CONMED Corporation
Q4 2008 Earnings Call Transcript

Published: 5 Feb 2009

[Operator:]

Good day, ladies and gentlemen, and welcome to fourth quarter 2008 CONMED earnings conference call. My name is Francine and I’ll be your coordinator for today. At this time, all participants are in listen-only mode. We’ll be facilitating a question-and-answer session towards the end of today’s conference. (Operator instructions) As a reminder, this conference is being recorded for replay purposes. I would now like to turn the presentation over to your host for today’s conference, Mr. Joseph Corasanti, President and Chief Executive Officer of CONMED. Please proceed, sir.

[Joseph Corasanti:]

Thank you, Francine. Good morning everyone, welcome to CONMED Corporation's fourth quarter 2008 earnings conference call. With me today is Rob Shallish, our Chief Finance Officer. After formal remarks, the call will be opened for questions. Before we begin, let me remind you that during this call, we will be making comments and statements regarding our financial outlook, which represents forward-looking statements that involve risks and uncertainties as those terms are defined under Federal Securities Laws. Our actual results may differ materially from our current expectations. Please refer to the risk factors and other cautionary factors in today’s press release, as well as our SEC filings for more details on factors that may cause actual results to differ materially. You will also hear Rob and me refer certain non-GAAP measurements during this discussion. While these figures are not a substitute for GAAP measurement, company management uses them to aid us in monitoring the company’s ongoing financial performance from quarter-to-quarter and year-to-year on a regular basis and for benchmarking against other medical technology companies. Non-GAAP net income and non-GAAP earnings per share measure the income of the company excluding credits or charges that are considered by management to be unusual or outside of the normal on-going operations of the company. These unusual items are specified in the reconciliation in the press release issued this morning. With these required announcements completed, I can now turn to our results. As we explained in the company’s press release in early January, CONMED’s fourth quarter financial performance was affected by economic volatility, specifically the exceptionally rapid changes in foreign currency exchange rates and cash conservation measures of hospital customers have led to reduced sales of the company’s capital equipment products. Before discussing how the company was impacted by these economic developments, let me run through a few of the fourth quarter numbers. Reported fourth quarter 2008 sales decreased 5.5% compared to the fourth quarter of 2007. Sales in constant currency were equivalent to that of Q4 2007. GAAP diluted earnings per share was $0.36 per share compared to $0.41 in the fourth quarter of 2007. After eliminating unusual items, non-GAAP EPS was $0.34 per share as opposed to the $0.44 in last year’s fourth quarter. For the full year of 2008, our results closely mirrored our original projections that we provided to you over a year ago. As you know, during the first nine months of 2008, the company gradually increased its earnings guidance as a result of better than anticipated financial results in the first three quarters of the year, partly due to the weakening in the US dollar and its positive effect on CONMED’s operation. However, the strengthening of the US dollar in the fourth quarter of '08 reversed the currency benefits derived earlier in the year. A moment ago, I provided some of the fourth quarter figures. Now, I’ll provide you with full year figures for 2008. Reported full year sales in 2008 grew 6.9% over 2007. In constant currency, the growth was 6.6%. GAAP diluted earnings per share for 2008 were $1.52 compared to $1.43 in 2007. Non-GAAP diluted earnings per share for 2008 were $1.54 compared to 2007 non-GAAP EPS of $1.37. Cash from operations continue to be strong. For the year, cash provided by operating activities was $62.9 million, 41% higher than the company’s net income for the year, demonstrating CONMED’s significant cash generation ability. As I previously mentioned, the company’s fourth quarter results were negatively impacted by certain economic conditions. First and most responsible for sales and earnings being less than we had anticipated is the effect of the adverse swing in foreign currency exchange rates during the fourth quarter. Compared to the fourth quarter of 2007, there was a 15% reduction in FX rate in the fourth quarter of 2008 that caused sales to be $10.7 million less that they would have been using the 2007 currency rates. So, on a constant currency basis, after adding the $10.7 million to reported revenues, the company’s sales in the fourth quarter of '08 were essentially consistent with sales in the fourth quarter of 2007. From an earnings viewpoint, approximately 60% of the adverse foreign currency sales effect falls through to pre-tax income. As a result, the fourth quarter pre-tax income is less than it otherwise would have been by approximately $6.4 million. Next, CONMED, like many other medical companies, has seen how the economic downturn is affecting hospital purchasing patterns. Overall, hospitals in the United States have slowed down their capital purchasing cycles in an effort to conserve cash resources. Now, the market's focus has moved down to the possible shift in the number of surgical procedures being performed, more specifically, to whether or not elective surgeries are showing signs of a decline. In our most recent fourth quarter, single use product sales of Bellwether for surgical procedures and 75% of our revenue were occurring at normal if not better than normal rates. As noted in the data in the product line sales table in this morning’s press release, CONMED’s total capital equipment sales experienced a constant currency decline of 17.4% compared to the fourth quarter of 2007. However, this percentage decline needs to be viewed in conjunction with an unusually difficult comparison with the prior-year period, as the fourth quarter of 2007 included approximately $10 million of integrated systems installation and an unusually large number of hospital customers that chose to delay installation until late in that year. In 2008, our integrated systems revenue has been spread out more evenly throughout the year. If we factor in smoothing for the fourth quarter of '07 integrated systems sales, the capital side of our business would have experienced a decline in constant currency of approximately 7%. On the other hand, sales at the company’s single-used products potentially [ph] as expected when analyzed in light of constant currency metrics. In the fourth quarter of '08, the growth rate in constant currency for single-used products overall was 8.4%, in line with our expectations. Of note are the Arthroscopy, Power Surgical Instruments, Electrosurgery and Endosurgery lines which each grew their single-use products in constant currency in excess of 11%. With that overall background, let us review each of the product categories in more depth. CONMED’s Arthroscopy product line which consists of minimally invasive medical devices designed to repair soft tissue injuries in the joints, such as ACL repair in the knee or rotator cuff repair in the shoulder. This business is also referred to as sports medicine because many of the injuries giving rise to the surgical repair are caused by sports related activities. In the fourth quarter of 2008, this product line had constant currency growth of 12.1% in the single use product category, but had constant currency sales decline of 28.2% in the capital equipment category. As I mentioned previously, much of the percentage decline with the capital products is due to the difficult comparison with the integrated systems business in the last quarter of '07 with the remainder, we believe, due to reduced capital spending on the part of hospital customers because of economic considerations. While the economy has had an impact on the sales for these capital products, the single-use products have very good growth when considered in light of constant currency. With regard to our power-surgical instrument line, which consists of electric battery or pneumatic power surgical instruments used to perform orthopedic and other surgical procedures, here the products are more capital related than any of our other product lines. On average historically, this product group drives approximately 50% of the revenue from the sale of the drill and saw hand pieces, and the other half from the sale of single use drill bits and saw blades. Similarly, to the Arthroscopy line, fourth quarter 2008 single use sales in constant currency grew 12.8%, while the capital products had constant currency sales decline of 6.8%. The Electrosurgery line had constant currency growth of 11.6% in the single-use categories and 3% growth in the capital equipment category. As a reminder, Electrosurgery is used in 80% to 90% of all surgical procedures and we hold the number two market share position in this market. Because Electrosurgery is used in almost all surgical procedures, we concluded that surgical procedures continued at a rate unaffected by the overall economic downturn in the fourth quarter. Switching to our Endosurgery line as anticipated in our last conference call, the line had double-digit growth in reported revenues for the fourth quarter of 2008 and a 17.2% increase in sales on a constant currency basis. Much of this growth came from sales outside of the United States. The line consists of a broad range of products enabling minimally invasive surgery of the abdominal region without making a major incision. Our Patient Care line of products consists of heart-monitoring electrodes, pulse oximetry monitoring, surgical suction tubing and various other devices used in clinical settings. These products experienced a 4.4% decline in constant currency during the fourth quarter. But it is not unusual for this product line to experience some volatility in its growth pattern since much of the sales of this line are through the larger medical supply distributors who often vary their ordering patterns as we have discussed in the past. For the full year of '08, the Patient Care line grew 2.1% in line with the expected market rate of growth for these types of products. Turning to our Endoscopic Technologies line, we are disappointed that the line had a constant currency decline of 4.4% in the fourth quarter. We believe we are still suffering in the eyes of our customers the effects of the product supply difficulties that we had some time ago, which have been rectified for more than a year. We continue to focus on regaining the confidence of the customers of this product group and believe that our four new products that we introduced at the end of 2008 will renew customer interest in our full Endoscopic Technologies line. As we look to the future, we anticipate the economic trends that became apparent in this last quarter of '08 will continue to affect the company in 2009. Specifically, using the foreign currency exchange rate in effect in the fourth quarter of 2008 as a guide, we estimate that there will be a 15% reduction in average translation rates that will cause CONMED sales to be $30 million to $35 million less than they would be using the average 2008 rates of exchange. From an operational standpoint, we continue to believe that the broad range of surgeries in which our medical devices are used will continue at a normal rate of growth as we saw in the fourth quarter, assisted by the benefit of new product introductions. Injuries and illnesses requiring surgery are not impacted by the economy, so demographics continue to be in our favor. The only question is whether some patients may elect to postpone an elective surgery. And while that may occur to a certain degree, injuries and illnesses requiring surgery continue to occur and will need to be addressed before too long. So, even if there’s a delay in procedures due to economic concerns, surgical procedures should return to historic rates of growth in a fairly short period of time. We have seen this to be the case in other periods of economic uncertainty. Our capital equipment sales may be somewhat reduced in 2009 compared to 2008, but the types of capital equipment that we sell are not big ticket items as we know that purchasing decisions are largely a product of normal replacement cycles of hospitals. Thus replacement is not susceptible to elongated deferral. Surgical video systems like the laptop computers that we all use, experience wear and tear and need to be replaced every five years or so. Similarly, powered surgical instrument hand pieces have many mechanical parts and require routine maintenance due to high heat and humidity that they’re exposed to during sterilization. I would remind you again of the ratio of our product portfolio being 75% single-use products used in a wide range of surgical procedures, with the remaining 25% being on capital products also used in a wide range of surgical procedures. Taking all of these into consideration, we anticipate constant currency growth rate of approximately 4% to 5% across the board, which would result in a sales increase of $30 million to $35 million. This would offset the anticipated reported sales decline caused by the lower foreign currency exchange rates. On a quarterly basis, we anticipate that the company’s financial performance will be more back-end loaded than is typically the case. Consequently, we believe that the company’s revenues for the first quarter of '09 should approximate $170 million to $175 million and that the non-GAAP earnings per share should be between $0.23 and $0.28. These expected non-GAAP per share estimates have eliminated the manufacturing restructuring costs that we have discussed in the past. Beyond 2009, we anticipate that several initiatives we have been incubating will result in improved profitability in margins. For example, the manufacturing restructuring we initiated last year will be completed during 2009 with the full benefit of cost savings realized in 2010. With regard to new products, we foresee that the recently introduced ECOM device for monitoring cardiac output will gain traction throughout 2009. We will venture 2010 with a base of business allowing for even more rapid expansion of this unique vital sign measurement device. In our Electrosurgery line, we anticipate the launch during the third quarter of 2009 of a tissue sealant surgical instrument which is expected to compete favorably in a $1 billion established market. Lastly, we believe that the recent new product launches in our Endoscopic Technologies product line will help return that business segment to profitability. We estimate that the execution of these four initiatives will enhance the company’s 2010 EBIT by at least $10 million above the normally anticipated earnings growth for the company. In summary, we believe our investment in R&D and manufacturing improvements have CONMED well positioned to continue its long-term growth and profitability. While economic matters in 2009 will be challenging due to foreign currency exchange rates and somewhat reduced capital spending in the part of hospital customers, we are excited about the company’s future products prospects and our desire to continue as a leading medical device manufacturer. I will now turn the call over to Rob Shallish for further review of our financials. Rob?

[Rob Shallish:]

Thanks very much, Joe, and good morning everyone. Before taking in a deeper dive into the numbers, I thought it would be useful to spend a few more moments on how the overall global economy affected our business in the fourth quarter. While Joe has already discussed at length our performance relative to surgical procedure rates and capital spending by hospitals, I would like to focus on three other matters that impacted or will impact our business, both positively and adversely. These matters are the market value of the company’s convertible bonds, interest rates and foreign currency translation rates. Each of these areas saw a dramatic change in the fourth quarter. First, with respect to our convertible bonds, as many of you know, the market for such bonds has seen significant change in the last few months. In the summer of 2008, our bonds were trading fairly closely to their par value. In October, however, their market value declined by 20%. The company took advantage of this decline in market value and repurchased $25 million of the face value of the bonds at a discount, with the result that CONMED recognized an overall gain of $4.4 million. Second, we have seen a dramatic decline in interest rates during the fourth quarter. The company’s floating rate financings consist of two components. The first is a term loan of approximately $58 million, and the second is the off balance sheet securitization program with a discount on the sale of receivables tied to a floating interest rate with approximately $42 million outstanding. Thus, CONMED has approximately $100 million tied to floating interest rates. Interest on these facilities averages to LIBOR+ 125 basis points. With LIBOR at all time lows, we anticipate lower interest expense in 2009 as a result of the economic volatility. These two matters resulting from overall economic conditions had a beneficial impact on the company. However, these benefits were more than negated by the rapid change in foreign currency exchange rates in the fourth quarter. Over the last several years, the company has developed a well-balanced geographic source of revenue such that approximately 55% of sales are derived from customers in the United States and 45% from outside the United States, similar to maintaining a vast product portfolio, which ensures that we are not overly dependent on any one specific product. Operating as an international organization ensures that we are not overly dependent on any one specific geography. Our international sales come from our direct sales operations in 12 countries and through independent distributor organizations in many of the other countries of the world. Approximately two-thirds of the international sales or 30% of our total sales come from our direct sales groups in the 12 countries where we sell in the local currency of that country. We are well represented in the Euro zone with 40% of our direct international sales denominated in that currency, 25% from Canada, 15% from the UK, 15% from Australia, with the remaining 5% denominated in the South Korean won. In the fourth quarter of 2008, the foreign currencies in which we sell our medical devices fell 15% to 20% in relationship to the US dollar. While there is always some fluctuation in currency exchange rates, such dramatic and rapid change in these currencies has not occurred in recent history. This change resulted in reduced revenues of $10.7 million that would have been achieved with the exchange rates from the fourth quarter of 2007. Because the company’s manufacturing facilities are primarily based in the United States, the cost of our sales in US dollars has been relatively unaffected by foreign currency translation swings. That means that the $10.7 million revenue reduction, as a result of the fourth quarter foreign currency change, has a direct impact on the gross margin. Now, we did see some modestly offsetting effects from the direct selling cost internationally from salaries, commissions, rents, and other such local currency-denominated expenses in our 12 international selling locations. As a net result, the company’s pretax income in the fourth quarter was adversely impacted by approximately $6.4 million. Finally, even with the recent adverse currency changes, the company has benefited from a weakening dollar compared to other currencies over the last 10 years. In addition, any changes in FX rates have been gradual over time. Therefore, we previously concluded that our foreign currency hedging program to minimize the risks of FX volatility was unnecessary. Given the dramatic changes in FX rates in the fourth quarter, however, we are reevaluating this and will keep you advised of how we proceed in this area. Now, I’d like to turn to the specific results for the quarter and full year. In doing so, I’d like to discuss comparisons to GAAP and non-GAAP financial amounts. It has been our practice to call out adjustments to the GAAP numbers, which we at management consider critical when analyzing our ongoing business operations and believe that investors may also find this information useful in evaluating our performance. In the fourth quarter of 2008, such adjustments reduced GAAP pretax income by approximately $1 million. As I mentioned, the company recorded a gain of $4.4 million on the repurchase of the convertible bonds that we include as a non-GAAP adjustment. Conversely, the company incurred costs totaling $3.3 million related to the additional costs of the previously discussed manufacturing restructuring plan. In the fourth quarter of 2007, there was a $1.3 million pretax settlement from a product liability claim that was included as a non-GAAP adjustment. So, on a GAAP basis, the company’s diluted earnings per share for the fourth quarter of 2008 were $0.36, compared to GAAP EPS of $0.41 in the fourth quarter of 2007, while the non-GAAP EPS for the fourth quarter of 2008 was $0.02 less at $0.34, compared to $0.44 in the fourth quarter of 2007. Now, turning to a discussion of our margins, our gross margin percent of sales was 49.6% in the fourth quarter of 2008. Adding back the $2.5 million in manufacturing restructuring costs included in cost of sales, the pro forma gross margin percentage was 51.1%, compared to 50.5% in the fourth quarter of 2007. This improvement is principally the result of both the higher gross margin on our Italian sales due to the fact that we are now selling direct to hospitals in that country and product mix considerations as the 2008 fourth quarter had a higher percentage of single-use products, which generally have an overall higher gross margin than capital equipment products. Now, if currency rates had remained consistent with 2007’s fourth quarter rates, the pro forma gross margin would’ve been 53.8% in the fourth quarter of 2008. SG&A as a percentage of sales was 37.1% in the fourth quarter, compared to 34.3% in the fourth quarter of 2007. The increase in the percentage is primarily a factor of the reduced sales in the fourth quarter of 2008 compared to 2007 and a reduced denominator in the calculation. In absolute dollars, SG&A increased $1.5 million or 2.2% over the fourth quarter of 2007 and all of this increase was due to the Italian distributor acquisition. Research expenditures were 4.3% of sales in the fourth quarter of 2008, slightly higher than the 3.9% of sales in the fourth quarter of 2007, with the increase in percentage a result of the lower sales denominator. The net of these changes results in a GAAP operating margin for 2008 fourth quarter of 7.8%, compared to the GAAP operating margin of 11.6% in the 2007 fourth quarter. However, on an operating basis, backing out the unusual items from both years and adding back the pretax effect of fourth quarter foreign currency, the adjusted operating margin for the fourth quarter is equivalent to 12.5%, which is slightly better than the 2007 fourth quarter adjusted operating margin of 12.3%. Interest expense was $2.3 million, a 34% reduction when compared to interest of $3.5 million in the fourth quarter of 2007. The reduced interest cost resulted from lower debt levels, as well as decrease in rates compared to a year ago. Our GAAP pretax margin for the quarter was 9% of sales, compared to 9.7% in the 2007 fourth quarter. Adjusted for the restructuring, gain on debt extinguishment and FX, our pretax margin was equal to 11.3%, 90 basis points higher than the 10.4% in last year’s fourth quarter. The company’s income tax rate in the fourth quarter was 34.2%, compared to 35.7% in the fourth quarter '07. As mentioned in past conference calls, payment of nearly all of this tax provision is deferred to future periods because of differences in reporting expense for financial accounting compared to tax accounting, thus increasing the company’s current cash flow. Again, with cash flow, CONMED’s cash flow provided by operations continues to be very positive, amounting to $62.9 million for 2008. I would especially like to highlight the fact that this operating cash amount is 1.4 times greater than the company’s net income. The superior amount of cash compared to net income is a result of the noncash charges associated with equity compensation, amortization, depreciation, and deferred taxes. Much of the deferred taxes would become payable only as a result of an unusual event outside of the normal operations of the business, such as the sale of a major part of our business. So, as a practical matter, the deferred taxes would not reverse and become payable in the foreseeable future. Now, turning to the balance sheet, CONMED’s cash balances are the same as December 2007. The company’s debt balance is $23.5 million less than a year ago. As a result of the company’s earnings and debt reductions, debt to total book capitalization declined to 27.3% at December 31, 2008, compared to 30.6% at the end of December 2007. Our days investment in inventory at December 2008 was equal to approximately 160 days, about where we have been running in the last few quarters. In absolute dollar terms, the company’s inventory balance declined approximately $5 million from December 2007. Accounts receivable days in December 2008, adding back the effect of the $42 million utilization of the securitization facility, were 70 days, in line with our historical average. In absolute dollar terms, receivables have increased since December 2007, as a result of the acquisition of the Italian distributor in early January 2008. Well, with that, Francine, that concludes my remarks and I would now like to open the lines for questions.

[Operator:]

(Operator instructions) Our first question comes from the line of Matt Miksic of Piper Jaffray. Please proceed.

[Matt Miksic:]

Hi, good morning. Do you hear me okay?

[Rob Shallish:]

Yes, fine Matt.

[Joseph Corasanti:]

Yes, good morning.

[Matt Miksic:]

So, thanks for taking the questions. On FX, just some clarifications. You'd mentioned in the past that you are looking at hedging facilities to help offset some of the bottom line impact of currency fluctuations. Does Q4 reflect that, or are we going to see some of the benefit of those efforts in Q1 or anytime in 2009?

[Rob Shallish:]

The hedging activities that we have been involved with through last year and the fourth quarter deal with hedging the transactions associated with out inter-company balances. So, we bill our foreign subsidiaries in a local currency such as the Euro, and they pay as back in Euros and we translate that to the US dollar. If there are changes in FX rates during that interim period between billing the customer – billing our subsidiary and receiving the cash, we take those adjustments to the P&L – or have to take those adjustments to the P&L immediately. So in order to avoid losses and I guess gains as well on those kinds of transactions, we've been hedging that portion of our FX situation since September of '08. With regard to our revenue, the flow of sales into the company, in 2008, we have not done any of that hedging, nor have at this point at least entered into any hedging transactions for '09.

[Matt Miksic:]

Okay. And clarification on the breakout you gave of some of your exposure to foreign currencies, I missed it, did you mention the British pound?

[Rob Shallish:]

Yes, the pound is – of our total exposure to foreign currencies, that would be 15% of our exposure. So it’s 15% – 30% of our sales are exposed to foreign currency.

[Matt Miksic:]

Got it, so 4.5% of total or whatever.

[Rob Shallish:]

Yes.

[Matt Miksic:]

Got it. So FX – the other thing I guess I would ask is, I know this is the first time you've given Q1 guidance, but you came in a little bit below our number, below consensus, and I’m trying to – it’s probably not a fair question, but if you had to put your finger on something that we were missing, and I know currency was part of it or I think it was for the first quarter, was there anything else factoring into your thinking about Q1 guidance?

[Rob Shallish:]

Well, just currency, we continue to be a little bit concerned about capital purchases by hospitals. We think that for the entire year, there should be not too much of an effect on capital purchases, but I think it is still very early to make conclusions about the first quarter, so we have tried to be conservative in our estimates.

[Matt Miksic:]

Okay, so maybe some of the behavior in Q4 is splashing over here into Q1. Another last thing here on currency is it looks like rates have gotten a little bit worse since early January; not a ton, maybe 50 to 100 basis points at least by my calculations. But it looks like you have maintained the same dollar guidance numbers in revenue and earnings. Are you taking a risk here or are you assuming that there is some easing or at least things don't get any worse in terms of FX?

[Rob Shallish:]

Well, it’s difficult for us to pick a number with regard to currency right now. So, we decided that we would continue to use the fourth quarter rates as a guide to our estimates for 2009. I think the Euro is about the same as it was on average last quarter. The pound is probably down a little bit, I agree. So overall, I’m not exactly sure where we might come out compared to the overall average at this point (inaudible) in the fourth quarter average.

[Matt Miksic:]

Okay. So, if we follow your constant currency growth number guidance, as we think about our own currency projections, in such that they are, then that would be a reasonable guide.

[Rob Shallish:]

Yes, I would agree with that.

[Matt Miksic:]

Okay. This other thing you have discussed here about procedures, and Joe mentioned some of them may be temporarily postponed, I’m wondering if you have a sense, and everyone’s procedure seems to be different, every one exposure to different kinds of procedures, but of the kinds that drive your business, how long do you think these things are postponable as they are, and how confident are you that the deferral does not push these out into 2010?

[Joseph Corasanti:]

When we talk about procedures being delayed or postponed, we are just talking about the concept that could happen, we actually did not see that in Q4, and I think we mentioned that. But going forward, if there were delay, it would only really occur in this sport medicine area for us, those procedures certainly have an element of being elective. But it’s still an injury that makes it very difficult for people to get around, walking, moving their arms, et cetera, for ACL repairs or rotator cuff repair. So with those types of elective procedure, yes, we acknowledge they could be delayed for economic reasons. But, at some point, the patient needs to have that treated. So whether it is a couple of months or half-a-year, it’s anyone’s guess. But I do not think it goes out beyond half-a-year.

[Matt Miksic:]

Okay, that is really helpful. I think I understand in talking to you last quarter and around the end of the year this idea that a big chunk of your sports medicine business is driven by something that I would characterize as kind of soft tissue trauma or joint trauma that is maybe different than, I don't know, other sorts of sports medicine procedures. Can you – I know it is probably hard for you to put your finger on an exact number, but do you think – I mean, is it greater than 50%, is it greater than three quarters of the procedures that really drive your sports medicine business? Would you characterize them as, these rotator cuff and ACL ruptures and repairs, how big and how important is that?

[Joseph Corasanti:]

That is the lion's share of our business. That is the sweet spot of our sports medicine businesses, the ACL repair and the rotator cuff repair. A meniscus tear is also a large part.

[Matt Miksic:]

Okay, so over 50%. Do you think it’s over 75%?

[Joseph Corasanti:]

Certainly over 50%, but I do not have kind of any hard data on that.

[Rob Shallish:]

Yes, Matt, it is hard to tell exactly. But almost all – I would say almost all of our products are used in arthroscopic procedure as a result of some kind of trauma that occurred to the patient. So it’s a soft tissue injury that was a result of an acute event, usually not a chronic situation. So it’s usually some sports activity whether it’s skiing or soccer or it could be anything, tripping on the stairs and falling down the stairs, it’s not usually as a result of a chronic situation.

[Matt Miksic:]

Okay, that is helpful. And then, last thing here on non-hospitals, just their behavior around postponing purchases, can you characterize – generally people have talked about cash conservation and being more cautious, putting things on hold. But is there – I guess, new hospital constructions a factor for this, is it just a policy decision that you are seeing at some hospitals that just say, we are putting a freeze on new capital purchases, anything you could do to characterize the drivers of those decisions to sort of pause the purchasing would be helpful?

[Joseph Corasanti:]

Some hospitals have actually enacted a policy saying we are going to freeze capital purchases. I do not have a number on how many of those hospitals have said that. Then there are other hospitals that have just simply delayed the actual issuing of the purchase order. They still have been willing to conduct an evaluation of video or powered instruments. They give us the results of the evaluation, but have held up their purchase order. Those are two examples of what is happening with capital. I will say that with our generators in electrosurgery, we really have not seen anything in the way of holding up purchase orders or delaying purchases in that area. And I guess that does not surprise us because that really is a replacement market for electrosurgical generators, and the numbers bear that out in Q4.

[Matt Miksic:]

Okay, so are you saying that – and I don’t want to put words in your mouth, but are you saying that all or most of the impact on the capital side was around video and not generators?

[Joseph Corasanti:]

Video powered and powered instruments and not generators.

[Matt Miksic:]

Got it, all right. And then, finally, last question here just taking your hospitals to the other geographies – your behavior of hospitals in overseas, in Europe in particular, are you seeing any of what we’re seeing here in the US splashing over there? Do you expect to – and maybe regionally, how do you think that might affect that group of countries?

[Joseph Corasanti:]

Well, from the standpoint of single use products, Matt, I think that the answer is the same. I don’t think that single-use product sales would be diminished because I think the procedures are going to be done. With regard to capital, I think the same situation could occur outside United States as we may see here in the US with – it’s just a slowdown in capital spending, perhaps more of the kneejerk reaction to the current economic situation. But if there is any slowdown, it would return to a fairly normal rate fairly quickly, because the products that we sell are used routinely every single day that you suffer wear and tear and damage. And there is just a normal replacement cycle that has to be followed if they’re going to have surgeries. So, surgical video is the same way, powered instrument is the same way, and electrosurgical generator is the same way.

[Matt Miksic:]

Is that slowdown in your guidance today, or is that something that should you see that, you need to rethink '09?

[Joseph Corasanti:]

We have considered the slowdown, so to speak, in the forecast. It is our best forecast at this point.

[Matt Miksic:]

Okay. Well, thank you so much for taking the questions.

[Joseph Corasanti:]

Thanks, Matt.

[Operator:]

Our next question comes from the line of Raj Denhoy of Thomas Weisel Partners. Please proceed.

[Raj Denhoy:]

Thanks and good morning.

[Rob Shallish:]

Hi, Raj.

[Raj Denhoy:]

I wonder if I could ask a little bit just on the outlook for procedure volumes. And if I’m not mistaken, you have not baked in any slowdown in procedure volumes in your guidance, is that correct?

[Rob Shallish:]

That would be correct. We’re assuming the procedure volumes are – let me put it this way, in the fourth quarter, it would seem to us the procedures were growing based upon our sales of, say, the electrosurgical devices at 11% or 12%. So, in our forecast for 2009, we are not assuming 11% or 12% growth in procedure rates. So I guess to some extent, we may have backed off the fourth quarter number, but we would expect that single-use products would be better than the 4% to 5% growth rate that we forecast overall. The offset being capital products which are –

[Raj Denhoy:]

Right, I guess, I’m just getting a sense – I mean, obviously, you’re one of many companies that hasn’t seen a slowdown yet in procedure volumes. But I think a number of other companies are being somewhat prudent in expecting there to be one, but it doesn’t sound like your taking that same position.

[Rob Shallish:]

Well, I guess, we have to look at the kinds of procedures that our products are used in. Getting back to Joe’s previous conversation, we may possibly see some – it is possible there could be some reduced procedure volume with respect to sports medicine. But a lot of these injuries, sports medicine injuries, occur to high school athletes. Kids are playing soccer, kids playing football, volleyball, whatever. And as a parent, I’m not going to delay an ACL repair. I’m going to get the ACL done. If I’m a 50-year-old skier and out having fun and popped the ACL, is it possible that I’ll hold off for a period of time? Maybe, maybe not, I don’t know. So, I guess, if we expect any slowdown at all, it would be very, very minor with respect to the sports medicine products.

[Raj Denhoy:]

What about areas like patient care where it’s dependent on just overall patient volume going into hospitals? Isn't there a chance that that business could be somewhat of a risk in 2009?

[Rob Shallish:]

Well, it is possible. But we don’t expect – of our traditional patient care products, we’re only expecting normal growth at the market rate which is between 2% and 3%. We are expecting that patient care would have some benefit during 2009 as a result of a new product introduction. So, we think that that would offset any slowdown in the Patient Care products. But, people are still going to be going to the hospital. They’re still going to need ECGs. They’re still going to need IV therapy. I think the assumption that there’s going to be a dramatic reduction in these basic kinds of procedures is very conservative.

[Raj Denhoy:]

Okay, and then just on the capital side, we’re a month into the first quarter of the year, a little more than a month. Have you seen any thawing in the frozen capital budgets in the part of hospitals, any change so far this year?

[Rob Sallish:]

I would say that – and we don’t want to get into forecasting on a monthly basis because that just leads to our discussion on a monthly basis. It just gets into how did we do this week, how did we do yesterday. But I would say that in January, we did not see any change from the fourth quarter trends.

[Raj Denhoy:]

Okay. Lastly, on your cash flow expectations for 2009, given the slower topline and maybe provide us, I might have missed it, but what are your expectations for cash flow this year?

[Rob Sallish:]

We’re expecting operating cash generated from operations to be in the neighborhood of the same number that we’ve been running in the last couple of years, so somewhere in the $60 million range. From a capital expenditure standpoint, we’re expecting that capital expenditures will be in the $20 million to $25 million range for 2009.

[Raj Denhoy:]

Okay, fair enough. Thank you very much.

[Operator:]

Our next question comes from the line of James Sidoti of Sidoti & Company. Please proceed.

[James Sidoti:]

Good morning, Rob. Good morning, Joe.

[Rob Sallish:]

Good morning, Jim.

[James Sidoti:]

I don’t want to beat the currency to death, but I just want to make sure my numbers are right. You’re saying it’s about $10 million effect in the topline, about $6 million to the operating income line, and probably about $0.13 or so to the EPS line. Does that sound about right?

[Rob Sallish:]

Well, that would be about right yes.

[James Sidoti:]

So, without currency, I mean even with the slowing economy, you would have come in pretty close to where you'd originally guided for the fourth quarter?

[Rob Sallish:]

Yes, I would agree with that.

[James Sidoti:]

All right, then on the R&D line, you’re down about $1 million from the third quarter. Is that just you’ve completed some products, so you’ve got some expenses rolling off. And do you think that those – your sold [ph] new products in 2009 and that will get back up to where it has been for most of 2008?

[Joseph Corasanti:]

Well, Jim, the rate of spending is not necessarily stable because – well, we obviously have our own R&D engineers and scientists, but we do use outside development houses from time to time so the rate of spending can go up and down on a quarterly basis. Overall, we are planning the same kind of spending in 2009 that we had in 2008, but roughly in 4.5% of sales range.

[James Sidoti:]

Okay. All right, and then can you just give us an update on ECOM, how many boxes were placed in the quarter, and what do you think the number would be for 2009?

[Joseph Corasanti:]

Sure, Jim. The reception that we are getting from ECOM is very, very good. As you know, we launched it to the entire Patient Care sales force of 32 people beginning on January 5, so they’ve had it for a month. We also have six specialists selling it. Soon, that number will be up to ten. Where we are right now is we have some 32 boxes in the field. We are expecting probably anywhere from 50 to 60 boxes to be in the field by April 1, to the end of the quarter. The number of evaluations continue to increase. We’ve got 17 completed now, 18 are in the works and not yet completed, so actually 35 evaluations. And we've got 60 schedules that haven’t even started yet. So, we’re seeing it ramp up significantly. And we think that we will probably get to a rate of getting about 50 boxes placed per month starting sometime after April or May. So, although not hitting our original schedule in terms of box placements, we think it’s been delayed slightly as a result of taking a little longer with evaluations, and then after that a little longer getting a PO. We are extremely encouraged. We think this is going to be a great product for us.

[James Sidoti:]

And what type of surgeries are they being used in so far?

[Joseph Corasanti:]

That’s actually been a surprise for us, a very pleasant surprise for us. We originally anticipated that these would first be used in cardiac surgeries, and then after, there’s been a significant adoption that it would spread out to being used in triple-care [ph] patients, high-risk patients, spine patients, and elderly patients. What we’ve seen is that it’s immediately being used in the high-risk patient population, which is the population of patients that are receiving an A-line, to be monitored via an A-line during surgery. So, we’re immediately getting both the cardiac cases and the high-risk cases. So, spine procedures, aortic aneurysm cases, lengthy procedures involving total hip replacements and knee replacements in elderly patients, all of those types of cases involving an A-line.

[James Sidoti:]

And is there a major learning curve to get doctors used to using this as opposed to the (inaudible) or does it go pretty quick?

[Joseph Corasanti:]

No. It actually is – it goes very quickly. It’s a very easy setup. We place the – the anesthesiologist places the trach tube plus – the connection at the end of our trach tube into the monitoring box, calibrates the box by typing in the patient’s height and weight and that’s it. The system is fully functional once that procedure’s happened or taken place, so it’s very easy to use and very easy to set up.

[James Sidoti:]

All right. And then, my last question, Joe, you mentioned that you thought that by 2010, you’d get a little boost EBIT by about $10 million. Can you just give us some sense how much of that is cost saving due to the facility consolidations? And how much of that is a little bit of acceleration in topline growth due to ECOM and some of the other products that you plan on launching in 2009?

[Joseph Corasanti:]

Yes. The four initiatives right now are the manufacturing consolidation, which we’ve estimated to have an impact of $3 million to $5 million on our bottom line in 2010, and then, the rest of it is the acceleration of ECOM, tissue ceiling, and basically bringing the endoscopic technology division to profitability in 2010 as a result of the four products that they launched at the end of '08.

[James Sidoti:]

Okay. All right, thank you very much.

[Operator:]

(Operator instructions) Our next question comes from the line of Dalton Chandler of Needham & Company. Please proceed.

[Dalton Chandler:]

Good morning. I guess we’ve gone over the assumptions about elective procedures or procedures in general quite a bit, but do you make any specific assumptions about hospital budgets and developing your CapEx sales forecast?

[Rob Shallish:]

Well, Dalton, I think we’ve assumed, on an overall basis for 2009, that our capital, the sale of our capital products would be pretty much on a par with the 2008 sales overall. There may be some dislocation relative to how that roles out on a quarterly basis, but on an overall basis, we’re assuming that the capital products would be, in dollar terms, about the same as 2008.

[Dalton Chandler:]

Okay.

[Rob Shallish:]

But no growth in other words.

[Dalton Chandler:]

And just on the tissue ceiling product, I think you said you’re planning to introduce that at AAOS. Is that right? Or when do you expect to actually be selling it?

[Joseph Corasanti:]

No. Tissue ceiling, we’re expecting a limited market release in June or July.

[Dalton Chandler:]

Okay.

[Joseph Corasanti:]

And then, probably a full launch sometime after that.

[Dalton Chandler:]

Okay, great. And then, if I did the math right here, it looks like you had a spike in CapEx in the fourth quarter. Was that related to the facility consolidation?

[Rob Shallish:]

That was, to some extent, facility consolidation, yes. That was basically a number of things. We had to get the – we’re leasing the building, so that’s not ours, but there’s IT infrastructure. There’s the internal machinery in that facility, the racking for finished goods. So, yes, that was one component of it, as well as we’re working toward the completion of the Oracle project, so we had costs associated with that. So, it’s basically just increased spending across the board.

[Dalton Chandler:]

Okay. All right, thanks a lot.

[Operator:]

You have no further questions. I would now like to turn the call over to Mr. Joe Corasanti for closing remarks.

[Joseph Corasanti:]

Well, I want to thank everyone for joining us today on our year-end and fourth quarter conference call. We look forward to discussing our further progress with you on our next conference call. Thank you very much. Have a good day.

[Operator:]

Thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect. Have a good day.