Integra Lifesciences Holdings Corp (IART) 2009 Q2 法說會逐字稿

Good day everyone and welcome to today's Integra LifeSciences' second quarter earnings conference.

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

Thank you. Good morning everyone and thank you for joining us for the Integra LifeSciences' second 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, Jack Henneman, Chief Financial Officer and Angela Steinway, our Head of Investor Relations are joining me today.

During this call we will review our financial results for the second quarter 2009 and our updated forward-looking guidance for the full-year, which we released this morning. At the conclusion of our prepared remarks, we will take questions from the audience. We will endeavor to keep the call to one hour, though 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. If you do have additional questions you may rejoin the queue.

Now I will turn it over the Jack who 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 telephonic replay is available through August 20, 2009 by dialing 719-325-4780. Access code 4105940. Additionally, a webcast replay will be archived on the Investor Relations page of our W\website.

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

Certain statements made during this call are forward-looking within the meaning of the Private Securities Litigation Reform Act of 1995. Among other statements concerning management's expectations of future financial results, new product launches, 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 can cause actual results to differ materially from predicted results. These forward-looking statements are made only as of the date hereof and the Company undertakes no obligation to update or revise the forward-looking statements, whether as a result of new information, future event or otherwise. For a discussion of such risks and uncertainties, please refer to the risk factors included in item 1A of Integra's annual report on Form 10-K for the year-ended December 31, 2008, and to information contained in our subsequent filings with the Securities and Exchange Commission.

Certain non-GAAP financial measures are discussed 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. In addition, 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 the 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 will now turn the call back over to Stuart.

Thank you, Jack. Integra delivered another quarter of top line growth and strong cash flows from operations. Our 8% constant currency growth in revenues, reflects the depth and breadth of our business, which enable us to perform well despite the tough economic environment. Our specialty Orthopedics businesses, which are growing by increasing market share, did very well. Not surprisingly our market leading businesses in Neurosurgery and Surgical Instruments had a tougher time of it.

The second quarter continued to present challenges, including the stronger US dollar compared to last year and the struggling global economy. Our hospital customers continue to take a conservative approach to capital equipment and instrument purchases. Our office-based instrument customers are still experiencing the pressure of the difficult economy, although we have seen signs that these markets are stabilizing.

With that said, Integra continues to focus on serving it's critical markets and indeed, the improved margin mix and focus on cost reductions, allowed us to deliver second quarter adjusted earnings per share of $0.51, slightly exceeding the street consensus. We report our revenues in three categories. Integra Orthopedics, Integra NeuroSciences and Integra Medical Instruments.

Integra Orthopedics, which is our largest product category, and which includes the products sold to foot, hand, spine and orthopedic surgeons, represented approximately 39% of Integra's overall second quarter revenue. The revenue from products in this category increased 28% to $65 million from the prior year period. Extremity reconstruction, which is the largest component of Orthopedics, again performed well this quarter, posting double digit growth. Strong growth in our domestic extremity revenues was offset again by the negative impact of currency on our international businesses.

Revenues from our Spine and OrthoBiologics business contributed substantially to our overall growth and grew sequential from the first quarter. Finally, private label revenue was down in the second quarter versus the prior year because certain of our customers sales were relatively weak and they are managing their inventories to lower levels.

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 second quarter declined 2% to $61 million versus the prior year period. However, sales across most product lines improved sequentially, which is encouraging.

Implants and Disposables grew over 2008, but were more than offset by year-over-year declines in capital equipment and the impact of currency.

Our final category, Integra Medical Instruments, includes medical and surgical instruments sold into the hospital and office-based practice channels and accounted for 24% of Integra's overall revenue in the second quarter. Revenues in this product category decreased 10% to $39 million versus the prior year period. Hospital sales were down because of reduced capital spending and the impact of the winding down of our distribution business. Office-based sales also declined due to lower end user demand and distributors inventory management. However we have seen indications that the office-based business has begun to stabilize and expect our business trend to improve once the big distributors have completed the process of bringing down their own inventories.

Now I would like to turn the call over to Gerry Carlozzi to discuss some recent developments across our selling organizations.

Thank you Stuart. We are pleased with the strong growth of our Orthopedic business. First I'd like to highlight our Extremity Reconstruction business, where we are investing in the expansion of our domestic sales organization. This team grew from 85 sales people at the end of 2008 to 110 people at the end of the second quarter and we anticipate increasing the sales force further to 115 through the remainder of 2009.

We have been investing in product development to provide a complete offering of clinical solutions for our expanded sales force. During the quarter, we introduced several new products including the [HALLU-LOCK Arthrodesis System], line extensions for our [UniCP] System and the Inforce Reinforcement Matrix. The HALLU-LOCK System is a unique next generation system that utilizes our Surfix Technology to provide improved patient care for the treatment of deformities caused from arthritis. The Multipleline Extensions for the UniCP Compression System will provide our customers with even greater clinical flexibility when using our highly successful UniCP Fixation System. The product line includes a line of compression places, staples designed for the correction and stabilization of osteotomies and fusions in the foot.

Tendon and ligament injuries are some of the most common musculoskeletal disorders, which includes Achilles tendon ruptures and flexor tendon injuries of the hand. Industry sources estimate that there are approximately 700,000 tendon and ligament repair procedures in the United States. To address this market opportunity, we introduced the Inforce Reinforcement Matrix. This product is a high strength scaffold that provides reinforcement and augments the tendons during the healing phase. Inforce will be a significant addition to our upper and lower extremity product portfolio. We estimate the market opportunity for this product could be as much as $80 million.

In addition to new products, we are investing in our core collagen products, although Integra Dermal Regeneration Template has been on the market for over 13 years, it continues to be a core product with strong growth. We have initiated a clinical trial for the use of our Dermal Regeneration products and the treatment of diabetic foot ulcers. We expect to file a PMA supplement during 2012 to support the expanded clinical indications and reimbursement for our wound management products. We have also invested in bringing our regeneration products to new geographic markets, as we received approval in Japan and expect to begin selling there this quarter.

Turning now to our Spine business. We are focusing on increasing our distribution network. We added several new distributors during the second quarter and we are working to achieve geographic coverage for US by year-end. We expect to begin selling our Spine products outside the US in early 2010. We have introduced several new Spine products that fill our product portfolio as we work to offer our surgeons a comprehensive package of clinical solutions.

During the second quarter we introduced the Atoll System, a posterior cervical spinal fusion system that is primarily used for fractures, instability and deformities of the cervical spine. As well as an option that can be used to repair failed anterior fusions. We introduced the Coral Extended Tab Spinal Screws. Extending the tabs makes a series pedical screws, particularly useful for the correction of spinal deformities and reduces the needs for additional hardware during surgery.

We have expanded our OrthoBiologics product offerings with the introduction of new configurations of Integra Mozaik to meet the specific needs of the spinal surgeon for their bone graph requirements. Toward the end of 2008, Accell Evo3, which is the latest generation in demineralized bone matrix was introduced. Accell Evo3 has been formulated to provide surgeons with superior interoperative handling characteristics.

Evo3 has been one of our most successful OrthoBiologic product introductions. We anticipate strong growth from our specialty Orthopedics business throughout 2009, as we increase our sales presence and expand our product portfolio with new and unique products.

In NeuroSciences, our most established business, we have been investing in our implant and disposable tissue ablation product portfolios, where we are seeing growth as procedural volumes appear to have leveled off.

For our Adhesion Barrier Trial, we have completed the enrollment of approximately 300 patients. We expect to complete our patient enrollment by mid-2011 and file our PMA during 2012. Our outside clinical trial advisors expect to conduct an interim analysis before the end of the year.

As we discussed during our last call, we introduced our next generation Ultrasonic Tissue Ablation System, the CUSA NXT. We continue to receive favorable reviews on the new system and surgeon support for the procurement of the system. The CUSA NXT system features NXT Digital Architecture, which delivers consistent tissue removal performance, enables advanced tissue aspiration and offers a touch screen user interface. The NXT Digital Architecture also provides an expandable platform, enabling future tissue ablation capabilities in clinical applications for selective dissection of soft and hard tissue, including bone. We are optimistic that this product will provide a major contribution when hospital capital spending improves.

Turning to Instruments for a moment, while we expect the second half of the year to continue to remain weak, we do not expect further sequential declines. The quarterly sales progression is expected to be consistent with our historical seasonal trends. We should see an increase in Instrument sales as hospital capital projects resume.

During the quarter, we introduced our next generation headlight, the Luxtec [Ultra Prolight].

In an effort to continue to add efficiency to our operations, we have consolidated our European corporate sites from four locations into one facility in Leon, France. We have already moved into the new site and our grand opening is scheduled to be in September.

Now I will the turn the call over to Jack for a review of our numbers.

Thank you Gerry. We are pleased with Integra's financial performance in the second quarter. We grew our revenues and profits sequentially, we generated strong cash flows from operations and we paid down approximately $79 million of our debt. Further, although the current environment is still uncertain, we are confident in reiterating our full-year revenue and earnings per share guidance for 2009.

We reported sales growth of 5% or 8% on a constant currency basis, international sales accounted for 23% of revenues, while US sales were up 10%, and international revenues were down 7% as reported and up 4% on a constant currency basis in the quarter.

In this quarter, we saw a negative foreign exchange impact to revenues of approximately $4.5 million versus the same quarter in 2008. Although the foreign exchange rates were slightly more favorable than the first quarter's rates, they remain substantially worse compared to the rates one year ago. If the exchange rates stay where they are today, the impact of currency on revenues in the third quarter should be negative, but less than the impact we saw in the first two quarters of this year.

Gross margin on total revenues in the second quarter of 2009 was 64%, including 130 basis point impact on purchase accounting from acquisitions and other charges. This is an increase of 90 basis points of gross margin percentage versus the same period last year, and is flat versus the first quarter of this year. The strength in our gross margin as a percentage of sales in the second quarter results from the addition of our Spine product lines and growth in extremity implants, particularly our Engineered Collagen products, which significantly and favorably shifted our mix of sales toward higher gross margin products.

We expect our GAAP gross margin to reach 65% to 66% by the end of year because the impact of purchase accounting for the Theken acquisition will be exhausted in the third quarter.

Research and development expenses in the second quarter of 2009 increased by $2 million to $10 million. The increase was due largely to Integra Spine activities and increased spending on the DuraGen Plus Adhesion Barrier Clinical Trial. We are targeting spending on research and development to be approximately 6% to 7% of total revenues in 2009. Most of this planned spending is concentrated on product development efforts for our Spine, Neurosurgery and Extremity Reconstruction product lines.

Selling, general and administrative expenses in the second quarter of 2009 increased by $5 million to $68 million, 41% of revenues. Selling expenses increased primarily due to commission costs associated with increases in revenues, particularly in connection with Integra Spine, which generated relatively higher distributer commission costs. We anticipate that SG&A will approximate 40% to 42% of sales for the full-year of 2009.

In the first quarter, we begin providing a calculation of adjusted EBITDA, both including and excluding stock-based compensation. We provide these metrics because we use them to measure the performance of the business and for credit analysis. Adjusted EBITDA excluded stock-based compensation approximates the EBITDA calculation used in the leverage and fixed charge coverage test under our credit agreement.

In the second quarter, we generated $35 million in adjusted EBITDA and $39 million in adjusted EBITDA, excluding stock-based compensation. These metrics were up 6% and 7%, respectively over the prior year period.

We reported a $400,000 increase in net interest expense to $6 million for the second quarter of 2009. As previously discussed, our net interest expense for both 2008 and 2009 includes a noncash component of our convertible debt instruments under FSP APB 14-1. Under this accounting rule our reported interest expense will increase over time.

Other expense was $500,000, which included a small reported loss on the early repurchase on the open market of $19 million par value of 2010 convertible notes. We paid $18 million, approximately $1 million under face value for these notes, however, the transaction resulted in a small loss being record on our GAAP P&L, due to accounting rule APB 14-1.

On a cash basis, the transaction will actually save us approximately $500,000 a year in cash interest. Together with the repurchase in the first quarter, our bond buy-backs will save over $1 million a year in cash interest. We also repaid $60 million of our credit facility in the second quarter and look for opportunities to take advantage of improving credit markets.

Our income tax expense was $6 million in the second quarter, reflecting an effective tax rate of 35%. In the third quarter, we expect that our effective tax rate will be lower due to the release of certain reserves for contingent tax liabilities. Accordingly, we now expect that our reported effective tax rate for the full-year 2009 will be 33%.

In the quarter, we recorded depreciation expense of $4 million and expense of the amortization of intangible assets of $5 million. Approximately $1.5 million of the amortization expense is included in cost of product revenues.

For the full-year 2009, we expect depreciation of approximately $15 million to $16 million in amortization expense of approximately $19 million. Approximately $6 million of the amortization expense will be included in cost of product revenues.

For those of you who are still tracking the impact of FAS 123-R, we expect the quarterly impact of share-base compensation expense to be approximately $4 million or $0.08 per diluted share during 2009.

We reported GAAP net income of approximately $11 million or $0.38 per diluted share for the second quarter of 2009. When adjusted for acquisition related expenses and other special charges, net income for the second quarter of 2009 was $15 million or $0.51 per diluted share.

We generated $31 million of cash flows from operations in the quarter, a very strong result and the fourth quarter in a row of cash flow from operations in excess of $25 million. We continue to make progress in our management of inventory and accounts receivable. This quarters strong cash flows from operations included approximately $6 million in balance sheet improvements.

We are pleased to report that we generated cash flows from operations of more than $120 million in the last 12 months. This has allowed us to repurchase debt and we remain confident in our ability to meet our financial obligations, including an estimated earn-out payment of $50 million to $60 million in the fourth quarter of this year for the acquisition of Theken.

Turning to the balance sheet, at the end of the June we had $139 million of cash, outstanding borrowings of $200 million under our credit facility, $114 million outstanding of our 2010 convertible notes and $165 million outstanding of our 2012 convertible notes.

We ended the quarter with 56 accounts receivable days outstanding, down from 57 days in the first quarter and down from 63 in the quarter ended a year ago. We had 212 days of inventory at the end of this quarter, down from 219 days in the first quarter and down from 234 days in the prior year period. Longer term we hope to get inventory below 200 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 reiterating today does not reflect the impact of acquisitions or other strategic corporation -- sorry, corporate transactions that have not yet closed.

We are reiterating today our 2009 annual revenue and adjusted EPS guidance. We continue to expect to recognize $680 million to $700 million in revenue in the full-year of 2009. Further, the Company is tweaking it's GAAP earnings per share guidance $0.01 to reflect a lower estimated GAAP tax rate and revisions to several discrete items for the year and we are reiterating our adjusted earnings per share guidance of between $2.00 and $2.20.

In the absence of any future acquisitions, we anticipate a quarterly progression in our earnings throughout the year that is consistent with our historical seasonality. While we were pleased with our second quarter performance we would urge investors and analysts to remain conservative in their third quarter and full-year estimates. We expect third quarter revenues to be up only modestly over second quarter and we would urge modeling at the low end of the full-year 2009 revenue guidance in recognition of the continuing uncertainty in the timing of any economic recovery.

That said, we believe we will continue to show good cost controls and earnings leverage. Based on our current mix of businesses, we anticipate our longer term revenue growth to return to a high single digit growth rate in 2010 versus 2009, as well as the 3 to 5 year period, thereafter. We expect to grow our bottom line even faster.

In summary, we believe that Integra 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 Specialty Orthopedics business continues to grow well.

We look forward to meeting with investors and we will be presenting at the Canaccord Adams Conference next week. On our medical conference agenda, we will be exhibiting at the World Federation of Neurosurgical Societies in Boston from August 30 to September 4. One final note, please mark your calendars for our 2009 Analyst Forum, which will be held this year on November 16 in New York City.

Now, we will be happy to answer your questions. Operator, you may turn the call over to our participants.

(Operator Instructions) And our first question today will come from Amit Bhalla with Citi.

Hi. This is actually (inaudible) for Amit.

Hi. How are you?

Good. How are you?

Good. Thank you.

First quick question. I know that last time you commented on Medical Instruments and in particular, gave a dynamic between the office and the physician-based practices. I know on the hospital side, with Gerard, you said people were delaying refurbishment and physicians were conserving cash. Any update in regards to those items?

I think our general perspective is that the second quarter played out the way we thought it would. As we pointed out, our revenues were down year-over-year, but sequentially we are solid. The physician office place is still being affected by the economy and we also saw distributors continue to manage their inventories down. I think we have seen some stabilization, but I think it would be early to call any improvement. Similarly, in the hospitals, there's an opportunity that hospitals have had to manage their capital down, and manage down or postpone purchasing and I think we continue to see that in the Instrument business. So, I think our commentary earlier this year that we don't expect a significant improvement in this market in the 2010 still holds. That being said, and you probably took it away from our words, it feels like there's some stability now.

Okay. And then just one quick follow up, any change in pricing trends that you guys are seeing, specifically I guess in the Orthopedics business?

This is Gerry Carlozzi. No, we have actually seen, when we have took a look at the comparison between second quarter of last year and the second quarter of this year, and we have did a pricing analysis, and our ASPs seem to be holding pretty well throughout the -- in a comparison basis. I mean we do see certainly pricing pressures on a regular basis, but nothing out of the normal course of business that we haven't h had to deal with. So, from our standpoint it looks like prices are holding pretty well.

Great. Thanks, guys.

And our next question will come from Matt Miksic with Piper Jaffray.

Hey, Matt.

Hey, good morning, Stu, morning Jack, Gerry. Thanks for taking our questions. So, one question on the progress on your Spine distributer front and Gerry I apologize if I missed this, but just any, any color on the types of distributors that you are finding if you are continuing to build that out, and any color around sort of difficulty in finding them, success in finding them in this market and then plans for Europe and I have one follow-up?

Okay. In terms of the US as far as building out the distribution channel, we have been adding on average several a quarter and we have been looking at from a geographic basis in the US, where the major populations are, where the procedures are being done and trying to target those areas for distribution expansion.

We have been pretty successful as far as finding good distributors. We're -- as we look at the distributors, we are looking at certainly currently Integra Spine distributors who have those products and then we are adding our OrthoBiologics to those distributors, which are giving us more leverage with them and then we are also finding OrthoBiologic distributors that are in need of a Spinal line and providing more leverage through that channel, as well as finding new distributors. We are seeing that there's a number of companies who are being distressed and a lot of our distributors in the network are concerned that they're not going to carry a Spine line some if some of these distressed companies go out of business or start losing market share.

So, we have been able to pick up some really good distributors who are experienced in the market that can help us expand our network.

Outside of the US, we -- our plans right now are to start in early 2010 to establish distribution in several countries and we are really focused right now on a few countries rather than trying to do a mass expansion outside the US in early 2010. I want to start off slow by adding several countries with distributors that we know who are in need of a Spine line and they have the relationships and the contacts in the hospitals outside the US.

Okay. Thanks for the color. One follow-up here on just sort of sequential -- sequential trends particularly in Orthopedics and sort of the impact on mix. I guess I am having -- looking at the Ortho numbers, it was a great number year-over-year, but a tad shy of our number and I am trying to find where am I, where am I wrong and any color you can provide maybe on, was private label down faster than last quarter? Were there any product lines that were maybe sequentially off in some kind of unexpected way in the quarter? That would be very helpful.

I would say the principle negative in the second quarter was the continued underperformance of the private label business in Orthopedics. Extremities was very strong, Spine was strong, OrthoBiologics was strong, the real challenge is the private label business and I think the private label business is down more than our customer's performance is down. It is a decision that many companies have taken in the first half of the year to bring down the amount of inventory that they hold and try to force that inventory down in the supply chain.

Okay. So, nothing else sequentially, sort of slow or weak in a Q2, usually not a sequentially weak quarter. Nothing else, no transitional events that caused any of your business to be slow?

No.

Okay. Thank you, Stuart. Thank you, Gerry.

Next we will hear from Jayson Bedford with Raymond James.

Good morning. Thanks for taking the question guys.

Hi, Jayson.

Just looking at the relative strength in the Instrument business. Do you think at all there was a catch up from a sluggish first quarter, meaning did you see orders that were delayed in the first quart that kind of came through in the second quarter or is this more reflective of true demand out there?

I think it is more reflective of true demand. The kind of order that we would get is not usually big enough to affect the quarter. So, it really is a just a reflection of the underlying business.

Okay. And then just looking at the Spine distribution, I think last quarter you had mentioned selling outside the US in the second half of the year, and now I think Gerry may have mentioned first half of 2010, is that more of an approval you are awaiting -- are you waiting for approvals or is that more of a distribution issue? I'm just trying to figure out the slight push out there.

I would call it focus. We did push it out to the first quarter. We are hiring as fast as we can inside of Theken and just the amount of management required to do Europe or Asia compared to just finishing the work that needs to be done in the US, it is just a lower priority.

We remain really enthusiastic about the share we can take in Spine and OrthoBiologics and it is a little bit like -- if you go back in time our decisions around Neuro. It took us a while to go outside the US because you can add more dollars and more return on the dollars right here in New Jersey, than some in some places outside the US. That being said, we don't want to push it beyond Q1, we just need to get enough manage in place to do all of these things and we have identified somewhere between 2 and 5 countries outside the US, where we do have distributors eager to have this product line. It is just a question of getting ourselves to the point where we can support it. It is not an approvals issue. Their CE marks already most of the major product lines. That's again, something Theken's done real well over the years and now Integra Spine intends to continue.

Okay. Great. Thank you.

Next we will hear from Joshua Zable with Natixis.

Congratulations on a great quarter. Thanks for taking my questions here.

Thanks.

A couple of questions about the general environment here. First obviously, on Spine, I know you guys are expanding across the country. So, it is hard for us to decipher growth in terms of what is expansion, what is sort of same-store sales. You also had procedures that we have some data points, obviously, with everything going on, the economy isn't great either. Can you just parse that out for us in some way, shape or form, help us understand exactly what you are seeing out there?

Gerry, why don't you talk about the Spine environment generally and then I can tell, maybe one or the other of us can tell you about what we are trying to do to take advantage of it.

Okay. As most of the reports have come out in the industry, the Spine volumes are down across the industry, but mostly because we are a small player and just starting to build up our distribution channel and expand, the volume decrease that some of the larger Spine companies have experienced are really not impacting our growth or our opportunity for growth in the Spine business. If you look at how we have attacked the market from a distribution side, when we purchased Theken Spine and then integrated it and created Integra Spine, the whole plan was to make it a distribution play right from the beginning.

They had limited coverage in the United States, they had good products, had some good surgeon followers who were continuing to buy their products, but what they lacked was the sales and marketing reach to get to a broader number of, excuse me, surgeons, and that was where we saw the opportunity to continue our expansion in the United States with the current products and then continue to add new products to fill in the portfolio in order to go after a bigger procedural volume within Integra.

In terms of outside the US, we don't see - we still see opportunities for growth there as well. So, we are really focused on right now expanding the product portfolio, expanding the distribution channel and a lot of the smaller Spine companies are having a difficult time sustaining growth, where we have been able to leverage both our OrthoBiologic products with our Spinal Hardware products and it is really offering us a competitive advantage in this space to be able to take some share from some of the smaller players.

I will add, if you go back and think about the last 12 months, we acquired Theken right in the face of the difficult economic environment, and I think it is probably realistic to say that in Q4 and even into Q1, we probably could have hired more aggressively. And we were slowing up in general across the Company. Looking at our financial performance in Q2 and the rest of the year, we are actually up regulating the hiring in Spine and OrthoBiologics, both inside and in term of distributors. So, I actually think we will continue to see this very significant growth that we have been seeing into the back half of this year and on to 2010. So, I don't doubt the, the decision to push off for a quarter or two. International is probably the result of some conservative behavior in fourth quarter and first quarter. That being said, boy those guys do well.

Great. And then just related to the Equipment and Instrument business, just I know you have talked about stabilizing, also we have seen some signs that Cap equipment spending is coming up a little bit. Just wondering if you are seeing that obviously, maybe into this quarter? And then just before I get cut off here, just on foreign exchange, Jack, appreciate the color. I know you guys get a benefit on the stronger dollar to the bottom line. Obviously, with the dollar weakening here, that's going to come back together (inaudible). I am just wondering, just in terms of modeling, if we should expect that this year or in 2010? Thanks very much, guys, congratulations.

The -- I would say that the gain in the margin should be rolling through, really now. If you look through the inventory, water falls from purchases and so forth and should continue for the next quarter or two, will not be huge gain because it primarily is focused on the inventory in the Instruments business, but it is there and we will get some of that benefit. It is small.

I would say, as you look forward beyond the back half of this year, with the Euro at 140, 142, that's kind of starting to match revenues and costs in the Instrument. So, for the first half of this year, we were suffering due to Instrument purchases at 155 to 160. As you look at the back half of this year, the overall business at 140 to 145 exchange rate and those inventories then flowing into next year, unless the gyrations in the dollar start to be 20% quarter-to-quarter, that will start to smooth out in 2010.

Oh, the other question which Jack missed, was capital. Let's not call a trend on capital. Let's be delighted that it seems to have stabilized and let's watch the next two quarters play out. We are sticking with our point-of-view that capital is going to not turn through the end of this year and we are really looking at next year as the first opportunity for it to turn.

I think we don't believe we have any unique insight. We read the same surveys that some of you do and some of you read coming out of the various groups and I would say that the feedback from our sales force tends to parallel what you read and not much more than that.

What we are doing is trying to make sure we are in a good position, particularly on the Ultrasonic line, that when some money is freed up we have the right inventory and the right new products and the right dialogue going on with hospitals. That being said, we have really aimed in particular, our Neuro sales force at focusing on Disposables and Implants for the time being and not banging away at a closed door.

Great. Thank you very much.

Your next question will come from Tao Levy with Deutsche bank.

Hi.

Hi Tao.

Hi Stuart. This is actually Seth for Tao. How are you doing?

Good.

Thanks for taking my questions. Just two quick ones. First, in the Neuro Implants division, I know you said that sales across most product lines improved sequentially. Specifically, I wanted to see if you could call out how DuraGen performed and were there any one product in that or product line that outshined others and any that potentially hurt growth in Neuro?

I would say generally, implants did well, and implants include DuraGen, our Hydrocephalus line of advanced shunts and a number of other product lines, so implants did well, were up by my recollection, high single digits. Capital was down year-over-year and continues to languish in the economy. So, if you look at the two, they to some extent, offset each other. If you go to Europe and internationally, currency has a big impact. Now, with our international revenues for the Company, only 23%, OUS, it affects the Company, and perhaps less strongly than some other companies, but indeed, our European business on a constant currency basis, is a very different story than our European business on as-reported basis and that clearly affected the Neuro number, as well as other numbers.

Okay. Great. That actually helps quite a bit. And also, as a follow up, on the last call you called for a tax rate of about 35% going forward and now it sounds like you are more comfortable with a lower number of around 33%. I wanted to understand if that gives you a bit more confidence of hitting the higher ranges on your EPS guidance? Thank you.

Yes, this Jack. Yes, look our tax rate has been, over the years, volatile for all kinds of reasons. That's because we manufacture in a number of countries with different tax rates, sales mix drives the profitability of those entities. We have obviously done a lot of acquisitions. We have reserves for contingent tax liabilities that we put up or release as facts develop.

So, in looking ahead, I would say we have improved visibility in how over the last couple of quarters and how these things are going to roll out over the next few quarters and having looked at these various things, we made the judgment that we are likely to report a lower GAAP tax rate, particularly in Q3 that will have the impact on the full-year results of a couple of points and that's why we guided that improvement.

Just by lower, we are talking 33% is the average for the year, is that right?

Correct.

Thank you.

Next we will hear from Amit Hazan with Oppenheimer.

Thanks. Good morning, guys.

Good morning.

First question, in the press release and in your prepared comments you made some comments on cutting costs, and I am assuming what you are referring to is in the current environment over the last couple of quarters that's what you have been doing. So, I am wondering if you can give us color on that? We have heard a lot about actually hiring and more along the lines of potentially increasing costs, I suppose. What are you doing specifically with cost cutting, what have you done so far and what do you plan to do over the next few quarters?

Okay. There's two aspects to the cost reduction efforts over the last 12 months. In all candor, this won't change going forward. First, we are being a lot more disciplined in identifying which of our business lines are appropriate to invest in and which of our business lines are appropriate to harvest.

Historically, we set aggressive revenue targets for all of our divisions and that meant that different divisions were investing in, for example sales and marketing expense, disproportionate to the potential return on that investment.

So, I think certainly in the last 12 months, we have in our communications with our various divisions, made it clear that they were meant to achieve both revenue and operating profit targets and contribute, perhaps disproportionately if they had lower top line potential. And so in particular, our Instrument division really has been instructed to generate strong returns and strong cash flow and perhaps be a little less focused on trying to drive the top line. If you recall our historical guidance for Instruments was high single digits and now we have brought it down to lower single digits, certainly growth, but perhaps more in expectation of 5% or 6% than 7% or 8% or 9%.

Well, that generates quite a bit of free P&L because it takes a lot of spending to generate those incremental dollars and those are better spent on Spine, OrthoBiologics, Extremities, Europe, Asia, where the return on a sales and marketing dollar just generates a higher return. That doesn't mean we don't love our Instrument business, it just means we want to manage it for what it is and make sure that we're building the franchise at a lower cost of sales.

So, that is the -- probably the most important point is a bit more disciplined in how we manage our different sales channels.

Now, corporate-wide, like many companies, probably one of the most important things we did early in the year was take a very hard line on all sorts of spending and that included labor inflation and included investments in G&A. The good news is it included significant reductions in external consulting and significant hiring, typically at about 1/2 to 2/3 the cost. As you recall and I am glad it is now a while ago, we had significant consulting spend in our finance, IT and other departments and the good news is we have hired quite a bit internally and brought the consulting spend down substantially. So, that's another important thing.

We have also been real sensitive on expenses and we have gone throughout the organization on T&E and travel -- sorry, on travel and entertainment spending, and on other nonessential activities. I think we have learned that there's money to be saved.

The other thing is on systems. I think we have done a good job of improving our systems inside the Company and that means, not some insignificant reductions in write-offs of excess inventory, in write-offs of field-based consignment, in just a whole host of things that better systems and better processes can indeed do in terms of eliminating waste without at all hurting our footprint with customers.

Okay. Great. I appreciate that color. And second question is more of a strategic one. I think you're speaking with your actions I suppose, you're paying down your debt and you're not making acquisitions. We are I guess, actually coming up on potentially a one, the first quarter here, that it will be in a complete organic number that I can't recall in the history of the Company. But I am wondering if you can kind of lay out to us in a time where valuations have come down, how you are going about your considerations in terms of making debt pay down versus actual acquisitions?

A quick thought and then Jack may have some comments on debt pay-down. First of all, please don't judge our long term organic growth based on performance this year, in the worst economy ever. So, I think our view on long-term same-store is high single digits and I think we have reiterated that early in our script today. So, I am optimistic as many people are that this won't go on forever. So, that is point one.

Point two is, we have gone now eight months without an acquisition. Recall we did one in the face of a very difficult December and indeed that was planned. Although, we did not plan not to do acquisitions this year. I think I have said on prior calls, there remains a big disconnect between sellers view and buyers view of value. And I think we have consistently said if our stock price is down 30% to 40%, then the valuations we intend to pay in the private market are down 30% to 40%.

I would say we are not alone in this point of view and so you haven't seen a lot of small deals get done, in auctions and other negotiations that we have had, we have not lost many, we have lost one or two, but we have not lost many deals based on our conservative view of value. There's a lot of -- just no deal.

So, I am optimistic as we go forward, Q3 through next year, that we will have opportunities to acquire and so I don't want you to take away that Integra will not be doing deals. That said, I think it is a highlight that having not done a deal in the last two quarters you are able to see that gross margin start to come through because of the continued reduction in purchase accounting and the fact that we haven't bought any lower margin businesses. So, that is at least a helpful benefit of the visibility.

In terms of debt pay-down, yes I think the finance team has done a really good job and we will continue to take advantage of the credit market opportunities and yes, I mean $120 million of cash flow in the last 12 months has allowed us to pay down or repurchase a significant amount of our debt.

I have nothing to add. I think that we have been saying now for quite some time that we will look for opportunities to pay down debt and we have been doing that and we will continue to do it.

Terrific. Thanks very much.

Our next question will come from Raj Denhoy with Thomas Weisel Partners.

Hi Raj.

Hi. Wonder if I can ask a little bit about your guidance commentary for the year, the revenue guidance commentary. It sounds like -- I think what you mentioned is you expect the third quarter to only be up modestly, on the second, but then for the full-year we are still looking for the low end of your $680 million to $700 million guidance. If we just play with the model a little bit, if that still implies a fairly steep ramp in the fourth quarter. I know historically you guys have had a pretty strong fourth quarter, but even in this year it might have to be a little bit stronger than it's been to hit those numbers. And given everything that's going on out there, I just wanted to gauge your level of confidence that that fourth quarter surge is going to come in and it's going to be at that level that's necessary to hit those numbers.

Well, I think you captured our commentary in your question. We really -- we have investors and analysts with a variety of numbers for the year and we were trying to be unambiguous that we would really like to see people model 2009 at the low end of our guidance. The good news is we seem to be on track with our guidance. The good news is we have I think decent visibility on what we are anticipating in the back half of the year. So, it is hard to say anything other than, yes we feel good about our numbers at the low end of the revenue guidance. Don't miss the point on earnings per share. You saw some real good leverage in Q1 and Q2 and we expect that to continue. So, we were not guiding people specifically to the low end of our earnings per share guidance. I think you can choose where you want to be in the range.

I appreciate that, but again that fourth quarter surge in revenue, you just mentioned that you think you have fairly decent visibility on that and I'm curious. Given everything that is going on out there with capital spending and inventory reductions, what gives you confidence that's going to come in? We are still several months away from ending the fourth quarter here and what sort of signs are you seeing that the fourth quarter is going to see that turn?

This is Jack. The sequential performance of our business Q2 versus Q1 gives us some encouragement that our seasonal patterns are fundamentally intact. Now, are they at a lower level than we would have all hoped for? If we would have thought about this a year ago, yes. But the seasonal patterns still seem to be intact, and there are a lot of different things that go through them, but we think that the prospects for a decent back half along our traditional seasonal line, relatively speaking, we think that is still there and we have walked through that.

Remember, we are seeing significant growth in our Orthopedics businesses. So, we have some sense for how they will play out from a growth perspective through the back half of the year and we have a reasonable understanding, although to your point, this is an unusual year, but we have a reasonable understanding of how the Instrument and Neuro businesses play out. So, I stand by our view. I understand that that makes fourth quarter a -- I don't think a differently difficult quarter than any prior year, but it is what it is. If it makes you feel better, we thought about it carefully.

Okay. That's fair. I just wanted to ask. One quick follow-up, you -- actually it's a different topic entirely. You mentioned there was going to be an interim look at the Adhesion Barrier Trial later this year. Is there anything we should be looking at for from that? What is going to be considered in that interim look and is there any chance we might hear something about that?

The interim look, which will be done at some point in the fall by our CRO is -- the only thing that would likely emerge from that would be -- I mean, if it were to come to come to pass that the interim look would reveal that the Trial were futile, we might well make the decision to discontinue it and save the money, but otherwise we would not expect to publish data or say anything else about the Trial. We just wanted people to know that that was coming so that if -- against we think -- so that if it were to come to pass that we had a result that was -- that motivated us to stop the Trial, that that fact wouldn't be a big surprise to people.

Okay. So, I guess no news is good news on that front.

Yes.

Thank you.

And our next question will come from Glenn Novarro with RBC.

Hi, Glenn.

Hi guys. Josh asked a question about Spine and same-store sales and I'm just trying to get a sense of in the quarter, you mentioned that Spine sales were up sequentially and I just wanted to get a feel for -- is that driven by the addition of more distributors or is it driven by a combination of more distributors and growth from existing distributors and existing accounts? So, I am just trying to get a feel for the day when the addition of your distributors in the US ends, what kind of organic growth we should suspect out of the Spine business? Thanks.

This is Gerry. It is actually both. I mean we, we certainly monitor growth of our existing distributors and they all perform to a quota basis. So, we are monitoring them at a regular basis, making sure they continue to grow to our performance expectations.

But, in terms of our overall growth, it is a factor of current distributors growing to their quota level or exceeding their quota level and then expanding the network to add more distributors. And then try to get some leverage out of the distributer network we have by putting more OrthoBiologics through our Spine channel, which gives us more management leverage with those distributors to get them to pull our products out of their bag more often.

So, I think it is, it is a combination, but I don't have a -- I don't see that going away right now in the short-term and mainly because every time you get to a point where you think you have all the right distributors and they're performing well, there's always opportunities to look for improvement in certain geographic areas. Where you can either split a territory and add another distributer or put in specialists that drive sales in certain accounts to allow us to provide a higher service level. I see it as a continuous progression of being able to build out a strong sales and marketing network within the Spine community.

I would say, Glenn, we are so far from reaching any kind of penetration in distribution that would limit our opportunity, and it really is not -- forget about a six month issue, I think it is not a three-year issue. The other major players are looking at between 350 and 700 full-time reps in the field. And we've been saying we have got 60% coverage plus or minus geographically and that means if somebody has a state, and they have a person in Philly, but don't have somebody in Pittsburgh, will we have geographic coverage? That's not geographic coverage.

So, I think we have a long way to go on filling out the distribution network in the US. But to Gerry's point, Integra Spine has a great product pipeline, and we look at new products as a percentage of the sales. And there's a lot of new products pushing through that sales organization as well, both Metal Implants and the OrthoBiologics.

So, I am really enthusiastic about the potential for continued above market growth in that organization for quite a while.

And just one other follow up on price, someone asked on the call about price and you said price was flat. And this being in the Ortho business and I would imagine price plus mix should be positive for you given that you are selling more Biologics. So when you made the comment about price, were you just referring to absolute price exclusive of mix? And would price plus mix equal a positive benefit for the Ortho division this quarter? Thanks.

Gerry is going to respond specifically, but since I spend a lot of time looking at other companies -- we do not have the kind of data that the big orthopedic companies have to be as precise on price and mix. I know you guys try to stock up and look at all of these numbers and we will get there eventually, but I think when we talk about price, we are looking at product-by-product, the ASPs across the country, and saying do we see either any significant increase or decrease on a product code basis.

If you then say well then what about mix? Yes, we get a benefit of mix. If we introduce a new product at a 10% price premium to an old one, then that's a mix improvement. Now your point about the OrthoBiologics plus Metal, the OrthoBiologics we would look at as a separate product and a separate ASP. It changes the game, of course, that we are getting a bigger piece of any case and therefore, getting a better return on the sales force investment. So, I don't know, Gerry, if you have got a different perspective.

No, I think that's right. I think as we -- as we mentioned earlier in the script, we talked about launching our Evo3 and that's an OrthoBiologic product that is being primarily sold into spinal fusion procedures. That's a premium price product and it's one of our fastest growing OrthoBiologic products. So, we do have that going into sort of the mix of ASPs and product mix. But, on a product code-by-product code basis when we do a look, we are seeing we are getting a slight increase in price and not a decrease in price. So, what we take back from that is that we are not seeing pressure that is anything out of the normal course of business on pricing, and we are, when we go and look at adding a premium price product to the portfolio, that price is sticking.

Again remember we are small. So the odds of us being the particular target, except in a case-by-case, hospital-by-hospital basis, is pretty low.

Okay. Great. Thanks for the commentary, guys.

(Operator Instructions). We will take our next question from Taylor Harris with J.P. Morgan.

Thanks a lot. Stuart, on your comment about the office space channel, was your comment on stabilization more on the inventory management side of things or the end demand side of things or both?

Well, it is a little bit of both. In our office-based channel we do have with certain of our distributors the ability to look at what we are shipping to them and have them report to us the out-the-door sales of what they're shipping to their customers. In the first quarter, the two were way off. They were really working hard to bring down what inventory of ours they were sitting on and while they were down in their end dollar sales, their customer sales, it was not nearly as much as we were down in our sales to them. Now, remember we don't have full visibility across that whole channel, but a couple of the big distributors can give us that data.

You saw the same phenomenon this quarter where our shipments to dealers were well below their out-the-door sales, but the gap was narrowing. And I think it is our expectation that that gap will start to approach 0 in either the third or fourth quarter, probably third, but you never know. Then we can look at what those out-the-door sales of those dealers are -- what they're reporting and a number of those are large public companies and what they're saying is that things are stabilizing, but not necessarily improving.

Okay. That's very helpful. Thank you. Then, Jack just a few little P&L questions. So, the foreign exchange, will that turn positive for you in the fourth quarter? At current rates?

At current rates it will turn positive in the fourth quarter, so the main rate that has an impact on our revenue is the Euro and dollar rate. That's the biggest. So, if you are talking about the revenue impact, if the Euro, which I think is at $1.44 or something today, if that were to continue through Q4, it would be a favorable benefit. I don't have on the top of my head exactly what it would be.

That's fine, just wanted to make sure.

It is close, it is close. Angela just showed. It would be, it would be a very small.

The bottom line is harder to predict because of these issues around inventory turns. It probably is a net positive in the fourth quarter because we will still be getting the benefit of some of the inventory turns back at 125 in the fourth quarter on the Instruments or 130 on the Instruments, but on the other hand, we will well get the benefit of a slightly higher Euro in the fourth quarter on our revenues and therefore gross margin.

Okay. Great. And on your interest expense line, did you get the full benefit of that debt pay-down in the second quarter or should we expect interest expense to continue to go lower in the back half of the year?

Well, there are a lot of things that influence interest expense. Obviously, if LIBOR for example would rise, it would have an impact on the $200 million we have borrowed on our revolving credit agreement, which is a function of LIBOR. But, we bought back -- the bonds we bought back in the second quarter, we did not buy back on the first day of the second quarter. So, the interest expense benefit, will, setting everything else equal, be a little bit better in Q3. But I gave you on the -- we gave you on the script the annualized number which is about -- well we gave you the cash interest benefit, which is annualized about $1 million for the bonds we have repurchased to date.

All right. Got it. Last question. On R&D, it's nice to see R&D tick higher and I think you raised your guidance to 6% to 7% for the year. To get up to 7% would be a big increase in R&D. I am assuming you're going to be closer to 6%, but I just wanted to make sure?

I think we see some real potential in continuing to invest in headcount in Spine, in Extremities, so these are Metal Implants and in our Tissue Engineered products, so Collagen and DBM. That being said, the other big impact is these two major clinical trials that are underway, the Adhesion Trial and the now Skin Trial. So, that is ramping it up. We set as an objective, 6% to 7%. I think you are probably right, Raj, it would be a stretch to get to 7% for the year, but we wanted to get across an ambition.

Okay. Great. It is Taylor by the way, but I am.

I'm sorry.

I will take that as a compliment. Okay. That's it. Thank you guys.

Oh, sorry. I apologize, Taylor.

(Operator Instructions) Actually, we do have a question. Ben Forrest with Summer Street Research.

Hi. Thanks a lot for taking my question. Orthopedics or I guess particularly on Spine, as you look to expand your product portfolio and look at what is out there for potential acquisitions, do you see more opportunity on the hardware side or OrthoBiologics?

I think it is more likely that we will do acquisitions on the hardware side. Our OrthoBiologics portfolio is probably the broadest of any company out there, if I can be so bold. So, our need for new technology, relatively limited, but on the acquisition side there are a lot of interesting small companies that are essentially running out of money and there may be some opportunities to pick up technology. At a quite low price.

Great. And then for 2010, with Spine outside the United States, I know it is early, but can you give us an idea of what you are thinking for revenues there?

I think it is too early to say.

Okay. Thanks a lot.

Gentlemen, there are no further questions.

All right. Well, thank you everybody and we look forward to reporting our third quarter later this year. Take care.

That does conclude today's conference. Thank you for your participation.