MiMedx Group Inc (MDXG) 2015 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the MiMedx Group Third Quarter 2015 Earnings Conference Call. (Operator Instructions) As a reminder, today's conference is being recorded. I'd now like to turn the call over to your host for today, Mr. Thornton Kuntz, Senior Vice President of Administration. Sir, you may begin.

Good morning, everyone. This presentation contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These statements are based upon current beliefs and expectations of our management and are subject to risks and uncertainties. Actual results may differ materially from those set forth in, contemplated by or underlying the forward-looking statements based on factors described in this conference call and in our reports filed with the Securities and Exchange Commission, including our Form 10-K for the year ended December 31, 2014, and our most recent 10-Q. We do not undertake to update or revise any forward-looking statement except as may be required by the company's disclosure obligations in filings it makes with the Securities and Exchange Commission under federal securities laws.

With that, I will turn the call over to Pete Petit, MiMedx's Chairman and CEO.

Good morning. Thank you for joining us for our third quarter shareholder call and update. I have with me Bill Taylor, our President and Chief Operating Officer; Mike Senken, our Chief Financial Officer; and Thornton Kuntz, our Senior Vice President of Administration; and certain other officers.

I'm not going to review our strategic initiatives today in any detail. There were numerous discussions covering those subjects at our Analyst Meeting, and those excerpts are available through our website. However, I'm going to start my comments with something that's just come up this morning that relates to the Food and Drug Administration. So it's newsworthy today relative to the announcement. It should be appearing on the FDA's or in the public register shortly.

There should be a notice in the Federal Register shortly about the FDA issuing a guidance document on homologous use of human tissue, which is skin, dermis, bone, tendon, ligament, and amniotic tissue, it's all of those. Also today, FDA senior staff is meeting with representatives of the American Association of Tissue Banks in Washington to discuss this document and its previous document they issued in December on manipulation of human tissue. We have one of our executives at this meeting and the information we have received is positive. It's positive from the standpoint that it seems as if the FDA has heard from the American Association of Tissue Banks, AlaMed, and the Alliance for Regenerative Medicine and their industry constituents that any attempt to change these regulations utilizing only guidance documents will be met with industry as well as Congressional disdain. At this point, it seems that the agency is agreeing to file its own regulations to go through the normal "notice-and-comment rulemaking" process, which involves industry and Congress and any endeavor to change or modify regulations.

As I think you know, MiMedx has spent the last two years working with FDA staff and congressional leadership on attempting to resolve issues associated with untitled letters and the agencies attempts to change regulations without going through this formal process of notice-and-comment rulemaking. There are a number of committee heads and committee members that have involvement with the FDA that are very knowledgeable about these issues and have concerns as great as industry does relative to the implications. Therefore, we feel that industry and the trade associations and Congress can all work with the FDA to resolve issues that may be related to their desire to further regulate human tissue products. This is the way the system and related processes are supposed to function.

Again, we're very knowledgeable about these issues and processes. We've got two years invested and a lot of work into this very issue that. We view this announcement as positive. Also, it looks like the first public hearing on these matters will be held on April 13, 2016. We expect the rulemaking process to start at that point and it can be a rather lengthy process.

All right. I'll take a few questions perhaps, if you still have some when we get to Q&A, but let me go on now and give you an update on the rest of the things we want to discuss this morning.

I want to start by trying to address some of the confusion on our operating metrics that has recently developed. This time, it started right after our Analyst Meeting. As we delineated, our Analyst Meeting this year was designed to provide some strategic insights into our new products, and in particular, the markets we're targeting for surgery, orthopedics, and sports medicine since they were relatively new initiatives for the company. Also, we provided insight into our two new product platforms and highlighted those opportunities.

As we've spoken to shareholders over the years, I've indicated that we firmly believe that our amniotic membrane technology is a platform technology. In other words, the science and clinical attributes of this technology are disruptive, and this technology will find its way to numerous medical procedures. Thus, it is a great growth asset.

MiMedx went from being a total unknown to the dominant leader in advanced wound care in the last four years. We plan to do the same thing in certain sectors of surgery, orthopedics, and sports medicine. Our technology has distinct advantages over numerous products, both clinically as well as cost wise in certain surgical areas. Yes, it is correct that our allografts do not have a high strength profile, but our collagen fiber technology has an excellent strength profile. Think about what products combining our amniotic membrane technology and collagen fiber technology could do in terms of improving surgical outcomes.

Now relative to our current near-term revenue growth, our operating profit growth and our gross profit margins, there needs to be some clarification. This morning, we'll try to highlight a number of operating parameters that seem to be confusing or overlooked. While our third quarter revenue only grew 46% over the third quarter of last year, our third quarter last year was an exceptionally high growth quarter; so the comparisons are somewhat confusing.

Revenues for the nine months of this year were up 72% over the similar period last year. That should be noted. Also, our adjusted EBITDA margin grew 62% over third quarter of last year. Our operating profit margin grew 80% over third quarter of last year. Most significantly, our gross profit margin grew from 87% in the first quarter this year to 90% in the third quarter this year. We will discuss the gross profit margins in more detail in a few minutes.

Now let's discuss our operating profit margins in more detail. I've stated numerous times that a company with the gross profit margins that we have and the operating structure we have should be a 30-plus percent operating margin company as our early heavy investment phases mature. For 2016, we could have operating profits of 30% or as low as 10%. We control those investment decisions. We have been very prudent over the last four years with balancing our EBITDA, which has been positive now for 15 of those quarters. We've made investments in our sales organization, do scientific and clinical trials, patent and new product development. These are balancing decisions that executive managements make daily with a rapid growth company.

I submit to you that fretting over operating margin is not very productive. We have plenty of cash and strong cash flow, and we are continually balancing our investment decisions versus operating profits. We continue to effectively invest in our assets to create intermediate and long-term value. That should not only be of interest to our shareholders today, but to our future shareholders.

Relative to operating profit margins, we've given you fairly good insight into where we think we'll be. We've told you some months back that our 15% goal for 2015 operating profit will be slightly reduced because of some investment decisions we've made. We clearly indicated that we made those operating profit forecasts that we would make decisions that could affect those depending on our investment opportunities. When we have investment opportunities that can give us a 200% or more return, we are certainly going to make that investment. I would think that as shareholders, you would want us to make those types of investment decisions.

I think that wise investments will begin to be focused on our gross profit margins. These margins are the most critical to any business, in particular our business, and frankly, the most critical to our investment and operating decisions. The reason is, is that market pricing is embedded in gross profit margin, and certain things can happen in the market that the company cannot control. From the gross profit margin down through the income statement, our executive decisions manifest themselves in the operating profit margin.

In the gross profit margin, decisions made by CMS, insurance companies, and for foreign revenues, dollar exchange rate and our competition affect that number. Therefore, gross profit margin is the most difficult parameter for management to control. If you will review our gross profit margin in the last several years, you will note they've continued to increase. Gross margin has continued to increase even this year when we took a major, a major price decline due to expiration of pass-through status. Now how's that possible? It's possible because our management had planned ahead and developed a number of production efficiencies that allowed us to improve the gross profit margin. We offset some of those pricing decreases with increased manufacturing efficiency.

We're at the point now, where we're automating a lot of our processing functions. For instance, we'll be using laser technology to speed the cutting processes. We'll continue to make these types of improvements. We'll continue to monitor the external environment and try to give you warning if we should see significant disparities occurring in pricing. However, I would strongly encourage you to focus on our gross profit margins not as much on operating profit margins. Please note that our gross profit margin has increased from 87% in the first quarter of this year, when that change in pricing occurred, to 90% in the third quarter. That's significant.

A second concern we've heard relates to why we entered into a $50 million bank line of credit with four major banks. First, you should be elated to the fact that this company has matured to the point where we can sign agreements of that nature. A year ago, we probably could not have accomplished this. Companies in our stage of growth are prudent to have those types of credit agreements in place as a contingency.

The concern that we've heard at our executive management may make a bad decision on an acquisition is without merit. If anyone understands my decades of experience with over 47 acquisitions during those decades, they will understand that we have not made bad or ill-timed acquisitions. All those acquisitions with the exception of one worked almost flawlessly. In this one case, we had to sell the business back to a physician owner because he could not adapt himself to corporate life. It was as simple as that.

At Matria, our last acquisition required us to borrow $445 million from the Bank of America. They were paid off in a reasonably short period of time and the acquisition worked well. We know how to make acquisitions, and most importantly, integrate them, and we're not going to do something "stupid." Take the bank line announcement for what it is, a positive event for the company that gives us a great deal of flexibility in terms of strategic investments, if and when the time comes.

Now another comment we've heard is that you no longer -- that MiMedx is no longer a "beat and raise" company. Well, I would not bet on that. 2015 has been a transition year, and I'll put quotes around that in several ways. I know when I use the word transition, many shareholders get concerned. If you look at our chart of 16 straight quarters of significant revenue growth, I hope you realize that this company has performed in spite of a number of tough issues with which we had to deal. This year, we had a very significant price decrease with some of our Wound Care products. We've prepared ourselves for that pricing issue, and we've offset that to a great extent with our new products. As I just stated, our gross profit margin was up from 87% in the first quarter to 90% in the third quarter. Thus 2015 is a transition year that's proven to be very successful and well managed.

We're now beginning to make major decisions relative to our surgical opportunities. We're adjusting our sales management structure for this new growth. We have numerous opportunities in several of these areas, particularly with some of our new products. Therefore, this is a time for more conservatism in our forecast. However, this certainly does not preclude us from beat and raise performance in the future.

I made it clear at the Analyst Meeting why we were not providing 2016 guidance now rather than December '15. We've provided that guidance in the middle of December after our budget review and board meeting every year except last year. We have a very disciplined budgeting process in which our board is involved. We made an exception last year since it was our first analyst meeting. Our board had strongly suggested to management that we go back to our decades of discipline related to our December '15 budget meeting with a press release of our 2016 forecast following the board's review.

As we have about 45 days to wait, I don't think you'll be disappointed. Recall that our growth in the surgical area for the third quarter over a year ago was 85%. We're launching several new surgical products that will produce revenues in 2016 and need to be thoroughly vetted for our 2016 forecast. We also have a number of other initiatives that will be on the forecast. A number of these things were noteworthy by the time our mid-December press release on our 2016 financial performance is released.

Our Commercial Wound Care revenues are growing dramatically. They grew 37% quarter-over-quarter. Our Wound Care revenues have been relatively flat at VA hospitals. However, we're not really losing that revenue to competition although that's what the concerns were two or three years ago. The third quarter, there were some specific constraints as VA hospitals finished up their fiscal year.

Relative to 2015 operating profit, remember we have made numerous investments in clinical trials, scientific studies, addition to sales force, and costs related to our patent suits. As Bill Taylor highlighted at the analyst meeting, we have won all of our preliminary battles relative to our patent suits, and we expect ultimately to be very successful in protecting our patent portfolio related to amniotic membrane allografts.

Again, I'd like to highlight the fact that the dire predictions a year ago related to the expiration of the pass-through status for HydroFix have not occurred. While there was significant price decreases, we offset those by significantly improving our production efficiencies and by placing new product innovations in the market that helped us to actually continue to take market share even on a higher, on the larger graph sizes.

We understand the value of "beat and raise." We're going through a period, where I believe it pays us to be a little more conservative as we transition our focus more towards the surgical orthopedic and sports medicine area. We have product introductions to complete, so we do not miss the ability to ship product once demand is developed.

Now, while we're not officially commenting on our analyst revenue or profit forecast for 2016, we're experienced enough to tell you that if we had some issues with our expectations and forecasts, we'd be very focused on bringing them down or up for that matter. We are not uncomfortable with what we've seen. There's one analyst with an operating profit forecast for 2016 of 30%, and we'll simply say that may be aggressive because of the investments we'll still be making next year in surgical sales infrastructure, some surgical-related clinical trials, and our patent litigation, although those costs should be trending down from this year. So the current revenue and operating profit consensus from our analysts, management is comfortable with at this point. Thank you.

I'm going to turn it over to Bill Taylor. Bill?

Thanks, Pete. Good morning, everybody. The third quarter was yet again, a solid quarter for MiMedx, and we gained momentum on numerous strategic and tactical initiatives. We expanded our portfolio with generative healing products with the introduction of OrthoFlo, our amniotic fluid offering, and we laid the foundation for additional significant growth opportunities. Our long-term strategic goals include expanding our leadership position in chronic Wound Care and accelerating our growth in other markets. Our Surgical, Sports Medicine and Orthopedic business grew 30% quarter-over-quarter sequentially, showing some great opportunities for us.

Also, our commercial revenue grew at a healthy 15% quarter-to-quarter sequentially because we gained leverage from our recent sales force initiatives. That said, we did have one mistake in the third quarter as we attempted to leverage our feet on the street in Wound Care to gain more traction in the surgical arena. While we had some success with a handful of sales executives, unfortunately, caused a loss of focus on Wound Care expansion, which, in turn, did not allow us to achieve as much growth as we could have. Since we've refocused our emphasis, and we're accelerating our hiring on our surgical sales force -- since we've refocused our emphasis and we're selling or hiring our surgical sales force now. Now like we always do, we admit our mistakes and correct them quickly and move on.

Also, as we discussed at the analyst meeting, we made some adjustments in our distributor network that will make us stronger in the long term. This decision put pressure on our revenue growth in the third quarter as well as our DSOs, but we expect to fully recover and then some within a short period of time. I'm sure you've noticed that our federal business was not as strong in the third quarter as earlier in the year. This was anticipated and expected. As we've stated previously, the federal business is not linear and it can be variable quarter-over-quarter. Among the factors that can affect this are stocking orders from blanket purchase agreements or BPAs, the rotation of residence and military personnel who get transferred in the VA and DOD, budget issues with the ending of the federal fiscal year, and in this year, our transition to our own FSS contract and so forth. So you may remember a few quarters ago, we discussed that we had a multimillion dollar BPA and that also contributed to our variability. Some facilities order weekly, some order monthly, some order quarterly or more. So fluctuations are quite natural.

Now overall, our federal business is very healthy. You may recall that a year ago, we projected our federal growth in 2015 would be about 15%, which is where we budgeted our growth this year. So year-to-date, we've grown our federal business about 25%, which is well above what we projected. So although the business is somewhat variable, it is even stronger this year than we anticipated. Our Commercial Wound Care business grew sequentially, and that's very strong for us as well. The overall Wound Care quarterly growth looked flat because of the federal business variability, but all these items considered we had year-over-year growth in the quarter of 37% in Wound Care and 77% in SSO.

Over the last year or so, we talked a lot about the pass-through and the bundle. We've done our best to educate our shareholders in this major change in reimbursement and the way that MiMedx can manage through it. Now that we're three quarters of the way through the year, I think I can safely say that we managed the expiration of the pass-through extremely well and the data proves it. From a unit perspective, I mentioned last quarter that our ratio of small to large sizes was about 80-20, 80% smaller sizes and 20% larger. This quarter, we've seen a little bit more of a shift to our larger sizes, frankly, because we have a few of those larger sizes, including our mesh products priced under the bundle.

The ratio for the third quarter was closer to 70-30 than 80-20. Now this is good because it means we're gaining traction again on the treatment of larger wounds. Now another metric of note, we've shipped over 80% more units this year than last. This is compared to our revenue which is about 70% higher than last year. This delta is a direct result of the expiration of pass-through and the resulting reduction in the average sale price of our Wound Care products. Now that occurred in the first quarter. Our pricing has basically leveled off now, and with this average price lower than last year, we must ship more units to achieve our desired growth rate. So this and the fact that we still have strong gross margins at 90%, and we've continued to meet and beat our guidance as a testament to how well this management team manages all these complex variables. So with all the changes in our distributor network, our less than optimal focus on our direct sales group, variable federal business, we still had a very nice quarter-to-quarter growth.

At our Analyst Day, I spoke about our leadership position in chronic wounds and amniotic tissue. I'd like to elaborate on this. One source of market information that we utilize is SmartTRAK. One of the markets they track is amniotic tissue. They've estimated that the U.S. market size last year was $256 million, and MiMedx was the market leader with a 46% market share. They estimate that the 2015 market will be approximately $338 million. Using that as a baseline, you would imply that this year, MiMedx will grow to about 55% of the amniotic tissue market.

Now on the Wound Care side, they estimate that the 2014 wound biologics market was $865 million. The CTP or cellular and/or tissue product segment is the largest segment and just over 60% of that wound biologics market. SmartTRAK estimated that the CTP market was just about $140 million in the second quarter of this year and that MiMedx was the market leader by a significant margin at 26.6%, with the number two company Organogenesis at 19.9% and declining. Integra was at 13.9% and Osiris at 12.8%. Generally speaking, we find their data to be reasonably accurate with occasional exceptions for some companies that do not publicly disclose for product line breakouts.

Now for example, we've analyzed the Medicare 2014 claims data for the hospital outpatient market. This data shows that in 2014, MiMedx had the market leadership position with 34%. Organogenesis was next at 31%, and Osiris was at just under 8%. Now this Medicare data tells us that the SmartTRAK data for MiMedx and Organogenesis are reasonably consistent with the Medicare data. But the SmartTRAK Osiris data is very likely significantly overstated. Although SmartTRAK data shows Osiris at about half or 50% of our Wound Care revenues, their sales in the category are most likely closer to 20% of ours in Wound Care based on the calculations from the Medicare data. They have far less health care, commercial health care plan coverage than we do too, so that does not account for the difference. The data implies that a large percentage of the revenue comes from products other than those used in chronic wound care. So we just don't see their chronic wound care products in the field being used at a level as described by SmartTRAKs. And obviously, they don't give a breakdown of their revenues either.

Now regarding our sales team. I already mentioned how we tried to leverage our wound sales force to help it make our surgical team more effective in the short term. It's certainly worked that we were able to leverage our surgical team's knowledge and expand our surgical business, but it did come at the expense of a loss of focus for some of our Wound Care reps. So we're refocusing their efforts and adding personnel to our surgical team. Overall, we had about 215 field sales personnel at the time of our last shareholder call. And within a week or so, we should be at around 230. By the end of the year, we should hit or exceed our 240 sales percent target for this year.

I spoke at the Analyst Day about our intellectual property and how our key configuration patents for EpiFix and AmnioFix were denied IPRs, interparty review, and that speaks volumes to the strength of our patents. As you may recall, an IPR is an inter partes review, which is a relatively new process in the patent world. It was designed to bring quicker review of patents that are questioned, and it's performed by a small panel of judges with a high level of patent law expertise.

I want to correlate this point to our operating earnings that Pete touched upon earlier. When we filed our patent lawsuits against companies that we believe are violating our patents, we expected to have to defend them and budgeted accordingly. As the cases developed, we spent more on our legal fees than we budgeted, but it has paid dividends strategically. I'm not going to go into the details regarding our IP's defense strategy, except to point out that it is very complex. Getting the best legal representation to work towards the best outcome is expensive, and from our view, it is a very good investment. These increased investments have already reaped strong dividends, with the two primary configuration patents being denied those IPR proceedings. This is a decisive victory for us.

Now how decisive is it? I previously mentioned the statistic. Approximately 93% of these cases where IPRs are filed move forward into the process and are granted a review. Only 7% are rejected. Our two core configuration patents are part of this 7% now. So all this increase expense dropped our operating margin for a few quarters. It was definitely the right decision and a great investment.

And before I turn this over to Mike Senken, I want to touch on one of the points that Pete made earlier. He described the deep experience in M&A work that he and his executive team has. But he forgot to mention one thing, the one and only acquisition we've done at MiMedx. Recall a small company called Surgical Biologics. Our market cap at the time was about $80 million. I'd say that acquisition worked out pretty well since we're about $1 billion or so in market cap. So I can't say that any new acquisitions will be this accretive, but this management team certainly knows how to make accretive acquisitions where it makes sense.

Now, I'll turn it over to Mike.

Thanks, Bill. The company reported revenues for the third quarter of approximately $49 million, an increase of 46% or $15.5 million over prior year third quarter revenue of $33.5 million. For the nine months ended September 30, 2015, reported revenues were $135.5 million, which represents an increase of 72% as compared to prior year. For the quarter, commercial revenue grew 71% to $38.7 million with strong growth in both Wound Care and SSO market segments. The company added over 350 new customers in the quarter as we continue our expansion into secondary cities in addition to opening up new federal accounts.

Federal revenue of $10.3 million represents a slight decline of 5% from prior year. The decline was in our SSO revenue, somewhat offset by an increase in Wound Care. Overall Wound Care revenue was $35.8 million, which represents a 37% increase over prior year. We continue to see strong unit sales growth, including the mesh configurations in Wound Care.

SSO revenue was $13.3 million, which represents a 77% increase over prior year. Growth is driven by direct sales in surgical and orthopedic applications as well as distributor sales. Gross margins for the quarter were 90%, which marks the third consecutive quarter of improvement in 2015 and are equivalent to the third quarter of 2014. 2015 year-to-date gross margins are 89% as compared to 88% in the prior year. The improvements in gross margins since the beginning of the year reflect the successful transition to the mesh configuration that was launched in mid-February to address the expiration of pass-through impacting large-sized grafts for DFU and VLU patients in hospital outpatient clinics.

R&D expenses for the quarter were approximately $2.2 million, or 4.5% of quarterly revenue as compared to $2 million in the third quarter of 2014. On a year-to-date basis, R&D spending increased $868,000 or 17% over prior year. The year-over-year increase in R&D spending is driven primarily by increased investments in animal studies and clinical trials.

Selling, general and administrative expense was approximately $34.9 million for the quarter or 71% of quarterly revenue as compared to $24.2 million or 72% of quarterly revenue in 2014. The year-over-year increase in SG&A spending was due to the continued build-out of our direct sales force in both wound care and surgical markets, additions to the reimbursement team, and other support areas as well as increased legal costs primarily related to our patent lawsuits.

Legal costs related to patent litigation for the quarter totaled $1.3 million or 3% of quarterly revenue. Patent legal costs have totaled $3.1 million on a year-to-date basis or 2% of total revenue. During the quarter, we added seven direct sales reps, and on a year-to-date basis have added 49 direct sales reps, bringing the total direct sales headcount to 217. On a year-to-date basis, SG&A expense was 72% of revenue.

The company reported a positive adjusted EBITDA margin of 24% or approximately $11.8 million for the quarter ended September 30, 2015, which is an increase of $4.5 million as compared to an adjusted EBITDA of $7.3 million in the third quarter of 2014. It is the 15th consecutive quarter of reporting positive adjusted EBITDA. Included in our press release is a reconciliation of adjusted EBITDA to reported net income. The improvement is driven by increased sales volume and corresponding operating leverage. Also please note that our EBITDA margin has improved, each quarter, in 2015 going from 22% in Q1 to 23% in Q2 and now 24% in Q3. For the 9 months ended September 30, 2015, adjusted EBITDA was $31.1 million or 23% of revenue as compared to $12.2 million or 15% of revenue in 2014.

Operating income in the third quarter was approximately $6.7 million or 14% of quarterly revenue, which represents an improvement of 80% or $3 million as compared to operating income of $3.7 million in the third quarter of 2014. On a year-to-date basis, operating income was $16.6 million or 12% of total revenue as compared to an operating income of $2.4 million or 3% of revenue in 2014.

The company reported net income for the third quarter of approximately $6.6 million or $0.06 per basic and diluted common share as compared to net income of $3.7 million or $0.03 per basic and diluted common share in the third quarter of 2014. Year-to-date, net income was $16.1 million or $0.15 per basic common share, and $0.14 per diluted common share as compared to year-to-date net income of $2.4 million or $0.02 per basic and diluted common share in 2014.

Turning now to the balance sheet. The company reported approximately $102.7 million in total current assets, including $41.1 million in cash, $6.5 million in short-term investments, which are comprised of fully insured and liquid bank certificates of deposit, $46.8 million in accounts receivable, $5.7 million in inventory, and $2.7 million in prepaid expense.

Days sales outstanding for the quarter were 86 days as compared to 76 days at the end of the prior quarter. The growth in DSO above our internal target of 75 days was driven by a continued rapid expansion of our customer base as well as certain adjustments regarding our network of distributors in the SSO segment. We continue to add collections and field reimbursement staff to improve collections performance, especially with new customers.

Inventory turns were 3.5 for the quarter as compared to 5.3 at the end of the prior quarter. The increase in inventory was in line with our production plan as we continue to add new SKUs in support of our planned SSO segment growth. Current liabilities were $24.4 million as compared to $19.5 million at the end of the prior quarter with the increase in line with the growth in our business.

Turning now to the statement of cash flow. The company reported positive cash flow from operating activities of approximately $7.3 million for the quarter, driven mainly by an increase in adjusted EBITDA somewhat offset by increased working capital. Cash used in investing activities includes $1.7 million in fixed asset purchases, including purchases related to the continued expansion of our tissue processing capacity as well as our IT infrastructure and production-related activities for CollaFix. Cash flow used in financing activities for the quarter includes $4.4 million for share repurchases somewhat offset by the proceeds received from the exercise of stock options. The company repurchased 455,000 shares in the quarter under the share repurchase program, bringing the cumulative total to approximately 3.2 million shares repurchased under the plan through the quarter end. In the month of October, the board approved an additional $20 million in share repurchases. And finally, we added a total of 16 associates in the quarter, bringing our total headcount to 500, which represents a 50% increase as compared to September 30, 2014.

Turning now to our guidance. The company is now guiding $49.5 million to $52.5 million in revenue for the fourth quarter, resulting in annual guidance of between $185 million and $188 million. The company is now guiding 14% to 15% operating margin for the fourth quarter, resulting in annual guidance of between 12% and 13% operating margin for the full year. Also please remember that the company will issue 2016 guidance, following our board meeting in mid-December.

And finally, management will be participating in several investor conferences in New York City in the month of November and December, as well as in San Francisco the week of January 11 through 15. Please check back to the Investor Relations page on our website for further updates.

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

Thank you, Mike. Let's go ahead and open the call up to questions and answers.

(Operator Instructions) And our first question comes from the line of William Plovanic of Canaccord Genuity. Your line is open. Please go ahead.

Great. Thank you. Good morning. So I just have two questions. One's related to the Wound Care. If I look at the business, the Wound Care was actually flat sequentially. And historically, we have not seen that Q2 to Q3 has typically been up, and I'm just trying to figure out what the puts and takes are on that? Was volumes up, but pricing was down? Was it competition? Was it stock, destock? And if so can you quantify that for us? And then I have a second question. Thank you.

Bill, really, the key sequentially was the federal business. The Commercial Wound Care business, as I had mentioned, was up nicely in the quarter and the federal business with its variability and the various stocking orders that we have with the -- unfortunately, the federal business doesn't order weekly like we'd like them to but sometimes monthly or even quarterly for some of the accounts. So that's really the biggest item we had and some of the accounts in the quarter you can imagine getting close to the end of the fiscal year actually stopped purchasing for a while and didn't turn it back on again, until October. And then add to that, the one thing that's different and unique compared to the previous years is our conversion to our own FSS, so that does also impact that as well. So those are the key factors, from my perspective, but I don't know if Mike has any other, further comments there.

No, that's pretty much handled, Bill.

Okay, great. And then just secondly on the draft document, as we read this, how should we think about this? Is this going to be the final rule that comes through? Is just this open for discussion? And if so, what is -- can you please lay out the timing for this, and if this will have any impact on the business given FDA's position?

Well, first of all, I want to be sure because we duly note the stock price declined this morning. I want to be very certain that this has got little to do with it. The short-sell thesis that we've gone through over the last couple of years have all been proven incorrect. We know probably more about this process than anybody in the industry because of our two years of being very, very involved.

What happens during notice-and-comment rulemaking process, which is normally the process that anytime FDA wants to change a regulation or modify one, they go through. Congress is involved, the public is involved, industry is involved, external scientists are involved. It becomes a rather lengthy process. The first meeting has already been scheduled for April, I think it was 13. That will be the first meeting of probably several. It will be a lengthy process.

When I said it was positive, I meant it was positive. The agency has been under scrutiny by Congress and industry for the last several years over changing regulations or attempting to change regulations by just publishing guidance documents and basically saying we're just giving you an interpretation. Well, that's not the way things have been done previously. That's not the way the FDA regulations and the way their governance policies work.

So we view this as a very positive disclosure. It means that industry and outside scientists as well as the oversight and process Congress goes through and the approval of these things, these changes, will take place. That's healthy. That's the way the system is supposed to work. It's not supposed to work with names you publish on a guidance document, using that guidance document to change regulations. So again, we view this as very positively. And if someone thinks that this company is going to go out of business because of an FDA announcement this morning, they're seriously, seriously mistaken. We've worked with this agency probably closer than anybody over the last two years. I think we know the issues that they have well and we know the issues Congress has well, and we know the issues the industry has well. So, again, we view this as a positive process that will take place in an orderly fashion now, with the number of constituents involved, both industry as well as Congress who has oversight here.

And I'd like to add to that, Bill, too. This is a guidance document. It's not a rule. You wondered if this was a final rule or not. Well, this is not a rule. It's a guidance only. And even though it's guidance only, what it's doing is describing, frankly, change in thinking by the FDA that must go through that notice and rulemaking period even though with guidance only. So it won't even be a final rule once all those hearings are complete.

That's all I had. Thank you.

Our next question comes from the line of Matt Hewitt of Craig-Hallum Capital. Your line is open. Please go ahead.

Good morning, gentlemen. A couple of questions. Starting off, well, all three related to this draft guidance that obviously everyone's scrambling to understand what it says and what the potential impact is. First off, you just went through what the process would be, but what are the potential outcomes? The FDA, obviously, there'll be their comment and question period. Everyone will have input. But what do think the potential outcomes are? And then I've got two follow-ups to that.

Well, the potential outcome should be that if they're going to make some reasonable changes, that the industry is fully appraised of those, and there's a period of time generally allocated for industry to adjust to it, et cetera, et cetera. What industry cannot cope with and the reason that Congress is very upset about this is documents being published and basically very little notice; give them 60 days, thank you very much, and we're moving on. That's not the way the regulations dictate is supposed to work, and that doesn't mean it hadn't happened like that.

But we're not just on the skin substitutes area or HCT/P area. We're not the only area that's been affected by these kinds of pronouncements by the FDA over the last many years. So there's a number of industry segments, not just ours that are very focused on this, have been to Congress, have talked about it; have been to the FDA and talked about it. So again, I view this as a very positive move, probably a change in some ways that the agency has been doing some business. And again, we've been very involved for two years, but so are other industry segments. And the issues of untitled letters and change in regulations or trying to change regulations through guidance documents, I think it's been thoroughly vetted. There are many senators and congressmen that are very, very -- and their staff, very, very appraised of this and very, very upset about some of the things that have taken place. So again, I can't say too much about how I view this as a very positive event. It's not a negative event. And a lot of progress has been made by a number of trade associations as well as industry participants like ourselves as well as congressional staff in the last couple of years on this very subject. So I view this as positive.

And I'd like to just throw one more thing, too, Matt, is the difference between intended use and indication for use in this draft guidance when they made the statement in there related to amniotic tissue, it was worded much more like an indication for use, which is much more specific than is allowed for 361 tissues. The FDA has, in the past, very clearly stated that amniotic membrane does act as an anti-inflammatory, anti-scarring, anti-angiogenic agent, and that it enhances wound healing. Those are the intended uses of amniotic tissue, and that's consistent with the function in utero.

I think, in my view, the issue is when you've taken a step further and you start advertising it for a more specific indication for use, and we don't do that. We keep it with the general intended uses. So I think that's one of the key things here that people get lost on, and it is the difference between intended use and the indication for use.

I'll add one other thing, I believe if we roll the clock back two years or a year as we've discussed our interaction with the FDA, we have some of the same concerns that they've had about -- and specifically our product area, the amniotic tissue area. There's a lot of organizations jumped into this, trying to ride our coattails seeing our successes, and they've done things they shouldn't do. That doesn't mean agencies always reacted as quickly as we thought they would and should. But there've been a lot of things that had gone on, and the agencies, in their planning process, I think, is highlighted, in our particular area, some things that they don't want to see continue to happen. As you all know, we have done everything the agencies have asked us to do in terms of filing an IND and BLA. But we've -- and that's on our micronized product, our sheet product. They've told us verbally that they have no issues with our sheet product. But this is much broader than that. It covers all tissue. So all the tissue banks in this country could very well be affected, and that's why everybody is interested.

So trade associations, all three of them, have sent in very strong statements when they filed the minimal manipulation guidance document in the last December. There'll be more of that coming relative to this homologous use document. And then there'll be hearings that start next April. And then there will be more than one. I can assure you that. So this is going to be a lengthy process, and I hope and think a productive process where federal agency begins to work with industry and some just conclusions are reached, and we go from there.

All right. Maybe to follow-up on that, that was all helpful, but specifically, I'm trying to get what are the potential outcomes? Obviously, if the FDA backs off of this stance, and like right now, I'm specifically looking at 4.2 or 4-2, if they back off of this stance, obviously, that bolsters your position within the industry, and that's very, very good news. If they, however, come back and say, "Listen, we've listened to all of your comments and we've seen all the data. And at this point, we are going to say that it's not homologous use, and therefore you need to go through an FDA approval process." Can you, at that point, seek grandfathered status where you can continue to sell during that process? Or would you need to potentially pull EpiFix from the market until you have that?

Here's a product that has had hundreds of millions of dollars of revenues, 500,000 units sold, thousands of physicians across this country and tens of thousands of patients that have been benefited. Do you really think that product's going to be yanked from the market without the first safety concerns? I don't, okay? My 45 years' experience say no. My last two years of involvement with this agency on this basis says no.

So -- but again, it's not just about amniotic tissue. There's a broader issue here, and the agency does have some points they want to get across. The concept here that somehow MiMedx is going out of business or our product lines are going to be yanked from the market, believe me, that's just preposterous.

And I just want to reiterate what Pete said. I'm not sure if people recognize that in dealing on our micronized issue over the last couple of years, the FDA specifically told us that they had no issues with our sheet product, okay? That needs to sink in. They had no issues with it. So I don't understand the concern here.

And this document that came out last December on minimal manipulation didn't seem to get this "Oh, my God, the world is coming to an end, focus on it." There's no reason for now the homologous use piece of it because there's two pieces in terms of tissue here: minimal manipulation and homologous use. This is generally, to a great extent, is a marketing issue.

Yes, I can elaborate on that, too. When you look at homologous use discussion here, go through the document, really, what they're talking is how the product is marketed, not necessarily whether or not it can be marketed. So I'll give you an example here. They've been pretty explicit too on other products that would have to just change their marketing to be something like a wound cover for acute and chronic wounds. That's happened actually to one of our competitors out there where the FDA said that, that was acceptable to market that product in that way. So we think kind of the worst case through this is a change in our marketing and labeling. As a worst case, we don't see that there's any possibility of having to retract the product from the market. So to your point of what could happen, we think that's really the worst that could happen to us here, but we don't even think that will happen.

Okay, great. And that's perfect. One last question and I'll hop back in the queue. Do you think that the FDA -- and I know they aren't tied to CMS directly, but -- so they're not really talking to each other, but do you think that before they put this draft guidance out, they looked at it and said, "Okay, well, CMS has changed to this bundled strategy," which is essentially excluded what had been the incumbent players. The standard of care takes a lot longer, and ultimately, more costly leads to more amputations. And now all of a sudden, they come out with a draft guidance that says we're going to look at this and say, "Boy, we're going to exclude the products that do seem to be working and do seem to save costs." I mean do you think that they consider or factor that into their thought process at all?

Our experience is that we found the agencies don't communicate at that level. Now -- but that's what notice and comment rulemaking is all about. When these public hearings take place and there's industry input, there's input from scientists and clinicians unrelated and outside the FDA, then those kind of things get vetted and people begin to say, "Oh, okay, that might be a bad policy. Let's see how it has to be modified."

So that's what the notice and comment rulemaking is all about. It gets everybody involved instead of agency just putting out a guidance document and saying, "Sixty days from now, this is what we're going to be using to regulate with." So that's why I am very optimistic about the process because two years ago, I wouldn't have been as optimistic. So there's been a lot of things that have gone on in the last two years that have gotten hopefully this -- particularly in this area that we're involved with. But again, it's not just these issues associated with untitled letters and guidance documents are not just related to skin substitutes and human tissue. They're related to other areas of FDA's pronouncements, and it's been problematic for everybody.

All right. Thanks for answering my questions, guys.

Our next question comes from the line of Jason Wittes of Brean Capital. Your line is open. Please go ahead.

Hi, I had same questions. I guess you've already gotten quite a few on the FDA guidance document, but I think that's really what the investors concern this morning, so I will ask a few more. Just my read of the document is, obviously we're all just getting it now is that if they're -- first of all, they're suggesting if it doesn't meet the requirements, if they anticipate it should be regulated as a PMA or VLA, specifically, is that your read of the document as well? Or do you think there's -- you still think this is simply a labeling issue?

Well, that's obviously just a regulation. If a tissue is determined not to meet certain requirements, then it flips over in another category. The issue is simply you cannot flip switches like that and turn the whole tissue industry upside down. It just doesn't work like that. When you get into the tissue -- when you get into the notice and comment rulemaking process, then some sanity generally settles in, and the agency makes its points, industry makes its points, congressional oversight has its points, and resolutions develop that are rational.

All right, Jason, I'd just point you to Page 2, on the background, Section 2, "HCT/P is intended for homologous use only." It all goes back to the intended use, okay? Intended use versus indication for use. So it's talking about the intended use. So if somebody changes the intended use to something outside of what is consistent with what it was in utero, then that's an issue. But if it's consistent with what it was in utero as an intended use, so that all comes down to marketing and labeling.

Those are all fair comments. I do want to ask, I think when we've seen this before, the FDA has maybe required more stringent regulatory requirements but, at the same time, they sort of -- and actually grandfathered the incumbent players out there, but they basically said you can keep selling the products while you're collecting data and submitting for these approvals. Is that also a scenario that's likely an outcome from this document?

That's exactly the kind of things the decisions they've made previously, yes.

So that is consistent.

Yes.

Okay. Just to switch gears, the surgery number looked pretty good, looked very good, better than we expected. I'm just curious, was there -- how much of that was related to your direct distribution network? And how much was related to distributors?

I don't think we've disclosed the exact percentages, but a higher percentage would be on the distributor side than direct. But that's natural because almost all of the business in the past was on the distributor side, and we're building the direct business. So I think, down the road, in the not too distant future, you're going to see that flip, but that's where it was at in the fourth quarter without giving the specific numbers.

Yes. So just to emphasize the point, the direct sales on SSO are growing, but the distributor sales are growing as well.

Yes, the direct grew significantly in the quarter, I can say that.

Okay. And was there -- I mean, I think third quarter of last year, you had some distributor stocking. Was that also a part of this number, especially in the surgical piece?

Well, the nature of distributor, yes. They order for stock, and then they sell off that stock, and then they come back and do a replacement order. So any time there's a distributor order, there's some element of that.

Okay. And then maybe last related question to that. Thinking about fourth quarter in terms of the trends of the two, the Wound Care versus the Surgical business, any kind of guidance you can give us in terms of how we should think about the growth rates for the split?

Well, this is Pete. The numbers should speak for themselves. They -- we've got some very robust growth rates in the commercial side, where we've built a lot of strength over the last several years in our Wound Care products. The federal dip, I think, has been thoroughly discussed. I think federal was up 25% this year so far compared to 15%, which is what we committed it would be. So we're doing very well in the federal area.

I think split-wise, it should be similar to third quarter, maybe a little bit more skewed back towards Wound Care but not significantly.

Okay, that's helpful. Thank you very much.

Our next question comes from the line of Mark Landy of Northland Capital. Your line is open. Please go ahead.

Thank you for taking my questions, folks. Good morning. So I guess I'll jump on the guidance document bandwagon just to finally beat it to death. But just so that I can put a bow around high-level thoughts, I mean we've seen the FDA do this before, in breast implants, in orthopedic products, the (inaudible) 01:20:11. Now as the product matures and the use grows, I guess they rethink the process that people have to go through specifically as the label changed. How much time do you feel would you or the industry would need to be able to fix these data together to file whatever the required filings would be, assuming that's what's required to keep the products on the market? And then do you think that you would have to choose the indication or the intended use because that's become a very hot topic at the FDA over the last couple of years in reference to off label use? Would you have to choose intended uses? Or do you feel that, through the process, you might be able to grandfather on one last time for broad use with a single label, and then going forward, it will be more along the intended use from the regulating pathway?

Well, let me make a comment, and Bill could chime in. As usual, I think The Street is doing its normal "Oh, my God, let's dig right down to the bedrock of the situation" okay? I wouldn't have told you earlier that I felt this was positive if I didn't feel it was positive, okay? There's things that will play out here. It'll take, frankly, much longer than anybody anticipates. Sometimes these things take, I've seen, three years. Hopefully, this will move along faster than that. But there's a lot of input here required from industry, a lot of science and a lot of other things that are going to take place. You got a new FDA Commissioner coming in shortly, probably with a different philosophy, we will soon find out. But the panic of "Oh, my God, this is going to take a company that's commercialized a very effective tissue for the last five, six, seven years and turn it upside down" that's just not going to happen. It doesn't happen that way, particularly a group that has been as involved as we are with this.

So there'll be some, a lot of back and forth, but I don't think -- I think our shareholders are being ultraconservative here by thinking, "Oh, my Lord, something's going to -- dire consequence is going to happen." We've been -- I have been personally involved. I've walked the halls of Congress. I've walked -- been to the FDA numerous times. I've had numerous conversations with them. I know a great deal about this process, sometimes more than I want to. But we don't see this as a -- we see this as a very positive event for us. We don't see it -- because we've been very, very in tune, I think, with FDA in terms of their concerns, and we had, as I said, some of the same concerns. My biggest concern about amniotic membrane tissue technology was some of the small competitors would do things they shouldn't do and give the technology a bad name, okay? We've done everything we can to keep the science and the clinical studies and everything else very effective and efficient. And we've been applauded for that.

So I don't think we're going to see some kind of draconian decision coming out of this agency. These decisions, by the way, could very well be a year down the road or two to three years down the road by the time all this is thoroughly vetted and goes through the Congress's overview, et cetera. So that's the situation as we see it. Bill, I don't know --

Yes, Mark, let me add a couple of things. Well, let's just take the one extreme and say that they decide to change the regulation and they grandfather people in that have been in the business and give them some time to put together what other data they're looking for. So the question is how long does that take, and what does that look like? Well, it depends. Are they going to ask for a full-out BLAs or something different? There's been a lot of talk between the FDA and the AATB and a number of other organizations. The FDA is looking at the cellular tissue products, the human tissue HCT/Ps. And when they want to regulate them differently, it should be something like a BLA light or something like a 510(k), something that's a little different than full-on BLA because it's -- the tissues have been proven safe. So it really -- there's a strong argument to not have to do the same thing as the BLAs. It really depends on where they end up on that item.

Relative to us, we've got reams and reams of data. We've got more than 20 peer-reviewed published articles. Whatever pathway it goes down, if it goes that direction, if it goes that direction, we've got a huge amount of data that I would expect we could leverage and utilize to get to the end pathway pretty quickly. So it -- but it really depends on what pathway they would ask people to go down. So it's hard to answer that question.

And the other issue here, we are the industry leader. We've developed more science and clinical studies around amniotic membrane tissue than anybody by orders of magnitude. This will be detrimental to our smaller competitors. It will. Whatever comes out of this, I can assure you, will be much more detrimental to them. We're -- we, with our scientists, clinicians and our experience here will be able to manage it carefully and quickly and move ahead with it, just as we've done with our first IND/BLA submission where we're already enrolling patients.

So to me, again, this is positive news. It's great news, and we've got a federal agency with their intentions working with the industry, with their intentions, with congressional oversight. That is good news, so.

Pete, maybe I'll ask that question better. Let me rephrase it. I fully understand and appreciate and respect what you're saying. I think you're right that with the regulation coming in, those people going through the process have the opportunity to set the bar and for those coming behind them. So as one of the leaders, as you said, and the most well-funded in this space, you've got the opportunity to set the bar at their hurdle. How far do you push that hurdle so that MiMedx doesn't struggle to get over it but yet leave a large-enough hurdle for others wanting to get into the [space]?

Well, Mark, again, we're two years into this process, and we've had a lot of dialogue, a great deal of dialogue with the agency. So I think we understand them reasonably well, and they certainly understand us, and so do congressional leadership understands both sides. And again, I don't want to just say it's a MiMedx issue because it's not. It's much broader than that. And when they issued their guidance document last December, they brought the whole industry into this thing. Prior to that, it was MiMedx standing alone as the -- and they often do this. They'll take the leader in an area. They will go after them with the changes they're looking for, and somehow think everybody else follows suit. Well, unfortunately, it didn't happen that way in our case. It probably doesn't happen that way very often. But that's what happened.

So I don't look upon this as us trying to position ourselves. I look upon this as a federal agency who has a job to do and responsibilities but being also responsible about involving industry and industry scientists and clinicians and outside scientists and clinicians in decisions like this. And I think that's what's getting ready to take place. So I just know that if we were a company that was $20 million in revenues, we'd have a difficult time, perhaps, doing some of the things that they want people to do, such as in an IND/BLA process.

We will end up coming out of this thing much stronger with much more knowledge about the process procedure than our small competitors, and that's what our strength should reward us. But I don't view it as something we're going to be trying to work with the agency to develop their thoughts and regulations, and that's pretty hard to do, anyway. They have their concerns, and it's not always our concerns. They have a different function in this country than we do. So I just want a logical, straightforward, legal process to take place. That's all we've ever asked for. And I think what we're seeing here is that process is playing out. And I appreciate what the agency is doing here.

Okay. I mean, my last comment today (inaudible) in terms of the Wound Care surgical split, obviously, it was up a little bit this year in favor of Surgical, and you mentioned the reasons why. You have started to address that with the sales force realignment. Should we think about the ratio of Wound Care to surgical going back in the fourth quarter to kind of what it has been in the past? Or will that slowly kind of trickle down towards normality? How should we think about that split, I guess, for the fourth quarter?

Well, again, Mark, I think what happened in the third quarter is a reflection of some of the strategic initiatives we've been undertaking to date. We started adding direct sales folks on the SSO side in the fourth quarter of last year. Some of that is starting to bear fruit. We're positioning ourselves for next year and the years to come to have as strong an SSO business segment as we do the Wound Care segment. So I don't think we're going to go backwards, but I think that's a good thing.

Okay, perfect. And then last question. How is OrthoFlo doing since the Analyst Meeting? Can you give us the two-week update?

I would hate to tell you that I don't know, but it's doing well.

Okay, thanks. Thanks very much.

Our next question comes from the line of Joe Munda of First Analysis. Your line is open. Please go ahead.

Good morning, guys. I'm not going to beat a dead horse here as a lot of my questions have already been answered on the draft guidance document. I'm just wondering, Bill, last quarter you, gave us an update as well at the Analyst Day, CollaFix, anything new there? Anything that's changed as far as the pathway is concerned?

Well, I think we gave a pretty good update at the Analyst Day where we continue to review and work with our specialists in the regulatory area to see if there are other configurations of CollaFix that could take some other pathways that may even be quicker. And we've actually got a few things. It looked pretty promising here. But until we get to the point where we fully have vetted them, we're not going to really talk about them. But there are a couple of opportunities that may even be better than what we showed at the Analyst Day.

Okay. Mike, can you give us some sense of what the, if any, the revenue that's derived from micronized products during the quarter?

Joe, as a policy, we don't disclose sales information by SKU.

Okay, I thought maybe in the past you had given out some indication of what it was running at.

Well, we did last year. We said that it was 14% of total revenue. The reason why we did that was because it was a focus area around the untitled letter. We can say, on a year-to-date basis, we're within that range.

Okay. And then finally, my last question. The sales force number, was it 215 or 217 exiting the quarter?

The actual official number -- and I know Bill and I were off by 2, but the official number was 217. Bill said around 215 by the Analyst Day.

Okay, great. Thank you.

Our next question comes from the line of Bruce Jackson of Lake Street Capital. Your line is open. Please go ahead.

Hi, thanks for taking my questions. First, if we could talk about the distributors this quarter, what was the revenue impact? And then when do you think you can have that back at a run rate where it was previously?

Let me make a quick comment. One distributor that had been with us a while and it was just time for us to go our separate ways. That probably cost us a bit. Well, it did cost us some revenue in the quarter, but it's what we needed to do for our longer term and immediate-term strategies, particularly in the surgical area. It just freed us up to do some other things, and we needed to be freed up to do those other things.

Yes. They were our largest distributor outside of the federal side of things. So you can think from our past case, you can see how big that product line was, but it was substantial. But in the next few quarters, we should be able to catch that up and then some.

I think one other thing we should point out is this isn't the first time that we've kind of readjusted our distribution strategy in certain segments. If you go back to, it was the tail end of 2013 and into 2014, we actually had several regional distributors that we consolidated. I'd also point out, if we ever come back to the question on DSOs, that in that quarter, our DSOs did move up to about 87 days. So we're looking at the long-term positioning of the company and how to best exploit certain opportunities in the marketplace. And as in the past, we have found at a given point in time, certain distributors have run their course, and we need to do things a different way.

So you would've been above the upper end of the range had you not switched out the distributor?

I think that's what we alluded to.

Okay. And then if we could talk about gross margins real quick, very strong in the quarter. You're developing some new products that reduced the level of scrap in the manufacturing process. How sustainable would you say these gross margins are going forward?

Well, the odds are that they'll come down at some point. Is that some point three years from now, a year from now? It's going to move around. The reason we highlighted it is because a year ago, the short thesis was when we lost pass-through status, the company is going to crash and burn. I mean, it was going to be very disastrous, okay? That didn't happen. And not only it didn't happen, gross margins went up when they should've come dramatically down, okay? There's reasons that management orchestrated that, that happened. So we're pretty good at what we do. We generally know when things are happening, and we deal with them and plan for them and then execute properly. So that's the reason we highlighted it. But that doesn't mean if it comes down 1% next quarter, for God's sake, don't think we're going to crash and burn again. It's going to move around. It's flexible. Some of these new products will come out with a little lower gross margin to start with. And then as production efficiencies go up on, and they'll have better margin.

So we can't get into this. This moved up 1%, this moved down 2%, oh, my goodness, the wheels are coming off. That's -- we are paid as management to manage those variables, but sometimes, there's only so much we can do, so.

Bruce, we guided coming into this year that we'd be in the mid to high 80s in terms of gross margin, and we've skewed towards the top end of that range. We also said we'd be coming out with a detailed guidance after our mid-December call. We'll give more flavor around the gross margins once we get to that point. But as Pete mentioned, I don't anticipate we'll see any dramatic change in the gross margins from what we've spoken to over the last year or so.

Okay. Then just a couple of housekeeping questions on the operating expense side. So we've had a slight increase in the R&D in 2015. It's been clicking up at a certain rate. You've got some new products and some new development projects coming online. Would it be safe to, like, say that the R&D is going to be moving up at that same rate in 2016? Not that I'm asking for a 2016 guidance, but would it be safe to assume that it's still heading up as opposed to flat?

Bruce, I would say you are asking for a 2016 guidance. Certainly, again, in absolute dollars, the R&D spend will go up. As a percentage of revenue, we think it'll -- well, wait until mid-December. It's not going to dramatically move, let's put it that way.

Okay. Last question. Legal expenses tend to be somewhat lumpy depending upon the activity in any given quarter. Should we look for that same rate of legal expenses in the fourth quarter that you had in the third quarter?

I think somewhere between the three of us, we signaled that the legal expenses were highly focused on our patent activity, and that should begin to come down somewhat. But that's an investment we feel very strongly about, and we'll continue to make, so. But it shouldn't perhaps be at the same levels because we've been very, very involved last year in terms of getting our foundation laid.

Okay. That's it for me. Thank you very much.

(Operator Instructions) Our next question comes from the line of Mike Matson of Needham & Company. Your line is open. Please go ahead.

Hi, thanks for taking my questions. I guess just on the Surgery business, the growth has been particularly strong there. And I was just wondering if you could give us some insights into which particular procedures you're seeing the most growth in.

Well, a year or so ago, we highlighted the fact that we had some studies going on in the urology area, nerve-sparing prostatectomies specifically. We had a paper published on the subject, and a lot of physician enthusiasm around it with some particular physician leader in this whole area, U.S.-wise and you could also say worldwide, being one of the sponsors of the research. So that's done well.

Yes. I would say that I don't have the exact statistics in front of me. But what comes to mind are a number of our orthopedic procedures as well as our surgical like the nerve-sparing prostatectomies, and some GYN and colorectal surgeries are getting some nice growth now. We're too premature to give specific details there, but hopefully, down the road, we can get to the point where we can give you a little better information. Those are the areas that I recall us getting some good momentum in.

Okay. And then you mentioned you're planning to add 30 to 40 reps. So I was curious if you have a target in terms of how that would break down between in Wound, Surgery, and Orthopedics. Or is it just more dependent upon whether or not you find the right people with the appropriate skill set in those various areas?

It's a little bit of that, but the available people, obviously, have an impact on when and where you can hire in the different areas. I would say that this next batch is going to be heavier weighted to the surgical side, although we're still going to bring in some nice number of people in the Wound Care side, but I don't know the exact split. But certainly, 1/3 or more of them are going to be coming in on the surgical side.

Okay. And just for these reps and particularly, in the surgery and orthopedics areas, where are you typically hiring those reps? I guess in the past, I know you talked about hiring some reps from Intuitive Surgical in the surgery area, but is that still the case? And the orthopedics reps coming out of kind of the bigger orthopedic companies or?

Yes. We are still hiring some folks out of that organization. We're not limiting to that. We're really looking for people that have heavy surgical experience that have relationships in, really, any of those three areas, the urology, colorectal or GYN, folks that have some good relationships there and some heavy experience. So there's a number of companies that have pretty good backgrounds there. I will point out that we're really focusing not on the people that have sold the capital equipment piece of it but are selling the disposable end of things. That's the product side of it, the product areas that are repetitive sales as opposed to a large capital sale. There is a bit of a difference in terms of personality and approach with those two. So we're focusing on the ones that have to have a continuous strong relationships with the surgeons as opposed to something in hospital administration.

All right. That's all I have. Thank you.

And I'm showing no further questions in queue. I'd like to turn the conference back over to management for any closing remarks.

Thank you, operator. Well, let me start by saying that we feel this was certainly a good quarter with all our operating parameters doing the right thing. It wasn't a beat-and-raise quarter, which is when I use the word excellent, but you've heard the reasons why that occurred. You also heard us say that don't count us out on beat and raise. We have taken -- certainly, have to do note of the dramatic price decrease this morning. All I can simply say, I view that as a very, very significant buying opportunity. I'll also add, I've had shareholders ask me from time to time, in fact, more often than not, why aren't you buying when we have these kind of price decreases? Well, often, I happen to know more information than the public knows, so I'm restricted from buying. I will just say that. I consider that where we're trading today is quite a valuation -- low valuation, whereas a year ago, I think I told you that I thought we were stretching valuations.

So we're continuing to do our management job here. I encourage you to ask further questions, if you need to. We'll try to keep you informed on this FDA matter. But again, I think it's very much overblown as everyone else, every one of these other FDA issues that have cropped up in our history have turned out to be. So please take that into account, but call us if you have other questions. And thanks very much. We appreciate it.

Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program and you may all disconnect. Have a great rest of your day.