Integra LifeSciences Holdings Corporation — Q1 2012 Form 10-Q
Business context and reporting period
Integra is a global medical-device company focused on orthopedics, neurosurgery, regenerative medicine, surgical instruments and related products. This unaudited quarterly report covers the three months ended March 31, 2012, compared primarily with the three months ended March 31, 2011. Beginning in 2012, the Company reported five segments: U.S. Neurosurgery, U.S. Instruments, U.S. Extremities, U.S. Spine and Other, and International.
Financial performance and liquidity
| Metric | Q1 2012 | Q1 2011 | Change |
|---|---|---|---|
| Revenue | $196.2 million | $181.0 million | 8% increase |
| Gross profit | $121.5 million | $116.1 million | 5% increase |
| Gross margin | 61.9% | 64.1% | Down 220 basis points |
| Operating income | $17.5 million | $20.9 million | 16% decrease |
| Operating margin | 8.9% | 11.5% | Down approximately 260 basis points |
| Net income | $6.7 million | $11.5 million | 42% decrease |
| Diluted EPS | $0.23 | $0.38 | Decrease |
| Cash flow from operations | $32.3 million | $21.3 million | Increase |
Revenue growth was led by Orthopedics, which increased to $86.2 million from $72.3 million, and by U.S. Extremities and U.S. Spine and Other. U.S. revenue increased to $148.7 million from $133.3 million, while international revenue was approximately flat at $47.5 million. Segment revenue was $40.2 million for U.S. Neurosurgery, $38.0 million for U.S. Instruments, $26.6 million for U.S. Extremities, $44.8 million for U.S. Spine and Other, and $46.6 million for International.
Cash and cash equivalents were $58.6 million at March 31, 2012, compared with $100.8 million at December 31, 2011. The Company held $53.8 million of short-term investments, consisting of time deposits held by non-U.S. subsidiaries. Working capital was $355.2 million, compared with $350.4 million at year-end.
Investing cash outflows were $63.8 million, including $10.4 million of capital expenditures and $53.2 million of purchases of short-term investments. Financing cash outflows were $12.6 million, primarily from $12.8 million of repayments under the senior credit facility. The resulting net decrease in cash was $42.2 million.
At March 31, 2012, borrowings under the senior credit facility were $166.9 million at a weighted-average interest rate of 2.2%, with approximately $433.1 million available. The Company also had $165.0 million principal amount of 2012 Convertible Senior Notes due June 2012 and $230.0 million principal amount of 2016 Convertible Senior Notes. Total liabilities were $649.9 million and stockholders’ equity was $508.5 million. The Company reported compliance with all credit-facility covenants.
Material changes versus the prior comparable period
- Revenue increased 8%, but profitability declined because of manufacturing remediation costs, unplanned idle time and underutilization at the Plainsboro, New Jersey facility.
- Gross margin fell to 61.9% from 64.1%, primarily because of Plainsboro remediation, discontinued-product write-offs and acquisition-related inventory step-up amortization.
- Interest expense increased to $7.9 million from $5.5 million, primarily because of the 2016 Notes issued in June 2011. Non-cash convertible-debt interest increased to $3.5 million from $1.6 million.
- Selling, general and administrative expense increased to $87.4 million from $80.1 million, reflecting global ERP implementation costs, employee termination charges, higher distributor-related selling costs and the addition of SeaSpine and Ascension operations.
- Intangible-asset amortization increased to $4.7 million from $3.0 million, mainly due to the SeaSpine and Ascension acquisitions completed in 2011.
- Foreign-currency translation increased accumulated other comprehensive income, contributing to comprehensive income of $13.6 million versus $25.6 million in the prior-year quarter.
- The Company made no share repurchases in Q1 2012; $29.1 million remained available under the $75.0 million authorization.
Guidance, outlook, risks and unusual items
The FDA issued a December 2011 warning letter concerning quality systems and compliance issues at the Plainsboro facility. The letter did not restrict manufacturing or shipments and did not require a product recall. The Company expensed approximately $1.6 million on remediation in Q1 and expected approximately $2.4 million of additional spending during the remainder of 2012, including idle-time and underutilization costs. Additional capital investments of approximately $2.5 million to $3.0 million were expected. Product backorders had substantially improved by the end of March, but further shortages remained possible in Q2.
Management expected 2012 consolidated gross margin to be flat to slightly higher than 2011, despite continuing effects from acquisition-related inventory amortization, regenerative-medicine expansion and lower private-label volumes. Management targeted research and development spending at 6% to 7% of revenue and SG&A spending, excluding special charges, at 41% to 41.5% of revenue.
Management expected a full-year effective tax rate of approximately 20.5%, compared with 30.2% in Q1, partly because uncertain tax positions were expected to reverse in Q3. Q1 income-tax expense included a $0.6 million accrual related to ongoing U.S. federal tax audits.
Special charges totaled $12.6 million in Q1 2012, including $1.6 million of Plainsboro remediation, $3.7 million of ERP implementation costs, $1.6 million of facility optimization, $0.5 million of employee termination costs, $0.8 million of discontinued-product charges, $0.7 million of acquisition-related charges, $0.1 million of impairment charges and $3.5 million of non-cash convertible-debt interest.
The Company expected to repay the $165 million principal amount of the 2012 Notes in 2012, with approximately $134 million classified as a financing cash use and approximately $31 million as an operating cash use for accreted interest. Planned 2012 capital expenditures were $65 million to $75 million. Management stated that cash and available credit were sufficient for near-term operations, capital expenditures and potential acquisition-related payments.
Key risks include manufacturing and regulatory remediation, product shortages, acquisition integration, pricing and volume pressure in spine, foreign-exchange exposure, interest-rate risk, tax audits and uncertain tax positions, litigation and other ordinary-course contingencies. The U.S. Spine business had approximately $31.7 million of allocated goodwill and estimated fair value only approximately 15% above carrying value at January 1, 2012, creating impairment sensitivity if performance deteriorates.
Important facts for investors to verify
- Progress and total cost of the Plainsboro FDA remediation, including whether production interruptions or backorders recur.
- Availability of cash and overseas short-term investments for U.S. obligations, including potential tax consequences of repatriation.
- Repayment or refinancing of the $165 million 2012 Convertible Senior Notes due June 2012.
- Actual full-year gross margin, SG&A ratio, tax rate and capital expenditures compared with management’s stated expectations.
- Integration results and incremental amortization or inventory costs from the SeaSpine and Ascension acquisitions.
- Goodwill impairment indicators for the U.S. Spine business and the outcome of the annual second-quarter impairment assessment.
- Developments in U.S. federal tax audits, uncertain tax positions and the anticipated third-quarter tax reversals.
- Material developments in product liability, regulatory, employment or other legal contingencies.