Integra LifeSciences Holdings Corporation — Q3 2013 Form 10-Q
Business context and reporting period
Integra is a global medical-device company focused on neurosurgery, orthopedics, regenerative medicine, wound care, spine, extremities, and surgical instruments. The filing covers the unaudited three and nine months ended September 30, 2013, compared with the corresponding 2012 periods.
Financial performance and key metrics
| Metric | Q3 2013 | Q3 2012 | 9M 2013 | 9M 2012 |
|---|---|---|---|---|
| Revenue | $213.2 million | $210.1 million | $615.4 million | $616.4 million |
| Gross margin | $129.1 million | $130.5 million | $368.0 million | $383.9 million |
| Gross margin percentage | 60.6% | 62.1% | 59.8% | 62.3% |
| Operating income (loss) | $(29.6) million | $19.7 million | $(21.7) million | $55.2 million |
| Net income (loss) | $(28.6) million | $13.2 million | $(29.2) million | $28.4 million |
| Diluted EPS | $(1.02) | $0.46 | $(1.05) | $0.99 |
Revenue was approximately flat year to date, while profitability deteriorated materially. The principal reported items were a $46.7 million non-cash goodwill impairment charge related to U.S. Spine, product-recall and remediation costs, higher selling and administrative expenses, and global ERP implementation costs. Nine-month special charges totaled $87.7 million, including $46.7 million of impairment charges.
Operating cash flow was $41.6 million for the first nine months, down from $62.5 million in 2012. Investing cash flow was $(40.2) million, including $37.7 million of capital expenditures and $3.0 million for the Tarsus Medical acquisition. Financing cash flow was $19.5 million, principally reflecting $30.0 million of new borrowings and $10.0 million of repayments. Cash increased to $118.9 million from $96.9 million at December 31, 2012.
At September 30, 2013, debt consisted of $341.9 million outstanding under the senior credit facility and $203.3 million carrying value of the 2016 convertible notes, with $230.0 million principal outstanding. Approximately $258.1 million remained available under the credit facility. The company was in compliance with its debt covenants. Working capital was $388.3 million.
Material changes versus the prior comparable period
- Q3 revenue increased 1.5%, but nine-month revenue declined 0.2%.
- Q3 and nine-month gross margins declined 150 and 250 basis points, respectively, primarily due to quality and remediation costs, recall-related inventory reserves, and the medical-device excise tax.
- U.S. Spine and Other revenue declined 5% in Q3 and 7% for the nine months. Segment profit fell to a $31.4 million loss in Q3 from $14.8 million of profit, and to a $6.0 million loss for the nine months from $42.2 million of profit.
- U.S. Extremities revenue grew 2% in Q3 and 7% year to date; International revenue grew 6% in Q3 and 3% year to date. U.S. Instruments declined 2% for the nine months.
- SG&A increased $2.8 million in Q3 and $19.1 million for the nine months, driven by higher headcount, ERP implementation, consulting, and commission costs.
- Interest expense declined $5.5 million year to date, primarily because the 2012 convertible notes were repaid in June 2012; this benefit was partly offset by higher revolving borrowings.
Guidance, outlook, commentary, and risks
- Management expected full-year 2013 gross margin of approximately 60% to 61%, compared with 62.3% for the first nine months of 2012.
- Management expected a full-year effective tax rate of approximately 36.3%.
- Expected 2013 medical-device excise-tax payments were $12 million to $14 million, and planned capital expenditures were approximately $55 million.
- Management expected approximately $8.5 million of 2013 quality-system and remediation spending, with activities expected to be completed in the fourth quarter.
- The FDA closed the warning letter concerning the Plainsboro, New Jersey facility effective September 24, 2013. The Andover, England remediation remained ongoing, and the FDA began another inspection of the Añasco, Puerto Rico facility on October 24, 2013.
- A voluntary recall of specified collagen products reduced nine-month revenue by $3.4 million and caused supply shortages, backorders, and lost private-label business. The company reported no patient injuries or adverse events attributable to the recalled products.
- The U.S. Spine impairment reflected lower actual and projected cash flows, distributor turnover, delayed product introductions, operational issues, market weakness, and expected pricing pressure. The second step of the impairment analysis was incomplete at quarter-end; management did not expect a material adjustment to the $46.7 million estimate.
- On October 25, 2013, after quarter-end, the company agreed to acquire Confluent Surgical from Covidien for $231.0 million at closing, a $4.0 million supply-agreement prepayment, and potential additional payments of up to $30.0 million. The transaction was not included in the reported results.
- Key ongoing risks include FDA and foreign regulatory compliance, recalls and manufacturing interruptions, reimbursement and pricing pressure, healthcare reform and the 2.3% medical-device excise tax, foreign currency exposure, leverage and covenant compliance, goodwill impairment, and the U.S. Attorney’s Office investigation into alleged improper billing by sales representatives.
Most important facts for an investor to verify
- Whether the Añasco inspection and remaining quality-system remediation were completed without additional regulatory action or supply disruption.
- The final fourth-quarter 2013 goodwill impairment analysis and the sustainability of the U.S. Spine business.
- Whether recall-related backorders and lost private-label customers were fully recovered.
- The cash funding, financing impact, closing conditions, and post-acquisition performance of Confluent Surgical.
- Liquidity after planned capital expenditures, medical-device-tax payments, and the Confluent acquisition, including compliance with amended leverage covenants.
- The extent to which special charges, ERP costs, remediation spending, and pricing pressure continue to affect margins and cash flow.