plan on giving more details, particularly, on some of our strategic overviews of both of the businesses. So more insights into these product synergies and geographical opportunities as well as how we see some of the outer years, taking shape strategically for us.

So again thanks for your time and that concludes our call. Thank you very much.

Thank you.

That will conclude today's conference call. Thank you for your participation, ladies and gentlemen. You may now disconnect.