Integra LifeSciences Holdings Corporation — Q1 2019 Form 10-Q
Reporting period: Three months ended March 31, 2019. The filing was submitted April 29, 2019. Integra is a global medical technology company operating through Codman Specialty Surgical and Orthopedics and Tissue Technologies.
Financial performance and position
| Metric | Q1 2019 | Q1 2018 | Change |
|---|---|---|---|
| Revenue | $359.7 million | $357.1 million | +0.7% |
| Gross profit | $230.8 million | $212.9 million | +8.4% |
| Gross margin | 64.2% | 59.6% | +460 bps |
| Operating income | $32.3 million | $25.6 million | +26.3% |
| Operating margin | 9.0% | 7.2% | +180 bps |
| Net income | $32.8 million | $11.0 million | +197.9% |
| Diluted EPS | $0.38 | $0.14 | +$0.24 |
| Operating cash flow | $29.5 million | $41.5 million | -28.9% |
- Net margin was approximately 9.1%, compared with 3.1% in the prior-year quarter.
- Codman Specialty Surgical revenue was $234.6 million, down 0.7%; Orthopedics and Tissue Technologies revenue was $125.1 million, up 3.4%.
- U.S. revenue increased 3.1% to $256.7 million, while international revenue declined $5.2 million, including a $5.3 million unfavorable foreign-exchange impact.
- Research and development expense was $18.3 million, or 5.1% of revenue. Selling, general and administrative expense increased 6.9% to $174.9 million, or 48.6% of revenue.
- Cash and cash equivalents were $157.0 million at March 31, 2019, compared with $138.8 million at December 31, 2018. Approximately $130.0 million was held by non-U.S. subsidiaries.
- Capital expenditures were $16.1 million. Investing cash use was $15.8 million, and financing activities provided $5.4 million.
- Total borrowings were approximately $1.365 billion: $1.239 billion under the Senior Credit Facility and $126.0 million under the securitization facility. Reported debt excludes operating lease liabilities of $74.3 million.
- The company was in compliance with debt covenants. The Senior Credit Facility matures May 3, 2023, and the first quarterly term-loan installment of $22.5 million is due September 30, 2019.
Material changes versus the prior comparable period
- Revenue was broadly stable, but gross profit and operating income improved materially, primarily because Q1 2018 included one-time Codman Neurosurgery acquisition-related costs, supplemented by improved product mix and manufacturing yields.
- Net income benefited from lower interest expense, higher other income and a significant tax benefit. Interest expense declined to $13.1 million from $18.8 million as debt was reduced from the prior year.
- The effective tax rate was a benefit of 32.0%, compared with a benefit of 20.4% in Q1 2018. The 2019 result included a $10.8 million benefit from a Switzerland federal tax holiday.
- Operating cash flow declined despite higher earnings because working capital absorbed cash, particularly inventories, receivables and prepaid assets.
- Q1 2019 special charges totaled $28.0 million, compared with $30.5 million in Q1 2018. The 2019 charges included acquisition and integration costs of $19.5 million, structural optimization costs of $4.8 million, discontinued product-line costs of $1.4 million, litigation matters of $1.2 million and European medical-device-regulation costs of $1.1 million.
- Effective January 1, 2019, Integra adopted the new lease standard, recording approximately $76.4 million of operating lease liabilities and $67.3 million of related right-of-use assets at adoption.
Guidance, outlook, risks and unusual items
- Management expects a full-year effective tax rate of approximately 10%, driven by the Switzerland tax holiday, excess tax benefits from share-based compensation and foreign jurisdictional mix. This estimate may change.
- The filing does not provide clear full-year revenue, earnings or cash-flow guidance.
- Management identified Codman Neurosurgery integration, portfolio optimization, new product development, commercial-channel investment and customer experience as strategic priorities. The Panta II ankle-fusion nail was launched outside the U.S. during Q1 2019.
- In January 2019, Integra paid $1.7 million for an exclusive worldwide license to commercialize a short-stem and stemless shoulder system. The company may later acquire the licensor for up to $80.0 million if specified conditions are met.
- An FDA Warning Letter issued in March 2019 cited quality-system issues at the Boston facility. The letter did not restrict manufacturing or shipping and did not require a recall, but additional regulatory action remains possible. Products manufactured there represented approximately 4% of Q1 consolidated revenue.
- The FDA continues to question whether certain BioD morselized amniotic-membrane products qualify for regulation solely as human tissue products. Related revenue was less than 1% of consolidated revenue, but enforcement could affect sales and operations.
- An FDA notification in April 2019 required a private-label contract manufacturer’s product to be removed from the market. The related customer generated approximately $0.6 million of Q1 2019 revenue, and Integra is assessing potential impairment of a $5.9 million customer-relationship intangible asset.
- Integra is involved in litigation concerning a potential BioD earn-out acceleration of up to $26.5 million; management believes the payment should not be accelerated if the former executive’s termination qualified as “Good Reason.”
- Interest-rate and foreign-exchange exposure remain significant. A 100-basis-point rate change would affect annual interest expense on unhedged debt by approximately $4.6 million. Interest-rate swaps had a total notional amount of approximately $1.5 billion.
- The company had $225.0 million remaining under its share-repurchase authorization but made no cash repurchases during the quarter. It has not paid cash dividends since formation.
Important facts for investors to verify
- Whether revenue growth accelerates after adjusting for foreign exchange, discontinued products and private-label order timing.
- Whether the Q1 gross-margin improvement is sustainable after excluding one-time 2018 acquisition costs and considering ongoing special charges.
- The sustainability of the approximately 10% full-year tax-rate outlook and the recurring versus one-time nature of the Switzerland tax benefit.
- Working-capital trends, particularly inventory and receivables growth, and their effect on operating cash flow.
- Progress in remediating the Boston facility’s FDA Warning Letter and any resulting restrictions, costs or product impacts.
- The outcome of the BioD regulatory and litigation matters and the potential impairment of the private-label customer relationship intangible asset.
- Debt repayment requirements, covenant headroom, variable-rate exposure and the company’s ability to fund acquisitions, capital expenditures and lease commitments.