Integra Lifesciences Holdings Corp

Note: This report contains substantially new information. Subsequent reports will have changes highlighted.

Reason for Report: 1Q13 Earnings

Prev. Ed.: Apr 15, 2012; 4Q12 & FY12 Earnings (share price and broker material considered till Apr 12, 2012)

Brokers’ Recommendations: Neutral: 66.7% (12 Firms); Positive: 27.8% (5); Negative 8.3% (1) Prev. Ed: 8; 8; 0

Brokers’ Target Price: $41.46 (↓3.54 from the last edition; 11 firms) Brokers’ Avg. Expected Return: 15.6%

*Though dated Jun 11, 2013 share price and brokers’ material are as of Jun 5.

Note: The tables below for Revenue, Margins, and earnings per share contain fewer brokers’ material than the brokers’ material used in the Valuation table. The extra figures in the Valuation table come from reports that did not have accompanying spreadsheet models.

Portfolio Manager Executive Summary

Integra LifeSciences Holdings Corporation (IART) is a diversified medical products company that reports revenue under three business segments: Integra NeuroSciences, Integra Orthopedics, and Integra Medical Instruments.

Of the 18 firms covering the stock, 12 (66.7%) assigned neutral ratings and 5 (27.8%) provided positive ratings and 1 (8.3%) firm had a negative outlook.

Neutral and negative or equivalent outlook (13/18): The firms hold mixed reviews about Integra for 1Q13. They remain disappointed with the fact that in spite of the company’s results being in line with the estimates, however, the guidance provided by them is quite conservative. Regular FDA scrutiny remains a cause of concern for the firms. In addition, they are also worried about the product recalls taking place on a regular basis, which in return is hurting the company’s revenue. They further believe that the only reason owing to which the revenue has grown marginally is because of the robust growth in U.S. Extremities. But they do not see a further upside in the foot and ankle business, and hence expect the revenue to lower. According to the firms, on a general basis, problems faced by the company include problems in integration of acquired business, quality control issues which attracts regular FDA scrutiny and inability to improve margins. Although the firms are encouraged with the company’s recently provided long–term growth plan, they remain on the sidelines till further visibility is obtained, which is expected no sooner than FY14. However, the firms are encouraged to note that Integra witnessed minimum slowdown in surgical volumes compared to its peers under the challenging macroeconomic environment. They expect Integra to gradually emerge as a stronger player in the market based on its broad range of products. The firms believe that management will remain disciplined in its acquisition strategy and product launches.

Positive or equivalent outlook (5/18): The firms are encouraged with the in-line results of the company. The positive firms believe that ex-recall figures would have beaten the estimates, and hence remain encouraged regarding company’s performance. They further believe that FDA matters will stay for a while, though these will not be likely to affect the company’s financials. They are encouraged with the company’s five-year detailed restructuring plan for achieving 5% to 7% revenue growth with focus on improved profitability. The firms expect these measures to drive the company’s margins further. They consider Integra’s International setup as the key long-term revenue growth opportunity. They are optimistic as Integra caters mainly to non-elective procedures, which makes it a relatively safe investment. The firms also remain positive regarding Integra’s continuous improvement in regenerative medicine, improved inventory management and manufacturing efficiencies.

Jun 11, 2013

Overview

Integra LifeSciences, a world leader in regenerative medicine, develops, manufactures, and markets cost-effective surgical implants and medical instruments. The products are used primarily in neurosurgery, extremity reconstruction, orthopedics, and general surgery to treat millions of patients every year. Integra is headquartered in Plainsboro, N.J. and has research and manufacturing facilities throughout the world. Additional information is available online at www.Integra-LS.com.

Analysts identified the following factors for evaluating the investment merits of IART:

Note: The company’s fiscal year ends on Dec 31.

Jun 11, 2013

Long-Term Growth

Integra is the industry-leading company for neurosurgery products with expanding orthopedic businesses in the Extremity Reconstruction and Spine segments, one of the faster-growing markets in the medical device space. The company has a leading market share in neurosurgical implants (34.5% of FY12 revenue) and surgical instruments (22%), as well as an emerging presence in orthopedics (43.5%) driven by investment in extremities and spine.

The company has historically built its portfolio through acquisition, executing more than 40 deals since 2000 and effectively diversifying from its legacy collagen matrix product lines. Besides acquisitions, the company generates growth by leveraging its core biomaterial technology, adding to its sales force, and by increasing distribution capacity. Integra’s products cater to non-elective surgeries, which should provide some stability on the demand side, as these procedures tend to be recession-resistant. Since the beginning of FY09, the company acquired 6 businesses or product lines. The company generates strong cash flow, which can be used for acquisitions or to pay debt. The firms believe that the expansion of sales and distribution capabilities in the extremity reconstruction and spine businesses could generate better-than-expected sales growth.

Overall, the firms have a mixed long-term outlook on Integra’s business. While Integra enjoyed steady improvement in sales based on both acquisitions and organic growth, the same pattern of periodic acquisitions may not continue in the future. The company has a healthy pipeline of products, particularly in the higher-growth spinal area. Further, Integra faces competition from several larger players in both the neurosurgery and orthopedics markets. Going forward, the firms expect Integra to record 5% and 9%–10% growth in the top and bottom lines, respectively.

Even amid near-term macro challenges in Europe, international expansion remains vital to the company’s long-term growth strategy. Orthopedics remains in focus as it still represents the largest market opportunity. The company is expected to invest more in the necessary infrastructure to support geographic expansion and new product introductions, which should drive gross margin further.

Five-year Growth Target: During its analyst meeting on Oct 25 2012, Integra outlined its five-year growth targets. The company sees itself as a 5%-7% top-line and 9%-13% bottom-line grower over the next five years. Integra’s new CEO Peter Arduini provided a path to generate $100 million in cost savings and 400-500 basis points in gross margin improvement over the next five years. The company’s key initiatives include supply chain optimization, facility consolidations and standardizing IT and quality systems across all locations. The firms are impressed with Integra’s margin expansion strategy as according to them, over the past few years, the company’s mergers and acquisitions integration efficiencies were not up to the mark. However, they believe that achieving the long-term revenue growth could be difficult if there is no macro-economic recovery.

Jun 11, 2013

Target Price/Valuation

Risks to the target price and valuation include a slowdown in the economy, which is likely to impact hospital capital spending and elective procedures, competition, slower spine market, and integration issues associated with acquisition.

Recent Events

On May 2, 2013, Integra LifeSciences reported its 1Q13 results.

Highlights are as follows:

Ø  The company reported net loss per share of $0.15 in 1Q13, significantly down from EPS of $0.23 in 1Q12. Adjusted EPS decreased to $0.39 in 1Q13 comparison with EPS of $0.71 in 1Q12.

Ø  In 1Q13, revenues grew marginally y/y, from $196.7 million in 1Q13 from $196.1 in 1Q12, while on a constant currency basis also the growth rate was negligible.

Ø  For FY13, Integra guided revenue in the range of $840 million – $852 million from previously guided range of $865 – 880 million. GAAP EPS is expected in between $0.90 – $1.22 from previously guided range of $1.68 – $1.87, while on an adjusted basis, the EPS is expected in between $2.40 – $2.70 from previously projected $3.08 – $3.27.

Revenue

Integra reported total revenue of $196.7 million in 1Q13, versus $196.1 million in 1Q12, up marginally y/y (up marginally at CER). Recalled products adversely affected the company’s revenue by $2.9 million. Additionally, recall-related shortages affected the revenue in the range of $6 million and $7 million. The product shortages primarily affected the DuraGen and few products in the private label business.

Guidance: For 2Q13, the company expects the revenue to grow in the range of $205 million and $211 million.

For FY13, Integra guided revenue in the range of $840 million – $852 million from previously guided $865-880 million. In terms of percentage, revenue is expected to increase in the range of 1% and 2.5%.

On a segmental basis, growth in U.S. Neurosurgery is expected to be within flat to mid-single digit, U.S. Instrument revenues are expected to increase flat to low single digits, U.S. Extremities to grow within mid-teens and U.S. Spine & Other revenues to grow from mid-to upper single digits.

On Oct 24. 2012, Integra, reaffirmed its five years organic growth expectation of 5%–7%, based on 3%–5% growth in U.S. Neurosurgery, 2%– 4% in U.S. Instruments, 9%–11% in U.S. Extremities, 1%–3% in U.S. Spine and Other, and 10%–12% in International.

Segment Reporting

Integra reports its revenue under five categories: International, U.S. Neurosurgery, U.S. Instruments, U.S. Extremities and U.S. Spine and Other.

International (23.3% of revenues in 1Q13)

This segment sells similar products of the other four categories in the following geographies:

(i)  Europe, the Middle East and Africa

(ii)  Central/South America, Asia-Pacific and Canada

Total international revenue in 1Q13 was down 1.7% y/y at $43.6 million. Recall related problems affected the revenues on an international basis. However, the losses were partially offset by growth in spine implants, dermal and lube franchises.

On Jan 18, 2013, Integra introduced a device used for filling deep soft tissue or tunneling wounds. This also includes diabetic foot and leg ulcers. Integra introduced Integra Flowable Wound Matrix after its received European CE Mark Certification.

Five-year International Expansion Plan: Integra is currently working on its global expansion plan with a three-pronged strategy, which is based on international expansion, international penetration and international growth. The company expects the share of outside U.S. revenues-to-total revenues to increase to 30% from current level by 2017. Notably, in the last 18 months, the company expanded its sales footprint added in some of its European direct markets. Moreover, in Asia, it hired dedicated contributors, one in China and one in India, as well as a leader located in Singapore, managing the rest of Asia in order to focus on the targeted countries.

U.S. Neurosurgery (19.8% of revenue in 1Q13)

The U.S. Neurosurgery segment sells a full line of products specifically for neurosurgery and critical care such as tissue ablation equipment, dural repair, cerebral spinal fluid management devices, intracranial monitoring and cranial stabilization equipments.

Neurosciences revenue was down 3.0% y/y to $39 million in 1Q13. Apart from the recall related problems, the segment witnessed growth in capital products in critical care and tissue ablation. Cranial stabilization increased at mid-single digits.

On Apr 29, 2013, Integra introduced a new product that provides titanium implants for non-loadbearing (non-facial) operative cranial neurosurgical procedures, named Integra Compact Cranial Closure System. Within this product a disposable, pre-sterilized, battery powered screwdriver called Integra Compact Disposable Powered Driver is used. This is useful for fixing implant screws and plates.

U.S. Instruments (18.8% of revenue in 1Q13)

The U.S. Instruments business sells more than 60,000 instrument patterns and surgical products and lighting to hospitals, surgery centers, and dental, podiatry, and veterinary offices.

In the U.S. Instruments segment, revenue came in at $36.9 million in 1Q13, down 2.8% y/y. The decline in the sales was brought about by weakness in sales of Xenon lighting and alternate site products. Strengths were seen in sales of retractors, LED lighting headlamps and instruments.

On Jan 31, 2013, Integra entered into a three-year contract agreement with Premier Healthcare Alliance. Under this agreement, Integra would be supplying products like Ruggles- Redmond neuro/spine instruments, plastic surgery instruments, Padgett reconstructive, sterilization containers, Jarit surgical and laparoscopic instruments.

U.S. Extremities (15.9% of revenue in 1Q13)

The U.S. Extremities segment includes the U.S. extremity reconstruction business, which includes such offerings as skin and wound repair, bone and joint fixation, implants in the upper and lower extremities, bone grafts and nerve and tendon repair.

The U.S. Extremities surged 18% y/y to $31.3 million in 1Q13. Within the Extremities segment, growth was largely brought about by regenerative medicine and foot and ankle business. All the products within this segment achieved double-digit growth rate.