Integra Lifesciences Holdings Corp (IART) 2003 Q3 法說會逐字稿

Good morning, and welcome to the Integra LifeSciences third-quarter earnings conference call. At this time, all participants have been placed on a listen-only mode, and the floor will be open for questions following the presentation.

I would now like to turn the floor over to your host, Mr. Stuart Essig. Sir, the floor is yours.

Thank you. Good morning, everybody, and I want to thank you for joining us for the Integra LifeSciences investors 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, Executive Vice President and Chief Administrative Officer. During this call, we will review our financial results for the third quarter of 2003, which we released earlier this morning, and our forward-looking guidance for the fourth quarter of 2003 and the year 2004. 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 and can be heard through telephone access or via our live Webcast. A 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 November 14, 2003, by dialing 973-341-3080 and access code 3609053, or through the Webcast accessible on our homepage. Today's call is a proprietary presentation of Integra LifeSciences Holdings Corporation, and is being recorded by Integra. No recording, reproduction, transcript, 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, October 31st, 2003. Unless otherwise posted or announced by Integra, the information on this call should not be relied upon beyond November 14, 2003, 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 Reform Act of 1995, among other statements concerning management's expectations for 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 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, and the 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.

Thank you, Jack. Integra develops, manufactures and markets medical devices for use primarily in neuro trauma and neurosurgery, plastic and reconstructive surgery, and general surgery. Our product lines include traditional medical devices such as monitoring and drainage systems, surgical instruments and fixation systems, as well as innovative tissue repair products that incorporate our proprietary absorbable implant technology.

We had a strong quarter, exceeding the analysts' consensus estimates for revenues and earnings per share. We reported net income of $6.8 million, or 23 cents per share, for the third quarter of 2003, as compared to net income of $1.6 million, or 5 cents per share, in the third quarter of 2002. Operating income for the period was $10.9 million, a more than fivefold increase over the third quarter of 2002. Results reported for the third quarter of 2002 reflected various special charges, including $2.3 million of in-process research and development charges associated with acquisitions. Total revenues in the third quarter of 2003 increased by $16.9 million to $47.1 million, a 56 percent increase over the third quarter of 2002, as product revenues increased by $14.2 million to $43.5 million, and other revenues increased by $2.6 million to 3.6 million. Other revenues in the third quarter included a $2.5 million event payment from Ethnicon, Inc., for the achievement of various regulatory objectives for the Integra dermal regeneration template.

Neuromonitoring revenues increased 20 percent, primarily as a result of increased sales of our drainage systems and intracranial monitoring products, including LICOX. Our operating room revenues increased by 33 percent, as a result of growth in sales of our DuraGen dural graph matrix and our NeuraGen nerve guide products, as well as the impact of the acquisition of the neurosurgical shunt products from NMT Medical and Radionics in 2002. Revenues from our instrument product line more than tripled, principally as a result of our acquisition of the Padgett and JARIT surgical instrument lines in 2002 and 2003. Increased sales of our ultrasonic aspirator products also contributed significantly to the growth in our instrument revenues.

Our private-label product revenue decreased by 12 percent, primarily due to a decline in revenues from the absorbable collagen sponge we supply for use in Medtronic's infused bone graft product.

Our gross margin on private revenues was 57 percent. Excluding inventory fair value purchase accounting adjustments, our gross margin on product revenues was 58 percent. Gross margin in the third quarter of 2003 was negatively affected by the change in our product mix, resulting from recent acquisitions and by temporary inefficiencies resulting from recent product manufacturing transitions. We expect these manufacturing transitions to have a positive effect on our gross margins in 2004.

Other revenue increased by $2.6 million from the prior-year quarter to $3.6 million, as we received a $2.5 million event payment from Ethicon. Total other operating expenses, which exclude cost of product revenue, but include amortization, increased 8 percent to $17.3 million in the third quarter of 2003, compared to $16 million in the third quarter of 2002. Sales and marketing expenses increased 50 percent over the prior-year period, to $10.1 million, as a result of increased sales commissions and the buildout of our marketing and sales support and management functions. Sales and marketing expenses were 23 percent of product revenues in both the third quarter of 2003 and the prior-year period.

Research and development expenses were $2.6 million, and general and administration expenses were $3.8 million in the third quarter. Amortization expense increased to $773,000 in the third quarter of 2003, due to acquisitions. In the third quarter of 2003, we completed the consolidation of our Integra neuro supplies distribution operation into our facility in Massachusetts. We expect to complete the consolidation of our corporate research center into our San Diego manufacturing facility by the end of this year.

In September, we signed an agreement Ethicon, Inc., for the orderly return to Integra of exclusive rights to sell, market and distribute the Integra Dermal Regeneration Template. In the four years that Ethicon has managed the Integra product, it has attained widespread use in burn units for the treatment of life-threatening burns. Timing is good for us to resume the sales, marketing and political education responsibility for this product. We have been expanding our sales force and product offerings in the plastic and reconstructive market since late 2002, when we acquired Padgett Instruments. Going forward, our objective will be to continue to expand the usage of the Integra product to the plastic and reconstructive markets.

In August, we acquired the assets of Tissue Technologies Inc., the manufacturer and distributor of the Ultrasoft line of facial implants for soft-tissue augmentation. These products, together with the products acquired in the Padgett acquisition, are sold through Integra's plastic and reconstructive surgery sales force. Effective January 1st, 2004, we will sell the Integra product through the same channel.

Earlier this week, we announce an agreement to acquire Spinal Specialties from I-Flow Corporation for approximately $6 million in cash. Spinal Specialties assembles and sells custom kits and products for chronic pain management, including the OsteoJect bone cement delivery system and the Accu-Disc pressure monitoring system. Spinal Specialties markets its products to anesthesiologists and interventional radiologists through an in-house telemarketing team and a network of distributors.

I will now turn the presentation over tuition over to David Holtz, our Senior Vice President of Finance, who will provide more information regarding our nonoperating results and our tax rate.

Thank you, Stuart. We recorded net interest expense of $188,000 in the third quarter of 2003, as compared to net interest income of $822,000 in the prior-year period. This change resulted primarily from interest expense associated with the $120 million of contingent convertible subordinated notes that we had issued earlier this year. Other income increased by $320,000 to 309,000 as a result of gains realized on the sale of marketable securities and gains recorded in connection with an interest rate swap transaction executed in August. The interest rate swap was designated as a hedge against changes in the fair value of our fixed-rate convertible debt. The weighted-average common shares outstanding used for the calculation of diluted earnings per share in the third quarter of 2003 was approximately 30.3 million shares. The $3.4 million increase in income tax expense in the third quarter of 2003 reflects an increase in our expected effective tax rate to 37.2 percent for 2003, as compared to 35 percent reported in the third quarter of 2002. This increase results primarily from a change in the geographic mix of projected taxable income for 2003, including the effects of the additional revenue associated with the amendment to our distribution agreement with Ethicon. We expect our actual cash tax rate to remain under 10 percent for the year, because we continue to use net operating loss carryforwards.

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

Thank you, David. As I had stated on previous calls, our management team continues to seek out external opportunities for growth, and any such opportunities that we consummate could affect our results going forward. It is a top priority of our management team to complete significant and accretive transactions this year an next. However, the forward-looking guidance that we have provided does not reflect the impact of any such future business acquisitions or additional strategic partnerships. Our forward-looking guidance for 2003 and 2004, that we will now update, includes the impact of the Spinal Specialties acquisition, as we expect the transaction to close in the next several days. We expect that product revenues will total approximately $45.5 to $46.5 million in the fourth quarter of 2003. We expect to book additional other revenues, expenses and other income in connection with and as result of the amendment to the Ethicon distribution agreement.

Earnings per share for the fourth quarter of 2003 are expected to be in the range of 28 to 33 cents. The Company expects total revenues to be between $205 and $215 million in 2004. I would like to take a moment to focus on the expectations for each of our product categories and other revenue for modeling purposes. Based on our total revenue guidance for 2004, we expect neuromonitoring revenues of approximately 49 to 52 million, operating room revenues of 77 to 81 million, instrument revenues of 63 to 65 million, private-label revenues of approximately 14 to 15 million, and other revenues of approximately $2 million. Revenues of Integra Dermal Regeneration Template will be included in operating room revenues, effective January 1st, 2004. And sales of Spinal Specialties products will be included in instrument product revenues.

Looking beyond 2004, we expect sales to grow in excess of 25 percent for the operating room product lines, in excess of 15 percent for the neuromonitoring product lines and in excess of 10 percent for the instrument product lines. We expect private-label sales to be flat through 2005, and then resume growing at about 15 percent per annum thereafter. We expect other revenue to decline to 1.2 million, beginning in the year 2005, and remain flat thereafter. Overall, we continue to forecast total long-term revenue growth at the target 18 percent. Gross margin is expected to be 62 percent of product revenues in 2004, as the effects of lower gross margin acquired product sales are expected to be more than offset by growth in the sales of our higher-margin products and the beneficial impact of recent manufacturing transitions. Longer term, we are modeling gross margins increasing to 65 to 70 percent. Excluding a potential in-process research and development charge related to a $1.5 million milestone payment that may become due in connection with the product development agreement, we expect our earnings to be within a range of $1.08 to $1.14 per share in 2004. To help with modeling the quarterly progression of earnings, we expect that our earnings will generally rise during 2004. Accordingly, we expect the fourth quarter of 2004 to be significantly higher than the first quarter.

We will be hosting an analysts' forum on November 18th, beginning at 3 PM, in New York City. Integra management will be providing an overview of our business, a review of our operations and financial performance, and a detailed discussion of our products and pipeline. Our senior clinical sales and marketing teams will also discuss clinical results and marketing strategies for our key products. All investors and analysts are invited. Access to the live presentations will be available by dialing 973-935-8511 or through a listen-only Webcast via a link provided on the homepage of our Website. A replay of the presentation will be available for two weeks following the live event through a Webcast via the same link.

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.

(OPERATOR INSTRUCTIONS). William Plovanic, First Albany Corporation.

Good quarter. A couple questions, if I may. Obviously, you don't want to give guidance on the other revenue from J&J in the fourth quarter. But if we look at current spending trends as a percentage of sales in your operating expense line, could we expect any major changes upward or downward? And I guess a subset of that question would be your G&A was down sequentially pretty big, and just a little clarification on what's going on there?

Thanks, Bill. A couple parts of that -- first of all, we tried to give very clear guidance for 2004, but the fourth quarter of 2003, we do expect significant other revenue expenses and other income. So we are accelerating a number of programs into Q4, both to be prepared to launch the Integra product in the first quarter of next year through our own sales organization, as well as to take advantage of what are very strong fourth quarter results we are expecting. So I don't think the percentages are going to be particularly relevant for the fourth quarter. So, where we have tried to guide people is to look at 2004 and the various ratios we've given you for 2004.

In terms of G&A, one of the things we are really pleased with is the benefit of the various plant reductions in the first half of the year and in the prior year are starting to show, predominantly in the G&A line. For example, plant management, historically in those plants, shows up in G&A. And so, in the third quarter, you really did see the benefit of those plant reductions. And keep in mind there is significant scale-up in corporate to take advantage of the -- or to invest in our ability to grow. So you really saw the impact of those plant reductions in Q3, and I wouldn't expect dollar G&A to keep shrinking; it was just real good in Q3.

And then, if we look at the gross margins, I know you gave us some reasoning on why it was a little lower. But I think, as we exited last quarter's conference call, there were expectations that it would be around 60 percent, excluding the one-time hit. And it's come down. What changed since the second-quarter conference call to the earnings here, that would cause so much of an impact on the G&A?

In terms of the gross margin, the main impact we're seeing is the continued turn of prior-period inventory through our selling. So we had hoped and expected to see the gross margin improvement in the third quarter. We continue to expect to see it as the year rolls out and into next year. But we had thought we would see more of it in the third quarter, and we didn't. We, on the other hand, saw a lot more of the G&A improvement than we expected. So, it for the most part is simply the impact of selling off inventory that was billed over the prior six to nine months with a lower standard cost, and we continue to expect to see that turn around, and have modeled the 62 percent for next year because we have a high degree of confidence. Also, a number of our acquired lower-margin businesses performed quite well. And those, therefore, lowered the gross margin -- or the gross margin percentage -- while contributing significantly to gross profit and earnings.

And one last question. If we look at acquisitions made, what were total acquisition revenues? We've got JARIT and Padgett at 8.8 million. We probably have some off of the neuroplating business. But I'm just trying to get an idea of total acquired revenues in the quarter.

My suggestion, Bill, is to turn -- we included in the press release footnotes, and in those footnotes to the press release, we in fact show you the product revenues for the period, as well as what the impact of product revenues acquired in 2003 were, and 2002. So if you look at footnotes A, B and C on the press release, you can get to all of the information. And rather than just walk you through numbers on this call, I can refer you to the footnotes and then tell me if there's something I need to clarify there.

Dave Turkaly, WR Hambrecht.

Good morning, nice quarter. Quickly, if I look at the guidance that you guys gave, obviously for the fourth quarter, the 45.5 to the 46.5 -- is that including some of the Spinal Specialties sales? I think you said that's closing. And if so, how much of an impact do you think that could have in the fourth quarter?

We modeled spinal specialties for 2004 at $4 million, and we frankly would like to see us do better than that, since that's the trailing revenues. But just to be conservative, and recognizing that acquisitions take a little bit of time to ramp, we modeled 2004 at 4 million. So in the fourth quarter, we modeled it at about a million, but assuming there was some negative impact of the transition. So we actually only put 0.5 million of revenues into the quarter. It's only two out of the three months that we'll be booking, by the way.

And is there an inventory adjustment -- I can't remember -- for the fourth quarter as well, like the 400,000 that was in this quarter?

Thank goodness, there's no further purchase accounting. Going through the numbers in the cost of goods, with the exception of what should be a relatively small impact of Spinal Specialties now. But we are through with the JARIT and Padgett turn of the inventory at the higher purchase accounting adjustment level.

One last one. I'm looking at the -- obviously, it looks like all the three -- the neuro divisions all did pretty well. On the neuromonitoring side, I had a nice sequential jump; it looks like it could be $1 million or more. I know you mentioned -- I don't know if you mentioned anything for that product line, in terms of what drove that, but if you could give us a little more detail on how that improved? And is that LICOX, or is that another -- I don't know where that upside came from; I'm just curious if you could explain a little of that?

Okay, thanks. Yes, I'll answer the question. Just to make sure I didn't confuse anybody, we modeled $0.5 million of Spinal Specialties into Q4, and there is a small amount of purchase accounting going into Q4, but only for Spinal Specialties. In terms of intracranial monitoring, we did have simply an extraordinarily good quarter. We were up significantly over prior quarter. We have sold a very significant number of monitors in the quarter. We were also up significantly on LICOX, and in general, it just was the benefit of the larger sales force, the education of the sales force and the ramp-up in LICOX.

Robert Goldman, Buckingham Research.

A quick financial question, and then maybe some more interesting ones. The $2.5 million from Ethicon in the quarter -- should we assume that that was taxed at your average corporate tax rate this quarter?

No. That's actually a great question. We had not anticipated achieving about 2 million of that, and that pushed us up into -- in addition to the impact of what we'll get in the fourth quarter -- a higher annual tax rate. And that higher annual tax rate, which was over 37 percent, as opposed to what we have previously modeled of 36.5 percent, caused us to have to accrue significant additional taxes, not just for this quarter but, in a sense, to catch up for prior quarters. So you can see the tax rate for the quarter was over 38 percent, and that, to a great extent, was due to the impact of that incremental $2 million plus what we expect to achieve in the fourth quarter.

If it wasn't for that $2.5 million, what would earnings per share have been in the quarter?

All right. To do an as-if -- we would just assume not do, because, in fact, what happened did happen. But to help you through it, the incremental $2 million -- because we had already modeled $0.5 million -- to a great extent, the taxes chewed up a significant part of that incremental $2 million, in terms of what could flow to the bottom line. A guess would be about 3 cents impact of the 2 million, less the impact of the taxes.

You are saying that, were it not for this, your earnings per share would have been about 20 cents?

Bob, we can't really, as Company management, give you an as-if. You have to model it yourself. What we can say is the net impact of going up by 2 million in other revenues, and then taking the impact of the taxes going from 36.5 percent to over 38 percent -- that math would be a 3 cent impact.

Thanks for that, Stuart. On your guidance for next year, clearly, something happened within the last 90 days to convince you to up your guidance for next year. You were at $1.05 to $1.10; now it's $1.08 to $1.14. So I'm wondering what happened within the last three months to give you the sense of confidence to do that?

Okay. First of all, it's the number of items. The artificial skin coming back, the Integra Dermal Regeneration Template, coming back. As of January 1st, we expect to bring some of that to the bottom line although, as we said when we announced that, we will invest a significant portion of the incremental benefit into growing that sales and marketing organization. But as much as we would like to grow, some of it is going to come to the bottom line. In addition to that, we were quite enthusiastic about our launch of DuraGen Plus and EnDura at the recent CNS. For those of you who attended, the reaction was extremely strong. And so we expect to get the benefit of those two duraplasty products, starting in possibly the fourth quarter, but certainly in the new year.

Furthermore, our intracranial monitoring business and our OR business have never been stronger, and that causes us to look forward and say we see significant benefit from that, as well. So when you take all those things together, and we just finished our budgeting process, and we look at where gross margin and expenses are going to be, there's just more than we had expected 90 days ago that can come to the bottom line.

I've got two more questions, if I can. But on DuraGen, I know you don't give out specific sales numbers. But can you give us some sense of what the growth rate was, maybe, in the third quarter and compare that, if you could, to what it was in the prior quarter?

We would prefer not to do that. We are the market leader, and we'd just as soon continue to leave our competition behind. We do give you the OR numbers; and, as you know, DuraGen is certainly an important part of that.

Let me ask it this way. We might naturally expect that some customers might have waited for DuraGen Plus and EnDura. I presume they might have had some sense it was coming, and therefore, the DuraGen growth rates might have declined a bit in this quarter, and then would reaccelerate. Is that reasoning rational?

I don't want to suggest your reasoning is not rational, but I don't think that's what happened, no. In fact, we, I believe, were able to keep the competition completely flat-footed on these two product launches.

Ryan Rauch, SunTrust Robinson Humphrey.

Hi, guys. Congratulations. Just three or four quick questions. First, what was the foreign exchange impact in the quarter?

It was approximately -- Dave, what was it? $300,000 -- $470,000 on the topline.

Okay. And then, can you walk us through -- do you have any incremental litigation expenses modeled? Where do you stand with Merck, currently?

We've modeled into the year 2004 approximately $750,000 to $1 million for the Merck litigation, and the next phase of the trial.

And can you walk us through -- JARIT was sort of lower than expectations last quarter. Can you just anecdotally provide where you feel you're at with them? Did it bounce back? An then, secondarily, some of the new product launches in '04 that we should be looking for to drive growth?

Yes. JARIT came back strong. I would say JARIT's net expectations for the quarter didn't yet exceed them, but we're seeing quite a nice performance from JARIT. We just had the JARIT regional managers in, a group of them, and they are looking at a very strong fourth quarter and 2004. So I think we got what we paid for in JARIT; it just took us a few quarters to get where we wanted to be.

In terms of product launches, at the CNS, we talked about a number of products. Obviously, DuraGen remains the most important activity for our neuro sales force. And then launching DuraGen Plus and EnDura -- the big focus for the fourth quarter and the first quarter will be on those. NeuraGen continues to come back strong -- excuse me, come on strong. We had certainly a record quarter last quarter in NeuraGen, and we're seeing significant growth there. So we also are starting to get the benefit of the CE marking of NeuraGen, and therefore we started shipping, really at the end of the second quarter of 2003, and saw only a significant impact of NeuraGen in the third quarter of 2003.

In terms of other products, LICOX continues to be strong. We sold, I believe it was, 12 LICOX in the United States last quarter. So we continue to add to the installed base, and we continue to have significant clinical evaluations on LICOX. We've sold significant numbers of our SPM, our single parameter monitor; that's our new Camino monitor -- lower cost, same technology -- and that's become an important part of the mix, both outside the U.S. and in the U.S., and will help us drive catheter sales. We launched our Hermetic Plus, as you know, earlier in the year. We saw significant performance of Hermetic Plus -- that's one of our new drainage systems -- in the third quarter. And we are starting to see -- although again the numbers are relatively small, we are starting to see improvements in the United States and our OSV II sales, with significant increase year-over-year in our Orbis Sigma shunt sales in the United States. In fact, we had approximately a 50 percent increase year over year -- again, small numbers, but very significant in our OSV II sales.

We're launching the epilepsy electrodes that we acquired in December of last year from Tyco Radionics. We have approximately 25 epilepsy centers up and running, using our product. Keep in mind, it was an acquired product, and we only have 25 out of 170 epilepsy centers, and our reps call on every one of those centers. So we see a lot of opportunity there.

In terms of next year, we continue to have the same set of expectations for product launches. The first half of the year, our NeuroSensor cerebral bloodflow product; middle of the year, our cranial plate and screw system; and toward the tail end of the year, our next-generation ultrasonic aspirator. So there's no particular news there, except that we continue to be on track for each of those three product launches.

Jason Bedford, Adams, Harkness & Hill.

A few quick questions. Maybe I missed this, but what's your gross margin expectation for the fourth quarter?

We did not give gross margin expectations for the fourth quarter in particular, but I just perhaps in some reassuring way. We're not expecting them to go down, and we expect to be on track to get to the 62 percent next year.

An then, just switching gears, can you just talk about your strategy with Spinal Specialties? Where is that going? Obviously, spine seems like a point of interest. And then kind of what is your acquisition pipeline maybe, also, with respect to the spine market?

Spinal Specialties is a great little acquisition. I-Flow did a wonderful job with a small business, and we feel privileged to have acquired it. As you all know, we have many products that can be sold into spine, but we have been unable to find an acquisition priced right for our spine business. And so this was the first opportunity we had to get a window on spine, but in the way that was not dilutive to our earnings and was not a significant distraction for our management team. So Spinal Specialties is, for the most part, a chronic pain management business, but they have a small vertiberplasty (ph) activity, and that's of greatest interest. We plan to build out their dealer network; they have a small dealer network. Geographically, they do not cover any significant geography in the U.S. or outside the U.S. So we will leverage many of our distributor relationships, hopefully including some of the JARIT distributors and some of their existing distributors and new distributors. That will keep us focused, in that business, on interventional radiology. We will then look, over the next year, at whether there's an appropriate launch into neuro, perhaps through our neuro sales force or perhaps just leveraging our significant marketing operation show activity. What this really does for us is give us some visibility on spine, and help us start to build out a strategy to drive our very high-margin products like DuraGen into spine.

And then, just to follow up that question on the sales and marketing line. Did you add any salespeople in the quarter? And kind of what's the status of your current sales force?

Yes; we continue to add salespeople. I think we are at 68 in the U.S., in terms of the direct neuro reps. We're at 8 in terms of the plastic reps, and we were not planning to build reps in our general group, our JARIT group, this year. We expect to finish the year over 70 in our neuro group, and our objective will be to expand to approximately 80 by the end of 2004 in the neuro group. We have a significant recruiting activity going on right now, including some of the former or current Johnson & Johnson Ethicon reps who sell skin. We hope to start 2004 with 12 plastic reps and 4 clinical people to take a good running start at taking skin at January 1st.

And then, just one quick question on the '04 guidance. It looked like you raised the top line by about 9 million. For of that was Spinal Specialties. Can you kind of give us a little granularity on the other 5 million, in terms of product line?

Yes. If you do the forensics on our last several press releases, we generally guided people to an extra 2.5 million of revenue, from taking back the skin next year, and an extra 4 million of revenue from Spinal Specialties. So the rest is just and improved outlook on our business, in particular in dural grafting and neuromonitoring.

Scott Davidson, Piper Jaffray.

Just a few quick ones, Stuart. I may have missed this, but did you speak specifically about the tax rate for next year?

We did not speak about the tax rate for next year, and it's a good question. For the moment, we are modeling the same, unchanged from this year, 36.5 percent.

And upward bias, downward bias? If that changes, which direction would it likely go?

Well, the better we do, the higher it goes. On the other hand, we're investing in the fourth quarter and into the first quarter, in looking at our structure internationally, and so we hope we will be able to get a benefit of that investment in our tax rate, which is why for the moment, we're just leaving it the same in our own model. I don't want to guide you one direction or the other, but we're certainly working to make sure it's flat or down. Also, just as a reminder -- I know you know this -- our actual cash tax rate is only about 10 percent. So we're throwing off significant cash flow, as compared to our GAAP net income.

And as it relates to the fourth-quarter guidance, my recollection, Stuart, is that Q4 of last year was a really big capital equipment quarter. Is that sort of baked into the assumption for this year, as well? And at this point in the quarter, how much visibility do you have on how well you will do on the capital equipment side in Q4?

There's certainly not a disproportionate or unusual new or heroic new expectation in Q4. On the other hand, Q4 is definitely the quarter for capital, so we're definitely building in some of that. Q3 was quite strong in capital. As I mentioned earlier, that had some impact on the margin, but I would say we're expecting a good Q4, as we had in the past. We're not stretching for anything; we just expect significant capital in Q4, and the guys are certainly ready for it.

And lastly, can you talk a little bit about cash flow expectations for next year? And specifically, maybe highlight things like CapEx and other big swing factors, from a cash flow standpoint?

Yes. We expect, for the most part, the impact on cash flow to be similar to what we've seen this year, where our cash flow is about 30 to 40 percent higher than our operating profit -- sorry, than our GAAP net income -- because of, for the most part, our lower tax rate and, to some extent, the goodwill amortization. With one exception, we're modeling our CapEx at or below our depreciation. And it's not because we're not investing in the business; it's because, as we shut down these facilities, we generally get to use the equipment there in some other plant. So there's no dramatic CapEx expectation in 2004. We are expecting to invest heavily in systems next year, so we will probably see a higher-than-usual CapEx next year, but not enough to be meaningful, in terms of our cash flow. But we've had significant -- the why I'd like to characterize it is there's really no change in the ratios (technical difficulty) or the cash flow, similarly to how you modeled it this year.

And then, just apropos of the large amount of cash sitting on the balance sheet right now -- I'm not trying to pin you down on specifics, but can you talk qualitatively in terms of expectations related to acquisitions? And obviously, you had a pretty big one this year. What, roughly, should we look for next year? And I think you mentioned in a recent conference call that you hired a business development person outside of the neuro area. Might we see some acquisitions that deviate a little bit more than other recent acquisitions, in terms of the extent to which they mesh with the existing neuro business?

I think it's business as usual, Scot. Certainly, we have invested enough in corporate, whether it be in business development or any of our G&A areas, that we could handle the kind of deal flow we have had this year or prior years, or a little bit more. We're certainly targeting four or five acquisitions next year. You can't predict how these things play out, as you know. But if I could have my way, we'd do three neuro acquisitions, something for the plastic group and something for the general group. But there's no significant change in what we're expecting. Certainly, we would like the deals to be bigger. But these little deals have been really good for us, and we'll just keep doing them.

Ted Stokes (ph), CIBC World Markets.

Good morning, guys. Good quarter. First question -- what was the total adjustment for Q3 '03 related to -- I know the 400,000 was the write-down of the inventory, but there was also some severance and reorganization expenses.

Best guess, about $200,000 to $250,000. We try to, since we mentioned it on the last call, try to segregate that. And it probably came in at just about 200, a little over $200,000.

And can you give us some color on how you brought the products in, Dura and DuraGen Plus were announced at the CNS, and I believe, speaking with one of the sales guys, that they were going to be launched the following Monday. I'm just curious; what's your expectation as far as the quarter? Have you guys begun shipping product yet, or can you provide some color in that area?

I think we shipped DuraGen Plus literally the day after the show, and I think we're starting to ship EnDura today -- I'm getting pointed out. It's going out the door today. So first, EnDura shipment today. We had orders at the meeting. So we have been working on these, obviously, for a while. We just tried to keep it a surprise and get the better of our competition. In terms of specific expectations, no, we're not giving specific guidance. But we certainly view it as (technical difficulty) particularly in Dura, incremental to our current DuraGen business.

And lastly, the five-person telemarketing sales force related to Spinal Specialties -- I assume -- are you keeping that as is? And how that's going to be operated in selling those products, or are you going to take that in-house with some of your other sales reps?

No, we're going to keep them. That's really their competitive advantage, is that telemarketing group. We do not, I believe, anywhere inside of Integra at the moment, have a telemarketing group. And so, like with many of our acquisitions, we're going to learn from those guys and hopefully built on it.

William Plovanic.

Just a question on -- remind us what the size of the NOLs are? And also, as we look at the debt deal you did earlier in the year, when would that -- or possibly what triggers a conversion, of that (multiple speakers)?

Hang on one second. Let me give your precise answers. We have, remaining on the balance sheet, approximately 25 million of deferred tax assets, so we'll continue to use that. And we also -- keep in mind, we're not only using our NOLs; we have significant tax benefits from the acquisitions we've done, from the employee stock option exercises and from, potentially, the convertible bond debenture. So the 25 million -- we still have actually quite a bit of time before we chew through that. In terms of the convert, it converts at $34.15, but it has to be about $3 over that for it to convert. But keep in mind from, I guess, a trading or owners perspective, they are unlikely to convert until the expiry of the bond. So even if they are in the money, they are going to hang out there for the full five years, because they get the benefit of the upside in the stock, and can continue to collect the 2.5 percent interest payment. So we don't expect Integra to be -- it's highly unlikely for anybody to convert early. But just to answer your question specifically, the bond converts at a $34.15 price, only when the stock is over that number by 10 percent.

And then, if I could just circle back on the number of plastic reps -- you said you had eight when you exited the quarter. Is that what you went into the quarter with?

I think is, actually. I think we lost two and hired two.

So not a lot of changes or buildout yet? We'll see the buildout there starting in the fourth quarter, really?

Correct. And it's not like we haven't been trying; it's just that sometimes some people don't work out, and sometimes you look for new people.

(OPERATOR INSTRUCTIONS). There appear to be no further questions at this time.

Thank you very much, everyone. I'll be looking forward to seeing you either on the 18th, for our analyst and investor meeting, or on the next quarterly call.

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