Integra LifeSciences Holdings Corporation — Form 10-Q Summary
Business context and reporting period
Integra is a global medical-device company focused on orthopedics, neurosurgery, regenerative medicine and surgical instruments. Reportable segments are U.S. Neurosurgery, U.S. Instruments, U.S. Extremities, U.S. Spine and Other, and International. This unaudited report covers the three and nine months ended September 30, 2012, compared with the corresponding 2011 periods.
Key financial metrics
| Metric | Q3 2012 | Q3 2011 | 9M 2012 | 9M 2011 |
|---|---|---|---|---|
| Revenue | $210.1 million | $202.2 million | $616.4 million | $576.6 million |
| Operating income | $19.7 million | $18.3 million | $55.2 million | $47.2 million |
| Net income | $13.2 million | $11.2 million | $28.4 million | $23.4 million |
| Diluted EPS | $0.46 | $0.39 | $0.99 | $0.79 |
| Gross margin | 62.1% | 61.1% | 62.3% | 62.5% |
| Operating margin | 9.4% | 9.0% | 9.0% | 8.2% |
| Net margin | 6.3% | 5.6% | 4.6% | 4.1% |
Revenue growth was 4% in the quarter and 7% year to date. Orthopedics was the primary growth driver, increasing 10% in the quarter and 15% year to date. U.S. Extremities revenue increased 33% in the quarter and 32% year to date, aided by Ascension. U.S. Spine and Other increased 2% in the quarter and 11% year to date, aided by SeaSpine and orthobiologics. International revenue declined 3% in both periods, affected by foreign exchange and weaker European hospital spending.
Cash and cash equivalents were $125.7 million at September 30, 2012, compared with $100.8 million at December 31, 2011. Nine-month operating cash flow was $62.5 million, compared with $69.6 million in 2011. Investing cash flow used $49.5 million, including $44.4 million of capital expenditures. Financing activities provided $8.9 million.
Borrowings under the senior credit facility were $321.9 million, up from $179.7 million at year-end 2011, with approximately $278.1 million available. The carrying amount of the 2016 convertible notes was $195.9 million, with $230.0 million principal outstanding. Total carrying debt was approximately $517.7 million. The Company repaid the $165.0 million 2012 convertible notes at maturity in June 2012, funded with credit-facility borrowings and cash. The Company was in compliance with its debt covenants.
Material changes versus the prior comparable period
- Net income increased 18% in the third quarter and 21% for the first nine months; diluted EPS increased to $0.46 and $0.99, respectively.
- Third-quarter operating performance benefited from higher revenue, improved gross margin and lower interest expense following repayment of the 2012 Notes.
- Nine-month results benefited from the acquired SeaSpine and Ascension businesses and did not include the $8.4 million of incremental stock-based compensation recorded in the 2011 period in connection with the former chief executive officer.
- Gross margin improved in the quarter but declined modestly year to date because of Plainsboro remediation costs, acquired-inventory amortization and discontinued-product charges.
- Operating expenses increased 5% in both the quarter and year-to-date periods. Selling, general and administrative expense increased, while research and development expense remained broadly flat.
- The Company’s reporting structure changed to five reportable segments beginning in 2012, and prior-period segment information was restated.
Guidance, outlook, risks and unusual items
- Management expected full-year 2012 gross margin to be flat to slightly higher than 2011 and the effective tax rate to be approximately 20.5%. Research and development spending was targeted at approximately 6% to 7% of revenue.
- Management expected Plainsboro regenerative-medicine remediation to be completed in the fourth quarter of 2012, with approximately $0.5 million of additional spending anticipated during the remainder of the year. Approximately $7.2 million of remediation and underutilization costs were expensed in the first nine months, and $4.9 million of related capital expenditures were incurred.
- Supply disruptions caused elevated backorders; management expected most disruptions to be resolved by year-end but cautioned that backorders might not return to normal.
- The Plainsboro facility remained subject to an FDA warning letter and additional Form 483 observations, including a repeat CAPA observation. The FDA indicated that exportation certificates would not be granted until the warning-letter violations were corrected, and new PMA applications manufactured at the facility could be restricted.
- Special charges totaled $39.7 million for the first nine months, including remediation, ERP implementation, facility optimization, employee termination, discontinued products, acquisition-related costs and non-cash convertible-debt interest.
- The Company identified approximately $31.7 million of goodwill allocated to U.S. Spine. At July 31, 2012, estimated fair value exceeded carrying value by approximately 13%; adverse changes in forecasts, discount rates or growth assumptions could result in a future impairment.
- The Company was cooperating voluntarily with a U.S. Attorney’s Office inquiry concerning alleged creation of invoices for products not sold or surgeries not performed by two sales representatives. The Company stated it was not a subject or target at the filing date.
- Ordinary-course litigation and regulatory contingencies remain. Management did not expect a material adverse effect in aggregate, but acknowledged that a particular period’s results, financial position or cash flows could be materially affected.
- On October 23, 2012, the Board terminated the prior repurchase authorization and approved repurchases of up to $75.0 million through December 2014. No shares were repurchased during the first nine months of 2012.
Important facts for investors to verify
- Progress and ultimate resolution of the FDA warning letter, Form 483 observations and Plainsboro manufacturing remediation, including effects on production, exports and backorders.
- Whether increased revolver borrowings, the 2016 convertible notes and future capital expenditures remain consistent with operating cash flow and covenant capacity.
- U.S. Spine performance and the sensitivity of its goodwill to forecast, discount-rate and competitive-pricing assumptions.
- Normalization of gross margins after remediation, acquired-inventory amortization and other special charges.
- International demand, European hospital spending and foreign-exchange effects.
- Resolution and potential financial impact of the U.S. Attorney inquiry and other product, compliance, regulatory and litigation matters.
- Cash requirements associated with taxes withheld on approximately 1.67 million deferred stock units scheduled for distribution to the former executive chairman in the fourth quarter.