Integra Lifesciences Holdings Corp (IART) 2011 Q3 法說會逐字稿

Good day, everyone and welcome to the Integra Life Sciences third-quarter 2011 conference call. As a reminder, today's call is being recorded. At this time I would like to turn the call over to Ms. Angela Steinway, Head of Investor Relations. Please go ahead, ma'am.

Good morning and thank you for joining us for the Integra Life Sciences third-quarter 2011 earnings release conference call. Joining me today are Stuart Essig, Chief Executive Officer, Jack Henneman, Chief Financial Officer, and Pete Arduini, President and Chief Operating Officer. Earlier this morning we issued a press release announcing our third-quarter financial results. Certain statements made during this call are forward-looking and actual results might differ materially from those projected in any forward-looking statements.

Additional information concerning factors that could cause actual results to differ is contained in our periodic reports filed with the SEC. The 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. Certain non-GAAP financial measures are disclosed in this presentation. A reconciliation of these non-GAAP financial measures is available on the investor section of our website at Integralife.com. I will now turn the call over to Stuart.

Thank you, Angela. Good morning. Total revenue for the third quarter of 2011 increased to a record $202 million up 8% as reported and 7% on a constant currency basis. Orthopedics which includes products sold to foot, hand, spine, and orthopedic surgeons represented approximately 43% of Integra's overall revenue during the third quarter and increased over the prior-year period by 18% to $86 million. Extremity reconstruction which is the largest component of our orthopedic category grew in the mid-single digits. Sales of foot and ankle and skin products were weaker than expected in the quarter. The addition of Ascension in the last week of the quarter contributed negligible revenue. Pete will provide an update on the Ascension integration later in the call.

Spine sales increased significantly in the quarter, driven by the SeaSpine acquisition. Both our spine hardware and orthobiologic product lines saw double digit increases. Private label revenue decreased versus the prior year period. We expect a mid-single digit percentage decline for the full year 2011. The combination of a reconnection in the volume of products sold to our partners and lower royalties caused the revenue decrease.

Neurosurgery revenues grew 4% to $72 million representing approximately 36% of Integra's overall revenue. While each neuro line increased, critical care and cranial stabilization products were the best performers. International neurosales benefited from currency. Instruments accounted for 21% of our overall revenue in the third quarter. Instrument revenue of $43 million represented a decrease of 1% compared to last year. Sales of instruments in our office-based sales channel held up well, while we saw some weakness in the acute care setting.

Consolidated international revenue increased 6% as reported and was down 1% on a constant currency basis. Sales in Europe were down 3% and Asia Pacific increased by 2%. Other foreign regions posted double-digit revenue growth. International sales accounted for 22% of revenue in the third quarter. The addition of SeaSpine's revenues, which are mostly generated in the US, and seasonally lower revenue in Europe during the Summer shifted the revenue mix back toward the United States.

While the selling environment in many of our markets remains tough, Integra continues to perform competitively. In addition, we closed the acquisition of Ascension Orthopedics in late September. We expect that our extremity recon, spine and developing market sales organizations will propel faster top-line growth. The benefit of our diverse revenue base coupled with the investments that we're making on our business will help us to achieve our goals for 2011 and beyond. Now, I will turn the call over to Pete to discuss operational highlights for the quarter.

Thank you, Stuart. First, I will update you on the recent acquisition of Ascension which presents a great opportunity for our extremities selling organization. Ascension brings a product suite of over 20 new and differentiated products, including our first entry into the $600 million shoulder market. We are also welcoming a great group of people to our Company, positioning this combination of products and talent as a key response to the rising competition in the high profile extremities market.

The shoulder market represents the largest and one of the fastest growing segments of the orthopedic extremities market. The Ascension acquisition gives us immediate access in the US to the recently launched TITAN Total Shoulder and the TITAN humeral resurfacing shoulder. Furthermore, Ascension's product pipeline will allow us to complete a diverse product offering in this segment with reverse shoulder and fracture plating options already available in Europe. We plan to have these available in the US by the end of next year.

In addition we are gaining valuable clinical experience in Europe with our PyroCarbon shoulder and expect this to be a source of competitive advantage internationally. The Ascension team based in Austin is well positioned to manage Integra's upper extremities and shoulder product lines. Our integration team is working quickly to drive opportunities that the deal has created. We are in the process of training our direct sales force on the whole Ascension line and the clinical advantages of its unique PyroCarbon material. The shoulder product will continue to be sold through Ascension's existing dealer network.

Turning now to spine, we are well into the SeaSpine transition having integrated the product portfolios, product development projects, internal teams and most processes and policies. We have discontinued some redundant product lines. As well, we recently commenced the merger of the 2 distribution channels and we're revising territory definitions, updating agreements to reflect the combined portfolio and terminating underperforming agents. This process will be complete by the end of fourth quarter, resulting in a unified Integra spine distribution network. We will cross-train the distribution channels and rollout the combined portfolios including our orthobiologics product lines which are now being introduced to the legacy SeaSpine distributors. In addition, we have completed the transition of all SeaSpine distributors outside the US so that they are now under the management of our international team.

Let me address our strategy on putting resources into spine. Spine is the largest market that we address and its gross margins remain well above our corporate average, even with new pricing pressure. Historically, the spine industry was characterized by very high marketing spend and a big premium on innovation. Recently, marketing spend has been less productive and innovation has slowed. We believe that over the next 5 years, surgeon preference will decline in significance as hospitals push to get control over purchasing. In this regard, the spine market is becoming a lot more like many of Integra's other selling channels where we have been very successful.

We believe that these changes will put pressure on small independent spine companies who will increasingly see their hospital access limited. Compared to small players, our substantial instrument and neurosurgical presence in hospitals will continue to secure our place on the short list of hospital-approved vendors. Our broad GPO relationships will enable us to put contracts in place as another tool for expanding market share. The largest manufactures will see margins erode as hospitals pressure them to lower price. We have less to lose than larger players when it comes down to price. Mid-sized players like us can meet the hospitals' demands in exchange for increasing volumes.

Further, we have 2 significant advantages that we believe will give us an edge the coming years -- our differentiated product suite and pipeline in orthobiologics and our very strong relationships and reputation among neurosurgeons. We will also continue to acquire smaller spine companies to expand our distribution and product suite. Overall, we are excited about the opportunity to grow this organization and become a significant player in the spine market.

Outside the US, the European market is under economic pressure. Tighter hospital budgets are resulting in cancellations of elective procedures, selection of lower cost alternative therapies or interventions and extended payment terms. In addition, some governments are considering whether to further centralize healthcare management, thus raising the possibility of additional pricing and reimbursement pressure. We are carefully evaluating our options for adapting to this difficult selling environment. In response, we are upgrading our management talent, reducing our overhead in Europe and adjusting our activities to focus on growth opportunities.

The next topic is our supply chain, something that I have focused on in my first year at Integra. Integra's supply chain is too complex, the result of having acquired a fair number of companies over the years. We have many facilities and not enough realtime visibility to make the best decisions around the production and procurement of inventory. That complexity compared to our revenue base makes it hard for us to operate as efficiently as we ought to. Part of the solution is the Oracle ERP implementation that we've talked about from time to time.

As importantly, we are rethinking each aspect of our supply chain, including the effectiveness with which we plan our inventory. Better inventory management avoids write-offs and optimizes working capital and we are also reviewing the robustness of our quality systems so that we can minimize disruptions in production.

The second point is particularly important. The unplanned idle time and other unplanned period expenses identified in the press release are the result of work that we are doing to remediate FDA 483 observations which we received after a tough inspection during the third quarter. A simplified and modern supply chain will save us money and time in the future. In the long term, we will consolidate production and other functions into fewer facilities more quickly than we have done in the past. Being on one global ERP system will help us make these moves.

In the short-term, we have modified our previously announced project for building a new collagen device facility in Plainsboro. Originally it was to have been, in effect, a new plant in addition to our existing facilities in Plainsboro and Puerto Rico. We have concluded, however that the expense of retrofitting the legacy Plainsboro plant to the state of art requirements exceeds the benefits. Instead, we will transfer various functions from the existing facility to the new plant in Plainsboro and to Puerto Rico with the ultimate goal of repurposing the original factory for uses other than manufacturing. This plan will result in 2 separate new facilities for the production of our regenerative medicine products, 1 in Plainsboro and 1 in Puerto Rico. This plan also expands our capacity significantly.

As we have done with other manufacturing transfers in the past we will identify the period expenses associated with these transfers each quarter in our calculation of adjusted earnings per share. We remain on track to begin certain production activities in the new collagen manufacturing facility in Plainsboro during 2012.

Now I'll turn the call over to Jack for a review of our financial results.

Thank you, Pete. Both revenue and earnings performance were roughly inline in the third quarter. In addition to walking through the elements of our P&L, I will update our guidance on the line items and discuss the charges related to the various transactions we completed during the quarter. Stuart will then discuss our overall outlook for revenue and earnings. We reported GAAP net income of approximately $11 million or $0.39 per diluted share for the third quarter. When adjusted for acquisition-related expenses, other special charges and intangible asset amortization, net income was $22.5 million or $0.70 per diluted share. In this quarter foreign exchange had a favorable impact on revenues of $3 million versus the same quarter in 2010.

Gross margin on total revenue in the third quarter was 61%, down from the prior year period and from the second year quarter. Gross margin as a percentage of revenue declined over the prior-year period primarily because we recorded higher write-offs and reserves for excess and obsolete orthopedics inventory. We had higher costs of manufacturing than in the prior-year period. In particular, our higher manufacturing costs included period expenses associated with the remediation of our Plainsboro collagen device facility and related unplanned idle time and underutilization. We now expect our GAAP gross margin to be about 62% for the fourth quarter of 2011 as a result of continued remediation activities from Plainsboro and from higher costs associated with the amortization of Ascension inventory purchase accounting step up.

We calculated adjusted gross margin by backing out the adjustments to cost of product revenues detailed in A of the adjustment table in our press release. During the third quarter, these adjustments total $5 million with a result that our adjusted gross margin was about 63.5%, down from the comparable measures in both the third quarter of last year and the second quarter. We would expect our adjusted gross margin to be approximately 64.5% for the full year 2011. Going forward we expect an annual improvement in gross margin of approximately 75 basis points from sales mix and better operational effectiveness.

Research and Development expenses in the third quarter increased from the prior year to $13 million and remained at about 6.5% of sales. We are targeting R&D spending of 6.5% to 7% of total revenue during 2011. Selling, General and Administrative expenses in the third quarter increased from the prior year to $87.5 million. Excluding about $7 million of special charges, most of which was related to our ERP system implementation, our spending on SG&A was 40% of revenues. Our charges for systems implementation, in all likelihood, peaked in the third quarter because we expect to begin capitalizing larger amounts of those expenses during the fourth quarter. We are pleased with our successful efforts to keep spending in check. Excluding all special charges, we target future Selling, General and Administrative expenses between 40% and 42% of revenues.

In the third quarter we earned $41.5 million in adjusted EBITDA and $44.5 million in adjusted EBITDA excluding stock-based compensation. We reported a $3 million increase in net interest expense to $7.5 million resulting from higher levels of debt and fees paid in the senior financing we did in June. We suggest modeling approximately $7.5 million per quarter of interest expense going forward. The Company recorded $400,000 of other income during the quarter. We recommend modeling this at zero going forward. Our income tax expense for the quarter was essentially zero reflecting a GAAP effective tax rate of 0.4% for the quarter. The implied tax rate on our adjusted net income during the quarter was 28.2%. For the full year 2011, we expect our tax rates will be about 8.5% on a reported basis and 28.2% on an adjusted basis.

As we have done from time to time, we repurchased approximately 300,000 shares during the quarter for about $12 million in cash. During the month of October we purchased an additional 400,000 shares. Going forward, we recommend modeling a share count of 28.5 million shares in the fourth quarter which averages to about 29.5 million shares for the full year 2011. During the quarter we recorded depreciation of $6 million and amortization of intangible assets of $6 million including $1.5 million in cost of product revenue. The amortization expense we recorded is greater than it has been owing in part to the addition of SeaSpine intangible asset amortization and the decision last quarter to shorten the estimated useful lives of certain trade names. In addition, intangible asset amortization resulting from the Ascension acquisition will also increase the expense.

Next quarter we expect depreciation of approximately $6 million and amortization of approximately $6.5 million. Approximately $1.5 million of the amortization will be included in cost of product revenue for the quarter. We expect the impact of share-based compensation expense in the fourth quarter to be approximately $3 million or $0.07 per diluted share. In the third quarter we generated about $24 million of cash flow from operations and we spent about $12 million on capital expenditures. The full year 2011, we expect to spend approximately $35 million to $40 million on capital expenditures.

Turning to the balance sheet, at the end of the third quarter we had $111 million of cash and borrowings of $192.5 million under our credit facility. Excluding the impact of Ascension, we have 53 days of accounts receivable and 201 days of inventory.

Now I will hand the call over to Stuart.

Thank you, Jack. Before providing full Company guidance for 2011, I will remind you how we are modeling the impact of the Ascension acquisition. We expect net revenue contribution of approximately $4 million in the fourth quarter and $20 million in 2012. Further, while the integration plan is well under way, we continue to expect adjusted EPS dilution to be approximately $0.05 to $0.06 in the fourth quarter of 2011. Thus due to the impact of the acquisition, Q4 adjusted earnings per share will be essentially flat with or slightly down from last year. For 2012, we expect $0.05 to $0.06 of dilution in the first quarter and a few cents in Q2. We expect the acquisition to be break-even or accretive in the second half of next year so the dilution will come disproportionately during the first half of 2012.

On a GAAP basis, Ascension related charges will lower reported EPS by approximately $0.08 to $0.09 in the fourth quarter of 2011 and $0.15 to $0.17 in 2012. For modeling purposes, most of the additional spending will fall into the SG&A line while R&D increases by about $1 million per quarter. Given how extensive the planned integration will be, we do not plan to break out the Ascension number separately beyond this call.

We are providing updated guidance. We expect revenues to land between the middle and lower end of our previously provided annual guidance range of $785 million to $800 million for the full year of 2011. The guidance includes the addition of Ascension revenue and current foreign currency exchange rates. If the rates stay where they we expect a positive impact from currency on reported revenues in the fourth quarter of roughly $1.5 million versus prior year -- excuse me, $0.5 million versus prior year. Within this guidance range, for the full year 2011, we are anticipating orthopedics to grow approximately 13% to 15%, neurosurgery, 4% to 6% and instruments, 3% to 5%.

The Company expects GAAP earnings per diluted share between $1.22 and $1.30 and adjusted earnings per diluted share between $2.88 and $2.96. While we are not yet providing formal 2012 guidance, including the impact of this year's previously announced acquisitions, we expect 2012 revenue to grow about 10% over 2011. Beyond 2012, we suggest modeling 5% to 7% constant currency revenue growth. Within this range we expect orthopedics to grow 7% to 9%, neurosurgery to grow 4% to 6% and instruments to grow 2% to 4%. Further, longer term, excluding the impact of the medical device, excise tax in 2013, we anticipate annual adjusted earnings per share growth between 9% and 12%.

In summary we are confident in the strength and diversification of our business. Longer term, we believe that we have the potential to continue growing faster than the market, both on the top and bottom lines. We expect our near-term investments to help realize the growth potential. With our strong cash flow, we hope to add to our internal growth through additional acquisitions and strategic alliances. We look forward to meeting with investors in the coming weeks. In November we will be presenting at the Lazard Capital Markets Healthcare and Piper Jaffrey Healthcare Conferences. Additionally we will be attending the North American Spine Society's Annual Meeting which will take place later this week in Chicago. Please contact Angela if you would be interested setting up a meeting.

Lastly, we also invite you to attend our annual analyst day meeting which will take place on November 14 in New York City. Details for attending that meeting or viewing the webcast are available in a separate press release published this morning.

Now, we will be happy to answer your questions. In an effort to keep this call to an hour while accommodating a large number of requests, please do limit yourself to one question. Rejoin the queue if you have more questions. Operator, you may now turn the call over to our participants.

Thank you, sir.

(Operator Instructions)

Raj Denhoy, Jefferies.

Hi, good morning. Great. Just a couple questions. I know you guided toward the lower end of your 785 to 800 range for the year. And I'm curious why that is. I listened to the call obviously but I'm still a little unclear as to what's prompting you to take it down to the lower end.

Sure, Raj. I think while we met, our objective this quarter for revenues at $202 million in change, that was at the lower end of our expectations within the quarter, even though we don't provide quarterly guidance. So when we look at the full year, the fact that we came out a little bit lighter this quarter than we had hoped impacts the full year. It also is an indicator of our expectations in the fourth quarter and I think we brought our own expectations down accordingly in the fourth quarter, even with the additional revenues from Ascension. We have, I think particularly in the first half of the year, been relatively immune to what was going on in Europe.

In this particular third quarter, we saw our European business down, which is the first time in my recollection we've seen that. And indeed, we also are not getting as much of a benefit from currency as expected this quarter and indeed next. So we're not alone in our sense that the US economy will continue to struggle in the back half of the year. We did see some softness in elective procedures, in extremities. We saw European business that was challenged and I think like so many other companies, that's an indicator that the recovery that we had hoped to see in the back half of the year is less likely. So I think our general view is to-- A, say what we think is going to happen and B, not be out as an outlier when we talk about our expectations.

Okay, and just as a follow-up, so to be clear, we should think about it as mostly softness coming out of Europe and then perhaps currency. But then I think you also mentioned in your prepared remarks that foot and ankle and skin in the quarter were weak, so is that really an indication of the other points you made just around procedure volumes being somewhat soft in the back half?

To answer directly, yes. We obviously had expected a stronger foot and ankle quarter and didn't see it. And so again, we don't think it's unique. We are aware of a number of our other competitors put a lot poorer extremities numbers this quarter than in prior quarters and so our question always is, are we losing something competitively or is it the market. And while the competition has definitely heated up, we also think that the market has been impacted by the economy.

Okay, great. Thank you.

David Lewis, Morgan Stanley.

Hi, good morning. Peter, I appreciate the detail you gave on the spine integration. I wonder if you could talk about discontinuation of certain products and realignment of the sales infrastructure. What impact do you believe that has had on growth in your core spine business and then when do you think we should expect those headwinds to begin to anniversary?

Yes, David, I think with the SeaSpine integration, we're quite happy with how the progress has been going along. I think as we've reported in the past, I think as you well know, we've integrated our marketing and really across-the-board, now working as one integrated group. We've been working with all of our distributors as well and feel pretty good about how we've been able to blend the territories. A big chunk of the work, as you can imagine, is where we have duplicate products that we've been trying to match up, which ones we would take out, which ones we would keep. And then that creates a little bit of a challenge that we then need to be able to actually increase the level of that type of consignment product, get it out to the new distributors and we're in the midst of that right now. And I would tell you we feel quite good about how that process has been working, how we've been able to hold on to the right distributors and also get some of the new products out into the line. So we're looking forward to NAS, which is obviously starting here this week, and feel pretty good about the products that we have and the overall distribution channel.

As far as your second part of your question on the overlap or coming in, when do we actually start to actually come back to the anniversary. I think we're on track. Obviously we purchased the company a few months ago. As far as synergies or dissynergies we actually are on track to what we had expected from the initial modeling, so we feel pretty good about things.

(multiple speakers) It's Stuart, just to chime in. I would say the extent of cannibalization or the extent of terminating some distributors impacting the business will play out into next year. Now, offsetting that is the orthobiologics business and we have started integrating orthobiologics sales into a number of the SeaSpine dealers and that's having a positive effect and will have a positive effect in the next quarter. We were delighted to put up double-digit orthobiologics growth which, as you know has no -- we didn't buy any orthobiologics growth with the SeaSpine acquisition, so it's all really the impact of our dealer performance.

Okay, and just one quick one, maybe for Jack. In terms of the gross margin, Jack, I appreciate the visibility that you gave. The write-off that you had in orthopedics, can you share with us which segment of the business that write-off was in and why?

Write-offs were -- we had write-offs in both spine and in extremities. I'd say that both are related to -- straightforward, we had changes in growth rates in the products we had relative to the planning that we had done some time ago. I'd say some of the incremental write-off that came out of spine came from integrating the dealer networks, focused counts of dealer inventory and so forth that we're doing as part of that integration and so forth. So, this is all part of us needing to improve our planning function and we certainly hope and expect to avoid these kinds of larger numbers in the future.

Amit Bhalla, Citi.

Hi, good morning, Stuart. I wanted to get a little bit more detail on the 483 at the collagen plant. Can you just talk a little bit about -- can you give us a little more detail there and also have possibly Jack, can you talk about the longer term implications to the margin for the remediation?

Hi, Amit. It's Peter. I'll comment and Jack, you can jump in. So as you know, obviously, we've been in an environment of high FDA scrutiny in the whole med tech sector and Integra has done well in the past by having few 483s really across all of our sites. But the bar has obviously been raised and as I commented, we had a tough audit in Q3 at our facility here in Plainsboro. And while we were in our summer shut down which is a planned annual shut down, we typically build forward safety stock to allow the shut downs. We had a routine FDA inspection which resulted in 483 observations.

We're obviously committed to correcting those and we decided to extend our shut down for a period to address many of those issues. The cost to address the observations has not been insignificant and that's obviously as we outlined in the Q. In addition, we have, Amit, remediation plans in Q4 that are costly and continue to address the observations. But we're committed to addressing all of these 483 observations as quickly as possible and we're working openly with the FDA on our plants. Jack? I don't know if you care to comment?

So, Amit, the way to look at this from a margins point of view is this -- we've decided to identify the costs associated with this and the calculation of the adjusted numbers. That allows you guys to decide how you want to treat it. From our perspective, the effects of all of this work longer term ought to be a much better supply chain, so we feel pretty good about that. But in the near term, we're certainly going to have some higher expenses which we're going to call out that will have an impact on GAAP gross margins but not directly on adjusted gross margin because we're going to call them out.

You might note from the press release that there was about $1.75 million in the third quarter and implicit in our fourth quarter adjusted gross margin and adjusted EPS is another $1.75 million or so. I'm sorry, $1 million, sorry another $1 million.

Chris Pasquale, JP Morgan.

Start off with Stuart, both neuro and instruments were a little weaker than we expected this quarter and it sounds like Europe was a big part of that, I would assume especially on the neuro side. But can you just talk a little bit about whether you also saw an incremental step down in hospital capital spending in the quarter?

Sure. So neuro and instruments were both a little weaker than we had hoped for. I think it is generally a reflection of both the US economy, and when I say the US economy, I think our original expectations were that the US economy would be improving in the third quarter and certainly when we put the budget together that was our thinking and indeed the opposite has happened.

Now, more impactful was the European situation on our neuro business. Indeed, our European neurobusiness was flat to down in almost all of the product lines. It was not disproportionately capital and indeed in the US, capital is solid. It's not inspirational, but it's solid, so it's not like the capital issues that we saw back in 2009. On the instrument business -- that's a predominantly US business and it was a little softer in the acute care business and surprisingly the physician side of it held up well.

Okay, so as we think about 2012, and I understand you don't want to give formal guidance yet, but is it possible for neuro to achieve your long term goal of 4% to 6% growth in the current European environment assuming we don't see a material improvement there over the next 12 months?

Yes, so we will provide our 2012 guidance after we complete our budget process which happens in December and, as is our practice, will provide our guidance at the essentially at the end of the year when we report our Q4. That being said, you should note our commentary around plus or minus a 10% increase over this year's reported number and that includes the impact of the various partial years for the acquisition. So while we didn't provide guidance, we at least gave you a sense for our current expectation. I think that current expectation does take into account the uncertainty about Europe, does take into account some uncertainty about a recovery in the US. And I think if you look at the long term guidance that we're providing around our orthopedics, neuro, and instruments, you can get to that 10% overall growth by being at or near the lower end of the ranges that we provided. So that was a long answer because I'm trying to help you model it, but yes in 2012, we can still get to the 4%, or 4% or 5% neuro guidance within the overall 10% expectation for our business.

Okay, great. Thanks.

Robert Goldman, CL King.

Okay, thanks and good morning. A couple questions on the remediation in Plainsboro. Let me just list them off. First is, what percent of sales for Integra are accounted for by that facility in Plainsboro? Second, when will the new facility in Plainsboro be completed? Third, how quickly would you be able to move all the production to Puerto Rico if you needed to do that? And finally, relative to this inspection, how many days was that inspection and how many observations were cited? Thank you.

Okay, Bob. So I'll try to respond to some of the questions. Candidly, some of the detail that you're looking for, I don't think we'll provide, but I'll try to give you as helpful an answer as I can. First of all, as you know, the Plainsboro facility manufactures collagen products and we also manufacture collagen products in our Puerto Rico facility. And indeed, we are on our way to being up and running on another facility in Plainsboro, essentially next door to the existing facility. Overall, collagen sales, which we provide in our 10-Q and 10K represent about 23% of the Company's total revenues. And some of the products are manufactured redundantly in New Jersey and Puerto Rico and some of them are manufactured just in New Jersey. In terms of the timeline on expanding the production capability, Puerto Rico can happen faster because we already have collagen activities down there and we will continue to accelerate the potential move of various products into Puerto Rico simply because it's a bit easier given that we already have the facility up and running for a number of collagen products.

The second Plainsboro facility will be up and running for a piece of manufacturing, some time in the first half of the year and we then expect that the ability to integrate the activities from the older Plainsboro facility into Puerto Rico and into the second collagen facility. Were you to move all of the production that would take approximately 2 years. So we're on track with our expectation of opening the second Plainsboro facility early in 2012 for some of the production. We're on track to continue to move production to Puerto Rico, but the last of the products to move into Plainsboro or Puerto Rico would take plus or minus 2 years, so I hope that was a comprehensive enough answer.

As to the details on the 483 -- we have had 483s from time to time in many of our facilities. It's fortunately not a regular occurrence but it's not an irregular occurrence. I think in the case of the Plainsboro facility, the fact that we had to spend $1.75 million and the fact that the products are significant gave us cause to provide a bit more detail. But 483s are generally not in the public domain. For competitive reasons I don't think we wish to provide that information. And I think for the time being, that we provided, I think, a comprehensive and relevant overview of the audit without providing too much detail that would be out of line with what most other companies provide.

Matt Miksic, Piper Jaffrey.

Hi, good morning. Thanks for taking our questions.

Hi, Matt.

So I'll give the 483 topic a rest for a minute. I wanted to talk a little bit about, Peter, your comments on the supply chain efforts to simplify what you view as a complex supply chain. Can you talk a little bit about how maybe -- help quantify the benefits of the work that you're doing there and then maybe talk about the timeline along which that will happen. Maybe how does it factor into the 75 basis points of improvements that Jack mentioned in gross margins or is that where we expect to see the benefits? And then I have one follow-up.

Yes, Matt, first of all, I mean from a standpoint of the 75 basis points, for the most part the majority of that is still associated with mix, with the combination of bringing in our orthopedics expansion, obviously Ascension, as well as with SeaSpine and the growth there. But a component of that is obviously associated with infrastructure and streamlining the overall operations. As Jack commented earlier about some of the write-offs we took, across-the-board we're really taking a very hard and critical look at our overall operations, so we're not planning to announce anything obviously today but you'll hear more about this actually at our analyst meeting on the 14th as well about how we're really critically looking at all of our plants.

We have obviously, with our ERP implementation, planning on getting down to a common instance that we can understand what benefit that brings from actually how we manage everything from receivables to how we look at the full distribution chain for our manufacturing and sourcing acquisitions. So there's been a lot of work on mapping that out, and that effort by itself, for a Company our size and complexity, is a good year piece of work to actually get that completed. One of the things that we've kicked off this year is a whole inventory task force where, setting par levels for different products, taking a look at benchmarking, best-in-class around the industry and then readjusting levels to that, as well as putting in new processes behind that so that we reduce the capability of having write-offs such as we've talked about today. That's a lot of the work that's been involved within that.

The other interesting area is with the amount of SKUs we carry as a diversified healthcare Company is taking a very critical look at those. And it starts out -- it's kind of a two phased approach of SKU rationalization, which is simply about low runners and such, eliminating those from the facilities. That generates some capabilities to do some plant integration, I think as we spoke of in the past, when we moved our lighting facility into Bloomington. That would probably be a good example of being able to reduce product lines and integrate.

The second part of it though, is the bigger step which is optimization and that's the work that, into 2012 we'll be working on, which is really about how we can compress and increase higher running lines to higher levels. And how we purchase our orthopedics products, how we source them so that we can buy in larger quantities from given vendors to reduce the amount of minimal charges and such. So there's a broad aspect of it, but I believe firmly from a long-run standpoint that we can be able to build a core base here which we can grow upon more efficiently and at a more effective rate into the future.

Okay, we'll look for more color on that from the meeting in New York. I wanted to follow-up for Stu on the guidance. I noticed that you obviously reduced your outlook for the reasons you described a little bit in the fourth quarter but kept your long-term growth rates for your core businesses and earnings kind of in line with what you've talked about before. Can you maybe shed some light? I know it's a moving target here, but shed some light on what you think gets better and maybe where. Do we see -- you mentioned there's discretionary pressure on extremities. Any color you can help us understand where you think the improvements will come to kind of stabilize your end markets either in the US or OUS?

Sure. So first of all long-term guidance in the last couple years has been harder and harder to provide. As you will recall just last quarter, we brought our long term guidance down from if my memory is right 6% to 8% to 5% to 7% to reflect the current and ongoing situation in the economy and in Europe. Let me try to take each business individually, at least tell you what goes into our thinking.

First, in the instrument business, it's predominantly a US business. It is already very impacted by price competition, GPOs, Managed Care, et cetera. Generally, that business has been able to, even with all of the pressure over the years, has been able to put up plus or minus 3% or 4% long-term growth. There is minimal pricing built into that expectation, although because it is contracted, many of our contracts let us put up pricing in the US by 1% or 2%. So we're assuming that that business, which is already characterized by intense competition, is already highly contracted, will continue relatively uninterrupted and indeed our market share position continues to strengthen as we take share from smaller players and as we have done some of the acquisitions that we've done, has allowed us to consolidate the market.

Neurosurgery, even back at the depth of the financial crisis has been a stalwart other than capital. And keeping in mind that capital is about 20% of that business, we've really been able to grow that business 5% to 7% in the last few years and in the first half of this year, plus or minus 4% or 5%. That business held up well in the quarter even with Europe being challenged and we have quite a nice new product pipeline in our neurobusiness as we go into 2012. Furthermore our neurobusiness has probably got the greatest opportunity in developing markets and our international division that we created last year and indeed is taking advantage of that driving those neuro products which are well recognized in Europe and into the US into big markets that continue to grow quickly such as China, Brazil, India and other foreign markets.

So orthopedics is a bit of the wildcard, and indeed, we've modeled into our 2012 guidance continued challenges in the private-label business which is increasingly a smaller part of the overall orthopedic category. Extremities, we are certainly not modeling in mid-single digits going forward, but I think we've got a reason set of expectations in the low double digits for the business in the US and again the opportunity to take advantage of developing markets which have minimal extremities exposure today.

And then finally spine -- the good news is, spine was a high point for the quarter. The acquisition integration going well, orthobiologics growing double digits, and so we think our ability to grow faster than the market in spine -- we've, I think discussed that ad nauseum on the prior conference calls. I think we continue to think that's a nice opportunity for us even if the spine market itself is relatively flat. So hopefully that gives you a sense for our longer term perspective. Clearly in this challenging year, longer term seems far away but the economy will recover, Europe will recover at some point and we are throwing a lot of resources at the developing markets where we still have a relatively limited exposure.

Very helpful, thanks.

Bill Plovanic, Canaccord.

Great, thank you. Good morning. My questions are 1, just simply put, does the shut down -- is there any risk to inventories dwindling and could that impact sales and if so how quickly for the collagen plant shut down?

Pete, do you want to get that?

Sure. So Bill, fundamentally we're up and running and producing while we're working on these observations. As I think I commented earlier, going into a shut down we typically build up multiple months of inventory to kind of manage through that so we're utilizing that product now as well, as I had said, selectively running in different areas within the plant as we work on these observations.

Okay, so the answer is no risk near-term. Secondly, on the Ascension on the buildout, the acquisition, are you going to use this platform of Ascension to really buildout a direct channel into the upper extremity or how do you -- are you going to address that with your current direct kind of lower extremity sales force?

Let me start and then Pete can give you a little more detail. First of all, like spine, the shoulder market is a distributor-driven market and we do not have a direct sales force at the moment experienced in shoulder. So it's our intention to work with and expand the shoulder distribution network to leverage their expertise in introducing our novel products. Now once you get beyond shoulder, we actually have quite a bit of expertise in both lower and upper extremities and so there's an opportunity to bring those upper products into our existing sales organization. Recall that our upper extremity products including our Total Wrist, our NeuroGen product for nerve repair and indeed, our orthobiologic products are already sold by our existing sales force to upper extremities.

I think, to Stuart's point we'll have a hybrid structure and, as you guys well know, with the extremities channel challenges there's a lot of different call points and so we've been really looking at how we optimize. One of the really nice parts with bringing Ascension into the family though is the match up with our direct sales force for a vast majority of the basket of products that we carry and so we've been hard at doing the training right now. The team's very excited. As I'd mentioned, we have got over 20 new products coming in. The PyroCarbon line is a nice addition as well. So that's a nice mix.

And then to Stuart's point, utilizing some of the deep expertise that we've got through the distributor network with shoulder. And then obviously, across the pond, particularly in Europe, we've got actually a nice combination of the Ascension team working in conjunction with our local team as well in Europe. We'll continue to utilize a combination of direct and distributor structures. But it's coming along well. We feel pretty good about where we're at, at this point in time and we'll actually, at the analyst day, share more of, kind of show and tell on products and things of that nature to talk about how the portfolios come together.

Jayson Bedford, Raymond James.

Good morning. Most of the questions have been answered here, but just a general one. You did temper cost a little bit here in the third quarter on the SG&A line. When you look at the opportunity to create leverage going forward, does it all come from gross margin or do you think you can leverage that OpEx line? Thanks.

Well, actually, if you look at this quarter, I think we did a pretty good job of reigning in SG&A to offset some of the softness in our gross margin. I think our overall guidance of staying within the 40% to 42%, 6.5% to 7% on R & D, I'm talking about percentages, is consistent with our long term strategy. And so I don't think it all comes from gross margin. But clearly, the mix impact of gross margin, some of the things Pete's working on to improve our supply chain, those factor in to the overall plan. But one of the upsides of the recent acquisitions is they do create some redundancy that we can then take some cost out. Certainly we're committed to taking costs out of the Ascension acquisition but even with the overlap in the spine businesses, there's been an opportunity to chip away at G&A in particular.

Okay, thanks. That's it for me.

Charles Chon, Stifel Nicolaus.

Stuart, I want to thank you for the detail on where operating expenses could go in 2012 especially as we think about the impact from Ascension. But to understand what we are layering on here, especially the fact that Ascension had a non-profitable profile as you acquired the company, can you give some appreciation of where spending is going for the underlying business? So if we didn't have Ascension impact in 2012, what would we be seeing from an operating expense standpoint and could we have seen operating margin leverage there?

Well that's a very hard question to answer. I'm not sure I can tease them apart because our whole effort in the integration has been to take costs out of both of the businesses to get leverage. Certainly, in our original 2011 budget and our 2012 and beyond strat plan, we were able to derive operating leverage, principally from driving the gross margin line but also with keeping the SG&A over time at the bottom end of the 40% to 42% range rather than at the top end. So we certainly had plans and continue to have plans to get margin. That being said, while Ascension was losing money, much of the spend are things that we can address.

For example, bringing much of the foot and ankle and hand product lines into our sales and marketing infrastructure-- the redundancy of their senior most management team at Ascension; the integration of some of our R&D functions into their R&D organization; the elimination of overlapping R&D projects. And we saw some of that as well in our SeaSpine integration plan. So it's hard to tease out the acquisitions given how far into them we are, but that being said, certainly before either of those acquisitions, we had plans to drive margin, operating margin as we had said 50 to 75 basis points each year in the 5-year plan principally from driving the gross margin, but certainly from also the coming in at the lower end of the range on SG&A.

Okay. The second question is just a bookkeeping one. I'm sorry if I missed this in your prepared comments, but did you specify how much in acquisition revenues SeaSpine contributed to the quarter?

We did not and I think we had given original guidance on SeaSpine revenue and then suggested eliminating a portion of that due to the overlap between the SeaSpine dealer network and the legacy Integra dealer network. And I would say, when we gave the guidance, we specifically said we were not going to break it out because frankly, it is integrated and it's hard to break out at this point.

Okay, so I just want to make sure I understand just kind of the updated 2011 revenue guidance here. As we back out all of the various acquisitions from the year FX, I'm coming in with organic revenue growth guidance for the year of roughly 0% to 2%. I'm just wondering, does that register somewhere in the ballpark of where the guidance is, the updated guidance is today.

I think you need to just stick with -- sorry, I can't tell you what to do. We're sticking with our presentation of the revenue guidance as we've done it. Teasing out what is organic when you're terminating some of the targets dealers and some of your own dealers and integrating the business is very hard to do. I guess I can say certainly, the implicit organic growth in the back half of the year is slightly lower than the front half of the year due to the things that we talked about earlier in the call, but to try to put a specific number on it, we've been reluctant to do for years and we'll remain silent on.

Glenn Novarro with RBC Capital Markets.

Hi guys, good morning. A question for Jack on the gross margin. I think your gross margin guidance adjusted for full year is 64.5% and to get there, by our modeling, it requires a big 4Q step up with a gross margin of 65% or better. Is our math in the ballpark?

I think you probably need to work on the math a little bit. Why don't we have that conversation when we do the one on one and Angela and I can walk you through or Jerry and I can walk you through the pieces of it.

Okay, but 64.5% is the right number for the full year, correct?

Yes, correct.

Okay. And then one follow-up on the biologics -- INFUSE has been rather weak from Medtronic. Is that one of the contributors to the better than expected results for your business? Thanks.

Yes, I mean I think -- this is Peter Arduini. I think from the standpoint of the biologics, the biggest driver really is we've been expanding our overall distribution structure, the synergies we talked about with SeaSpine and also bringing on a significant amount of new distributors and really quite frankly managing aggressively to drive up the productivity. That being said, the challenges with INFUSE to some level probably have some effects within the overall market but we think our largest growth capability has been tied to the extension of the actual distribution and particularly tied to the product called Evo3 which is our third generation demineralized bone product.

Dale Dootle, The Boston Company.

Good morning. Just on the systems implementations charges. I'm wondering if you can update us there. That number jumped up a lot this quarter. I think you had originally said it would be around $0.30 this year and we're kind of there. So is that running -- is that costing more than you had anticipated and can you talk about what's left to spend whether it's going to be expensed or capitalized? I think you said some stuff is moving out to be capitalized. I'm just trying to get a sense of where that project is if it's on schedule. And then secondly, and relatedly, can you talk about what the benefits are? Its been a lot of money you've spent and I know we've adjusted it out but what are the benefits we expect to see from that spend?

Sure. So a couple things. As we said in the script, we expect that the third quarter number is the peak of the expense associated with that project. It will in Q4 flip into -- at some point in the quarter depending on how the schedule unfolds exactly, it will flip into most of that money becoming capitalized. So that's why we've been adjusting it out all along is because we knew we would have the sort of step function switch in how the actual numbers got reflected in the financial statements and we didn't want that to result in surprising changes in our numbers, so that's the schedule. The project is on budget and on schedule so far. We expect to do our first go-live implementation at the beginning of 2013 and push it through around the Company that year, so we have a certain amount of distance yet to travel on it.

The benefits have potential to be considerable. We have not given guidance as to financial impact probably because this Company changes a great deal from 1 year to another. But the financial impact certainly we expect to be favorable. We ought to be able to get leverage in aspects of our G&A line, and more importantly, much better visibility in a Company that, as you well know, has grown by acquisition. We have this [grid] systems and the like, so we expect to have considerable benefits from the projects but have not given specific financial guidance as to what those benefits may be. We'll probably talk more about that about a year from now.

What, so I can see what you've expensed, because we've backed that out, but what will be capitalized. I mean how much between now and when you go live, how much more dollars will you be investing in the project?

The total project is budgeted to be in the ballpark of $60 million, and has been and right now is on target for that. About, ballpark, half of which is expensed, half of which will be capitalized. So you can sort of get to your numbers with that guidance. That will mean that a higher proportion of our CapEx next year is associated with this project than with other endeavors if our current plans -- if everything unfolds as planned, so that's the way to think of it. Will we have cost overruns? So far we're not having them. Will they happen? They may. We'll give updates as we see fit next year as the project rolls along.

Bob Hopkins, Bank of America.

So just 2 quick questions. I apologize if you disclosed this already but, how much do you expect to spend in total for the 483 remediation over how long a period?

So we spent about $1.75 million in Q3. We have in our press release guidance in the back half -- in the fourth quarter of about $1 million and we expect some additional expense in the first quarter. We haven't quantified it but at the moment don't expect it to be anymore than $1 million to $1.5 million.

This is Jack. One point just so everybody understands it, those numbers include in part dollars spent actually doing stuff and they include in part the expense from having occasionally idle clean rooms and the like as the work progresses through the plant and as we work on processes. So it's not all, if you will, out of pocket to fix stuff just so that everybody understands what that line item in the press release means.

Thank you for that and then a question on pricing. Can you give us a sense over the last couple quarters just for the total corporation, what the impact of pure price has been and how much worse did it get this particular quarter relative to your comments in the prepared remarks?

This is Jack. We have had a variety of different impacts from pricing around the Company in accordance with our businesses. In rough terms, the impact of pricing on our business has been slightly favorable in most of our lines including neuro and extremities, slightly down in Europe and a little bit more down as we've previously discussed in spine, but that's roughly the impact.

Did things get worse this quarter than what you've been seeing last couple quarters and if so by how much?

It's substantially similar kind of impact. We have as you know a lot of different parts of our business, different elements changed a little bit but the total effect is essentially as it has been.

Bruce Jackson, Morgan Joseph.

Thanks for taking my question. Getting back to Europe, how much of the softness was due to reduced procedure volume and how much was due to other factors. And I ask the question because some of the pharma companies have noted press pressure on new tenders and I was wondering if the same factors were at play in the med tech area.

I would say anecdotally, the same factors are at play in the med tech area, so certainly tenders drive pricing down in markets. Now that's not a new phenomenon, that's been the case for a number of years. Keep in mind, Europe is plus or minus 10% of our revenues so and we have so many product lines for us -- I don't think we can talk about one product line or the other and its impact. Jack did point out when we do the analysis, it looks like our pricing in Europe in the quarter was down but not dramatically. So I think certainly there is price impact; there is also rationing that the governments are imposing on the system in terms of limiting their availability of reimbursement dollars to hospitals and even to whole communities.

Okay, that's great. Thank you.

It appears there are no further questions at this time. I'd now like to turn the conference back over to the presenters for any additional or closing remarks.

Thanks to everyone for joining us on the call and we look forward to seeing you at our upcoming investor meeting.

Again that does conclude today's conference. We do thank you for your participation.