Integra Lifesciences Holdings Corp (IART) 2007 Q2 法說會逐字稿

Good day, everyone, and welcome to the Integra LifeSciences Q2 2007 Earnings Conference Call. As a reminder, today's call is being recorded. At this time, I would like to turn the call over to Mr. Stuart Essig, President and CEO. Please go ahead, sir.

Good morning, everyone, and thank you for joining us for the Integra LifeSciences Q2 2007 earnings release conference call. I'm Stuart Essig, President and CEO of Integra LifeSciences Holdings Corporation. Today I'm hosting this call from our facility in San Diego, California. Joining me today in California is Gerry Carlozzi, COO, and back in Plainsboro are Maureen Bellantoni, CFO, and Jack Henneman, CAO. Later today, Gerry and I will be visiting with the management and employees at IsoTis following this morning's acquisition announcement.

During this call, we will review our financial results for the second quarter of 2007, which we released this morning, and update our forward-looking guidance for 2007 and 2008. We will also take a few minutes later in the call to discuss the announcement this morning of our intent to acquire IsoTis. At the conclusion of our prepared remarks, we will take questions from members of the telephonic audience.

Before we begin, Maureen Bellantoni 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 a 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 August 21, 2007 by dialing 719-457-0820, access code 1463864, or through the Webcast accessible on the Investor Relations page of our Web site.

Today's call is a proprietary presentation of Integra LifeSciences Holdings Corporation and is being recorded by Integra. No recording, reproduction, transcripts, transmission, or distribution of today's presentation is permitted without Integra's consent. Because the content of this call is time-sensitive, the information provided is accurate only as of the date of this live broadcast, August 7, 2007. Unless otherwise posted or announced by Integra, the information in this call shall not be relied upon beyond August 21, 2007, 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 risk factors included in the business section of Integra's annual report on form 10-K for the year ended December 31, 2006 and to information contained in our subsequent filings with the SEC.

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 this morning, which is available on our Web site in the "Press Release" section under Investor Relations. Additionally in this press release and in the current report on form 8-K that we filed today, we provide explanations for why management believes the presentation of these non-GAAP financial measures provides useful information to investors regarding Integra's financial conditions and results of operations, and the reasons for which Integra's management uses the non-GAAP financial measures.

I will now turn the call over to Stuart to review the highlights of the quarter.

Thank you, Maureen.

The second quarter of 2007 demonstrated continued positive momentum in our revenue growth, with revenues exceeding the high end of our guidance by 6%. Total revenues in the second quarter of 2007 increased by $34.6 million to $134.8 million, a 35% increase over revenues of $100.1 million in the second quarter of 2006. The sales of product lines acquired since March 31, 2006 represent $26.8 million in the current quarter and $8.6 million in the prior-year quarter.

Our neur-ortho implant revenues in the second quarter increased over the prior-year period by 27%. Once again, sales of our DuraGen family of products, extremity reconstruction implants, and bone growth products led revenue growth in the implant category. Nerve and tendon repair products, the Newdeal family of products, and private label products all experienced strong year-over-year growth in the quarter. Sales of Integra skin products were tempered by adverse regional reimbursement decisions. Sales of product lines acquired subsequent to the first quarter of 2006 contributed $2.3 million to the increase in neurosurgical and orthopedic implant sales.

Revenues from our medical surgical equipment product line increased over the prior year period by 39%. The majority of the increase in revenue was due to products acquired since March 31, 2006, which contributed $24.5 million to revenue in the quarter. This compares to the $8.6 million generated in the year-ago quarter from the Miltex acquisition. Internally-generated growth was still significant, led by legacy Radionics and Jarit products, both of which posted double-digit year-over-year growth.

International sales were 25% of total sales this quarter, consistent with the prior-year quarter and the full year 2006. Given the strength of our U.S. business, this nonetheless reflects the positive impact of our recent expansion of our international sales infrastructure, which I will discuss later in the call. Foreign exchange impacted revenues by a positive $1.4 million.

During the second quarter, we announced the acquisition of LXU Healthcare and Physician Industries. The impact of the LXU Healthcare acquisition was included in the guidance given in the first quarter earnings call. The Physician Industries acquisition did not contribute significantly to revenues or earnings. Both acquisitions are included in our forward-looking guidance.

I'd like to take a moment now to talk specifically about highlights for each of our four selling organizations. The Domestic Neurosciences Sales Organization launched a number of new products this quarter and they've done a good job in selling across the board. I'd like to give you an update on one product in particular that has been talked about outside the Company. This is Integra Mozaik, our recently launched bone void filler, which had its first full selling quarter.

We have over 125 sales professionals selling Integra Mozaik, 20 of whom are dedicated to selling the -- selling to the orthopedic spine surgeon. Due to the efforts of our sales team, we've already opened over 160 accounts across the United States. Both the putty and strip forms are selling well, illustrating the versatility of the product and the surgeon's willingness to use it in interbody procedures, both cervical and lumbar, as well as the challenging posterior lateral lumbar gutters.

Our product development efforts continue with this product line. Since the launch of the original 15 cc strip, we have already added 2 additional configurations, the putty and the 5 cc putty and 1 accessory product, the bone marrow aspirate needle. Using the feedback from our surgeon key opinion leaders, we plan to launch several more configurations in the coming months. We expect to showcase Integra Mozaik at the upcoming Congress of Neurosurgical -- Neurological Surgeons in September, as well as the North American Spine Society meeting in October.

I'd also like to give you an update on the DuraGen Plus adhesion barrier clinical trial. Enrollment remains somewhat slower than we had initially anticipated and we are instituting certain programs to speed up the enrollment. The relatively slow enrollment means that we are now anticipating a 2010 filing of the PMA. On the positive side, the trial is generating substantial increased awareness of DuraGen Plus for use in the spine where it is indicated in use of dura repair.

We were pleased to announce last month that Integra Medical Instruments is now under the leadership of Bob Perrett. Bob has had a long and successful career in medical instruments and came to us with the Miltex acquisition. Bob now leads the combined efforts of Jarit, Miltex, LXU, and Integra Pain Management, which is the combination of spinal specialties and the newly acquired Physician Industries.

While both the Physician Industries and LXU acquisitions, which were closed in the second quarter, will provide cost synergies and the opportunity for enhanced revenue growth, we see the most opportunity from the integration of LXU with Jarit's acute care selling organization. The combined acute care sales force is almost 50 direct sales reps, with dealers covering the rest of the country.

We have had success in building our neuroscience and extremities reconstructive direct sales forces, but had previously sold our instruments almost exclusively through distributors. With the combined acute care sales force, we now have the opportunity to enhance our selling through the distributor-direct strategy in certain geographic regions. We believe that our initial efforts and direct sales channel will allow us to take this business to the next level. We see significant growth opportunities to continue to grow both the direct sales organization as well as expand our business with the strong existing dealer network.

As I previously discussed, we have significantly expanded our European sales infrastructure. We closed the second quarter with nearly 50 direct sales people in Europe, up from 35 at the end of the last year, and have plans to bring that number up to 60 before the end of 2007. As with all sales forces, we anticipate it will take several quarters for them to be fully productive. That said, international sales have remained steady at 25% of revenues. In light of our strong revenue growth and the significant impact of our 2007 acquisitions on U.S. sales, this has been particularly impressive. We are pleased with this investment and anticipate that our increased presence in Europe will continue the positive momentum that we have been seeing.

Revenue growth in our extremity reconstruction products continues to be well above the corporate average. Also, product development efforts have been exceptionally strong. We're excited about the pipeline of products that we have to launch in the second half of this year, including several line extensions and the launch of new product categories, such as Integra Mozaik or the extremities.

Before Maureen Bellantoni provides more information regarding our cash flow's operating expense, interest expense, and income tax rate, I'd like to turn the call over to Gerry Carlozzi to discuss our intention to acquire IsoTis, which was announced last night.

Thank you, Stuart.

This acquisition represents an excellent strategic fit for Integra. It provides significant growth opportunities for IsoTis and Integra sales teams by leveraging our combined strength and leading brand names within the orthobiologics community.

For those of you who do not know IsoTis, they're a publicly traded company that recently listed on the NASDAQ stock market. Their product lines include demineralized bone matrices marketed under the brand names of DynoGraft, OrthoBlast and Accell. They're used for bone repair and orthopedic procedures, which include the spine, trauma, reconstruction, and foot and ankle. Integra has been following the development of IsoTis for almost 8 years and now is the time -- and now at this time the transaction structure was finally right for us to do a deal.

We consider this deal in a context of a technology acquisition. As you know, we generally bought more mature products at attractive revenue multiples. Less frequently have we acquired platform technologies. This transaction should be considered in that context. For the transaction, we expect to gain access to new key tissue regeneration technology that has already been proven in the marketplace. With more than $40 million in revenue, IsoTis technology and products are already market tested. That being said, the technology is still in the early stage and is very synergistic with Integra's product categories.

IsoTis Allograph technology, together with our legacy collagen platform, would create a very broad platform of orthobiologics. This transaction will give us a more expansion technology portfolio and opens a new avenue for product development. Together, we have very relevant technologies in the field of neurosurgery, spine, extremities, and trauma.

The sales infrastructure we would be acquiring is also very synergistic. One of the limitations we knew when we had in executing our spine strategy was the lack of a broad distribution channel. Through this transaction, we gain access to a spine reconstructive and trauma sales organization that will be very relevant in the future for selling Integra Mozaik as well as other potential products. We plan to leverage and expand this channel for our orthobiologic products.

The two main challenges in this transaction are the Accell 510(k) approval, which is a closing condition for the transaction, and the financial turnaround of the business. The key to success of this acquisition will be the rapid integration of the sales forces in the implementation of cost-cutting measures. That being said, we start with a 60% gross margin, the current sales level for challenges to manage the SG&A and R&D costs, which I believe we can. We've identified approximately $15 million of cost reduction in the two companies, which will ultimately make the transaction accretive. But, as our practice, our guidance will not include the impact of the acquisition of IsoTis until the transaction has closed.

I'll now turn over the presentation to Maureen for further discussion of our financial results.

Thank you, Gerry.

The gross margin on total revenues in the second quarter of 2007 was 61%, reflecting the impact of inventory gross-ups from the LXU and Physician Industries acquisitions, and impairment charges related to certain technology-based intangible assets and other long-lived assets. These charges reduce gross margins by more than 2 percentage points. The impact of the LXU and Physician Industries acquisitions and the very strong performance of our instrument group had a slightly negative impact on our gross margin. However, the strong performance of the implant products continues to have favorable impacts on our gross margins.

R&D expense decreased by $100,000 to $6.2 million in the second quarter of 2007. The prior-year period included a $1.6 million charge for the discontinuation of product development program. SG&A increased by $18 million to $55 million in the second quarter of 2007, or 41% of revenue. This increase in SG&A expense over last year was primarily the result of our expanded selling organizations, which we have discussed on prior calls, and higher expenses for corporate staffing and consulting. We are adjusting target expense rate percentages for the remainder of the year to 38 to 40% of sales for SG&A and 4 to 4.5% of sales for R&D.

Operating income was $16.9 million for the second quarter, up $3.7 million for the second -- from the second quarter of 2006. In the second quarter of 2007, our operating cash flows were approximately $6 million, a decrease of approximately 60% compared to the year-ago period. This decrease in cash flow results from a significant increase in inventory during the quarter. The higher inventory was associated with the startup of manufacturing in Ireland and planned increases to support greater extremity reconstruction and surgical instrument sales anticipated in the back half of the year.

We continue to fund both acquisitions and share repurchases. Our share repurchases of over $200 million over the last 2.5 years have allowed us to continue to grow earnings per share faster than net income. Our expense for the amortization of intangible assets was $5.5 million in the quarter, of which $1.6 million is included in the cost of product revenues. $1.7 million of amortization of intangibles was related to the impairment of certain intangible assets, as we discussed in a press release last month. These impairments were split almost equally between technology-based intangible assets recorded in cost of product revenues and other intangible assets recorded in intangible asset amortization. We expect total amortization expense to be approximately $3.8 million per quarter through the end of 2007, of which approximately $900,000 will be reported in cost of product revenues.

In the second quarter of 2007, we recorded $2.6 million of net interest expense. Our effective income tax rate was 36% for the quarter. The impact of certain one-time charges in the quarter had the effect of raising our effective tax rate by 3 percentage points. We anticipate a full-year tax rate of 34%.

Before I discuss earnings, I would like to remind you that we are no longer adjusting our earnings for the effect of FAS 123R. The facility comparisons we have presented in our press release for the second quarter of 2006 adjusted earnings per share was only the non-FAS 123R adjustments.

We reported net income of $9.3 million, or $0.31 per diluted share for the second quarter of 2007. When adjusted for certain restructuring-related expenses and other charges, net income for the second quarter of 2007 was $12.4 million, or $0.41 per diluted share. For comparison, our second quarter 2006 adjusted earnings per share was $0.35.

The weighted average common shares outstanding, using the calculation of diluted earnings per share in the second quarter of 2007, were approximately 30.2 million shares. At the end of June, our cash totaled $121 million, and we had no outstanding borrowings under our $300 million Credit Facility.

Cash uses in the second quarter included approximately $34 million for acquisitions.

During the second quarter, we raised $330 million through the private sale of 2 Senior Convertible Notes. These notes pay interest semi-annually at the rates of 2.75% in the case of the 2010 notes, and 2.375% in the case of the 2012 notes. The notes convert at an initial conversion rate of 15.0917 shares per 1,000 shares, principal amount of 2010 notes, and 15.3935 shares per $1,000 principal amount of 2001 -- 2012 notes. This represents an initial conversion price of approximately $66.26 per share for the 2010 notes and approximately $64.96 per share for the 2012 notes.

However, for a net purchase price of approximately $25 million, the Company entered into several hedge and warrant transactions. The net effect of these transactions was to raise the effective conversion price for Integra to approximately $77.96, and $90.95 for the 2010 and 2012 notes, respectively. Although these transactions will reduce the number of shares paid out by the Company at final conversion, they will not increase dilution for GAAP purposes until such time as the notes convert.

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

Thank you, Maureen.

I would just like to remind you that our guidance does not reflect acquisitions that have not yet closed, and thus does not reflect the impact of the IsoTis transaction on our financials. Additionally, consistent with our reporting of adjusted earnings per share for the first half of 2007, our forward-looking guidance does not include any adjustments related to FAS 123R. Our adjusted earnings per share guidance includes the impact of certain purchase accounting and restructuring charges that we expect to incur in conjunction with the LXU and Physician Industries acquisitions. The details of the remaining adjustments are outlined in our press release issued this morning.

In the second half of 2007, we expect to incur an additional $1.6 million of acquisition and integration-related costs, including $1.1 million of inventory purchase accounting charges in connection with acquisitions already closed. These charges are reflected in our GAAP guidance. Adjusted earnings per share guidance for the full year remains at $1.70 to $1.80. Q3 and Q4 earnings per share are negatively impacted by expected revenue mix, which will be skewed towards recently acquired medical surgical equipment as well as higher planned SG&A spending.

2008 GAAP earnings per share is expected to be between $2.10 and $2.25, as improved revenues, gross margin, and SG&A spending translate into improved earnings. The significant investment Integra is making in its sales, marketing, and product development has been paying off in increased internal growth, as witnessed by this quarter. Our acquisition strategy serves to buttress this investment and accelerate the pace of change. We're excited about the continued benefit that this will bring to our customers, employees, and shareholders.

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

Thank you, sir. (OPERATOR INSTRUCTIONS) Mark Mulligan, Piper Jaffray

Stuart, can you comment a little bit more on the back half EPS progression here. Historically, I think you have heavier sales of some of the capital equipment in the fourth quarter, which tends to pressure margins, but the guidance here seems to imply that the third quarter is going to maybe be a little bit lower on the margin side. So can you just flush that out a little bit?

Sure, Mark. As you, I'm sure, noted we had a very strong second quarter. And, in particular, the gross margin was positively impacted by both the mix of revenues toward the neuro-ortho implant category, as well as the fact that we really only booked a short period of time for the LXU and the Physician Industries acquisitions. So, as we model out the back half of the year, we do need to show the full impact of those two acquisitions in the margin. We also -- in the gross margin. We also need to show the significant expected growth in both -- in what we're referring to as the Integra medical instruments products, including Jarit and Miltex, which, again, tend to have lower margins. So while the second quarter was particularly strong, the simple fact of adding those revenues and having those businesses growing in excess of previous expected rates does have an impact on the gross margin.

Now, keep in mind, gross margin is not gross profit, and gross profit continues to grow. It's just the matter of the mix that will impact the back half of the year. Also, we did have some significant buildup in inventory in the second quarter in anticipation of the growth. And that impact of the buildup of inventory is to substantially absorb costs in the second quarter and it's not the case that that will continue as we try to, in the back half of the year, manage down that inventory toward more reasonable levels. So that's an answer to the gross margin.

In terms of the overall earnings per share guidance, obviously, we left the year unchanged, but we did, indeed, give ourselves the flexibility to spend in the back half of the year reasonably substantially on sales, marketing, product development, and also infrastructure build, including G&A. And given the substantial growth in our business, as well as the desire to take costs out of the business over the next 18 months, we do need to continue to invest in the infrastructure, which then allows us to, for example, shut down various distribution sites and ultimately bring down cost.

The other thing we want to do is leave plenty of room in our budget to accelerate the activities in our R&D and our clinical trial activity. And, indeed, R&D did not grow as much in the second quarter as we wish it would have grown and that is, indeed, partially because of slower enrollment in the DuraGen trial. We have some very substantial efforts in place to accelerate the enrollment and we certainly want to leave room to afford that in the P&L. So net/net, the year remains unchanged for earnings. Next year remains unchanged at the high end. We did bring up the low end of earnings guidance by a small amount. And I think it all reflects our desire to continue to invest substantially in the business while delivering a good earnings per share progression to our shareholders.

So it's fair to say that you are, in the back half, sort of frontloading some of the costs and the investments and probably absorbing some dilution from the LXU Tech and Physician Industries acquisitions in the near term? Is that a fair assessment?

I think the first part of what you said was accurate. The second half was not. Physician Industries and LXU Tech really were not dilutive. I think, as we've said, they were not particularly accretive, but they weren't particularly dilutive. On the other hand, as we've said in a press release a while ago, we do have some substantial one-time spending that needs to be done to consolidate the multiple sites that LXU operated in and that -- and also to consolidate the Physician Industries and the final specialties sales and marketing infrastructure. Some of that shows up as one-time charges, but some of it really doesn't, as we have to build up corporate infrastructure and infrastructure in the places where -- that are the receiving end of those cost reductions.

So you spend a bunch before you end up taking out, for example, the site. So we're in the process of shutting 3 LXU sites, 2 sales offices in Atlanta and a distribution center in Alabama. Those costs remain until they're shut, but we have the additional costs of building the redundant site. Similarly, in the second quarter, you saw the benefit of the substantial effort that we've made over the last 18 months to build our own manufacturing activity for the CUSA. Keep in mind, we have been diligently working away at insourcing from Valley Lab, who is a part of Tyco, the manufacturing of all of the CUSA products. And so, again, while some of those costs show up as one-time, to the extent that they truly are one-time, what does not show up as one-time cost is the substantial build up of an entire factory in Ireland full of people working away building CUSAs. That cost, until the second quarter, generally just went down to hit the bottom line in a negative way. The good news is, as we started up in the second quarter, we built up a substantial inventory which we now expect to launch through our organization as we wind down our interrelations with Tyco. So, like always, I give you a complex story but one that seems to improve over time pretty well.

Sure. So is the Ireland facility and the ramp up of the CUSA manufacturing the primary reason for the jump in the inventory levels here?

It's a significant reason. We gave three significant reasons in our press release and in my script. I'll try to summarize them. One is the buildup of the CUSA inventory, which is substantial.

The second is if you remember KMI, Kinetikos Medical, which it seems like we bought a long time ago but actually is only 9 months ago. The biggest knock on KMI by the sales force was the lack of field inventory. Great products, but if the guys spend all their time moving loaner sets around and not doing implants, it's a pretty hard job. And so we have added substantially to the field based inventory. What does that mean? That means we have bought significant amount of trays of implants that then get put into the field, either at customer locations or in the hands of reps, and once they have that inventory, it's then incumbent upon them to drive revenues. And so that was a big chunk of the inventory buildup.

The third is, as we said earlier, we are expecting a very strong back half of the year for our instrument businesses, including Jarit and Miltex. That is all bought parts and that means we have to build up the inventory. If we don't have it, we can't sell it. And so you do end up building that inventory up many months before you actually ship it. And we do have pretty good insight into what the customers will buy because we're in a reasonable dialog with customers, particularly with Miltex, as to what, indeed, their needs are going to be.

So it's those three components that influence the inventory build so substantially.

Okay.

And by the way, one other thing is simply the acquisition of those two businesses would show up in our inventory line. So that is a big chunk of the significant growth in inventory, although that particular last item I mentioned would not be an explanation for impact on operating cash flow.

Right, okay. And then, I'll just ask one more and get back into queue. Can you talk a little bit about the adverse reimbursement decisions you mentioned in your comments on the Integra skin product in the quarter?

Yes. I don't want to overplay it, but on the other hand, I don't think we should underplay it. So we're trying to provide a balanced view. Certainly one of our growth drivers in the last 12 to 24 months has been Integra skin. And Integra skin is, as you're aware, primarily been used over the years in-patient application in the treatment of severe burns and for scar revisions. And these uses are supported by our PMA indications and the clinical data and therefore are very well reimbursed.

On the other hand, our wound products, which are often used in out-patient settings, were cleared under a 510(k), and, therefore, the reimbursement for advanced wound care products in out-patient settings, broadly speaking, including our own products, has varied considerably by product, region, and carrier. And not surprisingly we've been -- we've seen both -- on the other hand, a substantial increase in our sales of those products over the last few years, but that, again, then makes us a bit more of a target. And so we've seen in certain markets that sales of our wound care products are being adversely affected in places where one or more carriers have denied coverage. And so we have an active clinical reimbursement program to contend with the coverage denials, and, in general, to work to improve the reimbursement for our wound car products.

So it's a balanced response. I guess we're a little bit a victim of our own success and now we're going to have to manage that. But I wouldn't overplay it either because quite a substantial part of the business is in places that there aren't reimbursement challenges, in particular where we're supported by our PMA claim of burns and reconstruction.

Amit Hazan, CIBC World Markets

This is actually [Angela Wood], I'm his associate. I do have a question about actually organic growth. We have modeled that you had only 8% organic this quarter and it's down quite a bit from about 15 last quarter and 23 at the end of '06 and I was hoping you could put a little -- shed a little bit of light on that for us.

Yes, sure. I think the problem is that you guys get the calculation wrong. And I think the calculation is incorrect because you fail to subtract the prior-year quarter revenues of the acquired growth. So let me try, because we do struggle on our side to communicate this. Because the internal growth was a lot more than 8%.

So, if you recall, in the section of our press release where we talk about sales of product line acquired since March 31st of 2006, we say those represent $26.8 million, but a year earlier they were $8.6 million. So you need to subtract those two numbers to calculate, indeed, what the contribution was from the acquisitions. And I think in the past you guys have failed to do that and it's -- judging by the calculation you just did, maybe you made the same calculation. So, indeed, we grew by 34.6%, excuse me, $34.6 million, and of that you need to take the $26.8 minus the $8.6 to calculate the proportion of what I just said, which is acquired. So I'll say it one more time. You take $26, because nobody seems to -- all my guys here are looking at me, $26.8 million minus $8.6 is the stuff that we bought in the quarter. And you need to subtract that from the $34.6 million of actual growth in order to get the internal growth.

Okay, okay, I understand that. And could you give a little bit of guidance, I guess, I know you don't give official guidance, but could you lead us to what to expect for the remainder of this year with the new acquisitions in terms of organic growth?

We give, in the back of the press release, we provide ranges of revenues for Q3 and for Q4 and then for the first and second quarter of 2008 and then full year for both. That's our forward-looking guidance. We don't break down the proportion of that, which is acquired versus the proportion of it which is organic. I think we've consistently said that if you look at the 2008 and compare it to the 2007 revenue guidance that we've given, it's generally been an internal growth rate of 12 to 13%. Even though we had a couple of very strong growth rate quarters, I don't think it's still appropriate to change our long-term guidance, although obviously we hope to continue to outperform.

Glenn Novarro, Banc of America

A couple of questions. First, on the Med/Surge business, did much better than we expected. Were there any one-time orders? I know you signed some hospital contracts early in the year. I just wanted to see if you could flesh out why Med/Surge, it beat us by $5 or $6 million, why it was so much stronger? That's question one.

Question two, can you quantify a little bit more on the kind of the -- it sounds like for the second half of the year you're going to be spending more on SG&A. And I thought I heard you say you wanted to spend a little bit more maybe on sales force build-out. Can you quantify, maybe talk a little bit about the sales force build-out that you anticipate in the back end of the year?

And then I have one follow-up question on the acquisition, but why don't you answer those two first.

Okay. On the Med/Surge business, we really performed well across the board. Certainly, our acquisitions, and you have the information on the impact of the acquisitions because we break out that in the press release for each of the two categories, Med/Surge and Implants. And so certainly the acquisitions did better than we expected and that includes really all of them, including the Miltex, which is still for the quarter -- in the quarter. And so the acquisitions did well.

In addition to that, the product lines that we are selling into neurosurgery, such as Radionics, CUSA, Selector, these are all products that are really performing well and is a result of the sales force build-out and the training and the overall performance of the neurosurgery infrastructure. I mean, when we acquired Radionics, geez, now, it's a couple of years ago, we said that having those tools, the Radionics infrastructure, the ultrasonic aspirator, the product lines that we have acquired, having those tools in the hands of our sales force would be a real synergistic acquisition and it would help us drive DuraGen, which it did, we had a very strong DuraGen quarter, it would help us drive the sales of the products that we acquire, including the ultrasonic aspirator and the Radionics legacy products. So it's not a one-time thing.

And then we continued to see the benefit of the investment we've made in the Jarit business and the buildup of the sales and marketing organization. Instruments over performed. So, when we say instruments, that's really Jarit that we're talking about, since Miltex we would include in the acquired products still for this last quarter. So it's not really a one-time thing. The way that business works, there's so many units, it would be hard for there to be a one-time thing.

Okay. And just on kind of the SG&A kind of spend in the second half of the year, can you quantify, put something around how many sales people you have today, where you want to go by the end of the year, particularly as it relates to the spine. I'm wondering are you going to spend a little bit in front of the closing of the spine acquisition?

Yes, well, I think, first of all, in terms of headcount, we still have roughly, I'm just looking at a sheet I have here, roughly 10 to 15 additional heads that we expect to add by the end of the year in the neuro and the extremities reconstruction business. So as we go into the back half of the year, there is about 15 open heads that we still expect to fill, and that does include spine.

Now, also because of the LXU acquisition, we are in the process of adding heads in places where we have terminated dealers and are merging the activities of the LXU, which is the headlamp business, with the Jarit instrument business. That will be -- that will, in the short term, involve a buildup of expense as we build out direct sales force. In the longer term, as the dealers are terminated, we will get that back in the P&L. So there is a period of time when we fire a dealer where we're paying out both the dealer and our own new direct sales force for that period of time in order to provide an orderly transition and we'll see that into Q3 and Q4.

And then, as Gerry mentioned earlier, we are also continuing to add direct reps in Europe and there's about another 10 people we expect to build up before the year is out. So we're looking at, when you add it all up, somewhere between 30 and 40 heads, be 40 years out, in the sales and marketing organization.

Is this a new number or -- because I'm trying to get at what's changed. Was this the same number that you had in line in the plan at the first quarter or is it a higher number and that's why you're being more conservative in the back end of the year?

As for the neuro and recon, well, there are two ways to answer it. First, in terms of the additional headcount, in the neuro and extremities reconstruction, it's roughly the same, but we saw expenses come in substantially in excess of what we expected in the second quarter. So we need to be a bit more conservative on what it's costing us to run that additional sales force. And that is partly because of their improved performance. So there is an additional spend on sales and marketing in the back half of the year which we have now built into our numbers which is, indeed, a reflection of where second quarter came in and the fact that second quarter came in relatively high on SG&A and we do, indeed, still have open heads, it means we do need to add that spending to the back half of the year.

Okay.

The other side of that is the transition of the acute care sales force for Jarit and LXU to direct means that in the back half of the year we will be double-commissioning a number of product lines until the dealers are ultimately off of their compensation plan. So we do expect, as you go into the new year, those costs to be gone.

Then, lastly, we, given all the growth, we have to continue to invest in systems and overhead and right across the board and we do want to build conservative numbers into our P&L in the back half of the year to support that growth in infrastructure.

Now, to you hypothesis on IsoTis, I think we are giving ourselves some room to put into place the infrastructure to absorb IsoTis as well in the back half of the year. And so while we'll continue with our overall policy of not including acquired product lines in our forward-looking guidance until they have closed, and I again underscore that IsoTis is not in our forward-looking guidance, we do have to continue to build the infrastructure ahead of that deal as well as any other deal we might get done. And so I think our point of view is that we continue to want to deliver the 2007 earnings that we committed to our shareholders and we intend to deliver it and we intend to utilize any additional over-performance to make sure we have a good infrastructure that we can build upon and go into 2008 with a very solid plan.

Okay, that's fair. Just one question on IsoTis. What is proprietary that you're buying? Because there are a lot of players out there that sell DBM and I quickly looked on the Company's Web site and I don't see anything that's proprietary. So is this really Integra's way of getting kind of a bigger toe -- foot in the spine surgery market from which to further build down the road?

Well, that's a really good question and Gerry and I are going to try to answer it. Keep in mind we have some restraints on how we can respond because it is a public acquisition and also I would just refer you to the ton of stuff on their Web site and the press releases and what we've put out. So there is an opportunity to get more detail on IsoTis, and I realize we just announced it this morning, so it requires a little bit of time. I think we think they have a very differentiated product line and a very differentiated story for customers. And I think we believe that it also gives us an established base of revenue in spine, which -- as well as other places, extremities and reconstruction, and trauma, to continue to execute on the strategy that we focused on about a year ago, which is to build out our orthobiologics pipeline. So there is plenty inside of that company that is proprietary and is of value.

I also think that we bring a lot to the table with our collagen products. And, together, we have a really excellent opportunity to continue to launch the products that are in their pipeline, continue to launch the Mozaik products in our pipeline, drive those through their existing distributor network, which we said we were going into spine with a bit of a handicap to begin with, despite our good performance in Q2. By not having a broad distributor network, we'd pick up a strong distributor network. And there is plenty of opportunity in the spine area and it would not be our general approach to just buy one company and stick with it, but rather we would wish to close this transaction and integrate it and then look for other ways to build upon that platform.

So I think I answered all your questions, except maybe a little bit of color on their product line and Accell and maybe Gerry can do that.

Okay. Yes, if you look at the product line broken down into the three product categories that they have, the Accell product line is what we would consider the proprietary product line. Part of that product line has a reverse thermo setting polymer that they use as a binding agent. And what that does, it allows the surgeon to be able to handle it at room temperature inside the operating room. It's very pliable, like a putty, but once it's inserted in the body and achieves a temperature of 37 degrees C, or coming up to body temperature, the polymer starts setting up. And so it stays in place, it's easy to handle prior to placement, and then is secured in place post placement. And that's been the biggest advantage that we've heard from surgeons in terms of handling characteristics, as well as the improvements that they have in osteo-conductive and osteo-inductive properties of the material.

And, as Stuart said, I think if we take that platform of products, which are unique in the marketplace today and combine it with Integra's unique position in the collagen ceramic matrices, I think it gives us a pretty strong portfolio of products that we can provide the surgeon various options based on the surgical conditions that they're operating under and pick the best product for the patient. So we're not forcing them to do an either/or situation, but allows them to pick a better product for that particular patient in the surgery.

Brian Wong, First Albany Corp.

Just to expand a little bit more on your product offering and the -- or the biologic area. Are you -- maybe you could talk a little bit about how you intend to grow the IsoTis offering. Is that more just through pushing through your sales force or are there other products in the pipeline that IsoTis has and that you have that can move that beyond where it is now?

Okay, first let me talk about our pipeline. As you know, we have had a significant buildup in headcount and spend in our Plainsboro development activity and have recruited a broad array of engineers and scientists focused on building out our collagen platform and we have a very rich pipeline of products, like Mozaik and then -- and product line extensions in Mozaik and then other new and innovative things. And that's really been something that I think we have focused on in the last three or four years and demonstrated an ability to continuously innovate. So, for us, the challenge has always been, okay, we're going to drive those products through existing channels but can we also identify new channels.

I think we identified spine as a unique opportunity because on the one hand we can leverage our neuro group, which is the biggest neuro sales force in the United States, because a lot of those guys spend time with neurosurgeons who do spine. And we also said, though, we continued to be boxed out of orthopedic spine because of our lack of a calling effort. And, as I think you know, over the last several years, we've looked for spine acquisitions and haven't found any that met our various criteria.

The thing about the IsoTis acquisition, and again I have to really stick to the forum Q&A we put together, but the thing about it is it gives us that infrastructure, because they haven't established dealer network, they haven't established sales and marketing organization, so if we get the infrastructure to launch additional products, particularly into orthopedic spine but also in other orthopedic markets where we don't currently have a sales and marketing organization, and we also get the product pipeline that they have.

Now, I can't go into detail on their product pipeline, that's their business, but what I would say is we think it's interesting and innovative and similar to ours. With the application of additional resources, there is a good opportunity to grow it. Their biggest constraint over the last several years has been money. I guess that's everybody's biggest constraint. But they have always been operating with limited resources and I think have achieved an awful lot with limited resources.

Okay. And then, since we're talking about new products, could you give us a preview as to what you might be launching in -- for the Newdeal area and KMI area, what sort of internally-generated products we could see from that going forward?

Yes, I'll let Gerry talk about some of these products. I continue to be very impressed with our pipeline of products that are coming out of our Newdeal operation in France. And we have really I think executed well over the last 24 months on integrating their European and international perspective with our U.S. sales and marketing team's desires for the U.S. And it's really only in the last quarter where we've actually introduced products that come from that combined effort.

I mentioned on conference calls for the last 18 months that there are products in Europe that are launched but still haven't been brought to the U.S. and we're in the process of, and have been, launching those. But in the fourth -- sorry, in the second quarter, we also launched products that came really from the combined innovation of our U.S. sales and marketing team and the physicians who give us insights in the U.S. with the European organization. As for KMI, much of what we're still doing is just executing on their plan. The integration is essentially done, but there's still really mostly products that we acquired that we're, as I mentioned earlier, putting through the much larger infrastructure.

But now I'm going to turn it over to Gerry to talk a little bit about the specific products that we just launched at the most recent reconstructive meetings and -- that are coming through the rest of the year.

Okay.

Yes, as far as the product introductions we had during the second quarter in the reconstructive channel, one product that we developed that was a joint development between the Newdeal development team and the Integra Plainsboro development team, working with surgeons in the U.S., was the Advansys mid and hind foot plating system. We just launched the product. So far the results have been that the product is being received very well. It's a walking plate construction product. It has some very strong competitive advantages, being able to have a low profile locking plate in a mid and hind foot application. And it's been received very well into the marketplace. Still too soon to tell what the growth rate or the overall contribution of that is, but it's another product in the series of products that the foot and ankle surgeon needs.

In addition to that, we launched a Uni-CP plate, which is also a locking plate technology. And we combined our Surfix technology that we acquired when we acquired Newdeal, which is a locking plate construction, and combined that with a Uni-Clip to provide a surgeon with a more versatile compress -- staple-like, plate-like compression system. And in cases where a staple is not adequate to achieve approximation of the bones and compression, this product allows the surgeon to place the plate system into the site and then achieve compression by spreading the wings on the plate. It's a pretty unique product. So far the results have been very good on that too. But, as I mentioned, too soon to tell right now, we're just in the launch phases of that product.

The other product, which we just began selling, is [EON] memory staple system. And that is a staple system that is like the Uni-Clip, except you apply heat to it. It's made out of a nitinol material, and as you apply heat, the legs of the staple fold in on each other, creating compression at the fracture site. So far, again, the results have been very good, well received from the surgeons.

In addition to that, we have, in total for this year, we'll probably have somewhere between 15 and 20 different products that we'll launch. Some have already been launched and we'll launch the balance of them by the end of the year for our reconstructive channel. And one of the focuses that we've had in the second half of the year is introducing ranges of products in the upper extremities, mostly focused on hand, wrist, and elbow surgery, to expand our product offering that we acquired from KMI, as well as make improvements to the product line and try to bring them to the next level, the next generation of those products.

And as we continue to build out our reconstructive product portfolio, we're also continuing to invest equally in our neurosurgery channel where we have a significant amount of investment in new products that have been coming out. In the first half of the year, we had a little bit over 14 new product introductions in the first half of the year and about the same for the second half of the year scheduled for our neurosurgery. So we're trying to balance our investments in R&D across both neurosurgery and reconstructive surgery to continue to grow both channels effectively.

Great, thanks. And then two more questions and then I'll jump off. You mentioned the -- getting into the spine area by making an acquisition. Is IsoTis the spine acquisition that we've been looking for or could we expect another one that comes along, maybe [subtle] or something like that.

I think you should always expect another acquisition from us. It's always just a question of when. I think this is an excellent fit. I think we will work diligently to integrate the acquisition and I think we'll keep our focus on other acquisitions that would be additive and help us build out the platform. So I don't think we ever look at something as only one thing but rather as a process. And so I think you could potentially expect additional acquisitions. As you know, it's very unpredictable and, particularly in spine, we have an interest in growing, but we also want acquisitions which meet our financial and operational and other criteria. And I will stick with my words. When we launched the Mozaik product line, we do not need an acquisition to be successful, but as we find them, they could certainly accelerate the pace of growth.

Got you. And then, to the organic growth question, sorry to beat a dead horse here, but as I calculate it, you probably did a 19% organic growth this quarter. Couple that with the 18% you did in the first quarter, you're seeing 12, 13% long term. Does that mean that you're expecting a lower organic growth rate in the third and fourth quarters of this year?

I think the right answer is I have worked hard not to be whipsawed by short-term performance. And we think with the overall mix of the businesses that we have that the right long-term guidance is closer to the teens number and, when pressed, we just keep saying, well, teens probably mean 12, 13%. Business is a lot bigger. There are parts of the business which are slower growth, there are parts of the business which are very fast growth, as witnessed by our Med/Surge business.

I think to the technical question is what the organic growth is, you do, and I think you did, you do have to look at, and we try to make it easy but recognize there is a lot going on in our numbers, you take what we bought and you say how did it do this year and then you subtract out what it contributed last year and that's the incremental impact. I think you got those numbers right and we did have an extraordinary organic growth quarter.

So I'm not in any way tempering my enthusiasm for the business. On the other hand, I think it's appropriate for us to try to set reasonable expectations and then work hard to outperform them, as opposed to the other way around.

Jayson Bedford, Raymond James

Just a couple of quick questions. First, on KMI, it looks like you did, well, $2.3 million in the quarter. I thought when you bought it, it was doing $11 million annually. I'm just wondering, I think you alluded to some inventory issues, but what do you have to do to really start to see the growth out of that business?

Good question. I think we were doing, when we bought it, about $10 million, or they were doing, but it isn't worth quibbling about, it may have been $11, depending upon how you look at the quarters. And so it's reasonable to say the business is flat to down slightly. But keep in mind what we've done with the business. We have fully integrated the business. What I mean by that is we let go their full distributor network and we didn't retain more than a few of their people. And so that means there is a substantial disruption to their business.

We also loaded that roughly $10 million a year of revenue on a very new sales and marketing organization who itself was in the process of launching a lot of Newdeal products. And so the incremental revenue was helpful, the incremental products were helpful, in the sense of helping to fund and fill out the full bag, as it were, for that sales organization, but they have barely begun to become productive with those products. Indeed, I think at most recent count, roughly 15 to 20 of our reps still only have about 6 months of tenure with the Company.

So I fully expect that business to grow. The pipeline is good, the products are good, it's just a challenge to integrate all of those products and all of that infrastructure into our business. So -- and then, keep in mind, we pointed to substantial increases in extremities reconstructive sales. So what you're hearing is substantial growth in the Newdeal products because we didn't have substantial growth in the KMI products.

So I think we will see continued benefit of the acquisition. It has definitely taken time to get enough set into the field to service the business. We've only just begun to focus the sales force on upper extremities. Keep in mind Newdeal was entirely lower extremities. And so while it may seem frustrating, and since I'm an aggressive leader, I'm frustrated that it's not growing as quickly as I'd like. On the other hand, it's actually only been in our hands for just under a year.

Okay, fair enough. And then, you talked about the impact of inventory on the cash flow. What was the inventory number in the quarter?

I will look. And, Maureen, if you have it on your end, please call it out.

$114 million.

Thank you. And then, just on the IsoTis acquisition, it looked like you had also signed a strategic alliance to sell some of their DBM products. Is that just a function if the deal doesn't go through you'll distribute it or will you start selling it now?

It's a private label agreement. When you get a chance to look at their materials, they -- their strategy is the private label, the older technology, and to sell Accell as the proprietary technology. That's a smart strategy and I think we'll follow through on that. And I guess I'm making an open invitation on the call to those OEM partners to stick with those guys because we like that private label strategy.

As you know, in our own case, we provide collagen private label to high quality companies like Zimmer and Medtronic and Wyeth and J&J and that's a winning strategy for both of us. So what we did is enter into a similar relationship and that relationship will go forward whether or not the transaction closes. Obviously, we hope and expect it to close, but on the other hand, we have to get down to business.

And our foot and ankle group, in particular, wants a DBM and IsoTis has an excellent DBM. Candidly, we've been looking for a DBM and to put a deal together on an OEM basis for at least a year or two years. And some of our dialog with IsoTis over that period of time involved OEMing a DBM to us. So I think -- I'm not sure that we and they will be able to move quickly enough to have an OEM product in our hands before the end of the year, but one way or another, we'll have an OEM relationship with them as we go into the new year and fully intend to add the first-generation products to our platform in both our neuro and spine and foot and ankle platforms.

Okay.

I shouldn't say foot and ankle, extremities, because that includes the hands and wrist.

Okay. And just lastly, I think Gerry mentioned $15 million in savings. What's the baseline comparator there? And what's the time frame in which you'll see those -- that $15 million in savings?

Okay. I think we'll be limited in what we can say here given the forward-looking guidance. We did provide in the -- you should look at the joint press release we put out with the IsoTis people. They made a point that they are restructuring their European operations and that means -- that company was formed through the acquisition and merger of several different companies. They have continued to operate a relatively expensive European infrastructure which they're in the process of essentially winding down. They articulate in their press release an expectation of reducing costs there by $3 to $5 million. So the challenge on our side will be to find approximately $9 to $11 million.

Keep in mind very small public company, and they went through a rather extensive listing process over the last 12 months and that is all in their numbers. And so we will not need those public company expenses or a listing process going forward. There's obviously public company expenses of a board of certain of the senior management people, of the insurance, a whole variety of redundant costs, and we think between what they're planning to do, what we're planning to do, and also the opportunity -- I mean, we have a very big growth expectation in terms of our own SG&A and headcount and we fully expect a number of what we would have filled with third party people we will immediately look to utilize IsoTis people and, therefore, there is cost avoidance in our own P&L.

They have an excellent clinical regulatory product development team. We have in our own budget numbers, going out over the next 18 months, substantial expansions in each of those areas. And I would fully expect, given the quality of their people and our growth needs, to be able to integrate their people into our infrastructure and, therefore, some of the savings will be what I would call Integra cost avoidance.

Okay, but, Stuart, the public company listing expenses, that's assumed in the $15 million in cost savings?

When we talked about approximately $15 million of cost savings, we were talking about 3 to 5 of their savings of the European infrastructure, and then the rest would be synergies that we would identify between the two companies, and amongst those synergies would be public company expense.

Joshua Zable, Natexis

As you can imagine, most of my questions have been answered, but I just want to ask a couple of real quick ones. Just so I'm clear on the outlook, just because as I'm reading through the press release, I understand you are not including IsoTis in your outlook for 2007/2008 until the deal closes, but it seems to me that you might be including some costs associated with closing the deal. So am I misunderstanding that or are we just -- in other words, is there all upside to the outlook or are there costs associated there that you're also not including?

Again, because we're so acquisitive, we do not include the impact of acquisitions that we have not yet closed in our forward-looking guidance. So we have not included the impact of combining their business with our business. We did give a little hint in our press release that while the transaction will be dilutive to reported earnings for several quarters as we restructure the business, we expect the restructuring activities around the IsoTis acquisition to generate projected pre-tax savings of approximately $9 to $11 million for the year 2008 and beyond. So we are saying there will be additional costs that we're expecting and we are expecting some dilution for several quarters.

That being said, substantial savings will come from the reduction of public company costs, duplicative board and executive management costs, redundant insurance, and redundant advisory, legal, and accounting fees. And so by the end of 2008 we'd expect to complete the integration of IsoTis's marketing product development, administrative and logistics functions into our existing infrastructure and generate additional cost savings. And we did call out some expected pre-tax charges of $3 to $5 million in the forward-looking guidance that we would expect to give.

Now, as for what our guidance is for the back half of this year, we have built in some infrastructure builds into the SG&A that we will do irrespective of whether IsoTis closes or not. And so you can argue some of those anticipate the IsoTis closing, you might argue that if we didn't have that deal we might try to economize a bit more, but on the other hand, I think our objective was to deliver the annual earnings that we committed to. And I think our plan will be to spend on SG&A, whether it's systems and infrastructure and other costs, so that we go into the new year really feeling good about our infrastructure.

Okay, great. And then, can you just give us, I know you talked a little bit about it, just a little bit more color on the Radionics business and new product launches potentially there?

Sure. Radionics is combined, and over time we probably should stop talking -- calling it Radionics, but it's combined of legacy Radionics, which is the head frame business, the radiosurgery business, and the image-guided business. So that business, as you recall, was a turnaround, and I think we've really done an excellent job of turning it around. And when I say we, I mean the Radionics management team that we acquired from Tyco. Those guys have really worked hard, have rebuilt relationships that had deteriorated with customers, have grown the -- that business, which was a shrinking business when we bought it, and have become a very important part of our product development activity.

Now, that was the smallest part of the business. The biggest part of the business was the CUSA, which is the market-leading ultrasonic aspirator. And we had an ultrasonic aspirator called the Selector and we have now merged the product development and marketing activities, indeed we merged it up into Radionics, so they are now the responsible site for managing our -- all of our ultrasonic aspirator products.

They, indeed, do have a pipeline and we expect over the next 6 to 12 months to introduce upgrades in their radiosurgery software, upgrades in their image guided surgery software. They have already launched new product and upgrades to the head frame business. And we have been in the process of integrating their new product development activities on CUSA with our legacy new product activities on our Selector. And so with the market-leading position in ultrasonic aspiration, I believe that we're in an excellent position to launch next-generation CUSA product, next-generation Selector product, and then products that leverage the strength of both of those product lines in each of those different brands.

And things that we have already launched are bone-cutting tip, endo-pituitary tip. We have other additional ablation tips that we plan to launch throughout the year. That includes, it's probably not worth going through the names, but it includes two new tips for the Selector and the Excel, and additional, as we go into the back half of the year and into the new year, we anticipate next-generation devices starting to be shown at the meetings and out with customers for evaluation with the expectation of launching a next-generation device. But I don't think we want to go into more detail than that.

Okay, great. Well, thank you very much for taking my questions. Congrats on a great quarter.

Matt Miksic, Morgan Stanley

So one question on guidance. I know you had talked about this and gone through some of the drivers for the second half production. I was curious about 2008 and I noticed you sort of raised up the bottom end of the EPS range but kind of held the revenue range the same. Any reason for that?

I think our view was that the quarter was excellent. It puts us on track to achieving the back half of the year revenues. We certainly have the higher confidence in that achievement. We did, indeed, raise, I think, revenues in Q3. We have a good growth anticipated in 2008. I don't think it benefits us to set expectations beyond where we set them only several months ago. And I think the performance of Q2 probably gives us greater confidence in meeting those objectives, but we have tried to not let any one quarter drive our revenue expectations for numbers 12 to 18 months out. I would rather let the good performance play itself out in an overachievement if we're able to do that.

The bottom end of the range just was too low. On the other hand, we are building our infrastructure and we will continue to do that into next year. And so I think it would be our plan to utilize any excess margin flow-through to invest further in the business and eventually I guess we'll have to give people guidance on 2009 and we want to make sure we're properly investing in 2008 so as to have a good 2009.

So I can't give you a particularly more helpful answer, Matt, than we want to run the business to invest in the future and also deliver strong earnings performance and earnings growth and I think the guidance we give for 2008 properly reflects that balance.

We've never been short on ideas and opportunities. Where we've gotten into trouble is if we set our earnings expectations too high and then have to defer opportunities in order to meet earnings expectations.

Okay, all right. So maybe just early, still a little bit early to start getting more optimistic about '08 top line? The -- is that fair?

Yes. I mean, I'm very optimistic about '08. I just think we've got a good balance between achievable and optimism.

Got it. On IsoTis, you talked about this, I guess they have an independent distributor network like a lot of spine companies selling into the spine market have. I'm wondering if you could give us some idea of how your, which is a direct sales force, will integrate with this network and if there's any regional match-ups or advantages or sort of how the comp -- how the fit looks from being complimentary or what we can expect?

Okay. Yes, very good question. Let me try to answer it again in the confines of what we can say in the deal context. They have a, what I would call, an orthopedic dealer network. It's not really a spine dealer network, it's an orthopedic dealer network, and those dealers sell other products, in addition to the DBM products, and try to carry a full line and be in cases -- they're -- they have what I would think of as a conventional orthopedic dealer network and a high quality one. So we don't have that. And we don't have that in terms of direct calling. We definitely don't have it in terms of dealer calling. And I'm really talking about the U.S.

We do have a neurosurgery sales force and certainly one of the things that that neurosurgery sales force has been hungry for is Mozaik. And they will be hungry for a private label DBM that they can use in cases where they are doing -- where they are in surgery and a customer, who is the neurosurgeon, would like to have a DBM as part of the surgery.

Where there is some overlap is in the last year we've been in the process of building out a direct sales force for Mozaik that on the one hand acts as specialist for the neurosurgeons -- sorry, for the neurosurgery sales force, and on the other hand are building their own relationships with spine docs to, and these are orthopedic spine docs, to build Mozaik. When we knew -- when we launched the strategy, we basically said it's going to be a cream-skimming strategy where these 20 reps focus on each of them, anywhere from 3 to 5 big accounts, where they build relationships and sell the advantages of Mozaik and they basically build a small orthopedic infrastructure that's focused on spine.

Now, with IsoTis, we have a dealer network which we expect to leverage both for the existing IsoTis products and for other products that we have, possibly Mozaik as well, where they can bring those products to their customer base. And so really probably the people with the least amount of change will be the dealer network and our neuro sales force, because both will continue doing essentially what they're doing.

Where there is some overlap is in our 20-person spine sales force and in what they refer to as their specialist force. And what it does is instantaneously get us from, in our own case, 20 to now plus or minus 30, 35 direct specialists who will continue to work with the dealer network, who are likely to work with our neuro people, and who will likely themselves build relationships and drive the business.

So what I won't describe here for you is a cost-cutting strategy as it relates to the sales and marketing organization. There may be some overlap in management on our side and their side, but in terms of field force and distributor network, we basically bootstrap our way into a bigger footprint.

Okay. That makes a lot of sense. The -- one question on just looking at IsoTis and their revenue run rate, it looks like they have a certain amount of revenues from product revenues, you've got $10 or $11 million in the last quarter, and then this $4 million or so of other revenues. I'm just trying to understand is that -- are those revenues that are going to continue? Can you help me understand what that is?

Sure. I said --

I know some of these questions are really IsoTis's questions, but I'm hoping you can help me with a little color.

Yes, I should not answer for IsoTis, but in their own press release, I think they make it reasonably clear that the incremental revenue beyond the $10 million is somewhat unusual and has to do with particular transactions. So my interpretation of their press release, and I'm only saying it that way to be cautious, is that I don't believe they're leading anyone to think that those one-time deals would necessarily continue. And so if you note from our script, we say they have -- it appears to us to have about $40 million of revenue and for the roughly 12-month period. So I think I answered your question.

Yes, that's helpful. And then, the -- looking into next year, just as you put these two organizations together, is there any reason to think, taking KMI as an example, an extreme example, where you had sort of left the distributor network and moved that product line onto your existing direct platform, is there any reason to think that these sales going into '08 are going to be disrupted in any kind of significant way?

Well, I think I better wait until the deal closes to give forward-looking guidance. What I would say is probably the difference with this deal and with KMI is we went into KMI with a plan that they were aware of to terminate their dealer network.

Right.

We're going into this deal with a plan that they are aware of to build upon and grow the dealer network. So that, which is the most significant impact of these transactions, it's unlikely that we would have the same reaction given our desire to embrace that dealer network. With that being said, you know these dealer networks are always in flux and certainly an acquisition is definitely one of those things that makes them even more in flux. So it's possible there could be a period of some disruption and we will try to quantify that in our forward-looking guidance when we get there. With that being said, we're in it for the long term.

And even if there is some disruption, it would be our intention to build out the dealer network and grow it and utilize our additional direct sales support that we've already built out in the spine. And also we have an OEM relationship that we entered into to sell their products into neurosurgery. The other thing I would mention is that -- as well as in foot and ankle. And then, I mention internationally they have not been particularly strong and we've got a very good international dealer network. So net/net, we would be very positive on their business and even if there is a period of disruption, which is always likely in a transaction, we'll get through it.

Okay. And then, just one clarification, again back to guidance. You talked about the second half investment in SG&A and some mix issues going into the third and fourth quarter. I mean, understanding that the mix impact of some of these products, it seems like it's going to weigh more heavily on the gross margin than on the operating margin. Is it fair to say that the more than 50% or the majority of this second half kind of impact to your guidance is around sales investment, investment in the sales force?

Well, the gross margin impact is just the LXU acquisition and the Physician Industries revenues, which will be booked for the first full quarter in Q3. So those acquisitions that we talked about, which were somewhat north of $30 million of revenue when we announced them, those now roll in for a full quarter and that does have a gross margin impact.

And then, in terms of what we would expect for sales and marketing, I think I've articulated it. There's definitely substantial investment in sales and marketing spend in the combined LXU/Jarit organization, so the acute care sales organization. That is going to go through the back half of the year, but give us quite a bit of leverage as we go into next year as we complete the turnover of some number of their dealers to our direct LXU growth.

And, as I mentioned earlier, Matt, we are going to be spending on G&A, as well, with substantial infrastructure investments, including continuing to deploy our Oracle ERP system throughout the organization and building up our finance regulatory quality legal team. So I realize I'm being redundant, but we think we need to run the business well, and given the strong over performance on the top line and gross profit, it would be wise to invest in the business as we go into next year.

Understood. And then one last question on IsoTis, and just your -- I know that you can't give guidance yet on specific cost synergies and impact to earnings of dilution and so on, but just want to make sure I'm looking at this the right way. It seems like from their reported numbers this is something like a 60 to 65% gross margin business that is burdened with maybe a disproportionate amount of operating expenses at this point. And so by the end of next year, it sounds like with the cost cutting that you're describing and also the reference that you make to their own restructuring, the goal is to sort of get this to a profitable accretive business sometime next year, or certainly by the end of next year and into '09.

Yes, I think that's accurate. Again, without giving any new forward-looking guidance. We chose our words carefully in the press release, which were several quarters of dilution from the acquisition. The reality is they are burdened with substantial costs and we believe in the work that we've done with them that we've identified very specific synergies between the two companies and we've called out the number for those synergies of $3 to $5 million of their European infrastructure and $9 to $11 of our own combination synergies. And so, even if we execute on that plan very quickly, you still can't get away from several quarters of dilution. But the intention would be to get the business profitable. And then as we grow it, to have it be a substantial contributor to the Company.

And, again, the reason you get some confidence in that is also we know our own hiring plans and regulatory clinical product development and they've got a lot of good people, and, therefore, that's money not spent on our side as we roll out our growth plan over the next 12 months.

And that is the last question we have in the queue. At this time, I would like to turn the call back over to Mr. Essig for any closing comments.

Okay. Well, thank you to all of you and appreciate the questions. It was a very active and exciting quarter and we look forward to reporting on next quarter in the coming months. Take care.

This does conclude today's conference call. We appreciate your participation and you may disconnect at this time.