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

Good morning, and thank you for joining us for the Integra LifeSciences Third Quarter 2012 Earnings Results Conference Call. Joining me today are Peter Arduini, President and Chief Executive Officer; and Jack Henneman, Chief Financial Officer. This morning, we issued a press release announcing our financial results for the third quarter. Certain statements made during this call are forward-looking, and actual results might differ materially from those projected in any forward-looking statements. Additional information concerning factors that could cause actual results to differ is contained in our periodic reports filed with the SEC. The forward-looking statements are made only as of the date hereof, and the company undertakes no obligation to update or revise the forward-looking statements. Certain non-GAAP financial measures are disclosed in this presentation. A reconciliation of these non-GAAP financial measures is available on the Investors section of our website at integralife.com. As we aim to keep our prepared remarks short, we will reference the financial results in the press release and will not restate individual numbers. As a result, you may want to keep a copy of the release handy during the call. Further, given we will have our Investor Meeting shortly after the call here in Dallas, please focus your questions on our third quarter results and 2012 expectations. During the Investor Meeting, which you may access through a webcast link found on our website, we will lay out our strategy and business outlook. We ask that you defer long-term and strategy-related questions for the Q&A session at that time. This call will end by 9 a.m. Eastern Time. I will now turn the call over to Pete.

Thank you, Angela. We're pleased with our performance this quarter, particularly in the context of a difficult economic environment. Our revenues were a little lighter than we expected a few months ago. However, they were flat compared to Q2, which is our usual summer pattern, and up 5% over the prior year on a constant currency basis. Earnings came in ahead of our expectations, mostly because our manufacturing operations continued to improve and because we spent less on our initiatives than we had planned. Looking ahead, we have variances that will negatively impact our gross margin in the next several quarters. We also plan to make additional investments in our systems and quality improvements. These internal and external considerations influenced our upward revised annual guidance, which Jack will walk through later in the call. U.S. Extremities increased significantly versus the prior year period. Strong sales in our regenerative product lines were the primary contributor, followed by the impact of the Ascension acquisition which closed in September of last year. U.S. Extremities remains our strongest business and regenerative medicine products continue to fuel our growth. U.S. Spine & Other, which includes our Spine Hardware, OrthoBiologics and Private Label products, increased slightly. New product launches and another strong performance in OrthoBiologics overcame declines in Spine Hardware sales. Like many of our competitors, the Spine Hardware market was particularly tough this quarter. We experienced somewhat greater pricing pressure than in recent quarters, and our surgeon customers have not avoided the industry-wide phenomena of procedure delays. OrthoBiologics products, particularly Evo3 and Mozaik, experienced high demand, both through our existing base and through newly added distributors. This demand drove high teens growth in the third quarter. Private Label increased versus the prior year period. U.S. Neurosurgery revenues increased slightly over the third quarter of 2011.…

Thank you, Pete. I'm going to review the P&L in a bit more detail and touch on our updated 2012 guidance. For 2012, we expect reported gross margin to be around 62%, and after adjustments, a little under 65%. On a GAAP basis, our third quarter gross margin percentage improved 100 basis points over the prior year but declined about 70 basis points from the second quarter. Expenses in our Plainsboro facility increased, primarily due to underutilization attributable to the FDA inspection in July and continuing remediation work, which drove the decline from the prior quarter. Last year, the gross margin was particularly weak because of larger-than-usual inventory write-offs. We calculate adjusted gross margin by backing up the items to cost of goods sold detailed in Column A of the adjustments table on our press release. Our adjusted gross margin of 65.6% was quite strong relative to our expectations and prior year. We expect somewhat lower gross margins in the next few quarters because manufacturing variances incurred earlier in the year will go through the P&L and because of higher depreciation expense. For 2012, we expect R&D spending to remain between 6% and 6.5% of revenues, and the third quarter R&D expenses declined slightly versus the prior year to just over 6% of sales. For 2012, we expect reported SG&A to be in the range of 44% to 45% of revenues and after adjustments to remain at last year's level, around 42%. In the third quarter, GAAP SG&A increased versus a year ago, mainly because of an increase in selling expense, driven by the shift to orthopedics and increased customer service and logistics expenses. SG&A adjusted for about $7 million of special charges, as detailed in our press release, was 41% of revenues, up versus the prior year. Most of…

Thank you, Jack. We're certainly pleased with our performance in the third quarter, especially on the bottom line. That said, we still have much to do. We've set 3 major goals for the company. The first goal is to improve execution on fundamentals, specifically in our operational areas. Our highest priority is compliance. We're raising the bar on our quality systems, and we are in the final stages of our remediation program in both Plainsboro and other facilities. We do not expect the FDA to return to Plainsboro for another few months, but we are on track with our remediation efforts, and we believe we will address each of the new observations we received in the Form 483 in July during the fourth quarter. Importantly, we have been diligent throughout the company, aggressively upgrading our quality systems and enhancing capabilities. The second goal is to optimize the company, of which we will say much more at our Investor Meeting following this call. The most important thing that we can do to enable that optimization is to implement common information and quality systems. We expect to go live on our new ERP at our pilot site in the next few months and have kicked off our plans to implement a common global quality system over the next 2 years. Our third goal is to accelerate growth. Each of our businesses has been focused on evolving their R&D pipeline, as well as seeking business development opportunities that fit well into their portfolio. In our International markets we're making good progress on our plans, but results will be lumpy. Just 2 weeks ago at the CNS Meeting, we launched some of the most significant new products in our Neuro business in the last few years. DuraGen Secure, a new addition into our duraplasty…

[Operator Instructions] We'll have our first question from Matt Miksic, Piper Jaffray.

Just one, I guess on the acceleration in Extremities, let's focus on maybe the good news that, that business seems to be doing quite well. Can you talk a little bit about, is it products? Is it the integration with Ascension that's sort of hitting its pace? Maybe if you could touch on some of the highlights about what's driving the strength there. And then I have one follow-up.

Okay, sure. Well, obviously we were quite delighted with the performance. I think it's been a good consistency across the board. I think if you look at our regenerative products, our skin products and tissue products has done well. A little bit of that has been some catch-up that we had relative to our manufacturing. However, we've had strong growth there. In our upper Extremities and lower Extremities, we've done well, we've introduced some new products over that period. And clearly, the synergy that we've gained with the integration of Ascension, and what I mean by that is the combination of the new products, the combination of bringing new products from the Integra portfolio to doctors that were primarily using Ascension products and vice versa, is really starting to hit stride. So we feel good about that growth. And across the board, I'd say, it was a solid quarter for us in Extremities and really all of our key areas.

Okay. And then on the Neurosurgery side, the capital side of the business, and maybe this has impacted the Instruments side slightly as well, but the other focus in the group with capital exposure has also had kind of a tougher time in the back half of the year. I'd be curious -- it would be helpful to maybe hear what you're hearing from hospitals, what your customers are telling you or your sales reps are telling you in terms of the sluggishness there.

Yes, I think from a standpoint of capital, we're not seeing anything that is, I'll say, akin to what took place a few years ago where hospitals were putting the brakes on capital expenditures. But clearly, and it's similar to what we had talked about in our Q2 earnings call, that we see hospitals being more cautious. RFPs and RFIs taking more time to actually process more steps and questions involved, and so we see our hospital customers being just more diligent relative to their overall capital. And that's primarily a U.S. discussion. But as I had mentioned on the call, Canada and Australia as 2 other markets, similar items taking place. We don't project in the fourth quarter that we see any major downside from that, as far as a reduction in overall, but we don't necessarily see any rates picking up. We believe that it's still going to be about the same level of pace throughout the rest of the year.

And we'll go next to David Lewis, Morgan Stanley.

This is actually Jon Demchick in for David. On a relatively in-line, I guess, revenue quarter, you all had a pretty strong earnings feat, which, I mean, obviously it was very much built on the margins. And looking at the updated guidance, EPS was raised $0.05 at the midpoint. But I guess like given the $0.08 feat on the quarter, that kind of shows some sort of a decline going forward. Is that really all driven by the manufacturing variances that you guys pointed out? Or are there other factors to consider?

Jon, yes. So as we mentioned on the call, there's a combination of some expenses that are moving out and some variations, but I'll let Jack Henneman give a little bit more color on that.

Yes, I mean, basically, as we said in the prepared remarks, the margins in this quarter, both gross margin and, frankly, the EBITDA margin, were higher than we would expect over the next several quarters. I think to some degree -- I know for some degree, some operating expenses that might have been incurred in Q3 will probably be incurred instead in Q4. Also, we have manufacturing variances baked in or inventory that'll be coming out in Q4 that'll hurt the gross margin a bit. There's some little bit more depreciation coming onstream in Q4. So that adds up to somewhat lower margins overall, and I think that'll be reflected in the adjusted EPS in Q4.

Very helpful. And just a quick follow-up on Spine. Given, I guess, some of the comments from competitors, I just wanted to see what you guys have been looking at with like payer pushback and PODs.

Yes, Jon. I think -- I mean, we don't have a corner on the market on information. I mean, I think we're experiencing the same information that other people have reported. I would say from a POD standpoint, it really hasn't been an issue for us. We really haven't seen any fundamental changes there. It's been more around the fact of procedural approval has been taking longer for certain cases, and that's what we really hear from our clinicians. How much those are delays versus denials, I don't think we've got any better insight. But clearly, there's some added steps which are taking longer to get procedures approved and obviously, that has effect on our overall sales.

We'll go next to Chris Pasquale, JPMorgan.

To start with, can you quantify the decline in Spine Hardware this quarter? Was it down sequentially? It looks from a back of the envelope math that it might have been. And how much of that year-over-year decline was volume versus price?

This is Jack. Yes, if you sort of -- we don't break that number out. But if you sort of walk through the logic of our U.S. Spine & Other segment, clearly, the Spine Hardware was down. The effect, it was down in price particularly. So we're not going to break it out in full detail, but we've definitely experienced the pricing pressure that other companies have reported. It had a significant impact. Our OrthoBiologics number was pretty good, and our Private Label showed up as well, so that's how that segment lines up.

Okay. You mentioned some new product launches in Neuro. Growth in U.S. Neuro has decelerated each quarter so far this year, even though the o U.S. decline has moderated a bit. Can these new launches turn that trend in the U.S. around and get that business back up to the mid-single digits?

Yes, Chris. It's consistent with what we've been talking about really since the beginning of the year. We had a lot of launches that were back-end loaded. And as I've mentioned in the comments at the CNS meeting, we just really launched a lot of those products. And yes, we do believe that we'll see a pickup here in the fourth quarter on sales in the Neuro business.

Okay. One financial detail one, if I could. Can you just remind us what the impact the R&D tax credit is for you? Basically, if the credit's not extended, what does that do to your guidance? And that's it.

Probably about a point, but we haven't precisely quantified that.

[Operator Instructions] We'll go next to Robert Goldman, CL King.

A question and then a follow-up. The question for Jack on cash flow. That $28 million of operating cash flow, Jack, is that a gross number or a net number? There are issues of accrued interest and some cash impact from executive compensation that you spoke about previously.

So the $28 million for Q3 is a straight-up GAAP number. The accrued -- the accreted interest point was in Q2, and the executive comp points in Q4. So Q3, that's a straight-up GAAP number, operating cash flow.

Is that quarterly operating cash flow sort of the pace we should think of for the next couple quarters?

Well, we don't give operating cash flow guidance. But yes, I mean, we did a little over $30 million in the first 2 quarters -- each of the first 2 quarters. The Q2 was -- the business generated $32 million or so, was affected by the $30 million in accreted interest, round numbers. But this is again closing in on $30 million. It's not quite. There's a certain amount of volatility in the number. How the cash flow actually comes through, obviously, depends as much on working capital items as it does on the balance sheet -- on the earnings. But yes, I think that, that's a good number.

And then if I could follow up on the Plainsboro inspection with Pete. Pete, if memory serves, and correct me if I'm wrong, that on the last quarterly conference call, the FDA, at that point, I think was back in Plainsboro. And from what you've said today, they'll be back again perhaps in a couple months. And if all that is correct, did they find something 3 months ago that they just again needed fixed? Did you receive another 483? Or why the re-reinspection?

Sure. So Bob, you're right. At the last call, I had said that we actually had the FDA was in. And then shortly after that, they closed out the inspection, and we actually made public the 483 that we actually had received. And we received some observations within that 483. I think, I'd say the combination of news, some of the main items that we had, the top highest priority items in our warning letter, were not cited as any of the issues. There were other issues relative to certain procedural items and such. And what had I just mentioned on the call was that we had actually addressed those items. We fundamentally have one other item that we're working on, and that'll really be closed out here in the next 30 days. My comments about the FDA coming back are just the fact that to lift a warning letter in today's world, the FDA, we believe, is going to want to come back and do another inspection at the facility. My personal belief is I don't believe they're going to be back in the next few months, but it could be, obviously, anytime, and it could be out into the first quarter of 2013. And so we've been in dialogue with the agency, we understand our priorities. And again, relative to the warning letter and the 483 we received in July, we're well on track to getting all the items closed out.

We'll go next to Bruce Jackson, Northland Capital Markets.

I was hoping we could get a little more detail on the biologics piece of the Spine business. It's been strong now for a couple of quarters. Maybe you could tell us a little bit about some of the market conditions that are helping that growth.

Yes, Bruce, I'll comment, and I'll see if Jack wants to add any to it. I mean, we've obviously had some very strong performance really over the last year. As I had mentioned, 2 of our big product portfolios are demineralized bone products, and our Synthetics have continued to do well. We see a lot of the trends obviously that are taking place in the spine market today are being advantaged by the use of the right type of biologics. We also have multilevel tiered featured products, and so we have a third-generation demineralized bone product called Evo3, which, as I said, for its price performance point, has been well received in the marketplace versus other products that are more expensive out there. That is also complemented with the fact that we've been quite successful because of the portfolio of recruiting new distributors in. And so we've been able to grow our distributor network over the last year. In fact starting in fourth quarter last year, we had a big addition of new distributors brought into the organization, and so that's helped us out quite a bit with the stronger growth. The only comment that I would make is we'll be probably lapsing some of the additions of some of the bigger distributors here in the fourth quarter. And so it's not that we necessarily see our procedure growth slowing some, but we actually see the lapsing effect of those new distributors will probably moderate some of the growth. That all being said, we're still quite bullish about OrthoBiologics really out through the future. Jack, I don't know if you have anything to comment.

Yes, I mean, the only thing I would add which perhaps tempers expectations slightly is that to the extent that insurers are pushing back on spinal fusion, that is going to eventually hit OrthoBiologics as a market. We think our product portfolio is very strong and we're doing very well. But I think it would be a mistake to think that OrthoBiologics in Spine -- and not all these products are used in Spine alone -- but that OrthoBiologics and spine is immune from payer pushback elsewhere in Spine.

Okay. That's very helpful. Then one other question on the Extremities business. So in Spine, there's been price pressure on the Hardware side. Are you seeing the same kind of pricing dynamics in the Extremity Orthopedics market?

Bruce, it's Pete. Not anywhere to the level of what we've seen in the Spine Hardware market. But I would say, in general, all of the Hardware has some level of year-over-year price pressure. It's why new product launches are obviously a way of bringing in new products with some features that set a new price point. But relative to Spine, Extremities is on a different trajectory relative to any type of price pressure. And I would note that our regenerative portfolio, again, just to remind you that, really, half of our Extremities business is regenerative products, that we're quite stable from a pricing standpoint.

We'll go next to Dale Dutile, The Boston Company.

Just going back to Plainsboro, it sounds like things are in good shape. However, you've nearly doubled what you've thought it's going to cost this year. Can you explain some of that?

Yes. So I'll comment a little bit, and then, Jack, maybe you can fill in some of the other comments. So yes, we've made some good progress overall. One is addressing the FDA items. And then secondly, taking a look at the overall plan from a standpoint of certain capital investments and other expenses that we put in the facility that deal with 2 things: One is, obviously, addressing the FDA items; the second part is really about our overall yield and capacity. And so we believe right now, we're in good spot. And as we have been doing all year with the continued growth we're having in our regenerative products, is to be able to get more products out to deal with that overall demand. And Jack, you may want to comment just where we are from an expense standpoint.

Yes, the only other thing I would say is the number that we call out includes a significant piece of under utilization in the facility, essentially the period cost associated with running at less than full capacity. And so that -- and we detail that in our Q each quarter. When we file the next one, it'll show up there as well. And that increased frankly because we produced less during the period in June and July when we were under FDA inspection. So that was an impact in Q3 that showed up. A little hard to forecast that element of it. In fact, that's a significant part of the increment. It's not all the increment, but it's a part of it.

I mean, I've just never seen people -- someone to try to back that out. How do you quantify the impact of -- I understand discrete expenses related to an FDA inspection and the capital cost Peter just mentioned, I assume, are not on that number. They're capitalized, not an expense, period expense. How do you quantify an underabsorption?

Well, I mean, we have a sense of the fully absorbed running of the facility, and the extent to which we produce under that level attributable to this exercise, we deal with it. So...

So that would include forgone revenue of some sort? You make some estimate of what you could've sold?

No, we don't look at forgone revenue.

Primarily the cost of products that -- obviously the cost of goods would go up if the utilization in the plan is lowered, and then that product takes obviously an amount of time to work its way through inventory and show out and come out in sales.

So just to put a finer edge on it, we measure it by looking at the delta between normal and actual production hours. So we have a budgeted level of production hours for producing the...

A standard, if you will.

Yes. And if we are way below that, that gives us a sense of the costs that were -- the variance in effect. And it runs through in that period, so...

So don't expect this to be a 0 going beyond fourth quarter? We won't be talking about this anymore? Is that fair?

Well, we'll be obviously talking about what we're doing in Plainsboro relative to FDA, and we're stepping up supply. And so you're going to hear from that aspect. I think from a standpoint of overall expenses and costs, as we've communicated, that we believe that most of the substantial investments in cost that we've already put into the facility. Jack, I don't know if you want to elaborate further on that.

We expect that the underutilization component will be down a lot in Q4.

Okay. So the FDA will be back in a few months, things will be cleaned up hopefully, and so you'll be fully absorbing everything and that number should be 0. And if not, something's changed.

Correct.

Okay, fair enough. And then you mentioned, Pete, something about a new quality system that will be implemented over the next few years, I guess, globally, it sounded like. Is that correct? Could you elaborate on what you're referring to?

Yes, what I'm speaking to is not necessarily a new quality system, but we're actually creating a common quality system structure throughout the company. So obviously, we have compliant quality systems throughout all of our plants and facilities around the world. But as an example, how we may approach CAPA or certain parts of the A20 [ph] regulations, there might be slight differences and nuances. And what we're going to move to is what a lot of other companies have done is that we will do that consistently in all places around the world. Why is that important? The more that it's simplified and consistent, we believe we'll be able to execute it more effectively. As we move people around the different parts of the company, we have actually more common systems that makes us more effective. And ultimately, we think we can deliver higher quality at a better cost point. And so it's not necessarily new systems. It's actually our processes on the systems and tools that we already have.

Biologics expense side [ph] or was it just something in the normal course of the business?

It's pretty much within the normal course of the business is how we see it.

We'll go next to Amit Bhalla with Citi.

This is Nick [ph] in for Amit. So again, a few questions for you. One, on your legacy foot and ankle business in the Extremities, how's competition affecting performance in that side of things?

Well, I think, as you know, we reported a very strong quarter in overall extremities. We clearly are seeing more players in the market. I mean, I think that's no surprise. We've talked about it, many folks we have had out there. But what really helps us differentiate ourself, I think, is our broad portfolio. The addition of the Ascension products having some new technologies, such as PyroCarbon, and a lot of our soft tissue products help us differentiate that way. That being said, we're clearly seeing more people, more competitors showing up in podiatric, as well as orthopedic centers that we didn't, say 3, 4 years ago. And so what we've been focusing on is obviously bringing new products out and being able to really have a focused sales force that calls on many aspects, specifically in the upper, the lower extremities, as I had mentioned. Again to remind you, we have a direct sales force out there that reaches all those areas, and we feel quite good about where we're at. The fact is though, because of the growth in Extremities, it's an interesting area for many folks, and so we are seeing increased competition. At this point in time, we're doing well. And as I'd mentioned earlier, really haven't seen any major impacts at this point in time on overall price within the segment.

Okay, that's helpful. And then one last question. On your recent shoulder product that came out, how's the recent launch going with some of those?

Yes, so we -- if you remember, we purchased a shoulder platform really from -- that came part of Ascension, and that really brought us into the overall shoulder market. The key with that product is, is that we still have a few components that are in the R&D land that are going to be coming out here really within the next 6 months, and one of those is the reverse shoulder to really supplement the overall portfolio. Quite candidly, it's rather lukewarm at this point in time. But then again, that's pretty much as we had expected. And as we fill out the portfolio, particularly with the Reverse and some other products, we think we're going to have a very good opportunity to take advantage of this $700 million market.

And we'll go next to David Toung, Argus Research.

Two questions I have is on your -- if you can comment on the competitiveness in the spine market. I mean we've had some players who've underperformed; you talked about the insurer pushback. Given that with the acquisition you made last year, you've clearly made -- you clearly see the opportunities to gain share in a highly fragmented market. So given that, how do you see -- a little more details on how do you see the competitive landscape, and where are your opportunities?

Yes, so David, this is Peter. I'll make a couple comments, and Jack, if you want to jump in. I would also comment for everyone, I mean, we're going to spend some time on this as well later today at our Investor Day, so we'll talk. But fundamentally, if you look at spine, and I just want to kind of rebounds [ph], why we moved into spine. It's still a very large market with, we believe, a lot of potential for a company like Integra over the mid- to long-term range, and we think about that over the next 3 to 5 years. As far as the aging population, where it's headed, the technologies that are out there, and really, what leading technologies are going to evolve, and those are primarily going to be regenerative, which is one of our core competencies. That being said to your question, David, the market now, and we don't think it's going to change in any quarters anytime soon, are going to be rocky. And so what we've seen, as I commented in my prepared notes, is very consistent with what you've heard with other folks so far from some of the earnings reports that a lot of the procedures -- the demand has been out there, but a lot of the procedures are getting added questions, added components that either are delaying or having surgeons specifically have to address the payers' needs that, in many cases, they haven't had to do in previous quarters. And that results then either in procedures being delayed and potentially canceled. But I don't have any facts relative to what that mix is between delays or cancels. I think to Jack's point as well on OrthoBiologics, we've done quite well, but the phenomena also can affect a biologic the same way it can a metal implant. Clearly, the metal implants have had a bigger impact mainly because of pricing pressure and the combination of these, where we haven't had the same type of pricing pressure in overall OrthoBiologics. So I mean, Jack, any other comments you'd add?

No, I mean, I think we will have more to say at the Analyst Meeting, and I hope people dial in for that starting at 9:00 Eastern. It should be 9:00 Central, 10:00 Eastern.

We'll go next to Michael Rich, Raymond James.

This is Michael in for Jayson. Just my first question is for Jack. I was wondering if you could elaborate a little bit on the manufacturing variances that are going to cause gross margin to come down in the fourth quarter.

Yes. I mean, yes, these are just variances that went through -- recall, we operate through actually a large number of plants, we have a complicated supply chain. And when we don't produce as efficiently as we expect in a particular plant, those extra costs will go into the inventory and then they come out of the inventory according to the pace at which those products are sold in effect. And the consequence flows through the P&L. If you -- flip side is, is if you do better than you expect, the benefit flows through. And so we, therefore, know that we will have somewhat higher variances and therefore, somewhat lower gross margin in the fourth quarter based on costs that are already in the inventory.

Understood. Just a quick follow-up. I apologize if I missed this, but did you quantify the impact from Ascension on revenue this quarter?

No, we did not quantify the impact on Ascension. What I can say though is when we file our Q, there'll be pro forma numbers in there, and you can take a look at that. We report pro forma numbers, which are not actual results, but rather the pro forma for our acquisitions every quarter in the Q, and you can go there.

And we have no further questions in the queue at this time. I'd like to turn the conference back over to management to offer any additional or closing remarks.

Great. Thank you very much for joining the call. And again, our -- the webcast of our investor presentation will begin at 10 a.m. Eastern, and you can get the link on our website, integralife.com. Thanks.

That concludes today's conference. Thank you for your participation.