Integra LifeSciences Holdings Corporation — Form 10-Q Summary
Business context and reporting period
Integra is a global medical technology company operating in Specialty Surgical Solutions and Orthopedics and Tissue Technologies. This unaudited report covers the three and nine months ended September 30, 2017, compared with the corresponding 2016 periods. The company sells products for neurosurgery, surgical instruments, wound care, tissue regeneration, extremity orthopedics and related applications.
Financial performance and position
| Metric | Q3 2017 | Q3 2016 | 9M 2017 | 9M 2016 |
|---|---|---|---|---|
| Revenue | $278.8 million | $250.3 million | $819.6 million | $736.4 million |
| Gross margin | $177.1 million | $161.0 million | $532.3 million | $472.7 million |
| Gross margin percentage | 63.5% | 64.3% | 64.9% | 64.2% |
| Operating income | $10.6 million | $30.1 million | $37.6 million | $74.6 million |
| Operating margin | 3.8% | 12.0% | 4.6% | 10.1% |
| Net income | $3.2 million | $20.1 million | $20.4 million | $46.3 million |
| Diluted EPS | $0.04 | $0.25 | $0.26 | $0.59 |
| Operating cash flow | Not separately provided | Not separately provided | $103.0 million | $109.9 million |
Third-quarter revenue increased 11.4%; nine-month revenue increased 11.3%. Specialty Surgical Solutions revenue grew 3.4% in the quarter and 2.6% year to date. Orthopedics and Tissue Technologies revenue grew 25.5% in the quarter and 26.6% year to date, including $24.1 million and $58.4 million, respectively, contributed by the Derma Sciences acquisition.
At September 30, 2017, cash and cash equivalents were $481.9 million, versus $102.1 million at December 31, 2016. Current assets were $944.9 million and current liabilities were $210.2 million. Borrowings under the senior credit facility totaled $1.171 billion, including $18.8 million classified as current. The company was in compliance with its debt covenants and reported approximately $1.0 billion of additional borrowing availability, including the $700.0 million delayed-draw term loan.
Nine-month investing cash use was $237.8 million, including $225.6 million for business acquisitions and $29.8 million of capital expenditures. Financing activities provided $504.7 million, primarily from senior credit facility borrowings. Management expected 2017 capital expenditures of approximately $50 million to $55 million.
Material changes versus the prior comparable period
- Revenue growth was driven primarily by Derma Sciences, regenerative technology products, tissue ablation, upper-extremity products and certain neurosurgery products.
- Operating income and net income declined substantially despite revenue growth. Nine-month net income decreased $25.9 million, primarily because acquisition-related expenses increased by $51.9 million, while selling, general and administrative expense increased $89.9 million.
- Third-quarter SG&A increased to $145.9 million from $112.3 million; nine-month SG&A increased to $433.5 million from $343.5 million.
- Third-quarter gross margin percentage declined because of lower-margin Derma Sciences products and a $3.3 million impairment charge for discontinued Tarsus technology. The nine-month gross margin percentage improved modestly to 64.9%.
- Special charges totaled $28.1 million in the quarter and $79.9 million year to date, including acquisition-related, structural optimization, ERP, Hurricane Maria and discontinued-product charges.
- The company completed the $210.8 million Derma Sciences acquisition and the $5.4 million TGX Medical acquisition during 2017. On October 2, 2017, after the reporting date, it completed the $1.014 billion Codman neurosurgery acquisition and drew $700 million under the delayed-draw term loan.
Guidance, outlook, risks and unusual items
- Management expected full-year 2017 consolidated gross margin of approximately 63.0%, including the Codman acquisition.
- Expected full-year research and development expense was approximately 6.0% of revenue; SG&A was expected to be approximately 52.0% to 53.0% of revenue, reflecting acquisition and integration costs and commercial investments.
- Including Codman, management estimated a full-year effective tax rate benefit of approximately 65.7%, subject to revision.
- Hurricanes affecting Texas, Florida and Puerto Rico reduced third-quarter revenue by approximately $7.0 million. Hurricane Maria caused disruption and minor damage at the Añasco, Puerto Rico facility and generated $1.3 million of related expenses.
- The FDA continues to dispute whether certain BioD morselized amniotic products qualify for regulation solely under Section 361. The company continues to market the products; potential labeling, licensing, compliance or recall requirements could increase costs or reduce sales. Related revenue was less than 1% of consolidated revenue.
- The company faces ordinary-course litigation and product liability matters. Ten TEI cases remained active at September 30, 2017; management stated that insurance, indemnification and contractual protections apply, but outcomes could affect a particular period.
- BioD litigation involves whether a former executive’s departure could trigger a potential $26.5 million earn-out acceleration. The company believes the likelihood of loss is remote if the termination is determined to be for “Good Reason.”
- Interest-rate exposure remained significant: management estimated that a one-percentage-point change in rates would affect annual interest expense by approximately $7.7 million based on September 30 borrowings. The company had $400 million of interest-rate swaps outstanding.
- Following the Codman acquisition, the company sold specified businesses and assets to Natus for $46.4 million on October 6, 2017; $36.4 million of proceeds were used to repay revolving debt.
Most important facts for investors to verify
- Whether Codman integration produces the expected revenue, margin and synergy benefits without further material acquisition or restructuring costs.
- The post-acquisition leverage ratio, debt repayment schedule and compliance with senior credit facility covenants.
- The sustainability of revenue growth excluding Derma Sciences, Codman and other acquired businesses.
- The resolution and potential financial impact of the FDA’s BioD product classification dispute.
- The extent and duration of operational disruption at the Puerto Rico facility and any related insurance recoveries.
- Whether acquisition-related expenses, commercial investments and amortization normalize sufficiently to restore operating leverage.
- Final purchase accounting for Codman and any subsequent adjustments to goodwill, identifiable intangibles, deferred taxes or contingent liabilities.
- The outcome of the BioD earn-out dispute and TEI product liability matters.