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Executives

Jeffrey M. Schumm – Senior Vice President, General Counsel and Corporate Secretary

Robert S. Vaters – President and Chief Executive Officer

Emily Buxton – Interim Chief Financial Officer

Michael Finegan – Senior Vice President, Business Development, and President, Biologics

Analysts

David Turkaly – JMP Securities

Imran Jaffer – Jefferies & Co.

Spencer Nam – Janney Capital Markets

Sachin Kulkarni – Piper Jaffray

Michael Matson – Mizuho Securities

Charles Croson – Sidoti & Company, LLC

Orthofix International NV (OFIX) Q4 2012 Earnings Call February 21, 2013 4:30 PM ET

Operator

Good afternoon, ladies and gentlemen. And welcome to the Orthofix International-sponsored 2012 Fourth Quarter Earnings Conference Call. At this time, all participants have been placed on a listen-only mode. And the floor will be opened for your questions and comments following the presentation.

Now I’d like to turn the floor over to your host Senior VP and General Counsel Mr. Jeff Schumm. Sir the floor is yours.

Jeffrey M. Schumm

Thanks operator and good afternoon everyone. I’d like to welcome you to the Orthofix fourth quarter 2012 earnings call. Joining on the call today is our President and Chief Executive Officer, Rob Vaters and interim Chief Financial Officer, Emily Buxton. I’ll start with the safe harbor statements and then pass it over to Bob.

During this call, we will be making forward-looking statements that involve risks and uncertainties, all statements other than statements those of historical fact are forward-looking statements, including any earnings guidance we provide, and any statements about our plans, beliefs, strategies, expectations, goals or objectives. Investors are cautioned not to play undue reliance on such forward-looking statements as there’s no assurance that the matters contained in such statements will occur. The forward-looking statements we make on today’s call are based on our beliefs and expectations as of today February 21, 2012.

We do not undertake any obligations to revise or update such forward-looking statements. Some factors that could cause actual results to be materially different from the forward-looking statements made by us on the call include the risks disclosed under the heading ‘Risk Factors’ in our 2011 Form 10-K and subsequent 10-Qs filed with the SEC. If you need copies please contact my office at Orthofix in Louisville, Texas.

On today’s call we will refer to certain non-GAAP financial measures in which we exclude certain items from our GAAP financial results. We believe that in order to properly understand our short-term and long-term financial trends investors may wish to consider the impacts of these items as a supplement to financial performance measures to determine in accordance for GAAP. Please refer today’s press release announcing our fourth quarter 2012 results available on our website for reconciliation of this non-GAAP performance measures to our GAAP financial results.

At this point I’ll turn the call over to Bob.

Robert S. Vaters.

Thanks Jeff and good afternoon everyone. Thanks for joining us today for our fourth quarter 2012 earnings call. I’ll start by going over our overall performance in the quarter and full year part of which we pre-announced in January. I’ll then turn it over to Emily for further financial details.

The fourth quarter performance was highlighted by record profitability driven by strong margins of 83% and strong adjusted operating margins of 22%. The bottom line or adjusted net income from continuing operations grew 40% in the quarter.

In addition, we removed a multiyear overhang on the company by finalizing both our Blackstone Medical, Inc. and our Bone Growth Stimulation legal matters, including making final payments to the U.S. government. Even after making these payments, we continued to have strong cash position, zero net debt and obviously ample borrowing capacities supported by solid earnings.

We also won a major arbitration award against an insurance carrier providing product liability claims associated with the Sports Medicine Business that we divested last year. This win will provide us $13 million in expense reimbursement and up to $15 million in additional insurance coverage. We expect to receive the reimbursement sometime during 2013.

Revenues were in line with our prerelease made in January; while it was not satisfied with the overall top line growth this quarter do a number of challenges, which I will discuss. I am encouraged by strong growth in our U.S. Spine Repair Implants and Regenerative Biologics business. In addition, we have also once again proven our ability to navigate through a challenging environment to consistently achieve operating margin expansion and strong earnings growth.

So let me start by discussing our sales results for the quarter. Net sales were $112 million in the quarter, 2012 down 8% on a constant currency basis. As I just mentioned, we were pleased with the very positive results from our domestic Repair Implants and Regenerative Biologics product offerings. However, overall results were negatively affected by a continued challenging regulatory and macroeconomic environment for our Orthopedic business in the European and Brazilian markets.

Also some hired in usual sales force turnover in our Spine Stimulation business affecting our result, as we initially implemented our corporate integrity agreement last summer. Poor macroeconomic conditions impacting international spine implant markets and weaker Physio-Stim cells, especially in the U.S. also contributed to the final 2012 results. Foreign currency exchange rates negatively impacted net sales by $1.6 million or 1.3% when compared against prior year.

Starting with our Spine business, total Spine sales were $75.7 million and were down 4% versus the prior year. Domestically, we had a very strong quarter in both our repair implants and regenerative biologics business offerings, both of which were up double digits. The acceleration in implant sales in the U.S. was primarily due to new distributors that we added in the second half of the year. We believe that as we build upon the breadth and the quality of our product offering in 2013, we will be able to continue to increase our footprint and performance of our distribution network.

As a reminder, we commenced the full launch of the FORZA Spinal Spacer System at the North American Spine Society Annual Meeting during the fourth quarter. And we also launched our unique CONSTRUX Mini PEEK Titanium Composite Spacer System just a few weeks ago. This Anterior Cervical Interbody System incorporates a unique technology that combines the benefits of peaks. Our imaging capabilities with the potential of bone ingrowth from porous titanium endplates. Early feedback from the cases we have done have been extremely encouraging.

We are very excited about these product introductions as well as other 2013 launches, which include the (inaudible) and Tempus Anterior Cervical Plating Systems and [semperian] posterior cervical system. While these products will drive sales from our current distributors, the cumulative effect of strengthening our product portfolio will drive new long-term distributor partnerships.

Biologics continue to register solid growth for us during the quarter and we are enthusiastic about the buildup to the launch of the next-generation Trinity Elite tissue form in the second half of 2013. Just this week in fact we completed our first cases with Trinity Elite which went exceptionally well. With its unique puttylike handling characteristics, it offers a surgeon the graph containment and scaffolding characteristics that are designed for all applications.

Additionally, feedback from key opinion leaders has been universally and extremely positive and indicates that the Trinity Elite overcomes present challenges in the containment of cell-based tissue forms, especially with regards to the ease of implant in Trinity Elite within and around the facet joints, lateral gutters, and around metallic implants.

Offsetting strength and domestic implants in biologics during the quarter was weakness in some international markets, which are experiencing lower procedure volumes due to poor macroeconomic conditions. In addition, we’ve also experienced some delayed product launches in Brazil as a strike of the regulatory agency as of a long queue for product registrations.

Another source of weakness was regenerative stimulation, as we experienced an increasing turnover both involuntary and voluntary, within the spine stimulation sales forces. We have hired new talent in those geographies and expect to return to growth in those areas as our new representation takes hold. This usually takes between six to 12 months.

Although, this weakness existed in the third quarter, we were able to convert competitive rebilling accounts that more than offset this weakness. We do not have any of these rebilling conversions in the fourth quarter and revenue mix from our third-party billing channel directly to insurance peers increased in the fourth quarter compared to the third quarter. Overall, our combined spine revenues worldwide represented 68% of our total net sales.

Moving on to Orthopedics, our revenue was $36.4 million, down 15% on a constant currency basis. Weakness in the quarter was primarily driven as I mentioned by regulatory and macroeconomic conditions in Brazil and Europe. First, looking at Europe; we’ve experienced pressure both in pricing and volume in some of our markets as governments are trying to drastically reduce healthcare expenditures amid the economic slowdown in the Continent. For example, in Italy, there have been government driven and mandatory price reductions across all orthopedics implants. In addition, we have had payer challenges in France, which adversely impacted our Physio-Stim cells.

In Brazil, fourth quarter weakness was due to overhang from the issues we noted last quarter, namely the loss of cells from a larger payer due to increased competition. In addition, a striking third quarter of the Brazilian Regulatory Agency and Visa created a long queue for product registrations. These delays should be resolved in the coming months. Despite these challenges, we remain committed to Brazilian market and continue to treat surgeons on our market leading external fixation technology and stand ready to implement training for our new products as it become available.

In our U.S. Orthopedics business, sales of our Physio-Stim experienced negative growth and more than offset our positive hardware revenue growth. To address this negative trend, we began implementing an associate sales rep program focused solely on the clinic or office call point.

The high growth U.S. foot and ankle market continues to outperform the rest of the orthopedics markets. We currently have a solid hybrid distribution network serving this call point with our industry leading external fixation biologics. Our strategy includes a comprehensive new plating system for foot and ankle and we plan to add these complementary products by 2014. Overall, orthopedics revenue during the quarter represented 32% of our total sales.

Moving on to gross margins; overall, gross margin for the fourth quarter were 83.5%, up 240 basis points over the fourth quarter of the prior year. Favorable geographic mix was a contributor to this improvement.

Emily will now review some additional financial details, which led to adjusted operating margins of 22% and a 14% increase in net income – adjusted net income from continuing operations, along with highlighting our significantly improved financing capacity. Emily?

Emily Buxton

Thanks Bob. Going through the income statement for the quarter, Bob covered revenues and gross margin with the operating expenses and move onto the balance sheet. Finally, I will provide full year 2013 revenue and earnings guidance. SG&A expenses were $62.8 million for the quarter, which were down slightly when compared to the prior year, but remains roughly steady on a percentage of sales basis at 56.1%.

R&D expenses in the quarter were $5.4 million or 4.8% of sales, up 60% basis points from last year’s 4.2%. As Bob mentioned, during the quarter, we launched the TrueLok Hexapod System and FORZA Spinal Spacer System; two new products that are the result of our commitment to productive R&D.

Operating income from continuing operations when adjusting for $283,000 charge for a prejudgement interest related to certain settlements with the U.S. government was $24.8 million or 22.1% net sales compared to 21.3% in the prior year. This 80 basis point improvement was driven primarily by the increase in gross margin as Bob previously discussed.

Total stock-based compensation from continuing operations in the fourth quarter was $1.2 million and was flat with the fourth quarter at the prior year. Net interest expense in the quarter was approximately $600,000 compared to $2.6 million in the prior year, as a result of lower debt outstanding and lower interest rates. Our effective tax rate during the quarter was 36.8% when adjusting for a settle tax assessment and a foreign jurisdiction, the tax rate was 32.9%. Our effective tax rate for the full year was 34.8%.

Now moving on to net earnings from continuing operations; in the fourth quarter 2012, we reported net income from continuing operations of $14.6 million, or $0.74 per share.

Adjusting for the charges related to the prejudgement interest of certain settlement with the U.S. government, our foreign exchange loss and the tax settlement, our adjusted net income went $16 million or $0.81 per diluted share. This represents a 14% increase over $14 million and 9% increase over $0.75 per diluted share in the prior year.

Net income from discontinued operations was $5.9 million or $0.30 per diluted share compared to a net income of approximately $900,000 or $0.04 for the competitive period last year. This increase represents the $13 million arbitration award that the company won against an insurance carrier relating to its previous denial of coverage under excess products liability policies.

As a remainder, the product liability claims were primarily related to the Sports Medicine Business we divested last year. Our total cash position as of December 31, 2012 was $52.4 million, down from $120.9 million at September 30, 2012. This decrease was a result at the payment of the U.S. government settlements and imputed interest of total $76.7 million. With long-term debt of $20 million we now have a positive net cash position of $32.1 million.

Our cash flow from operations for the full year 2012 were $11.2 million and included the payments for all three U.S. government settlements achieved during the year, including the $7.5 million to close the FCPA matter. As a reminder, during 2012, the company also invested more working capital in the form of accounts receivable associated with its MTF partnership.

As you may recall, there is no inventory working capital required by the company for Trinity evolution as we over ceding a marketing service scheme. This additional investment was made to continue to fund additional processing capabilities from the rapid acceleration of Trinity evolution and is also important to a successful co-development and launch of the next generation cell based technology Trinity Elite. For the full-year 2012, capital expenditures were $28.8 million compared to $25.8 million.

Moving on to the non-financial metrics, these non-financial metrics have been adjusted for the sports medicine divestiture for all compatible period. Day sales outstanding or DSOs were 123 days at year-end, down two days from the previous quarter but up 99 days at year-end 2011. The higher DSO during the period was related to the additional working capital investment made which was associated with our MTF partnership I previously mentioned along with this investment and working capital required for the expansion of distribution and taking up market share in our regenerated stimulation business in the second and third quarters.

Our inventory turns at year-end were one-times which was slightly down from 1.1 time at the end of the previous quarter. Inventory has increased from the previous quarter due to new products lunched during the fourth quarter.

Now on to guidance for 2013, the company expects net sales from continuing operations to be between 1% and 3% over net sales in 2012. While we can’t predict foreign currency fluctuations included in our guidance as a negative FX impact on net sales of 0.5%, leading to reported net sales growth to be between 0.5% and 2.5% or $465 million and $475 million.

The Company expects GAAP earnings per share from continuing operations to be approximately $2.84 to $2.94 per diluted share. After adjusting for commercialization milestone payments to MTF that we expect to pay in the first quarter, earnings from continuing operations is expected to be approximately $2.90 to $3.00 per share. This range reflects an increased investment in R&D and distribution, continued pricing pressures in some markets and approximately $2 million to $3 million for the medical device tax. Our underlying assumptions for the medical device tax are that our stimulation products will be excluded from the tax based on the retail exemption and we will be recording these expenses in the G&A expense.

Please refer to the full-year outlook update section of our press release from today for a more detailed reconciliation of this updated EPS guidance with the identified adjustment items. Inherent in this earnings guidance, we expect full-year 2013 gross margins of approximately 80% and adjusted operating margins from continuing operation of approximately 20% to the reasons I noted earlier. We also expect interest expense and amortization debt placement cost of approximately $2.5 million and an effective tax rate in the range of 36% to 37%. While we do not provide quarterly guidance, I would like to point out that historically we are sequentially down on both revenue and earnings per diluted share in the first quarter, relative to the fourth quarter and we would expect a similar trend this year.

I will now turn it back to Bob for closing remarks.

Robert S. Vaters

Thanks, Emily. Let me just say a few things before we go to Q&A. 2012 was a great year of accomplishment, the divestiture of the sports medicine business was an outstanding success that left us with the higher margin company with a very strong cash position and financing capacity. We exceeded our adjusted operating margin goal of 20%, this was an objective we established a couple of years ago and as we stand today, we are one of the most profitable companies of our size in the industry. This has led to record earnings results for Orthofix.

Finally, the company removed its biggest overhang as our three major U.S. government investigation to finalize it. With the payment of these settlements significant risk has been mitigated. We now have one of the most robust compliance programs in the industry, which further differentiates Orthofix as a trusted partner for hospitals and healthcare providers.

Given this strong foundation, along with the investments and new product introductions, and distribution upgrades being made in 2013, I am excited about our long-term growth opportunities.

With that operator, I would now like to open up the line for questions.

Question-and-Answer Session

Operator

Thank you very much. Ladies and gentlemen, the floor is now open for questions. (Operator Instructions) And we’ll take our first question from Dave Turkaly with JMP Securities. Your line is live.

David Turkaly – JMP Securities

Thanks. You mentioned some of the distributors, I think for the metal side in the quarter, could you remind us what is your footprint today in the U.S. territory for that business? And where do you think that’s going over the next couple quarters?

Robert S. Vaters

Hey, David, it’s Bob. I don’t want to give specific, but I would say at this point, it’s improving. But we have a tremendous appetite to grow there and we have a lot of light territory of where we don’t have footprint. A big initiative for 2013 is to increase that and use our additional financing capacity and cash to acquire and do the deals with distributors which we did actually during the fourth quarter.

David Turkaly – JMP Securities

I missed on that, you may have said in the call I don’t know, your financing capacity how would you define that, what do you have available if you are to do something today?

Robert S. Vaters

Well, I mean that question can be look at lot of ways. We have a net cash position over $30 million. We have trailing 12 months of adjusted EIBTDA of $112 million and as Emily mentioned we have zero net debt, so you can spend and of course we have stock, so you can triple that in a lot of different ways, but I think we have certainly more capacity than we’ve had in many years and what resolution government settlements we’ve had be a substantial dry powder.

David Turkaly – JMP Securities

Thanks a lot.

Operator

Thank you very much. We'll take our next question from Imran Jaffer with Jefferies. Your line is live.

Imran Jaffer – Jefferies & Co.

Hi, good afternoon thanks for taking my question. I know you haven’t historically given revenue guidance by segment, but given all the company specific and I guess end market considerations, can you just talk about what is baked into your guidance in terms of recovery in Physio-Stim the Brazil situation and maybe more broadly pricing and volume trends in ortho and spine broadly? Thanks.

Robert S. Vaters

We're very cautious about Brazil and don't have a lot of recovery until the end of the year, so there's not a significant amount there particularly as these registrations pave our way through. We have recovery in Spine Stim, in Physio-Stim we don’t have a robust forecast, because we are trailing a new rep program as I mentioned. But overall we are continuing to look for a good year, strong year in the Spinal Implant business, particularly in the U.S. So I think all those things are driving our forecast for the year, which we’ve given the 1% to 3% growth in the strong profitability continued.

Imran Jaffer – Jefferies & Co.

Okay. And then in terms of the non-coverage in France, is that purely austerity driven, or is there any other clinical data basis for that, then as a risk of other healthcare economies doing same?

Emily Buxton

Hi, this is Emily. In France, we really believe this is purely driven by the French government. Our clinical data looks very good and we provide studies to them every two years. So we believe this is purely an economic situation there.

Imran Jaffer – Jefferies & Co.

Okay. And then lastly, [now] you’ve reached your objective of that 20% adjusted EBIT margin, can you talk about what your objectives are over the next couple of years on that metric?

Robert S. Vaters

Sure. Certainly it is going to be difficult to repeat what we’ve done over the last couple of years, particularly with things like on the operating margin level device tax I think we don’t have this. So I think in our guidance we feel like we are good at the 80% gross margin and 20% operating margin. But if we can grow the top line keeping those margins would be very satisfied.

Imran Jaffer – Jefferies & Co.

Okay. Thank you very much.

Operator

Thank you very much. We will take our next question from Spencer Nam with Janney Capital. Your line is live.

Spencer Nam – Janney Capital Markets

Thanks for taking my questions. Maybe you will start off with the both, Bob you concluded your remark by indicating that this core potential that is very promising. You guys have launched some new products that could be very interesting as well.

But having said that, you’re guiding 1% to 3%, which is certainly more in line with last couple of years if you will, maybe on the software side even. Just curious kind of how you guys aside from potentially acquiring somebody, how you’re seeing growth coming to the top line here?

Robert S. Vaters

Sure, thank you for the question Spencer. Just to be clear, this is a guidance that has no inorganic activity. So it’s an organic activity. Although we do have for the first time in many years a pipeline is coming out with several products this year. We are seeing cautious particularly with the European and Brazilian markets performance competitively. And not having complete certainty to when that turnaround happens when the registrations gets cleared up. And in case of the things like France when the reimbursement issue gets cleared up. So we were cautious and that’s all baked into those things.

In addition the one thing that we haven’t baked in with certainty is the launch of Trinity Elite, which we’re expecting in the second half of the year as opposed to beginning of the year. So all those things together lead us to forecast we get in. Obviously, to the extent we do anything in organically with this acquisitions or products that would increase those numbers.

Spencer Nam – Janney Capital Markets

Thanks for the color there. Emily, on the free cash flow side, I think you guys have not really talked about free cash flow in the past due to some of these outstanding issues, but now that's cleared up can we make any sort of a wealth estimate on what the free cash flow would be this year?

Emily Buxton

You are absolutely right, we have not provided that metrics, because there is lot of noise that’s been in there in the past several years. As the noise has cleared up, we will start looking at that metric and provide it in the coming quarters.

Spencer Nam – Janney Capital Markets

Okay, that's helpful. And then maybe going back to the Trinity Elite launch, besides the fiscal difference if you will between the Elite and Evolution are there any Bob I know you mentioned in your remarks that it’s a successful launch, successful trial if you will with physicians and so forth. Are there any specifics in the clinical differences that you are seeing would be lead, I know that you guys have a full trial on this (inaudible) comparing with Evolution, but I was curious if you have some specific thoughts at this point suggesting why Elite will be superior is superior and if so and what way?

Robert S. Vaters

Thanks for the question. Mike Finegan our President of Biologics is also joined us on the call today, I'm going to let Mike comment on that. Mike?

Michael Finegan

Yeah, obviously we've done very well on the Trinity Evolution as kind of the one the lease cell based tissue form out there. And launching that and having been successful about through the past really several many quarters and couple of year’s feedback that we've gotten from physicians has been – has offered a suggestions in terms of ways to improve that, specifically around the graph containment or handling characteristics or scaffolding characteristics of Trinity Evolution. And so those are some of the improvements that we made in Trinity Elite.

We have shown it to around 25 preliminary surgeons in the country and private channels have gotten very specific feedback. We had our first two cases this week. All the feedback has been tremendously positive with regard to the improvements made, with regards to the scaffolding, with regards to the handling characteristics. And we think the applicability based on that feedback is going to give us lot more penetration capability, a variety of different spinal and orthopedic procedures. So we’re very confident that we’ve made substantial improvements. We’re very confident that the market is robust and we think we’ll be very successful.

Spencer Nam – Janney Capital Markets

Thank you.

Operator

Thank you very much. We’ll take our next question from Matt Miksic with Piper Jaffray. Your line is open.

Sachin Kulkarni – Piper Jaffray

Hi, this is Sach Kulkarni on the line for Matt. We have three calls going on simultaneously here to night. So I apologize on Matt behalf and I do have a couple of questions.

Robert S. Vaters

Okay, welcome.

Sachin Kulkarni – Piper Jaffray

You hear me okay?

Robert S. Vaters

Yeah, we hear you, fine.

Sachin Kulkarni – Piper Jaffray

Right, on the biologic side, there seems to be an opportunity to pickup share after the warning letter and lawsuits effort infuse. Do you think that cycle is pretty much completed or do you see further acceleration away from infuse?

Robert S. Vaters

Yeah, I’ll take that. I think discontinued opportunity has evidenced by Medtronic’s recent commentary on infuse. So I think that is going to continue to be opportunity for all those in the market and certainly for us.

Sachin Kulkarni – Piper Jaffray

All right, at what point are you taking share from infuse and are you pricing product somewhere between bone graft in infuse or somewhere between a synthetic in infuse?

Robert S. Vaters

I think in terms of product positioning that's a broader question in terms of taking share, I can only comment on by telling you that we continue to grow quarter-in and quarter-out that we have grown for the past many, many quarters and we expect to continue to grow. So we think there is ample opportunity in a very, very big market to continue to take share from all other players.

Sachin Kulkarni – Piper Jaffray

All right. Thank you so much.

Operator

Thank you very much. We'll take our next question from Mike Matson with Mizuho Securities. Your line is live.

Michael Matson – Mizuho Securities

Thanks. I know Emily commented about kind of the first quarter revenue probably being down sequentially from the fourth quarter. And I know you don't give quarterly guidance, but just thinking through kind of the sequencing for the remainder of the year, I’m modelling kind of a little bit of improvement revenue growth just quarter-by-quarter as the year goes by, and I know the comps certainly get easier in the second half, does that sound reasonable?

Robert S. Vaters

Yeah, this is Bob, I think that's reasonable.

Michael Matson – Mizuho Securities

Okay. I apologize if I missed this, but did you give – did you quantify the U.S. growth of Spinal Implants and Biologics?

Robert S. Vaters

No, we do not.

Michael Matson – Mizuho Securities

Can you do that?

Robert S. Vaters

No.

Michael Matson – Mizuho Securities

All right, I thought I try. And then I remember talking in the past and I think with regard to your margins you mentioned you're looking at doing some evaluating anyway vertical integration of your Spinal Implant manufacturing, I think it was, is that something that you are still looking that and is that something, is that an area for potential gross margin improvement?

Robert S. Vaters

We continue to look at it, and I think it will continue to show some improvement, but it's going to be opportunistically like, for example, in areas like Brazil we're looking at the local manufacturing how that can improve our margins. But I don’t look at in a grand way, but certainly we are continuing to look at opportunistically. And just back to your prior question, I didn’t want to be able to see that, we’re clearly doing very well in our U.S. Spinal Implant markets and we finished the year in a sort of double-digit growth pattern so.

Michael Matson – Mizuho Securities

Okay. And then, just wondering if you could give an update on where things stand with your acquisition strategy. I know on the past, it sounds like you are getting close to doing something or multiple things, and I’m just wondering, I guess I’m a little surprise that we haven’t seen anything yet. So I know you can’t say specifically what you are looking at or give timelines, but just wondering if there is still a lot of activity there, and just thoughts around dilution accretion from potential deals?

Robert S. Vaters

Yeah, Matt, our activity has definitely increased, I’m spending more time on it, our business development team is spending more time on it. We haven’t closed a major transaction, [we’ve booked] that and made some progress on small product oriented activity, and we’ll continue to do it. Again, I can’t speculate. Also, on the dilution and accretion, I would say that it’s a factor, but it’s not the only factor. And to the extent, we complete something we’ll announce it as soon as we can.

Michael Matson – Mizuho Securities

All right. But I mean just in – is there a kind of a level of dilution you’re willing to tolerate, or it just really depends on the nature of the deal itself?

Robert S. Vaters

It would depend on the nature of the deal itself. But as you know, we will, Mike, dilution is something that I would factor in quickly, not necessarily in immediate, but I would always look to a transaction that would give us a pact of accretion.

Michael Matson – Mizuho Securities

All right. That’s all I have. Thanks a lot.

Operator

We have time for one more question. We’ll take that from Charles Corson with Sidoti & Company. Your line is live.

Charles Croson – Sidoti & Company, LLC

Hey, guys thanks for taking the questions. Most of my – in fact, have been answered. So I guess it was kind of give a basic, Emily, are you guys expecting for S&M expenses going forward. Should we kind of look at this level or should those kind of pair down for those we go out into 2013?

Emily Buxton

We’re not providing specific in the guidance. I think what’s key to remember is our gross margins are going to be 80% and the LI margins are going to be around 20%. And you’re going to see some increased investments in R&D like we spoke about. And as I also mentioned, the medical device tax will be in the G&A line.

Charles Croson – Sidoti & Company, LLC

I see, okay, thanks. Thanks for that. And in terms of that device tax, I’m looking at around $7 million or so. Is that a bottom line with what you guys are looking for?

Emily Buxton

No, we’re excluding our stimulation products from the medical device tax. So in our guidance, we have about $2 million or $3 million in medical device tax.

Charles Croson – Sidoti & Company, LLC

Okay, okay that’s helpful, thanks. And then just one more and I think others have already harped on this. But I’ll ask you to maybe a little bit different way. Given guidance has kind of come down here couple of times in the past two quarters, what’s the confidence that you think you can meet this level going forward, particularly in the base of pots and payer pushback. I know you highlighted on that the macro issues. But I’m just trying to dive a little bit deeper on some of the industry specific item that are affecting everybody as well.

Robert S. Vaters

This is Bob. Obviously, the guidance is based on how we look today and what we see. There is sort of pros and cons right, so what could provide upside is very successful Trinity Elite launch in the second half of the year. What gives us some pause is the registrations and activity in Brazil and the continued economic situation in Europe. I'm also confident that we can grow our stimulation as we get into the year. So all of those things together at this particular juncture give us the conclusion of our 1% to 3% growth, and of course, our continued profitability growth on a normalized basis is higher than that, so those are all the fact as we know today that went into the guidance.

Charles Croson – Sidoti & Company, LLC

Okay. All right, that’s very helpful. Thanks, Bob. Thanks guys.

Robert S. Vaters

Okay, I think that's about all. I thank everybody for joining us today. I'm glad that the fourth quarter now comes to close. And we have very excited about the activity that we have and I look forward to see you or hear you on the next call. Have a good evening.

Operator

Thank you very much. Ladies and gentlemen, this concludes today’s presentation. You may disconnect your lines, and have a wonderful day. Thank you for your participation.

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