Integra LifeSciences Holdings Corporation: Q2 2020 Form 10-Q
Reporting period: Three and six months ended June 30, 2020; filed August 10, 2020. Financial statements are unaudited and prepared under U.S. GAAP. Integra operates through Codman Specialty Surgical and Orthopedics and Tissue Technologies.
Financial performance and liquidity
| Metric | Q2 2020 | Q2 2019 | Six months 2020 | Six months 2019 |
|---|---|---|---|---|
| Revenue | $258.7 million | $383.6 million | $613.0 million | $743.3 million |
| Gross margin | 59.2% | 62.6% | 61.0% | 63.3% |
| Operating income | $14.1 million | $46.0 million | $41.2 million | $78.3 million |
| Net income (loss) | $(0.4) million | $29.7 million | $8.8 million | $62.5 million |
| Diluted EPS | $(0.00) | $0.34 | $0.10 | $0.72 |
| Operating cash flow | Not separately provided | Not separately provided | $53.9 million | $78.0 million |
- Q2 revenue declined 32.6% year over year; six-month revenue declined 17.5%. Codman Specialty Surgical revenue fell 31.9% in Q2 and 17.1% year to date. Orthopedics and Tissue Technologies revenue fell 33.9% in Q2 and 18.4% year to date.
- Q2 gross profit was $153.2 million, down from $240.0 million. Operating expenses decreased to $139.1 million from $194.0 million, primarily due to cost reductions and lower selling costs.
- Interest expense increased to $15.7 million in Q2 and $33.4 million for the first half, driven primarily by the 2025 convertible notes and related non-cash discount amortization.
- Cash and cash equivalents were $361.0 million at June 30, 2020, compared with $198.9 million at December 31, 2019. Approximately $183.4 million was held by non-U.S. subsidiaries.
- Six-month investing cash outflow was $25.4 million, including $23.7 million of capital expenditures. Financing cash flow was $133.5 million, reflecting convertible debt proceeds, debt repayments, share repurchases, and related issuance costs.
- Total debt principal included $877.5 million under the term loan, $150.0 million under the revolving facility, $68.7 million under the securitization facility, and $575.0 million of convertible notes. The company also had operating lease liabilities of $112.0 million.
- At June 30, 2020, the company was in compliance with its debt covenants. Total contractual obligations were approximately $1.9 billion, including debt, interest, leases, purchase obligations, and other commitments.
Material changes versus the prior comparable period
- COVID-19 caused hospitals to defer or cancel elective and non-emergent procedures, sharply reducing demand across both segments and geographic regions.
- April revenue was down 45% year over year, followed by sequential improvement in May and June. June sales were down approximately 13% versus the average daily sales rate in Q2 2019.
- Revenue pressure reduced gross margin by 340 basis points in Q2 and 230 basis points for the first six months.
- Income tax expense was $2.0 million in Q2 despite pretax income of $1.7 million, producing a 122.4% quarterly effective tax rate. The six-month effective tax rate was 32.7%, including a $3.4 million valuation allowance on certain foreign deferred tax assets.
- The company issued $575.0 million of 0.5% convertible senior notes due 2025, repaid $388.5 million of debt, and repurchased approximately 1.9 million shares for $100.0 million. Remaining repurchase authorization was $125.0 million.
- Accumulated other comprehensive loss increased to $103.1 million, primarily reflecting unfavorable changes in derivatives and pension items.
Guidance, outlook, risks, and unusual items
- Management expected sequential revenue improvement in the second half of 2020, but Q3 revenue was expected to remain below the prior-year level. Instruments and capital products were expected to recover more slowly because of their dependence on hospital capital budgets.
- Management expected a full-year effective tax rate of approximately 33.4%, subject to revision.
- On July 14, 2020, the company amended its senior credit facility to increase the maximum consolidated total leverage ratio temporarily from 5.0 to 5.5 for the four quarters beginning July 1, 2020, without increasing total indebtedness.
- COVID-19-related actions included compensation reductions, furloughs and reduced hours, a hiring freeze, lower discretionary spending, reduced capital expenditures, and increased inventory safety stock. Management stated that further cost reductions could be necessary if the downturn were more severe or prolonged.
- Q2 included $13.3 million of special charges, including acquisition and integration costs, structural optimization, EU medical device regulation, discontinued product lines, COVID-19-related charges, and $4.3 million of non-cash convertible debt interest. Six-month special charges totaled $38.1 million.
- The FDA continued to question whether certain morselized amniotic membrane products qualify for regulation solely as human cells, tissues, and cellular and tissue-based products. Enforcement discretion was extended to May 31, 2021; related products represented less than 1% of six-month consolidated revenue.
- A March 2019 FDA warning letter concerning quality-system issues at the TEI Boston facility remained unresolved. Products manufactured there represented approximately 4.4% of six-month consolidated revenue, and additional regulatory action could materially affect operations.
- Other risks include renewed procedure cancellations, hospital liquidity and delayed collections, supply-chain disruption, economic recession, foreign exchange volatility, interest-rate exposure, contingent acquisition payments, litigation, and regulatory or product-liability claims.
- Management concluded that disclosure controls and procedures were effective as of June 30, 2020, with no material changes in internal control over financial reporting.
Facts investors should verify
- Whether procedure volumes and revenue trends continued to recover after June 2020 and whether recovery differed by segment and product category.
- Compliance with the temporarily relaxed leverage covenant and the company’s ability to refinance or repay debt as maturities approach.
- Cash conversion, inventory normalization, accounts receivable collections, and operating cash flow under continuing pandemic conditions.
- The sustainability of cost reductions and their effects on research, development, sales capacity, and long-term growth.
- The resolution and potential commercial impact of the FDA matters involving amniotic membrane products and the TEI Boston facility.
- Future tax-rate changes, including realization of foreign deferred tax assets and the stated approximately 33.4% full-year tax-rate expectation.
- Potential dilution from the convertible notes and warrants, as well as the timing and economics of additional share repurchases.