Integra LifeSciences Holdings Corporation (IART) Earnings Call Transcript & Summary

Well, good morning, everyone, and welcome to the Morgan Stanley Healthcare Conference. My name is David Lewis, medical device analyst here at Morgan Stanley. Thanks for being with us here on day 1 of our 5-day virtual event. It's my pleasure here, as we progress through the morning, to have with us Integra LifeSciences and their CEO, Peter Arduini. We're going to jump right into Q&A with Pete. But before I do, make sure you go to the Morgan Stanley website under research disclosures and check out fun facts about me.

So Pete, just I want to start this morning, kind of how we've been starting with a lot of companies here, obviously, with the topic de jure which is COVID. You talked about June being down around 13%. I just wonder -- can you just update us here on what kind of improvement you're seeing here in July, August and September relative to some of your peers.

David, good morning to you, and good morning to everyone listening in. Yes, we communicated on the second quarter call that June was down about 13%, as you mentioned. And we talked about seeing sequential improvement coming out here through the rest of the year, honestly, but in particular in the third quarter, and referenced a range of around 5% to 15% down. And I would say we are seeing the sequential improvement that's taking place within the quarter. One of my biggest concerns as well as many folks during that time period, I think Arizona, Texas, South Florida, were really getting hit pretty hard. And the question is, will that translate into hospital lockdowns, in our case, in particular, ICU reductions. And we saw some, but not near what we saw, let's say, in the Northeast in the April-May time frame. So we feel pretty good about the sequential improvements that are taking place.

Okay. So you dipped down 5% to 15% you gave for sort of the third quarter. If I think about the 13% in June and I think about that sequential improvement, I mean, it certainly feels like if you saw sequential improvement month-over-month, you should be sort of towards the lower end of that range. It just seems like a pretty -- the 15% number certainly seems very conservative in light of 13% getting better. So should we be thinking something that's closer to that down mid-single digits? Is that the better way to think about the third quarter?

Yes. It's tough to imagine we actually have a discussion about being down 5% or 15% is good. But I would say, look, from the standpoint of the improvements that have taken place, with our midpoint of being down 10%, we definitely are more on that trend or are leaning a little bit better. We'll see how September ends up. Obviously, we'll have the impact. And our traditional kind of ramp was having a bigger September. August as for us, as many other companies, has a slower international component to it. But in this year, it's a strange year. We don't normally see the same hockey sticks. There's a little bit of different cadence and the quarter ends have been rather smooth into the beginning of the following months. And we've seen that trend. As we get healthier, we'll probably see more of an uptick towards the end of the quarter. And in our case, that will be probably some tick ups of some smaller capital items. So I remain reasonably optimistic here that we're probably going to be closer to the mid or lower end of that range and that we are continuing to see sequential growth.

Okay. And you mentioned resurgence, Pete. The resurgence activity, was that most intense in July? Was there any resurgence activity really in August? Or was July really the peak resurgence month?

Yes. I'd say July probably within the quarter was probably the mean, although there were hotspots. I mean, I think, as an example in the Phoenix area and stuff in August, the beginning of the month, there was -- a lot of the hospitals were actually quite limited. But again, in perspective to the second quarter, we haven't seen anything to the level of the type of pullbacks that we've seen as far as hospital access, ICU lockdowns. And as you know, in many cases, within April, a lot of jurisdictions, particularly around the eastern part of the United States and the West Coast wouldn't even allow elective procedures. And that had a significant impact. And we haven't seen that type of activity in Q3, which is great and also has led to continued improvements throughout the quarter.

Okay. So it sounds like the future is going to have expectations, maybe a little better here in the third quarter. You also talked about fourth quarter maybe getting back to kind of flattish trends. Obviously, the big caveat being capital. So let me just start with capital first. I mean we've heard different things. Some people, very worried about the capital environment still. Other companies are feeling that with hospital downloads being healthy and obviously the CARES Act capital has actually trended a little better than expected. How are you feeling about capital trends in your business and the ability to kind of do something that's flat or in the positive growth territory in the fourth quarter?

Yes. I mean so starting with the fourth quarter, I don't think anything's changed relative to our views that we have scenarios where we don't get back to flat. We have scenarios where we do get back to flat. I would say at this point in time, we feel a little bit better that our odds are increasing. The biggest caveat is what's always been there, which -- what happens in the October/November window on seasonal flu coupled with COVID. And I think we're obviously going to see that here pretty soon to understand how that looks. If it's managed more like Q3 has been seen, my confidence is definitely higher that we can get back to flat. If it feels a little bit more like what we saw in Q2 or worse, well then obviously, that changes it. So again, if you had asked me this question in July, and you asked me the question now, my confidence has improved that we're seeing better management of patients, better management of beds, which then translates to increased confidence in our sequential growth. To the point on capital, we don't have the largest dollar amounts of capital. So $200,000, it's about 10% of our total revenues, but traditionally amounts to at the end of a given quarter, particularly at the end of the year, a really nice uptick. And our product that's the largest contributor is called the CUSA. It's the top device for removing brain tumors. And we suspect we're having solid sales right now, but we're just not seeing the increases. And what we hear is even though endowments and such are strong, many of our buyers here aren't hospitals with large endowments. I mean it's a large swath across the country. And most CFOs are just trying to take a look and saying, when do I have a window here where we'll have stability? And back to the same question of if we're going to have some downs here in the fourth quarter because of resurgent, I want to keep my capital reasonably locked down during this time period. Outside the United States, we're seeing a little bit more openness to spend. Now obviously, how socialized med structure works versus our hospital systems in the U.S., it's different from how they'll manage cash. But that's been a little bit more consistent on at least our size of capital. And then for other components, I mean, we've had certain parts of our portfolio that are actually in growth mode. So internationally, we talked about Japan, up 20% for some new product introductions and also how they manage their -- the country, candidly. And then we have certain products within our portfolio, particularly right now, within our tissue portfolio that are starting to show some really nice resurgence here within the third quarter.

Okay. And just, last question on recovery here. We'll get into the more strategic stuff. Thinking about next year, and obviously, we're not in a position yet to give guidance, but the Street's got you kind of 2021, very similar to 2019, maybe kind of 1% above. Does that feel right to you? I mean based on the commentary today if things were to continue, that number looks a little conservative. How are you thinking about how the consensus Street estimates are capturing your '21 today?

Yes. Well, I mean, David, I mean, we're not obviously in a position to give guidance, but talking about how we feel about things, I mean, it depends on how certain things play out. I would say, let me start with profitability. We've had a lot of focus this year on the profitability of the company and our plans over the last couple of years. I think we've talked strategically about being a 28% to 30% EBITDA margin company. We've done a lot of things with EU MDR as well as with our portfolios to take products out of the portfolio that aren't contributing, and that's caused a little bit of a headwind, but it also, on a go-forward basis, really sets us up to improve in our margins. And I think through this year, you'll see some of those improvements even coming through this year. As I look into next year, I feel quite good about progress that we'll make even in a more challenged revenue market because of some of these critical changes that we've made in the structure of the company. That being said, with revenue, if we are to finish up, say, close to flat at the end of this year, that's the scenario that plays out. It doesn't necessarily mean that Q1 jumps back to plus 5% growth. And so the question is going to be, what's the Q1 recovery look like? And then you could clearly see Q2, Q3, Q4 getting back to more normative levels. If Q4 doesn't get back to the '19 levels, well then there's probably a 6-month window to kind of get there. If it does, it's probably a 3-month window is kind of how we think about it. And so do I see scenarios where we obviously put up positive growth in '21 versus '19? Absolutely. And I'm -- optimistically, the scenarios that play out for us well is we had a challenging 2019 relative to supply. If you think about our tissue business, we were only growing in the mid- to low single-digit window when we should have been high single to low double digits, solely tied to supply constraints. I mean one of the blessings in disguise for COVID for us this year is we were able to, with the reduced demand that was in the marketplace, get all of our safety stocks back to where they need to be on the tissue side as well as address any particular plant issue. So as we're in the second half, we have no supply constraints. And so as we go into next year, we'll be able to start off in a good position. So all those bode well for growth, but I think the market points that I made probably have the highest bearing, if anything, how that plays out.

Okay. Well, that's a great segue and where I wanted to go next, which is just one debate on Integra these last 6 quarters it's been -- LRP guidance was 5% to 7% organic. Last couple of years, you were sort of sub below end. Admittedly, you said it was going to be low and then build a high, but you probably didn't expect to sort of miss the low end of the outlook. So everyone is really trying to ask 2 questions. Number one, what went wrong? You addressed tissue is obviously one of the damage in '19 that obviously impacted growth. But what went wrong? And what can you say to inspire confidence in investors that you can deliver this 5% to 7% organic growth as we get into sort of that '21, '22 time frame?

Yes. Look, it's a very fair question. I think the first question -- the first point is that none of our underlying fundamentals, be our issues that we had as well as post-COVID change. If you look at neurosurgery, the aging population, the global growth within that core business being in the roughly in the 3% to 4% range with opportunities where we're expanding into the periphery vascular and also minimally invasive access could make that market grow even a couple of points faster. And so that business is solid, and we see lots of interesting opportunities, particularly with the acquisitions we made last year to add to that business, again, getting into intracerebral hemorrhage as well as being really one of the first players to bring minimally invasive techniques into neurosurgery. On the tissue side of the house in orthopedics, we've had some issues relative to supply. And so if you back up and you say, we laid out guidance in 2017 that said we'd be 5% to 7% growth and drive the 28% to 30% of EBITDA margins out into 2022. And to your point, we were like, well, in '18, fundamentally, we were finalizing the integration of Codman. We knew that, that would have a drag effect. When we bought the Codman business it was flat, only growing 1%. Now it's growing over 5%. And we also made major significant channel changes on both sides of the house. And then in '19, Codman did significantly well. We were 5.5 plus percent growth, but our OTT business was not anywhere near it needed to be. It was below 5% growth. And that was a combination of some of the challenges with ortho and the tissue. And I think between looking at the portfolio and plans that we have to correct ortho with the shoulder platform and the supply issues that I've talked about, we're actually at as good a position as we've been in the last 5 years to accelerate growth. And I think also coming out of this, our amniotic platform, which now we have stabilized and new products coming out, we've got actually some new indication opportunities within a broad spread of our portfolio. I feel quite good about how we're teed up for TT growth. And so how do you get there? You get a 4% to 6% growth in the neurosurgery business, and you put up high single digit, low double-digit business -- growth in TT, which we feel in all these scenarios that are playing out this year, we feel that, that's definitely doable once we get stabilized here in the market.

Okay. And a bit of a nit, Pete, I deal with this little bit with a company, [indiscernible], that has discontinued products. I mean you have put discontinued products sort of into the LRP, so to speak, that 5% to 7% with discontinued products, maybe it's 3% to 4%. Why is discontinued products the right way to think about the underlying organic growth in the business? And do you really see a cadence of discontinuations here on a go-forward basis?

So what we do, David, we put together divested and discontinued in the same bucket because they're either, we sold them off, so in some cases, we won't get Codman they went that way. And some of them, if there wasn't a buyer for some lower end products, then it really wasn't worth running the process. We just discontinue that. And so we break them out for all investors to see. If they want to add them back into the point, they can do it. But we want to just be very transparent to it to show what the underlying business is. I mean if you're looking at us as what's going to happen in the year, I can understand why the metric may be frustrating. If you're an investor that looks as at 3% to 4%, and you really want to see what the underlying business looks like and where it can get to, that's why we choose to do it. I would say the vast majority of all of this divested as well as discontinued products, we get through a lot of that in 2020. And so in '21 and beyond, it's a smaller amount of the overall percentage that we've had. And obviously, if you're growing 5% overall reported -- or excuse me, organic and 3% reported, it's a lot different if you're growing 7% and 5%. And so I think as the compression came down because of the supply issues, it became more of an acute point. But we feel very good about what we've been able to do as far as clean up the portfolio. And during this window of time during COVID between what costs are necessary and what we can do, we'd even thought more about it. And I think investors will be happy as they start seeing quarter-after-quarter, our ability to put up and consistently deliver on the numbers, which candidly has been an issue the last 18 months.

Yes. Okay. All right. So a lot of this is behind you heading into '21. I think in all the years we've looked at Integra, M&A has always been a significant component of the business. Codman was a very substantial transaction. You still got a couple of hundred million dollars of M&A kind of baked into the LRP. I'm just kind of curious, you haven't been as active post Codman, which just may have been Codman was a very big deal on a relative basis. And do you still think that $200 million-ish of acquired revenues is the right way to think about it? And what does the M&A environment look like for your business kind of post-COVID?

Yes. I would say when we laid the LRP out, I mean, the more important metrics there were 5% to 7% growth, 30% EBITDA, north of 70% gross margins and to demonstrate that, that could be a $2 billion business by '22. Obviously, that's interrupted by the COVID world. You needed some acquisitions. I would argue you could see $200 million to $500 million, depending on how things play out, and it's why we've been very focused on our cash flow and our profitability because we want to be in a very good position to take advantage of the right acquisitions when they come up. And I would say you saw it in '19 with nonrevenue, but technology acquisitions for neurosurgery. Again, a product that can take us in a minimally invasive neuro, a product that can take us into intracerebral hemorrhage and a product platform that can solve one of the biggest issues in neuro, which is all types of clogging of catheters that are used within the neuro procedure area. And so we could have done that without Codman. You're going to see, I think, those products come to light over the next 1, 2 and 3 years. On the tissue side, there's still a significant amount of small individual players, products that are out there. And I think we can build a large plastic, reconstructive as well as wound care franchise. And so I think you will see from us over the next few years, focus on how we can build that platform out. And I would say if you look at our position right now, we did the convert at the beginning of the year, which was very fortuitous, timing-wise for us. We're able to get an extension to kind of take our debt covenants up to 5.5. We're 3, 4 now. I think with our focus on the cost management, we'll focus on paying debt down. But we definitely want to be in the M&A game, and I think you'll hear from us over this next year, still very much active in the M&A market.

Okay. And just size for [ fluidity ]. I mean DuraGen's quite a bit of an outlier. So should we think about most of these transactions being on the smaller end, less than several hundred million? Or are they all across the spectrum?