Integra LifeSciences Holdings Corporation — Q3 2018 Form 10-Q
Reporting period: Three and nine months ended September 30, 2018; filed November 1, 2018. Integra is a global medical technology company operating through Codman Specialty Surgical and Orthopedics and Tissue Technologies. The results include the Codman Neurosurgery business acquired from Johnson & Johnson in October 2017, limiting comparability with 2017.
Financial performance and liquidity
| Metric | Q3 2018 | Q3 2017 | 9M 2018 | 9M 2017 |
|---|---|---|---|---|
| Revenue | $365.9 million | $278.8 million | $1,089.1 million | $819.6 million |
| Operating income | $23.7 million | $10.6 million | $76.9 million | $37.6 million |
| Net income | $13.3 million | $3.2 million | $35.7 million | $20.4 million |
| Diluted EPS | $0.15 | $0.04 | $0.43 | $0.26 |
| Gross margin | 60.8% | 63.5% | 61.0% | 64.9% |
| Operating cash flow | Not separately provided | Not separately provided | $157.0 million | $103.0 million |
- Q3 revenue increased 31.2%; nine-month revenue increased 32.9%. Codman Specialty Surgical revenue rose 45.1% in Q3 and 48.6% year to date, while Orthopedics and Tissue Technologies rose 11.2% and 10.6%, respectively.
- Q3 operating margin was approximately 6.5%, compared with 3.8% in the prior-year quarter. Nine-month operating margin was approximately 7.1%, compared with 4.6%.
- Gross margin dollars increased, but gross margin percentage declined because Codman Neurosurgery products carry lower margins and because of higher purchase-accounting and technology-intangible amortization costs.
- Cash and cash equivalents were $206.0 million at September 30, 2018, compared with $174.9 million at December 31, 2017.
- Net cash used in investing activities was $24.4 million, including $52.1 million of capital expenditures and $26.7 million received for a Codman working-capital adjustment. Net cash used in financing was $96.8 million.
- Debt under the Senior Credit Facility totaled approximately $1.43 billion: $545.0 million revolver borrowings and $900.0 million of term-loan borrowings. Approximately $754.4 million remained available. The Company was in compliance with its covenants.
Material changes versus the prior comparable period
- The Codman Neurosurgery acquisition contributed $78.9 million of Q3 revenue and $236.0 million of nine-month revenue. The 2017 comparison includes $9.6 million of Q3 and $27.0 million of nine-month revenue from products divested to Natus.
- In May 2018, Integra issued 6.0 million common shares and received approximately $349.6 million net proceeds, primarily used to repay revolving-credit borrowings.
- Debt declined from $1.84 billion at December 31, 2017 to approximately $1.43 billion at September 30, 2018, while interest expense increased because of higher rates and debt-related financing costs.
- Operating cash flow increased $54.0 million year over year, while acquisition-related investing outflows were substantially lower than in 2017.
- ASC 606 adoption increased opening retained earnings by $1.9 million and changed the timing of private-label revenue recognition; reported nine-month revenue and net income were only modestly different from the amounts excluding the standard’s impact.
- Special charges totaled $33.4 million in Q3 and $96.1 million for the first nine months, primarily acquisition and integration, structural optimization, impairment and litigation-related costs.
Guidance, outlook, risks and unusual items
- Management expects full-year 2018 gross margin of approximately 61.0%, research and development expense of approximately 5.5% to 6.0% of revenue, selling, general and administrative expense of approximately 45.0% of revenue, and an effective tax rate of approximately 0.4%.
- Management expects 2018 capital expenditures of approximately $65 million to $75 million and additional capital and integration expenses in the fourth quarter related to Codman Neurosurgery.
- Product development plans include launches and expansions in CUSA, wound care, extremity orthopedics, ankle fixation, electrosurgery, ICP monitoring and shunt products during late 2018 and early 2019.
- The FDA continues to assert that certain BioD morselized amniotic membrane products may require a biologics license rather than regulation solely under Section 361. BioD products represented less than 1% of consolidated revenue, but enforcement action could affect sales and require a different regulatory pathway.
- Integra faces ordinary-course litigation and product-liability matters. One active TEI case remained as of October 11, 2018; insurance and indemnification arrangements are expected to provide significant protection. The Company believes the likelihood of an accelerated BioD earnout obligation of up to $26.5 million is remote.
- During Q3, Integra recorded a $4.9 million impairment charge related to Metasurg technology, including a $2.5 million out-of-period component that management determined was not material to prior or current periods.
- Goodwill and the indefinite-lived Codman trade name passed third-quarter impairment testing with no impairment recorded.
- Interest-rate and foreign-exchange risks remain material. A one-percentage-point change in interest rates would affect annualized interest expense by approximately $5.5 million based on debt outstanding at September 30, 2018.
- On October 8, 2018, the Company repatriated $47.7 million from non-U.S. subsidiaries. Subsequent to quarter-end, it entered into additional interest-rate and net-investment hedge transactions.
Investor verification points
- Separate organic growth from the revenue contribution and margin dilution associated with Codman Neurosurgery and the effect of the Natus divestiture.
- Reconcile reported earnings with the $96.1 million of year-to-date special charges and assess which integration, restructuring and litigation costs may recur.
- Monitor debt reduction, interest rates, covenant headroom and the scheduled term-loan repayments beginning in 2019.
- Assess whether management achieves the stated 2018 gross-margin, operating-expense, tax-rate and capital-expenditure expectations.
- Track FDA developments concerning BioD products and the potential financial effect of any enforcement or required regulatory approvals.
- Review the impact of the Codman integration, product launches, international growth and foreign-exchange movements on future margins and cash generation.