Integra LifeSciences Holdings Corporation — FY2018 Form 10-K
Reporting period: Fiscal year ended December 31, 2018; filed February 26, 2019. The filing also reports fourth-quarter 2018 results. Integra is a global medical-device company operating through Codman Specialty Surgical and Orthopedics and Tissue Technologies, serving customers in more than 130 countries.
Business context and reporting period
- Products address neurosurgery, surgical instruments, neuro-critical care, regenerative medicine, wound care, extremity orthopedics, nerve and tendon repair, and related surgical applications.
- 2018 remained focused on integrating the Codman Neurosurgery acquisition completed in October 2017, expanding sales channels, launching products, and consolidating manufacturing and distribution infrastructure.
- Revenue is seasonally strongest in the fourth quarter because hospitals often increase purchases near the end of their budget cycles.
Key financial metrics
| Metric | FY2018 | FY2017 | Change |
|---|---|---|---|
| Revenue | $1,472.4 million | $1,188.2 million | +23.9% |
| Gross margin | $900.9 million; 61.2% | $752.7 million; 63.3% | Margin down 210 bps |
| Operating income | $111.0 million | $44.8 million | Improved |
| Income before taxes | $57.4 million | $11.4 million | Improved |
| Net income | $60.8 million | $64.7 million | -6.1% |
| Diluted earnings per share | $0.72 | $0.82 | Down |
| Operating cash flow | $199.7 million | $114.5 million | +$85.1 million |
| Capital expenditures | $77.7 million | $43.5 million | Higher |
- Fourth-quarter revenue was $383.3 million, gross margin was $236.9 million, and net income was $25.1 million.
- Codman Specialty Surgical revenue increased 33.8% to $963.9 million, including $235.6 million of incremental Codman Neurosurgery revenue.
- Orthopedics and Tissue Technologies revenue increased 8.7% to $508.5 million. Wound Reconstruction and private-label sales grew, while Extremity Orthopedics declined at a low-single-digit rate.
- Domestic revenue was $1,045.9 million, or 71.0% of total revenue; international revenue was $426.6 million.
- Interest expense increased to $64.7 million from $35.0 million, primarily due to higher borrowings and interest rates associated with the 2017 acquisitions. The weighted-average interest rate was 3.9% at year-end.
- The 2018 effective tax rate was negative 5.9%, reflecting tax benefits and a favorable geographic earnings mix. Management estimated a 2019 effective tax rate of approximately 18.5% to 19.0%.
Liquidity, debt and capital resources
- Cash and cash equivalents were $138.8 million at December 31, 2018, including approximately $110.5 million held by non-U.S. subsidiaries.
- Working capital was $512.5 million, compared with $473.2 million at year-end 2017.
- Total external debt was approximately $1.4 billion, consisting principally of $900.0 million under the term loan, $345.0 million under the revolving credit facility, and $121.2 million under a new accounts-receivable securitization facility.
- The amended senior credit facility has a $2.2 billion aggregate capacity, matures May 3, 2023, and had $954.4 million of remaining revolving borrowing capacity at year-end. The Company was in compliance with its covenants.
- The first $22.5 million term-loan installment was due September 30, 2019. Contractual obligations totaled $1.7 billion, including debt, interest, leases and other commitments.
- Management stated that cash, expected operating cash flow and available borrowing capacity were sufficient for foreseeable working-capital, debt-repayment and capital-expenditure requirements for at least the next twelve months.
- Integra issued 6.0 million shares in May 2018 and received $349.6 million net, using the proceeds to repay revolving debt. A $225.0 million share-repurchase authorization was approved in December 2018, but no shares were repurchased during 2018.
Material changes versus the prior comparable period
- Revenue growth was driven primarily by the full-year contribution from Codman Neurosurgery, a favorable $3.8 million foreign-exchange impact, Derma Sciences, and organic growth.
- Gross margin declined from 63.3% to 61.2%, principally because Codman Neurosurgery products carried lower margins and generated higher technology-intangible amortization.
- Operating income improved substantially, but net income declined because of higher interest expense, taxes, integration costs and other special charges.
- Operating cash flow increased materially, while investing cash use fell sharply from 2017 because the prior year included approximately $1.2 billion of acquisition spending.
- The Company adopted ASC Topic 606 using the modified retrospective method. The adoption increased opening retained earnings by $1.9 million and increased 2018 reported revenue by approximately $4.4 million compared with the amount that would have been reported under the prior standard.
- Special charges totaled $123.1 million in 2018, including $93.9 million of acquisition and integration costs, $19.6 million of structural optimization costs, $4.9 million of impairment charges and $4.6 million related to litigation.
Outlook, commentary, risks and unusual items
- Management expected continued Codman integration and transition activities in 2019, along with investment in manufacturing capacity, facility automation, research, clinical studies and commercial channels.
- Management anticipated product launches in 2019, including an electrosurgery generator, next-generation intracranial-pressure monitoring, additional shunt configurations and customer tools for the Certas valve.
- Annual amortization expense was expected to be approximately $66.2 million in 2019, with substantial additional amortization thereafter.
- The FDA continues to maintain its position that certain BioD morselized amniotic-membrane products are not eligible for regulation solely under Section 361 HCT/P rules. No further FDA enforcement notice had been received through February 26, 2019, and related 2018 revenue was less than 1% of consolidated revenue.
- Approximately 37% of 2018 revenue came from products containing bovine-derived material, creating regulatory, sourcing and product-acceptance risks.
- Principal risks include medical-device regulation and quality inspections, reimbursement and healthcare-cost pressure, product liability, competition, acquisition integration, goodwill and intangible-asset impairment, foreign exchange, variable-rate debt and LIBOR transition, cybersecurity, sole-source suppliers, international operations, and potential disruptions at manufacturing facilities.
- Pending matters included ordinary-course litigation, TEI product-liability claims, and a BioD-related dispute involving a potential $26.5 million earn-out acceleration; management considered the likelihood of loss in the BioD matter remote.
- There were no material off-balance-sheet arrangements, and management and the auditor concluded that internal control over financial reporting was effective as of December 31, 2018.
Important facts for investors to verify
- Determine how much future growth is organic versus attributable to Codman Neurosurgery and Derma Sciences, and whether Codman margins improve toward historical levels.
- Track gross-margin recovery, integration and restructuring spending, amortization, and the potential for additional impairment charges.
- Assess leverage, covenant headroom, variable-rate exposure, scheduled term-loan repayments and refinancing requirements through the May 2023 maturity.
- Review the sustainability of operating cash flow after capital expenditures and required debt service.
- Monitor FDA developments involving BioD amniotic products and compliance with evolving HCT/P and medical-device requirements.
- Evaluate reimbursement, competitive pricing and adoption trends in wound care, regenerative technologies, neurosurgery and extremity orthopedics.
- Confirm the impact of ASC Topic 606 and the 2019 lease-accounting adoption on reported revenue, assets, liabilities and comparability.