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Saturday, December 24, 2005

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OPERATOR: Good morning and welcome to the Integra LifeSciences second quarter 2005 earnings conference call. [OPERATOR INSTRUCTIONS] It is now my pleasure to turn the floor over to your host, Stuart Essig, President and CEO. Sir, you may begin.

STUART ESSIG, PRESIDENT AND CEO, INTEGRA LIFESCIENCES: Good morning, everybody, and thank you for joining us for the Integra LifeSciences investors conference call. I'm Stuart Essig, President and CEO of Integra LifeSciences Holdings Corporation. Joining me today are David Holt, SVP of Finance, and Jack Henneman, Chief Administrative Officer.

During this call we will review our financial results for the second quarter of 2005, which we released yesterday afternoon, and our forward-looking guidance for the third quarter of 2005 and the full years 2005 and 2006. At the conclusion of our prepared remarks, we will take questions from members of the telephonic audience.

Before we begin, Jack Henneman will make some remarks regarding the content of this conference call.

JACK HENNEMAN, SVP FINANCE, INTEGRA LIFESCIENCES: This presentation is open to the general public and can be heard through telephone access or via a live webcast. A replay of the conference call will be accessible starting 1 hour after the conclusion of the live event.

Access to the replay is available through August 22, 2005, but dialing 973-341-3080, access code 6175823, or through the webcast accessible on our home page.

Today's call is a proprietary presentation of Integra LifeSciences Holdings Corporation and is being recorded by Integra. No recorded, reproduction, transcript, transmission or distribution of today's presentation is permitted without Integra's consent.

Because the content of this call is time sensitive, the information provided is accurate only as of the date of this live broadcast, August 8, 2005. Unless otherwise posted or announced by Integra, the information in this call should not be relied upon beyond August 22, 2005, the last day that an archived replay of the call authorized by Integra will be available.

Certain statements made during this call are forward-looking within the meaning of the Private Securities Litigation Reform Act of 1995.

Among others, statements concerning management's expectations of future financial results, new product launches and regulatory approval and market acceptance of these new products, future product development programs and potential business acquisitions are forward looking.

Forward-looking statements involve risks and uncertainties that could cause actual results to differ materially from predicted results. For a discussion of such risks and uncertainties, please refer to the "Factors that may affect our future performance," included in the business section of Integra's annual report on Form 10-K for the year ended December 31st, 2004, and information contained in our subsequent filings with the Securities and Exchange Commission.

These forward-looking statements are made based upon our current expectations and we undertake no duty to update information provided during this call.

Certain non-GAAP financial measures are disclosed in this presentation. A reconciliation of these non-GAAP financial measures to the most comparable GAAP measures is provided in the press release we issued yesterday, which is available on our website in the press release section under investor relations.

STUART ESSIG: Thank you, Jack. We achieved record revenues in the quarter. Total revenues in the second quarter of 2005 increased by $13.3 million to $69.8 million, a 24% increase over the second quarter of 2004. Excluding recently acquired product lines, second quarter revenues increased by $7.4 million or 14% over the prior year period.

We reported net income of $7.7 million or $0.23 per diluted share for the second quarter of 2005. When adjusted for certain acquisition, integration and restructuring-related charges, net income for the second quarter of 2005 was $9.6 million or $0.29 per diluted share.

These acquisition, integration and restructuring-related charges included costs associated with the closing of various facilities and related transitions, employee terminations, product line discontinuations and other related costs, including inventory fair value purchase accounting adjustments. You will recall that in our first quarter earnings release and conference call we anticipated significant acquisition, integration and restructuring costs during the remainder of 2005.

Operating income was $12.1 million for the second quarter.

Acquisition, integration and restructuring-related charges reduced our operating income by $3.1 million.

Our implant revenues in the second quarter increased over the prior year period by 40%. Rapid growth in our nerve repair products, our dermal repair products and acquired sales of Newdeal products for the foot and ankle accounted for most of the increase in implant product revenues.

Sales of our NeuraGen and NeuraWrap products increased approximately 70% over the prior year period. Sales of our dermal repair products increased approximately 45% over the second quarter of 2004.

Newdeal product revenues were $4.1 million and we are receiving strong feedback on the Newdeal system of foot and ankle products.

Newdeal sales in the United States are growing, along with the expansion and training of our reconstructive surgery sales force, which we expect to reach 50 people by the end of the year. We have opened over 150 U.S. Newdeal accounts since we began selling the products in late Q1 of this year.

Sales of the NPH Low Flow Hydrocephalus Valve that we introduced in late 2004 also contributed to the growth in implant products revenues for the quarter.

We had record sales of DuraGen products this quarter. These products continue to grow, although at slower rates than in earlier years. We continue to see competition in duraplasty in line with previous quarters, but the total opportunity is such that we expect duraplasty to remain a very important, growing and profitable business for years to come.

Importantly, we introduced, in February, our third generation duraplasty product, the Suturable DuraGen Dural Regeneration Matrix.

Sales of Suturable DuraGen have been ramping significantly monthly since our launch. We believe this product will enhance our ability to compete against other suturable dural grafts. The product is intended for us by surgeons who want Integra's tissue remodeling technology for procedures that require suturing.

Revenues for our instrument product lines in the second quarter increased over the prior year period by 20%. Increased sales of our JARIT surgical instruments and ultrasonic aspirator product lines provided most of the internal growth in instruments. The Mayfield product line, acquired during the second quarter of 2004, also continues to provide strong results.

Monitoring revenues in the second quarter increased over the prior year period by 2%. Year-over-year growth in monitoring product revenues continues to be affected by slower-than-expected acceptance of our LICOX brain oxygen monitoring system in the United States and slower growth in external drainage systems.

We expect that our NeuroSensor cerebral blood flow monitoring system and the AccuDrain external drainage system will contribute to improvements in the performance of this category in future periods.

The NeuroSensor is currently in evaluation at approximately 20 institutions.

Our private label product revenue in the second quarter increased over the prior year by 26%. Increased revenues of the Absorbable Collagen Sponge that we supply for use in Medtronic's INFUSE bone graft product and revenues of Biopath, a product we sell to Johnson & Johnson, more than offset the removal of the Signature Technologies cranial fixation OEM revenues from our private label products category. You will recall that we discontinued manufacturing cranial fixation products for Medtronic at the end of last year's second quarter.

We received a one-time royalty payment of approximately $500,000 based on additional patent claims associated with the Biopatch product license.

Our gross margin on total revenues in the second quarter of 2005 was 61%. Although we had strong growth in higher gross margin products, we incurred $1.8 million in restructuring and manufacturing transfer costs, fair value purchasing accounting adjustments and certain inventory write-offs associated with a discontinued product line.

These charges reduced our gross margin by 3%.

We anticipate having additional restructuring and manufacturing transfer costs for the remainder of this year. Excluding these charges, we expect to continue to see a positive trend in the gross margin.

Selling, general and administrative expenses increased by $6.6 million to $26.0 million in the second quarter of 2005, with $2.2 million of the increase attributable to acquired operations. Selling, general and administrative expenses this quarter were significantly higher as a proportion of revenues than in the prior year.

Approximately $1 million of these higher expenses were related to costs associated with the closing of various facilities and related transitions, employee terminations and other acquisition, integration and restructuring-related costs. We excluded these costs from our calculation of adjusted earnings because we believe that, given our strategy of seeking acquisitions and the nature of the restructurings underway in our European operations, net income adjusted to exclude costs related to acquisitions, integrations and restructurings is a useful additional basis to measure the performance of our business operations, both in this quarter and in future periods.

During the second quarter we continued the integration of the Newdeal Group's international business with our existing international sales and distribution network and launched the Newdeal products through our reconstructive sales force. The Newdeal foot and ankle implant products are an important part of our strategy to sell the Integra wound repair and dermal and nerve regeneration products to the surgeons who see chronic wounds every day.

Our objective is to provide a full range of products for foot and ankle surgeons so that our reconstructive surgery sales force can be a one-stop-shop for surgeons in that specialty. We believe that Newdeal's first rate foot and ankle orthopedic products and Integra's high-tech wound repair and nerve regeneration technology are, together, the most compelling suite of products, both metallic and ortho-biologic, sold specifically to foot and ankle surgeons.

While other companies have much larger sales forces at their disposal, we're catching up fast. We are rapidly building our reconstructive surgery sales organization. Furthermore, we believe we are unique in building a direct sales organization dedicated to foot and ankle rather than one sharing selling time with other orthopedic specialties. Today we have approximately 40 sales professionals in the U.S. reconstructive surgery group and we are working to increase that number to 50 by the end of the year.

We believe that our track record in neurosurgery proves that we have the management expertise to build the best sales force in a market segment and we plan to do it again in foot and ankle. That being said, we have continued to model this year's growth in our U.S.

Newdeal revenues modestly for the remainder of this year, pending further evidence of the results of our efforts.

This past quarter we announced the restructuring of certain European operations and in June we entered into an agreement with our labor representatives of employees affected by the closing of one of our facilities. The company will continue discussion of further anticipated restructurings of its European operations with local labor representatives. The costs of these activities will depend upon various considerations, including the number of employees to be terminated and their locations, the availability of other jobs with Integra LifeSciences, and the level of severance benefits.

We expect to reinvest the bulk of the savings from these activities in further building our European sales, marketing and distribution organization and in integrating the Newdeal Group's business with our existing sales and distribution network.

The company expects to incur significant cost over the remainder of this year in connection with the employee severance, legal and other items related to restructuring and integration activities, largely in Europe. Based on management's preliminary assessment, Integra LifeSciences estimates that the cost of its restructuring and integration activities, including those discussed above, will not exceed $8 million in the aggregate. Through the 6 months ended June 30th, 2005, we have incurred $3.8 million of these charges. We currently expect the remaining charges to occur over the remainder of 2005 and to impact our 2005 GAAP reported earnings per diluted share guidance by approximately $0.14.

I will now turn the presentation over to David Holt, our SVP of Finance, who will provide more information regarding our interest expense, tax rate and foreign currency exposure.

DAVID HOLT, SVP FINANCE, INTEGRA LIFESCIENCES: Thank you, Stuart. We recorded interest expense of $822,000 and interest income of $907,000 in the second quarter of 2005. Net interest income decreased slightly from the prior year period.

Other expense was $541,000 in the second quarter of 2005 as compared to other income of $135,000 in the prior year period. Other expense this quarter included losses of $522,000 related to foreign exchange transactions. We currently do not have any hedging programs for these positions.

We continue to generate substantial cash flow from our operations. In the second quarter of 2005, we generated cash flows from operations of $16.2 million, a $6.5 million increase over the second quarter of 2004. Our year-to-date cash flow from operations, through June, was $29.5 million.

Accounts receivable improved approximately-- to approximately 69 days of sales outstanding at December 31st, 2004, to approximately-- from 69 days of sales outstanding at December 31st, 2004, to approximately 61 days at June 30th, 2005, as a result of increased collection efforts during 2005. We expect our days outstanding to remain constant with current levels.

International sales were 27% of total sales this quarter, compared to 21% of total sales for the full year of 2004.

Inventory days on hand were approximately 246 days at June 30th, 2005, compared to 244 days at the end of the first quarter. We have increased inventory levels in 2005 in order to minimize the impact on our customers as we complete various manufacturing transfers and restructuring activities.

In May 2005, our board of directors authorized us to repurchase shares on our common stock up to an aggregate of $40 million through December 31, 2006. During the second quarter we repurchased 750,000 shares under this program for approximately $24.7 million. We may continue to purchase up to $15 million in shares either in the open market or in privately negotiated transactions.

At June 30th, 2005, we had cash and investments of approximately $148 million. Our weighted average common shares outstanding used for the calculation of diluted earnings per share in the second quarter of 2005 was approximately 34.7 million shares.

Our income tax expense-- our income expense rate was approximately 34.5% in the second quarter of 2005 versus 36.8% in 2004 and our amortization expense for the quarter was $1.7 million, an increase of $619,000 over the prior year period.

And now let me turn the presentation back over to Stuart.

STUART ESSIG: Thank you, David. Our management team continues to seek out external opportunities for growth and any such opportunities that we consummate could affect our results going forward. It is a top priority of our management team to complete significant and accretive transactions this year and next, however, the forward-looking guidance that we have provided does not reflect the impact of any such future business acquisitions or additional strategic partnerships.

We are updating our expectations for total revenues and earnings per share for 2005 and reiterating our expectations for 2006. Total revenues in 2005 are expected to be between $283 million and $290 million. Total revenues in 2006 are expected to be between $340 million and $350 million. Our guidance for the third quarter of 2005 is for total revenues in the range of $70 million to $74 million.

Excluding charges related to acquisitions, integrations and restructurings, earnings per diluted share in 2005 are expected to be within a range of $1.29 to $1.34 in the full year and $0.33 to $0.36 in the third quarter. On a GAAP-reported basis, we expected earnings per share in 2005 to be within a range of $1.15 to $1.20 in the full year and $0.28 to $0.31 in the third quarter.

Earnings per diluted share in 2006 remain unchanged in a range of $1.65 to $1.75. Our expectation ranges for 2006 earnings per share-- earnings per diluted share, do not reflect the impact of expensing stock options beginning January 1st, 2006, under the accounting standard recently issued by the Financial Accounting Standards Board.

I would like to take a moment to focus on the expectations for each of our product categories for modeling purposes. Based on our total revenue guidance for 2005, we expect implant revenues of $112 to $114 million, instrument revenues of $95 million to $98 million, monitoring revenues of $49 to $51 million and private label revenues of approximately $27 million.

Looking beyond 2005, we expect sales to grow in excess of 25% for the implant product lines and 15% for the remainder of the product lines.

Overall, our long-term organic growth rate expectation for revenues is in the range of 15% to 20% per annum.

The consolidated gross margin percentage, excluding costs related to acquisitions, integrations and restructurings, for the full year is expected to increase to 66% of total revenues in 2006.

Long term, we are targeting SG&A expense at 32% to 34% and R&D at between 5% and 6%.

We are very optimistic about the prospects for our reconstructive surgery strategy. We believe that the combination of the Newdeal products and our soft tissue regeneration technology provides the perfect platform on which to build a rapidly growing extremities business. The first evidence in support of this strategy is the significant increase in sales of Integra tissue regeneration products during the second quarter. We believe that as we add sales representatives and Newdeal accounts, sales of our reconstructive products will accelerate.

Our instrument business also continues to be strong. Not only has the Mayfield business, which is not included in our organic growth numbers, grown significantly since we acquired it, but it has been an excellent means for pushing our neuro reps into accounts that have been closed to them in the past. JARIT continues to take share from its competitors.

This concludes our prepared remarks. I'll be happy to answer all of your questions. Operator, you may turn the call over to our participants.


DAVE TURKALY, ANALYST, WR HAMBRECHT: I was wondering, just in terms of the guidance for the restructuring costs of not to exceed $8 million and about $4 million so far, can you just remind us exactly, if you could, what plants these involve, what product lines, if there's any more detail that you can give us on that and why you think now you're about halfway through.

STUART ESSIG: OK, Dave. First of all, we did not discuss it on our last conference call because we were still at a phase in our discussions with the various labor representatives that we couldn't.

I can tell you more now.

We announced a significant restructuring of our Tuttlingen operation, which we call IMA -- it's where we make the Berchtold electrosurgery devices and we are in the process of transitioning that facility into our Andover facility, where we make our electronic processes-- products and processes. There'll be a significant headcount reduction as we shut down the site in Germany.

In addition, we are in discussions with labor representatives of our Biot manufacturing plant, so where we make the NMT shunts and epilepsy and drainage and there's no intention to shut that site, but rather we're in discussions with labor representatives about a reduction in headcount.

There are other restructuring activities going on, as well, in Europe, including a significant restructuring of our sales and marketing organization, of which a number of people, on the one hand have been terminated and on the other hand there's significant hiring going on and actually net/net we'll be up in heads in our sales and marketing organization, in particular leveraging the significant management organization that we acquired in Newdeal to take responsibility for much of the European sales and marketing.

We are, in the United States, shutting our spinal specialties facility in Texas and it's being-- it's in the process of being merged into our California location where we make the variety of Camino products and other products. We're also moving a significant number of activities out of our New Jersey facility, some of which are more appropriately in our California facility and many of which are being moved down to Puerto Rico.

So I was actually thinking about it last night. There is no site that we have right now that isn't at the receiving end of some significant restructuring activity designed to improve efficiency and take out costs.

When this is all done, we expect on the order of 75 heads to be reduced and that does not include, for example, adding heads into sales and marketing. So in terms of manufacturing and G&A we expect on the order of 75, maybe closer to 85, heads will come out of the organization. And we know, in particular, what the numbers look like in France and in Germany, but the way the accounting works is we're only able to accrue a certain proportion of it in the second quarter and we have a pretty good sense for what will be accrued in the third and the fourth quarters.

Our objective is to have all of this put behind us by the end of the year so as we go into the new year we will have accumulated all of the expenses, but some of that just depends on the process we follow and we obviously have to follow the local laws and negotiate in good faith with all of our labor representatives. So net/net we know we've spent -- from an accounting perspective -- about $4 million and we would expect to spend another significant chunk in the third quarter and then a much smaller amount in the fourth quarter.

DAVE TURKALY: Thanks for all the detail. Can you give us an update, too, on the-- kind on the implant side, your direct sales force kind of in that business now, where that stands today?

STUART ESSIG: Yes. Our objective is to finish the year at 50 people for what we're referring to as our reconstructive sales organization.

And keep in mind, reconstructive includes the following products, the Integra dermal regeneration and repair products, so all of the various flavors of the Integra artificial skin products. It includes the nerve products, NeuraGen and NeuraWrap, although our neuro group also sells those products. So you can think of the 2 divisions co-marketing the nerve repair products with the neuro group calling on neurosurgeons who do some of the procedures and the reconstructive group calling on, principally foot and ankle, plastic and, to some extent, other surgeons who would use the nerve products. And then the reconstructive group also sells the Padgett dermatomes and meshers.

So you put all of those products together and then add to that Newdeal, which we just began selling in March, I believe, of this year, and that's a pretty nice portfolio of products and that has really benefited from the increase in headcount. So what we're going to do is add another 10 sales reps between now and the end of the year to get to 50. 50 includes 4 or 5 management people and 3 clinical people and then the rest are reps and that's been a big ramp up and I would say, practically speaking, we've probably added 20 of those people in the last 3 to 4 months, so they still have a learning curve. But you can see the impact on the Integra numbers this quarter and also in the number of Newdeal accounts these guys have opened.

DAVE TURKALY: And your neuro group is how big?

STUART ESSIG: OK. The neuro group is approximately 110 people. We have been selectively adding reps this year, in particular as we've been promoting reps who are particularly successful into management or other facilities-- sorry, other activities, we've been able to split those territories and sometimes add 2 or 3 reps. So we're at about 110 field-faced people this year, with approximately 90 to 100 territories and that's up 20 from the end of last year, plus or minus.

DAVE TURKALY: Great and then just one last one, if I might. The-- the $500K of income you had for Biopatch, is that-- you're not showing-- that's not in "other," that's actually in the private label of $7.8?


OPERATOR: Raj Denhoy, Piper Jaffray.

RAJ DENHOY, ANALYST, PIPER JAFFRAY: Just a-- a couple broad questions. You took down guidance a little bit for 2005 here, took the top end of the range off. I'm curious what's driving that. Is there a particular weakness in particular areas you're look at or maybe you could just flesh that out a little bit for us?

STUART ESSIG: No, there's no particular weakness. We went product category by product category and discussed performance. I think the reality is, it's 3 months since we last gave guidance and while we were very pleased with the second quarter results, you just stare at the rest of the year and it just seems less practical to expect we would get that last $3 million of revenue. So we didn't take down the guidance range at the bottom of the range, we just trimmed the top end of the range because we want to have a realistic range at all times.

But actually, if we look at the performance of the business in the last 3 months, we've been very surprised and pleased with the overall performance -- record revenues of DuraGen, Integra continuing to grow at over 40%, NeuraGen over 70%, Newdeal international doing very well and a nice uptake in the United States. And the only one that's really continued to be a struggle is our neuro monitoring business, but on the other hand, a nice introduction of new products this quarter. NeuroSensor now in 20 accounts. AccuDrain, which has both improved features but also an improved price point, is an important part of that division.

And then finally, in the-- we've been talking about the private label business coming back for about a year and a half and it's happening exactly the way we said it would happen, but just a little bit earlier, which is there are a lot of product lines that got restructured, literally, 2 years ago, including the termination of the Signature relationship with Medtronic, and now a lot of the slower growth product lines have kind of trailed off and the faster growth products, like the Absorbable Collagen Sponge for the BMP, like Biopatch are really starting to dominate the numbers.

And so I have been saying for over a year and a half we expect that part of the business to grow at or above 15% and I think we're there now and we'll have an easy comparison next quarter, because it'll be the first quarter that Signature went away.

RAJ DENHOY: Fair enough. A couple of drill-down questions, though. On monitoring, I'm curious why do you think LICOX has yet to get traction? It sounds like-- I think last time I got an update that was at 150-180 centers. Is it still just not-- is the data not there? Or maybe you could give us some thoughts around that.

STUART ESSIG: OK. First of all, we remain absolutely committed to LICOX and the interest and technical development of LICOX has continued to be significant. As you know, it is not standard of care and it's going to be a while until it's standard of care and until it's standard of care, we've concluded that the uptake-- we just have to be cautious on any predictions.

This is one we've been wrong on in the last year and a half. We thought it would grow a lot more quickly, simply because of how innovative the technology was, but the truth is, it is a project and we have to work the project and the project involves training clinical people, training neurosurgeons. It's a significant effort.

The other reason it's not growing as quickly as we'd like has to do with the attention that we're giving it. The truth is, we have so many other opportunities, whether it's DuraGen and Suturable DuraGen, both the defensive battle and the offensive activities, whether it's the NPH valve, which has big opportunities -- those are all taking priority over a much more labor-intensive, time-consuming product line, which is LICOX.

That being said, I came prepared with some statistics. We have close to 200 monitors now in the United States and we sold 14 monitors during the quarter. So it's not like it's slowing down. It's just that it's not going to move our numbers until we're able to have a much more significant impact. And so we're, in some ways, turning our attention to doing a better job of selling the whole product category, from NeuroSensor, LICOX, Camino, drainage and are working on strategies to better position those products together in institutions with more additional focus, perhaps with some more clinical support in the coming year.

And I think we'll have more to say on that as we go into the next year, but in the meantime, it's important but we're not giving it the focus internally that we were giving it a few years ago and so we're trying to make we appropriately signal that to the investment community, as well.

RAJ DENHOY: OK and then just on DuraGen, are you expectations still that what you're seeing in the market place is trialing of these new products and that the business will eventually come back? And maybe you could comment a bit on what the pricing environment is out there, as well, whether you've seen J&J and Medtronic maybe compete a bit more on price?

STUART ESSIG: OK. First of all, we continue to think that most of the impact on our business is trialing. I would say the good news in the last couple quarters is some of the places that tried and switched have switched back to us. There's certainly going to be a level of competitive activity, reasonably indefinitely, with some accounts liking competitors' products.

But that being said, I-- we feel like this is settling in to a more typical competitive situation and the initial interest and thrust and enthusiasm from the competition is starting to wear off. Just like we have been battling hard and expending a lot of energy and focus on preventing the competition from taking share, picture them and the amount of energy and focus they've put into trying to take the share and I think, in a lot of cases, they're getting discouraged.

So I don't want to just describe it as indefinitely just trialing.

What I do want to say is we're not seeing a lot of competitive activity whereby people are taking accounts from us. At some point, certainly, they will take some accounts and will keep them, but we're just as active now in taking accounts away from them and we're just as focused on trying now to really grow the business, whether it's in spine, whether it's in taking autograft share, as we are in defending.

So, I guess, to be clear we will continue to defend the business.

We'll continue to see trialing and competitive activity but it's been close, now, to a year and a half since this process began and, candidly, I think we've won the battle. But that doesn't mean we won't continue to have an aggressive environment.

In terms of pricing, I don't really want to comment on pricing. What I can say is we had record revenues for the quarter, so whatever the impact of pricing was, it didn't impact our ability to have a record DuraGen quarter.


STUART ESSIG: So I want to strike the right balance to say this is going to be competitive. We are not positioning this as the leading growth driver like we were a year and a half, two years ago, and I think we've done the right things in terms of putting a lot of other growth drivers beside DuraGen, but, as I said in my script, we continue to see this-- expect this to grow, be a very significant focus for our salespeople, and be very profitable.

RAJ DENHOY: OK. And then just one-- just a housekeeping one. I don't know if you gave the FX impact in the quarter, foreign currency impact?

STUART ESSIG: We didn't, but I've got it written down. What is it, Dave, $300,000?

DAVID HOLT: Yes, $320.

STUART ESSIG: Yes, $300,000 on the top line.

OPERATOR: David Zimbalist, Natexis.

MIKE DUNCAN, ANALYST, NATEXIS BLEICHROEDER: This is actually Mike Duncan (ph) for David.

On gross margins, if you exclude the adjustments and the effect of the royalty payment for the Biopatch, it looks like they were actually slightly down sequentially. Could you discuss what's going on there?

STUART ESSIG: Well, we didn't exclude the adjustment for the royalty, so if you back that out, I don't know the answer. Maybe that makes it slightly down. I mean, overall the gross margin continues to grow on an adjusted basis and we tried to outline, in the footnotes to our press release as well as in this call, the significant number of adjustments and impacts from all of the restructuring activity we're doing. But we are not seeing gross margin come crashing, once you back out all of these adjustments.

And as I said-- I said in the script, we continue to expect 2006 to be at the 66% level and reiterated our guidance in that regard.

MIKE DUNCAN: OK, great. And then for inventory days on hand, it continues to be kind of 245 days. Can you talk about when you expect that rate to decline?

STUART ESSIG: Yes. If I can take, if you don't mind, a little victory lap. I've been promising our investors that we would get our balance sheet more in line with our historical performance and we stated on prior calls that because of the Oracle implementation that we were still living with at the end of the year and because of some of the restructuring activity, both our AR and our inventory would and then did expand.

This quarter our AR was down to 61 days, which is back in line with historical precedent. So we have been traditionally at about 60 days.

What might be missed is that our international business is up at 26% to 27% of revenue. So actually, if you look at our domestic AR, it's improved significantly and so I just want to remind people that we've really crossed the bridge. Our Oracle system is working well. Some of the surprises we had in the first quarter and before are behind us and our days inventory-- sorry, our days AR are in line with where we would expect them to be.

You are correct, the next big project is to get our inventory days down, although that has nothing to do with the Oracle implementation.

It really has to do with all of these transitions that are going on.

For example, in a number of our European operations we needed to get our inventory in place so that we can stop manufacturing and move the line from a particular location to another particular location.

Same thing with the San Antonio facility. Same thing with a variety of the restructuring activities we're doing. And in order-- with the kind of variable gross margins that we have, you really don't want to go on back order. You want to make sure you're shipping everything according to demand.

And so we have built inventories to levels that, by the way, are in line with other players in the industry, but are just ahead of our historical precedent. And so we do expect to get it back down, probably as we go into 2006, but don't look for anything significant this year. There's a lot going on inside of those numbers.

So, for example, we've built up inventory in one location. We'll be starting up inventory in another and we will be drawing down the inventory from the first location. So different things will move around, but don't expect the inventory days to come down significantly until we go into 2006.

All right. So that's the summary.

MIKE DUNCAN: OK, great. And then final question, on the private label, given the guidance that you gave for private label, it looks like you're expecting it to decline in the second half. Is that the right way to think about that?

STUART ESSIG: Well, a couple things are going on, keep in mind.

First, we had just an extraordinarily strong quarter in private label as all of our-- almost every one of our customers really had just a lot of demand. And that was every-- every one of the private label areas, even some of the ones that historically were shrinking. So, yes, we don't expect it to be $7.8 million in the next 2 quarters.

That being said, the organic growth inherent in the next 2 quarters, even at levels lower than the $7.8 million, is well above the last few quarters because Signature is out of those numbers. So when you do the year-to-year comparison in Q3 and Q4, the organic growth is actually going to be still quite high, well above the last few quarters, because we're finally through that Signature comparison.

But no, we don't expect $7.8 million, and, again, $0.5 million of that was, in fact, a one-time payment, although the-- that one-time payment has to do with additional patent protection, which is going to improve our royalties on that product going forward.

OPERATOR: John Calcagnini, CIBC World Markets.

JOHN CALCAGNINI, ANALYST, CIBC WORLD MARKETS: [audio interference] I wanted to ask you, so what is your target for inventory days over, say, a 5-year period? How much of this is just a function of having a lot of SKUs and a corporate decision to not stock out, et cetera, and how much of it is that you've got all these integrations going on and so you're safety stocking? I'm just trying to understand that picture.

STUART ESSIG: [inaudible] on mute or no one will be able to hear the answer. So the question, for those people who couldn't hear, was what's our target for inventory days and is it a short-term function that we have built this inventory or is it a longer-term trend?

And I would say that it's certainly the case that we've built a lot of inventory for all of these restructuring activities and we certainly expect it to come down. On the other hand, we're aggressively entering the orthopedic business with Newdeal and with some of the other products and we're aggressively building our international operations, which would drive the inventory days up.

I'm pretty happy with inventories anywhere between 200 days and 240 days and we've benchmarked ourselves with our peer group and that's pretty good. I would say we expect it to come down in the new year because we do have a big project to finish up these transitions and manage that inventory down to appropriate levels.

So I would say anywhere between 200 and 240 days is a pretty good number for us and certainly we've got a very strong balance sheet and it's not hurting us to have that inventory and we don't want to stock out. So I can't give you that good an answer, because it's reflected on a number of different factors.

JOHN CALCAGNINI: OK, but that range helps, 200 to 240. I wondered if you could also talk about, is there anything that's going to-- any inventory that had to be marked up associated with Newdeal or other transactions that cycle through the cost of goods line that result in the gross margin in the second half of this year being lower than it otherwise would have been? And what is your expectation for the gross margin in the second half?

STUART ESSIG: OK. First, on the question of Newdeal markups, there was markup-- acquisition accounting and that was in the first and the second quarter and it was about $200,000 a quarter. So our gross margin was depressed by $200,000 a quarter in Q1 and Q2 because of acquired inventory from Newdeal. And, by the way, we broke that out in our footnote in the adjustment categories.

In terms of the back end of this year, we're targeting, in line with historical guidance, we're targeting 63% without the adjustments and, obviously, a higher gross margin with the adjustments. So there's really no change in our perspective on gross margin and it should be growing toward the back half of the year so that we are in line with ability to achieve a 66% gross margin in 2006.

JOHN CALCAGNINI: And in '06, is the driver some of these headcount reductions you're doing that gets you to that 66% from 63% or 64% today?

STUART ESSIG: It's so many different things, John. Certainly the headcount matters, but as I've reiterated in prior calls, that won't even impact our numbers for a minimum of approximately 200 to 240 days, because we've got to turn the inventory and if we built those inventories we have to turn them before we put products into inventory at the lower cost of goods sold.

So the biggest impact on our numbers next year and our ability to get to 66% comes from, first, the overall growth in the business and the ability to absorb relatively constant overhead into more units. The second biggest impact is the impact of selling our highest gross margin products, such as DuraGen, NeuraGen and the Integra dermal regeneration template, but also, now, there's a number of other products that have very high gross margins, like Newdeal and KraniOS and NPH. So we have a lot of high gross margin products and that's probably the second biggest factor and then the third, longer term, is, in fact, the cost that we're taking out of the sites that we're shutting.

OPERATOR: Alex Arrow, Lazard Capital.

ALEX ARROW, ANALYST, LAZARD & COMPANY: If I could maybe start with just going back to the private label, I know you said the Signature relationship with Medtronic was a big part of the change. Can you tell us INFUSE and BMP contributed to that-- the very strong June quarter, understanding that you're not looking for that in the second half of the year? But just for this quarter, was it really an INFUSE effect?

STUART ESSIG: First of all, I'm not going to break out the individual product lines in the private label. We haven't in the past and don't intend to, going forward. What I can reiterate, Alex, is it was, essentially, all of the product lines, very strong, or most of the product lines, very strong. And it included, certainly, INFUSE, but also the Biopatch, also our dental products, also a whole host of other products that we generally don't even talk about -- the hemostatic agent, the cryosurgery. We've got a lot of stuff in that, either things that we had in the past or lines that we've acquired, and it just all was very strong, which is why we're not necessarily predicting that level of strength in the third quarter.

ALEX ARROW: OK, so since it's a very diversified base that would probably be all un-correlated with each other, why would you project that the growth would then taper off in the second half? I mean, the fact that it comes from a lot of different sources would make me think that that would be more of a sustainable trend?

STUART ESSIG: Because I just can't draw a line from one point. It may turn out to be stronger. It may turn out to be an anomaly. The mistake I don't want to make is saying we've got a trend in private label that's so much in excess of our guidance and say it's going to continue.

ALEX ARROW: OK. OK. On DuraGen, I understand you're not commenting on the pricing competition and that there is the trialing still continuing. On the issue of bundling, can you say how much bundling versus product features is what's really affecting the accounts?

You're taking some away from them, they're taking some from you. Are they using a lot of bundling? Are you able to use any bundling? And how much is that versus product features?

STUART ESSIG: I-- if I can try to give a qualitative-- or a quantitative answer to a good qualitative question, I think bundling is very unimportant and I think product features is very important.

So I don't think they're taking much business bundling from us and I don't think we're taking much business bundling from them. I think it's the features and benefits of our product and the relationships that our representatives have with the customers.

ALEX ARROW: OK, well-- STUART ESSIG: When I say "relationships," what that really means is service.

ALEX ARROW: OK, well, given that you seem to have the best features on your DuraGen product line, why would they be taking any accounts from you in that case?

STUART ESSIG: I mean, again, with close to 2000 accounts you're going to be some of their reps who either, for a moment in time have better relationships with customer or, on average, have better relationships with customers. Also, it's just the case that beauty's in the eye of the beholder and you're going to have a certain number of accounts that think the competitive product is better, despite our, either efforts or ability to prove that it's not or to prove that ours is better.

So we're the market leader and, therefore, we're the guy to shoot at.

That being said, we're also the guy to show leadership, which includes building the spine business, driving our adhesion indication in Europe, introducing new products like Suturable DuraGen and other products that we have in the pipeline.

So you're always going to have competitive activity and that was what we've been saying from day one. We compete with Medtronic and J&J every day in the drainage business and that is a business that is very competitive and generally we win. And the same thing, I expect, is going to be true in duraplasty.

ALEX ARROW: OK. All right, that's fair. If I could ask 2 questions on Newdeal. The $4.1 million was a little bit lighter than we had been looking for. I think that's-- from your comments it's on the U.S.

side. Can you comment on how the Wright Medical inventory transition--? Is that completely over and, therefore, that will probably help us figure out our Newdeal estimates in the second half of this year?

STUART ESSIG: The $4.1 million was just a little bit lower than our own internal expectation, but close enough that we viewed it as in line. It wasn't particularly more the European or the U.S. business, I just think it was a couple hundred thousand dollars one way or the other.

In terms of the U.S. business, we're actually pretty pleased with our guys' performance, 150 new accounts and keeping in mind that about 20 of these reps that we have haven't been working for us for more than 4 to 6 months. So it's kind of doing what we expected it to and I-- honestly, I'm just so happy that the group is doing this well. And we're hiring 10 more and we're going to keep taking accounts.

At this point, I do not know how much inventory they have. I can't even speculate what they have.

I do know that we continue to run into product-- Wright Medical product in the field and it's our job to convince our customers to acquire that product from us rather than buy it from Wright. I certainly hope they've gotten to the point where they've drawn it down. Their public statements would lead us to believe they're out selling the CHARLOTTE system in competition to us, which I can only assume is true.

But I don't know how much inventory is out there, but we're not-- at this point, I'm not talking about the inventory any more. We're just doing our job and growing the business and I don't really either attribute our success or our failure in the market to the remaining inventory that's out there. You won't hear me talking about it, because I just don't know.

ALEX ARROW: OK, thank you. But would it be reasonable for us to assume that at some point they're simply going to run out and not get any more and then you will have a step function up at that point?

STUART ESSIG: I don't know if they'll ever run out or they'll just throw it away. We're not selling any to them. I mean, at some point, if we were able to take all the accounts and convert them to Newdeal, it's theoretically possible they could have that product indefinitely and since they've written it off, I don't know what they're going to do with it. They certainly are not permitted to sell it outside the United States. They do have the right to keep bleeding it out in the U.S.

And, I mean, it's a sort of a funny thing. If we're real successful with our product line and they're real successful with CHARLOTTE, they could sit on the old Newdeal inventory for a really long time.

ALEX ARROW: OK. OK and then the other question I have on Newdeal, the amount of restructuring that's going on in Europe, which sounds like there's quite a bit of-- probably you've done most of this, I would think, but the negotiations with the labor representatives, the severance laws, which seem to be a lot different in Europe than the U.S. acquisitions you've done in the past, this is probably taking a lot of your time.

Is it fair for us to think that this is taking time away that you would otherwise be evaluating new acquisitions and should we figure that into our projections for the rate of your new acquisitions? In other words, a lot of-- a lot of just hours of the day that you spend negotiating Newdeal reorganization that you could otherwise be evaluating new stuff?

STUART ESSIG: Actually, I can say categorically the answer to that is no. We have built a pretty diverse and capable management team around the world. If I spend a few hours a week on the restructuring in Europe, that's the most I spend. We have a European operations team that is spending-- and G&A team that is spending the bulk of their time on restructuring those manufacturing facilities. But, candidly, our U.S. manufacturing and operations group is not-- they're spending the bulk of their time on reorganizing the U.S.


In terms of the sales and marketing group over there, we've kept them completely out of it. So a number of people have been taken out of the sales and marketing organization over there, but the sales and marketing leadership in Europe is not involved at all in the restructuring of the plants. So there's no involvement there, either.

And, in fact, the G&A team sitting here in Plainsboro, New Jersey, is as focused as ever on acquisitions and other leading-- sorry, leadership activities in new product development, in growing the business and really the 2 sets of restructurings and the European sales and marketing activity can all happen simultaneously with M&A activity.

The only thing we slowed down was in the first quarter as we were giving ourselves some time to make sure that our Oracle transition was stable, we certainly did slow some things down in the tail end of last year and in the first quarter to make sure that that transition in our Oracle ERP system went well and we didn't have some uncontrollable set of events. As I said, for the most part, that's behind us and we are as committed and enthusiastic about our ability to grow the business today as we ever have been.

And keep in mind, to anticipate one of your questions, there have been many other periods where we've gone 5 or 6 months or 7 or 8 months without doing acquisitions and it's not completely in our control when and which deals get done, but the strategy and the capacity to do those deals haven't changed at all.

ALEX ARROW: OK, great, and if I could have one last question just on the neuro-monitoring business, given that it's the one struggling business, your comments to us about the NeuroSensor and the AccuDrain launches, should we-- would it be reasonable for us to interpret that to mean that you're saying that this is probably the last struggling quarter we're going to see, given the growth of the new launches? Or is that a reach?

STUART ESSIG: I don't want to say that yet. You have our guidance for the year and for going forward on all of the product lines.

I think we should have an easier comparison in the back half of the year on monitoring. It's generally been the case the back half of the year has been stronger on monitoring than the first half of the year.

That's been the case for the last 3 years. And then you're going to ask me why and we still don't have a good answer why, but we would certainly expect the back half of the year to be an improvement over the first half of the year in monitoring.

But the overall trend in terms of the performance of our monitoring business requires some improved strategic activity on our part. And don't read that as we don't want to keep the business. What I mean by that is we're going to try to do things to make that business grow.

We've been waiting too long for LICOX as the reason for that business to grow and I think we have some other ideas for how to drive that business and we'll be starting to roll those out in the back half of the year and into the next year, but they do involve a refocusing of our activities in terms of growing the overall business rather than just continuing to beat on people's door over LICOX as the primary growth driver.

ALEX ARROW: Do you think you've lost any market share in neuro monitors to J&J, out with a new neuro monitor during the last couple quarters?

STUART ESSIG: We have definitely not lost any market share, to our knowledge. The issue is the overall growth of the market and we are the guys who have been growing it and we've put too much effort into growing it through LICOX and not enough effort into growing it in a more comprehensive way. But we do not believe we've lost any market share. In fact, we believe we've taken market share in the United States from J&J.

OPERATOR: William Plovanic, First Albany Capital.

WILLIAM PLOVANIC, ANALYST, FIRST ALBANY CAPITAL: I'm wondering if you could give us a little more color on the infrastructure that you are putting in place in Europe in terms of direct countries, size of that channel, what-have-you?

STUART ESSIG: Yes, sure. This is a real positive set of events. First of all, we've been really delighted by how quickly the Newdeal sales and marketing team have embraced being part of Integra and it's a real testament to the leadership of the individuals involved there.

We have really made a bet on those guys in terms of giving them responsibility for, in particular at the moment, the direct sales and marketing organization. So the President of Newdeal and the individuals in that organization have been put in charge of our European sales and marketing organization, reporting in to Bob Paltridge, who, as you know, is our sales-- is our SVP of Sales for the entire company.

That group there is responsible for the direct markets of France, Germany and England then in the last 6 months we've also gone direct in the Benelux markets, terminating a number of distributors in Belgium and the Netherlands and adding sales reps. Now in each of those countries we've scaled up the headcount and I'll try to rattle off some statistics.

By the end of the year, we should be at 10 direct reps in Germany selling all of our products other than Newdeal, because Newdeal will continue to go through an orthopedic distributor in Germany. But we've-- we're essentially doubling our direct sales force selling the neuro products and skin and NeuraGen and DuraGen adhesion in Germany.

In Benelux we have approximately 6 or 7 sales reps, broken into neuro focused and orthopedic focused. In England we'll be adding another 2 or 3 direct reps focused on all of our product lines -- again, other than the Newdeal, which goes through a distributor. And in France, Newdeal-- that was really their home market and we're adding additional neuro reps there and they've taken responsibility for managing our neuro sales force in France, as well. I would guess we have about 15, plus or minus, 15 to 20 direct people in France calling on accounts there.

So you put that together, it's a decent-sized organization. And then in the rest of the markets, we go through distributors and we've doubled our headcount of people in Europe calling on and managing the distributor network. So previously we really only had 1 or 2 people who managed hundreds of dealers and now with the leadership of the Newdeal group we've added another 2 or 3 dealer managers so I think we've got a total of 5 who are managing the distributors that we use.

And that will force focus on those distributors and encourage them to pick up not just the easy product lines like DuraGen, but some of the more difficult product lines, building opportunities.

So a significant headcount. We're in the process of recruiting a marketing team there. This will be the first time we had a direct European marketing group and, similarly, we're building a clinical organization over there. So I committed at the end of last year to essentially doubling our sales and marketing infrastructure in Europe and certainly with the addition of the Newdeal team we've more than done that already.

WILLIAM PLOVANIC: OK. And then if I look at the SGA, excluding all the one-time charges, it was pretty high, I think almost-- it was 35.9%, right around there. I was just wondering-- is that what this is, is just the buildout of the infrastructure and as we start to see the sales ramp up off all the new reps that have been added we should see this come down to what your guidance is?

STUART ESSIG: Yes. And I felt good about being able to answer Alex's question that it isn't just the guys here around the table managing all these restructurings. The other side of it is there's a fair amount of G&A that we've added in the last year and a half, whether it be to accomplish the restructuring activity, to put in the new and manage the IT system. We've been making a significant investment in growing the business and that includes regulatory, quality, legal, business development, all of those, and then certainly a big chunk of what you're seeing is the buildup in sales and marketing dollars in the recon business in the U.S. and in the European business and, frankly, no let up in neuro.

When we started the year we thought we would stick with roughly 80 reps and the more we looked at the opportunities that we were missing in various places around the country, we're ending the year closer to 90 to 95 territories in neuro. And so, yes, we're spending more than probably we anticipated spending a year and a half ago, but we see really good opportunities there and, yes, the model says that the sales market G&A are scalable and, therefore, will come down as a percentage of sales as the revenues grow.

WILLIAM PLOVANIC: OK. And last question, just on the R&D, that was significantly lower than what we were looking for. I guess the-- we're trying to find out, the PMA that you're doing to do for the anti-adhesion domestically, are there reasons for the delay in that and that's why the R&D is down or what-- can you kind of give us some reasons why that it's so low?

STUART ESSIG: No, it's a good question. First of all, we do expect the R&D to ramp. There's 2 aspects to it. About half of the shortfall is in just things that we didn't have the time or resources to do -- so various development and filing and other activities that just did not get down in the quarter that we would have liked to have gotten done and have nothing to do with the DuraGen adhesion PMA.

The second thing that impacted the number, so about the other half of the shortfall, is that the clinical trial will not start until the new year and we've budgeting assuming that there would be significant P&L impact in the first-- sorry, in the beginning and the first half of this year and going into the back half of the year and the truth is, until we enroll the first patient the costs are just not as high as we thought they would be.

So you'll see that start to ramp as the year rolls along and we start having things like investigator meetings and we start paying the fees for setting IRBs, but the truth is, we are in discussions right now with the FDA about what the clinical trials should look like and there is no delay and there is no lack of enthusiasm but the real spending won't start to hit until the first half of next year. A big part of that is the per patient fees are just the biggest part of the whole trial.

WILLIAM PLOVANIC: Right. In the discussion with the FDA, I mean, you're trying to get your IND, is it-- what's kind of the hangup? Are you-- is it just trying to figure out what the best primary end point's going to be, continuing that adhesion trials have always been difficult?

STUART ESSIG: There's-- Bill, there's no hangup. Our original guidance was we would start the trial in the fourth quarter and so we're saying we're going to start it at the beginning of the first quarter. So it's a few months delayed from what our expectations were, but, candidly, there's no hangup. It's just a question of working through all the aspects.

We hired a CRO. We've hired a group to assist in the imaging. There's no hangup, it's just a big project.

OPERATOR: Robert Goldman, KeyBanc.

ROBERT GOLDMAN, ANALYST, KEYBANC CAPITAL MARKETS: Just a couple remaining things. The expenses due to the expensing of stock options for next year, can you just remind us how much that's going to be?

STUART ESSIG: We haven't given any forward-looking guidance and we won't this quarter. What we can tell you is to refer you to the part of our 10-Q or our 10-K which talks about what the historical expensing has been and in Q2 what you'll find is that it would have reduced our earnings per share by $0.04. I think in the first quarter it was $0.05.

So I really-- I'm not prepared to give forward-looking guidance yet, but if you just used history, it would be $0.04 or $0.05 a quarter.

ROBERT GOLDMAN: OK. So then finally, there's been a question already on why the lowering of guidance for 2005 and I think it is reality that this is your second straight quarter of lowering guidance for 2005. Now that's either because the business is a bit weaker-- weakening or that your discretionary spending is increasing. And I get the sense that it's probably the latter and you cited some increase in the sales force territories beyond prior expectations, but I wanted to give you a chance just to react to that and if, in fact, it is your discretionary if you can give us some of the examples of how the spending is going higher than you might have been expecting 1 and 2 quarters ago?

STUART ESSIG: OK. I guess a couple of things. First of all, some of the guidance changes that we make, as you go through the year, is just a reflection of the history and rolling in the fact that in Q1, in Q2 we had a certain level of performance and we guide for the full year and those have to impact the overall number and so mathematically if you're coming in in the mean of the guidance, then you're-- you need to bring down the top end or you're just going to assume that in the fourth quarter there's some heroic performance.

So, I mean, I hate to state the obvious, but as the year rolls along you've got to look at the number and adjust it accordingly and we really do work hard to give guidance that's accurate and balanced and so I don't want a situation where we somehow leave outstanding the assumption that we're going to catch up in the fourth quarter for what was good but not the top end of the range performance in the first half.

So that's the biggest thing. Now to answer your question about how we've changed our spending during the year, I think you're right. We just have so many opportunities and I really don't want to slow down with some of the really extraordinary opportunities that we have, for example in the-- in the European business and we could control our spending and not ramp up, but then that's an opportunity missed and I don't think it's good for the long term for the company.

So if you ask where have we-- where could we have chosen, early in the year, to watch our spending and, therefore, put us in a position to really come in higher in our earnings per share, it's probably in the sales and marketing because most of what we've done in the G&A and in the infrastructure spending was just important to the long-term future. We probably could have spent loss on the growth of the reconstructive business and the growth of the European, but I think that would have been an opportunity missed and I think you'll look back as we go into the next few years and say those were smart decisions in terms of driving the revenue growth.

And you just look at the performance in the second quarter. 70% improvement in what's not a small business any more, this nerve repair business. 45% improvement in the skin business, which is not a small business anymore.

So I think what you're seeing is the strategy playing out and our decision as a management team that it's smart to reinvest but also to come in in the range of guidance that we gave.

ROBERT GOLDMAN: If I could just followup on the sales -- and it's important as we develop our '06 models. But when you looked at the first quarter results, you lowered for the year. You then looked at the second quarter results and you lowered your guidance for the year. So something on sales must be weakening beyond your expectations. And perhaps you could speak to that?

STUART ESSIG: Honestly, I don't really have anything more to say than I have. The business is performing well, our implant business particularly well. I don't have really anything to state except that we think the guidance is balanced.

OPERATOR: Jayson Bedford, Adams Harkness.

JAYSON BEDFORD, ANALYST, ADAMS HARKNESS: Most of my questions have been asked, but a few followups. First, can you put the number of Newdeal accounts in context in terms of the 150 accounts how many of those were using Newdeal before and then what's the potential number?

Where can that 150 go to?

STUART ESSIG: Well, we don't really know how many accounts Wright Medical had. If I could venture a guess, it was somewhere between 250 and 750, but we don't honestly know. Unfortunately, the way the original deal between Newdeal and Wright was structured, Wright was not obliged to provide us with a customer list.

Certainly many of the accounts that we're calling on have used the product before and really liked the product and so we had to prove to them that we could provide the same kind of quality service and support that Wright always did, which I think we are proving ourselves to those customers. The-- you'd be surprised, though, many of the accounts are new accounts.

And, again, the estimate for the market was well over $100 million of foot and ankle products and Newdeal wasn't even close to that number going through Wright in the United States. So there's a lot of potential out there with other players in the foot and ankle. And I'll reiterate, we're now the only player with a sales force exclusively focused on foot and ankle as opposed to that being one of the products carried, along with hips and knees and spine and all the other products that those distributor-based sales forces have. So I think our focus is going to pay off.

In terms of potential number of accounts, it's really huge, Jayson.

It's every orthopedic foot and ankle surgeon, frankly quite a few orthopods who just do foot and ankle from time to time and then surgical podiatry is a big part of the business, as well. You add it all up, I don't doubt that as we go into last year, we could have well over 500 accounts, certainly the way our sales reps are opening new accounts.

JAYSON BEDFORD: OK. And that $100 million market, is that U.S. or is that a worldwide number?

STUART ESSIG: I believe it's U.S., but I don't have that in my hands.

JAYSON BEDFORD: OK. That's helpful. And then just jumping over to the DuraGen side of the business, it came in a little higher than our expectations. Understandably, growth slowed a little bit from years past. Is that solely due to the impact of competition or is the market growth slowing a little bit?

STUART ESSIG: Boy, that's a hard question to answer, but I do not believe that the market growth has slowed. I think the market's actually increasing and, again, I can only say anecdotally having the other competitors in the market -- I mean, you go back 4 years ago, nobody even cared about duraplasty. And now the number of surgeons focused on getting the dura right, whether they're focused on a watertight seal, whether they're focused on tissue regeneration, whether they're focused on adhesion prevention, it's a real topic and that expands the market.

Also, we're not a spine company, so the focus that we've made has really been on neurosurgeons, but when you get up to 90 or 100 reps, there's just more time for them to call on spinal-- spinal orthopods and drive the product there. And as you go outside the U.S., the adhesion potential that we've got with our current labeling and, frankly, the interest that we're getting in this clinical trial in the United States, I only see the market size increasing. I don't-- we still think more than half of the market's available from autograft.

So I don't think it's market size. I think what you've seen-- the slowing in growth is clearly the impact of the competition over the last year, but if you just think about what we've accomplished, and a record quarter in DuraGen, we're going to win this battle.

JAYSON BEDFORD: OK and just as a follow-on, are you getting traction with DuraGen as an adhesion barrier in Europe? And then secondly, can you maybe talk about within the DuraGen family the product mix?

Obviously, you're trying to push higher price Suturable and DuraGen Plus.

STUART ESSIG: I don't want to talk about the mix except to say that Suturable DuraGen and DuraGen Plus are very successful, are growing and are at a price premium. I don't really want to provide the competition with a road map as to how.

As for adhesion in Europe, there's real interest. I would say it's still too early to claim that a big impact on our growth or on our revenues is coming from adhesion in Europe. Things are slower, for us at least, in terms of European having an impact on our numbers, particularly since our U.S. business is so big.

But there's definitely a lot of interest in adhesion in Europe.

There's definitely support from a number of our distributors and our direct group for marketing there. Again, we're not the strongest company in Europe, so we're not going to see that have the biggest impact on our numbers, although, obviously, with the reorganization of our sales group there I expect we'll do increasingly better.

So I really think on adhesion in Europe it's too early to say. But on our new products there's significant interest and uptake in our new products.

JAYSON BEDFORD: OK. And then finally, just on the dermal line, it grew 45% in the quarter. Is it mostly just the impact of selling into the orthopedic channel or is it the impact of new products? Are you seeing greater use in the burn units?

STUART ESSIG: Well, the good news is it's not burns. It's definitely the smaller sizes, the BMWD, the-- now the IMWD, the single-layer product, and it's not really yet most the orthopedic guys. It's have the 40-plus sales people in the field calling on plastics, reconstruction and foot and ankle. It's early for them to have built those relationships with the foot and ankle guys, so they're not really getting those sales principally from foot and ankle yet.

It's just the sheer quantity of them calling on wound centers, calling on foot and ankle, calling on reconstructive, calling on plastic. As they build those relationships, there's no question that there's a nice synergy between the Newdeal products and the NeuraGen and the skin, but at the moment it's really a numbers game. It's just having those additional reps and they're commissioned to sell product and that's what they're out there doing every day.

JAYSON BEDFORD: OK, sounds good. And then lastly, just housekeeping.

In terms of the share count exiting the quarter and what we should look for going forward on the share count? Is it just a little over 34 million shares?

STUART ESSIG: Yes, we're projecting about 34.5 for the third quarter.

OPERATOR: Glenn Novarro, Banc of America Securities.

GLENN NOVARRO, ANALYST, BANC OF AMERICA SECURITIES: 2 quick questions. One, Stu, on the NPH valve. You made a few comments on it.

Can you give us a little bit more color on how that is ramping up and whether or not this could be a material product for the company like DuraGen or the dermal products are?

And then just quickly on the tax rate for this year and next year, are you still projecting about 34.5%? Thanks.

STUART ESSIG: Yes, in reverse order. On the tax rate, yes, we expect 34.5%.

On NPH, our sales of NPH are up very significantly and continue to be up significantly quarter-over-quarter, month-over-month. It's not yet at the size where it's worth breaking out and saying it had a significant or material impact on the quarter, which is why we didn't, but it's to minimize the potential. And, yes, I believe it has the same potential as a DuraGen or skin for the company.

Keep in mind, we're not the market leader in hydrocephalus, so we're starting in neuro, really having to leverage our relationships in the ICU from the Caminos and the LICOXs, our relationships with DuraGen, but we do not have that market leadership position that Medtronic and J&J do in introducing new hydrocephalus technology. So it certainly is a-- is a significant effort on our part.

That being said, the price point is great. The margin is great and our sales force is highly incented to grow that business and is growing it and will grow it. So the potential is there, but I don't want to highlight it until the revenues are more significantly there.

OPERATOR: Amit Hazan, SunTrust.

AMIT HAZAN, ANALYST, SUNTRUST ROBINSON HUMPHREY CAPITAL MARKETS: Just a couple of followup questions. First, on the guidance, just so I understand -- and I apologize if I missed it -- if we look at the adjusted EPS guidance for 2005, the range has been lowered by $0.04.

Can you specifically kind of give us an idea of where-- what's been taken out of that, what's implied in that lowered EPS range?

STUART ESSIG: Not really, Amit. I mean, it's just a reflection of the revenue range is now-- I think it's the same bottom end of the range, but we've brought the top end of the range down by $3 million, so if you bring the top end of the revenue range down by $3 million you've got no choice but to bring the top end of the earnings down, because, particularly when you've got a gross margin of 63%-64%, that's coming out of somewhere and we're not going to cut spending to try to make it up.

AMIT HAZAN: Am I looking at it correctly? Because it looks like the bottom end was lowered by $0.04, as well?

STUART ESSIG: The bottom end was lowered, both because of the performance in the second quarter, which was in the middle of the range, and then our expectations as we roll out the sales and marketing with these additional revenues-- sorry, with the revenues being what they are, that it's going to-- it's going to hit those numbers.

I can't break it out in particular. We've got a model that we roll out every quarter and those are the numbers that it drives.

AMIT HAZAN: Got it. OK and then with regard to Mayfield, number one, did it contribute at all to organic growth in the quarter? And maybe if we kind of look at it going forward in the next couple of quarters, if you can tell us, just maybe what it's been growing at so we get an idea of how to-- how that's going to contribute to organic growth?

And then thirdly, if you can, I know you gave us a long term range of 15% to 20% now, but if you can give us an idea of what specifically for '05 you're looking for for your organic growth rate?

STUART ESSIG: OK. Mayfield was not included in any of the organic calculations, because the way we do our math is you have to own it for a year for it to count. So it'll start going into organic revenue growth next quarter, sorry third quarter.

When we bought it, it was growing at about 10% a year. We think we're outperforming that 10% in our hands, although, again, as I said it's not shown that way in the calculation of organic growth. I think it should be in line with the guidance that we've given, which is it should be a 15% grower along with the instrument business that we sort of placed it in.

In-- so that's the answer to that question. What was his other question?

DAVID HOLT: Year-over-year-- STUART ESSIG: Oh. Well, the organic growth rate that's implicit in the year-over-year guidance is-- we've given you the revenue guidance for 2005, so you just have to back into the organic growth rate. Use the range that we gave you. I don't have it at my hands here, but we gave you the range for 2005.

AMIT HAZAN: OK. And just a couple of last followup questions. Number one, on the LICOX question, if you can give us an idea of what your backlog might look at at this point and then, number two, with regard to the NeuroSensor product, is that contributing at all to revenues at this point? And when might you see a more meaningful contribution to revenues there?

STUART ESSIG: Well, it didn't-- there were no revenues for NeuroSensor in Q2. In Q3 there are revenues, but they're not going to be material.

We have 20 sites up and running evaluating the NeuroSensor and I would guess we'll finish the quarter with 30 sites up and running evaluating the NeuroSensor. Some of them will buy the product, but it's not going to be a material impact in the quarter.

In terms of LICOX, what we said was we have 195 monitors in the United States. We sold 14 in the second quarter. We have 37 monitors on evaluation in various hospitals. So we don't really calculate a backlog, but certainly with 37 LICOX on evaluation, some fraction of those will convert this quarter.

OPERATOR: Karen Mroz-Bremner, Shaker Investments.

KAREN MROZ-BREMNER, ANALYST, SHAKER INVESTMENTS: Most of my questions have been answered. I'm sorry if I missed this, though. On the gross margin, you had said 63% is what you're targeting for the back half of the year?

STUART ESSIG: That's the adjusted number. You can back out-- some proportion -- and we haven't given guidance as to what that proportion is -- but some proportion of the restructuring activities to get to an adjusted gross margin. Keep in mind, in Q2, the vast majority of the restructuring and integration costs actually hit cost of goods sold.

So the answer is, previously we gave guidance of 64% for the year and the-- if we adjust the 63% for the one-time charges, you'll be in excess of that 64% in the back half of the year.

OPERATOR: Thank you. We have no further questions at this time.

STUART ESSIG: OK. Well, then, thank you all for joining us for our second quarter conference call.

OPERATOR: Thank you. This does conclude today's conference. You may disconnect your lines at this time. Have a wonderful day.

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