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Biomet, Inc. (Pending:BMET)

Q4 2006 Earnings Conference Call

June 28, 2006 10:00 am ET

Executives

Dan Hann - Interim President and Chief Executive Officer

Greg Hartman - Senior Vice President, Finance, Treasurer and Chief Financial Officer

Chuck Niemier - Chief Operating Officer

Garry England - Chief Operating Officer

Analysts

William Plovanic – First Albany Corp

Jason Wittes – Leerink Swann

Michael Matson – Wachovia

Milton Hsu – Bear Stearns

Bob Hopkins – Lehman Brothers

Taylor Harris - J. P. Morgan

Steve Wichman – Banc of America Securities

David Lebowitz - Thomas Weisel Partners

Joanne Wuensch - BMO Capital Markets

Presentation

Operator

Good day everyone, and welcome to the Biomet, Inc. fourth quarter 2006 earnings conference call. (Operator Instructions). At this time for opening remarks and introductions, I would like to turn the call over to interim President and Chief Executive Officer, Mr. Dan Hann. Please go ahead, sir.

Dan Hann

Thank you, Melanie. Good morning everyone, and welcome to Biomet fiscal year 2006 and fourth quarter conference call. Also joining me today is our Chief Financial Officer, Greg Hartman; as well as our Chief Operating Officers, Chuck Niemier and Garry England, International and Domestic, respectively; and as always, Greg Fastow.

To address any forward-looking statements made during the course of this conference call, we refer you to the paragraph regarding forward-looking statements included in Biomet’s fiscal year 2006 and fourth quarter press release issued earlier this morning.

Let me begin today’s call by saying that we are pleased to announce that Biomet’s Board of Directors voted to declare a cash dividend of $0.30 per share, payable July 21, 2006 to shareholders of record at the close of business on July 14, 2006. The declaration of this dividend is in response to the Company’s record financial performance during fiscal 2006, in addition to our optimism for strong results during fiscal year 2007.

Biomet's current share repurchase program, authorized in December 2005, currently has available $47 million to purchase the Company’s outstanding common shares. This share repurchase program included authorization to repurchase up to $100 million of the Company’s common shares in open market or privately negotiated transactions.

Turning to sales, I’m pleased to report for fiscal year 2006; Biomet's net sales reached the $2 billion mark. I would like to thank all of our hard-working team members, sales personnel and loyal customers for helping the Company achieve this milestone.

For the quarter, net sales increased 10% worldwide, excluding the impact of foreign currency, which decreased fourth quarter revenues by approximately $11.7 million. International sales for the quarter increase 11% constant currency, while domestic sales increased 9%.

Unless otherwise noted, the following growth rates are quoted on a constant currency basis. During the fourth quarter, reconstructive device sales increased 11% worldwide to $372.7 million and increased 13% in the United States. I’m pleased to report that knee sales increased 21% in the United States, and 15% worldwide during the fourth quarter against last year’s fourth quarter growth rate of 22% in the US, and 18% worldwide. Excluding instruments, knee sales increased 13% in the United States and 11% worldwide. Biomet's solid knee performance compares favorably to the knee market growth rates of 8% in the US and 9% worldwide last quarter.

Worldwide sales for knees during the fourth quarter continued to be driven by extremely strong surging demand for the Vanguard Complete Knee System and the Oxford Unicompartmental Knee System. The Vanguard Patella Femoral Replacement, known as the Vanguard PFR, also received strong market acceptance during the fourth quarter. The Vanguard PFR offers a conservative treatment option for arthritic patients experiencing cartilage degeneration, isolated in the front or middle compartment of the knee. Additional knee systems exhibiting strong sales growth in Europe include the Maxim, Performance, and Alpina APS Knee Systems.

The Vanguard Complete Knee System is designed to provide precise fit for all patients regardless of gender, race, stature or any other variables contributing to anatomical differences. The Vanguard is the most comprehensive total knee system on the market today, offering full interchangeability of the system’s components, and providing greater bone preservation than competitive high flex systems. Additionally, Biomet rolled out the Vanguard Interior Stabilized Bearings during the fourth quarter, and we received regulatory clearance for the Vanguard Pop Top Tibia.

As the first company in the industry to offer minimally invasive total knee instruments, Biomet continues to outpace the market in this important technology. Prior to the second quarter of this fiscal year, the Vanguard System had been offered only with Biomet's Microplasty Minimially Invasive Knee instrument. During the past three fiscal years, approximately 1,275 sets of Microplasty Total Knee instruments were released in the US, with an estimated 1,350 surgeons having completed Microplasty Total Knee instrumentation training.

The rollout of the Vanguard premier instrumentation was initiated during the second quarter and is ongoing, with approximately 230 sets in the field today. The premier instrumentation is designed for implantation of the Vanguard System using a traditional open procedure. Biomet also rolled out more than 50 Vanguard Interior Resurfacing instruments and approximately 120 sets of Vanguard’s SSK Revision instruments during the fourth quarter.

The Oxford Unicompartmental Knee System continued to receive strong worldwide market demand during the fourth quarter. The Oxford is the only true mobile bearing uni-knee approved for sales in the United States where it’s receiving excellent market acceptance. More than 100 domestic surgeons completed Oxford-specific training during the quarter, with the total number of surgeons trained exceeding 1,300 during the past seven quarters.

The Oxford System’s long-term results have clearly demonstrated the clinical success of the Oxford Knee outside the United States, with 98% of success reported at ten years, 95% success at 15 years, and 93% success at 20 years of follow up.

Turning to hip sales for the quarter, sales increased 10% worldwide and 9% in the United States. Excluding instruments, hip sales increased 9% worldwide and 7% in the US. Biomet continued to gain market share in the hip market, which we estimate experienced 6% growth rates worldwide in the US this past quarter.

Domestic sales of our metal-on-metal Acetabular System increased 23% during the fourth quarter, and represented 50% of Biomet's Hip Articulation Units. The M2a Magnum represented approximately 75% of Biomet's metal-on-metal sales in the United States during the fourth quarter on a unit basis.

In Europe, the Recap Total Resurfacing System is experiencing strong market acceptance. The Recap is a bone conserving resurfacing system indicated for patients in the early stages of degenerative joint disease. During the fourth quarter, we introduced the Recap Ha, Hydroxy Appetite Coated Shell to the European market. In the US, we continue to enroll patients in our IDE study for the Recap Total Resurfacing System, which currently has approximately 50 patients enrolled. Our goal is to have 100 patients participating in the study by the end of the current quarter.

Additionally, Biomet's C2a Taper Acetabular System, featuring ceramic-on-ceramic articulation, and our proven porous plasma spray coating technology, received strong market acceptance during the fourth quarter. There are now more than 100 instrument sets in the field for the C2a Taper. Biomet's porous coated hip stems continue to receive excellent market demand during the fourth quarter with the Taper Loc and Biometric stems driving growth in the US, as well as Europe.

In the US, clinical trials are ongoing for the minimally invasive balance, and Taper Loc Micoplasty Hip Systems. More than 150 Microplasty stems were implanted during fiscal year 2006, and surgeon’s feedback continues to be very positive. Clinical trials have also been initiated in Australia for the Taper Loc Microplasty Hip Systems.

Biomet initiated the launch of the Microplasty ASI, Interior Supine Intermuscular Hip program, and began conducted cadaver lab training sessions for surgeons in the United States and Europe during this past quarter. During the quarter, 30 ASI instrument sets were rolled out, and 32 surgeons attended the first cadaver session. Additional ASI labs are scheduled during the first quarter and throughout fiscal 2007. Although there continues to be significant demand for cadaver labs, also there continues to be significant demand for cadaver labs training opportunities for Biomet's Microplasty Procureor Hip techniques.

Biomet's highly cross linked polyethylene, ArComXL, continues to receive strong market demand during the fourth quarter, attaining a penetration level of 48% of Biomet's metal poly articulation units in the US. ArComXL provides a 47% to 64% decrease in volumetric wear rate over standard ArCom in laboratory studies, and offers a 30% increase in ultimate tensile strength, along with similar wear particle shape and size with no measurable oxidation exhibited under accelerated aging.

The Company received FDA clearance during the fourth quarter for Acetabular cups manufactured with Biomet's Regenerex core titanium construct. Due in large part to Biomet's pioneering efforts, titanium has become a clinically proven material in the orthopedic market, resulting in optimal biological fixation. We believe the long term success of Biomet's titanium implants will translate into strong demand for Regenerex as the material of choice for porous metal constructs. We are scheduled to initiate the launch of Regenerex cups and augments during the second quarter of fiscal 2007.

Lastly, on the hip side, the Freedom Constrained Liner received excellent market demand during the fourth quarter, reporting 26% sales growth. The Freedom offers a metal poly acetablular construct for patients with a propensity to dislocate without sacrificing range of motion.

Turing now to extremities, sales increased 17% in the United States, and 14% worldwide during the fourth quarter. Growth drivers for extremities during the fourth quarter included the Biomodular Shoulder, Discovery Elbow, Copeland Humeral Resurfacing Head, and Comprehensive Fracture stem, Mosaic Humeral Replacement System, ExploR Radial Head Replacement, and the Maestro Wrist Reconstructive System. In addition, the test shoulder contributed to extremity sales growth in Europe.

The Biomodular Shoulder can be used as either a total joint replacement or the Hemi Arthroplasty. The bone sparing Discovery Elbow features an improved hinge design utilizing ArCom direct compression molded polyethylene.

The Copeland Shoulder, a bone conserving resurfacing system, is used to treat patients in the early stages of degenerative joint disease.

The Comprehensive Fracture Stem is utilized to treat complex shoulder fractures and is available in press bit and cemented versions.

The Mosaic System is a modular shoulder designed for revision, oncology, and salvage cases.

The recently introduced ExploR Radial Head Replacement continued to receive excellent market acceptance during the quarter. The ExploR, a modular device, includes a tapered stem and a head designed to articulate with the patient’s natural bone.

The Maestro Wrist, which was also introduced recently, can be used as a total wrist device or a hemi arthroplasty for carpal replacement.

The Test Shoulder, available in Europe, allows for maximum preservation of the bone due to its anatomical design. In addition, the Test Shoulder requires only one instrumentation system for implantation of all designs included in the system.

Sale of bone cements and accessories decreased 8% in the United States during the fourth quarter and decreased 17% worldwide. These results were against tough comparables from last year fourth quarter growth rates of 36% in the US, and 17% worldwide.

Biomet's StageOne Cement Spacer Mold continued to experience excellent market acceptance during the fourth quarter. The Spacer Molds are used in stage one of a two stage revision, and offers surgeons an advantage over the conventional handmade or pre-made cement spacers. Biomet initiated the rollout of the StageOne Cement Hip Spacer Molds during the fourth quarter with the full release scheduled for the current quarter.

Shifting to dental reconstructive implant sales, for the fourth quarter, sales increased 16% worldwide and 9% in the United States. During the fourth quarter, 3i introduced its Performance Post Provisional abutment. The Performance is a temporary abutment manufactured from PEEK materials, making it particularly appropriate for provisional restoration of an implant due to ease of modification by the clinician. The abutment is available in straight and pre-angled versions. It’s designed for up to six months of inter-oral use, and features a titanium interface for improved strength and quality of fit.

3i began distribution of the OSSEOCISION Surgical Drill System during the fourth quarter. The OSSEOCISION System offers a miniature contra-angle head for easy access between teeth. Clinical evaluation is scheduled to begin later this quarter for OSSIX PLUS, the next generation resorbable collagen membrane. OSSIX PLUS offers long lasting barrier function and excellent tissue response for guided bone regeneration, as well as improved handling characteristics with a more flexible membrane. OSSIX PLUS is available through our distribution arrangement with Colbar Life Sciences, and a full product launch is planned for the second quarter.

During the first quarter, a limited release of 3i’s Nanotite Surface is being initiated for the Prevail and Straight Wall Certain Implant design. Approximately 150 customers worldwide have been invited to participate with full product release scheduled for the fourth quarter of fiscal 2007. Nanotite is a hydroxy acetate surface treatment that will initially be used on 3i’s Certain and Prevail Implant Systems.

This breakthrough surface technology incorporates a discrete crystalline deposition of nanoscale calcium phosphate, which is applied to our existing OSSEOTITE Surface substructure. The treatment provides a profound improvement of implant integration performance, both in terms of quality at the bone implant interface, and the speed of Osseoconduction, providing a more rapid and predictable treatment of patients.

Next let’s take a look at fixation sales. During the fourth quarter, fixation sales increased 5% worldwide to $64.2 million and 2% in the United States. I am pleased to report Lorenz Surgical’s craniomaxillofacial fixation sales increased 18% worldwide during the fourth quarter and 14% in the US.

Effective June 1, our President of Lorenz, Joel Pratt, retired. Joel was a great contributor who was with Biomet for over 21 years. We wish Joel and his wife, Theresa, all the best in their retirement. I am pleased to announce that David Josa has become the new President at Lorenz. David joined Lorenz in June of 2005, after serving as our Vice President of Sales at 3i. I am confident David will do an excellent job at Lorenz.

During the fourth quarter, internal fixation sales increased 7% worldwide and in the United States. During the quarter, external fixation sales were flat worldwide and decreased 1% in the United States. Electrical stimulation device sales decreased 1% worldwide and in the US during the fourth quarter.

During the quarter, Lorenz Surgical received regulatory clearance to market the Titanium Texas Bar, including a pre-bent version, which will allow implantation in patients with nickel allergies. The Texas Bar is utilized to correct congenital deformities of the chest wall, and was previously available only in stainless steel. New craniomaxillofacial fixation products scheduled for first quarter launch include the Lactosorb Distraction device, the Thin Flap Low Profile craniofixation system, and the Sterile Tract Neurosystem.

Internal fixation products which received good market acceptance during the quarter, include the

Peritrochanteric Nail, the OptiLock Periarticular Plating System, and the Pediatric Locking Nail. The Peritrochanteric Nail is a unique hip fracture system, featuring a single leg screw, with multiple leg options for various fracture patterns.

The OptiLock Periarticular Plating System uses anatomically pre-contoured plates for treatment of lower extremity fractures. The system allows the use of different diameter bone screws in locked and non-locked options, offering increased surgical flexibility with minimally invasive techniques. The Pediatric Locking Nail is indicated for treatment of humeral fractures and reconstructive procedures in children.

Turning to spinal product sales, during the fourth quarter, sales increased 5% worldwide to $57.7 million, and increased 2% in the United States. During the fourth quarter, sales of spinal implants in orthobiological products for the spine increased 7% worldwide and 2% in the US, while spinal stimulation sales increased 2% worldwide and in the US.

The rollout of the Polaris Spine System continued into the fourth quarter of fiscal 2006. The Polaris is a 6.35 millimeter diameter top loading rod system, which uses EBI’s patented helical flange locking technology. We anticipate the Polaris System will help drive spine sales growth during fiscal year 2007.

During the quarter, EBI received regulatory clearance for the PEEK version of the ESL, Elliptically Shaped Lumbar Spine System. The ESL is EBI’s first spacer designed for a direct posterior surgical approach. EBI’s clinical trial for the Regain Lumbar Nucleus Replacement is scheduled to begin during the first quarter of fiscal 2007. The Regain Disk is a rigid one-piece device made of pyrocarbon, which is a highly compatible biomaterial. The device is held in the disk space by the natural boney anatomy of the [in-plate]. The implant geometry is designed to maintain disk height and to provide for normal motion of the lumbar spine.

As you were all aware, during the fiscal year, our EBI operations have underperformed, and our progress at EBI has been slower than we anticipated. During the fourth quarter, Biomet’s senior management team began an aggressive program to take corrective action at EBI.

We have created the position of Biomet's first Chief Information Officer, Rich Bore, who has over 20 years of experience at Biomet with a strong background in IT and manufacturing. Under the direction of our domestic COO, Garry England, Bart Doedens, President of EBI and Rich Bore have worked closely to effect change at EBI.

Our initial focus has been on accounting, logistics, IT, manufacturing, and related infrastructural changes. We have made numerous personnel changes in these areas, and I am please to report that solid progress is being made.

As we move into fiscal 2007, Bart and his team will increasingly focus on the expansion of the EBI sales force. I believe by the end of fiscal 2007 we will see meaningful improvement in EBI's operational performance. Additionally, we will be closing EBI’s Allendale, New Jersey orthopedic bracing plant during the first quarter and consolidating those operations into our facility in Puerto Rico.

Lastly, other product sales increased 10% worldwide to $45.4 million during the fourth quarter and increased 4% in the United States.

Arthroscopy sales increased 16% worldwide and 5% in the United States during the quarter. Products driving arthroscopy sales growth during the fourth quarter include the Easy Lock Femoral Fixation Device, the WasherLoc Tibial Fixation Device and the InnerVue Diagnostic Scope System.

Sales of soft goods and bracing products increased 1% in the U.S. and decreased 2% worldwide during the quarter.

I will now turn it over to our CFO, Greg Hartman, to provide some additional financial details.

Greg Hartman

Thank you, Dan, and good morning. The following discussion will focus on the Company’s results on an adjusted basis. Adjusted results for the fourth quarter and fiscal year 2006 excludes the following one-time items: $9 million in connection with separation package payable to former President and CEO Dr. Dane Miller; $5.4 million for expenses related to the Company’s review and reorganization of its EBI operations; $4.8 million related to the discontinuation of the Acumen Surgical Navigation product line and the Company’s investment in Z KAT; and $2.6 million for a cross-licensing and settlement agreement between Biomet Biologics and Cytomedix.

These charges negatively impacted the fourth quarter and fiscal year 2006 results in the following manner: $3.8 million charged to cost of goods sold, $15.1 million charged to SG&A expenses and $2.9 million charged to other income.

Adjusted results for fiscal 2005 exclude the impact of inventory step-up related to the March 2004 acquisition of Merck KGaA’s interest in the Biomet-Merck joint venture and the June 2004 acquisition of Interpore.

Dane Miller’s retirement was announced on March 27 and details of the separation package were outlined in an 8 K filed with the SEC on May 10.

As a result of continued underperformance of our Company’s EBI subsidiary, as mentioned earlier by Dan, during the fourth quarter the Company conducted a management review and reorganization, including management changes resulting in severance pay agreements and relocation packages.

Biomet discontinued the Acumen product line and is researching externally developed surgical navigation options in order to offer surgeons improved solutions in this area.

The agreement with Cytomedix provides our Biomet Biologics division with a worldwide license under the “Knighton” patent. This licensing opportunity further broadens our patent coverage and protection with respect to our GPS platform of biologic products.

During the fourth quarter of fiscal 2006 net sales increased 7% to $539.9 million. Gross profit increased 3% to $378.7 million, representing 70.2% of sales.

Cost of goods sold was inflated by approximately $1.5 million during the fourth quarter due to the previously announced price increase from the supplier of the company’s antibiotic delivery system in Europe.

Additionally, gross margins were negatively impacted by 110 basis points due to the large number of knee and hip instrument sales to Biomet’s domestic distributors during the quarter.

SG&A expenses increased 1% to $190.5 million, representing 35.3% of sales. This is a 210 basis point improvement over last year’s fourth quarter. Also in this quarter, SG&A expenses included approximately $2.5 million in direct-to-consumer advertising expenses. We anticipate that DTC expenditures will drop considerably during fiscal year 2007.

R&D expenditures increased 3% during the fourth quarter to $21.7 million, or 4% of sales.

Operating income increased 5% to $156.5 million, with operating margins at 30.9% of sales.

Net income increased 8% to $113 million, while diluted earnings per share increased 10% to $0.46 per share.

Receivables were up $1.6 million in the fourth quarter and inventories were up $4.4 million.

Cash flow from operations totaled $135 million during the fourth quarter and $413 million during fiscal year 2006.

Regarding the share repurchase program, we repurchased 1.5 million shares during the fourth quarter for an amount of $56 million.

Dan Hann

Thank you, Greg. As we begin this first quarter of fiscal 2007 we estimate foreign currency will have a slightly positive or neutral effect on Biomet’s first quarter results. Consequently, we remain comfortable with analysts’ sales and earnings estimates of $513 million to $530 million, and $0.43 to $0.45 per share for the first quarter of fiscal 2007, respectively; and sales and earnings estimates of $2.15 billion to $2.22 billion and $1.85 to $1.95 per share for fiscal 2007, respectively.

This guidance does not incorporate the effect of FAS 123R, Share-Based Payment, which the Company estimates to be $0.05 to $0.06 per share for fiscal 2007.

Although the Company as a whole did not meet our internal expectations during fiscal 2006, our orthopedic and dental reconstructive products continue to receive strong market demand. We are particularly pleased with our ability to drive market-leading growth in our core orthopedic reconstructive device business.

As we move into fiscal 2007, we will continue to implement positive change at EBI and we are confident we will experience operational improvements at EBI as we move through fiscal 2007.

Biomet is in the midst of several major product launches and we have an extremely strong development pipeline.

Additionally, our management team has been actively reviewing all operations to ensure that we are well-positioned for continued profitable growth throughout the organization.

Biomet will continue to adhere to its engineering driven product development heritage, however the Company will strive to become more centrally focused in key operational areas such as accounting, IT, human resources, regulatory and clinical affairs, and we will critically evaluate all of our worldwide manufacturing operations with the goal of optimizing our consolidated gross margin.

We believe the Company’s future is bright and we look forward to sharing with you our financial results throughout fiscal year 2007 and beyond.

Thank you, and we’ll now open it up for Q&A.

Question-and-Answer Session

Operator

(Operator Instructions) We’ll take our first question from William Plovanic from First Albany Capital.

William Plovanic – First Albany Corp.

Thank you. Good morning. First of all, the one-time charges for the fourth quarter, what was the impact to COGS and what was the impact to SG&A? You gave us for the full year, but not the quarter.

Then secondly, domestic was very strong, instruments helped out significantly there. How long would we expect instruments to continue to have the impact that they have?

Dan Hann

Well, I’ll answer your second question first. We will continue to be rolling out instruments at least early into fiscal 2007, this quarter and next quarter, but we don’t believe you’ll see them rolled out at the rate they were in the fourth quarter.

Greg Hartman

As far as your first question: the $3.8 million charge to cost of goods sold; $15.1 million charge to SG&A and the $2.9 million charged to other income are fourth quarter and year to date numbers.

William Plovanic – First Albany Corp.

Okay, great. On the EBI, you’re talking about the reorg. Would we expect to see the contribution from there earlier or later in ’07? That’s it. Thanks.

Dan Hann

Well, as to EBI I think each quarter, sequentially, you will see improvement. I would not look for meaningful, significant improvement until we get to the back end of fiscal ’07.

We are working very hard out at EBI; a lot of positive things are going on and I think you will see improvement. Certainly we expect to see some margin improvement. For example, the Interpore acquisition that we did two years ago in the spinal area, all those products continue to be manufactured by outside vendors and we have already initiated a program to bring all of that spinal manufacturing in house. So as we move through fiscal ’07, we’ll have some margin capture there alone.

William Plovanic – First Albany Corp.

Great. Thank you.

Operator

We’ll take our next question from Jason Wittes from Leerink Swann.

Jason Wittes – Leerink Swann

Hi. Thank you very much. First as a follow up to those questions, should we expect as you transition each product, to see a gross margin improvement throughout the year? And to what magnitude?

Dan Hann

Well, you will continue to see an improvement, initially a more modest improvement; beyond that we’re simply not quantifying what those improvements will be.

Jason Wittes – Leerink Swann

It sounds like the bullish from instrument sales is going to be the largest this quarter, then taper off. Can we assume a few percentage points in the first half of this year related to instrument sales for hips and knees?

Dan Hann

Well, yes. The trend, as I said earlier, will be less than you saw this quarter. We expect it to go back to last year’s levels on a quarterly basis.

Jason Wittes – Leerink Swann

Okay, so basically flat in terms of percentage of growth related to instruments in the next couple quarters?

Dan Hann

Well, they need to continue to grow at our revenue growth rates to generate that revenue growth rate.

Jason Wittes – Leerink Swann

Okay. Also, in terms of hips and knees, could you give us an indication of where price mix and volume are at this point for your guys?

Dan Hann

If you look at knees this past quarter domestically, mix price contributed 2%, units 11%, instruments 8%. As to hips domestically, mix price was 2%, units 5%, instruments 2%.

Jason Wittes – Leerink Swann

Okay. How about overseas?

Dan Hann

I don’t have the overseas numbers.

Greg Hartman

Overseas we really don’t get affected much by mix. Pricing was relatively flat overseas this past quarter, Jason.

Jason Wittes – Leerink Swann

Okay. Thank you very much.

Operator

We’ll take our next question from Michael Matson from Wachovia.

Michael Matson – Wachovia

Good morning. Can you repeat what you said about the recap approval process and where things stand with the study there?

Dan Hann

Yes. We have presently enrolled 50 patients. Our goal is to have 100 patients enrolled by the end of this quarter. Beyond that, the approval process is still a couple years or more out.

Michael Matson – Wachovia

You mentioned that the direct-to-consumer advertising expenditures were going to drop quite a bit in fiscal ’07. Are you moving away from your direct-to-consumer campaign strategy?

Dan Hann

No. We’re reconfiguring it. The expenses will significantly drop this fiscal year, but we are going to go to a different approach. We’re going to do more regional-based advertising and more product-specific focus advertising in those regions and see what the results are.

Michael Matson – Wachovia

Finally, is there any kind of an update you could give us on the M&A front? Criteria, what types of opportunities you’re looking at there? Anything you can provide there would be great.

Dan Hann

Well, specifically I have nothing to report or disclose and if there was something to disclose, we would obviously disclose it.

As I previously stated, as a Board and a management team, we’re working on a long-term strategic plan and part of that planning process will be to identify acquisition and investment opportunities.

I will say this. In terms of a longer-term focus, I would say a lot of our focus will be on filling the pipeline and rounding out areas of technology that we have not internally developed.

Michael Matson – Wachovia

All right. That’s great. Thanks a lot. I appreciate it.

Dan Hann

Thank you.

Operator

We’ll take our next question from Milton Hsu with Bear Stearns.

Milton Hsu – Bear Stearns

Hi. Good morning.

Dan Hann

Good morning.

Milton Hsu – Bear Stearns

Dan, can you just talk a little bit more – I mean, you highlighted some of the initiatives: accounting, IT, HR. Can you just give us a sense of over the short-term, maybe perhaps the next couple of quarters, which of these you see being completed the earliest? How long will this turnaround take? I know that you said it would be probably back-end loaded but perhaps margins would start to improve as early as next quarter?

Dan Hann

I think you will see a gradual improvement and I would certainly hope next quarter you’ll see a little uptick there.

I think certainly the message is, and not just EBI but globally we’re very much focused on margin improvement. Facilities rationalization is a priority for fiscal ’07 and beyond. The changes that we’ve discussed at EBI will be ongoing. There is no quick one month or one quarter fix. In addition the bringing in-house of spinal manufacturing.

We’re doing other things globally like moving more and more of our instrument production to China, where it’s very favorable from a cost point of view.

To answer your question, I think you can really expect to see more cumulative, meaningful change as we get to the back half of the fiscal year.

Milton Hsu – Bear Stearns

Okay, and then just a question on electrical stim. Is that business still a business you want to be in over the long term? If it is, is it really new products that you need to launch there or is it really just the sales force expansion, a better selling effort to turn around sales?

Dan Hann

Well it’s a combination and yes, we are committed to the business. Quite candidly, as we’ve gone through the restructuring of EBI in the past couple of years following the Interpore acquisition -- frankly and quite candidly -- we lost some focus on stimulation. We are committed to getting that focus back and we are committed to working much harder to develop and build that sales force.

As to the technology and the products, we think we’ve got a very solid platform. We probably need to improve our marketing effort along with our sales effort in stimulation, but we are committed to the business.

Milton Hsu – Bear Stearns

Okay, and just one last one. I think I missed the numbers, the growth numbers for the knee business, U.S. and international, excluding instruments. Could you just give those again?

Greg Hartman

Well, knee growth worldwide comped to currency was 15%, 21% in the U.S. and mixed price on these was attributed 2%, units 11%, instruments 8% in the U.S.

Milton Hsu – Bear Stearns

Got it. Thanks.

Operator

We’ll take our next question from Bob Hopkins from Lehman Brothers.

Bob Hopkins – Lehman Brothers

Okay, thank you. Good morning.

Dan Hann

Good morning.

Greg Hartman

Hi, Bob.

Bob Hopkins – Lehman Brothers

Just a couple quick questions. One of the questions that I’ve been getting from investors is obviously around the Department of Justice subpoenas that were received late last week and early this week. I understand there’s probably not much you can say there but Dan, especially given your history as corporate counsel, I was wondering -- I’m getting questions that say, how can I get comfortable investing in the orthopedic space knowing that these Department of Justice investigations are going on and where they may lead?

How would you respond to that as formerly the corporate attorney for Biomet? How should we be thinking about these investigations as it relates to investing in the orthopedic industry today?

Dan Hann

Well, I can give you a few limited comments on the investigation. Bob, obviously you’re correct. We’re very limited in what we can say publicly about an ongoing investigation.

But I will say this. The subpoena we received is a very broad subpoena. Frankly, we do not know specifically what the investigation is about. The subpoena does not signal anything other than an investigation into price and bidding in our industry. We’re obviously aware that our other major competitors have also received subpoenas and of course, we will fully cooperate with the investigation.

Unfortunately, Bob, other than that, since it is an ongoing investigation, there’s really not much more I can say.

Bob Hopkins – Lehman Brothers

I think your subpoena mentioned something about a grand jury subpoena. Could you just define what that is?

Dan Hann

Well, it’s a subpoena where they impanel a grand jury who’s going to look at the case initially.

Bob Hopkins – Lehman Brothers

Is there any significance to that versus just a plain old subpoena? I mean, excuse my non lawyerly questions.

Dan Hann

No. That doesn’t change anything or elevate it or diminish it from a legal point of view.

Bob Hopkins – Lehman Brothers

Any sense as to timing or next steps?

Dan Hann

No. Frankly, typically these sorts of investigations take course over a long period of time and frankly I have no insight as to what timing will be.

Bob Hopkins – Lehman Brothers

Okay. Also onto another sensitive subject. The Morgan Stanley letter, does that remain active or is that engagement ended?

Bob Hopkins – Lehman Brothers

Well obviously, as you’re aware, we announced in April that we had retained Morgan Stanley to explore strategic alternatives focused on enhancing shareholder value. Beyond that we still have nothing to report, nothing to update. Nothing specific to report about the engagement. You know frankly, from where we sit, both the Board and management, we’re working together, working on a long-term strategic plan and we’re focused on running the business.

Bob Hopkins – Lehman Brothers

Then last question and I’ll get back in line, just on the charge related to EBI, I think it was $5.3 million. Is a certain part of that related to the manufacturing closure that you announced? If you could just break that down that’d be helpful.

Greg Hartman

Frankly, we went through a lot of different things this quarter out at EBI and looked at the management team out there. Frankly, management terminations, relocation expense and some product rationalization-type issues.

Bob Hopkins – Lehman Brothers

Okay. Thanks very much.

Operator

Next we’ll go to Mike Weinstein from J. P. Morgan.

Taylor Harris - J. P. Morgan

Thanks. It’s Taylor Harris here. Just one follow-up on the DOJ investigation. Dan, you mentioned that it was targeting price and bidding in the industry. Is it fair to assume that this is a separate issue from the first round of subpoenas, or is this something that you think came out of that first round of investigations?

Dan Hann

We frankly do not know and really I have no further comment on the investigation other than what I’ve already stated earlier in the call here today.

Taylor Harris - J. P. Morgan

Okay. But by bidding you’re referring to contracts with hospital customers, I assume?

Dan Hann

By bidding, I’m simply referring to the precise language that’s in the subpoena and I’m not making any judgments about what that may or may not mean or imply. Once again, frankly, I don’t know.

Taylor Harris - J. P. Morgan

Okay, and then one additional question on your gross margin. If we add back the instrument effect and the supplier price hike, gross margin was still down maybe 150 basis points or so year over year. Is that all EBI-driven, or are there other factors leading to that?

Greg Hartman

Well obviously with our international sales growing at 11% constant currency and our domestic revenues only up 9%, our international sales did not experience the high gross margins or the amount of gross margins we get out of the U.S. and so that mix shift also has a negative effect on our gross margins consolidated wise.

Taylor Harris - J. P. Morgan

Okay. So between that and EBI, that probably explains it?

Greg Hartman

Yes. That’s pretty much most of it.

Taylor Harris - J. P. Morgan

Okay. Thanks a lot.

Operator

We’ll take our next question from Steve Wichman from Banc of America Securities.

Steve Wichman – Banc of America Securities

Thank you. Good morning, guys.

Dan Hann

Good morning.

Steve Wichman – Banc of America Securities

A couple of follow-ups. In EBI you talked about operational improvement goals. Just looking at the top line can you focus us on what are the key products that we should be looking for to improve sales beyond improvements in the sales force?

Dan Hann

Garry, do you want to go ahead and take that on EBI?

Garry England

Well, it’s improvements in gross margin or – ?

Steve Wichman – Banc of America Securities

In the sales.

Garry England

Okay. EBI has a very competitive trauma line and we can see a good growth rate there if we focus on improving the sales force and sales force management. That also applies to spinal.

The internal operations that will be improved will support those efforts. Simple things like accurate and timely commission payments and things like that will boost morale in the field and help stabilize the sales force. I think you’ll see a lot of the improvement coming from just enhanced confidence out in the field.

The Polaris Synergy System should certainly be a big driver as we progress through fiscal 2007 on the spine side. As Dan indicated in the script, we have a lot of internal fixation products like our locking plates and [inaudible] screws and those will be pretty much the big drivers for EBI as we look through fiscal ’07.

Dan Hann

I guess I would add, we feel the product pipeline is strong. The complement of products we got from the Interpore acquisition helps round out the spinal side We have a good product base, and the real opportunity as Garry mentioned is really focusing on the sales force and trying to drive those sales that way.

Steve Wichman – Banc of America Securities

Okay, and then on DTC I think you mentioned ramping that down. Have you tracked what impact the campaign has had on the business? Have you seen a positive impact?

Dan Hann

Quite honestly, I think that’s very difficult to measure. It’s hard to quantify what each dollar of advertising translates into top line revenue. As I mentioned earlier, we are going to significantly reduce our expenditure in that area. Quite honestly, I think the jury is still out on how effective in the orthopedic industry -- or at least medical devices -- how effective direct-to-consumer marketing and advertising really is.

We will continue to keep our finger in it in a less costly fashion, but again, I think longer term the jury’s out on that one. Selling medical devices directly to consumers is a lot different than selling pharmaceutical products where you see a lot of advertising.

Steve Wichman – Banc of America Securities

Okay, great and then just lastly, in bone cement, obviously the comps have been tough but can you discuss what kind of successes you’re seeing out in the field in terms of converting accounts to the internally developed product?

Dan Hann

Admittedly it’s been a difficult transition to our internally developed bone cement. We’ve especially faced a lot of increased competition on the international front.

Having said that, however, Cobalt has been a product that’s been well received now that we’ve got it out there and it’s been assimilated. The color of the product provides a much better contrast for surgeons, especially in a minimally invasive setting, and our patented packaging has been a real hit. It’s a soft pack so you don’t have any glass ampoule breakage in the OR.

So I think, as you pointed out, clearly we’ve been up against some pretty tough comps and I think longer term you’ll see these internally developed products continue to grab hold. Chuck, you want to add anything on the European front?

Chuck Niemier

I think the internally developed products, again, have already emphasized what we see of the future. Personally, I’m very pleased with the success we’ve enjoyed in maintaining the business we’ve been able to keep and with that, I think we’re positioned to further entrench ourselves in that market.

Steve Wichman – Banc of America Securities

When do your comps begin to ease on that? Is it after the current quarter they start to ease?

Chuck Niemier

Probably midway through fiscal ’07, as we approach the third quarter, Steve.

Steve Wichman – Banc of America Securities

Okay, great. Thanks, guys.

Operator

We’ll take our next question from David Lebowitz from Thomas Weisel Partners.

David Lebowitz - Thomas Weisel Partners

Thank you very much for taking my question. The first question I have is on the ceramic-on-ceramic hip. I’m just curious. What’s the typical profile of the doctor that’s using this? Is this a doctor who’s been using another ceramic on ceramic hip from another manufacturer beforehand, or is this a doctor that is kind of new to ceramic on ceramic?

Dan Hann

Well typically, our ceramic on ceramic sales are mostly to our existing customer base. When we could not offer that as an alternative, they would reluctantly use a competitive product.

We focused most of our hard on hard development efforts in the metal on metal area and that’s by far and away our largest hard on hard market segment. So the ceramic on ceramic is a nice addition but it really is not a product that’s going out and getting new customers; it’s to support our existing customer base for the most part.

David Lebowitz - Thomas Weisel Partners

So would it be fair to say that it’s kind of there pulling customers back that might have gone to Stryker for their ceramic on ceramic?

Dan Hann

For the most part. Yes.

David Lebowitz - Thomas Weisel Partners

Okay, and also on EBI, it seems like you re-energized your restructuring efforts over there. I’m just curious if you could characterize the re-energized effort versus the prior effort and differentiate the two as far as what is being done now that was not being done last time.

Dan Hann

Well, the prior effort, this is in a continual process for several months and started with putting Bart Doedens in as president there last summer.

Really our restructuring efforts, as I stated earlier, really began in earnest about two, two-and-a-half months ago and as I said, we’ve made a number of terminations in the senior and middle management area.

A great deal of the focus has been on accounting, IT, human resources, sales management issues. What we’re trying to do, the initial focus of the restructuring, is EBI is a great company with good products and we’re trying to create an infrastructure that will support those sales and the sales growth going forward.

We’ve also made a number of changes in the manufacturing side of the business, really converting over to what we have experienced as best practices with cellular manufacturing and that’s gone extremely well and those are the types of changes, I think, as we move into, get deeper into ’07, will yield some positive change.

Did that answer your question?

David Lebowitz - Thomas Weisel Partners

More or less.

Dan Hann

Okay.

David Lebowitz - Thomas Weisel Partners

Thanks for taking my questions.

Dan Hann

We’ll take one more.

Operator

Our last question will come from Joanne Wuensch from BMO Capital Markets.

Joanne Wuensch - BMO Capital Markets

Thank you very much. Under the topic of sticky questions, Dan can you give us an idea of what you are empowered to do or what you’re finding in your new Interim CEO position? Can you also give us an idea of when an announcement may be made on a permanent assignment?

Dan Hann

Well to the first part of your question, I am clearly empowered to be the President and CEO and I have the full power and authority to do anything that any other President and CEO would be allowed to do; and working very well with our Board of Directors and our management team. Frankly, the support has been just overwhelming and very positive, so I couldn’t be more pleased with that.

As to the interim status, as we previously announced, our Board of Directors has established a formal process where we will identify a permanent CEO and candidates will be considered from within as well as outside the Company.

I can now report that the Board has retained a consultant. The Board has started that process but as you can appreciate, this is a critical and important decision to the Company so it’s not one you want to rush. You want to ensure that you have the right person in the permanent position. So unfortunately I cannot give you a specific date that the permanent announcement will be made, but I can assure you that our Board is working expeditiously.

Joanne Wuensch - BMO Capital Markets

I appreciate that. When you take a look at the things you want to target, are they sales growth? Is it cost cutting? Is it pushing products into more hospitals? Is it pricing? Could you sort of highlight two or things that you’re going to try and make your mark?

Dan Hann

Sure. Yes, yes and yes. I think as I previously stated just some broad overarching statements here, we are focused on becoming a more centralized company.

I think in the past the high level of decentralization has hurt us and probably explains some of the operational issues that we’ve been trying to fix this year so one of my priorities would be to, you know, improve the level of centralization that we have as a global company.

Secondly, clearly the revitalization of EBI is a major priority for fiscal ’07.

And thirdly, as I touched on several times today margin improvement, EPS acceleration, is a major agenda item.

Lastly I would say, as a management team and as a Board of Directors, we’re focused on a strategic planning process which I think will yield some exciting opportunities for the company.

I’m very pleased with where we’re going. The attitude, the energy level here is very high and we view change as a great opportunity for the company.

Joanne Wuensch - BMO Capital Markets

Okay. Thank you very much.

Dan Hann

Thank you very much. Appreciate all of you for taking the time to join our call today and we look forward to talking to you in September. Thank you.

Operator

That does conclude today’s teleconference and we’d like to thank you for your participation. You may now disconnect.

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Source: Biomet, Inc. F4Q06 (Qtr Ending May 31, 2006) Earnings Conference Call Transcript (BMET)
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