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

Travis Steed - Bank of America Merrill Lynch Shagun Singh - Wells Fargo Securities LLC David L. Turkaly - JMP Securities LLC Robbie J. Marcus - JPMorgan Securities LLC Craig William Bijou - Cantor Fitzgerald Securities Rajbir S. Denhoy - Jefferies LLC Jonathan Demchick - Morgan Stanley & Co. LLC Matthew Taylor - Barclays Capital, Inc.

Steven Lichtman - Oppenheimer Jayson T. Bedford - Raymond James & Associates, Inc. William G. Inglis - Piper Jaffray & Co..

Good day, and welcome to the Integra LifeSciences' Fourth Quarter and Full-Year 2017 Financial Results Conference Call. As a reminder, today's call is being recorded. At this time, I'd like to turn the conference over to Mike Beaulieu, Director of Investor Relations. Please go ahead, sir..

Thank you, Andrea. Good morning and thank you for joining the Integra LifeSciences' fourth 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 fourth quarter and full-year 2017 financial results. The release and corresponding earnings presentation, which we we'll reference during the call are available at IntegraLife.com under Investors, Events & Presentations in the file named Fourth 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 an exhibit to Integra's current report on Form 8-K filed today with the SEC. I'd now like to turn the call over to Pete..

Thank you, Mike, and good morning, everyone. I'm going to start today's call with some brief comments on our performance for the fourth quarter and full year of 2017, and then I'll turn the call over to Glenn who will provide more details on our financial results and our outlook for 2018.

In 2017, we achieved several significant milestones, which include closing the two largest acquisitions in the company's history, successfully executing the global launch of the CUSA Clarity tissue ablation platform and launching seven new regenerative products.

I'm also pleased to report that in the fourth quarter we restored operations at our Puerto Rico facility, following Hurricane Maria ahead of schedule. Total sales in 2017 were $1.19 billion, an increase of over 20% over the prior year and 4.6% on an organic basis.

Adjusted earnings per share increased 10% to $1.94, marking four consecutive years of double-digit EPS growth. Turning to slide 4 in the earnings presentation, I'd like to share some highlights for the quarter.

Fourth quarter sales were $368.6 million, an increase of 44% on a reported basis and 5.8% on an organic basis over the prior year, ahead of our expectations. The outperformance was broad-based resulting from both high organic revenues and better-than-expected performance in both of our recently-acquired businesses.

The strong top-line performance led to adjusted earnings per share of $0.64 in the fourth quarter, an increase of over 23% from the prior year's quarter and $0.09 higher than the midpoint of our guidance range.

Looking at our segment highlights, Codman Specialty Surgical's fourth quarter sales increased 46% over the prior quarter, primarily attributable to the recent acquisition. Organic growth in this segment was 2.3% with sales in dural repair slightly better than our expectations and CUSA Clarity growing double-digits sequentially.

Fourth quarter sales from the acquired Codman business were $77 million compared to our guidance range of $69 million to $74 million. Immediately following the close of the acquisition in October, we implemented our transition plans, which minimized disruption in the sales channel, resulting in better-than-expected fourth quarter performance.

We're pleased that our plans are on track, but we have much more integration work taking place in the first quarter of 2018, which we'll discuss in more details in a few minutes.

Moving to our Orthopedics and Tissue Technologies segment, fourth quarter revenue increased about 40% on a reported basis over the prior-year and over 11% on an organic basis.

The strong growth in the organic sales was driven by regenerative products, which grew in the high-single digits area, while both our total ankle and shoulder portfolios grew double-digits.

Sales in our private label business were several million dollars above our forecast in the fourth quarter as we fully restored operations in our manufacturing facility in Puerto Rico. This increase accounted for about half of the over-performance in our organic growth.

Turning to Derma Sciences, fourth quarter sales were $26 million, which was ahead of our expectations, driven by higher sales in our advanced wound care portfolio. And since we closed the acquisition in February of 2017, total sales were almost $85 million, or $5 million over our guidance.

Wrapping up our discussion on the OTT segment, I'd like to provide an update on our channel expansion strategy, which we announced in December at our Investor Day. We've completed our new territory assignments and now have two distinct sales channels, with one focused on extremity orthopedics and the other on inpatient wound reconstruction.

We're continuing to add commercial resources and have put programs and incentives in place to encourage collaboration among our sales teams during this transition. Before turning the call over to Glenn, I'd like to announce that Sravan Emany has joined Integra and will take over the role of Vice President, Treasurer and Investor Relations.

Sravan has most recently been a member of the Bank of America Merrill Lynch Mergers and Acquisition team where he led a number of transactions in the health care sector, including Integra's recent acquisitions of Codman Neurosurgery and Derma Sciences.

We're excited to have someone with Sravan's combination of health care experience and financial acumen as part of our executive leadership team. Sravan's on the earnings call with us today, and we look forward to having him meet all of you in the near future.

And with that, I'll turn the call over to Glenn to review the quarter in more detail and provide information on our 2018 guidance.

Glenn?.

Thanks, Pete, and good morning, everyone. Total sales in the fourth quarter increased by 44% to $368.6 million, exceeding our expectations by almost $19 million when compared to the midpoint of our guidance range.

This over-performance resulted from better-than-expected results in both our newly-acquired businesses, which together exceeded expectations by about $10 million, as well as better-than-expected organic sales of about $6 million and foreign currency translation accounting for the remainder.

Organic sales increased 5.8%, almost two full points higher than our October guidance. The strong performance in organic growth came from two areas, most notably, dural repair and private label.

The higher-than-expected revenue performance as well as a lower tax rate resulted in a much better than expected adjusted earnings per share, which grew more than 23% over the prior year's fourth quarter. Turning to slide 5, I'll begin with a review of the Codman Specialty Surgical segment.

Reported sales for the fourth quarter grew 46.2% to $239.4 million. Acquired revenues from Codman Neurosurgery of $77 million drove this increase over the prior year's performance. Organic growth in this segment was 2.3% for the quarter.

Looking at the franchises within at CSS, dural access and repair increased about 5% organically on a year-over-year basis with strength in both our DuraGen and DuraSeal product lines.

We're seeing the benefits from the actions we took in the second and third quarters of 2017, which included the publication of our health economic study and increased contracting efforts that have combined to help reinvigorate DuraSeal's performance in the U.S.

In the first quarter of 2018, we're heavily engaged in integrating and training our commercial teams, and as a result, expect DuraSeal sales to be flat compared to the prior year. Once we get beyond these efforts, we believe that our overall channel expansion will foster higher growth in our dural repair business.

Moving to precision tools and instruments, fourth quarter sales increased about 2% compared to the prior year driven by growth in our MicroFrance business and specialty surgical instruments.

In the Advanced Energy business, organic sales increased low-single digits year-over-year, mostly because we faced a tough comparison to the prior year's quarter. Having said that, CUSA Clarity delivered strong sequential double-digit growth in the fourth quarter and remains on track with our launch plans.

In our neuromonitoring business, organic sales were roughly flat quarter-over-quarter, in line with our expectations. Sales in our CSS management franchise also performed in line with our expectations.

This business mainly consists of Codman Neurosurgery products such as the BACTISEAL catheters and our combined full line of hydrocephalus programmable and fixed pressure valves.

International sales within this segment increased almost 7% driven by the strong performance of instrument sales in Europe and several sizable international orders, which we previously mentioned would occur late in 2017.

Moving to acquired revenue, fourth quarter sales at Codman were $77 million, about $5 million higher than the outlook we provided in October, as we had lower than expected disruptions during the first three months of the transition. Excluding electrosurgery, sales were in line with past performance.

These results are an encouraging sign of our ability to maintain sales continuity through heavy transition and employee on-boarding activities. Turning to our full-year 2018 segment guidance, we expect revenues in CSS to increase 32% to 34% on a reported basis and about 2% on an organic basis.

We expect full-year Codman Neurosurgery revenue to be in the range of $325 million and $335 million, consistent with our prior guidance. Let me now move to our Orthopedics and Tissue Technologies segment on slide 6. Fourth quarter sales were $129 million, representing an increase of 40% over the prior year.

Strong organic sales, which increased 11.6% in the quarter, and $26 million of incremental sales from Derma Sciences, drove this performance.

Sales of our regenerative technologies increased high-single digits in the fourth quarter and were led by strength in our Integra skin and PriMatrix product lines, which increased double digits in both the inpatient and outpatient settings.

Pro-forma fourth quarter sales in advanced wound care increased double digits, resulting in mid-teens growth for the full year.

As Pete mentioned earlier, our manufacturing facility in Puerto Rico returned to normal operations during the fourth quarter and resulted in a double-digit increase in our private label business over the fourth quarter of the prior year.

Turning to our total extremities business, sales increased almost 8% during the fourth quarter, driven by double-digit growth in both our total ankle and shoulder arthroplasty product lines. Lower extremities, excluding ankle, was down about 5%, in line with our expectations.

International sales in this segment increased around 13% in the quarter, driven by strong sales of regenerative technology products and the Cadence Ankle in Europe.

Turning to full-year 2018 guidance for the Orthopedics and Tissue Technologies segment, we expect reported revenue to increase in the range of 10% to 12% and organic revenue to increase in the range of 8% to 10%. Please turn to slide 7 for our consolidated revenue guidance.

Based on the segment guidance that I just provided and a higher benefit from foreign currency, we expect to achieve the high end of our full-year 2018 consolidated total revenue guidance range of $1.46 billion to $1.48 billion, representing growth of about 25%.

This guidance range implies organic growth of about 5%, consistent with our prior guidance. For the first quarter of 2018, we expect total reported revenue of between $347 million and $352 million, which includes about 2% organic growth. This guidance reflects the expected channel disruption in both of our segments.

Turning to slide 8, I'll review the key components of our fourth quarter and full-year P&L performance. Fourth quarter adjusted gross margin was 67.1%, a decrease of 310 basis points from the prior year. For the full-year 2017, adjusted gross margin was 68.5%, down 100 basis points from the prior year.

The declines were largely attributable to dilution from both acquisitions, unfavorable manufacturing variances associated with restoring operations in Puerto Rico and unfavorable product mix. For the full-year 2018, we expect adjusted gross margin to be in a range of 68% to 69%, consistent with our prior guidance.

Fourth quarter R&D expense was 4.7% of revenue compared to 5.4% in the prior-year period. R&D was lower as a percent of revenue resulting from the addition of acquired revenues without the corresponding increase in R&D expenses, as we are in the process of rationalizing and prioritizing our R&D projects for CSS.

For 2018, we expect R&D expense to increase to about 6% of sales. Adjusted SG&A was 41.1%, a decrease of 80 basis points quarter-over-quarter, largely driven by better leverage of G&A costs. For the full-year 2017, adjusted SG&A was 43.5%, roughly flat versus the prior year.

In 2018, we expect adjusted SG&A between 42% and 43%, down about 100 basis points from 2017. Our adjusted EBITDA margin for the fourth quarter was 24.1% compared to 26% in the prior year's fourth quarter, while full-year adjusted EBITDA was 22.7%, a decrease of 70 basis points from 2016.

The decreases for both the quarter and the year resulted mainly from the dilution associated with the Derma Sciences acquisition. We expect our adjusted EBITDA margin for the full-year 2018 to be in the range of 23% to 24%, representing an increase of about 80 basis points over 2017 using the midpoint of our guidance range.

Also, as part of the Codman acquisition, we entered into cross-currency swaps to hedge foreign currency risk and to take advantage of lower interest rates in Switzerland. In the fourth quarter of 2017, we received a $2 million benefit, which is reflected in other income, and we expect a similar benefit in each quarter of 2018.

Our adjusted tax rate for the full-year 2017 was 23.2% compared to 26.3% in the prior year. The decline in our tax rate occurred mainly because of higher income in low-tax jurisdictions, principally in Ireland and Switzerland.

For 2018, we're forecasting an adjusted tax rate of approximately 20%, largely based on the recently enacted Tax Cuts and Jobs Act and from the benefit of a tax structure that we just established in Switzerland, following the Codman acquisition.

Adjusted earnings per share for the fourth quarter increased about 23% to $0.64, compared to $0.52 in the same quarter of the prior year. Higher organic and acquired revenues, as well as the effect of the lower tax rate, drove the increase and the over-performance versus our guidance.

Based on our full-year outlook for 2018 and the guidance I just provided for revenue, expenses and tax, we expect GAAP earnings per share to be in the range of $0.60 to $0.70 and adjusted earnings per share to be at the high end of our previous guidance range or about $2.35.

This guidance assumes an additional benefit of about $0.12 coming from the lower tax rate with about half of that offset by higher interest expense due to the interest rate swaps that we recently executed, as well as an assumption for higher interest rates in 2018.

In the first quarter of 2018, we expect adjusted earnings per share of between $0.48 and $0.51, which based upon the midpoint of the guidance, represents about 25% growth year-over-year. Please turn to slide 9 for information on our cash flow performance.

Our operating cash flow in the fourth quarter of 2017 was $11.6 million, largely impacted by one-time acquisition and integration costs. Fourth quarter capital expenditures were $13.7 million, down $7.5 million from the fourth quarter of 2016.

For the full-year 2018, we expect capital expenditures in the range of $65 million to $75 million, as we plan to make significant investments to build out our manufacturing facility in Massachusetts and an IT infrastructure outside the United States.

For 2017, our adjusted free cash flow conversion ratio was about 46%, a decline from 83% in 2016, due to significant one-time cash outlays associated with the acquisitions.

We expect the free cash flow conversion rate of about 50% for the full-year 2018 and then expect to see improvement beginning in mid-2019, as we move past these one-time integration costs. Please turn to slide 10 for an update on our capital structure as of December 31, 2017.

Our cash balance at the end of the fourth quarter was $175 million with net debt of about $1.7 billion. Our bank leverage ratio at December 31 was approximately 4.1 times, well below our bank covenant of 5.5 times. Consistent with our prior messaging, we had expected to reduce this leverage ratio by about a half a turn in 2018.

Given our slightly-lower bank leverage at the end of 2017, we now expect to end 2018 below 3.7 times, which is lower than our previous guidance.

In the fourth quarter, we entered into additional interest rate swaps to reduce our variable rate debt from about 80% at the close of the Codman acquisition to about 50% at the end of 2017, thus reducing our future interest rate exposure. The guidance that we provided reflects the additional interest expense associated with these transactions.

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

Thanks, Glenn. 2017 was a transformative year for Integra. We closed the two largest acquisitions in the company's history, added over 700 employees, expanded our regenerative portfolio with new, innovative products and successfully executed the global launch of CUSA Clarity.

Importantly, we effectively navigated a few challenges, specifically in our dural repair business and at our Puerto Rico manufacturing facility.

In December, we laid out our long-term strategy, which includes the following targets; organic revenue growth of 5% to 7%, EBITDA margin expansion of 650 basis points and consistent double-digits adjusted earnings per share growth. If you'll turn to slide 11, I'll wrap up with some closing thoughts.

Looking forward to 2018, we believe that we are well positioned for a year of strong performance. Our revenue guidance of nearly $1.5 billion and 5% organic growth clearly puts us on a path to achieve our five-year target of $2 billion in sales.

We expect to see 75 basis points to 100 basis points of EBITDA margin expansion in 2018, as we leverage our revenues through the cost base. Over the long-term, we have opportunities to improve our performance through further optimization and consolidation of our manufacturing footprint.

These efforts along with an improving product mix and sales productivity gains will drive us closer to our longer-term EBITDA target of 28% to 30%. As I mentioned in my opening remarks, our Codman integration efforts remain on track. We have a lot of integration work planned in the first quarter.

We just completed multiple global product training programs in the first quarter, where teams were cross-trained on the entire neuro portfolio.

This training coupled with territory realignment will result in more time out in the field in the first quarter than in previous years and this is in line with our plans and why we're forecasting some disruption in the first quarter.

Our next milestones in 2018 include ongoing activities to transfer and integrate acquired operations and systems into Integra's, so that we can begin to access transition services agreements. In the second quarter, we expect to see the merits of our larger portfolio and expanded sales coverage beginning to take effect.

Within OTT, we're also beginning the year with significant investments in the channel expansion strategy. We're confident that creating distinct focused sales channels in our extremity orthopedics and inpatient wound reconstruction franchise will begin to drive stronger performance in the second half of 2018.

We have been conducting intense sales training during the first quarter, focused on key product families and clinical indications, positioning us for improved growth.

With our deep and broad regenerative technology platform and new products in extremities orthopedics such as the Cadence Ankle, we're excited about the growth opportunities we can achieve with more focused channels, while leveraging our enterprise contracting capabilities. That concludes our prepared remarks.

And Andrea, if you would, please open up our lines for questions..

Thank you. And we'll go first to Travis Steed with Bank of America..

Good morning, Travis..

Good morning. Thanks for taking the questions. So first of all, is FX about a $0.02 tailwind on EPS in 2018? And then just wanted to get a better understanding about your margin guidance staying the same. FX is an incremental positive and the lower tax rate adds at least $0.12.

Just curious why your EPS range wouldn't move up more in 2018? It sounded like some of that would be higher interest expense, but how much has the interest expense assumptions changed since your Analyst Day?.

You want to take a shot at the FX?.

Yes. Sure. Good morning, Travis. It's Glenn. Relative to the FX tailwind, we did raise our revenue guidance to the upper end of the range, which reflects about $10 million of revenue coming from FX, and I would say it's probably a penny or two of EPS.

Relative to our EPS guidance, as I mentioned in my comments, the lower tax rate of about 400 basis points from our guidance drives around $0.12 of additional EPS and we did some things to lock in longer term rates here in the fourth quarter and our timing was quite good.

We locked in another $500 million of our debt for the next five years, and the result of that coupled with an assumption for higher rates in 2018 offsets basically half of that tax benefit.

And so when you net that out, call it $0.05 or $0.06 of additional upside and that's why we're moving from the $2.30 midpoint of our guidance range back in December to $2.35 now, and those are kind of the moving parts relative to EPS..

And I would just add, Travis, I mean, if you think about, again, both of the deals that we've done and just think of OTT, the channel expansion piece, we actually have a significant amount of hires yet that are going to be coming in, in that area.

And then if you think about on the Codman Specialty Surgical side, I think Glenn and I both mentioned the fact that we haven't come off of one TSA yet, so I mean, that will start happening in the latter part of Q2.

As we see how those costs are matching up, you know, is there some opportunity for upside? I think if everything executes extremely well there is, but as most things go, they never typically are run perfect, so we want to make sure that we're appropriately positioning what the profit picture will look like..

Okay. And then I wanted to ask a question about pacing over 2018, 2% revenue growth in Q1. How should we think about Q2? Is that more in the 3% range and then kind of back to 5% to 7% by Q4? And then also, a quick one on electrosurgery.

Once you launch the generator later in probably Q4, is there any pent-up demand? Just curious if there's any bolus of revenue that could come through with that launch..

Yeah, so Travis, maybe I'll take a shot at the first part of the question, and Pete, you can comment maybe on the generator. Relative to how we see the organic growth playing out in 2018, I mentioned 2% growth in the first quarter.

I would just say we're not going to provide guidance yet on the specific quarterly breakdown only to say obviously we'd expect faster organic growth in the second quarter, and most of the organic growth would obviously come in the back half of the year.

And again, I think driver behind that is getting the sales force trained, getting people in the field for a full quarter in Q2, and then just having incrementally significantly more resources selling should drive some faster organic growth in the back half of the year..

And then relative to electrosurgery, Travis, think about electrosurgery as when you think of a number, about 60% of it on disposables, 40% of it on the capital component. We have kind of part of the portfolio on the disposables right now.

We'll have the rest of the disposable portfolio I think in place here by summertime, and so we'll start seeing some of the benefits of that as we go into the second half of the year. And some of that's a combination of territories aligned, the ability for our instruments team and neuro teams to both reach out to customers on that.

As far as the capital side, plans are coming together well for later in the second half. I think we'll get that launch, but I think realistically, the capital's not going to have that much of a material impact at all within the year.

The bigger driver will be the disposables into the installed base, and we're on track with both the channel and training as well as the product lines to see some uptick in the second half..

Okay. Great. Thanks for taking the questions..

Sure..

And we'll move next to Larry Biegelsen with Wells Fargo..

Good morning, Larry..

Thank you. This is Shagun in for Larry.

Can you guys hear me all right?.

We can..

Hello? Okay. Great. I just wanted to follow up on Codman. Can you discuss the sales ramp a little better on Codman, especially as we look at 4Q 2018 year-over-year growth, it implies very robust growth into 2019.

And of course, you mentioned some of that is electrosurgery, but can you discuss how you can do about the underlying growth rate for that segment? And then just curious given the beat, why the degradation in (30:49) for 2018 with respect to the Codman revenue? Thank you..

So you were echoing quite a bit. I think your first question was related to – about the growth of 2018 into 2019.

Is that correct?.

That is correct. For Codman, 4Q 2018 ramps, it implies very robust growth into 2019, so just wanted to get clarity on the underlying growth rate for that segment..

Yeah, well, so if you think about CSS, which is where we have the neurosurgery business and obviously the Codman acquisition, we've talked about the underlying growth of that business being in the low-single digits, and that's kind of how we've seen it starting out the year.

I think the good news was ending 2017 into 2018, with all of the employee on-boarding and potential disruptions that we had, it performed in line. Now, we're not long-term happy with that kind of growth rate.

One of the reasons we purchased this asset, we think together our portfolio and the previous J&J portfolio, we can move that up into the mid-single digits growth range as we talked about when we modeled this out. And that's really tied to a few things. One is the much larger sales force that we'll have over a 35%, 40% larger U.S.

sales force and fundamentally doubling our O-U.S. infrastructure, entering into countries direct that we haven't reached before. So that's a big contribution of that growth and leverage that one will see coming out of the second half of 2018 going into 2019. And the other one is new products.

So the combination of the generator that I had mentioned, monitoring platforms, line extensions. Many of these extensions are very similar to the play we ran at Integra over the last few years.

And what I mean by that is very well-known Codman brands, tweaks that are needed to the product line that neurosurgeons are asking for, a very captive audience and the platforms that haven't been upgraded in a decade, and so as you bring those out, you see some pretty big pickup.

And our case in point would be something like our MAYFIELD head holder, which is a 40-year-old platform, but with the changes we made to that platform, which were an 18-month kind of turnaround process, we've been able to see double-digit growth come out of that platform.

So that's fundamentally how we do the out of back half of 2018 into 2019, and are pretty excited about getting this integrated and then be able to drive that. The second part of your question I think was also difficult to hear. Maybe you could repeat it. I think your second part of the question without the headset or into the normal phone was helpful..

I think you answered it, so that was fine. But just as a follow-up, can you provide color on the two countries, and if Codman China business has been transitioned to Integra? Thank you. That will be all..

So on Day 2 countries, so we've closed on China here in February. I think things are going very well. We've completed our training, the cross-training in China and both those actually in Japan, and so we're up and running. And I would say there's a series of other Day 2 countries that happen in the second half and into the beginning of next year.

Some of those are driven by long lead regulatory requirements like Brazil, but all on track and doing well. Thanks for your question..

Next we'll go to Dave Turkaly at JMP Securities..

Thanks. I was wondering you mentioned a channel expansion strategy in OTT, and I was wondering if you give us an update on where the two sales forces stand today and where you think they'll be by the end of the year..

Yes, Dave. It's a good question.

So, we in the fourth quarter communicated to folks about how the territories would be divided, how the structures would be setup, the leadership teams, the basic compensation structure so that was communicated in the fourth quarter and then literally the first few weeks of the year, comp plans were rolled out, so people would understand exactly how that would play out.

Also, I mentioned incentives to cross-sell.

As you could imagine, if you had a territory that had orthopedics metal and you also had tissue, you had some deep relationships on both sides and so as we split those, we have incentives throughout the year to have the two different channels share and make sure we make the appropriate tradeoffs and thus far, received quite well.

We have probably 25% of the reps that we will still be hiring throughout the year, so the biggest difference will be the channel will be fully trained and fully discrete by the end of the year. But as we start out the beginning of the year, I would say it's ahead of expectations relative to channel changes as they go. Everybody has been trained up.

We've had some very good training. Actually, there's some taking place this week. Our metal team was just trained recently, and we've been able to really, I think, focus on the needle movers in each of the areas.

Obviously things such as the ankle within the extremities area and the shoulder, in our tissue business being able to put significantly more time within reconstruction areas such as burn, as well as all types of surgical-type reconstruction that in the past we just haven't had the timeline.

So I think what we'll find out is much deeper relationships in evolving areas particularly in shoulder and ankle, and I think corresponding growth as well as on the inpatient tissue reconstruction, we're expecting more opening up of new accounts and new patients because of the time that's required in the lab, but all things look good as we start the year..

And I guess just a high level one, as you're looking at 2018 I'm glad to see that you're comfortable at the higher end of the earnings guidance that you initially gave, but would you say, as you look at the things that could move the needle the most in 2018 if there was potential upside, is Codman still sort of the biggest lever that you could see potentially deliver that as you move through 2018?.

Yes. I would say it's two things. First thing is, it's kind of global channel expansion for the whole company. And again, if you think about it, neurosurgery wise, we are double our presence outside the United States and 30% to 40% bigger in the U.S. and in certain segments within OTT, we're going to be almost double.

So we're going to be expanding, so just the channel growth associated with the coverage of high-quality products.

That's the biggest, and then the second is the point that you mentioned, which is the cross-selling and opportunity to detail and focus on Codman products, which we believe in prior years just didn't have the same focus they will at Integra..

Thank you..

Yes..

And we'll move next to Robbie Marcus at JPMorgan..

Good morning, Robbie..

Good morning. Was hoping you guys can provide a little more color on some of the different line items in 2018. So maybe the key drivers are the Advanced Energy and dural repair and your regenerative business. So maybe you could just give us your thoughts on the different line items and guidance..

Okay.

Glenn, do you want to take a shot at it?.

Yes. So when we look at Advanced Energy, obviously, quite excited about the CUSA launch, as we've talked about in the past, seeing some good momentum in the back half of this year. That should carry forward into 2018, so that will help the CSS overall organic growth....

With a larger selling team as well..

Much larger selling team.

Dural repair, we've stabilized that business here in the fourth quarter, as we mentioned, seeing a lot of the efforts that we put in place coming to be here with respect to the health economics study, the contracting efforts, and clearly we have the first quarter being down overall versus where went in Q4 from a data growth perspective because of the sales channel changes, but we expect dural repair to pick up growth once we exit Q1 and go into Q2, Q3 and Q4 and expect growth really coming from both our graft and our sealant business.

So, would expect that to be a nice contributor for us, especially as we exit Q1.

And then more broadly with regenerative products, we continue to see really strong growth in our legacy Integra skin business, PriMatrix is doing quite well both on the inpatient side and outpatient side, private label continuing to expect there to see double-digit growth, and overall, I think you've kind of hit the three key points in terms of drivers of organic growth for us in 2018..

And Robbie, I'll just comment about I used the words disruption in Q1 and just for everybody what we mean by disruption is disruption against actual selling time, and typically in the first quarter for us, it might be three to four days of out-of-the-field for a given rep for normal training and time, and this quarter, it's probably in the magnitude of about 12 days, and so think of that about half of it's sitting in training and learning the new products and half of it is working with your new counterpart to hand off some accounts, and so just that two-week component alone has probably the largest effect on the pull-down on growth rate in the first quarter..

Great. And just as a follow up, you have a key competitor who's at least on The Wall Street side going through some tough times with some investigations going on there.

This is also a time when you're out hiring sales reps, so have you seen any increased ability to get sales reps from your competitors here and is there any chance for you to take advantage of their potential weakness in the market? Thanks..

Yes, I would just say like with all scenarios, there's ebbs and flows on competitors being in tough situation, which always plays out there. So we don't typically comment on it.

I would just say when it comes down to opportunities, obviously when we're in a growing state, particularly in our product portfolios, we're going to be there for customers if they need the kind of support and the products that we can offer. So we'll be there.

And I would say as it comes to hiring, we're very much focused on our culture at Integra and finding the right individuals that fit the culture. If we find the right folks, we bring them in, but we don't bring in folks that may not fit our overall culture, and that's a really important part of our hiring process as well. Thanks for your questions..

We'll go next to Craig Bijou at Cantor Fitzgerald..

Hi, guys. Thanks for taking the questions. I wanted to start with the extremities number and I think if I heard you correctly, Glenn, it was up 8% in Q4, and while lower extremities was down 5%. So that would suggest, just given the relative size that ankle and shoulder were both very strong.

So I wanted to see if you could provide maybe a little color there on what's driving that strength. I know you guys have been doing well for the past few quarters, but any additional color..

Yes. So your numbers are accurate. We grew 8% overall in extremities. If you look at just ankle and shoulder together, they grew about 25% with the faster growth coming from ankle. And so we're seeing a really strong momentum with the Cadence launch both in the U.S.

and outside the U.S., so we're seeing really strong growth even in Europe with the Cadence launch and it's been very successful and that's driving a lot of the growth.

And shoulder continues to put up double-digit quarters for us, and part of that is continuing to add more distribution and distributors and part of it is we've got a really strong portfolio and some of the product launches we announced about 12 months ago are making a bit of a difference there as well.

Keep in mind, these are still relatively small parts of our business, but very fast growing, and we're very focused on increasing the investment there. I will also say we've added, as we talked about in the past, a number of specialists like in the ankle space. I think that's making a big difference in terms of our growth as well.

So we're quite excited now to have a dedicated channel that's just going to be focused on extremities metal and we think that the growth can continue going forward given the focused channel..

Yes. I would just add the fact that over the last 18 months, 24 months we have clearly made additional investments in the area. I think our R&D team, we really have the right group in place that we've kind of struggled with in the past. We've got a very good clinical team.

I think you've heard us mention about our Austin consolidation, where we really kind of huddled everybody, really coming to the realization that extremities weren't as different and you need to treat it that way.

And so everything from our really world-class lab, cadaver lab that we have in the location to how we're creating this focused channel, I think we're well positioned here to kind of move the needle on these businesses.

And as Glenn said, I think both shoulder and ankle really represent for us the biggest growth opportunities not only because they're the larger dollar amounts, but we do think both those platforms clearly have some of the best products out in the marketplace..

That's helpful. And then I'll stick with extremities and just a couple of follow-ups. One, on the total ankle DRG change, I know October 1 was the first day of the new DRG, so I wanted to see if you guys noticed any increase in volume due to that.

And then, just on – I don't think you provided a specific 2018 how we should think about extremities growth when you listed – when you went through the product segment, so just wondered if you had any color there on the 2018 growth..

Yes. Maybe I'll hit the DRG and then, Glenn, you can hit the growth piece.

So on the DRG, I would say in the fourth quarter we didn't necessarily see pure incremental, but I think what we have seen a lot as kind of evidenced by our training classes, folks that were doing more fixation and not mobile-bearing work, arthroplasty, there's definitely an increase.

The numbers now make sense for most, if not all, institutions, so yes we're clearly seeing more interest, more people wanting to come to our training. And, hence, the focus and the alignment around ankle right now probably happens at a very good time for us.

Glenn, do you want to comment on the growth?.

Yes. I'm not sure I want to give specific growth rates for all of our franchises for guidance, but we did indicate that OTT in total would be 8% to 10% organic growth. And I would just say relative to where we landed here in Q4, I would expect the growth for extremities to continue at least the pace where we exited Q4.

Keep in mind, Q1 will be a bit of a down quarter but then once we get past Q1 starting to see a pick-up in the growth rates probably somewhat higher than what we just had here in Q4, but that would exclude any of the channel changes, disruption and territory changes in Q1.

But, overall, I just think of it as an area of growth that should continue both in the back half of 2018, as well as 2019 and beyond..

Okay. Thanks for taking the questions, guys..

Sure..

And we'll go next to Raj Denhoy at Jefferies..

Hi. Good morning..

Hey, Raj..

Good morning. I wonder if I could maybe start with just the kind of the overall guidance for 2018. To your point, you finished 2017 here on a pretty high note. You seem to be pretty pleased with how Codman's tracking, but you look at the Codman Specialty Surgical guidance for 2018, it's 2%.

I'm curious why so low in a sense and I know there's going to be a little bit of disruption as you integrate Codman, but it sounds like things are tracking well there.

Should we view that 2% as perhaps a conservative view on 2018 for that business?.

Yes. I'd say, Raj, I mean the first part is until we get through the integration, you know how good it is, right? So yes it's good at this point. Could we have some issues? There's the potential to have some issues and some of that's rolling off the TSAs where J&J is supporting all of our order to cash and order transactions and such.

And so we think we've got it nailed but like in most things, we want to see the results come through before we increase it and so one could view that as conservative. I would just say it's prudent based on just where we are and getting through the first quarter into April, May so that we have all of the training behind us.

We have a clean month or two with numbers is really what we ultimately want to see, but again, I'm pleased where we are at this point. It's in line with our plans, but we have plenty of things that we still have to climb through here relative to the integration..

Okay. Fair enough.

And then on the orthopedic tissue side, the sheer number of sales people that you talked about at Analyst Meeting, I think 190 salespeople you wanted to add this year, I think the question was asked, but where are you in adding 190 sales people? And when you think about just that number, you know, as you're exiting 2018, with that much of an increase in the sales force, one would expect again that the growth will be significantly faster than when you were entering the year.

So I don't know if there's any comments you can really make around that..

I would just position it this way. So, how you do the number count, we look at it on an FTE, on a full time equivalent. So obviously, if we had somebody that we hired last year and now we have the beginning of the year, they've got a full year versus a six-month window so when you think of the count.

But think of it being as a little bit over halfway against that number is how to probably think about it, and a majority of those folks are really going to be coming on board here at the end of Q1 into Q2. So as in the second half, we should have a good quarter, quarter-and-a-half of the full team on board.

Codman is obviously a little bit differently. We're pretty much full up right now, which is great, so all of those numbers are in fundamentally full capacity. I mean, we always have a few opens, but around the world, we're pretty much in good shape there..

And then just one housekeeping. You know, the divested and discontinued revenue was only $2.4 million I think in the quarter. The guidance for next year is $25 million. We'd been thinking it was going to be a little higher this quarter.

Was there just a timing issue in terms of some of the divested businesses, or how should we think about that?.

Well, I mean, keep in mind for the 2018 window, we divested the Camino line and some other products, four products overall that were associated with the closing of the deal. So, Glenn, you may want to talk about the breakout..

Yeah, Raj, so the discontinued products you see in the fourth quarter and then our guidance for 2018 represents the sales we're recognizing to Natus as part of a transition manufacturing agreement, so we're not essentially counting that in our organic growth. We're removing that since it's temporary as we work through the Natus divestiture.

So that's what those revenues represent. In 2017, obviously the big part of that is the divested Camino products, so that's the bulk of 2017, and 2018 is really the TMA revenues to Natus..

Okay. Great. Thank you..

We'll take our next question from Jonathan Demchick at Morgan Stanley..

Hello. Thanks for taking the questions. Just two quick ones for me. One on I guess the tax benefits, and the other on dural repair. On tax, obviously you got a big tailwind and you talked about really it sounds like you're dropping a majority of it through.

Just given a lot of the investments that you plan to be making and ramping up some of the sales force reps, there's a lot of areas that you can invest in shoulder, ankle, wound, et cetera.

Why was the right decision right now to be dropping through basically the entirety of the benefit rather than investing some of it in maybe a faster sales ramp or sales force ramp at various points or into a variety of R&D initiatives?.

Yeah, Jon, it's a good question.

When we look at the investments that we need to make in 2018, I would just highlight that back when we provided our initial guidance, we did indicate incremental investments of about $0.07 that were going into the OTT channel, so we had included that in our initial guidance and we're still on track to our spending plan.

So, while there's always opportunity to spend more money in R&D, clinical studies, continuing to hire even more reps, we felt like we had factored in enough of an expense increase to support our plans for 2018.

Obviously, there were some things we wanted to do around our capital structure to lock in interest rates over the next five years given where we thought rates were going to go, and we took the opportunity to do some of that here in the fourth quarter.

So, obviously that's going to result in kind of a one-time cost to execute the swaps, but the timing was quite good. I mean, we locked-in in December where the yield curves were still relatively low, and they've obviously shot up since January and February, so we're quite happy that we did that.

But overall, given where we were for our spending plan, we felt like it was appropriate to let about half of that tax benefit flow through to the EPS for the year and get us to the $2.35 number now for 2018..

Understood. Thank you. Very clear. And then just a quick question on dural repair. Obviously over the last couple of quarters, this year, it's been a little more challenged, but certainly in the fourth quarter, it popped up a bit. It sounds like the expectations are relatively flat into 2018.

I mean, I know you gave a little bit of the rationale, but I was wondering if there was a little more color you could provide. It just seems that there's momentum back in the business following the changes. To see why it would necessarily decelerate that much is just a little bit confusing to me..

Yeah, well, I would say think about it this way, Jon. I think for the year, I mean, we're expecting a pick-up in the mid- to low-single digits area. But I think in the first quarter, it's really tied to the disruption component. Dural repair and access is driven by having reps in the operating room with the neurosurgeon.

That's the typically highest correlation to how we see the growth moving, and that's going to be down some just based on my comments about out in field. Now as you go into Q2, Q3 and Q4, the opportunity to grow counts, the opportunity to sell in a larger overall bundle, and the amount of increased reps, that's how we're going to see the uptick.

So I think if you take Q1 out of the mix, expect in the range of 3% or so to probably be the kind of growth range in the outer quarters..

Understood. Very clear. Thank you. Thank you very much..

Sure..

We'll go next to Matt Taylor at Barclays..

Hi. Thanks for taking the question. So I wanted to follow up on the thread on organic growth here. I guess when you look at the segment organic growth for this year, the 2% versus the 8% to 10%, you gave slightly different ranges for those segments in the long-term outlook last year.

And I guess I was wondering, especially on the 2% for Codman, is that lower this year because you're accounting for some potential disruption and your longer-term view has not changed from I think it was 3% to 5% before? Or is there something else that is different?.

So, Matt, that's exactly right. I think we believe that a underlying couple points growth business, we can double or triple that over the long run with the investments in channel, R&D and all that.

But starting the clock here at the beginning of the year with changing fundamentally everyone's territories, taking them out of the field for a couple weeks, and then starting to come off of transition services agreements in the second quarter, there's going to be disruption.

So that's been factored in, and the result of it is more of a muted organic growth rate, particularly within the first half. That being said, if we can navigate these waters and execute them with better-than-planned lower disruption, there's clearly upside potential as we get into the second half..

Okay. All right. That's helpful.

And maybe just because you are talking about the changes in the channel in both segments, could you kind of compare and contrast for us what's going on functionally differently in each one? Or is the process relatively similar, even though obviously one of them is bringing in more inorganically?.

Well, I mean, the channel is split directionally. I would say the process and the thinking and the analytics using the right kind of data and geo-mapping and all those kind of things were very similar to try to figure out how to minimize disruption, but the output was quite different.

I mean, in many cases with the Codman and the Integra integration, it was about we have more people than we need, who has a seat and who doesn't and where are they? And so we went through that in Q4.

And internationally, fundamentally it was all key performers have a seat, so making sure that we map territories the right way and train folks, and so as I previously said, we're fundamentally through most of the training and now it's about executing in a new territory.

The OTT is a little bit different from the standpoint of actually taking a legacy Integra rep that just had a bag that got too large and too diverse, and then figuring out who are the best at selling tissue, who are the best at metal, and dividing it, and knowing that as you divide that, you're going to have some deficits, meaning open territories.

So we have a little bit more of crossover coverage for a longer period of time as we get those territories backfilled, but we're on track to that and again, part of that is making sure that you're open, transparent and compensate your sales reps appropriately for the work they're doing, and so it has a little bit more of a different approach to it on OTT than CSS, but both of them are out of the blocks well and I think on track to what we want to achieve..

And Matt, maybe to put a finer point to some of Pete's comments, to put into context, we probably had our reps out of the field 12 days to 13 days this year versus historically three to four days, just to put that into context around a lot of comments that Pete's making.

So, that's really when we talk about disruption factor and the new territories and so forth what we're dealing with in the first quarter..

Okay. Thanks, Glenn..

We'll move to our next question from Steven Lichtman at Oppenheimer & Company..

Hi, Steve..

Thank you. Hi, guys. Codman obviously accelerated your international footprint plan by years.

Can you talk about how you're seeing cross-selling opportunities outside of the U.S., how they'll build here throughout 2018 and into 2019?.

Steve, I'll let our Head of International comment on that..

Yes, so Steve, it's still early days, but we've already identified several opportunities and closed several opportunities, cross-selling, specifically in Europe, between the two teams. I think that's really where we see a lot of value of this deal is the cross-selling opportunities, so some successes so far, early days in Europe.

I'm expecting more around the globe as we move into 2018, but clearly we're quite excited to now have the broadest portfolio in neurosurgery being sold through the largest channel, and I'll continue to expect more opportunities closing here as we get into 2018, but it's still very early days.

I can tell you in the first quarter alone, so far we've closed a couple of nice opportunities between the two teams. And then look forward, I would just continue to emphasize the big opportunities outside the U.S. for our teams is really in Asia Pacific.

As we've talked about in the past, our business in Asia doubled overnight with the Codman acquisition, and Japan, really exciting opportunities. We've now got a very significant sales force there. We've got several new products for launching in the back half of 2018, including our flagship product DuraGen.

CUSA Clarity will launch towards the tail end of 2018. And China, our team doubled in China, and we've put up very significant growth rates in China as well. And so for me, as we look towards the back half of 2018 and going into 2019, to your point, the cross-selling opportunities should continue to accelerate..

Yes. And, Steve, I think one of the things we've been acutely focused on, the old Drucker comment that culture eats strategy for breakfast. The culture of the two companies is very good and that's a big deal for us as we're expanding around the world to have J&J-trained individuals in all these different countries.

If we would have done it ourselves with different small acquisitions, that homogeneity, so to speak, of kind of beliefs and ideas is a big deal, and I think both of our teams, most recent training, I kind of gauge it by as I'm walking around, can I identify which side of the house were the reps from, and by the end of the training it's extremely difficult to see were you a legacy-Integra or Codman individual, which gets to the point that the teams are blending very well, and I use that as a bigger barometer more than anything just because the cultural component and do people feel comfortable, do they feel like they're in a place they want to be.

We feel very, very good about how the fit is with Codman..

Okay. Great. And then just secondly, just want to get a sense of how far along you are in the CUSA upgrade cycle overall.

Are we still in the middle innings at this point? And is this still a potential tailwind for more than a 12-month period ahead as you look at the funnel?.

Yes. Look, it's early days. It's early days and installed base that has many years in front of us for conversion. Obviously, what could change the trajectory of that is what competitors may come into the market and do they bring technologies that rival what we have with CUSA Clarity.

We think there's really nothing in the marketplace today that rivals it, so we think there's clearly a replacement and a competitive socket-win opportunity for the next two to three years for sure..

Okay. Great. Thanks, guys..

Thank you..

We'll go next to Jayson Bedford at Raymond James..

Good morning, Jayson..

Good morning, Pete. Thanks for squeezing me in. I'll try to be quick here. So, you mentioned several sizable orders in the fourth quarter on Specialty Surgical.

Can we assume $2 million, $3 million? Is that in the ballpark?.

Total of $2 million..

$2 million..

Total (1:03:51)..

Okay.

And then, in terms of – and I apologize if this is in the deck here, but $5 million in other income in the fourth quarter, what was that due to, Glenn?.

So, keep in mind the $5 million, we adjust out about $3 million of that in our adjusted EPS, which is the gain on the sale of Camino. You know the $2 million is income associated with the cross-currency swaps, which I mentioned we saw about a $2 million benefit in the fourth quarter and that's a benefit that will continue in 2018 and beyond..

A couple of million a quarter..

A couple of million dollars a quarter. Yes..

Okay.

And so as I look at your interest expense guide, the $75 million to $80 million, does that include the benefit of the swap? Is that a net number or...?.

No..

Okay. So interest expense is $75 million to $80 million.

Other income is at least $8 million based on this swap?.

I would model $7 million for the full-year 2018 in other income, somewhere between $75 million to $80 million on the interest expense line..

Okay. And that's helpful, and then the last one for me. Gross margin in the fourth quarter was a little softer than we expected. The 2018 guide calls for 100 basis point to 200 basis point improvement from that fourth quarter level.

Can you just comment on kind of the softness in the fourth quarter and then kind of what improves in 2018?.

Yes.

So keep in mind there was a couple of factors that drove the fourth quarter lower and it was a combination of Puerto Rico and the manufacturing, costs in Puerto Rico, we had unabsorbed costs there, that will get better obviously as we ramp production and we're expecting to see a much better gross margin picture in Puerto Rico really starting in the second quarter when those favorable variances start rolling through the P&L, so Puerto Rico is a driver.

Keep in mind a lot of the overachievement in the fourth quarter was from lower gross margin products like private label, like the Derma Sciences products, and so the mix was unfavorable relative to what we've seen in the past.

So we're counting on an improved mix here as we go into 2018 as well with where we're expecting some of the growth, especially in the regenerative products. So I would just really contribute it to mix and Puerto Rico manufacturing variances improving in 2018..

Thank you..

And we'll go next to Matt O'Brien at Piper Jaffray..

Hello. Good morning. This is Will Inglis on for Matt..

Hey, Will..

First off, a quick question on wound care. If you could provide any color on just kind of the adoption and utilization rates there. And then, I guess, more specifically with Omnigraft, has that been meeting expectations? Is it lighter than where it could be with more reimbursement? Any information there would be helpful. Thanks..

Yes. Well, I mean, wound care did quite well. We had a strong performance in the fourth quarter. I think our strategy particularly in the second half of the year was leveraging our amniotic platform, which had a very good performance, as well as our PriMatrix product.

I would say we're still not happy with the performance that we achieved with Omnigraft. Now some of that we've baked in strategically, because of the characteristics of the product that it actually heals with less applications isn't as necessarily compatible with CMS reimbursement to-date.

We have plans in place for the future that we think can change that. But, clearly, that's not contributing to the level that we like to see, so that would be the soft spot.

But when you look across the broader portfolio with our off-loading product, the EZ cast, the MEDIHONEY products, PriMatrix and AMNIOEXCEL, all actually did quite well and are continuing to grow sequentially at a level I would say that we're pretty happy with..

Great. Thanks for that and a quick follow up.

Just looking at your extremities sales force kind of restructuring, have you seen any disruptions in terms of customer relationships now that there's more kind of case coverage associates involved, and if not, are you expecting that structure to be helpful going forward?.

Well, I mean, so we've had some case disruption, but it's been pretty minimal and we've been able to actually at this point in time deal with it, but that's some of our cautiousness relative to the growth rates in the fourth quarter exactly that.

And to your point long-term, we feel very confident that a focused channel that has just more time to dedicate themselves to a given clinical area will return higher results, both in our wound reconstruction, our outpatient wound, our surgical products and extremities orthopedics, which in OTT now all have focus channel areas.

And so for sure, that is clearly an organic growth lever on the future for us..

Great. Thank you very much..

Thank you..

And that does conclude the question-and-answer session. I'll turn the conference back over to management for any closing remarks..

Just like to say thank you for joining the call and all the good questions, and I'll see many of you here I think at different road shows events over the next couple months. Thanks for joining the call..

Thank you..

And that does conclude today's conference. Again, thank you for your participation..