Integra LifeSciences Holdings' (IART) CEO Pete Arduini on Q2 2016 Results - Earnings Call Transcript

| About: Integra LifeSciences (IART)

Integra LifeSciences Holdings Corporation (NASDAQ:IART)

Q2 2016 Earnings Conference Call

July 28, 2016, 08:30 AM ET

Executives

Angela Steinway - Global Head of Strategic Initiatives and Investor Relations

Pete Arduini - President and Chief Executive Officer

Glenn Coleman - Chief Financial Officer

Analysts

Travis Steed - Bank of America

Robby Marcus - JP Morgan

Matt O'Brien - Piper Jaffray

David Lewis - Morgan Stanley

Steven Lichtman - Oppenheimer

Jason Bedford - Raymond James

Operator

Good day, everyone, and welcome to the Integra LifeSciences Second Quarter Financial Reporting Conference Call. As a reminder, today's call is being recorded. At this time, I would like to turn the call over to Angela Steinway, Global Head of Strategic Initiatives and Investor Relations. Please go ahead.

Angela Steinway

Thank you, Roby. Good morning, and thank you for joining the Integra LifeSciences second quarter 2016 earnings results conference call. Joining me today are Pete Arduini, President and Chief Executive Officer; and Glenn Coleman, Chief Financial Officer.

Earlier this morning, we issued a press release announcing our second quarter financial results and raising our full year 2016 guidance. We also posted a presentation on our website, which we will reference during the call today. You can find this presentation at investor.integralife.com under Events and Presentations in the file named Second Quarter Earnings Call Presentation.

If you would open that up to slide 2, please reference our Safe Harbor statements covering the forward-looking statements we will make on today's call. As well, please reference the reconciliations of non-GAAP financial measures at the end of the presentation beginning on slide 13.

Additionally, we noted in our press release today that we are electing the early adoption of FASB Update No. 2016-09, Improvements to Employee Share-Based Payment Accounting. Our six month results reported today reflect the year to date impact of this adoption. Going forward, we will present the first quarter of 2016 as if we had adopted at the beginning of 2016. We added a short supplemental financial schedule to slides 20 and 21 of the appendix into the website, which provides the first quarter 2016 financial results recast for the new accounting standard. This information should help you update your models.

And with that, I will turn the call over to Pete.

Pete Arduini

Thank you, Angela, and good morning, everyone. Turning to slide 3, I’ll start by making some brief comments on our financial highlights for the first half of 2016. Second quarter sales increased 17% $249 million ahead of our expectations. Organic growth in the second quarter reached a record high of 10.7% contributing to organic growth of 9.8% for the first half of 2016.

Domestic and international strength across both Specialty Surgical Solutions and Orthopedics and Tissue Technologies contributed to this growth. Our adjusted gross margin improved 130 basis points over the prior year and exceeded 69% reflecting favorable product mix. The strong top line performance enabled us to make additional clinical and commercial investment during the quarter while delivering earnings per share slightly higher than our guidance.

Turning to slide 4, I’d like to take a minute to discuss a few of our recent accomplishments. Strength in organic growth came from both segments. Dural repair and precision tools and instruments again grew faster than their respective markets. In orthopedics and tissue technologies our core regenerative portfolio delivered double-digit growth. International sales also contribute to a strong organic performance in both segments. Growth in our direct European markets reflects the benefit of investment we have made in sales training and infrastructure.

On the medical education front, in mid-June, our global team held a international tissue technologies training and educational symposium in Portugal. We brought together over 100 surgeons from around the world for clinical training in education in areas such as dermal regeneration and plastic and reconstructive procedures. Events such as this increase awareness of the breadth and depth of our portfolio and drive utilization in markets outside the U.S.

We were successful in moving forward with the controlled market release of Cadence total ankle system, and we received positive feedback from certain surgeons on this bone sparring design, simplified instrumentation and reproducible results. We also continue to see solid sales growth with the Salto ankle. Last week at the American Orthopaedic Foot & Ankle Society Meeting in Toronto, we were positioned as one of the leaders in ankle arthroplasty and had many physicians visit our booth to learn about our ankle systems. We also had a mobile lab on site, which allowed us to conduct hands on training for both the Salto and Cadence total ankle systems.

We're making progress with our global supply chain and inventory initiatives. These efforts are beginning to have a positive effect on operating cash flow. As part of our ongoing manufacturing optimization and efficiency efforts, we consolidated operations and distribution capabilities and closed two small European facilities. In addition, we kicked off a new company-wide customer excellence program focused on enhancing the customer experience in the many ways customers interact with us.

In the second quarter, we received FDA approval to begin commercialization of Omnigraft for the treatment of diabetic foot ulcers. Omnigraft currently has reimbursement for over 145 million covered lives and we are working with additional payers for even broader coverage. In addition to reimbursement coverage, there are typically three phases to the transaction cycle for commercialization a new product in the outpatient market.

The process begins with the approval from value assessment committees also known as VACs, followed by trialling by lead clinicians and then finally ongoing use and repeat orders from the broader clinic. The process of getting on the agenda of the VAC taking a little longer than we initially expected, but we're in the midst of summer and we initially expected a 60 to 90-day period for initiating the VAC process to being available in the clinic and now we pick the transaction cycle will be closed to 120 to 150 days.

We see that in other parts of the business that the market demand for regeneratives products is clearly growing and Integra is investing in new products, clinical studies and expanded indications. Early feedback from initial users of Omnigraft has been very positive. And Glenn will provide a more detailed update on the roll-out shortly. The commercialization of Glenn represents a significant milestone for Integra and we consider it a franchise product that can contribute to growth and profitability for many years to come.

Finally, we are increasing our total revenue and organic growth guidance for the full year. This increased outlook is based on our strong first half performance particularly within our specialty surgical segment. For the second half of 2016, our expectations have not changed as we expect our teams to execute on our previously communicating plans.

And with that, I will now turn the call over to Glenn to provide a more detailed review of the second quarter financial results.

Glenn Coleman

Thanks, Pete, and good morning everyone. Total sales for the second quarter were $249.3 million, up 17.2% on a reported basis and up 10.7% organically with strong contributions from both of our segments. We also thought geographic balance of organic growth with the U. S. showing an increase of about 10% and international up 11%. This was a great top line performance.

And before I jump into the segment details, let me highlight some of the puts and takes in the quarter. We're pleased sales in Dural repair and precision tools and instruments exceeded our expectations as with the orthopedics and tissue technologies regenerative portfolio and ankle arthroplasty sales. The strength across these areas with enough to offset slower than expected growth within our former TEI portfolio.

Please turn to slide 5 for a discussion on segment performance. My commentary for segment results will be in constant currency terms. Foreign currency translation had a minimal impact on our results in the second quarter. Sales in our specialty surgical solutions were $158.2 million in the second quarter, representing growth of 7.7%, while organic sales rose 7.2%. Dural repair sales increased mid-teens driven largely by bovine growth arising from an expanded customer base and border acceptance of two recent Dural Graft product line extensions DuroGen secure and bovine pericardium.

Sales in our precision tools and instruments franchise increased mid-single digits in the second quarter and again grew above market rates. MAYFIELD 2, our premium stabilization device as well as speciality laparoscopic and ENT instruments drove this growth.

Tissue Ablation and NeuroCritical Care each saw a modest growth in the quarter compared to last year and both were in line with our expectations. The international sales in this segment increased 12.5%. European countries in which we have a direct go-to-market structure led the growth, reflecting the benefits of recent sales methodology training. Asia also contributed to the overall growth in this segment with particular strength seen in Japan across our broad portfolio of specialty surgical products.

While we expect growth in Dural repair and precision tools and instruments to temper from the second quarter, we expect to maintain above market growth rates in these two franchises. With this outlook and our year to date performance, we're increasing our full year expectations for specialty surgical solutions. Both organic and reported sales growth are now expected to be in a range of 5% to 7%, up 1% from the guidance range provided in April.

Trying to slide 6, I will now discuss second quarter segment performance for orthopedics and tissue technologies. Sales in this segment were $91.2 million, an increase of 38% over last year. Organic sales grew 18.9% driven by our regenerative products, which make up over 70% of sales in this segment. Sales of our regenerative products, excluding the TEI acquisition, increased more than 25% in the second quarter and were a significant contributor to the overall organic growth rate for the company.

We have seen increased success from our commercial and channel investments made both this year and last year. As well as a steady increase in market adoption of regenerative products. In addition, we are seeing increased end user market demand in certain parts of our private label business.

Sales in our extremities franchise increased high teens driven by contributions from the Salto acquisition. Excluding this acquisition, extremities hardware saw a slight increase in sales driven by growth in shoulder products. We’re also encouraged to see several product lines within our lower extremities foot reconstruction portfolio resuming growth.

International sales in the segment increased about 22%, driven by contributions from the TEI acquisition and sales growth in Asia and Europe. For the full year 2016, we are tightening our revenue range for reported growth in the Orthopedics and Tissue Technologies segments to be between 25% and 28%, and increasing our organic growth guidance to a range of 12% to 16%.

Let me now provide a brief update on the TEI performance. It’s been just over a year since we closed the acquisition. The integration of TEI has been successful and positions us for a long term growth. However, second quarter sales were lower than we expected. Our in-patient legacy Integra sales team, which sells the majority of the TEI and Integra regenerative products, has recently absorbed a number of new product introductions. The breadth of these new products and the associated clinical ramp up reduced the ability of the team to open new accounts.

Additionally, some of the TEI sales were cannibalized by Integra’s IDRT, which resulted in over performance in our legacy regenerative product sales. In fact, on a pro forma basis, our regenerative technologies business grew double digits compared to the second quarter of 2015, including TEI. We put plans in place to make additional investments in our sales channel over the balance of the year and expect TEI sales growth to accelerate in 2017.

We remain confident in our broad portfolio of unique regenerative products and exciting market opportunities along with increasing market demand. As Pete touched on in his opening remarks, the early clinical results for Omnigraft are positive and customer interest levels are high. It is however taking us longer than we initially planned to work through the transaction cycle.

As a result, we feel as more appropriate to bracket our expectations around outpatient DFU sales in 2016 to $12 million to $15 million versus our prior guidance of $15 million. We believe Omnigraft is a differentiated and competitive product and feel very good about its long-term potential. Overall, the Orthopedics and Tissue Technologies segment is doing very well.

The regenerative markets we serve look strong, added manufacturing capacity has enabled us to expand business with a private label partners, and we’re executing on a robust new product pipeline. Additional investments will be made in our channels to take advantage of the opportunities we see and deliver future growth.

If you turn to slide 7, I’ll discuss the changes to our total revenue guidance. Based on our performance in the first half of 2016, we’re raising our full year 2016 revenues to a new range of $992 million to $1.002 billion, representing growth of between 12% and 13.5% on a reported basis. We’re raising our revenue range as a result of the strong organic growth in the first half of the year.

As a result, we’re also increasing our full-year organic growth rate to about 9%, a 1% increase from our April guidance. We expect about 4.5% of overall growth to come from acquired products and foreign currency to have a minimal impact based upon current exchange rates. For the third quarter of 2016, based upon usual seasonal patterns, we expect revenue to be roughly flat on a sequential basis. Organic growth of about 8% is implied in this guidance.

Now if you please turn to slide 8, I will review our second quarter P&L performance and update our expectations for 2016. In the second quarter, GAAP gross margin of 64.51% declined 50 basis points from the prior year, resulting from non-cash charges associated with acquisitions. Adjusted gross margin of 69.2% expanded 130 basis points over the prior-year period, due to a shift in revenue mix towards high gross margin regenerative products.

For the full year of 2016, we’re increasing our GAAP and adjusted gross margin each by 50 basis points to 100 basis points. Moving to operating expenses, our R&D expense increased 30 basis points to 5.9% of sales in the second quarter. For the full year 2016, our expectations for R&D expenses, remains in the range of 5.5% to 6% of sales. SG&A expense was 47.8% of revenues in the second quarter of 2016, an increase of 110 basis points year-over-year on a reported basis.

On an adjusted basis, SG&A increased 170 basis points for the quarter to 44.5%. As previously discussed, we’re investing in new sales channels and commercial infrastructure to support new product introductions and expansion into new markets. We also had a number of commercial activities such as national training meetings and major industry conferences during the first of the year, which will not recur in the second half of 2016.

For the balance of the year, we expect adjusted as SG&A to decline as a percentage of sales. However, given the high level of investments we’ve made in the first half of the year, we are increasing our full-year expectations for SG&A expenses by 50 basis points. Our adjusted EBITDA margin was 21.9% for both the second quarter and the first six months of the year.

Our stronger than expected topline performance has enabled us to make greater commercial investments, which we believe benefit our current your topline results and sets us up well for the future. Based upon the investments we've made in the first half of the year, we are slightly lowering our adjusted EBITDA margin guidance to a range of 23.5% to 24%.

Moving to income taxes, we are lowering our adjusted tax rate guidance by approximately 40 basis points to reflect higher R&D tax credits and higher income and lower tax jurisdictions. In addition, we’ve adopted a GAAP accounting standard regarding the tax treatment for stock-based compensation. This adoption will further reduce our adjusted tax rate by approximately 160 basis points, resulting in a two-point drop in our adjusted tax rate to 28%. We also expect a GAAP tax rate of between 20% and 20.5% down 350 basis points to 400 basis points from prior guidance for the same reasons.

Let me now spend a minute reviewing the changes to our adjusted EPS guidance for the year. If you please turn to slide 9. With the adoption of the new stock-based compensation accounting standard, we expect to realize a full-year benefit of approximately $0.07. In addition, due to the recent increase in our stock price, we’re expecting incremental share dilution of $0.04 associated with the December 2016 convertible notes and warrants.

And finally, we’re increasing our operational outlook for the year by $0.01 to reflect it slightly in the second quarter. Our new guidance range for the full year 2016 is now expected to be $3.43 to $3.53. For the third quarter, we expect our adjusted EPS to be in the range of $0.85 to $0.90. Turning to slide 10, second quarter cash flow from operations was approximately $38 million, a decrease from the prior year, due to timing of supplier and vendor payments. Capital expenditures were $8.3 million.

We’re increasing our guidance for operating cash flows by $5 million, largely to reflect the adoption of a new accounting standard. As a reminder, this guidance range excludes the accretive interest payment associated with our convertible notes. Full year adjusted free cash flow conversion of between 70% and 80% remains unchanged.

Turning to slide 11, I’ll wrap up with a quick update on our capital structure. As of June 30, we had net debt of $623 million borrowing capacity under our existing revolver of about $610 million and a bank leverage ratio of about 2.9 times.

And with that, I’ll turn the call back over to Pete.

Pete Arduini

Thanks Glenn. If you turn to slide 12, I’d like to spend a few minutes reviewing our key priorities for 2016 and beyond. The organic growth in the first half from both our global segments has put us on our path that meet or exceed the revenue targets we established at the beginning of the year. This growth has allowed us to make the investments necessary to position the company to reach our long-term targets.

With the launch of Omnigraft in the second quarter, we’re in the very early stages of executing on our outpatient wound care strategy. And as we wait for Omnigraft to work through the value assessment committees, we’re enhancing our product positioning alongside PriMatrix and now VolTAC, which we began distributing earlier this month.

We’re also working to optimize the sales channels by adding some new and exciting products into the portfolio over the last few months. In addition to Omnigraft, we have a pipeline of new products to help fuel our organic growth. The controlled market release of the Cadence total ankle system is expanding and we had our first international surgery this month. We've been working to increase the speed to market around the world for new products and are pleased to see Cadence launch nearly simultaneously in the U.S. and in Europe.

Finally, we are continuing to evaluate M&A opportunities in Specialty Surgical Solutions and Orthopedics and Tissue Technologies. Our capital structure is strong and we have the flexibility to invest in a business and pursue strategic M&A opportunities to reach our long-term growth plans. Overall, through the first half of 2016, we've been able to meet or exceed our near-term targets and still make the long-term investments that position the company for industry-leading performance.

And with that operator, please open the lines for questions. In an effort to accommodate everyone, we ask that you limit yourself to one question and one follow-up, after which you may rejoin the queue.

Operator you may now open the call for questions.

Question-and-Answer Session

Operator

[Operator instructions] And we will take our first question from Travis Steed with Bank of America. Please go ahead.

Pete Arduini

Good morning Travis

Travis Steed

Good morning. So your expectations for the second half are pretty much unchanged, but you’ve had two quarters where things came in well ahead, can you just comment on why you are not comfortable enough at this point to think growth of the second half could also be better and also what kind of visibility do you have, where you think Dural repair is going to slow? In the second half you had two quarters, which came in above expectations?

Pete Arduini

You know Travis, good questions. This as Pete, I have a few comments and then maybe Glenn will focus on. I think when you think Orthopedics and Tissue Technology it is pretty consistent or on track to what we estimate. Really the Specialty Surgical had performed stronger in the first half and the reason we believe that’s tempered some in the back half is consistent to what we've talked about in the past. If you thing about Dural repair there is two parts to that. There is our Dural sealant and then there is our online business.

And a few quarters back the sealant business was growing up in the high double digits - high 20% range and that’s tailing down some to what we had estimated. Again, the market is growing at in the neighborhood of 4% to 5% overall on the high end. The Dural online business, we actually have Glenn mentioned, there is two recent launches that have really taken a little bit of time to move through the hospital systems, but now they’re doing quite well. This is the [indiscernible] and also our DuraGen secure product and that’s actually giving us a really nice boost here this year, but again we see that that beginning to plateau to market levels.

And again still having a very strong performance, but we see that leveling out and I think that's really how we take a look at what that performance is. I think the other aspect of this is, we mentioned about TEI being great fit for the company and going on. We don't see a big pickup in the second half on TEI, although I would say from the investments we've made we see that benefiting out into 2017. I mean those where the main components. Glenn what did I miss?

Glenn Coleman

Well, look Travis, I think when I frame up the year, this is the second time half way through the year we’ve raised our organic growth expectations, started the year off with 7%, went to 8% after our April call and now we’re at 9% and to your point, we’re not changing expectations in the back half of the year. I think that's an important point that we came into the year, we are expecting 8% to 9% organic growth in the back half. Expectations have not changed relative to that. The reasons why we’ve raised our guidance is because of the outperformance in the first half of the year. And as Pete mentioned, the Dural repair business, we are modeling a little bit of a slower ramp in the back half of the year.

When you look at year-over-year growth rates, we have a new competitor in the Dural sealant space. And also within our precision tools and instruments business, we had a record quarter with our Mayfield product, and we are modeling a little bit slower growth relative to that. Still very healthy year-over-year growth, but we’re modeling a little bit slower growth. The other thing I would say is, we’re still being somewhat cautious on the international side of our business.

Most of the international side of a business is in Europe, obviously there’s some uncertainty with the Brexit situation, Latin America still not where it needs to be from a stability perspective. So, we’re being a little bit cautious also with our international business when we look at the back half of the year. So, those are really the reasons why we're not raising our guidance for the back half of the year at this point, but feel great about the progress we’ve made overall for organic growth and the fact that we’re sitting here now talking about 9% organic growth is a great story.

Travis Steed

Yes, definitely agree there. Can you talk about the uptake for Omnigraft in the centers where you’ve gotten to the value committees as the conversion rates kind of been what you would expect in the feedback from doctors been, what you would expect? And also give us a sense for doctor training, you know demand versus your capacity for offering training?

Pete Arduini

Yes, I would say Travis, first of all on the demand in the training component, we’re in very good shape, I think we've got the right cues, and again we've talked about all along with roughly 50 sales folks. We have a very targeted focus, we're not trying to hit all accounts and all areas. And so from that standpoint, we’re very well aligned and properly funded and that's a big chunk of some of the investments that we made in the first half of the year, both reimbursement, as well as training of clinicians and our sales teams.

As well as their reception for those that have used this point has been very good, I mean, we have cases of products being used on DFU’s that weren't healed by other products that have actually performed well using the Omnigraft product, and so we again very much aligned to what came out of the clinical studies, which is no surprise what we got expected. As I mentioned, I mean it is summer months, you know the story on value assessment communities, many of those are used as a control point for IDN’s in big centers, makes a lot of sense, the approval process and sometimes if the agenda is filled in August, you don't get on until September to have your case laid out.

And I think we were a little bit over optimistic that we could get through some of these a little bit faster, but that's a small setback relative to how we think about things, I think the bigger point is, it’s received very well, teams well trained, doctors are excited about getting our hands on it. In fact some of our investigators haven't been able to get the product yet this is just getting through their backs as we speak, and so they’ll be starting use within August and again just part of the process that’s evolving really within overall healthcare and value assessment communities, but it’s doing quite well and I’m as optimistic as ever about potential for this product.

Travis Steed

Great, thank you.

Operator

And we’ll take our next question from Robby Marcus with JP Morgan. Please go ahead.

Robby Marcus

Great. Congrats on the good quarter guys.

Pete Arduini

Thanks Robby.

Robby Marcus

Wanted to maybe head down to lower extremities, looks like the ankle business continues to do well looks like there’s could pull through coming on the rest of the product portfolio, maybe you could just talk about lower extremities, how you feel about the $12 million guidance for the year?

Glenn Coleman

Yeah sure. So, we had a really strong quarter in lower extremities. The best we've had in quite some time. The $12 million you’re referencing is the ankle guidance we gave on the last call. Clearly, we are seeing a lot of great traction on the Salto ankle, I would say that the $12 million or is probably conservative when we look at the run rates of the ankle business. So, we would probably do better than the $12 million overall.

And the nice thing is the pull through effect we’re seeing on lower extremities now having access to some of these key opinion leaders is actually driving some growth in the rest of the portfolio, whether it be screws and plates or other hardware parts of the business. This is the first quarter in the foot system. We've had a number of quarters, we actually saw some growth versus declines in the past five or six quarters and we said last year, this would be the point in the year when we would actually see some growth and we are actually are seeing it now and the lower foot system. So, I know Pete just recently came back from a conference, may be you could give some additional color Pete from...

Pete Arduini

Yes. So Robby to Glenn's point, I think the sales team is doing a very nice job. I think, two things kudos to our teams with the integration on Salto, probably has been about one of the most well executed integrations, I think of people coming into the organization and taking an asset that fundamentally was declining down to just a few million dollars and exhilarating with just some focus and energy around it. And I would say the other part is, is that our internally developed Cadence ankle really looks like a home run.

I think it’s a product that has all the capabilities and has all the features that many have been seeking with this ankle arthroplasty market for years.

I just got back from the new ankle and foot meeting, which was in Toronto last week, where we had our online lab, which I mentioned, which is a semi with eight operating [indiscernible] tables and we were over booked, we couldn’t even meet the demands for everyone coming through. And just great feedback on the simplicity of our instrumentation versus some of the other new ankles that we're just launched by other companies and the bone-sparring design a huge deal. Some of the three piece ankles just really utilize a lot of the bone that don't leave and don't allow a lot for revision work or anything in future and this design has really contemplated that and all the feedbacks judges it’s a winner. So that brings then new luminaries that we never dealt with before that want to work with us on ankle then start asking about other components within the foot and we're starting to see that reenergizing our lower systems overall.

And I would also tell you I think the team has done a nice job with our focused R&D efforts in Austin, Texas. We are really starting to get our Cadence of R&D development out here, our ongoing series of developments. And so it's a good structure I think we have right now, really built around both of these ankles. And again positioning works out quite well with an ankle that brings different capabilities such as biasing, the ability to change the gate of an individual that's what the Cadence product. And then Salto which has the longest and the most amount of clinical data of any ankle in the market and so now all that’s at Integra. So that's been a real energizer for our organization, I think, customers looking at Integra.

Robby Marcus

Great. And then looking at the guidance for third quarter and the back half of the year, it looks like the Cadence is a bit different on the bottom line versus what the street was thinking. Maybe you could just spend a minute and walkthrough some of the puts and takes of how that'll impact third and fourth quarter.

Pete Arduini

Yeah, so when I think about the third quarter, seasonally we've had a flat quarter from Q2 to Q3 historically, we expect to see a similar trend this year. So, on the top line, expectancy is pretty flat sequential quarter. Having said that, we're expected to see an uptick in our gross margins in Q3, so you may probably looking at gross margins that are close to 70% in the third quarter and getting some leverage on our SG&A cost to get us to the $0.85 to $0.90 EPS range. And then we think about the fourth quarter, we expect our gross margins to land higher from the third quarter along with higher revenue volumes and getting more leverage for SG&A getting up to our full year EPS guide range. So that's how we've kind of modeled out the year. We feel very good about our plans to get there. And again, it's pretty consistent with what we've seen when we look at some prior years relative to Q2, Q3 trend and then Q4 being the largest quarter of the year.

Robby Marcus

Thanks.

Operator

And we'll take our next question from Matt O'Brien with Piper Jaffray. Please go ahead.

JP Peltier

Hi, good morning, everyone. This is JP in for Matt. Thanks for taking the question and congrats on the quarter. I think I want to touch on the last comm we had during gross margin. I think just given this product mix that you had in this quarter in that, the growth drivers for 2017, I’m just trying to frame out where gross margins can get as a company? I mean, it is getting to 75%, it doesn’t seem that too far away, is that a long shot?

Glenn Coleman

I think 75% is pretty far out there. We'd like to see 70% first, which is still – in our guidance now in the top end of the range, but clearly when we look at the mix that's going to help us, we're seeing better utilization in our plans to expectancy, some of the headwinds from our new collagen manufacturing center become less of a headwind as we get into the end of 2017 and 2018, but we're not going to call a gross margin that's at the level this year suggesting at this point. But clearly we’ve been really good our plans. I mean we’ve laid out a long term target of 70% to 71% gross margins by 2018. You can see we are starting to bump up against those probably towards the end of this year. And so we feel really good about it. And I think at the last Investor Day meeting as well, Pete laid out his aspirational view of how we saw Integra as a multibillion dollar company when we laid out targets that were in the 72%, 73% type range. So I think 75% is ways out there, but clearly making some great progress on gross margins and expect to see that continue towards the latter half of this year and then going into 2017. So Pete may be have a couple of additional comments.

Pete Arduini

Yeah, I like the way you're thinking, but I would agree with, Glenn. I think, look, if you step back from 30,000 feet about our strategy and again this idea of once we gain scale, does the company have the potential to reach there, I mean, we had mentioned at some point down the future we think that this as a company we can reach those kind of goals at some point down the road based on the mixes we are in. So if you think about our regenerative product lines have margins significantly above those levels and things such as the ankle products have margins that are in that range or above that. But the investments that we need to make to be able to get the kind of growth, to be a sustainable grower and to really have the scale to compete in a consolidating market, we're going to have to continue to make those ongoing investments. But again to the point, we feel quite good that we’ve got that kind of portfolio where markets are growing significantly and the margins are quite healthy mainly because they bring highly differentiated advantages to patients and we believe that differentiation again combined with our expertise warrants the kind of gross margin that we're seeing.

JP Peltier

Got it. And then just one if I could on the region portfolio especially in the outpatient, I know you took the guidance down to 12% to 15%, down from 15%. I just want to get a sense is that more the timing around that VACs and Omnigraft or is it more the TEI distractions and I guess I just want to – just ask your confidence in these markets remains unchanged, it's just more of a timing issue for the back half of the year, but your outlook here hasn’t changed for the future.

Pete Arduini

Yeah, I mean look our confidence in the product, in the market is completely unchanged. I would say as we dig into it further, our confidence has increased that this is going to be great market and we've got a winner of a product. It's a tiny scenario. And again, this is our first entrée into the outpatient market. And realistically, it’s even little bit of seasonal here, again. Obviously, folks take a lot of vacations in August, you have things that are booked up relative to access to get on the VAC. I think a VAC is actually a very smart move by an integrated delivery network to say we only want four products, well, we're going to bring another one in, one has to go after us to be a body to make those decisions and they have a lot of products going through it. That's what we're entering into. But I think as we come out the other side, our confidence and the step up in the adoption, there's nothing that’s changed there.

So this is just a slower start, a little but bigger lamp that will take place over time. And then for the broader regenerative market as you commented on, what's interesting is we are starting to see use in applications more broadly than we traditionally have in the past, and this is on inpatient as well as outpatients, the acceptance of more regenerative products. And that goes for things such as placental based products too matrices products. There's just more of an adoption in different applications because obviously using a product that helps the body regenerate is much better than putting a synthetic product or something that stays in you for life and doesn't regenerate. And so we're seeing that and I think that's also some of the benefits that we're feeling on our legacy product lines as well as more and more of these products are used in broader applications.

JP Peltier

Great. Thanks for taking my questions.

Pete Arduini

Sure.

Operator

And we'll take our next question from David Lewis with Morgan Stanley. Please go ahead.

Jon Demchick

Hello, this is actually John Demchick in for David.

Pete Arduini

Good morning, Jon.

Glenn Coleman

Good morning.

Jon Demchick

Good morning. I know we’ve talked about the investments that needed to made for Omnigraft and TEI ahead of the launch. And now that launch has started, are there still more incremental investments that we need to be making into the back half of the year and where are we on reps compared to where you think you'd like to be over the next few years?

Pete Arduini

Yeah, so I’d just say on the on the TEI front, which again the emphasis [ph] is more around the inpatient scenario and the products that are held, it's more around optimizing how we think about training, how we think about secondary support specialists and things of that nature. So there is some incremental investment there, but they're not a tremendous change. And again part of it's been also getting through some of the trainings then a lot of new products has come through there.

When it comes to the outpatient space, as I've always communicated, our plan was the never get really out – over ski tips and forward – forward invest before we start having sales. So we are at 50 reps right now. Many of our competitors are double that or triple that. I think to be a long term player with the kind of growth that we expect, we're going to be needing to double our sales force and you know the reason in near future. But what we've been trying to do and I think successfully take a look at how the ramps are looking and add on appropriately as this ramps increase. And so we are at 50 reps now, we will add some more reps second half, most likely we will and then as we see the ramp coming up in the second half of the year, most likely we will have a more substantial increases as well within 2017.

Because, again, this is a game of reach and coverage and our initial strategy with Omnigraft and outpatient is again just to focus on a very select set of customers to start and then we will continue to expand it out and that comes to IDNs that are doing wound care in their outpatient setting, it’s dedicated wound care clinics. There are doctors’ offices that do wound care and there's the veteran affairs area. And so those are all areas that obviously one could see easily over 100 sales reps to be able to cover those areas. And so, at this point in time, we are quite focused. So, when appropriate, we will add more additional reps into the channel and that would be the – probably the biggest ongoing investment associated with the sales that we believe will follow.

Jon Demchick

Thank you. Very helpful. Just one on M&A, still seems to be one of the main focus areas you’ve seem to list. Made a few deals recently, mentioned there's a lot of capacity on the call, seems like all the end market surgical extremities, wound care is still on the table. Are there any areas that you view yourself as still subscale where more sizeable deal makes a lot of sense, are we thinking at this point deals are still likely to come, but not likely to be of the same size?

Pete Arduini

Well, I would say – first of all, I’d say, Jon, if you look broadly, I think on both segments, there's plenty of room for tuck in acquisitions either in specialty surgical or orthopedics and tissue. Both of them can benefit from OUS international acquisitions to build our footprint. So when we find those right deals that actually lean us more towards a bigger footprint or capability, that's an important aspect. If you look at specialty surgical, we have a really strong sales organization. We've got a strong marketing group and we will expand it out from our traditional just neuro world already into ENT, we’ve already moved into certain other areas within the body. And a lot of things that are common there are our ability for how we cut tissue and how we seal tissue. And so technologies that help us constantly be seen as a leader in those spaces, I think we will fit well within our overall portfolio.

And then on the orthopedic and tissue side, you could argue obviously in burn and broader skin, we are really one of the top three players in burn and by far the number one player and we’re either two or three player when it comes to when you start thinking about how you think about different types of chronic and acute wounds. But we still need some scale within those areas and the types of acquisitions that could actually build out our focus within plastic and reconstructive surgery can make a lot of sense for us. As you can imagine a big call point for us are plastic surgeons; many that do difficult work inpatient around burns to folks that do reconstructive surgery throughout the body. And so that's still an interest for us, but by far the area that we are under scale today is in extremities.

And I think, the right plugins that enhance our capabilities, we will be interested in looking at it. I mean I think the Salto/Cadence together, and the results we're seeing are great example of as you bring in more scale and focus what it can do for us. So that's kind of how we think of the landscape. There is an interest at this point in time. We go outside of those areas, we're going to stick to our focal areas, but we still believe and we see in our pipelines that there is quite a few tuck-ins of different sizes that would continue to enhance the company's performance.

Glenn Coleman

And Jon, I would just add to that in the orthopedics and tissue business, we are investing very heavily with organic money as well, so you look at the investments that we're making in clinical studies, new product launches, we think that that can get us some scale as well. And we're investing 5.5% to 6% of R&D across the company; it's much more heavily weighted in our orthopedics and tissue business. So that's just another factor when we think about scale. Yes, it is about going out and acquiring some technologies, but also developing in-house as well, combination of both of those.

Jon Demchick

Thank you very much.

Operator

And we'll take our next question from Steven Lichtman with Oppenheimer. Please go ahead.

Steven Lichtman

Thank you. Hi, guys.

Pete Arduini

Good morning, Steve.

Steven Lichtman

So just first on total ankle, obviously, very good early start here. I guess two questions one, when should we expect the cadence on Cadence roll out to pick up and then secondly can you talk a little bit more about maybe the halo effect you’re starting to see on the rest of the lower extremity portfolio based upon now hovering the two total ankle offerings?

Pete Arduini

Yes, I would say, well first of all on the Cadence we’re still on what we call our controlled market release phase, which is kind of getting everything finalized up and with a controlled amount of users we will start expanding that in the second half, but realistically with the lead time to bring incremental sets in all of our instrumentation and - it’s still going to be quite controlled here in the second half of the year and then 2017 is obviously the point where we see a bigger ramp up associated with Cadence. The effect of ankle and the halo, so-called halo effect is simply put that the ankle is the most complicated really lower procedure that’s out there.

If you have products obviously that are performed by many of those clinicians that do those cases, a lot of those are in larger groups or in groups that do these more sophisticated areas. Once they start liking your training, your products, and your team there is obviously a lot of questions that open up about what you have in these areas. And honestly with you, I’d say there are some areas that we have some products that still need to be refreshed, we’ve been very candid about that and will be refreshed at the - through the end of this year and into next year, which I think is going to open up giving more business for us.

And then new products and leadership products that we already have such as the product like Panta Nail with its internal fixation, we've come out with a new novel ex-fix positioning, external fixation device as well which is being released. So, the thought with that is well is if we were to bring in not only products that we develop, but some that we actually acquire into the lower portfolio. We are really quite well positioned as we bring more of these advanced clinicians on for ankle to actually fill out the rest of the portfolio. So that’s what’s going on and like anything else we've got a lot of energy in that area and a lot of excitement, other products typically benefit from that. And that's what we're seeing.

Steven Lichtman

Great and then, thanks. And then just secondly, on international, certainly understanding the macro visibility that Glenn mentioned, but it sounds as though you are feeling better about your international business, maybe talk to us a little bit more about some of the progress you’re making there with some of the initiatives that are having some positive effect?

Pete Arduini

Yes, I would reiterate Glenn's point. It’s obviously, there is still a lot of unrest in markets around the world and a lot of uncertainty, so that's why we remain cautious, but the performance to your point Steve came from just really better execution and I would say, an increased focus on what our strategy should be and isn’t in certain markets.

So, as an example, we spend a good chunk of money in the first half, working on the type of training that would help us be much more effective in capital type selling situations throughout the world and we’re clearly seeing better execution and forecasting against selling things like the [indiscernible] and we saw that in our overall numbers. The other aspect is that we focused in on certain country strategies, Italy is one that comes to mind where we've gone direct with our neural products, we recently brought in our regenerative products and so having more control of that end market and really seeing what's going on and then having our global franchise leaders, which other marketing folks really help leverage to support a country is something we really haven't done in the past.

We've typically been a little bit further away from that and that sometime happens with the distributor structure. So where we put in more direct structures and as well as where we partnered it more intimate levels with certain distributors, we’ve been able to see the results in the growth. And again, I think we believe in the second half that will continue, but we are cautious relative to market disruptions and that we can be associated with macro items you never know when they are going to pop up, but we feel quite good about how Dan and international team are executing and the focus that they put on specific markets and they've been able to actually deliver those results.

Steven Lichtman

Great, thanks Pete.

Operator

And we’ll take our next question from Jason Bedford with Raymond James. Please go ahead.

Jason Bedford

Hi good morning, can you hear me?

Pete Arduini

Yes.

Glenn Coleman

Yes.

Pete Arduini

Good morning.

Glenn Coleman

Good morning.

Jason Bedford

I jumped on a little late, so I apologize if things were asked, but on TEI where are you seeing the weakness, is it more on the private label business, is it PriMatrix or is it more on the surgery side?

Pete Arduini

So Jason, I would say the way I would frame it up is, look I mean year-over-year we're going to be flat to slightly up from the whole business area and I think Glenn you might have missed the comments that we were up double-digit when you take a look at the full regenerative portfolio, including TEI on a pro forma basis.

Jason Bedford

Right.

Pete Arduini

When we talked about earlier in the year, we actually were lighter on some private label business, I mean that business continues for the whole year and I think part of that was as we acquired the business, I think the run rates that we actually thought where there probably weren't as that high. I think the good news is, we've had a lot of good discussions with all our private level partners and we know where we are and are quite confident within that business. The majority of the focus is really about the internal PriMatrix product that goes through our internal sales or acute-care hospital sales it also saw IDRT.

And again that sales organization has had numerous other products that have actually been introduced to them simultaneously. It’s been on a lot to digest, I think as we move here into second half and into next year, we're going to start seeing the ability to actually open new accounts, and also have the right product positioning to optimize which account would be a better PriMatrix account then an IDRT account.

And that’s really kind of the tale of the tape, but as far as the technology, as far as the fit between the two, we feel very good about it. In fact we have a pipeline of some incremental products that we’re already started. The TEI pipeline that will be coming out at the end of this year and also through 2017, which we think are going to make a difference. And so there are some further investments that we’re going to be making commercially to be able to adopt these between training, as well as may be thinking about some different coverage points, but overall it’s been a good fit. I think people feel very good about being part of Integra and the TEI team, but we, you know it is probably overestimated how many new products we could kind of move into a given channel in one year.

Jason Bedford

Okay. On the outpatient for you guys the 12 to 2015 versus 2016 is it more due to PriMatrix or Omnigraft?

Pete Arduini

Omnigraft timing. So, it’s really about - we had hoped that the ramp up would begin probably know and it’s probably a couple of months later until we see really the main ramp up and that’s what I referenced on the prepared remarks as the transaction cycle, which is the combination of scheduling of VAC, getting through the VAC and then there is typically a trial after that, right. Someone wants to use it for 5, 6 weeks and then they adopt it. And again that's about 60 days longer than we estimated. That's really the whole effect of it.

Jason Bedford

Okay. And not to get too much into the weeds here, but is there a specific or common source of - I don't want to use the word push back, but I think you know what I mean in terms of the delay here, is there something that these VAC committees are not liking or…?

Pete Arduini

No. I think the guys that love - we have people put. So, VAC will meet once a month. They have a slot to talk about 20 products, they have a queue of 25 and in some cases, we convince some folks to take 10 of the agenda and put ours on, but cardiology other specialties are wanting to get their products on and it literally is just kind of the third time to get on the schedule and again as you could imagine, August people take vacations, if the agenda is already booked you get moved to September. So that's literally what it's all about, it’s literally a scheduling component to get through.

Jason Bedford

Okay fair enough. And then just lastly from me, I realized you kind of gave a few numbers out there, but total extremities was that flat mid-single, what was the growth rate there Glenn? Thanks.

Glenn Coleman

Single digits, excluding ankle. So with ankle it was up high teens.

Jason Bedford

Okay.

Glenn Coleman

Obviously that's a big driver being the Salto ankle and if you remove Salto from our numbers extremities grew within the single digit range.

Jason Bedford

Thank you.

Glenn Coleman

You’re welcome.

Operator

We have no further questions at this time. I will now turn the program back over to our presenters for any additional or closing remarks.

Pete Arduini

Thanks, Robby. Well first of all I’d like to just reiterate couple of the key messages that we had commented on here on our prepared remarks and Q&A. So, first we are executing on our 2016 objectives quite well, we are raising our overall revenue guidance to $992 million to slightly over $1 billion, raising organic growth to 9% and increasing adjusted earnings per share to a range of $3.43 to $3.53. Second, we exceeded 69% adjusted gross margin in the second quarter and are now expecting a record 69.5% to 70% margin for the full year, based on our strong performance in regenerative products that are driving this favorable mix we’ve talked about. Third, we have the launch of Omnigraft in the outpatient would care center to look forward to and it’s really becoming a franchise product for us, we feel very comfortable about that and now it’s going to contribute to growth and profitability for many years to come. And then finally, that are continuing to drive organic growth for new products that we develop and we will be launching at least seven new products in 2016.

And so with that, I’d just like to thank you gain for listening and we look forward to speaking with all of you in the near future. Thanks.

Glenn Coleman

Thank you.

Operator

This concludes today’s program. Thank you for your participation. You may now disconnect.

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