Integra Lifesciences Holdings Corp (IART) 2003 Q1 法說會逐字稿

Good morning ladies and gentlemen welcome to the Integra LifeSciences sponsored Q1,2003 conference call. All lines are in a listen-only mode and we'll take questions following the presentation. I'd like to turn the floor to Stuart Essig, CEO of Integra LifeSciences.

Sir the floor is yours

Good morning, everybody and thank you for joining us for the Integra LifeSciences investors conference call. As many of you know I'm Stuart Essig president and chief executive officer of Integra LifeSciences holdings corporation. Joining me today are David Holtz senior vice president finance and Jack Henneman (ph) chief executive officer.

During this call we'll review our financial results for the first quarter of 2003 which we released earlier this morning and our forward-looking guidance for the years 2003 and 2004, including the impact of our recent acquisition of JARIT (ph) Surgical Instruments our issuance of 120 million of contingent convertible notes and repurchase of 1.5 million shares of common stock.

At the conclusion of our prepared remarks we will take questions from members of the telephonic audience.

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

This presentation is open to the general public can be heard via telephone access or via web cast replay of the conference call will be accessible starting one hour after the conclusion of the live event. Access to the replay is available through May 9th, 2003 by dialing 973-341-3080, access code 3609049 or through the web cast accessible on our home page.

Today's call is a proprietary presentation of Integra LifeSciences holdings corporation and is being recorded by Integra and no reproduction transmission or distribution of today's presentation is permitted without our consent because the content of this call is time sensitive the information provided is accurate only as of the date of the live broadcast April 25th, 2003.

Unless otherwise posted or announced by Integra the information on this call should not be relied upon beyond May 9th, 2003. The last day that an archive 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 Reform Act of 1995. Among others statements concerning management's expectations of future financial results, new product launches and market acceptance of these new products, if you the product development programs, potential business acquisitions are forward-looking. Forward-looking statements involve risks and uncertainties that could cause actual results to differ materially from predicted results.

For a discussion of such risks and uncertainties, please refer to the risk factors, included in the business section of Integra's annual report on form 10-K for the year ended December 31st 2002 information contained in our subsequent filings with the Securities and Exchange Commission these forward-looking statements are made based upon our current expectations and we undertake no duty to update information provided during this call.

Stewart-

Thank you, Jack. Integra develops, manufactures and markets medical devices for use primarily in neuro-trauma neuro-surgery plastic re-constructive surgery and soft tissue repair. Product lines include traditional medical devices such as monitoring and drainage systems, surgical instruments and fixation systems, as well as innovative tissue repair products such as Duragengraph (ph) Matrix, Neurogen Nerve Guide and Integra Dermal Regeneration Template that incorporate our proprietary absorbable implant technology.

We have historically managed our business and reported our results under two separate operating segments. Integra Neuro Sciences and Integro Life Science.

Following our integration of several diverse businesses we acquired in 2003, we began to manage our business and review financial results on an aggregate basis instead of through these two operating segments we redefined internal management structure to use a single centralized organization to operate such as manufacturing, research, sales marketing and administration.

Accordingly, we now report our financial results under a single operating segment, the development, manufacturing, and distribution of medical devices.

We had a very strong quarter. Exceeding our own internal estimates for net income and achieving record revenues. We reported net income of 5.4 million or 18 cents per share for the first quarter of 2003 as compared to net income of 4.1 million or 13 cents per share in the first quarter of 2002. All reported earnings exceeded the analysts consensus estimate by two cents per share.

Total revenues in the first quarter of 2003 increased by 10.9 million dollars to 36.8 million dollars, a 42 percent increase over the first quarter of 2002. Product revenues increased by 10.6 million dollars, or 43 percent over the prior year period and accounted for substantially all of the growth in total revenues.

Acquisitions continue to contribute greatly to our revenue growth. Revenues from product lines acquired since the beginning of the first quarter, 2002, accounted for 6.2 million dollars or 58 percent of the increase in our total product revenues. Excluding revenues attributable to product lines acquired, since the beginning of the first quarter of 2002, first quarter 2003 product revenues increased by 4.4 million dollars, or 18 percent over the prior year period.

Revenues from our instrument product lines increased by 63 percent, principally as a result of revenues from the Padgett (ph) and JARIT Surgical Instrument lines we acquired in 2002 and 2003. Our operating room product line revenues increased by 60 percent. Largely as a result of sales of Neurosurgical Shunt (ph) products acquired from (inaudible) and continued in 2002 the sales of Duragengraph Matrix and Neurogen Nerve Guide.

Our private label product revenue grew by 36 percent due in large part to revenues from Integra Signature, which we acquired in 2002 and to increased revenue from the absorbable collagen sponge we supply for Midtronics (ph) Bonegraft (ph) Product and Vitacuff (ph) Product.

Neuro monitoring product line revenues increased 23 percent primarily as a result of increased sales of our drainage and cranial access kits. Our gross margin on product revenues in the first quarter of 2003 was 61 percent, consistent with that of the first quarter of 2002. Our costs of goods sold in the first quarter of 2003 included 346,000 dollars of inventory fair value purchase accounting adjustments for acquired inventory sold during the quarter.

Other revenue which consists of development funding from strategic partners and government grants, license and distribution revenues, and royalties are in from the licensing technology increased by 250,000 dollars from the prior year quarter to 1.7 million dollars. An increase in product development revenue offset a decrease in licensing and distribution fees.

Consistent with our increase in revenues, total other operating expenses, which exclude cost of product sales, but include amortization, increased 41 percent to 15.6 million in the first quarter of 2003, compared to 11.1 million in the first quarter of 2002.

Sales and marketing expenses increased 34 percent over the prior year period to 7.6 million dollars, as a result of growth and product revenues, subject to commissions, and to the buildout of our marketing and sales support and management function.

As a percentage of revenues, sales and marketing expenses declined slightly from 16 percent in the first quarter of 2002 to 15 percent in the first quarter of 2003.

Research and development expenses increased 28 percent to 2.7 million dollars in the first quarter of 2003, largely as a result of research and development activity in businesses acquired in 2002.

General and administrative expenses increased 62 percent to 4.8 million dollars in the quarter, due primarily to costs incurred in operating and integrating businesses acquired in 2002 and 2003.

Amortization expense increased 227,000 dollars in the first quarter of 2003, because of acquisitions, including the impact of the JARIT acquisition we expect future amortization expense to approximate $800,000 per quarter.

On March 17th, 2003, we acquired JARIT Surgical Instruments, an established and respected marketer of high quality surgical instruments for use in both traditionally and minimally invasive surgeries, for 42.4 million dollars in cash. JARIT brings to Integra an established and respected name in surgical instruments a highly successful distribution network and management team and an efficient instrument design and procurement system.

JARIT generated 1.1 million dollars of product revenue during the last two weeks of the first quarter. JARIT sales and distribution networks serves over 5,200 hospitals and surgery centers worldwide and allows us a new opportunity to bring our innovative products to new market segments.

In addition, we believe we can employ JARIT's expertise and tooling (ph) a Germany facility to source our instrument lines efficiently.

This quarter we continued the process of rationalizing Integra's manufacturing facilities. We completed the consolidation of our Padgett operation from its Kansas City facility into our New Jersey distribution center. We've began manufacturing of the Radionics epilepsy electric TROIDZ ( inaudible). We expect to close our (inaudible), Pennsylvania facility in June and we have nearly completed the transfer of our monitoring from our San Diego facility to our Andover (ph), England operation.

Each of these activities should improve the efficiency in the Integra's operations in the next 12 to 18 months.

Looking forward we expect to consolidate our corporate research center into our Camino (ph) plant in San Diego.

I'll turn the presentation over to David Holtz, our senior vice president of finance who will provide more information regarding our issuance of contingent convertible notes, our tax rate and our sources and uses of cash.

Thank you, Stuart. On March 31st we received approximately 101.9 million in net proceeds from the issuance of 105 million of two and a half percent convertible, contingent convertible subordinated notes due March 15th, 2008.

On April 11th we received an additional 14.5 million in net proceeds from the sale of an additional 15 million of the notes, for total net proceeds of 116.4 million dollars. Holders of the notes may convert them into our common stock at a conversion price of 34.15 cents per share. So if all the notes were to convert, we would issue approximately 3.5 million shares. However, holders may convert their notes only if the prior day's closing price of our common stock equals or exceeds 37.56 cents per share.

The consequences of this contingent conversion feature is that we will not reflect the conversion shares as outstanding for earnings per share purposes until the price of our shares has risen to a level that permits the holders of the notes to convert into shares.

We used approximately 35.3 million dollars of the net proceeds to repurchase 1.5 million shares of our common stock. We intend to use the remainder for general corporate purposes, including additional repurchases of our common stock and the development of new products. The notes contain no covenants restricting our ability to borrow or invest or otherwise operate our business. We will file and will maintain for up to two years a shelf registration statement for the resell of the notes and the common stock issuable on their conversion.

As of March 31st, 2003, we had cash and investments of approximately 170 million dollars. We had the entire notes offering closed in the first quarter, we would have had the entire notes offering closed in the first quarter we would have had cash and investments of approximately 184.5 million dollars.

In the first quarter of 2003, as a result of our strong operating performance, we generated cash flows from operations of 8.8. We used 42.4 million in cash to acquire JARIT. Excluding the effects of the JARIT acquisitions, we ended the first quarter with 203 days of inventory on hand and 56 days of receivables outstanding.

The weighted average common shares outstanding used for the calculation of diluted earnings per share in the first quarter of 2003 was approximately 30.9 million shares. We expect weighted average common shares outstanding used for the calculation of diluted earnings per share for the second quarter of 2003 to be approximately 30.3 million.

Finally, I will note that our two -- excuse me. 923,000 increase in income tax expense in the first quarter of 2003 reflects a slight increase in our projected effective tax rate for 2003, the 36.5 percent, which is what we currently expect to report for the full year of 2003. We expect our actual cash tax rate to remain under 10 percent for the full year.

And now let me turn the presentation back over to Stuart.

Thank you, David. As I have stated on previous calls, our management team continues to seek out external opportunities for growth. And any such opportunities that we consummate would affect our results going forward. It is a top priority of our management team to complete significant and accretive transactions this year and next.

However the forward-looking guidance that we have provided and will now update does not reflect the impact of any such future business acquisitions or additional strategic partnerships. We expect that product revenues will total approximately 41 to 42 million dollars in the second quarter of 2003, including approximately 7.5 million dollars in sales of JARIT products.

Other revenues are expected to be approximately 1.5 million dollars in the second quarter. The company's guidance for the second quarter of 2003 is for total revenues in the range of 42.5 to 43.5 million dollars. We expect that our third quarter revenues will be up slightly from those of the second quarter and that consistent with our past experience the fourth quarter will be our strongest this year.

The company expects total revenues to be between 168 and 171 million in 2003. And between 196 and 206 million in 2004. Gross margin is expected to be 60 percent of product revenues for the year 2003 and 62 percent of product revenues for the year 2004.

We expect to earn 18 cents per share in the second quarter of 2003. This guidance includes the negative impact of approximately 700,000 dollars of inventory fair value purchase accounting adjustments from the JARIT and Padgett acquisition.

Earnings per share for the full year 2003 excluding the potential for a in process research and development charge related to a future milestone payment are expected to be in the range of 80 to 82 cents per share. We currently anticipate paying the 1.5 million dollar milestone payment in the fourth quarter of 2003. We expect earnings per share for 2004 to be within a range of $1.05 to $1.10 per share.

I'd like to remind everyone I'll be presenting at the Deutsche Bank Securities 28th Annual Healthcare Conference on May 6. You could listen to the live presentation on the web cast that can be accessed from the presentation's page of the investor relations section of our web site. This concludes our prepared remarks. I'll be happy to answer all of your questions.

Operator, you may turn the call over to our participants.

The floor is now open for questions if you do have a question press the numbers 14 on your touch tone phones at this time. Once again if anyone on line does have a question it's 1 followed by 4 on your touch tone telephone at this time. Please hold while we take questions.

Our first question today comes from Ryan Rauch from Adams Harkness and Hill, Inc.

Congratulations on a good quarter. Just three quick questions. First, Stuart, it seemed like organic growth was solid once again at 18 percent. What drove that? Could you give us a little bit more detail? I mean Neuro Cap equipment, was that strong, et cetera, could you sort of walk us through what drove the organic growth in the quarter?

Okay. Yeah, we'll take you through that. First of all, yes, the growth in the core business absent the acquisitions was quite strong this quarter. In the neuro monitoring revenue grouping you can see or we saw significant increases in particular in the drainage and cranial access lines. That this quarter was particularly strong and I think again it came from the significant increase in sales force coverage this year with more than I think at this moment 66 territories filled.

Also, in the operating room, Duragen again very strong year-over-year. And I would say finally some contribution, again not nearly to the level of some of the other products, Neurogen, Neurogen up quite significantly from prior year. It's still not a big enough product line to make a huge difference to the overall revenues, but in terms of the growth, very significant.

Not a particularly strong although not weak, but not a particularly strong quarter for neurosurgical systems. Again, that we figured out is typically a fourth quarter event, where at the end of the hospital fiscal year in the fourth quarter of last year we saw some very significant capital sales. But disposables in those systems, which result from those installed base of capital, certainly is strong.

And then in the private label lines, obviously the impact of Signature and then the orthopedic lines from Life and Metronics (ph) and Vitacuff, I remember last time it was just a really bad Vitacuff quarter and had expected return to slightly below historical levels and so that on a quarter year-over-year basis contributed to the growth.

Okay. Can you provide us any specifics with respect to sort of the number of hospitals using Neurogen or the number of accounts using Duragen et cetera, like you have on past quarterly calls?

Yeah, I have some statistics. I will try to give you as many as I can. First of all, Neurogen, we have well over a thousand implants with Neurogen. I don't have a number of accounts specifically, just looking around the table. It's certainly well over a hundred accounts, probably closer to 150. I don't have a specific count on them. I did update our Duragen. We have almost 1,300 accounts now. up and running. The reorder rate remains high.

Interestingly, still, 85 percent of our sales of Duragen remain in the United States. And we saw significant growth internationally in Duragen this quarter. So it's just that I guess this is good. The U.S. just keeps growing so fast and since it's 85 percent of the sales it's still dominates the growth. But we had significant international growth in Duragen.

We sell Duragen now in 47 different countries. And in our direct markets in Germany and England, we have 100 accounts up and running using Duragen. So Duragen again real strong.

And then with Neurogen, again without breaking out the particular product, we just are really happy with the performance of Neurogen and feel like it's starting to show that kind of growth that we had hoped for

Okay. And then two quick questions. Can you walk us through some new product introductions we should be looking for and then secondarily how is your relationship with Johnson and Johnson and has the plastic and re-constructive indication (inaudible) sales there.

On new product introductions, we will be next Monday at the American Association of Neurosurgeons so we'll be showing both new data on a number of our products, including Duragen and Lycox based on clinical studies that have been done now post-launch in the field. So there are some interesting papers people will be able to look at and post centers at the AANS (ph) and we'll have speakers in our booth talking about that new data available on Duragen and on Lycox. And that's now experienced data. Obviously very positive experienced data from a number of different hospitals.

In terms of new products, we will be launching a new -- we've been talking about a new drainage system for about three months now. And we'll be launching it. It's the Herrmatic Plus EVD System (ph). It includes an Anti Microb Hi Filter (ph) and MI Safe (ph) capability which is kind of hard to explain on this phone call. But we have been the market leader in drainage for quite some time. And we have been a strong innovator. But as you know one of my objectives is to more rapidly turn our products. And you I believe know that Herrmatic Plus was quite delayed the prior Herrmatic Plus but when introduced rapidly became our fast advertise growing and I believe now our largest EVD product. This is the next generation of that. We turned it around I would say in about six months so an improvement in our ability to turn around our product development activities on a faster and more predictable basis in the areas outside of tissue engineering.

And so I think that's going to be quite a significant product and be quite interesting to our customers there.

We'll also be really launching for the first time what we call the Smart Valve (ph) which is a second generation of the ORBA (ph) Sigma Valve and we'll be promoting that against the programmable valves as a flow controlled valve that doesn't require continuous reprogramming. And one of the things we're seeing in the hydrocephalus (ph) market is while our competitors have taken share from the older technologies, frankly their own technologies, with programmable valve, there is a growing and discernible backlash against those programmable valves because of the need of patients and doctors to have frequent office visits when those products become out of line, whether it be because of a magnetic field or because the patient has a complaint about the perceived pressure in their head. And our flow control valve, the OSB Smart Valve will in fact allow a flow control rather than pressure control so the pressure changes overtime depending on the patient's physiologic condition.

So we will be launching that at the upcoming AANS. We'll also be launching this Neuro Endoscopi Ballon (ph) and that is the project that we inherited from our NMT (ph) acquisition and it's the thinner Neuro Endoscopic Balloon, I can't remember the French, but it was a smaller French Neuron Balloon.

As in previous meetings there will be a lot of discussion and presentation on Lycox, Duragen, Neurogen and our other product lines.

I think you also asked about skin. We continued to have a good relationship with J and J and a constructive relationship. They continue to market the product. J and J is an excellent marketing organization and has a strong sales and marketing effort. That being said, as we disclosed in our 10-K, they are not needing -- they are not selling as much as they're required to provide minimum payments for. So as you I believe know, under the agreement every quarter we receive in cash from Johnson and Johnson a certain amount of dollars. And that reflects no show minimums in the contract. And they are not selling to those no show minimums and, therefore, continue to have a build-up of prepays with us. And as we disclosed in our 10-K, they have come to us and requested to renegotiate the deal. And we have engaged them in a dialogue on that. And we may or may not choose to do that.

That being said, they continue at least to my knowledge to be out there selling the product. We continue to have significant sales of that product. We continue to expect what we have said on every conference call for the last two years, roughly 20 percent revenue growth in that product line. And so we're really negotiating over is not the quality or their interest in the product but the fact that they're having to absorb effectively a lower gross margin because they are paying us more than they are actually selling.

So I can't give any more guidance than what we gave in our recently filed 10-K which is there may or may not be a negotiation over this. Quite honestly, from our perspective, we like working with J and J. They certainly have a bigger footprint in the wound care market than we do. That big said, we're a much bigger company than we were four years ago when we did this deal with J and J and were we to change the deal in some way, either to be more flexible with them, or to take over sales and marketing distribution ourselves, it would not be significant burden on our P&L. In fact, we've done the math. It could probably improve our P&L

Okay. Thanks a lot. Congratulations once again.

Thank you

Our next question comes from Bill Plovanic of first Albany Corporation.

Hi Bill.

Good morning Stuart. Just a couple of questions. First, if you could give us an idea, you're restructuring how you report your revenue segments to us. I was wondering maybe off line if you could forward us what's going to be included in each of the new segments that you have out there.

Yes, as we speak, we are in the process of posting to our web site for all investors and the public and anyone who is interested, spreadsheets and explanations and a new corporate presentation, which has all of the data for the way in which we're now displaying our numbers.

Just a quick clarification. It's not multiple segments. It's one segment. But there are multiple product lines and we'll be breaking them out as neuro-monitoring operating room, instruments and private label. And if you look at neuro-monitoring and operating room, that's predominantly neuro products. There's a few other products in there but it's predominantly neuro products. If you look at instruments, we've included the capital products like the ultrasonic aspirators as well as (inaudible) Padgett, JARIT. And then the private label products include all of the products that we sell to and through strategic partners.

But yet to answer your question specifically, we'll post-it on the web site and of course we can also provide to anybody interested e-mail copy of the spreadsheets

Thanks. Secondly we see that your other revenues increased pretty significantly year-over-year. By our estimates the out performance in the top line came from that. I was wondering is that the J and J payments are going into that licensed and royalty line versus into a product revenue line? It was like a million more than we're looking for, or has some of the, I think you had mentioned a while back you had hired somebody to help work on what you used to call the life sciences, kind of the OEM product, or are we starting to see some of those efforts come to fruition?

Hang on one second. I just want to look at this and make sure I answer your question properly. If you're looking on our press release, are you looking at the third, the three months ended March 31st and the fact that there's 1.65 million of other revenue as opposed to 1.4 million in the prior year?

Bill Plovanic Yes

You expected it to go down?

Correct

Yes. In fact, in that other revenue category, there were two changes from what we had expected in our prior, I don't know if it was guidance, but certainly what we had in our model. One is we received $250,000 in what we call a C and R payment for a publication of a study, having to do with the Integra skin. So that was additional J and J revenue. And as you know we get those C and R payments from time to time. They're unpredictable and we got one in the first quarter. And they just depend on when things are published or when products are approved.

The second thing is I wish I could give, by the way, our new development officer that. And I expect I will be giving him credit in the coming quarters. But the other unbudgeted or unanticipated revenue was additional funding from WYETT (ph) for additional R&D for the BMB absorbable collagen sponge

Since we're on the topic you have the new corporate development for that division. I was wondering if you could give us a little insight or maybe a little color on things we could expect, announcements possible over the next six to 12 months in that area, things that are being worked on

Most of his activities are involving identifying opportunities to do research and development and manufacture collagen-based products for other large sales and marketing partners. And as I think we said on our last call, and I'll just reiterate, I would expect to be able to announce I'd like to say one or two, probably one, but one or two deals a year based on his activities and the activities of our research and development and regulatory people.

And areas of interest where we don't have partners at the moment are in general surgery, in orthopedics, outside of the spine, in cardiovascular, and other places where collagen-based products are used as a bio-material or as a scaffold for tissue regeneration, hemostasis (ph) and closure. And more specific than that, we've never told people about alliances we might do until we actually done (ph). But what I can give you is a high degree of confidence that this activity is productive and actually I think in this quarter there maybe a little bit of money from an alliance not signed but that we are getting some funding for what is it pre-clinical work where we've said, hey, look, we want some funding for pre-clinical work so we can both look at the outcome of that data to see if it's worth moving forward with a product. And I don't remember the number, but there's probably, looking David, 30, $40,000 of other revenue from a three to six-month feasibility study or maybe even two of them that are coming out of those as resource. Not enough to be worth mentioning on the call but hopefully enough to give you a hint that there's going to be some life in that activity

Okay. And then just back track for a second, the WYETT (ph) Additional research you're doing for them. Will that be an ongoing revenue stream we could expect?

Yes and no. We included it in our forward-looking guidance based on what we believed will be happening. It is a collaborative R&D effort and it's not a long-term contract, for example, like this particular activity, like our J and J relationship. And so it is predictable, I would say three to six months out, what the activities will be and there are additional activities underway as we speak in the second quarter. So we built into our guidance for this quarter, I think we said a million and a half of other revenue, which is probably, again based on my recollection, half a million dollars more than we probably said six to nine months ago. And that's because there is additional activity in a number of areas including WYETT, Medtronics, Sofmore (ph) Data and others and yes you can expect it certainly this quarter probably into third quarter. I think we probably built not very much into our 2004 model, because those particular projects don't have any commitments going into 2004

Okay. Then two last questions and I'll jump back into queue. First, gross margins were pretty strong in the quarter. But I think for the year you had suggested guidance of 60 percent for full year for product gross margin and actually that is it

That's the question, Bill? Did I interrupt you?

No the question was it was 61 percent in the full year guiding to 60% for the full year. I wondered what your thought process is there. The other question actually was on you touched briefly on the distribution. Just give us a full update of all the territories filled and the reps and what have you

On the gross margin, remember, every bit of guidance that we give in all of the statements that we make are GAAP. So we are giving you GAAP guidance. And so we said for this quarter we booked a 61 percent gross margin under GAAP but we also had 350,000 dollars of purchase accounting impact on our cost of goods sold. And so our guidance for the year is 60 percent gross margin. That's GAAP gross margin. And we also said that in the second quarter we will be reporting a -- we expect about $700,000 of purchase accounting impacts from the JARIT and the Padgett deals.

So this quarter you saw what I was delighted to see, honestly, because we always have so many purchase accounting impacts on our numbers. You saw the strength of the underlying business, 61 percent gross margin, including the impact of 350,000 dollars of purchase accounting adjustments. So when we talk about 60 percent gross margin for the year, what we're talking about is GAAP gross margin. And that includes flowing all the appropriate purchase accounting adjustments through our P&L.

I guess the question is excluding the purchase adjustment charges, so you're running it over a 61 percent real gross, product gross margin would that continue at these current levels? And the only reason it's lower for the full year is because of the inventory write down?

We're not allowed to give non-GAAP numbers so what you need to do is take the 60 percent and make whatever adjustments you think is appropriate we told you in the first quarter $700,000 is purchase accounting. So you know that the gross margin of our non-purchase accounting products -- sorry for the gross margin of our other products has to be greater than 60 percent to have a GAAP, blended gross margin of 60. I'm not being cute, Bill. We're only allowed under the new regulations to give GAAP measures.

I understand

So the business, the underlying strength of our gross margins is obviously improving if it's able to eat all this purchase accounting and still report 60 percent gross margins, which was our guidance last year, without the impact of the purchase accounting

Great.

In terms of territories, we have chosen in the new year to take a more gradual approach to expanding the sales force than we did last year. I think last year we made a very aggressive expansion activity hiring in the first quarter, roughly 25 new reps. And I think the strength of the business that you saw in the fourth quarter and in the first quarter was the natural result of that. I also acknowledge that some of the weakness and confusion in the first half of had year was also probably the natural result of being so aggressive.

So learning from our mistakes, in the new year we're going to do a more gradual increase and in particular, as reps either leave, retire or are promoted, if they've got territories that generate say on average a million dollars or more, we're likely to split those territories and add two reps.

That way we're not displacing anybody, we're not changing anybody's hospital relationships, we're just taking advantage of the fact that if somebody has built a two million dollar territory and gets promoted we can bring in two people and let them drive each of those new territories aggressively.

And so through that natural evolution, we are now running at I think it's 66 territories up from our target of 63 at the beginning of the year and I'm certainly hoping that we'll finish the year with 72 plus or minus territories. Why the very precise numbers, we generally like to keep our regions at nine reps per region. So if we end up at eight regions at some point then we'll have management capabilities for nine reps per region or 72.

When did we add them in the logical places where we had very strong reps who had generated big territories and then either were promoted, retired or agreed to split the territory and that, for example, is in Washington State where you've got a very big Seattle business in Chicago and in the Baltimore, Washington area. All of those are great regions built by great people and we feel we can support them with an additional headcount.

Thanks, Stewart. Great quarter.

Our next question comes from John Calcagnini from Alliance Capital

Good morning. Congratulations. Everything pretty much -- I'm sorry if I missed this, did you mention DSO is

I didn't but we have that statistic. We were up, excluding the effect of the JARIT acquisition, because it was really just the last 11 days of the quarter, accounts receivable days outstanding was 56 days at March 31st, compared to 53 days in December. So we were up slightly in AR (ph). And as you recall, our target is 60 days. I think I mentioned on the last call we're actually pushing our international people to get more aggressive and (inaudible)

Occasionally that does mean we'll have longer terms. Also as we go direct in England, France and Germany, we're actually holding the paper for those hospitals as opposed to dictating terms to our distributors. Naturally as those grow we'll have longer days. In terms of inventory, we were up from 183 days to 203 days. So we were up 20 days, which seems significant. I don't think it's a trend at all. And to some extent it reflects the fact that we had a higher gross margin in the first quarter and so as you build inventory, and as your gross margin improves you can actually have the confounding effect of mathematically having more days. Our target remains 180 days. And we didn't do anything clever or cute to build inventory days in the quarter.

As far as international, what percent of the top line is now international?

It's approximately 18 percent

And any amplification you'd like to make on what's going on internationally and the opportunities there?

I'm real excited about our international business. I mean for a small company, I think we've done a lot. We have a significant direct sales force in England France and Germany. In each of those markets those people are increasingly being trained on our products. Remember, all of those salespeople for the most part are a year or so with Integra, but many of them have ten years or more in neuro-surgery. So it's really cross training them on all of the products.

Many of them came from companies with single products or relatively narrow product ranges. And so there's a training element. I think we're doing the right things. I think also Europe doesn't happen fast. And so we're trying to be measured in not overspending to try to push something that is only going to go so far. But on the other hand we're providing clinical support with two clinical educators.

We're a very French company, which means we have quite a few salespeople, quite a significant presence in France, similarly in England, we manufacture the ultrasonic aspirate tore in England and can leverage the fact that we have a plant on site and then again in Germany we manufacture. So in each of our direct markets we're a manufacturer and I think in the long run that will play well to the local customers.

Also I want to point out in our recent acquisitions, JARIT and Padgett, those two were predominantly domestic businesses.

Even more so than the 18 percent Integra. And so there's work to do with the shop to grow the international businesses. But my experience is every time we do one of these acquisitions it gives us an opportunity to leverage some skill set that we've acquired and take advantage of it, in particular in the case of JARIT, we acquired a procurement office of 15 individuals in Germany in which there's such great expertise and instrument manufacturing procurement that we were able to now we're able to leverage those people

What percent, last question, do you expect international would be by end of the year? What percent of revenue?

I don't have a target for that. But I'll bet it's not much more than 18 percent, Mark, because the U.S. domestic, neuro business, continues to dominate the growth of the overall business. So no matter how good a job our Europeans do, it's going to be hard to be better than the Americans.

Thanks for the hardwork

Our next question comes from Jeff Kolly (ph) of Essex (ph).

Could you explain what goes on in purchase accounting adjustments with regard to inventory and what the effect could be on cash taxes (ph)

Generally what happens is when we buy a business, we need the right inventory on their balance sheet up to an accounting notion al fair value (ph) Which is generally higher than the normal value that we put on the balance sheet which we build our acquire something, because it includes a notional accounting fair profit. So it takes time to work that written up inventory through the balance sheet and through the P&L.

Historically in our acquisitions it's taken a quarter to three-quarters to fully write off or fully utilize the written up inventory and therefore then put into inventory product manufactured at standard cost. So in this most recent quarter there was 350,000 dollars worth of that kind of impact and we would estimate in the second quarter about $700,000 of that kind of impact. So it's real but it's accounting and it's writing up the value of the inventory to fair value and then working through that. And since we generally have approximately 180 days of inventory, you would expect it takes a couple quarters to turn that. And that's really what we're talking about when we talk about fair value inventory adjustments

Okay. Thank you

Our next question comes from Cabor Racht (ph) Chaney Capital (ph)

I'd like to ask about the JARIT acquisition and more generally about your acquisition strategy. First of all about JARIT, it seems to me this is a bit different from previous acquisitions in that the product area is outside your core competence and also it seems that the organization will be more loosely integrated only into Integra than previous acquisitions. So I'd like you to comment on that. And then based on this experience with JARIT, I guess I'd like you to specify a bit what the nature and the justification of the future acquisitions may be

Okay. First of all, I actually think that JARIT plays greatly to our core competence, which is JARIT is an excellent selling organization. One of the Premiere selling organizations in the medical device business. And in particular in instruments. And what we have built over the last three or four years here in Integra is a core competency in selling and marketing medical technology. Now, JARIT is not in the in neuro-surgery business and neither is Padgett. Padgett is in plastic and re-constructive surgery and we now have a sales force of eight people calling on plastic and re-constructive surgeons.

And we bought that even though it was an instrument business, we bought it because it gave us unique access to a set of clinicians through which we could then flow new products and in fact we've launched the Neurogen nerve guide which is a tissue-engineered product with a very high gross margin through this well established plastic and re-constructive surgery business. Similarly, having bought JARIT, which is an excellent sales and marketing organization with 20 distributors, 20 direct salespeople managing those distributors, and over a hundred people whose number one product they typically are selling to the operating room is JARIT.

So now I've got exactly the call point I want to launch other tissue-engineered products for general surgery through. So like all of our acquisitions, what we're trying to do is find a leverage point that allows us to take advantage of some other skill set. And in this case it's we've acquired a Premiere sales and marketing organization which calls on a group of people that we otherwise could not get to them or otherwise by getting to them would be by partnering our technology with private label business significantly lower Marge than we could get by ours.

While it's not neuro we have the strength now overrule of our business and we have the balance sheet to go beyond that and to leverage excellent sales and marking organizations and drive them with additional engineered products. The other real benefit we get is the one thing we're not all that good at are procuring and designing instruments. But our neuro reps absolutely need neuro instruments to call on that your neurosurgeons.

So I guess in a bootstrapping way what we did now is we want to hand that instrument, not the sales and marketing activity, but the (inaudible) Quality and engineering capabilities over to JARIT who is excellent at this and therefore make the products that our neuro people sell high quality more innovative and also a higher gross margin. So I look at these things as multiple leverage points and how can we take advantage of them.

So the good news it's not that we're going to manage JARIT any more differently in terms of the insistence we'll have on managing quality systems and systems we'll have on controls and compliance, that will be just like many of our other acquisitions. But what we did get is an actually well-functioning, stand-alone company with an excellent management team.

And so to be honest, it's less work for us here in plains borrow to do the things we were going to do anyway was add new technologies to the sales and marketing organization or drive our instrument through there. So we intend to manage that as tightly as anything else we manage, but we don't have a significant consolidation activity we need to do to JARIT.

We do have a significant consolidation activity we will do to other Integra sites to put it into this high quality organization, JARIT. So I hope that wasn't too PODANTIC but I think it illustrates our strategy

I think it's quite useful. Would you also comment on your objectives in future acquisitions, i.e., what types of things are you looking at, what is the nature of the enhancement of the existing organization you're looking for?

I think our M and A activity focus is the same as we've always articulated. We want to buy profitable, growing companies, where we have some leverage point, whether it be adding tissue-engineered products through an existing sales and marketing organization or leveraging some kind of gross margin capability in terms of consolidation, or adding items to the bag of our neuro reps.

We would certainly expect to do four to five acquisitions this year, as we have done in the past. That's certainly our objective. And they will again typically be smaller product lines or stand-alone companies, five to 15 million of revenues. We've generally paid cash flow type multiples for those. And without committing -- last year we did I think it was six acquisitions -- it was five acquisitions and three of them were in neuro and two of them were in closely aligned fields and so if I'm betting on what we do this year, I'd certainly hope it's three neuro deals and a deal for JARIT and maybe another deal for Padgett that tries to leverage the sales and marketing organization effectively.

And as we have said in the past, we'll also look for larger deals if we think we can get good values on those deals, if we think they'll add to the overall growth of the business, if we think they're accretive to our earnings per share and if we think they are within our managerial capabilities

Thank you

Our next question comes from Scott Davidson of US Bancorp Piper Jaffray Inc.

Good morning. And congrats on a nice quarter. I may have missed this, but I was wondering if you could quantify the impact of foreign exchange on the top line in the quarter

Yeah. It was minimal. We guessed -- it's a little hard with the acquisitions to precisely state the impact. But we did expect the question so we tried to quantify it. If you look at our total revenues for the quarter, and you then assume we had them all a year ago, so this includes all the acquisitions. So you say take the current revenue base for the quarter and then recalculate it using the currency rates one year ago, it had a positive impact of approximately $600,000 on the quarter.

Great. Thank you. And then can you talk just briefly about the conditions in the capital equipment markets right now? I've heard from a few other companies that there are some challenges out there. I think Q1 of last year was a weaker capital equipment quarter for Integra. Can you just talk about what your sales team is reporting back about current conditions?

We are getting no negative or positive statements. And if you look at the capital for the quarter, it was kind of what we expected. No matter, no worse. So I don't think I can flag -- there was no surprises this quarter. We were up certainly versus prior year. But then again prior year was weak as you pointed out. So we're not seeing any capital equipment challenges this quarter. It's not something we saw fit to raise on this call or I can't think of any comment I got in this quarter, even from a sales rep, that somehow this is a challenging capital equipment quarter. That being said, the thing we did figure out last year is Q4 is the quarter. And you know we were extremely strong in the fourth quarter. And I think we figured out as we've gotten bigger you see some of that seasonality or whatever you want to call it magnified in our P&L.

Great. Thanks. Lastly, relative to the competitive environment in neuro, I think we heard anecdotally that perhaps one of your bigger competitors might be performing a little bit below trend line of late. Can you sort of spec out what you're seeing from a competitive standpoint, any changes there?

Sure, it will be interesting at AA and S to also evaluate this F our primary competitors are Medtronics, neuro technologies, the cognitive division of J and J, to a lesser extent the ask a lab[phonetic] Of BRAUN [phonetic] I'm really talking about the neuro line business. And by product by product line various other competitors. And I think in particular we've been able to -- I don't want to characterize whether our competitors are good or bad but what I'll be able to say is we've been able to capitalize on the strength of our technology platform in the drainage and cranial access and ICP monitoring. The fact that Lycox is so interesting, a rep can always get a meeting to talk about it and always get an opportunity to trial it, that that's been allowing us to pull through, not insignificant amount of what otherwise would be considered too mundane to talk about.

And so I think our technology advantage, the fact that we've got a significant technology advantage in my opinion vis-a-vis (inaudible) and the fact that Medtronics doesn't play in the advanced monitoring segment of the ICU really gives us an advantage to push that part of the market. That's certainly one aspect of it. There's also as I've pointed out a bit of a battle going on in the hydrocephalus market between our two competitors in programmable SHUNTS and we do not have a entry there, which is not a good thing. I wish I had an entry there. But it means it's not hurting us they're both spending significant time competing against each other on this topic. We will play in this segment. At the moment through our flow control valve or BA sigma and what we're trying to do with the Smart Valve is go after those who are disenfranchised with the programmables now that there's been several years of experience with them

Great. Thank you

Our next question comes from Sanjiv Arora from UBS Warburg

Good morning, Stewart. Congratulations on a great quarter. Most of the questions have been asked and answered. I just want to ask a couple more things. One, if you could really detail, excluding the inventory adjustments, what is driving the improvement in gross margins to date? Is it the consolidation? Is it kind of a mix shift? What are you focused on

I think the simplest answer is it's getting bigger and by selling more stuff out of the same plants you just drive your gross margins up. So overhead absorption, when our products have significant overhead in them, is the most significant impact. The second most is mix. And the more we sell of Duragen, the more we sell of Neurogen, the more we sell of Lycox, the more we sell of our new drainage systems, the better our margins. So new products sell at better margins than older products

And you talked about your OUS strategy could you talk about the specific growth rates you're seeing in the two segments, U.S. and international?

I don't believe we have that broken out. I will ask David to reviewpoint it as we're on this call and if he can identify that, we'll try to answer it sometime later in the call. The one other point, Sanjiv, is consolidations will matter. But I don't think we're seeing any of it in our P&L yet. Because they're all happening in the last three, last two quarters and this year. So the likely impact of the consolidations are more likely than not not going to have a benefit until 2004

Is most of the consolidation primarily in Plainsborrow (ph) and France?

In a nutshell, yes. We're also moving some things to Puerto Rico

Okay. Last question, I guess. You talked about the sales force and the expansion of the territories. As you look at your management structure, and kind of the depth that you have within your management team, any additions you'd want to point out or any things you plan to add as you go through the year?

Actually, a great question. Even if it's a soft one. We're working very ladder to take advantage hard to take advantage with the fact that we have the flexibility in our P&L to add good people. It's my expectation as to add a chief operating officer this year. We've expanded the sales force significantly. We're expanding the sales management over the next three to six months for additional support for Bob pal TRICH with additional support for international people for JARIT. We'll take advantage of the JARIT's large BPO contracts which means it justifies for the first time in the company's history have somebody focused on GPOs and managed care. So, yeah, we're adding significantly. We're adding significantly in our quality systems organization. We are adding in our engineering group. So, yes, significant new talent. And if you happen to make it to the AA and S meeting, there will be quite a few of those people there and you're welcome to ask questions of them and get to know them

Okay. And any timing on the COO hire?

The objective is by the end of the year

Great. Thank you.

Next question comes from Kevin Gill (ph) Glen Capital (ph)

Nice quarter, guys. I was wondering if you could give a little bit more detail on the timing and size of expected acquisitions

I don't think I can give any more detail than I gave in answering the last question, which is we expect to do four to five deals a year. You certainly wish they would happen once a quarter but they don't usually happen when you expect them to. Last year we had three happen in a month after a soft spell of four to five months. So I can't give you timing. I can tell you we have a very full pipeline. It's a good environment to acquire companies. Values are not up. If anything they're down. There's not a lot of capital available so the fact that we have significant capital plays to our advantage. But we don't just buy things because they're there. We buy them because they've got some leverage, some synergistic value and we got a very clear vision of the companies that we would like to own

Okay. And I guess sort of associated with that, if you would be open to raising more money for doing those acquisitions or if you plan to try to use, this being cash and operating flow to do that?

I think at the moment we're extremely well capitalized, and we've got between the cash we have on our balance sheet and our significant cash flow, I don't anticipate raising additional money in the short-term, unless it would be in the context of some acquisitions that would require such. But we just did in the last quarter raise approximately 115 million dollars. 35 million of which was used to buy back shares. So certainly we're not constrained simply by capital. We're certainly constrained by what we're prepared to pay. But not by the availability of capital

Great. Thanks a lot, guys.

Thank you our next question comes from John Lindquist of CIBC World Markets.

Hi. Good morning. Great quarter. But most of the questions have been answered. I was wondering about the impact of the JARIT acquisition in terms of your other products. I mean can you talk about how you're going to use the JARIT acquisition to source other products, that is, what exactly are you going to be doing differently for these product lines and what effect will this have on the business? And I was wondering about Lycox in the quarter, how many systems did you guys place and how many did you have out in the field as well as the Neurogen launch in Europe, I was wondering how that was going

Okay. Start with JARIT. Let me first say, it's just great when you acquire a group of just totally enthusiastic, hardworking and just forward-looking people. So I can't tell you how much fun we're having with it. In terms of sourcing products, I even found a guy in Germany who is faster at wanting to get things done than some of the people here in new Jersey so about a day after we acquired the business he was complaining as to where the list of our 6,000 SKUs of neuro instruments were so he could figure out cheaper and better ways to source them. So yeah I think there's just a huge opportunity and it is underway.

I understand, by the way, that in a few weeks we've been able to on a number of instruments we were on back order on for our neuro group, and this is just anecdotal, source several instruments directly from that organization to meet customer back orders which we could not find the instruments in a timely manner before. So it's tangible. You can taste it. It may take six to nine months to fully integrate the sourcing skill set we have here in new Jersey with the German skill set. So it is not going to have an impact on our gross margins instantaneously, but in terms of quality, availability, innovation, I think our neuro people are just super excited about it. In terms of launching new products through the JARIT organization, again that then becomes a priority for us. And in our development organization, projects that we wouldn't have allowed in the past, because we didn't have the strategic partner for them, we're now evaluating, because we do have a strategic partner, ourselves. And so having now this call point in the OR is going to have an impact on the way in which we spend in our tissue engineering business. So there's a real upside there. Is there anything I missed on the

Sure in terms of the Lycox in the quarter

Yeah, on the Lycox, we placed that means either sold or put on loan 25 units for the quarter. Domestically. We've tried to report this consistently. Internationally I don't actually know the number but I'm sure it's still higher than the U.S.. but it was 25 for the quarter, which was quite good. I think that's a record in the two years or so since we launched this product. So strong uptick with Lycox. We've got some good papers next week at the AA and S and a number of speakers. So reception to Lycox continues to be strong.

And again it's a little bit hard to measure the number of sites because we have so many of them at this point. And sort of a moving target. But I'm going to estimate, what do you think, about 100 to 125 sites? It's probably between 100 and 125 sites up and running regularly using Lycox

Then in terms of Neurogen, the launch in Europe after getting approval in February, how is that going? Was that the major contributor in the quarter?

No, zero contribution for the quarter. I think we'll sell our first product this month or next. If you recall we got the approval but said it would take a couple months to finish the labeling and get the inventory in stock. So to my knowledge I don't believe we've sold our first European Neurogen. And when we do I'm sure I'll know about it

Great.

So it's U.S. I guess I wish we were moving faster in Europe but all growth is in the U.S. to date

Okay thanks. Great quarter

Question from Linda Miller (ph) of John Hawaiian Handcock (ph).

On the growth you reported both organic and acquired, can you comment on the VOFL trends, be it unit or mixed and also on any pricing opportunities you've been able to take advantage of

That's a really hard question for us to answer because we have so many different product lines. It would be hard to give you unit trends. Certainly in Duragen units are up dramatically. We know that. Certainly in drainage units are up dramatically. So in the product lines that I identified that grew really fast, you know it's clearly unit volume increases. We are able to get across the board, for many of our neuro products, I would say a majority of our in your row products, about a four percent pricing yield. So we put up our prices at various levels each year. But I think after discounting and whatever rebates and you work your way across the various product lines, I think this is not a scientific number. But I think based on our experience we got three to four percent pricing every year on our not new products. Obviously we introduced new product if it's got new advantages we'll introduce it at a higher price. But there is room to increase prices in the neuro products every year

Thank you, that's what I was looking for

Okay

Once again if anyone on the line does have a question press 14 on your touch tone phones at this time. Gentlemen, we have no further questions

Thank you very much and I appreciate everybody taking the time to join us on this conference call.

Thank you, ladies and gentlemen. This does conclude this morning's teleconference. You can disconnect your lines at this time. Have a nice day.