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

Good morning, everyone. Welcome to the 2021 Wells Fargo Healthcare Conference. I'm Shagun Singh, part of the medical device team at Wells Fargo, and I'm pleased to host our next fireside chat with Integra Life Sciences. Joining us from the company are Carry Anderson, Executive Vice President and Chief Financial Officer; and Mike Beaulieu, Head of Investor Relations. Thank you, everyone, for joining us today.

So let's dive right in. Let's begin with a discussion of business performance in the first half of '21. So it appears that Integra saw improving trends in the first half, despite the pandemic. If you look at growth in '21 over 2019, it appears that Q1 growth was 3% and it improved to about 4% in Q2. So Carrie, can you just level set us here and discuss the drivers of your performance in the first 6 months of the year? And where is procedure and capital recovery relative to baseline, that is 2019?

Sure. Q1 certainly had an impact related to COVID. We saw that in the winter months, December, January, February, really seeing impacts on COVID. And we felt that in our revenue, we did exceed our expectations. We had set expectations maybe a little bit lower because we didn't know what that impact would be. And I think things played out largely as expected in terms of where we saw weakness in the portfolio and where we saw some strength. The weaker areas in Q1 were surprisingly on the neuro side on the procedure-based pieces of the business, again, COVID-related, seeing some patients not going in, procedures being deferred there. But what we saw in the second quarter is a lot of that procedure-based pieces of the business that were weak in Q1 came back very, very nicely and resiliently in the second quarter. In Q1, a little bit of a mixed bag on capital, where international particular capital sales in Japan and China were really strong. More of a function of those particular countries, Japan's fourth quarter fiscal year ends in our first quarter. And in China, we use a distribution model, and more of that was timing related. But U.S. capital is still weak, still below 2019 levels. And in the second quarter, U.S. capital is still below 2019 levels, but the encouraging sign there is seeing sequential improvement in capital from Q1 into Q2. The other area that we saw in terms of trends that COVID impacted in Q1 was in our surgical reconstruction area, think about hernia repair, think about breast reconstruction, more deferrable type of procedures. So weakness in Q1, nice rebound coming back in Q2. So I think what this demonstrates is there is a resiliency in our model, that if we can get to a point where COVID is behind us, our expectation is the portfolio will rebound very, very nicely. And there's still parts of our portfolio like capital and our indirect markets where we're still -- even in the second quarter, we were not back at 2019 levels. So still, as I think about the glass half full, still opportunities for the portfolio to see some further strengthening once we can get past COVID here and see some nice rebound.

I got it. So it seems like just if you can elaborate on the geographic performance here. So 30% of sales is OUS, and you have a greater mix of OUS sales in your CSS business versus tissue technology is about 40% versus about 10% or so. So you did touch on capital, but can you elaborate a little bit more on where you're seeing that differential recovery?

Yes. In the OUS markets, most of our OUS business is on the CSS side of the portfolio. We have a smaller presence on the tissue technology. So my comments will be more geared towards the CSS portion. And I would say, generally, core Europe has been -- if I think about direct markets in Europe have been fairly steady. Their vaccination rates have been very similar to the U.S. You have pockets of impacts and other areas where it's being a bit more controlled and say, just generally, I would say, describe Europe as steady in the first half. Where we've seen the growth on the international side has been China and Japan in the first half of the year. We talked a little bit about that on the capital side in the first quarter. But Japan has been one of those regions that has just been extremely resilient even throughout COVID. Even when you go back to 2020, we've had six quarters in Japan, where we've seen double-digit growth out of Japan. And certainly, there's some characteristics of the country as it relates to the government's response as it relates to COVID. But I'd also attribute some of that double-digit growth that we saw in the first half and last year was the nature of our product portfolio. We've introduced a lot of great new products in the country. And in 2020, we moved from an indirect to a direct model that certainly has helped. And so still seeing some nice growth coming out of Japan and China there. And it will continue to be a source for us as we think about 2022 and 2023. But the indirect markets, so when I think about the indirect markets, we have a couple of indirect markets in Europe. Spain is an example of that in our South America regions. And even in Greater Asia, when I think about excluding China and Japan, we have weaker indirect markets. Nothing has changed from a competitive landscape perspective, it's mainly the COVID disruption. And again, the glass half full here says that at some point, we will get through this COVID interruption and those parts of the business, we'll see recovery as well. And as I think about 2022, those are nice opportunities for us as we think about building momentum back into 2022 and beyond.

Got it. That's helpful. And then on the Q2 call, you did release guidance by about $15 million, and it included a lower contribution from ACell, which implied a strong recovery in the base business. So can you just talk -- give us an update on ACell? Do you expect the issue of restricted access, especially given your new sales force to be an incremental headwind in the second half, just level set us how you're thinking about ACell currently? And I guess you did touch on underlying procedure recovery, but how is that tracking given the Delta variant?

Yes. For ACell, we had a slower start to our integration as it relates to revenue growth. And I think the factor here that we underestimated is the impact of doing an integration in the middle of COVID. You have to remember that this was a business when we took it over was at breakeven. It was not a profitable business. And we obviously identified synergies to get that to be a profitable business for us to ensure that we could get it to accretive in year 2 in 2022. And as a result of that, there were synergies that we're identifying in the sales channel. There is a lot of complementary nature of their products and a lot of the sales channels are similar. And so that's where the bulk of a lot of those cost synergies came from is in the sales channel. So we've executed on that, but what we underestimated is the impact of COVID when you take new products, new to our portfolio and drop them into the legacy Integra sales force where they have restricted access. So a slower start and certainly, as the COVID continues here, that restricted access is still going to be a factor. But I would say, Shagun, let's try to separate out COVID kind of short-term impact versus longer term, very excited about the ACell acquisition, a really great acquisition for Integra. Our enthusiasm for this business is still very, very great, very complementary in nature in terms of adding it into the regenerative tissue portfolio. A couple of great products here. They're a powderized formulation for skin and for wound healing. So we don't have that in our portfolio. So ACell, that was incrementally new. And then the opportunity on the complex hernia side to bring an indication -- a product that is an indication for laparoscopic approach. So I would say -- remember, though, for ACell, it doesn't get counted in acquisition or organic growth for 2021. But as we move to our anniversary date here next year, all of that growth will move into organic growth. So the slower start for 2021, we're, obviously, working to correct that so that we can see some really nice growth in 2022, and all of that will be a contributor to organic growth for us in 2022.

Got it. That's helpful. And just as a follow-up, you said that the restricted access will still be a factor in the back half of the year just given the Delta variant, are you still comfortable in the $70 million to $74 million range that you have given?

Yes. I think we'll talk about that more in the third quarter call, overall, and we'll provide any update to that at this point, but I think it's a little early to talk about where we're going to land for the third quarter, particularly on ACell. So let's kind of stay tuned for that one. But obviously, we're working to rectify some of that slower start and in some cases, adding some headcount back in, relooking at training opportunities and marketing opportunities and territory. So doing the right things to, again, to think about accelerating that growth, certainly beyond COVID and into 2022.

Got it. That's helpful. And I'm hoping you can at least give us some directional color into some forward-looking trends here. Specifically, your guidance for the back half implies about 5% to 7% growth, which is where your LRP is. And can you help us step through a few factors here, Q3, Q4 seasonality, how should we think about that? Second half backlog, I don't believe you've factored a lot in your guidance for backlog or anything for backlog in the second half, how are you thinking about that? And then just with respect to the Delta variant, if you can elaborate on the impact that you may be seeing.

Yes, a lot packed in there, and I'll try to give you as much color as I can here. We're early into September at this point, so -- the third month of any given quarter is typically an important month of a quarter, and that's no different here for our third quarter. So while I can't give specifics on Integra's performance, just a couple of things as it relates to commentary on more of the macro things that you're seeing, we're seeing and that are being reported on because it's helpful to put that in context. So clearly, there's been a pretty substantial rise in the number of COVID cases and hospitalization rates. I would say, as I think about what's happening here in the third quarter, specifically in August and I compare that back to the winter months in January and February, a couple of things that are different for me as I think about that, vaccination rates have increased since the winter time. Absolutely, there's no doubt about it. But obviously, the Delta variant, a bit more contagious, right? And so despite the vaccination rates increasing, still seeing that impact. And the other thing that I think is a contributing factor is staffing shortages, whether you're inpatient, outpatient settings, hospitals are dealing with the same labor constraints that we are in many of our facilities. And so I think that's an incremental factor that weighs heavily in the hospital setting here and in the outpatient setting on a hospital's ability to do all of the procedures that they want to do, and certainly, is a constraining factor as you think about ICU bed availability. And so I think that is an incrementally kind of change versus what we saw back in January and February. I would say that its -- but we're not seeing it blanket the same way across the U.S. It's certainly having pockets of different waves of impact. Certainly, California, Texas and Florida seeing larger impacts, states that have lower vaccination rates, larger impacts. And you compare that to states on the Northeast side that -- like New York that haven't seen the same level of impact. What I think it's difficult to know right now is, have we peaked? Was August the peak? And what's going to happen in September, as I mentioned to you that we're still early into September and we just crossed Labor Day, right? So there is a view of unknown on what Labor Day -- post Labor Day brings us. And certainly, there are more schools, whether it's elementary schools all the way up to universities, that schools are now in mass, kind of in full session now. And I think that's the unknown is what happens here for the balance of September. So we'll have to stay tuned. What I would do is reference you back to our guidance for the third quarter that we talked about on our second quarter call in July, we provided a range of a revenue guidance. We did that very purposefully because at that point, we didn't know how COVID would play out. And we talked about the variability of COVID, and I'd anchor you to those ranges. At the low end of the range for Q3, certainly, that comprehended some COVID impacts there. The high end of the range, that did not reflect COVID impact. So I would say that as Q3 plays out and as we hear about these COVID impacts, anchor you back, we provided that framework for investors to help us think about where we might land in the third quarter. But Shagun, before I leave this question, I want to emphasize the fact that Integra has done a lot of things to address what I'd call accelerated growth opportunities in the portfolio. There is no doubt that COVID is disruptive. But we have shown, even when you look at Q1 to Q2 and when you got through a COVID surge, there is a resiliency in our portfolio that revenue does come back. So again, I want to talk a little bit about what I see as some of those accelerators for our business for 2022, 2023 and even beyond 2023. And if I could just have a few moments here to talk about those. Going back to the glass is half full here, there are parts of our business that are still being -- that are still lagging in that recovery on the capital in the indirect side. I view those as opportunities that those revenue pockets will come back. It's just a matter of time. The competitive landscape has not changed fundamentally in any of those areas of our portfolio. And so that's an area that we'll see some rebound come in. When that will happen? We'll have to see how that plays out, but no doubt that we'll see some opportunity for revenue rebound there. The international expansion that I talked about before in China and Japan continues to show some nice momentum there and certainly will be a catalyst for us in 2022 and beyond. We talked about ACell already, that that moves into organic growth. So any slow start that I had in 2021, hopefully, we will rectify that and confident that we'll see some nice growth in 2022, and that will be an organic growth driver. CereLink ICP monitor, it's our new ICP monitor, there hasn't been fundamentally any technology advancement in that space for many years. So this is a gap that this product will address. We are doing a controlled market release here in the third quarter. Not a lot of revenue in the third quarter, but obviously, more revenue in Q4. And as I think about 2022, 2023, it will be an accelerator. And then the opportunity for us to launch that product in 2025 to China, half the installed base for those ICP monitors are in China. So that will be a long run rate product for us that has clearly some nice implications for growth for us. Just a few other ones to hit on here before I close out, again, just wanting to think about beyond the COVID distractions here on what's really shaping up nicely for Integra. The PriMatrix DFU study, we talked about a little bit on that on our second quarter call, a great clinical outcome for PriMatrix here. What that means for us in the next 12 months is essentially almost doubling the number of covered lives from a reimbursement perspective. And so that's helpful as we think about moving into 2022. NeuraGen 3D, it's our new nerve repair product. It addresses the mid-gap repair part of the market. The current product we have is the short-gap. This gets us in the mid-gap. We still need to get to long-gap, and we're working on that. But incrementally, this opens up about half of the market for us with the NeuraGen 3D, and that's a 2022 launch. And the last one -- two other things I'd leave you with. One is the Aurora Surgiscope, two shots on goal here: minimally invasive tumor resection as well as deep bleeds in the brain, so the stroke market there. We're doing a clinical launch here in Q3. Not going to be a significant revenue contributor for us in the second half, probably not even in 2022 because it's more clinically based in terms of our launches that we're doing but the opportunity is for 2023 and beyond. And the last thing I want to leave you with is really exciting, is some of the steps and the movement we're seeing in getting that breast indication for SurgiMend. There is no product on the market that has the breast indication for postmastectomy reconstruction. We have been working with the FDA to get that lined up. We've got our PMA filed. We are on the calendar on the docket for October 20 to have the FDA panel. That is a first step in a long process, but the first -- a very critical step on our road to get that breast indication. And that is definitely an accelerator for us. SurgiMend is being used in breast reconstruction today, nice growth in that product, but we can't promote for it. So if we can get that indication, and one of the only products that can get that indication, we can get it -- that will be what I would call an accelerator probably in the 2023 time frame. So a lot there, but I know that COVID dominates a lot of the conversation, and I just want the investor base to understand there's so much great momentum that's in the Integra portfolio right now. And I wanted to make sure people are really focused on those things that I think will drive our growth in the next couple of years.

Yes. No, that was extremely helpful. I do have a couple of follow-up questions. So sorry, I'll start with the short-term one. But with respect to Q3, it looks like consensus is towards the upper end for both revenue and EPS. But historically, during COVID times, you've done a pretty good job on the P&L in terms of expense management. So how are you thinking about it in the current environment at this point? How are you thinking about it?

Yes. From a margin perspective, some of the comments that I made on the second call -- second quarter call is still appropriate. In the first half, our gross margin is a little bit under pressure related to some of that labor constraints that many companies are facing, we're no different than that. And that obviously hurts from a factory perspective when you can't fill your open positions in your factories and you can't ramp your production the way you want to, that has that impact on idle capacity there. The reverse of that, though, it helps your operating expenses because to the extent that you can't fill some open G&A positions, your OpEx is not coming back. So overall, there is a put and take as it relates to gross margins, but overall EBITDA margins, balancing that out because your OpEx is not coming back as strong. And I would say those factors are still at play as even when we think about the second half. So my remarks on the second quarter call was that gross margins would still be under pressure here in the second half related to labor constraints, but also some -- as it relates to supply challenges, whether that's longer lead times, some freight issues, some escalations of cost there. So watching that very, very closely. But the opposite is you're going to see lower spending in the OpEx lines that will tend to balance that out a bit on the EBITDA margins. And overall, our expectation is that our EBITDA margins for the full year 2021 would be at the higher end of our investor day guidance range because of that -- the way that that's playing out.

Got it. That's really helpful. So the 24.5% to 25% you expect to be at the higher end of the range.

That's correct. And that's consistent with my comments on the second quarter call, and I don't see that playing out very differently from that overall color that I just gave you.

I got it. And then just a question on Q4. And obviously, it's still muddy out there. But should we expect a lot of this -- should we, if the disruption is not as severe and we do think -- it seems like there may be a 4-week lag between when hospital capacity kind of stabilizes, but would you expect a return of these procedures or capital in Q4, especially since you've indicated that the majority of the business is not deferrable by more than 30 to 45 days. How are you thinking about Q4 like exiting the year at this point?

Yes. I mean I certainly think that is possible, Shagun. I mean if you go back to what we saw in the dynamics of Q1 and Q2, where you had some surging going on in the winter months in Q1 and saw some nice recovery in the second quarter. I would hope that Q4 could play out the same way that we'll see some nice rebound. In terms of capital, that's been one of the areas that has lagged in the recovery. And just like how I manage my own capital and my own business here in terms of capital spend, that's an easier one to kind of throttle back when there's some uncertainty. I still think about that capital could be very strong in the fourth quarter. Again, you're still with the budget years ending. Most of the countries where their budget years end in the fourth quarter. And typically, fourth quarter is our heaviest capital quarter. And it could play out the same way. I do think that hospitals are figuring out how to live with COVID a bit more and understand that they have to figure out how to get on with business and to be able to kind of live with a certain amount of COVID. And hopefully, that means that that capital will throttle back in. To what level? I don't know, but I'm encouraged by what we saw in the second quarter compared to first quarter, and that could mean that there's some nice rebound that happens in the fourth quarter. But we'll have to see ultimately how Q3 lands and where the team's confidence on those are on what they're seeing for Q4.

I got it. I got it. And just with respect to some product-related questions, just a follow-up. So you mentioned CereLink, and you are in a global launch for that product. And you mentioned China, that about half of the installed base opportunity is in China and that is kind of later in the -- in your projected period. So how should we think about CereLink and the ramp to the $30 million? Is it more back-end weighted? Like how should we think about contribution maybe in this year or next year?

Yes. So I want to go back to the reference of the $30 million. So that was a $30 million product line for us when we did the Codman deal. Because of certain FTC reasons, we essentially needed to divest of our legacy ICP monitor business at the acquisition. And that -- at that point, that was a $30 million divestiture for us. Now remember that that was a very mature product line. So you had capital, but you also had a recurring revenue stream. There's micro sensors that go with that capital unit. So it's got a nice business model and that you've got a capital piece, but you've got this recurring revenue stream. And so when we divested that, that was a very mature product line where you were probably 60% type of recurring revenue. So it's going to take us some time to get back up to that type of mix. So initially, when you launch, you're going to get the installed capital out there and then the recurring revenue stream will start to build. So it will take a few years to get out there. Half of the installed base is -- sits in the U.S. and Europe, and that's where our launch is. Our focus right now is in those 2 areas. And then as I mentioned before, the other half of the installed base, you're talking about like 8,800 type of units for the installed base globally. And about half of those sit in China. The launch for CereLink is planned for 2025. So you think about this -- steadily, you're launching, you're getting your units out in the U.S. and Europe, building your recurring revenue stream over the next few years. And then in 2025, you get another accelerator with the opportunity to bring that into China and continue to see that nice revenue growth. So it's a very nice product opportunity for us that will contribute to growth for many, many years for us.

I got it. That's helpful. And then I guess another follow-up, you mentioned the peripheral nerve repair business and the focus there. Can you just give us a little bit more of an update there and if that is an area where you need to build scale in order to be competitive? And I guess, just tied to that question, can you -- just M&A, like how are you thinking about M&A given the CEO transition? If you can give us some color for that particular business as well as overall, how Integra's thinking about deal capacity given your leverage and your need to build scale within the tissue technology business?

So just really quickly on nerve. We have a channel set up. We've got specialists. So we obviously have our wound reconstruction sales force that would be selling the nerve, but we've supplemented that with nerve specialists. Those are in place already. And so there's not a lot of what I'd call added infrastructure that we need. We're obviously very excited about getting that product launch in 2022, dropping it in the bag of our sales team with our nerve specialists and being able to address a part of the market that we haven't had before. So not a lot of incremental investment needed there to support that other than some marketing, promotional dollars and things like that, that we'll want to do. As far as your other question on M&A, the balance sheet is in really super good shape. Our net debt leverage is 2.4x. We talked about a window being comfortable of 2.5 to 3.5x. So right now, we're actually way at the low end of that, and that gives us a lot of flexibility. We are disciplined acquirers. Valuations still are high. And so it's important for us to find the right mix of assets that can fill the needs and the gaps that we have in our portfolio whether that be technology, whether that be market, international or whatnot. But we still expect to be very opportunistic here. And even with the CEO change, balance sheet is in really good shape. And I think Integra has proven to be a good acquirer of assets, and that will play very important in a prominent area of our capital allocation strategy, Shagun.

Got it. And a lot of -- a lot more questions, but we are out of time. Carrie, any last words from you?

No. I would just say, as I go back to my comments, I know COVID has had -- it's dominating a lot of conversations, but I go back to some of those comments of the great portfolio work that Integra has done and a lot of great catalysts here for the business over the next several years. I'm excited about what we have to bring to market.

Great. Carrie and Mike, thank you so much for time. I appreciate it.

Thank you so much.

Thanks, Shagun.