Integra LifeSciences Holdings Corporation — Q1 2017 Form 10-Q Summary
Business context and reporting period
Integra is a global medical technology company focused on neurosurgery, surgical instruments, tissue repair and regeneration, and extremity orthopedics. It reports two segments: Specialty Surgical Solutions and Orthopedics and Tissue Technologies. This report covers the unaudited three months ended March 31, 2017, compared with the three months ended March 31, 2016.
Key financial metrics
| Metric | Q1 2017 | Q1 2016 | Change |
|---|---|---|---|
| Revenue | $258.6 million | $236.8 million | +9.2% |
| Gross profit | $172.1 million | $152.0 million | +13.2% |
| Gross margin | 66.5% | 64.2% | +230 bps |
| Operating income | $10.0 million | $22.1 million | -54.9% |
| Operating margin | 3.9% | 9.3% | Down 540 bps |
| Net income | $6.4 million | $13.4 million | -52.4% |
| Diluted EPS | $0.08 | $0.18 | -$0.10 |
| Operating cash flow | $28.9 million | $25.0 million | +15.4% |
Specialty Surgical Solutions revenue increased 3.4% to $156.3 million, while Orthopedics and Tissue Technologies revenue increased 19.6% to $102.3 million. Derma Sciences contributed approximately $10.4 million of revenue after its February 24, 2017 acquisition.
At March 31, 2017, cash and cash equivalents were $124.1 million, compared with $102.1 million at year-end 2016. Short-term investments were $11.3 million. Total assets were $2.05 billion and total stockholders’ equity was $852.5 million.
Borrowings under the Senior Credit Facility totaled approximately $855.0 million, consisting of $500.0 million under Term Loan A and $355.0 million under the revolving facility. Approximately $1.3 billion remained available, including the $700.0 million delayed-draw Term Loan A-1. The facility matures December 7, 2021, and the Company was in compliance with its financial covenants at quarter-end.
Material changes versus the prior comparable period
- Revenue growth was led by dural repair, instruments, skin and wound products, upper-extremity products, and private-label business.
- Gross margin improved primarily because of higher sales of higher-margin products and better manufacturing utilization.
- Operating income and net income declined despite revenue growth because operating expenses increased $32.2 million, including higher acquisition, integration, commercial investment, compensation, and amortization costs.
- Selling, general and administrative expense increased 27.3% to $142.5 million, and rose to 55.1% of revenue from 47.3%.
- Special charges increased to $25.5 million from $13.8 million. Q1 2017 included $20.3 million of acquisition-related charges, including $14.3 million more than the prior-year period, as well as ERP, restructuring, severance, and discontinued-product charges.
- Interest expense declined to $5.1 million from $6.4 million, primarily because the 2016 Convertible Notes were settled in December 2016, partially offset by higher borrowings.
- The effective tax rate was negative 34.8%, compared with 10.5% in Q1 2016, primarily due to lower pretax income and excess tax benefits from stock-based compensation. Management estimated a full-year 2017 effective tax rate of approximately 11.1%.
Cash flow, acquisitions, outlook, and unusual items
Operating cash flow was $28.9 million. Investing cash flow used $193.1 million, including $193.9 million for the Derma Sciences acquisition and $9.2 million of capital expenditures. Financing cash flow provided $185.0 million, primarily from $210.0 million of new borrowings, partly offset by $20.0 million of debt repayments.
Integra acquired Derma Sciences for an aggregate purchase price of approximately $210.8 million, including approximately $201.7 million paid in cash to former shareholders. The preliminary allocation included $66.5 million of goodwill and $103.7 million of acquired identifiable intangible assets. The acquisition also added contingent liabilities with estimated fair values of approximately $36.3 million, including potential BioD and Medihoney-related payments.
Integra made a binding offer to acquire Johnson & Johnson’s Codman Neurosurgery Business for approximately $1.0 billion, subject to adjustments. The transaction was expected to close in the fourth quarter of 2017 and was expected to be funded through the delayed-draw term loan and revolving credit facility. If the offer was not accepted before expiration, DePuy Synthes could owe $10.5 million of expense reimbursement; certain circumstances could trigger a $41.8 million termination fee.
Management expected 2017 capital expenditures of approximately $50 million to $55 million and full-year gross margin of approximately 65.0% to 66.0%. Research and development expense was expected to be approximately 6.0% of revenue, and selling, general and administrative expense approximately 51.0% to 52.0% of revenue, reflecting acquisition and integration costs and investment in commercial channels.
Material risks and contingencies include the FDA’s continuing position that certain BioD morselized amniotic membrane products may require a biologics license, with possible labeling restrictions, additional compliance costs, or product recall. The Company also disclosed approximately 50 active product-liability cases involving TEI, pending litigation and indemnification matters, acquisition-integration risks, supplier concentration, foreign currency and interest-rate exposure, animal-derived product regulation, and the costs and potential effects of new EU medical-device regulations.
On April 4, 2017, the Company agreed to acquire TGX Medical for $5.3 million, subject to working-capital adjustment. The Company also reported that plaintiffs dismissed the Derma Sciences acquisition lawsuits and settled for $225,000 of attorneys’ fees.
Most important facts for an investor to verify
- Whether the Codman Neurosurgery acquisition closed on the expected timetable and at what final purchase price and financing cost.
- The pace and profitability of integrating Derma Sciences, including realization of expected revenue and cost synergies.
- The FDA’s ultimate regulatory position on BioD’s morselized amniotic tissue products and any related sales, recall, or compliance impact.
- Whether acquisition-related and other special charges normalize, allowing operating margin to recover from the 3.9% Q1 level.
- Debt growth, leverage covenant compliance, interest-rate sensitivity, and repayment capacity following the planned Codman transaction.
- Changes in contingent consideration, including the potential BioD earnout and product payment obligations.
- Progress on remediation of the TEI FDA warning letter and developments in related product-liability litigation.
- The effect of EU medical-device regulation, foreign exchange, supplier constraints, and animal- or human-tissue regulatory requirements on revenue and margins.