Integra Lifesciences Holdings Corp (IART) 2013 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 conference 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 2013 earnings results conference call. Joining me today are Peter Arduini, President and Chief Executive Officer, and Jack Henneman, Chief Financial Officer. Earlier this morning, we issued a press release announcing our financial results for the fourth quarter and full year of 2013, and issuing 2014 guidance.

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.

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. As you all know, we had a year with lots of ups and downs, but as a result, are a stronger Company today. We also had some real successes in the Business that should not be overlooked.

In Q4, not only was our US extremities business up 16%, but our global extremities business was up 13% over the prior year. Our global orthopedics category was up 7% in the fourth quarter versus the prior year. Our total business in Europe was up 4% in the fourth quarter, with particular strength in western Europe. As a reminder, all of those are organic growth numbers.

So, while we're still recovering from the downstream effects of the recall and collagen supply issues, which affected the US neuro and private label businesses, parts of the Company that were less affected are putting up growth numbers that we expect from them over the longer term.

Finally, gross margin on a GAAP basis hit 61% in Q4, and 64% on an adjusted basis. Without the effect of the medical device tax, even the GAAP gross margin percentage would have grown over the prior year, despite significant spending for quality remediation and site transfer projects.

We have also made a number of significant accomplishments in the past year. To highlight a few of those, we closed the DuraSeal transaction last month, which is a great strategic fit with our neurosurgery division, and will add to our growth and profitability in 2014. We closed out the FDA warning letter in our Plainsboro, New Jersey, manufacturing facility, and made significant improvements to the quality systems in our Anasco, Puerto Rico, site.

We announced two additional site closures in Burlington, Massachusetts, and Andover, England, as part of our optimization initiatives, and have begun the transition process in both sites. As well, we completed the consolidation of two of our surgical instrument sites into one state-of-the-art facility in Germany. This now brings us down 6 sites in total to 25 sites since we began consolidating our footprint in 2012.

We launched over 20 new products in the US, and filed over 50 product registrations in international markets. We look forward to a productive 2014, and I'll share more with you about that later in the call.

Turning to top-line results from the fourth quarter, US neurosurgery revenue increased 2% over the fourth quarter of 2012. Neurocritical care and tissue ablation drove the growth, each increasing low-double digits. New Camino and LICOX monitors, launched in the fourth quarter, are driving growth in critical care, and strong capital sales led the increase within tissue ablation.

DuraGen decreased mid-single digits, in line with the share we lost due to the supply challenges earlier this year. We estimate our DuraGen share loss to be less than 5% as of year end.

Our US extremities business grew 16% over the prior-year period. Our hardware product lines led the growth, increasing more than 20%, in part because of the success and the controlled market release of our shoulder product lines. Both upper and lower hardware products also increased double digits in the quarter. Regenerative products were up low-double digits, driven by skin and wound.

US spine and other, which includes our private label products, decreased 3%. Private label decreased low-double digits, primarily due to a long-term decline in sales in one of our larger partners. The discontinuation of certain products also contributed to the decline in sales as compared to the prior-year period.

Our US spine business grew in the quarter, with a small decline in hardware, offset by a mid-teens increase in orthobiologics, led by sustained demand for our third-generation DBM. US instruments revenues decreased 2% versus prior year. The discontinuation of lower-margin products in this segment allows our team to prioritize product lines that generate higher overall margin, although, in the near term, it results in lower reported top-line growth rates.

Both alternate site and acute care sales increased slightly. Sales in lighting and retractors declined versus a strong prior-year comparison.

Revenue in our international segment increased 5% over prior year, with comparable growth in Europe and rest of world. The spine product franchise grew across our international markets off a small base, and extremities hardware revenue growth drove the increase in Europe, particularly in western Europe. This modest increase is in line with our current expectations, and we believe the planned changes within our distribution channels and new product introductions will accelerate growth in 2014.

Now I will turn the call over to Jack to discuss the financial results in more detail, and review our new 2014 guidance. Jack?

Thank you, Pete. Taking into account our higher tax rate and share count, we fundamentally met our profit expectations for the fourth quarter, albeit at the lower end of the range. Of note: We ended the year with our fourth-quarter gross and operating profit margins, after adjustments, slightly ahead of where we ended the fourth quarter of 2012. Considering the effect of the medical device tax and elevated quality expenses, we believe this reflects strong underlying profitability in our Business.

Now I will walk through the P&L, providing both fourth-quarter results and expectations for 2014. In the fourth quarter, GAAP gross margin declined 1 point versus the prior-year period to 60.8%. The medical device tax, which we report in cost of goods sold, can account for the entire decline. We also had lower scrap and manufacturing costs that were offset by higher cost of quality remediation and recall-related expenses, and costs related to the Burlington and Andover transfers.

We calculate adjusted gross margin by backing out the adjustments to cost of goods sold, detailed in Column A of the Adjustments Table in our press release. During the fourth quarter, our adjusted gross margin of 63.9% was basically flat versus the comparable measure in the fourth quarter of 2012. The higher expense from medical device excise tax is roughly offset by lower scrap and other manufacturing costs.

For 2014, we expect GAAP gross margin to be between 61% and 62%, subject to finalizing the purchase price allocation for the DuraSeal acquisition, which may have an effect on the amortization expense or acquisition-related charges that are booked to COGS. This is an improvement of about 1.5 points over 2013. We expect adjusted gross margin to be between 64% and 65%.

In the fourth quarter, R&D expenses increased versus the prior year, and rose to 6.6% of sales. The completion of the enrollment of the diabetic foot ulcer trial, a licensing fee paid for new technology in extremities, new projects in neurosurgery drove the increase. Excluding the technology licensing fee and an asset write-off, R&D expense was 6.1% of sales. We expect full-year R&D spending in 2014 to increase with revenue, remaining around 6% of sales.

GAAP SG&A during the fourth quarter declined slightly versus a year ago, both in real terms and as a percentage of revenue. Lower headcount and compensation expense was partly offset by higher selling and marketing expense in extremities and neurosurgery, and increased spending on our ERP project. SG&A, adjusted for special charges, as detailed in our press release, was 41.4% of revenue, down nearly 1 point from the fourth quarter last year. For full-year 2014, we expect reported SG&A to be 44% to 45% of revenue, and, after adjustments, to be 41% to 42% of revenue.

In the fourth quarter, our adjusted EBITDA margin was 19.5%, about 0.5 points above the prior-year period.

For 2014, we suggest modeling approximately $36.5 million in depreciation expense, approximately $22.5 million in intangible asset amortization, $6 million of which will be recorded in COGS. Please consider the amortization forecast preliminary, as we are still working to complete the purchase price accounting of the DuraSeal acquisition. We expect to update this guidance on our Q1 earnings call.

Cash interest expense, net of interest income, was $3.1 million in the quarter. For the first quarter of 2014, the cash interest expense will be about the same as Q4, and then increase and remain steady for the remaining quarters. We expect a total of about $13.5 million of cash interest expense, and about $20.5 million of total interest expense in 2014.

During the fourth quarter, we recorded about $300,000 of other expense. We recommend modeling this line item as zero going forward.

We ended the fourth quarter with an effective tax rate of 7.2% for the quarter. Because of the reported pre-tax loss during the full year, we report a tax benefit for 2013. For 2014, we expect our reported tax rate to be 21% to 22%. Our adjusted tax rate was 27.4% in the quarter and for the full-year 2013. We expect our adjusted tax rate to be 30% to 31% in 2014, because we anticipate a higher proportion of profit will be generated in the United States.

We generated $12 million of cash from operations during the fourth quarter. We invested $10 million in capital expenditures in the quarter. In the first half, we expect operating cash flow to be down compared to the second half of 2013 because we expect to continue to build inventory ahead of the manufacturing transfers in Burlington and Andover. Cash flow should then return to our more normal level of about $25 million to $30 million per quarter during the second half of the year.

Before I provide color on the 2014 full-year revenue guidance that we provided in the press release this morning, please note that we transferred the management of two product lines currently reported within US extremities. One moved to US instruments, with historical revenues of about $1 million per quarter, and the second product line moved to US spine, with historical revenues of a little under $500,000 per quarter. Because these amounts are immaterial, we will not revise our financial statements.

So, based on the segment revenue as reported for 2013, without adjusting for these transfers, we expect US neurosurgery revenue to be up between 30% and 35%, US instruments revenue to be up low-single digits, US extremities revenue to increase high-single digits to low-teens, US spine and other revenue to be down low- to mid-single digits, and international revenue to increase low-double digits to mid-teens. We will break out the actual revenues of DuraSeal when we report Q1, so you can calculate a growth rate excluding acquisitions. Finally, we expect our revenue growth rate, excluding acquisitions and discontinued products, to be 4% to 6% for 2014.

To add some color to our US spine and other segment performance, our private label revenues were about $59 million for the full-year 2013, and we expect that to decline more than $10 million during 2014. We will break out private label revenues on our earnings calls this year, to help you model it separately from our core spine revenues.

Turning to earnings, while we closed DuraSeal in mid-January, we are being careful in integrating the sales networks, and will, therefore, continue paying the higher distributor commissions where it makes sense to do so. This will make for a steeper quarterly progression of earnings than is typical for us, and is also one of the reasons why we are leaning toward the lower end of the preliminary earnings guidance we gave in October.

In addition, we have two new expense burdens that we have previously mentioned hitting the P&L in 2014. These items consist of about $8 million of depreciation, fees and license expense, which we will begin to recognize with the implementation of the ERP system in early Q2, and an increase in the P&L expense from medical device excise tax of about $4 million to $5 million. We suggest you take these into consideration when updating your models. The other puts and takes in the P&L are relatively small, and are contemplated in the ranges I just provided.

For the fourth quarter, taking into account our typical sequential decline from the -- excuse me -- for the first quarter, taking into account our typical sequential decline from the fourth quarter to the first, and the partial contribution of DuraSeal, we expect our revenues to bracket the Street consensus and be in the range of $210 million to $215 million.

Now I will hand the call over to Pete.

Thank you, Jack. We have made important headway towards our strategic goals of execution, optimization, and accelerating growth. The quality in operation is much more stable at the beginning of 2014, and the next phase of our site and systems optimization plan is progressing nicely. I'm looking forward to spending more time and resources this year on the growth component of our strategy.

Looking ahead, I would like to give a brief update on our key priorities in 2014, including the DuraSeal integration, new product launches, furthering our commercial strategy for DFU, and a couple of significant operational projects.

First, the integration of the DuraSeal product line into our US neuro and international teams is a major focus over the next several months. The teams are finalizing channel decisions to maximize growth potential; the sales, customer service, and logistics teams have completed their product training and are working diligently to ensure a smooth transition. The regulatory team is also working on our registration strategy in our international markets; and our operations and manufacturing team members are fully engaged in the process of transferring DuraSeal manufacturing into Integra. Although we are just one month into the integration, sales rates are running -- are coming in as we expected. Overall, the transition process with Covidien has been a very cooperative one, and the teams are working well together.

We also had several product launches in the fourth quarter, and plan to launch more products throughout 2014. Execution on those will be essential -- was essential to our success this year. Just to name a few by area: in neuro, we refreshed our monitoring line in critical care in Q4, and a new DuraGen product, DuraGen Secure, is planned for full market release in the second half of this year.

In spine, we introduced several new products to the market at the end of 2013, and we'll be transitioning those to full market launches this year, including the NanoMetalene interbody device and our new Laminoplasty device. In addition, we have new products on tap for 2014, including an expandable interbody device.

For extremities, we've had several new products that we'll be introducing throughout the year to refresh our wrist, foot and product -- excuse me, ankle product lines, and the shoulder is clearly a significantly new opportunity and new market that has the team's focus. We kicked off the full commercial launch for our shoulder portfolio last month. The complete portfolio includes total, reverse, and humeral plating solutions. Our limited launch in the second half of 2013 resulted in positive feedback on systems. Since then, our monthly case volume has more than doubled, and is in line with our expectations for 2014.

The complete shoulder portfolio has positioned us to recruit high-volume shoulder specialty distributors and some direct reps. We are investing in sales reps and surgeon training in order to support surgeon conversion to our product line.

Overall, the market projections for shoulder estimate a healthy growth rate, sustained by increases in reverse and revision procedures. We're optimistic that we can obtain a meaningful share position in this market, and are investing in early-stage technology that will further strengthen our shoulder portfolio.

In December, we announced the completion of the enrollment of our diabetic foot ulcer, or DFU, study. After a 28-week follow-up, we will validate the data, then submit -- prepare and submit a regulatory filing to the FDA, which we anticipate in late Fall of this year. We've not decided when or how we will announce the outcome of the study because we are carefully working through a publication strategy that does not jeopardize the FDA's review of our application.

As you may know, our skin products currently on the market are not reimbursed in the outpatient setting. Reimbursement there was the impetus for doing this study. CMS recently announced changes to their outpatient reimbursement in this treatment area, and the new rules place Integra's current set of products in the low-cost reimbursement category.

It is our intention to get one or more of our products into the high-cost reimbursement category. We also believe that the reimbursement is likely to evolve between now and our regulatory approval. But we remain optimistic about our full commercialization of Integra Skin for DFU in 2016.

I'm also delighted to announce that Ken Burhop is joining Integra to take on the role of Chief Scientific Officer. With over 30 years of experience in research, development and commercialization, Ken brings a depth to the scientific leadership that will be critical as we continue to expand our product pipeline. Ken is uniquely qualified to lead our R&D efforts, and advance our growth strategy.

Finally, the Burlington and Andover moves are scheduled to be completed by the end of 2014, and in early Q2 we plan to turn on our new ERP system across our US commercial operations. These are significant projects that are critical to our optimization plans and simplifying our structure.

Although the financial savings from these activities won't be realized in 2014, the successful systems implementation, sourcing initiatives, and product -- production transfers will be a major milestone in our overall margin improvement plans. These move us closer to achieving our stated 300 to 400 basis points of margin improvement by 2018.

Looking ahead, we hope you can join us for our Investor Day meeting on May 6, either in person in New York City or via webcast. At that time, we plan to provide you with more details on our progress against our optimization plans and these growth initiatives. We'll also be in a position to update our five-year outlook, and outline clear goals to help us achieve those objectives in the near and medium term. Please contact Angela for more event details, if you don't have them already.

Now we'll be happy to answer your questions. In an effort to accommodate a large number of requests, please limit yourself to one question and one follow-up. If you have additional questions after that, you may rejoin the queue.

Operator, you may now open our lines for questions. Thank you.

Thank you.

(Operator Instructions) We'll pause for just a moment to allow everyone an opportunity to signal for questions.

Matt Miksic, Piper Jaffray.

Good morning. Thanks for taking our questions. So one follow-up, just on the quarter. I appreciate the detailed color on guidance and there was a lot of it, which is very helpful.

But on the quarter, is -- I don't know if I caught it in the prepared remarks, but International and maybe if you could just elaborate or remind us again what the issues are that are holding spine back a little bit. But was there something on the International side that came up a little softer? And then I have one follow up.

So just to hook into the spine point, our -- actually globally, our spine hardware number was up about 2%. Domestically, it was down a little bit, so off a small base, we had quite a lot of growth in spine hardware internationally. In general, International has been, for us in the past year, a story of, I think, relative strength both against our history and against most of our competitors in Europe, where we've done a pretty good job over the last several years rebuilding the management and our strategy.

Outside of Europe and the other rich countries, we've been not as successful in launching in the larger developing world countries. So I'd say we have a weakness in places like China, relatively speaking, strength in places like Europe.

I would say, Matt, and part of that isn't anything long term that precludes us from having strength in those areas. A lot of it comes back, as we've mentioned, about growth being lumpy in a lot of those markets as we're actually bringing in a significant amount of new products, registration changes and timings.

We've had some scenarios, where we've had some gaps and some registration timing which is, in most cases, being corrected, if not corrected already, coming into the new year and changes in distribution structure. So I think as an example here of good growth, a lot of changes that we made about 18 months ago in Europe within our own distribution structure and the launches are now bearing some very good fruit.

Western Europe numbers were very strong with our launches and again, many of those markets feel like emerging markets to Integra because of our low share position. And we believe in coming into 2014, markets like China and such, we've got a lot of those changes already in place and actually, a lot of registrations that we worked through last year should become effective in 2014.

Okay, thank you. Then one on the DuraSeal acquisition. I think, like a lot of folks, we were encouraged and looking forward to some of the leverage and accretion that that deal affords you and your Neurosurgery business. Do you have any comments about how you're integrating the field force?

Has anything changed in the way you're looking at that? Is the pace of that been going different? Any color or are there any thoughts and how maybe it's different from the way you're looking at the deal three or four months ago would be very helpful.

Yes, Matt, I would say, in general, nothing has really fundamentally changed how we're looking at the deal. It's a great fit; it plays well into our mix. If you remember, we have a lot of work to do to transfer distributor structures and align distributor structures around the world. There's a significant portion of the efforts there. And then in the United States, what we're taking a look at is the combination of direct and distributor model.

In many cases, where we have highly productive areas with distributors to maintain, some of those -- some of that brings a little bit higher cost than we initially planned. But at the same time, as we value those, we're looking at where that's going to bring additional growth with it, which we believe will offset some of that. I think the other aspect that, again, only being a month into this is the synergies relative to having a dural closure set of product lines and how that will be valued in the marketplace, with the DuraGen product, the DuraSeal Cranial Closure.

We believe that that will be a very nice opportunity for us as well. It's way too early to know what that's worth but in short, we've tweaked some things, changed some approaches but at a high level, none of the major assumptions have changed. I don't know, Jack, do you want to add any other comments?

Yes, I guess I'd just -- to focus specifically on the financial impact. It's still the case that our view of this acquisition for 2014, net of all of the financing activity that enabled it, so net of the equity offering, net of the incremental borrowing, we still think that it's on the order of -- and there's obviously a ton of puts-and-takes but on the order of $0.20 accretive to adjusted EPS in 2014. So it's still a really accretive deal, taking into account everything around it. So that's point one.

I think what we're saying is that we've made some judgments to manage the commercial integration, in particular, in a way that will, I think, lower the risk for everybody, including our stockholders. And that that will result in a steeper ramp during the year in our earnings than we otherwise would have. Because we do expect somewhat higher selling expense in the first half of the year to take that into account. But we expect to get a benefit from that conservatism in the topline, as Pete just said, that should play itself out well as the year progresses.

Great. Thanks, guys.

Thanks.

David Lewis, Morgan Stanley.

Morning, David.

Good morning. This is actually Jon Demchick in for David.

Hi, Jon.

Hi. On 2014 guidance, you guys did a -- it's a very, very good job at explaining why EPS was lowered a little bit. But I was curious what drove the modestly lower revenue expectations, given Confluent closed a little earlier than expectations?

I'd say it was just a series of assessments. Recall that we originally gave our view on 2014 very preliminarily at the end of October. At that point, we had not, among other things, completed even the operating plan in our base business. So from our standpoint, this is our first, call it, seriously deep dive guidance for the year.

In any case, and the other point, which I think is obvious, is that 2013 was probably finished a little softer than we would have hoped in October. This, I think to some degree, reflects no change in the progression but a recognition that we had somewhat less momentum coming out of Q4 than we might have said or anticipated we would have had in late October.

But that's more of a detail than the broader point that we had to hammer through all the work we did. So what we gave you in October was taking into account a really, very wide range of assumptions and meant to be preliminary. And I think this is, what you're getting today are the numbers that we feel quite confident in.

Understood. Very, very helpful. And Jack, just a quick follow-up on some of the non-GAAP adjustments that you all are projecting into 2014, specifically ERP and optimization charges are a bit higher than I think we originally forecasted in the next year. Can you discuss the pacing of these costs and if you'd expect them or how you'd expect them to continue into 2015?

Sure. So the ERP expenses actually peaked last year. This year, they will be down a little bit. We're going to do a big go-live on order to cash for most of the Company in the first half, as we said, early Q2 and those expenses will be lower thereafter. We're -- we still have more to do on that project so they're not going to zero right away but they will be coming down.

Structural optimization charges include our real assessment of the dollars we're going to spend on the plant consolidations that we've announced and work we're doing to anticipate the next leg in our ongoing optimization plans. So when we, again, I'd say, last gave -- when we gave our preliminary guidance and thought this through in October, at that point, we had not nailed down the detailed plans for these plant transfers. That work has now been done so we have a sharper view of 2014 adjustments than I think we had then.

Thank you. Very helpful.

Chris Pasquale, JPMorgan.

Thanks. To start off with, can you give us a sense of what extremities hardware grew, excluding the shoulder contribution? Just trying to get a sense of how much of that [gravy] that's greater than 20% growth was due to that launch versus an acceleration in the base business?

Sure, I can give you some -- hang on. Let me get to the right little summary here. So I would say that of the growth, the Foot & Ankle and Hand & Wrist segments both grew very well. Foot & Ankle in our US business grew, call it, mid-teens and Hand & Wrist grew very high.

I wouldn't expect this number to continue but well into the 20%s. So the shoulder was a significant jump off of a very small base but was not, by any means, the lion's share of the growth in either US Extremities or in, frankly, the hardware.

Got it. Okay, that's helpful. And then I just want to circle back on the comments about the skin reimbursement. What are the steps you need to go through to improve your standing there? Is the catalyst the DFU results or do you anticipate having more work to do even after you have that approval in hand to get where you need to be?

Yes, Chris, there's a couple of things. So with the outpatient codes coming out and really, lower across the board and having this lower reimbursement bucket, and higher bucket and as you probably know, that's calculated now based on the square centimeter of the size of your product, so what the historical price cost of that is and that's how it's priced out.

We primarily were moved into the lower because we are a product, the majority of that product is used obviously not in DFU at all but in [Burn]. Burn there's very large pieces and so from that price standpoint, it's lower. So even before we get, I'd say, the product for DFU ready and out, we do have some options in our current install base. We actually have quite a few different product configurations that range in all types of size configurations, in fact, from like 25 to 500 square centimeters, so we have a big array.

Our ability to change some configurations and pricing structure is one option. In fact, in one of our product areas, we're only maybe about $1 or $2 away from where the line is, so there's -- from a square centimeter standpoint; in other areas, it's obviously much larger. So we have some, I'd say, marketing position work that can be done.

We're also going to be laying out our case, to be clarified with CMS, to help them understand the points as well. This product comparison is off of a large sheet burn versus non-DFU. And then the other piece you hit on is the outcome of the study. At the end of the day, the quality of the study will be the most important piece, from my standpoint.

And obviously, our hope is, is that we will have very good closure rates and that the amount of product that's needed to use to reach those will be lower than many of the other products that are used out in the marketplace. Now we'll see how that ultimately plays out. But based on that, that will obviously derive the demand for the product in that therapy.

And we also have some pretty good opportunities to talk to ACOs on the private side as well to actually lay out our case, if our data is strong. So if we've got 18 months of a lot of different plays and work to kind of work through, so we think we've got a fair amount of options in front of us to still make this a very lucrative product for us. But again, I want to reinforce we won't see our data until July time period, July/August, at the earliest, and that's the really most important drivers, the quality and the outcome of the study.

If the reimbursement situation doesn't change, for whatever reason, is this still an attractive opportunity for you?

Yes, mainly, because my ability to change configurations and stuff to deal with that is still an available card and I also think with compelling information, I think, actually, having a discussion with payers about what the true cost of a product would be to actually enclose a DFU and actually be able to negotiate some items separately, I think comes back to the quality of the data. So there's still, again, quite a few scenarios.

I think, as I had mentioned in the past, because this product is also a part of our legacy Burn products, from the standpoint of a cost structure, our ability to have a very competitive cost-based product, we believe this will be as competitive as any product out in the marketplace. But having a reimbursement that incentivizes actually the user between what goes to their clinic and what goes to the user, we realize is very important. And so that's something that we think we have got, as I mentioned, quite a few options to address it.

Thanks.

Bob Hopkins, Bank of America.

Thanks. Can you hear me okay?

Yes. Hi, Bob.

Great. Good morning. So just my first question is on the guidance relative to DuraSeal. I had originally thought that that could be a much more accretive transaction for you in 2014. I know what you have articulated is obviously very nice for the Company. But originally, I had thought it could be almost -- I had it twice as much as you are articulating today.

So was I just off in my calculations as to how profitable this business was for Covidien? Or are some of the things that you're talking about today, at least temporarily, really boosting the expense level? Just trying to get a sense for ultimately how profitable a business could be and what you're assuming for 2014?

Well, I think -- look, it's an extremely profitable product. There are -- I'm not intimately familiar with your model on that thing, Bob, but in broad terms, the accretion that we have been supplying has taken into account the financing costs and the larger number of shares outstanding because we wouldn't have done those two deals without having -- we wouldn't have done those financing without the need for it driven by the acquisition. So I'd say that, that's a -- one element.

The second element is that we did anticipate in our revenue guidance, even as we've been talking about it in the last couple of months, that the first year's annualized revenues would be down somewhat versus Covidien's performance. I don't know the extent to which you took that fully into account in your numbers.

And then the final element is we have decided, as we've gotten to know the product over the last couple of months and really gotten to know everybody involved, that investing more in selling expense now is a smart move. And I don't know to the extent to which that's fully reflected in your 2014 numbers. So just taking all of that into account, we still regard this is an extremely accretive deal but we want to manage it in a way that maximizes our opportunity for success here.

And then just housekeeping, as related to the first question, and I'm sorry if I missed this, but what share count assumption are you using to drive the EPS guidance for 2014?

About 33 million.

Okay, and then lastly on this product, once you've -- kind of through the transition period, the assumptions that I was assuming, just to kind of use specific numbers, was that this could be an operating margin product for the Company that was 40% or better, given the gross margins that I know it carries. Is that assumption way off, you think, in terms of where you think you can take it?

No, I do not think that assumption is way off.

All right. I'll get back in queue. Thanks for taking the questions.

Thanks.

Raj Denhoy, Jefferies.

Hi, good morning. I'm wondering if I could ask -- I know it's a bit of a nitpicky question, but the longer-term guidance you guys are still putting out there, it's kind of 5% to 7% yet here in 2014, you're guiding to 4% to 6%. Again, I know it's only 1 point but in terms of, again, what might be a little softer this year and then what do you hope will accelerate as you move into 2015 and beyond? Just any broad thoughts would be helpful.

Raj, it's Pete. In short, it's because as 2014, as we've been communicating, is still a rebuilding year of many parts of the Company. And if you think about, we've got our ERP implementation, which has a big impact across the Company that we're rolling out. We've got plant transfers built in as well. We've got a lot of different integration things going on.

So from a standpoint of 2014, we'd always plan for it to be a little bit more, I would say, less growth just because of the different moving parts and the things that we have going on into the overall business. We also have been doing a lot of work, as you know, on discontinued products. We continue to, actually, this year, be aggressive on those. And so obviously, we have more products that we're going through the portfolio and culling, if you will, but we haven't fully come out with.

And then the other aspect, and Jack mentioned in his comments, is private label. Private label is quite a headwind for us, really, since probably 2011, we've had a significant headwind. And the hope is moving into future years -- private label is one of those businesses that you don't go in it separately. It's obviously an adjunct of using -- our capacity is bringing in new customers and new base off of that. If you remember, we have a new plant, the 109 facility, that's going to allow us to have more capacity for manufacturing, not only our own products, but potentially doing some more private label.

So when you incorporate those items, that's really at least 1 point. And then the potential upside around that is really refreshing our whole Extremities portfolio and the growth of the Shoulder. I wanted to say, based on how well we do the shoulder this year, that could be worth a component of it. Are we being conservative?

No, I think we're just being realistic about the competitive of the market. So we've got a lot of bets that we're kind of playing out this year, but the real impact of them starts being felt more later in this year since we'll have a bigger topline, especially as we move into 2015 and 2016.

Okay, maybe just a couple of follow-ups, just on the plant side, on the facility side. Are we still on track for the Anasco facility to get reinspected this year, mid-this year?

We're on track -- yes, I mean, with the work that we need to do and the work we've done, absolutely, when the agency decides to come back in -- you know how that plays out. But yes, I mean, I -- we, as far as our internal plans, have wrapped up pretty much everything here at the end of Q1. We'll be, obviously, constantly working on getting ready for when the agency comes in. And there's no reason that we don't think it's going to be sometime in Q2 or Q3.

Okay, and then just lastly on that. As you noted that you're down to 25 sites, physical sites down 6 since you started this process of consolidation. Where do you take that from here? Because my sense is that's running probably a little better than we had been expecting or people had been expecting in terms of the pace at which you've been able to consolidate sites. Do you still have significant room there or are you kind of moving out of that phase?

Yes, I mean, just to clarify the first part is, is that we're not completely out of all of those yet. This is -- there's a lot of that happens through this year, Burlington as well as Andover. But on top of that, no, we still have other locations and you've heard me speak about this before.

One of the important parts is less about the actual count but yes, there is more plans and more room there. It's more about creating these centers of excellence that actually have the capacity to have multiple shifts at one location, optimize our G&A more effectively, one of our key areas that we're focused on.

And then other aspects of how we manage, really, our customer service capabilities and our distribution and logistics. But, yes, we feel good about the progress the team is on and we're -- I'll say, being cautious about how we move forward. That, coupled with the growth, that's a tricky balance. But we feel pretty good about it and there's a reasonable amount of plays moving forward.

Great. Thank you.

Larry Biegelsen, Wells Fargo.

Hi, Larry.

Good morning. Thanks for taking the question. So, Pete, some of the other tech companies have talked about January being soft because of weather and certain factors, which boosted Q4, such as increased seasonality and uncertainty around Obamacare maybe pulling some procedures forward. It would be helpful to get your impression of those issues.

Larry, I think one is, how it will play out, I don't know. We'll see how the quarter ultimately plays out; we'll talk about it when it comes in. But the effect of orthopedic doctor's office visits, either in Extremities or clearly, Spine, are guys reporting back that there were a lot of cancels and things changed? Yes, there definitely were. Will they get rescheduled? Will they get accomplished in the quarter?

We think that's hard to tell but clearly, some of those will. Relative to the effect of -- from the Obamacare standpoint, candidly, and a lot of it's probably because of our size, we haven't really seen positive or negative effect, one way or the other, from anything playing out on Obamacare.

We actually have it across all of our segments, a watch, so to speak, of new patient indicators as well as certain retractors. I would tell you at the end of last year, some of our Instruments business, there was clearly more conservative buying patterns in the hospitals. If you don't need things, they were not making larger purchases.

As far as new starts, I wouldn't say they were down significantly, but you didn't see maybe some of the same starts that you would see in other areas. And again, hypothesizing is people being a little bit more conservative coming into a new year with the ACA. But I think it's going to take us a few more months or quarters to kind of see how some of those things play out.

Okay, that's helpful. And then last for me, just what turns around US Instruments from the negative growth in 2013 to the positive growth in 2014? And in Shoulders, when we look at market share expectations, do you think you could take, let's say, 1 point of globalized share per year? What do you think is realistic? Thanks.

So you broke up a little bit. The first question was around Instruments and then the second part was around Shoulder; correct?

No, the first question was what turns around US Instruments? And then the second question was do you think you could take 1 share point in the worldwide shoulder market per year, or what do think would be realistic there? Thanks.

Yes, I think -- look, on the Instrument standpoint, keep in mind, a large percentage of our eliminated -- our reduced SKUs was high with the Instruments business. So that's one of the headwinds that a lot of that moves through coming into 2014. So that's probably the biggest component thereof, as well as I would say, some just new focus on different approaches and promotional plays that we actually have going within that area.

We've spent a lot of time taking a look at our clinical call point areas and clinical areas from that standpoint. The other piece is that we've had some product transfers from Extremities. If you remember, there were some devices that, realistically, weren't the perfect call point that are going into Instruments.

So when you take a look at the combination of the products that we took out, products transferred in and some of the focus, that's really the growth in Instruments from 2013 into 2014. And relative to the Shoulder, we think we've got a nice product that keeps us a little bit out of the herd, so to speak. We've got features, not only in scalability of the current product and even, I'll say, the utilization of the instrumentation, and that's been getting some very good reviews.

We have been able to bring over couple of higher level distributors that had worked with some other major shoulder players, just really in the last few months. That's been quite successful for us. And so our hope to get to a 5% share in the next few years, I think, is realistic.

I think also having a goal of a 10% share position in the global market is something that we're aspiring to and we know to be able to do that, we just can't be a one-trick pony, which is why we actually have a nice pipeline of added long technologies. So being able to actually scale up our current platform with the use of potentially some pyrocarbon capabilities, either in a hemi or in resurfacing.

So we've got some interesting things on the horizon but the focus right now is really bearing down, obviously, on having our core reverse and full shoulder be successful and that's really all about our capabilities to ramp it up and getting all of the right distributors and clinical capabilities in place. And we feel good about the start to the year and look forward to giving more updates on it as they come in.

Thanks for taking the questions.

Daniel Sollof, Barclays.

Hi. Thanks for taking the question, guys. Just digging a little deeper into the stronger Extremities numbers in the quarter. So the component, both upper and lower, if I recall correctly, that's less than half the business and that component certainly grew very well on, including a contribution from Titan Reverse.

But if we look at the soft tissue component, where I guess there's a less competition. Has that business also been stable with the strong growth you've seen? Looking forward, given that you now have a competitive shoulder, does the mix shift more to 50% hardware and 50% soft tissue or is soft tissue still going to be the majority?

Dan, I think, well, first of all for the quarter, as you know, we spoke about in Q3, we had a soft skin quarter overall, and a lot of that business, if you recall, is associated with burns. And there is a little bit of, I'll use the term seasonality. It's obviously associated with when you have larger occasions for the use of the product, and it typically is a little bit up and down.

So we did see that come back within the fourth quarter and that provided a teens-type of growth within that skin product. I think going forward, relative to the metal mix in that, I -- we think that that mix is probably going to be pretty similar.

If our strategies play out longer term, we're going to have uptick in Diabetic Foot Ulcer and the use of our skin platform and we're going to be able to grow our metal platform. So I don't see a significant change within that split, at least on our near horizon, how we think about it.

Yes, I'd say the only thing I would add is life is not a straight line. The proportions have and the growth rates have moved around a certain amount from one quarter to the next. This was -- you will recall, or those of you who have been watching for some time, our US Extremities growth rates were a bit lower in Q2 and Q3, as we said then, that was not indicative of what was really going on in the business and that we'd have stronger growth rate in Q4 and that has happened.

Similarly, this was a strong quarter, but not a straight line from the fiscal, I'll say, quarter next year, so please don't be disappointed when the growth rate bounces up and down a bit next year as well. But I do think that this quarter's results -- that we have a really excellent Extremities business, and (technical difficulty) sell across its product lines in 2014, as new products get introduced, and (technical difficulty) progress.

Thanks, guys. That's helpful. And if I could, just a quick follow-up on DuraGen. If I heard you correctly, it was a 5% share loss in 2013 roughly. Just wondering how that compares relative to what you would have expected to recapture once you got the product back on the market? And how you see that playing out in 2014, if there's an expectation to regain more share contemplated in your guidance for that business?

Yes, Dan, I mean, tangibly after having 20% of your customer base that you couldn't serve for over a quarter, if you would have asked me, if we could get half of that back, that would have been a heroic effort. The fact that we got three-quarters of it back says a lot for the team and obviously, the brand itself. So I feel quite good about what we've being able to claw back in that time period. I think coming into this year, we -- our plans were that we wouldn't necessarily get all of it back.

One of the unknowns is with the ramp-up of DuraSeal and DuraGen, we have a new DuraGen product coming out. Can we actually claw that back? Can we grow from that base? That's what our teams are focused on and we'll see how we do and obviously, that's the target that we're going to go after.

Very helpful, guy, thanks.

Jayson Bedford, Raymond James.

Good morning. Can you hear me okay?

Yes, good morning, Jayson.

Good morning, Pete. Just a couple of quickies here. Appreciate the detail on the guidance, but what are you assuming in terms of contribution in 2014 from DuraSeal as well as discontinued products?

So I'd say we spelled it out as much as we're likely to spell it out. We walked you through -- if you look at the total growth profile in 2014, we expect about a 1%-ish headwind from discontinued products. And of the remaining growth, call it, 60% of it is DuraSeal and 40% of it is embedded organic growth.

Okay. Or I can do (multiple speakers) -- yes, that's fair. That's helpful, Jack. And then just secondly and I apologize if I missed this but did you give first quarter EPS guidance?

No, we did not. What we said was that the revenue range in the first quarter, taking everything into account, would fall in the $210 million to $215 million range. And then we said that adjusted EPS would have a steeper ramp during the year, partly to take into account our decision to spend more in selling expense on DuraSeal early on to lock down the success of that product line.

So I would take your estimates for EPS and assume somewhat higher selling expense in the first half than you may have already. I'm not speaking to your model specifically, but sort of how you might think of the delta. And then ramp the EPS over the course of the year, perhaps a little steeper than we have in the past. That's the reason why.

Okay, so basically steeper than consensus, given that 2013 was pretty steep.

I'm not such a student of the quarter by quarter consensus for the year so I'm not going to go to that, but rather, to say, setting everything else equal, compared to probably where we might have been in October when we gave our preliminary guidance, this is how we feel about it now.

That's fair. That's fair. Thanks. I will jump back in queue.

Steven Lichtman, Oppenheimer and Company.

Hi, Pete. Just really one topic question on Shoulder. I just want to make sure I understand the cadence this year. Where will you be in a full launch? And also, how do see the distribution playing out vis-a-vis the Foot & Ankle reps?

Will it be a mix or are you going to be carving out an upper extremity focus? Talk to us a little bit about the ramp here over the next 12 months or so.

Yes, so Steve, so what we did in late Q3 to Q4 when we talked about a pilot or controlled launch, it's to make sure that we get all the type of feedback on all of the Instruments and all of the products, making sure that we can get manufacturers/suppliers ramped to the levels we need. And that was achieved.

And so we effectively are in that launch phase of full ramp-up now as we speak. So we had signed up distributors in Q4; some were still bringing on a lot of distributors as we speak in this first half of the year. So, the way you think about this, it will ramp throughout the year but technically, we're actually in it. So this is, we're counting on to be, obviously, a key growth part of our plan this year.

Now to your point on channel, we made a decision awhile ago that we would use on Shoulder, distributors primarily. So our foot and ankle guys really call on the foot and ankle market as well as hand and wrist. And obviously, we have some big overlap with our tendon repair and some of our soft tissue products but they don't sell to shoulder. And then in the shoulder market, we're doing a combination of some direct reps that just do shoulder as well as distributors within that space.

Obviously, we've been going after high-volume, experienced shoulder distributors, mainly because they'll have one of the highest effects to be able to ramp us up. And now we're looking at key territories where we'd like to have a direct presence and we're also building that out. So relative to critical mass, it's still going to be until probably midyear until we're probably at the level we would like to be.

But we're well over 60% of the right type of distribution structure in place, and now it's a matter of all of the types of demos and clinical work. We've got low -- mobile labs up in the Northeast; we're doing different cadaver work in different parts of the country right now. So we've got a significant amount of training and ramp-up going on. And obviously, once that gets all in place and physicians get more comfortable utilizing our system, we think then obviously, that's when we'll see more of a ramp-up coming into the second half of the year.

Okay, great. Thanks, Pete.

Thanks, Steve.

(Operator Instructions)

At this time, there are no questions in the queue. I will turn the call back over to our speakers.

Thanks for calling in and we'll look forward to speaking to you again in May.

That concludes today's conference call. Thank you for your participation.