Wright Medical Group, Inc. Q4 2008 Earnings Call Transcript

Wright Medical Group, Inc. (WMGI)

Q4 2008 Earnings Call

February 19, 2009 4:30 am ET

Executives

Gary D. Henley - President & Chief Executive Officer

John K. Bakewell - Executive Vice President & Chief Financial Officer

Analysts

Taylor Harris – J.P. Morgan

Raj Denhoy - Thomas Weisel Partners

Matt Miksic - Piper Jaffray

Mike Matson - Wachovia Capital Markets

Kurt Kruger - Kruger Capital

Jeff Johnson - Robert W. Baird & Co.

Bill Plovanic - Canaccord Adams

Presentation

Operator

Good morning ladies and gentlemen and welcome to the Fourth Quarter 2008 Wright Medical Group Incorporated Earnings Results Conference Call. My name is Wayne and I will be your coordinator for today. (Operator Instructions) This conference call may contain forward-looking statements as defined in the Federal Securities Laws. In fact, every statement made during the call except for those of historical fact will be forward-looking statements. Forward-looking statements reflect the current knowledge, assumptions, beliefs, estimates and expectations of our management. They also express our management’s current views of future performance, results, and trends. We caution you that actual results might defer materially from those described in these statements. Forward-looking statements are subject to a number of risks and uncertainties, including those discussed in our filings with the Securities and Exchange Commission. These SEC filings include our 10-K for 2007 and our subsequent 10-Qs for 2008. These risks and uncertainties could cause our actual results to materially differ from those described in the forward-looking statements. Although we believe that each forward-looking statement is accurate, there can be no assurance that it ultimately will prove to be so. You should not view a forward-looking statement as a representation by us that is described that the results will be achieved. We caution you not to place undue reliance on any forward-looking statement. All forward-looking statements are made as of today’s date, and we assume no obligation to update any such statement after this date.

With that ladies and gentlemen, I would now like to turn the call over to Mr. Gary Henley, President and Chief Executive Officer. You may proceed sir.

Gary Henley

Thank you, Wayne and good afternoon everyone. Welcome to our year end earnings call. I am pleased to share with you the details of our fourth quarter 2008 financial results, which reflect a strong finish to an outstanding year highlighted by excellent sales growth and significant operating expense leverage.

With me on the call today is John K. Bakewell, Executive Vice President & Chief Financial Officer. Together John and I will be discussing the fourth quarter results, the progress that we’ve made and have been making in our business and our latest outlook on the business going forward.

Before we begin I would like to note that we will be using a number of non-GAAP financial measures to describe our performance. Regarding that I will refer you to the reconciliations that appear in the tables of today’s press release as well as on our website. Further, that our Form

8-K filed today provides a detailed narrative that describes our use of such measures. Please note that unless otherwise stated, all of today’s discussions regarding results of operations refer to our as adjusted results.

As stated in today’s press release our sales results for the third quarter came in near the mid point of our original outlook range, which is modestly better than the lower end expectation which we communicated to you at our December guidance call. At the same time we posted excellent profitability for the quarter, with our adjusted EPS at $0.31 coming in above our communicated outlook of $0.28 to $0.30. While we are quite pleased with that outcome, particularly in light of the current global economic environment, we are also growing a bit more cautious about how that environment might impact gross in 2009 and will share out thoughts about that later in the call.

As we have done in past calls, I will start today with a summary of our top and bottom line results and then move into a detailed review of our revenue performance. John will then address the other key line items that make up our financial performance and share with you our guidance outlook both for Q1 as well as our latest views on the full year 2009. Together we will wrap up our prepared section of today’s calls with some business updates and then we will begin taking your questions.

To get started, net sales for the fourth quarter of 2008 were $120.1 million representing a 16% over net sales of $013.2 million in the fourth quarter of 2007, finishing near the middle of our previously communicated guidance range of $119 to $122 million. Excluding the unfavorable impact of foreign currency on our international revenues, which totaled approximately $2 million, global net sales increased 28% during the fourth quarter. We are pleased to see the strength of our Q4 sales performance was so broad based and balanced with solid performance in all of our major product lines as well as in both our US and International markets.

Additionally, we achieved adjusted net income of $12.6 million or $0.31 per diluted share for the fourth quarter of 2008, finishing above the upper end of our adjusted EPS guidance range of $0.28 to $0.30. Our strong sales performance, combined with excellent operating leverage resulted in adjusted operating income totaling $17.1 million, representing a year-over-year growth of 23%. This was a nice finish to an outstanding year in which we produced adjusted operating income growth of 36%.

Net sales for the full year 2008 totaled $465.5 million, representing growth of 20% as reported and 18% before favorable impact of currency.

Net income for the full year increased from $28.9 million or $0.79 per diluted share in 2007 to $36.3 million or $0.92 per diluted share on an as adjusted basis, growing by 26% and 16% respectively.

We are particularly pleased with our ability to deliver EPS near the mid point of our guidance range despite the $0.02 of dilution from our second quarter INBONE acquisition and $0.06 of negative impact from the significant declines of our short-term investment return which began in early 2008 and worsened through out the year.

Looking now at our sales results in detail, first geographically, we had a strong fourth quarter in both the US and International markets. Domestically our sales totaled $74.8 million during Q4 and $282.1 million for the full year, representing increases of 19% and 20% respectively over the prior year period.

During Q4 extremities continued to lead the way in the US with 38% growth, complimented by strong performances in biologics and our large joint reconstructive business which posted growth rates of 13% and 12% respectively. The extremities performance is particularly notable because in Q4 extremities became our largest product line in the US.

Internationally we had another strong quarterly performance as sales totaled $45.3 million representing an increase of 13% as reported and 18% before unfavorable impact of currency. This growth was driven by double-digit performance from substantially all of our major International markets, although we did begin to experience headwinds from some of our stock end distributor markets, consistent with what we mentioned during our December guidance call.

We are also pleased with the success of our acquired products. The sales from all products acquired during the past 12 months contributed 3% points to our Q4 domestic revenue growth rate and 2% points to our global growth rate. We are particularly pleased with the performance of the INBONE total ankle acquisition.

I would now like to discuss our sales by product line.

Knee product sales totaled $29.8 million in Q4, a 9% increase as reported and an 11% increase over prior year before currency; domestic knee sales in Q4 increased by 9% from the prior year. This domestic knee performance was driven by the continued success of our ADVANCE STATURE specific components as well as our ADVANCE BIOFOAM tibia base; International knee sales increased by 10% on an as reported basis and 13% in cost and currency driven by growth in certain European markets.

For the full year 2008 knees increased at a rate of 17% as reported and 15% in constant currency.

During the fourth quarter our global hip sales totaled $41.9 million increasing by 22% as reported and 23% in constant currency. Domestic hip growth totaled 16% during the quarter, reflecting strong unit sales gains and our most popular Acetabular and Primary Stem Systems and also in our Revision Systems, while International hip growth totaled 27% as reported and 29% before currency.

International hip growth was broad based, a strong performance in certain European markets, Latin America and Asia, as well as in Japan. For the full year 2008 hips increased at a rate of 20% as reported and 16% in constant currency.

Extremity sales totaled $24.8 million during the fourth quarter, increasing by 31% as reported and 33% before currency. Domestic extremities grew 38% during the fourth quarter while International growth totaled 8% as reported and 17% before currency.

Excluding acquisitions within the last 12 months, domestic extremities grew 26% in the fourth quarter, driven by the continued success of both new and core products within our CHARLOTTE line of foot and ankle products as well as excellent in our DARCO product line.

Acquisitions within the last 12 months contributed nicely, adding 12% points to our US extremities growth rate. For the full year 2008 extremities increased at a rate of 43% as reported and 42% in constant currency.

Our global biologic sales totaled $20.9 million during the fourth quarter, representing a 5% increase over prior year as reported and a 7% increase on a constant currency basis. Domestic biologic sales increased 13% in Q4 driven by our ProHance injectable synthetic bone graft, [conselopure] wedge and the continued success of our GRAFTJACKET soft tissue repair line.

In the fourth quarter International sales of our biologics products decreased by 26% as reported and 17% before currency, primarily due to reimbursement challenges we faced specific to the Turkish market.

For the full year 2008 biologics increased at a rate of 8% and 8% in constant currency.

In summary, we are quite pleased with our sales performance for this quarter, with double digit growth in our large joint recon business and continued outstanding extremities performance, we have posted our fifth consecutive quarter of overall constant currency global growth rate ahead of our long-term corporate sales objectives.

At this point I would like to introduce John Bakewell our Chief Financial Officer and John will discuss additional financial details of our fourth quarter. John?

John Bakewell

Thanks, Gary. Good afternoon to all of you joining us today. I will follow our usual format today and I will pick up where Gary left off by reviewing with you our P&L components below the revenue line that contributed to our fourth quarter results and then I will discuss our current financial outlook for Q1 and the full year 2009.

As has been our practice in the past, today’s press release provides you with our P&L results in accordance with GAAP requirements and also includes tables which provide reconciliations of certain of our P&L components from an as reported GAAP basis to one that is adjusted to exclude the impact of those items noted.

Including the impact of restructuring charges related to the initiative we previously announced to close our Toulon, France operations, non-cash stock based expenses and charges related to the ongoing US governmental inquiries. We recognize that most of you evaluate our performance on a basis that excludes non-cash stock based expense, as well as other non-recurring items, so we provide you with all the information necessary for you to model our P&L on that adjusted basis.

With that, let’s move into our discussion of our as adjusted results. I will begin with a review of our gross margin performance and from there work downward through the rest of our P&L.

Beginning with our Q4 gross margin, overall we achieved 71% for the quarter, as we were expecting, is lower than the 73% posted in prior year Q4, but also slightly below the expectations that we set for Q4 during last quarters call. The variance from our expectation and from the prior year is due primarily to the geographic mix of sales experienced this quarter, as well as unfavorable currency impact and the current period impact of commodity pricing pressures experienced through the first three quarters of 2008.

On a full year basis for 2008, we achieved an adjusted gross margin of 71.4% as compared to 72.6% in 2007. Going forward, consistent with the guidance provided in December, our gross margin outlook for 2009 remains intact; therefore we continue to expect a 2009 gross margin performance somewhere in the mid to upper 71s for the full year 2009. However, for the first quarter of 2009 we expect to see a gross margin performance closer to 70%, primarily due to the impact of currency and the commodity pricing pressures experienced through out 2008, both of which we expect to be more significant in the first half of 2009 than moderating as we move through the remainder of the year.

Turning now to our operating expenses, on an as adjusted basis, total operating expenses for the fourth quarter totaled $68.2 million or 56.8% of sales, compared to $61.5 million or 59.6% of sales for Q4 of last year. This was a 280 basis point improvement and significantly better than our stated long-term objective of 100 to 150 basis points of leverage. We certainly don’t expect to produce this type of operating expense leverage on a sustained basis, but we’re pleased to see it here in Q4 and we’ll certainly take it whenever we’re able to produce that.

As for our line items making up our Q4 operating expenses, on an adjusted basis selling general and administrative expenses totaled $58.9 million or 49.1% of sales for the fourth quarter, compared to Q4 ’07 SG&A expense of $54.6 million or 53%, a 390 basis point improvement year-over-year.

As adjusted, our R&D expenses totaled $8.1 million in Q4, or 6.7% of sales compared to $5.9 million or 5.7% of sales in Q4 of last year. Finally, amortization expense totaled approximately $1.3 million for the quarter, compared to about $990,000.00 in Q4 of 2007. Excluding any future acquisitions, you can expect quarterly amortization expense to remain at this level going forward.

To summarize our performance at the operating income level, our fourth quarter operating income as adjusted was $17.1 million or 14.2% of sales, up from $13.8 million or 13.4% of sales in Q4 of 2007, reflecting operating margin expansion of 80 basis points overall and a strong adjusted operating income growth outcome, as Gary noted previously, of 23% for the quarter.

Below the operating income line, net interest expense totaled approximately $1.1 million for Q4, which was in line with our expectations. With approximately $145 million in cash and marketable securities on our balance sheet, we are moderately sensitive to interest rate changes, as we have explained in prior calls. We have continued to monitor our cash investments carefully and consequently our excess cash portfolio continues to consist entirely of US Treasury backed assets. We anticipate net interest expense quarterly for 2009 of approximately $1.5 million. Given the current safety and liquidity issues that exist in today’s fixed income market, we feel this is the correct choice for us. Positioned as we are today, we are very comfortable with both the safety and the availability of our cash balances.

Moving now to taxes, our Q4 effective tax rate as adjusted was approximately 23.4% for the quarter, as compared to 28% in Q4 of ’07. The primary reason for our lower than normal effective tax rate is the R&D credit. As we’ve discussed in our previous calls, the R&D credit expired at the beginning of 2008, which has increased our ETR during all three quarters so far this year.

As anticipated, the R&D credit was retroactively restated in October, therefore as we have been guiding all along this year, our Q4 effective tax rate includes a catch up to reflect the benefit, of the R&D credit for all of 2008.

With that said, our ETR for Q4 of ’08 was better than we had anticipated and this better than anticipated rate contributed about three pennies to our Q4 EPS and results in a full year 2008 ETR of approximately 34%. Going forward from here, consistent with our December guidance, we continue to anticipate an effective tax rate of approximately 37% through out 2009.

To wrap up our P&L review, as Gary reviewed with us earlier, net income as adjusted totaled $12.6 million or $0.31 per diluted share for the fourth quarter of 2008. On the strength of 16% top line growth and SG&A leverage, fourth quarter adjusted operating income grew by 23% with net income and earnings per share as adjusted growing by 25% and 15% respectively over the prior year.

Briefly regarding share count, our fourth quarter per share per share results as adjusted are based on an adjusted, diluted share number of $43.5 million for Q4 of 2008 and average diluted shares of $39.3 million for Q4 of last year. Going forward we expect that our average share count for full year 2009 will be approximately 44.7 million shares diluted, consistent with our previous guidance. For Q1 we anticipate an average share count of approximately 44.1 million shares diluted.

Before we get into our guidance review, let me point out that our balance sheet continues to remain very strong with combined cash and marketable securities balance totaling $145 million as of December 31. We invested approximately $18 million in capital expenditures during the fourth quarter.

The final topic in my portion of today’s call is our current sales and earnings per share outlook for full year 2009 and for the first quarter.

When we spoke with you on our December guidance call we provided an outlook for the year that incorporated a measure of cautiousness given the global economic outlook and the challenges it could present for the orthopedic sector. At that time that caution related primarily to the outlook for our International stock end distributor markets, specifically, related to the impact of bank credit availability was having on their businesses. Since that time we’ve gotten more visibility into the 2009 outlook for that area of our business and it appears that our level of cautiousness was indeed warranted.

Additionally, since our December call, all of our major orthopedic competitors have released Q4 results and have offered up their views of overall market procedure growth rates heading into 2009. Although we haven’t yet seen any meaningful slow down in our direct markets, that one would ascribe to general economic conditions, based on our competitors results and outlook, it is clear that there was a slow down in market growth rates in Q4 and that the general outlook for the industry is for slowing growth in 2009.

Given this additional information, we want to be sure we’re applying enough caution in our guidance process given the degree of economic uncertainty we’re dealing with. So, rather than enter the year with expectations that don’t fully consider what we’re hearing from most of the rest of the industry, today we are reducing our 2009 global sales growth expectations by approximately 2% points.

Accordingly, we’re reducing our previously communicated expectations for full year 2009, which had previously been $510 to $520 million, downward by $10 million, or approximately 2% points, resulting in a revised 2009 sales outlook of $500 to $510 million, which represents an as reported growth rate of approximately 7.5% to 10% and constant currency growth of approximately 11% to 13%. At the same time, we’re revising our previously communicated full year 2009 as adjusted earnings per share outlook from $0.96 to $1.02 per share to a current outlook of $0.85 to $0.92 per share reflecting the contribution margin effect of today’s revenue revision as well as the addition of spending that will enable us to devote more resources to the global compliance requirements of our industry.

All together, despite a more cautious revenue outlook for the year, and the additional compliance costs we have planned, we anticipate adjusted operating income growth of approximately 16% at the upper end of our range and another year of operating leverage despite an estimated 110 basis points of currency rate pressure on our operating margins for the year.

As for our guidance relating to the first quarter of 2009, I’d like to recap for you what we’ve stated in the outlook section included in today’s release.

Our anticipated targets for the first quarter of 2009 for net sales is in a range of $120 to $123 million representing as reported growth in the range of 4% to 6% and constant currency growth of approximately 7% to 10% for the quarter, with adjusted EPS results ranging from $0.17 to $0.19 per diluted share. Our Q1 EPS estimate is lower than prior year due to touch comparables on both interest and other income and expense as well as the previously discussed pressure on our gross margin; however, we expect both of these factors to be temporary and to moderate as we progress through the year and reach less difficult comparables.

Please note that these targets to both the upcoming first quarter 2009 and the full year 2009 exclude the effect of possible future acquisitions or other material future business developments; restructuring charges associated with our Toulon closure; acquisition related inventory step up amortization; the impact of non-cash stock based expense and special costs associated with our current US governmental inquiries.

For those of you who consider stock-based expense in your models, our estimated full year 2009 impact of expenses associated with FAS 123-R is a range of approximately $0.23 to $0.26 per diluted share for the full year 2009 and $0.05 to $0.06 for Q1. Applying a $0.25 mid range estimate to our adjusted EPS outlook for ’09 implies an EPS outlook inclusive of stock based expense of $0.60 to $0.67 per diluted share.

With that I will conclude our financial review and I will turn our call back over to Gary for his additional comments.

Gary Henley

Thanks, John. In closing, I would like to say how pleased I am with our performance through out 2008. The team here at Wright has done a great job of executing on our strategy and delivering outstanding results. On the strategic front, we significantly increased our share of the foot and ankle market through a balanced combination of acquisitions, internal development, and expansion of our specialized sales force.

From a financial perspective we delivered an industry leading top line growth rate of 20% combined with meaningful operating margin expansion resulting in a 36% adjusted operating income growth.

We were able to produce these results even as we continue to make important investments in the business and integrate our acquisitions. This operational and financial performance gives us a good momentum as we move into 2009.

As we look into the uncertain times that lie ahead for our economy, we believe that the people, the products, and the programs we’ve put in place will serve as a solid foundation for our continued growth and success. Although we’ve made adjustments to our 2009 revenue outlook, it is important to note that we have not cut vital resources or support for those people, products, and programs that are the core of our strength.

In closing, I would like to comment further on something John mentioned earlier, and that is our decision to devote more resources to global compliance related requirements in the area of physician interaction. We are committed to enhancing our compliance efforts with regard to physician industry relationships. In 2004 we incorporated the AdvaMed code of ethics on interactions with health care professionals in our customer relationship policy, which is posted on our website, and we endorse the newly revised AdvaMed code just updated in January of this year. We are committing additional resources to ensure our compliance commitment is fully realized.

With that, that concludes the prepared remarks section of our call today and we are now ready to take your questions, so I will turn this program back over to our moderator, Wayne, who will be coordinating the question-and-answer session.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Taylor Harris from J.P. Morgan.

Taylor Harris – J.P. Morgan

On the earnings reduction for ’09 guidance, how much of that would be related to the sales reduction and how much is related to this increased spending on compliance?

John Bakewell

There is $0.03 associated with the additional compliance related spending. The remainder is all the contribution margin effect of the reduced revenue outlook.

Taylor Harris – J.P. Morgan

Okay and related to the compliance, did something specific happen that triggered, either with your discussions with the DOJ or otherwise, that triggered your thoughts around increasing spending there and in what way did some of the changes you’re putting in place affect the way you relate to physicians?

John Bakewell

Well consistent with what I’ve said all along in questions about our investigation and our compliance efforts, we have continued to monitor what is taking place in the public domain, what we can glean from press releases, DPAs, those kinds of things, conferences that are held for AdvaMed and other organizations. So, we have been trying to stay ahead of the compliance game all the way. We are continuing to do that and we see that it requires more global resources and we’re putting those in place. Our goal is to be the most compliant company we can be in our industry sector and we’re going to do that.

Taylor Harris – J.P. Morgan

So what are you spending more money on, is it more people? And, what happens with physician relationships? Is there a change in that or is this simply spending more to ensure that you’re acting with physicians properly?

John Bakewell

It is people. It is software systems. It is consultant. I mean it is a variety of things and again, it is on a global basis, but these are all prudent things to do based upon what we gleaned from the public domain and what the big five are doing and what the government is asking us to do. We are trying to do this ahead, voluntarily, and with our stated goal of being a very compliant company.

Taylor Harris – J.P. Morgan

Okay and Gary just shifting to the way you guys have given guidance for ’09 for revenue growth, I feel like I’m hearing on the one hand that you’re not seeing any slow down in your markets like what the big five are talking about. On the other hand, you’re constant currency guidance for the first quarter is lower than for the full year. So what exactly are you seeing in the first quarter and why should we expect that growth increases through the balance of the year?

Gary Henley

Well again, I think, as I have said before, we haven’t seen it, but anecdotally when we talk to surgeons we hear things like well my bookings are down a little bit. But, I think we wouldn’t be prudent if we didn’t view what the majority of the market leaders have said. I mean they’ve already reported and they put out their guidance and I think, to be prudent, we should listen to what they’re seeing. I mean they represent a larger sector of the market than we do. We haven’t seen, as yet, anything. We are just being cautious here.

John Bakewell

Taylor, I’ll add one more thing to that. It’s important to point out that in terms of number of selling days, there are two fewer selling days in the first quarter, which translates into, basically 3% points of growth. If you’re looking for why, we might have a slightly lower growth rate in Q1, that’s the principle reason.

Taylor Harris – J.P. Morgan

Okay, thanks a lot.

Operator

Your next question comes from Raj Denhoy of Thomas Weisel Partners.

Raj Denhoy of Thomas Weisel Partners

I was just curious if I could maybe follow up a little on Taylor’s questions. To your point, we are now sort of almost two months through the first quarter here. Is it fair to say that you have yet to see any slow down in your business at this point? Just anecdotally you’re hearing things, but you’re not seeing any impact in your business yet?

Gary Henley

Well, the International side of it, as we communicated even back in December, that’s come to fruition. I mean we are seeing some of that on our stock end distributor business, has been affected by the financial turmoil in the economy. That is as we thought and as John said, the fewer days. Again, a bit of being cautious and again, we haven’t seen so much of it empirically, but anecdotally, talking to surgeons they say that geographically some places are a little slower than others, so we’ll see.

Raj Denhoy of Thomas Weisel Partners

Okay, that’s fair enough. If you do look at your guidance and when you look at how much slow down you’ve baked into that, I mean would you consider this to be a worse case scenario? You know, you’ve taken into consideration the worse case of what you’re hearing out there and baked it in or is there still some potential further downside we could see in these numbers when we come back out here in another couple of months and report first quarter numbers?

Gary Henley

Well, as I’ve said many, many times, if I’m going to put a number out and I’m going to miss it, I hope I miss it on the high side. This is our current view.

John Bakewell

Raj, I think we’re trying to be consistent with what we’re hearing out of the 90+% share of the market that’s already reported. I think the general consensus among the larger industry players is that there is probably a full 2% points of slow down showing up in procedure growth rates.

Gary Henley

Again, I think you look at our guidance, we’re guiding to the upper end of anybody that’s out there today. I mean our growth rates are still going to be, if we achieve these, even the reduced ones, we’ll still be at the top of the heap in terms of growth rates.

Raj Denhoy of Thomas Weisel Partners

Sure, fair enough. You mentioned that the International biologics division was down sharply. I mean the growth rates you put up were surprisingly low, because of reimbursement changes in Turkey? Could you maybe explain what that is?

Gary Henley

Yes. That was a change in reimbursement in their whole health care reimbursement metrics and it took awhile for that to catch up to the biologics side. They didn’t, they just missed it. They put sort of a, it’s a modified type of DRG reimbursement system and it was pretty quickly adopted for the hardware side, but they just forgot to take into consideration the biologics, so there is a gap of a few months there where we couldn’t get reimbursement for our DVM products, our ALLOMATRIX.

Again, it’s a small number in total. It’s a big percentage, but it’s a small dollar amount.

Raj Denhoy of Thomas Weisel Partners

Then just lastly on the extremities business, I mean that’s one area that continued to be very strong. As you look out into ’09 though, do you think there’s any reason to think extremities might be more exposed to any slowing down in procedure volumes or how do you really think about that?

Gary Henley

No, I think that business is quite robust. We’re pleased with what we’re seeing and that, in our mind, is probably maybe a little bit less at risk.

Raj Denhoy of Thomas Weisel Partners

Okay so you probably have better clarity in that business than your larger competitors you’re basing your larger guidance on, so I suppose…

Gary Henley

That’s true.

Raj Denhoy of Thomas Weisel Partners

You’re not seeing anything in that business at this point?

Gary Henley

No, we’re not.

Operator

Your next question comes from Matt Miksic from Piper Jaffray.

Matt Miksic - Piper Jaffray

I’m going to hammer on this guidance thing; everybody is going to be scratching their head about. Why are you being conservative? I think I get the point about looking at the other players and reading what they are saying and seeing and building that maybe into your market forecast. But, I remember you often times saying that you make your own weather at Wright, in part because you are a relatively small player in this large market. So, the punch line I’m taking away from this is that you feel compelled to be cautious, but it has more to do with what the big guys are saying than what you’ve actually seen showing up in your numbers.

Gary Henley

That’s probably fair to say, but again I have to sit her and say it would be unwise not to heed what they have all said and reported at this point. And the fact that, as I said, the uncertain times we face. I mean just look in the rear view mirror for 120 days, we’re in a very different world than we were just that short period ago. Again, read into what I said is that I’m very bullish on our business. I mean we have built a great, solid business here. I mean we have got great products; we’ve got great initiatives, great programs. I’ve got a heck of a team assembled here. I’m very bullish about our future, but again, I have to temper that bullishness with the realities of the economy today.

Matt Miksic - Piper Jaffray

Sure, then I’ll give up this guidance thing in just a second, but your comment to Raj just now, if I look at the delta between where you were guiding to, this roughly 2% decline, we should think about that whether its cautious, prudent, conservative, or however we want to read it, as coming primarily out of total joints and not so much out of what we were thinking extremities might do this year.

Gary Henley

You know, I would probably weight it heavier towards total joints. That’s a fair statement.

Matt Miksic - Piper Jaffray

Okay. You talked about stock end distributors resulting in some pressure in Q4. Can you help us quantify what the impact of that is, or how big that is, or how to think about that for 2009?

Gary Henley

Yes, it’s a significant part of what we face as a headwind. There is no doubt about it. When you look at it on an International basis versus a US basis that is a more difficult situation for us, there is no question about it.

John Bakewell

Yes and Matt, when we got together in December and gave you a guidance outlook then, those numbers in December incorporated a level of cautiousness related pretty much specifically to the stock end distributor business and the impact that credit availability was having. At the time we were asked and we said yes that was probably about 2% points of growth that we had taken out of ’09 to contemplate that. I would have to say that since that time we’ve gotten more visibility and I would say that that estimate is pretty close to being on. I think the stock end distributor pressure probably is going to take up that full 2%, which is why we also feel compelled to address what we’re seeing in unit demand by the others who have reported while we are adding this next 2% of caution related to that.

Matt Miksic - Piper Jaffray

Got it, and so the incremental cautionary trends, as we lay them into our numbers, we should be thinking about pushing down maybe a little harder on the US numbers than the OUS numbers?

Gary Henley

Oh, no, no, OUS numbers is more affected in total.

John Bakewell

I think if end user demand declines here in 2009, we’ll see it both outside and inside the US.

Matt Miksic - Piper Jaffray

Okay. Again, the issue here with the stock end distributors credit availability, they’re essentially pushing some of their working capital burden back up the channel to you guys I guess?

John Bakewell

They are and we’re only willing to take on so much balance sheet risk, so sometimes the right answer is for them to just kind of reduce their order rate, which is right, you see it show up in the revenues.

Gary Henley

They’re managing their inventories pretty dramatically. They’ve got pretty skinny warehouses right now.

Matt Miksic - Piper Jaffray

On the P&L the operating leverage and performance in the quarter was pretty good and better than we were expecting. As we look at the fourth quarter and into ’09, can you walk us through maybe where you’re seeing the improvements there? Where you saw them in Q4 and where you expect to see them in ’09.

John Bakewell

Well the main contributor to leverage in Q4 was SG&A and don’t forget that 2008 benefited. All four quarters benefited from the closure of our Toulon facility, so probably, I’m going to say not quite half of that was associated with savings in the closure of Toulon. The rest of it was just good expense leverage as we managed to keep our controllable costs low across a lot of different areas within SG&A.

Matt Miksic - Piper Jaffray

And for 2009?

John Bakewell

2009, where we sit now, kind of the high end of the guidance range that we communicated today, will probably still see 60 or 80 basis points of leverage, but that’s after the effect of probably about 110 basis points of FX headwind. Again, if we were in a constant currency environment we’d be seeing 150+ basis points at the top end of our range. Again, that’s coming from the expense categories principally.

Matt Miksic - Piper Jaffray

Okay and that $0.03 you mentioned by my math is $2 or $2.5 million of spend on these compliance systems is that right?

John Bakewell

Yes, that’s about right.

Matt Miksic - Piper Jaffray

Could you give us an update on BIOFOAM availability on the knee side, whether that played a factor in Q4, whether that is going to improve?

Gary Henley

It will improve. We hope to have that pretty much full availability at the end of this quarter. It is ramping up nicely, so we should have a pretty full bag of BIOFOAM for the balance of the year after Q1.

Operator

Your next question comes from Mike Matson from Wachovia Capital Markets.

Mike Matson - Wachovia Capital Markets

I understand that the estimate of the economic impact is coming largely from what you’re seeing or hearing your competitors talk about, but I guess of that roughly 2% that you’re referring to that you think the market has slowed by, is your assumption that that’s really purely a volume issue or do you think that there’s any impact to mix or pricing in there as well?

Gary Henley

We see it as volume.

Mike Matson - Wachovia Capital Markets

Okay and do you see any risk then that with the struggles that the hospitals are going through that there could be some pricing and/or mix pressure in the next 12 months or so?

John Bakewell

Well our original guidance for 2009 already had a pretty flat outlook for pricing. Our US assumption was, we had a + to maybe +1% and the OUS was flat to -1.

Gary Henley

We think we’ve got that baked in and now it’s just the volume issue.

Mike Matson - Wachovia Capital Markets

Okay and then just on the compliance costs. I guess I’m just wondering why that wasn’t baked into your original guidance. I mean what happened? Did it just end up being more than you expected it was going to be or did something happen and you decided that you needed to kind of double down on your efforts there?

Gary Henley

No, I think it just is ever evolving. Again, as I said, as we glean information from the public domain and what other companies are doing, what the governments around the world are requiring of us, you know new guidelines, AdvaMed just coming out with theirs; if you get those systems robust and updated to achieve the new guidance just costs money and people.

Mike Matson - Wachovia Capital Markets

Okay. Do you have any plans to disclose physician payments?

Gary Henley

That’s being required of some. I don’t know of anybody that’s doing that voluntarily as yet. There may be a few, but at this point I’m not prepared to discuss that.

Mike Matson - Wachovia Capital Markets

Okay and given the selling day issue in the first quarter that John talked about, can you just give us the selling days for the rest of the year? I guess just any differences versus the quarters last year?

John Bakewell

I don’t have that with me. I don’t have the information.

Mike Matson - Wachovia Capital Markets

Okay, but I would assume that you’re going to make that three days up somewhere else that’s here right?

John Bakewell

Presumably, yes.

Operator

Your next question comes from Kurt Kruger of Kruger Capital.

Kurt Kruger - Kruger Capital

Looking at the way you finished the year, the fourth quarter, with those huge growth rates, I mean 22% in hips for instance. Can you give us a sense of which competitor that’s coming from? I take it a lot of it is Zimmer at this point.

Gary Henley

I don’t know that’s really difficult for me to quantify. It comes from all over. I couldn’t point to a specific. It’s just good performance by our team and acceptance of our good products.

Kurt Kruger - Kruger Capital

Again, I am trying to get at this reduction in your outlook. I know every one has asked the same question, but your sales forces out there and your marketing group and they are sensing that there is a pretty big disparity between the way you’re running down the track and the way your competitors are running down the track. You are growing at a lot faster rate, kind of two or three times the growth rates that your competitors are experiencing. Have you sensed lately, like in the last couple of months, that you’re not making your own weather as much and you’re migrating towards that growth rates that they’re experiencing, whereas before you have been so decoupled from their growth rates.

Gary Henley

No, I mean, we are still doing well. As I said, I’m very bullish on the business. We’re still converting customers to our products both on the knee with BIOFOAM and with the hips with our PATH and SUPERCAP products and techniques. I mean we’re just executing on our strategy and I think, again, I’m very bullish on it, but I’m also cognizant of the headwinds that may face us with the economic turmoil.

John Bakewell

Let me just add to that. There are probably only a couple of growth points separating our large joint reconstructive joint business from the rest of the market. We don’t expect anything heroic out of that business. We think we can outgrow the market, but we’re quite pleased to see upper single digit, lower double-digit growth with the recon. What’s really giving us the lift is our extremities business which has grown exceptionally well in 2009 and even with the tough comps we think we’ll grow 25+% in 2009. That’s really what’s creating the differential there.

Operator

Your next question comes from Jeff Johnson from Robert W. Baird & Co.

Jeff Johnson - Robert W. Baird & Co.

Gary, daily run rate in sales in Q1 here, is it fair to say not really seeing a slow down on a daily run rate if we adjusted the selling days?

John Bakewell

I don’t know that we’ve ever commented on run rate. Is your question around are we seeing any kind of procedure rate decline in the industry?

Jeff Johnson - Robert W. Baird & Co.

Yes, I mean that and just talking about if we adjust Q1 for the fewer selling days, now we’re back to pretty much where you expect to be for the year or so the simple math would seem to work. So I’m just wondering if you feel confident on a daily basis that that’s what’s showing up in the numbers?

John Bakewell

Keep in mind, part of what we’re talking about in terms of headwinds into ’09 is our International stock end distributor business and the credit related issues in those markets began to show up in Q4 and so that means that they’re showing up to an even greater degree in Q1, so that would have to be factored in as well when you look at our run rate.

Jeff Johnson - Robert W. Baird & Co.

Understood and then it just sounds like you’re highlighting commodity costs a little more this quarter than we’ve heard in the last quarter or two. Is it just that your inventory is just now starting to turn into the P&L? Is that the main reason, or how should we think about that?

John Bakewell

Yes, that’s part of it and then the real headwind in Q1 from a gross margin standpoint is currency. It is a particularly tough comparable year-over-year.

Gary Henley

There is a big difference in the euro last year than this year.

John Bakewell

And it’s just as bad, even maybe a little worse in Q2, although the commodity headwinds will have gone away by Q2.

Jeff Johnson - Robert W. Baird & Co.

What percentage of your International biologics business is related to Turkey? Gary, did I hear you correctly that that was just a reimbursement issue in the quarter that you couldn’t get reimbursed for some DBM product, but that has now been solved, or how do we think about that?

Then John, if you could just give me some clarity on maybe GAAP tax rate for 2009. Is that going to be impacted again by your option grants, US versus OUS, or how do we think about the GAAP tax rate going forward?

Gary Henley

On the Turkey side and those were issues that went throughout the year. There are still some ongoing issues with it. They have solved some of the issues, but not all of them, I guess is the best way to say it. But, it’s a small percentage of our total biologics business. I don’t know exactly what it is for Turkey.

John Bakewell

Our GAAP tax rate will be impacted by stock based expense and a lot of it depends on just kind of the mix of stock based grants, International versus domestic. I guess as we move through the year we’ll just kind of see what that input means.

Jeff Johnson - Robert W. Baird & Co.

Should we continue dropping your stock option expense through only maybe a 10%, 20% tax shield?

John Bakewell

Yes that’s about right.

Operator

Your next question comes from Bill Plovanic from Canaccord Adams

Bill Plovanic - Canaccord Adams

The only question I have for first quarter OUS revenues, OUS X the stock end distributors, is that business holding in? Then just simply for the first half of ’08, roughly what percentage of your International sales on a normalized basis, so first half of ’08, came from stock end distributors?

John Bakewell

Yes, the direct business outside the US is performing consistent with what we had guided to in December, so yes the pressure that we’re experiencing here, you saw a little bit in Q4 and now into Q1, is all pretty much isolated to the stock end distributor business. If you wanted us to quantify what percentage of our global business is stock end distributors, just very generally it’s around 10% or so.

Bill Plovanic - Canaccord Adams

It is 10% of your total business or 10% of your International?

John Bakewell

It is approximately 10% of our global business, maybe 10% to 12% somewhere in there.

Bill Plovanic - Canaccord Adams

Okay that’s helpful. Then just on the extremity non-trauma component of that, are you seeing any impact on the trauma business versus the non-trauma in general?

Gary Henley

First of all, we’re not in the trauma business in a big way in extremities. I mean most of our business is reconstructive. It may be secondary to trauma, but we’re not in a lot of the hot trauma business. That business has remained pretty robust, as you can see.

Bill Plovanic - Canaccord Adams

My point is more finger joints are more of a, may be considered a discretionary spend, elective procedure type of thing versus a dorsal plate or something. If you break a wrist you have to get it fixed. The question stems from are you seeing a slow down in the general joint stuff versus the trauma kind of holding in steady?

Gary Henley

If anything there may be a few of the elective procedures, as you say, but it hasn’t materialized as yet. Anecdotally we hear, and again that leads us to being as conscious as we are, but we haven’t seen a great deal of it as yet.

Operator

Your final question comes from Taylor Harris from J.P. Morgan.

Taylor Harris – J.P. Morgan

On the stock end distributors, I just wanted to make sure I totally understood that. I guess one possibility is they cut their inventory levels and you have a quarter of impact, but then they continue to keep the same share in the markets they serve, etc… and no impact to you beyond that, but it sounds like you’re guiding to beyond that. So, is the read just that because of these lower inventory levels that they’ll be holding, they are going to miss out on procedures?

Gary Henley

That and the fact that their inability to get credit to buy new products.

John Bakewell

A lot of the stock end distributors rely on bank lines to finance their businesses and when their banks pull back and reduce the limits that they’re willing to borrow to, it probably isn’t just a one-quarter phenomenon. They probably have to slow their growth rate down just a little bit. They can’t be as aggressive in growing their business.

Gary Henley

Again, in many of these countries they may not lose market share because this is affecting all of the people in that particular country.

Taylor Harris – J.P. Morgan

Therefore, surgeries just won’t get done.

Gary Henley

That’s right.

Taylor Harris – J.P. Morgan

Okay so you don’t think you’re going to lose market shares to the big guys who maybe operate in those countries in a different way?

Gary Henley

If they are in there on a direct basis, there is a chance that we could lose them. There is no question about that. But, we’re talking about a lot of countries here that they are all serviced by stock end distributors from all of our competitors.

Taylor Harris – J.P. Morgan

Then just philosophically, with the revenue cut it seems like basically everything flows through to the bottom line. So is there no ability to cut cost or just did you decide we don’t have any discretionary expense that we could cut to offset this?

Gary Henley

No, as I said in my prepared comments, we have not cut vital resources and funding for our people, products, and projects. Obviously there is that opportunity should we need to, if doomsday comes. Right now we are continuing to invest in our infrastructure, our company, that is the right thing for us in the long term and we are going to continue to do that. We’ve built a super business and we’re going to keep driving it pedal down.

Taylor Harris – J.P. Morgan

All right and then John, on the expense that you back out with respect to the DOJ, I assume it’s outside counsel. Does all of that absolutely go away once the DOJ situation is resolved?

John Bakewell

The expenses that we call out are things that are indeed non-recurring at the end of a project like this. They are not compliance related expenses that become built in to your expense run rate that are going to stay with you. We’re only calling things out that are of a special nature.

Taylor Harris – J.P. Morgan

Have you changed your cash flow outlook for 2009?

Gary Henley

No we haven’t. Again, as I will remind you, we have got a very significant delta ’08 to ’09 and much better cash flow metrics, they are much improved, and we are staying with that.

Taylor Harris – J.P. Morgan

So earnings go down by call it $0.10, but cash flow stays the same?

Gary Henley

Yes.

Taylor Harris – J.P. Morgan

So how does that happen? Is it better working capital management or what?

Gary Henley

Absolutely, better working capital. We’ve got a team in place that’s doing a lot of good stuff for our logistics and inventory management.

Taylor Harris – J.P. Morgan

Okay then if you’ve been any more specific than just saying that you’re going to be free cash flow positive would you care to tell us the basic magnitude of that?

Gary Henley

No, we are cash flow positive. I think we’ve talked about the delta being somewhere year-on-year of around $70 to $80 million of improvement delta between ’08 and ’09.

Taylor Harris – J.P. Morgan

Do we have all the information to get your free cash flow for ’08?

John Bakewell

Not yet. We’ll get it out soon though, the Q files very shortly after the earnings call.

Gary Henley

Again, that is a significant improvement for a company our size and still to keep the pedal down as I said.

Operator

At this time we have no additional questions. I would like to hand the call back over to Gary Henley for final remarks.

Gary Henley

Thank you, Wayne. I want to thank all of the participants for joining us today. As I said earlier, I’m quite pleased with the performance we’ve made to date and how well positioned we are as we move into 2009 and beyond.

With that, good afternoon and we look forward to speaking with you on our upcoming quarter one earnings call and I will see some of you in Vegas next week. Thank you.

Operator

This concludes the presentation. As explained at the beginning this conference call may have included some forward-looking statements as defined in the Federal Securities laws. We refer you to our earlier explanations for a more detailed description of forward-looking statements. We again caution you that actual results might differ materially from those described in the forward-looking statements. We also direct your attention to the risks and uncertainties discussed in our SEC filings including our 10-K for 2007 and our subsequent 10-Qs for 2008. These factors could cause our actual results to differ materially from those described in the forward-looking statements. In addition, you should not view a forward-looking statement as a representation by us that the described results will be achieved. We again caution you not to place undue reliance on any forward-looking statements. Finally, all forward-looking statements are made as of today’s date and we assume no obligation to update any such statement after this date. Thank you for joining us today.

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