Integra LifeSciences Holdings Corporation — Q2 2018 Form 10-Q
Reporting period: Three and six months ended June 30, 2018; comparative periods ended June 30, 2017. The financial statements are unaudited. Integra operates in two reportable segments: Codman Specialty Surgical and Orthopedics and Tissue Technologies.
Financial performance and position
| Metric | Three months ended June 30 | Six months ended June 30 |
|---|---|---|
| Revenue | $366.2 million, versus $282.2 million | $723.3 million, versus $540.8 million |
| Gross margin | $228.6 million; 62.4%, versus 64.9% | $441.5 million; 61.0%, versus 65.7% |
| Operating income | $27.6 million, versus $17.0 million | $53.2 million, versus $26.9 million |
| Net income | $11.4 million, versus $10.8 million | $22.4 million, versus $17.2 million |
| Diluted earnings per share | $0.14, unchanged | $0.27, versus $0.22 |
| Operating cash flow | Not separately provided | $77.7 million, versus $57.8 million |
- Second-quarter revenue increased 29.8%; first-half revenue increased 33.8%. Growth primarily reflected the Codman Neurosurgery acquisition, favorable foreign exchange, and growth in both segments.
- Codman Specialty Surgical revenue was $239.5 million in the quarter and $475.6 million year to date, increases of 49.8% and 50.4%, respectively. Orthopedics and Tissue Technologies revenue was $126.7 million and $247.7 million, increases of 3.6% and 10.2%.
- Operating income benefited from higher sales and operating expense leverage, but net income was constrained by higher interest expense. Interest expense was $17.5 million in the quarter and $36.3 million year to date, versus $6.2 million and $11.3 million in the comparable periods.
- Cash and cash equivalents were $183.8 million at June 30, 2018, versus $174.9 million at December 31, 2017. Current assets were $821.3 million and current liabilities were $233.3 million.
- Senior Credit Facility borrowings totaled $1.476 billion, consisting of $590.0 million under the revolving facility and $900.0 million under the term loan, net of applicable presentation adjustments. Approximately $709.4 million remained available.
- The Company reported no debt maturities within the next 12 months and stated that cash and available borrowings should fund operations and planned capital expenditures for the foreseeable future.
- Capital expenditures were $35.4 million in the first half, and full-year 2018 capital expenditures were expected to be approximately $65 million to $75 million.
Material changes versus the prior comparable period
- The October 2017 Codman Neurosurgery acquisition contributed $79.2 million of second-quarter revenue and $157.1 million of first-half revenue. The acquisition was completed for approximately $1.014 billion and materially increased revenue, debt, intangible assets, amortization, and integration costs.
- The Company issued 6.0 million common shares in May 2018 and received approximately $349.6 million of net proceeds, which were used primarily to repay revolving credit borrowings. Shares outstanding increased materially year over year.
- Revolving credit borrowings declined from $655.0 million at December 31, 2017 to $590.0 million at June 30, 2018; term-loan borrowings declined from approximately $1.2 billion to $900.0 million.
- Gross margin percentage declined because Codman products carried lower margins and because of acquisition-related inventory fair-value adjustments and technology-intangible amortization.
- Operating expenses increased to $201.0 million in the quarter and $388.3 million year to date, reflecting acquired operations, additional sales personnel, commissions, and integration activity.
- The Company adopted ASC Topic 606 using the modified retrospective method on January 1, 2018. Opening retained earnings increased by $1.9 million, and reported first-half revenue was $3.9 million higher than it would have been excluding the adoption effect.
Guidance, outlook, risks, and unusual items
- Management expected full-year 2018 gross margin of approximately 61.5% to 62.5%, research and development expense of approximately 6.0% of revenue, selling, general and administrative expense of approximately 45.0% to 47.0% of revenue, and an effective tax rate of approximately 6.1%.
- Management expected additional capital and integration expenses during 2018 related to the Codman integration. Reported special charges totaled $32.1 million in the second quarter and $62.6 million in the first half, including acquisition and integration costs, structural optimization, litigation, inventory purchase accounting, and financing-related items.
- Product and pipeline activities included the CUSA Clarity launch in Japan, planned launches of AmnioExcel Plus and the Integra XT ankle revision system, and anticipated late-2018 and early-2019 launches in electrosurgery, intracranial monitoring, and shunt products.
- The FDA continues to dispute whether certain BioD morselized amniotic membrane products qualify for regulation solely as human cells, tissues, and cellular or tissue-based products. These products represented less than 1% of consolidated revenue, but regulatory action could affect sales and require an alternative approval pathway.
- The Company is exposed to variable interest rates, foreign currency movements, international regulatory and trade requirements, Brexit-related uncertainty, and potential tariffs. A one-percentage-point interest-rate change would affect annualized interest expense by approximately $5.9 million based on June 30 borrowings.
- TEI remains involved in product-liability litigation, although the Company reported nine active cases as of July 16, 2018 and stated that insurance, Boston Scientific indemnification, and merger protections provide significant coverage. No related indemnification payments were received or owed as of July 26, 2018.
- A BioD-related dispute could potentially affect a contingent earn-out of up to $26.5 million; management stated that acceleration was not expected if the former CEO’s termination is determined to have been for “Good Reason.”
- The Company was in compliance with its Senior Credit Facility covenants at June 30, 2018. The amended facility matures May 3, 2023, with maximum consolidated total leverage ratios stepping down from 5.50:1.00 to 4.00:1.00 over time.
Important facts for investors to verify
- Separate organic revenue growth from the $79.2 million quarterly and $157.1 million year-to-date contribution of Codman Neurosurgery, as well as the effect of divested products and foreign exchange.
- Whether the anticipated gross-margin recovery and operating-expense leverage offset the lower-margin Codman portfolio and continuing integration costs.
- Debt reduction progress, interest-rate exposure, covenant headroom, and the ability to refinance or repay the $590.0 million revolving balance and term-loan maturities.
- The sustainability of cash generation after capital expenditures, contingent consideration payments, integration spending, and working-capital requirements.
- Final resolution of the FDA’s BioD regulatory position, associated litigation and contingent consideration matters, and any resulting financial impact.
- Updates to the provisional tax accounting under the 2017 Tax Cuts and Jobs Act, including GILTI, toll-tax liabilities, and the projected full-year effective tax rate.