Angela Steinway - Head, Investor Relations Peter Arduini - President and CEO Jack Henneman - Chief Financial Officer.

Daniel Zulauf - Barclays Matt Miksic - Piper Jaffray Jon Demchick - Morgan Stanley Chris Pasquale - J.P. Morgan Craig Bijou - Wells Fargo Bob Hopkins - Bank of America Mike Rich - Raymond James Dale Dutile - The Boston Company Imron Zafar - Jefferies Rosemary Liu - Oppenheimer & Company.

Please standby. Good day, everyone. And welcome to the Integra LifeSciences First 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 Ms. Angela Steinway, Head of Investor Relations. Please go ahead..

Good morning. And thank you for joining us for the Integra LifeSciences first quarter 2014 earnings results conference call. Joining me today are Peter Arduini, President and Chief Executive Officer; and Jack Henneman, Chief Financial Officer.

Earlier this morning we issued a press release announcing our financial results for the first quarter 2014 and updating 2014 guidance. Certain statements made during this call are forward-looking and actual results may differ materially from those projected in any forward-looking statement.

Additional information concerning factors that could cause actual results to differ is contained in our periodic reports filed with the SEC. The forward-looking statements are made only as of the date hereof and the company undertakes no obligation to update or revise the forward-looking statements.

Certain non-GAAP financial measures are disclosed in this presentation. A reconciliation of these non-GAAP financial measures is available on the Investors section of our website at integralife.com. We will reference the financial results in the press release and will not restate the individual numbers.

As a result you may want to keep a copy of the release handy during the call. I will now turn the call over to Pete..

Thank you, Angela, and good morning, everyone. We are off to a solid start in 2014. In the first quarter our revenue came in at the top end of the range we provided in February. While DuraSeal sales contributed about 7 points of consolidated growth during the quarter, our Global Neurosurgery business increased over 11% on organic basis.

Worldwide skin and wound revenues also increased 10% over the prior year. Our business in Asia-Pacific was up 17%, increasing 9% on an organic basis. Although the year ago period includes the effect of the recall in collagen supply issues, we’re pleased with our first quarter revenue performance particularly in the Neurosurgery business.

Finally, our profit margins increase significantly versus the prior year. Driven up by increased revenue, improve product mix and lower year-over-year quality expenses. This is important year for us to move forward on our key initiatives, which are positioning -- which are progressing as planned.

To highlight a few of these, this marks our first quarter after closing the DuraSeal acquisition in January and the integration process is moving along as we expected. The DuraSeal product line is a great strategic fit for our Neurosurgery division and will add to our growth and profitability in 2014.

Yesterday, we began a cutover processed in our ERP system go-live and we will be turning on the new system this month.

This brings the majority of our revenue into a single ERP system for order to cash processes We’ve commenced the production transfers out of two facilities we announced we would close last fall and are on track to be done by the end of this year. We expect to have a productive 2014 and I’ll share more about that later on the call.

Turning to topline results for the first quarter, U.S. Neurosurgery had an all around great performance. U.S. neuro increased about 13% on an organic basis. Sales of products outside Dura repair increased 6% and total reported segment revenues increased 39% over the first quarter of 2013.

DuraSeal and DuraGen were both strong contributors, and neural critical care and tissue ablation drove the remainder of the segment growth, each increasing double digits. New critical care monitors launched in the fourth quarter are driving the growth in critical care and strong capital sales led the increase within tissue ablation. Our U.S.

Extremities business grew 6%, taking into account the previously discussed transfer of approximately $1.4 million of revenue to our U.S. Instruments and US Spine businesses. Sales of skin and wound and the success in the new launch of our shoulder product lines drove the segment growth.

Other extremities hardware procedures were slower due to a strong comparison of prior year and some weather-related impact in certain markets. We expect our U.S. Extremities growth to accelerate next quarter and are on track to the full year guidance range we provided. U.S. Spine and Other decreased 6% as reported.

Private label decreased 10% to $12.9 million. Private label performance has been negatively affected by a long-term decline in sales in one of our larger partners and the affect of product line discontinuations. Our U.S. Spine business declined 7%.

The decline was entirely within the hardware business, while orthobiologics revenues grew mid single digits. Although, a tough market exists in Spine, we see our outlook improving in Spine Hardware as we’ve added new distributors and recently launched new products. We expect our Spine Hardware sales to grow year-over-year for the remainder of 2014.

U.S. Instruments revenue decreased about 3% over comparable product sales or 1% as reported, with a product line transferred in this quarter from U.S. Extremities. Discontinued products and lower sales in retractors pushed reported topline growth lower, alternate site, acute care sales and lighting each increased slightly.

Revenue in our International segment increased 11% over prior year, 3% excluding the impact of the DuraSeal acquisition. The growth in Europe was about 7% and growth in the rest of the world was roughly twice that, both on a reported and adjusted basis. DuraGen made a strong international recovery and skin and wound increased nicely in both regions.

This modest increase is in-line with our current expectations and we believe the plan changes within our distribution channels and new product introductions will accelerate growth as we move through 2014. Now, I’ll turn the call over to Jack to discuss the financial results in more detail and review our 2014 guidance.

Jack?.

Thank you, Pete. We met both our top and bottom line expectations for the first quarter, even taking into account our higher tax rate and the change in medical device excise tax accounting. We were reporting three changes that adversely affect our financial results and therefore our guidance, but not our substantive business.

The first change is in our accounting for the medical device excise tax. As we note in the press release and reconcile a supplemental financial information on our website, we now recognize the expense, the excise tax in SG&A when tax is paid versus in COGS, when the product is sold to the ultimate customer.

We are making this change to make our substantive improvement in gross profit margin more visible to investors, to more closely align our cash flow and earnings and to bring our accounting in-line with the majority of the industry.

The effect of this change is to increase reported expense, the excise tax for 2013, which we have revised to reflect the change and to reduce our earnings forecast for 2014 by approximately $0.05.

The second change reflects the recently completed purchase price accounting for the DuraSeal acquisition, which resulted in less goodwill and more amortizable and tangibles than initial estimates.

Accordingly, we have increased our forecast of intangible asset amortization expense for 2014 from $22.5 million to $30 million, which will adversely affect GAAP but not adjusted operating income. The third change in our adjusted tax rate arises from the perspective resolution of certain state and foreign tax audits and the U.S.

corporate tax consequences of the 2013 medical device excise tax expense. We are not revising our guidance around the performance of our actual business, which supports our revenue and adjusted EPS guidance otherwise. Now I will walk through the P&L providing both first quarter results and expectations for 2014.

In the first quarter, GAAP gross margin increased 2 points versus the prior year period to 61.7%. Greater revenue of high-margin products drove most of the improvement, higher amortization expense related to the DuraSeal acquisition offset lower cost from remediation and recall-related expense versus the prior year.

We calculated adjusted gross margin by backing out of the adjustments to cost of goods sold detailed in Column A of the adjustments table in our press release. During the first quarter, our adjusted gross margin of 65.1% was 2.5 points higher than the comparable measure in the first quarter of 2013.

As with the GAAP result, the greater revenue of high margin products drove the majority of the improvements. For 2014, we expect GAAP gross margin to be between 61% and 62%. We expect adjusted gross margin to be between 65% and 66%.

This is 1 point higher than our original guidance because we move the expense related to the medical device excise tax to SG&A. In the first quarter, R&D expenses were flat versus the prior year and were about 6% of sales. We expect full year R&D spending in 2014 to increase with revenue remaining around 6% of sales.

GAAP SG&A during the first quarter declined as a percent of revenue by 2 points versus a year ago, while it increased in dollars. The deal fees related to closing the acquisition of DuraSeal drove the increase. In addition, selling expense increased in U.S. Neurosurgery and U.S. Extremities to reflect a launch of DuraSeal and our shoulder respectively.

SG&A adjusted for special charges as detailed in our press release was 45.1% of revenue, down nearly 3 points from the first quarter last year. For full year 2014, we expect reported SG&A to be 46% to 48% of revenue and after adjustments to be 42% to 44% of revenue.

In the first quarter, our adjusted EBITDA margin was 17.2%, about 6 points above the prior year period. For 2014, we suggest modeling approximately $36.5 million in depreciation expense and approximately $30 million in intangible asset amortization, $18.5 million of which will be reported in COGS.

Cash interest expense net of interest income was $3.3 million in the quarter. We expect a total of about $13.5 million of cash interest expense and about $20.5 million of total interest expense in 2014. During the first quarter, we recorded about $300,000 of other income, we recommend modeling this line item at zero going forward.

We ended the first quarter with an effective tax rate of 44.5% for the quarter. For 2014, we expect our reported tax rate to be 23% to 24%. Our adjusted tax rate was 31.9% in the quarter. We expect our adjusted tax rate to be between 31% and 32% in 2014 for the reasons I discussed earlier.

We generated $11 million of cash from operations during the first quarter and invested the same amount in capital expenditures in the quarter as planned. As I noted before, the excise tax and amortization in tax rate changes are non-operating in nature.

As such, there is no revision to total operative cash flow from our 2013 results and our expectations for operating cash flow in 2014 remain unchanged.

While we expect our operating cash flow results to be both lower in the first half of the year and somewhat volatile from one quarter to the next, we expect our operating cash flow for the year to be between $60 million and $80 million.

As with our cash flow, we expect our quarterly progression of earnings to increase steeply during the year, a steep revenue progression driven in part by new product launches ramping up through the year and the DuraSeal integration activities should push profitability higher in the second half.

Looking at the current analyst estimates, our forecast calls for a steeper progression in both top and bottom line and the consensus reflects. Turning now to our 2014 full year revenue guidance. We are reiterating our segment growth rate expectation.

Remember that these segment growth rates are based in the segment revenue as reported for 2013 without adjusting for product transfers. As an aside, note that we expect to file a Form 8-K in the next month or so, that contains the revision of our 2013 financial results the change in medical device excise tax accounting.

At that time, we will also revise our revenue segments for 2012 and 2013 to reflect this product transfers, so that you have apples-to-apples comparisons for the whole year. Our segment growth guidance ranges are as follows. We continue to expect U.S. Neurosurgery revenue to be up between 30% and 35%, U.S.

Instruments revenue to be up low single digits, U.S. Extremities revenue to increase high single digits to low-teens, U.S. Spine and Other revenue to decrease low to mid-single digits and International revenue to increase low double digits to mid-teens.

Finally, we expect our consolidated revenue growth rate, excluding acquisitions and discontinued products to be 4% to 6% for 2014. Before I turn the call over to Pete, I’d like to take a moment to speak about my plans to retire next year.

Tomorrow, I will resume the title of Chief Administrative Officer and as such, I will retain all the responsibilities that I have today. But will begin transitioning the financial organization to our new Chief Financial Officer, Glenn Coleman.

Glenn is currently the Corporate Controller at Curtiss-Wright Corporation, a $2.5 billion global company that delivers highly engineered, critical function products and services to the commercial, industrial, defense and energy markets.

Glenn’s broad experience is in complex and highly regulated industries, and with a restructuring programs in multiple M&A transactions make him ideally suited to be a strategic partner to Pete and lead Integra forward. With that, I’ll hand the call over to Pete..

Thank you, Jack. I’m also excited to welcome Glenn to our leadership team and I think he will be a great asset to Integra. He brings diversified financial leadership experience from major multinational companies, which will be important to us as we enter our next phase of growth and I look forward to continually working with Jack over the next year.

Now Jack’s career at Integra has spanned more than 15 years, a period in which the company has increased its revenues almost 60 fold. He has also been a valuable strategic partner for me in my first two years as CEO and I know continue to work hard to ensure a smooth transition of CFO.

I’m also delighted to announce that Mark Augusti is joining Integra to take on the role of President of Orthopedics and Tissue Technologies. With over 25 years in medical technology management and strategic decision making at leading international organizations, Mark brings unique expertise and strengthens our leadership bench.

For those of you joining us in New York next week, you’ll be able to meet both Glenn and Mark in person, as well as the rest of the leadership team. As noted previously, we rounded out our shoulder portfolio towards the end of 2013 with the launch of the reverse shoulder system and the proximal humeral plating system.

We had over 20 new user implants of our shoulder in the first quarter and we added a couple of key distributors that previously sold shoulders to the competition. Some of our competitors have begun trying to convert their distributors to direct sales because not all distributors are interested in becoming part of a direct sales team.

This opens up an opportunity for us to recruit talented, experienced distribution. At the moment, we are in discussions with several key distributors across the United States that are interested in our current shoulder technology and the future of developing PyroCarbon-based shoulder solutions.

We’ve continued to invest in the development of advanced glenoid solutions and PyroCarbon technologies that will differentiate our shoulder portfolio from that of our competitors. Additionally, we continue to develop our team of key opinion leaders and leverage their expertise to build out our surgeon education program.

Our optimism remains high that we will win a meaningful share of the shoulder market. We also completed the DuraSeal acquisition in January and the integration into our US neuro and international teams has been a major focus in the first quarter of 2014.

Our commercial efforts have been successful in delivering DuraSeal product and service support to global customers and we will continue to optimize our commercial model going forward. We’ve continued to execute on our global registration strategy.

The transition process with Covidien continues to be a very cooperative one and we look forward to finalizing our commercial and supply chain integration within the next few months. Throughout our businesses, we continue to develop and launch new products.

We are excited to showcase some of these and talk more about our pipeline plans next week at the investor day meeting. As I mentioned earlier in my comments, the Burlington and Andover moves are progressing well. These are on schedule to be completed by the end of 2014.

And yesterday, we began the data conversion on our new ERP system, which we will turn on later this month across the U.S. commercial operations. These are significant projects that are critical to our optimization plans and simplifying our structure, which we will discuss in more detail at next week’s meeting.

We hope you can join us for our investor day meeting next week on May 6 either in person, in New York City, or via webcast. At that time, we plan to provide you with more details on our progress against our optimization plans and these growth initiatives.

We’ll also be in a position to update our five-year outlook and outline clear goals to help us achieve these objectives in the near and medium term. Please contact Angela for more event details if you don’t have them already.

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

(Operator Instructions) And we will take our first question from Daniel Zulauf with Barclays..

Hey, guys, good morning. Thanks for taking the question. Just going back to last quarter, you mentioned the year finished a bit softer than you expected and that you contemplated that in the guidance.

So I just want to get your read on what you have seen in 1Q and how that’s changed versus your expectation?.

Yes, Dan, I would say from a standpoint of how we thought about the transition and when we laid out guidance, pretty close to as we expected.

Our view is and for a couple reasons, one from a market standpoint that most of the markets that we’re competing in aren’t doing badly but they clearly were not seeing major surges in inpatient or outpatient volume. So I think our estimations how we saw things seem to be pretty accurate.

Our loading of just products and distribution ramp up either new distribution, extremities, new products in spine, new products in neuro, new products in extremities as well, more of those are coming to let’s say full market capacity in the second half of the year, so which tends to move some of that.

I would say the only surprise so to speak for the first quarter was that the weather in select businesses clearly had more affect than we probably had seen even at the time back in February, meaning that cases were delayed in certain markets.

Obviously, other markets around the United States weren’t affected as much but we had certain markets in the Midwest and the Northeast that were a little more sluggish.

I don’t know, Jack, if you’d want to add anything else?.

I think that pretty much covers it. We hit our expectations on a consolidated basis, I’d say some of the procedural oriented businesses were a little bit slower than our plan and some of the flow-based business were probably ahead of our plan a little bit. So all-in-all, a good result..

Thanks. It’s very helpful. And just one quick follow-up on DuraSeal. So, I mean, the performance in the quarter was that there was a little bit stronger than we were expecting. So just kind of commenting versus I guess your expectations in the guidance you set.

I know was for the full year but was there anything about DuraSeal that was particularly strong in the quarter versus what you were thinking?.

I would say I think the important part of it is that we believe we got out of the blocks well if you would. And the integration, again the handoff with Covidien, the work with the distribution teams and our direct teams has worked quite well. I would say we haven’t viewed a change or need to change any type of guidance for the rest of the year.

Just based on how we see the year taking place, there is the potential for a competitor coming into market. We factored that already into our guidance but we are very pleased with the strength of the product line.

I think the other part that I would add with DuraSeal is the fact that the synergies with DuraGen at the call point, meaning having both products that really have minimal overlap, they are fundamentally discreet in their use but actually having a rep that can be a consultant to advise on either product use, we believe that theory is playing out well and again are very happy with the results so far..

Thanks so much, guys. And Jack, congratulations and welcome aboard to Glenn as well. Thanks so much, guys..

Thanks..

And we will take our next question from Matt Miksic from Piper Jaffray..

Good morning..

Hey, good morning Pete, good morning Jack. Thanks for taking my questions. I wanted to follow up on your comment. I think it was Pete about the spine business and the opportunity to kind of improve the hardware trends there for the remainder of the year. And I know you had some new products in NASS. You mentioned new distributors.

Maybe if you could expand on what gives you the confidence that things will begin in and you said the second quarter, or is this more of a back half affect? And any color you would be willing to share would be helpful?.

Sure, Matt. I’ll comment and then Jack has been quite involved too with some of our spine work. I will have him add a few comments.

But I think look as I mentioned last year, between system issues and let’s just categorize them as internal challenges as we did some transitioning work, we hampered our ability to add distribution as fast as we would have liked and we didn’t get as many products up as we would have liked. That is fundamentally behind us.

In Q1, we actually had some I think good efforts in progress on that direction. We’ve been able to add a reasonably significant amount of new distribution into the portfolio. We’ve actually, as you said at NASS, brought out a new set of inter-body devices.

First, the NanoMetalene, we’ve got a product that’s yet waiting FDA approval but we believe is going to be happening quite soon, which is also an inter-body category. We’ve got now a really full robust [fully] (ph) across titanium, as well as stainless, all the different types of adaptation thereof.

So we’re actually awaiting a strong scoliosis season, which you know starts here really in the next month or so.

So when you add those together and you view that our operations are stable, our supply chain is stable, we’re adding new distribution and we’re topping that off with some new products, even with the price pressure that’s in the market, we expect that we will start being able to show some positive growth in Q2 and through the rest of the year.

So, that’s really how we kind of look at it, Jack.

What did I miss there?.

I think you got it. I think that through 2012, our spine business was executing well and adding distribution robustly and as I think we talked about numerous times. Mainly for reasons that went beyond the spine group, we have made some operational footfalls and we’ve got that fixed.

So we’re actually pretty optimistic about it right now and are hoping for a real turn there..

Okay. That’s very helpful. And then just to maybe drill down a little bit on the shoulder. You talked about this a number of times, not a huge product but an important product.

I would love to understand maybe how you are coming at that market, if you could share a little bit about that? There are some folks that seem to have a strength in the academic center more so than the community and then others are kind of vice versa.

Given the distribution you have or maybe the distributors you’ve been able to pickup, if you could talk a little bit about what your strategy is there for rolling it out, that would be helpful?.

Yes, Matt, good question. So look our shoulder just to remind everyone, we go to direct obviously in our lower extremity and our upper x-shoulder. The shoulder, we actually take through a distribution model and we purposely did that to allow us to have a much more focused channel.

I would say that channel coverage is primarily on broad community and larger metropolitan centers, as we start our rollout as you typically would.

But one of the key things through part of our strategy and we believe with a lot of good products are out on the market, that first you need to have some interesting products that add some differentiated features and then you need to show that you’re not just a one trick pony, if you will, that you’ve got a pipeline of interesting products, which then does bring in more academics.

And so as our first step, we believe because we have this modular system and we will talk more about this and actually do a little bit of show and tell next week at our Investor Day.

The modularity of our full shoulder and a reverse shoulder, the interplay of some of those components, as well as the instrumentation, we believe allows a user to actually get up to speed faster and actually have greater confidence, limited uncertainty if you will, which is part of our main strategy as the company and (indiscernible) part of the design criteria as we build out to set.

So that’s one aspect. The other aspect is about our pipeline.

And with the PyroCarbon technology we have, that really has the opportunity of having, let’s say, lower friction than other types of metal or other types of materials for implants, we believe it could be quite revolutionary in the shoulder, particularly when you talk about its effects on the glenoid.

So we will be actually having brought, we will be bringing more I’d say academics into our fold as we get involved with our development processes there in that pipeline and we already have quite a bit of interest. But if you back away from that, our core focus is about getting solid distribution with strong users right now that like the product.

They are primarily in metro areas and I think you’re going to see later this year as we ramp up that will expand more as again we expand our development plans in the pipeline itself. But at this point, I couldn’t be more pleased. I think we’re out of the blocks very well and very happy with the results that we have with the shoulder at this point..

Great. Thanks very much..

Thanks..

Moving on we will hear from David Lewis with Morgan Stanley..

Good morning, David..

Good morning. It’s actually Jon Demchick in for David..

Hey, Jon, good to see you, hear you..

I wanted to discuss the optimization initiatives for a second. I think that is probably going to be a larger part of the discussion for the Analyst Day next week.

But I noticed that the international product registrations, the amount of company running on, common systems and also the number of facilities look like they didn’t progress as much this quarter as they have in prior quarters. And I was just wondering if there was an update on the optimization that maybe as you going to pick up a little more later..

Well, I think, Jon, as you know, some of these things are, they are not quite glacial but they are big items, right, that they’ll move every quarter. So we actually feel we’re making some really good progress. And John Mooradian, who is the Head of Operations, will actually give a pretty detailed overview of that progress.

I think some of the big things though in the quarter they’re going to move to switch quite a bit as this implementation of our ERP, putting roughly 75% of our revenue through a new order to cash integrated system. It’s a big deal for us and we’re really -- in this next 30 days, we’re in the midst of turning that on.

And so that’s been multiple years in the making. So that’s great progress, an obviously post-implementation that will have a big impact on the numbers. Just to remind you on the plans, at this point time, we’ve already -- we’re in the process of actually six facilities that were in the midst of either, completely closed or transferred.

Two of the larger ones I’ve mentioned, Andover and Burlington and Jon will give more of a detail next week but we’ve already commenced movement or either closed on four other facilities to-date. So those things are all moving along well and our sourcing initiative as well, you’ll hear an update on.

And that’s a critical one, probably one of the bigger enablers on top of mix of actually driving the gross margin. So plans intact and we feel quite good about the progress to-date. Jack, I don’t know if you want to add anything else on the optimization..

I think Pete is right. I invite everybody to pay close attention to our presentation on Tuesday, where I believe the detail will be both rich and exciting..

Thank you. Very helpful. I just had a quick clarification question for the tax, for the medical device tax adjustment from COGS to SG&A..

Sure..

I was just wondering on an absolute basis. We probably have the medical device tax being modeled as $2 million to $2.5 million quarterly. And I was wondering how this adjustment changed that number..

Well, this year, the change is going to lower our consolidated EPS by $0.05 for the entire year. So in effect, that means, that’s a forecast of course but that’s the -- essentially the consequence of the change.

And the reason is, is that it’s still the case -- under the old method we were putting the tax in the inventory as essentially we built the inventory. And now we’re expensed -- and then it wouldn’t be expensed until we sold inventory, so there would be a little bit of lag there. Now we’re expensing it right away.

And so that has the effect of accelerating the tax. Of course, as the years go by, even under the old method, the expense that would run though inventory and the current expense would tend to converge very closely. So this change in effect, reverses a temporary benefit that we got last year.

And I think the benefit is much greater transparency, especially on the gross margin line. We’re obviously, we’re putting a lot of our efforts in the optimization plan. So we want people to see the consequences of those efforts..

Thank you. Very helpful..

Our next question comes from Chris Pasquale with J.P. Morgan..

Good morning Chris..

Thanks. Good morning. I want to circle back on the DuraSeal number.

Was there any one-time stocking this quarter as you rolled that product out to your customers? And has your thinking changed at all on the potential full year contribution from the acquisition?.

Chris, no. And it’s really not a product that is stocked, if you will. I mean, there’s product that’s carried for the most part on shelf stock. But there’s really no type of -- it’s not really carried that away.

So no, nothing is fundamentally changed from our view from that standpoint within the overall model other than what we had mentioned on the call from some basic accounting items. Jack, you may want to elaborate..

Yes. So a couple of things, actually, in Q4 Covidien had quite a strong quarter. So I think that right before they sold it to us, they had a strong quarter. If anything, this is evidence that the product has a little bit of inherent strength to it which we’re very pleased about.

We’re being -- we’re sticking with our original 12-month guidance on the numbers. Friendly reminder that was $57 million to $62 million for the first 12 months we own it, which is a little less than a full year during 2014.

And the reason why we’re sticking with that, is we do expect an incremental competitor to come in this year yet with a similar product. Now one further thing I should add, call your attention to the proponent in the script where we talked about a steeper ramp to our earnings progression this year.

We are putting more into selling expense around this than we originally planned to do in the first half of the year. And that’s to ensure success in integrating the top line revenues into our business. That incremental selling expense will tend to come off as the year goes by, which will improve our total profitability.

But that extra effort has, I think, really locked down the top line in a way we feel very happy about. These integrations can go badly and I think we feel really good about how this one’s going so far and its kudos to the management in that division..

Okay. That’s helpful. And then just real quickly, any sense what’s allowed the orthobiologic segment to decouple from spine hardware over the last few quarters and continue to do well while hardware has struggled.

Just trying to get a sense of how sustainable the biologic’s performance could be and whether an improvement in hardware should necessarily flow through to biologic’s or if they’re really being driven by different factors at this point?.

So I’ll give you my thoughts on that and then Pete may elaborate. Our orthobiologics product line is compared to our spine hardware line, it’s a stronger line with much higher market share. So I think everybody here knows that we are a miniscule market share in hardware but we are a meaningful player in orthobiologics.

And indeed, a lot of our orthobiologic are sold through distributors that don’t sell our spine hardware. We wish they did but they don’t. They sell the spine hardware of other bigger players.

So that’s actually -- since those other bigger players also have orthobiologics, the fact that those distributors carry ours rather than theirs is a testament to the strength of our orthobiologics product line. So they have not been coupled really at any point in the last two, three years in a deep way. I hope that’s helpful..

So with that then, Chris, the fact that we’ve actually had windows time here, when we’ve had high-teens growth as we added distribution faster within the orthobiologics area. We tend to actually have a more broader consistent growth that’s probably more consistent with the market in general for spine within orthobiologics.

So that’s good, bad obviously, as the market picks up with a broader reach that Jack talked to. We typically benefit from that. On the other side for our spine hardware standpoint, we don’t have that same reach. But as I mentioned earlier with Matt’s question, as we actually get some of these things behind us.

We actually think we do have more room to accelerate in spine hardware because of the smaller share position. And candidly, some of the things that we’ve had that handicapped the business last year. So that kinds of give you both dimensions there but orthobiologics is a strong franchise.

Our mosaic line which is our synthetic line combined with collagen and our Evo3 line which is really advanced DBM. A lot of the products get categorized together as all the same. You know we’ve got some good clinical evidence and some really nice differentiation to show that those products actually make a significant difference in heal time.

And with that, we tend to actually pick up more share than others within that marketplace..

Great. That’s helpful. Thanks, guys..

And our next question comes from Larry Biegelsen with Wells Fargo..

Good morning, Larry..

Good morning, guys. It’s actually Craig on for Larry.

Hi, Craig.

Hi. Just a question on DFU.

I wanted to see if you guys had made any headway either with CMS or private payers in terms of the reimbursement and where you guys are going to fall in the bucket?.

So Craig, I would just say this. We’ll talk more about it next Tuesday. I will give you a lot more details next Tuesday. Phil Weber, actually, who kind of owns that whole piece, will walk through it. So I won’t go in a lot of detail here, other than to say that we’re making very good progress.

The key component here again is when we actually get our data, which we still believe we’re on track to here by this summer. We’ve actually had different discussions with CMS and with FDA on different strategy points.

And we actually feel confident that although it’s not a single path to get to where we need to get to, there’s multiple paths that can enable us to achieve what we need to do with reimbursement. And that’s just -- that’s relative to the CMS reimbursement that you’re referring to.

But the other part that we’re quite focused on is as well with private payers and a lot of that is going to come down to the quality of our data and what that represents. And we’ll talk again as I’ve mentioned. We’ll talk a little bit more in detail what that means.

We believe that this has the opportunity for us to really become more of a meaningful player in the broader wound burn area. So as you probably know, we have a major position in inpatient in burns, there is a little bit of inpatient work obviously within the wound care. And this is our opportunity to move into the outpatient area.

And we believe that our technology beyond just DFU is very applicable. So we’re very focused on making sure that we get the right entree in and then we also have follow-on plans with that. So -- but it will be one of the main items that we will discuss in more detail next Tuesday..

Great. Thanks. And then as my follow-up, I wanted to ask on the accounting change and the EPS impact. There was a negative $0.07 impact in Q1. For the full year, it’s going to be $0.05. So obviously for the rest of year there is a $0.02 benefit.

And I just wanted to see to the extent that you’ll share, do you expect a benefit in 2015?.

Just to clarify. The change in the tax did not result in a $0.07 hit this quarter -- the change in the accounting. It resulted in a revision in the year ago period because in the year ago period, the tax just been enacted, which meant that only a little bit of the inventory that we manufactured went in and therefore we paid a very low tax.

And had we accounted for that but in any case. The answer to your question is an interesting one. And it depends upon the trend in our inventory and our growth. But you are correct that with the current method, if sales accelerate faster than inventory builds, the current method will result in upside versus the previous method.

So in 2015 and as we move beyond, the restructuring that we’re doing because we have to build a lot of inventory to get through these plant closures. We ought to start seeing benefit in this method versus the other method..

Okay. Thanks for the clarification, Jack. Thanks, guys..

You’re welcome..

Moving on, we’ll hear from Bob Hopkins with Bank of America..

Hey, guys can you hear me. It’s Bob..

Hey, Bob..

Hi Bob..

Good morning. Thank for taking the questions. Just a couple of quick things on guidance. One, I think you emphasized that your modeling is a little more back-end loaded than the streets current modeling.

So I was wondering if you give us some help there and what percentage of earnings do you expect to fall in, kind of, the first half of the year versus the back half? And if you’ve mentioned that already I apologize I missed it..

So I’ll just frame a couple things up Bob and then have Jack go through some of the points that he iterated. So if you remember, even we gave guidance one of the things that we spoke about, on the top line standpoint, there was a combination of a lot of our new products and the ramp-up of some of the changes.

So the shoulder, some of the items that I mentioned in spine, some of the new products actually coming out in neuro. There is a new DuraGen product, some other products as well within that pipeline, that have a much bigger second-half effect.

From more of a profit standpoint, DuraSeal by itself, since we didn’t acquire bringing the account receivable over had a bigger cash impact as well as in the first half and part of the discussions that we’ve actually had is that, we get back to more of normative level in Q3, Q4.

And I think Jack mentioned in his prepared comments, that we estimate that to be $60 million to $80 million for the year but with the predominance of that happening really in the second half.

So Jack, do you want to kind of reiterate some of the views in the guidance?.

Yes. Let me give you a little feeling for the progression that we are thinking about. And I’ll give you some sense around the adjusted EPS number..

Yes..

We expect Q2 to be, call it, 8% higher than Q1. We expect Q3 to be approximately -- I’m trying to walk it up, we expect Q3 to ramp from Q2 and Q4 to ramp from Q3. And that should get you to roughly the total number..

Okay. Just curious how you guys are thinking about it, that’s helpful. And then….

Normally our Q3 is about the same as Q2, but we’re -- and that’s going to be the case in revenue this year. But in profit, it will increase in part because we’re getting past some of the incremental selling expenses that we talked about in connection with the DuraSeal acquisition..

Okay. Got that. Thank you. And then just with the three things you guys spelled out earlier in terms of guidance issues. Two of them were accounting related and we’ve talked about that.

But excluding the accounting changes, is the tax rate the only thing that’s really changing here in your 2014 guidance? And what is, kind of, your outlook for the tax rate this year and going forward?.

Yes. So the answer is, other than the accounting changes, the tax rate is the only other thing that’s going on. And that’s really a function of the items we talked about and the location of our income on an adjusted basis.

So remember, the number we’re talking about here is the adjusted tax rate, which is actually quite a bit higher than the GAAP tax rate. And the reason for that is we have all these expenses that are predominantly in the United States.

And if we add those expenses back to get you the adjusted EPS number, to the extent that those expenses would have been taxed, they would’ve been taxed at the much higher blended U.S. rate and that drives a higher adjusted tax rate. But in that sense it’s really the output of a formula. And that’s probably the way to look at it.

Obviously, as we become a more multinational company and as the proportion of our income outside the U.S. rises, we’re going to do what we need to do to manage the tax rate over the long term..

And then lastly, really quickly for me, I know you had a tough comp in your Extremities business.

And I know you have moved some numbers around and you gave that 6% number but was that -- was the lower extremity business different than what you thought this quarter? Was it a little below what you thought or no?.

It was probably a little bit soft because of the macro weather considerations that we talked about. But I’d say, recall that our year-over-year growth rates in Extremities in particular which is our smallest division in terms of dollars has been volatile all along.

I mean last year, I think, the year-over-year growth rates last year were 18%, 5%, 2% and 16%, but we hit our number for the year as we said we would all along. Pete, you may want to add a little more..

Yes. Just -- other than, Bob, I think your point is, it was -- it’s been up and down. I think from a standpoint of the Extremities, lower extremities in particular, it was probably hit more by this related weather situation.

We clearly had some cases that were delayed at a higher level within the Extremities world just based on where a majority of our business comes from. The confidence to the rest of the year comes from the fact that we have a new, lower flit system. We’ve got, actually, quite a few other new launches that are coming out.

We have been expanding our channel in combination, probably almost about 17, 18 new reps that we’ve brought in the fourth quarter that are now really kind of getting up to speed. So that’s why we still feel very confident for the overall year. And our skin and wound business which, as you know, ties into this, actually had a quite on plan performance.

So, I don’t see any alarm bells at all. In fact, I think with the new systems and some of the product lines that we refreshed. But candidly, we are probably six to eight years old that needed some refreshing, we’ve done that.

And again, to that point, we’ll actually talk in more detail about those product lines and some of the new offerings that we actually have, next Tuesday at the Investor Day Meeting..

Great. Thank you very much..

(Operator Instructions) We’ll take our next question from Jayson Bedford with Raymond James..

Hi. This is Mike Rich calling in for Jayson. Thanks for taking the questions..

Good Morning, Mike..

Good Morning.

I apologize if I missed this, but is it a very solid quarter for the international business? I was curious if you could give us some detail on what drove the growth? Was it new product registration, new territories, new distributors or something else? And then is that level sustainable, or do we expect some ebbs and flow going forward?.

Yes so, good question. I think the 11%, a large chunk of that was actually due to the addition of DuraSeal within to the portfolio. Our core business, it really pretty much was on track to what we expected. We’re going to spend a good chunk of time as well next Tuesday talking about our international strategy.

Dan Reuvers, who runs our international business will go through that in detail. But if you take a look at target markets in the Asia-Pacific area, we actually had some very nice growth in a lot of our core business areas. We had, probably some of the more mature markets, I would say, like Canada were a little bit more sluggish.

But that tends to be with our size, how we see it. We tend to have some, very much lumpiness across the board. In aggregate though, 11% was really in line with what we had planned. We do have pretty extensive focus within the international world. And it comes down to focusing on key countries that we can build out adequate structure to grow.

It’s around key franchises and we’ll talk about both of those in more detail, how we see those playing out. International will be a key part of our growth focus, really over the next five years and one of the top most important growth vehicles for us. And so I think that the plan for Q1 played out as we thought.

We’re in the midst -- as rolling out new products, if you remember we mentioned last year that we’ve registered about 50 new products. Some of those new products now are going from registration into actually launch. And we’re going to see more and more of the benefit through the year of those new products coming into the portfolio..

Okay. That’s very helpful. Thanks..

Probably just to throw out, we’re also -- we are going to talk a fair amount about that at the Investor Day Meeting as well..

Yeah. Great. And then just as a follow-up. I was hoping you could provide us an update on your thoughts around M&A. DuraSeal is obviously a pretty large deal. But I think there was an interesting comment in the release yesterday around Jack’s transition and his focus on the acquisition strategies.

So any updated thoughts there?.

Sure. I think it’s no secret that we’ve talked about within the company and some of the changing landscape that the need to gain scale in critical business areas is going to be more and more important for us as well as other companies to compete and just how the landscape is changing.

Areas for us in extremities, within our tissue areas, actually even billing out into near neighbor areas, where we can leverage capabilities as such neuro, all are very much interesting for us in the aspect of building our overall scale.

And why is that important? Obviously, having more relevance in the eyes of the customer based on how their buying patterns is changing, that’s one aspect. But another critical one is, we need our scale within the company to be able to really, fundamentally reduce our overall costs as a percentage of sales.

And so with that, yeah, we’re clearly focused on acquisitions such as DuraSeal. But we’re also quite interested in bringing in other acquisitions that can help us scale-up businesses in our portfolio that aren’t at the scale that we need, that we believe to be ultimately competitive long-term.

And then where we have very strong franchise positions, we believe there is some interesting near neighbor capabilities as well. And part of the announcement we made with Glenn coming in and Jack has, over his 15 years done a significant amount of deals, has quite a rare background as being a CFO.

And also securities attorney background as well, has done a lot of different deals. Having him spend a higher percentage of his time to help us fill out our inorganic strategy is clearly one of the things that we want to be able to enable.

So, Jack, I don’t if you want to add anything?.

Yeah. I mean -- for those who have been watching the company a long time, as people know that I probably spent about half or more of my time on acquisitions and alliances until 2007, when I became CFO. And since then, that percentage has fallen enormously. And our business development group is really good.

But the environment is very target rich at the moment. And it seems that if I can raise the proportion of my time I spend on this, I hope to have an impact..

So, I mean, I’d just make the point I emphasize -- if you think about our three prongs, we have optimization plans if you will, which are really coming together well to drive some of the cost platform work.

We’ve spent a lot of time on organic focus from channel effectiveness, R&D, those areas and obviously the third rung that has been a hallmark of the company and something that we want to continue to accelerate in business development. And I think some of these changes we just talked about are actually going to help us put more focus in those areas..

Great. Thank you very much..

Yeah..

And next we’ll hear from Dale Dutile with The Boston Company..

All right. Good morning. Just a question on the device tax.

What was the total amount in 2013 that you incurred for the medical device tax?.

Under the new -- hang on -- let me pull up the sheet. All right. So the number under the new treatment that we incurred in 2013 was 13.2. Sorry, I didn’t have it right in front of me..

It’s okay. So, I mean, you had $6.5 million of that on the balance sheet at the end of the year as originally reported. I mean, the medical device tax is incurred when you sell some.

What was the logic for not expensing that earlier? What was the original logic for putting that on the balance sheet instead of running it on P&L?.

So our original approach was always-- our original intent was always to follow the majority of the people in the industry. But we had a hard time hearing from the majority of the people in the industry before we had to make our own decision a year ago to be honest.

Zimmer was rather vocal in its expression of its intention to put the device tax into the balance sheet at the end of 2012, whenever that was. And so we thought that would be a good direction for us to go and we proceeded that way. And it dovetailed to some degree within our planning around the managing of the actual cash expense burdens as well..

But you have 250 days of inventory. The tax is incurred when you sell something. It has nothing to do with producing something, so all that was going to do was delay recognizing it as an expense until this year..

Not entirely correct. The tax is due on its first sale of the United States. And therefore, the cash tax is often paid in advance of an actual sale to the customer. So the structure of the tax is such that it actually has a negative impact on cash flow.

If we manufacture a product in one part of our company and it gets sold to another as part of our distribution mechanism, the tax is paid then long before, or perhaps it’s sold to a customer as a matter of cash flow..

So, I was trying to understand in your comment to an earlier question about something with sales growth impacting tax or something. I’m not sure what you’re getting at.

So is that your point, if you produce inventory you’ll incur more taxes even you don’t sell it?.

Correct. The affect of the device tax -- depending on how one has its own distribution company set up and everything, companies can use different mechanisms. It’s a manufacturer’s excise tax, not a sales tax.

If you grow -- in general terms, if you grow inventory much faster than you grow revenues, which has been the case for us in the last few quarters and will be as long as we’re doing these restructurings. You pay tax essentially ahead of your actual revenues. And therefore, it has an adverse effect under prior method especially.

If, however, you can achieve the reverse, which is grow revenue faster than you grow inventory, okay, you get a benefit in theory..

Okay. Great.

And just quickly, the revenue contribution from DuraSeal and the revenue headwind from some discontinued -- did you quantify both of those?.

We did. And we laid them out in the press release actually..

Okay. Okay.

And the recall last year was a headwind at that time of about $10 million? Is that about right?.

Yes. Well, it depends on the period that you’re talking about but…..

First quarter.

….probably somewhat more than that for the whole year, but in the first quarter. Yes.

First quarter..

Yeah..

Okay. Great. Thank you..

Yeah..

And our next question comes from Imron Zafar with Jefferies..

Hey. Good morning. Thank you for taking my question. Just a couple of quick ones.

First, anything new on the FDA warning weather front in Puerto Rico?.

No. I would say from a standpoint of our overall progress with quality, we remain quite diligent and generally are making very good progress, kind of moving into our next phase of just reaching all of our plants, kind of moving to the next level of changing some of our systems. From the Puerto Rico standpoint, we’ve been in contact with the agency.

They know where we are from the status standpoint. Actually, the team, I met with them recently just on kind of an update status. Nothing really, we believe changes in what we have discussed before, which is they will be back this year.

Our best estimates are probably this summer to do the full up audit and from a standpoint of how the plants running, it’s running quite well. And we’ve implemented all the fundamental changes associated with the 483s. But we’re obviously always continuing to improve the facility. And so that’s kind of what’s taking place there..

Okay. And then if you could just give us sort of an update on what the pricing environment is? I guess, specifically in spine and also in extremities and a market that’s becoming more competitive? I just wonder what the outlook is on that business in terms of price..

Yeah. I think if you take a look at our spine business, orthobiologics has some pressure, a point or two. The metal business in hardware and spine has typically had somewhere. It’s been as high as five to six. I think we’re viewing it a little bit lighter than that now, probably in the four to five range. And we’ll see how that plays out this year.

I think that’s one of the questions that we have in our mind as well. Extremities, from a stand point of the regenerative products, it’s minimal pressure at this point in time. And from a metal standpoint, we’re probably in a point or two of overall pressure. Our neuro business tends to have less pressure than both of those in general.

And our instruments business is probably, roughly neutral from a standpoint of the overall pricing dynamic. So that would kind of give you a view of, kind of how we see the different markets..

Okay. Great. Thanks very much..

Sure..

And next question comes from Steven Lichtman with Oppenheimer & Company..

Hi, guys. This is actually Rosemary in for Steve. Good morning..

Good Morning, Rosemary..

I just have a really quick one.

Can you remind us what you guys are assuming in terms of the competitor impact on the DuraSeal product and maybe when we should expect to see that impact later this year?.

Yes, Rosemary, we actually haven’t quantified it. But as we actually did our diligence, some of our discussions and as we took a look at the overall business, we’d had factored much of that in from this year. As far as when the product comes out, it’s a good question.

There have been some discussions where the product has been discussed as experimental at tradeshows. But there really isn’t any clear evidence or information we have, if it’s going to be in two months or a year. But at this point in time, we think it has actually minimal impact from a standpoint of our numbers here for 2014..

Great..

I think it’s worth mentioning from the product standpoint. That’s a U.S. point that I’m making. The product actually is for sale outside of the United States. It has been for a handful of years. So the characteristics in understanding the product, I think we understand it quite well. It really comes down to their U.S. approval..

Perfect. Thank you..

Sure..

And we have no further questions. I’ll turn the conference back over to Peter Arduini for any additional or closing remarks..

Thank you, Operator. And I’ll just say, look, thanks everyone for your attendance this morning. We hope to see all of you in New York City just in a few days, next Tuesday. And we’ll spend a lot more time with our five-year strategy, our updated models and a good chunk of discussion on our growth plans. Thank you very much for calling in this morning..

That does conclude today’s conference. Thank you for your participation..