Integra LifeSciences Holdings Corporation — Q2 2010 Form 10-Q
Business context and reporting period
Integra develops, manufactures, and markets medical devices for cranial and spinal procedures, extremity reconstruction, peripheral nerve repair, small bone and joint injuries, soft-tissue repair, and surgical instruments. The company reports one operating segment and presents revenue across Orthopedics, NeuroSciences, and Medical Instruments. This unaudited filing covers the three and six months ended June 30, 2010, compared with the corresponding 2009 periods.
Financial performance and position
| Metric | Three months ended June 30 | Six months ended June 30 |
|---|---|---|
| Revenue | $178.6 million, up 7.8% | $351.3 million, up 7.5% |
| Gross margin | $114.1 million; 63.9% | $223.6 million; 63.7% |
| Operating income | $24.6 million; approximately 13.8% margin | $47.2 million; approximately 13.4% margin |
| Net income | $15.2 million; 8.5% margin | $30.4 million; 8.6% margin |
| Diluted EPS | $0.50 | $1.00 |
| Operating cash flow | Not separately provided | $47.5 million |
- Revenue growth was led by Orthopedics, which increased 11.7% in the quarter and 10.4% year to date, and NeuroSciences, which increased 7.9% and 8.2%, respectively. Medical Instruments increased 0.9% in the quarter and 1.6% year to date.
- Research and development expense was $11.8 million in the quarter and $23.1 million year to date. Selling, general and administrative expense was $74.2 million and $146.7 million, respectively.
- Cash and cash equivalents were $93.6 million at June 30, 2010, versus $71.9 million at December 31, 2009. Working capital increased to $302.0 million from $208.6 million.
- Total assets were $941.8 million and stockholders’ equity was $460.4 million at June 30, 2010.
- Debt consisted primarily of $220.0 million outstanding under the senior secured revolving credit facility and $151.9 million of long-term convertible securities, for approximately $371.9 million of reported debt. The credit facility carried a weighted-average interest rate of 1.13% and expires in December 2011.
- The $77.9 million principal amount of 2010 convertible notes was repaid in June 2010. The company borrowed $75.0 million under the credit facility and repaid $15.0 million during the first six months.
Cash flow and liquidity
- Operating cash flow declined to $47.5 million from $67.8 million in the prior-year period, primarily reflecting less favorable working-capital changes and $6.6 million of paid accreted interest.
- Investing cash use was $14.1 million, including $11.7 million of capital expenditures and $2.4 million for the Welch Allyn surgical headlight acquisition.
- Financing cash use was $3.2 million, compared with $104.2 million in 2009, as net credit-facility borrowings substantially offset the note repayment.
- Management stated that cash and available revolver capacity were sufficient for near-term operations, capital expenditures, and potential acquisition-related earn-out payments.
Material changes versus the prior comparable periods
- Net income increased 35.0% in the quarter and 46.1% for the first six months; diluted EPS increased from $0.38 to $0.50 and from $0.71 to $1.00, respectively.
- Interest expense decreased to $4.3 million from $6.2 million in the quarter and to $8.8 million from $12.9 million year to date, following note repurchases, the 2010 note repayment, and lower borrowing rates.
- The effective tax rate decreased to 28.1% from 35.4% in the quarter and to 24.8% from 35.7% year to date. The first-half rate benefited from a $2.3 million reversal of uncertain-tax-position reserves and a greater expected proportion of foreign earnings taxed at lower rates.
- Gross margin percentage was flat in the quarter but declined year to date to 63.7% from 63.9%, reflecting higher production costs and increased inventory reserves.
- Operating expenses grew faster than revenue, increasing to 50.1% of quarterly revenue from 49.5% and to 50.2% year to date from 49.7%.
- Comprehensive income was $2.4 million for the first six months, compared with $26.5 million in 2009, primarily because of a $27.9 million unfavorable foreign-currency translation adjustment.
Outlook, commentary, risks, and unusual items
- Management expected faster growth in spine and orthobiologics products during the balance of 2010 and anticipated improvement in consolidated gross margin from a higher mix of implant products.
- Management targeted 2010 research and development spending at 6.5% to 7.0% of revenue, selling and administrative spending at 41.5% to 42.0% of revenue, and a full-year effective tax rate of approximately 26%.
- Capital equipment represented approximately 10% of quarterly revenue and increased 17.2% year over year, although management remained cautious because economic weakness was affecting elective procedures and certain orthopedic products.
- The company acquired the Welch Allyn surgical headlight business for approximately $2.4 million in cash plus $0.2 million of working-capital adjustments.
- A $0.8 million impairment charge was recorded for legacy brand names as part of a rebranding strategy. Additional impairment or accelerated amortization charges may occur.
- Goodwill was $252.1 million and indefinite-lived intangible assets were approximately $49.7 million. No goodwill impairment resulted from the second-quarter 2010 annual assessment.
- The former Theken seller’s representative alleged that an additional $6.7 million revenue-performance payment was owed. The matter remained under discussion and the filing did not state a final resolution or accrued amount.
- Key risks include healthcare cost containment and reimbursement changes, pricing pressure, possible loss of reimbursement for certain wound products, foreign-exchange exposure, interest-rate exposure, product and ordinary-course litigation, acquisition integration, and impairment of goodwill or intangible assets.
- The company had a $10.0 million equivalent foreign-currency forward contract with a net fair-value loss of $2.2 million at June 30, 2010. A 100-basis-point rate change would affect annual interest expense on the revolver by approximately $2.2 million.
Important facts for investors to verify
- Available borrowing capacity and covenant compliance under the credit facility, which expires in December 2011.
- The ultimate resolution and potential cash impact of the $6.7 million Theken earn-out dispute.
- Progress toward the expected 2010 revenue mix, gross-margin improvement, and approximately 26% effective tax rate.
- Whether elective-procedure weakness, reimbursement changes, and healthcare pricing pressure affect Orthopedics and wound-care products.
- Potential future brand-name, goodwill, or other intangible-asset impairment charges.
- The sustainability of operating cash flow given inventory growth, capital expenditures, acquisition activity, and debt service requirements.