Integra LifeSciences Holdings Corporation — Q3 2016 Form 10-Q
Business context and reporting period
Quarterly report for the three and nine months ended September 30, 2016, filed October 28, 2016. Integra operates through Specialty Surgical Solutions and Orthopedics and Tissue Technologies, serving neurosurgery, surgical instruments, regenerative technologies, wound repair, and extremities orthopedics. Results are presented as continuing operations following the July 2015 distribution of SeaSpine; the prior-year nine-month period includes a $10.4 million loss from discontinued operations.
Financial performance and liquidity
| Metric | Q3 2016 | Q3 2015 | 9M 2016 | 9M 2015 |
|---|---|---|---|---|
| Revenue | $250.3 million | $226.4 million | $736.4 million | $641.6 million |
| Gross margin | 64.3% | 62.0% | 64.2% | 63.1% |
| Operating income | $30.1 million | $10.0 million | $74.6 million | $55.6 million |
| Operating margin | 12.0% | 4.4% | 10.1% | 8.7% |
| Net income from continuing operations | $20.1 million | $(31.9) million | $46.3 million | $(8.1) million |
| Diluted EPS from continuing operations | $0.50 | $(0.90) | $1.18 | $(0.24) |
- Specialty Surgical Solutions revenue increased 8.4% in Q3 and 8.1% year to date. Orthopedics and Tissue Technologies increased 14.7% in Q3 and 28.8% year to date, supported by acquisitions and regenerative products.
- Operating cash flow was $109.9 million for the first nine months, compared with $91.4 million in the prior-year period. Capital expenditures were $26.1 million.
- Cash and cash equivalents were $107.6 million at September 30, 2016, up from $48.1 million at December 31, 2015. Working capital was $350.5 million.
- Senior Credit Facility borrowings totaled $462.5 million, including $120.0 million revolver borrowings and $342.5 million of term loans. The carrying amount of the convertible notes was $225.2 million, with $227.1 million principal outstanding and maturity in December 2016.
- Approximately $630.0 million remained available under the Senior Credit Facility, and the company was in compliance with its financial covenants.
Material changes versus the prior comparable period
- Revenue increased 10.6% in Q3 and 14.8% for the first nine months. Growth reflected new products, stronger dural repair and regenerative technology demand, international orders, and the full-period contribution from the 2015 TEI, Salto/Futura, and Tekmed acquisitions.
- Gross margin expanded 230 basis points in Q3 and 110 basis points year to date, primarily from favorable product mix and manufacturing utilization.
- Net income improved materially because the prior-year period included a $35.6 million valuation allowance related to the SeaSpine spin-off. The 2016 period also benefited from $3.4 million of excess tax benefits from early adoption of ASU 2016-09.
- Interest expense increased to $19.3 million year to date from $17.4 million, reflecting higher borrowings and rates; $6.3 million of 2016 expense was non-cash convertible-note discount amortization.
- Year-to-date financing cash flow was a $28.9 million use, reflecting $48.8 million of debt repayments partially offset by $15.0 million of new borrowings and $9.9 million from stock-option exercises.
Guidance, outlook, risks and unusual items
- Management expected full-year 2016 gross margin of approximately 64.5% to 65.0%, research and development expense of approximately 6.0% of revenue, selling, general and administrative expense of approximately 46.0% of revenue, and an effective tax rate of approximately 17.0%.
- Management anticipated 2016 capital expenditures of approximately $35 million to $40 million, primarily for manufacturing support, facility automation, ERP implementation, and orthopedic instrument kits.
- The company intended to refinance, extend, or use available credit capacity to settle the $227.1 million principal amount of convertible notes maturing in December 2016. Refinancing availability and cost depend on market conditions and company performance.
- Q3 special charges totaled $12.6 million and included ERP implementation, structural optimization, severance, acquisition-related costs, and non-cash convertible debt interest. Nine-month special charges totaled $42.6 million.
- An FDA warning letter remained outstanding concerning TEI promotional activities for SurgiMend. Approximately 50 product-liability cases were active against TEI; BSC was managing the litigation, insurance and indemnification arrangements applied, and no indemnification payments were owed or received for the initial indemnification period as of October 28, 2016.
- The company entered into $150.0 million of interest-rate swaps effective December 31, 2016. It remains exposed to foreign-currency and variable-rate debt risk, as well as acquisition integration, regulatory, product-liability, healthcare-market, and execution risks.
- After quarter-end, the board authorized a new $150.0 million share-repurchase program through December 2018, approved retirement of approximately 8.9 million treasury shares, and proposed increasing authorized common shares from 60 million to 240 million in connection with, among other matters, a proposed two-for-one stock split.
Key facts for investors to verify
- Progress and final terms of refinancing or repayment of the convertible notes due December 2016.
- Whether acquisition-driven growth, especially from TEI and extremities products, translates into sustainable organic growth and margin expansion.
- Resolution of the TEI FDA warning letter and approximately 50 related product-liability cases, including the scope of insurance and indemnification coverage.
- Actual full-year gross margin, tax rate, operating expense ratios, capital expenditures, and ERP implementation costs versus management’s estimates.
- Impact of the new repurchase authorization, treasury-share retirement, proposed stock split, and increased authorized share count on dilution and capital allocation.