Integra Lifesciences Holdings Corp (IART) 2014 Q2 法說會逐字稿

Good day, everyone, and welcome to the Integra LifeSciences second quarter 2014 financial reporting conference call. As a reminder, today's call is being recorded. As 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 second quarter 2014 earnings results conference call. Joining me today are Peter Arduini, President and Chief Executive Officer; Glenn Coleman, Chief Financial Officer; and Jack Henneman, Chief Administrative Officer, who will join us for Q&A.

Earlier this morning, we issued a press release announcing our financial results for the second quarter of 2014 and affirming 2014 guidance. Certain statements made during this call are forward-looking and actual results may 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 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 this 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. With the first half of 2014 behind us, we are pleased to report that we're making progress against our plans to execute, optimize and accelerate growth. In the second quarter, worldwide neurosurgery, skin and wound, enjoyed strong performances and led us to record sales of $231 million.

DuraSeal beat our expectations for the quarter, contributing about 9 points of consolidated reported sales growth, while our global neurosurgery business increased 10% on an organic basis. Worldwide skin and wound sales increased 12% over the prior year, which represents excellent progress in this area of strategic focus. Finally, our profit margins and cash flow increased significantly versus the prior year, resulting from increased sales, improved product mix and lower year-over-year quality expenses.

From an operational standpoint, we're proud of our team's successful implementation of our new ERP system. We encountered no major issues transitioning our normal operations into a new system at the go-live in early May.

Now approximately 75% to 85% of sales are flowing through a single ERP system and we eliminated roughly 50% of our legacy systems during this implementation. Our team will kick-off phase 2 to bring additional domestic international sites onto our common platform later this year.

In addition to this key accomplishment, we made significant progress integrating the DuraSeal acquisition, launching the reverse and full shoulder product lines, transitioning production activities from our Burlington and Andover sites and onboarding new executives.

This morning we're also very pleased to announce that we closed out our diabetic foot ulcer trial and believe that the data achieved our goals for the study. We're currently assessing and finalizing our data and preparing submissions to government agencies and clinical publications.

As you know, this is the first critical step in securing indication and reimbursement for new DFU products in the outpatient setting. Executing on these important initiatives increases our confidence that we will achieve our goals we laid out at the Investor Day meeting.

Turning to second quarter top line results. US neurosurgery had another stellar performance across the portfolio. US neuro increased about 12% on an organic basis. Sales of products outside of Dura Repair also increased 12% and total reported segment sales increased 45% over the second quarter of 2013.

DuraSeal and DuraGen were both strong contributors and NeuroCritical Care and Cranial Positioning drove the remainder of the segment growth, each increasing low double digits. The new ICP monitor we launched in the fourth quarter drove the growth to critical care and strong capital sales led the increase within Cranial Positioning.

Our US Extremities business grew 8%, driven by higher sales of skin and wound products. The addition of a few specialized regenerative wraps and the launch of our new Thin, primarily used for second-degree burns, were the main drivers of growth in this franchise. We're excited about the pipeline of opportunities in skin and wound and expect continued growth in this important product franchise, which represents more than half of our US Extremities sales.

In addition, the shoulder launch contributed to growth in the quarter and we expect it to be a larger contributor in the second half of the year. We have expanded our customer base through new distribution and continue to attract new customers with the features and benefits of our new reverse and total shoulder offerings.

We were disappointed in the results of our Lower Extremities Hardware, which declined in the quarter over strong performance in the prior year. We believe we lost some share in this area, partially as a consequence of sale turnover, which is being addressed and new product pipeline conversions, specifically in our new Total Foot System, which we launched in the latter part of the second quarter, mainly in the second quarter.

We expect recovery in the second half to result from improving target sales execution, mainly in territories that experienced turnover in the second quarter, and increasing contributions from new product launches.

The US Spine and Other segment increased 4% over the prior year, increasing for the first time since the fourth quarter of 2012. Product label increased to $14.1 million, improving over its weak performance in the second quarter of last year. We expect private label sales to decline in the second half, consistent with our prior forecast for this business. Our US Spine business was relatively flat, with an increase in biologics making up for a small decline in spine hardware.

US Instrument sales decreased about 4% over the prior quarter mainly due to lower sales in acute care and discontinued products. Alternate site instruments saw growth and lighting sales increased double digits in the quarter. As hospital spending in the segment is still cautious, we believe hospital investments in new instruments will be slower through the rest of 2014.

Sales in our international segment increased 9% over the prior year. DuraSeal was the largest contributor to this growth and sales also increased in Dura Repair, tissue ablation, skin and wound, which are the franchises of focus for international expansion. These contributions were largely offset by weak orthopedic sales and delayed tenders in a few large markets.

With that said consistent, with our strategy for growing our international presence, we've incorporated the effect of uneven quarterly results into our expectations and we'll continue to concentrate on our efforts in driving growth in our focused products and markets.

We successfully added new leadership to our international team and are launching various new products in the second half of the year, both of which should lead to accelerating growth. Now I'll turn the call over to Glenn to discuss the financial results in more detail and review our 2014 guidance. Glenn?

Thank you, Pete. Before discussing the financial results and guidance for the second quarter, let me start by saying that I'm excited to be part of the Integra team. The Company has a really unique opportunity not only to drive top line sales growth at or above the market, but also to grow earnings faster than sales to better leverage of our operating structure and cost reduction opportunities.

I joined when we were at an inflection point. I look forward to being part of the leadership to drive positive change in the business moving forward. I have met many of you in my first three months of CFO and I look forward to meeting more of you in the future at various investor conferences and road shows.

Turning to our financial results, overall I would characterize the second quarter as a solid quarter, with 13% sales growth in line with our expectations while earnings and free cash flow came as flowing better than expected.

Based upon our sales performance through six months of $446 million, or 11% growth over the prior year period In our account projections for the remainder of the year, we are currently maintaining our overall sales guidance for the full year to be between $920 million and $940 million, which would represent sales growth of 10% to 12%. Having said this, we are making some minor modifications to the segment growth rates to reflect recent performance and trends in our business.

Starting with US Neurosurgery, given the strong start to the year, we now expect full-year sales to increase between 35% and 40% over the prior year, up from our previous guidance of 30% to 35%.

In our US Extremities segment, we are lowering our full-year sales expectations to reflect weaker-than-expected year-to-date performance in our Lower Extremities business. Our revised full-year guidance for this segment has now pushed sales to increase in the high single digits to low double digits, as compared to our previous guidance for growth in the low to high teens.

Finally, in our US Instruments segment, we now expect sales for the full year to decrease in the low single digits, versus prior guidance of being roughly flat, largely due to new starts in hospitals and surgical centers being lower in the first half of the year than initially expected. Consistent with our prior guidance, we expect full-year sales for US Spine and Other segment to decrease low to mid-single digits and International segment to increase low double digits to mid-teens.

Let me now spend a few minutes to walk through the income statement line items and consistent with Integra's past practice, provide commentary for both the second quarter results and our expectations for the full year. In the second quarter, GAAP gross margin increased 220 basis points versus the prior-year period to 62.4% while adjusted gross margin increased 320 basis points to 66.3%.

This improvement was largely driven by a higher concentration of our sales coming from our high-margin products such as Skin and Dura Repair, improved manufacturing capacity utilization for our regenerative products, and lower remediation and recall-related costs, versus the prior year.

The improvements in gross margins on a GAAP basis were not as significant as our adjusted gross margins, mainly due to intangible asset amortization for the DuraSeal acquisition, as well as higher plant consolidation costs, as we're nearing completion of a shutdown and transition of our Burlington and Andover sites, which are expected by the end of the year.

For the full year 2014, we continue to expect GAAP gross margins to be between 61% and 62% and adjusted gross margin to be between 65% and 66%, unchanged from our prior guidance. In the second quarter, R&D expenses increased over the prior year to approximately 6% of sales.

As planned, increases primarily associated with funding critical work in product development in extremities and neurosurgery, two areas we believe will be key growth drivers for us long term, we expect R&D spending for the full year to remain at 6% of sales, which is consistent with our prior guidance.

On a reported or GAAP basis, our second quarter SG&A expenses increased by approximately $12 million but improved 40 basis points as a percentage of sales as compared to the prior-year second quarter. The increased SG&A costs were the result of higher commissions, distributor fees, and integration expenses from the DuraSeal acquisition, higher depreciation expense from our ERP system that went into service in the current quarter, and employee severance costs.

SG&A, adjusted for special charges as detailed in our press release, was 45.0% of sales, an improvement of 90 basis points compared to the prior-year period, largely due to better leverage and fixed costs. For full-year 2014, we expect reported SG&A to be in the range of 46% to 48% of sales and adjusted SG&A to be between 42% and 44% of sales, both of which are unchanged from our prior guidance.

In the second quarter, our adjusted EBITDA margin was 18.8%, up 360 basis points over the prior-year period, driven by both the aforementioned higher gross margins and leveraging of our SG&A expenses on higher sales. For 2014, we're expecting approximately $33 million in depreciation expense and $30.5 million in intangible asset amortization.

Cash interest expense was $3.5 million in the quarter. We expect a total of about $14 million of cash interest expense and approximately $21 million of total interest expense in 2014.

As a reminder, we expanded our credit facility at the beginning of July, which provides us with greater financial flexibility and borrowing capacity up to $900 million and enhances our ability to pursue our M&A strategy. This renewal and extension does not change our interest rate of variable borrowings and has a negligible impact on total interest expense going forward.

We ended the second quarter with a reported effective tax rate of 32.9%; however, for the full year, we continue to expect our reported tax rates to be between 23% and 24%, which is unchanged from our prior guidance. Our adjusted tax rates for the second quarter of 2014 was 31.9% as compared to 26.7% in the prior-year period.

The increase in the adjusted tax rate in the current year was largely due to higher income generated in the US, versus foreign-sourced income as well as certain one-time favorable tax benefits in the prior year that did not occur in the current period. We expect our adjusted tax rate for the full year to be between 31% and 32%, unchanged from prior guidance.

Turning to cash flow, we generated $16 million of cash from operations during the second quarter and invested $9 million in capital expenditures, resulting in a free cash flow of $7 million or an adjusted free cash flow conversion of 32%. This was a significant improvement of $18 million of cash flow over the prior year's second quarter and primarily resulted from an increase in our operating cash flow.

Higher cash net income, as we move past our recall from the prior-year period, as well as improvements in working capital, drove the increase. In addition, we have lower capital expenditures versus the prior-year period, most notably for our new manufactured facility in Plainsboro, which is nearing completion as well as lower ERP system expenditures.

As we discussed at the Investor Day meeting in May, we believe adjusted free cash flow conversion will be an important measure for us moving forward as we execute against our optimization plans and roll-out of our ERP implementation. Given the variability of free cash flow from quarter to quarter, we are also providing the trailing12-month performance in our press release, which should help paint a better picture of the overall trend.

We continue to expect our full-year operating cash flow to be between $60 million and $80 million, capital expenditures to be between $45 million and $50 million, and adjusted free cash flow conversion to exceed 10% consistent with prior guidance ranges.

Let me wrap up by providing an update to our guidance for the second half of the year. For the third quarter, consistent with historical trends, we expect sales to be essentially flat through the second quarter but earnings to increase sequentially, largely due to lower SG&A costs as we complete the transfer of DuraSeal to our direct sales force, which will create synergies at the ballpoint.

While we expect our earnings to grow sequentially, the increase is not as steep as original projections because our second-quarter earnings came in higher than we had anticipated. So we do not expect to sustain the same level of gross margin performance generated in the second quarter.

Moving to the fourth quarter, we would then expect to see a steeper increase in both sales and earnings to reach our full-year guidance.

With that, I will hand the call back over to Pete.

Thank you, Glenn. At our Investor Day meeting in May, we spent a lot of time outlining our strategy to accelerate growth, optimize our business and improve execution. We've made progress in each of these areas since the meeting and here's an update.

On accelerating growth, we've completed our diabetic foot ulcer, or DFU clinical trial, as I mentioned earlier. And we're pleased to have the study closed out and see results that set us up nicely to get approval and to bring a new DFU product to the marketplace. This news, which is a big step forward, is nonetheless just part of our multi-year plan to develop our Dermal Regeneration products for the diabetic foot ulcer market and expand selectively into the wound care space.

We are still the process of evaluating our data and we're also focused on our filing and publishing strategy. We plan on releasing the data via a peer-reviewed journal, which we anticipate to be sometime in 2015. Please keep in mind that we are on track to the dates we previously communicated, and if successful this would be a mid-2016 launch of the product in the US.

Also we were encouraged to see progress being made in addressing reimbursement for packaged skin substitutes. Based on the proposed changes, Integra skin substitute products are projected to be in the high cost reimbursement category in 2015. These events and milestones increase our confidence that we will develop a successful DFU offering for the US market, which would be a key contributor to our long-term organic growth profile.

As noted previously, we rounded out our shoulder portfolio towards the end of 2013 with the launch of a reverse shoulder system and approximate humeral plating system. We expanded our customer base with additional users brought in with new distributors and we are developing our distribution network to expand coverage and bring on high-quality, experienced shoulder distributors and direct sales reps in select areas.

Training the sales force and surgeons continues to be a major focus, so we have added local regional mobile labs, on-site education, and digital online training. Finally, we're building a team of key opinion leaders so that we can leverage our expertise to build out our surgeon education program.

Our enterprise selling efforts are beginning to show promise and open new doors. As a reminder, enterprise selling is about taking Integra's existing product offerings into the C-suite of the hospital networks and creating opportunities for our sales team to better reach potential customers, thereby increasing our market share.

The premier group purchasing organization contract for small bone orthopedic implants has generated access to the top IDN systems in the premier network. And we're in the early stages of identifying our primary opportunities and building a priority list to expand our extremities market share.

We've also made substantial progress in our veteran affair strategy where Integra has not typically had a strong presence. We've submitted contract proposals for several of our business areas, the most mature one being neurosurgery. Once approved, our contract in this space would provide a sales team with approved access to government facilities and open up new market opportunities to Integra which we believe will benefit sales in 2015 and beyond.

Finally, we're executing well on the DuraSeal integration. We recently consolidated the US sales efforts supporting DuraSeal into our direct neurosurgical sales team. The ongoing transition from legacy distributors has gone smoothly, as everyone involved is working hard to ensure customer service is not impacted.

Outside the US, we're still working to optimize our global distribution of DuraSeal with the right mix of direct and distribution structures. Overall, this deal has been a success and met, and in many cases, exceeded our expectations.

We have the plans and capabilities in place to deliver on our long-term profitability targets by simplifying the business and accelerating growth. Over the next 12, 6 to 12 months, we will accelerate growth with our new products, particularly in our shoulder and skin businesses. With continued execution, we're on track to drive above market performance in our results over the coming years.

Before we move onto Q&A, I'd also like to thank Jack Henneman for all the hard work over the last three-and-a-half years that we've been working together. Jack's been a pillar at Integra, serving for seven years as CFO and 16 years all in.

Jack will be retiring on September 30, so this is his last earnings call. During his tenure as CFO, he transformed the finance function to accommodate Integra's growth, recruited and developed key leaders in accounting, tax, financial planning and analysis, and treasury; and raised almost $1 billion in new capital from banks and into debt and equity capital markets.

During the last 16 years, Jack has been responsible at various times for the Company's regulatory affairs, quality, clinical affairs, human resources, information technology, legal affairs and the management of the Company's surgical instruments business, fundamentally touching all functions at some point. He's led the business development functions since 1998 and played a key role in more than 40 acquisitions and alliances that the Company has completed during his tenure. Jack, thank you for all your contributions to Integra and we wish you all the best.

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 the lines for our participants.

(Operator Instructions)

Chris Pasquale, JPMorgan.

Good morning, Chris.

Good morning. Pete, Can you talk a little bit more about the moving pieces within the extremities business, in particular, how much you think shoulder can move the needle in the back half of the year? And then what the issues were in the Lower Extremities segment this quarter and how you correct those?

So Chris, I would start out to say, overall, 8% in extremities was obviously down below where we wanted to -- where we wanted to be. Our skin business looks promising. Some of the plans that we have on actually how we're going to market. Some of the new launches look robust, and so we see that continuing on not only in the second half but into next year.

Shoulder is doing quite well. I think we've been adding in the first half, obviously distribution, but we've been doing it at a methodical pace. Part of that is to make sure that we have, in many ways, don't outrun our supply line; have the right sets, have the right support as you bring distributors on and so, as well as some direct territories.

So we see in the second half that picking up and accelerating, and that's kind of the plans that we put in place. As you know, you kind of have that initial launch of users. You bring new folks on. There's a lot more training and development, and that's where a lot of investments been going into Q2 to accelerate for the second half.

I think other parts, as well, have been doing great. We just launched a new called Freedom Wrist, which is a new product in the wrist, literally just launched at the end of the quarter. It's a unique product that we believe is also going to be adding to growth in the second half.

And then on lower, I think it comes down to this. We actually, with some territory changes and alignment, actually opened up some territories with some promotions.

And we actually lost some folks, I would say in the midst of due turnover, probably should have a little bit better backfill plans, now with some of the new changes we've got in the leadership team and sales organization. We actually have a bullpen structure in place.

So chugging it out in some open territories. As you know, if you don't have folks in the territories, you don't sell. So we had some miss there.

And then we launched a new lower foot system, which is a really nice system. It's called our TFS2. But as we did the conversion from the old to the new, we had a little bit of a little bit of a freeze in the marketplace where folks wanted the new system.

So that's behind us and we're launched. In the spectrum of things, it was probably a couple hundred thousand of business in that range but it had the impact. And so we've addressed the sales territories. we've got the right product launch out.

And we see acceleration in the second half but as Glenn commented on, obviously with a little bit slower start in the first half, but overall lower, we adjusted our expectations for the total year. But we still see it accelerating sequentially into the second half.

Okay. That's helpful. And can you walk through the timeline for DFU in some more detail. When do you expect to be in position to complete the FDA submission? And what are you anticipating for a review timeline that would put you out at mid-2016 before you could commercialize? Are there other steps beside the approval that you need to complete before that launch?

Yes, well I mean, there's a series of things, but the key parts are -- is we get through all of our data here and the submission happening before the end of the year is a combination of making sure we're really tight on with claims and things that we obviously want to go after.

And we spent the time and money to do a robust enough study that we think we have different ways to look at the data which is a good thing, different cohorts. But then obviously from that filing standpoint, we're estimating it's probably in the neighborhood of somewhere between nine months to a year til we get the full approval based on just timing.

Obviously, those things could accelerate if we received the approvals a little bit faster but that's kind of how we see the normal window in the broader PMA process. And candidly, other markets around the world could be around the same time period.

I think when it comes to the publishing, the challenges with that, we've got multiple journals that will be approaching, obviously, our lead author as well. And the timing on those things will vary. And then obviously from how that all plays out from a launch standpoint, there's operational components here.

So we have a new plan coming up online. We have new packaging approach, new type of actual product and things that we'll be working on between now and then, as well as building out our sales channel.

So those are all the different items but obviously, the things that we're very excited about is really having met our goals for the study, which keys us up well to have a strong data set that we believe will put us in position for the goal, which we want, which is moving toward reimbursement in the outpatient setting.

Thanks, Pete.

Glenn Novarro, RBC Capital Markets.

Good morning, Glenn.

Good morning. Good morning, guys. Just a follow-up on DFU, just to be clear. The take-away you want us to have this morning is that you've seen the DFU data, and there are a lot of positives in the data, a lot of positive aspects to the data.

That's why you put out a press release. That's what you're filing and then the only last-minute -- the only last changes or last adjustments you're going to make is specific claims. Is that -- do I have that correct?

Yes, well, Glenn, as you know, like in many cases and this plays probably more out when you think about a biologic's pathway in a lot of cases on how some of these play out. We've done a multi-center conical trial.

We believe that it's very much empowered appropriately, that we focused on our primary endpoint and we had many other secondary endpoints that were pointing to the data. Yes, the point is that we look at our data at this point in time.

We feel very good that we've met our goals of the study. And so now that it kicks us into the next level of reducing uncertainty, meaning that we can start cementing our file as two different government agencies, publishing strategy.

And then as I also mentioned in the script, some of the preliminary evaluations that are coming out of the federal registry show that -- how our product would be categorized would move us into the higher reimbursement bucket.

So that's the combination of the news and so none of that gives us 100% confidence that we're going to have a product within the space, but we have a very good study. We think we've got good news on reimbursement. We have a very clear plan on moving ahead with publication strategy as well as with our filing strategy.

And we are quite clear internally what we need to do to actually manufacture the ramp-up as well as what we need to do with our sales channels. So -- and you're right on, that the point here, the most important point was to have a successful study, to have the kind of data and support that we believe will support appropriate reimbursement within the marketplace.

Okay. So primary endpoint was met; secondary endpoints were met. Let me ask you just quickly on lower extremities. You discussed losing some reps on the lower side.

I guess the take-away here is those positions have since been filled. And if that's the case, have they been filled with experienced reps that you've taken from the competition without any limitations that can go in and immediately start approaching the hospitals that they've been selling to in the past?

I would say, Glenn, well, first of all, we're pretty much all filled up. We've got a couple areas that we're moving some folks around but fundamentally we've filled 85%, 90% of the gaps we had in Q2. And it's a mix. We've got some very experienced folks; we've got some new folks in. But what we've done is we've created, what we call, kind of a bullpen approach.

We actually have some junior reps that work with senior reps in multiple territories. So when territories come open, we're able to plug them in pretty quickly. And so yes, when it comes to knowing the Integra portfolio, have sold the portfolio, understand our processes, the vast majority of people we plug in are already experienced within our systems.

Okay. Great. Thank you.

Thanks, Glenn.

David Lewis, Morgan Stanley.

Hello, this is actually Jon Demchick in for David.

Hey, Jon. Good morning.

Good morning. So I had a question for Glenn. I was hoping to get some clarification on the second half guidance that was mentioned at the end of your script. I'm try to figure out if anything, I guess, changed on the expectation side for the third and fourth quarters outside of shifting some revenue lines?

Or if the commentary you offered was more a reflection that better-than-expected performance in 2Q, driven from some gross margin outperformance won't necessarily translate into a second or to a stronger second half results?

Yes, Jon, thanks for the question. Relative to our guidance and I'll comment first on Q3. We had a very strong second quarter, and our gross margin did come in higher than we were expecting largely due to DuraSeal, DuraGen, and skin and wound having a very good quarter for us which drives high margins for us.

And we're not expecting that to continue as we get into Q3. So if you look at it historically, we've had sequentially sales being flat and we're expecting our margins to be down slightly. Having said that, we are expecting a pick-up in our earnings in the third quarter and it's predominantly due to lower SG&A costs. I mentioned the DuraSeal transfer to our direct sales force.

That's going to create synergies for us at the core point with our customers. We are in a process of eliminating the distributors we have in the US and we are expecting that to be pretty much phased out by the end of August.

We also had some lower marketing expenses expected in the third and fourth quarters, as we had some product launches in the first half of the year and just G&A, in general, being lower in the second half of the year, with some cost-containment efforts that we were putting in place. So if you think about the sequential trending, sales flat in Q3, margins down slowly but a pick-up in earnings.

And I would kind of characterize the earnings pick-up to be in the mid- to high single digits, just to give you some context around sequentially how you would see that playing out. And then the fourth quarter, obviously, a much deeper ramp to get through our full year. So that's kind of the way we see the second half playing out. And really nothing fundamentally has changed other than just had the quarters are shaking out for us.

Thank you. Very helpful, Glenn. And then Pete, I just had a quick follow-up. I mean, I guess similar to some of the other questions that were already asked on DFU, but maybe I didn't quite get it through to me, but I was trying to figure out if the commentary that you gave on the call was saying that you did hit the primary and secondary endpoints?

You expected the primary endpoints and the secondary endpoints or you think the data is positive but you haven't had a chance to, I guess, delve all the way in there yet? I'm just try to figure out what the take-away from the (multiple speakers) trial --

I think that's a good question, Jon. I think -- we've obviously want to be forthright but also appropriately careful and conservative on how we comment. Our statistician outside resources when we look at it, our confidence that we achieve what we want to achieve in the endpoints is very high.

Obviously, that has to be agreed on by respective government agencies as they review those studies. But from our analysis of our study, our CRO and assistance, yes, we feel quite good that we've achieved the endpoint that we outlined working in the study.

Thank you. Very clear.

Daniel Solis, Barclays.

Thanks very much, guys. I wanted to just ask a follow-up on margins. So obviously, very strong improvement year-over-year, 320 basis points. Can you help us bridge how much of that was mix; how much of it was a cycling out of remediation and really to the comments on about potentially not maintaining those margins. Is that really mainly because of mix shift? I think you mentioned DuraGen and skin and wound, or -- what I'm trying to get at is what, from that improvement is sustainable versus what isn't?

Let me, Daniel, I'll comment and then Glenn will fill in some color. So obviously, and Glenn discussed this in his prepared comments. Many of you remember last year this quarter, we were in the midst of -- in our recall. We were actually down about 20 points of share at this point within DuraGen. Many of our questions obviously in the following quarters were discussing that.

At this point time, we believe we've pretty much clawed back all of that share and are on the current run rate of where we were pre-that recall, which I think it's a great success for sales team on being able to achieve that and really, the synergistic value of our neurosurgery product line. That being said, there's still a good chunk of recovery within the second quarter to get back to that level. So that's some of that ongoing or some of that one-time benefit.

However, you know between DuraSeal, DuraGen and skin, three strong products, all of them had very, very different performances in this quarter. It's not to say that we don't see that continued good performance. Just not at the same level as we achieved within Q2 and particularly, the outlier is DuraGen because this was pretty much our recovery window quarter over quarter. I don't know if, Glenn, if you want to add a little bit more detail

Yes, so, when looking at the second quarter, obviously, we think most of the margin beating improvement was largely due to mix. What I would say is not only do we have favorable mix, but we also saw some really good production utilization variances in our regenerative facilities.

So when you look at DuraGen for example, Plainsboro and Ascot had very strong quarters relative to the manufacturing capacity there, so that helped to drive our margin performance as well. So it's kind of a double benefit, if you will.

Going forward, again, we expect to have strong margins in the back half of the year but it's not going to be at the level we achieved in Q2, so you should expect to see margins in the 65% to 66% range in both Q3 and Q4. And that will be largely driven by mix as we go forward.

Thanks. It's helpful. And then one follow-up on the lower extremity. Can you just talk about how you see the breadth of the portfolio as you see it today? Do you feel that you have what you need or is there more and you really need to add to the back to be competitive to maintain reps, and I guess to get back to approaching market growth?

It's a good question. I think in general, one of our big focus has been and with Mark Augusti coming on board, he's brought some fresh eyes into the business as well as I think Bill Weber has done a very nice job with our kind of revamping our whole product development pipeline.

And in particular, we've been really refreshing a lot of our structures, our locking systems, plating systems, profile structures and our instrumentation. So I think there's a big move and we'll actually have completed a reasonably large chunk of it this year, of refreshing the line. I think that's the first job.

Second piece is, clearly, we've had an ankle product outside the United States. We haven't one inside the United States. I've mentioned at the Investor Day meeting that the focus on an ankle for the United States, which we believe is a 2016 event as well. We're making good progress on that with our different research work. So that's kind of the mix.

I think there are some clear forefoot products and things that we're going to be adding into the bag, but the combination of the refresh plus a few new larger products is what we believe will keep us quite competitive in that area. I'd also say on lower, one of our advantages, clearly going head to head with some of the bigger players within the segment, is when we combine regenerative technologies with our metal implants.

And so different tendon solutions, different types of even cases where you've got Charcot foot, you've got issues where you actually have skin healing and you can use Integra Skin. You're dealing with arch issues.

A person may have diabetes or other related issues. Those are areas where we excel, and I think you'll start seeing us as well more focused to create more of a brand around some of those areas to differentiate us as the space candidly gets a little bit more crowded.

All right. Thanks guys. Helpful.

Raj Denhoy, Jefferies.

Good morning, Raj.

How are you doing? Wonder if I could ask about the revenue guidance for the year, the $920 million to $940 million, 10% to 12%. I think you described it. How much are you assuming and therefore acquired revenues from the DuraSeal product as well as currency?

So, Raj, overall, we haven't completely broken all that out. I mean, we can give you a flavor here for how we're looking at what as far as DuraSeal looks like for the second half of the year. We see clearly for the revenue growth that our core organic growth in the second half of the year continues to pick up.

I mean I would note, too, it's one of the interesting things about DuraSeal itself that actually within the quarter, when you compare it versus its last year's performance, we actually had about a 20% growth. And so our view that we can not only obviously integrate it in, but continue to get some leverage out of that and then have some corresponding organic benefit with the rest of our portfolio is pretty high.

So Glenn, I don't know if you want to -- I don't think we've called out anything relative to FX for the second half but maybe something on how we take a look at the growth of the profile.

Sure. So good morning, Raj. Relative to DuraSeal on a global basis, we're modeling about $65 million for the full year. As Pete mentioned, a lot of that is organic growth relative to year-over-year performance, although we don't characterize it as that if it's an acquired business. So that's what we're expecting relative to the full year for DuraSeal.

Okay and then really the basis of the question, I think the first half of the year, organic growth is still a tad below 4%. And I think the guidance you laid out at the Analyst Meeting was for 5% to 7%. And I realize that's kind of a longer-term target, but if you kind of think about the pieces that allow you to get there with the skin products, the DFU product launching in 2016, what helps you accelerate prior to that?

I mean, is there a chance that you could pull the number from this 4% range into that 5% to 7% over the near term? Or do we really have to wait until 2016 and beyond for some of these new products to hit?

So Raj, just to kind of reinforce the counterpoint. So we talked about this year, 4% to 6% overall growth rates. And you're right, first half has been 3%, 4%. I would point out that Q2 over Q1 grew roughly 6%. Q2 is quite a big step-up over Q1 for the Company.

But on the 4% to 6%, we're probably on the low end of the range of organic growth for 2014. But you know, candidly, I'm okay with that. If you think about all the things we've got going on, plants being actually consolidated, new ERP system in the Company, integrating a new acquisition, consolidating divisions which we actually do with the quarter, all of those items and still being able to drive within the 4% to 6% organic range, I feel very good about.

Now, what brings us into our longer-term range of net, instead of 4% to 6%, 5% to 7% really is getting some of those things behind us, which we're on track to do beginning in 2015 and being able to put more and more energy on our growth and channel focus. So it's a combination of new products, some I mentioned, ankle, acceleration of the shoulder, obviously the DFU is in the outer range of that area but we also have a nice pipeline across the board within each of the products. And that's what's gets us into that 5% range.

But realistically, I think as we characterize 2014, we have a lot of moving parts. We're making good progress on those items. And as we get those behind us, we're going to be able to put more energy, focus and, candidly, dollars, actually into frontline selling efforts.

Okay, that's helpful. Just thought I might ask a DFU question as well. I realize you guys are being purposefully opaque in terms of the treatment effect you saw in the trial but if you look at some of the recent publications in -- on some competitive products, there are pretty strong effects being shown by some of the other competitive products out there.

And I'm guess -- if you could at least help us understand how you think you're going to stack up competitively, will you show a 20, 25, 30 points in improvement relative to control with that product, and do you think you need that ultimately to be successful with that product?

So Raj, I appreciate the question. I'm obviously not going to go into saying where we think we are versus competition, but I will say this. We realize there's some great products out there.

There's some very good data and we're going to have to have very competitive data to be one of those players. So I think there's a lot of good solutions out in the marketplace. That being said, we designed a study so that we would be in that pack. That's one point.

I think the other aspect of it is the treatment cycle in diabetic foot ulcer is very different than a lot of other achievement areas, clearly, in the acute care area. In many cases, some of these patients come back 10, 15, 16 weeks, and there's that continual visit to the doctor. There's ongoing applications of product. There's a significant amount of cost to the system.

We believe with some of the secondary endpoint data, taking a look at those aspects of quality of actual closure as well as the cost and the amount of applications, all those things together, the Integra products are very, very well suited to, in some cases, be a very much a differentiator. We've got a long way to go yet.

Again, I'm just very excited. Our team's excited about the quality of the study, hitting our dates, staying on track to our timelines so that we're in good shape here for publication as well as the submissions. But we believe that if we can get ongoing success, as we've laid out, that we'll have a very competitive product.

That's helpful. Thank you.

Larry Biegelsen, Wells Fargo.

Good morning, Larry.

Good morning, guys. Thanks for taking the question. Congratulations on the DFU study. I'll start with my DFU questions. Another congratulations on CMS proposing to move you into the high-cost bucket.

Could you talk about, Pete, I know it's early, your pricing strategy there, or how you're thinking about it given that the list price is meaningfully higher, I believe than the high cost bucket of about $1,400? And then I had a follow-up. Thanks.

Yes, Larry, it's really early to talk about the pricing strategies, since we don't have any even filing at this point in time, but I would just say this. We will be competitively priced. I mean, the market will dictate the ultimate price. Again, one of the interesting opportunities for Integra, and this has been a hallmark of the Company in our regenerative product lines, is to create platforms that can support multiple products across the line.

And so the DFU product being based off the larger burn platform and regenerative template, our cost structure and our scale is really second to none in the industry. So as much as the initial Federal Registry data looks positive and we hope that continues. Obviously, there's no guarantees that, that will continue into the future, but we believe that it should and most likely will.

We also know that our cost structure as well as that coupled with compelling data is what's really going to determine what price you should get in the marketplace. So no other comment other than at this point time, knowing what the line up is in the marketplace, we feel good about where we are at this point in time.

Thank you. And then given the extended credit facility, how should we think about your M&A strategy going forward? Does this mean that you have an appetite to do deals of a similar size to the DuraSeal acquisition or even larger? And can you talk about your thoughts on potential divestitures and businesses which are sub-scale? Thanks.

Yes, so let me commented and then I've had Jack really focused on a lot of M&A for us as well. Maybe add some colored comments here as well, but I would say this. Obviously, we took advantage of updating our capital opportunities here just in the last few months. We had some good rates.

We've well-positioned the Company for a lot of interesting tuck-ins and potentially some larger deals. We think the market is very, very active. We think that across our portfolio, even ranking from instruments, obviously in the extremities world, but all of our businesses, neuro, across the line there's quite a few opportunities for us to add into the portfolio.

So I think, yes, you will see us do some deals here hopefully this year. We're looking at a lot of things. It's one of my major focuses, I think, between the legacy that Stewart really created and Jack really drove. It's been one of my personal areas that I spend a significant amount of energy on to really try to capture and be able to kind of grow what Integra has built on, which has been our M&A strategy, and feel quite good about our pipeline.

You know when it comes to divestitures, we don't have specific items keyed up. We clearly have opportunities in the portfolio. I had mentioned there are certain areas that aren't major targets right now for continued M&A activity. Spine is one of those that we don't plan to necessarily go out and do a significant amount of acquisitions.

We plan to focus on organically running that business. At the same time, we've talked about extremities and actually, in our wound space, growing scale is some of our target areas and in our M&A activity is really focused around that standpoint. So anyhow maybe Jack could add a few things --

I'd say the only thing I would add is we are continuing and will continue our careful approach to acquisitions. We've always been careful about price and we've always been careful about due diligence. And that formula has led to a very, I think, low risk approach in this area for us.

In times of great M&A frost there's always a lot of discussion about well, why don't you do more deals right now? And the answer is we're working on a lot of stuff but we're maintaining all our traditions and I think our stockholders can count on that.

Thanks, guys.

Obviously, with Glenn and I, that same tradition going forward is what we plan on carrying out. We have a very focused eye on deals that we know that in year two, operationally, we can get subsequent organic growth integrated into the Company. And I think that's a really important aspect of how we think about M&A, as well as core blocks and building out the company structure for the long run.

Thank you very much.

Bob Hopkins, Bank of America.

Good morning, Bob.

Good morning. One thing I don't think we've touched on much so far is your international growth in the quarter. You guys have obviously held out international growth as a major potential growth driver going forward.

It looks like ex-acquisition, there wasn't a much growth this quarter. Just wanted to get a better understanding of kind of what happened in the quarter internationally. And then you know should we expect international growth to rebound nicely in Q3 and Q4?

Bob, it's a good question. I would say the short answer is fundamentally in line with how we thought things would play out. Yes, we do see acceleration in the second half of the year. And as I've mentioned before, about the kind of lumpy nature, we've been working through different countries, registration strategies and plans, and we actually have quite a few products that are coming up live in the second half of the year.

So we see acceleration in international in the second half of the year. The majority of it for this quarter was some of the DuraSeal acquisition, but we feel quite good about it.

But I alluded to the fact that we brought put on some new executives. We brought on some country managers, some first for us in the Asian Pac markets. Some new leadership down in Latin America and with some of those changes, we're also looking forward to seeing some continued growth in those markets.

Great. And then two other quick things. One on extremities. I was wondering if can you just give us a sense as to what the growth trends have been in the lower extremities, just hardware-only portion of your business?

And then I think you said it was slightly negative this quarter just wanted to make sure I heard you right there. Such I just want to get a sense as to trends. What has been the trend and where was it specifically this quarter?

Yes, so we didn't give the specific number out, but in the quarter, we were down within the quarter. We've actually had a trend of being roughly in the low single digits to in some cases, being flat in some of that mix. Last year coming out that year, we were in the, for the most part, in lower -- we were in the double-digit range across the board.

I think we're still also, Bob, trying to get our arms around where the market growth is. We're still a small guy there.

We've seen reports that move from low double digits into high single digits; that kind of feels about right. But some of ours has been induced by, as I again said, the turnover within the portfolio.

And we believe we've got some of the right products coming into the mix and then some of the changes that we had in the channel. And so we're keyed up, we believe, for some acceleration in the second half but not at the same level that will obviously get us back to where we had thought we were at the beginning of the year.

I would say through for lower -- longer term, the ankle, the new foot systems, bringing in some of our new locking and plate structures is going to make us significantly more competitive in the market. And the last point is, we're focusing on some regenerative solutions that specifically will help differentiate us in the lower.

Great --

The only thing I would add is we had a really strong second quarter last year in lower extremities. So year-over-year was a tough comp for us in terms of our Lower Extremities business so I just put that out there as well in terms of the year-over-year decline.

Right, and then just real quickly on gross margins in Q3. Just curious as to why you think those will roll over a little bit relative to what we saw in Q2?

I would assume that on the neurosurgery side, some of your higher-margin products will continue to expand. So just curious as to what drives a sequential decline there?

Sure. So it's more of a portion of our instruments and international business coming up in the third quarter. So we're still expecting to see pretty strong growth out of skin, DuraSeal and some of the products that drive our higher margins, but when you look at the mix, we are expecting to see a higher concentration of sales coming from instruments and international, which will drive the overall mix down slightly.

All right. Makes sense. Thanks so much.

Jayson Bedford, Raymond James.

Good morning, Jayson.

Good morning, Pete. Thanks for taking the questions. Just a couple of quickies. Realizing that you had an easier year-over-year comparison given the recall on DuraGen, can you just comment on growth in the quarter here and then what's the growth portfolio of this category going forward?

And you're speaking specifically about DuraGen?

Correct.

I -- look, the growth actually did quite well. I'll have Glenn take a look at it. I don't have the number right offhand where we are on it. But specifically, we recovered, and when we take a look at our daily run rates of actual volume on DuraGen, and we take a look at where we left off pre-recall, we're actually running at those levels.

And so obviously, that equates to us being back to the same share position that we were pre-that marketplace. I think from a standpoint of synergistic opportunities at the call point, we're just starting to explore those with DuraSeal and DuraGen.

I mean, again, as I think we laid out with the acquisition, there's minimal overlap between the products that complement each other. And I think the buzz of a new product, it's in the DuraClosure space, being able to outclaw back business within our DuraGen franchise and things obviously has played well to our favor. So Glenn, you want to comment?

Sure. So Jayson, year over year, DuraGen was up double digits for us so it did have a very strong quarter. Having said that, I would also say that we are probably back to our pre-recall volume levels, post-recall.

And I say that because when we look at our growth even versus 2012 second quarter, we still had nice growth even going back two years in DuraGen. So we think our volumes are back relative to DuraGen. In addition, the other businesses within our US Neurosurgery business have done extremely well outside of DuraGen and DuraSeal.

Just to give you a context around that, we had organic growth of about 12% across our US neuro business. So the other businesses are also showing very strong growth and we had a record quarter in NeuroCritical care, with the new monitors we introduced at the end of the fourth quarter. So that business is kind of hitting on all cylinders right now.

Okay. So once we're kind of lapping the recall or the impact of the recall, is DuraGen a high single digit grower going forward?

Yes, I think the question here is, is that within DuraGen, we start moving back to more market-based levels, which has been in the kind of mid-single digit performance is where we see it. Obviously, new indications and things of that nature can open that, but the low to mid-single digit growth is kind of how we see the DuraGen playing out.

I would say the upside to that, if there are more synergistic plays with the combination of the two products over time, DuraSeal/DuraGen, we might see that but I think it's not realistic to think were going to see high single digit growth to continue within the DuraGen franchise but low to mid, we -- is very much in line with how we look at the business.

Okay. That's helpful. And Glenn, just as a clarification, you mentioned mid-to high single digit growth. Is that in reference to the 3Q EPS? The sequential increase in 3Q EPS?

Yes, so sequentially, we're expecting our EPS to grow mid- to high single-digits from Q2 to Q3.

Okay, great.

It puts us in the range of about $0.72 to $0.74.

$0.72 to $0.74, okay. Thank you.

Steven Lichtman, Oppenheimer.

Thank you. Hi, guys. Just on US Spine. Pete, at the Analyst meeting, you thought it was turning a quarter -- a corner and you did post an improvement here.

Is maintaining the full-year guidance despite that growth here in Q2 more of a reflection of more normalized comparables in the second half or is it conservatism? And maybe you can just give us an overall sense of where you think you are in that US Spine business?

It's a big quarter, Steve. We're making some good changes within that business. We feel pretty good about the distribution in some of the new products. I think some of the things we talked about with our NanoMetalene product is doing well and our expandable interbody device, which is coming out to the market.

So we're cautiously optimistic that we'll continue to have some improvements within that area. I would say in the segment though, however, as we report US Spine and other, that we see US Spine and other, the whole category to be down in the second half. And really, the main driver of that is tied with private label.

And if you recall last year, a big chunk of the recall affected private label business. And a lot of that was recovered in the third quarter going into fourth quarter and as we talked about, we'd actually discontinued and actually taken out some customer base. So the segment overall is going to be slower, but within that area between biologics as well as within the hardware business, we see that stabilizing in the second half of the year and actually outperforming obviously, the first half from a standpoint of hardware and biologics.

Got it. Just secondly on US Instruments, you've been proactively sunsetting a lot of product lines. How much you think that has taken off growth or will take off growth this year, both for that business and overall at the end of the day on the top line?

And looking forward, this is a business that can accelerate as a result of the Affordable Care Act? You're hearing more hospitals talking about a bump from ACA; you're not seeing that yet. Is that a potential opportunity in this business line?

Let me comment on the ACA piece and I have one comment just about the growth. So I would say at this point time, on the ACA, we're not seeing, at least from all precincts reporting in, any significant volume coming in yet. We still are seeing more of a cautious approach to spending as hospitals look at how their mix is.

Although, we're starting to hear potentially, either they're going to be seeing more patients in the second half. So in our view, instruments has been one of those areas that if you can wait a little bit longer before you actually do a larger new start, maybe open up a surgery center or something like that, we've actually seen that to be a little bit more sluggish this year than in prior years.

That being said, I would agree with your point. I think as more patients come into the system, either in a surgical outpatient center or into the hospital, we believe instruments will continue to be a steady grower. So it's obviously going to be correlated highly with patient -- procedure volume.

And as you know, besides outpatient volume, most of the inpatient volume that we've seen has been either flat or slightly down for the year. So we'll believe that, that trend changes, we'll see our instruments business pick up relative to that. So Glenn, do you want hit the other point?

Yes, so the discontinued product piece of this, both in the second quarter and full year, would have about a 1% impact on sales growth. So if look at instruments for the quarter, down about 4%.

If you excluded discontinued products, it would have been down about 3%, as an example. And we're expecting that trend to be similar for the full year. So it's about a 1% impact.

Got it. Thanks, guys.

Matt Miksic, Piper Jaffray.

Good morning, Matt.

Good morning. Thanks for sneaking me in here. So I just wanted to follow up on some of the questions, some of the comments you made on extremities and one follow-up on spine. So I guess for, I don't know, as long as we've been covering the Company, I think folks have been asking whether the large strategics were moving into your extremities space and whether we should worry about that?

You now have three or four guys doing that. I think we've probably asked the call, the question last year at this time as to whether you seeing any pressure?

And I wonder, reps are certainly the commodity in that space, good, experienced reps in foot and ankle. If you could provide any color as to what degree sort of M&A assets or product assets are -- what the climate is like for that and how you're responding to that?

And also maybe where your portfolio is? It's a nuance question but sort of forefoot, hind foot and ankle, if there's pieces of that, where do you think that by focusing, you could pick the growth back up in lower extremities? And then I have one follow-up.

That's a good question, Matt. So I would say, look, I mean the fact is there is more competition within the space. Our focus has been to how we can differentiate ourselves with the combination of regenerative solutions, as well as metal.

Obviously, going head to head with like metal applications or systems isn't something that we necessarily want to head-to-head with some of the large players coming into the market. That being said, we have refreshed our forefoot, mid-foot and hind foot lines.

We're in the process of getting all of that done this year which is going to make us that much more competitive and ankle product coming out here in the next few years, as well as some solutions. I'm not ready to speak to right now that do combine a lot more in the lower extremities area, the combination of soft tissue as well as metal.

So you know that's kind of how we take a look at what we can do across that portfolio. I would say from a sales standpoint, we've seen more activity, obviously, as people come in for cross-recruiting. But it hasn't been anything of a major issue at this point in time.

I think as we're growing and we're reducing territories because there's more products in the bag, that's been more of a challenge for us to make sure that we, actually, as we grow, we have a proper pipeline of folks, and I think the team now has a right plan in place to do that.

As far as assets, in the spectrum of things that we do our shopping in from M&A, clearly extremities is a pricier area than most other areas that we're involved in. That being said, we think there's a reasonable amount of assets out there that fit into our M&A criteria and that are probably the right size to fill out our portfolio. There's quite a few that we're actually in the process of looking at and thinking about as we speak right now.

So that's kind of how I'd answer your current question. We expect the competition to increase. We don't expect it to be a full frontal attack.

We expect the fact that our ability to wrap around regenerative metal is what's going to differentiate us. And that's really what's going to give us with a competitive advantage space.

That's fair. That's helpful. And then a follow-up on spine, I guess it's been a tough area for a lot of folks. And I guess the question is, is what is it -- every -- many of the companies that have some level of success, whether they're the market share leaders or they're some of these faster growing, smaller companies have some elements that is helping to drive their growth.

Whether it's a new product or the pace of new products, probably sort of positioned in bundling in sort of legacy market share position seems to help the larger players even though they're not necessarily growing with the market. What is it that you think will help you get that moving absent acquisition activity? Well, what's the hit that's going to drive that business for Integra?

Yes, so the two things -- it really comes down to two things, Matt. One is selective new products and being products that bring out -- that are -- we're one of five folks as opposed to one of 20 folks. The two interbody devices I talked about are great examples.

Our expendable will be one of two or three folks with that, and then the second thing is really utilizing our scale and enterprise selling. To bring spine into institutions at very cost-effective solutions, and be able to package that with other offerings that we have. Those of the two approaches we see that are going to help us make a difference in the spine area.

Okay. All right. Thanks. I'll leave it there and thanks for, again, squeezing me in.

Sure. Thank you.

This does conclude today's question-and-answer question. Mr. Arduini, I'll turn the conference back over to you for any additional or closing remarks.

Thank you everyone for joining the call for the second quarter and we look forward to seeing many of you on the road. Thank you.

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