Business Context and Reporting Period
Integra LifeSciences Holdings Corporation filed this unaudited Form 10-Q for the quarter and nine months ended September 30, 2015. Integra provides medical technology products for neurosurgery, orthopedic extremity surgery, reconstructive surgery and wound care through two continuing reportable segments: Specialty Surgical Solutions and Orthopedics and Tissue Technologies.
On July 1, 2015, Integra completed the tax-free spin-off of its spine business into SeaSpine Holdings Corporation. SeaSpine’s historical results, cash flows, assets and liabilities are presented as discontinued operations, and current-period results exclude SeaSpine activity after the separation.
Financial Performance and Key Metrics
| Metric | Q3 2015 | Q3 2014 | First 9 Months 2015 | First 9 Months 2014 |
|---|---|---|---|---|
| Revenue | $226.4 million | $197.5 million | $641.6 million | $577.6 million |
| Gross profit | $140.3 million | $123.6 million | $405.0 million | $359.7 million |
| Gross margin | 62.0% | 62.6% | 63.1% | 62.3% |
| Operating income from continuing operations | $10.0 million | $17.1 million | $55.6 million | $38.3 million |
| Income before taxes | $5.4 million | $11.0 million | $41.2 million | $22.2 million |
| Net income from continuing operations | $(31.9) million | $9.0 million | $(8.1) million | $15.9 million |
| Net income (loss) | $(31.9) million | $9.8 million | $(18.5) million | $16.8 million |
| Diluted EPS | $(0.90) | $0.29 | $(0.55) | $0.51 |
Q3 operating margin was approximately 4.4%, compared with 8.7% in the prior-year quarter. The nine-month operating margin was approximately 8.7%, compared with 6.6% in the prior-year period.
- Specialty Surgical Solutions revenue increased 7% in Q3 and 8% for the nine months, supported by MicroFrance, dural repair and instruments. Tissue ablation and neuro critical care were weaker.
- Orthopedics and Tissue Technologies revenue increased 32% in Q3 and 18% for the nine months, benefiting from TEI and Metasurg acquisitions, regenerative technologies and upper-extremity products. Lower-extremity and wrist arthroplasty sales were weaker.
- Q3 operating expenses increased 22% year over year to $130.3 million, including higher research and development, selling and marketing, acquisition-related, facility optimization and spin-off costs.
- The reported Q3 effective tax rate was 694.6%, and the nine-month rate was 119.7%, primarily because of a $35.6 million valuation allowance related to deferred tax assets affected by the SeaSpine spin-off. Excluding that allowance, the rates were 29.8% and 33.1%, respectively.
Cash Flow, Liquidity and Capital Structure
| Metric | September 30, 2015 | December 31, 2014 |
|---|---|---|
| Cash and cash equivalents | $79.3 million | $71.7 million |
| Working capital | $365.0 million | $403.3 million |
| Total assets | $1.83 billion | $1.59 billion |
| Senior credit facility borrowings | $513.1 million | $416.9 million |
| Convertible securities carrying amount | $216.6 million | $213.1 million |
- Operating cash flow from continuing operations was $81.3 million for the first nine months, compared with $40.9 million in 2014. Consolidated operating cash flow, including discontinued operations, was $69.1 million.
- Investing cash flow was $(327.1) million, including approximately $310.1 million for the TEI acquisition and $20.3 million of capital expenditures.
- Financing cash flow was $276.0 million, including $545.0 million of credit-facility borrowings, $448.8 million of repayments, $219.9 million of net equity-offering proceeds and $47.0 million distributed to SeaSpine.
- The amended senior credit facility provides up to $1.1 billion of capacity, consisting of a $750 million revolving facility and a $350 million term loan. Approximately $586.9 million was available at September 30, 2015, and the company was in compliance with its covenants.
- The 2016 convertible notes had $227.1 million of principal outstanding and mature December 15, 2016. Total contractual obligations were reported at $833.3 million, excluding contingent consideration and uncertain tax benefits.
- Management stated that cash and available borrowing capacity were sufficient for operations and planned capital expenditures. The company anticipated approximately $30 million of 2015 capital expenditures.
Material Changes, Outlook and Unusual Items
- Integra acquired TEI Biosciences and TEI Medical in July 2015 for approximately $312.4 million. TEI contributed approximately $13.2 million of Q3 revenue and added substantial goodwill and acquired intangible assets.
- The company completed an August 2015 public equity offering generating approximately $219.9 million net proceeds, used in part to fund TEI.
- Q3 included $23.6 million of identified special charges, including ERP implementation, structural optimization, acquisition-related costs, spin-off costs and non-cash convertible-debt interest. Nine-month special charges totaled $47.8 million.
- Integra completed the buyout of its UK defined-benefit plan and recorded approximately $5.6 million of expense, including approximately $1.8 million of cash contributions.
- Management expected 2015 gross margin of 63.0% to 63.5%, research and development expense of 5.5% to 6.0% of revenue, selling, general and administrative expense of approximately 46.5% of revenue, and a full-year effective tax rate of approximately 87%. Excluding the SeaSpine-related valuation allowance, management expected approximately 32.0%.
- Management expected the stronger U.S. dollar, particularly weakness in the euro, and costs related to regenerative-technology manufacturing capacity expansion to pressure revenue and gross margin.
- The FDA had issued a warning letter to TEI regarding promotion of SurgiMend for breast-surgery applications that were not cleared or approved. Integra submitted a corrective action plan and stated that material remediation expenses were not expected, but the FDA could require additional corrective action.
- Approximately 50 active product-liability cases involved TEI’s bovine-derived surgical mesh business. BSC was managing the litigation, insurance coverage was available after a $3.0 million retention, and Integra had contractual indemnification protections subject to stated limits.
- On October 2, 2015, after the reporting date, Integra acquired U.S. rights to certain Tornier ankle and toe replacement products for approximately $6.0 million.
Investor Verification Points
- Verify the sustainability of revenue growth after separating SeaSpine and adjust comparisons for acquisitions, discontinued operations and foreign-exchange effects.
- Assess the impact of the $35.6 million tax valuation allowance and the company’s ability to achieve the approximately 32.0% normalized tax-rate expectation.
- Monitor leverage, the December 2016 convertible-note maturity, term-loan repayments and compliance with senior-credit-facility covenants.
- Evaluate whether TEI integration, FDA remediation and product-liability matters create costs or restrictions beyond management’s current expectations.
- Review the recurring versus nonrecurring nature of the $47.8 million of nine-month special charges and the effect of ERP, facility expansion and restructuring spending on margins and cash flow.
- Confirm the effects of currency movements, regenerative-facility start-up costs and acquired intangible-asset amortization on future profitability.