Integra LifeSciences Holdings Corporation — Q1 2018 Form 10-Q
Business context and reporting period
Integra is a global medical technology company operating in two reportable segments: Codman Specialty Surgical and Orthopedics and Tissue Technologies. This unaudited filing covers the three months ended March 31, 2018, compared with the three months ended March 31, 2017. Results include a full quarter of Derma Sciences revenue and the first full quarter of the Codman Neurosurgery acquisition, completed October 2, 2017.
Key financial metrics
| Metric | Q1 2018 | Q1 2017 | Change |
|---|---|---|---|
| Revenue | $357.1 million | $258.6 million | +38.1% |
| Gross profit | $212.9 million | $172.1 million | +23.7% |
| Gross margin | 59.6% | 66.5% | Down 690 bps |
| Operating income | $25.6 million | $10.0 million | +156.6% |
| Operating margin | 7.2% | 3.9% | Up 330 bps |
| Net income | $11.0 million | $6.4 million | +71.9% |
| Diluted EPS | $0.14 | $0.08 | +75.0% |
| Operating cash flow | $41.5 million | $28.9 million | +43.8% |
Codman Specialty Surgical revenue was $236.1 million, up 51.1%, including $77.9 million from Codman Neurosurgery. Orthopedics and Tissue Technologies revenue was $121.0 million, up 18.2%, including $24.7 million from Derma Sciences. Foreign exchange favorably affected revenue by $4.9 million.
Research and development expense was $18.3 million, or 5.1% of revenue, versus $15.5 million, or 6.0%. Selling, general and administrative expense was $163.6 million, or 45.8% of revenue, versus $142.5 million, or 55.1%. Interest expense increased to $18.8 million from $5.1 million because of acquisition-related borrowings, higher leverage and higher LIBOR rates.
Cash and cash equivalents were $189.4 million at March 31, 2018, up from $174.9 million at December 31, 2017. Total borrowings under the senior credit facility were approximately $2.0 billion, consisting of $660.0 million under the revolver, $493.8 million under Term Loan A and $691.3 million under Term Loan A-1. Approximately $340.0 million remained available under the facility. The company was in compliance with its debt covenants.
Material changes versus the prior comparable period
- Revenue increased primarily from the Codman Neurosurgery and Derma Sciences acquisitions, organic growth and favorable foreign exchange.
- Gross margin declined substantially because acquired Codman and Derma products carry lower margins and because of acquisition-related inventory purchase-accounting adjustments and technology intangible amortization.
- Operating income and net income improved despite higher interest expense and higher selling, marketing and integration costs.
- Operating cash flow increased by $12.6 million. Investing cash use was only $9.3 million versus $193.1 million in Q1 2017, which included the Derma Sciences acquisition.
- Special charges totaled $30.5 million, including $28.9 million of acquisition and integration-related charges and $1.6 million of structural optimization charges, compared with $25.5 million in Q1 2017.
- The company adopted ASC Topic 606 using the modified retrospective method, increasing opening retained earnings by $1.9 million. Reported Q1 revenue was $357.1 million versus $356.6 million excluding the adoption effect.
Guidance, outlook, risks and unusual items
- Management expects full-year 2018 gross margin of approximately 61.5% to 62.5%, research and development expense of approximately 6.0% of revenue, and SG&A expense of approximately 45.0% to 47.0% of revenue.
- Expected 2018 capital expenditures are approximately $65 million to $75 million, including manufacturing capacity and the new Mansfield, Massachusetts facility for Codman products.
- Management expects additional capital and integration expenses related to Codman Neurosurgery during 2018 and believes cash and available credit are sufficient to fund operations and capital expenditures.
- The company faces regulatory uncertainty concerning BioD morselized amniotic membrane products. The FDA maintains that certain products may require a biologics license; related revenue was less than 1% of consolidated revenue.
- BioD litigation could potentially trigger an earnout payment of up to $26.5 million, although management believes the likelihood of loss is remote because it asserts the former executive’s termination was for “Good Reason.”
- Ten product-liability cases remained against TEI as of March 31, 2018. Insurance and indemnification arrangements are available, and no indemnification payments were received or owed as of April 26, 2018.
- In March 2018, the company received regulatory approval related to the Confluent Surgical contingent consideration and paid $19.0 million in April 2018. Additional European contingent consideration is expected within the following twelve months.
- Interest-rate and foreign-currency exposure remains material. A one-percentage-point change in interest rates would affect annualized interest expense by approximately $9.5 million based on March 31 debt levels.
Important facts for investors to verify
- Whether Codman integration produces expected revenue synergies and whether gross margins recover toward management’s 61.5%–62.5% full-year target.
- The sustainability of revenue growth excluding acquisitions and foreign exchange.
- Debt reduction, refinancing capacity and compliance with leverage covenants as scheduled principal repayments increase.
- The extent and timing of acquisition, integration and restructuring charges during the remainder of 2018.
- Final accounting adjustments for the Codman acquisition, including the preliminary purchase-price allocation and goodwill.
- Developments in the FDA’s position on BioD products and the potential financial impact of related regulatory or litigation outcomes.
- Updates to provisional tax accounting under the 2017 Tax Act, including GILTI, the Toll Tax and deferred-tax remeasurement.