Integra Lifesciences Holdings Corp (IART) 2005 Q4 法說會逐字稿

Good day, everyone, and welcome to the Integra LifeSciences Holdings Corporation 2005 fourth quarter and year-end earnings conference call. I would like to turn the call over to Mr. Stuart Essig, President and Chief Executive Officer. Please go ahead, sir.

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 David Holtz, Senior Vice President - Finance, Jack Henneman, Chief Administrative Officer, Jerry Carlozzi, Chief Operating Officer, and Maureen Bellantoni, Chief Financial Officer. During this call, we will review our financial results for the fourth quarter 2005, which we released yesterday afternoon and our forward-looking guidance for first quarter 2006 and full years 2006 and 2007. 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 contents 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 will be available starting one hour after the conclusion of the live event. Access to the replay is available through March 20, 2006, by dialing 719-457-0820, access code 3248191, 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, March 6, 2006. Unless otherwise posted or announced by Integra, the information in this call should not be relied upon beyond March 20, 2006, the last day that an archived replay of the call authorized by Integra will be available.

Certain statements 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, 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 including -- included in the business section of Integra's annual report on Form 10-K, for year ended December 31, 2004, and new information contained in our subsequent filings with the Securities and Exchange Commission. That's forward-looking statements are made based upon 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 yesterday, which is available on our website in the press release section, under Investor Relations.

Thank you, Jack.

We achieved record revenues in the quarters. Total revenues in the fourth quarter of 2005 increased by $11.2 million to $73 million, an 18% increase over the fourth quarter of 2004. Total revenues for the full year 2005 increased by $48.1 million to $277.9 million, a 21% increase over the prior year. Excluding recently acquired product lines and changes in foreign currency exchange rates, fourth quarter revenue increased by $7.2 million, or 12% over the prior year period. Changes in foreign currency exchange rates had a negative impact of $900,000 on our quarterly year-over-year revenue growth.

We reported net income of $10.6 million, or $0.33 per diluted share for the fourth quarter 2005. When adjusted for certain restructuring related charges, net income for the fourth quarter of 2005 was $12.1 million, or $0.37 per diluted share. Praying income was $14.9 million for the fourth quarter, and 56.1 million for the full year 2005. Restructuring-related charges reduced our operating income for the quarter by $2.1 million, and for the year by $7.6 million.

Our implant revenues in the fourth quarter increased 43% over the prior year period. Sales of our reconstructive surgery product grew particularly well. Rapid growth in the NeuraGen Nerve Guide, the Integra Dermal Repair products and sales of Newdeal products for the foot and ankle accounted for most of the increase in implant product revenues. Integra Dermal Repair product revenues increased approximately 86% over the fourth quarter of 2004. Nerve repair product revenues increased by 55% and our Newdeal foot and ankle products achieved record revenues of $4.8 million in the quarter.

We continue to be very pleased with the progress we have made since we launched the Newdeal product in the United States since last March. We have now opened 400 U.S. Newdeal accounts since we began selling the products, adding 50 new accounts during the month of December alone. Our U.S. reconstructive surgery group now includes 52 sales professionals.

Our DuraGen family of duraplasty products continues to grow, although at slower rates than in recent years. Sales of the DuraGen Plus and suturable DuraGen Dural Regeneration products led the growth in sales of this group of products. Monitoring revenues in the fourth quarter increased over the prior year period by 4%, an improvement over the last several quarters. Increased sales of our intracranial monitoring products, drainage systems and cranial access kits accounted for the increase in monitoring product revenues.

Sales of our Licox brain oxygen monitoring system product line increased approximately 39% over the prior year period. We have developed a new targeted account sales and marketing strategy for products in this category and we expect that it will continue to contribute to improvements in the performance of our monitoring product in the future periods. Our private label product revenue in the fourth quarter increased over the prior-year period by 13%. Increased revenues from the absorbable collagen sponge that we supply for use in MedTronics infused bone graft product led the growth in revenues of our private label product.

Our gross margin on total revenues in the fourth quarter of 2005 was 61%. Although we had strong growth in higher gross margin products, we incurred $1.3 million in restructuring and manufacturing transfer costs. That's charges reduced our gross margin by approximately 2%. Selling, general, and administrative expenses increased by $5.4 million to $25.7 million in the fourth quarter of 2005. Increasing as a percentage of revenue to 35%, from 33% in the prior year period.

This increase was primarily attributable to expenses of acquired operations, as well as the further development of our European infrastructure. The increase included approximately $752,000 of charges associated with the closing of various facilities, and related transitions, employee terminations, and other acquisition integration and restructuring related costs. These charges increased selling general and administrative expense by 1% of revenues.

In December 2005 we established a $200 million five-year senior secured revolving credit facility. This new line of credit provides us with increased financial flexibility and access to capital to support the Company's continued growth. The credit facility currently allows for revolving credit borrowings in a principal amount of up to $200 million, which can be increased to $250 million should additional financing be required in the future. We plan to use the credit facility for working capital, capital expenditures, share repurchases, acquisitions, and other general corporate purposes.

In January of this year, Maureen Bellantoni joined Integra LifeSciences as Executive Vice President and chief financial officer. Maureen joins with more than 20 years of experience in finance, accounting, and operations. Most recently she served as Senior Vice President and Chief Financial Officer of C. P. Kelco from 2003 through its sale to JM Huber. Maureen will be focusing on all aspects of our financial organization. I look forward to working closely with Maureen as together we continue to build Integra, through internal development and strategic acquisitions.

We continue to realize the benefits of the Newdeal acquisition. 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 surgeons who treat chronic wounds every day. 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 are the most compelling suite of product sold to foot and ankle surgeons. Our Newdeal foot and ankle products achieved record revenues of $4.8 million in the quarter.

International sales were 25% of total sales this quarter, compared to 21% of total sales for the fourth quarter 2004. We continue to make progress in restructuring our European operations. We closed a German facility during the fourth quarter of 2005 and continued the restructuring of our manufacturing operations. We also continued to build our sales and marketing organization in Europe, opening a sales office and adding nine direct reps in Germany, expanding our Belgian operations and adding several additional marketing people in France. Overall in 2005 we nearly doubled our headcount committed to European sales, clinical and marketing activities.

After the market closed on Friday, we closed the acquisition of Radionics, a leader in the design, manufacture, and sale of advanced minimally invasive medical instruments and systems for radiation therapy. The transaction represents an ideal strategic fit for Integra. Product include the CRW stereotactic system, the XKnife stereotactic radiosurgery system, Omnisight EXcel image guided surgery system, and the CUSA EXcel ultrasonic surgical aspiration system.

As part of the transaction, Integra has assumed the lease on the Radionics facility in Burlington, Massachusetts, approximately, 135 employees, and has entered into a transitional supply and distribution agreement with Tyco Healthcare for products currently manufactured at Tyco's facilities not included in the transaction. Tyco Healthcare sold the Radionics products in over 75 countries, using a network of independent distributors in the United States and both independent distributors and Tyco Healthcare affiliates internationally.

We expect the Radionics acquisition to contribute approximately $4 million of revenue for the first quarter of 2006 and approximately $40 million of revenue for the full year 2006. We expect this revenue to be evenly distributed throughout the year, with a slight ramp from Q2 to Q4. Expectations for the contribution of the Radionics business to our revenue reflect the direct impact of the Radionics acquisition and our assumption that our sales force will in some situations sell the CUSA EXcel ultrasonic aspiration system in lieu of our existing ultrasonic aspiration products.

I will now turn continue presentation over to David Holtz, our Senior Vice President of Finance, who will provide more information regarding our income tax rate, interest expense, and cash flow.

Thank you, Stuart.

Income tax expense was approximately 28.4% in the fourth quarter of 2005, or 38.4% in 2004. Both our reported net income and our adjusted net income benefited from a reduction in our effective income tax rate, which decreased to 32.5% for the full year. This decline was primarily related to our ability to recognize net operating losses in a foreign jurisdiction due to the settlement of an income tax audit, tax credits that became recognizable in the fourth quarter, and changes in the geographical mix of our pretax income. We have revised our income tax rate assumption for 2006, which includes the impact of the financial accounting standards statement number 123R to 33.5%.

Our amortization expense for the quarter was $1.5 million, an increase of $313,000 over the prior year period. Our expectation is for amortization expense in 2006 is $8 .1 million, reflecting our initial estimate of $2.3 million of additional amortization from the Radionics acquisition for the remainder of the year. We continue to generate substantial cash flow from our operations. We generated cash flows from operations of $15 million in the fourth quarter of 2005, and $57 million in the full year 2005.

During the quarter, we repurchased 900,000 shares of our common stock, at an average price of $35.21 per share for an aggregate purchase price of approximately $31.7 million. At December 31, 2005, we had cash and investments of approximately $143 million, and $200 million of availability under our revolving credit facility which we established in December. We expect net interest expense for the full year of 2006 to be approximately $3.3 million.

Our board of directors recently authorized to us repurchase additional shares of our common stock, up to an aggregate of $50 million through December 31, 2006. We may repurchase shares either on the open market or in privately negotiated transactions. The weighted average common shares outstanding used for the calculations of diluted earnings per share in the fourth quarter 2005 was approximately 34.1 million shares.

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

Thank you, David.

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 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 acquisitions or other strategic corporate transactions that have not yet closed. Our guidance includes the impact of the just closed Radionics acquisition.

Our guidance for the first quarter of 2006 is for total revenues in the range of $78 million to $82 million, including a contribution of approximately $4 million from the Radionics acquisition. We expect total revenues of between $365 million and $380 million in 2006, including a net contribution of approximately 40 million from the Radionics acquisition, and between 420 million and 440 million in 2007.

We expect that unfavorable foreign currency exchange rate movements will have a negative impact on our revenue growth rates in 2006. If foreign currency exchange rates hold at current levels, our forward-looking guidance anticipates an unfavorable impact on net sales of approximately 2% in the first quarter 2006, and an unfavorable impact on net sales of approximately 1% for the full year of 2006. The Company may incur significant costs this year in connection with restructuring and integration activities, including purchase accounting charges related to the Radionics acquisition. We currently expect these charges to be approximately $2.5 million in 2006.

Our guidance for the first quarter of 2006 is for adjusted earnings per diluted share of $0.34 to $0.36, excluding restructuring and integration charges of $0.02 and the impact of estimated share based compensation expense of $0.07. On a GAAP reported basis, we expect earnings per diluted share to be within a range of $0.25 to $0.27 in the first quarter of 2006. We expect the impact of estimated share based compensation expense for 2006 and 2007 to be in the range of $0.27 to $0.29 per diluted share.

Earnings per diluted share are expected to be within a range of $1.69 to $1.76 in 2006, excluding restructuring and integration charges, and the impact of estimated share based compensation expense. Earnings per diluted share are expected to be within a range of $1.95 to $2.10 in 2007, excluding the impact of estimated share based compensation expense. On a GAAP reported basis, we expect earnings per diluted share to be within a range of $1.35 to $1.44 in 2006 and within a range of $1.66 to $1.83 in 2007.

I would like to take a moment to focus on the expectations for each of our product categories for modeling purposes. Based on our total revenue guidance for 2006, we expect implant revenues of 132 to $140 million, instrument revenues of $148 to $155 million, monitoring revenues of $53 million, and private label revenues of $32 million. Looking beyond 2006, we expect sales to grow in excess of 25% for the implant product lines, and 15% for the remainder of the product lines.

Overall, our expectation for revenues to continue to grow in the range of 20 to 30% per annum. We expect organic growth in excess of 15% per annum. We expect our consolidated gross margin percentage to increase to 65% to 66% of total revenues in 2006 and 2007 respectively, including the impact of purchase accounting related to the Radionics acquisition and share based compensation costs. Longer term, we are targeting SG&A expense of 35 to 37% of total revenues, and R&D is between 5 and 6% of total revenues. These revised targets include the impact of share based compensation charges.

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.

Certainly. [OPERATOR INSTRUCTIONS].

We'll go first to Alex Arrow with Lazard Capital Markets.

Good morning, Stuart.

Good morning, Alex.

If we could start with Newdeal which outperformed expectation doing so well was there something that correspondingly offset that in the product category, since you had the outperformance in Newdeal we would think either artificial skin or shunts or NeuraGen or something else in that category had to do correspondingly not so well, otherwise the whole category would have outperformed. Can you comment on what offset it?

I don't know how to answer that, Alex. I don't think anything in the implant category missed our expectations. So, of course, the guidance that we've been given, then there's the various analyst models. As I reiterated on the call, DuraGen grew, but certainly at lower rates than in prior years. We gave you the dermal repair growth of about 86% and the NeuraGen growth of 56%, and Newdeal really did do well, so there's nothing that went in the wrong direction or went differently than our expectations but perhaps it's somewhat off of your expectations.

okay. That makes sense. You said 86% for the dermal, artificial skin?

The whole skin portfolio. So IMWD, BMWD, IDRT --- we're just starting to -- it's too many little acronyms, so we're referring to them as the dermal repair products, and as a group they were up 86% year-over-year. If I could ask a similar question about the private label products, you have this extra 1.3 million benefit by changing the way you recognize the royalties for BMP, but the whole category of $7.6 million for private label is right in line, and is actually, just like you did last quarter, so was there something else that was 1.3 less? No, I would say in that category there are certain products, because we ship on an OEM basis to a number of companies, there's certain things that did, in fact, slip into the new year that will probably see a little bit of a benefit from in Q1. So that was -- that did, in fact, those did, in fact, offset some of the positive benefit we got from the ACS.

Okay. So the guidance, you broke out what was from -- what you expect from Radionics versus from the rest of the company for '06 and then for '07 you didn't do that. Are you willing to say what you think Radionics will do in '07?

No and yes. Let me try to answer the question. We obviously want to be as helpful as we can in the modeling process for our analysts, and so we've tried to do that by giving you a net number for Q1 of approximately $4 million, then a net number for the rest of the year of an additional $36 million, with the additional guidance that we expect that to ramp slightly throughout the year.

That being said, it is a rather complex analysis that we're doing, because we do expect that while the overall category of powered surgical instruments will go up, there will be some give and take between our historical product lines, for example, Selector and Dissectron, and the new product lines coming from Radionics, including the Cusa. So we don't want to do it for 2007 because it will I think force people to focus on the wrong things. We would rather present the overall impact of the transaction, and not get into what went up and what went down since we are telling our sales people to basically sell whatever the customer wants.

Okay. How about a slightly different way of asking that question? The amount of revenue that it was doing under Tyco, how long might it take before Integra generates the same amount of revenue from Radionics that it was getting under Tyco?

It could take awhile. Let me try to answer the question. Recall that part of what's going on is outside the U.S., they sell direct through their own subsidiaries predominantly, and only about half of the business will go through our own subsidiaries O-US., so quite a bit of the O-US business we will start to back at a 30 to 50% discount off of hospital price.

The good news is we won't have any SG&A spending around those, and Tyco did, because they had a sales marketing and G&A organization in those direct subsidiaries. So it's not going to be comparable, and then you're saying, well, how quickly might it grow, and I think our overall perspective is that we think the business as a whole, so the ultrasonic category as a whole, certainly can grow for us in that range of guidance that we've given for the instrument categories, which is in excess of 15%.

Said differently, the Radionics business generated revenues that were an increase over prior year this year of about 10%.

Okay. Great. If I could ask one last little detail, in vinyl specialties, that's something you acquired about three years ago at this point, and we were looking forward to hearing about the launch of your disposable vertebra plastic product and haven't seen anything or heard anything. Can you give us an update when you're going to be competing in the vertebral plasty space?

The answer is that we haven't launched it yet. We anticipate launching it in 2006, but it has not been launched yet. Needless to say, it hasn't been a high priority for us, certainly there's no significant revenue expectations in our guidance.

All right.

That doesn't many it's dead, it just means it's not a big priority at the moment.

Okay. All right. Thanks.

And we'll go to Robert Goldman with KeyBanc.

Okay, good morning.

Hi, Bob.

Hi, Stuart. On Radionics, it looks like the earnings per share guidance that you are providing includes Radionics top to bottom on the income statement, which is to say sales as well as the earnings impact. But it also looks, at least to me, that there's no, perhaps, earnings impact, net earnings impact resulting from Radionics in '06. Perhaps you could speak to that, and to the extent that, it is your intent to make accretive acquisitions, is Radionics accretive to the bottom line in '06, and by how much?

Okay. As -- first of all, on a stand-alone basis, Radionics is certainly an accretive acquisition. But as you know, no acquisition stands alone, and so we had an opportunity, as we went through our budgeting for 2006 and our business plan, to leverage some of the synergy from the Radionics acquisition into our business plan, and so there are a number of things that we now have the financial flexibility to do, post the Radionics acquisition, that we did not have in our original 2006 business plan.

So what we tried to do, then, is recast our plan, and you are absolutely right, the numbers do include, just so there's no misunderstanding, do include the full impact of all of our plans, including the Radionics acquisition, and as you can see, we brought some of it to the bottom line because we did, indeed, raise our range of guidance for 2006, but we didn't bring a heck of a lot of it to the bottom line. There is an impact in 2007 which is certainly in excess of the impact in 2006. So I guess what I would say is the numbers reflect our best estimate as to, in fact, what we will do for the remainder of the year.

I'd point out one of the things that certainly did limit some of the accretion in 2006 is the closing date on the Radionics deal. Because there's sort of a two-headed aspect to it. First, we don't get a significant amount of accretion in the first quarter from the transaction, because we only closed it a few days ago, and as you know, accretion tends to come toward the back half of the first year of the acquisition, which has now been pushed to some extent into the first quarter of 2007. So net-net, it's definitely an accretive deal, but as I think we said when we announced the deal, we are using the accretiveness of the -- or the accretion of the deal to reinvest in the business, which I hope will drive the top line in the future.

If I could just follow up two things on that, it's quite rational that you would be building an infrastructure to spend away some of that accretion, but could you tell what you say you're building? Then two, on R&D, you've given guidance, although it includes the FASB, of an increase in R&D to sales to the 5 to 6% range. And, of course, that would reverse multi-years of R&D to sales going down. So perhaps you can break out what R&D to sales trends are, excluding FASB, and to the extent some of the Radionics accretion is finding its way into R&D, maybe give us some sense which programs or personnel?

let me try to answer that, and I'll start with the second question first. First of all, we clearly have an ambitious R&D plan, and probably the most significant aspect of that in 2006 is the adhesion barrier trial. We hope to have our first patient by the end of the summer. We are starting to spend somewhat significantly on the investigator activities, the signing up of IRBs, initial pilot investigations, and studies, and so, as you get to the back half of this year, there is a significant ramp in our R&D related to that transaction.

In addition, we are in the process of adding significant project management development and engineering support behind the Newdeal products. In particular, we really have been happy with the performance of that business, both O-US, and now in the U.S., and so in the spirit of trying to put resources where we are successful, we're putting significant resources there.

Finally, we have added significantly to our collagen development group. We have an expectation of continuing to launch new formulations of DuraGen and Dural Graft related products, as well as next-generation skin products. I think you will see that ramp as well. Finally, Radionics does have a significant R&D activity to support, both the Cusa and the other product lines, and you will see 1 plus 1 adding to that as we put the businesses together.

One thing that is pervasive in the way we're presenting the P&L in our forward-looking guidance is the impact of the share-based accounting, and so keep in mind, in all of our forward-looking guidance, we have included in, for example, our reported gross margin, our reported sales, and -- SG&A, our reported R&D, forward-looking statements the impact of FAS 123. So the only place you will see it backed out in our reported numbers, and in our -- sorry, in our forward-looking statements and ultimately in our reported numbers, is in an adjusted number for EPS, and then we also, of course, adjust out the tax impact.

So it is going to be a little bit hard to compare the historical sales and marketing to the going forward sales and marketing and the historical R&D to the going forward R&D because going forward will be amortizing into those line items the share based compensation expense for the individuals in those particular categories. You've obviously heard Jerry Carlozzi talk about the activities we have going on in our marketing and product development group, and we're adding resources accordingly. So we expect those to ramp.

Having answered what I think was your question, is there any part of it I didn't answer, Bob?

Just one little piece, and that is, ex-FASB 123, just wondering what that 5 to 6% R&D to sales ratio would be.

Dave, is it 4 to 5?

Yeah, it's still in the 4 range without the share-based compensation. It's still -- it's about 4.2% without it.

Okay. Thank you.

You're welcome, Bob.

We'll go next to David Turkaly with WR Hambrecht.

Stuart, could you quickly tell us -- I'm just reading through the release right now -- the total impact of FAS 123 on 2006 and maybe on 2007?

We gave a range for both years of $0.27 to $0.29.

$0.27 to $0.29?

Yeah.

And what is that? Just in dollars amount? Can you tell me that or no?

There's two pieces to it. There's a gross number, which is pretax, and it's around $14 million roughly in both periods. There is a tax impact because we have incentive stock options in our stock option plans, those have a negative tax aspect to them, which is that you do not get the benefit of that deduction for tax purposes unless it's exercised and disqualified. So it's not just the raw numbers of about $14 million, but it actually has a negative impact on our tax rate by about 0.5% in 2006. Did that make sense?

Yes. I got it now. And then the CoCo bond interest add back, I'm just trying to get the numbers right for going forward. Are you still going to show your EPS GAAP and with that add back in there?

Absolutely. And nothing's changed in the treatment of the convertible bond. We gave you some forward-looking statements about our net interest expense, and we -- and that reflects no change to the convert, but rather the fact that we've used approximately $80 million of cash now to fund the Radionics deal. So historically, it would have been safe to have modeled about 0 for the net interest expense, so our interest income on our cash balance roughly equaled our interest expense on the convertible debt.

Now Dave gave you roughly a -- what was it, Dave? $3.3 million net impact going forward, because we now have, at least for a while less cash interest than we have less -- than we have debt expense.

Okay. Great. Then quickly, maybe just a quick update on the sales force, where that stands and how -- what will be going on with the Radionics? Are you going to continue to build out while you're integrating that, and maybe any kind of new products that are coming on the monitoring side? Thanks a lot.

Okay. Well, on the sales force, we've obviously had a significant ramp in our sales organization this year, and we really put the effort into growing the reconstructive group. Right here sitting in Q1 '06, we have 46 sales reps in the recon group, five managers, and three clinical people. We do not plan to expand that group in any significant way this year. Now, things can change, and we may make a different decision down the road, but at the moment, the plan is we've got so many new people, and they have so much training that is required, we really want to focus on getting them productive.

One of the great things about that Newdeal number is still only about half of our reps have even generated Newdeal sales. So many of them are new. So when I think optimistically about what's going to happen with that group in the new year, I think I have a lot of reason to be optimistic. The other side of that is the top three or four reps are generating significant revenues in the U.S. So, there's no significant ramp in the recon group going forward this year, and so I think we'll see an improvement in the productivity of that group.

The neuro group finished the year at about 105 people, including reps and managers, and while we do not have a significant expansion built into our plans for the neuro group this year, as people get promoted into other divisions or move along either out of the Company or up into management, we have selectively split territories, and that, again, I think, improves the productivity of our reps. So we should finish this quarter, Q1, with about 110 direct field-based people.

And then, as you know, we have a significant ramp in the groups focused on neuro monitoring. We have about five on board now, and we hope to get to 20 by the end of the third quarter. And these are sales support people, whether they're nurses or field-based engineers that will spend the bulk of their time on the neuro monitoring area, thereby accomplishing two things, hopefully reviving our neuro monitoring revenue growth and also freeing up our reps to continue to focus on not just DuraGen and not just Neuragen, but now the Cusa, which is a great product for the neuro-operating room.

No big change in Jarit. Certainly we'll be providing them more support. Their performance has been excellent for the last year. As you know, we've doubled the number of sales reps in our direct markets in Europe. We will scale up and I think we'll use this Radionics transaction as a chance to continue to scale up the field-based support in Europe, including field-based marketing, significant service and repair function, and again, I think we did a good job this year in terms of increasing our o-U.S. exposure from approximately 20% to 25% of revenues, but again, compared to our peer group, we could do a lot better than that.

So certainly one of the things we'll use some of the Radionics accretion to invest in is continued growth in our international business.

Great. Thanks a lot.

We'll go next to Chad Suggs with CIBC World Markets.

Stuart, I wanted to know if you could talk a little bit about what's going on with DuraGen. Just wanted to see how that business is doing now that you've probably kind of worked through some of the competition out there.

We continue to be pretty pleased with our group. Clearly the thing that has characterized 2005 is a need to grow our non-DuraGen product lines and to make sure that we invest in, for example, reconstructive and other areas so that we achieve our long-term organic growth rate. While that is all getting done, we have been fighting a very aggressive battle on the duraplasty front, and I believe we've won. Our sales and marketing organizations in the fourth quarter have taken back significant account from both [Conman] and Medtronic.

We continue to certainly stay focused on that area, but the theme for 2006 is going back on the offensive and driving the sales of DuraGen into the spine. You know our penetration in the spine is very limited. We've been approved for the spine for quite a few years, but our reps have never really had the time to focus on it. In the context now of Cusa being in our portfolio, Mayfield being in the portfolio, and having the flanks covered with folks to focus on the neural monitoring area, I think we're back on the offensive, and "on the offensive" means continuing to push back at Medtronic and J & J but more importantly, driving the product line into the spine.

Don't forget the adhesion barrier trial is thou well-known in the community, and because the product is on-label in spine, not as an adhesion barrier, but as a duraplasty product, our guys are free to go back and reeducate our customers on DuraGen in the spine as a duraplasty product. It's been amazing to me as I've met with the members of the clinical trial group, many of whom are neurosurgeons in addition to spine surgeons, and there is still not a real awareness of the DuraGen product in the spine.

So I think we're back on the offensive this year. I think our reps are much more comfortable in dealing with competitive activities. We have the opportunity with such a broad range of products to show the hospitals a good value when presented with a competitive threat by bringing to the table other products, and we certainly have an opportunity to pursue that as we go into to 2006. So I feel pretty good about what we are doing in duraplasty.

Great. I just thought if you could give us a little bit of an update of what we could possibly see in 2006 as far as some significant product launches.

Well, we have a number of things going on in the first half of the year, and then we have quite a bit going on in the back half of the year. We have, in terms of duraplasty, and, again, we won't break out specific product, we expect to have a new product in duraplasty in the back half of the year. We expect to have a new format of the artificial skin products in the back half of the year. We have in the neural monitoring area the mobius product, which is the integrated multiparameter monitor for showing our Licox oxygen measure, our pressure measure, our temperature, and other vital signs in one screen. So that makes it easy for a surgeon to analyze -- that's looking to be a mid-year launch.

We just began the launch in Newdeal of the -- would we call the be-bop plate and the pantonail, which are two important new launches, and then Jarit has introduced something on the order of 200 new patterns, including a new retractor system. Finally, in the powered area, the Radionics product lines have a new bone cutting tip which will really provide a very competitive product that can take the ultrasonic aspirator into the spine and into other orthopedic applications. We introduced the buzz in the fourth quarter, and that's having a significant impact. That's a bipolar device, and that will be a important product in the new year. And then finally, for the foot and ankle group, we expect to launch our tendon wrap sometime by the early third quarter.

So that was a mouthful, and you will really start to see what we have at the AANS in a couple of months.

Could you tell us what CapEx was for the quarter, and would you be able to provide gross margin assumption for 1Q '06?

Sure. Hang on. Dave's going to get you the CapEx.

You asked for the annual CapEx, right?

For the quarter.

For the quarter?

Yeah.

About 1.5 million for the first quarter '06. About 1.5 million. We're expecting for the year about 6.5.

Okay.

And then in terms of gross margin, we're estimating poor the full year approximately a 65% gross margin, and then in 2007, approximately a 66% gross margin, and again, that includes the impact of FAS 123. So I think that's hitting us by plus or minus 0.5% to 1%. I think we would have shown better sequential growth if we weren't including that.

okay. Thanks, guys.

Your next question comes from David Zimbalist with Natexis Bleichroeder.

I wonder if you would talk about the Medtronic royalty change, the mechanics, what drives your change in accounting methods here? Then second, what kind of implication that had for the gross margin in the quarter?

Okay. In terms of the accounting around it, we now have eight quarters of royalty from Medtronic sales, and we now have a reliable basis in which to estimate it as well as a consistency of information on their sales. So what we've now done is we've gone -- we have an accrual process for that royalty. Previous to this quarter, we had only recognized revenue when received from Medtronic, and that's the main change there from an accounting perspective. In terms of the impact on the margin, I mean, it is a positive impact on the margin, because there is no cost of goods sold associated with that royalty.

Okay, so my calculation is if you took this out of the gross margin for the quarter at 100% margins, you ended one about 62.5% gross margins in the fourth quarter, which is down sequentially versus the first three-quarters of the year, and you're talking about basically going back up to 65 for the full year '06, with all the incremental costs related to -- or accounting costs related to stock-based compensation, or purchase accounting just curious to know what has to happen in order for you to get that leverage, because it seams like you're talking about 300 basis points of leverage off the fourth quarter run rate, or was there something in the fourth quarter, even taking out all the other adjustments that suppressed the fourth quarter gross margin?

Well, start with-- don't forget that in all of our reported numbers, other than the adjusted, is the restructuring charges for the quarter, which were significant. So when you look at the reported gross margin for the quarter, there's actually -- and we break it out for you, in our press release, there's actually significant restructuring charge that hit the reported gross margin for the quarter. So --

I actually excluded that from my analysis, so that's why I'm asking about the lift-off from 62.5%.

Okay. The other aspect is, you know, it's -- you can look at things in a vacuum. There are other -- while on the one hand we had the positive impact of the royalty, there are other things that created negative impacts in the quarter, and they tend to not happen in a vacuum. If you go to the new year, one of the things that's benefiting our gross margin is the impact of the euro, which has come from 130, which is the number for much of the year 2005, to, in our going forward assumptions, 120. As you know, because we have such significant costs in denominated in euros and pounds, a change in the euro, while hurting our top line, helps our gross margin line.

Okay.

The one other thing to keep in mind is we did significant headcount reductions, close to 75 people, in the second, third, and fourth quarter of 2005, and much of that, as you know, came from our plants in Europe. You don't really see the benefit of that for approximately 180 days, as we turn our inventories, so certainly built into our gross margin assumptions, as we go into the new year, is the benefit of that roughly $7.5 million that we spent last year in terms of cost cutting in Europe.

Is Radionics also higher gross margin than your run rate?

It's about the same.

Okay. Second, on the ultrasonic business, do you expect to have opportunity in that tubes sort of work on pricing or perhaps structure given your expanded market share? When I talk about structure, I'm talking about maybe shifting a little bit more of the revenue toward the disposables and being able to place the hardware with a different kind of structure?

I think it's a little early to say. I don't think we're expecting significant pricing in our numbers, rather, there's quite a bit of interest and utilization of these ultrasonic aspirators outside of the neuro area. Some of the growth we've seen in selector over the past two or three years, people have been using it in related areas, and so I think if anything would we'll have ability to do with the three product lines, Selector, Cusa, and Dissectron, is segment them so we're better able to drive the use of the product. These product actually compete with things like RF Ablation, electrosurgery, powered surgical instruments, and I think with the suite of products we have, we can drive more aggressive growth in competitive areas, some of those other energy technologies. So, no, we haven't been any significant pricing into our numbers.

Okay. All right. And any comments on your expected contribution for Newdeal in 2006? No. In fact, the other way around. I don't think we'll be breaking it out in the new year. It will just be reported in our implant category. We haven't really, as you know, broken out our product lines for competitive reasons.

It just so happens that because it's the only thing we've acquired this year, you can pull that out of our K, anyway, so we figured we'd highlight it for you guys. But going forward we won't break it out. We do expect significant domestic growth out of the product lain, and I know candidly, we've been taking share in the U.S. from the likes of -- Depew, and certainly Rice. last question, if would you clarify your SG&A target as a percentage of sales, all in?

We said in the earlier presentation -- hang on -- SG&A is targeted at 35 to 37% of total revenues, but again that includes the FAS 123 impact. So we're not suggesting we're ramping it up from where it was, it's just that the reported numbers will look higher because of the impact of FAS 123.

And the percentage of, or rough number for the contribution of FAS 123 in SG&A specifically?

Gee, I don't know that we have that broken out for you. Sorry.

All right.

We'll go next to William Plovanic with First Albany.

You talked about DuraGen a little. Just wondering if we could potentially get some color on the quarterly progression. Would you say that the growth rates year-over-year are starting to reaccelerate again?

I think it's too early to say. No, I wouldn't say that yet, no.

Okay.

We haven't given the quarterly breakouts. We said that the business grew again over prior year. We really don't want to get in the habit of signaling, in particular, to our competition what we're doing on a quarter to quarter basis. But, no, I think the growth that we're guiding in the new year is not really from some acceleration of DuraGen, although we certainly expect it to grow, but rather to a much greater extent coming from other product lines, both in neuro and in recon, as well as in Jarit.

Okay. As we look at the Jarit business, the instrument growth rate year-over-year I believe was only 6%. Just some color on why that would happen. You mentioned there's a slew of new products rolling out. Is this just people slowing down their purchasing before a new product introduction, or is there something else going on?

Yeah, actually, I think the biggest impact is that we definitely saw some orders held back in ultrasonics on our Selector and Dissectron line in anticipation of the Cusa deal. One of the issues we had competitively in a funny way we were com petitioning against ourselves because we certainly want Cusa's to be sold, because that goes into our installed base, but we want to make our numbers in Selector. I think that impact is a lot of hospitals said let's see when this deal gets closed, let's see confirmation that Integra's going to support the Selector going forward, because there were rumors that we were not, and that's just not true. So the bulk of the impact that you saw in the quarter, and the reason that the instrument line was not at historical rates had to do with powered instruments part of it, and the other part, the Jarit's and the Ruggles and the Redmen and all of those were growing in historical ranges.

in terms of the Newdeal it seems lake we finally saw a good snap back in the performance there. And I know you're not going to give this information going forward, but just for our own edification, if we could get a feel for what the U.S./O-U.S. mix was for the quarter, and is the year-over-year growth we're seeing more of a function of the U.S. starting to pick up?

Well, two things. First of all, it was really not a snap back. If you remember when you bought it, we said that the business always has a soft third quarter, and so if you look at the trend, it looked like a downward trend, and we kept saying to you guys, please, we'll have a strong fourth quarter, because Newdeal always did. Keep in mind that this is the one product line really that we have that's elective surgery and keep in mind it has a huge exposure to Europe, which is very weak in the third quarter. So it's really the one product line that's got a pronouncedly weak third quarter for us.

So fourth quarter was candidly in line with our expectations, not exceeding our expectations, and that was both in Europe and in the U.S. I would say we saw a good pickup in the U.S. I don't want to break out the U.S. versus O-U.S., except to say that we believe we're getting back a significant amount of the business that we essential -- that was foregone by terminating Wright as a distributor in the U.S.

Historically your international business I believe was growing in the 20% range. Is it fair to believe that that has continued for Newdeal?

For Newdeal, probably 15 to 20%. I don't have that broken out separately. It certainly hasn't slowed, but it's probably 15 to 20%.

Okay. And then lastly, the European consolidation that you completed last year, is there anything else in the foreseeable future, post the Radionics acquisition, that we might see potentially more consolidation, or are the one-time -- you have basically done all the prep work for this deal?

Well, I wish I could tell you it's over, but with Integra it's almost never over. Let me say this. First of all, there are some spillover costs in the first quarter. We did notify all of the employees that were affected in Europe by this transaction -- sorry, by the restructuring during the second, third, and fourth quarter last year. Some of them, under the law, do not leave until this quarter, and so if you note, we gave a guidance for the quarter of approximately $0.02 of restructuring in Q1, and to a great extent, that is the impact of the remaining individuals departing in Europe in the quarter.

There is not a significant additional site shut down that we're anticipating, but we guided you to about $2.5 million of what we're calling restructuring expense for the first through fourth quarter of this year that have to do with the remaining activities going on in Europe, the impact of Radionics, and the completion of several other transitions of product lines. In particular, we continue to move product lines from New Jersey to Puerto Rico and we have, for example, in the first quarter, some headcount reduction built into the quarter in New Jersey here that will impact the quarter as well. But to answer your question, there's no significant site shut down built into the plan for this year. And we absolutely will see the impact of what we did last year. It's very significant.

Just to kind of go off of that same thought process, we've been hearing for, I would say, probably the last 12 to 18 months. you've been very confident that gross margins would tick up. Somebody else asked the question, how confident are you that we're finally going to hit that 65% level?

Very confident. And keep in mind, the thing that's offsetting it is we've outperformed in terms of expanding our international business. To some extent, you can't look at any one of these measures in a vacuum. We continue to ramp our gross margin here in the U.S. We've also, if you think about it, increased our international business by approximately five percentage points, and the margins O-U.S. are just not as strong as the margins in the U.S. But to answer your question directly, we believe we will achieve, with the FASB impact, the 65 and 66% that's in our forward-looking guidance, otherwise we wouldn't have provided it.

Then, on the monitoring business was strong in the fourth quarter. I know you've gotten I think you said five reps in place. How much of a contribution do you believe those five reps gave you, because this is definitely the first decent quarter -- we've seen in '05. What do you think is the driver of that?

I wish could I give the individuals credit for it, but it's really just our sales force. The truth is what I think you're seeing is their ability to go back on the offensive and spend time. This is just the regular reps as opposed to the specialists -- go back on the offensive and spend time trying to get back into the growth mode as opposed to being in the mode of defending DuraGen. More than the absolute growth, I think the 39% growth in Licox was a very positive outcome. I didn't mention, but should, that we sold significant new additional capital as well in the quarter. Historically, the growth from Licox came just from increasing the unit volume of the disposables. I think we're seeing a pickup as well in the interest in the devices.

Great. Thanks a lot.

And we'll go to Amit Hazan with SunTrust.

Hi. Good morning. Thanks for taking my call.

Hi. How are you, Amit?

I'm good. Just a few questions. Number one, just to follow up on the monitoring, it does sound like you have a lot of confidence there, and the quarter was very good for monitoring. Can you explain why it went down from 65 million last quarter to 53 million guidance for '06 now?

Because I'm tired of being wrong, and so we would like to state what is achievable and beatable, and so looking at the numbers and how we performed in the fourth quarter, even though it was a good quarter, we reroll up all the numbers and 53 is what we think we can do. So it's not some lack of confidence. It's wanting to have realistic numbers out there and having been kind of wrong so many times on neural monitoring, I'd rather not go into the new year being wrong again.

It looks like ex-FASB that SG&A as a percentage of sales guidance for '06 would have been around 32 to 34%. Does that feel about right?

Yeah, that's right. That's what we've provided in the third quarter as well. We're not planning any significant tick up in the percentage, so yeah, thank you for helping with us the numbers. It's no real change from last quarter.

Got it. We're looking here just at the guidance you provided last quarter, it lacks exactly the same on the P&L but we've got this increase on the top line of $35 to 40 million. We're trying to understand, if everything stays the same on the P&L, you have an increase of 35 to 40 million on the top line, and you have actually a lower tax rate than most of us have been modeling, why we're not seeing any flow-through to the bottom line?

Well, I guess I would say, Amit, I think you are seeing flow through. If you look at the range that we had out in terms of earnings guidance last quarter, my recollection is 165 to 175, so we brought it up by, I think it's $0.04 on the bottom, and $0.01 on the top, I think that provides the appropriate balance between the reinvesting we intend to do and the accretion, and it's just what our business plan is.

Okay. Just on organic growth, it looks like if you include FX it would have been about 10%. Just for modeling purposes, I want to make sure I didn't miss it, but historically we've never seen you guys break out FX impact to organic growth. Is this the first time you've done that or do we need to go back historically and make sure that the number also included FX impact in your press release?

Do you know, David?

I was going to say, it didn't include it unless we noted it. I believe we did, when the euro increased significantly at the end of 2004, but I'd have to go back and look at the releases. If it wasn't clearly noted, then we did not include it.

Got it.

It wasn't buried in the organic number itself.

Just one competitive question, I suppose, a company [Foamanetics] that we're continuing to hear about with continuous monitor for blood oxygen levels. Give us clarity how that would compete with Licox, or perhaps it doesn't compete at all.

I think we think it doesn't compete at all. We've seen the product, it's a good product. We've heard good things about it but it's really used in anesthesia for the most part or to monitor generally the brain oxygen, not specifically -- remember, Licox is literally placed in the damaged area, and it's looking for very local changes in the oxygen as a way to treat the particular damage to the brain. I believe their product is not meant for damaged brains, it's meant for healthy brains in order to make sure they don't become damaged. So it's a very different product.

Okay. Perfect. Thanks.

We don't view it as competitive at all. I guess the only positive thing I would say, it eats great to have somebody else out there talk about brain oxygen monitoring.

Appreciate the comment. Thank you very much.

We'll go next to Mark Mullikin with Piper Jaffray.

Hi. Thanks for taking my questions.

Hey, Mark.

I just want to ask a higher level question around organic growth. Guidance for the first quarter top line looks really strong and would imply that you're probably already seeing a good acceleration in the organic growth rate given that we're most of the way through the quarter. Can you tell what you say are some of the drivers of that acceleration and how you expect that to play out in '06?

I think the best way to think about '06 versus '05 is a stabilization in DuraGen, so we're not getting hurt by the deceleration of DuraGen, and the fact that our skin and our nerve and our Newdeal and our Jarit product lines, which are growing quickly, are a bigger part of the company. And so what you see is, a skin up 86%, that's big number. So even if it's not that up much this year, it's going to have a big impact no matter what, and it's a big part of the business.

So I think that's the high level answer, is some of our growth drivers, which were relatively smaller product lines last year are now relatively bigger product lines. And that's sort of the simplest way to think about it. So certainly skin is going to have -- a big impact this year. The Newdeal, particularly in the U.S., is having a big impact, and also some of the other product lines, like Jarit and even the ACS, so all of those things together give us gritter confidence in our organic growth rate this year.

As we said, last year was a little bit of -- a lot a bit year playing defense, being heard both on neural monitoring, because our guys were focused on duraplasty, and duraplasty because they were competing. And I think we feel like we're going into the new year with more confidence and more ability to execute.

If I can just ask a couple more specific questions on the skin product, are you seeing a benefit already from Smith and Nephew's exit from the market in that area?

I think so. So it's always a little bit hard to say. I actually anticipated the question and asked our guys, and I think the answer is there's certainly some benefit. We estimate Smith and Nephew was doing about 12 to $14 million of derma graft in the U.S. and perhaps the same amount O-U.S.

The product was specifically indicate only for diabetic foot ulcers, and the product did have issues in terms of its userfriendliness because of the fact that it had cells in it opposed to an acellular matrix like ours. The presence of our 50 guys and the fact that our BMWD product can be used for diabetic foot ulcers and many more ulcers certainly provides a significant alternative, and it's definite a land grab going for those dermagraft accounts, and we've encouraged our reps to be out there getting them. so it certainly can't hurt us. The bulk of our sales of these products are in reconstructive surgery and so the bulk of the growth that you've seen is in recon, not in wounds, but certainly wounds is a big focus for the new year, particularly with reps calling on foot and ankle surgeons who also treat diabetic and venostasis ulcers. What's the split there? Is it 80/ 20, recon versus wound or can you give us a break out? I don't think I can break that out.

Medtronic has an application for the amplify carrier. Have you factored that into guidance? Will you be making the sponge for that device as well?

We do make the sponge for that device, we have not factored it into our guidance in any way other than whatever purchase orders Medtronic -- Wyeth provides us. Remember, we don't deal directly with Medtronic on the PMA. We deal through Wyeth, and so we're totally reliant on the guidance that Wyeth provides in terms of purchase orders. But I think we probably have some upside from amplify, but I can't really break it out for you, both because I genuinely don't know, and also because it's confidential.

Thank you.

[OPERATOR INSTRUCTIONS]. We'll go next to Alex Arrow with Lazard Capital Markets.

If I could follow up on the implants categories, since this is your highest growth category and the clues that you've given us are important for forecasting, you gave us the $4.8 million for Newdeal, which I understand you're not giving us going forward, but we have in the year so we're going to use it. If you back that out of the total operating products or implants, the rest of the business, apples to apples over last year, looks like 18.6% growth. So trying to reconcile that with the 86% growth in skin and 56% growth in duraplasty, the only thing we can conclude is that the other part of it, which is hydrocephalus shunts, and the other, which is NeuraGen and carotid shunts, must have gone way negative. Perhaps I've got some part of that wrong.

I don't know how to help you, only to say that none of our product lines went way negative, Alex. You're usually good with the numbers, I'm struggling to find an answer for you. But there's something flawed in what you're asking, because certainly our hydrocephalus product lines didn't go down significantly, we had good performance in NPH.

I know there must be something I have wrong. I'm just trying to figure out what it is.

We can try while the call is going on to see if we can find anything.

Let me ask the question this way: Is the 28.4 million you posted for implants, ex Newdeal, that would have been 23.6, right, and then there's -- that compares to 19.9 from 2004. Right? So that's about 18.5% year-over-year growth. And about half of -- about half of that total category is DuraGen.

How about this: do you perhaps have the wrong number for skin for last year? Because I don't think we ever broke it out.

Yeah, I know you didn't. We just had our own assumption, but whatever that number is, it has to be part of the category that adds up to the 19.9 million total number that you gave for implants. Yeah, I know you didn't break it out.

no, I guess my point, and again, I'm struggling to answer your question, but maybe you can't get the 85% to foot on the dermal repair because your Q4 '04, because we never broke it out, and your own model might have been too high. And therefore you're assuming the other stuff either went down or had to make up for it. And, I mean, again, I don't want to break out the numbers, but Dave and Maureen put them right here in front of me, and we do have 19.9 million for implants in Q4 '04 and we do have 28.4 million for implants in Q4 '05 I can stare at the numbers and tell you nothing went down significantly. Actually, nothing went down at all.

I don't want to take up too much of your time, one last pass at it, if the total apples to apples year-over-year growth was 18.5% and skin was up 86% and duraplasty was up 56% to average out to 18.5% --

Oh, duraplasty was not up 56%. NeuraGen was.

Oh, just NeuraGen.

That's where it is. Duraplasty we said was up year-over-year but not with historical growth rates, because remember the competition we're having in duraplasty clearly in 2005 brought our growth rate down. So maybe that's where we either misspoke or you misunderstood. Neuro general, our nerve repair product, up 50 plus%. DuraGen up but not at historical levels.

That's probably it. I'll take another pass and if I can't figure ut out I'll call you after the call.

Thanks, Alex.

And there are no further questions at this time.

Okay. Well, thank you all for joining us for the call. We look forward to reporting our first quarter results later this year. Take care.

This does conclude today's conference. Thank you for your participation. You may disconnect your line at this time.