Acclarent, Inc. (IART) Earnings Call Transcript & Summary

Hello, and welcome to the Integra LifeSciences Investor Update Conference Call and Webcast. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to turn the conference over to Chris Ward, Senior Director, Investor Relations. Please go ahead.

Thank you, Norma, and welcome, everyone. We appreciate you joining on short notice to review today's exciting announcement that Integra LifeSciences has entered into a definitive agreement to acquire the Acclarent ENT business from Johnson & Johnson. The release and corresponding presentation, which we will reference during the call, are available at integralife.com under Investors, Events and Presentations. Joining me on the call this morning are Jan De Witte, President and Chief Executive Officer; Lea Knight, Chief Financial Officer; and Mike McBreen, Executive Vice President and President of Codman Specialty Surgical. Jan and Mike will provide a high-level overview and the strategic highlights after which, we'll open the call for Q&A. We expect the call this morning to last about 30 minutes. As a reminder, certain statements in this presentation are forward-looking, and these statements are based on management's current expectations and are subject to uncertainty and changes in circumstances. Actual results may differ materially from those included in these statements due to a variety of factors. So more information about these factors is contained in the company's filings with the SEC. And with that, I will now turn the call over to Jan.

Thank you, Chris, and thank you for joining us in this call on short notice. Please turn to Slide #3. So today, I'm excited to announce that Integra has signed an agreement to acquire Acclarent, an innovator in ENT procedures from Ethicon, Inc., the Johnson & Johnson Medtech company. As we told you during our Investor Day, we have a clear strategic road map and active M&A game board with a focus on deals to drive further profitability and growth acceleration. We screen acquisition or partnership opportunities based on key strategic and financial filters with the aim to deepen current positions or broaden our presence on the care pathway, deliver accretive revenue growth and attractive margins and build out our international portfolio and channels to accelerate our international ambitions. Finally, we aim for M&A targets that are accretive to growth and earnings and clear a hurdle of 10% return on invested capital by year 5 or sooner. The acquisition of Acclarent delivers on pretty much all of these metrics and presents a rare opportunity for Integra to become a key player in the ENT segment. This acquisition not only aligns with our strategic road map for growth and financial commitments, this also supports our mission to innovate treatment for [indiscernible] to advance patient outcomes and set new standards for surgical care. If you will turn to Slide 4 to go a bit deeper in the Acclarent opportunity. Acclarent's culture of pioneering technologies aligns with Integra's legacy of innovation to transform care and restore patients' lives. In 2022, the business generated approximately $110 million in U.S. revenues, with gross margins in line with the Integra company average. Integra introduced balloon sinus dilation to open nasal sinuses and developed the first device for eustachian tube dilation. The ENT segment itself is anatomically adjacent to neurosurgery, which includes access to brain tumors through skill-based approaches. Acclarent was founded in 2004 and is headquartered in Irvine, California with R&D operations in Irvine and Haifa, Israel. The vast majority of the Acclarent employees are U.S.-based with about half of which are sales employees. This acquisition will allow us to capitalize on the attractive ENT category to add more than $1 billion to our total addressable market growing mid-single digits. This segment is a focus area for Integra. And as you know, we already participate in ENT with our MicroFrance line of instruments. Acquiring Acclarent will enable Integra to successfully access the ENT device segment with immediate relevant scale and accretive growth via direct and dedicated U.S. ENT sales channel. We are acquiring Acclarent for $275 million in cash at closing, an additional $5 million upon the achievement of certain regulatory milestones. We expect the adjusted earnings per share impact to be neutral in year 1, accretive in year 2, and the ROIC to exceed 10% by year 5 in 2028. We expect to close this deal before the end of the second quarter of 2024. And following the close transition services, including transition manufacturing services will be provided for up to four years. Please turn to Slide 5 now. The Acclarent business will be integrated into our Codman Specialty Surgical division under the leadership of Mike McBreen. And therefore, I'd like to turn the call over to Mike now to provide more color on why we believe this acquisition is such a terrific opportunity and a great fit with our CSS business. Mike?

Thank you, Jan. Over the next few slides, we'll describe how this strategic acquisition fits within our organization. You may recognize this framework from our Investor Day presentation in April, which reinforces our vision of restoring patient lots through technologies that transform surgical, neurological and regenerative care. As Jan mentioned, Integra participates in the ENT today with our MicroFrance line of instruments. Acquiring Acclarent gives us an immediate leadership position with relevant scale to accelerate growth in this market, while also building important capabilities, which we will highlight later. We will integrate Acclarent within our Codman Specialty Surgical division. Can we turn to Slide 6, please? As you can see, this acquisition adds $1 billion to our total addressable market, increasing from $5 billion to now to more than $6 billion in total opportunity for CSS and contributes market growth at the high end of our range between 5% and 6%. We will report our ENT performance within our CSS segment as shown and this acquisition will be an important contributor to our combined neurosurgery and ENT performance. Please turn to Slide 7. ENT is a natural and complementary adjacency to neurosurgeons in our instrument platform. In addition to being an anatomical adjacency, we like specialized markets that address: one, high-impact disease states; two -- specialization and focus wins; and three, where surgeons have a significant influence over purchasing decision. These characteristics apply to our served markets, particularly in neurosurgery and ENT. Integra has been able to devote a high-level focus to meet customer needs in our legacy neurosurgery and instrument businesses and we bring the same mindset to ENT. ENT enables several key adjacencies in our core markets today. For example, neurosurgery and ENT are clear anatomical adjacencies, particularly in skull-based procedures where neuro and ENT surgeons may work together in the operating room to gain the right surgical pathway and access to a brain tumor. Secondly, we are excited about the R&D and technology capabilities of the Acclarent team, and we believe they will help us to raise all ships as we fuel future innovation across the enterprise. On the instrument side, we've had success selling our premium MicroFrance ENT specialty instrument line, and we believe there will be pull-through with additional commercial resources focused on ENT. Please turn to Slide 8. We've been keeping a close eye on the ENT market for the past few years, evaluating several opportunities and refining how to best expand our presence in this attractive market. What we like about this deal and it gives us immediate leadership position with relevant scale to accelerate growth. Today, this deal is focused on the U.S. market segment, and we're showing on the left, how this breaks up by product category. Overall, this is a $1.1 billion market growing between 5% and 6% and we've highlighted the areas in green where Acclarent plays today. These include legacy sinus balloons and some of their more recent innovations in advanced navigation systems, shavers and other disposables. These segments represent about 2/3 of the overall market, the majority of which are growing at mid- to high single digits. The area in gray includes areas that are not scoped for this deal, such as direct visualization, endoscopic systems and energy and RF solutions and nasal stents. These may be future opportunities, but are not an area of focus for today's deal. Now back to the green section. Acclarent created the anti-balloon category in its pioneered new differentiated innovation, more recently in eustachian tube and navigation systems, which we'll cover in the next few slides. They have strong brand equity and best-in-class sales channel, giving Integra an expanded footprint and to adjacent sites of care such as outpatient surgery, ambulatory surgical centers and physicians' offices. Please turn to Slide 9. One of the jewels of this acquisition is Acclarent's TruDi Navigation System and software, which initially launched in 2018 and has been delivering strong commercial adoption over the past several years. TruDi is a surgical navigation system with electromagnetic instrument track that provides consistent accuracy, simplified workflow and advanced software. For example, Fast Anatomic Mapping is a real-time imaging tool that documents surgical changes to the anatomy. TruSeg uses artificial intelligence to apply auto segmentation to predefined anatomical structures. TruePath can calculate and present the shortest valid path between two points specified by a physician. In addition to advanced software, Acclarent's R&D has focused on building a portfolio of differentiated navigated disposable instruments, such as balloons and shavers, providing physicians more consistent accuracy and building a more consistent and growing disposable revenue stream for each capital unit. Acclarent has a robust, robust pipeline, and we're excited about the opportunity to incorporate new software functionality to improve physician workflow and continue to expand the portfolio of navigated instruments and accessories. Please turn to Slide 10. Fifteen years to balloon innovation, Acclarent has continued to pioneer new standards of care in areas of high unmet need. Many of you on the phone probably have family members that have had to have tubes -- get tubes placed in their eardrums to help prevent ear infection and provide fluid ventilation for the middle ear. That procedure works for many people, but for patients who have chronic dysfunction, surgeons now have the option to address the issue through a different approach by dilating the eustachian tube with a balloon is shown in the images. This procedure is backed by compelling, prospective, multicenter, randomized clinical trial data. This procedure will continue to be a growth driver for the business. Acclarent has had some recent wins with expanding payer coverage and reimbursement for this procedure, and we expect continued growth as more surgeons are trained on the surgical procedures. Please turn to Slide 11. In summary, we are excited about the clinical needs and opportunities in the ENT market and the Acclarent acquisition provides a strong business foundation to support sustainable growth. We spoke about innovation and navigation, and we anticipate further enhancements in our capabilities, including software and navigated accessories. The AREA Eustachian Tube system is currently indicated for patients 18 years old and older, and we are evaluating the potential to expand usage into younger patient populations. Acclarent has a strong brand and category leadership, driven by their legacy of innovation and the best-in-class sales channels. We have been impressed by the team's deep clinical knowledge, strong surgeon relationships, professional education focus and these are strong fits with the CSS commercial capabilities. Acclarent has exciting R&D capabilities, particularly in digital innovation and software development. Given Integra's legacy capital footprint, products like CUSA and CereLink, there will undoubtedly be learnings to apply next-generation systems. As I mentioned before, we've had our eye on ENT for a while is a natural and business -- anatomical and business adjacencies. This scale enables future opportunities to capitalize a fast-growing segment and extend our market presence with future organic and inorganic innovation. And with that, I'll turn the call back over to Jan.

Thank you, Mike. Let's turn to Slide 12 to conclude our prepared remarks. Let me summarize the key highlights of our Acclarent acquisition. First, the Acclarent business is a unique asset that enables Integra to effectively address the attractive ENT market with established commercial scale, strong brand recognition, a differentiated portfolio and a robust innovation pipeline and class-leading R&D capabilities. Second, the ENT market is highly complementary with the commercial portfolio and R&D capabilities of our neurosurgery business and has $1 billion to our total addressable market growing at mid-single digits, further enabling our long-range growth commitments. And finally, the Acclarent acquisition presents attractive growth, value and financial returns for our shareholders, adding approximately $110 million of revenues, growing high single digits with attractive gross margins. The transaction is expected to be accretive to our earnings per share in the first full year with a return on invested capital greater than 10% by 2028. We look forward to welcoming the Acclarent team to Integra and are excited about the prospect of making a profound impact on ENT and neurosurgical care. The Board and I are confident that our CSS team under Mike's leadership has the right experience and focus to effectively integrate the business and deliver value to our shareholders. So with that, I'd like to open up the line for Q&A.

[Operator Instructions] And our first question comes from the line of Matt Taylor with Jefferies.

Thanks for the question. Sorry, the feedback there. I just wanted to ask you, you talked about the growth profile and the accretion in the first year. How would you see that growth evolving over time? Do you view it as steady growth through that period through the longer-term ROIC goal? Or are there inflection points along the way that we should be aware of? I'll just stick it with that.

Yes. And I'll take that. Thank you, Matt. So in general, I think as we bring Acclarent on board, we do see some opportunities in the near term, short term to drive higher growth. But in general, it will be still in that same range of high single-digit growth accretion over the long-range plan. So still within the high single-digit range, a little higher in the near term, averaging out to the lower end in the long term.

Thank you. Our next question comes from the line of Vik Chopra with Wells Fargo.

Congrats on the deal. I'll also keep it to one. Can you just maybe talk about how the deal is being financed and how we should think about interest rates that you're expecting for this transaction?

Yes. So thank you, Vik. So the deal will be financed through the use of our revolver, and so that will be as of day 1. That will take our leverage overall -- leverage ratio to kind of the upper end of the range that we've talked about, that [ 2.5 to 3.5. ] But we do see an opportunity through the cash generated off of our core business, especially as we bring Boston back online to drive that leverage ratio down, back down to kind of where we anticipate ending this year by the same time next year.

Our next question comes from the line of Ryan Zimmerman with BTIG.

Can you hear me okay? Yes, can you hear me okay?

Yes, we can.

That's not my question. Okay. My question is just two parts here. First, of the $110 million, how much is specifically balloon sinus dilation versus navigation and shavers because that is a very different call point than some of the navigation shavers that could be used in more skull-based surgery and that's primarily geared towards Mike. And if you could comment also on the operating margin profile of the business. Given that this will be a separate sales force, I understand that it's neutral to EPS, but what does that our margin profile look like today? And what does it look like a year or two from now as you integrate business?

So Ryan, thank you. I'll take part A of your question. So when we really looked at this acquisition, what excited us is, the portfolio is actually very broad. There's good focus in the ambulatory surgery channel. There's good focus in the operating room, we're strong. And we feel there's good balance across this portfolio, not just in sinus balloons, but in other products like we referenced like the TruDi NAV. And I did reference also this anatomical adjacency that we're very excited about because we play there today for surgical access for tumors. So I think we do -- we did very much like the balanced aspect of this portfolio on not only sinus balloons, but ranging across new technologies and really strong OR focus in the hospital where we play well. So we do think it's got a good balance across the total portfolio, which really should serve us well. But I think there was a part two.

Yes. Yes. So from a margin -- overall margin perspective in our hands, I would characterize it this way. As you think about EBITDA margins, it becomes accretive on an EBITDA basis by the -- towards the end of our LRP period.

Our next question comes from the line of Robbie Marcus with JPMorgan.

This is actually Lilly on for Robbie. Can you talk through what you're thinking in terms of dissynergies and what's assumed in that outlook for neutral next year and accretive in '25? And part two, you have a small presence in ENT already today. So can you talk through how you're thinking about sales force integration planning within the portfolio?

Let me take the first part of that, and then I'll turn the second half to Mike to talk about sales force synergies. So from an overall business perspective, we're not expecting significant cost synergies from the acquisition in the near term. This is a new platform for us where we will leverage kind of our technology to drive innovation. In the near term, we will see some modest kind of G&A cost synergies where we have an opportunity to leverage our infrastructure. And as we discussed earlier, we will see some revenue synergies as we see an opportunity to include our MicroFrance ENT instruments as part of the ENT sales force that we are acquiring. On a medium to maybe longer-term view, though, we do believe there is complementary adjacent R&D and innovation opportunities that we can use to strengthen both the CSS and Acclarent capability in terms of delivery of innovation. And then I'll turn the second half.

Thank you, Lea. So on the sales kind of portfolio, how does this come together complementary in sales structure. One of the things that excited us was that we had some complementary things like our MicroFrance line, which we spoke to. I've also spoke on surgical procedures and skull-based tumors that we think is really good alignment. And then in addition, new capabilities that will not only add strong revenue for us, but also capabilities that are going to make us a stronger company and the way we develop products and the way we think about digital and software capabilities. So as you can imagine, we're sorting through all that right now, and we'll work with the team at Acclarent over time to develop the right approach. But there's a lot of strong sales synergies here for us to get to work on, and we're excited about that.

Our next question comes from the line of Kristen Stewart with CL King.

I just had a quick clarification. Are you including revenue synergies in your forecast? Or is that something that we should think about as potential upside?

Yes. So, yes. So in terms of the MicroFrance instruments opportunity that I mentioned, yes, we are including that in our forecast.

One moment for our next question, please. Our next question comes from the line of Craig Bijou with Bank of America's.

Just a quick follow-up on the high single-digit sales growth. Just how should we think about that within the segmentation that you have laid out for the market. So does the existing balloon business, given your leadership position grow low single digits, mid-single digits like you could outline on Slide 8? And then to get to that high single digit, it's the incremental opportunity in instruments and the other segments?

Yes. So thanks for the question. I think -- so when we've kind of modeled our sales growth on this, one, this business has been enjoying strong growth. And so we're picking up a business that we think has really hit its stride from innovation and commercial execution. So much of our modeling, as you would guess, was based on that. In addition, there's a pipeline we're excited about that we'll continue to add innovation and we'll fuel that. And as per an earlier question, we actually think there's some good, strong pull-through capabilities through some of our own businesses. So I think that really has driven us to that growth profile. And much of it is in some new products that we're excited about and continued growth on products that they've actually launched fairly recently in the last few years.

And Craig, you referred to, I think, Page 8 on that. By chart, it gives an indication of the different segments. You referred to sinus balloons that it was low mid-single digit growth, the accretive growth, mid-single, high single digits is in the navigation systems and shavers and drill segments.

Our next question comes from the line of Steven Lichtman with Oppenheimer & Company.

This is Ron on for Steve. I just wanted to ask what opportunities do you guys see for the Acclarent portfolio outside of the U.S.? And is there anything specific on their products pipeline that you can point to?

Yes. Thank you for the question. I think as we mentioned before, today, this is a U.S. business. However, we see the OUS as the international business is clean landscape that we're working through. And I had the opportunity to run Integra's international business for three years. And we have examined country by country and product by product, and we do have a list of opportunities we'll start to work through. Obviously, we need to think look through registration, regulatory. But yes, there are some opportunities that we're in the early stages, we've got a select group of categories that we're starting to work through, and we'll certainly be reporting back progress on that.

And just for clarity, in the model assumption there, there's no international assumed in there. So that would be growth upside opportunity if we tap international markets.

Thank you. One moment for your next question. Our next question comes from the line of Jayson Bedford with Raymond James.

I have two questions that require quick answers. Just on Slide 8, what percent of sales come from Acclarent legacy?

I'm not sure I follow the question. What...

What percentage of sales come from Acclarent legacy?

Yes. I assume that expanding presence, you have some revenue generation. So if I just look at the pie chart, I'm just looking at the light green, is that 90% of sales?

I'm sorry. Yes, I understand the question. Yes. Yes, as I mentioned before, Acclarent got business that I think you're a lot of you are well aware of in sinus balloons and other categories, that is a good foundational business for them. And then you do see the expanding presence. And you can -- as you can take a look at the chart, it's a good mix between both sides of the business. And then within expanding presence, that's in different stages. There are some products that are earlier in the ramp-up. There's ones that will follow, but as you can say -- as you can see, just from optical look at the chart, it's a good mix.

One moment for your next question, please. Our last question comes from the line of Drew Ranieri with Morgan Stanley.

Maybe just sticking on that market slide for a second. But when you are looking at the expanding presence opportunities that you're laying out here, I mean, how much of this growth or penetration will be based on competitive share gains and maybe kind of what's required from a market development perspective to double, triple kind of your presence, your share in these areas? And will M&A be required to kind of build scale and expanding presence to drive growth there? And then just second, on the gross margin side. I know you said in line with your corporate average, but this year has been a little bit mixed because of the recall. So should we be thinking your 2022 gross margin or where you are today?

So I'll tackle the first part of the question. So when you take a look at Slide 8 and you look at the expanding presence, right. These are products that, for the most part, are commercialized. And so the -- it is really more market development and essentially continuing the momentum that Acclarent has established in the marketplace. So the technologies have been well received and it's your traditional aggressive market development and professional education, good strong sales execution, market access, so it's things we understand very well, and it's on product lines that, for the most part, they have commercialized. So there is no -- the portfolio is there. Second question related to follow-on M&A. We -- when we search for M&A and ENT for quite some time, we were heavily focused on business that had very strong commercial scale, particularly in the United States. And we're excited that this deal delivers that to us. And on top of that, it offers big platforms of growth for us. So we're very interested in future M&A, but we feel this deal on its own for scale allows us a long runway.

And I'll take the question on gross margins, and thank you for it. So you should definitely think about this kind of in line with company averages, kind of [ pre the ball ] often impact. And so much more in line with kind of where we landed in 2022 versus some of the dynamics we saw playing out in 2023.

Thank you. This concludes our presentation and Q&A. We thank you for joining us today. You may now disconnect. Everyone, have a wonderful day.