Michael Beaulieu - Integra LifeSciences Holdings Corp. Peter J. Arduini - Integra LifeSciences Holdings Corp. Glenn G. Coleman - Integra LifeSciences Holdings Corp..

Matt Miksic - UBS Securities LLC Jonathan Demchick - Morgan Stanley & Co. LLC Robbie J. Marcus - JPMorgan Securities LLC Brad Mas - Bank of America Merrill Lynch Matthew O’Brien - Piper Jaffray & Co. Steven Lichtman - Oppenheimer & Co., Inc. Travis Steed - Cantor Fitzgerald Securities Jayson T. Bedford - Raymond James & Associates, Inc.

Craig William Bijou - Wells Fargo Securities LLC Young Li - Barclays Capital, Inc. Christian Moore - Jefferies LLC David L. Turkaly - JMP Securities LLC.

Good day, ladies and gentlemen, and welcome to the Integra LifeSciences Second Quarter 2017 Financial Results Call. As a reminder, today's call is being recorded. At this time, I would like to turn the call over to Mr. Mike Beaulieu, Director of Investor Relations. Please go ahead, sir..

Thank you, Elaine. Good morning and thank you for joining the Integra LifeSciences Second Quarter 2017 Earnings Conference Call. Joining me on the call are Peter Arduini, our President and Chief Executive Officer; and Glenn Coleman, our Chief Financial Officer and Corporate Vice President of International.

Earlier this morning, we issued a press release announcing our second quarter 2017 financial results. The release and corresponding earnings presentation, which we will references during the call, are available at integralife.com under Investors, Events and Presentations in the file named Second Quarter 2017 Earnings Call Presentation.

Before we begin, I would like to remind you that many of the statements made during this call may be considered forward-looking statements. Factors that could cause actual results to differ materially are discussed in the company's most recent filings with the SEC. Also, the discussions will include certain non-GAAP financial measures.

Reconciliations of any non-GAAP financial measures can be found in today's press release, which is in exhibit to Integra's current report on Form 8-K filed today with the SEC. I will now turn the call over to Pete..

Thank you, Mike, and good morning, everyone. If you'll turn to slide four, I'll begin by sharing some highlights from the second quarter and provide updates on our acquisition and integration programs.

Second quarter's total sales were $282 million, which was at the low end of our guidance range, resulting in organic growth of 4.6%.The underperformance of organic growth largely resulted from competitive pressures in a few accounts in our Dural Sealant business, causing slower sales growth than expected.

While we're taking actions to address the issue and minimize any further impact in the second half of the year, we're revising our full year consolidated organic growth target to a new range of 6% to 7% to reflect the lower performance of the Dural Repair business through six months.

That said, strong performance in other parts of the business had better than expected sales and Derma Sciences enabled us to achieve the lower end of the revenue guidance range in the quarter. We believe that the broad based strength in various product lines within both segments and international will continue to accelerate growth in the second half.

Glenn will give more detail on the quarter and second half in a few minutes. We also made significant progress in the quarter on our two acquisitions. We remain on track to close the planned acquisition of the Codman Neurosurgery business in the fourth quarter.

We've completed our organizational design for day one readiness and we're working closely with J&J for a seamless transition of critical processes for key countries immediately after we close.

We've advanced our operating model, established all required new legal entities, and are in the process of developing sales, marketing and commercial strategies. We also feel confident that the transition services agreement that we have negotiated will ensure a seamless hand over from J&J to Integra.

On the regulatory front, we've obtained the necessary clearances outside the United States. In the United States, we are in discussions with the FTC and expect to make select divestitures. Importantly, based on our progress to-date, we are reiterating the financial framework that we provided in February.

This includes pro forma 2016 preliminary total revenue of approximately $300 million and an expectation for at least $0.22 of accretion to adjusted earnings per share in the first full year post close and accelerating thereafter inclusive of divestitures.

As part of the integration planning process, we've had the opportunity to interact with many Codman team members. And I've been extremely impressed with the passion, professionalism and experience they bring. And we're excited about the prospects for a new combined organization.

While we still have a lot of work ahead of us, the progress that we've made in the integration planning to-date further strengthens our belief that Codman Neurosurgery is a strategic fit and will generate significant shareholder value for years to come. Moving to Derma Sciences. The integration is going well.

Earlier this month, we held a national sales meeting and completed the commercial integration of our outpatient wound care channel. Our sales representatives are now fully trained, integrated into one unit, and selling the combined portfolio of products. Second quarter sales of Derma Sciences products were higher than expected.

And as a result, we are increasing our full year revenue target to $80 million up $10 million from previous guidance. Overperformance in wound care and minimal disruptions in sales channels during the integration drove this result. Importantly, we're also experiencing good momentum in our U.S.

advanced wound care business and are now on track to exceed the $60 million performance sales target that we established earlier this year. The addition of new products such as smaller sizes in PriMatrix and Omnigraft and strength in Derma Sciences are expected to drive the overperformance in outpatient sales.

We remain confident having the broadest portfolio of advanced wound care products, combined with the increased reach of our sales channel, provides a competitive advantage and the scale to accelerate top and bottom line growth. I'd now like to turn your attention to our performance in orthopedics.

The global rollout of new products such as the Cadence Ankle continues to be well-received as the growth in the second quarter demonstrates. Our total ankle portfolio, which includes both Cadence and Salto Ankles, achieved strong sales in the second quarter, generating roughly 50% organic growth.

In our upper extremities business, sales increased double-digits in the second quarter. The Titan Shoulder led the growth as we expanded our distributor base and added new surgeons from an enterprise contract we signed earlier this year.

We still have some work to do to update our broader extremities portfolio, but the performance that we've achieved with products such as the Titan Shoulder and Cadence Ankle is a strong indication of the capabilities that we have within our organization to develop, market and sell innovative solutions for surgeons and their patients.

Switching over to our specialty surgical solutions segment, CUSA Clarity, our state-of-the-art tissue ablation platform was launched in the U.S., Canada, Australia and select EU countries at the end of the first quarter.

The launch is off to a good start and we've received very positive feedback related to clinical capabilities and higher surgeon productivity. This favorable reception is creating a robust pipeline of opportunities in our tissue ablation franchise. We expect this multi-year growth opportunity to ramp up in the second half of the year.

While organic revenues were lower than expected in the quarter, I was pleased with the improvement in our profitability. Adjusted net income increased 17% in the quarter and our cash flows demonstrate the strength of the business. With that, I'll now turn the call over to Glenn to review the quarter in more detail.

Glenn?.

Thanks, Pete, and good morning, everyone. If you turn to slide five, I'll provide an overview of second quarter's segment performance starting with specialty surgical solutions. Second quarter reported sales were approximately $160 million, an increase of 1.5% on an organic basis.

Sales across this segment were in line with our expectations except for Dural Repair where sales increased approximately 4%, which was lower than forecasted. As Pete mentioned, we're seeing the impact of competition in a few customer accounts, which resulted in slower growth of DuraSeal sales in the quarter.

While we expect to continue to achieve volume growth for the balance of the year, we've lost a few points of market share, primarily associated with price, that are launching new marketing tools, health economic campaigns and channel strategies to address the competition and re-accelerate the growth in this area.

As a reminder, a significant number of surgeons have not yet converted to an advanced Dural Sealant product. DuraSeal remains the only product with an FDA approval for use in both spinal and cranial repair. It has more clinical and economic data than all other competitive products on the market.

Lastly, as many of you know, we have a patent infringement litigation pending against this competitor. Last month, we filed an additional lawsuit against the same competitor alleging infringement on recently issued patents. This litigation will extend into 2018 and essentially beyond and we plan to defend our broad patent portfolio vigorously.

We remain confident in our Dural Repair growth opportunities and the plans we've put in place to improve performance. I now would like to turn your attention to the performance of other areas within specialty surgical solutions.

Sales in precision tools and instruments increased low single-digits compared to the prior year quarter with MAYFIELD and MicroFinance driving the growth.

Since we acquired the MicroFinance assets in 2014, we have seen sales exceed the overall growth rate of the market and remain confident that this growth will continue based upon the opportunities we see in the United States. Tissue ablation experienced strong capital equipment sales with the launch of CUSA Clarity.

We expect to see double-digit growth in this franchise in the second half of the year because of the positive feedback that CUSA Clarity is receiving and the corresponding strong funnel of sales opportunities. International sales within this segment increased mid-single digits driven by double-digit growth in China.

This growth can be directly attributed to the infrastructure investments we've been making over the last couple years outside the United States.

Moving to our full-year segment outlook, given a lower than expected sales growth in Dural Repair, we're adjusting our full-year Specialty Surgical Solutions organic sales guidance to a new range of 3% to 4% as compared to our prior guidance range of 4.5% to 6.5%.

Turning to slide 6, I'll now cover the revenue performance in Orthopedics and Tissue Technologies. Second quarter sales in this segment were about $122 million, representing an increase of 34% than the prior-year's quarter and an increase in organic growth of approximately 10%.

Sales of our regenerative technologies excluding Derma Sciences increased double digits compared to the same quarter in the prior year. Strength in our skin portfolio, new products and new sizes of SurgiMend and PriMatrix and Omnigraft as well as continued strong growth in private label products drove this performance.

Sales in Derma Sciences contributed approximately $24 million, which exceeded our expectations for the second quarter.

Given the positive momentum since closing on the acquisition and less disruption from the integration that we initially anticipated, we now expect Derma Sciences sales to be about $80 million for the full year, an increase of $10 million from our previous estimate. Our U.S.

advanced wound care portfolio, featuring products that are used to prepare, treat and protect acute and chronic wounds, increased double digits on a pro forma basis. The strength was driven by sales in our core business, new product launches as well as Derma Sciences.

With the commercial integration on track and expansion of our advanced wound care sales channel, we now expect to exceed our previous guidance of $60 million for pro forma revenue. The Cadence Total Ankle launch is off to a strong start and the Salto Ankle is also performing well.

Combined, these products generated close to a 50% organic sales increase in our total ankle portfolio in the quarter. Earlier this month, we attended the American Orthopedic Foot and Ankle Society Meeting where we hosted a launch event featuring our Cadence Ankle.

Throughout the conference we received positive feedback from a large group of potential new users who visited our mobile training lab. This enthusiastic response gives us confidence for the continued strong rollout and growth of the Cadence and Salto Total Ankle Systems.

In upper extremities, we expanded our distributor network and signed new contracts at targeted hospital systems which listed more surgeons adopting our Titan Shoulder. The increase in volumes generated record quarterly sales of the Titan Shoulder and drove double-digit growth in upper extremities.

International organic sales in this segment were up high-single digits compared to the same quarter last year driven by strength in Europe. For the full-year 2017, we're increasing our reported sales guidance for the Orthopedics and Tissue Technologies segment to reflect higher sales expectations for Derma Sciences.

Accordingly, we now expect full-year reported growth to be in the range of 31% to 35%, an increase from our prior guidance range of 27% to 32%. We expect organic growth in this segment to be in the range of 9% to 14%, consistent with our prior guidance. Please turn to slide 7 for our consolidated revenue guidance.

For the full-year 2017, we're increasing the low end of our full-year revenue guidance by $5 million to a new range of $1.125 billion to $1.140 billion, reflecting a lower impact from foreign currency based upon current rates. This results in a slight increase to our reported revenue growth rate to a range of 13% to 15.5%.

Excluding the impact of foreign currency, our consolidated revenue guidance remains unchanged. However, we are adjusting the components of our guidance. Because of the lower projected growth in Dural Repair, we are reducing our organic growth guidance to a new range of 6% to 7%.

This represents roughly a $10 million decrease in organic revenue, but importantly, is being offset by outperformance in Derma Sciences associated with growth in advanced wound care. As a reminder, the planned acquisition of Codman Neurosurgery is expected to close in the fourth quarter of 2017.

And the sales from this pending acquisition are not included in our guidance. For the third quarter of 2017, we expect total revenues to be in the range of $284 million to $289 million, representing reported growth of between 13.5% and 15.5% and organic growth of about 6%.

We expect the majority of a sequential increase to come from Specialty Surgical Solutions. Turning to slide 8, I'll review the key components of our second quarter and full-year P&L performance. As a reminder, the pre-closing costs associated with the Codman Neurosurgery acquisition are included in the GAAP P&L and cash flow guidance.

Second quarter GAAP gross margin increased 80 basis points over the prior year to 64.9%, while adjusted gross margin was 68.4%, a decrease of 80 basis points from the prior year.

The lower adjusted gross margin resulted from the dilution associated with the Derma Sciences acquisition, which had a negative impact of more than 100 basis points on gross margin for the second quarter.

For 2017, we expect GAAP gross margin to be in the range of 65% to 66% and adjusted gross margin to be about 69%, which is at the lower end of our previous guidance range and reflects the unfavorable mix of higher than expected Derma Sciences sales and lower Dural Repair sales.

During the third quarter, we will be performing maintenance and repair in our older New Jersey manufacturing location, resulting in lower utilization, and thus, a slight sequential decline in gross margin.

Gross margins for the fourth quarter are then expected to show a sequential improvement from the third quarter, getting us to our full-year guidance for adjusted gross margin of 69%. Turning to operating expenses, SG&A expenses in the second quarter were 51.4% of revenue and adjusted SG&A expenses were 43.9%.

We are maintaining our full-year 2017 guidance for GAAP and adjusted SG&A expenses. Our second quarter 2017 adjusted EBITDA margin was 22.2%, an increase of 30 basis points from the prior-year second quarter.

For the full-year 2017, we expect our adjusted EBITDA margin to be about 23.5%, which is the midpoint of the prior guidance range and includes over 100 basis points of dilution from the Derma Sciences acquisition.

GAAP net income and earnings per share were both lower compared to the prior-year quarter, largely because of the acquisition-related costs. Second quarter adjusted net income increased 17% and adjusted earnings per share increased 13%, compared to the prior-year quarter, largely because of higher sales, better G&A leverage and a lower tax rate.

For the full year, we are not making any changes to our EPS guidance and expect GAAP earnings per share to be in the range of $0.49 to $0.55 and adjusted earnings per share to be in the range of $1.88 to $1.94. For the third quarter of 2017, we expect adjusted earnings per share to be up slightly from the second quarter.

This increase includes costs of the previously-discussed maintenance and repair charges and $7 million of expenses associated with hiring additional resources in advance of closing of the Codman acquisition. Turning to slide nine. Our operating cash flow in the second quarter of 2017 was $28.9 million with capital expenditures of $12.8 million.

On a trailing twelve-month basis, our adjusted free cash flow conversion ratio was 72.4%, up from 59.8% in the prior year.

Our first half 2017 cash flow generation has been strong, taking into account the incremental acquisition and integration cash outlays of approximately $15 million to $20 million this year, associated with the Derma Sciences and Codman acquisitions.

For the full year 2017, our guidance remains unchanged with operating cash flow in the range of $115 million to $145 million and free cash flow conversion in the range of 40% to 60%. Please turn to slide 10 for an update on our capital structure as of June 30, 2017.

Our cash balance at the end of the second quarter was approximately $155 million with net debt of $725 million. Our bank leverage ratio was approximately 2.7x. Our year end 2017 pro forma bank leverage ratio, which includes the planned acquisition of Codman Neurosurgery, is expected to be less than 4.5x unchanged from our prior guidance.

As we previously stated, we are committed to lowering this leverage ratio between one-half and one full turn per year beginning in 2018.

Before I turn the call back over to Pete, I want to reiterate my confidence in the Codman deal and the financial expectations that we outlined on our call in February for Codman Neurosurgery that included 2016 pro forma revenues of approximately $300 million and at least $0.22 of accretion to adjusted earnings per share in the first full year post close inclusive of divestitures.

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

Thanks, Glenn. I'd like to provide a brief update on our key focus areas for 2017, so if you'll turn to slide 11. We're committed to achieving our 2017 financial targets through continued strong execution.

In the first half of 2017, revenue growth met or exceeded plans in much of our portfolio including regenerative tissue products, CUSA capital, shoulder and our ankle portfolio. And we gained traction in the advanced wound care business.

While I'm disappointed that we underperformed in Dural Repair, the franchise did grow roughly 4% and I'm confident that we have the right plans in place to achieve long-term above market growth. I also look forward to accelerated growth in the second half, arising from numerous new product launches and investments in channel expansion.

We remain focused on executing on our plans for the Derma Sciences and Codman acquisitions and continue to have dedicated teams focused on integration, thereby, freeing up the commercial teams to execute on our plans to achieve our financial targets for the year. We completed the commercial integration of Derma Sciences in the third quarter.

And because of our success to-date, we've increased our revenue expectations from $70 million to $80 million for the full year 2017. We're energized to have the Derma Sciences employees fully combined into Integra and we will complete the remaining IT and systems integration by year end.

And I'd like to thank all the Derma employees for embracing Integra, their professionalism and their strong contributions to our success in the first half. The planned acquisition of Codman remains on track to close in the fourth quarter and we reiterated the financial framework we outlined in February.

Integration planning is well underway and the teams are focusing on driving value as a combined organization immediately after closing. As Glenn mentioned, we'll be hiring a substantial amount of resources in the third quarter in anticipation of a fourth quarter closing.

As I look beyond 2018, I'm optimistic about the strategic value and the additional accretion that this acquisition will generate over the long-term. We've greatly advanced our wound care portfolio with the addition of Derma Sciences.

The two sales teams are integrated and training has been completed on a full set of products which will significantly increase our account coverage. Based on our success in the first half of 2017, we're in a position to exceed the 20% growth target for the full year and are well-positioned for long-term growth.

We believe that we have the most compelling portfolio of advanced tissue products with Omnigraft, PriMatrix, AMNIOEXCEL, MEDIHONEY and EZ-TCC (sic) [TCC-EZ], providing wound care professionals with the broadest toolbox for fighting this challenging disease state.

Finally, it's noteworthy that our operations and supply chain teams continue to perform very well and our overall level of quality remains very high, serving as key foundational elements to foster growth.

We also continue to improve our ability to design, manufacture and launch new products as evidenced by the number of successful product launches in the first half, most notably the Cadence Total Ankle, all new regenerative tissue products, and the CUSA Clarity, all of these new launches performed in line or exceeded expectations in the second quarter and position us to accelerate growth in the second half.

That concludes our prepared remarks. And, operator, if you'd please open up our lines for questions..

Thank you. We will take our first question from Matt Miksic of UBS. Please go ahead..

Good morning, Matt..

Please go ahead, sir. Your line is open..

Matt?.

Hello, Mr.

Miksic?.

Hi, can you hear me okay?.

We can now, Matt..

Okay. Sorry about that. So just a couple of follow-ups on the quarter and some of your comments. On the DuraSeal competition, so the source of the weakness in SSO, you talked a little bit about that.

I just want to clarify, this is competition on the DuraSeal side, not the DuraGen side obviously, and love to get any color you can provide on – give me the relative size of those businesses at this point or the relative growth or perhaps on the DuraGen side. And then I have one follow-up..

Yeah, so Matt, relative to – I mean, first of all, just to kind of frame up the point, we had, for Dural Repair, which is a combination of onlay products, DuraGen and Sealant, the DuraSeal product, we planned in the neighborhood of 7% to 8% growth in the year, and as we've mentioned on the call, came in about 4%.

Relative to DuraGen, it was a little soft. We had a very challenging comp versus last year, really no competitive changes at all. I would probably say we might have had a little less focus on DuraGen just based on so much energy around the Clarity launch that took place within the quarter.

But overall, nothing, I'd say, out of the ordinary from a DuraGen standpoint, although we were a little bit softer. DuraSeal, fundamentally, same competitor that we've been competing against in the marketplace about the last 18 months. We're clearly the broad leader within the marketplace for these types of products.

And it's been praised at a few select accounts, where they've been trying to get into the accounts. And in many cases, the customer's saying, well, this deep of a price discount; I'll give it a try. And with that, they've had some success in a few accounts for trialing. And again, that doesn't mean that they keep the accounts.

It means in some cases, it disrupts the sales for a period of time while the trialing is taking place. We've got plans laid out. Glenn highlighted some of those on the call. We feel quite good that our overall portfolio was very robust and quite strong.

And that that will continue on, but we've adjusted our (29:36) growth just based on our first half performance in that area..

And, Matt, the rough sizing of the two products, they're about 50/50 relative to the Dural Repair franchise..

Okay.

And just to clarify on the DuraSeal pressure you mentioned, do you have a record, a track record at all or examples of where you've seen channeling come into accounts and you've been able to sort of sustain that and roll back some of that in the past?.

Yeah, if you remember a couple years ago with DuraGen, specifically in that segment, we actually did it as people try the other products in the marketplace. Since we're really kind of the innovator in this space with new products, we're able to bring back all of – any of that share at that point in time, which was tied to supply challenges.

But no, it's quite difficult. And candidly, just like in other product areas, it's not uncommon for someone to carry multiple brands in a given clinical area as well.

And I think the bigger point here on Dural Repair, particularly in Dural Sealant market is, less than half of the market still use an advanced sealant product and that's why we're still quite bullish relative to the longer-term growth within Dural Repair.

So, again, said another way, when you close the dura, particularly in the head, only half the surgeons use something other than a suture to supplement the closure. So that's still a big component of the growth, and obviously, this competitor has entered into the market, has made a little bit of progress in a few accounts.

As we outlined as well, this is also the competitor, HyperBranch, that we have litigation ongoing with as well. And as Glenn commented, we recently submitted a second piece of litigation. The first components were associated with the product itself.

The second part is associated with actually the applicator and we feel confident in our case and are going to exercise these patents vigorously..

That's helpful. And then if I could, just one on wound care.

You mentioned better than expected, things are going apparently better than expected both in the integration and perhaps some of your core organic launches there, could you talk a little bit about what is working better and if you've had any change in sort of the pace of success on the Omnigraft side?.

Yeah, I would say when you think of – first of all, when you bring Derma together with our advanced wound care, it's really a good set of assets that we're underscale in both sides. And so when you bring them together, the attention that they gain, because of the toolbox that we've created, is substantial.

And so, as we're going from $70 million to $80 million, a big part of the step-up obviously has been someone's success with the Derma products and minimal disruption. And I would say, the minimal disruption is tied to, when you have products that are viewed as competitors and channel overlaps, that's when you run into issues.

When you actually see a lot of complements to both the channel and the products, that's when it typically works well. And I think that's what we're seeing here. We've brought in a really good group of people. I think the AMNIOEXCEL product is a very strong product, coupled with Omnigraft and PriMatrix. Makes this a really great trio.

They complement each other and I think we've got our product positioning figured out now on how to position, what products are different phases.

From customers that have a revenue base structure, customers that are focused really on a cost base model, customers that have different algorithms for different levels of wounds, we think we now have this broad portfolio. And I would comment, I mean, Omnigraft, the new sizes have helped out.

PriMatrix, the smaller sizes made a substantial difference for us. I think this is probably one of the first quarter's and second quarter that we've had a really nice outperformance and the older TEI assets, particularly PriMatrix.

So it's a combination of a lot of things, but I think the bigger part is, is that we really start to become more relevant in these accounts. We now have 80 reps that sell that full portfolio as opposed to 40 reps and 50 reps that only sold part of it. And their territories overlap.

So, at the end of the quarter, where we were spiffing each channel, we started seeing some very good cooperation and benefit that drove sales at the end of the quarter. And now we have the channels fully aligned so we're looking forward to just continuing to accelerate.

And again, that gave us the confidence to increase the annual number about $60 million.

Great. Helpful. Thank you..

Thanks, Matt..

Thank you. We will take our next question from Jonathan Demchick of Morgan Stanley. Please go ahead..

Good morning..

Good morning, Jon..

I wanted to, I guess, follow up on Matt's Dural Repair question and really the impact of that business on the organic guidance. By my math, Dural Repair contributed to about 1 point of the sequential slowdown and organic growth, actually I guess, the guidance was brought down a little more than that.

Can you help me think about the drivers of that reduction and then the expectations for Dural Repair into the back half of the year as you combat the competition?.

I'll comment and then I'll let Glenn comment as well. I think the main component of it is, for overall growth, I think you're right. The majority of it, for sure, is within the Dural Repair, specifically within the Dural Sealant. I'd say the other areas that was a little bit slower than we'd like to see was in our lower foot system, outside of ankle.

And so we've got good plans in place there as well to be able to improve our overall growth. The experiment, so to speak, on channel and focus and ankle, we think are serving us very well. And we're going to be applying those to the rest of the system. But it's, basically, 75%, the Dural Repair.

There's a little bit in the lower foot system and orthopedics' health, I'd think about it. Glenn, I don't know if you want to add any important color..

Yeah, Jon, relative to our full year guidance for organic growth, the entire decline and decrease is specialty surgical and it's all in Dural Repair. That is the change we've made to our full year. So that $10 million is all indoor repair and really it's around the Dural Sealant product..

Is the expectation for Dural Repair to stay, I guess, at this quarter's level for the balance of the year or do we expect them to be back more into upper single-digit growth range..

Yeah, we're modeling right now to be pretty consistent with where we landed for Q2 for the rest of the year. And obviously, we're taking a lot of actions around that to drive more growth, but that's what we're modeling right now. And that's just reflected in our guidance of 6% to 7% for the full year..

Okay. Very helpful. And I guess, as I think about guidance, it still implies, I guess, about 2 points of acceleration into the back half of the year. Can you point us to some of the drivers there? It sounds like Dural Repair probably isn't but there is a handful of product launches and build up with Cadence, CUSA, the regenerative portfolio.

Are those the big areas that we should be expecting to see acceleration in?.

Yeah, Jon, it's the stuff that we've consistently talked about. I think especially surgical, it does come down. CUSA will be a big contributor. I mean that will probably be the main item within specialty surgical.

And then you hit the other items in OTT, we expect that the ankle and the multiple new tissue products that we brought out, the new product versions in PriMatrix, the other advanced wound care product components we also have within SurgiMend, we've got the macroporous products.

So it's a combination of those products as they ramp up in the second half of the year. But I would say, particularly back to Specialty Surgical with keeping Dural Repair kind of at the lower rate, obviously, we're going to put actions in place that we feel that will be able to bring back growth at a higher level within that area.

We're cautious on how we set the numbers for the rest of the year. And again, based on the funnel we have for CUSA Clarity, it looks pretty optimistic about the growth that we'll be able to bring in, in the capital market in the second half of the year, just based on the rollout we had here in Q2..

Very helpful. Thank you very much..

Thank you..

Thank you. We move to Robbie Marcus of JPMorgan. Please go ahead..

Good morning, Robbie..

Good morning. I just wanted to follow up and clarify a bit on some of the questions asked already. On guidance, organic growth of around 6% in third quarter and a few pennies higher on EPS implies fairly aggressive numbers. By my math, about 9% organic to hit the midpoint and closing in on $0.60 on EPS.

So maybe you could just help us clarify the drivers that's moving from third quarter to fourth quarter and what gives you confidence in that acceleration?.

Robbie, let me take a shot at this, and Pete could add some color. Relative to the sequential increase from Q2 to Q3, we're obviously expecting higher revenues. And I mentioned that really coming sequentially from Specialty Surgical and the new product launches, specifically around CUSA Clarity.

I did mention we've got some repair and maintenance work we have to do on the equipment in our older collagen plant here, which will put a little bit of pressure on gross margins in the third quarter.

And we're also doing some hiring in advance of Codman close, so EPS will be up slightly in the third quarter, which leaves, to your point, a bigger ramp in the fourth quarter. But again, we expect the new product launches to continue to ramp up into the fourth quarter. Traditionally, it's our largest quarter.

And getting to $0.60 or so of EPS we feel is very achievable when we think about the gross margins coming up sequentially and what we expect for mix to be in the fourth quarter. We're expecting to see some meaningful leverage on our operating expenses in the fourth quarter.

Good news is we got the meaningful leverage on G&A costs here in the second quarter and we're seeing that play out in the back half of the year. And then potentially a lower tax rate getting us to the $0.60 or so for the fourth quarter. But we feel confident we'll get the leverage, continue to see some good progress on the tax rate.

And it really boils down to getting to the 9% organic growth and that's going to be the success we expect from the new product launches and the momentum we have in our U.S. advanced wound care business..

Okay. And last question from me, I know it's somewhat early in the year, but the Street is modeling, looking out for 2018 on the bottom-line around 15% EPS growth and mid to high-ish single digits on organic growth.

Are those numbers maybe that you can comment on or give some qualitative comments at this point in the year?.

I'd say, Robbie, at this point, we're not ready to obviously give any guidance update or comments on 2018, other than to say that, our 6% to 8% that we've talked about in our longer-term guidance is still holding. We're still focused on double-digit return. We want to get through, obviously, getting the Codman deal closed and get that integrated in.

And as we've talked about, our plans are here before we get into the new year, to focus on an investor meeting where we can give some more clarity and update once we get the deal closed and behind us. So that's kind of what I'd say at this point in time relative to 2018..

All right. Thanks a lot..

Yeah..

Thank you. Our next question comes from Bob Hopkins of Bank of America Merrill Lynch. Please go ahead..

Hey, guys, this is Brad in for Bob. Just first, I'm curious if you can talk about – I mean, most of it (42:26) you have in front of you, but just pro forma growth, if you were to include Derma in the year-ago period, just how that compares to the 4.6% organic..

Yeah, so Brad, I'll take this one. We're very pleased with the performance of Derma Sciences. It outperformed our expectations. If we think about pro forma numbers for Derma Sciences, keep in mind for the full year, we had modeled the business to be down. So full-year Derma Sciences last year in 2016 was about $95 million.

And our initial guidance was $70 million coming up now to $80 million within our portfolio. On a pro forma basis, second quarter year over year was actually flat, which we viewed as very good performance given first full quarter with some disruption with the territory changes that we're working through with the cross-selling that's taking place.

So pro forma in the quarter was actually flat. As we look at the back half of the year, we're obviously on a pro forma basis, anticipating some decline. But moving into 2018, we'd expect this business to be growing in the mid-single digit range.

Having said all of that, I would just say within the components of Derma Sciences, we are actually seeing pro forma growth in the advanced wound care part of the business with the clients coming from traditional wound care. So the advanced wound care part of this business even on a pro forma basis is doing quite well.

And we expect that to continue here in the back half of 2017 and moving into 2018. But as you know, the traditional wound care business is actually a flat to declining business..

Okay.

So sorry, by pro forma flat, you mean Integra plus Derma pro forma was flat in Q2?.

No, that's just Derma Sciences on a stand-alone basis..

Okay..

I don't have the numbers if you want to do pro forma with Derma in our numbers..

Okay, just making sure. And then just one on common (44:30), on the $0.22 accretion, I think it's been suggested that, that could be a little bit higher.

And I'm just curious, you could talk a little about that delta if the opportunity is more on the revenue growth side or the cost synergy side, especially in light of some of the comments that are made today on the divestitures?.

Yeah, well, I'll comment and then have Glenn comment. Obviously, we can't give a lot of comments around because we're in discussions with the FTC. But I think from previous discussions, this is probably the first time we've communicated here, relative to the – divestiture are included within that number.

We think with the divestitures that are outlined at this point, that the $300 million pro forma that I outlined as well as the $0.22 is a very realistic number.

What would change those things are how the business finishes up the year, what the base is going into the first full year, the type of new products that'd be coming out in the launch windows related to those. I think from a cost synergy standpoint, we actually have very good line of sight.

And again, remind you that this is a carve-out acquisition, which means we actually are adding resources. There isn't a reduction of resources net when you do this because we need to add significant amount of infrastructure, particularly OUS to stand up the business. So it really would be on the commercial growth side, that would bring that.

Which is why when we talk about beyond the first 12 months, beyond 2018, we see significant accretion beyond that because we think the commercial opportunity OUS as well as in the United States associated with channel effectiveness, as well as scale, we think there's significant upside in the outer years..

And Brad, I would just add, the other items that we're working through that could provide some upside for us. We've already completed the financing, have a term loan in place, that came in a little bit better versus what we had modeled. So that's obviously good news when we look at the interest costs going forward.

And then I think there's some opportunities to do some things around the tax side to drive a lower tax rate. When you have a significant operation in Switzerland, we see some opportunities to potentially drive our tax rate down over a period of time.

And so we're working through some of that now and we haven't finalized all of that yet, but I would just say some of those types of items, if they go in our favor, which seems to be the case, could provide some upside to the $0.22 that we've outlined for the first full year post close..

Awesome. Thanks so much, guys..

Thank you..

Thank you. We will take our next question from Matthew O'Brien of Piper Jaffray. Please go ahead..

Great. Thanks for the questions. Just sticking on the outpatient side and the performance in the quarter quite strong, would love to hear a little bit about where the source of that strength was. I know you've been hiring a lot of new reps.

Is it a function of having more presence in the field over the last several quarters or new products proliferating within accounts? I guess what I'm really trying to get to is the durability and the strength that you're seeing there..

Matt, this is related to outpatient wound?.

That's right, yes..

Yeah, so I think it's a combination of things. First of all, it's really kind of getting the formula with the right type of reps and the right training. I think we're making some good progress there. I would say the marketing team has done a nice job, working on product positioning.

If you have just one product in your portfolio, the positioning is a lot straightforward, so to speak, as you're kind of offering that up for a pretty every much (48:08) situation. And if you have more products, you have to be a little more focused and a little more thoughtful. And I think we're starting to be able to get some traction around that.

I would also say that, from a standpoint of the right sizes and configurations, these smaller sizes that we referenced clearly had an impact in the quarter. Specifically, around PriMatrix would be a good example. We had a probably the size in that product line that was just not the right size for several of the disease areas.

We've actually had smaller sizes developed and those have really had an impact within the quarter. As I mentioned earlier, it was probably one of the biggest performers that we had.

And then I think the Omnigraft structure is aligned well and now with the combination of an amniotic product, that has a pretty broad-based set of approvals, we feel quite confident that, that's going to be a really nice addition to the portfolio.

And as Glenn commented, it was one of the bigger growers within the Derma portfolio on a percentage basis within the quarter.

And now that we have the channels brought together, obviously, selling our amniotic product, along with the other products in the portfolio, we think we can start realizing more of this one-stop shop vision that we've talked about over the last 12, 18 months. So a lot of good things kind of coming together..

Okay. Sounds like its more product at this point versus really coverage. So there's more to come then..

Yeah, coverage wise, keep in mind, we really just brought the teams together just a few weeks ago. I'd say, the folks feel very good about it. We expect in the third quarter that, that will start ramping up as everybody has taken over their new territories, really in the last few weeks.

So that reach and expansion, we'll see the impact of that here in the second half. And that's again part of our confidence why we believe that we can grow at a faster rate in the second half is because of the expanded coverage..

Okay. And then flipping over to extremities, again, very strong performance and another sustainability question, but you know the 50% growth in, I think you said, on the ankle side and then upper extremities double-digits.

Are you benefiting from some of the competitive disruptions that we're kind of hearing about in the marketplace? Or is this more within existing accounts, just better execution on your end?.

Yeah, it's a good question. I would say if you go to upper, it's really about adding the right incremental distributors in the right geography. And this is something we spent a good chunk of time on, so that's the part of it, filling out the gaps in our coverage plan.

And now, we've been focused on working on contracting as well for some of these larger joints in our extremities portfolios and some of the success, particularly in shoulder, has come from a large IDN contract that we've had, that we've been able to convert over clinicians from competitive units. So that would be shoulder.

And we view that that is a strategy that will hold on and it is something that we can continue to grow here in the second half. Relative to ankle, I'm not convinced that we're going to be able to grow at a 50% level.

But I think what it shows though is that, in the marketplace, there's a lot of energy around moving from fusion into ankles and finding the right solutions.

So, at the recent congress, which Glenn mentioned, there was just a significant amount of energy around the whole ankle space and I think we talked about in the last call as well as others, reimbursement in the Medicare space has just increased significantly, which has made it a much more economically viable procedure.

And now with Cadence and Salto, we just have, I think, a very good lineup.

You've got the product with the best clinical information out there, and we think, with the Cadence, the feedback that we get is versus a three piece or some of the older two piece systems out there, you can complete a case on Cadence in 45 minutes where it may take an hour-and-a-half on one of the older systems.

And so that has a lot of surgeons coming our way, giving it a try and that was evidenced by at the recent congress. We had a semi there with multiple training labs in it and we pretty, well, booked out the whole event.

So, again, still small base for us, but this is a pretty exciting area, and as you know, probably the fastest growing area within orthopedics right now. So we're happy to have that kind of lineup in the ankle portfolio..

Very helpful. Thank you..

Thank you..

[Operating Instructions] Thank you. We will take our next question today from Steven Lichtman of Oppenheimer & Company. Please go ahead..

Good morning, Steve..

Thank you. Hi, guys, Good morning..

Good morning..

Guys, things are going well, obviously, you just mentioned in total ankle and shoulder.

I wonder if you could flesh out a little bit more, what are you seeing as the opportunity to pull that through, particularly on the broader lower extremity business looking forward?.

Yeah. Steve, so it's a great question. And as I commented, I mean, I wasn't happy outside of ankle with our overall lower performance. It's still a very, very small part of our business. But the fact is, is that if we can be able to turn that around to market performance, it can be a pretty significant lift for us.

And so, in the beginning of the year, in the second quarter, we put a lot of energy around shoulder. We put a lot of energy around the ankle program. And I think what we've learned from that experience is, is that more focus, particularly in the right metro areas delivers the kind of results that are transferable to the rest of the lower system.

So that's one message, which means that we've already added just in the end of Q2 into Q3, what we call is associate sales reps, ASRs. And what they are is non-commissioned reps that come in and help run cases, spend time really taking care of surgeons, while our key rep can be out finding new business.

And that's been a capacity constraint for us that, that model we believe is going to help us. Then the ASRs, obviously, after a few years of experience are perfectly positioned to take over their own territory. So that's one method and that's something that we're ramping up on.

But in general, having more focus on a particular part of the anatomy, more focus in a particular geographic area to allow more specialization is how we think success will come.

Again, back to the ankle, what we've been able to do is we have a very effective group of ankle specialists that actually work with our broader full line rep and that combination has made a big difference. I'd say those are the two biggest contributors, and then obviously, the third part is a more robust portfolio, which we are making progress on.

And I'd say at the end of the year going into next year, we actually have a few updates to that lower system. But we have plans in place, I would say, to take the lessons that we've learned here from ankle and apply it to the rest of the orthopedics portfolio later in this year..

Great. Thanks. And then just as a follow-up, one of the strategies you mentioned on Dural Repair is channel strategies. That sounds like an interesting counter lever to some of the competitive dynamics you talked about. I'm wondering if you could discuss that a little bit more..

Well, I mean, a simple thing is, I would say, if you're selling a capital piece of equipment, you have some time with the surgeon in the OR but you have a lot more out of the OR and you have a lot more time with the administration.

If you're selling Dural Repair products, you're typically in the OR with the surgeons and spending a whole lot more time as during the procedures.

So when I talk about that channel (56:47), it's actually in the lab with your surgeons, really being able to talk about, really the whole broad spectrum of products we have, but in particular, special focus was on Dural Repair.

And I think probably within the end of Q1 and Q2, just because of the overall excitement and candidly the amount of opportunities that we've had on Clarity and tissue ablation, we probably took our eye a little bit off of the Dural Repair side of things. And I think it's correctable pretty easily with the focus that I mentioned.

But I think that's my honest view of kind of how we ended up in Q2 being light on the Dural Repair side..

Got it. Great. Thanks, Pete. Thanks, guys..

Thank you. We will now move to Travis Steed of Cantor Fitzgerald. Please go ahead..

Thanks for taking my question. So I wanted to get a little more color on the CUSA Clarity launch.

Some of the initial trialing that you've seen so far, how much of that's been with competitive accounts? And for the second half of the year, are you still expecting that launch to accelerate the business to the high single-digit growth area or it's going to be more than that?.

Hey, Travis, it's Glenn. So far, the feedback we've got from CUSA Clarity has been extremely positive. For the second quarter, our capital business for CUSA had double-digit growth. We expect that growth to continue to do well in the back half of the year with at least double-digit growth in our capital business.

Hard to say how much of that is coming from competition versus replacing the installed base. I am aware of some accounts that we have flipped from competitor to Integra, but I can't give you the exact percent.

But we're seeing progress on both fronts in terms of the excitement around the capabilities of the CUSA Clarity, the ease of use, the ergonomics and then the handpiece feedback we're getting has been tremendous. The fact that it removes fibrous tissues at a 50% faster rate.

All great feedback and we're seeing that growth starting to pick up here in Q2 and we expect it to continue in the back half of the year..

Yeah, Travis, the other thing I would add to it is, typically, the way this plays out with capital is you spend a lot of time with your friends and your current users that want to upgrade or work their fleet. And since we've had a really strong response there, that's been a pretty consuming part of it.

To Glenn's point, we clearly, around the world in different countries, have already some competitive conversions.

But typically, the way I expect more of that to happen is probably in about a little bit three or third (59:27), the fourth quarter into the launch as the trials typically, from a competitive system, take a little bit longer, obviously, because they've been using another system. They want to think through a little bit more.

But the feedback has been, I think, from users of all types of systems that we've really hit the mark here relative to the ease of use, the setup, the reliability, thus far, looks very, very good from all the metrics that we've laid out and its capabilities.

So we're pretty excited about, again, not just what this means for next two quarters, but there's a large installed base of our systems as well as others, and this can be a three- to four- to five-year type of an upgrade path that will continue to drive growth for us..

And some of the (01:00:12) that we have today, Travis, will end of life some of the older CUSAs. That's obviously helping to upgrade our funnel opportunities here as well. And we have a very strong funnel heading into the back half of the year..

Okay. All right. Great.

And then one quick one on Codman, in terms of the divestitures and some of the conversations you're having with the FTC, are those businesses overlap kind of in line with what you expected going in into the acquisition? And also, in the international tenders that you expect in the second half of the year, is there any more thoughts or visibility on how you'll perform with those tenders?.

So I would just say on the FTC, I really can't comment a whole lot more. I think coming into the acquisition, we obviously had spent a lot of time thinking about where we match up with them and where there may be questions. And so I would say, it's not out of the ballpark of how we thought about the deal and whether there may be questions that arise.

So that's kind of what I would say from that standpoint.

I think on the tenders, Glenn, you may want to talk about the international front?.

Yeah, so we're still counting on probably $3 million to $4 million of tenders in the third and fourth quarter outside the U.S. It's mainly in Europe with our instruments business. And we feel very confident we're going to win those. These are instrument tenders that we've won in the past, so they're not new tenders or new customers, so to speak.

And we feel confident we'll get those, but they're not significant. We think about the international tenders that have to happen to get to our international growth targets for the full year, is probably to the tune of $3 million to $4 million. We've got good line of sight to them and we feel confident we'll get those closed in 2017..

Okay. Great. Thanks for taking my questions..

Sure..

Thank you. We now take a question from Jayson Bedford of Raymond James. Please go ahead..

Good morning. Thanks for squeezing me in. Just a couple of quickies.

Glenn, just around ablation, how much of that segment is capital? Meaning, you're talking about double-digit growth in capital, I'm just wondering what is kind of the expectation for revenue growth in that segment?.

So roughly, 35% to 40% of the total sales in tissue ablation is capital. The majority is still disposables..

Okay.

And so, if capital is growing double-digit, what's your expectation for the disposable growth?.

Well, it's going to – what the plan is, Jayson, is as we go into the second half, that's going to grow probably in the high single-digits range. What drives a lot of that is the fact that the new disposable structure on CUSA is a full captive system.

So, in the past, the disposables kind of lagged in other systems because, in many cases, there was a sharing of handpieces and subs because this is a (01:03:12) new system. I think, out of the blocks, we expect that the run rates on the disposables won't be as high as the capital because, obviously, the capital pricing is significantly different.

But it will have a pretty big pickup relative to what we've historically seen in disposables..

But clearly, most of the growth, if not all of it, is going to really come from the capital side in the back half of the year..

Yeah, for sure. Disposables only come with use..

Okay. Maybe just kind of (01:03:45) revenue line, SG&A generated a bit better leverage then we thought. I think you alluded on the call to lower G&A being the source of the strength. So I guess two questions.

First, what is G&A as a percent of sales? And then second, outside of the Codman spend that you're pulling forward in the third quarter here, are the reductions that you saw in G&A this quarter sustainable going forward?.

Yeah, again, when we talk about SG&A as a percentage of sales, we were down year over year 170 basis points on G&A. So if you remember last year, we were in the mid-16% range. That means we're approaching something around 14.5% to 14.7% right now. And we expect more leverage to come. So the answer is, yes, it's sustainable.

And we expect to continue to get leverage as we grow revenues at a much faster rate than G&A costs. Keep in mind, our G&A costs are going up but just at a much slower rate than revenue. So we're not necessarily cutting G&A, but it's just managing it to grow much slower than the overall top-line growth we're seeing..

Okay. Thank you..

Thank you. We will now take a question from Larry Biegelsen of Wells Fargo. Please go ahead..

Hi, guys, it's actually Craig on for Larry..

Hi, Craig..

Just wanted to ask on DuraSeal, on the competition there from HyperBranch, Pete, I think you said, as you alluded to earlier in the call, they've been on the market for roughly 18 months. You guys have been tracking them pretty closely.

So I know you said that there were some trialing and some price – maybe it was an issue of price getting into some of these accounts.

So I just wanted to ask, was there anything else that you were seeing specifically in the past quarter? Were they – the competitive pressure did ramp up?.

Well, it's kind of – the comment that I made, Craig, is the fact that much more aggressive use of price to get a shot at trialing the product and some success with a more integrated delivery system hospital. And that allows them to actually get some trialing in a couple different areas.

So nothing other than really getting hyper aggressive to try to get their product in to get trialed. And we've had accounts already where it's been trialed and then the account hasn't taken it. They've come back to DuraSeal. Or in many cases, they keep both on the shelf because, again, the HyperBranch product only has a cranial indication.

It does not have a spine indication, which can be 30%, 40% of the use of the product. And so obviously, they wouldn't promote it for off-label use. And so you'd still need to use DuraSeal as well.

But it was aggressive use of price and access into some larger accounts that actually did trialing and between the price impact and maybe slowing of volume in those accounts, that's the impact that we felt..

And, Craig, just keep in mind, even when we're holding these accounts, where Adherus is getting their trial, even a failed trial cost us procedures. And so that's what we're seeing here in the quarter. So we're holding a lot of the accounts, but it is costing us a procedure growth.

And so, yeah, we think we'll get through this in the short-term, but just keep that in mind in terms of the inroads that they're making. We're actually doing quite a good job of keeping them out of most of our accounts..

Okay. Thanks. That's helpful. And secondly, I wanted to ask on the outpatient reimbursement for wound care, I know the proposed rule that just came out, I know that there were no changes to wound care products for 2018.

But there was some mention that some products were identified that might eventually be moved to the lower cost bucket and PriMatrix was one of those.

So I just wanted to get your thoughts on kind of the reimbursement landscape at least from CMS and kind of what you see there and what impact it could have if PriMatrix fell into the lower cost bucket?.

You know what, I would say, first, Craig, you're right. It isn't falling into the low-cost bucket based on their grandfathering, so to speak, the structures. And I think there is a lot of learnings going on relative to the whole reimbursement structure with CMS. Our guys have actually spent some time with them as well.

There's been a lot of other companies been involved in some of the different dialog.

I would say just based on the new sizes that we actually have as well on how the algorithm is calculated, the growth of our new sizes alone in smaller sizes, based on nothing changes, really takes the risk of our change in reimbursement bucket, down significantly because of the growth of those smaller sizes.

And why is that? Well, the price per square centimeter is much higher than larger sizes. So we think that risk for 2019 is significantly lower.

And the fact that there has been some changes that would keep it into the higher reimbursement bucket in 2018, we think, obviously, is the right decision because it's obviously a more cost effective way to treat the wound. But I feel pretty confident based on what we've seen and the growth of what size is the PriMatrix.

Based on current calculations, that will be fine..

Great. Thanks for taking the questions..

Yeah, thank you..

Thank you. We now take a question from Young Li of Barclays. Please go ahead..

Hey, guys, thanks for squeezing me in. Just, I guess, on the international side, you had a nice rebound in performance this quarter.

Can you talk about the sustainability of that growth, given the investments you made there?.

Yeah, so if we look at our international business, mid-single digit organic growth was in-line with our plans. Seeing very good growth coming out of certain parts of Europe, we had a really strong quarter in France and Germany. And outside of Europe, China posted very strong growth.

And that's something we've seen now for three consecutive years in China. And a lot of that has been the investments that we've been making. If you look at China, as an example, four years ago, we didn't even have an entity, so to speak. And we've gone from one employee now to up to close to 30 commercial resources in China alone.

And so those investments that we're making both around the people, infrastructure, are really starting to pay off. And as we look out the rest of the year, we would expect the international growth to continue to at least being in the mid to high-single digit range..

All right. Great. That's helpful. I guess with the positive CMS reimbursement update for ankles, it's a pretty substantial increase to current rates.

Can you maybe talk about how that changes your view on the opportunities for that business and maybe expectations for market growth or potential for price increases?.

Well, I would say that we've been expecting that there was going to be some corrections at some point this year. So we're pleasantly surprised that it is coming in place here in the second half. I think, as I mentioned, ankle really, it's obviously a smaller market at this point in time, but it is the fastest-growing segment within Orthopedics.

And it's going to grow, we think, in the upper-double digit range from a market standpoint. So we're obviously very excited to have two of the leading ankles within that realm.

I clearly think for the area of dealing with ankle issues and having United States market being 80% plus fixation, this clearly has the opportunity to convert more of those fixations into mobile-based ankles.

And so that's the part that we believe with the size of the fixation market could be a nice growth engine for all orthopedic companies with a competitive ankle over the next few years..

All right. Great. Thank you so much..

Thank you..

Thank you. We now take a question from Christian Moore of Jefferies. Please go ahead..

Hi, good morning, and thanks for squeezing me in here. Just had a question on the gross margin line. This is the first quarter in a long time that we've seen it down year over year and also sequentially, pretty significantly. I know that you addressed the integration of Derma at lower margin, outperforming being a contributing factor there.

But was there anything else in the underlying business? May be more international revenues that also drove the margins and then with the revision down 69% this year, what do you see is kind of a longer-term rate looking into 2019 and 2020? Are you able to achieve north of 70% in the longer-term? Thanks..

Yeah, Christian, thanks for the question. Relative to our gross margins and the sequential decline from Q1 to Q2, keep in mind we had a full quarter of Derma Sciences dilution versus essentially one month in the first quarter of the year.

So the reason why the sequential decline was having Derma Sciences in for the full quarter, in addition just keep in mind the mix is unfavorable as we have higher Derma Sciences sales and also lower Dural Repair sales.

Dural Repair is a very profitable franchise and so I just highlight the mix issue and that's the reason why we took our gross margin guidance down to 69% for the full year. As we exit 2017, clearly, we see more opportunities to drive gross margins higher and would expect to get into the 70% or so range given the next couple years post Codman close.

So we still think there's an opportunity to do better on gross margin. We see 70% as feasible after we integrate these two acquisitions..

Thanks. And then maybe just one last one, I know it's been asked a lot.

But on Dural Repair and what you're seeing in the business overall there, understanding that you lost a few points of market share maybe in the quarter and doing things to address that, but in the market in general with the increased pricing pressures, do you view the overall market growing at a slower rate in the medium- to long-term? And then what is that market growth that you're seeing coming out of the quarter?.

So I would say, this is Pete, we haven't seen really any major market changes from a growth standpoint within the quarter. I mean, if you think about neurosurgery, it's still a market that, from a procedure standpoint, only been growing in the range of 3% to 4%, in that range at the most.

So we haven't seen any significant changes from that and really don't expect any this year..

Great. Thank you..

Yep..

Thank you. We'll take our next question from David Turkaly of JMP Securities. Please go ahead..

Thanks. Just quickly, I saw the announcement from you guys in May to distribute a product and I don't usually think of you guys as necessarily being sort of a distributor. I always kind of think of you guys as buying sort of ancillary technology. So I'd just like to get your thoughts on sort of that deal.

And then, if you look at maybe trauma more broadly, your build versus buy versus kind of distribute, what were your thoughts might be there for some of the complementary products?.

Dave, I mean, when it comes to filling the portfolio out, we typically take a look at a lot of different plays, everything from manufacturing our products, and design ourselves to actually sourcing some different products, particularly if there are some very good ones in the market that have IP clearance. So it's not a typical.

It's something that we do and in that case, I think you're referring to a distal radial plate I think. So those are things that we would typically do, and obviously, helps us fill out the broader extremities portfolio a little bit faster than going through a normal R&D development process.

What was the second part of your question? Dave?.

I guess maybe – yeah, can you hear me now?.

Yeah, I can, sorry..

Sorry about that.

I guess maybe your thoughts on sort of the trauma in general and then, as you look at getting bigger, let's say even on the extremity side, your thoughts on how you'd do that, whether it's by build or distribute other products?.

Yes, as you know, we're really -- what we would categorize as a cold trauma, not a primary trauma company. And so our goal is not to be in that primary trauma business but into all types of related issues or secondary where there's follow-up within orthopedic surgeons or the prod's (01:17:41) office.

And so we think that market's going to continue to expand and grow, obviously, it ties to the older age of the population, some of the obesity trends and such and so that's the – our focus is to be able to fill that out.

There's a lot of reasons why we think lower extremities in particular, surrounded around this ankles platform that we're building out, makes a lot of sense, and complemented with the soft tissue plays. I think when you go to upper, we think that we've got a solid shoulder and a tight shoulder.

And the platform that we are advancing behind the scenes is this pyrocarbon shoulder product as well.

And so those were the two kind of key product areas that I would say would have the biggest impact on the long-term growth of the portfolio and to some previous questions, I think with the success we're seeing in some of the channel changes that we've made, we think we can apply that to the rest of the portfolio and see market in above market profile coming out of orthopedics down the road..

Thank you..

Thanks..

Thank you. Ladies and gentlemen, I would now like to turn the call back over to Mr. Peter Arduini, President and CEO for any additional or closing remarks..

Thank you, operator. And again, thanks everyone for the longer call today and getting through all of your questions. I just like to reiterate that, again, we're tightening our revenue range for the full year and we are reiterating our earnings per share outlook.

We're also getting some good traction in our new product launches and are really looking forward to continued acceleration in the second half. And then second is that we're looking forward to this planned acquisition of Codman Neurosurgery in the fourth quarter. And that we are reiterating our financial framework around the acquisition.

So again thanks again for participating in the call and we look forward to updating many of you in person later in the year. Thank you..

Thank you..

Thank you. Ladies and gentlemen, that will conclude today's conference call. Thank you for your participation. You may now disconnect..