Integra LifeSciences Holdings Corporation — Q2 2015 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2015; filed July 31, 2015. Integra is a medical technology company serving neurosurgery, surgical instruments, orthopedics, tissue technologies, reconstructive surgery, and spine markets. Beginning in 2015, management reported three global segments: Specialty Surgical Solutions, Orthopedics and Tissue Technologies, and Spine. The Spine business was spun off as SeaSpine on July 1, 2015 and will be reported as discontinued operations beginning in Q3 2015.
Financial performance and condition
| Metric | Q2 2015 | Q2 2014 | Six months 2015 | Six months 2014 |
|---|---|---|---|---|
| Revenue | $244.1 million | $231.4 million | $477.7 million | $446.4 million |
| Gross profit | $157.5 million | $144.4 million | $304.5 million | $277.1 million |
| Gross margin | 64.5% | 62.4% | 63.7% | 62.1% |
| Operating income | $14.0 million | $12.4 million | $30.7 million | $21.1 million |
| Net income | $5.0 million | $4.8 million | $13.4 million | $7.0 million |
| Diluted EPS | $0.15 | $0.15 | $0.40 | $0.21 |
| Operating cash flow | Not separately provided | Not separately provided | $49.7 million | $27.6 million |
Q2 revenue increased 5.5% year over year, while six-month revenue increased 7.0%. Six-month net income increased 90% and diluted EPS increased from $0.21 to $0.40. The gross-margin improvement was attributed primarily to higher sales of higher-margin DuraSeal, DuraGen, skin and wound products, and improved manufacturing utilization.
- Specialty Surgical Solutions: Q2 revenue of $146.7 million, up 7%; six-month revenue of $286.8 million, up 8%. Growth reflected MicroFrance, dural repair, and Precision Tools and Instruments, partly offset by declines in tissue ablation and neuro critical care.
- Orthopedics and Tissue Technologies: Q2 revenue of $63.8 million, up 10%; six-month revenue of $125.2 million, up 11%. Regenerative technologies and upper-extremity products performed well, while lower-extremity revenue declined.
- Spine: Q2 revenue of $33.5 million, down 7%; six-month revenue of $65.8 million, down 5%. Management cited pricing pressure, delayed product launches, and slower-than-expected distributor additions.
Liquidity, cash flow, and debt
- Cash and cash equivalents were $131.3 million at June 30, 2015, compared with $72.0 million at December 31, 2014. Approximately $70.0 million was held by non-U.S. subsidiaries.
- Working capital was $452.5 million, compared with $403.3 million at year-end 2014.
- Six-month operating cash flow was $49.7 million. Investing cash outflow was $18.7 million, including $22.0 million of capital expenditures. Financing cash inflow was $30.5 million.
- Borrowings under the Senior Credit Facility totaled approximately $436.9 million, including $286.9 million under the revolving facility and $150.0 million under the term loan. Approximately $463.1 million remained available.
- The 1.625% convertible notes had $230.0 million of principal outstanding and a $217.3 million carrying value. A $2.9 million portion related to holders electing cash settlement was classified as current.
- The Company was in compliance with all credit-facility covenants at June 30, 2015. Management stated that cash and available borrowing capacity were sufficient to fund operations and capital expenditures.
- Management was discussing a potential $200.0 million increase in the term loan to repay revolving borrowings; no agreement was assured at the filing date.
Material changes and unusual items
- Special charges totaled $22.7 million in Q2 and $39.4 million for the six months, including spine spin-off costs, ERP implementation, structural optimization, acquisition-related costs, and non-cash convertible-debt interest.
- Spine spin-off charges were $9.9 million in Q2 and $14.8 million year to date. The Company expected approximately $5.2 million of additional post-separation costs and disclosed total separation-related costs of approximately $20.0 million.
- Goodwill allocated to the Spine reporting unit was fully impaired, resulting in a $0.4 million charge during the first half of 2015.
- Foreign currency translation reduced accumulated other comprehensive income by $17.2 million during the first six months. Management said currency movements reduced revenue by $6.7 million in Q2 and $12.5 million year to date versus the comparable periods.
- On July 17, 2015, Integra acquired TEI Biosciences and TEI Medical for $312.0 million, subject to working-capital adjustments. Integra drew $310.0 million under its revolving facility to fund the transaction. Purchase-price allocation had not yet been completed.
- TEI was subject to approximately 45 active product-liability cases and several hundred additional lawsuits that had not been served. BSC was managing the litigation under an indemnification arrangement, subject to insurance and contractual limitations.
Guidance, outlook, and risks
- Management expected full-year 2015 gross margin of 63.5% to 64.0%, research and development expense of approximately 5.5% of revenue, selling, general and administrative expense of approximately 46.5% of revenue, and an effective tax rate of approximately 32%.
- Management expected 2015 capital expenditures of $40.0 million to $45.0 million, primarily for regenerative-technology manufacturing capacity, existing facilities, ERP implementation, and orthopedic instrument kits.
- The Company expected to commercialize a diabetic foot-ulcer product in mid-2016, assuming FDA approval and timely publication of supporting clinical data.
- Key risks include execution of the SeaSpine separation, reduced diversification after the spin-off, potential tax liabilities if the spin-off is not tax-free, indemnification obligations, medical-device regulatory actions, the TEI FDA warning letter, product-liability claims, foreign-exchange volatility, dependence on specialized or sole-source suppliers, and costs or delays from facility consolidation.
- The FDA closed the prior warning letter related to Integra’s Andover, UK facility effective June 30, 2015. However, TEI had received an FDA warning letter dated May 29, 2015 concerning promotion of SurgiMend for an unapproved breast-surgery indication.
Most important facts to verify
- Whether the SeaSpine separation produces the anticipated strategic and financial benefits and how discontinued-operations presentation changes future comparisons.
- The final purchase-price allocation, financing impact, and operating contribution of the $312.0 million TEI acquisition.
- Progress and potential exposure related to TEI’s FDA warning letter and product-liability litigation.
- Whether the Company completes the proposed $200.0 million term-loan increase and reduces revolving debt.
- Achievement of the 63.5%–64.0% full-year gross-margin outlook amid currency pressure and capacity-expansion costs.
- Future contingent consideration obligations, which had a fair value of $22.2 million at June 30, 2015, and were excluded from the contractual-obligations table because payment amounts and dates were not fixed.