Integra Lifesciences Holdings Corp (IART) 2009 Q1 法說會逐字稿

Good day everyone and welcome to the Integra LifeSciences first quarter financial reporting conference call. As a reminder, today's conference is being recorded.

At this time I would like to turn the call over to Mr. Stuart Essig, President and Chief Executive Officer. Please go ahead, sir.

Good morning everyone. And thank you for joining us for the Integra LifeSciences first quarter 2009 earnings release conference call. I am Stuart Essig, President and Chief Executive Officer of Integra LifeSciences Holdings Corporation. Gerry Carlozzi, Chief Operating Officer, and Jack Henneman, Chief Financial Officer, join me today. Gerry is in San Diego, where he is attending the American Association of Neurological Surgeons' annual meeting.

During this call, we will review our financial results for the first quarter of 2009 and our updated forward-looking guidance for the full-year 2009, which we released this morning. At the conclusion of our prepared remarks, we will take questions from members of the telephonic audience. We have heard from several of you that you would like us to keep the call to one hour, which we will endeavor to do. That said, we would like to continue our tradition of answering all of your questions. For this reason, please try to limit yourself to one question and one follow-up during the Q&A period. Similarly, we will try to provide more concise answers. If you do have additional questions, you may rejoin the queue. Before we begin, Jack will make some remarks regarding the content of this call.

This presentation is open to the general public and can be heard through telephone access or via live webcast. A replay of the conference call will be accessible starting one hour after the conclusion of the live event. Access to the replay is available through May 20th, 2009, by dialing 719-457-0820, access code 4833677. Or through the webcast accessible on the Investor Relations page of our website.

Today's call is the proprietary presentation of Integra LifeSciences Holdings Corporation and is being recorded by Integra. No recording, reproduction, transcript, transmission or distribution of today's presentation is permitted without Integra's consent. Because the content of this call is time sensitive, the information provided is accurate only as of the date of this live broadcast, May 6th, 2009.

Unless otherwise posted or announced by Integra, the information in this call should not be relied upon beyond May 20th, 2009, 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, regulatory approval, 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 certainties please refer to the risk factors included in item 1A of Integra's annual report on Form 10-K for the year ended December 31st, 2008. And to information contained in our subsequent filings with the Securities and Exchange Commission. These forward-looking statements are made based upon our current expectations and we undertake no duty to update information provided during this call.

Certain non-GAAP financial measures are disclosed in this presentation. A reconciliation of these non-GAAP financial measures to the most comparable GAAP measures is provided in the press release we issued this morning, which is available on our website 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 this morning, we provide explanations for why management believes that presentation of these non-GAAP financial measures provides useful information to investors regarding Integra's financial condition and results of operations and the reasons for which Integra's management uses the non-GAAP financial measures. I now turn the call back over to Stuart.

Thank you, Jack. Integra delivered another quarter of growth in the top line and strong operating cash flow. Our 6% constant currency growth in revenues reflects the depth and breadth of our business and effectiveness of our strategy of balancing internal and acquired growth. Our specialty orthopedics businesses, which are growing by increasing market share from a small base, did very well.

Not surprisingly, our market leading businesses in neurosurgery and surgical instruments had a tougher time of it. As with many other companies, the first quarter presented unprecedented challenges, including a dramatically stronger US dollar compared to last year, and a deteriorating global economy. The difficult economy particularly affected the ability and willingness of hospital based customers to purchase our neurosurgical capital equipment products and surgical instruments and lighting. Also, as hospitals suspended or delayed the construction of new operating rooms, they also suspended or delayed large orders for new surgical instruments to stock those rooms.

Finally, we saw a market reduction in activity amongst our dental, veterinary and physician office based instrument customers who are seeing declining procedure volumes. The distributors who serve them brought down inventories materially in response, and because of their own higher cost of capital, so our orders from those distributors have declined even more quickly than final demand. Despite these significant challenges, Integra continues to focus on serving its critical markets, and indeed the improved margin mix and focus on cost reductions allowed us to deliver first quarter adjusted earnings per share of $0.47 in excess of the Street consensus.

We report our revenues in three categories. Integra Orthopedics, Integra Neurosciences and Integra Medical Instruments. Integra Orthopedics which is now our largest product category, and which includes the products sold to orthopedic surgeons, foot and hand surgeons and spine surgeons, represented approximately 40% of Integra's overall first quarter revenues. The revenues from products in this category Increased 28% to $64.4 million, from the prior year period.

Extremity reconstruction, which is the largest component of orthopedics, again performed well this quarter, posting double-digit growth. Domestic extremity revenues grew more than 20%, but were offset by the negative impact of currency on our European business. Revenues from Spine and OrthoBiologics contributed substantially to our overall growth and grew sequentially from the fourth quarter.

Finally, private label revenue was down in the first quarter versus the prior year, because our customer sales are slowing down, and they too are managing their inventories. We expect this phenomenon to continue in the second quarter.

Integra Neurosciences encompasses the products sold to the neurosurgeon and the neuro nurse. The products in this category represented approximately 37% of Integra's overall revenues in the quarter. Integra Neurosciences revenues in the first quarter declined 3%, to $59.7 million, versus the prior year period.

Sales of implants and disposables were less affected by the economy, growing in the mid single digits, but were more than offset by declines in virtually all capital product lines, as well as the impact of currency on our international operations. Domestic neurosurgery sales were flat over last year, but international sales were weak, Down 8% due to a combination of declines in the sale of capital equipment and the impact of foreign currency.

Our final category, Integra Medical Instruments, includes medical and surgical instruments sold into the hospital and office channels, and accounted for 23% of Integra's overall revenue in the first quarter. Revenues in this product category decreased 16% to $36.9 million, versus the prior year period. Revenue in hospital based distributed products and surgical lighting product lines declined, because we discontinued certain lines and because hospitals have largely suspended capital spending.

Office based sales also declined, due to lower demand amongst end users and inventory management amongst distributors. We believe that the office based business will improve once the big distributors have completed the processes of bringing down their own inventories. Now I'd like to turn the call over to Gerry in San Diego at the AANS meeting to discuss some recent developments across our selling organizations.

Thank you, Stuart. We have launched several new products since our last earnings call. A number of which have been highlighted here at the AANS, including two next generation ultrasonic tissue ablation systems, the CUSA NXT and CUSA EXcel plus that will address the needs of the neurosurgeon. These next generation CUSA systems will provide surgeons with the power, precision, and control they need for selective dissection of soft tissue and hard tissue, including bones for neuro and spinal applications.

Integra's extensive ultrasonic tissue ablation engineering expertise and years of development efforts have resulted in these next generation products that provide truly an innovative advance in ultrasonic tissue ablation technology, further separating us from the competition. We have over 2,000 centers worldwide that use the CUSA products for a variety of tissue ablation procedures, including the removal of brain and abdominal tumors as well as bone.

We also introduced several new spinal fixation products at this meeting that will enhance our broad portfolio of spinal fixation devices. We are very pleased with the reception to these product launches with a continued commitment, expertise and innovation demonstrated by our product development and marketing teams.

We continue to be pleased with the strong growth in Orthopedic businesses. We are continuing the investment in the expansion of our domestic Extremity Reconstruction sales organization. Which delivered over 20% growth last quarter. This team grew from 85 direct salespeople at the end of 2008, to 100 at the end of first quarter and we anticipate increasing the sales force further to 115 during the remainder of 2009, Which will allow us to support growth in excess of 20% in this category. In Integra Spine, with the integration complete, we are focusing on increasing our distribution network.

In fact, since our New York investor meeting in November, where we reported sales coverage in approximately 20 states, we now have approximately 55 distributors in 36 states. We continue to target near 100% coverage by year end. We also expect to begin selling our Spine products outside the US in the second half of 2009.

I would also like to point out that to date we have not seen any significant slowing in the growth of our Orthopedic business. We anticipate strong growth from our extremity, Spine and OrthoBiologics businesses throughout 2009. Notwithstanding fewer total procedures, our increased sales presence will help us take market share from our competitors. Now I'll turn the call over to Jack for a review of our numbers.

Thank you, Gerry. International sales accounted for 24% of revenues in the quarter. Foreign exchange rates were again volatile. This volatility is rolled through our results, particularly on the top line for more than a year. Foreign exchange had a favorable impact of $3.6 million in the first quarter of 2008, and a negative impact of $3.5 million in the fourth quarter of 2008, versus the same periods in 2007.

In this quarter, the negative foreign exchange impact increased roughly 50% from the fourth quarter to $5.2 million.

In the first quarter, while US sales were up 8%, international revenues were down 10% due to foreign exchange effects and slower capital equipment sales. On a constant currency basis, non-US revenues were up 2%. Europe was up 2% in local currency, though down 12% as reported. The rest of the world was up 2% on a constant currency basis, but down 6% on a reported basis, again due to the strong US dollar.

Gross margin on total revenues in the first quarter was 64%, including a nearly 1.5 percentage point impact of purchased accounting from acquisitions and charges related to employee terminations, facility consolidations, manufacturing transfers and systems integration. The strong increase in our gross margin as a percentage of sales in the first quarter was the result of growth in our spine product lines and extremity implants, including particularly our engineered collagen products, which significantly and favorably shifted our mix of sales toward higher gross margin products.

We expect reported gross margins to reach 65 to 66% by the end of the year. By then, we will have exhausted the impact of the purchase accounting from our 2008 acquisitions, and turned most of the inventory billed at a high Euro to dollar exchange rate in 2008. Finally, the business mix impact versus the prior year should continue to benefit our gross margins.

Research and Development expenses in the first quarter of 2009 increased by $2.8 million to $10.6 million, compared to $7.8 million in the same period last year. The increase was due largely to the purchase of Theken in August 2008 and to increased spending on our multi-center clinical trial initiated in 2006 to support FDA approval of the DuraGen Plus adhesion barrier matrix product. We target 2009 spending on research and development to be approximately 6% of total revenues. Most of this planned spending is concentrated on product development efforts for our Spine, Neurosurgery and Extremity Reconstruction product lines.

Additionally, we are continuing the adhesion barrier matrix clinical trial, and the clinical trial to support FDA approval of expanded claims for our Integra Dermal Regeneration Template product.

Selling, general and administrative expenses in the first quarter of 2009 increased by $4 million to $66.5 million, compared to $62.5 million in the same period last year. Selling expenses increased by $5.6 million, primarily due to increases in revenues and the corresponding commission costs, particularly in connection with our Spine revenues, which generate relatively higher distributor commission costs. General and administrative costs decreased $1.6 million, despite the addition of several companies acquired in 2008, primarily due to decreases in cash bonuses, lower professional fees, small salary increases, and general belt-tightening.

We have shifted spending on sales and marketing from capital and instrument products to the higher growth area of orthopedics. We have reduced personnel modestly, primarily through attrition and the elimination of a small number of positions, and we continue to spend cautiously while working to identify other areas in which to reduce costs without limiting our potential in 2010 and beyond. We anticipate that SG&A will approximate 40 to 42% of sales in 2009, as we continue to leverage our selling organizations and limit corporate overhead costs.

Starting this quarter we're providing adjusted EBITDA and adjusted EBITDA excluding stock-based compensation. We're providing EBITDA because this is one of the metrics that we use to measure the performance of the business. We're also providing adjusted EBITDA excluding stock-based compensation, because this measure approximates the EBITDA used to calculate leverage and fixed charge coverage tests under our credit facility. In the first quarter, we generated $33.8 million in adjusted EBITDA, and $37.5 million, excluding stock-based compensation. These metrics were each up 8% over the prior year period.

For those of you who are still tracking the impact of FAS 123-R, we continue to expect the quarterly impact of share-based compensation expense to be approximately $0.08 per diluted share during 2009. Our expense for the amortization of intangible assets was $4.9 million in the quarter, of which $1.4 million is included in cost of product revenues. In 2009, we expect amortization expense of approximately $19 million, of which $5.6 million will be included in cost of product revenues.

Operating income in the first quarter was $22.3 million, an increase of 8% over the prior year period. We reported a $1.4 million decrease in net interest expense to $6.4 million for the first quarter of 2009. As previously discussed, this quarter we implemented FSP APB 14-1. Which requires that we recognize a component of our convertible debt instruments as interest expense on our P&L, with retroactive retrospective as it were application. This may be a new number for you and may be worth focusing on.

As noted in our table of adjustments, non-cash interest expense related to the implementation of APB 14-1 decreased from the first quarter of 2008 by $1.6 million. Due primarily to the maturity of our first series of convertible notes in March last year. Other expense was $900,000, primarily the result of an unfavorable foreign currency transaction loss of $1.9 million that resulted from the restructuring of a European entity in the fourth quarter of 2008.

Recall that in the fourth quarter we booked a $10 million tax benefit related to the same restructuring. We excluded that benefit from our fourth quarter and 2008 adjusted results and have likewise excluded the foreign currency transaction loss from this quarter's results. We also recognized a $1.2 million gain on the early repurchase of $32.1 million par value of 2010 convertible notes on the open market.

Repurchasing bonds is a good use of our cash, allowing us to reduce not only our cash interest, but also the ultimate cash principal payment. We will continue to review our capital structure and as always look for opportunities to take advantage of improving credit markets.

We reported net income of approximately $9.6 million, or $0.32 per diluted share for the first quarter of 2009. When adjusted for acquisition related expenses and other special charges, net income for the first quarter of 2009 was $13.8 million, or $0.47 per diluted share. We generated $37.2 million of operating cash flow in the quarter, a very strong result, and the third quarter in a row of operating cash flow in excess of $25 million.

In addition to relatively strong operating income, excluding non-cash items, we continued to make progress in our management of inventory. Accounts receivable also came down, cash taxes were lower than in the prior period, and like everybody else, we kept a lid on capital expenditures. Over the long run, we expect operating cash flow to be a bit below EBITDA, rather than above it.

At the end of March, we had $186 million of cash on the balance sheet, and outstanding borrowings of $260 million under our credit it facility. We believe that our cash flow, the availability under our bank line and our cash on hand are more than adequate to meet all our obligations including both the maturity of the June 2010 notes and the contingent purchase price for the Theken acquisition through 2011 when our credit facility matures.

We also ended the quarter with 57 accounts receivable days of sales outstanding, down from 62 in the quarter ended March 31st, 2008. We had 219 days of inventory at the end of this quarter, up slightly from 211 in the prior year period due to the addition of Theken inventory, but improved in our legacy business. Through a variety of operations, management initiatives, we aim to achieve a long-term target of under 200 inventory days. Now let me turn the presentation back over to Stuart.

Thank you, Jack. Our management team continues to seek out external opportunities for growth. And future acquisitions could affect our results going forward. However, the forward-looking guidance that we are providing today does not reflect the impact of acquisitions or other strategic corporate transactions that have not yet closed.

While we were pleased with the extent to which our revenues held up in the first quarter, given the overall economic climate, much has changed since we developed our annual guidance. Even then, we recognized that predictability around our results was less certain than in prior years. In particular, the sustained impact of the capital crunch on our customers and the rapid slowdown in economic activity continues to be very real, and affects our instrument and capital equipment product lines.

Our original expectations were for some back half improvement in the purchasing environment in 2009. At this point, we think that any improvement will happen sometime in 2010. That said, we have also adjusted our expense structure for the year accordingly. We are lowering our 2009 annual revenue and EPS guidance to account for the impact of our more conservative outlook. We now expect to recognize $680 million to $700 million in revenue in the full year of 2009.

We continue to assume a constant Euro to dollar rate of approximately of approximately $1.30 per Euro in these numbers. Consistent with our historical seasonality and our earlier comments on the impact of currency on our gross margin, in the absence of acquisitions, we anticipate a positive quarterly progression in our earnings through the year. As a result, the Company expects earnings per share between $1.63 and $1.83 on a GAAP basis, and between $2 and $2.20 on an adjusted basis.

In summary, Integra LifeSciences is performing well in a challenging economy. We remain confident in the underlying strength and resilience of our business. The diversification of our business has proven to be a real strength, particularly for our cash flow. While our economically sensitive businesses are being challenged, our procedure based orthopedics business continues to grow well.

Based on our current mix of businesses, we anticipate our longer term revenue growth to return to a high single digit growth rate in the three to five year period beyond 2009, while we expect to grow our bottom line faster. We look forward to continuing to meet with investors. We will be presenting at the Banc of America and Merrill Lynch conference next week and the JMP Securities conference later this month. Now we will be happy to answer your questions. Operator, you may turn the call over to our participants.

Thank you. In order that everyone may ask questions, please limit yourself to one question and one follow-up. (Operator Instructions). Just one moment. We'll pause. We'll first hear from Raj Denhoy, Thomas Weisel Partners.

Hi, good morning. Wonder if I could ask a little bit about the guidance for the year. It sounds like in your prepared remarks, sounds like you're not expecting a return on the capital side for the balance of the year and now it sounds like it's 2010. I'm curious, did you bake in anything for procedure slowdowns in the back half? And then also you talked about this inventory issue going on on the part of some of your distributors. What are you contemplating as far as them coming back and starting to order again?

Okay. Let's take it in reverse order. First of all, clearly, the impact on our instrument business of the economy was our biggest disappointment or surprise this quarter. Each of the instrument product lines were down on the order of 10 to 15% year-over-year. So both the hospital based and the physician office based part of the business was down.

Also impacting the instrument business was the previously discussed discontinued product lines that we acquired with Luxtec and we look forward to anniversarying those by the end of the year so we don't have to keep talking about them. In terms of what we expect from distributors, particularly in the physician office based part of the business, everybody in the first quarter, including ourselves, did everything they could to work down inventory. We, as you probably know, took quite a bit out of our balance sheet. And we've seen that both at the hospitals, at the physicians, and at distributors.

It can't go on forever, and many of the distributors which are publicly reporting have commented that they worked hard to do that in the first quarter. We're not expecting somehow them to then reverse that trend going forward but we think the declines will stem as we progress through the year. So at some point, they're just holding the inventory they believe they need for the next two or three months, and I think many of them are working toward that objective and much of that may have been completed in the first quarter but things are very unpredictable, and so this is something people haven't seen in the past.

In terms of Orthopedic business, I'll give Gerry a chance to comment, but we've heard the same thing that you've heard. Expected declines in the back half of the year in a variety of Orthopedic categories, both in reaction to the impact of individuals losing insurance and people being concerned that if they take off to have a procedure, there might not be a job waiting for them when they return. So I think we've baked that into our expectations, but for us, it's reasonably de minimus, because our business is such a small fraction of the overall Orthopedic market and as we said I think over and over again, at the moment we're all about taking share and about growing our product lines and about growing distributions so we're less impacted by any slowing trends in those procedures.

I will say to the extent that the procedures are economically sensitive, there have been declines, and our sales force has reacted accordingly by focusing on sales of trauma products and sales of things that are not discretionary on the part of patients. So I think we've thought that through and built it into our back half expectations. Gerry, do you want to comment further?

Yeah, I think as Stuart said, most of our business in the Orthopedic segment, since we're not a market leader is less affected by a slowdown in procedural growth. Most of our growth is based on increasing our distribution presence in the United States and outside the United States, and to continue to capture market share from our competition, and especially in the Spine space, where we're dealing with a lot of small, undercapitalized companies who are struggling in this environment, opens up an opportunity for us to pick up good distributors who have presence in Spine procedures, and get into accounts that we probably wouldn't have been able to get into if the economy was better. So we're actually benefiting from the economic tough times on some of the smaller competitors, going in to capture that share.

One last point and then we'll move on to the next question. We also commented in our Orthopedic business that indeed our private label sales were down year-over-year and I think that is also an impact of just everyone in the economy trying to bring inventories to the lowest possible point and generate cash.

Okay. That's fair. Just a couple quick follow-ups, if I could.

Raj, I'm going to ask you to get on queue. We had pushback from all of the analysts saying they would like us to keep our answers shorter and limit one question per person. If I could ask you to get back in queue and we can turn it to the next analyst. No disrespect intended.

We'll now here from Matt Miksic, Piper Jaffray.

Good morning. Thanks for taking the question. Can you hear me okay?

Yeah.

So one quick clarification on a couple of your products here and then I had a follow-up question on Spine and some of the trends you're seeing there. So the first is just I apologize if I missed this, I'm not sure if you talked at all about the NXT. I know this environment isn't that -- all that amenable to the new sort of capital oriented roll-outs. I know you talked about it for a while. You have been excited about it. The NXT. The other clarification is on Mosaic. I'm just wondering if that's what you mean by engineered collagen products and uptick in Spine. I mentioned I had one question here generally on Spine.

I'm going to let Gerry handle most of this. What I'll say about NXT, it's a slick new product. We've sold several of them. The customers like them but we couldn't think of a worse economy to sell into. We have a lot of confidence that when the market for capital comes back, this product is a winner. Gerry, you want to elaborate?

Sure. I mean, we launched this in a controlled market release as we were evaluating the unit during the beginning of the first quarter. We've sold a few during those evaluations. We've done a formal introduction and launch at the AANS meeting out here in San Diego. The reception has been very positive.

Because of the holdback on buying capital, a lot of the physicians are looking at it and sort of trying to key it up so when the capital cycle frees up, they'll be in a position to acquire the new equipment. There's a lot of advantages built into it. There's a lot of features that are very attractive to the neurosurgeons. And I think that as our sales force is starting to collect leads and generate potential pipelines for sales once capital frees up, I think as that frees up, we'll see some good benefit of sales.

In the Mosaic, you had mentioned, that is our engineered collagen products and we did see some good growth in the spinal area.

Great. And then just one follow-up, generally on Spine. I guess one of the things that's become apparent maybe in the last quarter or so and certainly at the SAS last week and AANS this week is the significant shift around MIS and traction and MIS procedures kind of across the board. You had talked before about your efforts there to roll out -- focus your R&D efforts in Integra Spine to address that.

Point number one is, anything you can highlight there, or upcoming products that you think will expand your presence in MIS. The other thing is, I'm wondering if your neurosurgeon base, you know, the fact that that is where a lot of your relationships are on the clinician side, it seems, if that lends itself to a more sort of MIS oriented demand among the clinicians that you already serve?

Gerry, why don't you handle that?

Okay. I think as far as the pipeline, certainly we are actively investing in R&D programs to develop products for minimally invasive spine surgery. We're not at this stage at a point where we want to disclose and talk about specifically the features of the product and competitively how they'll be positioned. But we are actively pursuing those in the development pipeline.

And in terms of the surgeon base, I think that certainly neurosurgeons and the relationships we have there help us for those surgeons who do spine surgery, but I do have to say Integra Spine has really built a nice network of surgeons, both Orthopedic and neurosurgeons who focus mainly in spine surgery, and that's what's really helping us capture our market share and grow the business. Less so dependent on their relationships that we have in our neurosurgery sales organization that focus on tumor resection, brain tumor and trauma.

But we have been using those relationships for getting introductions to more private practice and university based physicians who focus mainly on spine surgery within the neurosurgery practices, even though they might not have been a primary call point in the past, they're becoming a nice collaboration between our neuro group and our Spine group, being able to build stronger relations across the surgical specialty.

Okay. Thanks, Gerry. Thanks, Joe.

Let's take the next question.

Thank you. We'll now move on to Taylor Harris, JPMorgan.

Hey, Taylor.

Mr. Harris, if your mute button is turned on, please turn it off so we can hear you.

Can you hear me now.

We can. Please go ahead.

Great. Thanks. I just want to follow up on the ortho business as well. If I back out what I think Theken probably did in the quarter, seems like the ortho business was up in the mid single digits. Is that about right? I know you said the private label business was down, could you maybe quantify that for us just so we can get a sense of what some of your more specialty Orthopedic franchises were growing at?

I think, Taylor, we provided the level of detail that we had planned to disclose and so I'm not sure how much more I can give you. We mentioned that the Spine and OrthoBiologics grew sequentially from the fourth quarter as a whole. We mentioned that the extremities business grew in low double digits or low -- was it high -- no, the US grew over 20 and the overall extremities grew in the low teens because of the impact of currency. And then private label was down reasonably substantially over prior year. So I think in the spirit of trying to be consistent and provide the same information to you guys quarter-to-quarter, that's the level of detail at the moment we're providing.

Okay. And then my follow up is on cash flow, which was obviously very strong this quarter, and I was wondering if you could share with us your outlook for the full year. I know you said it would be slightly below EBITDA. Can you maybe give us some ballpark figures on both of those?

We don't have formal guidance on cash flow and Jack will give you some comments. As you can probably tell, and I think we talked about this on our last call, we tried, when we saw the economy beginning to implode in late fourth quarter and early first quarter, to put a brake on a lot of things and I think we were reasonably effective. In particular, we did a good job of refocusing effort on inventory management and also refocusing effort on AR management, and Jack gave you some statistics.

Now, the first quarter number is particularly good in some regard because of the change in revenue from Q4 to Q1. So I don't want to take a huge victory lap for that, if the revenues are down there's less accounts receivable. That all being said, nonetheless, they were very strong and we expect that strength to continue throughout the year because of our controls over spending.

You can see also we worked hard to bring our cost structure down quickly and I would say our general approach on cost structure is we are looking hard at everything but we kind of view our objective of making sure 2010 is a good year as paramount and I think to some extent reflected in our new guidance was a desire to cut but also a desire to invest. And so there is some balance in that. Jack, you had some comments on cash flow.

Yes, I mean, the main -- Stuart, you hit a number of them. I think the main point is this quarter did include a good adjusted -- I mean, if you go back and look at the adjusted EBITDA number we gave, excluding the share based comp, that came in very close to the cash flow number. The cash flow number, as Stuart said, and as we said in the script, incorporated some improvement in the management of balance sheet line items, which obviously cannot go on forever.

We think that the inventory gains will continue for a while, because we've not yet achieved our objective. The AR gains were partly an artifact of lower revenues. We hope that doesn't continue. So, what we said was even though cash flow was in excess of adjusted EBITDA this quarter, ordinarily, we would expect it to be below. Now, we haven't given adjusted EBITDA guidance either, but we have given you the other pieces you need I think to construct a reasonably good estimate of that.

Okay. Thanks a lot.

Does that all make sense?

Yep, absolutely.

Thanks, Taylor. Next question.

Next question will come from the Amit Hazan, Oppenheimer.

Good morning.

How you doing?

If I could start with guidance, I think we all recognize how much more difficult it is to set guidance in this environment but I've got to put this out there. The last time you gave guidance was in early March, so less than a month left in the quarter and we're seeing guidance come down by about $40 million for the year. If I'm hearing you right, you're talking about the capital crunch is the main reason, but your capital business is only about $70 million for the year.

So I'm having a hard time, if you can help us with the $40 million reduction in guidance, how much of that was because of capital, and how much of that is because of instruments and why is it that we're just hearing about the instrument part now, because if I recall correctly on the last call you were talking about Miltex growing 5% and Jarit growing high single digits.

We were wrong on instruments and when I'm talking about capital crunch, I'm talking about the lack of financing for hospitals or for companies, impacting the way in which they behave. So we went back as you recall in the first quarter, and did a lot of work on what we defined as capital in the Company and indeed we, in preparing for this call, we went and looked at it again. It's about 10% of revenues that are products that are a couple thousand bucks or more that are equipment in the hospitals.

So that hasn't changed and indeed that is what represented along with currency the bulk of the shortfall in the fourth quarter. What we absolutely did not anticipate was the behavior of hospitals and physician offices, and our own distributors in reaction to the availability of -- and it's unfortunate it's the same word. What it means is the availability of cash.

And so we learned that our instrument business was dramatically more economic sensitive, economic sensitive than any of us anticipated, and indeed there was no reflection of that in the fourth quarter. So if you look at what we're bringing down in this roughly $40 million reduction, it's mostly instruments, and if you look at our performance in the first quarter, indeed we really underperformed by 10 to 15% in our instrument category.

I would say, again, and we certainly brought other things down beyond instruments, in our guidance that we prepared, both at the end of last year and then into when we reported Q4, I think we generally had the point of view that there would be a rebound of some sort in the second half of the year and we've just taken that out of our expectations now and when I say a rebound, I mean a rebound in the overall economy.

Okay. If I can ask, then, on surgical instruments as my follow-up, I guess, I always thought of that business as the type of replacement business that can't really be sensitive. If something breaks you have the type of product that then they would ask you to replace it and put in an order.

What am I missing here? What type of products here can they actually push back? I understand the inventory issue but that seems to be a short term issue that over the course of the year would correct itself. So what specific type of instruments do you have in there that they could hold off on for more than nine months?

I'm going to let Jack talk a little bit about the instrument business, but I want to be clear. Our expectation until we got into the quarter was the instrument was exactly what you thought it was. We saw some phenomenon in the first quarter that we had not seen in our experience over the last five years of owning instrument businesses. Now, I would say we're not the only Company that saw really unusual experiences in Q1. But it's a reality so I can't back away from that. Jack?

I'd say broadly speaking, broadly speaking there's two pieces of it. On the hospital side, which you recall we sell under the brand name, primarily brand name Jarit, as you suggested, the day-to-day replacement business is pretty normal. So when a hospital has to buy something to replace a thing in a set that broke or whatever else, it's pretty normal. They're doing more repairs than they were. So there's some effort to conserve money over there. But that's the main normal business.

But remember, hospitals in the ordinary course and we have 5,000 hospital customers in the US, they do things like refurbish or add operating rooms and for example, when they do that, they might order several new trays of instruments that might go for $100,000 or $150,000 from a Company like Jarit and those I would say new orders for operating rooms are much harder to come by this year than they have been in the past. That is probably an artifact.

Our sales group thinks that's an artifact of the hospitals' issues with access to capital, and I think it's widely understood that hospitals themselves have delayed, stretched or suspended their own expansion plans and that's having an impact on the Jarit side.

On the office side, which we sell under the brand name Miltex, there are two factors at play as we said in the script. One is that the 200,000 physician, dentist and vet offices around the country are really small businesses, and they are to varying degrees suffering the same way other small businesses are around the economy, depending on where they are, the nature of their practice and so on and so forth and, therefore, they're conserving cash like everybody else.

Then, you recall, Miltex sells through distributors and wholesalers. Some are small local businesses and others are big companies, big public companies that themselves have been trying to manage down their own inventory. Our Miltex people do believe that as the inventories and the distributors reach more normalized -- reach the objective they've got, that ordering will return closer to something like normal. It's not totally clear to us when that will happen. We do think it will happen during this year. And so those are really the two phenomenon that are driving it.

Can we take the next question, please.

We'll now hear from Tao Levy, Deutsche Bank.

I was wondering if you could comment on some of the pricing trends you might have seen specifically, across the entire Company, but then more specifically within the Orthopedic business where we've heard of some pushback out from hospitals these days?

Okay. Well, I would say probably best to take it by product category. If you're looking for a silver lining in the instrument business, there never was much pricing, so we don't expect much. So we haven't seen much downward pressure and on the other hand we never build in much upward expectation. In terms of our neuro business, we do look at pricing trends and I would say the ability to put through and hold price increases is limited and we certainly have in this particular market the objective of to the extent that we do wish to put through price increases, tying that in one way or another to increasing volume or use of a broader product line.

As the market leader, it provides some limitation as to what we can do, and some of the categories of sales are pretty competitive and, therefore, won't take a price increase. Other parts of it, we have such unique products that we can continue to put through pricing. Orthopedics, Gerry, why don't you take that because it's sort of all over the place.

Yeah. I think in the Orthopedics area, if you look at just the three components that make up our Orthopedics businesses, in the Extremity Reconstruction area we have fairly specialized products targeted toward hand and wrist and foot and ankle surgery. They're not the commodity products of some of the trauma companies and so we're really not getting pushback on any pricing in that area.

We're very competitively priced and procedure volume, although it's not growing at a faster rate than we would like it to, it's actually still growing. There's still procedures being done, reconstructive surgery, and our ability to take market share through increased distribution, just enabled us to add higher service levels to those accounts and that's what's been more important to those procedures than the actual pricing of the products, being able to provide higher levels of service.

In terms of the Spine area, again, it's similar to Extremity Reconstruction. We're very competitively priced. We're going after market share. We're expanding distribution coverage. We're getting very little pushback on pricing. On an account level, and it's more service expectations from the accounts, that we're driving that as a value add to our product, which is expected by the accounts and there's less pushback on the pricing.

On the OrthoBiologics we see a little bit more pushback on pricing probably because in some areas of the OrthoBiologics, especially in the demineralized bone products versus the collagen ceramic matrix, we see some pushback on price. It is very competitive. We are usually a premium price supplier of OrthoBiologics and so we do run into some pricing pressure but nothing that's not usual with the business of being competitive, having the full portfolio of OrthoBiologics and our sales organization has been really pushing on the collagen ceramic matrices which really differentiates us from some of our competition and from a pricing standpoint that has not been an issue.

So if I were to summarize all that, it seems like not much as changed in the grand scheme of things, Q1 versus Q4, Q3 of last year, is that a fair statement?

I think that's right, Tao. I don't think we see particular impact on our business to date.

And can you -- for clarification, the CUSA business specifically in the quarter, I know you don't want to break out how that did, but is that considered CapEx or how much of that business is considered CapEx and what was the trend in the quarter? Sorry if I missed that.

Well, CUSA is half CapEx, so the equipment is in the CapEx category, and half disposables. Because we sell tubes and hand pieces and a variety of disposable devices. So of the overall CUSA business, broadly speaking, it's about half capital and half disposable. And actually, of our total capital business, it represents close to 40% of our -- or 30% of our total capital. I would -- I don't have a number at hand, but I would be surprised if it wasn't down 15% year-over-year.

On the capital side or --

On the capital side. Not on the disposables. But on the capital side I'd be surprised if it wasn't down that much.

Then disposable side --

Particularly if you include the impact of currency on the O-US business which is not insignificant. What was the second question?

Did the disposable part increase?

Again, I don't have the specifics, but I think it would probably be in line with our other disposable and implants. There was no -- we didn't see a decrease in use of ultrasonic aspirators. We saw a decrease from prior year in sales of capital.

Perfect. Thank you.

We'll now hear from Amit Bhalla, Citi.

Hi, Amit, how are you?

I'm doing well. Good morning. Can you give us an update on the clinical trials for the wound product as well as the two piece ankle and to clarify, just on the inventory management, and inventory reductions, so you're looking for decline in the second quarter and then a rough leveling off in the second half of the year, is that fair?

Do you mean in our inventories?

No, in overall, how you're talking about the distributors managing inventories, that's where I'm looking at.

Okay. So you're talking about in sales to customers. Well, keep in mind, of our instrument business, a fraction of it is Miltex. Off the top of my head, it's about a third. And so it was down approximately 15% year-over-year.

So when we talk about the impact of distributors, it's not a huge number for the entire company. It is a big number for the instrument business. I don't think we want to be specific as to when they will stop reducing inventories. It would demonstrate an understanding of what's going on in the economy beyond what we profess to have. But at some point, they have to stop bringing down their inventories because out the door is equaling in the door.

They clearly took them down in the first quarter. It's possible to take them down in the second quarter. At some point, going into the distributor is the same as coming out. But for the overall company, it's not a big number, so let's be clear. In terms of our own inventories, we seek to bring them down to 200 days. I don't have a time line for the target, but I would guess before the end of this year. So I'm answering two questions because I wasn't sure which one you wanted me to answer.

That's fine. Clinicals, then I have one quick follow-up.

On the clinical trials, Gerry, why don't you take them. There's nothing new to report on the DuraGen adhesion, except that it's going at the pace that we hoped it to and there's no new news, and we talked about it at the November meeting and continue to look forward to that product, and I don't think there was any change in our time line or anything like that. Gerry, do you want to talk about the skin trial and just give a little more detail?

Sure. As we reported in our last call, we're initiating the wound trial that will expand the indications of use for our Integra Derma Regeneration Template, for use in diabetic foot ulcers, which can be tied to outpatient centers, and primarily we're doing this to run a controlled randomized clinical trial to collect data to support the reimbursement for this product in an outpatient setting. We've initiated the trial, and again, not much has changed in the last couple of months. We've initiated with enrolling patients, but we still anticipate the trial to take a two to three-year period before we complete the trial and get FDA submissions to support the PMA supplement. This is a supplement to our current pre-market approval on the Derma Regeneration Template.

On the Integra, again, not much has changed on that. Three-piece ankle, two-piece ankle studies. We're in the process of compiling the surgeon group. We've had some meetings with the FDA, and we're getting prepared to initiate a clinical trial for a two-piece ankle that will allow us to then go on further in the future to position our three-piece ankle, and we expect to initiate the trial later in the year.

Okay, and my follow-up is on your comment about spine, OrthoBiologics growing quarter over quarter. Can you at least tell us if it grew low single digits, mid single digits, or just some qualitative around that? Thanks.

I think as far as we're going to go is that the spine and OrthoBiologics met our objectives. I think we have consistently said we expect those businesses to grow on average year-over-year 15 to 20%. That's what Theken was doing before we bought them. I think there's no change in our expectations, and the performance in the quarter was very good.

Thanks.

And we'll now hear from Joshua Zable, Natixis.

Hey, most of them have been answered, but a couple of quick follow-ups. First on the guidance, here, I know you talked about the instrument business, but you also made some comments in the Q about the distributed businesses and foreign exchange. I'm just trying to understand. Understanding that part of your strategy is to constantly reevaluate businesses that are lower gross margin products, especially ones being sold through distributors or whatnot, going forward in the year, I know you're always evaluating, but is it something we could continuously see or do you think we're done for the year to at least to get a handle on revenues?

Okay, well, we don't expect any significant changes in our strategy for how we're handling these product lines this year. When we talk about distributed businesses, to be clear, the Luxtec acquisition, which mercifully we'll be done anniversarying by the end of this year, involved the discontinuation of more than -- it will turn out, about 60% of the product lines. And as they get discontinued, that impacts the year-over-year revenue comparison. That was still a significant factor this quarter, and you saw that in the instrument product line. So when you compare the quarter -- the first quarter 2009 with the first quarter 2008 for instruments, and you see these 16% declines that includes the impact of having discontinued a significant number of product lines.

All those decisions have been made. I wish they were all done at exactly the same time and awhile ago, but they weren't. And so in our guidance this year is the continued bad comparison of those product lines. Now, we're not talking about discontinuing sales of Miltex through distributors, so don't be confused by that. The two are totally unrelated. There's no intention to change at all. We're not discontinuing the people who distribute our products. We discontinued our behavior as a distributor for other companies.

I guess I'm referencing just a comment about sort of we expect sales growth to temper because of the recent elimination of many product lines we distributed for third parties. So I'm just trying to understand going forward.

That's done, and it's done, although you will continue to see that impact basically through the end of the third quarter.

Okay. And so then just again, just on the outlook being lower then, so this is really primarily the instrument business? I mean, just because -- I'm just reading through. You mentioned foreign exchange, you mentioned capital equipment. So I'm just trying to understand if the lower guidance really just references the instrument business, or are there other factors at play?

I think there are a variety of factors at play, and I would say the dominating theme is we've taken out a back half recovery for the economy. So we've taken out, in our capital product lines, a ramp in the back half of the year that is -- to the extent that that was there, we've removed it. We certainly brought the instrument number down hard.

On the topic of currency, our guidance is based on 1.3. So when we talk about this quarter versus prior year quarter, we're really talking about change in currency, which my recollection was about 12% in the Euro from Q1 of last year to Q2 -- sorry, to Q1 of this year. That won't change throughout the year. The comparison gets better through the year because the Euro stabilized, or the dollar stabilized. But I think when you think about our guidance, our guidance did not change this quarter because of the Euro, because when we gave the fourth quarter guidance, when we gave the guidance in fourth quarter it was also $1.30.

That's very helpful. Just a quick follow-up. Just the tax rate going forward for the year. Any change to that?

The tax rate going forward for the year is inherently the tax provision in effect that we book, because that is in itself essentially a product of a forecast. So that was 35% for the year, and that's how you should work it through your model.

Great, guys, thanks for taking my questions.

We'll now hear from Matt Mims, Pro Vibra Technology.

Thank you for taking my call. Just a question on the e-disk and your thoughts on the artificial disk market and reimbursement trends you're seeing there?

Gerry, you should probably take this. I think our statement that we had when we bought Theken, which was that while the e-disk presents a unique opportunity, particularly based on the technology, it was originally designed to address the lumbar market, and the world has changed, and so we have not invested in beginning any clinical trials for that product or for a cervical version of it. So I would say, from Integra's perspective, we certainly don't have a lot to say about the disk market as it relates to our numbers. That being said, Gerry is pretty knowledgeable, and I'll let him respond.

I think Stuart summed it up pretty well. I think that the jury is still out on lumbar spine disk technology, certainly cervical disk is more readily accepted, but again, there's still questions as far as the efficacy of a cervical disk and the need of that disk clinically. And we're sort of actually just watching the market dynamics right now and watching some of the other companies out there who are in the disk space and seeing what they're having for results. It's a fairly expensive program to invest in. We have a lot of technology, so sitting there ready to deploy, but rather than make the investment, based on the current market trends and questions that are out there, we think our money is better spent putting it into product line improvements and filling other gaps in our portfolio to support our distribution expansion at this time. So we're staying on top of what the current trends are, but we're not heavily investing in bringing a disk to market at this stage.

Okay, thank you.

Jayson Bedford of Raymond James has our next question or comment.

Hi, Jayson.

Hi, Stu. I don't think anyone's asked about gross margin, and that seemed to be a silver lining in the quarter. A couple of questions: were there any purchase accounting adjustments included in the number? And then as we look at it, it looked like about 170 bips year-over-year improvement. Can you break out the components of that increase? What is attributable to mix, manufacturing improvements, and any FX impact on the margin?

This is Jack. Hi, Jayson.

Hey, Jack.

Yes, the gross margin as reported, the 64%, included the effects of purchase accounting and a couple other things, and we read through that in the script. It was about a point and a half. So that's the answer to the first question. The second question, the gross margin impact was overwhelmingly mix, and it was a consequence both of -- actually, pretty strong performance in our highest margin products, which are centered around the specialty orthopedics business. So they did relatively well. The areas that were weak in the top line, as we've already discussed, instruments, and some of the capital stuff, tend to have margins below our corporate average. So the upshot was a very attractive gross margin number. Almost all from mix. It doesn't mean we're not also working to improve operations and so forth, but it's hard to tease that out in any particular way.

Okay. That's fair. Just quickly, as my follow-up, the instrument business, any way you can break up the contribution from hospital versus office space revenue?

Well what I would say is, we're trying to, again, be consistent in the information that we're providing, which is these larger categories. I think, if you go back and look at what we acquired years ago, and the growth rates we've been telling you, you can pretty easily get to what's Jarit, what's Miltex, and some of the other product lines. I'd rather stick with our position that these separate breakouts are just not that relevant. We told you, the hospital space performed better than the physician office space this quarter, and they're both similar size components.

Okay, thank you.

We'll now hear from Bill Plovanic, Canaccord Adams.

Hey. One simple question: the business of Jarit, Miltex, and all of those are down. I noticed that you did not take a write-off for them. We've seen a lot of our companies to have take one-time write-offs of the intangibles. How much more do you think they'd have to decrease for that to happen?

Well, I'll make a point, then Jack can answer the intangibles question. Even though the businesses are down, we did, after all, generate $37 million of cash flow. So down is all relative, and while we don't deserve any great huzzahs for the performance of our instrument business, it still is incredibly profitable and strong business. So we review our intangibles annually, and we haven't seen any need to -- or any even indication that Jarit or Miltex are impaired.

Actually, we review the impairments quarterly. Sorry to correct you, Stuart. Obviously, I think you're absolutely right, every company out there is thinking harder about issues that they didn't have to think about under happier economic times, and so are we. I don't want to get into how much room there is for exactly the reasons Stuart described. It's a functioning of a mixture of economic returns that play out in a model, and so anything I would say would turn out to be wrong in some way. Suffice it to say we do look at it every quarter, and we're confident where we are right now.

Okay. Stuart, I'll give you a blue ribbon, and nice job on the squeezing the cash out of the company. That's it.

Thank you.

Dev Joshi, PearlDiver Technology has our next question.

Actually, all of my questions have been answered, but quick question on the extremity market, how did the upper extremity market fare compared to the lower extremity?

I would say that's a level of detail that's competitively sensitive that we'd just as soon not provide. That being said, the extremity business did nicely in this quarter.

Thank you.

We'll now take a follow-up from Raj Denhoy, Thomas Weisel Partners.

I was curious. At the end of your prepared comments, you made some allusion to the fact that you expect the business over the next three to five years return to kind of a high single digit growth profile on the topline. Thinking back, is that a little slower than you have alluded to in the past? In the past you have talked about pricing in high single digits or even low double digits as a more sustainable rate. Is there anything we should be reading into that?

Yeah, you should read into it high single digits. I've been criticized enough for saying low double digits and being wrong. I'm now hoping to be correct and do better from time to time. We think the right guidance is high single digits, and we were not uncareful in what we scripted.

Okay, thank you.

Take another follow-up from Matt Miksic, Piper Jaffray.

A couple follow-ups on the hospitals. I know it's hard to predict how they're going to behave, what they're going to do, but what one thing, as you're talking about adding ORs, and the impact on instrument sales, could you maybe give us some color around that business, like if it's Jarit and the equipment business is driven by new hospital construction since that seems to be one factor of capital conservation that's been happening over the last six months, and may, I guess, drag on a little longer if the start of new wings and hospitals continues to remain slow.

Yeah, again, I wouldn't overplay it. All these things are relative, and so maybe it's 5% of the business' new hospitals, new ORs within hospitals is certainly included in what an expansion would be. Just the overall desire when a new doc comes to build out a whole new set of trays for them. All of those sort of unusual and typically practical things that have been done in the past, you see drying up. But I would venture a guess, and Jack and I are looking at each other to see if either of us have a better guess, but probably of our Jarit business historically, and use Jarit as a shorthand for hospital based instrument business, maybe it historically was 5 or 10%. So there's a lot going on. People can definitely extend the life of a handle of a surgical instrument by repairing it. They can definitely try to bring the inventory down a little bit in the hospital. They can -- clearly, hospitals not building out ORs or not building whole new hospitals, there's also the impact on ambulatory care centers, which was a big growth thing in 2007 and 2008, these specialty surgery centers, that whole phenomenon has ground to a halt. The overall economy has definitely impacted this medical profession.

And then just one, again, and I'll put you on the spot to predict what hospitals are going to do, but is it your sense, from the distributors, either on the handheld instruments or the equipment side, that when we come out of this, and I don't know if it's credit availability, or if it's just the overall economy that brings hospitals out to spend a bit more. Are you expecting a bolus of demand that comes on the back end of that because of what they needed to have replaced over the last six months, or maybe the next six months, or are you expecting hospitals to come back at a more conservative rate with maybe more a tighter profile in terms of how they consume these capital items?

Well, first of all, I want to acknowledge that it's very hard to predict, and certainly our attitudes or guidance this year reflects the fact that it's hard to predict. And so I don't want to come off with a strong prediction in what is a market that nobody, including ourselves, has done a good job of predicting. We continue to believe that we provide life-saving products that are not discretionary. You're going to remove the brain tumor, you're going to need an ultrasonic aspirator, we have a very market share in that market, and we have an aging installed base, so when it is comes back, we would expect to the come back strong, but what we don't know is when it's going to come back, and I think we've proven we're unable to predict that. I don't think we're different than anybody else in our proof of being unable to. But keep in mind, we've been working on this product, the irony is, we've been working on this next-generation ultrasonic aspirator as long as any of you analysts have been following Integra. We finally have it, and we're all dressed up with no place to dance at the moment, but when it comes back, I think we've got a great product, and it's going to create some real up side when it comes back.

Okay. That's helpful. Thank you.

We'll take another follow-up from Taylor Harris, JPMorgan.

Hey, Taylor.

Thanks, this will definitely be my last one. Thanks for taking it. Appreciated your comments on longer term revenue growth and being deliberate in talking about the high single-digit range. Can you give us your thoughts on what that translates into in terms of EPS growth?

As we were deliberate in providing the long-term revenue guidance, we were deliberate in not providing EPS. I will tell you why. It's pretty complicated. We've tried to move to this annual guidance and be specific, and we're going to obviously work to be right. What I don't want to do is start providing all sorts of new guidance that we're then held to. We do believe that we're providing high single-digit revenue growth. We clearly have leverage in our gross margin. We clearly have opportunity to continue to look for improvements in our operating spending, and don't forget, there's also some nice opportunities in de-leveraging the company, which will drive EPS. But I don't want to put a number on it yet.

Okay. Is there anything that changes materially at that revenue growth rate in terms of your ability to drive some of those leverage items that you talked about? I know, for example, historically, you've talked about gross margin leverage in the 100 to 150-basis-point range each year?

No, I don't think that's changed. Indeed, to the extent that our mix has moved toward the implants and disposables, the gross margin leverage is evident. Again, I've been, for several quarters, trying to convince people there really is a hidden 65% gross margin in our numbers, if could you just get through all the purchase accounting and the acquisitions of instruments. So, the reality this quarter is that showed through.

Right. Okay. Thanks a lot.

And there are no further questions.

Thank you all, and we look forward to our next quarter report and taking any questions at the conferences coming up. Thank you.

And that concludes today's conference. We do appreciate your participation. Have a great day.