Hello, everyone. My name is Kristen Stewart. I'm the medical device analyst here at CL King. I'm very pleased to have Integra LifeSciences joining us today for this presentation, joined by Lea Knight, Integra's Executive Vice President and CFO, and Chris Ward, Senior Director of Investor Relations. This will be a moderated Q&A session. If you'd like to ask a question, please type it into the box on your screen and send it over to me. With that, let's begin. Lea, I'd like to start on the more significant news that came out of the last quarter, and that was the Compliance Master Plan. Can you discuss what led you to initiate the program, whether it was the finding of the audits, the FDA inspections, or whatnot, and what the program entails?
Certainly, and good morning, Kristen. Thank you for the opportunity of being here. So to your point, the Compliance Master Plan, what we learned coming out of the Boston remediation is that we needed to reevaluate quality systems across our manufacturing and supply network. Specifically, what we learned is we needed to be more effective at standardizing our control environment across the company. The Compliance Master Plan is our systemic holistic approach towards quality system and GMP compliance. As part of the scope of that plan, we are bringing together observations that we've made from our internal audit reviews across our network, along with observations we've received from regulatory authorities.
We're coupling that with assessment around the standardization of our control environment as well, and that's the work that we're going to progress over the next eighteen months, and we're going to deploy external resources as well as internal resources towards that effort. As you can imagine, this is also come with increased focus from a management team perspective, from a board perspective. We've created an entirely new standing committee that's now an official part of the board of directors that will focus in on quality and operations. We've increased investments in terms of our culture, our talent, our leadership.
We've also increased investments at our manufacturing facilities, focused on quality, resilience, as well as capacity, because we understand that we have to drive supply resilience not just for today, but in a more proactive fashion as we provide for the long-term growth potential on the business. And we know, as I mentioned, this is not going to be a quick fix, right? This is going to be a journey, but we are absolutely committed to doing the right thing for our customers, our patients, our employees, as well as our shareholders.
Okay, great. Can you just provide us with an update on the ship holds in neurosurgery? What is your level of conviction you can resolve them in the third quarter, and what does the guidance imply?
Yeah. So in the guidance that I provided in July, what we share is that, relative to the shipping holds, which relate to certain products within our neurosurgery division, we would expect to be able to release those shipping holds on a by-product, by-country basis as we progress through the third quarter and into the fourth quarter, and we're doing just that. As you can imagine, there is no greater focus in this business at this moment than getting our products back into the hands of our customers. As part of the guide that we provided for Q3 and Q4, what we said is majority of the shipping holds we expect to release in Q3, so that would bear most of the projected supply impact, but that some of it would continue into Q4 with a much smaller impact in that quarter.
The guide also provided, as you think about the top end and the low end of the guide, it provided for us an ability to release shipping holds either faster or slower. That's how you get to the top end or the bottom end of the guide for Q3. Beyond that, I'm not in a position to provide specific inter-quarter updates.
Okay. And to what extent should investors be prepared for additional findings that prompt additional ship holds or supply constraints beyond the ones you've identified?
Yeah, so we provided color as part of our Q2 call. As part of that color for 2025 , to think about kind of what's next, what we've said is, we think it's appropriate to expect that this business grows mid-single digits off of where we're now calling 2024 , and that contemplates both the strong demand for our products and our portfolio, along with the potential for additional supply disruption in 2025 as we progress the Compliance Master Plan.
It's important to note that as we progress the Compliance Master Plan, it's possible we will find additional items that require corrective action that result in a shipping hold, but it's also possible, and the expectation, that we're going to find just areas to strengthen our control environment that only require incremental resources and don't, in fact, require additional shipping holds. At this point, we don't have any knowledge of specific shipping holds that would be on the order of magnitude of what we've experienced in 2023 and 2024, but that is just the benchmark that we used as we thought about how to think about 2025 and the potential that exists, again, until we've progressed the Compliance Master Plan. Our 2025 color also includes things like Acclarent being in for a full year in 2025 versus 2024.
It also includes, you know, a general strength of the belief we have in the strength of this business, in terms of our ability to maintain mid-single-digit growth across, again, the core of the business that remains strong in 2024. Beyond that, I do want to be clear, we have not provided official guidance at this point. We will do that in our normal course, which is as part of our Q4 call. At that point in time, that will reflect also not only what's happening inside of Integra, but it'll also reflect those additional factors that have the potential to impact our performance, in terms of macroeconomic dynamics, like interest rates, currency, inflation, geopolitical dynamics. Those sorts of things will be part of our final guidance when we get to that point in our process.
Should we look at your preliminary outlook for FY 2025 as more of a worst-case scenario, more of a floor, since you're assuming, I think you mentioned, ship holds that are of the same magnitude as 2024?
Yeah. So, we're not going to characterize it as either a ceiling or a floor at this point. I think we just want investors to understand our early thoughts on 2025, understand that we still believe in the solid growth potential of this business, but also understand that we still need to do the work around Compliance Master Plan, and that as we deploy that, there could be the potential for additional disruption. And that, you know, as we know more and get further along the process, we'll be in a better position to provide those insights.
Okay.
And the other, and Kristen, the other thing I would call out is, I think the other piece of that we wanted to make sure was clear is that the nature of the investment in the Compliance Master Plan does require these incremental resources that I also mentioned, where, you know, we're going to be bringing on external resources and internal resources, which will have an impact on, you know, our gross margins, at least while we're progressing the Compliance Master Plan.
Okay, great. Maybe we can turn to the Boston manufacturing facility and Braintree facility. Can you provide us with your latest thinking on the moving to the new facility and your level of visibility on the timelines there?
Yeah. So as we announced in July, we have shifted our focus in terms of manufacturing SurgiMend and PriMatrix away from our original South Boston location into our long-term site in Braintree, Massachusetts. As you may remember, we always planned to get to this long-term site because we knew we were going to need additional capacity, and so that build-out was commissioned in 2022. Construction began in 2023. We now have a facility with kind of the four walls that are up, but we're still in the process of completing the construction, getting new equipment in, and getting our manufacturing systems up and running. As we mentioned, we expect to operationalize the site in the first half of 2026. But at this point, it's, you know, too early to speculate beyond that in terms of more precise timing.
As we complete our milestones or make progress against our milestones, we'll communicate them at that time.
What would be some of the milestones that you would be looking for?
Right now, the major one is getting the site operational. So that's the first major op erational milestone that's in front of us, again, recognizing that we're starting with a structure where the structure is up, but we still have to, you know, get the equipment in and turn the systems on and get it, you know, validated.
Okay, and will you need to conduct another audit or have an FDA inspection in order to start the facility?
We get this question a lot, and so I do want to clarify. As it relates to our 510(k) products, so SurgiMend, PriMatrix, we do not need an inspection in order to resume commercial distribution of those products. So as soon as we get the site operational, the manufacturing processes have been validated, we've addressed the observations that we've gotten, we can make the determination and resume commercial distribution for those products. As it relates to our PMA products, so we did receive a PMA approvable for SurgiMend, pending GMP certification. So in short, what that means is we completed the clinical submission requirements to get a PMA on SurgiMend. We still have outstanding items as it relates to the manufacturing requirements for the PMA.
And so, yes, we do need an FDA inspection to come in, make sure we've addressed those manufacturing elements. Once we've done that, we can complete our manufacturing part of this submission and then wait for full approval.
Okay, but just to be clear, for the rest of the 510(k), you don't need any sort of-
We do not.
Internal audits or anything?
Correct.
Done.
That's correct.
Okay, and then how should we think about the potential for share recapture once you've relaunched these products?
So we are confident in the market demand and market growth for markets like IBBR, implant-based breast reconstruction, complex hernia, complex wound reconstruction. We also have confirmation that both SurgiMend and PriMatrix are products with proven clinical outcomes that are competitively positioned in their respective markets in a way that other products can't easily replace their features and functionality. And as we look across the competitive landscape, we don't see other competitive products coming in that will completely replace how SurgiMend and PriMatrix perform in this space.
And so, we also have, at the same time, a broad portfolio that allows our reps to remain in front of our customers, and offer the position for other products to help in that space. So maintaining those relationships will become or will remain an important part of how we maintain our presence. As we get closer to commercializing and coming back, returning to market for SurgiMend and PriMatrix, we'll be in a better position to talk about actual share, regain, and capture. But as we're thinking about it, we still believe we have products that are well-positioned to perform that market when we're ready to return.
Okay, great. And, maybe we could switch gears to another product that was off the market for a little while and relaunching, which is CereLink. Can you maybe just comment on how the relaunch is proceeding and whether it's meeting your expectations?
Certainly. So we relaunched CereLink. We began our relaunch internationally in Q3 of 2023 , and continued it through Q4. We completed the relaunch in the last market, which was the U.S market, in February of 2024 . That business, on an annual basis in terms of the monitors, is projected to be about $12 million, and we've included a pro rata portion in our guide for 2024 , based on the final market relaunching. Through Q2, that business has been performing as expected, and we've seen not only performance on the monitors as we expected through Q2, but also double-digit growth in terms of our disposables on that business.
Okay. And are you still planning on launching a combo CSF catheter this year, and what do you see as the potential for that product?
Yeah, so we have market-leading offerings to address infection and occlusion, but we don't have an offering that does both in a single product, and so the combo product will do just that. It combines two world-class materials to minimize infection and occlusion risk in the form of our Bactiseal antimicrobial, as well as an Endexo additive that reduces surface thrombus accumulation, and so together, we believe the combo catheter will enable us to expand and protect our market-leading share in EVD shunts and other applications. Right now, the timing for that launch is planned to be 2025.
Okay, perfect. And Aurora Surgiscope is another product that you've highlighted in the past as being a growth driver. Any updates on how that's doing and the expected market opportunity there?
Yeah, certainly so. Aurora is advancing minimally invasive surgical approaches for brain lesions, as well as bleeding. It's actually a single-use visualization device that enables minimally invasive access as well as illumination. Yeah, we launched our next-gen Surgiscope, which seeks to improve overall visualization in the second half of 2023, and right now we're in the process of developing additional supporting instrumentation as well as accessories. We also know that to drive revenue in this space, we are going to have to drive surgeon adoption, and so we are investing in clinical trials as well as developing publications to help accelerate that. Right now, minimally invasive neurosurgery represents about a $50 million device market today, but we believe it has the potential to get to over $200 million by 2027.
Okay, and maybe switching gears to Acclarent. Revenue came in a little better than expectations in the most recent quarter. Can you talk just a little bit about how the acquisition's going and the market opportunity there?
Yeah. So Acclarent, Acclarent is tracking really well. It's tracking well, to your point, from a performance perspective through Q2, where we did exceed our guide by about $5 million for that quarter, which we've rolled into kind of our full year call. Our guide for the balance of the year does continue to reflect some level of conservatism. We're still early days in our integration. There's still the potential for some disruption, so that's contemplated in the guide. But the integration's also progressing well in terms of how the teams are coming together to cut over from all the kind of services from a manufacturing, operations, and supply chain perspective. As part of this deal, we negotiated with J&J transition services agreement, transition manufacturing agreement.
Some of them go up to about four years, because for us, it's a priority to make sure that we have a smooth transition with respect to all those dimensions, and that we're cutting over in a way that allows us to sustain the growth trajectory that we see on this business. The ENT market is growing mid-single digits. We expect Acclarent to be able to exceed that as we progress the acquisition, and we're expecting to do it on the back of some of the more recent innovation that this business has been able to launch, specifically innovation around navigation systems, so their TruDi navigation systems, along with opportunities that we see in an expanded indication that we've gotten in their Aera Eustachian tube system.
And so I think those things represent kind of our growth potential as we move this business forward to be able to sustain those kind of above ENT market rates.
Do you still expect the acquisition to be accretive to results in 2025?
Yeah, at the time we announced the acquisition, what we communicated was on an adjusted EPS per share basis, the business would be accretive in 2025, and yes, we're pacing to that. It'd be slightly accretive in 2025. We're pacing to that.
Okay, great. Maybe switching gears to tissue technologies, can you provide us an update on Integra Skin? How big of a business is that, and what are the challenges there?
Yeah. So Integra Skin is just under $200 million, strong gross margin, above our company average. We are continuing to make good progress in terms of driving production levels back to a place where we can meet our normal quarterly run rates. Originally, we had anticipated hitting those levels by the end of Q2. As part of the Q2 call, what we communicated is our production pacing at that time indicated that we would not get to that point until Q4. And based on that production pacing, we would expect the business to return to growth in 2025.
What's been some of the major challenges there?
Yeah, so in the, well, originally, when we communicated the challenges on Skin, it was, as part of our Q4 results. We had acknowledged that we had had equipment issues, that led to an inability to keep up with the demand that we were seeing on that business, and we had been seeing really strong demand on Integra Skin for the past couple of cycles. And, through Q1, we had anticipated addressing the equipment issues and then re-ramping our production capacity to get back to a point where we could keep up with demand. So that's kind of what triggered it. And since that, we've addressed the equipment issues and are now addressing kind of getting the production levels back up to where we need them.
Okay, great. And so you said it can return to growth in 2025. What level of growth generally could one expect?
Yeah, so for across tissue tech, that business, we expect a high single-digit growth across that business, and clearly, Integra Skin is one of the key products as part of that portfolio.
And can you talk a little bit about the implant-based breast reconstruction opportunity with DuraSorb and SurgiMend? I know earlier you mentioned that you got the approvable for the PMA for SurgiMend in breast reconstruction, but how should we just think about the timing of the opportunities and the size of the market as well?
Yeah. So the IBBR market is about $600 million and growing about 10%-12%. So as you can imagine, it's an exciting opportunity to opportunity for us, and we think represents we'll have an opportunity to have the first and second PMA in that space. So even as we look across DuraSorb and SurgiMend, which I should step back and mention, SurgiMend is our bovine-based biologic product. DuraSorb is our resorbable synthetic product. So we believe together form a complementary portfolio of options for surgeons in this space. And by having kind of what we believe will be first and second PMA in that space, it gives us an ability to promote in that $600 million market in a way that other competitive products currently cannot.
And so for us, as we move forward, you know, again, believe there's huge opportunity that we'll be able to provide more insight in terms of framing specifics as we come forward with our next LRP, but we're clearly excited about the current size of the market.
Just timing-wise for DuraSorb, is that something that could come, you know, in 2025, or is that something that we could see earlier? What are the timing there?
Yeah. So, the timing we've communicated on DuraSorb is 2025, 2026. That's the timeline we've given.
Okay, perfect. And you've also identified international expansion as a driver to top-line growth. Can you give us an update on how your international business is performing, and what regions do you expect to see the greatest growth?
Yeah. So international business, and we also continue to be excited about that business was growing, high single digits, and low double digits at times, depending on the region within that we're talking about. And it's done it on the heels of a strategy that's kind of three-pronged, right? First, it's just a sheer opportunity to take what currently exists within our portfolio in the U.S., outside the U.S. And then also to build on it, leveraging the innovations that we're bringing forward, and taking places where we currently operate outside the U.S. and penetrating those markets more deeply. And so we've been executing against that strategy. We've seen really strong double-digit growth levels specific in China and Japan. We've also seen strong growth coming out of Canada and Australia.
And so, yeah, we continue to be excited about our ability to drive forward along that path and have international be a key contributor to our long-term growth strategies.
Okay, and maybe switching gears to the P&L, how should one think about gross margins at the company this year and next? How much should the spending levels associated with the Compliance Master Plan come into play? And are these a permanent increase in compliance spending versus a more temporary increase?
Yeah, so what we've communicated for 2024 is on a full year basis, 2024 will decline in terms of gross margins off of 2023 by 150 basis points. Seventy of that we had framed as we started the year because of the supply challenges we had at that time, because of some product mix, some geography mix, and some higher scrap, lower utilization that we were seeing at that time. As part of Q2, when we shared the Compliance Master Plan, we also shared the fact that that plan comes with a need for increased investment in internal as well as external investment, that would drive an incremental 80 basis point impact in 2024 versus 2023. That's how we got to the 150 basis point.
And I should mention, part of that investment is not just resources, it's because we're likely to have lower productivity as we implement corrective actions. That's contemplated in that eighty basis points. So that describes 2024 versus 2023. As we move forward into 2025 , what we expect to happen is we will now be operating this Compliance Master Plan on a full year basis. So the annualization of that plan will have an additional 60-80 basis point headwind on margins, gross margins versus 2024 . To your point, as we get through the end of 2025 and we've implemented corrective actions, we start to stabilize portions of our network, we would expect a portion of the increased investment to continue going forward. At this point, we can't quantify exactly what portion continues going forward versus what portion goes away.
We look to do that in our next update around long-range plan, but I should also underscore the fact that the goal with respect to strengthening our overall quality control environment is we now have a manufacturing supply network that has a much more stable source of supply, so that you don't have these disruptions that we've seen as of late, and in doing so, we also will enjoy, from a margin perspective, the benefit of, you know, stronger product mix, right, as some of the products that we've seen impacted recently are products that have margins above our company average, so that should help as well as become more stable. Again, dimensionalizing that will be part of the work that we do in our next long-range plan update.
I guess directionally, should we think about gross margins improving in 2026? And maybe just talk a little bit more about some of the longer term drivers behind the margin improvement.
Yeah. So in addition to stabilizing our supply environment, which is again a core underpinning that we believe will drive margin improvement, it will be about implementation of a continuous improvement plan that will again seek to drive efficiencies in our cost structure as we move forward. We will also continue to look for opportunities to optimize our footprint that will also contribute to driving improvement from a gross margin perspective as we move forward. Again, splitting apart the piece parts to tell you exactly what the contributions are gonna be from each will be a function of the work that we do in long-range planning, so I can provide more specifics on that.
When should investors think about you guys updating the long-range plan? What's kind of the timing for that?
Yeah. So we would, what we said was, we are no longer gonna provide an update in 2024 . We would wait for the CEO successor to be on board and have time to digest the business before we come forward with our next long-range planning update.
Okay, and maybe on that topic, what is the latest on the CEO search? What are some of the key attributes you're looking for in terms of the candidate?
The latest update we have is the update that Stuart Essig, our chairman, provided as part of our Q2 call. Our board is currently underway with the CEO search. The board believes, based on the progress that they made, they'll have a CEO by year-end. As you can imagine, the number one priority for the business in this moment is a focus on continuing to strengthen our operation, quality, system, and supply. Absolutely, as you think about the next candidate, it'll be somebody with the capabilities to do just that.
Okay, perfect. Maybe we could talk a little bit about your balance sheet. Your leverage ratio is at 3.8x , which was above your targeted 2.5-3.5 goals. What are the timelines to bring that down?
So we, to your point, our ideal goal is 2.5-3.5 . We knew we would be above that at the end of Q2 as we completed the Acclarent acquisition, so that was expected. At that time, we had anticipated being able to drive leverage back down to within range by the end of 2024 . That said, with the announcement of the shipping holds, that changed. That's no longer true. As we get beyond the shipping holds and we start getting back to kind of our normalized cash flow generation, that's when I would anticipate being able to drive our leverage back down into our ideal range.
Timelines for that, we're projecting 2025- 2026, and the reason why it's that range is because it does depend on as we progress the Compliance Master Plan, to the extent we identify additional supply disruption, it could impact kind of how fast or slow, right? We drive our leverage back down. So that's the only reason why it's that wide.
Okay, and can you talk a little bit about how you're planning for the convertible debt that comes due next year, and how one should think about your interest rate risk exposure?
Yeah. So, to your point, we have $575 million of converts that are coming due in August of 2025. Given the strength of our balance sheet and the flexibility and the size of the revolver that we have, we do have an ability to settle that maturity on a revolver, and we would do that just for the mere fact of kind of where our stock price is right now, along with kind of the current interest rate environment. At the same time, we also have an interest rate swap portfolio that will allow us to fix, in terms of interest rate, about $900 million of our debt. Doing that will allow us to keep our interest rates in the low three- our all-in interest rates in the low kind of 3% range through 2027.
That flexibility is what we're going to leverage to be able to give time to adjust the stock price and evaluate the interest rate environment to determine a more permanent solution from a financing perspective.
Okay, and how should one think about your free cash flow and free cash flow conversion this year and next? Is there a lot of CapEx spending related to the Compliance Master Plan and Braintree build-out?
Yeah, so originally, again, we had anticipated getting back to kind of north of the 75% free cash flow conversion rate by Q4, and that was prior to our Q2 kind of update. Post that, right, we now need to get beyond to kind of more normalized cash flow generation to start to get back into that range. Which we again, getting back into kind of the north of 75% is still doable, but again, once we get to more stabilized cash flow generation. From a CapEx spending perspective, we have in our 2024 CapEx spend is around $75 million-$80 million. It does reflect, to your points, investments in Braintree, that we would have expected to start to tail off.
Given our Compliance Master Plan and the fact that we will be investing in incremental capacity, as well as assets across our manufacturing footprint, we would expect to stay in that $75 million-$80 million range for longer, and so certainly in the next couple of years. As part of our long-range planning, though, we'll pull together a more fulsome picture as to what that investment profile will look like and for how long. Certainly in the next couple of years, we would look to stay in that $75 million-$80 million range.
Okay, and then, we just have about a minute left. Are there any closing remarks you'd like to make, or maybe comments on what you think is the most underappreciated part of the Integra story?
Yeah. So it's, you know, clearly, as we talked about, some of the operational challenges that we are facing as a business. It would be very easy to let those challenges define the potential for this business, and I would caution anyone against that. I think, you know, as you look at the attractive markets in which we operate, they're stable. They're characterized by markets where surgeons' choice still matters, product differentiation matters, and we have differentiated products that our surgeons want. We also have a large sales force that has well-established, trusted relationships with our customers that go a long way to, you know, helping surgeons in terms of meeting their unmet needs, but also in driving the growth that we've seen on this business, and we're continuing to invest there.
We also have attractive growth potential in terms of the innovations we're bringing to market, some of which we talked about here, around our combo catheter, as an example, and our international expansion strategy. So there are a lot of great things that this business has the potential to continue to drive and do, but we know and understand that we have to address the operational challenges that are in front of us, and we are committed to doing exactly that.
All right. With that, I think we're out of time. So Lea, I just want to thank you again for your participation today, and everyone can now disconnect.
Thank you, Kristen.