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Executives

Joe Newcomb – VP, General Counsel and Secretary

Josh Levine – President and CEO

Mike O’Neil – VP and CFO

Ed Northup – VP and COO

Analysts

Greg Gilbert – Merrill Lynch

Larry Biegelsen – Wachovia Securities

Frank Pinkerton – Banc of America Securities

Amit Hazan – Oppenheimer

Jonathan Cohen – Natixis

Annabel Samimy – UBS

Gary Nachman – Leerink Swann

Hesham Shabaan – Maxim Group

Anthony Vendetti – Maxim Group

Jayson Bedford – Raymond James

Peter Bye – Jefferies & Company

Julie Hoggatt – Noble Financial

Jonathan Block – SunTrust Robinson

John Harloe – Barrow Hanley

Mentor Corporation (MNT) F2Q09 (Qtr End 09/26/08) Earnings Call Transcript November 5, 2008 5:00 PM ET

Operator

Good day, and welcome to Mentor Corporation’s second quarter earnings release. At this time, all participants are in a listen-only mode. Later during the program, there will be an opportunity to ask the questions. At this time, I’d like to turn the call over to Mr. Joe Newcomb, Vice President and General Counsel for Mentor Corporation. Please go ahead, sir.

Joe Newcomb

Thank you, operator. Good afternoon, everyone, and thank you for joining us today. With me are, Josh Levine, President and Chief Executive Officer; Ed Northup, Vice President and Chief Operating Officer; and, Mike O’Neil, Vice President and Chief Financial Officer.

This conference call elaborates on a press release that was issued earlier today. If you have not already received the copy of our press release, please call Vicky Johnson at 805-879-6082, and she will fax or e-mail a copy to you. The press release may also be found on our Web site www.mentorcorp.com.

As a reminder, Mentor has a fiscal year that ends March 31st, and we make reference to any quarter or year today on the call, we will be referring to our fiscal year unless otherwise noted. During this call, we will discuss, among other matters, our financial results for the second quarter ended September 26, 2008. This conference call will include a discussion of non-GAAP financial measures as that term is defined in Regulation G. The most directly comparable GAAP financial measures and information reconciling these non-GAAP financial measures to the company's financial results in accordance with GAAP have been provided with the press release and posted on the company's Web site.

Before we begin, I've been asked to read the following Safe Harbor statement pertaining to forward-looking statements, which we will be making during the course of our conference call. Today's conference call includes statements regarding Mentor's financial results for the second quarter of fiscal year 2009, the MemoryGel silicone gel-filled breast implants post approval study, updated guidance for fiscal year 2009, and several product development and clinical programs as well as other forward-looking statements within the meaning of the Federal Securities Law.

It should be clearly understood that these forward-looking statements and our assumptions about the factors that influence them are based on the limited information available to us at this date. Such information is subject to change, and we undertake no obligation to revise or update publicly any forward-looking statements for any reason. Actual results may differ substantially from those anticipated. Specific factors that may affect our business and future results are disclosed in our SEC Forms 10-K, 10-Q, 8-K, and other SEC filings. A partial list of these important risk factors is set forth at the end of today's press release.

Now, I’d like to turn the call over to Josh Levine.

Josh Levine

Thanks, Joe. Good afternoon, everyone, and thanks for joining us. As we reported in our press release earlier today, Mentor continues to see the effects of a challenging economic environment that has adversely impacted procedure volume for cosmetic breast surgery. While we can’t influence the broader economy, we’ve continued to manage the elements of our business that we can control. And we are seeing the positive impact of our efforts in continued share growth as well as increase in MemoryGel product mix in the domestic marketplace.

We are pleased to note that we are at a 50% MemoryGel penetration rate for the quarter versus 45% penetration for Q1. Strong growth in the domestic reconstruction market continued during the quarter as many of our plastic surgery customers have refocused their efforts on this procedure segment. As you know, our reconstruction business, which includes tissue expanders and NeoForm, our dermis tissue product, currently represents roughly 20% of our business. And we are very focused on expanding this non-economically sensitive component of the business.

During the quarter, the international segment of our business continued to show procedure growth as measured in units, with overall volume growing in the mid single digits. While Western Europe has been showing signs of the same economic pressure that we have seen domestically, activity in emerging markets such as Brazil, China, and Russia as well as key markets in the Pacific Rim showed positive growth.

Investments in key marketing programs that help our surgeons support new patient consultations and drive the MemoryGel product mix have continued during the quarter, but we are managing spending very tightly going forward given the continued pressure on procedure demand. Additionally, the company is in the preliminary stage of an extensive review of our current operating cost structure, with the ultimate goal of ensuring that overall costs are aligned with the revenue and economic realities that we face going forward.

I know that some of you have raised questions regarding an article that was published yesterday in the Journal of the American Medical Association suggesting a possible correlation between breast implants and an extremely rare form of non-Hodgkin’s Lymphoma known as anaplastic large cell lymphoma or ALCL.

For those familiar with the history of the breast implant industry, you know that breast implants are arguably the most studied medical device in the history of medicine. Over the past decade, there have been numerous independent studies performed by credible, unbiased researchers that have examined whether breast implants are associated with connective tissue disease or cancer. These studies, including the study by the Institute of Medicine, have concluded there is no evidence – no convincing evidence that breast implants are associated with either of these diseases. Previous epidemiological studies have examined that there is an increase in risk for non-Hodgkin’s Lymphoma in patients with breast implants, and no causal relationship has been established. I want to be clear that based on the extensive body of research in Science, we remain confident in the safety of our products.

One last time I’d like to comment on before turning the call over to Mike, we’ve recently completed patient enrollment in our MemoryGel Post-Approval Study. We are proud of this accomplishment, and are pleased to have fulfilled this commitment well in advance of the mandated deadline. I want to thank our clinical regulatory group for their incredible efforts in completing this enrollment process. I also want to thank – and take this opportunity to thank all of our employees and executive team in the face of this challenging environment.

Now, I’ll turn the call over to Mike to review the financials in detail.

Mike O’Neil

Thanks, Josh. As required on the generally accepted accounting principles, the operating results of our discontinued businesses are recorded below net income from continuing operations. I’d like to explicitly note that my comments today will only cover our continuing operations.

As a reminder, our fiscal Q2 is historically our seasonally lowest quarter of the year in terms of revenue. As a result, our spending ratios tend to be among the highest of the fiscal cycle given that some costs are clearly fixed in the near term. We finished the second quarter with $84.5 million in sales, a decrease of 1% from the $85.4 million in the second quarter of 2008. The quarter includes $1 million of positive currency effects. Excluding the effects of foreign exchange, we were down 2% from the prior year.

Breast aesthetic sales were $74.4 million in the second quarter, a decrease of 2% from sales $75.7 million in the second quarter of fiscal ’08. Our domestic breast aesthetic business was down 5% year-on-year, with procedure volume declines being offset by the price impact of MemoryGel conversions, strong reconstruction sales across all markets, and moderate international growth.

Sales of liposuction equipment and disposables were $3.4 million into the second quarter, down slightly from last year of $3.7 million. Sales of our other aesthetic products, which includes the facial products, were $6.7 million in the second quarter of fiscal 2009, compared to $6.1 million for the second quarter last year. The increase over prior year was due in part to higher sales of general products.

I’d now like to review some of the significant differences between last year’s total results and this year’s current performance.

With effective gross margin, last year’s second quarter was negatively impacted by a $1.4 million charge for the step up valuation of inventory related to the Perouse acquisition. Without this step up charge, last year’s future gross margin would have been 71.8%. This compares to 69.7% for Q2 of this year. The current new gross margin percentage has been negatively impacted by lower production volumes, manufacturing support costs, and inventory reserves.

Our SG&A spending in Q2 FY’09, which represents 45% of sales, includes additional expenses of $1.5 million related to the evaluation of our strategic opportunities. Excluding this expense, SG&A would have been 43.2% of sales. This compares to 39.1% of sales in Q2 of ’08. Our level of spending reflects the expansion of our international presence, strengthening our core capabilities to support the breast implant business, and our entering the facial aesthetics.

Due to the restructuring of our foreign operations, the second quarter of fiscal ’09 includes a $2.3 million tax benefit, which is reflected in the 5.2% tax rate for the quarter.

In moving to earnings per share, we reported diluted earnings per share from continuing operations of $0.28 in the second quarter of fiscal 2009, compared to $0.27 cents per share in the second quarter last year. Excluding the $1.5 million in expenses relating to the potential strategic opportunities and the $2.3 million tax benefit included in this quarter, non-GAAP EPS was $0.24 in Q2 FY’09, and this compares to non-GAAP EPS of $0.29 in Q2 of FY’08.

In turning to our cash division and cash flow, we reported cash and marketable securities of $98 million as of September 26, 2008. This compares to $110 million as of March 31st, 2008. For the first half of fiscal 2009, our operating cash flow from continuing operations was approximately $25.3 million. Depreciation and amortization was approximately $8.4 million. And our capital spending on milestone payments was $22.6 million.

Additionally, we recently drew down $150 million from our credit facility in preparation for potential capital structure changes. We reported inventory and net accounts receivable balances of $52 million and $77.1 million, respectively, versus prior year end balances of $49.9 million and $82.1 million. We did experience a moderate increase in day sales supply and day sales outstandings due in part to the current economic environment.

And finally, as noted, we are updating our full year FY’09 guidance as follows, sales are in the range of $335 million to $370 million, diluted GAAP earnings per share from continuing operations of $1.10 to $1.20, and we are not providing specific spending ratio guidance at this point in time for the remainder of fiscal ’09.

Thank you. And now Ed will provide a review of our product development programs.

Ed Northup

Thanks, Mike. Turning first to breast aesthetics, as we reported for the last few quarters, the PMA application for our contour profile gel anatomical breast implant remains under active FDA review.

Moving on to our dermal filler programs, for PREVELLE Shape, our PMA is currently under review by FDA, and we continue to believe this product will be approved in the fourth quarter of fiscal 2009. For PREVELLE Volume, we’ve completed the clinical trial, and expect to submit this to PMA in fiscal Q4 2009, the year we have submitted the product for CE approval as well.

Our botulinum toxin initiative, we have now completed enrollment in all three phases of the Phase 3 trials required to support the cosmetic indication. The first of these, a randomized study with six months follow-up, is fully completed and was submitted to the FDA in early September. The results from this study are highly encouraging. All study end points were met with a high degree of statistical significance.

The second study, a randomized repeat dose trial, is in the follow-up phase with completion anticipated in fiscal Q4 2009. We expect to file the BLA in Q3 fiscal 2010, with approval approximately one year later.

The last of the three studies, a three-year open label repeat dose safety study is in the follow-up phase, and will provide supplemental safety data, which will be submitted to the FDA after the initial BLA filing.

The Phase 1 torticollis/cervical dystonia study has been completed. And the clinical study report is being prepared for submission to FDA. Early clinical results remain encouraging, and are being used to inform – to inform the design of the next phase of the clinical study for this important indication.

With that, operator, we’d like to open the call for questions.

Question-and-Answer Session

Operator

(Operator instructions) We’ll take our first question from Greg Gilbert with Merrill Lynch. Please go ahead.

Greg Gilbert – Merrill Lynch

Thanks. So I’ll ask my two right upfront. Can you talk more about that evaluation of a strategic opportunity and where that has led you? And whether the spending on that item will continue? And the second question is around SG&A, maybe perhaps you can comment on how much more flexibility is there to take it down as needed without significant changes to the company’s infrastructure?

Josh Levine

Great. We’ll tag team this. I’ll take the first one, and Michael, take the back end. The answer on the first question is we don’t comment specifically on that kind of strategic M&A activity. We’ve been consistent in the messaging over time that says, “We’re looking at opportunities strategically that allow us to expand our business. And we continue to do that actively.” I think that it would be most accurate, I guess in the current situation, to say that it’s not likely that that expense that you saw in the quarter would continue.

Mike O’Neil

Hey, Greg. SG&A, obviously one of the things as, really, the fiscal year has unfolded, we’ve been looking at discretionary spending across the business, particularly in the area of SG&A. And we’ll continue to do that. So we’re looking at those areas that we can modify first. And I think part of the prepared remarks that Josh noted is we are looking at the overall cost structure on a go forward basis.

Part of the reason that we didn’t want to get into specific ratio guidance at this juncture of the year is we want to make sure that we’ve got the latitude and flexibility to make those short term and long term decisions as we go forward from here. So making sure we’re managing the business for the long term as well as making the appropriate short term adjustment.

Greg Gilbert – Merrill Lynch

Thanks. I have a bunch more, but I’ll get back. Thanks.

Operator

And our next question comes from Larry Biegelsen with Wachovia Securities. Please go ahead.

Larry Biegelsen – Wachovia Securities

Hi. Thanks for taking my questions. First one is in the most recent 10-Q, you said that you have received a bank commitment to extend the credit agreement by $150 million through October 2009 with the purpose is to possibly refinancing the notes. As we think about modeling fiscal year 2009, is it a most likely scenario using the facility to pay for redeeming the convertible – the convertibles rather than refinancing the converts? And what’s included in your guidance?

Mike O’Neil

Yes. We actually did an amendment to the credit facility for 13 months. And we filed that in late September. And that actually – it maintains our existing credit facility of $200 million with an accordion of $50 million. The drawdown that we recently undertook was in preparation for what would inevitably a put come January 1st if we don’t do anything. And potentially, also, positions us to be able to be more proactive as it relates to the converts. We’ll still want to maintain, in terms of the comments in the prepared remarks about capital structure that may not be the only sole use of the money. But clearly, that’s on our minds right now.

As it relates to forward-looking guidance, given the timing is really nine months before – nine months with the convert and three months without it, on a weighted average share count and EPS basis, it has very little effect on ’09 EPS.

Larry Biegelsen – Wachovia Securities

Thanks. And then, secondly, could you comment on just a volume trend in the quarter in the US and non-US, for cosmetic procedure volume obviously? Thanks.

Josh Levine

Yes. I’ll take that. I mean basically, the – this is a – it’s a difficult environment. It’s probably the most difficult environment in terms of overall market conditions I’ve seen in my time with the business. I will tell you that the feedback from surgeons and customers is that they’re working hard to try and do the best they can in the face of the environment that we’re dealing with. I think the people that fairing better, Larry, are people that have maintained the better balance in terms of procedure mix in their practice. People that have really been almost exclusively focused on the cosmetic side of the procedure mix really have taken it on the chin, so to speak, here in a more substantial way.

Clearly, volume is down. And I think the positive news here is that we’re still getting – and it looks like we’re doing a good job with the – managing the product mix. I mean there’s a lot of focus right now on silicone gel conversion, significant piece of the sales force compensation program. Ad a matter of fact, all of us, quite frankly, from an executive management standpoint are being measured on managing product mix and the gel conversion discussion in the context of delivering the forecast that we had for this year.

And I think, as I mentioned, we showed the quarter – the average penetration for the quarter. And I think around 50% versus 45% for Q1. So that’s having some offset on the volume decline.

Operator

And our next question comes from the side of Frank Pinkerton with Banc of America Securities. Please go ahead.

Frank Pinkerton – Banc of America Securities

Great. Thanks for taking the question. First of all, Josh, can you just remind us when we think of – with the JAMA article out, what has Mentor done from the standpoint of long term insurance that remain – if these liabilities do come up? How is the company somewhat buffered there?

Josh Levine

Well, before I get to that. I think I would go back and refer to the comments we made just a moment ago. This, obviously, is hot off the press. We’re monitoring reaction in real time. I will tell you that over the course of the day, we haven’t gotten any questions from customers. And it doesn’t appear to be a significant degree of input or concern at this point from a market or a customer standpoint. We’re going to continue to monitor market feedback at this point.

But what we’re talking about here is on an absolute risk level, ALCL is exceedingly low in this patient population. We’re talking about one to three cases per one million women in million people per year. So very, very small in terms of absolute occurrence, no causality between the implants and ALCL has been established in this study. There are elements of the study that I would say – need further investigation. Confounding factors were not taken into account on the study. So at this point, we take all of these things seriously. But in the near term, I don’t see anything that we’re overtly or usually concerned about.

From an insurance standpoint, we self-insure. We’ve got a captive insurance on. And again, this – the litigation profile on this business is – has been and continues to be nothing really different than what you find in many other medical device businesses in terms of risk profile.

Frank Pinkerton – Banc of America Securities

Great. And then, Mike, I guess if I can ask one to you. I know you don’t want to guidance for specific line items. But when I think of – when I think of investment capital for your business, which would be R&D plus CapEx that is running as a percentage of sales somewhere in the 23%, 24% range. I know there’s a lot of investing going on right now for Puretox both with the new facility and the R&D programs. Just when we think of normalizing long term, what do you see – major new investments, what should that normalized rate be when we think of R&D or CapEx as a percentage of sales? Thanks.

Mike O’Neil

Dealing with CapEx first because I think the Madison facility over a two-year period is an exceptionally high investment for us. And certainly that dominated our ’08 and now our ’09 CapEx ratios. In terms of R&D, I think we’ve been very clear that as we move into the Post Approval Study and the toxin clinicals, we have a high watermark of clinical investment for our expense as well. So as we come out of, frankly in this period now, at least through the enrollment of Post Approval Study. We have a little bit of leverage there in R&D.

And I think as we move through – in the future years without getting specific around fiscal ’10, normalized R&D for our breast implant business is probably around 6% to 7%, depending on the level of clinical trials that are going in there as well. I think if we stopped to broaden the portfolio, the high watermarks that we’re seeing in ’09 will come down by a couple of points. But again, I don’t want to get too specific around timing of that.

So I think that the overall message is that we’re in a period right now of both high CapEx and high clinical trial expenses. And I’m expecting that to come down to more normalized levels in the future.

Operator

And our next question comes from Amit Hazan with Oppenheimer. Please go ahead.

Amit Hazan – Oppenheimer

Thanks. Hey, good afternoon, guys.

Josh Levine

Hi, Amit.

Amit Hazan – Oppenheimer

My first question is regarding the credit facility and the convert. I just want to be very clear about this. On the credit facility, can you talk about any covenants that you have in there, in particular with EBITDA? I think I was reading about – and give us some comfort as to whether you can – to what extent you can hit that within the guidance that you’ve given, and any other covenants that we should know about. And then I have one more question.

Mike O’Neil

Yes. Okay, Amit. So obviously if we went into drawdown the credit facility, we do a covenant check on a pretty routine basis. Even to establish the amendment for the credit facility, we provided the bank syndicate with a forward-looking view as it related to adherence to the covenants. We don’t have any concerns at this point in time with any covenants that we’re going to trigger any issues there.

Amit Hazan – Oppenheimer

Okay. So I mean, the follow up on that one would be whether there was an EBITDA number I know that you were required to hit. And then, my separate question is with regard to your comment in the press release about market share gains. I’m just looking at the last few quarters here, just the last three quarters. And since your acquisition of Perouse, in terms of revenues for breast implants, you are well ahead of Allergan for three straight – for a few quarters now. This is the lowest you’ve been ahead of Allergan this calendar year. So I don’t know where the share gains come in, if you can help us with that? And then also, as it relates to that – sales and marketing expense, if you’re reducing that, are you confident you can continue to maintain your market share if you lower sales and marketing expenses, if that’s indeed what you’re planning on doing?

Mike O’Neil

Hey, Amit. Okay. So as it relates back to the covenants, again I want to emphasize that we’ve done a covenant check. There is indeed a dollar requirement. We’ve satisfied that requirement. And I’m not concerned about triggering a violation of that covenant. I really don’t want to get anymore specific than that.

Josh Levine

Amit, on the market share discussion. I would think – I think that our data internally and some of the third party data suggests that dipping some modest domestic market share gains – so that really is what I’ve been referring to. I think the other point is, from an international market standpoint, we have a significant amount of activity going on in the distributor channels of the international marketplace. And in many of those markets, you’re looking at six, seven, eight different competitors. The first company that comes to mind, obviously, in competitive context with us, is Allergen. But there are a lot of other companies that we can be taking share from given the fragmented nature of the marketplace in the – in the international arena. So those would be the references I’d point at.

Operator

And our next question comes from Jonathan Cohen with Natixis. Please go ahead.

Jonathan Cohen – Natixis

Hi. Good afternoon, gentlemen. Sorry to keep harping on this. With regard to the EBITDA covenant, could you state under the bank definition of EBITDA what it was, actually, for the current quarter and on the LTM basis?

Mike O’Neil

We actually have an adjusted calculation that goes in there. It’s not a straight EBITDA, but you could lift off our P&L in my prepared remarks.

Jonathan Cohen – Natixis

And can you give us some idea what that number was for the quarter?

Mike O’Neil

I’m not going to be specific about it, but we’re fine.

Jonathan Cohen – Natixis

All right. Thank you.

Mike O’Neil

Okay.

Operator

And our next question comes from Annabel Samimy with UBS. Please go ahead.

Annabel Samimy – UBS

Hi. Thanks for taking my call. Just a quick question, I mean it’s clear that the volumes and the breast implant market are coming down. In order to keep the shares that you’re keeping, have you had to take – make any pricing concessions or increase your discount programs at all? And is there – is the share of the silicone really increasing more because the volumes have dropped so much? Can you give us a little bit more color on that?

Josh Levine

Sure, Annabel. I would say pricing in general has been reasonably stable, nothing that from ASP standpoint that I would say is anything out of reasonably recent historical context or ranges. And so, we are not – we’re not leading with price. That has never really been our view in terms of approach. We also will not walk away or allow anyone to target our business and have us just roll over either. So if we’re challenged, we’re going to do what we need to do to hold on to our volume. But we’re not leading with price in anyway. And I would say, again, that pricing has been reasonably stable.

I mean I think if you look year-on-year, we maybe down low single-digit kind of ASPs, but that’s not – that is not anything out of historical ranges. So there’s nothing there that I would point that I’m concerned about. I apologize, what was the other piece of your question?

Annabel Samimy – UBS

Just in terms of the conversion, I guess, 50%. Is that more a factor of you increasing your – is it because of the volumes have declined a bit, and so the denominator is smaller for – your shares increased? I mean, do you actually – do you feel like you’ve actually targeted more and your increase in shares significantly–?

Josh Levine

I think that the – the answer to that is that, I think sailing demand – overall, absolute sailing volume is coming down. And the mix in the market is becoming – moving more to silicone gel. Again, we have a significant amount of emphasis in terms of focus internally on this, programs that are supporting it, comp plans that are aligned and have people aligned to it. So it’s a very, very big focus as a company. And again, if you looked at Q1, I think on average for the quarter, we were probably 45%. Q2, on average, we were close to 50%. And so, I think it’s cause and effect. We’ve got a lot of emphasis on it. And we’re seeing improvements in those areas.

Annabel Samimy – UBS

Okay. Do you have your share – what’s your precise share of the market in the US now, their market share? Around 52% or–?

Josh Levine

I’d say about 55%.

Annabel Samimy – UBS

Okay. Great. Thank you.

Josh Levine

Yes.

Operator

And our next question comes from Gary Nachman with Leerink Swann. Please go ahead.

Gary Nachman – Leerink Swann

Hi. First question, just back to the conversion of silicone, I actually would have thought it would more associated to the economy. I was surprised to see that it jumped up that much. Can you comment on that? And what kind of trends are you guys assuming for the rest of the year, something similar to what we’ve seen in the first half? Thanks.

Josh Levine

Well, we haven’t – Gary, we haven’t given a forecast for the year or on a quarterly basis at all on the conversion fees. And I don’t think we’re going to be giving any indications, specifically, of that today. But it’s interesting. I think that if you would ask me four, five months ago and I think we – in public comments, we alluded to this. We were really cautious about the impact on the silicone gel penetration based on the economy and based on the price point differential and the sensitivity of the price point from an economic standpoint.

I know that we have an enormous amount of emphasis and focus on this from both the marketing and a sales perspective. We will see some variability month-to-month in the numbers. But in terms of overall average for the quarter, it’s been significantly higher in Q2 than it was in Q1. So maybe to some degree counter-intuitive and somewhat surprising, but I guess the only thing I could attribute it to is just an awful lot of focus and emphasis on it from our end.

Operator

And our next question comes from Hesham Shabaan with Maxim Group. Please go ahead.

Hesham Shabaan – Maxim Group

Hi. I just want to follow up with the question regarding discounting. We’ve been hearing some RN that there has been some discounting on the silicone side, specifically. Would you care to comment on that? And if so, would that correlate to the up-tick in a silicone percentage this quarter.

Josh Levine

Yes. My answer to the question is the same as I answered, and I think for Annabel, before, which is pricing has been reasonably stable. We’re not leading with price. We’re not letting competitive pricing or discounting activity take our volume away from us. So we are responding and competing in our existing business and existing accounts. But again, on a year-on-year basis, we’re not seeing pricing dramatically change, either on saline or silicone.

Mike O’Neil

And I would just add, while Josh just gave you a flavor of the year-on-year, sequentially, quarter-on-quarter, there was virtually no change in our average selling price.

Hesham Shabaan – Maxim Group

Okay. That’s good to hear. Just a follow-up, you had mentioned potentially low single-digit decline on ASB. Is there something specific there that you can attribute that to? Or is that just normal run of the business?

Josh Levine

Again, from a historical perspective if you look back over a long period of time, that is not out of historical ranges. So I don’t see anything there that’s atypical or unusual in terms of overall change or variance year-on-year or quarter-on-quarter.

Hesham Shabaan – Maxim Group

Okay. Thanks for taking my questions.

Operator

And our next question comes from Anthony Vendetti with Maxim Group. Please go ahead.

Anthony Vendetti – Maxim Group

Okay. Good afternoon.

Josh Levine

Hi, Anthony.

Anthony Vendetti – Maxim Group

Internationally, you said there have been certain countries that have been strong. Could you talk specifically about which countries are still seeing some decent volume?

Josh Levine

Yes. I mean, procedure volume in places like Brazil, Venezuela, Colombia, Chile are still, I would say, healthy markets in terms of procedure growth – procedure growth probably in high single-digit kind of volume ranges. As I mentioned in the prepared remarks, markets in the Pacific Rim, China, Taiwan, and Korea are both strong markets, Thailand to a degree as well. Those would be examples of the places where there is positive procedure growth, and again comparatively, strong unit volume growth, high single-digit kind of growth.

Anthony Vendetti – Maxim Group

Okay. Did you break out the percentage of your procedure volume that’s international?

Josh Levine

I mean, the mix of the business, Anthony, is about 65% domestic, 35% OUS.

Anthony Vendetti – Maxim Group

Okay. And last–?

Josh Levine

That’s reasonably consistent. That’s dollars.

Anthony Vendetti – Maxim Group

Dollars, okay. And reconstruction, is that still just about 20% of your business?

Josh Levine

It is.

Mike O’Neil

Yes.

Anthony Vendetti – Maxim Group

Okay. Great. Thanks, guys.

Operator

And our next question will come from Jayson Bedford with Raymond James. Please go ahead.

Jayson Bedford – Raymond James

Hi, good afternoon.

Josh Levine

Hi, Jayson.

Jayson Bedford – Raymond James

Just a couple of quickies, is there any commercial benefit to Mentor from completing the Post Approval Study?

Josh Levine

I’m going to let Ed fill that one.

Ed Northup

Yes. We actually think that there are several benefits for completing the task. First, our clinical and selling teams have been investing a tremendous amount of time on this initiative. And they’re now going to be able to redirect valuable resources to new studies and increase selling time. Secondly, we’ll be able to market MemoryGel without additional requirements in old patients in post approval studies or to incur significant administrative burden on the part of the doctors and patients. And lastly, it will reinforce our commitment to the clinical community, in our minds, the regulatory authorities, and the general public to execute one of the largest post approval studies in the history of this product line. So we think there are really three significant benefits to our business.

Jayson Bedford – Raymond James

Okay. That’s helpful. And then, Mike, I’ll ask you the easiest question you’ll get tonight. In terms of the EPS guidance, the $1.10 to $1.20, does that assume $0.28 or $0.24 for the second quarter?

Mike O’Neil

It’s $0.28 because I tried to emphasize a diluted GAAP EPS.

Jayson Bedford – Raymond James

Thank you.

Mike O’Neil

Okay.

Operator

And our next question comes from Peter Bye with Jefferies & Company. Please go ahead, sir.

Peter Bye – Jefferies & Company

Hey. Good afternoon, guys.

Josh Levine

Hi, Peter.

Mike O’Neil

Hey, Peter.

Peter Bye – Jefferies & Company

Just the historical breast business with NeoForm, did that grow and Perouse grow as well? Or was one significantly up from the other because it seems like the countries you mentioned are maybe a little bit stronger with other body parts? Can you just–?

Mike O’Neil

NeoForm was probably a reasonable contributor of growth there versus the prior year.

Peter Bye – Jefferies & Company

Breast units for maybe Perouse, is Perouse still growing on its own?

Mike O’Neil

Perouse is still growing on its own. But Peter, I should be clear about this. The NeoForm product is a domestic product.

Peter Bye – Jefferies & Company

Right. I’m talking about the unit growth of the other body implant parts from the Perouse business. Sorry, that’s what I meant. Thanks. And then, you still have – is the growth margin then on the quarter – it’s similar revenue that you had in Q2 last year and you had Perouse as well. Sometimes I know there’s a lot of quarterly variations and the like. Is there anything that you can sort of step out on that relative to the decline year-over-year.

Mike O’Neil

I think so. The positive thing is you’ve got the international mix that comes through. It’s a bit – it’s somewhat detrimental. Frankly, we are looking at the impact on our volume profile going through the plant. In some of my prepared comments, I talked about lower volumes, manufacturing support. And those would be – they were the bigger impact in terms of gross margin.

Peter Bye – Jefferies & Company

Okay. So that means – even higher silicone mix is not enough to offset that off to–

Mike O’Neil

Yes. The other thing there is, and I think we’ve tried to be a little clear about is over time. The gross margin percentage of the silicone gel is not that different. It is a little higher, but it’s not that different from a saline product. The real benefit is the ASB uptake that you get. That’s where the leverage comes into P&L.

Peter Bye – Jefferies & Company

Okay. I guess that’s my two. I’ll jump in back in queue. Thanks.

Operator

And our next question comes from Julie Hoggatt with Noble Financial. Please go ahead.

Julie Hoggatt – Noble Financial

Actually, guys, all of my questions have been answered. I tried to jump out of queue. I appreciate it. Thank you.

Operator

And then our next question will come from Jonathan Block with SunTrust Robinson. Please go ahead.

Jonathan Block – SunTrust Robinson

Thank you, and good evening.

Josh Levine

Hi, John.

Mike O’Neil

Hey, John.

Jonathan Block – SunTrust Robinson

The first one just pertains to facial. I think if you will look there, the revenue growth rate seem to be decelerating meaningfully over the past three quarters. So obviously aware of what’s been going out – going on out there, but just thinking that maybe some of the newer products Silk maybe able to stabilize that. So maybe if you can speak specific to facial, and then, what are your experiences with Silk?

Josh Levine

I think, John, we’ve been consistent in the – where we were at launch and what we’ve learned over time. We were pretty clear upfront. We saw Silk as a niche product, interesting product in a lot of respects, but not a – not a restoring or (inaudible) killer in any sense. The feedback from customers has actually been positive about this product. And I think it has – in the places where it’s been used and with the injectors that have used it, they’ve been pleased, as have patients.

As we’ve said upfront though, we have – this was not a product that would have allowed us to have made decisions around resourcing and infrastructure build out for this stand-alone SKU. So we’re going to continue as we have indicated that evaluating infrastructure needs and costs, and the timing thereof as we get further into the build out of the portfolio. And that really, again, has been very consistent over the last couple of quarters. So we still like the product lineup. We’re looking at Q4, late Q4, this year for the PREVELLE Shape discussion. And we expect that I think the PMA submission for PREVELLE Volume should be in late Q4 as well.

Jonathan Block – SunTrust Robinson

Okay. Great. Most of mine have been answered, but let me try the gross margin question a little bit differently. It was weak. It was below what we were certainly looking for. And I think you cited more efficiency as rather than price. So as we look forward maybe over the next couple of quarters, I think you’re telling us the volume should remain under pressure. Is there any reason to believe that gross margins should tick back up over 70% going forward?

Mike O’Neil

Without getting into the specifics of the P&L ratios, I think, obviously, we’re looking at our higher gross margin business, which is breast implants in the US coming under pressure. We’re still seeing and still looking forward to continuing to grow our international business. By definition, that has a lower gross margin. But I don’t want to get specific in terms of the numbers. But I think that the overall conclusion is not too wrong.

Jonathan Block – SunTrust Robinson

Okay. Thanks, guys.

Josh Levine

John, I would just amplify on that. As we talked earlier in our prepared remarks about, essentially, the initial stages of our review and analysis on the company’s cost structure, overall cost footprint, that’s a wall-to-wall look – that will also prove that the manufacturing component as well. While I agree with Mike that directionally that probably is the right assumption, we’re going to have a better sense about where we land in the overall cost structure discussion over the next several months.

Operator

And our next question will come from Greg Gilbert with Merrill Lynch. Please go ahead.

Greg Gilbert – Merrill Lynch

Hi, Mike. Can you share with us the terms of the revolver in terms of rate or what it’s tied to?

Mike O’Neil

My wall clock is 200 basis points, all prime.

Greg Gilbert – Merrill Lynch

Okay. And then for Josh, you talked about the recon market a bit in your prepared remarks. So I’m just wondering what you can actually do to enhance your business in that market. I assume that market is what it is in terms of size and growth characteristics. I think you can’t make it bigger per se, but are there initiatives that you can put forward in terms of share specifically for that market? Is that what you’re getting at?

Josh Levine

Yes. I think more the latter. Again, I agree it is not a – this is not a business that you look at and say is necessarily high growth. But we have, I think, a product line up, Greg, that really causes right now more of – more selling time in the operating room than our competitors. And NeoForm is a good example. The reconstructive sling, in the launch of that product, our reps have spent and continue to spend a fair amount of time, base time in the OR. And that makes – that makes a difference. I think while there’s a reasonably comparable product line up, I think that we have some incremental product portfolio advantages today. I think the market believes that our tissue expander is the premier device of its type in the category. I think the NeoForm sling is a – is an incremental benefit from a surgical armor (inaudible) standpoint for the docs. And so we’ve spent a lot of time in the OR. And I think that that’s been translating into us getting – at least having a position with the certain community in that – as those cases present themselves. We’re going to get a nod.

It’s interesting, just coming back from the ASPS in the last several days. It seems reasonably consistent in terms of feedback that the surgeons that have maintained the balance of the recon cases and the cosmetic cases have been fairing better, obviously, in the current environment. Those people that were, I’m going to guess, five to seven, or five to eight years out of residency who really made a conscious decision when they came out to go exclusively cosmetic. They didn’t do any recon. They took no insurance cases. They have had a harder time in the current environment. And in some of those markets, geographically, actually because there really wasn’t a board certified plastic surgeon available to do reconstruction procedures, many general surgeons stepped in to fill the void.

And there are other products that are being used out there, there are other companies PMT, Silver Med, with breast expansion devices that are used in reconstruction that probably have a bigger piece of that general surgery market segment or specialty segment than we do because that hasn’t been a focus for us. So that represents, as we see more (inaudible) applied by plastic surgeons perhaps that haven’t had a lot of activity in the reconstructive cases, as they apply more effort in energy there, I think we’re positioned well to capture some of that business.

Greg Gilbert – Merrill Lynch

And back to cosmetics, perhaps for Ed, have you seen physicians more aggressively price and advertise augmentation procedures. I know you already commented on your pricing. I’m not asking about that. I’m asking about physicians’ willingness to take a smaller piece of absolute profit. Thanks.

Ed Northup

I think that they are using all the tools at their disposal. How they run their office, how they capture more patients coming in and make sure that they book surgeries, being more efficient. I think they’re doing more advertising, and trying to reach out and do more reimbursed cases as well.

Operator

Our next question will come from John Harloe with Barrow Hanley. Please go ahead.

John Harloe – Barrow Hanley

Thank you. I’ve got an easy question. I know all these experts are tossing out the big ROAs. But I’d just like to get a simple explanation or understanding of what the difference in cost is between saline and silicone in the US? And then, what the total cost would be after the surgical and hospital? And if it’s more extensive or not. That’s what I’m searching for, and the same thing for international, for Europe?

Mike O’Neil

I’ll take the US piece. The average selling price for saline depending on – it is geographically dependent, is probably around $7.70 to $7.75 per unit.

Josh Levine

That’s for Gel.

Mike O’Neil

I’m sorry for Gel, my apologies. And for saline, it’s around $3.75 per unit. So you can talk – again, depending anywhere, you are about an $800 to $1,000 difference per procedure cost. The important thing is that the pricing is a straight cost through the patient. So the physician really doesn’t capture any of that incremental benefit or incremental cost benefit. It goes straight through to the patient. So if the average cost of a saline procedure was $5,000, then the average cost of a Gel procedure would be say, $6,000. And again, I’m using averages that are somewhat geographically determined as well.

John Harloe – Barrow Hanley

Then how about for Europe?

Mike O’Neil

Atypically, at least pricing from us and into the market place is anywhere from 25% discount to the US depending on market.

John Harloe – Barrow Hanley

But the spread’s the same?

Mike O’Neil

Spread’s basically the same.

John Harloe – Barrow Hanley

And it costs the surgeon, in terms of his time in the hospital, expenses et cetera, is the same for whether it’s saline or silicone?

Josh Levine

Yes.

John Harloe – Barrow Hanley

Okay. Thank you very much.

Operator

And our next question comes from Gary Nachman with Leerink Swann. Please go ahead, sir.

Gary Nachman – Leerink Swann

Hi. Mike, could you speak generally about what kind of currency headwind you’re expecting for the rest of the year especially as the international business does better and just how that factored into your guidance?

Mike O’Neil

Yes. So we’ve obviously had a fair amount of volatility positively and negatively over the last six months. We have a fair number of natural hedges in our business. And yet the business is on a secure enough footing that we’ve been able to put in six currency hedges. But typically, the exposures, we have Pound, Euro, dollar more – and Canadian dollar more than anything else.

We’re assuming from our forecast, I won’t get into what forecast break I’m assuming, but I do have forecast exchange rates that map out for what we would expect the rest of the year to look like. The challenge obviously is that if anybody can predict what those rates really would be, we probably like to be talking to them. So I’m not anticipating dramatic shifts in currency exposure that would flow through and cause us to adjust guidance.

Gary Nachman – Leerink Swann

Okay. And also another one on the guidance, are you still expecting a contribution from PREVELLE Shape in their – this year? It sounds like you are. And just, would there be a fair amount of pre-launch cost for that product? Or is it just going to be nominal given, I guess, how you’re going after that market. Thanks.

Josh Levine

Gary, I wouldn’t assume in terms of faking in revenue impact. We expect we’re going to be probably towards the latter portion of the quarter in terms of an approval. And so I don’t think – if there is impact there, it’s minimal. And really, the answer to your question on – from a pre-launch expense or investment standpoint, I would, again, also say that incrementally, I wouldn’t be expecting or planning on a big pre-launch build in terms of spend.

Gary Nachman – Leerink Swann

Okay. Thanks.

Operator

And our next question comes from Amit Hazan with Oppenheimer. Please go ahead.

Amit Hazan – Oppenheimer

Thanks. Hi, sorry, just a couple of couple of follow ups. Maybe this is easy to explain, but if you drew down on your credit facility, you still have the convert. Can you just walk us through what might happen here in the next couple of months? And are you paying it up soon? Or is there something that we should know about that will delay the pay up?

Mike O’Neil

Let me give you the range of scenarios as opposed to being outright specific. So if we do nothing between now and January the 1st, and the stock price is below $28.92, unless someone’s going on vacation, I’m expecting a 100% of the bonds to be put back to us on that day. It’s also the date that our head contract for active expires. Options ahead of that are really two core options if we want to take the bonds out. One is to incent [ph] the bond holders and pay for a premium to pay them out early. Another one is to perhaps conduct open market purchases of bonds. And as you can imagine my phone has been ringing recently productively on this very issue for some time.

I don’t want to get into specifics about what our immediate next steps are. But these are three of the four options that are available to us. The fourth option from one would question whether it’s going to be able to us. If we could actually extend or try to negotiate an extension of the first date and move it out. But obviously that would dramatically impact the cost of the bonds to us right now. So they’re really the four options that we have. I don’t want to be any more forthcoming than that as to what the immediate next steps are. And again, that fourth option is one that could actually be quite expensive for the company.

Amit Hazan – Oppenheimer

Oh that’s great. That’s actually very helpful. And then on the guidance, can we assume that in your current guidance you’re still assuming or implied in there is that outside the US procedure growth is still positive?

Josh Levine

Yes. I mean I would say that in the markets that we’ve highlighted in the last couple of quarters we’re continuing to see growth. And those trends are reflected in the guidance.

Amit Hazan – Oppenheimer

Great. Thanks very much, guys.

Operator

And we will take our final question from Larry Biegelsen with Wachovia Securities. Please go ahead.

Larry Biegelsen – Wachovia Securities

Thanks for taking the follow up. I’ve been sitting here. Josh, just a clarification on your last point, the overseas procedure growth, was that in the aggregate or you still expect growth in some of those pockets?

Josh Levine

I mean if you go back to our prepared remarks, Larry. I think we’re saying right now that, internationally overall, we’re seeing unit volume growth in the mid single digit range. That’s overall. That includes Western Europe where we’re starting to see, as I mentioned, more of the pressure than we’ve seen here domestically. Obviously that’s being offset in a number of those emerging markets and pockets in Asia Pacific, pockets of Eastern Europe, Russia as an example. And so there’s – it’s kind of a mixed bag or a broad cross section of growth rates. But overall international, at least in this last quarter, is still growing in mid single-digit range, unit volume wise.

Larry Biegelsen – Wachovia Securities

The FDA panel on fillers on November 18th, any impact on you guys? Have you been asked to present if you could speak to that. And then just lastly, any movement at all on CPG since the last quarter? Any sense that we could get approval of these products in calendar year 2009. Thanks.

Josh Levine

So let me take the latter question, which is the CPG question. And I’ll turn the filler piece over to Ed. The answer is the CPG file and application remains under active review. And we believe we’ve given the FDA all of what they’ve asked for over time. And it is difficult at this point. There’s been really very little discussion about timing. There’s been little to no discussion about whether or not a panel is going to be called for or going to be required for CPG discussion.

At this point again, I think as I’ve said in the past, I don’t – I wouldn’t imagine that that would be something that the FDA would really want to see happen in the context of the anatomical Gel PMA applications. But it’s really impossible to determine. I think the other part of this that is potentially impacting the timing is where and how much progress the sponsors make in terms of completion of the post approval studies. I think we’re really pleased, quite frankly, that we’re – we’ve got enrollment behind us.

One could make an argument, and I don’t know that this is just conjecture on my part, but just given the environment, it certainly wouldn’t be totally surprising if the FDA said, “We’re going to hold on the CPG or the 410 product PMAs until we get the patient enrollment process done for what was arguably one of the major past approval conditions of the first PMAs we approved in silicone gel devices.” I know that’s a long answer and it’s a lot less precise than you’d want, but unfortunately that’s kind of the environment that we’re dealing with right now as far as this topic with regards to the agency.

Ed Northup

With regards to the filler panel, as you know, it wasn’t recalled – it wasn’t called to review a specific product. So we’re not participating to actually review a product. But we will be participating in that meeting to provide information as required.

Operator

With no further questions, would you gentlemen have any closing remarks or statements you’d like to make?

Josh Levine

I just want to thank everyone for participating today and joining the call. And we’ll look forward to talking to you next quarter. Thank you.

Operator

This concludes today’s teleconference. You may now disconnect your lines. Thank you, and have a great day.

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Source: Mentor Corporation F2Q09 (Qtr End 09/26/08) Earnings Call Transcript
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