MiMedx Group, Inc. (MDXG) Q3 2015 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen. And welcome to the MiMedx Group Third Quarter 2015 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will be given at that time. [Operator Instructions] As a reminder, today’s conference is being recorded. I’d now like to turn the call over to your host for today, Mr. Thornton Kuntz, Senior Vice President of Administration. Sir, you may begin.

Good morning, everyone. This presentation contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These statements are based upon current beliefs and expectations of our management, and are subject to risks and uncertainties. Actual results may differ materially from those set forth in, contemplated by, or underlying the forward-looking statements, based on factors described in this conference call and in our reports filed with the Securities and Exchange Commission, including our Form 10-K for the year ended December 31, 2014, and our most recent 10-Q. We do not undertake to update or revise any forward-looking statements, except as may be required by the company's disclosure obligations in filing it makes with the Securities and Exchange Commission under Federal Securities laws. With that, I will turn the call over to Pete Petit, MiMedx's Chairman and CEO.

Good morning. Thank you for joining us for our third quarter shareholder call and update. I have with me Bill Taylor, our President and Chief Operating Officer; Mike Senken, our Chief Financial Officer; and Thornton Kuntz, our Senior Vice President, Administration and certain other officers. I'm not going to review our strategic initiatives today in any detail. There were numerous discussions covering those subjects on our Analyst Meeting and those excerpts are available through our website. However, I am going to start my comments with something that just come up this morning that relates to Food and Drug Administration. So it is a newsworthy today relative to announcement. It should be appearing on the FDA’s or in the public register shortly. There should be a notice in the Federal register shortly about the FDA issuing a guidance document on homologous use of human tissue, which is skin, dermis, bone, tendon, ligament and amniotic tissue, it's all of those. Also today the FDA senior staff is meeting with representatives of the American Association of Tissue Banks in Washington to discuss this document and its previous document that issued in December on manipulation of human tissue. We have one of our executives at this meeting and the information we have received is positive. It’s positive from the standpoint that it says if the FDA has hurt from the American Association of Tissue Banks, [Allomed] [ph] and the alliance of Virginia’s Medicine and their industry constituents that any attempt to change these regulations utilizing only guidance documents will be met with industry, as well as congressional distain. At this point, it says that they agency is agreeing to file its own regulations to go to the normal “Notice and Comment Rulemaking Process" which involves industry and congress and any endeavor to change or modify regulations. As I think you know, MiMedx has spent the last two years working with FDA staff and congressional leadership on attempting resolve issues associated with untitled letters and the agencies attempt to change regulations without going through this whole process of Notice and Comment Rulemaking. There are number of committee heads and committee members that have involvement with the FDA that are very knowledgeable about these issues and have concerns as greatest industry does relative to the implications. Therefore, we feel an industry and trade associations and Congress can all work with the FDA to resolve issues that maybe related to their desire to further regulate human tissue products. This is the way the system and related processes are suppose to function. Again, we are very knowledgeable about these issues and processes. We've got two years invested and a lot of work into this very issue. We view this announcement as positive. Also it looks like the first public hearing on these matters will be held on April 13, 2016. We expect the rulemaking process to start at that point and it can be a rather lengthy process. All right, I will take a few questions, perhaps, if you still have some, when we get to Q&A, but let me go on now and give you an update on the rest of things we want to discuss this morning. I want to start by trying to address some of the confusion on our operating metrics that has recently developed. This time it’s started right after our Analyst Meeting. As we delineated our Analyst Meeting this year was designed to provide some strategic insights into our new products and in particular, the market we are targeting for surgery, orthopedics and sports medicines since they were relatively new initiatives for the company. Also we provided insight into our two new product platforms and highlighted those opportunities. As we have spoken to shareholders over the years, I have indicated that we firmly believe that our amniotic membrane technology is a platform technology. In other words, the science and clinical attributes of this technology are disruptive and this technology will find its way to the numerous medical procedures. Thus it is a great growth asset. MiMedx went from being a total unknown to the dominant leader in advanced wound care in the last four years. We plan to the same thing in certain sectors of surgery, orthopedics and sports medicine. Our technology has distinct advantages over numerous products both clinically, as well as cost wise in certain surgical areas. Yes, it is correct that our allografts do not have a high strength profile, but our collagen fiber technology has an excellent strength profile. Think about what products combining our amniotic membrane technology and collagen fiber technology could do in terms of improving surgical outcomes. Now relative to our current near-term revenue growth, our operating profit growth and our gross profit margins, there needs to be some clarification. This morning we will try to highlight a number of operating parameters that seem to be confusing overlooked. While our third quarter revenue only grew 46% over the third quarter of last year, our third quarter last year was an exceptionally high growth quarter. So the comparisons are somewhat confusing. Revenues for the nine months of this year were up 72% over the similar period last year. That should be noted. Also our adjusted EBITDA margin grew 62% over third quarter of last year. Our operating profit margin grew 8% over third quarter of last year. Most significantly, our gross profit margin grew from 87% in the first quarter of this year to 90% in the third quarter of this year. We will discuss a gross margin in more detail in a few minutes. Now let’s discuss our operating profit margin in more detail. I have stated numerous times that the company with the gross profit margins that we have and the operating structure we have should be a 30 plus percent operating margin-company as our early heavy investment places mature. 2016 we could have operating profits of 30% or as low as 10%. We control those investment decisions. We have been very prudent over last four years with balancing our EBITDA, which has been positive now for 15 of those quarters. We have made investments in our sales organization, new scientific and clinical trials, patent and new product development. These are balancing decisions that executive management make daily with our rapid growth company. I submit to you that writing over operating margin is not very productive. We have plenty of cash and strong cash flow and we are continuing balancing our investment decisions versus operating profits. We continue to effectively invest in our assets to create intermediate and long-term value. That should not only be advantages to our shareholder today, but to our future shareholders. Now to operating profit margins, we have given you fairly good insight into where we think we will be. We have told you some months back that our 15% goal for 2015 operating profit will be slightly reduced, because of some investment decisions we have made. We clearly indicated that we made those operating profit forecast that we would make decisions that could affect those depending on our investment opportunities. When we have investment opportunities that can give us a 200% or more return we are certainly going to make that invest. I would think that as shareholders you would want us to make those type investment decisions. I think that wise investments will begin to be focused on our gross profit margins. These margins are the most critical to any business and particular our business. And frankly, the most critical to our investment and operating decisions. The reason is, is that market pricing is embedded in gross profit margin and certain things can happen in the market that company cannot control, from gross profit margin down to the incomes -- down to the income statement our executive decisions manifest themselves in the operating profit margin. In the gross profit margin decisions made by CMS, insurance companies and for foreign revenues dollar exchange rate and our competition affect that number. Therefore, gross profit margin is a most difficult parameter for management to control. If you review our gross profit margin over the last several years, you will note that continued to increase. Gross margin has continued to increase even this year when we took a major, a major price decline due to expiration of pass-through status. Now how is that possible? It’s possible because our management had planned ahead and developed number of production efficiencies that allowed us to improve the gross profit margin. We also have some of those pricing decreases with increase manufacturing efficiency. We are at a point now where we are automating a lot of our processing functions. For instance, we will be using laser technology speed cutting processor. We will continue to make these types of improvements. We will continue to monitor the external environment, try to give you warning if we see significant disparities occurring in price. However, I would strongly encourage you to focus on our gross profit margin as not as much on operating profit margins. Please note that our gross profit margin has increased from 87% in the first quarter of this year, when that change in pricing occurred to 90% in the third quarter. That's significant. A second concern we have heard relates to why we entered into a $50 million bank line of credit with four major banks. First, you should be elated to the fact that this company has mature to the point where we can sign agreements of that nature. A year ago we probably could not accomplish this. Companies of our stage of growth are prudent and have those types of credit agreements in place as a contingency. The concerns that we've heard at our executive management may make a bad decision on an acquisition is without merit. If anyone understands, excuse me, my decades of experience with over 47 acquisitions during those decades, they will understand that we have not made bad real-time acquisitions. All of those acquisitions with exception of one worked almost flawlessly. In this one case we had to sell a business back to physician or owner, because we cannot adapt themselves to corporate life. It was simple as that. At major, our last acquisition required us to borrow $445 million from the Bank of America. They were paid-off in reasonably short period time and the acquisition worked well. We know how to make acquisitions and most importantly, integrate them, and we are not going to do something “stupid”. Take the bank loan, announce it for what it is, a positive event for the company that gives us a great deal of flexibility in terms of strategic investments if and when the time comes. Now, another comment we have heard is that you no longer -- that MiMedx is no longer “beat and raise” company. Well, I would not bet on that. “2015 has been a transition,” and I will put quotes around that in several ways. I know when I use the word transition, many shareholders get concerned. If you look at our chart of 16 straight quarters of significant revenue growth, I hope you realize that this company has performed despite a number of tough issues with which we have deal. This year we had a very significant price decrease with some of our wound care products. We prepared ourselves for that pricing issue and we've all set that to great extent with our new products. As I just stated our gross profit margin is up from 87% in the first quarter and 90% in third quarter. Those 2015 is a transition year that's prudent to be very successful and well-managed. We are now beginning to make major decisions relative to our surgical opportunities. We are adjusting our sales management structure for this new growth. We have numerous opportunities in several of these areas, particularly with some of our new products. Therefore, this is a time for more conservatism in our forecast. However, it certainly does not preclude us from beat and raise performance in the future. I made it clear at the Analyst Meeting, why we were not providing 2016 guidance now rather than December ’15. We have provided that guidance in the middle of December after our budget review and Board meeting every year except last year. We had very -- we have very discipline budgeting process in which our Board is involved. We made an exception last year, since it was our first Analyst Meeting. Our has Board strongly suggested management that we go back to our decades of discipline related to our December ’15 budget meeting with the press release of 2016 forecast following the Board’s review. As we have about 45 days to wait and I think you’ll be disappointed. Recall that our growth in the surgical area for the third quarter over a year ago was 85%, we’re launching several new surgical products that will produce revenues in 2016 and need to be thoroughly vetted for our 2016 forecast. We also have a number of other initiatives that were there on the forecast. The number of these things noteworthy by time of our mid-December press release on our 2016 financial performance is released. Our commercial wound care revenues are growing dramatically. They grew 37% quarter-over-quarter. Our wound care revenues have been relatively flat with VA hospitals. However, we’re not really losing that revenue to competition. That’s what the concerns were two or three years ago. For the third quarter, there were some specific constraints as VA hospitals finished up the fiscal year. Relative to 2015 operating profit, remember we have made numerous investments in clinical trial, scientific studies, efficient sales force and cost related to our patent suits. As Bill Taylor highlighted at the analyst meeting, we have won all our preliminary battles relative to our patent suits and we expect ultimately to be very successful in protecting our patent portfolio related to amniotic membrane allograft. Again I like to highlight the fact that data predictions a year ago related to the expiration of pass-through status for EpiFix have not occurred. While there were significant price decreases, we offset those by significantly improving our production efficiencies and by placing new product innovations in the market that helped us to actually continue to take market share even on a larger graft sizes. We understand the value of court being raised. We are going to a period where I believe it placed us to be a little more conservative as we transition our focus more towards our surgery, orthopedics and sports medicine area. We have product introductions to complete. So we do not miss the ability to shift product launch demand is developed. Now, while we’ve not officially commented on our analyst revenue, our profit forecast for 2016, we are experienced enough to tell you that if we had some issues with their expectations and forecast, we will be very focused on bringing them down or up for that matter. We are not uncomfortable with what we’ve seen. There is one analyst with an operating profit forecast for 2016 at 30% and we will simply say that maybe aggressive because the investments we’ll still be making next year. In surgical sales infrastructure, some surgical related clinical trials and our patent litigation, all of those costs should be trending down from this year. So the current revenue and operating profit consensus from our analyst management is comfortable with at this point. Thank you. I’m going to turn it over to Bill Taylor. Bill?

Thanks Pete. Good morning, everybody. The third quarter was yet again a solid quarter for MiMedx. And we gained momentum on numerous strategic and tactical initiatives. We expanded our portfolio of regenerative healing products with the introduction of OrthoFlo, our amniotic fluid offering. We laid the foundation for additional significant growth opportunities. Our long-term strategic goals include expanding our leadership position in chronic wound care and accelerating our growth in other markets. Our surgicals, sports medicine and orthopedic business grew 30% quarter-over-quarter sequentially showing some great opportunities for us. Also, our commercial revenue grew at a healthy 15% quarter-to-quarter sequentially as we gain leverage from our recent salesforce initiatives. That said, we did have one mistake in the third quarter as we attempted to leverage our feet on the street in wound care to gain more traction in the surgical arena. While we had some success with the handful of sales executives, unfortunately call for lot of -- loss of focus on wound care expansion which in turn did not allow us to achieve as much growth as we could. Since we refocused our emphasis and we’re accelerating our hiring on our surgical salesforce -- excuse me -- since we refocused our emphasis and we are controlling hiring surgical salesforce now. Now like we always do, we made our mistakes and corrected them quickly and moved on. Also as we discussed at the analyst meeting, we made some adjustments in our distributor network that will make us stronger in long term. This decision put pressure on our revenue growth in the third quarter as well as our DSOs but we expect to fully recover and then submit under short period of time. I’m sure you’ve notices that our federal business was not strong in the third quarter as early in the year. This was anticipated and expected. As we’ve stated previously, the federal business is not linear and we can be -- an it can be variable quarter-over-quarter. Among the factors that can affect this, our stocking orders from blanket purchase agreements or BPAs, rotation of residence in military personnel and get transferred in the VA and DoD, budget issues with the ending of the federal fiscal year and in this year, our transition to our own FSS contract and so forth. So you may remember a few quarters ago, we discussed we had a multi-million dollar BPA and that also contributed to our variability. Some facilities order weekly, some order monthly, some order quarterly or more. So fluctuations are quite natural. Overall, our federal business is very healthy. You may recall that a year ago, we projected our federal growth in 2015 would be about 15%, which is where we budgeted our growth this year. So year-to-date, we’ve grown our federal business about 25%, which is well above of what we projected. So although the business is somewhat variable, it is even stronger this year than we anticipated. Our commercial wound care business grew sequentially and that’s a very strong force as well. Overall, wound care quarterly growth looked flat because of the federal business variability but all these items considered we had year-over-year growth in the quarter, 37% in wound care and 77% in SSO. Over the last year or so, we had a lot of -- talked a lot about the pass-through in the bundle. We’ve done our best to educate our shareholders and this made you changing reimbursement and the way MiMedx will manage through it. Now, that we are three quarters of the way through the year, I think I can safely say that we managed the expiration of pass-through extremely well and the data proves it. From a unit perspective, I mentioned last quarter that our ratio of small to large sizes was about 80:20, 80% smaller sizes and 20% larger. This quarter we’ve seen a little bit more of a shift to our larger sizes, frankly because we have a few of those larger sizes including our mesh products priced under the bundle. The ratio for the third quarter was closer to 70:30 and 80:20. And this is good because it means we’re gaining traction again on the treatment of larger wounds. Now another metric of note, we shipped over 80% more units this year than last. This is compared to our revenue which is about 70% higher than last year. This delta is a direct result of the expiration of pass-through and resulting reduction in the average sale price of our wound care products. Now that occurred in the first quarter. Our pricing has basically leveled off now. And with this average price lower than last year, we must ship more units to achieve our desired growth rate. So this, in the fact, that we still have strong gross margins at 90% and we have continued to meet and beat our guidance is a testament to how well this management team manages all this complex variables. So with all the changes in our distributor network, less than optimal focus on our direct sales group, variable federal business we still had a very nice quarter-to-quarter growth. At our Analyst Day, I spoke about our leadership position in chronic wounds and amniotic tissue. I’d like to elaborate on this. One source of market information that we utilize is SmartTrack. One of the markets they track is amniotic tissue. They have estimated that the U.S. market size last year was $256 million and MiMedx was a market leader with 40% market share -- 46% market share. They estimated that 2015 market will be approximately $338 million. Using that as a baseline, we would imply that this year MiMedx will grow to about 55% of the amniotic tissue market. Now on the wound care side, they estimate that the 2014 wound biologics market was $865 million. The CTP or cellular and/or tissue products segment is the largest segment and just over 60% of that wound biologics market. SmartTrack estimated that the CTP market was just about $140 million in the second quarter of this year. And MiMedx was the market leader by significant margin at 26.6% with the number two company Organogenesis at 19.9% and declining, Integra was at 13.9% and Osiris at 12.8%. Generally speaking, we find our data to be reasonably accurate with occasional acceptance for some companies that do not publicly disclose the product line breakouts. For example, we’ve analyzed the Medicare 2014 claims data for the hospital outpatient market. This data shows that in 2014, MiMedx had the market leadership position with 34%, Organogenesis was next at 31% and Osiris was at just under 8%. Now this Medicare data tells us that the SmartTrack data for MiMedx and Organogenesis are reasonably consistent with the Medicare data. With the SmartTrack, Osiris data is very likely significantly overstated. Our SmartTrack data shows Osiris at about half or 50% of our wound care revenues. The sales in the category are most likely closer to 20% of ours in wound care based on the calculations from the Medicare data. They have far west healthcare -- commercial healthcare playing coverage than we do too so that does not account for the difference. The data implies that a large percentage of the revenue comes from products other than those using chronic wound care. So we just don’t see their chronic wound care products in the field being used at a level as described by SmartTrack. And obviously, they won’t give a break down of their revenues either. Now regarding our sales team, I already mentioned how we tried to leverage our wound salesforce to help make our surgical team more effective in the short term. It certainly worked that we were able to leverage our surgical team’s knowledge and expand our surgical business but it did come at the expense of a loss of focus for some of our wound care reps. So we’re refocusing their efforts and adding personnel to our surgical team. Overall, we had about 215 field sales personnel at the time of our last shareholder call. And within a week or so, it should be at around 230 and by the end of the year, we should hit or exceed our 240 sales person target for this year. I spoke at the Analyst Day about our intellectual property and how our key configuration patents and EpiFix and AmnioFix were denied IPRs, inter-party review. And that speaks volumes to the strength of our patents. As you may recall, an IPR is an inter-party’s review which is a relatively new process in the patent world. We’re designed to bring quicker review of patents that are questioned and is performed by a small panel of judges with a high level of patent law expertise. I want to correlate this point to our operating earnings that Pete touched upon earlier. We filed our patent lawsuits against companies that we believe were violating our patents. We expected to have to defend them and budgeted accordingly. As the cases developed, we spend more on our legal fees than we budgeted but it has paid dividends strategically. I’m not going to go into details regarding our IP’s defense strategy except to point out that it is very complex. Getting the best legal representation that worked towards the best outcome is expensive and from our view it is a very good investment. These increased investments have already reached strong dividends with the two primary configuration patents being denied those IPR proceedings. This is a decisive victory for us. Now, how decisive is it? I previously mentioned the statistic. Approximately 93% of these cases where IPRs are filed, move forward into the process and are granted a review. Only 7% are rejected. Our two core configuration patents are part of this 7% now. While this increased expense dropped our operating margin for a few quarters, it was definitely the right decision and a great investment. Before I turn this over to Mike Senken, I want to turn on -- touch on one of the points Pete made earlier. He described a deep experience in M&A work that he and his executive team has. But he forgot to mention one thing, one and only acquisition we’ve done at MiMedx. Recall a small company called Surgical Biologics. Our market cap at that time was about $80 million. I’d say that acquisition worked out pretty well since we were about $1 billion or so in market cap. So I can’t say that any new acquisitions will be this accretive but this management team certainly knows how to make accretive acquisition that makes sense. Now I’ll turn it over to Mike.

Thanks Bill. The company recorded revenues for the third quarter of approximately $49 million, an increase of 46% or $15.5 million over prior year third quarter revenue of $33.5 million. For the nine months ended September 30, 2015, reported revenues were $135.5 million, which represents an increase of 72% as compared to prior year. For the quarter, commercial revenue grew 71% to $38.7 million, with strong growth in both Wound Care and SSO market segments. The company added over 350 new customers in the quarter, as we continue our expansion into secondary cities in addition to opening up new federal accounts. Federal revenue of $10.3 million represents a slight decline of 5% from prior year. The decline was in our SSO revenue, somewhat offset by an increase in Wound Care. Overall, Wound Care revenue was $35.8 million, which represents a 37% increase over prior year. We continue to see strong unit sales growth, including the mesh configurations in Wound Care. SSO revenue was $13.3 million, which represents a 77% increase over prior year. Growth was driven by direct sales in surgical and orthopedic applications as well as distributor sales. Gross margins for the quarter were 90%, which marks the third consecutive quarter of improvement in 2015 and are equivalent to the third quarter of 2014. 2015 year-to-date, gross margins are 89% as compared to 88% in the prior year. The improvements in gross margins since the beginning of the year reflects the successful transition to the mesh configuration that was launched in mid-February to address the expiration of pass-through impacting large sized grafts for DFU and VLU patients in a hospital outpatient clinics. R&D expenses for the quarter were approximately $2.2 million, or 4.5% of quarterly revenue as compared to $2 million in the third quarter 2014. On a year-to-date basis, R&D spending increased $868,000, or 17% over prior year. The year-over-year increase in R&D spending is driven primarily by increased investments in animal studies and clinical trials. Selling, general and administrative expense was approximately $34.9 million for the quarter, or 71% of quarterly revenue as compared to $24.2 million, or 72% of quarterly revenue in 2014. The year-over-year increase in SG&A spending was due to the continued build out of our direct sales force in both Wound Care and surgical markets, additions to the reimbursement team and other support areas, as well as increased legal costs primarily related to our patent lawsuits. Legal costs related to patent litigation for the quarter totaled $1.3 million, or 3% of quarterly revenue. Patent legal costs have totaled $3.1 million on a year-to-date basis, or 2% of total revenue. During the quarter, we added seven direct sales reps and on a year-to-date basis have added 49 direct sales reps, bringing the total direct sales headcount to 217. On a year-to-date basis, SG&A expense was 72% of our revenue. The company reported a positive adjusted EBITDA margin of 24%, or approximately $11.8 million for the quarter ended September 30, 2015, which is an increase of $4.5 million as compared to an adjusted EBITDA of $7.3 million in the third quarter of 2014. It is the 15th consecutive quarter of reporting positive adjusted EBITDA. Included in our press release is a reconciliation of adjusted EBITDA to reported net income. The improvement is driven by increased sales volumes and corresponding operating leverage. Also please note that our EBITDA margin has improved each quarter in 2015, going from 22% in Q1 to 23% in Q2 and now 24% in Q3. For the nine months ended September 30, 2015, adjusted EBITDA was $31.1 million or 23% of revenue as compared to $12.2 million, or 15% of revenue in 2014. Operating income in the third quarter was approximately $6.7 million, or 14% of quarterly revenue, which represents an improvement of 80%, or $3 million as compared to operating income of $3.7 million in the third quarter of 2014. On a year-to-date basis, operating income was $16.6 million or 12% of total revenue as compared to an operating income of $2.4 million or 3% of revenue in 2014. The company reported net income for the third quarter of approximately $6.6 million, or $0.06 per basic and diluted common share as compared to net income of $3.7 million or $0.03 per basic and diluted common share in the third quarter of 2014. Year-to-date net income was $16.1 million or $0.15 per basic common share and $0.14 per diluted common share as compared to year-to-date net income of $2.4 million, or $0.02 per basic and diluted common share in 2014. Turning now to the balance sheet. The company reported approximately $102.7 million in total current assets including $41.1 million in cash, $6.5 million in short-term investments, which are comprised of fully insured and liquid bank certificates of deposits, $46.8 million in accounts receivable, $5.7 million in inventory and $2.7 million in prepaid expense. Day sales outstanding for the quarter were 86 days as compared to 76 days at the end of the prior quarter. The growth in DSO above our internal target of 75 days were driven by continued rapid expansion of our customer base, as well as certain adjustments regarding our network of distributors in the SSO segment. We continue to add collections and field reimbursement staff to improve collections performance, especially with new customers. Inventory turns were 3.5 for the quarter as compared to 5.3 at the end of the prior quarter. The increase in inventory was in line with our production plans as we continued to add new SKUs in support of our planned SSO segment growth. Current liabilities were $24.4 million as compared to $19.5 million at the end of the prior quarter, with the increase in line with the growth in our business. Turning now to the statement of cash flow. The company reported positive cash flow from operating activities of approximately $7.3 million for the quarter, driven mainly by an increase in adjusted EBITDA, somewhat offset by increased working capital. Cash used in investing activities includes $1.7 million in fixed asset purchases, including purchases related to the continued expansion of our tissue processing capacity, as well as our IT infrastructure and production related activities for CollaFix. Cash flow used in financing activities for the quarter includes $4.4 million for share repurchases, somewhat offset by the proceeds received from the exercise of stock options. The company repurchased 455,000 shares in the quarter under the share repurchase program, bringing the cumulative total to approximately 3.2 million shares repurchased under the plan through the quarter end. In the month of October, the Board approved an additional $20 million in share repurchases. And finally, we added a total of 16 associates in the quarter, bringing our total headcount to 500, which represent a 50% increase as compared to September 30, 2014. Turning now to our guidance. The company is now guiding $49.5 million to $52.5 million in revenue for the fourth quarter, resulting in annual guidance of between $185 million and $188 million. The company is now guiding 14% to 15% operating margin for the fourth quarter, resulting in annual guidance of between 12% and 13% operating margin for the full year. Also please remember that the company will issue 2016 guidance following our Board Meeting in mid-December. And finally, management will be participating in several investor conferences in New York City in the month of November and December, as well as in San Francisco, the week of January the 11th through 15th. Please check back to the investor relations page on our website for further updates. With that, I'll turn the call back over to Pete.

Thank you, Mike. Let’s go ahead and open the call up to questions and answers.

Yes, sir. [Operator Instructions] And our first question comes from the line of William Plovanic of Canaccord Genuity. Your line is open. Please go ahead.

All right. Great. Thank you. Good morning. So, I just have two questions. One’s related to the Wound Care. If I look at the business, the Wound Care was actually flat sequentially and historically, we have not seen that. Q2 to Q3 is typically been up and I'm just trying to figure out what the puts and takes are on that? Was volumes up, the pricing was down, was the competition, was it stock, destock? And if so can you quantify that for us, then I have a second question. Thank you.

All right, Bill. Really the key -- sequentially was the federal business, the commercial Wound Care business as I have mentioned was up nicely in the quarter. And the federal business with its variability and the various stocking orders that we have. Unfortunately, the federal business does not order weekly like we'd like them to, which sometimes monthly or even quarter for some of the accounts. So that's really the biggest item we had. And some of the accounts in the counselor the quarter you can imagine, getting close to the end of fiscal year, actually stock purchasing for a while. And it didn’t turn back on again until October and add to that one thing that’s different and unique compared to previous years is our conversion to our own FSS. So that does also impact that as well. So those are key factors from my perspective. I don’t know if Mike has any other further comments here.

No. That’s pretty much handful, Bill.

Okay. Great. And then just secondly on the draft document. As we read this, how should we think about this? Is this going to be the final rule that comes through or is just this open for discussion and if so, what is -- can you please lay out the timing for this and if this will have any impact on the business given FDA's position?

First of all, I want to be sure because we usually note the stock price decline this morning. I want to be very certain that this has got little to do with it. The short sell thesis that we’ve gone through over the last couple of years have all been proven incorrect. We know probably more about this process anybody in industry because of our two years of being very, very involved. What happens during notice and comment rulemaking process, which is normally the process that anytime FDA wants to change the regulation or modify one, they go through. Congress is involved. The public is involved. Industry is involved. External scientists are involved. It becomes a rather lengthy process. The first meeting is already been scheduled for April, I think it was 13th. That will be the first meeting of probably several. It will be a lengthy process. When I said it was positive, I meant it was positive. The agency has been under scrutiny by Congress and industry for the last several years over changing regulations or attempting to change regulations by just publishing guidance documents and basically saying we are just giving you an interpretation. Well, that’s not the way things have been done. Previously, it’s not the way the FDA regulations and way the governance policies work. So, we view this as a very positive disclosure. It means that industry and outside scientists as well as the oversight and process and Congress goes through and the approval of these things, these changes will take place. That’s healthy. That’s the way systems supposed to work. It’s not supposed to work with names we published in the guidance documents and use of guidance documents to change regulations. So again, we view this as very positively and if someone thinks that this company is going to go out of business because of an FDA announcement this morning, they are seriously mistaken. We’ve worked with this agency, probably closer than anybody over the last two years. And I think we know the issues that they have well and we know the issues Congress has well. And we know the issues in industry as well. So again, we view this as a positive process that will take place in an orderly fashion now with a number of constituents involved both industry as well as Congresses who has oversight here.

I’d like to add to that, Bill too. This is a guidance document. It’s not a rule. You wondered if this was a final rule or not. Well, this is not a rule. It’s guidance only. And even though it’s guidance only, what it’s doing is describing, frankly change in thinking about the FDA that must go through that notice and rulemaking period, even though with guidance-only. So it won’t even be a final rule once all those hearings are complete.

That’s all I had. Thank you.

Thank you. Our next question comes from the line of Matt Hewitt of Craig-Hallum Capital. Your line is open. Please go ahead.

Good morning, gentlemen. A couple questions. Starting off, well, all three related to this draft guidance, obviously everyone is scrambling to understand what it says and what the potential impact is. First off, you just went through what the process would be, but what are the potential outcomes, the FDA obviously -- well there would be the comment and question period. Everyone will have input, but what do you think the potential outcomes are? And then I have got two follow-ups to that.

Well, the potential outcome should be that if they’re going to make some reasonable changes that industry is fully appraised of those and there is a period of time generally allocated for industry is just too much etcetera, etcetera. What industry cannot cope with and the reason that the Congress is very upset about this is documents being published and basically no -- very little notice given seek today’s thank you very much and we are moving on. That’s not the way the regulations dictate they are supposed to work and that doesn’t mean that that happened like that. But we’re not just on the skin substitutes area or HCT/P area, we are not the only area that’s been affected by these kinds of pronouncements by the FDA over the last many years. So there is a number of industry segments, not just ours, that are very focused on this. In the Congress, they have talked about it. In the FDA, they have talked about it. So again, I view this as a very, very positive move, probably a change in some ways and days, so you have been doing some business. And again, we’ve been very involved for two years, but so other industry segments and the issues of untitled letters and change in regulations. We are trying to change regulations through guidance documents. I think it’s been thoroughly read. There are many centers in congressmen that are very, very -- and the staff very, very appraised of this and very, very upset about some of the things that have taken place. So again, I can’t say too much about how I view this as a very positive event, it’s not a negative event and a lot of progress has been made by a number of trade associations as well as [adjustments] [ph] like our sales as well as congressional staff in the last couple of years on this very subject. So I view this as positive.

I would like to just throw in one more thing too Matt is the difference between intended use and indication for use in this draft guidance when they made the statement in their related to amniotic tissue, it was worried much more like an indication for use which is much more specific than is allowed for 361 tissues. The FDA has in the past very clearly stated that amniotic membrane does act as an anti-inflammatory, anti-scarring, anti-angiogenic agent and then enhances wound healing. Those are the intended uses of amniotic tissue and that’s consistent with the function in utero. I think in my view the issue is when you take it a step further and you start advertising it for a more specific indication for use and we don’t do that, we keep it with the general intended uses. So I think that’s one of the key things here that people get lost and is the difference between intended use and indication for use.

I will add other thing. I believe that withdrawal of clock back two years or year as we discussed our interaction with the FDA, we have some of the same concerns that they’ve had about and specifically in our product area, the amniotic tissue. There is a lot of organizations jumped into this trying to ride our quartile, seeing our successes and they have done things they shouldn’t do. That doesn’t mean industry has always reacted as quickly as we thought they would and should, but there have been a lot of things that have gone on in AMCs and their planning process I think is highlighted in our particular area. So things that they don’t want to see continue to happen. As you all know, we have done everything AMCs has asked us to do in terms of volume in IND and BLA. But we -- and that’s on our micronized product, our sheet product, they have told us verbally that they have no issues with our sheet product. But this is much broader than that, it covers all tissues, so all of tissue bites in this country are very -- could very well be affected. And that’s why everybody is interested. So trade associations, all three of them sent very strong statements when they filed a guidance document in last December, there will be more of that coming relative to this homologous document and then they will be hearings which start next April and then there will be more than one I can assure you that. So this is going to be a lengthy process and I hope and thank a productive process where the relationship begins to work with industry and some adjust conclusions are reached and we go from there.

All right. Maybe the follow-up on that and that was all helpful. But specifically I am trying to get to what are the potential outcomes, obviously if the FDA backs off of this stance and like right now I am specifically looking at 4.2 or 4-2. If they back off of this stances, obviously that bolsters your position within the industry and that’s some very, very good news. If they however come back and say listen we’ve listened to all of your comments and we’ve seen all the data and at this point, we are going to say that it’s not homologous use and therefore you need to go through an FDA approval process. Can you at that point seek grandfather status where you can continue to sell during that process or would you need to potentially pull that EpiFix from the market until you have that?

Here is the product that has had hundreds of millions of dollars of revenues, 500,000 units sold, thousands of physicians across this country and tens of thousands of patients have been benefited. Do you really think that product is going to be yanked from the market without the first safety concerns? I don’t think. My 45 years of experience say no. My last two years of involvement with this agency on this basis says no. So again, it’s not just about amniotic tissue, there is a broader issue here and the agency does have some points they want to make, get across. The concept here is somehow our medics is going on a business or product lines are going to be yanked from the market believe me that’s just in preposterous.

I just want to reiterate what Pete said, I am not sure if people recognize it. In dealing on our micronized issue over the last couple of years, the FDA specifically told us that they had no issues with our sheet product, okay, that needs to fixed in, they had no issues with it. So I don’t understand the concern here.

And this document that came out last December on minimally manipulation didn’t seem to get this, oh, my god, the world is coming to an end, focus on it. There is no reason for now the homologous use piece of, because there is two pieces in terms of the tissue here, minimally manipulation and homologous use. This generally took great standards is a marketing issue.

I can elaborate it Matt too. When you look at homologous use discussion here, go through the document, really what they are talking about is how the product is marketed not necessarily whether or not it can be marketed. So I will give you an example here they have been pretty explicit to on other products that would have to just change their marketing to be something like a wound cover for acute and chronic wounds, that’s happened actually to one of our competitors out there, but the FDA has said that that was acceptable to market that product in that way. So we think kind of the worst case through this is a change in our marketing and labeling is a worst case. We don’t see if there is any possibility of having to retract the product from market. So to your point of what could happen, we think that really the worst that could happen to us here, but we don’t even think that will happen.

Okay. Great. And that’s perfect. One last question and then I will hop back into queue. Do you think that the FDA -- and I know they aren’t tied to CMS directly, so there are not really talking to each other, but do you think that before they put this draft guidance all they looked at it and said okay, well CMS has changed to this bundle strategy, which is essentially excluded what had been the incumbent players. The standard of care takes a lot longer and ultimately more costly leads to more amputations and now all of a sudden they come out with the draft guidance that says we are going to look at this and say, boy, we are going to exclude the product that do seem be working and do seem to save cost. I mean do you think that they consider a factor that into their thought process at all?

Our experience is that we found the agencies don’t communicate at that level, but that’s what notice and comment rulemaking is all about. When these public hearings take place and the industry input is input from scientists and clinicians unrelated and outside of FDA, then those kind of things get credit and people begin to say, oh, okay, that might be a bad policy, let’s see how that has to be modified. So that’s what notice and comment rulemaking is all about. It gets everybody involved instead of agency just putting out a guidance document saying 60 days from now this is what we’re going to be using to regulate. So that’s why I am very optimistic about process because two years ago I wouldn’t have been as optimistic, so there has been a lot of things that are going on in the last two years that have gotten, hopefully this [dinginess] [ph] area that we’re involved with. But again, it’s not just these issues associated with untitled letters and guidance documents have not just related to skin substitutes and human tissue, they are related to other areas of FDA’s pronouncements and has been problematic for everybody.

All right. Thanks for answering the questions guys.

Thanks, Matt.

Thank you. Our next question comes from the line of Jason Wittes of Brean Capital. Your line is open. Please go ahead.

Hi. I have a same questions. I guess you’ve already gotten quite a few on the FDA guidance document, but I think that’s really what’s investors concern this morning, so I will ask a few more. Just my read of the document is obviously we’re all just getting it now is that if there -- first of all they are suggesting if it doesn’t meet the requirements they anticipate it should be regulated as a PMA or BLA specifically. Is that your read of the document as well or do you think there is, do you think this is simply a labeling issue?

Well, that’s obviously just the regulation. If issue is to determine not to meet certain requirements, then they it flips over to another category. The issue is simply you cannot flip switches like that and turn the whole tissue industry upside down, it doesn’t work like that. When you get into the notice and comment rulemaking process, then some sanity generally settles in and agency makes its points, industry makes its points, congressional oversight has its points and resolutions develop that are rational.

All right. Jason, I will just point you to page two on the background section two. HETP is intended for homologous use only. It all goes back to the intended use, okay, intended use versus indication for use, so it’s talking about the intended use. So if somebody changes the intended use to something outside of what is consistent with, what it was in utero, then that’s an issue, but if it’s consistent with what it was in utero as an intended use, so that all comes down to marketing and labeling.

Those all are fair comments. I do want to ask I think we’ve seen this before the FDA has maybe required more stringent regulatory requirements, but at the same time there is sort of and actually grandfather the incumbent players out there, but they basically said you keep selling the products while you’re collecting data and submitting for these approvals. Is that also scenario that’s likely an outcome from this document?

That’s exactly the kind of things, decisions they have made previously, yes.

So that is consistent.

Yes.

Okay. Just to switch gears on the surgery number, look pretty good, look very good, better than we expected. I'm just curious was there -- how much of that was related to your direct distribution network and how much was related to distributors?

I don’t think we’ve disclose the exact percentages, but higher percentage would be on the distributor side than direct. But that’s natural because almost all of the business in the past is on the distributor side and we’re building the direct business. So, I think, down the road in the not-too-distant future you are going to see that flip, but that's where was at in the fourth quarter without giving the specific numbers.

Yeah. So just to add Mike point, the direct sales on SSO are growing, but the distributor sales are growing as well.

Okay. And then…

Yeah. The direct sales grew significantly in the quarter, I can say that.

Okay. And was there, I mean, I think, third quarter last year you had some distributor stocking, was that also part of this numbers, especially in the surgical piece?

Well, the nature of distributor, yes, they order for stock and then they sell off that stock and then they come back and do a replacement order. So any time there’s a distributor order there is some element of that.

Okay. And then maybe last related question to that, I think, about fourth quarter in terms of the trends of the two, the wound care versus the surgical business, any kind of guidance you can give us in terms of how we should think about the growth rates for the split?

Well, this is Pete. The number should speak for themselves. We’ve got some very robust growth rates in the commercial side whereas -- where we built a lot of strength over the last several years in our wound care products. The Federal date I think it has been thoroughly discussed. I think Federal was up 25% this year so far compared to 15%, which is what we committed it would be. So we’re doing very well on the Federal area.

I think, split-wise it should be similar at third quarter, maybe a little bit more skewed back towards wound care, but not significantly.

Okay. That’s helpful. Thank you very much.

Thanks, Jason.

Thank you. Our next question comes from the line of Mark Landy of Northland Capital. Your line is open. Please go ahead.

Thank you for taking my questions folks. Good morning.

Good morning.

Hi, Mark.

So, I guess, I’ll jump on the guidance document then, well, again, just to finally be to date? But just so that I can put a bow around just high level thoughts, I mean, we’ve seen the FDA do this before in interesting plans being orthopedic products, [Indiscernible]. Now as the product matures and use grows, I guess they rethink the process that people have to go through specifically [indiscernible] range. How much time you feel would you or the industry would needs to be able to detect this data together to file whatever required filings to be assuming that’s look to require to keep the products on the markets? And then you think that what has to choose the indication or the intended, just because, that’s become a very hot topic at the FDA over the last couple of years reference to off label use. Would you to choose intended uses or do you feel that through the process you might be able to grand further on last time for broad use for the single-label and then going forward it will be more long intended use from the regulatory pathway?

Well, let me make a comment and then, Bill can jump in. As usual, I think, the street is doing its normal, oh my god, let’s dig right down of the bedrock of situation, okay. I wouldn’t have told you earlier that I felt it was positive, if I didn’t feel it was positive, okay. There is things that this -- that will play out here. It will take, frankly, much longer than anybody anticipates, sometimes these things take, I have seen three years. Hopefully this will move along faster than that. But there’s a lot of input here required from industry, a lot of science and a lot of other things that are going to take place. You got a new FDA Commissioner coming in shortly, probably with the different philosophy, we’ll soon find out. But the panic of, oh my god, this is going to take a company that’s commercialized very effective tissue for last five, six, seven years and turn it upside down. That’s just not going to happen. It doesn’t happen that way. Particularly, a group that has been, as involved as we are with this. So there will be some a lot of back-and-forth. But I don't think -- I think our shareholders are been ultra conservative here about thinking, oh my lord, some thing is going to better consequence is going to happen. We have been -- I have been personally involved. I walked the halls of congress. I walked -- been to FDA a numerous times. I’ve numerous conversations as well. I know a great deal about this process, sometimes more and I want to. But we don’t see this -- we see this is a very positive and bad for us. We don't see it because we've been very, very in tune, I think with FDA in terms of their concerns and we had, as I said, some of the same concerns. My biggest concern about amniotic membrane tissue technology was some of the smaller competitors would do things they shouldn't do and give the technology a bad name, okay. We’ve done everything we can to keep the science and the clinical studies and everything else very effective and efficient, and we’ve been applauded for that. So I don't think we’re going to see some kind of draconian decision coming out of this agency. These decisions by the way will be -- could very well be a year down the road or two to three years down the road. By the time, all this is still embedded and go shoot the congresses overview, et cetera. So that’s the situation as we see it. Bill?

Yeah. Mark, let me add a couple of things. Let’s just take the one extreme and say that they decide to change the regulation and the grandfather people in that have been in the business and give them some time to put together what other data they looking for. So the question is, how long is that taken? What does that look like? Well, it depends. Are they going to ask for a pullout BLAs or something different? There's been a lot of talk between the FDA and the AATB, and a number of other organizations. The FDA is looking at the cellular and tissue products, the human tissue HCT/P and when they want to regulate them differently, it should be something like a BLA light or something like a 510(k), something it’s a little different than full on BLA because it had the -- the tissues have been proven safe. So really there’s a strong argument to not have to do the same thing as a BLA. So it really depends on where they end up on that item. And relative to us, we’ve got reams and reams of data. We’ve got more than 20 peer-viewed published articles. Whatever pathway it goes down, if it goes that direction -- if it goes that direction, we’ve got a huge amount of data that I would expect we could leverage and utilize to get to the end pathway pretty quickly. But it really depends on what pathway they would ask people to go down. So it’s hard to answer that question.

And the other issue here, we are the industry leader. We’ve developed more science and clinical studies around amniotic membrane tissue than anybody by orders of magnitude. This will be detrimental to our smaller competitors, it will. Whatever comes out of this, I can assure you will be much more detrimental to them where we with our scientist, clinicians and our experience here will be able to manage it carefully and quickly and move ahead with it just as we've done with our first IND BLA submission where we’re already enrolling patients. So to me again, this is positive news. It’s great news and we’ve got a federal agency, with their intentions working with industry, with their intentions with congressional oversight that is good news.

Pete, maybe I ask the question that has many phrases. I fully understand on the [indiscernible] and respect what you’re saying. I think you’re right that with regulation coming in, those people going through the process have the opportunity to set the bar and for those coming behind them. So as one of the leaders as you said in the most well-funded in the space, you’ve got the opportunity to set the bar and their hurdle. How far do you push that hurdle so that MiMedx doesn’t struggle, get over it but yet leave large enough hurdles for others wanting to get into the space?

Well, Mark, again, we’re two years into this process and we’ve had a lot of dialogue, a great deal of dialogue with the agency. So I think we understand them reasonably well and they certainly understand us and so do congressional leadership understands both sides. And again, I don’t want to just say it’s a MiMedx issue because its not. It’s much broader than that. And when they issued their guidance document last December, they brought the whole understand under this thing. Prior to that, it was MiMedx standing alone and they often do this. They will take the leader on an area. They will go after them with the changes they’re looking for and somehow think everybody else follow suit. Well unfortunate, didn’t happen that way in our case and probably it didn’t have in that way very often but that’s what happened. So I don’t look upon this as us trying to position ourselves. I look upon this as a federal agency who has a job to do and responsibilities but being also responsible about involving industry and industry scientist and clinicians and outside scientist and clinicians and decisions like this. And I think that’s what’s get ready to take place. So I just know that if we were company that was $20 million in revenues, we will have a difficult time perhaps in doing some of things that they want people to do such as an IND BLA process. We will end up coming out of this thing much stronger with much more knowledge about process procedure than our small competitors and that's what our strength should reward us. But I don't view at this something we're going to be trying to work with the agency to develop their thought in regulations. And that’s pretty hard to do anyway. They have their concerns and it’s not always our concerns. They have a different function in this country than we do. So I just want a logical straightforward legal process to take place that's all we’ve ever ask for. And I think, what we’re seeing here is that process is playing it out and I appreciate what the agency is doing here.

Okay. I mean, my last [Technical Difficulty] in terms of the wound care surgical split, obviously it was up a little bit this year in favorable -- this quarter in favorable surgical you mentioned the reasons why. You have started to address that with the salesforce realignment. Should we think about the ratio of wound care to surgical going back in the fourth quarter to kind of what it has been in the past or will that slowly kind of trickle down towards normality? How should we think about that split I guess for the fourth quarter?

Well, again Mark, I think what happened in the third quarter is a reflection of some of strategic initiatives we've been undertaking to date. We started adding direct sales folks on the SSO side in the fourth quarter of last year, some of that is starting to bear fruit. We’re positioning ourselves for next year and the years to come to have a strong in SSO business segment as we do the wound care segment. So I don't think we’re going to go backwards but I think that's a good thing.

Okay. Terrific. Thanks. And then last question, how is OrthoFlo doing since the analyst meeting? Can you give us the two-week update?

I will hate to tell you that I don’t know but its doing well.

Thanks. Thanks for answering my questions, guys.

Thank you.

Thanks, Mark.

Thank you. Our next question comes from the line of Joe Munda of First Analysis. Your line is open. Please go ahead.

Good morning, guys. I’m not going to repeat the words here as a lot of my questions have already bit answered on the draft guidance document. I’m just wondering, Bill, last quarter you gave us an update as well at the Analyst Day. CollaFix, anything new there, anything that’s changed as far as the pathway is concerned?

Well. I think we gave a pretty good update at the Analyst Day, where we continue to review and work with our specialists in the regulatory area to see if there are other configurations of CollaFix that could take some other pathways that may even be quicker. And we’ve actually got a few things that look pretty promising here. But until we get to the point where we fully have bettered them, we are not going to really talk about it. But there are a couple of opportunities that may even be better than what we showed at the Analyst Day.

Okay. Mike, can you give us some sense of what, if any of the revenue was derived from micronized products during the quarter?

Joe, as a policy, we don't disclose sales information by SKU.

Okay. I thought maybe in the past, you had given out some indication of what it was running at?

Well. We did last year. We said that it was 14% of total revenue. The reason why we did that was because it was a focus area around the untitled letter. We can say on a year-to-date basis we're within that range.

Okay. And then finally, my last question. The sales force number, was it 215 or 217 exiting the quarter?

The actual official number and I know Bill and I were up by two. But the official number was 217. Bill said around 215 by the Analyst Day.

Okay. Great. Thank you.

Thanks, Joe.

Thank you. Our next question comes from the line of Bruce Jackson of Lake Street Capital. Your line is open. Please go ahead.

Hi. Thanks for taking my questions. First, if we could talk about the distributors switch out this quarter. What was the revenue impact? And then when you think you can have that back at a run rate where it was previously?

Let me make a quick comment. One distributor that had been known us a while and it was just time for us to go our separate ways. That probably cost us a bit or did cost us some revenue in the quarter. But it is what we needed to do for our longer term and medium-term strategies taken in surgical area. It just freed us up to do some other things and we needed to be accretive to do those other things.

Yeah. They were our largest distributor outside of the federal side of the things. So you can think from our past case you can see, how big that product line was. But it was substantial but in the next few quarter, we should be able to catch that up and then some.

I think one other thing we should point out that this isn’t the first time that we’ve kind of readjusted our distribution strategy in certain segments. If you go back to, it was the tail end of 2013, and into 2014, we actually had several regional distributors that we consolidated. I’d also point out, if we ever come back to the question on DSOs that in that quarter, our DSOs did move up to about 87 days. So, we're looking at the long-term positioning of the company and how to best exploit certain opportunities in the marketplace. And as in the past, we have found at a given point time, certain distributors have run their course and we need to do things in a different way.

So, you would have been above the upper end of the range, have you not switched out the distributor?

I think that's what we alluded to.

Okay. And then if we could talk about gross margins real quick, very strong in the quarter. You are developing some new products that reduce the level of scrap and the manufacturing process. How sustainable would you say these gross margins are going forward?

Well. The odds are that they will come back at some point. Is that some point three years now, a year from now? It is going to move around. The reason we highlighted it is because a year ago, the short thesis was when we lost pass-through status, the company's is going to crash and burn. I mean it was going to very disastrous. Okay. That didn't happen. And not only it didn't happen, gross margins went up when they should have come dramatically down. Okay. There is reasons that management orchestrated that that happen. So, we are pretty good at what we do. We generally know when things are happening and we deal with them and plan for them and execute properly. So that's the reason we highlighted it. But that doesn't mean that if it comes down a percent next quarter, for god sakes don’t think we’ve come crash and burn again. It is going to move around. It is flexible. Some of these new products will come out with a little lower gross margin to start with. And then as production efficiency go up, we will have better margins. So, we can get into this. This moved up a 1%. This moved down 2% of my business, the wheels are coming on. We are paid as management to manage those variables but sometimes there is only so much we can do.

Bruce, we guided coming into this year that we would be in the mid to high 80s in terms of gross margin and we skewed towards the top end of that range. We also said, we’d be coming out with a detailed guidance after our mid-December call. We’ll give more flavor around the gross margins once we get to that point. But as Pete mentioned, I don't anticipate we will see any dramatic change in the gross margins from what we’ve spoken to over the last year or so.

Okay. Then just a couple of housekeeping questions on the operating expense side. So, we've had a slight increase in the R&D in 2015 and slightly picking up at a certain rate. You've got some new products and some new development projects coming online. Would it be safe to like say that the R&D is going to be moving up at that same rate in 2016, not that I’m asking for 2016 guidance? But would it be safe to assume that it’s still heading up as opposed to flat?

Bruce, I would say you are asking for 2016 guidance, certainly and again in absolute dollars the R&D spend will go up. As a percentage of revenue, we think it will -- well wait for mid-December, it is not going to dramatically move, put it that way.

Okay. Last question legal expenses tend to be somewhat lumpy depending upon the activity in any given quarter. Should we look for that same legal expenses in the fourth quarter that you had in the third quarter?

I think somewhere between three of us, we signaled that the legal expenses were highly focused on our patents activity and that should begin to come down somewhat, but that's an investment we feel very strongly about and we will continue to make so, but it shouldn’t perhaps beat same levels because we’ve been very involved in last year in terms getting up our foundational.

Okay. That’s it for me. Thank you very much.

Thanks, Bruce.

[Operator Instructions] Our next question comes from the line of Mike Matson of Needham and Company. Your line is open. Please go ahead.

Hi. Thanks for taking my questions. I guess just in the surgery business, the growth has been particularly strong there. And I was just wondering if you could give us some insight into which particular procedures are seeing the most growth in?

Well, a year or so ago we highlighted the fact that we had some studies going on in the urology area, there has been prostatectomies specifically. We had a paper published on the subject and a lot of physician enthusiasm around it .There was some particular physician leader in this whole areas US wise and you could also say worldwide being one of the sponsors of the research. So that’s done well.

I would say that I don’t have exact specifics in front of me. But what comes to my mind are a number of our orthopedic procedures as well as our surgical like prostatectomies and some GYN and colorectal surgeries are getting some nice growth now. We are too premature to give you the specific detail there, but hopefully down that we can get to the point we give you a little better information. Those are the areas that I recall is getting good some momentum in.

Okay. And then you mentioned you’re planning to add 30 or 40 reps. So I was curious if you have a target in terms of how that would break down between surgery in orthopedics or is it just more dependent upon, whether or not you find the right people with the appropriate skill set in those various areas?

It is a little bit of that, but the available people obviously have an impact on when and where you can hire in the different areas. I would say that in this next batch it is going to be a heavier weighted to the surgical side, although we’re still going to bring in some nice number of people in the wound care side. But I don’t know the exact split, but certainly third or more of them are going to be coming in on the surgical side.

Okay. And just for these reps and particularly in the surgery and orthopedics areas, where are you typically hiring those reps? I guess in the past I know you talked about hiring some reps from Intuitive Surgical in the surgery area, but is that still the case and the orthopedics reps coming out of kind of bigger orthopedics companies or…?

Yeah. We are still hiring some folks out of that organization. We are not limiting to that. We’re really looking for people that have heavy surgical experience that have relationships in really any of those three areas, the urology, colorectal or GYN, folks that have some good relationships there and some heavy experience. So there’s a number of companies that have pretty good background there. I will point out that we’re really focusing not on the people that have sold the capital equipment piece of it, but are selling the disposable end of things. Those are the product sides the product areas that are repetitive sales as opposed to a large capital sales. There is a bit of difference in terms of personality and approach with those two. So we’re focusing on the ones to have to have continuous strong relationships with surgeons as opposed to something in hospital administration.

All right. That’s all I have. Thank you.

Thanks, Mike.

Thank you. And I'm showing no further questions in queue. I'd like to turn the conference back over to management for any closing remarks.

Thank you, Operator. Well, let me start by saying that we feel this was certainly a good quarter with all our operating parameters doing the right thing, it one of the biggest quarter, which is when I used the word excellent, but you heard the reasons why that occurred. You also heard to say that don’t count us on big rise. We have taken certainly, have to do denote the dramatic price decreases this morning. All I can simply say I view that as a very, very significant buying opportunity. I’ll also add -- I have had shareholders ask me from time to time like more often than not why don’t you buy when we have these kind of price decreases, well often I happened to know more information than the public knows so I am restricted from buying, I’ll just say. I consider that what we’re trying today is quite valuation, low valuation versus the year ago, I think I told you I thought we were stretching valuation. So we continue to do our management job here. If you wanted to ask further questions if you need to, we’ll try to keep you informed on this FDA matter, but again I think it’s very much overblown as everyone else, everyone is other FDA issues that have cropped up in our history have turned out to be. So please take that into account, but call us if you have other questions. Thanks very much. We appreciate it.

Ladies and gentlemen, thank you for your participation in today's conference.