Integra LifeSciences' CEO Discusses Q4 2013 Results - Earnings Call Transcript

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 |  About: Integra LifeSciences Holdings Corporation (IART)
by: SA Transcripts

Integra LifeSciences Holdings Corporation (NASDAQ:IART)

Q4 2013 Results Earnings Conference Call

February 25, 2014, 08:30 AM ET

Executives

Angela Steinway - Investor Relations

Peter J. Arduini - President and Chief Executive Officer

John B. Henneman III - Corporate Vice President, Finance and Administration, and Chief Financial Officer

Analysts

Matthew S. Miksic - Piper Jaffray

John Demchak - Morgan Stanley

Christopher Pasquale - JPMorgan

Robert Hopkins - Bank of America Merrill Lynch

Larry Biegelsen - Wells Fargo Securities

Daniel Sollof - Barclays Capital

Jason Bedford - Raymond James

Steven M. Lichtman - Oppenheimer & Co.

Operator

Good day, everyone, and welcome to the Integra Life Sciences Fourth Quarter Financial Reporting Conference Call. As a reminder today's call is being recorded.

At this time I would like to turn the conference over to Ms. Angela Steinway, Head of Investor Relations. Please go ahead.

Angela Steinway

Good morning, and thank you for joining us for the Integra Life Sciences Fourth Quarter 2013 Earnings Results Conference Call.

Joining me today are Peter Arduini, President and Chief Executive Officer and Jack Henneman Chief Financial Officer. Earlier this morning we issued a press release announcing our financial results for the fourth quarter and full year of 2013 and issuing 2014 guidance.

Certain statements made during this call are forward-looking and actual results may differ materially from those projected in any forward-looking statement. Additional information concerning factors that could cause actual results to differ is contained in our periodic reports filed with the SEC. The forward-looking statements are made only as of the date hereof and the company undertakes no obligation to update or revise the forward-looking statements.

Certain non-GAAP financial measures are disclosed in this presentation. A reconciliation of these non-GAAP financial measures is available on the Investors section of our website at integralife.com. We will reference the financial results in the press release and will not restate the individual numbers. As a result you may want to keep a copy of the release handy during the call.

I will now turn the call over to Pete.

Peter J. Arduini

Thank you, Angela. As you all know we had a year with lots of ups and downs, but as a result are a stronger company today. We also had some real successes in the business that should not be overlooked. In Q4, not only was our U.S. extremities business up 16%, but our global extremities business was up 13% over the prior year. Our global orthopedics category was up 7% in the fourth quarter versus the prior year. Our total business in Europe was up 4% in the fourth quarter with particular strength in Western Europe. As a reminder all of those are organic growth numbers.

So while we are still recovering from the downstream effects of the recall and collagen supply issues which affected the U.S. neuro and private label businesses, parts of the company that were less affected are putting up growth numbers that we expect from now will grow longer term.

Finally gross margin on a GAAP basis hit 61% Q4 and 64% on an adjusted basis. Without the effect of the Medical Device Tax even the GAAP gross margin percentage would have grown over the prior year, despite significant spending for quality remediation and site transfer projects.

We've also made a number of significant accomplishments in the past year. To highlight a few of those we closed the DuraSeal transaction last month, which is a great strategic fit with our neurosurgery division and will add to our growth and profitability in 2014.

We closed out the FDA warning letter in our Plainsboro, New Jersey manufacturing facility and made significant improvements to the quality systems in our Añasco, Puerto Rico site. We announced two additional site closures in Burlington, Massachusetts and Andover, England as part of our optimization initiatives and have begun the transition process in both sites, as well we completed the consolidation of two of our surgical instruments sites in to one state-of-the-art facility in Germany.

This now brings us down six sites in total to 25 sites since we began consolidating our footprint in 2012. And we launched over 20 new products in the U.S. and filed over 50 products registrations in international markets. We look forward to a productive 2014 and I will share more with you about that later in the call.

Turning to top line results from the fourth quarter; U.S. neurosurgery revenue increased 2% over the fourth quarter of 2012. Neuro critical care and tissue ablation drove the growth, each increasing low double-digits. New Camino and Licox monitors launched in the fourth quarter are driving growth in critical care and strong capital sales led the increase within tissue ablation. DuraGen decreased mid-single-digits, in line with the share we lost due to the supply challenges earlier this year. We estimate our DuraGen share loss to be less than 5% as of year-end.

Our U.S. extremities business grew 16% over the prior year period. Our hardware product lines led the growth, increasing more than 20% in part because of the success in the controlled market lease of our shoulder product lines, both upper and lower hardware products also increased double-digits in the quarter.

Regenerative products were up low double-digits driven by skin and wound. U.S. spine and others which includes our private label products decreased 3%, private-label decreased low double-digits, primarily due to a long-term decline in sales in one of our larger partners. The discontinuation of certain products also contributed to the decline in sales as compared to the prior-year period.

Our U.S. spine business grew in the quarter with a small decline in hardware offset by a mid-teens increase in ortho-biologics led by sustained demand for our third generation DBM. U.S. instruments revenue decreased 2% versus prior year. The discontinuation of lower margin products in this segment allows our team to prioritize product lines that generate higher overall margin, although in the near-term it results in lower reported top line growth rates.

Both alternate sites and acute care sales increased slightly. Sales in lighting and retractors declined versus a strong prior year comparison. Revenue in our international segments increased 5% over prior year with comparable growth in Europe and Rest of World. Spine products franchise grew across our international markets off a small base, and extremities hardware revenue drove the increase in Europe, particularly in Western Europe. This modest increase is in line with our current expectations and we believe the planned changes within our distribution channels and new product introductions will accelerate growth in 2014.

Now I will turn the call over to Jack to discuss the financial results in more detail and review our new 2014 guidance. Jack?

John B. Henneman III

Thank you, Pete. Taking into account our higher tax rate and share count we fundamentally met our profit expectations for the fourth quarter, albeit at the lower end of range. Of note we ended the year with our fourth quarter gross and operating profit margins after adjustments slightly ahead of where we ended the fourth quarter of 2012. Considering the effect of Medical Device Tax and elevated quality expenses we believe this reflects strong underlying profitability in our business.

Now I'll walk through the P&L providing both fourth quarter results and expectations for 2014. In the fourth quarter GAAP gross margin declined one point versus the prior year period to 60.8%. The Medical Device Tax which we report in cost of goods sold can account for entire decline. We also had large scrap and manufacturing cost that were offset by higher cost of quality remediation and recall related expenses and costs related to Burlington and Andover transfers.

We calculate adjusted gross margin by the backing out the adjustments to cost of goods sold detailed in Column A of the adjustments table in our press release. During the fourth quarter, our adjusted gross margin of 63.9% was basically flat versus the comparable measure in the fourth quarter of 2012. The higher expense for medical device excise tax was roughly offset by lower scrap and other manufacturing costs.

For 2014 we expect GAAP gross margin to be between 61% and 62% subject to finalizing the purchase price allocation for the DuraSeal acquisition which may have an effect on the amortization expense or acquisition related charges that are booked to COGS. This is an improvement of about 1.5 points over 2013. We expect the adjusted gross margin to be between 64% and 65%.

In the fourth quarter R&D expenses increased versus the prior year and rose to 6.6% of sales. The completion of the enrollment of the diabetic foot ulcer trial, a licensing fee paid for a new technology in extremities, new projects in neurosurgery drove the increase. Excluding the technology licensing fee and an asset write-off R&D expense were 6.1% of sales. We expect full year R&D spending in 2014 to increase with revenue remaining around at 6% of sales.

GAAP SG&A during the fourth quarter declined slightly versus a year ago both in real terms and as a percentage of revenue. Lower headcount and compensation expense was partly offset by higher selling and marketing expense in extremities and neurosurgery and increased spending on our ERP project.

SG&A adjusted for special charges as detailed in our press release was 41.4% of revenue down nearly one point from the fourth quarter last year. For full year 2014 we expect reported SG&A to be 44% to 45% of revenue and after adjustments to be 41% to 42% of revenue.

In the fourth quarter our adjusted EBITDA margin was 19.5%, about half a point above the prior year period. For 2014 we suggest modeling approximately $36.5 million in depreciation expense, approximately $22.5 million in intangible asset amortization, $6 million of which will be recorded in COGS. Please consider the amortization forecast preliminary as we are still working to complete the purchase price accounting of the DuraSeal acquisition. We expect to update this guidance on our Q1 earnings call.

Cash interest expense, net of interest income was $3.1 million in the quarter. For the first quarter of 2014 the cash interest expense will be about the same as Q4, a net increase and remain steady for the remaining quarters. We expect a total of about $13.5 million of cash interest expense and about $20.5 million of total interest expense in 2014.

During the fourth quarter we recorded about $300,000 of other expense. We recommend modeling this line item as zero going forward. We ended the fourth quarter with an effective tax rate of 7.2% for the quarter because of the reported pretax loss during the full year we reported tax benefit for 2013. For 2014, we expect our reported tax rate to be 21% to 22%. Our adjusted tax rate was 27.4% in the quarter and for the full year 2013. We expect our adjusted tax rate to be 30% to 31% in 2014 because we anticipate a higher proportion of profit will be generated in the United States.

We generated $12 million of cash from operations during the fourth quarter. We invested $10 million in capital expenditures in the quarter. In the first half we expect operating cash flow to be down compared to the second half of 2013 because we expect to continue to build inventory ahead of the manufacturing transfers in Burlington and Andover. Cash flow should then return to a more level of about $25 million to $30 million per quarter during the second half of the year.

Before I provide color on the 2014 full year revenue guidance that we provided in the press release this morning please note that we transferred the management of two product lines currently reported within U.S. extremities. One moved to US Instruments with historical revenues of about $1 million per quarter and the second product line moved to US Spine with historical revenues of a little under $500,000 per quarter. Because these amounts are immaterial we will not revise our financial statements.

But based on the segment revenue, as reported for 2013 without adjusting for these transfers we expect U.S. Neurosurgery revenue to be up between 30% and 35%, U.S. instruments revenue to be up low-single digits, U.S. Extremities revenue to increase high single-digits to low-teens, U.S. Spine and other revenue to be down low to mid-single-digits and international revenue to increase low double-digits to mid-teens.

We will breakout the actual revenues of DuraSeal when we will report Q1, but you can calculate a growth rate excluding acquisitions. Finally we expect our revenue growth rate excluding acquisitions and discontinued products to be 4% to 6% for 2014. To add some color to our U.S. Spine and other segment performance our private label revenues were about $59 million for the full year 2013 and we expect that to decline more than $10 million during 2014. We will breakout private label revenues on our earnings call this year to help you model it separately from our core spine revenues.

Turning to earnings, while we closed DuraSeal mid-January we are being careful in integrating the sales networks. And we'll therefore continue paying the higher distributor commission where it makes sense to do so. This will make for a steeper quarterly progression of earnings than is typical for us and is also one of the reasons why we are leaning towards the lower end of the preliminary earnings guidance we gave in October.

In addition we have two new expense burdens that we have previously mentioned hitting the P&L in 2014. These items consists of about $8 million of depreciation fees and license expenses which we will begin to recognize with the implementation of the ERP in early Q2, and an increase in the P&L expense from medical device excise tax of about $4 million to $5 million. We suggest you take these into consideration when updating your models.

The other puts and takes in the P&L are relatively small and are contemplated in the ranges I just provided. For the fourth quarter, taking into account our typical sequential decline -- for the first quarter taking into account our typically sequential decline from the fourth quarter to the first and the partial contribution of DuraSeal we expect our revenue to bracket the Street consensus and be in the range of $210 million to $215 million.

Now I will hand the call over to Pete.

Peter J. Arduini

Thank you, Jack. We made important headway towards our strategic goals of execution, optimization and accelerating growth, with operations much more stable at the beginning of 2014 and the next phase of our site and systems optimization plans progressing nicely. I am looking forward to spending more time and resources this year on the growth component of our strategy.

Looking ahead I would like to give a brief update on our key priorities in 2014 including the DuraSeal integration, new product launches, furthering our commercial strategy for DFU and a couple of significant operational projects.

First the integration of the DuraSeal product line into our U.S. Neuro and international teams is a major focus over the next several months. The teams are finalizing channel decisions to maximize growth potential, the sales, customer service and logistics teams have completed their product training and are working diligently to ensure a smooth transition. The regulatory team is also working on our registration strategy in our international markets and our operations and manufacturing team members are full engaged in the process of transferring DuraSeal manufacturing into Integra.

Although we are just one month into the integration sales rates are running -- are coming in as we expected. Overall the transition process with Covidien has been very a cooperative one and the teams are working well together.

We also had several product launches in the fourth quarter and plan to launch more products throughout 2014. Execution on those will be essential to our success this year. Just to name a few by area. In neuro we refreshed our monitoring line in critical care in Q4 and a new DuraGen product, DuraGen Secure is planned for full market release in the second half of this year.

In spine we introduced several new products to the market at the end of 2013 and we'll be transitioning those to full market launches this year, including the NanoMetalene interbody device and our new Laminoplasty device. In addition we have new products on tap for '14 including an expandable interbody device.

For Extremities we’ve several new products that we’ll be introducing throughout the year to refresh our wrist, foot and ankle product lines. And the shoulder is clearly significantly new opportunity, a new market that has the team's focus. We kicked off the full commercial launch for our shoulder portfolio last month. The complete portfolio includes total, reverse and Humeral plating solutions.

Our limited launch in the second half of 2013 resulted in positive feedback on the systems. Since then our monthly case volume has more than doubled and is in line with our expectations for 2014. The complete shoulder portfolio has positioned us to recruit high volume shoulder specialty distributors and some direct reps. We are investing in sales reps and surgeon training in order to support surgeon conversion to our product line. Overall the market projections for shoulder estimate a healthy growth rate sustained by increases in reversed and revision procedures. We are optimistic that we can obtain a meaningful share position in this market and are investing in early stage technology that will further strengthen our shoulder portfolio.

In December we announced the completion of the enrolment of our diabetic foot ulcer or DFU study. After a 28 week follow up we will validate the data then submit, prepare and submit a regulatory filing to the FDA, which we anticipate in late fall of this year. We’ve not decided when or how we will announce the outcome of the study because we are carefully working through our publication strategy that does not jeopardize the FDA’s review of our application.

As you may know our skin products currently on the market are not reimbursed in the outpatient setting. Reimbursement there was the impetus for doing this study. CMS recently announced changes to their outpatient reimbursement in this treatment area and the new rules place Integra’s current set of products in the low cost reimbursement category.

It is our intention to get one or more of our products into the high cost reimbursement category. We also believe that the reimbursement is likely to evolve between now and our regulatory approval. We remain optimistic about our full commercialization of Integra Skin for DFU in 2016.

I am also delighted to announce that Ken Burhop is joining Integra to take on the role of Chief Scientific Officer. With over 30 years of experience in research, development and commercialization Ken brings a depth of scientific leadership that will be critical as we continue to expand our product pipeline. Ken is uniquely qualified to lead our R&D efforts and advance our growth strategy.

Finally the Burlington and Andover moves are scheduled to be completed by the end of 2014 and in early Q2 we plan to turn on our new ERP system across our U.S. commercial operations. These are significant projects that are critical to our optimization plan and simplifying our structure.

Although the financial savings from these activities won't be realized in 2014 successful systems implementation, sourcing initiatives and production transfers will be a major milestone in our overall margin improvement plans. These move us closer to achieving our stated $300 to $400 basis of margin improvement by 2018.

Looking ahead we hope you can join us for our Investor Day meeting on May 6th either in person in New York City or via webcast. At that time we plan to provide you with more details on our progress against our optimization plans in these growth initiatives. We are also to be in a position to update our five year outlook and outline clear goals to help us achieve those objectives in the near and medium term. Please contact Angela for more event details if you don’t have them already.

Now we’ll be happy to answer your questions. In an effort to accommodate a large number of requests please limit yourself to one question and one follow-up. If you have additional questions after that you may rejoin the queue. Operator you may now open our lines for questions, thank you.

Question-and-Answer Session

Operator

(Operator Instructions). We’ll go first to Matt Miksic with Piper Jaffray.

Matthew S. Miksic - Piper Jaffray

Good morning, thanks for taking our questions. So one follow-up just on the quarter. I appreciate the detailed color and guidance and there was a lot of it, which is very helpful. But on the quarter is -- I don't if I caught in the prepared remarks but international and maybe if you could just elaborate or remind us again what the issues are that are that are sort of holding spine back a little bit. Was there something on the international side that came up a little softer and then I have one follow-up?

Peter J. Arduini

So just to dive into the spine point, actually globally our spine hardware number was up about 2%. Domestically it was down a little bit. So off a small base we had quite a lot of growth in the spine hardware internationally. In general international has been for us in the past year a story of I think relative strength but against our history and against most of our competitors in Europe we've done a pretty good job over the last several years, rebuilding the management and our strategy.

Outside of Europe and the other rich countries we've been not as successful in launching in the larger developing world countries. So I'd say we've weakness in places like China relatively speaking, strength in places like Europe.

John B. Henneman III

Yeah I'd say Matt and part of that isn't anything long-term that precludes us from having strength in those areas. A lot of it comes back as we've mentioned about growth being lumpy in lot of those markets as we're actually bringing in a significance amount of new products, registration changes and timings. We have had some scenarios, we've some gaps in some registration timing which is in most cases being corrected, if not corrected already coming into the New Year and changes in distribution structure.

So I think as an example here we've brought a lot of changes that we've made about 18 months ago in Europe within our own distribution structure, launches now are bearing some very good fruit, Western Europe numbers were very strong with our launches. And again many of those markets feel like emerging markets to Integra because of our low share position. And we believe in coming in '14 markets like China and such we've got a lot of those changes already in place and actually a lot of registrations that we've worked through last year should become effective in '14.

Matthew S. Miksic - Piper Jaffray

Okay. Thank you. And then one on the DuraSeal acquisition, I think like a lot of folks we were encouraged and looking forward to some of the leverage and accretion that, that deal affords you in your neuro-surgery business given your comment about how you are integrating the sales force has anything changed in the way you are looking at that, has the pace of that been a little different, color on the thoughts and how maybe it's different from the way you are looking at the deal two, four months ago would be very helpful?

Peter J. Arduini

Yeah, Matt I'd say in general nothing has really fundamentally changed our look at the deal. It's a great fit, it plays well into our mix. If you remember we've a lot of work to do to transfer distributor structures, align distribution structures around the world. There is a significant portion of the efforts there.

And in the United States what we're taking a look at the combination of direct and distributor model. In many cases where we've highly productive areas with distributors to maintain some of those, some of that brings a little bit higher cost than we initially planned but at the same time as we value those we are looking at where that's going to bring additional growth with it which we believe will offset some of that.

I think the other aspect that again only being a month in to this is the synergies relative to having kind of the Dura closure set of product lines and how that will be valued in the marketplace with the DuraGen product, the DuraSeal, cranium closure and we believe that will be a very nice opportunity for us as well. It's way too early to know what that's worth. But in short we've tweaked some things, changed some approaches but at a high level none of the major assumptions have changed I don't know Jack if you want to add any other comments.

John B. Henneman III

Yeah I guess I just to focus specifically on the financial impact, it's still the case that our view of this acquisition for 2014, net of all the financing activities that enabled it, net of the equity offering, net of the incremental borrowing, we still think that it's on the order of and there is obviously a ton of puts and takes but on the order of $0.20 accretive to adjusted EPS in 2014. So it's still a really accretive deal, taking into account everything around it, so that's point one.

I think what we're saying in that, we have made some judgments to manage the commercial integration in particular in a way that will I think lower the risk for everybody including our stockholders and that will result in a steeper ramp during the year in our earnings then we otherwise would have because we do expect somewhat higher selling expense in the first half of the year to take that into account, but we expect to get a benefit from that conservatism in the top line as Pete said, that should play itself out well as the year progresses.

Matthew S. Miksic - Piper Jaffray

Great. Thanks guys.

John B. Henneman III

Thanks Matt.

Operator

We will go next to David Lewis with Morgan Stanley.

Peter J. Arduini

Good morning David.

John Demchak - Morgan Stanley

Good morning. This is actually John Demchak in for David.

Peter J. Arduini

Hi, John.

John Demchak - Morgan Stanley

Hi. On 2014 guidance, you guys did a very good job of explaining why EPS was lower a little bit, but I was curious what drove the modestly lower revenue expectations given Confluent closed a little earlier than expectations.

Peter J. Arduini

I'd say, it was just a series of assessments. Recall that we originally gave our view on 2014 very preliminarily at the end of October. At that point, we had not among other things completed even the operating plan in our base business. So from our standpoint this is our first call it seriously deep dive guidance for the year.

In any case and the other point which I think is obvious is that, 2013 was probably finished a little softer than we would have hoped in October and it's I think to some degree reflects no change in the progression but a recognition that we have somewhat less momentum coming out of Q4 than we might have said or anticipated we would had in late October. But that's more of a detailed and a broader point that we have to hammer through all the work we did.

So what we gave you October was taking into account a really very wide range of assumptions and meant to be preliminary. I think this is -- what you are getting today are the numbers that we feel quite confident in.

John Demchak - Morgan Stanley

Understood. Very helpful. And Jack, just a quick follow up on some of the non-GAAP adjustments that you are projecting in 2014, specifically ERP and optimization charges are bit higher than I think we have generally forecasted in the next year. Can you discuss the pacing of these costs and how you would expect them to continue into 2015?

John B. Henneman III

Sure. So the ERP expenses actually peaked last year. This year they will be down a little bit. We are going to do a big go-live on [audited] cash for most the company in the first half, as we said early Q2. And those expenses will be lower thereafter. We still have more to do in that project, so they are not going to zero right way but they will be coming down.

Structural optimization charges include our real assessment of the dollars we are going to spend on plant consolidations that we have announced and work we are doing to anticipate the next leg in our ongoing optimization plant. So when we again -- I'd say, when we gave our preliminary guidance and thought this through in October, at that point we had not nailed down the detailed plans for these plant transfers, that work has now been done, so we have a sharper view of 2014 adjustments then I think we had then.

John Demchak - Morgan Stanley

Thank you. Very helpful.

Operator

We will go next to Chris Pasquale with JPMorgan.

Christopher Pasquale - JPMorgan

Thanks. To start off with can you give us a sense of what extremities hardware grew excluding the shoulder contribution? Just trying to get a sense of how much of that is greater than 20% growth was due to that launch versus an acceleration in the base business?

Peter J. Arduini

Sure I can give you some -- let me just get to the right little summary here. So I would say that of the growth, the foot-neck or hand and wrist segments both grew very well. Foot-neck in our US business grew, call it mid-teens and hand and wrist grew very high. I wouldn’t expect this number to continue but well under the 20. So the shoulder was a significant jump off a very small base but was not by any means the lion share of the growth in either U.S. extremities or in frankly the hardware.

Christopher Pasquale - JPMorgan

Got it. Okay, that’s helpful. And then I just want to circle back on the comments about the skin reimbursement. What are the steps you need to go through to improve your standing there, is the catalyst the DFU results or do you anticipate having more work to do even after you have that approval in hand to get where you need to be?

Peter J. Arduini

Yeah, Chris there’s couple of things. So with the outpatient codes coming out and really lower across the board and having this lower reimbursement bucket and higher bucket and as you probably know that's calculated based on this square centimeter of the size of your product and so what the historical price cost of that is and that’s how its priced out. We primarily were moved into lower because we are a product, the majority of that product is used obviously not in DFU at all but in burn, burn there is very large pieces and so from that price standpoint it’s lower.

So even before we did I would say the product for DFU ready and out we do have some options in our current installed base. We actually have quite a few different product configurations that range in all types of size configurations in fact for 25 to 500 square centimeters we have a big array.

Our ability to change configurations in pricing structure is one option and in fact in one of our product areas we are only maybe about a dollar or two away from where the line is. So there’s from a square centimeter standpoint, in other areas it’s obviously much larger. So we have some I will say marketing position work that can be done. We are also going to be laying out our case to be clarified with CMS to help them understand the points as well. I mean this product comparison is off of a large sheet burn versus not DFU and then the other piece is on the outcome of the study.

I mean at the end of the day the quality of the study will be the most important piece from my standpoint and obviously our hope is that we will have very good closure rates and the amount of product that’s needed to use to reach those will be lower than many of the other products that are used out in the marketplace. Now we’ll see how that ultimate plays out but based on that that will obviously derive the demand for the product in that therapy and we also have some pretty good opportunities to talk to ACOs on the private side as well to how we should lay out our case, if our data is strong.

So if you got 18 months, lot of different plays and work to kind of work through so we think we got a fair amount of options in front of us to still make this a very lucrative product for us but again I want to reinforce we won’t see our data until July timeframe, July-August at the earliest and that’s the really most important drivers the quality and the outcome of the study.

Christopher Pasquale - JPMorgan

If the reimbursement situation doesn’t change for whatever reason is it still an attractive opportunity for you?

Peter J. Arduini

Yeah, I mean because my ability to change configurations and stuff to deal with that is still an available card and I also think with compelling information I think actually having a discussion with payers about what the true cost of a product would be to actually close DFU and actually be able to negotiate some items separately, I think it comes back to the quality of the data.

So there is still again quite a few scenarios. I think as I mentioned in the past because this product is also part of our legacy burn products from a standpoint of a cost structure our ability to have a very competitive cost based product we believe this will be as competitive as any product out in the marketplace. But having a reimbursement that incentivizes actually the user between what goes to their clinic and what goes to the user we realize is very important and so that something that we think we've got as I mentioned quite a few options to address it.

Christopher Pasquale - JPMorgan

Thanks.

Operator

Go to our next from Bob Hopkins with Bank of America.

Robert Hopkins - Bank of America Merrill Lynch

Hi, thanks, can you hear me okay?

Peter J. Arduini

Yeah hi, Bob.

Robert Hopkins - Bank of America Merrill Lynch

Hey great, good morning. So just my first question is on the guidance, relative to DuraSeal, I had originally thought that could be a much more accretive transaction for you in 2014 and I know what you've articulated is obviously very nice for the company but originally I had thought it could be almost twice as much as you're articulating today.

So was I just off in my calculations as to how profitable this business was for Covidien or are some of the things that you are talking about today at least temporarily really boosting the expense level, just trying to get a sense for ultimately how profitable business this could be and what you are assuming for '14?

Peter J. Arduini

Well, I think it's an extremely profitable product. There are, I am not intimately familiar with your model on that thing, Bob but in broad terms the accretion that we've been deploying just taken into account the financing cost and the larger number of shares outstanding because we wouldn't have done those two deals without -- we wouldn't have done this financing without the need for it driven by the acquisition. And so I would say that that's one element.

Second element is that we did anticipate in our revenue guidance even as we've been talking about it in the last couple of months that the first year of the annualized revenues would be down somewhat versus Covidien's performance. I don't know the extent which you took that fully into account in your numbers.

And then the final element is we have decided as we've got to know the product over the last couple of months and really got to know everybody involved that investing more in selling expense now is a smart move. And I don't know the extent to which that's fully reflected in your 2014 number.

So just taking all of that into account we still regard this is an extremely accretive deal but we want to manage it in a way that maximizes our opportunity for success here.

Robert Hopkins - Bank of America Merrill Lynch

And then just housekeeping, it's related to the first question. Sorry if I missed this but what share count assumption are you using to drive the EPS guidance for 2014?

John B. Henneman III

About 33 million.

Robert Hopkins - Bank of America Merrill Lynch

Okay, and then lastly on this product once you've kind of through the transition period kind of the assumptions that I was assuming just to kind of use specific numbers, was that this could be an operating margin product for the company that was 40% or better given the gross margins that I know it carries is that assumption way off you think in terms of where you think you can take it?

John B. Henneman III

No, I do not think that assumption is way off.

Robert Hopkins - Bank of America Merrill Lynch

All right, I'll get back in queue, thanks for taking the questions.

Peter J. Arduini

Thank you.

Operator

We'll go to our next question Ross [Tinfly] with Jefferies.

Unidentified Analyst

Hi, good morning. I wondered if I could ask -- I know it's a bit of nitpicky question but the longer term guidance you guys are still putting those kind of 5% to 7% yet here in '14 you are getting to 4% to 6%, again I know it's one point but in terms of again what might be little softer this year and then what you hope to accelerate as you move into '15 and beyond just some of the broad thoughts would be helpful.

Peter J. Arduini

Yeah, Ross it's Pete, I mean in short it's kind of this '14 as we've been communicating is still a rebuilding year of many parts of the company. And if you think about you've got our ERP implementation which has a big impact across the company that we're rolling out, we've got plant transfers built in as well, we've got a lot of different integrations and things going on. So from a standpoint of '14 we would always plan for it to be a little bit more of say a less growth just because of the different moving parts and the things we have going on into the overall business.

We also have been doing a lot of work as you know on discontinued products. We'll continue to actually this year be aggressive on those. So obviously we have more products that were going to the portfolio and calling if you will that we haven't fully come out with. And the other aspect and Jack mentioned in his comments by the way would be private label is quite a headwind for us really since probably 2011. We had a significant headwind in and the hope is moving into future years, private label is one of those businesses that you don't go in separately. It's obviously an adjunct using our capacity, is bringing in new customers and new base off to that.

If you remember we have new plant, the 109 facility that's going to allow us to have more capacity for manufacturing not only our own products but potentially doing some more private label. So when you incorporate those items that's really at least the point, and then the potential upside around that is really refreshing our whole extremities portfolio and growth of the shoulder. I'd say based on how well we do the shoulder this year that can be one component of it. Are we being conservative? No, I think we're being realistic about the competitive market.

So we have got a lot of bets that we are trying to -- playing out this year. The real impact of them starts being felt more later in this year and we'll a bigger top line effect as we move in 2015 and 2016.

Unidentified Analyst

Okay. May be just a couple of follow-ups just on the plant side on the facility side, are you still on track for the Añasco facility that to get re-inspected this year, mid this year?

Peter J. Arduini

I mean we are on track, yes. I mean the work that we need to do and the work we have done absolutely. When the agency decides to come back and you know how that plays out. But, yes, as far as our internal plans, have wrapped up pretty much everything here at the end of Q1. We will be obviously constantly working on getting ready for when the agency comes in and there is no reason that we don't think it's going to be sometime in Q2 or Q3.

Unidentified Analyst

Okay. And then just lastly on that, as you noted that you are down to 25 sites, physical sites down six since you started this process of consolidation. Where do you take that from here because my sense is that's running probably a little better than we had been expecting in terms of the pace which you have been able to consolidate sites? I mean, do you still have significant room there or you are kind of moving out of that Phase?

Peter J. Arduini

I mean, just to clarify the first part that we are not completely out of all those, yes. This is -- a lot that that happened through this year, Burlington as well as Andover, but on top of that yes, I know we still have other locations, and you've heard me speak about this before one of the important parts is less about the actual count but yes, there is more plants and more room there. It's more about creating these centers of excellence that actually have the capacity to have multiple shifts at one location, optimize our G&A more effectively; one of our key areas that we are focused on.

And then other aspects of how we manage really our customer service capabilities and our distribution logistics. But, yes we feel good about the progress. The team is on and we are I will say being cautious about how we move forward. That coupled with the growth, it's a tricky balance but we feel pretty good about it and there is a reasonable amount of [prize] moving forward.

Unidentified Analyst

Great. Thank you.

Peter J. Arduini

Thanks.

Operator

We will go to next question from Larry Biegelsen with Wells Fargo.

Peter J. Arduini

Hi, Larry.

Larry Biegelsen - Wells Fargo Securities

Good morning. Thanks for taking the question. Can you hear me okay?

Peter J. Arduini

Yes.

Larry Biegelsen - Wells Fargo Securities

Great. Pete, some of the companies have talked about the January being soft because of weather and certain factors which boosted Q4 such as increased seasonality and uncertainty around Obama Care may be pulling some procedures forward. It will be helpful to get your impression of those issues?

Peter J. Arduini

Yeah, Larry I think one is how it'll play out, I don't know. We will see how the quarter ultimately plays out. We talked about what comes in, but the effect of orthopedic doctor's office visits, either in extremities or clearly spine, our guys reporting back that there were a lot of cancels and things changed. Yes, there definitely were -- will they get rescheduled, will they get accomplished in the quarter, we think that's hard to tell but clearly some of those will.

Relative to the effect from the Obama Care standpoint, candidly and a lot of it probably because of our size, we haven't really seen positive or negative effect one way or the other from anything playing out on Obama Care. We actually have across all of our segments a watch so to speak of mutation indicators as well as certain tractors.

I'd tell you at the end of last year some of our instrument business there was clearly more conservative buying patterns in the hospitals. If you don't need things they were not making larger purchases as far as new starts. I would say that we are down significantly but you didn't see maybe some of the same starts that you would see in other areas. And again hypothesizing is people being a little bit more conservative coming into a new year with the ACA. But I think it's going to take us a few more months or quarters to kind of see how some of those things play out.

Larry Biegelsen - Wells Fargo Securities

Okay. That's helpful. And then last from me just on what turns out U.S instruments from the negative growth in 2013 to the positive growth you expect in 2014? And in shoulders if we look at market share expectations do you think you could take let's say one point of worldwide share per year what do you think is realistic? Thanks.

Peter J. Arduini

So you broke up a little bit over there. First question was around instruments and then the second part was around should, correct?

Larry Biegelsen - Wells Fargo Securities

Yeah. The first question was what turns around U.S instrument and then the second question was do you think you could take one share point in the worldwide shoulder market per year? What do you think would be realistic there? Thanks.

Peter J. Arduini

Yeah, I think look on the instrument standpoint keep in mind a large percentage of our eliminated -- our reduced SKUs was tied with the instruments business. So that's one of the headwinds that a lot of that moves through coming into 2014. So that's probably the biggest component there off. As-well-as I'd say so just new focus on different approaches and promotional plays that we actually have going within that area. We've spend a lot of time taking a look at our clinical call point areas and clinical areas from that standpoint.

The other piece is that we've got some product transfers from extremities, if you remember there were some devices that realistically weren't the perfect call point that are going into instrument. So when you take a look at the combination of the products that we took out, products transferred in and some of the focus that's really the growth in instruments from '13 into '14. And relative to the shoulder look we think we've got a nice product that keeps us a little bit out of the herd, so to speak.

We've got features not only in scalability of the current product and even I'll say the utilization of the instrumentation and that's been getting some very good reviews, we've been able to bring over a couple of higher level distributors that had worked with some other major shoulder players just really in the last few months that's been quite successful for us. And so our hope to get to 5% share in the next few years, I think is realistic. I think also having a goal of a 10% share position in the global market is something that we're aspiring to and we know that we would be able to do that, we just can't be a one trick pony which is why we actually have a nice pipeline of added on technologies.

And so being able to actually scale up our current platform with the use of potentially some PyroCarbon capabilities either in a [hammy] or in re-surfacing, so we've got some interesting things on the horizon but the focus right now is really bearing down obviously on having our core reverse and full shoulder be successful. And that's really all about our capabilities to ramp it up and getting all the right distributors and clinical capabilities in place. And we feel good about the start to the year and look forward to giving more updates on and as they come in.

Larry Biegelsen - Wells Fargo Securities

Thanks for taking the questions.

Peter J. Arduini

Thanks.

Operator

We go to our next question from Daniel Sollof with Barclays.

Daniel Sollof - Barclays Capital

Hey. Thanks for taking the question, guys. Just digging a little deeper into the strong extremities number in the quarter. So a lot of components both upper and lower if I recall correctly that's less than half the business and that component certainly grew very well, I am including your contribution from Titan Reverse. But if you look at this component wide I guess there is a less competition you have that business has also been stable with the strong growth you have seen. And looking forward given that you now have the competitive shoulder does the mix shift more to 50% of hardware and 50% soft tissue or soft tissue's still going to be the majority?

Peter J. Arduini

Dan I think, first of all for the quarter is we spoke about in Q3 we had a soft skin quarter overall and a lot of that business if you recall is associated with burns. And there is a little bit of I’ll use the term seasonality I mean it's obviously associated with when you have larger occasions for the use of the products and it typically it's little bit up and down so we did see that come back within the fourth quarter and that provided a teens type of growth within that skin product.

I think going forward relative to the metal mix in that -- we think that mix is probably going to be pretty similar. I mean if our strategies play out longer term we are going to have uptick in diabetic foot ulcer and the use of our skin platform and we are going to be able to grow our metal platform. And so I don’t see a significant change within that split at least on our near horizon how we think about it.

John B. Henneman III

Yeah I’d say the only I would add is life is not a straight line, the proportion have and the growth rates have moved around a certain amount from one quarter to the next. This was, you will recall or those of you been watching for some time, our U.S. extremities growth rates were a bit lower in Q2 and Q3 as we said then that was not indicative of what was really going on in the business and then we’d have stronger growth rate in Q4 and that has happened.

Similarly this was a strong quarter in [all lines of the business] out there every quarter next year, so please don’t be disappointed when the growth rates bounces up and down that next year as well. But I do think that this quarter's results, we have a really excellent Extremities business and if we sell across its product lines in 2014, as new products get introduced, then it is good progress.

Peter J. Arduini

Thanks guys, that’s helpful, and then if I could just a quick follow-up on DuraGen. If I heard you correctly it was a 5% share loss in ’13 roughly. Just wondering how that compares relative to what you would have expected to recapture once you got the product back on the market? And how you see that playing out in 2014 if there is any expectation to regain more share contemplated in your guidance for that business?

Peter J. Arduini

Yeah Dan I mean tangibly after having 20% of your customer base that you couldn’t serve for over a quarter if you would ask me we could get half of that back that would have been a heroic effort, the fact that we got three quarters of it back says a lot for the team and obviously the brand itself.

So I feel quite good about what we have been able to cull back in that time period. I think coming into this year our plans were that we wouldn’t necessarily get all of it that back. One of the unknowns is with the ramp up in DuraSeal and DuraGen, we have a new DuraGen product coming out, can we actually claw that back, can we grow from that base that’s what our teams are focused on and we’ll see how we do and obviously that’s the target that we are going to go after.

Daniel Sollof - Barclays Capital

Very helpful, guys, thanks.

Operator

We’ll take our next question from Jason Bedford with Raymond James.

Jason Bedford - Raymond James

Good morning, can you hear me okay.

Peter J. Arduini

Yeah, good morning Jason.

Jason Bedford - Raymond James

Good morning Pete just a couple of quickies here. Firstly the detail on the guidance but what are you assuming in terms of contribution in ’14 from DuraSeal as well as discontinued products?

John B. Henneman

All right so I'd say we build it that out as much as we are likely to spell it out. We walked you through -- if you look at the total growth profile in 2014 we expect about a oneish percent headwind from discontinued products and of the remaining growth, call it 60% of it, DuraSeal and 40% of it is embedded organic growth.

Jason Bedford - Raymond James

Okay that’s helpful. I can do -- yeah that’s fair, that's helpful Jack. And then just secondly and I apologize if I missed it, but did you give first quarter EPS guidance?

John B. Henneman III

No, we did not. What we said was that the revenue range in the first quarter taking everything into account would fall in the $2.10 to $2.15 range and then we said that adjusted EPS would have a steeper ramp during the year, partly to take into account our decision to spend more on selling expense on DuraSeal early on to lock down the success of that product line.

So I would take your estimates for EPS and it’s been somewhat higher selling expense in the first half than you may have already. I’m not speaking to your model specifically, but sort of how you might think of the delta. And then ramp the EPS over the course of the year perhaps a steeper than we have in the past. And that’s the reason why.

Jason Bedford - Raymond James

Okay. Okay, so basically stiffer than consensus given that their team's pretty steep.

John B. Henneman III

I’m not such a student of the quarter-by-quarter consensus for the year. So I’m not going to go to that, but I'd rather just say, setting everything else equal compared to the probably where we might have been in October when we gave our preliminary guidance that's how we feel about it now.

Jason Bedford - Raymond James

That’s fair. Thanks, I’ll jump back in queue.

Operator

We’ll go to our next question from Steven Lichtman with Oppenheimer and Company.

Peter J. Arduini

Hi Steve.

Steven M. Lichtman - Oppenheimer & Co.

Hi Pete. Just a really one topic question on shoulders, just want to make sure I understand the cadence this year. Where will you be in a full launch and also how do you see the distribution playing out, vis-à-vis the foot and ankle ramps, will it be a mix or are you going be carving out an upper extremity focus. Talk to us a little bit about the ramp here over the next 12 months or so?

Peter J. Arduini

Yes. So Steve so what we did in late Q3 to Q4 when we talked about kind a pilot control launch is to make sure that we get all the type of feedback on all the instruments, towards making sure that we can get manufacturer and suppliers ramped to the levels we need and that was achieved. And so we effectively are in that launch phase of full ramp up now as we speak.

And so we’ve signed up distributors in Q4, some we’re still bringing on a lot of distributors as we speak in this first half of the year. So the way to think about this it will ramp throughout the year, but technically we’re actually in it so this is we’re accounting on to be obviously a key growth part of our plan this year.

Now to your point on channel, we made a decision while ago that we would use on shoulder distributors primarily. So our foot and ankle guys really call on the foot and ankle market as well as hands and wrist. And obviously we have some big overlap with our attendant repair in some of our soft tissue products. But they don’t sell the shoulder. And then in the shoulder market we’re doing a combination of some direct reps that just do shoulder as well as distributors within that space.

And obviously we’ve been going after high volume experienced shoulder distributors mainly because they have one of the highest spects to be able to ramp us up. And then we’re looking at key territories where we like to have a direct presence and we’re also building that out. And so relative to critical mass it’s still going to be until probably mid-year till we’re probably at the level we would like to be, but we’re well over 60% of the right type of distribution structure in place and now it’s matter of all the types of demos and clinical work, we’ve got mobile labs, up in the Northeast we’re doing different cadaver work in different parts of the country right now.

So we've got a significant amount of training and ramp up going on. And obviously once that's all in place and physicians a bit more comfortable utilizing our system we think than to obviously that’s what we’ll see more of the ramp up coming into the second half of the year.

Steven M. Lichtman - Oppenheimer & Co.

Okay great. Thanks Pete.

Peter J. Arduini

Thanks Steve.

Operator

(Operator Instructions). At this time there are no questions in the queue. I will turn the call back over to our speakers.

Angela Steinway

Thanks for calling in. And we forward to speaking to you again in May.

Operator

And that concludes today’s conference call. Thank you for your participation.

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