Integra Lifesciences Holdings Corp (IART) 2002 Q2 法說會逐字稿

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Good morning ladies and gentlemen, and welcome to the Integra LifeSciences quarter two earnings release. At this time, all participants have been placed on a listen-only mode, and the floor will be open for your questions and comments following the presentation.

It is now my pleasure to hand the floor over to your host, Mr. Stuart Essig. Sir, the floor is yours.

Thank you. Good morning everybody, and I thank you for joining us for the Integra LifeSciences conference call. I'm Stuart Essig, President and Chief Executive Officer of Integra LifeSciences Holdings Corporation. Joining me today are David Holtz, Senior Vice President of Finance, and Jack Henneman, our Senior Vice President and Chief Administrative Officer.

During this call, we will discuss our financial results for the second quarter of 2002, and update our forward-looking guidance for 2002 and 2003 for the expected impacts of our acquisition of and the NeuroSciences Division of NMT Medical, the details of which were announced in a press release issued last evening. There will be a question and answer session following this call that can be heard by all participants; however, only those participants listening via telephonic access will be able to answer--to ask questions.

Before we begin, Jack Henneman will make some remarks regarding the content of this conference call.

This presentation is open to the general public, and can be heard through telephone access or via live Webcast. I replay of the conference call will be accessible starting one hour following the live event. Access to the replay is available through August 16th, 2002, by dialing (973) 341-3080, or through the Webcast, accessible on our home page. Today's call is a proprietary presentation of Integra LifeSciences Holdings Corporation, and is being recorded by Integra. No recording, reproduction, transmission or distribution of today's presentation is permitted without Integra's consent.

Because the content of this call is time sensitive, the information provided is accurate only as of the date of this live broadcast, August 2nd, 2002. Unless other wise posted or announced by Integra, the information in this call should not be relied upon beyond August 16th, 2002, the last day that an archived replay of the call authorized by Integra will be available.

Certain statements made during this call are forward-looking within the meaning of the Private Securities Litigation Act of 1995. Among others, statements concerning management's expectations of future financial results, new product launches and market acceptance of these new products, future product development, programs and potential business acquisitions are forward-looking. Forward-looking statements involve risks and uncertainties that can cause actual results to differ materially from predicted results. For discussion of such risks and uncertainties, please refer to the information set forth under Risk Factors, included in the business section of Integra's annual report on Form 10-K for the year ended December 31st, 2001, and information contained in subsequent filings with the Securities and Exchange Commission. These forward-looking statements are made based on our current expectations, and we undertake no duty to update information provided during this call.

Thank you, Jack.

Integra develops, manufactures and markets medical devices, implants and biomaterials primarily for use in neurosurgery, orthopedic and soft-tissue repair. Our business is divided into two divisions; Integra NeuroSciences, which is a leading provider of implants, devices and monitors used in neurosurgery, neuro trauma and related critical care, and Integra LifeSciences, which develops and manufactures a variety of medical products and devices, including products based upon our tissue--proprietary tissue-regeneration technology, which is used to treat soft-tissue and orthopedic conditions.

In the second quarter of 2002, we reported record revenues of $26.4 million, and net income of .14 per share. Revenue growth was led by a $3.3 million increase in our product sales, to $24.7 million, a 16 percent increase over the prior year quarter. Our earnings of .14 per share were a penny above our previous guidance, and the analysts' consensus estimate. Product sales growth was primarily related to a $3 million increase of Integra NeuroSciences Division product sales, and 18 percent increase over the second quarter of 2001. This increase reflected $1.4 million of products acquired since the end of the second quarter of 2001, and continued strength in the DuraGen product line.

Other revenues for the second quarter of 2002 included a $500,000 payment from the Ethicon division of Johnson & Johnson for the achievement of a clinical and regulatory objective for INTEGRA Dermal Regeneration Template, related to the expanded indications for the product that were received for during this quarter. This is the second payment received this year.

Consolidated gross margin on product sales improved by one percentage point to 62 percent in the second quarter of 2002, which is ahead of our previously stated target of 60 percent for the full year of 2002, and 3 percentage points better than the 59 percent reported for the full year 2001. The improvement in gross margin in the second quarter of 2002 reflects an improved sales mix of higher margin products as compared to the second quarter of 2001, and increased direct sales in Europe. Additionally, lower sales of certain capital equipment products had a favorable impact on gross margins for the quarter.

Other revenue, which consists of development funding from strategic partners and government grants, royalty income, and license and distribution revenues increased by 200,000 for the prior year quarter, to 1.7 million in the second quarter of 2002. Consolidated total other operating expenses, which exclude cost of product sales, but include amortization, increased $330,000 to $11.5 million in the second quarter of 2002, as compared to $11.2 million in the second quarter of 2001. Sales and marketing expenses, which increased 660,000, to $5.9 million, decreased to 24 percent of product sales in the second quarter of 2002, as compared to 25 percent in the second quarter of 2001. To date, we have increased the number of neuro-specialists in our domestic sales force to 57, which puts us on track to meet our goal of reaching a total of 63 neuro-specialists in 2002.

Research and Development expenses increased $235,000 to $2.1 million in the second quarter of 2002, primarily as a result of increased product development activities in the Integra NeuroSciences Division, while General Administrative expenses decreased $200,000 to $3.1 million in the quarter. The $365,000 decrease in amortization expense in the second quarter of 2002 was related to the full adoption of FASB Statement 142 in January. Under FASB Statement 142, goodwill is no longer amortized, but is subject to annual impairment review, which the Company completed in the second quarter of 2002.

I will now turn the presentation over to David Holtz, our Senior Vice President of Finance, who will provide more information regarding divisional financial results, income taxes, and earnings per share.

Thank you, Stuart.

On a divisional basis, revenues and profitability in both the Integra NeuroSciences and Integra LifeSciences Divisions increased in the second quarter of 2002. Sales in the Integra NeuroSciences Division drove the top-line growth with a $3 million increase in the sales to 20.1 million, an 18 percent increase over the second quarter of 2001. The $3 million in product sales increase included 1.4 million in sales of products acquired since the end of the second quarter of 2001.

International distributor sales for the quarter were below our expectations, particularly in Japan and China--and Argentina, and sales of capital equipment, including both Camino's intracranial pressure monitors and Selector Ultrasonic Aspirators decreased in both the U.S. and international markets; however, we continue to make progress in the market launch of our recently approved products. Sales of our NeuraGen Nerve Guide exceeded our expectations this quarter, and since the launch of our LICOX system in the U.S., we have sold 73 monitors in 43 hospital accounts, and placed an additional monitors for evaluation in 49 hospitals. Like our other capital products, LICOX monitor sales were below expectations in the second quarter, but sales of LICOX disposables increased by approximately 25 percent sequentially over the first quarter of 2002. To date, we have sold more than 1300 LICOX disposable systems, including the recently launched Catheter.

Sales or our Neuro Intensive Care Unit products increased $100,000 to 7 million in the second quarter of 2002, and Neuro Operating Room product sales increased 1.5 million to 10.6 million, led by increased sales of our DuraGen Dural Graft Matrix product. The $1.4 million increase in other NeuroScience products, to 2.5 million, was related to acquired product sales. The $250,000 decrease in other revenues was a result of decreased royalty revenues from an agreement that expired in 2001.

Gross margin on product sales for the NeuroSciences Division was consistent at 64 percent of product sales in both the second quarter of 2002 and 2001. As a result--as the effect of our increased direct sales in Europe and lower sales of certain capital equipment products was offset by lower gross margins from our Integra business.

Total other operating expenses in the Integra NeuroSciences Division increased 900,000 to 7.6 million in the second quarter of 2002, a $900,000 increase in Sales and Marketing expense, to 5.7 million was related to the continued expansion of our Integra NeuroSciences sales force. Sales and Marketing expenses remained consistent at approximately 28 ½ percent of product sales in both the second quarter of 2002 and 2001.

A $230,000 increase in Research and Development expense to 940,000 was offset by a $220,000 decrease in general administrative expenses to 940,000 in the second quarter of 2002. The Integra NeuroSciences Division reported an operating profit of 5.3 million for the second quarter of 2002. This compares to an operating profit of 4.5 million in the second quarter of 2001.

The Integra LifeSciences Division reported an operating profit of 2.6 million in the second quarter of 2002 on product sales of 4.6 million, and other revenue of 1.7 million. This compared to an operating profit of 1.4 million in the second quarter of 2001, on 4.3 million of product sales, and 1.3 million of other revenues.

Sales of tissue repair products increased $500,000 to 2.3 million, a 27 percent increase over the second quarter of 2001. This increase was primarily related to increased sales to of our Absorbable Collagen Sponges that are used as a component in Medtronic's recently approved bone graft. Sales of other medical devices decreased 200,000 to 2.3 million.

Gross margin on product sales in the LifeSciences Division increase 2 percentage points to 51 percent in the second quarter, primarily as a result of increased sales of higher-margin products.

Total other operating expenses in the Integra LifeSciences Division decrease 440,000 to 1.5 million. Sales and marketing expenses decrease 230,000 in the second quarter of 2002 to 190,000. General Administrative expenses decreased 210,000 to 170,000 in the second quarter of 2002, and Research and Development expense were flat at 1.1 million in both the second quarter of 2002 and 2001. Integra's combined divisional operating results of 7.9 million excludes amortization of intangible assets and corporate, general and administrative costs. Corporate, general and administrative costs increased 235,000 in the second quarter of 2002, to $2 million, primarily related to spending on the appeal of the judgment in our favor in the litigation with Merck, and increases in the Company's various insurance policies. Amortization expense decreased 365,000 in the second quarter of 2002, to 64,000 as a result of the full adoption of FASB Statement 142 in January. As of June 30, we had cash and investments of approximately 139 million, and we reported net interest increase for the quarter of $1 million. Given the current low interest-rate environment and the use of 8.2 million in cash for the two recent acquisitions, we expect net interest increase to approximate $900,000 per quarter through the balance of 2002. We generated 6.8 million of operating cash flow for the second quarter of 2002, and 6.7 million of earnings before interest, taxes, depreciation and amortization.

Our effective tax rate increased from 13 percent in the second quarter of 2001 to 35 percent in the second quarter of 2002. The effective tax rate for the second quarter of 2001 reflects the utilization of the Company's net operating loss carry-forwards during the period. In the fourth quarter of 2001 the Company reversed a portion of the valuation allowance recorded against the deferred tax assets related to these net operating loss carry-forwards, which is expected to result in an ongoing effective tax rate of 35 percent.

The Company's actual cash tax rate is expected to be in the 6 to 8 percent range in 2002. Given the Company's continuing sustained profitability, the Company may again be required to reverse a portion of the valuation allowance recorded against the deferred tax assets, relating to its net operating loss carry-forwards. The Company is currently assessing the impact, if any, that the recent acquisitions will have on our effective and actual tax rates.

The weighted average common shares outstanding, used for the calculation of diluted earnings per share in the second quarter of 2002, was approximately 3.8 million. On April 16th in 2002, all of the holders of the Series-C Preferred Stock converted their shares into 600,000 shares of Common Stock. The non-cash preferred stock dividends deducted from net income to compute earnings per share was $24,000 this quarter, reflecting the non-tax dividends attributable to the Series-C Convertible Preferred Stock for the period before conversion.

I would also like to highlight Integra's cash earnings per share, which is computed by adding back amortization and deferred income taxes to our reported diluted earnings per share. Cash earnings per share for the second quarter of 2002 is .21 per share, as compared to .13 per share in the second quarter of 2001.

And now, I will turn the presentation back over to Stuart.

Thank you, David. As I stated on previous calls, our management team is constantly seeking out external opportunities for growth, and any such opportunities that we come consummate would affect our results going forward. I would now like to discuss briefly each of the two acquisitions we recently completed.

In July, we acquired the assets of , a specialty contract manufacturer of titanium and stainless-steel implants for the neuro-surgical and spinal markets, and certain other intellectual property assets, for $2.8 million in cash, paid at the closing, and certain other considerations to be paid upon the release of new products to be sold through the Integra NeuroSciences sales force. The company, based in , Massachusetts, has been renamed , effective immediately. Michael , Founder and President of , will serve as General Manager of . The company and its 20 employees will continue to manufacture and distribute its products from its Massachusetts facility. will continue its contract manufacturing relationships while developing its own line of products to be sold by Integra NeuroSciences sales force. The acquired product lines generated approximately $3.2 million in sales during the year ended December 31, 2001, primarily from the manufacture of cranial fixation systems for sale under our contract manufacturing agreement. For modeling purposes, we expect that ongoing sales from existing relationships will be approximately $2.5 million per year. Following the acquisition, the financial result of the will be included in the Integra LifeSciences segment until its products are sold by our Integra NeuroSciences sales force. We expect to offset the positive operating profit impact of the acquisition with the increased development in marketing spending as we develop our own line of metal implants to be sold by the Integra NeuroSciences sales force.

This week, we also acquired the NeuroSciences Division from NMT Medical, for $5.4 million in cash. Through this acquisition we had a range of leading differential pressure valves, including Orbis-Sigma, Hakim and , and external ventricular drainage products to our Neurosurgical product line. The acquired product lines generated sales of approximately $12.7 million for the 12 months ended June 30th, 2002. The acquired operations include a facility located in , France, that manufactures, packages, and distributes shunting, catheters and drainage products, and a distribution facility located in Atlanta. The plant will become an important part of Integra's Continental European distribution activities, and the Atlanta operations will be consolidated into our , New Jersey National Distribution Center.

Integra will combine NMT NeuroScience's five direct European sales representatives with its growing Direct Sales team, and will be transitioning sales of the acquired products to our own Direct Sales organization in the United States.

In international markets, where both Integra and NMT sell through distributors, we will be evaluating these competing distributors with an eye toward improving international results in these product segments. As we look to rationalize the combined businesses over the next several months, we will be reviewing the potential elimination of redundant or under-performing product lines of both Integra and NMT. We estimate that the net effect of the acquisition and the product rationalization will be to increase product sales by approximately $2 ½ million per quarter. As we plan to continue building our European infrastructure through the NMT acquisition, the impact of the transaction, excluding special charges, is expected to reduce earnings per share by one cent per share in 2002, and be accretive to earnings thereafter. It is a top priority of our management team to complete significant and accretive transactions this year and next, and to double our revenue base in the next 18 months through internal growth and our acquisition strategy. These two acquisitions bring us only part of the way to that objective. The forward-looking guidance that we have provided does not reflect growth from any such future business acquisition or additional strategic partnerships.

We expect sales of existing Integra products not affected by the product line rationalization to increase by approximately 18 percent per annum through 2003. Other revenues, which include research grants and other development funding, royalties and distribution and licensing fees are expected to be $1.1 million in this third quarter, falling gradually to $800,000 per quarter for 2003. In addition to these quarterly amounts, we may also earn additional one-time event payments upon the achievement of certain clinical and regulatory objectives for INTEGRA Dermal Regeneration Templates and certain of our other Integra LifeSciences products.

Gross margins for the third quarter of 2002 are expected to be adversely affected by the planned rationalization of our product lines, and by inventory fair-market value adjustment to be recorded in connection with the acquisition. After giving effect to these items and the lower gross margins associated with the recently acquired product lines, we expect consolidated gross margin to approximate 60 percent for the remainder of 2002, and 62 percent for the full year 2003. Accordingly, excluding certain anticipated special charges, associated with the recent acquisition, such as personnel and transition-related costs, 2002 earnings are expected to be within a range of .55 to .56 per share, while 2003 earnings are expected to be within a range of .72 to .75 per share. Third quarter 2002 earnings are expected to be .13 per share, excluding any special charges.

I would like to remind everyone that I will be presenting at the Adams, Harkness & Hill Summer Seminar Conference in Boston at 11:00 a.m. next Tuesday, August the 6th. You can listen to the live presentation or a replay via Webcast that can be accessed from the Investor Relations section of our website.

This concludes our prepared remarks. I will be happy to answer all of your questions. Operator, you may turn the call over to our participants.

Thank you. The floor is now open for questions. If you have a question, or a comment, you may press the numbers one, followed by four on your touchtone telephone at this time. If at any point your question has been answered, you may remove yourself from the queue by pressing the pound key. And we do ask all participants to please pick up their handsets while posing their questions.

Your first question is coming from Dave Turkaly of CIBC World Markets. Please state your question.

Good morning guys. Stuart, in terms of the--in the pipeline, specifically from the metallic implants you think these guys can develop, can you comment on, just give us the update on, kind of your internal product pipeline, and then when you think some of these products might become available?

Sure Dave, thanks. First of all, as it relates to , this deal for , I feel is sort of a classic Integra deal, which is, we buy a profitable stand-alone business, in this case a contract manufacturer, with some core competencies, metallic implants in their case, a well-established quality system, they've manufactured for a number of the large orthopedic companies, and we put into place the ability to bring the bottom line through by putting a little bit more of investment into it in product development. So we have something with very positive operating profit, and offset that with the product development program.

In particular, as you know, we've been looking to enhance our sales organization with a line of cranial plates and screws. All of our competitors have that, and we've not, in the past, been able to acquire or develop that. So by acquiring this company, we now have the capacity to manufacture those types of products, we have acquired the intellectual property around this area, which gives us the basis for product development projects, and we've acquired prototypes of . We will now be working with Product Development and with outside neurosurgeons to develop a product, and we would expect to be able to launch such a product in about two years, in the second half of 2004. And we're really excited about this, it is right up our sales force's strike zone, it is exactly the kind of product they've been looking for us to acquire or develop. Also, we developed the capability to manufacture certain spinal products, and as you know, we've been looking to acquire some niche products in the spinal area to the extent that neurosurgeons do the procedures. So our first swing will be at the cranial area, but through our acquisition strategy as well as now through some internal product development, we'll have the opportunity to use our neuro-surgical sales force to get access to the very fast growing spine market. So that's the strategy behind the acquisition.

Now, in terms of our pipeline, let me talk about some of what's there, and what's in our goals. First of all, as you know, Medtronic received approval for its BMP product in early July, so we're looking to work very closely with and them toward that launch, which as begun, as well as toward additional product development in that area, and we've got a lot of opportunities there. We expect to launch in August our low-cost Neuro Monitor for O.U.S., as you know, one of the opportunities we've had and have not been able to capitalize on, is to grow Camino outside the United States where there is a lack of a willingness to spend the $8 or $9,000 for the monitor that we sell the monitor for in the U.S., and so we have a low-cost monitor which we'll sell for under $3,000 outside the United States, which we think will give us a big opportunity to grow our O.U.S. Camino business.

This quarter, the first of the Integra artificial skin Dermal Regeneration Template trials will begin with J&J, and that will start in the middle of this quarter, and we will begin the process of trying to get even greater expanded indications and marketing capabilities for Integra. We would hope, by the end of either the third or fourth quarter to hear the final BMP approval for bone for , and then, into the new year--excuse me, by the end of the fourth quarter, we hope to have our mark on NeuraGen and launch that into Europe. And hopefully, I 'd say this one slipped a little bit, hopefully a filing for our--one of our tyrosine products with the FDA by the end of this year, although I think that one has slipping. We hope to have expanded indications for our Selector Ultrasonic Aspirator in the United States either this year or early into next, and then as we look toward 2003, 2004, approval for Integra Artificial Skin in Japan. We don't have a timeline for approval of DuraGen yet in Japan, and then, in addition, the beginning of chronic wound trials for the INTEGRA Dermal Regeneration Template, the next generation Neuro Monitor, the new Ultrasonic Aspirator, which combines the benefits of both our Selector device, our Dissectron device and some new developments, additional products for our NeuraGen product line, and hopefully, the introduction of an advanced Hydrocephalus Valve, although I think the technology we've acquired here with NMT is a step up in technology from what we have had inside of Integra in the past.

So I hope that wasn't too long of an answer.

No, that's fine. I know there's a lot of people online, I'll just ask one more. I didn't catch your breakout for Neuro Operating Room and ICU, could you just tell me what that was again, and then I'll jump back.

Yeah, for the second quarter, we came in at just under 7.0 million on Neuro ICU, and 10.6 million on Neuro OR, and 2.5 million on other Neuro, for a total of just over 20 million on Neuro.

Thanks a lot.

Thank you. The next question is coming from Ryan of Adams, Harkness & Hill. Please state your question.

Hi guys, good morning.

Hi Ryan, how are you?

Oh, fine. Just a few questions, first, can you walk through the Neuro business as far as DuraGen, as far as the reorder rate, the number of accounts, from a positive perspective, and then NeuraGen as well, and then walk through LICOX, Selector and Camino, why capital equipment Neuro sales were maybe a little weaker than expected, as well as international Neuro sales, from the distribution standpoint? So can you just give us a little bit more detail throughout your entire Neuro business?

Sure, Ryan. First of all, let me go through it, just by the segment, and then also talk about the new products in the segments. First of all, in the Neuro OR, we were very pleased with the DuraGen performance, up sequentially, quite substantially, as well as year-to-year, quite substantially. As you know, we don't break out any of our OR product lines specifically, but DuraGen was up quite substantially both from prior year and quarter-to-quarter. So that strong growth--and NeuraGen, we exceeded our objective in NeuraGen; as you know, we guided people to roughly half a million dollars for the year for NeuraGen, and we're certainly on track based on the second quarter performance. NeuraGen, as you recall, was launched in the fourth quarter of 2001. To date with NeuraGen, we've had approximately 75 to 80 surgeons use NeuraGen as an implant for peripheral nerve repair, and that was through the end of June. We have roughly 50 accounts, 50 hospital accounts outstanding, and just by way of an example, we have an orthopedic hand surgeon who has used NeuraGen successfully in over 12 cases in the last four months. And so our feedback from the field is quite good, for NeuraGen was submitted on May 3rd, and we expect approval, as I say, hopefully in this quarter or the fourth quarter. Actually, without going into the numbers for this quarter, July was as awesome quarter for NeuraGen, so we're real happy with how--not quarter, excuse me, an awesome month for NeuraGen, so we're real happy with the progress on NeuraGen.

Neurosurgical Systems, the Ultrasonic Aspirator, was a disappointment. Disposables were quite good, but we did not sell as many systems either domestically or internationally as we would have liked to, and that seems to be, or as this quarter has been a seam in our business, is that capital was not as strong as we had hoped, and as we said in the opening statement, that was true for Selector, Camino and LICOX, and even though capital is under 10 percent of our total revenues, it nonetheless did impact our numbers this quarter. And so Selector was roughly flat from prior year, and we had anticipated selling more systems, which would have made it grow from prior year quarter. The rest of the Neuro OR line, again, was roughly where we expected it to--I'll make a comment that our instrument sales, which we view as sort of a mix of capital and disposables, but our instrument sales were not as strong as we had expected them to be as well, and again, it seems to be a reflection, at least in the second quarter, of some conservatism in U.S. hospitals on capital, as well as international capital.

The Neuro Intensive Care line, let me go back to that--$7 million roughly. Our Drainage and Cranial Access Systems was up sequentially, as well as year-to-year, but Camino--or sorry, ICP Monitoring, was not up, it was actually down slightly, and so even though we had a strong LICOX quarter, that was offset by weakness in sales of, in particular, our MPM Monitors, which had been very strong in the last several quarters, and disappointed us this quarter. So again, LICOX was strong, and--let's see, I had some LICOX statistics, although we went over them in the script, to date, we've sold 73 LICOX Monitors in roughly 43 hospital accounts, and that was up from 60 monitors at the end of the first quarter. So in the last four months, we've sold roughly 13 or 14 LICOX Monitors, which is less than we would have anticipated. I'd say the very positive news on LICOX is sequentially, from this first quarter, we were up--Dave, what was it, 25, 20 percent? Sequentially ...

Twenty-five percent.

Twenty-five percent sequentially, in our disposable sales, so I am very pleased with the acceptance of LICOX in the market, although the capital cycle has been longer than we had guided people toward, or anticipated. We have sold 100--sorry, 1,300 LICOX disposable systems, including just under 100 of our new catheters, so remember, our strategy on LICOX is to sell the monitors, and we think that's still an important strategy as opposed to just giving away the monitors and getting the disposable stream. So--and then, the other Neuro line performed as we had expected; our NeuroSupplies business actually had a record quarter in its history, since both our acquisition and prior to our acquisition.

Okay, and then, on as far as DuraGen reorder rates still over 85 percent, and the number of accounts maybe up to 12 to 1300, is that fair?

You know, we didn't check the number of accounts, but it's certainly up. We had--I have in my notes here 1100 accounts, so that's the same as last quarter, and I honestly don't know if we--we probably added 50. I doubt is was 100 or 200, but I--you know, we've kind of got a lot of accounts at this point, but I'd be surprised if it wasn't 50 to 100.

Okay, and then two other quick questions ...

And the reorder rate is again, I would say, unchanged; there's no change at all in the tone for DuraGen, which is extremely positive.

Okay. And then, how is J&J Ethicon doing with your Dermal Regeneration Templates, and the new indications first, and then secondly, what is the importance of the Orbis-Sigma Valve, as far as from a technological differentiation, in comparison to the competition with what you acquired from NMT? How does that ...

Okay, first ...

... to better compete?

Yeah, first, on our LifeSciences business, let me underscore, 27 percent growth, year-to-year, on our Tissue Repair business, and that was straight, both our skin products, and the orthopedic products to and , so we're real pleased with the growth of our Tissue Repair business; on the other hand, the other medical business continues to be somewhat soft, although we--or not somewhat soft, soft, but we expect that to improve in the second half of the year as well. In terms of skin, the--it's really too early to get the benefit of the Plastic and Reconstructive, honestly. Their performance this quarter was up quite significantly just based on the additional reps that they have selling the product, and a lot of what the additional reps are getting are burn sales. We actually just had our quarterly meeting with J&J, and are quite excited about Plastic and Recon, and the number of Plastic and Recon cases are up significantly, but actually the big bulk of what they've gotten from Q1 to Q2 is just from having trained the additional--I think it's roughly 20 or 30 sales reps in their Hemostasis sales force, so I'm still quite optimistic that as they roll out this plastic indication, we'll get additional improvement over what we got in the second quarter. But the field feedback on Plastic is quite good, and you know they gave examples of some of their reps being able to also bring in burn business for the existing Sales Managers. Due to a lot of promotional activity around Plastic and Recon, their symposium coming up in this third quarter, and I'm quite enthusiastic about the opportunity for Skin there.

Did I answer your question, or was there one more in there?

No, just the Orbis- ...

Oh, yeah, yeah. Okay, Orbis-Sigma, as you recall, our Hydrocephalus line, we were probably number four in the market, it's one of the few places we're not number one or number two in the segments of the Neuro market that we're calling on, and Heyer-Schulte was roughly number four in the market, with a focus on low-end valves. An Orbis-Sigma valve is a much higher-tech valve, and in fact, the Orbis-Sigma valve was the first valve to be able to manage hydrocephalus through flow regulation, rather than what's know as conventional differential pressure regulation. What's the significance of that? It actually adjusts automatically to the patient's condition, and it eliminates the need for surgeons to intervene to change the pressure range. Frankly, it also eliminates the need for programming, so it does give us an opportunity to compete with the programmable valves that Systems of Medtronic's-- , sorry, of Medtronic's, and sell. It is a higher-tech valve, it's a self-regulating valve, and it gives us the opportunity to answer some more complex demands from neurosurgeons in hydrocephalus. That being said, there's still no question the trend in the market is toward programmable valves, and it's still one of our objectives to either acquire or bring in for our reps a programmable valve, but this does give us the opportunity in particular in the U.S. to compete at a much higher price point than we compete with some of our other valves.

Sounds good. Thanks a lot.

Thank you. Our next question is coming from of . Please state your question.

Good morning, and two things: First, congratulations on the quarter, and the acquisitions.

Thank you, Chris.

Two things, quite different, first, a follow up on the Skin, with the Plastic and Recon growth starting to accelerate, it sounds like, have you started production of a number of different sizes, and perhaps small sizes, or are you waiting for the completion of the other indications on that? And secondly, switching to , are there current products that you will convert into the Manufacturing, and what types of products do you expect to acquire that would be manufactured by ?

Okay, first question, Integra Skin: Under our arrangement with J&J, we don't talk much about our pipeline in Skin, but you are right to address the fact that as we move into Plastic indications, and even further, into chronic wounds, we do need to identify and develop small sizes, and that is in the product map for Integra Skin, and there are developments underway. There's also developments underway to get Integra Skin out of alcohol, and into a different type of delivery mechanism, and the advantage of that is that you move from a hospital-based practice into either alternate care or office-based practice, there's a less of a willingness to rinse the Integra alcohol and implant the product, so we have a number of product development activities underway, and you've put your finger on at least one of them, and you know those we expect in the pipeline, absolutely. In terms of , first of all, we intend to continue the contract manufacturing operations, and we will be aggressively looking for other companies who can manufacture metal implants for. We have a very high variable gross margin at , so the ability to bring in additional work and provide that additional support will be important--well, will be very positive in terms of improving and growing that business. There is also the opportunity to manufacture for Integra, and one of the key things that we will be looking at in the new year is to bring in from some of our outside vendors who manufacture, for example, things like bolts and drill bits, and the disposable metal components of our Camino and LICOX products, there is an opportunity to bring that in-house to , and to substantially reduce costs. So, none of that is really built into our projections, but we do see a big opportunity, as we have done to some extent with our silicone manufacturing down in Puerto Rico, we do see the ability to leverage some of the other plants gross margins by reducing the costs of some of our .

All right. Then on the, kind of the quest for new products that could be maybe manufactured by , is that part of the acquisition road map?

Yes, and one of the things we've said is that we have a strong interest in getting into spine, and and the people at have had a great deal of experience in developing and manufacturing spinal implants. Let me be careful here, we don't want to become a full spine company, that's not our objective. We would like to manufacture some of the implants in the spines that neurosurgeons use, the most obvious of which would be plate.

Good clarification. Super, thank you.

Thank you, the next question is coming from Bill at First Albany. Please state your question.

Actually, my question has just been answered, thanks a lot, Stuart.

Hi Bill. Bye Bill.

Thank you. The next question is coming from Chris of W.R. Hambrecht. Please state your question.

Good morning, guys.

Hi Chris.

Hello. Quick question for you. Could you give us a sense of the U.S./O.U.S. revenue mix for the rest of the year, and possibly next year, as well as the contributions that these two acquisitions might make to that? And then, lastly, with the European operations from these two acquisitions, will you do anything more than just roll them into the existing infrastructure, from a sales and manufacturing standpoint, and consolidate? Meaning, does it change your sort of, your business strategy for Europe at all going forward?

Okay, on current U.S./O.U.S. mix, it has been about 80/20. I'll reserve the specific details for our Q, because I just don't have them in front of me to be honest. As it relates to the acquisitions, is all U.S., because we're just providing OEM now. Our customers may sell it outside the U.S., but it will all be reported as U.S.. The NMT acquisition is roughly 50 percent U.S., and 50 percent O.U.S., so it does extend our outside the U.S. exposure, which is one of our objectives, and in fact, its strongest O.U.S. positions are in France and Germany. We will have a great opportunity to take advantage of the French infrastructure that plant has. By way of example, our estimate for market share in France of the Orbis-Sigma valve is roughly 30 percent of the market in France. There's no place else in our Hydrocephalus business currently that we have such a large market share with the possible exception of Heyer-Schulte in Japan. So we have a big opportunity to capitalize on this French operation, and the sales force that we've acquired, and that we've been building, we're getting very close to being at critical mass in France and Germany. We'll have our sales meeting in September, of all our new reps, plus our current reps, and I think, you know, part of this whole strategy was to acquire a number of businesses in France, Germany and England, so that we could have an integrated and more successful European infrastructure. We're seeing it to some extent in Germany and acquired a number of product lines, including LICOX in Germany, and having a direct sales force, we're starting to see the benefit it DuraGen really taking off in Germany, which when we were going through distributors, was not happening. We will be reorganizing the European business; there's an opportunity to take cost out, more importantly, there are some opportunities to invest in Europe, and to greater utilize this plant we've just acquired. The plant is a magnificent plant; it was built by several--quite a few years ago. It is by far and away the most modern plant that Integra has, with the possible exception of our Collagen Manufacturing Plant, and so we see a great potential to add products in there, and take advantage of what is a very professional local organization.

Similarly, it is very important to be on the ground in the continent of Europe, and so having a French customer service capability and French distribution capability is going to, again, just make us a more European, and a more local company.

Great. Okay, one ...

Oh, oh, you asked about--could you re-ask the question on the numbers? I didn't quite get the question you were asking on the acquisition numbers.

Oh, well just--I think actually you took care of that with the contribution ...

Okay.

From a revenue standpoint from those two overseas. One other question on the sales force side: For the existing spot that you have yet to remain filled--or it remains unfilled, are those currently just open territories, or are other reps kind of doubling down for those?

No, the strategy has been, we don't leave open territories. If there is a territory that doesn't have a permanent, newly hired rep in it, there is a existing rep who is both serving those customers and being compensated. That's one of the ways we bridge the growth in our sales force, and not lost any significant reps, is because what we've been able to do is compensate them until we bring in a new rep, on both their old territory and their new territory. By the way, the 57 reps that we have actually underestimates the number of new reps we've hired, because as the organization gets bigger, we do terminate and we do lose people, and so we've actually added more reps than the 57 would indicate, because we have territories that are currently not filled, because we've lost reps. We've either terminated them or they've left. So we've gone a long way to filling the 19 open territories we created at the beginning of the year.

Okay, great. Thanks for the .

Thank you. Our next question is coming from Alex Arrow of Ladenburg Thalmann. Please state your question.

Thanks. Good morning, Stuart.

Hey Alex.

Congratulations on the acquisitions.

Thanks.

First, on your NMT acquisition, you mentioned that the $3 million per quarter run-rate is going to result in a $2.5 million addition to your existing business because of some redundant lines that are being discontinued, or that you plan to discontinue. My question is, of you're discontinuing redundant lines, wouldn't you regain those sales, since the physicians ordering these products would presumably then order more of the new consolidated product line? I'm not--I can't quite grasp the concept of why .5 million per quarter would go away, because you're--just because you're discontinuing redundant product lines.

Okay, there's a couple of parts to that. First, the NMT revenue base that we're acquiring has been shrinking at about 5 percent a year. That was in line with what happened when we acquired--or what was happening when we acquired the Selector line. It took a while to turn the Selector line around, and you know one of our big successes, that we feel good about, is having taken the time to turn the Selector line around, which took about a year. We then grew the U.S. Selector business quite dramatically just by the larger Sales and Marketing organization. So I am optimistic, but really don't want to model turning around the NMT shunt line, at least until after the period that we have guided through, which is after 2003, so I would like to be appropriately conservative. Now, the reason we pointed out the $3 million for the last quarter was because the business has shrunk from the prior year, and we want to make sure people understand, we're starting with a business that is shrinking, and therefore as we roll into the next four quarters, we have to model it going down from 3 by a certain amount per quarter in the forward six periods.

Now, that all being said, what are we doing in terms of discontinuation? Well, clearly, part of our going-forward strategy, in particular in Europe, was to aggressively market Heyer-Schulte, and our Drainage lines, and in our projections and in our expectations was additional penetration in France, Germany and other European markets of our Drainage line and our Shunt line. So there is a market share gain that we had modeled coming out of NMT and out of other competitors that we will no longer be able to include in our numbers. There's--in a sense, we're replacing our expectations of additional Heyer-Schulte and Drainage revenues of our current product lines with the acquired product lines. We are also going to genuinely eliminate certain product lines, in particular, product lines that are not profitable, and there will not necessarily be a replacement product line for product lines that are not profitable.

Okay, that makes sense. Any notable ones that are not profitable, or just a lot of little ones that are not worth mentioning?

It's mostly smaller product lines. Again, you know, all of these companies that we've acquired, while they have some strong product lines, like the Orbis-Sigma valve, also have some legacy product lines, and when you're trying to absorb capacity in plants like , you may not discontinue lines, but you want to absorb overhead. We have some plans to add product into , and therefore there may be some product lines that we can get rid of. I'll give you another example which we did over the last two years, which is down in Puerto Rico, Heyer-Schulte, we moved a very high labor-content product out of our Collagen Plant, which is BioPatch. We moved that down to Puerto Rico, and it now is a big part of the absorption of overhead down in Puerto Rico. That allowed us to discontinue quite a few low runners of Heyer-Schulte in the last few years, and that allows us to improve the overall gross margin, which in--to some extent, based on overhead absorption, and to some extent, variable. And so, we think we have the opportunity to do the same thing in .

Okay, great. Thanks. On you acquisition, you know, you're coming in at a early in the supply chain, as I understand it, where you'd be supplying metallic materials to the cranial plate and screw companies. What gives you the confidence that there is room for additional cranial plate and screw products, given that that's already fairly crowded, and also I suppose you might be competing with some of the same customers that are buying materials?

All right, what gives us the confidence is we've done it over and over again with our existing sales force. There's no question that the market for these implants is competitive. We believe the intellectual property we've acquired is very differentiated, be believe our ability as an organization to work with neurosurgeons and make that product line very neurosurgeon-focused. A number of the other companies that compete in this area are competing really, based on expertise in maxillofacial and plastic surgery, and there's a difference in how the neurosurgeons want to work, versus some of the other specialists. Also, it's just brute force. We have now what is perhaps either the largest, or tied for the largest sales force in the United States, and that means relationships. We've acquired companies with relationships, and we've been building now for four years, relationships with neurosurgeons. In a toss-up, the neurosurgeon's going to use a cranial plate that our guys deliver, the same guy who delivers innovative DuraGen into their hospital, and we think we can really move even somewhat less differentiated products like cranial plats and screws, based on those relationships.

Okay, that's a good point. And you mentioned there were some new indications for that J&J was beginning trials for. Have you told us what those indications are?

Not specifically, I haven't. But the--and don't at the moment plan to, because I don't really want to lay out our strategic plan for Skin, but as you know, we plan to expand the Plastic indications, and we plan to expand into Chronic Wounds.

Okay, great. Thank you very much.

Thanks, Alex.

Thank you. The next question is coming from Scott Davidson, of U.S. Bancorp Piper Jaffray. Please state your question.

Hi Stuart, good morning.

Good morning, Scott.

Hi. Just a couple of clean-up questions; I think a lot of good questions have been asked. To the extent that you are talking about getting into titanium and stainless plating systems, any thoughts about leveraging some of your resorbables technology, and doing resorbable versions of some of those systems as well?

Absolutely. The whole purpose of the tyrosine polycarbonate programs, which has essentially been funded by our strategic partnerships with others, as well as by government grants, is to bring that tyrosine polycarbonate, which, remember, is a resorbable polymer that is similar in its properties, to the polylactic acid, polyglycolic acid implants, but when it breaks down in the body, does not leave an acid dump. And one of the objectives of having acquired is in fact to build our capability to introduce a resorbable line based on tyrosine. And as you know, we filed a tyrosine master file about a year ago with the FDA, so we've got a master file on board, we've been working closely with , although it has been moving much more slowly than we would have liked, but we have been working closely with to develop their implants, manufacture out of the tyrosine polycarbonate, and although we don't have a tyrosine polycarbonate-based cranial plate and screw system yet, based on the that we've acquired at , you should certainly expect, down the road, that we will be developing a full line of tyrosine-based resorbable implants.

Great. And then, just on the product liability insurance front, we've seen rates rise just a tremendous amount. You know, actually for one company we cover up to, I think between 1 and 1 ½ percent of sales. Can you just sort of frame for us what you're seeing on that front, and how we should think about that in terms of economic impact?

Yeah, we have built into the guidance we've given, the negative impact of what is a substantial increase in all of our insurance, whether it be health insurance, product liability insurance, insurance, the numbers have been dramatic. What are the updates?

Yes, Scott, I guess my--it's David--my comment would be, is they're not as significant as some of the headlines that you're reading. We are experiencing double-digit percentage increases, but not doubling, or 150 percent increases, so it has affected our model a little bit, and we have modeled it in, but I would say it's not some of the headlines you read of doubling and 50 percent increases.

Okay, terrific. And then, just given the weakness in the capital equipment market in Q2, can you talk about some of the factors that drove that weakness, and specifically, whether you're going to see them continuing into the third and fourth quarters, and maybe at what point you would envision them beginning to turn the corner?

Yeah, there are several different things that have gone on. Japan has been weak, and I can't particularly come up with particularly good reasons for it, and so I've got a strong hope that it's going to turn around. I don't believe there's anything fundamentally going on there. Argentina, we've gone at 2/4 now, essentially being able--unable to sell anything into Argentina, because they can't take money out of Argentina. We have moved toward a way of working with them, which I hope will mean that as the economy stabilizes, we'll get that business back. It's not a huge business for us, but you know, it's a couple or $300,000 a quarter, which is not insignificant in our numbers. And so, again, I'm not sure that's coming back this quarter, but in the longer run, I think it will. In terms of the Selector business, and the MPM business, I think the reality is, is we should be more conservative in our models, at least for the next couple of quarters, but again, I don't believe it's an issue with our devices, it's an issue with the environment, and the environment, as you know, economically, is not--hospitals are just more cautious right now. So we have no reason to believe that there is a lack of acceptance in our technology, but we should be somewhat more cautious in what we've--we will be more cautious in what we're projecting for the capital. LICOX, again, it may have hurt us a little bit, but the pick-up in Disposables is so strong, and we are continuing to expand the number of demo units that are in hospitals being used, and we are getting advantages of the Disposables business, so that was not a great answer. I guess my point is, yeah, in the short run, you know we'll be more conservative in our revenue guidance for the capital. In the long run, I don't think it's any impact. It's not a technology issue.

Okay, and it sounds like you're not going to do it on LICOX, but are there other products where, just given the lower propensity for hospitals to buy capital equipment, you might think about that transitioning from a strategy of selling systems to placing systems?

No, it's still not what we want to do. What we will do, and this is going to have a big impact, I hope, in the next 12 months, you know it's just foolish for us to be selling a $9,000 system for Camino outside the U.S. And you know, one of our lowest margins is on our Camino Monitors, so it's not like selling it for $8 or $9,000 is somehow helping our bottom line. This development project we've had going on for well over a year and a half now, for a low-cost monitor will mean that we'll be able to sell our Camino product at a much lower price outside of the United States, and not have any hit to our gross margins. So I'm pretty optimistic, when we have what we're calling the SPM, the Single-Parameter Monitor, outside the U.S., we won't get back the capital revenue, but it will really give us the chance to drive our Disposable revenue outside the U.S.

Thanks very much.

Thank you. Our next question is coming from of UBS Warburg. Please state your question.

Hi Sanjeev.

I just have two quick follow-ups. Regarding , what are your capabilities internally today, from an R&D standpoint, that would allow you to move into the Metal Implant line?

Okay, were there two questions?

That was just the first--that was the first question. The second one was, if you can talk a little bit about the timing of the NMT sales transition domestically; basically, how quickly, and then, what the potential financial impact of that as well.

Okay, on , the way in which works, the President of , now who is now a VP of Integra, is very much involved in the product development process with the OEM customers. is a collaborative developer of the products with the customers; it does not have the clinical capability--in other words, it does not have the neurosurgeon or the Clinical Director on staff. We will be hiring a dedicated Product Development person, but the capability of taking a concept, so a product development concept, and turning it into a prototype, is the unique capability they have, and their track record is, if you take the time to get to know them, is quite good in that regard. So we do need to add the product development capability, which is why we budgeted that additional cost into the model, and we will need the clinical, although we have that through our neurosurgeon relationships, the ability to turn what is essentially a paper concept into a prototype is their strength. And they have a well-documented track record of doing that, so I we've got, I think, a lot of capability there.

Okay.

In terms of the overlap, and the transition in sales force, yeah, that's an important one. NMT has, in the United States, distributors, and the distributors sell the product, and get a commission for detailing the product, and that commission is roughly 25 percent on the products. We will commission our reps 9 percent, and until we complete the termination of the distributors in the United States, we will be double-commissioning, so we will have--and that's one of the reasons we gave the guidance to put those increased costs in for the third and the fourth quarter, because there will be a period in time where two people are going to be commissioned for roughly a 35 percent of revenue sales and marketing cost, which is well above our 9 percent commission rate. That should be done, I would hope, in most places, by the end of the year, and I think I'm confident it will all be done by the end of the year, and most places by the end of this quarter. And then, similarly, we will have to have both the costs of their Atlanta distribution facility, and our own national distribution facility for some period of time, until we are able to close the Atlanta facility, so that's going to have--that's the main cause for the redundancy and the additional expected expenses in this quarter, and to some extent in the fourth. We'll be working hard to get the U.S. transition done this quarter.

All right, thank you.

Thank you. Our next question is coming from Bill of First Albany. Please state your question.

Hi Bill.

Great, thanks. I do have a question. In regards to the , you had mentioned the possibility of moving into the cervical plate line in the fusion piece of the business there. Is there anything in the development right now at , or do you think you'd buy somebody with an existing--you know, a company out there with an approved product, and then just bring the manufacturing in-house? What's your strategy on that?

Our strategy has always been to be very--what's the right word?

Opportunistic.

Opportunistic. Thanks, Jack. The point being, we're looking at a number of acquisitions in the spine; we'd like to get an acquisition done in the spine. We'll only look at profitable companies, and our objective there would be to bring in a product line with existing revenues that we could then leverage and grow. Alternatively we would work with clinical people to develop a product. There is nothing in the pipeline at the moment in the spine though. So all there is, is the capability; there is not, and I would not expect us to build a--not a project around the spine at the moment, so we would have to take a proactive, opportunistic activity before we get into the spine, but it is an objective.

Great, thanks.

Thank you. For any further questions or comments, you may press one, followed by four, on your touch-tone telephone at this time. We are showing no further questions, gentlemen.

Well then thank you, everyone, and we will look forward to continued exciting opportunities at Integra at our next quarter.

Thank you for your participation. This does conclude today's teleconference. You may disconnect your lines at this time, and have a wonderful day.