Integra LifeSciences Holdings Corporation — 2019 Q3 Form 10-Q
Business context and reporting period
Integra is a global medical technology company operating through two segments: Codman Specialty Surgical and Orthopedics and Tissue Technologies. This unaudited Form 10-Q covers the three and nine months ended September 30, 2019, compared with the corresponding 2018 periods.
Key financial metrics
| Metric | Q3 2019 | Q3 2018 | 9M 2019 | 9M 2018 |
|---|---|---|---|---|
| Revenue | $379.1 million | $365.9 million | $1,122.4 million | $1,089.1 million |
| Gross profit | $236.5 million | $222.6 million | $707.2 million | $664.1 million |
| Gross margin | 62.4% | 60.8% | 63.0% | 61.0% |
| Operating income (loss) | $(20.6) million | $23.7 million | $57.7 million | $76.9 million |
| Net income (loss) | $(27.6) million | $13.3 million | $34.9 million | $35.7 million |
| Diluted EPS | $(0.32) | $0.15 | $0.40 | $0.43 |
| Operating cash flow | Not separately provided | Not separately provided | $142.2 million | $157.0 million |
Q3 revenue increased 3.6%; nine-month revenue increased 3.1%. Gross margin improved by 160 basis points in Q3 and 200 basis points year to date, primarily due to lower Codman acquisition and integration costs. Operating margins were approximately (5.4)% in Q3 and 5.1% for the nine-month period.
At September 30, 2019, cash and cash equivalents were $208.0 million, compared with $138.8 million at December 31, 2018. Total debt was approximately $1.43 billion, consisting of $1.32 billion under the Senior Credit Facility and $110.0 million under the securitization facility. Operating lease liabilities totaled $108.7 million. The Company was in compliance with its debt covenants. Its Senior Credit Facility matures in May 2023, and the term loan includes $45.0 million classified as current.
Material changes versus the prior comparable period
- Codman Specialty Surgical revenue increased 5.8% in Q3 and 3.1% for the nine-month period, driven by programmable valves, dural repair, CUSA products, precision instruments and new product introductions.
- Orthopedics and Tissue Technologies revenue decreased 0.6% in Q3 but increased 3.0% year to date. Q3 growth in wound reconstruction and extremity orthopedics was offset by lower private-label revenue.
- Q3 operating results included $59.9 million of non-cash in-process research and development expense related to the Rebound acquisition, which acquired the AURORA Surgiscope system. Total Q3 special charges were $82.7 million, compared with $33.4 million in the prior-year quarter.
- For the nine-month period, special charges totaled $135.8 million versus $96.1 million in 2018, including acquisition and integration costs, structural optimization, discontinued product lines, EU medical device regulation and impairment charges.
- The Company acquired Arkis BioSciences for $30.6 million, plus potential contingent consideration of up to $25.5 million, and acquired Rebound for an upfront payment of $67.1 million plus potential development milestones of up to $35.0 million.
- Operating cash flow declined $14.7 million year over year, primarily because of increased inventories, accounts receivable and other working-capital requirements associated with product launches and Codman integration.
- Investing cash use increased to $142.1 million, including $47.3 million of capital expenditures and $95.5 million paid for the Arkis and Rebound transactions. Financing activities provided $73.2 million, principally from new borrowings.
Guidance, outlook, commentary and risks
Management expects a full-year effective tax rate of approximately 18.9%, subject to changes in taxable income mix, tax planning, settlements and other factors. The filing does not provide specific revenue or earnings guidance.
Management identified integration of the Codman Neurosurgery acquisition, portfolio optimization, new product development, international commercial investment and customer experience as strategic priorities. The Company stated that substantial Codman transition services activities were completed during the third quarter.
- The FDA has maintained concerns regarding certain BioD morselized amniotic membrane products and their eligibility for regulation solely under Section 361. Related revenue represented less than 1% of consolidated revenue for the nine months ended September 30, 2019.
- TEI Biosciences received an FDA Warning Letter concerning quality-system issues at its Boston facility. The letter did not restrict manufacturing or shipping or require a product recall, but additional regulatory action remains possible. Products manufactured at the facility represented approximately 4% of nine-month consolidated revenue.
- The Company faces a BioD-related legal dispute involving a potential accelerated earn-out of $26.5 million. Management believes acceleration should not occur if the former executive’s termination was for “Good Reason.”
- Arkis contingent consideration had a September 30, 2019 fair value of $13.1 million and may increase based on development and commercial milestones.
- Foreign exchange and variable-rate debt remain material risks. Management estimated that a 100-basis-point interest-rate change would affect annual interest expense on unhedged debt by approximately $5.3 million.
- Management believes available cash and borrowing capacity are sufficient to fund operations and capital expenditures for the foreseeable future. No material off-balance-sheet financing arrangements were reported.
Most important facts for investors to verify
- Whether the Rebound acquisition and other special charges normalize in subsequent periods and whether the Company returns to quarterly operating profitability.
- Progress resolving the TEI FDA Warning Letter and the potential effect on manufacturing, product approvals and approximately 4% of revenue.
- Performance of Codman Specialty Surgical and the sustainability of improved gross margins after acquisition integration costs decline.
- Working-capital trends, particularly inventory and accounts receivable growth, and conversion of earnings into operating cash flow.
- Debt repayment capacity, covenant headroom, interest-rate exposure and the substantial term-loan maturities beginning in 2020 and concentrated in 2023.
- Potential payments under Arkis milestones, the BioD litigation and earn-out matters, the Integrated Shoulder Collaboration acquisition option of up to $80.0 million, and other contingent obligations.