Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Executives

Joe Newcomb - VP and GeneralCounsel

Josh Levine - President and CEO

Loren McFarland - VP and CFO

Analysts

Tom Gunderson - Piper Jaffray

Greg Gilbert - Merrill Lynch

Alex Arrow - Lazard CapitalMarkets

Frank Pinkerton - Banc of AmericaSecurities

Jonathan Block - SuntrustRobinson Humphrey

Angela Waddell - CIBC WorldMarkets

Jayson Bedford - Raymond James

Roy - Leerink Swann

Peter Bye - Jefferies &Company

Mentor Corp. (MNT) F2Q08 (Qtr End 09/30/07) Earnings Call November 7, 2007 5:00 PM ET

Operator

Good day and welcome to theMentor Corporation Q2 Earnings Conference.

I would now like to turn ourprogram over to Mr. Joe Newcomb, Vice President and General Counsel of MentorCorporation. Go ahead, please.

Joe Newcomb

Thank you, Andrea. Goodafternoon, everyone, and thank you for joining us today. With me are JoshLevine, President and Chief Executive Officer, and Loren McFarland, VicePresident and Chief Financial Officer.

This conference call elaborateson a press release that was issued earlier today. If you have not alreadyreceived the copy of our press release, please call Vicky Johnson at805-879-6082 and she will fax or e-mail a copy to you. The press release mayalso be found on our website, www.mentorcorp.com.

As a reminder, Mentorhas a fiscal year that ends March 31st and we make reference to any quarter oryear today on the call, we will be referring to our fiscal year unlessotherwise noted. During this call, we'll discuss our financial results for thesecond quarter ended September 30, 2007, which is our fiscal year 2008.

This conference call will includea discussion of non-GAAP financial measures as that term is defined inregulation G. The most directly comparable GAAP financial measures and informationreconciling these non-GAAP financial measures to the company's financialresults in accordance with GAAP have been provided with the press release andposted on the company's website.

Before we begin, I've been askedto read the following Safe Harborstatement pertaining to forward-looking statements, which we'll be makingduring the course of our conference call.

Today's conference call includesstatements regarding Mentor'sfinancial results for the second quarter of fiscal year 2008, guidance for fullfiscal year 2008, the MemoryGel silicone gel-filled breast implants postapproval study and several product development and clinical programs as well asother forward-looking statements within the meaning of the Federal SecuritiesLaw.

It should be clearly understoodthat these forward-looking statements and our assumptions about the factorsthat influence them are based on the limited information available to us atthis date. Such information is subject to change and we undertake no obligationto revise or update publicly any forward-looking statements for any reason.Actual results may differ substantially from those anticipated.

Specific factors that may affectour business and future results are discussed in our SEC Forms 10-K, 10-Q, 8-Kand other SEC filings. A partial list of these important risk factors is setforth at the end of today's press release.

Now I'd like to turn the callover to Josh Levine.

Josh Levine

Thanks, Joe. Good afternoon,everyone and thank you for joining us on the call. For the quarter ending September 30, 2007, we recordedstrong sales and operating performance in what has historically been aseasonally slow quarter.

We finished the second quarterwith $85.4 million in sales, an increase of 28% over sales of $66.9 million inthe second quarter of 2007. Breast aesthetic sales were $75.1 million in thesecond quarter, an increase of 29% over the sales of $58.2 million in thesecond quarter of fiscal 2007.

USsales were favorably impacted by the increased market penetration of MemoryGelimplants. Also contributing to sales growth was our successful domestic launchof the NeoForm product and strong global sales of tissue expanders, both ofwhich are primarily used for breast reconstruction. We also experiencedexcellent revenue growth in our international markets.

In addition to strong organicinternational growth, our Perouse Plastie subsidiary contributed approximately$4.5 million of breast aesthetics revenue. Sales of liposuction equipment anddisposables were $3.7 million for the second quarter, a decrease of 4% from thesame period in the prior year.

As previously discussed, ourdecision to exit from a number of low margin product lines in our liposuctionbusiness has resulted in lower sales, however, we believe it has improvedprofitability for the body contouring business overall.

Sales of our other aestheticproducts, which include our facial products for the second quarter, were $6.7million, an increase of 37% over the same period prior year. During the quarter,we saw strong international sales growth in our dermal fillers and [another]line of skin care products that we sell domestically. Also included in thegrowth and other aesthetic products is $400,000 of non-breast implant relatedPerouse products.

I'll now turn the call over toLoren who can give you a more detailed review of our financial results.

Loren McFarland

Thanks, Josh. As required undergenerally accepted accounting principals, the operating results of ourdiscontinued urology business are reported below net income from continuingoperations. My comments today will only cover our continuing operation.

Starting first with sales: Netsales for the second fiscal quarter were $85.4 million, an increase of 28% from$66.9 million reported in the prior year, and included $1.2 million of positiveforeign currency effect.

Sales from our new Perousesubsidiary for the quarter were approximately $4.9 million, primarily breastimplants. Excluding the effect of currency and the Perouse acquisition, ourorganic sales growth rate from all products was 19%.

As we introduced on our last call,we are now providing a unit demand statistic for domestics market splitsbetween gels and saline breast implants. For the second quarter, in the USmarket, over 42% of the average unit demand was MemoryGel products, whereas theremaining 58% of the average unit demand was saline implants.

We expect that this willgenerally increase for the remainder of the year, and that MemoryGel demandwill approach half of all domestic breast implant unit volume by the end of thefourth quarter of our fiscal year 2008.

We are reiterating our full yearguidance of sales to be in the range of $370 million to $385 million. Grossmargin for the second quarter of fiscal year 2008 was 70.2% compared to 72.3%for the comparable period in fiscal year 2007.

Cost of sales for the secondquarter of fiscal year 2008 included $1.4 million of cost related to the saleof inventory valued at fair value, as a result of the purchase accountingtreatment under FAS 141 business combinations in our Perouse acquisition.

These fair value cost go to thecost of sales line of the income statement with the sale of the acquiredinventory, the first inventory turn and then cost of sales were normalized. Weexpect this adjustment will add $1 million more to cost of sales in the thirdquarter.

On a non-GAAP basis, excludingthese extra costs, gross margin was 71.8%. The gross margin was also affectedby lower gross margin from Perouse sales and non-cash amortization expensepartially offset by the benefit of higher sales in MemoryGel breast implants,favorable manufacturing variances and lower warranty costs.

As a reminder, our Septemberquarter is our seasonally weakest quarter and we are maintaining our guidance atgross profit margin for the full year will be in the range of 73% to 75% ofsales.

SG&A expense in the secondquarter of fiscal year 2008 was $33.4 million, or 39.1% of sales, compared to$28.7 million, or 42.9% of sales in the second quarter of fiscal year 2007.

SG&A expense in the secondquarter of fiscal 2008 included approximately $2.6 million of compensationexpense associated with the company's long-term equity compensation program andapproximately $700,000 of integration expenses related to the integration ofPerouse Plastie.

We expect SG&A expense to bein the range of 39% to 41% of sales in FY 2008. This will include equitycompensation expense in the range of $13 million to $14 million.

Research and development expensesin the second quarter of fiscal 2008 were $12.2 million, an increase of 36%over the $9 million reported in the second quarter of fiscal year 2007.

For the quarter, our investmentin R&D supported our botulinum toxin clinical development program, ahyaluronic acid dermal filler development program, the MemoryGel post-approvalconditions and the ongoing FDA review of the Contra Profile Gel breast implant,PMA.

Of the second quarter R&Dexpenses, approximately $2 million were related to the MemoryGel post-approvalcondition. As far as guidance for R&D, we now expect a cost of theMemoryGel post-approval condition to be approximately $9 million in fiscal year2008 and we expect total R&D expenses to be in the range of $12 million to$14 million in fiscal year 2008.

Operating income in the secondquarter was $14.3 million, an increase of 34% over the $10.7 million reportedin the second quarter of the prior year. We estimate operating income for thefull year 2008 will be approximately 20% of sales on a GAAP basis.

This includes a full year chargefor equity compensation expense under FAS 123R, the results of Perouse Plastiefor the remainder of the year and the additional cost of sales as a result ofcharging the acquired Perouse inventory through cost of sales at fair value andour substantially increased investment in R&D.

Interest expense net of interestincome in the second quarter was an expense of $100,000 as interest income hasdecreased significantly as a result of lower cash balances due to our sharerepurchase program.

Moving onto taxes: The effectivetax rate for the continuing operations in the second quarter of fiscal year2008 was 26% compared to 32.7% in the second quarter of fiscal year 2007. Theeffective rate in the second quarter of prior year was unusually high as theFederal Government had not yet approved the extension of the tax credit forresearch and development activities. These credits have since been re-enactedand decreased the rate.

Year-to-date, our effective taxrate is 28.7% compared to a full year rate in fiscal 2007 of 29.9%. We aremaintaining our guidance for the effective tax rate for the full fiscal year2008 of approximately 30% of pretax income. Excluding the results ofdiscontinued operations, we reported diluted earnings per share from continuingoperations of $0.27 in the second quarter of fiscal year 2008 compared to $0.24per share in the second quarter of fiscal year 2007, an increase of 13%.

Including the diluted GAAP EPSfrom continuing operations for the second quarter of fiscal year 2008 were netof tax effect approximately $0.02 per share of cost recorded in the cost ofsales related to the sale of inventory recorded at fair value under theprovision to FAS 141 "Business Combinations" related to company'sacquisition of Perouse Plastie.

Included in the diluted GAAPearnings per share from continuing operations, the second quarter of the prioryear were, net of tax effect, approximately $0.02 per share of costs related tothe company's business rationalization initiative.

Excluding these charges, dilutednon-GAAP earnings per share from continuing operations were $0.29 per share inthe second quarter of fiscal year 2008, an increase of 12% over the $0.26 pershare diluted non-GAAP earnings per share from continuing operations reportedfor the second quarter of fiscal year 2007.

We expect diluted GAAP earningsper share from continuing operation for the full fiscal year 2008 to be in therange of $1.40 to $1.45 per share. This guidance include the full year chargefor equity compensation expense under FAS 123R, the result of Perouse Plastiefor the remainder of the year, and the additional cost of sales as a result ofcharging the results of acquired Perouse inventory through cost of sales atfair value.

And a substantial increased investmentin R&D, as well as, a lower number of shares outstanding as a result of ourshare repurchase program. As previously discussed in our last conference call,since April 1, we have retired 8.7 million shares at an average price ofapproximately $41 per share for total of approximately $358 million.

These repurchases represent 20%of our diluted outstanding shares as of March 31, 2007. No, additional shares have been repurchased since ourfirst quarter call. As a result of the shares repurchased and retired in thisprogram, we expect the number of shares outstanding for the diluted earningsper share calculation purposes to decrease to approximately 40 million sharesfor the third and fourth quarters and approximately 42 million shares for thefull year.

I will finish up with the commenton our cash position and cash flow and then turn the call back over to Josh. Wereported cash and marketable securities to $102 million as of September 30, asubstantial decrease from our March 31st balance of $488 million, primarily asa result of our share repurchase program.

In the first half of the fiscalyear we repurchased 8.7 million shares approximately $358 million and alsofunded the cash portion of our acquisition of Perouse Plastie for approximately$53 million and paid dividends of $16 million. For the second quarter, ouroperating cash flow from continuing operations was approximately $20 million.

Depreciation and amortizationexpense were approximately $3.7 million and our capital spending on PP&Ewas $4 million. For the full year, we expect depreciation and amortization forfiscal year 2008 to be in the range of $12 to $14 million.

Investment and capital spendingin FY 2008 includes an expansion of our botulinum toxin facility to providewith the eventual vertical integration of certain processes currently beingoutsourced and the anticipated milestone payments to Genzyme as we progresswith our HA dermal filler program.

For those of you modeling cashflows, you should include accurate capital spending for FY 2008 in the range of$20 million to $25 million. Josh?

Josh Levine

Thanks, Loren. Starting firstwith our HA dermal fillers, all of which are formulated with Lidocaine forpatient comfort, we are pleased to announce that during the quarter our PMA forPuragen Plus was accepted for filing by the FDA and we expect approval inmid-fiscal year 2009.

This represents a modest delayfrom earlier forecasts and is being driven primarily by the timing of the FDaudit of the manufacturing facility as part of the PMA review process. ForPrevelle Plus we anticipate FDA approval in late fiscal year 2008. We continueto make progress in our development of dermal gel extra and during the quarter,we completed patient enrollment in that clinical trial.

We expect to complete the followup for this study in mid-2009 and project the product will be availableinternationally sometime during fiscal 2009 and domestically in fiscal 2010. Onthe implant side we completed our PMA for our Contour Profile gel anatomicalbreast implant in September of last year and the FDA has accepted that filing.We are working actively with the agency to provide additional requested data.

On our botulinum toxindevelopment efforts the results in botulinum toxin Phase II clinical study werevery encouraging. All of the study endpoints were met. While we will not becommunicating dosing specifics we can confirm that a dose dependent responserate was observed with a positive correlation between dose levels and overallresponse rates.

For competitive reasons, we willnot be more specific regarding the speed of onset, although, we were pleasedwith what was observed in terms of timing.

In summary, botulinum toxin waswell tolerated. There were no apparent dose dependent differences in terms ofadverse events identified and we met all safety and efficacy endpoints. We areconfident that we have a solid drug candidate to take through the next steps ofthe regulatory process.

During the quarter, we completedpatient enrollment and treatment ahead of schedule in the initial Phase IIIa ofour pivotal trial. As a reminder, Phase IIIa is a single dose approachrandomized the placebo and is focused on safety and efficacy for the cosmetictreatment of rhytides.

The endpoints for this Phaseinclude assessment of frown line reduction, subject satisfaction and speed ofonset of effect. Early feedback is positive and we are on target to completethe six-month follow-up by mid-March. There were two additional pivotal phases,Phase IIIb and IIIc.

During the quarter, we receivedspecial protocol assessment approval for our Phase IIIb study. We beganstart-up activities and we can expect to begin enrollment by calendar year end.Phase IIIb is “a repeat dosing trial ‘randomizing’ the placebo”, with a 13month follow up. For Phase IIIc we have begun study start up activities forthis open label repeat dosing safety trial and anticipate patient enrollment tobegin by calendar year end.

Follow-up on this study is threeyears and the study can run concurrently with Phase IIIa and IIIb. In addition,we are making significant progress in our Phase I multi-center, dose escalationstudy of our Botulinum Toxin for the treatment of pain fromtorticollis/cervical dystonia. Multiple cohorts of patients have been treated andfollow-up is ongoing.

The study is on target forcompletion by the end of the fiscal year and we are pleased with the efficacywe are seeing thus far. Before I wrap up our prepared remarks, I want to updateyou on the progress of our MemoryGel post approval study. We submitted ourthird interim report to the FDA on-time, and we anticipate a timely submissionof our fourth interim report by November 16th.

As of November 6th, we haveenrolled approximately 21,000 patients towards the total target of 42,900patients. And now, we're ready to take your questions.

Question-and-Answer Session

Operator

(Operator Instructions). Thankyou. We'll go ahead and take our first question from Tom Gunderson of PiperJaffray. Go ahead, please.

Tom Gunderson - Piper Jaffray

Hi, good afternoon.

Josh Levine

Hi, Tom.

Tom Gunderson - Piper Jaffray

Two quick questions: One issummer season has got that slower seasonality to it, but then you did well onthe revenue site. Did you see any change, unusual change, in the unit salesduring the fiscal second quarter? And then the other question I have is sort ofthe broad one: I'm sure you've been talking to your docs, and others, about anychange in consumer demand. Could you comment and give a little color on that,Josh?

Josh Levine

Yeah, great. So, the answer isthat, during the last month of the quarter, we did start to see the beginningof some softening in demand and the channel research that we did and thestudies that we conducted say that some plastic surgeons were starting to seesome drop off in patient consultations, which Tom, as you know is usually alittle bit of a precursor to lighter surgical calendars maybe 45 or 60 daysout. And some of this feedback was reinforced with additional feedback that wereceived at the ASPS show in Baltimorein a broader universe of docs.

For the quarter, we projectedthat procedure or unit volume was growing in about the mid-single-digit range,but based on some of the data points that I just spoke to, we are closelymonitoring the demand situation going forward. I've been asked a lot about theimpact in terms of spillover on the economy and consumer demand and it wasclear that towards the latter part of the quarter, we were starting to see alittle bit of a slow down. Again, I can't predict what that means in terms oflonger term at this point. It's just something we're going to have to monitorand stay close to.

Tom Gunderson - Piper Jaffray

Josh, you probably, we all wantto take one fact, and one assumption, and put it together, but can you give usa sense of how many times in the past you've seen those one-month slowdowns andthey didn't portend anything for the future?

Josh Levine

Yeah. It's a good question andI've answered this question a lot over the course of the last, probably four tosix weeks, given the economic, the broader economic trends. I have personally,in the last 11 years, had two experiences with what I'll call: “broadereconomic trends” or “macro trends” that have impacted the basic demand of thebusiness.

The first was associated with the.com meltdown in 2000 and the second was really associated with post-9/11environment. And in both of those cases, as the market, as the economy, startedto slow and consumer confidence was impacted, there's no question that theintrinsic demand for our products and our procedures was impacted.

The interesting thing about bothof those cases was that the impact wasn't a lengthy impact. I mean there were acouple quarters in both of those situations, at the outside, and then withinthree quarters, or so, after we started to see the demand return to historiclevels.

And when you start talking to thephysicians in both of those cases, and getting whatever kind of empiricalfeedback you could get, one of the things that you found was that patients werejust, from a psychological standpoint, the purchasing psychology around goingforward with our procedure, or cosmetic breast surgery, was really a differenttype of an impact than other large consumer purchase type of decisions.

Patients were considering andlooking at this as: “an investment in themselves” and, as an investment, theywere still willing to go forward with over time. So, again, probably a littlebit different psychological profile of your patient than of your typicalconsumer product type of a purchase.

But, I guess in summary, what Iwould say is that if we are going to have a real problem in the broadereconomy, the likelihood is that we are not going to escape that. We will seesome impact from it, but I don't project it will be a long range, long termkind of a hit to the demand.

Tom Gunderson - Piper Jaffray

Okay and then just one quick lastone for Loren. I'm assuming, Loren, there were no sales for Perouse in Q1? Isthat correct?

Loren McFarland

That's an easy one, that'scorrect.

Tom Gunderson - Piper Jaffray

Okay, thanks.

Operator

Thank you. We'll go to our nextquestion from Greg Gilbert of Merrill Lynch. Go ahead, please.

Greg Gilbert - Merrill Lynch

Thanks. Good afternoon, guys.

Loren McFarland

Hi, Greg.

Josh Levine

Hi, Greg.

Greg Gilbert - Merrill Lynch

Just following on your commentsabout the economic situation: are you speaking mostly to the demand overall ordo you think there's something to be said about the choice of saline versussilicone within that?

Josh Levine

I guess I'm referring to demandoverall. I mean the truth is that while there is a difference in price point inthe products and therefore, when you look at the quotes that are being made topatients from a total procedure fee, the choice between saline and gel, I meanour research Greg shows that from a price gap standpoint, there's a fair amountof resiliency there in terms of the difference in price point. I was referringto really kind of intrinsic demand overall.

Greg Gilbert - Merrill Lynch

That's what I thought. And yourconvergent rate up to the 40s seems to be in line with what you were expectinganyway, right?

Josh Levine

It is.

Greg Gilbert - Merrill Lynch

Loren, any other negative factorsin gross margin, other than amortization and mix from Perouse? Smaller thingsthat you didn't mention?

Loren McFarland

We did mention the amortization,it was just to be recognized that at our slow quarter. So, there's some fixedcost impact on just the slower base of business.

Greg Gilbert - Merrill Lynch

Right.

Loren McFarland

And then, we talked about thenon-cash amortization expenses, which until we get ramped up particularly onthe HA business, it'll have a little larger effect on the gross margin.

Greg Gilbert - Merrill Lynch

So, there was nothingunexpectedly negative in gross margin for you?

Loren McFarland

No.

Greg Gilbert - Merrill Lynch

Okay. And lastly, Josh, onbusiness development: how would you characterize both your appetite at thispoint, as well as the environment? Thanks.

Josh Levine

Appetite is there. It hasn'tchanged. Again, we are looking for and have been looking for opportunities thatare strategic opportunities for enhancing our core business strengths or corebusiness positioning. So, I'd say that the appetite hasn't changed over time.As far as what the environment is like, I think that it's consistent with whatwe've seen over the last several years. The valuations in the marketplace forthings especially on the facial aesthetic side are still fairly robust maybemore robust quite frankly than they deserve to be in some sense.

But I mean our view is that, ifthere were an opportunity to come down the pipe that made sense for us, we'd beinterested in considering it.

Greg Gilbert - Merrill Lynch

Thank you.

Operator

Thank you. We'll go to our nextquestion from Alex Arrow of Lazard Capital Markets. Go ahead, please.

Alex Arrow - Lazard Capital Markets

Hi, good afternoon, Josh.

Josh Levine

Hi, Alex.

Alex Arrow - Lazard Capital Markets

The new policy for thepost-approval study, in which you've allowed it to be voluntary, can youdescribe what benefit you are perceiving and perhaps if you could quantify inmarket share gains or how is that affecting your competitiveness versus[reselling] it?

Josh Levine

It's an interesting question. Ithink I'm going to answer your question, but I think I'm going to take thisopportunity probably, to give you or give everyone a little bit broader senseabout the PAS discussion or the post-approval study discussion in general.

Just to clarify the question, wewent back to the FDA after we had launched the post-approval study withmandatory patient enrollment requirements and physician enrollment requirementsbased on input from IRBs, and the IRBs were giving the agency the same feedbackthat there were concerns on their end about mandating patient enrollment for aFDA-approved device.

So, just to clarify that, had weknown that this was going to be a sticking point before we locked down the protocol,we certainly would have addressed that upfront. So, a change wouldn't have beennecessary. But I think that, at the end of the day, the adjustment that we madeand the agency agreed to was the right one based on what patients and whatpatient safety advocates were asking about.

In terms of competitive advantageor market share gains, I mean, I think in general, this topic about thepost-approval study requirements hasn't gotten the kind of visibility and thediscussion level that it really deserves. And I guess the 21,000 patients as ofyesterday that we have enrolled, puts us about halfway to that total patientcommitment.

And I think that the progresswe've made there, Alex, truthfully is a direct result of the philosophy and theeffort that we've applied to this thing from the very beginning. We've beenconsistent in our comments, both internally with our own people as well asexternally with physicians and the investment community, that patientenrollment in the PAS is one of the most important initiatives our company hason its plate, and we've been really consistent about that.

We set our goals to get patientsenrolled as quickly as possible and that we wanted to do that with a minimum ofburden on patients and surgeons, and I think we are executing on that.

Alex Arrow - Lazard Capital Markets

Well, but presumably, it musthave slowed down a little bit since if you're relaxing the requirement? Theremust be some surgeons who are opting out, even if it's only a few of them,right?

Josh Levine

I can tell you that, in allhonesty, we have not seen any major shifts in ongoing enrollment rate onaverage over the course since we launched the study. And I think the fact thatwe're now a halfway to the commitment speaks to that. The FDA told us thattheir expectation was that they wanted completion of enrollment within twoyears of approval. And we took that input really seriously. And as a result, weput very high expectations on our salespeople and our clinical studiespersonnel to get this done and we're executing against that goal.

Alex Arrow - Lazard Capital Markets

Okay. Thank you. If I could askabout the stats you gave on gel versus saline: does that apply to the UScosmetic market or does that include the reconstructive part of the USmarket?

Loren McFarland

That's the entire USmarket, reconstructive and augmentation.

Alex Arrow - Lazard Capital Markets

Okay, thank you. And then finallyyour comments on liposuction being light: can you say, does that have anythingto do with the smart lipo devices competition or is that independent?

Josh Levine

It's independent, I mean again,the smart lipo device, and some of these “less invasive” technologies, havecertainly been out in the last several quarters and I think patients are, andphysicians are, taking a look at these things.

The practical reality is this:For your typical patient in a typical multi-site lipo procedure that gets done,the amount of that post-tissue that gets removed is dramatically more than whatcan be done with the technologies like the ones that you're talking about:these “less invasive” technologies.

So, while there may be patientstrying those new technologies, if they want lasting results, many of them endup coming back for traditional lipo procedures, which is really the only surefire way to provide a guarantee that the amount of tissue that needs to beremoved can be extracted, because it's a fool proof mechanical extraction. So,while there may be some impact from some of these new technologies, I thinkthese patients will come back; at least that's what we are hearing from thedocs that are seeing the patients.

Alex Arrow - Lazard Capital Markets

Okay. Thanks, Josh.

Operator

Thank you. We'll go ahead to ournext question from Frank Pinkerton of Banc of America Securities. Go ahead,please.

Frank Pinkerton - Banc of America Securities

Hi, good evening. Thanks fortaking the question. I'll throw one out to start off with here: You didn't givemuch data on your botulinum toxin product. Can you give any specifics regarding:“compared” or maybe: “between” what we know about either Reloxin or Botox thatare already out there? So, as you look at these Phase II studies: how it stacksup with those two products?

Josh Levine

Well, you're right. We didn'tgive any specific dosing data but the fact that all safety and efficacyendpoints were met in our Phase II study I think was a positive. I think one ofthe product attributes that was worthy of mention was a relatively rapid onsetof action that we saw in Phase II and we are very strongly expecting to confirmthat observation, Frank, in Phase IIIb and IIIc of the trial. So, I would say,that's one data point or one area in terms of potential product attribute thatmay be differentiated.

Frank Pinkerton - Banc of America Securities

Okay and then can I ask, Loren,two questions for you? First of all: the Perouse acquisition was that basicallyfor the entire quarter, did that close for about the beginning of July?

Loren McFarland

It did. It closed on July 2nd.

Frank Pinkerton - Banc of America Securities

Okay. So, even though it'sprobably a seasonal edition that's kind of the -- if we think of seasonallythat's kind of the full contribution it would have put to the quarter for whatyou guys talked about, correct?

Loren McFarland

Right, that $4.9 million isindicative of a full quarter of sales.

Frank Pinkerton - Banc of America Securities

Okay. And then lastly, you arekind of reserved for product warranties that have been in a range somewherebetween $12 million and about $14.5 million, $15 million, but it looks likeit's moving towards the bottom part of the range there. Are you seeing anythingdifferent with the assumptions you need to make regarding now that you're doingthe larger percentage of silicone or is this just natural fluctuation on thebalance sheet or on the recording of the accounting for the warranties? Thankyou.

Loren McFarland

Yeah. A couple of things, ingeneral, are helping the product warranty reserves: one is that the shift togel is a favorable shift. The gel products perform better than the salineproducts over the long run. And then secondly: our improved quality has alloweda lower rate of claim from our customers for product problems. And so, both ofthose where these are claim rates, our historic claim rates to predict ourfuture ones have been beneficial.

Frank Pinkerton - Banc of America Securities

Okay. Thank you.

Operator

Thank you. We'll go to our nextquestion from Jonathan Block of Suntrust Robinson Humphrey. Go ahead please.

Jonathan Block - Suntrust Robinson Humphrey

Well, hey, guys, good afternoon.

Loren McFarland

Hi, Jon.

Josh Levine

Hi, Jon.

Jonathan Block - Suntrust Robinson Humphrey

Just first one: on thepost-approval study expense, I think, Loren, you said $9 million for the year.And just taking the figure of around $21,000, $22,000, it seemed that you guysare tracking to a complete enrollment maybe early to middle of fiscal year '09.So, can you give us a feel for where this expense, where the expense run rate,what that might look like upon completing enrollment?

Loren McFarland

Well, we're not giving anyguidance for fiscal year '09 yet. So, I think I will decline trying to kind ofpredict where that'll be next year. But when we first started the post-approvalstudy in all the conditions, we said $30 million to $45 million over 10 years.And so, we had $3 million last year, fiscal year 2007, we have $9 million thisyear. So, you can kind of reverse engineer that $15 million out of the range,so $15 million to $30 million remaining over the remaining eight years.

Jonathan Block - Suntrust Robinson Humphrey

Okay. Great.

Loren McFarland

Talking too many numbers.

Jonathan Block - Suntrust Robinson Humphrey

No, that's helpful. And then,just in terms of the competitive landscape, if I normalize for the Perouseacquisition, I have you guys losing, maybe about 100 basis points, in terms ofmarket share between you guys and Allergan.

So, is this maybe the normalswing of the pendulum if you would or are you seeing maybe a little bit more ofan impact from Allergan's DTC program?

Josh Levine

Jon, I'll take that one. I thinkit's a multi-part answer. We clearly, again excluding the Perouse acquisition,your number is accurate in terms of the share hit that we took. I'd say thatwas primarily domestically. During the quarter, I will tell you that we sawsome, what I'll call, targeted competitive activity focused on our largestdomestic accounts, an activity for whatever it was worth it was primarilyfocused on price discounting.

I wouldn't characterize that asan across the board kind of national situation, but really more selectivelytargeted at specific accounts of ours. At the end of the day, it had littleimpact on our ASPs, because we didn't respond to any of those situations withprice matching. But as a consequence, we did give up some volume.

And we take the share, a sharediscussion and a competitive positioning conversations very seriously andpeople that follow the company and our business for a long time know that whilewe said very clearly we've great respect for Allergan. In our core business,we're not going to take a back seat to anyone and in my mind nothing haschanged in that regard. So, I'm not in a state of panic over the quarter. I don'tthink that people should read a lot into the share shifts on a short-termbasis. The real story is what happens from a relative share position over time.

On the DTC discussion, it'sdifficult to say whether the DTC campaign is actually getting traction or not.I'll tell you what it is doing. The fact that Allergan is making -- the kind ofinvestment that they're making allows them to go to plastic surgeons and saythat they're doing the kind of things that help to grow their practices andthat's probably getting some leverage.

But it is more difficult toquantify: if what they spend promotionally is actually getting any traction? Isee a couple of disconnects quite frankly that are worth, I guess, pointing outif nothing else between the DTC activity that they're talking about and otherthings. If their DTC campaign was really driving patients, one question I havewould be: why would there be a need from a tactical standpoint to cut priceswhere they are in some of the larger accounts that I mentioned? So, that wasone point.

And, I guess, the second I wouldsay is a disconnect for me is, if you look at the DTC effort and the patientenrollment levels with their post-approval study, I would have thought thatthere would have been more positive correlation between the two. In otherwords: if they were really driving a significant number of patients, some ofthose patients would have spilled over into patient enrollment activity intotheir dip study, and I don't think that's happening.

So, the whole discussion aboutDTC, and that it's getting traction, is interesting. Just as a point ofreference: we have some personal experience with DTC advertising on our own. Weran the first consumer direct response marketing campaign in the cosmeticbreast surgical back in 2000. We ran another one again in 2003. And what welearned from those experiences is that in terms of its impact on surgicalprocedures, DTC investments draw patients into the marketplace to find out moreabout the procedure and even to consider a surgical consultation with a plasticsurgeon of their choice.

But what it wasn't very effectiveat was: “driving brand preference”. It's not the same type of model as atopical skin or injectable facial procedure. And when you start talking aboutphysician mindset on these things the aesthetic outcomes that are at stakealong with the doctor's reputation and even legal liability, if a patientaesthetic outcome expectation isn't met is something that the doctor thinksabout quite a bit.

So, as a result, most of theplastic surgeons that I know won't relinquish responsibility for productselection in the patient in those situations. So, in my mind, while DTC may bea very cost-effective means to drive demand and brand preference on the facialproduct side, I think, from personal experience, it's a lot less effective inthe surgical aesthetic segment.

Jonathan Block - Suntrust Robinson Humphrey

Okay, great. Thanks for thecolor, guys.

Operator

We'll go to our next questionfrom Amit Hazan of CIBC. Go ahead, please.

Angela Waddell - CIBC World Markets

Hi, this is actually Angela[Waddell] speaking on Amit's behalf tonight. I just have a quick question,actually to follow up on the market share. What about the long term? How can webe confident that the share loss is not going to continue? And do you assumeany US marketshare decline in your FY '08 guidance?

Josh Levine

Yeah. I mean all of what we'vecommunicated vis-à-vis guidance, [Andrea], has been baked in. All of thoseelements have been baked into the calculations. So, the guidance that you'vegot encompasses all of that.

As far as the longer term lookagain, I'm going to go back to what I said before which is we, I'm not panickedabout the quarter. I don't think that there is a lot to read into share shiftsof 100 basis points on a quarter, a short-term basis. I think the realdiscussion is, let's see where we are three or four quarters from now and whatthe momentum in the business is in the market overall.

Again, I think that theadvertising and the DTC investment that's being made may be having a positiveimpact in terms of drawing patients into the market to find out more about theprocedure. But I don't necessarily think that, as a brand preference driver,that again, from our experience, that it has all the impact that you'd hope itwould. So I guess, I just have to say: “stay tuned”.

Angela Waddell - CIBC World Markets

Okay. And, also, do you have anymarketing plans yet for the facial filler products in terms of building a sternsales force?

Josh Levine

Yeah. We spent a lot of time onthe “go-to-market” strategy on the derm side and I can tell you that given thetiming of the launch of our Prevelle Plus product, we're in the final stages ofa thought process around that. I think, that you will undoubtedly see, probablytowards the first quarter next fiscal year, a ramp up, the start of a ramp upin infrastructure build for that. But past that, I don't think, at this point,I want to get too specific as to expense ratios or what our specific plans are.

Angela Waddell - CIBC World Markets

Okay. Great. Thanks. And also doyou have any updates on the progress on your CPG and have you receivedsufficiency letter?

Josh Levine

Yeah. Our CPG filing is stillactive. We're still in active conversations with the agency. During thequarter, we did receive a request for additional information and clarificationon certain parts of our submission. But I would say or characterize those aspretty routine in terms of the nature of the questions.

Angela Waddell - CIBC World Markets

Okay. Great. Thank you very much.

Operator

Thank you. We'll go to our nextquestion from Jayson Bedford of Raymond James. Go ahead, please.

Jayson Bedford - Raymond James

Hi, good evening, guys, just acouple questions. First: you just talked about the kind of the procedural slowdown and drop off in September. Is it fair to say that you haven't seen a snapback in October or at least the first week in November?

Josh Levine

Jayson, no, we're not going tocomment on the current quarter. I mean we've been pretty consistent about that.The comments that we are going to make are specific to Q2, which was thefinancial release.

Jayson Bedford - Raymond James

Okay. I guess maybe for Loren.Loren, is there any way you can kind of quantify the impact of Perouse? I guesswe're assuming: it's lower than corporate gross margin average, but is thereanyway you can? If you were to parse out Perouse, what would have been grossmargins?

Loren McFarland

Well, the Perouse gross margin,you have to remember Perouse operates entirely in our international channel andprimarily through distributors. So, that has an impact on the gross margin. Itdoesn't mean it's not good gross margin. And as a [comfort], we also have lowerSG&A and so, the key is to get as much as possible to the operating line.

And so, you have to kind ofremember that gross margin isn't the entire story when it comes to that. Well,we talked about the different channels, but there's also a negative influenceon the non-cash amortization impact of Perouse and it's actually somewhat ofthe Genzyme agreement as well.

The Perouse numbers are, I think,$300,000 a quarter. And so, that's about 30 basis points at our current runrate. And then the Genzyme one adds about another $400,000, $450,000 a quarterand so the combination of that non-cash amortization gets you in the 80, 90basis point range of our total business.

And so, that's probably the mostcolor I can give on that. The $2.4 million number has a pretty big impact aswell, of course, because it's going through cost of goods sold. But that's kindof a non-cash item. I'd have you think about that as a one off.

Jayson Bedford - Raymond James

And the Genzyme impact has beenthere for a few quarters, though?

Loren McFarland

It has.

Jayson Bedford - Raymond James

Okay. The inventory build in thequarter, is that just Perouse?

Loren McFarland

Primarily, yeah, it is thePerouse. I forget the exact number that it was. I think Perouse we acquired $9million and so, our inventory would have been $37.5 million, thereabouts, andso that's almost flat with the June quarter.

Jayson Bedford - Raymond James

Okay. And then lastly, I guess,for Josh. Josh, in terms of timing of a new CFO: what are your thoughts there?

Josh Levine

In the release, we put out wesaid we're kind of in final stages of the decision making, and again, I referback to that. I'd say: “we're rounding third, heading towards home”. I don'texpect this to be a very long transition window. So, again, pretty soon.

Jayson Bedford - Raymond James

Fair enough. Thanks, guys.

Operator

Thank you. We'll go to our nextquestion of from Gary Nachman of Leerink Swann. Go ahead, please.

Roy - Leerink Swann

Hi. This is Royin for Gary. On the CPG study, thatyou had to submit additional data: do you have a timeline of when the FDA isgoing to get back to you? Or: when they might approve it? Or: if they're goingto go panel? Or: anything like that?

Josh Levine

No. It's an interesting question,Roy. We really have not receivedany indication from the agency vis-à-vis their intentions on a panel poll forthis or a turnaround time on the additional data we're providing.

I get the sense, and again, I'velearned the hard way, over a long period of time, to not try to predict whatthe FDA will, or won't, do, especially around breast implant PMAs. But I getthe sense that there's really not a lot of urgency on their part, or strongdesire, to see this go to panel. So, I mean, you might look at that and say: “well,that's a positive”.

Again, that's just conjecture onmy part. I don't have anything that confirms that, or refutes it, but I thinkthat the general topic of breast implant PMAs in the world that the agency isliving in right now, at CDRH is, I can't imagine that that's high on their hitlist in terms of desires is to see a panel called for it. And again I don'thave any indication in terms of turnaround time.

Roy - Leerink Swann

Okay. And in your preparedremarks, I may have missed this, but did you say that you won't be presentingpeer tax Phase II data for competitive reasons?

Josh Levine

Well, there are certain elementsthat we won't be presenting. I mean I think we've been much more expansive onthe protocol specifics, the protocol design, but if you're asking specificallyabout dosing specifics, I think our view is that we probably would rather notget public with dosing specifics.

Roy - Leerink Swann

Okay. And then my last questionis with Anika and Galderma: they recently announced that they're going to beterminating their agreement for Elevess, and how does that maybe change, oraffect, your plan for launchings the Puragen Plus, Prevelle Plus?

Josh Levine

It doesn't.

Roy - Leerink Swann

It doesn't. Okay. Thank you.

Operator

Thank you. We'll go ahead andtake our last question from the line of Peter Bye of Jefferies & Company.Go ahead, please.

Peter Bye - Jefferies & Company

A couple of questions, I guess,Josh, first: why are you so defensive on the quarter and then still reaffirmingguidance? Our numbers is the breast implant (inaudible) just your numbers in(inaudible) grew 21% in Q1, 22% in calendar Q2 and 25% in calendar Q3. So, toassume it's actually accelerating. Can you just explain the dichotomy betweenthe two? You beat the numbers on the top line of consensus, you reaffirmed it:why the pessimism?

Josh Levine

I think, well let me fully backup, first of all, if I communicated that I'm defensive on our quarterlyresults, clearly that isn't the message I want to send. I mean: I'm prettyproud and pleased with what we did in the quarter and I recognize that we didbeat the Street in term of the top line number by almost $1 million.

I think that when I look again atsome of the data, and some of the trend that we started to get visibility on towardsthe latter part of Q2, I think you have to ask: is there a continuing trendthere going forward into Q3 and later in the year?

Again, every time I look, thebackdrop from an economic standpoint doesn't look like it's getting better andI just think that it's prudent to recognize that if there is a broader meltdown, if you want to call it that in terms of the economy, the likelihood thatwe're going to be able to avoid that or side-step it with our products and ourprocedure, I think the answer is, we would probably be affected to some degreeby that.

Peter Bye - Jefferies & Company

Then: why would you reaffirmguidance on that front, just take down the top end?

Josh Levine

This is kind of “pick your poison”,right? If I take down guidance, I'm going to get a bad report card on that, ifI…

Peter Bye - Jefferies & Company

Well, put it this way: the trendsyou're seeing now, is top kind of guidance still realistic?

Josh Levine

Yes. I think it is.

Peter Bye - Jefferies & Company

That's fair enough, thanks. Andthen on Prevelle Plus and Puragen Plus: if you look at '09, and I know Josh andLoren, you've not given any guidance, but the market for dermal fillers in '07certainly exceeded most people's expectations.

Our numbers show it grew 38% in thefirst half of '06, '07 and then it looks like it's actually growing north of40% in Q3 '07. So, when you look at those launch numbers, you're getting verylittle credit for that, I think and your numbers in '09 in consensus. What's arealistic share? If you just look it that way? What's the share of the market?You launch out there from a competitive standpoint, who the injectors are, isit 2%, 5%, 50%, 20%, I mean, can you give us any range?

Josh Levine

Peter, I don't think I'm going togive you any specifics in that regard. I think a way to be thinking about theshare is this: I think the share discussion is a hybrid discussion. I thinkthere's a share discussion in the plastics channel and then I think there's ashare discussion in the cosmetic derm channel.

I think from a plastics channelstandpoint, where we have our strongest relationships, a fair amount ofrelationship equity, if we want to call it that, the access to the physicianfrom a surgical aesthetic franchise standpoint. I think, we're going to get alot of support in the plastic surgery channel, with our products, our facialproducts.

Peter Bye - Jefferies & Company

Well, I understood, sorry aboutthat, I understand that, Josh, I understand where you're going, everyone'sconscious about what not loading up the expenses on flowing out a dermfranchise and derms are bigger injectors than plastics. But obviously thatbleeds in, you know, how many plastic injectors are and they're growing alittle bit faster than derms, because they're coming from behind the curve alittle bit. Give, is it 2 or is it 20, or somewhere in between?

Josh Levine

I think, again, I'm not going togive you an exact number. I think that the product lineup that we believe we'regoing to have, the portfolio of product we're going to have to compete with, isgoing to fair pretty well.

Again, I think that we'rerealistic in our view about the people that are currently, the primarycompetitors in the market, I think it would be unrealistic to try and getanyone to believe that we're going to supplant a Metafist or an Allergan in thechannel that they have their best strength in, but I think that we willsurprise some people with our products and the degree of support we get and theoutcome in our core business channel.

And I think, we've got a numberof things from a strategy standpoint, that will prove to be the best way for usto go to market in cosmetic derm in a way that doesn't completely dilute ourP&L, and I think that's something that we need to be cautious of because Ithink that, to say that we're going to go out and do, add a dedicated group ordedicated sales force of the size and magnitude or headcount that ourcompetitors have to call specifically on cosmetic derm would be a difficultsituation for our income statement in the near term.

Peter Bye - Jefferies & Company

Sorry again, it is the last one.And on the plastics, our look there was it was really poorly attended so sortof saying what the data comes back on that whether it was location or guysdoing procedures or not doing procedures, they want to come or lack of productflow, and you're saying sort of reaffirming guidance but also showing somehesitancy, we all appreciate the candor, but again, just trying to reconcilethe two, can you just give us one synopsis for that?

Josh Levine

Let me be clear, if there wassomething to restate in terms of guidance, I'd restate it. So, the guidancethat we have, and that Loren reaffirmed, is the guidance.

Loren McFarland

Peter, this is Loren. When yousubtract Perouse from our guidance, just under the run rates that we've beentalking about today, it gives you a range of growth in the second half of 15%at low end and 25% in the high end. So, I think that's a range that's veryachievable.

Peter Bye - Jefferies & Company

I know but, Josh, I guess whatpeople are trying to estimate is when you see slow down, is it mid, frommid-to-high or whatever how you're going to say it, you guys saymid-to-negative or is it sort of mid to like low double-digits?

Josh Levine

You've got business that in Q2 weprojected was growing in the low-to-mid single-digits in terms of proceduresunit volume, and that was for the entire quarter. Again, in the last part ofthat quarter, we saw some at the beginnings of some slow downs. This is notsomething that we're going to be able to project for on a long-term horizon.

If you're asking for what theimpact is three months out, six months out, nine months out, we're going tohave to see. I think that we gave up some share during the quarterdomestically. We know where we lost the share. We know why we lost the share,and we're going to take these appropriate actions, and I think you'll see theappropriate competitor’s response from us going forward.

Peter Bye - Jefferies & Company

I appreciate that. And again,Josh, your candor is unprecedented. I appreciate it. Thanks.

Josh Levine

No problem.

Operator

Thank you. This does conclude ourQ&A session. I'd like to turn it back over to Josh Levine, President andChief Executive Officer, of Mentor Corporation.

Josh Levine

Thank you, operator. Before Iconclude the call, I just want to take a minute and personally acknowledgeLoren McFarland's 22 years of service to the company. Thank him for his manycontributions to Mentor over thatperiod of time. We'd always want the best for Loren in his future endeavors.And with that I guess I'd like to thank everyone for participating in today'scall. We look forward to speaking with you when we report third quarterresults. Thanks very much. Bye, bye.

Operator

Thank you. This does conclude ourconference call for today. We appreciate everyone's participation, and you maynow disconnect.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Mentor F2Q07 (Qtr End 9/30/07) Earnings Call Transcript

Check out Seeking Alpha’s new Earnings Center »

This Transcript
All Transcripts