Integra Lifesciences Holdings Corp (IART) 2005 Q1 法說會逐字稿

Good morning, ladies and gentlemen. And welcome to the Integra LifeSciences first quarter 2005 earnings conference call. At this time, all participants have been placed on a listen-only mode. And the floor will be open for your questions following today's presentation. It is now my pleasure to introduce your host, Mr. Stuart Essig. Sir, the floor is yours.

Thank you. Good morning, everybody. And thank you for joining us for the Integra Lifesciences investors conference call. I am Stuart Essig, President and Chief Executive Officer of Integra Lifesciences Holdings Corporation. Joining me today are Gerry Carlozzi, Chief Operating Officer; David Holtz, Senior Vice President of Finance; and Jack Henneman, Chief Administrative Officer.

During this call we will review our financial results for the first quarter of 2005, which we released yesterday afternoon, and our forward-looking guidance for the second quarter of 2005, and the full years' 2005 and 2006. 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 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 May 23, 2005 by dialing 973-341-3080, access code 5937953. Or through the webcast accessible on our home page.

Today's call is a proprietary presentation of Integra Lifesciences Holdings Corporation and is being recorded by Integra. No recording, reproduction, 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, May 9th, 2005. Unless otherwise posted or announced by Integra, the information in this call should not be relied upon beyond May 23, 2005, 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 others, statements concerning management's expectations of future financial results, new product launches, and regulatory approval 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 factors that may affect our future performance" included in the business section of Integra's annual report on Form 10-K for the year ended December 31st, 2004, and 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.

Certain non-GAAP financial measures are disclosed in this presentation. A reconciliation of these non-GAAP financial measures to the most comparable GAAP measures is provided in the press release we issued today, which is available on our website in the press release section under Investor Relations.

Thank you, Jack. We achieved record revenues in the quarter. Total revenues in the first quarter of 2005 increased by 13.4 million, to $65.8 million, a 26% increase over the first quarter of 2004. Product revenues increased by 28%. Excluding recently-acquired product lines, first quarter product revenues increased by $5 million, or 10% over the prior-year period. We reported net income of $8.4 million, or $0.26 per diluted share for the first quarter of 2005. When adjusted for certain acquisition and integration related charges, net income for the first quarter of 2005 was $9 million, or $0.27 per diluted share. Our operating income was $13 million for the first quarter.

Our Implant revenues in the first quarter increased over the prior-year period by 41%. Rapid growth in our nerve repair products, the Integra Dermal Regeneration Template and the Integra Bilayer Matrix Wound Dressing products, and new sales of the Newdeal products for the foot and ankle accounted for most of the increase in Implant product revenues. Sales of our NeuraGen and NeuraWrap products increased 96% over the prior-year period.

Sales of our dermal repair products, including the Integra DRT, the Integra BMWD and the newly released Integra Single-Layer Matrix product, increased 56% over the first quarter of 2004. Newdeal product revenues of $4.5 million met our expectations for the quarter. Sales of the NPH Low Flow Hydrocephalus Valve that we introduced in late 2004, also contributed to the growth in Implant product revenues for the quarter.

Lastly, our DuraGen family of duraplasty products continued to grow, albeit at slower rates than in recent years. We continue to see competition in duraplasty. We estimate that the impact of this competition in the first quarter was approximately $500,000 to $1 million of business missed. We believe that the cases lost while hospitals trialed competitive product had the biggest impact on our revenues. Rather than actual lost accounts for declining average selling prices. The impact on ASPs was de minimus. A number customers have chosen to stock both Integra and a competing product and we continue to see customers that had used competing products return to our Dural Grafting profits.

Importantly, we recently introduced our third-generation duraplasty product, The Suturable DuraGen Dural Regeneration Matrix. We believe this product will help us defend and grow the business. The product is intended for use by surgeons who want Integra's tissue remodeling technology for procedures that require suturing. We expect to win this competitive battle.

Revenues from our Instrument product lines in the first quarter increased over the prior-year period by 40%. Increased sales of our JARIT surgical instrument lines and recently-acquired product lines provided the year-over-year growth in Instrument product revenues for the first quarter. JARIT sales grew 17% over the first quarter of 2004, and we had our strongest quarter of Mayfield product revenue since we acquired the line in May of last year.

Monitoring revenues in the first quarter increased over the prior year period by 2%. Year-over-year growth in Monitoring product revenues suffered due to slower-than-expected acceptance of our LICOX Brain Oxygen Monitoring System in the United States, and slower growth in external drainage systems. We expect that the launch of the Integra's NeuroSensor cerebral blood flow monitoring system during the second half will improve the performance of this category. We recently displayed the NeuroSensor at the American Association of Neurosurgeons and were pleased with the attention it received.

Our Private Label product revenue in the first quarter increased over the prior-year period by 3%. Increased revenues of the Absorbable Collagen Sponge that we supply for use in Medtronics INFUSE bone graft product offset the removal of Signature Technologies cranial fixation OEM revenues from our Private Label products category. You will recall that we discontinued manufacturing cranial fixation products for Medtronic at the end of last year's second quarter. If you exclude OEM cranial fixation revenues from the prior year, our Private Label products revenue would have grown 15% over 2004.

Our gross margin on product revenues in the first quarter of 2005 was 63%. This represents the fifth quarter in a row in which our gross margin on product revenues has increased. The current quarter's gross margin benefited from strong sales growth in our higher margin products, in particular, our Implants. Our gross margin for the quarter includes inventory fair value purchase accounting adjustments of $269,000 for the Newdeal acquisition. Which had a negative impact of 1% on our gross margin. Excluding the impact of purchase accounting, we are already operating at our 2005 target gross margin of 64%.

Total other operating expenses, which exclude cost of product revenue, but include amortization, increased 39% to $28.8 million in the first quarter of 2005. Compared to $20.7 million in the first quarter of 2004. Selling, general and administrative expenses increased by $6.9 million to $23.9 million, in the first quarter of 2005. Approximately half of this increase was attributable to acquired operations.

Selling, general and administrative expenses this quarter were significantly higher, as a proportion of revenues that in the prior year. Some of these higher expenses were related to costs associated with the closing of various facilities, and related transitions, foreign dealer terminations and other costs related to acquisitions and integration. We excluded these costs from our calculation of adjusted earnings because we believe that, given our ongoing active strategy of seeking acquisitions, focusing on net income adjusted to exclude costs related to acquisitions and integrations, is a useful additional basis to measure the performance of our business operations. Both in this quarter, and in future periods.

Other expenses were simply greater than anticipated. The costs associated with the implementation and maintenance of our Enterprise Business System, the upgrade in our customer service and physical distribution activities in the United States and Europe, and the recruitment of top flight sales representatives for a growing reconstructive sales force, exceeded our estimates. Since we believe these are all important investments to make, our guidance for the second quarter and the rest of the year reflects a more conservative view of these costs.

In January, we acquired Newdeal technologies. During the first quarter, we began the integration of the Newdeal group's international business, with our existing international sales and distribution network, and launched the Newdeal products through our reconstructive surgery sales force. The Newdeal foot and ankle implant products are an important part of our strategy to sell the Integra Wound Repair and Dermal and Nerve Regeneration products to the surgeons who see chronic wounds every day.

Our objective is to provide a full range of products for foot and ankle surgeons so that our reconstructive surgery sales force can be a one-stop shop for surgeons in that specialty. We believe that Newdeal's first-rate foot and ankle orthopedic products and Integra's high-tech wound repair and nerve regeneration technology are together the most compelling suite of products, both metallic orthobiologic sold specifically to foot and ankle surgeons.

We are rapidly building our Reconstructive Surgery sales organization. While other companies have much larger sales forces at their disposable, we are catching up fast. Furthermore, we believe we are unique in building a direct sales organization dedicated to foot and ankle, rather than one sharing selling time with other orthopedic specialties. Today we have 32 sales professionals in the U.S. Reconstructive Surgery Group and we are working to increase that number to 50 by the end of this year.

We believe that our track record in neurosurgery proves that we have the management experience to build the best sales force in a market segment, and we plan to do it again in foot and ankle surgery. That being said, we continue to model the growth in our U.S. Newdeal revenues modestly for the remainder of this year, sending further evidence of the results of our efforts.

I will now turn the presentation over to David Holtz, our Senior Vice President of Finance, who will provide more information regarding our interest expense, tax rates, and foreign currency exposure.

Thank you, Stuart. We recorded interest expense of $927,000 and interest income of $954,000 in the first quarter of 2005. Net interest income decreased slightly from the prior-year period. Other expense was $93,000 in the first quarter of 2005, as compared to $17,000 in the prior-year period.

Other expense this quarter included a $204,000 loss related to the change in the fair value of the $38.5 million foreign Euro exchange collar contract we executed in November of 2004. This contract reduced our exposure to fluctuations and currency exchange rates resulting from our agreement to acquire Newdeal Technologies. You will recall we booked a gain of $1.4 million in the fourth quarter of 2004, on this collar. This collar has now expired in conjunction with the closing of our acquisition of Newdeal.

We continue to generate substantial cash flow from our operations. In the first quarter of 2005, we generated cash flows from operations of $13 million. A $2.1 million increase over the first quarter of 2004. This represents a significant improvement over the fourth quarter of 2004 operating cash flows of $7 million.

Accounts receivable were 70 days of sales outstanding at the end of the quarter compared to 69 days in the prior quarter. The small increase was principally due to a significant increase in the portion of our sales being made outside the United States. That increase is primarily due to the acquisition of Newdeal, the sales of which are mostly outside the United States.

International sales increased to 28% of total sales this quarter, compared to 21% in the prior-year quarter. Inventory days on hand increased from 217 days at the end of the year to 240 days at the end of the quarter. We increased our inventory to minimize the impact on our customers of various manufacturing and distribution transitions we are undertaking. In addition, we have added a significant amount of inventory for the launch of the Newdeal products by our reconstructive sales force in the United States.

At March 31st, 2005, we had cash and investments of approximately $158 million. The weighted average common shares outstanding used for the calculation of diluted earnings per share in the first quarter of 2005 was approximately 35.1 million shares. Income tax expense was approximately -- excuse me, income tax expense was approximately 34.5% in the first quarter of 2005, versus 36.8% in 2004. We expect our actual cash tax rate will continue to be substantially lower than our effective tax rate as we continue to use our net operating loss carry-forwards.

During the first quarter of 2005, our foreign currency denominated costs continue to exceed our foreign currency denominated revenues. We expect this balance to continue for the remainder of 2005. The acquisition of newdeal which derives its revenues primarily in Euros has helped reduce this imbalance. Finally, our amortization expense for the quarter was $1.5 million, an increase of $592,000 over the prior-year period.

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

Thank you, David. During the quarter, we made great progress in the business. We have already discussed the tremendous effort we are putting into our new Reconstructive Surgery business. We recently announced our third-generation duraplasty product, the suturable DuraGen dural regeneration matrix. Suturable DuraGen combines DuraGen history of safety, more than 350,000 successful implants to date, with a stronger profile that permits suturing in procedures where suturing is desirable. Suturable DuraGen is the only dural regeneration matrix that can be used both as an onlay and as a suturable graft with a resorption profile consistent with the growth of new dural tissue.

The launch of suturable DuraGen, along with the launch of the DuraGen Plus adhesion barrier matrix in Europe at the end of last year, reaffirms Integra's commitment to extra cellular matrix technologies for neurosurgical applications. We are very excited about the reception that both products have received from the surgeons who have used them. These new products will position DuraGen to accelerate its growth during the back half of this year and beyond.

The next step for the DuraGen line will be to establish its effectiveness as a barrier to postoperative adhesion, with sufficient data to gain FDA approval for that new indication. We have already announced that by the end of this year we expect to commence a multi-center 400 patient trial of the product for the reduction of adhesions following spinal surgery. This trial is further evidence of our continuing commitment to tissue regeneration, remodeling and repair.

In January of this year, we completed the reorganization of our R&D group. We completed the restructuring of our development groups to support our biomaterial development activities, as well as our other key product segments, monitoring and internal fixation. We also recruited a Vice President of Project Management, John Barrett, to improve the management of project timelines and improve our execution of critical product development programs.

To complete the organization, and ensure we are invested in the appropriate areas of research, we promoted Simon Archibald, our Vice President of Clinical Affairs into the role of Chief Scientific Officer. In this new role, Simon will continue to work with the key opinion leaders in the field to identify new trends in surgery. He will work closely with research groups in many universities conducting research in our areas of interest, to evaluate new opportunities.

The combination of Simon Archibald's and John Barrett's expertise and focus will enable us to achieve a balance between long-term research opportunities and short-term product programs. We will continue to strengthen our R&D organization as we build the group to add technical resources in our Plainsboro facility.

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 and 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.

We are updating our expectations for total revenues and earnings per share for 2005 and 2006. Total revenues in 2005 are expected to be between 283 million and 293 million. Total revenues in 2006 are expected to be between 340 million and 350 million. Our guidance for the second quarter of 2005 is for total revenues in the range of 66 to 69 million. Excluding charges related to acquisitions and integrations, earnings per diluted share in 2005 are expected to be within a range of $1.33 to $1.38 in the full year. And $0.28 to $0.30 in the second quarter.

On a GAAP reported basis, we expect earnings per share in 2005 to be within a range of 1.31 to 1.36 in the full year, and $0.27 to $0.29 in the second quarter. Earnings per diluted share in 2006 are expected to be in a range of $1.65 to $1.75. Our expectation ranges for 2006 earnings per diluted share do not reflect the impact of expensing stock options beginning January 1st, 2006, under the accounting standard recently issued by the Financial Accounting Standards Board, FASB.

I would like to take a moment to focus on the expectations for each of our product categories for modeling purposes. Organic growth for the full year is expected to be slightly below our 18% long-term growth target and more heavy weighted toward the second half of the year. Based on our total revenue guidance for 2005, we expect Implant revenues of $112 to $117 million, Instrument revenues of $98 to $101 million, Monitoring revenues of $50 to $52 million, and Private Label revenues of approximately $23 million.

Looking beyond 2005, we expect sales to grow in excess of 25% for the Implant product lines, and 15% for the remainder of the product lines. Overall, we continue to target long-term revenue growth at 18%. Consolidated gross margin is expected to increase to 64% and 66% of total revenues in 2005 and 2006 respectively. We are targeting SG&A expense of 32 to 34% and R&D of between 5 and 6%.

We expect DuraGen growth to accelerate in the second half of 2005, as evaluation of competitive products subsides, we increased our distribution of suturable DuraGen, accounts continue to more intensively use DuraGen in lieu of autograft and spinal applications continue to grow. We are very optimistic about the prospects for a Reconstructive Surgery strategy.

We believe that the combination of the Newdeal products and our soft tissue regeneration technology provides the perfect platform on which to build a rapidly growing extremities business. The first evidence in support of this strategy is the significant increase in sales of Integra tissue regeneration products seen during the first quarter. We believe that as we add sales reps and new deal accounts both synergistic sales will accelerate.

Our Instrument business also continues to be strong. Not only has the Mayfield business, which is not included in our organic growth numbers, grown significantly, since we have acquired it, but it has been an excellent means for pushing our neuro reps into accounts that had been closed to them in the past. JARIT also continues to take share from its competitors. We have also established a national accounts function center on JARIT, which we believe will help us to sell all of our products in the sort of multi-line transactions that have long been available to our larger competitors.

In May of 2005 our Board of Directors authorized us to repurchase shares of our common stock up to an aggregate of $40 million through December 31st, 2006. We may repurchase shares under this program either in the open market or in privately-negotiated transactions. I would like to remind everyone that Integra will be presenting at the Banc of America Securities 2005 Healthcare Conference on May 18th.

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

Thank you. [OPERATOR INSTRUCTIONS] Our first question is coming from Adam Galeon with CSFB. Please go ahead.

Hey, guys it is David DeMartino for Adam.

Hi, David.

Two questions. One, your lower 2006 sales guidance but maintained EPS guidance. Does that imply margin improvement, share repurchases or both?

A couple points. We lowered the 2006 number by 5 million at both the high and the low end of the range. At the same time, we're still on track. In fact, a bit ahead on our gross margin objectives of 66 -- 64% this year and 66% next year. So we believe that the combination of that 66% gross margin and the revenues that we've guided to, allow us to achieve the earnings guidance in an unchanged way. We have not baked any significant impact of a share repurchase into our forward-looking numbers.

Great. And how aggressive do you plan on being with the share repurchases? Should we look for you to start buying back in the open market this quarter or is it something that will take, maybe until 2006 for you guys to implement?

Obviously, we will do it when we see an opportunity and we feel the right time is here. I don't want to specifically talk about when, but certainly, we are open minded to doing it this quarter.

Great. And lastly, what measures has your sales force taken in response to the increased competition for DuraGen? Thanks.

Well, there is a number of things that we're doing. First of all, the sales organization has refocused on its existing accounts and made sure it's giving those accounts the highest level of service. In addition to that, we are upgrading many of those accounts from DuraGen to DuraGen Plus, and I would note that we are not seeing any significant impact on our ASPs. Part of that is the fact that DuraGen Plus comes at a price premium to DuraGen. And DuraGen Plus, we believe, is significantly improved over both DuraGen and the competitive products.

In addition, beginning really at the very end of the last quarter, and going into this quarter, we have the launch of suturable DuraGen, which is really a third-generation product, and we consider our competitors' products competitive with our first-generation DuraGen product. So the sales force is refocusing on existing accounts making sure they're not missing any opportunities, making sure all of the surgeons in those accounts are using DuraGen. They're upgrading people to DuraGen Plus. And I wouldn't forget also, we've been able to segment the market and grow the Endura product, which is for suturable accounts only.

Great. Thanks a lot.

Thank you. Our next question is coming from Raj Denhoy with Piper Jaffray. Please go ahead.

Great. Thank you. I was curious if I could ask you about the Newdeal products, in particular, now that you've had them for a while, how is your ability to retain those accounts now that Wright Medical has launched their own products, their Charlotte products, which compete with the Newdeal?

So the question is, how are we doing in the United States with the Newdeal products? Keep in mind, we took over responsibility for those sales in mid to late February, so we were not in a position to even begin to sell into those accounts until Wright Medical's exclusive contract expired. So we really have, in terms of the first quarter, only one month of operations.

In addition to that, Wright Medical had a significant inventory that they are permitted to sell and they're permitted to sell both in the first quarter into the second quarter, and based on what we've heard, they will probably run out of that inventory at the end of the second quarter, and into the third quarter. At the same time, we've scaled up aggressively, as I pointed out on the call, to a 32 people in our recon sales force, and expect to continue to scale up as we go through the year, to a number of about 50. And we have gone into as many of the Newdeal accounts as we can identify, which is certainly well in excess of a couple hundred, and tried to shore up our business there, and position Integra as the provider of Newdeal, and Wright as the provider of this competitive product, Charlotte, which we obviously knew was going to be launched.

Wright has the relationships. We have the product. So it is a real competitive battle. I would say we are doing very well based on only a couple of months of observation. We're pleased with the number of surgeons who, A, think the Newdeal product is an excellent product. B, don't see any significant advantages of the competitive products. And C, want to do business with a focused sales force that cares about foot and ankle, and that's really how we're positioning ourselves.

Our competitors, including Wright, are obviously excellent companies, but they have a large number of distributor sales people who spend less than 10 or 15% of their time on foot and ankle, and we're going to have a dedicated direct sales force spending the majority of its time on foot and ankle. So we've already seen, frankly, to a greater extent the impact on our Integra skin product from having all of those reps, than we have yet seen the impact of Newdeal. But the ramp in Newdeal is very significant. I don't want to give numbers, because it is sort of month-to-month growth is pretty uninformative, but as we get through to second quarter, we certainly expect Newdeal products to ramp and continue to ramp, and we're pleased with the number of accounts who have chosen to move over to Integra providing Newdeal as opposed to, either by the inventory from Wright or switch to the Charlotte system.

If I could ask you another question, when you sort of look at the way that the sort of two product offerings to that particular sales channel stack up, I know you've mentioned that the Newdeal products have the track record, versus the Charlotte, but I guess now Wright is also now selling this graft jacket product for diabetic foot ulcers. I'm curious if you could comment on how you think the Integra skin products maybe match up against the graft jacket products in that particular market.

So the question is about graft jacket. Integra has been selling the Integra Dermal Regeneration Template for over 10 years against Life Cells Alloderm. We've both been on the market. As I understand it, the graft jacket product is essentially Alloderm, so we have 10 years of experience competing in the burn market against Alloderm, and at least to date, we've had the dominant position in the burn market when we've gone head-to-head.

Now the advantage Alloderm and, therefore, graft jacket has had until very recently is the ability to sell it into almost any indication. Because the nature of the product is an allograft. We've had to go through a very substantial regulatory hurdle in getting our BMWD products and our IMWD products approved. We only launched them at the beginning of last year. And we've already seen, as we pointed out in our earlier comments, over a 50% growth in our dermal regeneration products. So I believe we stack up head-to-head against the competitive products, certainly comparable and perhaps superior in certain areas, and what we don't have and are in the process of getting to is distribution.

So if you go back in time, our objective in early 2004 of taking the Dermal Regeneration Template back from Johnson & Johnson. Combining it with our paget [ph] Instrument business and then doing an acquisition to launch Newdeal is very similar to what we did five years ago, in the neuro business. We took Instruments, we took Implants, and then we did acquisitions to grow the sales organization, and those combined led to substantial growth.

I would point out that our Implant business grew substantially year-over-year this quarter. And obviously, as we pointed out, that DuraGen sales were below our expectations. We more than made up for it with the Integra skin sales and the NeuraGen sales. So I think our strategy of driving the reconstructive business is a good one, and one that is going to help us, in particular, when we're through this period of dural competition, help us accelerate our growth.

And one last one and I will get back in line. You're obviously guiding towards a pretty big re-acceleration in the back half of the year. I' curious if you were going to lay out sort of the two or three main drivers you think have got you there, whether it's the re-acceleration of the dural products, or the neuro monitoring, coming back online, or if you can just maybe highlight what you think are the biggest points you have to hit in order to hit that towards the end of the year?

Okay. A couple of different parts to it. First, start with -- I will start with the smallest and go from there. We have for the first half of the year a very bad comparison in our Private Label business, because of the discontinuation of Signature. So in Q1 and Q2 of last year, we had $0.75 million in each quarter of Signature revenues, which we discontinued that OEM, but we have to compare our revenues this quarter and in the second quarter to the prior-year quarter.

And I pointed out in our script, once we're through that comparison, in fact, we grew 15% in our Private Label business, so I certainly expect in the back half of the year, an acceleration of our Private Label business, and the reason for that again is the ACS product that we provide to Wyeth and to Medtronic, that infused product is growing very quickly. As well as other items in our Private Label business that have been growing at 15%, but we masked in the first half of the year because of the comparisons with Signature.

If you get into the neuro monitoring business, obviously that has been a disappointment to us in the last quarter, and we're not projecting in the second quarter any significant improvement. The real benefit is in the back half of the year, as we launch our NeuroSensor product, which is on track for a mid-second quarter launch, and the impact of our newly-launched drainage system, the AccuDrain system, which is a substantial advance over competitive and our own systems. So that will help us restore our neuro monitoring revenues in the back half of the year to growth rates at least in excess of the flat growth we've seen here, and closer to our 10 to 15% range.

In implants, we've been doing very well, and we expect to continue to duke it out with Medtronic and Johnson & Johnson in the first half of this year, but we have seen competitive activity in each of those accounts, the net result of which has been in almost all cases, is the return to either Integra alone, in the form of DuraGen, or DuraGen and the competitor's product being stocked. And so we continue to believe, based on our analysis, that we're not getting hurt in any meaningful way in ASPs, and mostly what we're losing is the competitive evaluation periods, and we expect that to start to subside as we get into the back half of the year.

We also expect significant benefit from our suturable DuraGen product, which literally was only launched in the last weeks of the first quarter, and we believe will allow us to both continue to take back competitive accounts, continue to win in the one-off competitions in hospitals, and frankly, open up a much larger part of the business to us. The group of sutured accounts that would like a re-sorbable device, but do not buy into online. And as you know, a number of our competitors have tried to position their product as a combination of suturable and re-sorbable, and we think we have the best of both worlds with this product. So that's in the dural grafting area.

An then Instruments, Instruments continues to do well. We were delighted with Instruments. We expect it to continue to grow in excess of our corporate growth rate for the rest of this year. And we will start to get the favorable benefit as we get into the back half of the year in terms of the calculation of organic growth of the impact of our Mayfield line. So don't forget, the way we're reporting organic growth, which is consistent with historical period, excludes two of the things we're spending much of our time on, the impact on Newdeal, and the impact on our Mayfield business, which are both very positive and are achieving record revenues.

Great. Thank you very much. Very helpful.

Thank you. Our next question is coming from Dave Turkaly with WR Hambrecht.

Hi, Dave.

Hi, thanks. Can I get your guidance range for Implants again for 2005? I think I missed that. Just quickly.

Sure. Let me just reiterate the ranges we gave earlier in the script. Bear with me. We expect Implant revenues of 112 to 117 million in 2005. Instrument revenues of 98 to 101 million, Monitoring revenues of 50 to 52 million, and Private Label revenues of approximately $23 million. So if you look at how we've guided the rest of the year, the biggest impact is our feeling that we needed to bring down our expectations on Monitoring, to reflect both the reality of the first quarter, our expected reality in the second quarter, and then growth but growth off of those numbers as you get into the back year. So our -- I think the largest impact this quarter of our re-evaluation of our range of revenues came from our, I guess more cautious view of the Monitoring business.

And if we just stay there, on the Monitoring side for a second, can you give us an update on LICOX and where that stands? And I know you mentioned a launch of a new monitor in the back half of the year. Can you talk about how big you think that market could be?

Okay. Let me first talk about the NeuroSensor while I get you some statistics on LICOX. Basically, the NeuroSensor measures cerebral blood flow. It is another advanced parameter and a parameter that is widely viewed by neurosurgeons as quite intuitive and something they would like to know when measuring the health of the brain.

We have had planned to launch that earlier this year, but were unsuccessful in the timing of that launch, hence some of the impact in the first and second quarter. We are on track to launch it during this quarter, second quarter, and we believe it can have an impact in the third quarter third quarter and fourth quarter. We will be selling monitors for $15,000 to $20,000 each, and then catheters at roughly $800 to $1,100 price point and we believe the opportunity for this product line could be in line with or in excess of the impact of the LICOX product.

Now, that all being said, LICOX, we have about 180 LICOX monitors sold in the United States, we sold another seven in the fourth quarter, we have probably 30 monitors under evaluation, -- I'm sorry we sold seven in the first quarter, excuse me, we have 30 monitors plus or minus on clinical evaluation, and we believe there is about 110 hospitals in the United States currently using LICOX.

What I would say about LICOX is the hospitals that are using it are seeing significant benefits in their patient populations, and are producing publications that demonstrate the potential importance of this technology as potential standard of care. But I also believe that until we're able to more specifically get the product established, if not a standard of care, but as a recommendation from the American Association of Neurosurgeons, we're not going to see the kind of growth that we had previously anticipated.

So certainly nobody is backing away from LICOX, and neither are we, but we have not seen and not been able to see the substantial growth that we had hoped for when we launched it several years ago. I don't believe we are expecting heroic numbers out of our cerebral blood flow monitor, but at least the presence of a new product, the CBF monitor, as well as the -- and I wouldn't underestimate this, the launch of the AccuDrain and the ability of that product to improve our drainage sales, combined should be able to get us back to historical growth rates in monitors or somewhere in the 15% range.

Great. And then to jump back up to the implant, have you done anything on the sales force front? I know the Newdeal adds significantly, but your neuro reps, where is that sales force now? Will you be adding to kind of offset maybe some of these new competitive devices? And then at what tax rate are you using going forward in '05? Thanks a lot.

Dave, you make a very good point. We are not letting up in our competitive activities in neurosurgery. Quite the opposite. We are continuing to invest significantly in building out our sales, clinical, our management, our national contracts, and we certainly continued to do that in the first quarter. I believe we had 84 territories up and running in NeuroSciences at the end of the first quarter, up from 80, and we expect to finish the year closer to 90 territories, up and running.

We've also chosen to add specialists. We have a field specialist from Mayfield. We intend to start to add field clinical engineers to help drive our Monitoring business. So we would expect to continue to grow selectively the neuro group this year, not as dramatically as obviously the recon group is growing, but we're not letting up at all.

Great. And the tax rate, if you could, and that's it.

I'm sorry, Dave. 34.5% is our expectation for the year. We really did make good progress on our tax rate last year. If you recall, we spent a fair amount in the year as well as showing well over 36% tax rate last year. So some of that investment we made in restructuring our international asset paid off this year and we will be running the numbers at 34 or 35 this year.

Thanks.

Thank you. Our next question is coming from Alex Arrow with Lazard. Please go ahead.

Thank you. Stuart, if I could first start with the neuro monitoring, the LICOX effect that you were describing in which this level of acceptance wasn't quite as fast as you anticipated, to us doesn't look like it would quite account for the difference in the neuro monitoring business, both this quarter and in your forward-looking statements, so perhaps the Camino and the Ventrix are becoming less popular. What is it that is going on with the rest of the neuro monitoring business other than LICOX that you think may be responsible for what is going on?

Candidly, Alex, we are not aware of any significant competitive activity in the neuro monitoring area taking share from us. We have not lost any significant accounts. We have not seen a lack of acceptance of our products, the Camino and the Ventrix products. That business historically has been relatively flat. And what we've gotten our growth from has been new modalities, such as the impact of LICOX.

So I would say in this particular quarter, our drainage business was a little light, but I wouldn't call that a trend. That business has generally grown at about 10% of a year. This quarter was flattish. But I don't view that as a trend. And in fact, I see the impact of our AccuDrain improving that performance in the back half. Really, it was the lack of any significant growth in our LICOX business that prevented the business from growing this year.

The more conservative stance you're taking on the neuro monitoring business going forward does not have anything to do with Camino and Ventrix, I mean, that is exactly doing as you thought it would be doing?

Yes.

Okay. Thanks. On to the duraplasty business, the competitive evaluation period that you were describing in which the hospitals are trialing the competitor and you said that that would be letting up in the second half of this year. What gives you the confidence that there won't be additional competitive evaluation periods going on? Have you tracked the number of hospitals that have gone through competitive evaluations and were pretty much through all of them? Or I mean can you give us more color on that?

Okay. First of all, we do track where the competitive evaluations are going on. We do track what the impact is, and that is what gives us comfort to tell you that we are not losing significant accounts. And that most of the impact is from the evaluations. We're not going to give that data out. I view it obviously as extremely proprietary from a competitive point of view.

We do see that subsiding as we go through the second quarter, and into the back half of the year, and again, I can't really give you specific numbers, but certainly, you're looking at any one time, well over 100 competitive activities going on. But they don't come back after they're done. And we've seen it going on since the fourth quarter for Medtronic and since mid last year for Johnson & Johnson. So I mean that -- we're just watching it roll through and we believe by the second half of the year, that will subside.

At least as important is the ability to launch and to drive the suturable DuraGen product, which was only launched in the fourth quarter. Many of the analysts had an opportunity to see it at the AANS, it is a significant improvement over the DuraGen and DuraGen Plus and we believe against the competitors, and is available at a 10% price premium to the other products. So we do see the opportunity to drive the overall business in the back half of the year.

Don't also forget the positive impact that we're seeing from the adhesion label that we've got, and the potential for beginning that trial in the new year, which we think will be important in terms of perception of our DuraGen franchise, as a market-leading innovative franchise versus how maybe perhaps the competitors are positioning themselves.

Could you also address how the dura seal [ph] liquid product might affect, whether that would be a help or a hindrance? And if in some accounts, if it would be used instead of, instead of in addition to, could that be another round of competitive evaluation period for that one?

Well, we're certainly not underestimating the importance of the dura seal [ph] product, although candidly, we're not sure whether it is a help or a hindrance. In as many accounts -- well, first of all I don't think I can think of accounts who have seen it yet, but in terms of our dialogue with surgeons at the AANS and what we're hearing anecdotally, there is certainly the potential that it is actually a help. Remember, the product is not approved for the spine. And is also only approved as an adjunct to an existing graft to get to a -- to get to a water-tight seal. So we don't view it as competitive with our bread and butter dural grafting business, which is closing larger holes.

The place where it could be competitive would be in nicks and tears, but that that is a relatively small part of our business. So all in all, it is hard to know whether it will help or hurt. I think that's got to play itself out. But at the moment, we're not expecting any significant impact from it.

Thanks. In those accounts, where they decide eventually to stock both Integra and a competitor, is it more Medtronic or is it more J&J?

That again is hard to say. It is a little bit of both.

Okay. Let me go on, if I could, to the Newdeal part of the business. You said that you've now become a bit more conservative with the SG&A guidance because of the cost of recruiting top-flight sales people and so forth. Is this something we should view as just a one-off unusual because it is a European company and out of the 20 or so acquisitions you've done, this one is different fundamentally in some way? Or is this something where new acquisitions going forward, we should be looking at a little bit of a higher SG&A integration cost because of the size that Integra has now become and so forth?

Let me clarify it. Because I certainly don't want to -- or did not intend to imply that Newdeal was the significant impact on our SG&A. We put in an ERP system in August of last year. We went live in August of last year. And have over the last three quarters continued the implementation of that system. We also moved our distribution facility from New Jersey to Reno, Nevada, and in the first quarter, consolidated our European distribution into Andover, England, from several of our other sites.

There were significant costs associated with that, which we showed in our adjusted -- in our adjusted analysis. On the other hand, it just cost more than we had anticipated and we expect it to cost more than we anticipate, and so we've built that into our guidance. The point on the reconstructive is, we did not throttle back on growing our reconstructive business and in fact continued to invest in our neuro business. And when all of those things added up, it added up to more than we had hoped to spend in the quarter. So rolling that forward into the second quarter, our objective was to not have any lack of including that in our guidance, and so we adjusted our second quarter accordingly.

Now, as we grow, we see no reason that our SG&A needs to remain at -- slightly in excess of 36%. And so we expect that to come down through the year, as a percentage basis, and we expect to grow our way out of it. And so what we tried to get across in the guidance was A, that there was one-time costs from the Newdeal acquisition, including the step-up of inventory, which we showed you, including the unwinding of the collar which showed up in the other income line, and then some integration costs. That accounted for about $0.01 when it all added up on an after-tax basis. The other costs were real. An we expect them to recur in the second quarter, but we expect to grow out of them as well. So I would hate to blame it on Newdeal, because it is really just a series of specific items which add up to being significantly higher than we expect it to be in SG&A.

I get that. So the series of items, part of it was Newdeal. Is the fact that Newdeal was more expensive than you anticipated, would that have any impact on the rate at which your next few acquisitions are going to happen? In other words, for those of us who are modeling additional acquisitions, should we interpret the that that Newdeal overran a little bit meaning that there is a little bit more integration work to be done, meaning that integration will take a little bit longer, meaning that perhaps you'd wait a little bit longer than you otherwise would to make your next acquisition, or is that reading too much into it.

I think you're reading too much into it. I don't believe that these activities were unique to Newdeal as an acquisition. No, and frankly, as I pointed out in my guidance, Newdeal performed very well for the quarter and it performed very well, both in terms of the revenues, the gross margin that it afforded us, as well as the infrastructure costs. It is just the combination of all the activities that we're doing at once just added up to a higher SG&A.

Keep in mind, our performance this quarter in terms of the gross margin was substantially higher than we expected. And to some extent, that came from Newdeal. It was really the SG&A that came in poorer than we had hoped.

And my last question, on the Medtronic matrix that you're getting there for Enfuse, at one point you'd indicated that there will be a renegotiation of that contract at some point that would get you better terms so there could be a step-up in the -- even though it is a highly successful product and it is growing, there could even be a step function in your portion of that because you would be able to renegotiate the deal. Can you say when we might be able to see the impact of that, of when that's going to happen?

I would say that -- there is no renegotiation going on. We did get a price increase from them last year as part of some -- maybe that's what you're thinking of, as part of some of the dialogue we had with Wyeth, actually, not with Medtronic, but Wyeth and we provide that product to Medtronic. We do see the opportunity as the business grows to improve the product and to work with Wyeth and Medtronic to improve the product and there certainly are development activities underway an those would lead to higher transfer pricing. That would not be in any numbers we've given this year, and I wouldn't expect to see that this year. As you go into the 2006 and beyond, we certainly intend to work with them to improve the product as well as the transfer pricing.

Thanks a lot, Stuart.

Thanks.

Thank you. Our next question is comes from Bill Plovanic with First Albany Capital.

Hi, Bill.

Great, thank you. Good morning.

Good morning.

A couple of questions. First of all, the cranial fixation systems was moved from Private Label up to OR or Implants. What type of contribution did you get from that this quarter?

Very little, Bill. A move would be a compliment. No, that -- we should have -- and a little bit, this is to the point I've made about where we are in R&D. With the promotion of Simon Archibald and the recruitment of John Barrett, and the impact that Gerry Carlozzi is having on the business, we are going to have better performance in our product development activity. We just launched, in a significant way, the cranias [ph] this year. So there was no benefit in terms of revenues shown up in the Implant line, but we did get the negative impact of that OEM contract. So that was a little bit like the NeuroSensor. That was not a tremendous success in our product development activity.

That being said, we are out in the market with a newly redesigned set, and we will see the impact of that, positive or negative, in the next couple of quarters. But -- and we say positive or negative, either zero or positive, but we just took it on the chin on that product line.

Okay. And then if -- was DuraGen -- it looks to me like DuraGen was just slightly down sequentially. Is that pretty fair?

As you know, Bill, we don't give out our DuraGen numbers. The only thing we're going to say is that it was not at or in excess of our 18% long-term guidance. I do not want to get into giving out the DuraGen number, either on a sequential basis or on an absolute basis.

Okay. And then the R&D rate was a lot lower than what we were looking for and you did say it is going to be, I think it was 5% or so, going forward.

Our guidance was 5 to 6%. That is identical wording to last quarter. There is no change in our point of view on R&D, Bill. You'll see the pickup in R&D as we start to scale up the adhesion study. If you recall, we said on the call that it would -- last quarter, that it would be our ambition, and it would be a challenge to get the 6%. Given the various activities that we're doing. The way it is going to get there, as we start to roll into 2006, is the impact of the adhesion study, which is not insignificant. Remember we said that would be a cost over the two to three-year period of the study of anywhere between $8 and $10 million. And as you model going forward, certainly as you get to the -- toward the tail end of this year, and more importantly into next year, are you going to see that 5 go up towards 6.

Okay. And then have you gained any IRBs in starting enrolling patients yet?

Not yet. And the plan wasn't to do so. Remember what we said. We would expect to start the study at the end of this year. All the activities right now -- I'm sorry, let me be clearer because the guys here are looking at me. We would start the enrollment at the end of this year. So all the activity right now is on the development of the protocol, the identification of the different surgeons, we pretty much know who we're going to work with at this point, the next step would be them working with their own hospital IRB and us in our dialogue with the FDA, we've already had contact with the FDA on what the study would look like.

Okay. Two questions and then I'm done. I think for David, the cash tax rate is roughly what?

It is still in the -- just under -- just over 10%. About 10 to 13%. Depends on -- I mean it is an annualized rate so it would be 10 to 13.

Okay. And then if I look at the guidance, just to kind of reiterate what you're telling us, is that you're basing -- I mean your expenses were up about 1.8 million sequentially in SG&A -- or higher than what we were looking for in the SG&A line. And that is just the cost of the business, but you would expect that to be kind of more of a fixed type of cost and grow into it in the back half of the year?

Yes, said differently, we had approximately $0.5 million of integration and acquisition costs this quarter, plus the 300,000 impact from the purchase accounting, plus the $200,000 impact from the Newdeal hedge. So you add all that up it is about $1 million of costs that really didn't -- it won't go into the forward spend.

Over and above that, the spending around our ERP system, the expansion of our European and U.S. distribution and customer service activity, the integration of our facilities also exceeded our expectations. For example, we hired, when you include the new reps and the infrastructure people, close to 100 people in the first quarter. Our recruiting costs, which were one time, were close to $0.5 million. Combine SG&A costs were 36%, with much larger proportion of revenue than usual and so we're targeting that expense to come down into the range of 32 to 34%, essentially like you said, Bill, as we grow out of them. But we're not expecting them to go down absolutely. We're expecting, as the business grows, to grow into those, and end up in a 32 to 34% SG&A range. Obviously, it will be 34 before it is 32.

Okay. And, David, can you split out what sales and marking was and what G&A was in the quarter?

We are not going to do that this year. We stopped allocating certain costs within the group so it is not even really a meaningful number. There is a whole set of overheads around the infrastructure, the facilities, and the ERP system, stuff like that, that we just -- we eliminated allocating, so I couldn't really give you a good comparison.

As you know, we stopped at the end of the fourth quarter last year, breaking out the two. And just to give you a sense for why it is not meaningful, a number of the European P&Ls would allocate the leadership group in the European entities as G&A, when actually most of what they do is sales and marketing, and the U.S. is the opposite. It is just a meaningless -- it is just a meaningless distinction at this point. So we're not breaking it out.

Okay. Thank you very much.

Thank you. Our next question is coming from Chad Suggs with CIBC World Markets. Please go ahead.

Good morning, guys.

Hi, Chad.

I was wanting to know if you could provide a little bit more color. Obviously, you lowered the revenue guidance by, I believe about 7 million for '05. Can you kind of give a little bit more color about where that is -- where that is really being taken out of? I mean are you continuing to expect lower DuraGen sales, obviously the next couple of quarters, and obviously neuro monitoring but I just wanted to see if you could provide a little bit more color on that.

What we tried to do in breaking out the ranges for our 2005 model, with the 112 to 117 for Implants, and the 98 to 101 for Instrument, and the 50 to 52 for Monitoring, and the 23, was to do that for you, and you will see as you compare it to our guidance that we gave last quarter, the most significant impact is on the Monitoring. We brought Implants down, I think a million or two, we brought Instruments down maybe one. Private Label actually went up one.

So the biggest impact is on the Monitoring. And, the problem with the first quarter guidance is when you then perform differently than the first quarter, you got to roll that through the rest of the year and so we can't say well we came in at a 2% growth on monitoring in the first quarter and voila, it is going to up in the second quarter. So as we rolled that through the year, we thought the most prudent thing to do was to be more cautious on the revenues. But the biggest impact is Implants.

And again, we don't expect DuraGen to be down. What we said was that the growth was not in line with the corporate growth rate this quarter. But on the other hand, the skin and NeuraGen, which by the way, keep in mind, not only are they growing fast, they're getting bigger. And so that growth and that fast growth will continue to have more and more of an impact on our -- on our numbers going forward. So don't underestimate the positive opportunity from our skin and nerve product lines.

What are you expecting for DuraGen in your estimates for the next two quarters? Are you expecting it to be above or below your growth, corporate growth rate?

Again, I would prefer not to sort of play -- to play out for you the actual numbers. Certainly, we're not assuming in the current quarter, if we were below the corporate growth rate, the second quarter to somehow reaccelerate, because we said we were going to continue to fight these battles for a little while.

Okay. And then on the Monitoring business, when do you -- you said in the second half is when you would expect to see a pickup. When is the new LICOX -- is that going to hit in the third or fourth quarter?

The cerebral blood flow monitor is in the process of being launched as we speak. So to actually see an impact is unlikely in the second quarter. You will see the bulk of the impact as we get into the third and fourth quarter.

Okay. And then what was the foreign exchange in the quarter?

Hang on one second and we will give you that. I've got it. In the first quarter of 2005, approximately 23% of our product revenues were generated in foreign currency, principally the Euro and the pound as compared to 16% in the first quarter of 2004. Approximately 45 to 50% of our cost of goods. And 25% of our operating expenditures are generated in non-dollar, in Euros and pounds.

The weak dollar had a favorable impact on revenues for the first time of 375,000, but on the other hand, because five of our facilities and close to 300 of our employees are European, and because we purchase our instruments in Germany, the negative -- it was a significant negative impact year-over-year of the Euro that obviously hurt our P&L. The purchase of Newdeal is a very positive aspect of that, because since it is a very profitable business, and its profits are counted in Euros, it will, going forward, help us hedge some of the Euro expense, or the natural hedge in the Euro expense in our P&L.

So note that we're up to 28% OUS in our sales. Now, most of that did come from the two acquisitions we did in the last 12 months of non-U.S. businesses. But one of our objectives has been to scale up our European sales and marketing infrastructure, and having those revenues does support a larger sales and marketing organization, which we've also been in the process of building and integrating with Newdeal in the first quarter and going forward.

Okay. And then my last question is as you -- for the accounts that are trialing DuraGen, how -- when you say the reps are refocusing on main accounts or on existing accounts, I should say, what is the -- I mean can you provide more detail, what exactly are they doing? Are they just trying to counter-detail the other products? Are they trying to sell the DuraGen Plus? What -- can you provide some more detail there? And then can you give any anecdotal feedback on what doctors are saying about the other products?

Well, again, in terms of what the reps are doing, they're making sure that they are very knowledgeable of whether there is any either pending or ongoing competitive activity in their large and, frankly, every account. They are making sure that they understand each of the surgeons. Remember, there could be anywhere from 5 to 20 neurosurgeons. Each of whom has some impact on choice, making sure they are redetailed on DuraGen. They're working with purchasing and with the materials management to upgrade the DuraGen to DuraGen Plus. And also, to try to develop a multi-line strategy, leveraging our broader portfolio, both in neuro and outside of neuro, of products.

They are, as we speak, brings in suturable DuraGen, which is a significant improvement and helps position us in particular, vis-a-vis the Medtronic product, as their product is both suturable and onlay, and also positions us versus the J&J product which is not suturable. And that, I would say, is the bulk of their activities. They're also working to segment the market so that if there are two grafts on the shelf, one is DuraGen, and the other is either DuraGen suturable or Endura, as opposed to some of the competitors' products, including the suturable-only products.

The other thing, obviously, that they're working on is expanding the use in particular, targeting spine. We brought in, in addition to our marketing department, to focus on DuraGen spine, and obviously, we're learning more about the spine market, as we get ready for our adhesion trial in the new year. So those are the major activities.

Anecdotally, nothing has changed in our point of view on the competing products. And in particular, the long patient history over 350,000 implants. The clinical study that we have, that neither of our competitors have. The substantial sales organization, which is larger than our competitors' sales organization, and the differentiation of our products in terms of segmenting the products so that we have multiple products, multiple sizes, and therefore, can outmarket our competitors. Those are the activities that you're seeing in duraplasty.

Great. Thanks.

Thank you. Our next question is coming from Robert Goldman with Key Corp. Please go ahead.

Hi, Bob.

Good morning, Stuart.

Good morning.

A couple of remaining financial questions and then one product question. On the impact of this foreign exchange hedge contract, I think I heard that any impact from this is now gone. Is that correct?

Yes.

Going forward, that there is no impact from this hedge contract that you had acquired from Newdeal?

Correct. And let me just be clear. Because we didn't acquire it from new deal. What happened is because we paid 38.5 million Euros for new deal, we bought a hedge contract to hedge that significant Euro commitment. We bought it in the fourth quarter.

We actually booked a gain in the fourth quarter, but because of the move in the Euro, literally in the first three days of the quarter, before we closed on Newdeal and closed out the hedge contract, we actually bought a couple hundred thousand dollar loss in this quarter. So in the prior quarter, there was a gain. In this quarter, there was a loss. Both of them are reported in the other income line.

Any outstanding hedge contracts that we should be aware of that could impact earnings per share by more than $0.01, plus or minus, going forward?

No. We do not have any foreign exchange hedges. In fact, the Newdeal hedge was the only hedge we had on. And obviously, in the last year, one of the things that has negatively impacted our numbers has been the impact of the Euro because we are unhedged. And our costs are still exceeding our revenues in Euro. Even after Newdeal.

Then the add back of this after-tax interest expense, I assume, but wanted to check, that this is the impact of this EITF-04-08?

Yes, correct. Again, in our -- yes, in our adjustments that we showed, there was no impact of that -- the hedge. The add back to get to the earnings per share calculation is the impact of the convertible security and backing out the interest on that convertible security. There is no change in the way we treated that from the prior quarter.

Then on -- as you mentioned in the press release, your '06 guidance does not include the expensing of stock options, but I would suspect you've now gone through that calculation given that to delay '06 is a recent phenomena. So what will be the impact in '06 of the expensing of stock options?

Again, like most companies, we don't have a forward-looking statement to that effect and don't plan to until probably the end of the year. That being said, probably the best estimate for the impact of expensing stock options is provided in our pro forma net income that we provide in the notes to our financial statements, so you can find it in the Q. For the first quarter of 2005, if we had expensed stock options according to FASB 123, the impact would have been to reduce our diluted earnings per share by $0.05 but we don't have any forward-looking guidance on this topic.

That $0.05 is for the quarter or the year?

Correct, for the quarter.

And then the product question is, there is this angiogenesis inhibitor that Merck is developing, and I gather in part based on Integra technology. Any insights on that? Especially as we're getting close to ASCO? You know, will there be any data presented at ASCO? Any updates on that project?

I have no updates on that project, no. As you know, we actually took this case to the Supreme Court this quarter. We will probably get a response before the end of the second quarter or into the third from the Supreme Court. But I have nothing to report on other than the court case.

Nothing to report on the product development side as well?

Correct.

Okay. Thank you.

Thank you. Our next question is coming from Jayson Bedford with Adams Harkness. Please go ahead.

Hi, Jason.

Hi, Stuart. Just a few quick questions for you. Just in terms of intra-quarter revenue, you issued guidance in mid-March, was there anything that happened late in the quarter in terms of a significant order that we -- that you missed? Or could you just talk about the visibility given that the guidance was given so late in the quarter?

Well, first, no, there was no significant order missed. Second, keep in mind, we came -- our original guidance range, we came in the bottom half of the range. And certainly with two weeks left in the quarter, there always are significant sales in the back half of the quarter. Certainly those could have been higher, and therefore could have gotten us to the high end of our range. But no, there is nothing unique or specific, except that obviously they weren't as high as we would have liked.

Okay. Fair enough. Of the 9.4 million in acquired revenue, can you break that out between the four categories there, just so we can get a better look at organic growth on a category basis?

I don't think we have numbers prepared to do that on this call, but keep in mind, we said that Newdeal revenue -- we try to be helpful in that regard. We said that Newdeal revenues for the quarter came in, what was it, Dave, at 4 --?

4.5.

4.5, so you can certainly back that out. The bulk of the rest would be -- is in instruments.

The rest is in instruments?

Yes, and it is either going to be the Mayfield or the Bertle. So you can actually solve for that. I don't have the numbers, I mean we can do the math, but it is either in Instruments, which is Bertle or Mayfield or it is in Implants, which is the number we gave you for Newdeal.

Okay. That's helpful. And can you just comment, your expectation for market growth in the duraplasty market, cranial and spine, for '05, from a market standpoint?

Boy, that's a hard one. I don't think anything has changed from what we said in the past. We think it is $120 million market, and about half of the market is unpenetrated because of the opportunity to take you otologist grafting. So we continue to have the leadership position. We don't see big numbers for our competitors. And the opportunities to keep taking share from suturable only, in the market that already exists for off-the-shelf products, and driving the use of product instead of otologists.

If you want a positive statement there, it is certainly useful that we are now marketing a suturable DuraGen product, because there is a group of neurosurgeons who like using the otologist product because they can suture it into place and like the fact it is the patient's own tissue and remodels into the patient's own tissue, and no matter how hard we push sutureless grafting, there is always going to be a group of surgeons who say, I still want to suture. And now they can do both.

And in fact, if you saw our advertisement at the AANS, we sort of highlight a product that is sutured on one side and sutureless on the other to make the point. This new product that we've got is both an onlay graft and will act by fibrin clot, but is strong enough to suture into place, and we can take, we believe, significant otologist share.

The other thing is the spine and we are on label for spine. So it is just a question of continuing to drive our group to penetrate into the spine. We get a bigger market opportunity as we get the label for adhesion prevention. But that's a few years out. So what we're really talking about is further penetrating what we think is a $120 million market and as I said, we don't see significant impact on ASPs, so we don't see the market dollar shrinking.

Is it fair to say though that maybe a 20% grower? In terms of the conversion?

I don't have a way to answer that, Jayson, that is not just seat of the pants.

Okay. That's fair. And then maybe finally, can you just talk about the cross-selling of DRT into the orthopedic channel in terms of your DRT sales in the quarter? How much is it to orthopedic surgeons versus the burn unit?

Well, what I would say, I mean you're asking actually a question that I would rather answer with a little bit more detail, which I think will be helpful. First of all, burn units, there are over 100 burn centers in the United States using Integra skin. And it really is the proven and well-established market leader in burn units. The -- that being said, our dermal repair products were up 56% over prior-year period, and we have not suggested that the burn market is growing. So all of that is coming principally from reconstructive surgery sales.

Now, foot and ankle? No, we're still getting the benefit of last year's expansion of our sales force into reconstructive surgery, and the continued drive of BMWD into restruction and wounds. As I understand it, we added 50 accounts in the first quarter for the BMWD product, up 20% over the prior quarter. So we're adding a lot of new accounts now for BMWD.

Also the launch of Integra TS, which is just a product enhancement over the BMWD, that has a price increase built into it, and that is rolling through the rest of this year, even if it is just used in burns. So I would say the combination of last year's launch of BMWD, the larger sales force, and then the Newdeal as something for these guys to now go on a focused call point to foot and ankle, all of those are really very synergistic. But the bulk of our sales people selling effort is selling reconstruction, not burns, and you're seeing a it pay off.

The other place that's true is in NeuraGen. I don't want to repeat what I said last quarter, but we've not yet encountered a foot and ankle surgeon who hasn't been quite enthusiastic about the NeuraGen product, and we are definitely seeing cases now of folks who we only encountered because we were in there converting their Newdeal business to us, who got interested in the nerve guide and did a surgery with it. So there is definite synergies there.

The other thing that is intriguing to the foot and ankle surgeon is our NeuraWrap product, which can be wrapped around a nerve and doesn't -- is not only designed for completely severed nerves.

Great. That's helpful. And then finally, when are you launching the new drainage line?

The new drainage line was launched at the AANS, I think we have by now five or six accounts converted in the last month.

Thank you.

Thank you. Our next question is coming from David Zimbalist with Natexis.

Most of my product questions have actually been answered. Just one quickie and then some financial questions. In terms of your collagen sponge sales to Medtronic, has there been a change in the relative mix of the royalty component and the sponge transfer pricing component over the last couple of quarters?

We're looking at each other. Nothing that we can think of, no.

Okay. Great. Second, can you tell me a little bit about why gross margins throughout 2005 at this point, you're essentially saying that there is very limited incremental growth in terms of your guidance at any rate. And what might be driving that sort of limited sequential growth?

I don't think we're implying -- well, I think for modeling purposes 64% is right. There could be some upside there, but given that we were not happy with our SG&A number, we didn't think that the thing to roll into was to talk about upside in our gross margin, but there is certainly potential for that. It was a solid first quarter. And there is no reason to think it would go anywhere but flat to up.

Okay. And what would be the -- assuming it is up sort of bit by bit for the rest of the year, what would be the primary driver of the step-up into 2006?

Implant sales. Anything we sell that's tissue engineered and now I would say also Newdeal, those are all higher margins than our 64% target for this year and even our 66% target for next year.

So basically everything --

The nice part of our model is that the fastest growing part of the Implant, part of the business, is the Implants, and it's got substantial margin leverage.

So essentially --

And NeuraGen and skin and hopefully Newdeal are becoming increasingly important parts of that margin expansion.

Okay. So essentially all the second half new product launches with the exception of the blood flow monitor, are enhancing the margin as you go into 2006?

It is the combination of growth in existing products, and continued launches of products that you know about, including NeuraGen, NeuraWrap, Newdeal in the United States, DuraGen suturable, it is not some unknown new product launch we haven't talked about in the back half of the year, no.

And then the last question, DSOs, can you talk -- you talked about international being a big contributor to the [inaudible], can you talk about what is going on with your U.S. DSOs, in particular as it relates to your ERP conversion as well as your -- as well as your product is sales mix and what not?

Well, the good news is our U.S. DSOs were down one day. We expect them to continue to come down. You're definitely right that ERP conversion has pushed up, I mean, we've run the company on the AR and inventory side very tight over the last several years. And this ERP conversion, as well as the significant restructuring activity that we have both -- we have done and have been scaling up to do, that has driven up both our AR and our days of inventory outstanding, and we absolutely remain committed to getting them down.

In the case of the DSOs, I certainly hope we're on track to reduce them. Keep in mind as David pointed out, though, earlier, with 28% of our sales overseas, the number of DSOs should go up, and if you recall a few quarters ago, we said one of our objectives was to get the number of DSOs up, obviously not as an independent objective, but by driving our percentage of sales overseas. So we do expect and hope that the DSOs will come down, but that really is as a result of getting our U.S. AR back to where we want it to be, post the impact of our ERP conversion. And candidly, we're still seeing that impact in the first and the second quarter.

But a positive statement is the DSOs in the U.S. were actually down a day, and what drove the DSOs to be up as a company total of one day was the two-day impact of the 28% of sales which is overseas. A little bit the same story with -- keep in mind, our DSOs, we have objectives and the objectives are lower than these, but if you put us against our comparables in the medical device industry, our DSOs are good. It is just that nobody likes to see DSOs go up, including this management team.

Same thing is true for inventories. Our inventories are high. We are not happy with where they are. A chunk of that is the inventory we're putting out in the field for the launch of Newdeal here in the United States. Another chunk of it is the impact of some of the restructuring activity. We certainly -- when we have been shutting sites, we certainly have built up inventory in anticipation of that, and you saw that happen with the shut down of our Pembrook site. It is happening in the shut down of our neuro supply site. And as we do -- and if we do our restructuring activity you will see that happen. Again, 240 days, I don't like, but it is not different than most of our medical device peers.

Okay. Also your DSOs by segment, are they also similarly adjusted fourth quarter versus first quarter?

We don't produce DSOs by segment so I can't answer the question.

Okay. Thanks.

Thank you. Our next question is coming from Glenn Novarro with Banc of America Securities. Please go ahead.

Thanks. Stu, as expenses kind of climbed in the quarter, such as for ERP, as those expenses started coming in higher, did you look elsewhere in the organization for potential cost cutting? Is there anywhere else in the organization for headcount reduction? Or more plant consolidation down the road that could help offset some of these higher expenses if they continue to climb a little bit out of control? Thanks.

Let me answer the question in two parts. First, during the quarter, we felt it was appropriate to continue making those investments in all the transition and, I.T., and customer service, and distribution, we felt it was the right thing to do. And we also felt that we wanted to continue to reinvest in the growth of the recon. All of those things did lead to expenses in excess of what we had hoped to achieve.

Is there room to do additional restructuring in this Company? Absolutely. And obviously, that's something that we've always looked at. We've not been shy about reducing head, and we've not been shy about reducing sites here in the United States. And we will look hard at our expense structure and get it into line.

That being said, we do believe we have so much opportunity on the top line, and our margin opportunity, particularly when you talk about selling another piece of Integra skin or another Newdeal implant, or another piece of DuraGen, is very high, and so what we tried to balance, and you see it in our days of inventory, is the need to have product available, and not do things that in the process of taking out costs, have a negative impact on the revenue line. And that's the fine line that we're walking, frankly that fine line led to too much expenses in the first quarter in the SG&A line. But yes, I -- again, we've shut a site about once every three to six months here at the Company, and we have 15 sites.

Is it fair to say then, Stu, that you know of the proper levers to pull within your P&L going forward so that we don't have to face another situation where numbers have to come down?

Certainly, that's our objective, and we were disappointed with where the SG&A came in in the first quarter. And we intend to make sure that we are efficient. And you see in our forward-looking guidance an expectation of SG&A back in the 32 to 34% range, and certainly, we don't expect to see that come out of our sales and marketing activities.

Okay. Great. Thanks, Stu.

Thank you. Our next question is coming from Alex Arrow with Lazard. Please go ahead.

Thanks. The date of the announcement of Newdeal, which is about six months ago, I think is the longest that you've gone since you've been CEO of Integra in between announcing additional acquisitions. Can you comment on that pattern?

A, I don't know the answer, but everybody in the room here is shaking their head saying probably not. I think we went a year without doing acquisitions or nine months a couple or three years ago, Alex. I hope you and others realize it is not like we've got a chalkboard on the wall that we're trying to knock one out every quarter. We are aggressive in our acquisition strategy, but the objective is to run the business strategically and to do acquisitions that are accretive to our earnings, and build our organization.

We certainly have done a number of European acquisitions in the last 12 months to achieve one of our objectives, which is to have a significant and -- both significant presence and opportunity in Europe, but on the other hand, I think last year, we did four deals, not including Newdeal. Newdeal closed in January. It has been four or five months, but we're not letting up. There is plenty of deal activity. And again, there is no plan to either accelerate them or decelerate them. I think the right way to look at it is we have a core competence in doing them and, therefore, you should continue to expect us to do them. We don't -- even despite too much spending in the first quarter, that's not a reason to not do acquisitions, nor is it a reason to rush around and do more of them.

Okay. Okay. Thanks, Stuart.

Thank you. Our next question is from Chad Suggs with CIBC World Markets.

Hi, Chad.

I had just one quick follow-up and I apologize if I missed this, but I guess I was surprised to see the Instruments guidance come down. I mean you had a strong growth of JARIT. I just didn't see anything or -- that would be a reason for your Instrument guidance to come down.

We did have a really strong JARIT. I just think -- I don't have a specific answer. I think it came down by like $1 million or $2 million, and it is just -- we roll up this model every quarter, we look at where we're at, and my hunch, and I really do not have a good answer for you, my hunch is we probably took a little bit out of the activities of the neuro group, selling instruments, because the bulk of their focus is on driving DuraGen and Instruments is something they do in their spare time. But I would not put any particular stock in any particular activity.

Certainly, our various components of the Instrument line are do doing well. JARIT is doing well. Mayfield is doing great. Neuro Instruments is not particularly interesting right now, but no particular reason. I can't give you a great answer, Chad.

How about apirators, ultrasonic aspirators? Are those still continuing --?

They seem to be doing just fine. It was a good quarter for aspirators, it was not a bad quarter.

Okay, great. Thank you.

And there appears to be no further questions at this time, I will turn the floor back over to you for any further closing remarks.

Thank you, everybody an we look forward to seeing you on our next earnings conference call.

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