Integra Lifesciences Holdings Corp (IART) 2012 Q4 法說會逐字稿

Good day everyone, and welcome to the Integra LifeSciences fourth-quarter financial reporting 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.

Good morning, and thank you for joining us for the Integra LifeSciences fourth quarter and full-year 2012 earnings release conference call. Joining me today are Peter Arduini, President and Chief Executive Officer and Jack Hennerman, Chief Financial Officer. Earlier this morning, we issued a press release announcing our financial results for the fourth quarter and full year. 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 continued 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. In an attempt to shorten our prepared remarks, we will reference the financial results in the press release and will not restate the individual numbers. As a result, you may want to keep a copy of the release handy during the call. I will now turn the call over to Pete.

Thank you, Angela. Before we launch into discussing our quarterly results, let me give you a brief update on the recent warning letter. On Tuesday afternoon, we announced that we've received a warning letter relating to our Anasco, Puerto Rico facility. We furnished the warning letter in the form 8-K we filed Tuesday evening. The warning letter cites concerns relating to process validation, corrections and preventative actions, and document controls. As we described in the 8-K, we stopped distribution of the collagen products manufactured in Anasco, and ordered confirm that we had successful validation for all such products. We believe we have complete and successful validations for all of our collagen products made in Anasco, and as we speak a third party expert is reviewing every applicable validation, and will confirm to us that our assessment is correct.

Once we receive that confirmation, we will resume shipping. We believe we're on track to begin shipping early next week, at which point we will file an 8-K. At this time, we do not expect the warning letter in Anasco to result in either materially higher costs or materially lower revenues, and the guidance we are providing today reflects our current expectations. Further, this warning letter and its observations do not impact our progress and plans to remediate our Plainsboro, New Jersey manufacturing facility. Turning to our quarterly financial results. We are pleased with our performance this quarter. Our revenues and earnings were in line with our guidance. For the year, we are at the high end of our guidance range that we provided a year ago, and we're looking forward to another productive year.

With as many as 25 new products launches planned in 2013, our cost saving initiatives well underway, and a successful implementation of our new ERP system at the pilot site, we have strong momentum. However, there are also headwinds. The ERP implementation and other important initiatives require additional investments in 2013 to drive our long-term growth and cost savings. The Medical Device Tax hits us hard, as any other company with a big portion of domestic revenues. And we've incorporated these considerations into our guidance for 2013, which Jack will walk through later in the call. We're pleased with the revenue performance across the majority of our segments.

To walk through a few fourth quarter highlights, US Extremities grew almost 9% in the quarter, our skin and wound products lines led the growth in US Extremities, increasing double digits. The shoulder line continues to perform in what is effectively a controlled market release, pending the availability of our modular reverse product to round out the offering. Our lower extremity hardware products also performed well. Finally, we completed a small product line acquisition in the extremities business in January. We forward to give you more details when we formally launch the product later this year. US Spine and other, which includes our spine hardware, OrthoBiologics and private label products, increase 5% in the fourth quarter.

Each of these components posted increases over prior year revenues, including spine hardware, which remains under significant pricing pressure. In spine hardware, new product introductions, including the Malibu minimally invasive surgery system and the Daytona products for deforming correction, drove growth in the quarter. Demand remains high for our Evo3 and Mozaik products, driving growth in our OrthoBiologics franchise. US Neurosurgery revenues increased 5% over the fourth quarter of 2011. Sales of our market-leading duraplasty and cranial stabilization products continue to drive the majority of this segment's revenue growth, making up for some softness in tissue ablation.

US Instruments posted a strong quarter, growing 7% over an admittedly disappointing Q4 last year. Alternate site Instruments, acute care Instruments, and surgical lighting all grew well. International revenues increased 4% on a reported basis during the fourth quarter. Growth was driven by our rest-of-the-world markets, which reported a 12% increase. We were pleased to see significant revenue growth in China, where early results of our transition to our new distribution network are having a positive effect. We're also please of the performance in Canada, Australia, and Spain, all of which grew low double digits in the quarter. Now I'll turn the call over to Jack discuss the financial results in more detail and comment on our 2013 outlook. Jack?

Thank you, Pete. I'll focus the majority of my comments on the items below the sales line, and discuss the impact of the Medical Device Excise Tax, the out-of-period capitalized interest adjustment in the fourth quarter, and the treatment of the R&D tax credit. Then I will elaborate on our 2013 guidance we provided in the press release. During the fourth quarter, GAAP gross margin percentage increase 2.5% versus the prior year period. Lower expenditures on quality remediation in our or regenerative medicine facility in Plainsboro and improved mix drove the improvement to gross margin. We calculate adjusted gross margin by backing out the adjustments to cost-of-product revenues, detailed in Column A of the adjustments table in our press release.

In the fourth quarter, our adjusted gross margin of 63.7% was flat versus the comparable measure in the fourth quarter of 2011. Compared to the third quarter of 2012, our adjusted gross margin declined, manufacturing variances, scrap and excess and obsolete inventory write-offs drove up our production costs, most of which were known and reflected in our guidance in October. Medical Device Excise Tax will negatively impact our 2013 gross margins. We are accounting for this tax as a cost recorded in inventory, which we estimate will reduce our gross profit margin by approximately 1% of sales. At a high level, we expect our optimization programs to bear fruit as the year progresses, partly offsetting the rising impact of the Device Tax on gross margins.

For 2013 we expect reported gross margin to stay around 63% throughout the year, and adjusted gross margin to be around 64.5% to 65.5% throughout the year. Research and development expenses declined slightly versus the prior year, and were 6% of sales. The decrease in spending versus last year reflects savings from rationalizing our orthopedics product development organizations. Overall, we are investing in R&D, and we are developing multi-generation product portfolios in key product areas. In addition to these investments, we are focusing our research dollars on regenerative medicine where we have the most differentiated products and on a robust clinical studies to support the use and reimbursement of our products.

During 2013, we expect R&D spending to increase and remain between 6.5% and 7% of revenues. Reported SG&A increased significantly versus a year ago. Higher commission dollars, mainly in our Spine organization, and additional headcount in key functional areas drove this increase. SG&A, adjusted for special charges, was 42.2% of revenues, up versus the prior year. Selling expense in particular increased because of the shift in revenues to higher cost distributor sales and higher headcount. Despite these increases, we are pleased overall with our efforts to keep spending in check. For 2013, we expect reported SG&A to be between 44% to 46%. After adjustments we expect SG&A to range between 42% to 44% of revenues.

In the fourth quarter, our adjusted EBITDA margin was 19%, unchanged from last year. For 2013, we suggest modeling approximately $33 million in depreciation expense, a significant increase over 2012 depreciation expense of $27 million. We plan to implement our ERP system, which will trigger the recognition of additional depreciation expense of the key initiative. In addition, we recommend modeling approximately $19 million in intangible asset amortization, $6 million of which will be recorded in COGS. During the fourth quarter, we recorded $600,000 of other expense. We recommend modeling this line item as $0 going forward.

We made an out-of-period adjustment during the quarter for capitalized interest expense, resulting in a $0.04 benefit to adjusted EPS in the fourth quarter and a $0.02 benefit to adjusted EPS in the full year 2012. This one-time adjustment to our interest expense line reverses the effective interest that had been expensed over the last two years, but should have been capitalized. For 2013, we recommend modeling approximately $5 million per quarter in total interest expense, about $1.5 million of which is non-cash, and will be included in special charges. Our fourth quarter effective tax rate was 23%, and we ended the full year 2012 with a rate of 20.8%. Our results for 2012 did not include any benefit from the R&D tax credit, which was not reauthorized until 2013.

The implied tax rate on our adjusted net income for both the fourth quarter and the full year 2012 was 30.7%, again including no benefit from the R&D tax credit. Our previous guidance to the 2012 adjusted tax rate assumed a benefit related to the R&D tax credit of approximately $900,000. For 2013, we expect the reported tax rate to be approximately 17%, and our adjusted tax rate to be approximately 28%. Both of these include the roughly $900,000 benefit from the R&D tax credit for 2012, in addition to the benefit related to the R&D tax credit for 2013. We used $4 million of cash from operations during the fourth quarter. Cash from operations was negatively impacted by a one-time tax withholding payment of $29.8 million, related to our prior CEO's deferred equity compensation, which was treated as an operating cash item.

In 2012 we significantly increased our capital expenditures as a result of our European implementation project, and the construction of our new regenerative medicine facility. During 2013, we expect to spend between $55 million and $65 million on capital expenditures, and then converge toward our sustaining level of CapEx, $35 million to $40 million in 2014. I will now provide some color on the 2013 guidance that we provided in the press release this morning. The full year 2013, we expect revenues to increase 4% to 6%. Within that guidance, we expect US Neurosurgery revenues to increase mid- to high single digits, US Instruments revenues to be flat to up low single digits, US Extremities revenue to increase 10% to mid-teens, US Spine and Other revenues to be approximately flat, and International revenues to increase mid- to high single digits, with sales in Europe tempering growth elsewhere in the world.

We expect our year-over-year revenue growth during 2013 to be lowest in the first quarter, and to increase throughout the year. We expect our revenues in the first quarter to be down relative to the fourth quarter of 2012, in the mid- single-digit range. Returning to earnings, we expect to increase our bottom line, notwithstanding the Medical Device Excise Tax, due to depreciation associated with turning on our ERP system, increased headcount, and other expenses related to our other strategic initiatives. Strong topline growth from new product launches in Neurosurgery, Extremities, and International markets, plus cost savings from a manufacturing and sourcing initiatives, will make our forecasted earnings growth possible. Due to seasonal trends in our business and the timing of the various product launches, expense reduction initiatives, and the other business issues that Pete and I have outlined, we expect adjusted earnings per share in the first quarter to be down slightly versus the prior year and step up throughout the course of 2013. Now I will hand the call back over to Pete to conclude.

Thank you, Jack. Overall, we were pleased with our performance in the fourth quarter and we're optimistic about 2013. That said, we still have much to do to reach our goals. Our vision to become a multibillion dollar medical technology company, and in 2013 we are focused on delivering on certain projects that will improve our top and bottom line growth. Our strategy to accomplish this includes improving overall execution, optimized the Company, and accelerating growth. In recent meetings, we've spoken a lot about the initiatives behind each pillar of our strategy. First, towards execution. We are working on simplification of our systems throughout the Company. In particular, the implementation of our ERP system is off to a good start. We went live in a pilot site that addresses about 8% of our revenues a few weeks ago, and as progressed pretty much as we anticipated.

Certainly, quality and regulatory affairs remain a critical priority for us in 2013. We are developing a single quality system, which will allow us to operate more efficiently and increase our overall quality capabilities. The closure of our warning letters is clearly are top quality priority. Second, to optimize. We are focusing on our infrastructure and operational excellence. We reduced the number of suppliers that we use significantly during 2012, and look to reduce that reduce that number further. Actions taken by our newly formed centralized sourcing team have already generated over $1 million in annualized cost savings.

In addition, we're making progress against our plans to optimize our manufacturing and distribution footprint. In the fourth quarter, the number of Integra facilities declined from 30 to 27. We've closed our Akron area facilities, and consolidated their operations into other Integra facilities. Both of these actions are aligned with our goals to drive savings and simplify the Company. Together they will generate about $3 million of savings a year. To elaborate on our efforts to accelerating our topline growth, I'll highlight some of our new product launches. I'm particularly excited about the number of new products we're planning to bring to the market this year across all of our divisions. Our International team is building on its initial success in China, registering and launching several products in new markets this year.

We're also optimistic about the growth of our regenerative products in both Brazil and Europe. Recently, you might've seen our press release for our flowable wound matrix for diabetic foot and leg ulcers. It's an advanced device that is now approved in the European Union for filling deep soft tissue, or tunneling wounds, including diabetic foot and leg ulcers. Our Neurosurgery team has been working closely with the International group on six global product launches that are scheduled this year, including our first new product in the DuraGen franchise in a few years. From our Extremities group, we plan to launch a modular shoulder system with a reversed option this year.

This new introduction will fill out our product line and enable us to build a more comprehensive distributor network for our shoulder and elbow product lines. We expect our shoulder offering to be differentiated, and by pairing it with our regenerative medicine portfolio, we believe we can take market share and become a significant player in the attractive shoulder market. We also have launches planned for our upper and lower extremities portfolio this year. Longer-term, we're making important progress toward completing our diabetic foot ulcer clinical trial, otherwise known as DFU. We expect to complete enrollment and began our submission for the PMA supplement by the end of 2013. The purpose of the trial is twofold. First, to gain approval to market our skin product for diabetic foot ulcers in the United States; and second, to generate clinical evidence obtaining favorable coverage decisions by insurance carriers.

Pending favorable decisions from the FDA and CMS, we hope to launch the product for the syndication in the United States with reimbursement in 2015. At our investor meeting last fall we discussed our long-term plans to streamline our operations, processes, and activities, as well as our plans to accelerate growth for the new product launches, expansion of our sales and distribution capabilities, and strategic acquisitions. We've included updated information on our progress on these initiatives in the supplemental presentation slides on our website. Now we will be happy to answer your questions. In an effort to accommodate a large number of requests, please do limit yourself to one question and one follow-up. You may rejoin the queue if you have additional questions. Operator, you may now turn the call over to our participants.

Thank you.

(Operator Instructions)

We'll pause for just a moment to allow everyone an opportunity to signal for questions. Matt Miksic, Piper Jaffray.

Morning, Matt. Matt?

Sorry, guys. Had you on mute. So thanks for taking our questions. Can you hear? Okay. (Multiple speakers) Sorry about that. So I wanted to follow up with you a little bit on your comments on the shoulder market. You made the Ascension acquisition. There was a shoulder there. You're getting ready to launch a new product. It is a tricky market. There is a fair number of big and established long-term competitors, some of them your neighbors here in New Jersey. Maybe outline what kind of investments you need to make in distributions, do you feel? What kind of gaps do you need to fill? You mentioned reversal shoulder. Is there a convertible element to the shoulder that you feel like you need to have? What are the critical elements of that strategy? And then I have a follow-up.

Yes, Matt. Thanks for the question. First of all, I think as we purchased Ascension, we basically came into, I think, a very good core shoulder product, as well as a roadmap. And we were working on, as we have purchased Ascension, actually the reverse product was in process. We're actually in the filing process as we speak with that. And clearly I think one of the things that we knew, but fully had gained a greater appreciation for, really in the last probably nine months, was having this complete shoulder offering, particularly for the United States market, was critical to drive share. And the reason being, is that is obviously many of these procedures are opened up with a question mark of what type of shoulder approach will we utilized?

Hence, having that complete offering is critical. And so we believe we're going to have that critical offering coming in here to the second half of the year. So that's what we're targeted on. From a distribution standpoint, we've actually made, I would say, great inroads as far as building the right relationships, bringing on some distributors, but we also have a lot of folks teed up that we believe that we can convert into our stable, once we have the full line. And you can imagine from a distributor perspective, if a lot of the procedures are question marks, the diagnostic imaging doesn't give you a definitive is it a reverse, is it a traditional. A lot of distributors aren't going to necessarily switch and come to your line until you have that filled out.

So that's some of the realities we see in the marketplace. That being said as well, we also think that we've got a few other things that we're thinking about that at this point in time, I don't want to openly speak about that we're going to fill out even further in the line. But our real entree into this market will be later this year with a full offering. And I guess the last part of that is that the modularity of the design already was a leadership component. You're starting to see some other people bring it to market. We think we have a quite a modular product that allows revisions and such to take place in a way that are a lot more simplified, and we believe actually more overall accurate for the clinician. And so that's been a core part of the design that we acquired from Ascension.

Okay. That's helpful. And then one, I'm sure we're going to get a fair number of questions here about the San Juan letter. I was wondering, you've made a certain amount of investments across your entire plant infrastructure in the past year since the first letter. Not to say that the first one was a surprise, and this one wasn't a surprise, but it seems like the way at least you're talking about it, you're a little bit more prepared for some of the issues that were raised by the FDA, it seems. Can you talk about, is that true? Am I reading that right? And maybe, what leads to your confidence that you'll be able to sort of get supplies back out in the next several weeks, as you mentioned, whereas say, heading into the first letter, I think there was a period of maybe two or three months of evaluation and discussions before you sort of have that confidence as to the way things were going to go?

Yes, let me -- I'll frame a couple of comments and I'll ask Jack to jump in. So first of all, as we have been communicating really over the last 18 months, we've been spending money throughout a lot of our facilities, really to upgrade our overall quality systems. Much of this is focused around just the raising of the bar of the Food and Drug Administration. So that's been a core focus. And it also plays into my comments about driving a single quality system. The more aligned, the more consistent, we believe the more reliably we will be able to run our overall facilities. So that's part of our operational strategy. We've been really investing in the Puerto Rico facility, really over the last 18 months. And so we've made a lot of progress.

At the same time, many of the points that were brought up in our for 43 observations, we had Capas and we had plans already in place. Understandably, that doesn't necessarily mean that they are fully aligned with where the QSR need to be at that point and which the FDA pointed out. But we have items identified. We have taken a look at overall of our safety of our products. We feel very comfortable about where we are with the safety profile of our products, and we're working diligently to get these items closed. I think when you look at the two locations, we've got process items that we're closing out that we've already been working on in Puerto Rico. If you compare that to Plainsboro, we had facility changes. We made structural changes in the facility, which then clearly was the major difference which extended the time out. Jack, I don't know if you want to, comment a little further?

Yes, I think the -- here's a very high altitude way of looking at. When we have the inspection in Plainsboro, that was -- frankly a lot of it was a revelation to us, and we reacted forcefully throughout the Company, starting in the fall of 2011. Going to our most significant facilities first, and Anasco was high on that list. So we began an expensive and lengthy deep dive remediation program starting in the fourth quarter of 2011. And we think we've made tremendous progress against that. So this warning letter I view as something of a lagging indicator. And that makes it quite different. So that's sort of how we look at this. In fact, the inspection happened in the fall, and by the time we got the warning letter, we actually felt that we had fully validated everything, and then we're running it through -- we went through it again ourselves, essentially over the weekend, and now we've got in front of a third-party expert to confirm for us that our judgment in that regard is correct. And when that third party review is finished, assuming it comes out right, we'll release product immediately.

Excellent. Thank you.

(Operator Instructions)

Chris Pasquale, JP Morgan.

Thanks.

Morning, Chris.

Good morning. I want to start with the Extremities business. This was the first quarter since the Ascension deal that we really have a clean year-over-year comparison. And the 9% growth you posted was at the low end of your long-term target range, and a little bit below where we estimate the market's tracking. So your guiding to an acceleration from that level in 2013. Could you just comment on how you think that business is performing overall? And then how much of that projected improvement is due to the shoulder ramp-up versus other factors?

We think that business is performing really well. And has -- just about a week ago, Pete and I were at the national sales meeting for that business. And the sales force is energized. It's a very well functioning business, we're not troubled at all by little ups and downs in the sales growth. We have a high level of confidence that's driven by both short-term considerations, new product launches, and growth in the sales force itself and longer-term considerations, such as the possibilities for the DFU trial, which is obviously not complete, and the potential upside to that market. So that's how we think of the long-term opportunity there.

Yes, I would just add to it, Chris, that to Jack's point, we feel good about it. We've got a fair amount of products coming out as well out of R&D shop for lower and upper, which are going to add to the overall bag for the sales team. And we believe that we've got some pretty good leads and growth opportunity in our regenerative product in our skin as well currently, which will be reflected in our guidance here coming into 2013. All in all we look at Q4 was a solid quarter, based on how we were looking at expectations.

And to close on one question. Shoulder is not a huge part of the success in dollars. It's not a huge part of the success to that division this year. And the trick is to get to the right product mix that can attract the really strong distributors in the field that we need to attract to make next year a big success in that area.

That's helpful, thanks. Maybe just one on neuro, then. You're guiding to 2013 growth there at or above your long-term goal. This was a good quarter for that business. What's driving the better outlook there? Is on the capital side, or the procedural? And since that's the piece of your business most exposed to Europe, maybe you could just comment briefly on your latest thoughts on the environment there.

Yes, Chris. I think across the board we've had a pretty solid performance. I mean, Q4 we said we're a little bit lighter on the capital ablation side. I think as anything, it was more timing of deals then I think any market-specific dynamics. But our flow products and our regenerative products, particularly our Duraplasty products, are doing well. We are in the process of launching roughly about six new products in neuro that are refreshing, really across the line from where we take a look at our monitoring some of our critical care catheters, our stabilization products. We've rolled out some new tips as well recently on our CUSA product line, and as I mentioned, we have a new product coming out in DuraGen.

So we see the procedural rates staying pretty stable in the 2%, 3% range, not really major changes there, but this has been at the end of last year coming into this year, really the refreshing of our product lines, and we see that driving, as Jack communicated earlier, upper single digit growth for us this year. And your second part on Europe. I think look, we think we create some tailwinds for the neuro business because these lunches, as I mentioned, are global and they will be launched for the most part in Europe. That being said, we believe that it's still going to be another tough year for the European marketplaces out there, and we've reflected that within our guidance. I would say broadly for Europe, we're also introducing our spine products and bringing some new products to market. It's also what's helped us have a little bit stronger growth versus what a lot of other people are reporting. Mainly because we have had the luxury of introducing some new products into that market.

Thanks, guys.

Thanks, Chris.

Raj Denhoy, Jefferies.

Good morning. Quick question. So your guidance for the year, 4% to 6% here in '13. You've put up some long-term guidance of 5% to 7% back at your analyst meeting. Given what you're seeing out there now, are you still comfortable that after a year or two you'll be able to accelerate up to that level, and what drives you back to the 5% to 7% level?

Well, we are. I mean, I think we're quite confident in what we laid out in the fall and how that projects. I think if you remember, when we spoke about it, we talked about it ramping up over that five-year window. And probably the number one component that gives me that confidence is our increased capabilities to execute against our plans. That's the first part, and that's the sales execution and commercial part. I think Jack's points about our sales meeting, seeing the confidence of our team, the quality of our sales organizations increasing, the quality of the marketing tools and products, that's part of it. The other aspect is in the short term, we're disrupting quite a few things. I mean, we have -- I talked about facility moves, ERP implementation. We know that some level of that effect will have an affect on our ability to grow faster early because we're changing things. So as we get those change items solidified here in the next 18 months, the majority of them, that alone has an effect on accelerating growth, not to mention obviously on top of that, deals. And fundamentally we haven't really done a new deal now since --

September of '11 was the last time, so.

Which we plan on obviously bringing in some more acquisitions into the portfolio as well.

Okay. Well if I'm not mistaken, from the guidance you laid out to which your longer-term guidance relative to what you're talking about for '13, perhaps the biggest differences is in International, where you're talking about getting to double digits longer-term, but you're still sort of mid-single digits now. I know there's some offsets with what's happening in Europe, but again where's the confidence that that business is going to be able to accelerate to that level?

Yes, look. Again, I mentioned, I used the words, I think, on a previous call, lumpy. Again, our strategy in International is really two key components. One is by marketplace, aligning the distribution structure so that we have deeper penetration, and really more control over our products. I think China's a great example of that where we've gone from fundamentally 1 or 2 core distributors to a structure where we have 15, and we have deeper reach within to the countries, we're registering our products. That allows us to bring faster follow-on products. So that's one set of items. The fact is, as we make some of those changes, we actually have periods, quarters and such where we're going to have some decreases followed by accelerations.

So right now, as we're going through some of those changes, we really had projected that we would have some slower growth in the front followed by some stronger acceleration on the back end. The other part of that, Raj, is that we actually have about 25 to 50 products over the next couple of years that were very applicable, strong margins we believe in our target market that we've never registered. And so some of those, even if we get the registrations submit this summer, are still going to take 18, 20 months actually have those products selling, but we're driving that now, and we see how that will play out over the next couple years. But I still feel quite bullish, particularly about the rest of the world for growth potential for our products.

Okay, and then just one quick one on the warning letter. This is the third warning letter, I'm sure you know in the last 14 months, the Company's received, if you include the one in England, the Andover facility. Three warning letters in 14 months is a lot, and I guess I'm curious, if you're doing anything proactive, because the FDA may have some broader questions here about the Company's quality systems, and is that a concern for you at this point, and how are you addressing that?

Well, obviously with three warning letters, it's a strong concern for us. I mean, that's what we're very much focused on to get those closed out. We actually have reached proactively out to the FDA, and really in the near future we're going to be sitting down with them with my new head of quality in manufacturing, and laying out our broader plan for how we're really focusing on our one quality system, our plans to get these items addressed. And so, yes, as I'll emphasize, reaching out proactively to have the Agency understand what we're doing. And to play off of Jack's Jack's comments before, we believe, like all things, that we've been working on this pretty aggressively over the last 18 months, and we've made a lot of good progress.

We want to show that to the Agency, but ultimately we have to prove to them that we can get these items closed out. And so we have specific plans at each of the locations to do that, but as importantly, our other sites where we've been focused on. We've really looked at all of our sites, and as I've mentioned in other areas, we've had multiple inspections, where we've had no 483 observations. We know how to do it, we know what good is, and at this point in time, we literally have either plans in place in all of our facilities to make sure that we are in great shape. And we want to share that with the Agency, and we plan to, as I said, really coming up here in the month of March we're going to be sitting down.

Okay, thank you.

Yes.

Amit Bhalla, Citi.

Hi, this is actually Adam in for Amit today. Thanks for taking my question.

Hi, Adam. How are you?

Good, how are you? So just a start with on Instruments. Instruments looked a little bit stronger this quarter after last quarter. I mean, can you talk about what's happening in that market in the US, and on the EU side as well?

What was your second question?

Just on the breakdown between what's happening in the US versus the EU.

Okay, US versus EU. All right. I'll take a shot on the instruments, I'll have Jack comment on US and Europe. So look, for the Instruments, the first thing is, for the full year, the Instruments team had a really nice year. I mean, from a standpoint of the revenue, and candidly, also the work that Dan and his team have done on profitability of that business. They've done a very nice job throughout the year. And in Q4, we were up, I believe, 7%, particularly strong, but as I've noted, last year in Q4 we had a miss that fundamentally the majority of the miss for the Company was associated with our alternate site Instruments business. And so we had a weaker comp year-over-year.

But from a full year perspective, the Instruments business, with a lot of our specialty items, our lighting products, the LED product has done extremely well. It's been received well into the market, and we see that continuing into this year. Our retractor business, as well as really some of our specialty products, such as our Ruggles product as well, have done well. And I think our on-site business as well has fully recovered, and with some of the new channel structures that we put in place on how we're selling, we feel quite good about that. That being said, from a standpoint of where the market growth is, we see low single-digit growth is realistically how we've projected what 2013 looks like. Jack, on US, Europe?

Yes. So, I assume you're asking about the whole business, rather than just Instruments, just to be clear. Instruments is our most domestic, least international division. So I'm going to talk about the whole business. In rough terms, domestic revenues were 77% of the total. So the rest of the world was obviously 23%. Of that, and I think most people know this, Europe on the one hand, and the rest of the world on the other, are pretty evenly split outside the US. We were actually down less than a point in Europe, but we were up double digits rest-of-world on the top line. So that's roughly how we look at it.

Okay. All right.

Yes. We expect Europe to continue to be challenging on the one hand. On the other hand, we've been executing well in a tough environment, especially against our previous execution in Europe, which was challenged in many respects. So we're pleased with the progress that we're making in that part of the Company, and that momentum can help us going forward.

All right. Thank you very much.

David Lewis, MS.

Good morning.

Morning, David.

Jack, just wanted to the table here to EPS for a second. The raise you're guiding for in 2013 is a little bit lighter than the raise that we've seen in prior years, and certainly in 2013. I wonder if you could help us with sort at the polls, what are the factors that are sort of underpinning in that wide range? I mean, how much of that is just cost savings, versus how much is conservatism, how much is potential Med Tech Tax timing? Can you just help us understand the magnitude of the gap, that would be great?

I think it's an excellent question, and it's essentially those three things. So to start with, we have a lot going on inside the Company. To be blunt, you guys haven't even seen the detail behind the plans we have this year to build a strong, optimized foundation for the Company. So we have a lot going on, and very specific things we will no doubt call out from the adjusted number, but we're going to have a lot of movement on the expense side for sure. The Med Tech Tax in COGS and will flow through inventory, the timing of that from an accounting perspective is going to vary a lot, depending on the mix of products we sell in a quarter. And frankly, from our standpoint, it's a little tough to model precisely.

We have a huge number, as you know, you've heard famously from us at this point, we have a huge number of SKUs in the Company. So forecasting what actually happens, for example, to the device tax, or really any other variance in COGS, is a little bit of a law of large numbers estimation game for us rather than a granular precision game for us. So we thought we'd leave a little room there. And so we have actually, frankly, on the one hand a lot of optimism about the business in the abstract, and on the other hand a very realistic view of all the stuff we are working on. And that sort of drives, perhaps, a wider range in our expectations for what happens in the year, and I think it's only, frankly, prudent for us to do that. Pete, I don't know if you want to elaborate on that?

No, I think you've covered it, Jack. I think this is an important year for us, as we expressed, really, in our STRAP plan. So we're well on our plans from working what we're thinking about from facilities strategies. Our sourcing piece is actually doing quite well, but were consolidated suppliers We're actually being able to get some good cost savings that are going to have benefits, at the same time shifting some products around. So a lot of moving parts, but we feel quite good about those plans; and hence, driving a little bit more range so that if we have a couple challenges we work through, we have a little bit room on the lower end of the range, and if all things align very well, we could be a little bit higher on that higher on that scale.

Okay, very clear, thank you. So great detail, and just maybe two quick ones. I guess Pete, just for you. I know people have been dancing around this international dynamic, and you turned some commentary on how you can move the international growth rate over the next couple of years, but just specifically for '13, there's a pretty interesting acceleration from '12 to '13 internationally. Is there a particular product set outside of neuro or a particular geography that you're optimistic is coming online in '13 that really gets you comfortable with that just year-over-year improvement?

Well, I mean, I would specifically call out, I mean, China, we made a lot of the changes last year within the alignment. So we're expecting China to be a market that's going to be accelerating at a more faster, smoother rate in '13 than in '12, as an example. I think Brazil, as an example, there are some reimbursement items that became through on our skin products, and so as we're increasing our capacity and rollout there, I see specific markets, and there are select other markets as well, David, that we've actually had registrations that we had submitted last year that we're getting approvals this year that will commence rollouts, even in Eastern Europe as well. So that's how I would take a look at it.

I think our extremities business is probably going to be one of the ones, from a standpoint that we've spent a good chunk of time on some those trials, as well as spine. So we've had select spine products, that realistically for rest-of-world, even outside of Europe, we've never really even launched, before. So we did a lot of the pre-registration work at the end of the year. So that's why I have confidence in those markets we're going to see some sustained growth. But back to my previous point, it doesn't still change the point that when you go into a market you're making some major changes in structure for the long-term benefit. It clearly has a negative impact for a quarter or two, as you put those items in place, and so we reflect that in our guidance, and that's kind of how we see the plan.

Okay. And that's very clear, Pete, and (inaudible) one more quick one, sorry. On Anasco, it sounds like the likelihood that the third party, or [shipho] gets delayed is very low, but is there a point here, is it a week, a two weeks, a month, where if the shipho were maintained, do you start to run up against capacity issues in Plainsboro? Thank you.

So first let me get back to the Anasco point, just to make sure the table's set. So we've been through all the validations and question ourselves, and we believe we have accomplished what we need to accomplish. The third party is going through that now, and has been for a couple of days. And we have what I would describe as a pretty high level of confidence we're going to hit the date. Obviously, in situations like this, it is unwise to make absolute promises, so we're not doing that. Now, to get to the capacity question. Two things could be said about it. One, there is a bunch of product in the field, and there is a bunch of product on hospital shelves, and if we don't believe that near-term we'll have any disruption in sales and so forth.

If it came to pass that we couldn't ship out of Anasco for a longer period of time, and I'm going to emphasize we think that's remote, we would need to engage in a pretty detailed production planning exercise in Plainsboro, and frankly the capacity of the existing plant in Plainsboro, (technical difficulties) condition to meet the total demand for our products. So we would be in a very careful planning mode and have to make some real trade-off decisions. We're not at that point, we don't believe we're going to get to that point, but we could meet the demands of select customers and work through our issues, if it came to that. And that's about all it's worth saying at this point, because we don't think we're at that stage.

Okay, thank you very much.

And Dave, just remind you, as we said in the prepared comments, we will release and8-K once we begin shipping.

A further point, which may be a little unclear, and we're hitting home. We're continuing to manufacture in Anasco. This is not a manufacturing hold, it's a shipping hold. So there's not going to be some big burp in the supply chain once we are able to ship. Just to add that further detail.

Robert Goldman, CL King.

Okay. Thanks and good morning. A couple of follow-up questions. Good morning, Pete. On the warning letter. Just so that's we're clear, since you got warning letters both in Plainsboro and Puerto Rico, are you allowed to do any trials on new products that are based on collagen? Or is the approval of new products suspended until the warning letters are lifted?

Yes, Bob, it typically touches two areas, which is the approval of PMAs, not necessarily five 10-K's usually are not approved when you have a warning letter, and also, letters of certificates from foreign governments, which I am sure you know, governments that rely on the US to kind of provide certification. The FDA doesn't typically issue those. Those are typically the two things. That being said, if you have PMA products in process, you can submit subsections, you can be working on it during all this time, but your ultimate approvals typically aren't approved until the letter is actually lifted.

Okay.

So just to nail a key point, the DFU trial, which is the high-profile thing we're doing, will proceed on schedule, point one. Point two, the dermal products are made in Plainsboro. And it is the case that we'll need to get the Plainsboro warning letter lifted before we can get approval on that product. The lead times, though, are such that we're pretty confident we'll get there, because it's a long time in the future before we'll be up for approval on that product. So that's a key thing to bear in mind. The final point is, the impact around the certificates to foreign government issue is de minimis, it's well under $1 million over the next 1.5 years or so, if you play it out. So it's not a big deal.

Okay. Then second is that the Puerto Rico warning letter speaks, or suggests, that you should use independent experts, and the Puerto Rico warning letter references Plainsboro as well. Of course, you are using, from what you are telling us, independent experts, and FDA was in your plant in Puerto Rico for months. So I am sure you made that point to them. Are they uncomfortable with the experts that you are using? Or do not view them as experts?

Well, Bob, I don't believe it's that they're uncomfortable with the experts that we're using. I think it's just the stated language about how they worded things in the warning letter about how we need to review. We've actually had a dialogue with the San Juan District, and we've expressed to them our approach and who is actually doing the work, and we have fundamentally the support that we're proceeding in the proper direction. So we believe that we're doing the right things, and on track to that, and I think as it comes to our Plainsboro facility, the individuals that we're using are highly respected by the FDA, and candidly by us.

They've given us some great advice and helped us out. The references that you see in the letter are that these plants, some of the processes are done in New Jersey and shipped to Puerto Rico, and so there are references to incoming goods and products that are brought up. And just to be clear for everyone, the letter from Anasco does not reference -- excuse me in Puerto Rico does not reference the Plainsboro from that warning letter item. It's very discreet to that, but these two plants work together. I mean, there are products and raw materials that go back and forth.

And then finally, Pete, sort of more of an overview question. You provided some guidance on 2013 at the analyst meeting in October. And the guidance that you presented today on the press release really is consistent with that. Yet you do have two warning letters that have come up since October until now. It sounds like you are comfortable enough in what you are doing on remediation that you're not budgeting for any step-up in remediation costs over the last few months?

Well, first of all, from the guidance comment, I would agree with that. And again, why is that? Well, we've been working on these plans for the last 18 months. So, what does that mean? That means when we gave our guidance, we had already built in cost to work on remediation. Because we knew we wanted to actually increase our overall quality capabilities. We knew what it would cost to spend the time on a common quality system, and again I think it's another point to reinforce, we did our assessments of our facilities, and the observations in Plainsboro had clear items that were associated with things that we had to change structurally in the plant, and that's what drove a lot of the cost investment.

Our own assessment, and also the assessment that came back from the Agency in Puerto Rico, were process changes, the dock controls validation, items that we understood. We opened Capas on these items, and we properly, I believe, budgeted at this time for that scope. That being said, if things were to change, obviously we would have to change that, but we believe at this point in time our plans, and what's articulated in the warning letter that it is within the range of the cost that we've laid out on the call and on the press release.

Okay, thank you.

Thank you, Bob.

Spencer Nam, Janney Capital.

Good morning everybody. Thanks for taking my questions. Just a couple of quick follow-up questions. I guess I'll throw one in for on the warning letter, and then I just have a quick question on the US Instrument guidance. On the warning letter, so when we think about these things, I'm just curious, how you guys are thinking in terms of the timeframe? It's obviously difficult to estimate when these things could be resolved, as more issues could come up, but having said that, I'm curious how you guys are thinking. Whether we could roughly sort of think that all being in line with your expectations that these issues could resolve within this calendar year, for example?

So I'll take a shot at that, and then Pete can elaborate. Excellent question. On the one hand, it's early in the calendar year, on the other hand, no company, including Integra, can set the FDA's scheduled for the FDA. So we believe that we will be in a position to absorb a new FDA inspection in any of these plants during the year. We've been clear with the FDA in our calendars for these plants. We give them regular reports. So they know when we will be done at our work in the plants. The question then would be, how quickly thereafter they would schedule an inspection and come in, and then after that, if the inspection went well, how quickly they would give us a clean bill of health. And we obviously would very reluctant to speculate about that, because it's outside of, it's frankly outside of our control.

Yes, I think, Jack, you've covered it. We, again, we understand the issues. It's not as if we're going through it to try to understand root cause or issues. All three of these locations we understand what the Agency is asking for. We have plans in place, and we're closing on them. All of them have obviously different timelines, and all of them have different districts that we will be interfacing with, and we have been with, as Jack commented, on monthly updates. Our plan is to be as transparent and open with them, and to reinforce the discussion and the comment I made a little bit earlier, literally sitting down with the heads in CDRH to kind of lay out our plans an discuss that with them in the near term is a meeting that we requested and were granted.

Any sense right now whether there may be -- when you look at sort of the line items from these three spots that where you have issues with the FDA, are you sensing that there could be other areas? I mean, how sort of in this point-to-point, or one-to-one sort of situation where you guys are sort of taking this -- an isolated situation, or the isolated property, or is it more of -- how confident are you guys that you're not going to see more of these popping up, say new cases that is three- to six-month timeframe?

Well, look. I mean, I'm not going to predict on the call, will we not get another warning letter, will we not have another issue? Obviously, as I'd mentioned, one of our concerns is we don't have any escalations above this., another site or something broader. And so that's why we're meeting, Spencer, with the Agency to lay out our plans. Now, my confidence that we've looked very critically at all of our, not just crucial plans, but all of our plans and made an assessment what needs to be done, how plans that already we've been working on into the last year, are quite high. So I think we have a good handle and know what the risks are. We've had other inspections that have been closed out that we haven't necessarily made comment on. So we have a pretty good inventory of our overall site. That being said, these are warning letters, are not to be taken lightly, and we do not. And we take this very seriously, and we're moving aggressively, and to Jack's previous points, we think we've got plans of each location to meet the Agency's expectations.

It's also worth adding, for the people on the call, we've made substantial changes in our quality QA leadership team. And, we have built up a really first-rate group of people, really to a great degree in the last six months. And that is, frankly, one of the reasons why we have a somewhat higher SG&A planned for 2013, which came up in the guidance. So embedded in the guidance is our investment in really a much beefed-up quality leadership team. And the effects and the impact of that are being felt all over the Company. And the agenda for our agenda for the meeting with the FDA will be to introduce them directly to that team and show them our level of leadership commitment and financial commitment to resolving the issues.

Thank you.

David Toung, Argus Research.

Yes, good morning. Thank you or taking my question. I was a little late to the call. But I was wondering if you could go back in and repeat the details of your international growth. I heard that you, Europe and the rest of the world were about evenly split, and that Europe was down one percentage point, and then you mentioned 12%. Does that relate to the rest of the world non-Europe?

I'm sorry, the last -- what was your last, the last few words of your question? You broke up. I'm sorry, David.

I'm sorry. You talked about Europe being down 1%. And then I heard 12% the rest of the world. Does that relate to non-Europe rest of the world up 12%?

Yes. So, just to refresh. I gave two lines of numbers, okay? The first was the basic split of our revenues, which is pretty much the same as it's been. Domestic revenues account for 77% of the total. The world outside the US, 23% of the total, so it adds up to 100%. And of the world outside the US, it's roughly 50% Europe, roughly 50% everything else. Now, growth rates, all right? The international growth rate as it's reflected in the press release, you should track that down. Europe, the Europe component of the international growth rate was actually down less than 1%, okay? IT rounds to about a point, but it was actually a little less than that, close to flat. The rest of the world outside of Europe and the United States, was actually up double digits. And it adds up to the growth rate we describe. So that's how it lays out, and we can handle some of the rest of that in the calls off-line if you want, and give you more granularity on that, or you could talk to Angela and get more detail.

Okay. So given what you've said about product registration and distributor build-out. You mentioned Brazil, you mentioned China, and so there is considerable opportunity in the rest of the world that you could, if you have considerable opportunities, given that all of this was still work-in-progress and there's still more work in progress, and if you look out in '13 and '14, you have some clearly robust opportunities in the rest of the world.

Correct. Definitely, and I think the fact is, as I've mentioned a couple of countries that we believe we're going to making progress in '13. But we're working on many other countries. I mean, even Japan, as an example, which not everyone obviously thinks as a growth market. We're very underpenetrated, but our products are greatly appreciated. And we're working on plans there to be able to expand our growth deeper. So from those markets, as well as some of our more mature markets, such as Australia, we've made some gains. So yes, I think it's across -- my (technical difficulties) there is really as we make channel changes and strategies, it's going to be lumpy. We're going to have some markets that actually we have some flat growth for period of times, and then we'll have some with new structures in place, accelerate and higher double digits. On aggregate, though, we feel comfortable with our projections that we've laid out here for '13, and candidly well in line with what we've laid out for our five-year plan we laid out back in the fall.

Great, thank you.

Steven Lichtman, Oppenheimer & Company.

Thank you. Good morning, guys. Pete, a lot of the gross margin benefit this year, as you've talked about before, comes from sourcing, longer-term facility closures should play a larger part. You mentioned three facilities closed last year. Are there any goals we should be focused on in terms of plant closures this year that will benefit costs going forward? In other words, if we think about 2014, what are the items that should benefit gross margin that year incrementally versus 2013?

Yes. I think it's a good question, Steve. As we talked about, obviously these are sensitive items that we're not going to call out the specifics until we're actually ready, but as you've seen what our plans look like over the next five years, it means that we need to have progress each year. And so I would say, expect to hear some updates from us when we're ready to announce that on those specific items. Around the facilities components, whether it be distribution or other. On the sourcing standpoint, it is clearly a momentum game. Obviously the savings that you get roll over from an annualized basis, and this is -- we had a good start in Q4. This is an important year for us, and that will parlay into '14 as probably some of the bigger savings around sourcing. And as we get into our next call and we have more information on that, we will continue to elaborate more.

So just as my prepared comments today talked about some of the fourth quarter items, as we get into our first quarter call, we will talk more about as we can how those items are evolving. So yes, I think you're right, that is a big component. We feel that we're on track to those plans. The other aspect is mix. I mean, we have good growth in what's taking place with Extremities, and also in our Spine business, and we're also having some favorable product mix within each of our businesses. I think something to highlight each of the teams has been looking at as they've been eliminating lower margin SKUs and focusing on higher margin, that is also a play we don't talk about as much. But I think our Instruments team is a great example where they've been able to life their overall whole business margin, not by cost reduction but by smart positioning and optimizing their product portfolio. And so that's also built into some of the growth we're expecting.

Great, thanks. And then Jack, it doesn't look as though stock buybacks are contemplated, at least meaningfully, in the guidance for '13. Understanding it looks like a lot of cash is earmarked for CapEx, but is there a potential for us to see an increase in share repurchases in '13, or is the cash being directed elsewhere?

Well, I would say right now for 2013 we don't have any plans for stock buybacks. We have done in the past, as you know, and broadly speaking our business generates a lot of cash, but in 2013 we have significant plans for capital expenditures, as you point out, and we do also expect to put some cash into working capital items. When we get to talking about, for example, facility moves and that kind of thing, one of the things that always happens in connection with those is you build up safety stock in the inventory and that kind of thing, and that will happen as well. So this year we don't expect to have sort of a lot of extra cash to make a move like that. We have a plan authorized so we can, if our judgment changes, but we're not building into the plan.

Understood. Thanks, guys.

Jayson Bedford, Raymond James.

Good morning. Thanks for taking the question. In Plainsboro from a manufacturing standpoint, are you kind of at historical or normalized levels? Basically is there less underutilized than in quarters past?

We're pretty well at normalized levels.

Okay. And can you remind us where you are with the new facility in Plainsboro in terms of bringing that up and running?

Yes. So roughly where we're at is, I mean, we're coming to getting everything fully finished within the facility, and later at the end of this year, we'll actually began certain product line areas, the migration. So bringing up some pieces of it, but it won't have a substantial impact on volume and manufacturing, really until 2014. But the facilities coming along well. We're very happy with what we've got laid out, and keep in mind, many of the procedures and processes that we use to manufacture those products, we utilize in 105, and so we're making sure that we have everything tied down in 105. Those will be the same procedures we make our collagen products for, we will utilize in our new facility, which we call 109, and obviously sharing that with the FDA when we bring that facility up, but things are on track, and we will actually start bringing some products up later this year.

Thanks, and just lastly for Jack. Clarification the 64.5% to 65.5% in adjusted gross margin for '13, that includes the Device Tax, correct?

Correct. We're not adjusting out the device tax.

Thanks.

At this time, we have one question remaining in the queue. (Operator Instructions) (Operator Instructions)

Bruce Jackson, Northland Capital Markets.

Thanks for taking my question. I just want to round out the FDA discussion. They've been making the rounds to the various tissue banking companies, and I wanted to know if they've visited the IsoTis plant? And if they haven't, when was the last time they were in?

Yes, we actually had an inspection. I don't know exactly the date, but it was last year, and we came away with that with no observations. Okay, that's great.

It was a very clean inspection.

Okay, that's it. Thanks.

And it appears that there are no further questions at this time. I'd like to go ahead and turn the conference back over to management for any closing or final remarks.

Thank you for listening to the call. We look forward to speaking to you when we report our first quarter earnings. Thanks.

That does conclude today's conference. Thank you for your participation. Please have a good day.