Business Context and Reporting Period
Integra LifeSciences Holdings Corporation filed this unaudited Form 10-Q for the quarter and six months ended June 30, 2011. Integra develops, manufactures and distributes medical devices through a single reporting segment, with products in orthopedics, neurosurgery and instruments. The company operates globally, with most revenue generated in the United States.
Financial Performance and Liquidity
| Metric | Q2 2011 | Q2 2010 | Six Months 2011 | Six Months 2010 |
|---|---|---|---|---|
| Revenue | $193.3 million | $178.6 million | $374.4 million | $351.3 million |
| Gross margin | 62.3% | 63.9% | 63.2% | 63.7% |
| Operating income | $8.0 million | $24.6 million | $28.9 million | $47.2 million |
| Net income | $0.7 million | $15.2 million | $12.2 million | $30.4 million |
| Diluted EPS | $0.02 | $0.50 | $0.40 | $1.00 |
| Operating cash flow | Not separately provided | Not separately provided | $45.8 million | $47.5 million |
- Q2 revenue increased 8%; six-month revenue increased 7%. Orthopedics grew 11% in the quarter and 7% year to date, neurosurgery grew 9% and 7%, and instruments grew 3% and 5%, respectively.
- Q2 operating margin was approximately 4.1%, versus 13.8% in the prior-year quarter. Six-month operating margin was approximately 7.7%, versus 13.4%.
- Cash and cash equivalents were $137.3 million at June 30, 2011, compared with $128.8 million at December 31, 2010. Working capital was $377.8 million, compared with $243.0 million at year-end.
- Six-month investing cash use was $93.9 million, including $80.8 million for the SeaSpine acquisition and $13.1 million of capital expenditures.
- Six-month financing cash flow was $50.9 million, reflecting the issuance of the 2016 convertible notes, credit-facility activity and related hedging transactions, partly offset by debt repayments and $57.0 million of treasury-stock repurchases.
- At June 30, 2011, $144.4 million was outstanding under the revolving credit facility, with approximately $455.6 million available. The company was in compliance with its financial covenants.
Material Changes Versus the Prior Comparable Period
- Revenue growth was more than offset by higher costs. Selling, general and administrative expense rose 26% in Q2 and 20% for the six-month period, primarily because of stock-based compensation, enterprise-resource-planning implementation, acquisitions, sales expansion and other personnel costs.
- Q2 included an $8.4 million stock-based compensation charge related to the chief executive officer’s employment agreement. Total identified special charges were $22.4 million in Q2 and $30.1 million for the first half, compared with $4.1 million and $7.9 million, respectively, in the prior-year periods.
- Interest expense increased to $6.7 million in Q2 and $12.2 million for the first half, from $4.3 million and $8.8 million, respectively, primarily due to higher borrowings, the interest-rate swap and debt-refinancing costs.
- SeaSpine was acquired on May 23, 2011 for approximately $89.0 million. Management stated that its effect on consolidated operating results was not material for the period.
- Gross margin declined due to intangible-technology impairments, discontinued-product costs, higher manufacturing costs and amortization of SeaSpine inventory at acquisition value.
- The effective tax rate was 65.0% in Q2 2011 versus 28.1% in Q2 2010, partly reflecting a $1.7 million correction to a 2009 deferred tax asset and a $0.7 million New Jersey tax-law adjustment. The six-month rate was 27.6% versus 24.8%.
Guidance, Outlook, Risks and Unusual Items
- Management expected full-year 2011 gross margin to be in line with full-year 2010, supported by manufacturing efficiencies and a higher mix of orthopedic products.
- Management expected selling, general and administrative expense to remain between 40% and 42% of revenue and expected a full-year effective tax rate of approximately 10%.
- Additional amortization related to trade names being phased out was expected to be approximately $1.6 million in the second half of 2011 and $2.7 million during 2012; further impairment or accelerated amortization charges were possible.
- The June 2011 refinancing increased the revolving credit facility to $600 million, eliminated the term-loan component, reduced borrowing rates and fees, improved covenants, and extended maturity to June 8, 2016.
- The company issued $230.0 million of 1.625% convertible notes due 2016. The notes had a carrying value of $187.2 million at quarter-end. Related call transactions cost $42.9 million and warrant transactions generated $28.5 million; the warrants could dilute earnings per share if the stock price exceeds the applicable strike price.
- The $165.0 million of 2.375% convertible notes due 2012 was classified as long term based on management’s intent and ability to refinance through the credit facility.
- Management believed cash and available credit were sufficient for near-term operations, capital expenditures and potential acquisition-related payments.
- Key risks include hospital and healthcare-spending conditions, acquisition integration, restructuring, regulatory approvals and inspections, product acceptance, reimbursement, product recalls or field corrections, raw-material costs, manufacturing execution and foreign-exchange movements. European healthcare austerity measures continued to affect demand.
- The company accrued $4.6 million to settle the Theken earnout dispute and carried $4.8 million of product-liability accruals, offset by an insurance receivable. Management stated that other claims were not expected to have a material adverse effect, although individual periods could be affected.
- Disclosure controls were deemed effective as of June 30, 2011, and no material changes to internal control over financial reporting were reported.
Most Important Facts to Verify
- Whether revenue growth, particularly from SeaSpine and international markets, translates into sustainable operating-margin improvement after special charges normalize.
- The recurring versus nonrecurring nature of the $30.1 million of first-half special charges, including executive stock compensation and ERP implementation costs.
- The company’s ability to refinance or repay the $165.0 million 2012 convertible notes and maintain compliance with credit-facility covenants.
- Integration performance, revenue contribution and margin impact from the SeaSpine acquisition.
- Execution of the re-branding strategy and the resulting future amortization or impairment charges.
- Realization of the approximately 10% full-year tax-rate expectation, given the unusually high second-quarter rate and changes in projected earnings.
- Exposure to product-liability claims, the Theken earnout settlement, regulatory actions and other contingencies.
- Potential dilution from the 2012 and 2016 convertible notes and associated warrants, as well as the effect of ongoing share repurchases on liquidity and share count.