Hello and welcome to the Integra LifeSciences Third Quarter 2022 Financial Results. My name is Caroline, and I will be your coordinator for today's event. Please note call is being recorded. For the duration of the call, your lines will be on listen-only. However, you will have the opportunity to ask for questions at the end of the call. This can be done by pressing star one on your telephone keypad to register your questions. If you require any assistance at any point, please press star zero and you'll be connected to an operator. I will now hand over the call to your host, Chris Ward, Senior Director, Investor Relations, to begin today's conference. Thank you.
Thank you, Caroline. Good morning, and thank you for joining Integra LifeSciences Third Quarter 2022 Earnings Conference Call. Joining me on the call are Jan De Witte, President and Chief Executive Officer, and Carrie Anderson, Chief Financial Officer. Earlier today, we issued a press release announcing our third quarter 2022 financial results. The release and corresponding earnings presentation, which we will feature during the call, are available at integralife.com under Investors, Events and Presentations in a file named Third Quarter 2022 Earnings Call Presentation. Before we begin, I would like to remind you that many of the statements made during this call may be considered forward-looking statements. Factors that could cause actual results to differ materially are discussed in the company's Exchange Act reports filed with the SEC and in the release. Also, in our prepared remarks, we will make reference to both reported and organic revenue growth.
Organic revenue growth excludes the effects of foreign currency, acquisitions, divestitures, as well as discontinued products. Unless otherwise stated, all disaggregated and franchise-level reporting revenue growth rates are based on organic performance. Lastly, our comments today will include certain non-GAAP financial measures. Reconciliations of any non-GAAP financial measures can be found in today's press release, which is an exhibit to Integra's current report on Form 8-K filed today with the SEC. With that, I will turn the call over to Jan.
Thank you, Chris, and good morning, everyone. Let me start by reviewing our third quarter and year-to-date business highlights on slide four. Looking back to Integra's performance over the past nine months, we started the year strong, with the second quarter building nicely from our first quarter momentum. Despite choppy waters in the microenvironment and disruptions within our supply chain, we capitalized on the steady recovery of procedures in our markets while protecting our profitability in an inflationary environment. Over the third quarter, we continued to see a recovery of procedure volumes leading to solid growth across most of our product portfolio. At the same time, we largely contained the impact of the challenges, such as increased foreign exchange headwinds and continuing supply challenges. While also reacting decisively to minimize.
Growth of 3.5% and absorbing the impact of the recall of CereLink in the quarter. For a bit more color in the third quarter of just over 5% for the remainder of the portfolio. Solid performance in the first half of 2022. I will provide an update on the CereLink recall shortly. Overall, I'm pleased with our sales performance in the quarter. We continue to see solid recovery in our markets, and our diverse portfolio gives us confidence in our ability to grow through the current challenges and into the future. As expected, supply challenges and elevated backorders have continued through the third quarter, and we anticipate these higher levels will remain through the remainder of 2022, with most of the impact felt in our CSS business.
We're deploying mitigation strategies to reduce the backorder levels to keep up with strong customer demand, such as increasing raw material safety stocks on constrained commodities like packing materials, metals, and electronics, and qualifying and validating alternative sources for supply of critical items. Our top priority remains ensuring our patients get the life-saving products that they need. Despite the challenges faced in the quarter, we proactively managed our cost and delivered adjusted earnings per share above the top end of our guidance range at $0.86. As a result of our strong third-quarter earnings performance, we are raising our full-year adjusted EPS guidance by $0.15 at the midpoint, above the high end of the August range. Moving now on to a number of business highlights for the quarter. Let me start by providing an update on the status of the recall of our CereLink ICP monitor.
As a reminder, on August 18, we initiated a voluntary product removal of all CereLink monitors as a result of customer reports about units whose pressure readings were out of range. These out-of-range readings occurred at a low incidence rate and at a limited number of sites. However, out of an abundance of caution, we decided to remove CereLink monitors from the field. Over the past two months, we have worked with customers to get loaners of the previous generation ICP monitor, the ICP Express, out to them. ICP Express, a less feature-rich monitor, but is compatible with our CereLink microsensor. As a result, we've been able to provide the large majority of our customers with a solution that secured their continuity of operations and care for their patients.
Engineering team has been working diligently, and we believe we have identified the root cause and a technical fix to rework the CereLink product. Now focused on developing test procedures to validate our remediation plan and meet the regulatory and quality requirements to enable us to start shipping the product again. There's still some uncertainties as to specific dates, but based on our current pathway, we aim to bring CereLink back into our markets in the first half of next year. As we turn to our Q3. Over the third quarter, we advanced two new CUSA Clarity products, further extending the functionality of our ultrasonic tissue ablation product line. First, we launched CUSA Clarity extended laparoscopic tip in the U.S., bringing the benefits of ultrasonic ablation to minimally invasive laparoscopic liver procedures.
Second, we received approval for our CUSA Clarity bone tips used when controlled fragmentation, emulsification, and aspiration of bone is necessary. Additionally, we continue to refine our portfolio with successful completion of the divestiture of our traditional wound care business. In the third quarter, we also announced organizational changes and new leadership appointments. Please move to slide five for this. As we eliminated the COO position leading to the departure of Glenn Coleman, operations and quality now reports directly into me. In addition, two new leaders joined our executive leadership team in roles that align with key strategic growth factors of the business. Harvinder Singh joins us as President of International. Harvinder brings 25 years of experience in global healthcare commercial roles, specifically in the medical technology and pharmaceutical industries.
With Harvinder, we will look to deepen our focus on developing and executing local product market strategies while continuing to build out Integra's international commercial capabilities and strengthen our presence in these key strategic markets. Mark Jesser also joins Integra as Chief Digital Officer. Mark has 15 years of experience successfully developing and launching digital platforms and strategies that create transformational solutions for healthcare customers and patients. He also has prior experience in consulting, marketing, and product management. Mark is partnering with our commercial, strategic marketing, and business development teams to define and execute digital proposition strategies that will enhance Integra's device portfolio and our positioning in the digital health ecosystem. Now before I hand it over to Carrie to go deeper into our financials, I'd like to turn to slide six for a progress update on our ESG journey.
Sustainability is an integral part of how we do business, and we hold ourselves accountable for being good stewards of our resources for the benefit of our customers, employees, shareholders. Effective ESG management enables us to produce life-saving products, reduce business risks, minimize our impact on the planet, and drive strong financial results. In 2022, we have made great strides in formalizing our ESG roadmap. We completed a materiality assessment with our key stakeholders and continue to use that feedback to guide our priorities. In the third quarter, we issued our inaugural ESG report as part of our commitment to transparency in this area. We have invested in our culture of diversity and inclusion and the development of our people. We are excited about our future as we set new targets and measures of accountability to pursue tangible results and benefits for our stakeholders.
With that, I will turn the call over to Carrie, who will go into our third quarter performance and updated guidance.
Thanks, Jan, and good morning, everyone. I'll start with a brief summary of our quarter financial highlights on slide seven. Third quarter total revenues were $385 million, approximately flat on a reported basis, inclusive of a TWC divestiture impact of $3 million and a $12 million impact due to unfavorable foreign exchange compared to last year, representing an approximate 300 basis point negative impact to reported growth. The US dollar further strengthened in the quarter, creating an additional 40 basis points of FX headwinds compared to our guidance. Excluding the impact of FX and discontinued and divested products, we delivered 3.5% organic growth in the quarter.
As Jan mentioned, excluding CereLink, organic growth across the remainder of the portfolio was just over 5%, which speaks to the diversity of our portfolio and continues to give us confidence in our long-term growth expectations as we move past the current macro challenges and target to bring CereLink back to market in the first half of next year. In Q3, we recorded a $1.5 million provision for CereLink product returns as a reduction in net revenue. This was much lower than initially expected for the quarter as we evaluated customer feedback, including refund requests and the timing to return the product to market.
We view this as very positive as it demonstrates the success of our efforts in assisting our customers in minimizing the disruption in their care for patients through our loaner program, and even more importantly, it showcases that our customers see differentiation with the CereLink product and are willing to wait for its return. Two highlights in the quarter were Tissue Technologies with organic growth above 7% and International organic growth of 4.6% despite the impact CereLink recall. Adjusted EBITDA margin for the quarter was up 30 basis points versus the prior year, and adjusted earnings per share was flat at $0.86, much higher than our guidance expectation, reflecting strong operating expense management and a lower CereLink impact.
If you turn to slide eight, I'll review the third quarter revenue performance of our CSS segment. Reported Q3 revenues in CSS were $240 million, an increase of 1.6% on an organic basis from the prior year. Excluding CereLink, organic growth was 4.3% across the remaining parts of the CSS portfolio, in line with our long-term growth expectation of 3%-5%. Global neurosurgery sales were up 2.3%. Advanced energy increased low double digits, driven by strong CUSA capital sales. CSF management grew high single digits, driven by continued growth in our programmable valves. Sales in neuro monitoring were down low double digits due to the CereLink recall.
Sales in instruments declined approximately 1% in line with expectations as year-to-date growth of 2.8% aligns to our long-term expectations of low single-digit growth for this franchise. International sales in CSS increased low single digits, led by double-digit growth in China and Japan and mid-single-digit growth in our indirect markets. Growth in China was driven by timing of orders in the third quarter from our distribution partners who anticipated COVID lockdowns would ease in Q4. We now expect lockdowns to continue on a rolling basis, and consequently, we anticipate our fourth quarter sales in China to be sequentially lower than in Q3. Moving to our Tissue Technologies segment on slide nine. Global Tissue Technologies reported revenues of $135 million, 7.2% organic growth over the prior year.
Our strength in TT was driven by 8.5% organic growth in wound reconstruction, led by sales of Integra Skin, AmnioExcel, and ACell MicroMatrix. We were pleased with the continued momentum of ACell, delivering both sequential growth and high single-digit year-over-year growth. In our private label franchise, sales grew 2.9%. This result was better than expected as year-to-date growth of 11% continues to be above our long-term expectations for this business. We expect full-year private label growth to continue to moderate to mid-single digits in line with long-term expectations. Finally, international sales in tissue technologies increased mid-single digits, driven by SurgiMend. Turning to slide 10, I'll now review our third quarter and nine-month key P&L components. Adjusted gross margin was 66.7%, down 180 basis points from the prior year.
The lower gross margin was due in part to unfavorable regional mix driven by higher international sales and by a 30 basis points impact from accruals booked in the quarter for the CereLink recall, including the returns provision I talked about earlier and an $800,000 rework accrual. The largest drivers of the lower year-over-year gross margin, which were expected and included in our guidance, were currency impacts as well as higher unfavorable manufacturing variances from earlier in the year, moving to the P&L as we sold through our inventory during the quarter. Q3 adjusted EBITDA margin increased 30 basis points, and year-to-date adjusted EBITDA margin and EPS finished better than our August expectations. We actively managed operating expenses through the quarter as we navigated through the uncertainty of the recall and continuing macro challenges while remaining focused on advancing our key growth initiatives.
As we think about margins for the year, we expect adjusted gross margin to be down modestly, largely due to the impact of the CereLink recall. However, we now expect adjusted EBITDA margins to be slightly higher compared to 2021, benefiting from continued cost optimization. If you turn to slide 11, I'll provide a brief update on our balance sheet, capital structure, and cash flow. Operating cash flow in the quarter was $68 million, and free cash flow was $59 million. Free cash flow conversion was 70% on a trailing 12 basis points, reflecting higher capital spending compared to the prior 12 -month period. Our balance sheet remains strong with ample liquidity to support our short and long-term plans. As of September thirtieth, total debt was $1.5 billion, of which over 90% was fixed, and net debt was $1 billion.
Our consolidated total leverage ratio was 2.4x . The company had total liquidity of $1.75 billion, including $512 million in cash and the remainder available under our revolving credit facility. Turning to slide 12, I'll update our consolidated revenue and adjusted earnings per share guidance. For the full year 2022, we are reaffirming our revenue expectations at the midpoint of our August guidance with a tightened range of $1.551 billion-$1.563 billion. The revenue range represents reported growth of 0.5%-1.3%, inclusive of the divestiture of the TWC business and an updated foreign currency outlook. Our full year revenue guidance reflects an additional 25 basis points of unfavorable foreign currency impact relative to guidance provided in August.
Foreign currency is now expected to unfavorably impact full year reported growth by approximately 250 basis points compared to the prior year, driven by the continued strength of the US dollar. Full year organic growth is expected to be in a range of 3.7%-4.5%. Our organic growth range reflects the impacts of continuing regional COVID-19 lockdowns in China and potential adjustments to the CereLink returns accrual that may be necessary in Q4. Full year 2022 adjusted EPS guidance is being raised to a new range of $3.29-$3.33. This represents $0.18 raise at the midpoint of our August guidance, reflecting our outperformance in the third quarter.
For the fourth quarter, we expect reported revenues in the range of $391 million-$403 million, representing reported growth of approximately -0.5% to -0.6% and organic growth of approximately 1.3%-4.3%. Adjusted EPS for Q4 is expected to be in the range of $0.87-$0.91. If you turn to slide 13 to provide further helpful context, we've included a reconciliation of our original full year 2022 guidance from February to our current October guidance. Let's start with the table on the left, which shows you the revenue walk.
After adjusting our original February guidance for $27 million from the change in currency rates and $10 million from the divestiture of our TWC business, our October revenue guidance remains above the midpoint of the pro forma February range, overcoming additional revenue headwinds related to supply challenges and the CereLink recall. We've provided a similar walk on the right side for adjusted EPS. By delivering on our revenue and actively managing costs, we expect to fully cover the impact of FX, the TWC divestiture, as well as additional inflation and manufacturing inefficiencies this year, resulting in an updated earnings outlook above the pro forma February guidance. I'll now turn the call back over to Jan to provide a brief recap of our 2022 growth catalyst and margin drivers.
Thank you, Carrie. Let's turn to slide 14, our final slide. Our year-to-date organic growth of 4.6%, including the CereLink headwind, and approximately 5% excluding CereLink, reflects the diversity of our portfolio and our team's ability to navigate the current unique challenges. In addition to delivering on our 2022 commitments, we have remained focused on strengthening our key growth catalysts to build towards our long-term organic growth target of 7%. In our international business, we have delivered just under 6% organic growth year-to-date. As we plan for 2023 and beyond, we have identified investment opportunity in our international markets based on the roadmaps we developed earlier this year. With an experienced international commercial leader like Harvinder joining the executive leadership team, we're further building our capabilities to capture incremental international opportunities across our segments.
On CereLink, we're working aggressively to limit the impact of the recall on the operations of our customers and their care for patients. We are pursuing a path to bring the CereLink monitor back to the market in the first half of 2023. Our customers remain excited about the product features that set the CereLink monitor apart from legacy intracranial pressure monitors. We continue to believe CereLink will be a multi-year growth driver for the company. As we discussed in our second quarter call, we set a goal to return our ACell portfolio to growth in the second half of 2022. We have met this with our third quarter results. With ACell products now solidly contributing along with our legacy Integra Skin portfolio, we enjoyed organic growth for our wound reconstruction franchise north of 8% for the quarter.
We're also looking forward to the launch of ACell's MicroMatrix and Cytal products in several European markets scheduled for the first quarter of 2023, which will be a great demonstration of our opportunities to take existing products into new international markets. Our Aurora Surgiscope is continuing to build momentum with our early adopters. Aurora was included for the first time in a peer-reviewed publication. We have provided a link in our press release and invite you to read the article and view the short video vignettes. With regard to our SurgiMend breast PMA, we continue to work interactively and collaboratively with the FDA on our response to the feedback we received panel meeting prior to submitting a final PMA amendment. This was planned for February 2023.
However, last week, the FDA proposed an unsolicited COVID-19 related 180-day extension of the PMA amendment timeline. We're still assessing whether we believe the extra time will benefit our submission. In any case, we continue to feel optimistic we will receive FDA approval of a specific indication for use of SurgiMend in post-mastectomy reconstruction. As a reminder, the FDA has not cleared or approved any surgical mesh device, whether synthetic, animal collagen derived, or human collagen derived, specifically for implant-based breast reconstruction. Today, Integra is the only company to file a PMA for a specific indication. We remain committed to help solve the urgent clinical need for an FDA-approved ADM to help restore quality of life for women undergoing alloplastic breast reconstruction. In the meantime, SurgiMend continues to be a strong growth contributor in our portfolio with year-to-date growth of low double digits.
Finally, with NeuraGen 3D, our nerve repair product engineered for optimized mid-gap nerve regeneration, we enrolled our first patient in our re.INVENT Nerve Registry. The re.INVENT Registry will allow us to gather real-world data across our nerve repair portfolio, identify key points of clinical differentiation, and leverage the database to engage our KOLs and key customers. We're also keenly focused on securing our operations and margins for the remainder of the year and on driving margin expansion beyond 2022 as inflationary and supply chain pressures abate. We have continued our portfolio optimization with the divestiture of our traditional wound care business, with the closure of a high-cost production site, and we are in the stages of completing the back-office outsourcing initiative we announced last quarter.
We're also stepping up our focus on driving manufacturing and supply efficiencies, optimizing our sales effectiveness, and pursuing opportunities to further capture price in order to drive long-term margin improvement. In summary, we continue to drive the business forward in a number of ways by focusing on our customers and their patients, our strong portfolio of market-leading products, our engaged organization, and on the external environment with its mix of opportunities and challenges. In parallel, we're building out capabilities and investing in our longer-term strategic opportunities. We'll remain focused on executing in the fourth quarter and delivering a strong finish to the year. Also, before concluding and going into Q&A, we'd like to announce that Integra will host our next Investor Day in May of 2022. With that, I'll open the line for questions. Caroline, could you please open the line for Q&A?
Sure. Noted. As a reminder, if you would like to ask a question or make a contribution on today's call, please press star one on your telephone keypad. We will take the question from line Robbie Marcus from JP Morgan. The line is open now. Please go ahead.
Hi, this is Alan on for Robbie. I had one quick one followed up by another question. Just to start off, for your updated guidance, CereLink, you know, clearly came in quite a bit better than expected when it came to the return provision. What are you really baking in for the fourth quarter impact here?
Yeah. We're not providing specific guidance on CereLink in Q4. I would say that we booked $1.5 million returns provision in Q3. That was, as you said, much better than where we expected, and we view that very positively as customers continue and are willing to wait for the new CereLink to be relaunched. We view that as a sticky product, which is great to see, and we continue to help them ensure that they've got continuity of care in the interim. I think in Q4 we have a range of our guidance for Q4 that would consider both potentially positive and negative adjustments to that accrual.
In Q4, we will assess new information, any new trends that we're seeing on customer returns, credits processed. We'll also assess our progress on our return to market. We'll also assess our manufacturing plans, and we'll take a look at all of that information in Q4 to make an assessment on whether the $1.5 million returns provision is sufficient in Q4 or whether we need to make an adjustment plus or minus, and the same thing for the rework accrual of $800,000. We'll take in all available information in Q4 and make a sufficiency assessment there in Q4. Our range of the high and the low end of that range contemplates, again, potential favorable or unfavorable adjustments to CereLink.
Overall, I think our view is a positive development as we currently assess where we sit on the returns.
Got it. Another question just on SG&A. We clearly saw, you know, really good leverage this quarter, a very significant step down sequentially of around $50 from Q2 to Q3. I'm just curious how sustainable that really is going forward. Is that really kind of, you know, the kind of down to the $140s, the kind of spend that we should expect on SG&A in third quarter? Was there any kind of one-time spending items that, you know, didn't happen or not, I guess, the opposite of one-time spending items that didn't happen in the quarter that will resume going forward? Just trying to get an idea of what we should think of as a sustainable SG&A spend level going forward. Thank you.
Yeah. It's a great question. Obviously, we worked actively to manage the spend in Q3. A couple of things that I would point out. Normally, as you move from Q2 to Q3, there is a little bit of seasonality of lower OpEx. If you look historically, Q3 OpEx is typically a little bit lower than Q2. I would expect in Q4 that our OpEx will increase a little bit from the Q3 levels. I would expect that our OpEx levels for 2022 are very similar to 2021. I think we'll be in that same level as we were year-over-year.
One of the things that, you know, we've been focused on in the second half of 2021 and in the first half of 2022 is we brought on a lot of headcount. At this point, I think we're absorbing that headcount, we're integrating that headcount in, and also just watching our expenses and making sure that we get the full optimization of that investments that we've made over the last 12-month period. I think that's what you're seeing there. Caroline, can we take the next question?
Sure. We will take the next question from Ryan Zimmerman from BTIG. The line is open now. Please go ahead.
Oh, thank you for taking my question. Couple questions for me, Carrie and Jan. I appreciate the color.
Just to maybe follow up on Alan's question. I understand CereLink can go in a lot of different directions, but, you know, the 50 basis point decline in organic growth guidance for the full year, is that all assumed to be the impact from China? Is there anything else in there that we need to contemplate in terms of the updated organic guidance? Then I have a follow-up.
I think, you know, it's a combination of obviously. Let's start with the reported first, because obviously FX is a big impact in the fourth quarter with updated FX information. I would say as we move to organic growth, considerations of obviously potential adjustments in CereLink that may be necessary, as well as COVID continued rolling lockdowns in China. Then the fact I would say also, Ryan, is that we're not considering any significant improvement in back orders. I think when we were sitting probably here in the July timeframe, we had hoped that we would have seen some amount of modest improvement in back orders over the course of Q3 and Q4.
At this point, we're seeing continued elevated back orders and don't expect any significant improvement in back orders in Q4. All of that's comprehended and staying at the midpoint of our guidance range that we gave in August.
Okay. Very helpful. Just maybe a bigger picture question in terms of procedure recovery. You know, if we look at kind of where neurosurgery is right now, you know, 2%, you think about that in contrast to wound recon. I'm wondering, Jan, if you'd kinda talk about the procedure recovery amongst the two segments and, you know, 2.3%, you know, still is under kind of that normal threshold, I think that we think of for neurosurgery in that 3%-5% range. You know, how are you thinking about the procedure recovery amongst neurosurgery and then maybe, you know, contrast that with wound recon and how that's, you know, kind of progressed back and how you think that progresses going forward. Thank you.
Ryan, I'll take that first, and then I'll ask Jan to add his comments. Remember that the neuro number there is impacted by the CereLink recall. If you exclude the CereLink recall, for CSS, our number moves to 4%, over 4% growth. There's a footnote on that slide that gives you the adjustments there. I would say that excluding the impact of taking CereLink out in both periods, the underlying business of CSS is. It was actually right in line with our expectations of 3%-5%. Jan, additional comments there?
It partially answers the broader question. If you look, we've seen over 2022 procedures recover steadily. We're not at 100% yet, neither in CSS nor in Tissue Tech. When in US markets, European markets, we estimate we're around 95%, plus minus at this point. We expect that between now and the end of the year, beginning next year, we'll be back to normal procedures level, except China, right? As long as the rolling lockdowns continue in China, we see China at around 80% of normal procedure levels, but the rest of the world steadily going back to the 100%.
Thank you. Appreciate the color.
Thank you. We will take the next question from line, Dave Turkaly from JMP. The line is open now. Please go ahead.
Hi, good morning. Just looking at the highlights of some of the initiatives you announced last quarter. You know, you sold the nontraditional or non-core wound, closed the facility in France. You mentioned some outsourcing, I think, back office type stuff. I was curious how those efforts progressed during the quarter. It looks like you're able to offset some of the cost increases. Yeah, I guess how should we think about that and maybe what would that impact on our gross margin moving ahead?
Yeah. Hey, Dave, I'll take that question. TWC, we did close that divestiture at the end of August as we had planned. One of the reasons for the divestiture was that it was not core to us, either from a top line, it certainly was not additive to our 5%-7% growth ambitions. It was also lower than our corporate average margin as well. Moving away from that, divesting that business and focusing on our core portfolio, ultimately, we'll see as we move through more of these macro inflationary challenges, we'll start to see the positive impact of that on our margins into 2023. That was completed as planned in the quarter. For the facility in France, we closed that.
The production is now moving into our Switzerland facility there. That transfer should be complete by the end of the year. That's a high-cost facility. Again, as I think about levers in terms of gross margin improvement, that continues that cost optimization. I would expect you'll see again a full year benefit of that moving into 2023. For outsourcing, you will start to see some of that benefit in the fourth quarter. I know there was a question regarding OpEx expenditures. Certainly, in the fourth quarter, we'll start to see the benefit of the lower cost to serve of some of those outsourced back-office activities, and you'll have the full impact of that into 2023.
In my view, there's a lot of underlying levers here for gross margin improvement as well as OpEx leverage as we move into 2023. Hopefully, we're in an environment where the inflationary increases abate and combined with our other initiatives like price capture, favorable mix as we continue to drive NPIs and TT growth, all of that will be able to be more visible in our gross margin and our EBITDA margin lines in 2023.
Great. I guess my very quick follow-up would just be, it sounds like you're still confident that 70%-72%, you know, that long-term target for gross margin is still achievable, when we get back to a bit more normal environment. Is that fair?
I think that's the key is, you know, when do we get back to a more normalized environment? There's nothing that I would say that nothing in the business that has been impacted suggests that we could not reach 70%-72% gross margins. It's a question of the timeline to get there and to reach that. I think we continue to work on a number of visible levers to expand our margins. We've just got to get through some of these macro challenges and get to a more normalized environment. I think all of those drivers are still there. They're just being masked by some of those macro challenges.
Thank you.
Thank you. We will take the next question from line Vik Chopra from Wells Fargo. The line is open now. Please go ahead.
Hey, good morning, and thanks for taking the question. Just to follow up on that OpEx question, Carrie. I'm just wondering, you know, if you'll be able to get back to the high end of the 5%-7% growth range while managing your expenses. I appreciate any color you have on that. My second follow-up was on the capital environment, the CapEx environment. You know, what are you guys seeing over there? Maybe if you can sort of parse that out between US and international, that would be appreciated. Thank you so much.
Yeah, I'll start with the capital question and then go to your cost question then ask Jan to add some comments there as well. In terms of capital, I think you have to kind of separate out the CereLink impact. If you take out CereLink, both from the prior period and this period, our underlying capital was strong. It was low double-digit growth in the quarter, and that was the direct result of a very strong growth in CUSA capital. We've seen some nice growth, you know, year to date, but certainly third quarter showed the resiliency of the portfolio in terms of CUSA and that double-digit, low double-digit growth.
I would say we saw growth both in international and the U.S. in that CUSA capital. We do expect that we would see sequential growth going from Q3 into Q4, and still year-over-year growth in capital into Q4, but probably not as high as a level that we saw here in Q3. It could be timing issues. We were quite surprised at the strength of the CUSA capital here in the third quarter, which was nice to see. On your question of balancing the OpEx, the operating expenditures against the growth target of 5%-7%. Certainly, I'd ask Jan to comment here, but in terms of my view, it's about cost optimization. It's about prioritizing and challenging what we've historically spent on.
In an environment where you have lots of macro challenges, including inflationary headwinds, it is up to us, our management team here, to really scrutinize what we're spending on, almost apply a zero-based budgeting approach and really looking at what we spend and making the hard and tough decisions on pivoting towards what's most important in our spend. Maybe I'll ask Jan to comment there as well.
Yeah, just to build on that. As over the summer, we were looking into the business, and after me having been here more than six months, it was the right time to challenge, you know, all the costs that we had brought on board over the past couple of years, and question with a zero-based approach, but question redeploying of resources rather than continuing to add in all those areas. We translated that into a slowdown of some of the hirings, yeah, but a stepped-up activity to redeploy costs, yeah, from left to right, challenging legacy investments, challenging the return on investment of those investments, yeah, to further strengthen our investment in the strategic priorities of the business.
At no point, yeah, have Carrie and I held back on things that we consider strategic investments that are behind the growth catalyst and the longer-term initiatives we have going.
Thank you. We will take the next question from line Matt Taylor from Jefferies. The line is open now. Please go ahead.
Yes.
Okay, great. I had just a couple follow-ups on some of the macro things you highlighted. I guess I was wondering, you gave us some color on the sequential progression of the backlogs and supply chain issues. Could you help just to quantify any of that and talk about
In the line of sight over the next few quarters, you know, when do you think we'd most likely see some of that start to alleviate, and what would be the catalyst for it?
Let me answer that. As Carrie indicated in her prepared remarks, our backlog today is more or less at the same level it was in the third quarter. We expect this to continue until the end of the year. We do see improvement as of next year as we execute on several levers to get over some of our supply shortages or late supplies. Very much focused on building further raw material inventories in areas where raw materials have been constrained. Think about packaging materials. Some metals have been unpredictable in their supply. Then second, we are developing alternative suppliers, second suppliers or third suppliers in those areas that have been constrained.
All of that is gonna start to become online in the fourth quarter, and that's where, yeah, we see a further catch up, yeah, in back orders as of next year.
Yeah. Thank you for the additional specificity there. I just had one for Carrie on the delta in earnings from the August update to now. You know, is that all the outperformance from Q3 and CereLink, or could you unpack that at all crosswalk to where you got to from where you were before at the last update?
Yeah. I mean, it really is the Q3 outperformance. We beat the midpoint in Q3 by about $0.15, and that is the raise for the full year at the midpoint is $0.15. We're really flowing through that outperformance in the third quarter into the fourth quarter and into the full year guidance there. As we talked about our revenue as well as our continued cost optimization of our operating expense line items, we believe that we could flow through that entire Q3, which again is continuing to offset. You know, that last slide that we added in, I hope is helpful because I think there's so much noise around, you know, the FX and our divestiture and obviously the CereLink recall.
We wanted to help you provide some additional perspective of that when you unpack all of that. Our EPS performance has actually been quite strong this year and flowing through that third quarter performance to the full year.
Thanks, Carrie. Thanks so much.
Thank you. We will take the next question from line, Steve from Oppenheimer. The line is open now. Please go ahead.
Thank you. Morning. It seems like you have a good line of sight on CereLink here. I was wondering if you could talk about, you know, the progress your sales force, you know, has made this year in terms of driving interest in CereLink's new orders, and maybe can continue to make on the ground as you work toward a return of the product next year. Can CereLink sort of be an outsized contributor next year based on any sort of pipeline build ahead of the product relaunching in the first half?
Yeah. The feedback we've received on CereLink since the launch has been positive. Customers do like, yeah, the breadth of the features, yeah, and the ease of the user interface that brings to them. By acting decisively and solving the problem for our customers by bringing ICP Express, I think we're definitely have protected the brand of Integra and the brand of CereLink, yeah, as a great partner to work with. Feedback we keep getting, yeah, from customers is that ICP CereLink is a product that in the market does not have a comparable yet, so we're well ahead, yeah, of the market. As we are preserving that relationship with customers, yeah, we feel when we bring the product back in the market in the first half of next year, this is not really gonna be a relaunch.
This is a continuation of the launch, yeah, that we have in place, and we do see CereLink as a contribution to 2023.
There is a backward compatibility to that microsensor, Steve, as well. As the good news is, you know, when surgeons are using a microsensor and placing that into a patient's head, there is a familiarity with that microsensor. There's a certain stickiness to the product that as we are out of the market for a period of time and they're using the ICP Express, again, that uses the same CereLink monitor or, I'm sorry, microsensor. As we bring the product back in, there will be a continuity of that microsensor that helps with that keeping that continuity there.
Great. Thanks. Just secondly, you know, given the year to date performance on free cash flow and as you mentioned, the ample liquidity, just what are your thoughts on M&A, your appetite for M&A, your ability to really execute on that right now? Should we expect some pickup in activity here as we look over the next several quarters?
Yeah, definitely M&A remains a priority to leverage our strong balance sheet over the past year as we went through strategy. I think we have clear line of sight what type of assets we're going after, you know, opportunities to broaden or scale up in our current CSS or tissue tech markets. Clear line of sight of adjacencies that we'd like to broaden into or pure technology additions and of course, international expansion opportunities. Four areas where we're actively looking into opportunities at this time. Definitely the market is getting more ready and fluid for opportunities to start moving.
Great. Appreciate it. Thanks, Jan. Thanks, Carrie.
Thank you. We will take the next question from line, Jayson Bedford from Raymond James. Line is open now, please go ahead.
Hey. How you doing? It's Eric on for Jayson this morning. Just wanted to ask a question on the breast PMA. Have you generated any more new data to support the submission? Do you know if any of your competitors have also filed or plan on filing?
First off, to your second question, no, at this point in time, no other competitor has filed. We expect several competitors to be thinking about filing, but none are in filing stage yet. In terms of further data, we've been working interactively, very positively with the FDA to further provide answers to some of the questions that were asked at the panel. Those have been defined in a deficiency letter. Some of those answers are about more data from the MROC database. Other answers have to do with more GMP manufacturing practices questions. There's been a steady exchange of additional information. All of that will come together in an amendment submission, which we plan to submit by mid next year.
Okay. Thanks on that. Just a separate question, just wondering where you're at in terms of your ability to pass on price overall?
On price, we've been able over this year to with price cover the inflation pressure that we've seen in the business. We over the past years have always been able to get net price. This year, we've gotten more than the typical years in the past. We continue to focus on price also going forward to leverage price getting as a way to deal with inflationary pressures on our materials and our labor input resources.
I would say as we think about price, it can take a number of forms, right? There is increases in list price. You decrease the level of discounts. You look to increase price on new customers, on a new product introductions. You have the opportunity in enterprise contracts to negotiate price or volume offsets there in your enterprise contracts. So there's a lot of different levers that we have. But we're also looking at other things as well beyond price to shore up margin buffers. Those include tightening up our customer returns policy. You know, that's a source of leakage that if we can ensure that our customers are adhering to our T's and C's as it relates to returns, that's a way to net capture more price on the initial revenue.
We're also working on inventory management, more effective inventory management, as well as other cost reduction areas and yield manufacturing improvements in our plants as well. All of those things, as we think about levers to offset some of the inflationary pressures and the impacts of FX, all come to bear into the solution set that we're leaning on right now.
Okay. Thanks a lot.
Thank you. We will take the next question from line, Greg from Bank of America. The line is open now. Please go ahead.
Good morning. Thanks for taking the questions. Wanted to start with 2023, and I don't expect you guys to provide guidance at this point. But did want to see, you know, if you look at where the street is, they're expecting above 5% organic growth, I think over 100 basis points of operating margin improvement. I wanted to see, get your thoughts, see if that's reasonable in your view, given some of the moving parts. And, you know, if not, or if you guys aren't willing to provide, you know, whether that's reasonable or not, you know, maybe just some color on how we should be thinking about 2023.
Yeah. Yeah. I mean, I can appreciate the question on 2023. We're not at a position at this point that we wanna comment on 2023. We'll do that in our February earnings call that will provide that level of detail. Certainly like to see how the rest of the year plays out. From a macro perspective, just from an environment perspective, you know, understanding where FX rates kind of come out at the end of the year as well as just overall, you know, risk to the business in terms of macro challenges of recession risk that not only impact our company, but many companies in other industries as well. I think we'll see how things play out over the next few months.
The good news is I think procedure rates continue to improve as Jan mentioned earlier. I do think that in a recessionary environment, I think hospital procedures will continue to hold up with our portfolio. As you think about our products that are used in the various procedures, I think our revenue has an opportunity to hold up very nicely. I would say that certainly as we think about 2023, we'll need to advance our return to market for CereLink. We'll want to be able in February to give you more definitive information of what our timeline looks like for the return of CereLink to the market, as that would be a key growth driver for us in 2023.
I think there are a lot of fundamental growth drivers that Jan took you through. One of his last slides that he took you through shows all the various things that are working in our favor, as we advance our product portfolio that provide opportunities for organic growth drivers for next year. Ultimately, as we talked about, there are some other questions on some of the margin drivers that I think in combination with a more conducive environment to revenue growth, as macro challenges abate, combined with the levers that we have on the cost side, ultimately would lead to some margin expansion in 2023. Jan, any comments there?
No, I think you summarized it well, right? If you look at this year in the market, yeah, markets are good. Yeah, we have momentum. We've been investing and continuing to invest in the catalysts. Next year, we should start to see the return, yeah, of that momentum and the further investments.
Great. Thanks for that. Just as a follow-up on the CereLink recall, maybe just a little bit, if you guys could provide a little bit more on the steps necessary for the recall. I understand that timing is still uncertain, but if you could just kinda walk through the steps. I believe you said that you're close to identifying the root cause, so maybe when will that be finalized? Then any other regulatory or quality steps that you need to do to hit that mid-2023 relaunch.
At this point, we have identified the root cause and also the technical fix for that root cause. As of this point, Three parallel work streams. Okay, the first one is to put the validation and verification in place. We need to now provide a statistical number of tests that prove that the fix is a true fix. That data is important for submission to the regulatory authorities. In parallel, we're implementing the work procedures in our manufacturing to bring the technical fix into the product as well as supply a number of new components that will be added to the product.
Then the third stream is to submit the data to the regulatory authorities. That's where the timeline is not fully clear yet, whether that's gonna go to longer submission. It's the submission to regulatory authorities that drives a bit of the uncertainty in the timeline more than the technical and the manufacturing execution.
Great. Thanks for taking the questions.
Thank you. We will take the next question from line Drew from Morgan Stanley. The line is open now. Please go ahead.
Hi. Jan and Carrie, just, I'll ask one question, for time's sake. Jan, as you were kinda talking about you're continuing to invest in your strategic priorities, you just brought on head of international and head of digital. I'd be curious just to see how maybe your R&D or really your OpEx spending has maybe evolved over the past quarter or two, and how you're going to kinda reposition R&D spending maybe going into next year. If you can give us, like, any sense of how much you're going to be spending on those initiatives versus what's kinda core in the portfolio today. Thank you.
I can't give you specific guidance to that, but we definitely are on track to further step up our R&D spend as percent of top line. Some of that additional R&D spend will be either used for digital features to be added to our products, but also stepped up clinical research that is a key element in accessing new international markets. From a further building out of SG&A or OpEx on support staff, I think that's gonna be marginal given that if I look at the international organization, we have a solid footprint and we're gonna be redeploying rather than adding a lot of OpEx to that organization.
Thank you. We will take the next question from line, Richard from Truist. The line is open now. Please go ahead.
Hi. Thanks for taking the questions. Just one on capital and one on the procedure environment. I guess on capital it sounds like the cap environment is pretty benign for now on the pressures hospitals may be feeling and how it relates to your business. Or I guess if you could clarify, is that just Integra-specific CUSA sales? You know, what can you comment on the environment relative to your specific implant performance and how you're feeling about your customers' kinda capital spending health as we look forward into the next budget year? I'll just ask the second one on procedures.
Any comments you can offer on the exit trajectory from Q3 in September, what you're seeing into Q4 and kinda how that specifically for the procedure part that is factored into your guidance? Thanks.
Yeah. Just on your capital question, as a reminder, capital is roughly about 6% of our total revenue, so it's not a significant portion of our total revenue. You know, we saw some really nice growth coming out of CUSA, as I mentioned, low double digits. I think what that shows that even when there are perhaps budget constraints, that if you have a compelling value proposition that you can offer hospitals and operating theaters, that ultimately drive the efficiency of their operating theater, then there is room. There is a place for capital to be spent, and that's what I think we continue to see with our CUSA capital.
There's no doubt that the selling cycles are longer than they have been in the last couple of years because of COVID and the fact that there is more scrutiny on capital budgets at hospitals. I think this continues to demonstrate that if you have a great product and a compelling value proposition, there is room for hospitals to spend, and that's what I think we continue to see on CUSA. As Jan mentioned earlier, we did some line extensions on CUSA to continue to add a few more tips to the portfolio that continues to help with the utilization of that investment for our surgeons going forward. Then I think you had a question on exit rate, procedure rates. Maybe I'll have Jan just comment on that.
I think the question is about how we see procedures further evolve, right? Like I said before, over the past nine months, we've seen every quarter a steady improvement in procedures going back towards the pre-COVID levels. As hospitals either solve the situation of nurse shortage or learn to organize to deal with a different nurse staffing. As well as, of course, COVID capacity utilization is more and more a non-factor. We've seen this in pretty much in every country across the world. Some are a bit ahead, some are a bit behind, but all move in the same direction. As I indicated, the one outlier is China, where with the rolling COVID lockdowns, we still only see procedure levels at around 8% of pre-COVID normal levels.
Thank you.
Thank you. This now concludes our call. Thank you for joining the Integra LifeSciences Third Quarter 2022 Earnings Call.
Thank you.