Integra LifeSciences Holdings Corporation — Q1 2020 Form 10-Q Summary
Business context and reporting period
Integra is a global medical technology company operating through Codman Specialty Surgical and Orthopedics and Tissue Technologies. The filing covers the unaudited three months ended March 31, 2020, compared with the three months ended March 31, 2019. The quarter was materially affected by the COVID-19 pandemic, particularly from mid-March as hospitals deferred elective procedures and redirected resources.
Key financial metrics
| Metric | Q1 2020 | Q1 2019 | Change |
|---|---|---|---|
| Revenue | $354.3 million | $359.7 million | Down 1.5% |
| Gross profit | $220.8 million | $230.8 million | Down $10.0 million |
| Gross margin | 62.3% | 64.2% | Down 190 basis points |
| Operating income | $27.1 million | $32.3 million | Down 16.1% |
| Operating margin | 7.7% | 9.0% | Down approximately 130 basis points |
| Net income | $9.2 million | $32.8 million | Down 72.0% |
| Diluted EPS | $0.11 | $0.38 | Down $0.27 |
| Operating cash flow | $20.8 million | $29.5 million | Down $8.7 million |
Revenue from Codman Specialty Surgical was $231.4 million, down 1.3%, while Orthopedics and Tissue Technologies revenue was $122.9 million, down 1.8%. Neurosurgery revenue increased to $184.9 million, but Instruments revenue declined to $46.5 million. Domestic revenue fell 3.8% to $246.9 million, while international revenue increased to approximately $107.5 million.
Net income was reduced by lower revenue, COVID-19-related costs, higher interest expense, unfavorable foreign exchange effects, and a $3.3 million valuation allowance on certain foreign deferred tax assets. The prior-year tax rate benefited from a $10.8 million Swiss tax benefit; the current-quarter effective tax rate was 19.8% versus negative 32.0% in the prior-year period.
Cash flow, liquidity, debt, and capital resources
- Cash and cash equivalents increased to $357.7 million from $198.9 million at December 31, 2019; approximately $152.2 million was held by non-U.S. subsidiaries.
- Operating cash flow was $20.8 million. Investing cash outflows were $21.5 million, including $16.5 million of capital expenditures and a $5.0 million Rebound development milestone payment.
- Financing cash flow was $162.0 million, principally reflecting proceeds from $575.0 million of convertible notes and other borrowings, offset by debt repayments, debt issuance costs, and $100.0 million of share repurchases.
- At March 31, 2020, borrowings included $1,027.5 million under the Senior Credit Facility, $98.5 million under the securitization facility, and $575.0 million principal amount of 2025 convertible notes. The balance sheet carrying amount of the convertible debt was $460.2 million.
- The Senior Credit Facility was amended and extended to February 3, 2025. It provides approximately $2.2 billion of aggregate capacity, including a $877.5 million term loan and a $1.3 billion revolving facility. The company had $150.0 million drawn on the revolver and $877.5 million outstanding under the term loan.
- The company was in compliance with its debt covenants and expects sales and earnings to be sufficient to remain compliant over the next twelve months, although a more severe or prolonged downturn could require additional cost reductions.
- Total contractual obligations were $1.95 billion, including debt, interest, leases, purchase obligations, employment agreements, and other commitments. Contingent consideration, a potential acquisition option of up to $80.0 million, and certain other obligations were excluded because timing or amounts were not fixed.
Material changes versus the prior comparable period
- COVID-19 caused an estimated $20 million to $25 million reduction in first-quarter revenue relative to original expectations, with the impact concentrated in March.
- Gross margin declined primarily because of higher inventory reserves for discontinued products and COVID-19-related charges.
- Interest expense increased $4.6 million to $17.8 million, reflecting the convertible notes, debt refinancing costs, and non-cash amortization of the convertible debt discount.
- Total special charges were $24.8 million, including $4.7 million of COVID-19-related charges, $6.2 million of acquisition and integration charges, $3.2 million of discontinued product charges, $2.9 million of structural optimization charges, and $2.7 million of debt refinancing and convertible debt non-cash interest expense.
- Inventory increased to $338.1 million from $316.1 million as the company maintained supply levels and supported new product launches and manufacturing changes.
- The company repurchased approximately 1.4 million shares for $100.0 million and had $125.0 million remaining under its repurchase authorization.
- Comprehensive loss was $19.0 million, compared with comprehensive income of $21.5 million, primarily due to derivative and foreign currency losses recorded in accumulated other comprehensive loss.
Guidance, outlook, risks, and unusual items
Management expects revenue to decline more substantially in the second quarter of 2020 because of ongoing restrictions on surgical procedures, shelter-in-place policies, and hospital resource constraints. Management stated that the full-year effective tax rate was expected to be approximately negative 14.6%, driven primarily by a projected full-year pretax loss; this estimate was subject to revision.
The company implemented cost-saving measures in April, including reductions in executive and employee compensation, furloughs and reduced hours, a hiring freeze, elimination of overtime, reduced third-party services, lower capital expenditures, and reduced discretionary spending. Critical research and development and clinical programs remained priorities.
- Key COVID-19 risks include deferred or canceled procedures, lower hospital and distributor liquidity, delayed customer payments, supply-chain disruption, manufacturing interruptions, restricted sales access, reduced capital spending, and a prolonged recession.
- Regulatory risks include an FDA Untitled Letter concerning certain BioD morselized amniotic membrane products and an FDA Warning Letter concerning quality-system issues at the TEI Boston facility. Products manufactured at the Boston facility represented approximately 4.9% of consolidated revenue in the quarter; BioD morselized products represented less than 1.0%.
- The company remains exposed to foreign currency and variable-rate debt risk. Interest-rate swaps had an aggregate notional amount of approximately $1.3 billion, and management estimated that a 100-basis-point change in rates would affect annual interest expense on unhedged debt by approximately $2.3 million.
- Contingent consideration related to Arkis was estimated at $13.2 million at March 31, 2020, with potential maximum milestone payments of up to $25.5 million. A separate Medihoney-related contingent obligation had a maximum undiscounted payment of $3.0 million and an estimated fair value of $0.2 million.
- Management determined that disclosure controls and procedures were effective as of March 31, 2020, with no material changes to internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether elective procedure volumes recover as expected and the resulting effect on second-quarter and full-year revenue.
- Compliance with the Senior Credit Facility leverage covenants if COVID-19 produces a deeper or longer downturn.
- Cash flow conversion, inventory levels, receivable collections, and the company’s ability to preserve liquidity while maintaining supply.
- The ultimate financial impact of the FDA matters involving BioD and the TEI Boston facility.
- The final settlement of the accelerated share repurchase and any additional shares or cash required in the second quarter.
- Whether the projected negative full-year tax rate and other COVID-19-related estimates change as business conditions develop.