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Executives

Stuart M. Essig - Chief Executive Officer, President

Gerard S. Carlozzi - Chief Operating Officer

John B. Henneman III - Chief Financial Officer

Analysts

Glenn Novarro - RBC Capital Markets

Matt Miksic - Piper Jaffray

Raj Denhoy - Thomas Weisel Partners

David Roman - Morgan Stanley

Amit Bhalla – Citigroup

Tao Levy – Deutsche Bank Securities

Joshua Zable - Natixis Bleichroeder

William Plovanic - Canaccord Adams

Spencer Nam - Summer Street Research

Jayson Bedford - Raymond James

Integra LifeSciences Holdings Corp. (IART) Q4 2008 Earnings Call March 2, 2009 9:00 AM ET

Operator

Good day ladies and gentlemen, welcome to the Integra LifeSciences fourth quarter financial reporting conference call. As a reminder, today’s call is being recorded. At this time, it is my pleasure to turn things over to Mr. Stuart Essig, President and Chief Executive Officer.

Stuart M. Essig

Good morning everyone and thank you for joining us for the Integra LifeSciences fourth quarter and year end 2008 earnings release conference call. I am Stuart Essig, President and Chief Executive Officer of Integra LifeSciences Holdings Corporation. Gerry Carlozzi, Chief Operating Officer and Jack Henneman, Chief Financial Officer, join me today.

During this call, we will review our financial results for the fourth quarter and full year 2008 and our forward-looking guidance for the full year 2009 which we released this morning. At the conclusion of our prepared remarks, we will take questions from members of the telephonic audience.

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

John B. Henneman III

This presentation is open to the general public and can be heard through telephone access or via live webcast. A replay of the conference call will be accessible starting one hour after the conclusion of the live event. Access to the replay is available through March 16, 2009, by dialing 719-457-0820, access code 1460424, or through the webcast accessible on the Investor Relations page of our website.

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

Because the content of this call is time sensitive, the information provided is accurate only as of the date of this live broadcast, March 2, 2009. Unless otherwise posted or announced by Integra, the information in this call should not be relied upon beyond March 16, 2009, the last date that an archived replay of the call authorized by Integra will be available.

Certain statements made during this call are forward-looking within the meaning of the Private Securities Litigation Reform Act of 1995, among others statements concerning management's expectations of future financial results, new product launches, regulatory approval and market acceptance of these new products, future product development programs, and potential business acquisitions are forward-looking. Forward-looking statements involve risks and uncertainties that could cause actual results to differ materially from predicted results.

For a discussion of such risks and uncertainties, please refer to the Risk Factors included in Item 1A of Integra's annual report on Form 10-K for the year ended December 31, 2007, and the information contained in our subsequent filings with the Securities and Exchange Commission. These forward-looking statements are made based upon our current expectations and we undertake no duty to update information provided during this call.

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

Additionally, in this press release and in the current report on Form 8-K that we filed this morning, we provide explanations for why management believes that presentation of these non-GAAP financial measures provide useful information to investors regarding Integra's financial condition and results of operations and the reasons for which Integra's management uses the non-GAAP financial measures.

I will now turn the call over to Stuart.

Stuart M. Essig

Integra delivered its 11th consecutive year of high-teens or better revenue growth in 2008. Our 18% constant currency growth reflects the depth and breadth of our business, and the effectiveness of our strategy of balanced internal and acquired growth.

As with many other companies, 2008 presented us with unprecedented challenges including dramatic increases in the volatility of currencies as well as the deteriorating global economy which contracted sharply in the fourth quarter affecting in particular the ability and willingness of customers to purchase capital equipment.

Despite these significant challenges, Integra continues to focus on serving its critical markets, and indeed the strength and the balance in our business allowed us to deliver full year adjusted earnings per share of $2.09, right in the middle of the initial annual guidance range that we provided more than a year ago and ahead of the Street estimate of $2.04.

As we reported early in January, Integra’s total revenues in the fourth quarter of 2008 increased by $17 million to $174.4 million and 11% increase over revenues of $158 million in the fourth quarter of 2007. The strengthening in the US dollar led to a negative currency effect of $3.5 million on sales in the quarter. Excluding the effects of currency exchange rates, revenues increased 13% in the quarter.

For the full year 2008, revenues were $655 million, an increase of $104 million or 19% above 2007 revenues on a reported basis and 18% excluding the effect of the change in currency exchange rates. We are pleased with our revenue growth for the year.

At the beginning of 2008, we guided the sales of $635 million to $655 million for the full year, taking into account revenues from acquisitions which were not yet closed at the time that guidance was given. Our actual revenues came in roughly in line with the bottom of the original annual guidance range we presented. In addition, Integra’s orthopedic business which are both newly acquired and legacy products exceeded our expectations for the year. As you can see, despite the tough environment, we delivered on what we said we would do at the beginning of the year.

In the fourth quarter, US sales were up 16%. International revenues were down due to foreign currency effects and up only modestly in constant currency. To get a little more specific, Europe was up 3% in local currency, though down nearly 8% as reported. Rest of the world was up 5% on a constant currency basis despite capital freezes in several of our main markets. However, on a reported basis, rest of world sales was down almost 2% due to the strong US dollar.

Growth for the full year 2008 was reasonably balanced. The US posted a 19% increase, while Europe was up 15% on a reported basis and 9% in constant currency. Our business in the rest of world was up 27% on both a reported and a local currency basis. Approximately 18% of our revenues are denominated in foreign currencies.

As we discussed in January, our fourth quarter revenues were negatively affected by both exchange rates and a slow-down in spending for capital equipment. We have worked to further refine our assessment of the impact of the economy on hospital capital spending and are developing strategies to grow affected product lines despite these challenges. We believe that approximately 10% of our worldwide revenue can be categorized as capital products. So, more could be affected by a customer’s strategic decision such as to suspend expansion plans.

In the fourth quarter we saw significant decrease in our sales of capital products which were down from the prior year by approximately $3.5 million or 18%, and well below our prior expectations for growth. For the full year, sales of capital products were down slightly because of fourth quarter performance as we’ve previously seen growth in these products during the first 9 months.

We’ve seen the impact of reductions in our customers’ capital spending in both the US and in foreign markets. Indeed, as you may be aware, declines in capital spending are not only a US hospital phenomenon; in fact, freezes on capital expenditures in several foreign markets contributed heavily to our slower sales.

We reported our revenues in three categories; Integra neurosciences, Integra orthopedics, and Integra medical instruments.

The first revenue category, Integra neurosciences encompasses the products sold to the neurosurgeon and the neuro-nurse. The products in this category represented approximately 37% of Integra’s overall revenues in the quarter. Integra neurosciences revenues in the fourth quarter declined 2% to $64 million versus the prior year period. Neurosciences revenues were weak across all capital product lines declining from the prior year period. However, we continued to grow our disposable and implant lines with duraplasty products in particular recording growth rates in the upper single digit range interest eh quarter. From a geographic perspective, domestic sales held up reasonably well and were up over 5% in the quarter. Internationally, however, sales were weak predominantly in the sale of capital equipment. Of course, currency also negatively affected our neurosciences revenues.

Integra orthopedic revenues which include the extremity reconstruction product lines, Integra orthobiologics, Integra spine, and private label product lines grew by 40% to $63 million from $45 million in the prior year period. We are excited about the orthopedic franchise that we are building. It constituted approximately 36% of Integra’s revenues in the quarter. With $63 million of revenue in the quarter, this category is running at more than $250 million annual run rate. Revenues from the recently acquired take-in companies exceeded our expectations in the period. We continue to see strong domestic growth at our extremity reconstruction business of 20% which currency tempered our overall extremity growth in the quarter.

Collagen based products including artificial skin, nerve, and tendon repair products grew 25% in the quarter. Metal fixation implants for the extremities grew to double digit range. Private label revenue was down in the quarter versus the prior year because of a combination of declining growth rates of certain of our customers’ products as well as efforts by many customers to limit or reduce inventories. We expect this phenomenon to continue for several quarters.

While we run the extremities, orthobiologics, and spine sales organizations separately, they reinforce each other, and all benefit from our leading position in tissue engineering. Our acquisitions of IsoTis and Theken Spine over the last and the expansion of Integra's extremity reconstruction sales organization reinforce our commitments to the high growth segments of orthopedics.

Our final category is Integra medical instruments. This includes Jarit, Miltex, Luxtec, and several smaller product lines including the recently acquired Omni-Tract line of retractor systems. This category accounted for just over a quarter of overall revenues in the quarter. We reported revenues of $47 million in the fourth quarter which was essentially flat with the prior year period; however, internally generated growth of proprietary products and acquired products were offset by the effect of the continued elimination of third party distributed products. Slower capital sales hurt our Luxtec surgical illumination line, while our hand-held medical instrument line grew in line with our expectations.

Overall, we continue to run the company to balance growth in revenue and profits. Eliminating low margin product lines accomplishes both of these objectives because it improves our profitability and focuses our resources on the products that have the most potential.

Now, I’d like to turn the call over to Gerry to discuss some recent product launches and the performance of our sales groups.

Gerard S. Carlozzi

As Stuart said, I would like to take a few moments to recap the performance of our sales organizations.

Our neurosciences group launched 7 new products in 2008 and has a full flight of products lined up for launch in 2009 including a next generation tissue ablation system, the CUSA NXT. This will address the needs of the neurosurgeon. The next generation CUSA will provide surgeons with the power, precision, and control they need for selective dissection of soft tissue and hard tissue including bone for neuro and spinal applications. This is the result of Integra’s extensive ultrasonic tissue ablation engineering expertise and years of development efforts. The next generation product provides a truly innovative advance in ultrasonic tissue ablation technology further separating us from the competition. This addition will enhance our diverse line of CUSA tissue ablation products including the CUSA EXcel, CUSA Selector, and CUSA Dissectron systems.

Over 2000 centers worldwide use CUSA products for a variety of tissue ablation procedures including the removal of brain and abdominal tumors. Whenever we see a rebound in a demand for capital equipment, we’re optimistic that we can drive an upgrade cycle with this innovative new product.

To minimize the economic impact of capital purchases, we’ve been aggressively promoting service and repair contracts for existing equipment. The service and repair contracts will not offset the current demand for new systems, but they will enable us to secure a relationship with our existing customers and put us in a better position to upgrade existing systems when capital hospital budgets free up.

We’ve had quite a bit of activity in the orthopedics area of our business. In extremity reconstruction, we continue to invest in the expansion of our direct sales organization. Our extremity reconstruction team expanded from 75 direct sales people at the end of the third quarter to 85 people by the end of 2008, and we anticipate expanding the sales force further to 115 people during 2009. This expansion will allow us to continue to broaden our coverage of the extremity market and provide value-added services to support the growth in excess of 20% in this category.

In addition, I would like to update you on the progress of two important projects. First, we are on track to begin our wound trial in 2009. We expect the trial to last about 3 year, and the purpose of this trial is to gain FDA pre-market approval for the use of our Integra Dermal Regeneration Template for the treatment of diabetic foot ulcers, especially in outpatient settings. Second, we continue to make progress in the development of the Integra two-piece ankle for the domestic market. We continue to be on track for release to a controlled group of surgeons late in 2010.

In Integra spine, with the integration complete, we are focusing on increasing our distribution network. In fact, since our New York investor meeting in November, we reported sales coverage of approximately 20 states. We now have approximately 50 distributors covering two-thirds of the US.

We also have expanded from three regional managers to six, and we plan to add one more in order to manage the growing distribution network. To-date, we’ve not seen any slowing in the growth or our expectations for growth in this business. We’re also expecting to begin selling these products internationally in the second half of 2009.

In addition to expanding our distribution network, we also continue to launch new products. In January we announced that we received clearance from the FDA to market the Vu e-POD and the Vu L-POD, spinal intervertebral body fusion devices. Prior to receiving the status, the FDA cleared the devices as spinal vertebral body replacement devices. This dual classification of the Vu e-POD and Vu L-POD increases the number of procedures these products can be used. The Vu e-POD’s unique technique of distraction during insertion reduces the number of steps and instruments required to perform the surgery, and as a result, reduce the amount of time needed to perform the procedure.

In orthobiologics, we continue to launch new products. We recently launched Accell Evo3, the latest generation in demineralized bone matrix products. Accell Evo3 is composed of an optimized blend of particulate demineralized bone matrix, the proprietary Accell bone matrix in a unique Reverse Phase Medium. The Reverse Phase Medium is a thermo-reversible carrier that thickens at body temperature and is more flowable at room temperature. The optimized platform Accell Evo3 enables the bone healing process to take advantage of the naturally available bone proteins and it’s specifically formulated to provide surgeons with the best possible inter-operative handling characteristics.

We’re also driving synergies between our spine and orthobiologics platforms. Through our consolidation efforts in the past 6 months, we now have a majority of our top spine distributors carrying an orthobiologics platform.

We’ve also added Theken’s comprehensive line of synthetic orthobiologics to our Integra orthobiologics product platform. We have the most comprehensive line of synthetic collagen and demineralized bone matrix based orthobiologic products in the industry. We view our orthobiologic portfolio as the cornerstone of our spine strategy at a competitive advantage driving our products into the spine market.

Now, I’ll turn the call over to Jack, for a review of our numbers.

John B. Henneman III

Before I discuss expenses, I’d like to expand briefly on international sales. In the fourth quarter, international sales were 21% of revenues compared to 24% for the full years 2008 and 2007. Foreign exchange had a favorable impact of $5.6 million a year, but in the fourth quarter, we saw a negative impact of $3.5 million. Half of this impact came from the euro which accounted for approximately 70% of our foreign currency denominated sales and the remainder of the impact came disproportionately from the British pound, Canadian and Australian dollars. The euro was down 9% against the dollar in the fourth quarter from prior year while the British pound and Canadian and Australian dollars fell about 20% against the dollar.

As we said previously, we opt to manufacture or procure a significant percentage of our products in Europe. As a result, the strengthening dollar lowers our European period cost, eventually will improve the gross margins of products that we make or procure there. The favorable impact on gross margin is delayed, however, because the benefits of these lower period cost reduce the actual cost of inventory manufactured or procured and is only realized in our profits when those products are sold. Therefore, we anticipate that our gross margins will realize the benefit of the sharp decline in the euro as we progress through 2009.

Gross margin and total revenues in the fourth quarter of 2008 was 61%, this included the 1.3 percentage point impact of purchase accounting, acquisitions, charges related to facility consolidations, manufacturing transfers, and systems integration. Gross margin was slightly lower than projected as the negative impact on revenues from the stronger dollar was matched with cost of goods coming out of inventory that was manufactured or procured and valued at a time when the US dollar was much weaker. In fact, a $3.5 million negative impact of currency exchange rates and taking into effect the offsetting impact of period cost and manufacturing decreased overall gross margin by approximately 1.5 of a percentage point.

We expect that this dynamic may continue to pressure our gross margins slightly in the first half of 2009, potentially offsetting this downward pressure as the mix benefits that we expect to see from the rapid growth in orthopedics business where the products have higher gross margins.

In 2009, we expect gross margins to ramp up through the year. For the full year 2009 we anticipate gross margins in the range of 63% to 65% excluding the impact of purchase accounting and other special charges. These numbers remain volatile and will continue to depend on the lagged impact of currency fluctuations in our P&L.

Research and development expense in the quarter decreased by $1.6 million to $10.2 million or 6% of sales from the prior period quarter. Last year’s R&D expense included $4.6 million in in-process R&D charges related to the IsoTis acquisition. In 2009, we anticipate R&D spending to be 6% of sales.

Selling, general, and administrative expenses increased by $2.5 million to $67.4 million or 39% of revenue compared to 41% of revenues in the fourth quarter of 2007. Although SG&A expense increased in absolute dollars over prior year, the increased spending resulted primarily from acquisitions. We saw a decrease in expenses within the corporation as we implemented belt-tightening measures especially in personnel costs including the elimination of most cash bonuses for the year. We anticipate that SG&A will approximate 39% to 41% of sales in 2009 as we continue to leverage our selling organizations and limit corporate overhead costs. That said, the inclusion of Integra spine has the decision to go direct in Australia, New Zealand, and the planned expansion of orthopedic sales organizations will put upward pressure on our SG&A expenditures.

Like many other companies, we’re taking a hard line on compensation expense, severely limiting executive compensation and wage increases. We’ve limited our total 2009 compensation increases across the company to less than 1% versus approximately 4% in prior years. Indeed most of the Integra executive management team including Stuart, Gerry, and I are not receiving any cash bonus for the year 2008 despite having achieved most of our objectives and anticipating another ambitious year of growth. Unless the climate improves significantly, we’re unlikely to pay cash bonuses to executives this year either. We believe that this belt-tightening is prudent in the current climate.

Our expense for the amortization of intangible assets was $5 million in the quarter of which $1.3 million is included in cost of product revenues. In 2009, we expect amortization expense of approximately $19 million of which we expect to report approximately $5.6 million in cost of product revenues.

Operating income in the quarter was $25 million, an increase of 61% over prior year period. We reported a $1.6 million increase in net interest expense to $4.3 million for the fourth quarter of 2008 primarily from increased borrowings under our credit facility for general corporate purposes in November, to fund the purchase of the take-in companies in August, and the repayment of our $120 million convertible notes in April 2008. Other expense was $1.6 million, primarily as a result of unfavorable foreign currency transaction losses due to the rapid strengthening of the dollar in the fourth quarter.

Let me take a moment to discuss our GAAP and adjusted tax rates and I recognize that they could be very complicated because the number of acquisitions we’ve done and continue to do so, the difference between GAAP and adjusted tax rate seems to always have a disproportionate effect on reported numbers.

Let me first discuss GAAP. In the fourth quarter, a $10 million deferred tax benefit relating to the restructuring of one of our German subsidiaries significantly benefited our GAAP tax rate. This affects only the accounting treatment in the quarter and represents a one-time GAAP tax benefit. That said, we expect to see the benefit on cash taxes of the same amount over the next 15 years.

To calculate an adjusted tax rate, we’ve excluded that GAAP benefit as well as all the tax benefits from the purchase accounting and other special charges that we use to calculate our adjusted net income. These exclusions give us an adjusted tax rate of 30% for the full year 2009, which reflects the ongoing mix of our profitability around the world.

We reported net income of approximately $25 million or $0.85 per diluted share for the fourth quarter of 2008. When adjusted for acquisition related expenses and other special charges as well as the tax adjustments discussed above, net income for the fourth quarter of 2008 would have been $15.5 million or $0.53 per diluted share.

The weighted average common shares outstanding used in the calculation of diluted earnings per share in the fourth quarter of 2008 is approximately 29 million shares for both GAAP and adjusted calculation.

We generated over $27 million of operating cash flow in the quarter, a very strong result. The full year operating cash flow was nearly $73 million, up 54% from full year 2007 results.

At the end of December we had nearly $184 million in cash on the balance sheet and outstanding borrowings of $260 million under our credit facility. We believe that our cash flow, the availability under our bank line, and our cash on hand are more than adequate to meet all our obligations through 2011. Integra did not repurchase any shares during the quarter.

Finally, I’d like to comment on the status for material weaknesses. We’ve been working hard to remediate these weaknesses and are pleased to report that we’ve resolved all the material weaknesses in our internal control over financial report with the exception of the one described in prior filings related to tax. We’re still assessing the controls around that weakness and we’ll conclude our assessment prior to the filing of our 10-K. In the event we conclude that we indeed still have such a weakness, we have a waiver from our bank group related to that issue. Therefore, there’s no negative implication if the ongoing weakness should persist for our banking arrangements or other debt securities including the convertible bonds will pay a one-time fee of just under $1 million in the fourth quarter to obtain that waiver. We expect no change in our cost of borrowing.

Now, let me turn the presentation back over to Stuart.

Stuart M. Essig

Our management team continues to seek out external opportunities for growth as future acquisitions could affect our results going forward. However, the forward-looking guidance that we are providing does not reflect the impact of acquisitions or other strategic corporate transactions that have not yet closed.

We are reiterating our 2009 revenue and EPS guidance provided in January. We are assuming a euro-dollar rate of approximately $1.30 per euro in those numbers. Historically, we have had quarterly fluctuations in our performance relative to our expectations. Thus we continue to believe that annual guidance remains the appropriate benchmark for our business. By focusing on our annual guidance, management and investors will be better able to focus on the full year objectives and less on the quarter to quarter variability that is inevitable in our business.

Although we are not providing quarterly guidance, we noted in our prior guidance that consistent with our historical seasonality and in the absence of acquisitions, we anticipate first quarter 2009 revenues to be sequentially lower than the fourth quarter of 2008 by about 3% to 5%. Further, the revenue impact has a disproportionate effect on the bottom-line as period expenses are much less variable on a quarter to quarter basis than revenue.

When combined with our earlier comments on the impact of currency on our gross margin, we expect a steep quarterly progression in our earnings through the year. Because of the current economic climate, I would suggest that you be conservative in your estimates. I’d also like to point out that some of the published annual assessments do not seem to reflect the disproportionate impact that we reiterated would be felt in the first quarter EPS.

For those of you who are still tracking the impact of FAS123R, we expect the quarterly impact of share based compensation expense to be approximately $0.08 to $0.09 per diluted share per quarter during 2009. We look forward to continuing to meet with investors. We will presenting at both the Raymond James and Lazard conferences later this month, and we’ll be exhibiting at The American College of Foot and Ankle Surgeons’ Meeting later this week in Washington DC. I’d also like to welcome Angela to Integra, our first employee devoted full time to investor relations. Over the next 6 months, Karen Mroz-Bremner will be transitioning out of investor relations as Angela comes up to speed.

Now, we will be happy to answer all of your questions.

Question-and-Answer Session

Operator

(Operator Instructions). We’ll hear first from Glenn Novarro - RBC Capital Markets.

Glenn Novarro - RBC Capital Markets

Two questions, one, just to clarify, I just want to make sure I heard your spine comment correctly; are you saying that, one, the US and overall spine market is not seeing a slow-down from the economy or are you saying that your business is not seeing a slow-down in the economy? And then question two, obviously, in the last several days we’ve gotten some updates on Obama’s policy and I’m just curious, we’ve seen all the stocks sell off, Stuart, if you can give us your insight into this, is Integra at all impacted by any of this power fee talk coming out of Washington?

Stuart M. Essig

Gerry will take spine and I’ll take the overall economy and how we perceive the impact on Integra; on the spine market, as you know, we bought a relatively small company growing at about 20% per year. As we evaluated that company and integrated it into the Integra portfolio, at that time we covered about 20 states in the United States which had about 40% of the procedural coverage in the United States and no distribution outside the United States.

So, as we talk about spine for Integra we see two opportunities. One is a distribution strategy or execution which is expanding distribution in the United States to go from 20 states to get to full US coverage and that will give us opportunity to get broader coverage in the market, and to be able to take market share from some of the smaller less capitalized companies competing in this space. In addition to that being able to expand internationally using our infrastructure in Europe and Asia that we’ve established over the last two years and being able to take the current spine products and putting it into that infrastructure and expanding distribution outside the United States provides an additional opportunity and a growth opportunity. Again, this is mostly about execution of our distribution, expansion strategy both the US and globally.

As far as the overall market, there is a lot of discussion about pressuring some of the larger companies in terms of their procedural volume, but as we’ve talked to our sales people in the field, we’ve not seen the impact of that pressuring as we’ve been just penetrating the market and taking market share. So, we’re seeing still strong growth in that segment, and you have to also put in perspective that we’re not the number one or two player in the spine market where we’re controlling procedures; we’re so distant from the number one and number two position, in that market it’s a totally different opportunity for us to go in and capture market share from undercapitalized small companies which there are well over a hundred of them in this marketplace as well as some of the larger competitors.

One of the things that are driving our success in this space is also the addition of our orthobiologics platform to our spine channel as the companies when we acquired them had the Therex orthobiologics, there’s very little attention or focus on integrating the orthobiologics into those spinal column planes. With the Integra Orthobiologics in having both a mosaic platform as well as a demineralized bone platform and the Accell technology, we’ve been able now to integrate that into several of our strong spine distributors and we’re starting to see a lot of leverage in that channel by expanding our orthobiologic sales and giving our spine people a competitive advantage in order to capture share, being able to provide the surgeon with both a full portfolio of fixation and metal reconstruction devices and instrumentation as well as the orthobiologics to stimulate the bone growth during the bone grafting and vertebroplasty procedure. So, I think we’re in a different situation than some of our larger competitors and we have a real competitive advantage over the smaller competitors in this space. This enables us to really continue to grow this business, and we see that continuing on throughout the year.

Glenn Novarro - RBC Capital Markets

So net-net Gerry, can I just sum up what you’ve said there. Are you saying that yeah, there is overall pressure on procedure volumes, maybe not significant, but for Integra, you’re not seeing any pressure within your business. Is that fair to say?

Gerard S. Carlozzi

That’s fair to say.

Glenn Novarro - RBC Capital Markets

Would you be willing to give us your assumption of certain market growth rates this year; for instance, what do you think the orthobiologic market will grow? What do you think the fusion market will grow?

Gerard S. Carlozzi

I’ve read the reports on some of the market growth rates. The spine market is still reported to grow at 10%. There’s a lot of tempering of those numbers downward based on the economy and just some of the pressures on procedure volume, and I’ve heard numbers as well as 3% to 5% in the spine market. And orthobiologics, they’re about the same rate, at about 5% to 7% growth rate.

Stuart M. Essig

Glenn, just to follow up on some thoughts about the overall policy impacts on Integra. A couple of things; first, you know well that we’re a pretty broad-based company. Our whole strategy over the last 3 to 5 years has been one of diversification into multiple hospital supply areas, and indeed with only 10% of our revenues in capital, we’re relatively less affected than certainly capital equipment companies. Now, if you think about what has been going on on the policy side, what’s happened is there is some lack of confidence by hospital purchasing people, financial administrators, etc., in what’s going on in the economy. There is not a lack of capital. There is a lack of confidence, and the lack of confidence then has caused conservative behavior, and that conservative behavior for example on the fourth quarter caused the slowdown in our capital product lines simply because they can be postponed for a quarter or two as they’re mostly replacement.

Now, if you then look specifically at some of the topics that have been floated, the biggest target appears to be Medicare and we have very little exposure to Medicare. Indeed, one of the opportunities under the Obama plan is the addition of some 40 million people under Medicaid program or under some form of program. Now, those people are not being served. They’re being served at great expense to hospitals, and so indeed much of what we provide, hospitals have to provide to patients; brain tumors, burns, head trauma, there is no choice to turn those patients away from the hospitals; so they then become indigent care, and so there’s actually an upside to the addition of these uncovered patients to the hospitals. Sure, they would like it to be insured or Medicare, but even under Medicaid, given that a lot of our products are not reimbursed are indeed covered under either DRGs or covered under general hospital operating funds. There’s actually an opportunity for them to be positively impacted.

Again, keep in mind that while we have a very broad base of business, our overall perspective is we don’t have high-ticket products for the most part, we don’t have products that are priced in the $10,000 to $15,000 range of implants or disposables. Indeed our typical implant a $1000 DuraGen-type implant, and so in a way, and I guess it’s in my nature to be optimistic; I’m enthusiastic about the fact that people be cared for, and I believe our mix of business indeed could be positively impacted over time. The hospitals are certainly being conservative and that’s certainly impacting behavior, particularly on the capital side, but I think as things start to be clarified, maybe some of that uncertainty goes away as we get to the back half of the year.

Glenn Novarro - RBC Capital Markets

Let’s just hope things get clarified.

Operator

We’ll take our next question from Matt Miksic - Piper Jaffray.

Matt Miksic - Piper Jaffray

I had two questions, but if I may, I just wanted to clarify your comments just now on spine; on the spine market in particular, less so on your business, Gerry. So, you officially entered the spine market, spine fusion market, I should say, in terms of hardware and implants recently; are you making the call here that based on what you’re seeing that you see a deceleration from 10% to 3% in spine, Gerry? Or are you talking more about reports that have been published, comments from the larger players over the past month or two as they put in their quarters? I just want to understand your view on the spine market specifically.

Gerard S. Carlozzi

Sure. It’s mostly reports that have been published from some of the larger spine companies and some of the analysts in the market who are covering the spinal space. We’ve read mostly 10% going into the year and then as most companies have started feeling some pressure and reporting their earnings as well as analysts’ reports out there are seen as low as 3% or 5%.

Stuart M. Essig

Matt, I’ll add in and I think I’ve said this to you before. We certainly do our homework and we certainly talk to our sales team and we talk to our customers, but we cannot provide a unique insight into the overall spine market compared to some of the larger players. What we can tell you is what our salespeople are saying to us, and that is that we’re net share takers, and that there is an enthusiastic embracing of our strategy of combining orthobiologics with metal, and there’s an enthusiastic reaction to our building out of our geographic expansion plan. So, in some ways we do have perhaps better insight than people on the sidelines, but I would not wish to take that point of view that we somehow know better than some of the larger companies. What we do know is what they’re saying and what we do know is what our salespeople are saying and indeed we believe we’re net share takers over the coming year, and if you look across all our orthopedic businesses, I think that’s true. None of our salespeople have reported a decline in procedure volume in any of the accounts that they support, and instead they’ve actually reported increases in procedure volume as they’ve continued to improve the service levels to those customers and provided new products to those procedures. I would reiterate, and I know you know this, but I’ll just make the point for others on the call; extremities is the largest part of our orthopedic business, and indeed there we have substantial growth as we do in spine, and indeed there you again, don’t have the kind of high-ticket products, but rather just a huge opening in terms of new procedures that are being supported, reaction and opportunity to treat diabetic and obesity conditions, and I think that strategy continues to play out very effectively.

Matt Miksic - Piper Jaffray

That’s helpful clarification. If I may, just two questions; one drilling into your comments on the capital spending markets, in particular oversees, you talked about some of these international markets also showing pressure in addition to the US; just wondering if you could highlight where you’re seeing that and maybe where you expect to see that going forward, and I have one quick followup.

Stuart M. Essig

I think you heard from our numbers that we reported that indeed currency is a significant impact and it’s worth highlighting that when you compared fourth quarter to fourth quarter. Markets that we’re direct in such as the UK, Australia, and Canada had currency had declines of 20%. So people are really focused on the euro, but indeed a lot of other countries had major currency impacts in the fourth quarter. Indeed some of those countries had their currencies nearly collapse which basically put on hold purchases from manufacturers in the fourth quarter because they had literally seen their currencies half, and these are developing countries. In terms of capital, historically there was much more pressure outside the United States than in the United States on capital; so you did not expect the kind of growth that we had historically been getting in these capital products outside the US, but indeed some markets, for example, Canada in the fourth quarter shut down capital spending. The government basically said, ‘see you next year.’ Now that doesn’t go on forever, and indeed again, because our products are capital products are really replacement and upgrade cycles; for example, a 2000-box installed base for the CUSA, these things need to be bought. It’s just a question as to how long they can be postponing. Certainly they can be postponed for several quarters, but we certainly are not losing to other players, we’re certainly not selling a product that is not needed, you have to use an ultrasonic aspirator to take out a tumor, and eventually they’re going to buy the upgrade or replace the old product. We’re also enthusiastic about this new NXT, and I realize this is not the quarter where everyone is thinking about new products, but it is worth pointing out that after quite a few years of development, we finally launched this product, and we’re enthusiastic that it will help us generate an upgrade cycle as we move through the year, and it’s very differentiated from either the other products on the market or our historical products.

Matt Miksic - Piper Jaffray

Last question here, just on acquisitions; I didn’t see it in the press release, if you could provide us with what was acquired in the quarter and then if there’s any particular areas where we can look for either tuck-ins, additional acquisitions going forward, the tendency towards instruments, the tendency to implants or neuro, any color would be of course helpful.

Stuart M. Essig

The small impact of our late December acquisition of Omni-Tract was a trivial contributor to the quarter. In terms of our overall strategy, we intend to continue to be acquisitive. We think it’s an appropriate strategy for the company. Certainly in this environment we’re much more focused on cash flow and on accretion and profitability, and I think all of our expectations are appropriately balanced to more conservative acquisitions. So, I think you’ll see us do acquisitions this year. I mentioned that in the fourth quarter, we were able to get off a very conservative acquisition over this small company, Omni-Tract, and I would point out that we did with a lower EBITDA multiple than we would have done in a different environment, we did it with a more conservative capital structure than we would have done in a different environment, but we’ve got some good expertise in getting deals done. Certainly, we’ve made it clear to all of the potential acquisition targets that given the stock market including ourselves is down well over 40% we certainly expect acquisition prices to be down a similar amount, and that takes a little bit of time to sink in for sellers to react, but they will. So, expect acquisitions this year, expect them to be smaller than in the past, and expect the profile of those acquisitions to be more conservative.

Operator

We’ll take our next question from Raj Denhoy - Thomas Weisel Partners.

Raj Denhoy - Thomas Weisel Partners

I’m wondering if I can follow up a little bit on that last question, you mentioned you are still working at acquisitions, but you obviously do have some cash flow obligations over the next year or two years, and with your stock price where it is, I doubt you’re going to do much using equity as far as acquisitions. So, how do you plan to structure deals going forward?

Stuart M. Essig

Keep in mind our historical track record on acquisitions. We’ve generally used cash and we’ve generally paid anywhere from 5 to 8 times EBITDA or cash flow. We’ve done typically deals in the $10 million to $20 million range, certainly in 2006 and 2007 we got several larger deals done which dramatically increased our orthopedic business and I certainly feel great about the fact that we put together this now close to quarter of a billion dollar orthopedic business with a growth profile and good balance to our more mature instrument business. To some extent it’s a story of relative value. If our stock is down 40%, then we just need to be sure that our prices that we pay are conservatively down on the order of 40%, and that just takes some getting used to for sellers, but the fact of the matter is most of the companies we buy are smaller private companies, the sellers aren’t getting any younger, and that doesn’t change as each year goes by. So, I’m optimistic we’ll be able to get deals done, and also while we do have cash obligations, we also have a lot of cash and a lot of cash flow, and so we fully intend to be conservative, but you’ve got reasonably experienced people here at Integra in getting deals done, and really the company was build on $10 million and $20 million acquisition, not $200 million or $300 million acquisitions. We certainly don’t think in this environment we could do deals of that size and we certainly as you point out Raj would not be wishing to use our stock to do anything more than smallish transactions.

Raj Denhoy - Thomas Weisel Partners

Using current indicators, you guys expanded the taking sale coverage by quite a bit. Where are you getting those distributors from? Are these folks that are experience spine reps that are moving away from other companies from the avid Zimmer acquisition or where have been able to take these folks off from?

Stuart M. Essig

Back to our orthobiologics group at the same time, historically we had, when we acquired the IsoTis business and integrated into Integral Orthobiologics, we had some C and D level distributors, and during the course of 2008 we turned over about 40% of the distributors in our orthobiologics group to really strengthen that grip and get to a higher level of distribution and now we end up with more of the A and B players. In the spine space, as we continue to look at expansion in the space, we’ve also taken the same approach, by being able to get the full portfolio of spinal reconstruction and then blending that with some of the orthobiologics products, gives us a lot of opportunity to secure a higher-level distributor. What we’re finding is these are a number of smaller companies, a little over a hundred companies out there that some of these distributors were covering carrying multiple lines into the spinal surgeon and those companies are just undercapitalized and cannot afford to continue to support the distributor networks like they did in the past. They historically paid out high commission rates; they gave away instruments sets and tried to support the sale growth.

We’ve taken a much more traditional point of view where we’re not paying out distributor commissions, we have a reasonable loaner program and consignment program on our instruments, we’re not giving them away, and we’re managing the distributor network, but we’re actually providing a much higher level of service to the group with specialist management support and programs as well as investment in new product development we continually have new product introductions in both the orthobiologics and the spinal fixation devices. This enables us to get higher-level distributors. I don’t want to talk about the actual names of the companies where we’re taking from, but it’s apparent from the surgeons and the hospitals that we’re doing with now, we’re picking up much better distributors who are much more established in the market and have the presence in the territories in which we’re now expanding into.

Raj Denhoy - Thomas Weisel Partners

Okay, that’s helpful as well. One last one on the extremities business, I think most of us just got back from the Academy Meeting last week, the booze of the independent extremity companies keep getting bigger and a lot of the larger companies now are starting to call out extremities as an area that they want to focus on. Could you just talk a little bit about what’s going on as far as the competitive dynamic out there; are you seeing more, is it tougher to get new accounts? Just maybe some comments, that would be very helpful.

Stuart M. Essig

Sure. I’d say right now we have about 85 direct reps in the US and we have a number of specialists covering some of the wound centers and burn centers. As we expand our coverage out to 115 people in the US, we believe that and we’ve seen it through the expansion from 75 to 85 in the fourth quarter that there are opportunities in the marketplace to continue to expand our penetration and growth in that market by just providing better coverage and better service to our customers. Some of the dynamics competitively we’re seeing; again it goes back to the economy where some of the smaller companies in this space are being pressured right now to continue to provide a higher level of service and they just cannot afford it. They cannot afford to put more instruments in the market because it’s cash flow, they can’t afford to continue to invest in their sales organization, they’re holding back on some of the new product launches, and I’d say probably most of the bigger competitors that we have, there are only a couple of them as you know that are out there in this space who are growing in excess of 20% a year really continuing to put their money into distribution and value-added services for the customer.

We have heard lots of discussion about some of the larger orthopedic companies entering this space, that’s not new news for us, that’s been happening over the last couple of years, and we still feel very comfortable with continuing our strategy of having a direct focused sales organization focusing on this market, and we believe we can provide a much higher level of service to those accounts than some of the larger orthopedic companies because this is our business, this is the only thing our salespeople think about everyday. They’re not thinking about should I be in a total knee or total hip case today or should I be in a $400 or $500 foot reconstruction or hand reconstruction case; that is their only option and we’ve been very successful and we believe that the sales organization will continue to expand our penetration and grab market share from both larger and smaller companies in this space.

Gerard S. Carlozzi

Raj, it’s also worth pointing out that when we talk about extremities it’s hands and feet. When a larger company talks about it, they’re often talking about shoulder, and so again, we’ve tended particularly in this market to go after niche market opportunities and these are the challenges larger guys always have is that it’s always still better to put a guy into a hip or knee or spine procedure than it is into a foot procedure. So, some of the extremity numbers that you see for the larger companies in their breakout are disproportionately weighted to shoulder, which we don’t plan.

Operator

We’ll take our next call from David Roman - Morgan Stanley.

David Roman - Morgan Stanley

Just a couple of followups here; on R&D when you take out the IP R&D charges from last year, it looks like a pretty healthy increase in the quarter. Can you give us a sense as to what the key projects are driving that increase, and with a lot of new projects, could you give us a sense as to what we should expect in 2009?

Stuart M. Essig

Just keep in mind that in particular one of the biggest step-ups that you’re seeing in R&D comes from the acquisition of Theken. Theken historically has spent more than 10% of sales on R&D and we intend to continue that trend; so that’s an important piece of it. In addition to that we continue to grow our spending on clinical activities, the DuraGen adhesion barrier trial continues to move at pace and that continues to enroll patients and move them through the process and that adds to the R&D spend, and then in 2009 we’re excited about our wound care trial and that adds to the spend in the clinical area in R&D. So all positive things, but a long-term investment in the company and consistent with our commitment to grow R&D as a percent of revenues. Gerry is going to talk now about some of our product pipeline activities by our sales organizations.

Gerard S. Carlozzi

We’ve tried to make sure we continue to invest in our higher-margin products and the areas where we’re seeing strong growth in the marketplace and as we look at that we started investing heavily in the orthobiologics space, we have several new products, we’ve taken the Accell technology and we’ve continued to invest in the Evo3 and we also have several product line extensions that we’ll introduce over the next year based on the Accell technology for demineralized bone graft matrix products. In addition to that we’ve also had some of the mosaic platform which is a collagen ceramic product and the Therex ceramic products as well. We started looking at how to continue to expand the portfolio to further differentiate ourselves and provide a real clinical advantage over some of the synthetic and non-synthetic bone graft substitute materials. So as we’ve continued to invest in that area, we’ll launch several new products during 2009 in orthobiologics. As Stuart mentioned, neurosurgery we have the adhesion barrier trial we’ve invested heavily in. We’ve continued to invest in the DuraGen family of products and looking at next generation products to further differentiate our products form potential competitors that may come out into the marketplace, and then we’re also looking at our monitoring systems. While we’re not introducing new capital to our ICP monitors, we’re looking at catheter systems to make it easier for the surgeon to insert them in a tunnelable fashion as well as in a bolted fashion so that it allows more utility for the same piece of capital purchase that they have by providing a single use catheter per patient that allows them to use one piece of capital, multiple catheters to achieve what they’re trying to achieve rather than buying a second piece of capital equipment.

David Roman - Morgan Stanley

Then you talked a lot about some of the smaller players in spine being undercapitalized. Can you give us a sense of what technologies you think you’re missing in the spinal area and where you think you’d like to get bigger?

Stuart M. Essig

In the spinal area, we’ve continued to invest in our internal portfolio mostly for reconstruction and if you look at the spine market, certainly in motion preservation area as well as dynamic stabilization and minimally invasive, those are areas where we have products either in development or on the horizon right now, but we’re also looking at how do we expand our offering in that space to address the growing trend in minimally invasive surgery, and probably the number one focus is how do we accelerate our opportunities in minimally invasive surgery as the market trends in that direction. We feel our position pretty well with the portfolio that we have and the products in development that will be coming out over the next year or so, but we still are looking at how do we get to accelerate that, how do we add differentiation between some of the products that are currently on the market, or have been projected to come out of the market in the area of minimally invasive, and also to minimize tissue and muscle disruption, to get patients back to normal activity in a shorter period of time and being able to do that in a way that’s unique and innovative that provides a better clinical result for the patient.

David Roman - Morgan Stanley

You talked briefly about taxes in the quarter. Can you give us a sense what the cash flow impact was of the tax benefit in the quarter?

Stuart Essig

We may be able to pull that up while you are talking here. The $10 million had no cash flow impact in the quarter. Indeed, the point is it’s a GAAP impact for the quarter because it is considered a temporary impact, and the cash flow benefit will happen over the next 15 years, so that cash flow of $27 million which we think is very positive included zero having to do with the $10 million GAAP benefit.

David Roman - Morgan Stanley

On the change in accounting on the converts, I assume the way you are going to report that going forward is as a one-time item or non-GAAP adjustment.

Stuart Essig

Yes, and indeed I know you know this because I’ve seen your note. It is posted on our website, and has been, I guess, for a month now or two, and so the details there we’ve actually gone ahead and calculated the impact through the life of the converts which go out another several years, and so if you are building a long-term model and want to model out the GAAP impact, it’s actually all posted on the website by quarter and also the historical impact is posted, so that data is all done. We got that all calculated and available for your review, and as we’ve done with items, we will reconcile between GAAP and adjusted as every company will.

Operator

Your next question comes from the line of Amit Bhalla with Citigroup.

Amit Bhalla – Citigroup

I wanted to ask you a couple of questions on the neuro business. Historically, this is not necessarily a discretionary-type procedure, but the capital equipment portion certainly is weak as you mentioned in the prepared comments. Can you just walk us through the components that actually are doing well? I think you’d mentioned that neuro-monitoring was a little weak which I was a little surprised about, but just talk to us a little about the dynamics within the neuro business and your growth rate outlooks within the segments.

Stuart Essig

I don’t think anything has changed in our perspective on neuro first of all. It is indeed the fact that the business performed not poorly in the quarter, but it was a result of capital and also currency. The business is composed of a number of different product lines, ultrasonic aspiration or CUSA being one big component of it, and there we saw a significant growth and good performance of the disposable part of the business, the procedure based part of the business which is literally tied to the number of brain tumors that are treated on a quarter by quarter basis, and obviously that’s not an economically impacted part of the business, so disposables were up, consistent with prior quarters, but capital was just not there, certainly not there compared to prior quarters or prior year, and we gave some statistics on capital overall for the quarter being down 18% year over year rather than growing in line with the rest of the business as has historically been the case. DuraGen we said was again good growth year over year, again negatively impacted by currency but still strong. Our neuro-monitoring business again has a capital component and a disposable component, and again the capital component is, I think, we have something on the order of 3000 monitors. They tend to break down after 5 to 7 years. They can certainly be repaired. They can certainly postpone the replacement cycle, and so I think we saw that going on in the monitoring part of the business, and then the last major part of that business is hydrocephalus, which again is not really a choice on the patient’s part, and that performed consistent with prior trends. As you heard from our talk, international was tough in the fourth quarter, and that’s the combination of currency and conservatism, in particular again, in places where there is opportunity to postpone capital purchases.

Amit Bhalla – Citigroup

In terms of the cost structure of the business going forward, I appreciate that you did mention that you are not taking cash bonuses, but what kind of leverage is there in the overall cost structure because you aren’t really talking about making much in the way of changes there, and you certainly are investing on the sales force side, but if trends get much weaker or just significantly different from what you are expecting, what kind of leverage do you have on the cost structure?

Stuart Essig

As you know, we generate a very strong EBITDA, and while it’s not always what the investors are focused on, it’s something we are focused on quite substantially, and so we are a company that tries to balance driving our operating cash flows, delivering on earnings objectives, and growing the top line, and I think in 2009, we see some really good opportunities to grow the top line in orthopedics, and we will continue to do things like expand the extremity sales force where we see a direct correlation between heads and performance, less of an impact in spine because we go through dealers, and therefore if they generate a dollar of revenue, they generate a commission, and if they don’t, then they don’t, and so there is less overhead or fixed cost attached to that. We really do have in my opinion a lot of flexibility in our SG&A, in our R&D, and in the longer term in our gross margin. The real question, and I know every company you cover is probably saying the same thing, is to balance the short term with long term, and we don’t want to disinvest in our business in this 12-month period by cutting critical programs that will benefit the long term.

On the other hand, we fully intend to deliver on our operating performance and our operating profit and EBITDA, and we’ve got quite a few levers, and I don’t believe we are close to cutting fascia or bone or muscle. We are cutting fat. The fact of the matter is that our people have performed well in the last several years and have certainly earned cash bonuses, and in this environment, that’s not the thing to pay, and there’s been substantial wage inflation over the past several years, and we know that’s not the case any longer, and so we communicated the reality of that to our people several months ago. I think people embrace it. Nobody likes to be told they are not going to get a cash bonus, and nobody likes to be told they are not going to get an increase, but it’s a hell of a lot better than being told you are going to lose your job, and so we are trying to do the right thing for our people and make sure we are appropriately prudent in certainly things like compensation, and we are certainly looking hard at underperforming people or underperforming particular areas, and we will take advantage of the fact that there is a lot of good people on the market who are being made redundant at other firms and give us an opportunity to recruit, but we don’t have yet built into our plans any significant changes in the way in which we’re strategically driving the business, but if the economy were to perform dramatically worse, well, then we could react.

The good news is that the company generated well over $650 million of revenue last year which means we spent half a billion dollars, and there’s certainly room to spend less should we need to. This company has done a great job over the years as a cost cutter. In the last several years, we’ve tried to balance the general approach of being the cost cutter with a desire to build out these strategic franchises. I think as we go into next couple of years, I’m actually quite eager to make sure we improve our cost structure, and I actually think a number of changes we are making will position us for the long term, although I know a lot of people are very focused on the short term, but we’ll position us for the long term as a more profitable and well run company.

Amit Bhalla – Citigroup

Can you just provide us the number for the revenue from acquisitions over the last 12 months that contributed to the quarter?

Stuart Essig

We as you know have asked people to focus on the different sales categories that are provided in the appendix or the addendum to the press release and have not broken out acquired versus other revenues, so I don’t have that number for us.

Amit Bhalla – Citigroup

Not even for just total company?

Stuart Essig

No.

Operator

Your next question comes from the line of Tao Levy with Deutsche Bank Securities.

Tao Levy – Deutsche Bank Securities

Generally, what are you seeing on the pricing front? Are you seeing hospitals trying to put greater pressure on you guys, and if you look specifically at the fourth quarter, were things generally stable there?

Stuart Essig

Anticipating that question, we did what ever we could to try to get an answer to that question by talking to sales people internally, looking at our different product lines, and we have not seen an impact on pricing. Now, we want to take an advantage of any sensitivity to pricing that customers may have by trying to drive them to buy our bundle as it where, and we have many different neuro product lines, for examples, many different instrument product lines, and so trying to get volume in a cost sensitive environment is a strategy. Again, keep in mind that we are a little bit different than many of the companies that you and many analysts follow. Our instrument business for example is, in particular JARIT business is 85% GPO. You don’t get much pricing. We never did. In the neuro business, we have historically gotten some pricing and don’t expect that to change, and on the orthopedic side, we haven’t seen it in pricing at all. We are certainly watching for that and trying to be sensitive to it as that’s a topic of some discussion in the analyst community more than amongst our sales people. Jerry?

Gerard Carlozzi

You just have to look at it in two pieces. There’s a capital budget within the hospital, and there is an operating room budget in the hospital, and most of our implant products and the products that we selling into procedures are coming out of the operating budget. The capital equipment is what’s under pressure, and that’s in a different budget within the hospital system, so as Stuart mentioned, pricing on a per procedure basis for the products that we sell to do those procedures, we are not seeing any pricing pressure on those, and in fact that’s one of the reasons started offering our sales and repair service contracts because it comes out of the operating side of the budget and not the capital budget. It allows the hospitals to maintain their equipment and allows them to continue to establish a strong relationship and be in there on a regular basis so when they are ready to go to an upgrade, which may be out a quarter or two we are there in place, still have that relationship, and then we can offer an upgrade option for their capital, but so far on the per procedure basis, we have not seen pricing pressure affect us, anymore than it would normally have been as we do business.

Tao Levy – Deutsche Bank Securities

You talked about the diabetic foot ulcer indication for the artificial skin. Why is that a 3-year trial, why isn’t it 12 months? We’ve seen similar products being able to get a product on the market in less time or at least an expanded indication in less time?

Gerard Carlozzi

Currently we have the product on the market. We have the Integra dermal regeneration tablet, and it is approved under a PMA for primarily for burn patients, and in addition to that, we have the Bilayer Matrix wound dressing which is approved for chronic and acute wounds which is currently used to treat some of the diabetic foot ulcers. There is a piece of the market that we just don’t have access to or we have access but we don’t have much sales in it. That’s in the outpatient surgery center. The reason we are going through a clinical trial right now, and we have many years of clinical data to support the safety and efficacy of the products. We have many years of data that show that this product actually works in treating diabetic ulcers, and it’s used currently today to do that as well as other tissue regeneration applications in both hand and wrist and foot and ankle procedures. What we are really fighting with or addressing is the reimbursement issue for the product in outpatient surgery centers.

There are 6000 surgical podiatrists in the US who currently treat these patients in wound centers. Because of the way the reimbursement structure is, there are only a few products that have gone through the PMA or control clinical trial period that show safety and efficacy with clinical outcomes in a randomized control clinical trial, and that’s what the insurance companies requires to support a reimbursement decision. We’ve gotten denials on some reimbursement decisions in outpatient clinics, and we believe that there is about a $300 million market opportunity if we can expand our coverage and get a positive reimbursement decision for this product in outpatient.

To go back to your original question why 3 years and why not 12 months, it’s a process. We go through an FDA pre-IDE preclinical meeting. We have to compile our data on all of the preclinical results, prove that there are minimum safety issues or there are no safety issues using this product in the trial, and we’ve gotten through that stage. Now we are at a point where we have to do a pilot study according to the FDA protocol to show that if we follow the protocol that we are going to submit in our IDE and we follow up our patients for a 6- to 9-month period and then make sure there is no recurrence of the diabetic foot ulcer out over a year, so there is an enrollment period, there is a followup period, and you have to wait till the majority of the patients passed over the half way point of our followup period before you can get to anything conclusive, so based on the size of the trial, the negotiations we have with the FDA, the followup requirements, and the followup to make that there is no recurrence, which is the most important part of the trial, it just takes time, and it’ll take about 2 years to do a trial. It’ll take us another year almost to complete the followup with statistical analysis and filing, and we anticipate that the FDA will take approximately 6 months to approve the supplement to the PMA based on the new trial data. Now, this is a supplement to our existing PMA that we currently have, so it is not a question of factoring processes, it’s not a question of design of the product, not a question of safety. It’s a question of making sure we can prove efficacy in this application and then use that to support a positive reimbursement decision to allow us to sell it and expand our applications into the outpatient clinic.

Operator

Your next question comes from the line of Taylor Harris with J.P. Morgan.

Taylor Harris – J.P. Morgan

On the acquired revenues, are you guys going to be disclosing that in your K’s and Q’s still or is this just a change in disclosure policy?

Stuart Essig

I think we want investors to focus on what management is focused on, and our view is, for example, we fully intend through our efforts to meet our objectives of generating $720 to $740 million of revenues in 2009, and we don’t want to be distracted with chasing an organic growth number based on having given out these numbers. What we want to do is put our resources against the most important and fastest growing parts of the business, some of which were acquired this year, and so I think our approach is going to be to give annual guidance, provide an annual revenue number, and do our darn best to hit it.

Taylor Harris – J.P. Morgan

It just seems really hard. I realize you guys disagree with the street on the way we look at organic growth. I think it just makes it really hard for us to analyze how the base business is doing, so I would encourage you to continue providing it for what it’s worth. Just moving into the orthopedics business, the extremities business, you said the US portion had grown 20%, what was the total worldwide growth there?

Stuart Essig

The US was at 20. I think the total worldwide was mid-teens, again mostly driven by currency as we’ve got a significant international business in extremities.

Taylor Harris – J.P. Morgan

On the capital equipment side, when did you see that during the fourth quarter start to deteriorate and is the same trend in place so far this year?

Stuart Essig

Well, as you know, we were surprised. We are tracking well through the end of November, and the hints that we had had a slowdown when we had our finial numbers in and keep in mind the final numbers were below the street, but modestly below the street, and below our guidance. We didn’t really expect to miss the guidance, so it was really late in the quarter or even into the new year that we had any inkling that the capital was going to be affected. I think it’s the same as fourth quarter. In another words, we brought down our numbers principally when we gave our preannouncement just before your conference based on capital, and I don’t think it’s changed. It certainly hasn’t gotten better, and I don’t think it’s gotten worse. It’s sort of where it was.

Taylor Harris – J.P. Morgan

If the month December caused $3.5 million decline year over year, should we read into a full 3 months worth of capital equipment weakness being closer to a $10 million year over year decline?

Stuart Essig

I have to think about your question. We brought our topline down approximately $15 million, some of which was currency, some of which was our expectations on capital, for the year. Differently, we told you we got about $70 million capital number for the year and that we don’t expect growth. In fact, we’ve expected capital to be down year over year in our new guidance, and that is now anticipated in the guidance, so I think the expectation and certainly the way we are resourcing the business is that capital will not recover certainly until the back half of this year.

Taylor Harris – J.P. Morgan

I’m sure that generally capital sales pick in the last month of the quarter, but still it would seem that if December caused an 18% year over year decline for the fourth quarter, then the run rate is a lot more than that. Is that right, or are we just looking at the numbers wrong?

Stuart Essig

I think our expectation in the capital, and I don’t really know how to answer the question Taylor, only to say that we are expecting capital down year over year, and we’ve built that into our guidance, and I think December is indicative of the slow-down, but I certainly wouldn’t take $3.5 million and multiply by 12 and assume that is the impact on the year because that’s just not the way it plays out. Maybe that’s where you were getting at.

Taylor Harris – J.P. Morgan

Yes, that’s what I’m asking.

Stuart Essig

No. It’s not that bad, but I think we’ve assumed that it’s down year over year particularly in the first half of the year, and then we will just have to see how the economy plays out. There comes a point where I believe these things have to be bought because they don’t last forever.

Taylor Harris – J.P. Morgan

Luxtec, you said I believe, was down $3.2 million year over year or that third-party distributed products fell off 3.2. I believe we had had it at about 9.7 in the fourth quarter of last year, which would put it at 6.5 or so for the fourth quarter of this year. I want to confirm that that’s about right, and is that the right run rate for the business going forward.

Stuart Essig

That feels about right without having the specific number right in front of me, and we’re planning to get the business down to running at about $20 million. The lines that we had acquired to keep were about $20 million. We expected some of the distributed products to be maintained for a period of time, and we’re reaching the point or have reached the point where we have virtually no distributed products as of the fourth quarter, so we continue to see difficult comparison in that business for another several quarters until we’re down to just the Luxtec product line which we acquired the business for, and again it makes for touch comparisons and makes it challenging to articulate the various performance of the business.

Taylor Harris – J.P. Morgan

So, you think that Luxtec component is going to go down to about $5 million a quarter then?

Stuart Essig

Yes.

Taylor Harris – J.P. Morgan

What that means is that either JARIT or Miltex is doing pretty well or at least did in the fourth quarter to compensate for that.

Stuart Essig

JARIT and Miltex continue to and we said this I think at our analyst meeting, we expect Miltex to be generally a 5% or so grower, and we expect JARIT to be generally a high single digit grower, and there have been periods where JARIT has grown 10 to 15%. Luxtech product line is synergistic with both, and Omni-Tract, our recent acquisition, is synergistic with both, and we’ve had an opportunity to both cost out of all those acquired business and also build out the sales force to approximately 60% of the country direct, so it makes for really messy reported numbers, but on the other hand the strategy is unambiguous, and you’ll see the results as we anniversary the discontinued product lines.

Taylor Harris – J.P. Morgan

I have a couple of cost questions. SG&A was done sequentially from the third quarter, and it sounds like that was a lot of corporate overhead and compensation expense. Did you reverse some accruals for bonus compensation in the fourth quarter? It just seems like a very meaningful decline sequentially, and so how exactly did that occur?

Stuart Essig

A number of things were cut, and we did indeed reverse some accruals for bonuses, so that’s true, and we also as we gave our forward looking guidance are not planning to accrue bonuses other than for our lowest level people next year, hence the expectation of a reduced SG&A into the next year.

Taylor Harris – J.P. Morgan

If I look at gross margin year over year in the back half of 2008, it was about flat year over year, and yet the product lines you acquired were in orthopedics, I would say Theken is probably above corporate average and the other maybe close to inline with corporate average, so the acquisitive impact should have been a benefit, and yet gross margin was about flat, so I realize currency was a hit to you. Anything else or any other reason we’re not seeing more of a gross margin increase?

Stuart Essig

You pretty much covered it with currency, and we’ve reiterated this point, but I’ll just make it again. We’ll just use the euro-dollar rate. For the first half of the year, it was close to $1.50. In the third quarter, I think it was $1.46 or so. In the fourth quarter, plus or minus $1.30, so if you figure we have 8 or 9 months of inventory, which we by the way have been bringing down and that’s part of our process, then it takes that amount of time to turn those inventories. In particular, in the fourth quarter and we pointed out for first quarter as well, we’re bringing revenues at $1.30 or so, but we’re stuck with the cost at $1.45 to $1.50. That starts to diminish and match themselves in the second half of this year, so Q3 and Q4 of ’09, and so that’s not insignificant for us because we have so many foreign expenses, in particular our instrument product lines and our manufacturing in Europe, and I’ve mentioned in the past, we’re a little different than other companies in that regard. We’re well positioned in the back half of the year, assuming again the currencies don’t change dramatically to be then back to matching $1.30 revenue with $1.30 inventory and then seeing the impact of these orthopedic businesses which are unambiguously higher than, in particular the instrument business, but the overall corporate gross margin.

Taylor Harris – J.P. Morgan

So do you feel like 100 to 150 basis points of improvement excluding acquisitions and foreign currency is still the right target?

Stuart Essig

Yes, and that’s going to be sequential through the year. You will see it as we get through the year, and particularly anniversarying the purchased inventory.

Operator

Your next question comes from the line of Joshua Zable with Natixis.

Joshua Zable – Natixis

I think you said relative to what you were seeing in December, things are improving, things are at least not getting worse. Can you just quickly give us clear color? I know you talked about pricing, you kind of got around it, but I’m just trying to get my arms around it.

Stuart Essig

I think where we are in the first quarter is I don’t think anything has changed from where we were in the back half of the fourth quarter. In other words, look around, you’re not seeing an improvement in the economy, but on the other hand, we haven’t seen a deterioration in the various trends whether it be in the orthopedic lines, our critical care products, our instruments, etc. We’ve certainly not seen an improvement in capital, but we haven’t seen a worsening, and so sitting here two months into the quarter, I think we feel real good about our guidance and real good about our understanding of 2009 recognizing these are unprecedented times, and anybody who would tell you they’ve got tremendous visibility, I think, is not close to their business, but I think we feel like there’s not been any deterioration. The reality is a lot happens in the last month of the quarter, but where we stand now, there’s not anything new.

Joshua Zable – Natixis

On the CUSA launch, obviously what’s going on with the equipment, I know you’ve kind of talked about it a lot, so I don’t need to get into that, but can you just help us understand exactly when you’re launching that? I know you talked about it as throughout the year. Is it this quarter, is it next quarter, just in terms of timing when that new product will launch?

Stuart Essig

The good news is we quite deliberately held off on this until we actually sold on, so it’s launched and we’ve sold one, and it was trained at our national sales meeting in February, and it is off to the races with this product, and it’s been a long time in coming, so we’re certainly not approaching a robust capital market with it, but on the other hand, we’ve got something differentiated to talk about. Jerry will give you more detail.

Gerard Carlozzi

We did a lot of controlled sales releases, market evaluations during the first couple of months of this year. We did a number of cases and surveyed the users of that equipment just to make sure that it was going to be a well-accepted product, and it would actually service the market at the level in which we believe it should be serviced, and what we’ve found is we’ve got just outstanding comments and results from the customers who use the product, and we brought it into customers who had never used a CUSA before, and we brought it into existing CUSA and Selector accounts, and what we found is we had just tremendous response from those customer bases, so much so that some of the original evaluators wanted to buy a piece of equipment. They wouldn’t upgrade, so we’ve started to sell the product, we’ve trained our sales organization, we have limited inventory with controlling our cost of inventory. The turnaround cycle on the manufacturing side is not very long, so to be able to control the inventory levels, we’ll have to make a high cash investment to support the launch of the product as we continue to grow that business throughout the year or be able to place these units and upgrade programs throughout the year, we should be in very good shape.

Stuart M. Essig

I would just reiterate, we pointed out to you guys the objective of reducing our inventory days and reducing our receivable days, and we made a lot of progress this year and expect in 2009 to make more. Again, one indicator of the economy is AR and whether it has been increasing and candidly we’ve been able to bring down our AR days just through better management and haven’t seen them deteriorate at all, and as I said, we’ll be filing our K and you’ll see our AR days have actually come down. So, that was a general view on managing our balance sheet.

Gerard S. Carlozzi

I just want to add one other important feature of the new NXT is that we’re very sensitive to the hospital’s environment, their cost structure, their expenses, and as we develop the piece of equipment, we made sure that we’re upgrading the capital, the console unit of the system, but also being sensitive to the fact that they have tips and hand pieces and other products that they’ve used from their existing CUSA Selector models, and so we’ve made this forward and backward interchangeable with their current hand piece with tip designs. So the hospital can actually upgrade the capital if a lot more features of benefits out of the system without going out and repurchasing hand pieces and tips, and so, while the hospitals have reacted favorably to that because of not making another deplete investment, and as for the disposable side of the business, if they can continue to use and when they deplete that they can upgrade to the new disposables.

Joshua Zable - Natixis Bleichroeder

That’s helpful. Just on housekeeping, I know you guys made a million-dollar donation in February, how is that going to play out in the P&L when you report Q1?

Stuart M. Essig

The donation was a product that had already been classified as excess and obsolete; so, it has no P&L impact either in Q1 or actually in Q4. It’s just stuff in the warehouse that when we give it away, we can actually also take our tax deduction.

Joshua Zable - Natixis Bleichroeder

And then I’m sure you won’t give this to me, but I think I’ll ask, obviously you guys talked about Q1 being lower, I know you gave some sort of relative on the top-line 3% to 5% down, you didn’t say anything on the bottom-line, you said obviously we can kind of figure out, it’s going to be lower than that or more than that, is there any sort of range you want to give just because I know obviously, you gave pre-announced, and numbers seemed to be too high, still just trying to get some understanding and maybe a range if you’re willing to give it.

Stuart M. Essig

I think we’re not going to give it and it’s not because we’re not trying to be helpful, but we found in the past that we’ve been reactive to trying in the process of being helpful to give estimates on quarterly guidance, particularly on earnings that turn out to not be right, and we don’t want to do that. Fourth quarter is a good example; we had a great third quarter; it seemed logical to therefore include that in the full year number, and indeed we gave it up in the fourth quarter, and had we not changed our annual guidance, we actually hit our annual guidance last year. So, I just think particularly in this economic environment, but also is just a better approach to how we want to manage our company, we think the annual guidance makes the most sense. What we were trying to do in terms of being helpful is, be conservative in your numbers, we gave a range of revenues, be conservative in how you interpret them, and also keep in mind that while we do have the opportunity to bring down our period costs and our fixed cost, one, it happens over time, and two, we’re trying to not disinvest in the future. So, if indeed the top-line is down Q1 to Q4 by 3% to 5%, there’s going to be a disproportionate impact on the earnings line and you saw some of that in the fourth quarter.

Operator

We’ll take our next question from William Plovanic - Canaccord Adams.

William Plovanic - Canaccord Adams

A few quick questions; one, the 10-K filing, when is it officially due to be filed and do you think that it’ll be filed on time?

John B. Henneman III

It’s due to be filed today and we’re working to tie everything up, it should be filed today.

William Plovanic - Canaccord Adams

Is there any reason it wouldn’t be?

John B. Henneman III

We’re working hard all weekend and we’re tying stuff up and I’ve learned a hard lesson and I don’t want to make hard fast promises I cant keep, but in the abstract, we’re doing right and we’re heading there soon.

Stuart M. Essig

I think the fact of the matter is we’ve released our numbers, so the numbers are final.

William Plovanic - Canaccord Adams

And then of the charges, are those all going to flow in the first and second quarter or is that going to be rolling through the year?

Stuart M. Essig

Which charges, Bill?

William Plovanic - Canaccord Adams

Acquisition related charges, facility consolidation charges…

Stuart M. Essig

It’s principally in the first half of the year because of the take- in inventory step-up. There’s certainly some in the back half, but it’s very front-end loaded, and as you know, we don’t put any acquisitions that haven’t closed, so, in principal by the end of the year, there’s nothing in there.

Operator

We’ll move on to Spencer Nam - Summer Street Research.

Spencer Nam - Summer Street Research

One quick question, about acquisition outlook for 2009, do you guys have any specific guidance or some additional details on what area that you guys may be looking for in terms of padding some extra assets here; historically it seems like the orthopedics has been the key target. I was wondering if you guys are looking to neuro instruments this year.

Stuart M. Essig

I think we’re looking across the board. It’s interesting in orthopedics the prices tend to be a little higher but there’re some really good deals out there now because of some of the phenomenon Gerry was talking about of lack of liquidity in the smaller companies. In instruments, the instruments tend to meet our EBITDA objectives in terms of pricing and the like, and neuro is still our largest sales force, and therefore, we are always looking for neuro acquisitions. So, I realize that was a very general answer, but we are looking in each of the areas and it’s unpredictable which one comes first simply because it’s hard to predict how deals get done, but we’re looking in all of the areas. What I would say is we’re not looking outside of the core areas at the moment, that was something we did several years ago to get to the diversification that we’ve got now, but we would not be expecting diversified acquisitions in the next 12 months; we’re much more focused on stick to the knitting.

Operator

We’ll hear from Jayson Bedford - Raymond James.

Jayson Bedford - Raymond James

Just a couple quickies here, you mentioned that take-in exceeds your expectations, what were take-in sales in the quarter and did the Omni-Tract acquisition contribute to fourth quarter?

Stuart M. Essig

Again, we’re not breaking out the sales of the acquisitions or various product lines, but what I can tell you is, the Omni-Tract was trivial for the quarter. I think we only owned it a few days, and our general point is that our orthopedic business is outperforming.

Jayson Bedford - Raymond James

And then just switching gears, on the neuro side, how much of this business is capital equipment related?

Stuart M. Essig

Well, it is disproportionate since there is no capital equipment in the orthopedic, so the bulk of the capital impact that the company saw is in the neuro business. We mentioned there’s a small amount as instruments come from Luxtec, but to the extent that we talk about capital being soft, you’re seeing pretty much all of it in the neuro segment.

Jayson Bedford - Raymond James

And then just lastly, operating cash flow, you highlighted that for the year, when you looked up ’09, is your expectation that operating cash flow growth will be similar to your EPS growth?

Stuart M. Essig

It might even be better than our EPS growth. I remember our EPS and I realize it is to many of your important number, but there’s so much that hits our EPS, there is close to $20 million of goodwill, there’s close to $20 million of depreciation expense, there’s FAS123 which is close to $20 million; our operating cash flow and EBITDA far exceeds our net income. So, I would expect to significantly outpace our earnings per share growth.

Operator

At this time we have no further questions in the queue.

Stuart M. Essig

Thank you all. I realize it was a long call. I hope you got all your questions answered and we look forward to reporting next quarter.

Operator

Once again, this does conclude our conference today. Thank you all for joining us.

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Source: Integra LifeSciences Holdings Corp., Q4 2008 Earnings Call Transcript
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