Welcome to the Integra LifeSciences Q1 2020 Financial Results Conference Call. Today's conference is being recorded, and at this time, I would like to turn the conference over to Mike Beaulieu. Please go ahead.
Thank you, Savannah. Good morning, and thank you for joining the Integra LifeSciences Q1 2020 Earnings Conference Call. Joining me on the call are Peter Arduini, President and Chief Executive Officer, Glenn Coleman, Chief Operating Officer, and Carrie Anderson, Chief Financial Officer. Earlier this morning, we issued a press release announcing our Q1 2020 financial results. The release and corresponding earnings presentation, which we will reference during the call, are available at integralife.com under Investors, Events and Presentations, with the file name Q1 2020 Earnings Call Presentation. Before we begin, I'd like to remind you that many of the statements made during this call may be considered forward-looking statements.
To that end, given the ongoing uncertainty associated with the COVID-19 pandemic, we intend for today's call to include more information about the current and anticipated future status of our business than has been typical during our past quarterly earnings calls. 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, the discussions 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'll now turn the call over to Peter.
Thank you, Mike, and good morning, everyone. On behalf of everyone here at Integra, I'd like to start by expressing our gratitude to healthcare workers for risking their lives to serve patients during the COVID-19 pandemic. I would also like to thank all our employees around the world for their support and resiliency during these difficult times. If you turn to slide four, I'll begin the presentation. We started 2020 off strong, and our performance from January to early March was tracking ahead of our plans, despite the initial effects of COVID-19. In China, strong distributor relationships and our selling model helped to limit the financial impact from COVID-19 in February. In March, as the virus spread throughout Europe and the U.S., international health organizations, as well as federal and state agencies, recommended postponement of all non-urgent medical procedures.
In addition, shelter-in-place policies resulted in a lower incidence of traumatic injuries. We, like most other med tech companies, experienced a significant decline in business beginning in mid-March. Our revenue declines in March were entirely related to COVID-19. The underlying end markets, especially neurosurgery and regenerative medicine, remain strong, and we are confident they will return to growth. Treatment of many underlying conditions for which our products are used can only be deferred for a limited period of time without a risk of more serious consequences. Throughout the pandemic, our priorities have remained consistent. First, to ensure the health and safety of employees. We implemented work-at-home policies for our office-based staff. We took a number of steps to aggressively limit travel while ensuring our essential products remained available to our customers.
In addition, we added safeguards within our manufacturing and distribution facilities, including PPE and new processes to reduce the risk of infection to our employees who continue to work on-site. Second, we're leveraging technology to maintain a high level of service across our business. Throughout April, we conducted online training and professional education for our customers, and we've used video conferencing platforms and other communication tools to remain in continuous contact with colleagues and customers around the world. Third, in April, we initiated cost-saving programs to protect our strong cash position and liquidity in this challenging environment. We entered this crisis in a strong operational and financial position. The organization is flexible and able to adapt quickly to a changing environment enabled by investments in technology we've made over the last few years.
This past February, we strengthened our capital structure and currently have over $350 million in cash on hand and over $1.1 billion undrawn on our credit facility. We remain focused on managing the business for the long term by maintaining investments in critical R&D and clinical programs and preserving full-time jobs that will position the company for growth as soon as procedure volumes return. In challenging times like this, we also benefit from the breadth and diversity of our portfolio and end markets, our market-leading technologies, which are supported by clinical and economic data, and our leadership positions in many of the markets in which we compete. I'm extremely proud of the efforts of our people to support customers and patients.
We have over 4,000 talented and dedicated global employees who are committed to Integra's vision of providing the best possible care to our patients by limiting uncertainty for healthcare professionals. Glenn and Carrie will provide additional details on our plans and preparations for the Rebound of procedures. Let me first provide some perspective. We've built our recovery plans based on an underlying assumption that procedure volumes will return with sequential acceleration. Our commercial teams are in close contact with customers, evaluating feedback by geographic region and hospital system. We're using this data not only to build our sales forecast, but also to find ways to work remotely with customers today while preparing for the recovery of procedures. Our executive leadership team is conducting daily briefings to monitor and adjust our response to the COVID-19. Without question, many challenges to a full recovery still exist.
ICU bed availability, which is critical to a vast majority of neurosurgery procedures, is one example, while others include operating capacity and the confidence of patients returning to medical facilities. As these challenges are overcome, we are optimistic that we will see month-over-month improvement throughout the year. Before turning the call over to Carrie, I'd like to provide a view of where we were before the pandemic and to demonstrate why we feel confident that we will exit the year on a growth trajectory. Please turn to slide five. In this chart, you can see that global orders were trending above our 2019 levels from January through mid-March of 2020. Our performance was driven by several factors, including continued momentum in new product introductions, higher regenerative orders fueled by improved manufacturing supply, and strong capital sales.
In mid-March, you can see the dramatic decline that occurred as soon as surgical procedures were postponed on a wide scale. For the company as a whole, run rates for the last two weeks of March were down about 28% compared to 2019 and varied by product line. Despite these declines, we closed the Q1 with revenues of $354 million, roughly flat on an organic basis compared to the Q1 of 2019. To be clear, our performance in April will bear the full effect of COVID-19, and based on what we know today, the Q2 will be the most challenging of the year. In the Q3, we expect year-over-year declines, although not at the same rate as in the Q2, as many procedures in which our products are employed cannot be deferred for more than 90 days.
In our base case scenario, we assume the Q4 of 2020 will be roughly in line with the Q4 of 2019, and under more favorable scenarios, we see opportunities for growth. While a global impact of this magnitude was unimaginable just three months ago and the timing of a full recovery remains uncertain, I'm confident that once the environment returns to growth, the actions we're taking and the plans we have in place will position Integra for outperformance over the long term. Now I'd like to turn the call over to Carrie for a more detailed review of our Q1 performance and the ongoing impact of COVID-19. Carrie?
Thanks, Peter, and good morning. I'll keep my comments on the Q1 results relatively brief so we can move to a more detailed discussion of the impact COVID-19 has had on our revenue profile and how we're thinking about the Q2. Q1 total revenues were $354 million, representing a decline of 1.5% on a reported basis and unchanged on an organic basis compared to the Q1 of 2019. This performance was at the high end of our preliminary results announced on April 7th. Adjusted earnings per share were $0.48 compared to $0.65 last year. Both the revenue and EPS declines on a year-over-year basis, as well as the unfavorable variance to our original guidance expectations, were entirely due to the adverse impact of COVID-19. If you turn to slide six, I'll start with a review of our CSF segment.
Reported revenues were $231 million, an increase of half of 1% on an organic basis. Global neurosurgery sales increased 4.5% on an organic basis. Despite the slowdown we saw at the end of the quarter, organic growth was strong across all neurosurgery franchises. We reported high single-digit growth in both CSF management and advanced energy, and low single-digit growth in both dural access and repair, neuro monitoring. Sales in our instruments franchise declined about 14% on an organic basis. While instruments continued to show low double-digit growth through early March, in line with our previous expectations, we did see significant softness in late March as our largest distributors deferred their typical end-of-quarter orders in light of the decline in medical and dental office-based procedures. We also saw capital purchases such as surgical lighting slow late in the quarter.
International sales in CSF were up high single digits during the Q1, led by strength in Japan and advanced purchases in several indirect markets, including China, due to precautionary concerns over the global spread of COVID-19. Moving to our Orthopedics and Tissue Technologies or OTT segment on slide seven, revenues were $123 million, representing a decline of 1.2% on an organic basis. Sales of AmnioExcel Plus and SurgiMend increased double digits in the quarter, driven by the increase in supply coming from the capital investments we initiated last year at our Boston and Memphis facilities. Our broader regenerative portfolio was on track for low double-digit growth through the first two and a half months of the quarter until COVID-19 related procedure deferrals took effect in the last two weeks of March. Most impacted were non-emergent chronic wound treatments and plastic and reconstructive surgeries.
In total, Q1 sales in wound reconstruction were down low single digits compared to the prior year. Sales in private label increased mid-single digits in the quarter in line with expectations. We saw limited COVID-19 impact to our private label business in the Q1 as orders were largely pre-scheduled. In orthopedics, we were seeing positive year-over-year growth in both our U.S. and international markets until COVID-19 related deferrals virtually shut down non-emergent procedures in mid-March. For the full quarter, orthopedic sales declined mid-single digits. International sales in OTT increased low single digits based on strength in tissue products early in the quarter in Europe. Turning to slide eight, I will now review our Q1 performance of the key P&L and cash flow components. Adjusted gross margin was 68.3%, unchanged from the Q1 of 2019.
Our adjusted EBITDA margin was 21.4% compared to 24.3% in the prior year. Q1 GAAP earnings per share were $0.11 compared to $0.38 in the prior year. Adjusted earnings per share were $0.48 compared to $0.65 in the Q1 last year. The decreases in gross margin in EBITDA were primarily related to COVID-19, which caused lower than expected revenues as non-emergent surgical procedures were deferred, primarily in the U.S. This decline in U.S. revenue relative to growth in international revenue resulted in an unfavorable gross margin compared to our original expectations. Lower revenue relative to our SG&A and R&D spending levels, as well as a higher blended tax rate contributed to the decline in EPS and were down by these same COVID-related factors. Diluted shares outstanding were down slightly year-over-year due to the share repurchase program.
Recall that in early February, we did initiate an accelerated share repurchase agreement. In the Q1, approximately 80% of the expected total shares to be repurchased under the program were delivered. Operating cash flow was $21 million in the Q1, about $9 million lower than last year, driven by lower earnings and higher inventory levels, both of which were adversely impacted by COVID-19. Before I leave this chart, let me elaborate on the steps we have taken to manage our cost structure and preserve cash during this period of revenue instability. In April, we announced sweeping cost reductions across the organization. We estimate these cost actions will reduce our operating expenses by about 30% in total, including a more than 60% reduction in variable expenses. We have decreased hours in some of our manufacturing facilities, amounting to an overall reduction of 20% to 25%.
We have also significantly reduced capital expenditures. The duration of these actions will largely depend on the shape of our revenue recovery, but will likely last into the Q3. At the same time, we have been very deliberate on our prioritization of critical capital, R&D, and clinical programs and the supply of certain regenerative products to ensure the company is positioned for growth as the environment improves. Even with these significant cost actions, with the expected sharp decline in revenues, we expect lower profitability and low single-digit EBITDA margins in the Q2. If you turn to slide nine, I'll provide a brief update to our capital structure as of March 31st. We ended the quarter with net debt of approximately $1.3 billion and a bank leverage ratio of three point one times.
The company's maximum allowable consolidated total leverage ratio under its credit agreement remains at five times through June of 2022. Importantly, we have cash and cash equivalents of $358 million and $1.15 billion undrawn on our revolver. The company does not have any credit facility principal repayments due until June of 2021. If you turn to slide 10, I'll provide you some insight into our revenue profile in the context of the current COVID-19 environment and how to think about likely revenue scenarios for the Q2. We have reviewed the various guidelines recommending deferral of certain elective surgical procedures during the pandemic and have been talking to our customers throughout this period. This data has enabled us to plot where our products fall on the spectrum of more urgent, moderately urgent, and more deferrable surgical procedures. The following slide illustrates our current thinking based on available information.
We have attempted to provide a qualitative scale with the boxes that are skewed to the left indicating slightly more urgent procedures, and those skewing to the right, procedures that can be deferred for a longer period. Traumatic brain injuries and acute burns and wounds are typically treated on a more urgent basis. Extremity orthopedic procedures are deemed more elective, and many capital purchases, which are tied to hospital budgets, are expected to be deferred longer. In analyzing the moderately urgent category, a much wider set of variables, which range from patient-specific to the broader hospital environment, must be considered. Also, it's important to remember that many of the underlying conditions in which our products are used can only be deferred for a short period of time without risk of more serious outcome for the patient.
Now I'd like to turn the call over to Glenn, who will provide some additional insights into how we're thinking about recovery. Glenn?
Thanks, Carrie. Good morning, everyone. If you turn to slide 11, I'd like to build on Carrie's comments as we look at the Q2 and H2 of 2020. On the left side of this chart, we provided revenue declines for the month of April compared to the prior year for our two segments and our U.S. versus OUS business. Overall, revenue declined about 45% for the month of April compared to the prior year. Within our revenue base, there was a wide range of variability in decline rates, with parts of neurosurgery and acute trauma down less than 30%, while others, such as orthopedics, were down over 80%. The rates of decline roughly corresponded to the surgical procedure categories Carrie just outlined.
Geographically, we saw less decline in our international business, with markets such as Japan, Australia, and Canada remaining stable during the early part of the Q2. The lifting of country and state shelter-in-place restrictions will be a key factor in determining how quickly procedures recover. However, as Peter mentioned, even in locations where procedures have resumed, variables such as ICU bed availability will impact the pace of recovery. As a company, our revenues are over 75% weighted towards in-patient procedures. We believe hospitals' shift in resources from COVID-19 back to moderately urgent procedures will be critical to an improvement in our revenues. We anticipate revenue in May will sequentially improve over April, as we're encouraged by the news that certain states are beginning to reopen. Outside the United States, we've also seen positive signs of recovery in places like China, Japan, and Germany.
If the trend continues, we expect a more significant improvement in June. The Q3 should show a healthy sequential improvement, but is expected to be below 2019 sales levels. In our base case scenario, we assume the Q4 of 2020 will be roughly in line with the Q4 of 2019, and under more favorable scenarios, we see opportunities for growth. If you turn to slide 12, I'll provide a final brief review of the steps we've taken to restore growth quickly once customer demand returns. In March, we implemented contingency plans in many of our manufacturing facilities to ensure our essential products continued to be produced and delivered to our customers and patients. In addition, we've been building safety stock of a number of key products, focusing on our regenerative products.
We've been supply constrained over the past 12 months and are taking advantage of this temporary slowdown by building safety stock of select products to meet demand we expect to see once procedures return later this year. These efforts have been made possible by our dedicated manufacturing employees, who have continued to make essential healthcare products throughout the pandemic. I'd like to thank them for making a difference for our customers and patients. As mentioned earlier, we implemented aggressive cost reduction measures while preserving full-time jobs in key clinical and R&D programs. These cost containment actions included curtailments in hiring, travel, meetings, temporary workers and consultants, and employee benefit costs. In addition, we've taken pay cuts to our executive leadership team and board of directors, furloughed employees at select plants, and moved to a 32-hour workweek company-wide.
We also implemented temporary compensation adjustments for our field sales teams to help them bridge this period and keep them motivated as our business recovers. As we work through multiple recovery scenarios, our commercial teams are mobilized. To that end, we've distributed essential personal protective equipment, enabling engagement with our customers on a regular basis while closely monitoring and adhering to local restrictions. Our sales teams have been holding virtual customer meetings and online training to maintain close relationships, even as access to hospitals has been restricted. The company's adaptability and resiliency in the face of this crisis was made possible in part by our prior investments in technology infrastructure and operations, and investments we have made in our talented and committed global workforce. We are addressing the short term while at the same time planning for the long term.
In closing, I would echo Peter's comments that we're confident in the underlying demand for our products. We feel we have the right people and plans in place and believe there are recovery scenarios in which we can restore year-over-year growth as soon as the Q4.
That concludes our prepared remarks. Thank you for listening. Operator, would you please open the line for questions?
Of course. If you would like to ask a question, please signal by pressing star one on your telephone keypad. If you are using a speakerphone, please make sure that your mute function is turned off to allow your signal to reach our equipment. Again, that is star one if you would like to ask a question. We will take our first question from Raj Denhoy with Jefferies. Please go ahead.
Hi. Good morning. I wonder if maybe I could start with the commentary around the expectation for the Q4 of this year to look like last year. You described it as your base case, I'm just curious what's baked into that. Does that contemplate perhaps a second wave of COVID-19? What does that assume in terms of the economy? My follow-up to that, really, as it relates to the economy, is several of your major categories, neuro trauma, burn, are sort of related to economic activity, I imagine. Perhaps you could just describe sort of your thinking broadly around that recovery outlook.
Thanks, Raj, for the question. I would say when we talk about our base case, we think of it as probably more of a U recovery. We're not contemplating a sharp V. We're not contemplating a W, but we're contemplating what we think is reality, which is that there clearly will be the effects of COVID in the fall, and that it won't reach the similar peaks that we saw here in the spring. For us, as Glenn had mentioned, and Carrie, that a high percentage of our business, two-thirds in neurosurgery, is tied to the availability of ICU beds. Even having an ongoing level of cases out there, but having access to ICU beds to take care of neuro procedures, we think that we'll see the sequential growth coming on board.
To your point about the broader economy, if you think about burns, acute trauma, which is typically tied to accidents from driving. On the neurosurgery side, traumatic brain injuries obviously related to falls or work-related incidents. It clearly had an impact here early on, and we would view as the economy opens up, that we'll continue to see that increasing. How do we do better than that? Obviously, the opportunity for the amount of recurrence to be lower is kind of how we're thinking about it. At this point in time, that's how we see it.
Okay. That's helpful. Maybe just, Carrie, a follow-up question for you. I think you commented that you think you can reduce your operating expenses by 30%, and I'm curious how to think about that. Is that sort of, if we look at the operating expenses in the Q1 or even in the Q4 of last year, sort of a run rate to assume you can take the absolute dollar amount down by 30% in the Q2?
Yeah, that's the way we're looking at it. If you look at where we landed for Q1 in operating expenses, that's essentially our selling, our G&A, and our R&D lines. We think the actions that we have announced to employees and the steps we're taking would take out about 30% of those expenses. That's our plan.
Okay. That's helpful. Thank you.
Our next question will come from Matt Miksic with Credit Suisse. Please go ahead.
Hi, Matt.
Hey, good morning. Thanks for taking the question. Maybe a follow-up just on some of your comments on the early signs that you've talked about in terms of recovery in May. I think, Peter, you've mentioned something like accelerating improvements or accelerating pace of improvements over the next several months. Can you talk about what you've seen and I guess, as you get through Q2, Q3, Q4, and maybe just to follow up on Raj's comment about the assumptions that go into that sort of base case scenario. What sort of capacity do you expect these hospitals to be operating as you get into the Q2 and the Q3 and the Q4? Then I have one follow-up.
Matt, it's Glenn. I'll take a crack at this one. We look at May, obviously, the shelter-in-place orders being removed is obviously a positive sign for us. We see more and more ICU beds opening up, it's a positive sign for us. We are seeing an improvement in the U.S. and even many markets outside the U.S., places like Japan, China, Germany, all getting back to 80% or so levels from what's considered normal. One of the things that we learned during this COVID-19 situation is we have a lot of non-elective procedures, but they are deferrable. We saw a number of neurosurgical procedures being deferred for 30, or in some cases, they could be deferred up to 60 days, but they really can't go beyond that without starting to have issues with the patient.
When we look at our recovery plans, we clearly expect now that we have been into this for several months, that we will start to see a pickup in procedures in May. We are already seeing it in the first week or so. That should continue into June, assuming no setbacks, and then a further acceleration going into Q3 and Q4. From our perspective, that is the way we see things at the moment. Obviously, we do not have a crystal ball and things could change if the virus comes back in a big way in the late Q3, Q4 timeframe. But for now, I think this is what we are modeling and different scenarios could play out different ways. For now, given everything we know, we would expect to be in a position where we are flat to 2019 when we get to Q4.
Okay. If I read your comments correctly, it sounds like not improving the use of capacity, but not maybe reaching, you know, not banking on 100% as you get into the end of the year just yet.
Yeah, I think that's fair, and I think to a certain extent, we'll see pent-up demand for procedures that have been put on hold. At the same time, we have seen just a decline in traumatic injuries and procedures in neurosurgery as well as burn and wounds with everybody on the shelter-in-place situation. Peter, you want to add anything to this?
Yeah, I would just say, Matt, I think if you compare what we went through in April to what we think the fall will be, the difference is, I think everybody would say, as a country, we had more surprise issues to deal with. More draconian actions like no elective procedures will be done, hold all your ICU beds for this pending wave of COVID patients, whether they come or they didn't, had a bigger effect on clearly what aren't elective procedures. You don't see neurosurgery as elective, you don't see burns, you don't see trauma. When you basically say we're shutting everything down for those cases, it has an impact. If you go to the fall, the improved testing that's out there, better understanding of the disease, how to create green zones within the institution to manage that's the feedback we're getting.
We have our sales forces with a pretty nice quantitative way to collect ongoing weekly data from IDNs, different health systems around the world. I think that's the feedback that we're seeing. I think you know, and as many folks know, neurosurgical procedures tend to be reasonably profitable procedures for health systems as well as some of the particular trauma cases. On top of the fact, in our prepared comments, we said you can delay maybe up to 90, that's maybe a benign tumor. Something that's malignant, you get past 30 to 45 days, you start creating other issues. We're starting to see some of those cases come back in. Again, we believe with properly managing whatever types of peaks happen here in the fall, that those type of procedures will get priority.
Got it. And then the follow-up, you've mentioned ICU beds and hospital acute care centers as a site of service and procedures. Maybe if you could talk about alternate site, ASCs, wound care, if you're seeing anything there and remind us kind of how that mix impacts your business, how that's baked into your expectations. Thanks.
Yes, so a good question. We have in our chronic wound care business, which is the AWC Advanced Wound Care business, some parts of our instruments business and parts of our plastic and reconstructive areas all deal with ASC surgical centers or actually doctor's offices. As you can imagine in the hotspots, New York and L.A., the coast and inside Chicago, through the beginning of this till up to the end of April, those were very limited cases as well. They're not hampered by hospitals and those capabilities, so we're starting to see some of those procedures come back. I would say, as Glenn mentioned, orthopedics would probably be one of the laggards, but even at that standpoint with our extremity orthopedics business, most of those are done actually outside of the hospital.
And so we have confidence that we're going to be able to see those come back at a reasonable rate. I would also say that on the chronic wound care front, many areas we're basically trying to have patients stay at home and do what they can with lower technology type solutions. What that means is there are many patients that were delayed for a period of time that may actually have more acute issues to deal with. That's a hypothesis. We'll see how that plays. We're assuming that we'll start seeing volumes pick up again on a sequential rate for that as well. The reality of it is the majority of our revenues are still driven by inpatient procedures.
Thanks for the call.
Yep. Thank you.
Our next question will come from Kaila Krum with SunTrust. Please go ahead.
Great. Thanks, guys, for taking our questions and for all the detail and transparency on the COVID-19 impact. Can you just talk a little bit about your neurosurgery business? You have a mix of business that's moderate or more urgent, but you have some exposure on the capital side, which is more deferrable. Would you just talk through sort of the puts and takes in that business and what you're assuming as it relates to the CapEx environment later this year?
Yeah. Maybe I'll give a little bit of a comment and then Glenn or Carrie, you guys can jump into anything. I'd say if you look at the chart that we went through, I think the chart, I think it was page 10 or so on the deck, the implications for revenue profile does a nice job of framing up between more urgent and more deferrable. If you think of our neurosurgery business or our CSS business, which has instruments in it, obviously capital, which includes the CUSA, the tissue ablation products, lighting, and MAYFIELD, those clearly could be viewed as more deferrable. Now that being said, they are small capital purchase items. Some of these are 20,000, 30,000. Some of these are a couple hundred thousand. They're not $2 million objects.
We believe that there's obviously a level of deferrability that's tied to how big the capital items are. But our assumptions are that those are going to be delayed through the majority of the year. If you think about DuraGen and CUSA disposables. These are the products that are used to do a craniotomy to remove the tumor. They're the disposables used in the case. We're the market leader in all of those, and so those are on the shelf. As we see those move through our sales, that gives us pretty good insights and confidence on cases coming back. To the point that I made earlier, if you have a malignant tumor, you lean obviously more to a more urgent, but some of those can even be delayed 30 days.
If you have a benign tumor, someone could make a decision that it's not pressing on anything that would cause damage for 60 days, they may hold you off, and I think that's what we're seeing. CSF management, or managing the pressure in your brain, there are different levels of it. A child that may have a hydrocephalus issue can be deemed very urgent, as well as certain adult patients. We see those cases taking place more, and in many cases, don't need any type of ICU follow-up for the most part. Those are more enabled. Things such as instruments, as an example, we show spanning a broader area. Why?
Some of our more deferables could be into an individual doctor or dentist office, while some of the more urgent ones are instruments that are actually being used in potentially COVID-19 patients or some of these urgent procedures. That's kind of our view of it and the mix. The key part for neurosurgery is you want to start a neuro procedure when you know you have a corresponding ICU bed to move the patient to, and we're now starting to see that open up, where that, for the most part of June, or excuse me, of April, was not available.
Got it. Now, that makes a ton of sense. It's a lot of great color. You mentioned, I guess, a $20 million to $25 million impact in this Q1. Also, a lot of your procedures, like you mentioned, can't be deferred beyond 90 days. How are you thinking about those procedures sort of coming back? Are you seeing any signs of that yet?
Glenn, do you want to comment?
Yes. I would just say, to the point, yes, we are starting to see these procedures come back in early May. It'll be gradual as ICU beds open up, and that's part of our whole modeling and scenario that we've outlined here in terms of why Q2, back half of the quarter, should be better than the H1 and how we get better into the Q3. We are starting to see the recovery. It'll be gradual, and we do expect that to continue really throughout the rest of the year.
Great. Thank you, guys.
Thank you.
Next we will hear from Robbie Marcus with JP Morgan. Please go ahead.
Hi, this is actually Lily for Robbie. Thanks for taking the question.
Good morning.
Good morning. You're implementing fairly strong expense control measures. Do you think that this will impact your ability to ramp up and compete in the H2 of the year and in 2021?
Now, I'll take a stab at-
Yeah. Why don't you, Carrie, why don't you go ahead and comment?
I would say, I think we have, in everything we've done, really taken the most aggressive stance on discretionary spending. We flexed that pretty hard. Obviously, we can unflex that. We can turn the faucet back on pretty rapidly. We have really tried to protect and preserve full-time jobs. We think that is a great factor that's going to allow us to recover. So I think in terms of the spectrum of cost actions that we've done, I would say there's nothing that we can't turn and flex back on when we need to. I would say that as we've looked at the prioritization of our spending cuts and what we want to preserve for spending, we have really tried to prioritize and protect critical R&D and clinical programs, as well as even in our plants.
As I think about the average 20% to 25% hour reduction across our facilities, even then, and I'll ask Glenn maybe to talk a little bit more about this, it wasn't a peanut butter spread. It was really very plant-by-plant specific in terms of the actions we took at the plants. In some cases, we were below safety stocks, particularly on our regenerative tissue products. Those are the areas where we'll continue to build some inventory, because we do expect to be able to see some recovery in those areas, and we want to take advantage of getting our inventory levels back to where we need. Glenn, maybe you can talk a little bit about the approach we've taken on the manufacturing facilities.
Yeah, sure. We have about 17 manufacturing sites. Not all is equal at each of the sites. To Carrie's point, there are certain plants like Boston and Memphis, which are regenerative plants. We make amniotic tissue in Memphis and SurgiMend used for hernia, abdominal wall, and plastic reconstructive, along with PriMatrix for wound care in Boston. Those plants are pretty much running normal capacity, and during this period of lower demand, we're actually building safety stock. These are going to be products that we should see very good growth when things come back to normal, when we get back to the regular procedures. So, double-digit growth we were posting last year, we continue to expect that once we get back to normal, and we're going to have plenty of safety stock to support that ramp when it comes back. That's the good news.
The other point I would highlight is during this period in our recovery is making sure our reps are carefully taken care of during this. We've done some things to shore up the financial incentives for our reps to get through this period. When we do see the ramp back, we'll recover even faster. We obviously continue to make sure we've got all the personal protective equipment for our field, for our office-based employees when they come back. That's obviously been a priority for us as well, so that we can come back into a normal routine as quickly as possible.
Great. Thank you. One more quick one. You have a fairly robust pipeline. How should we be thinking about the potential delays to new product launches?
Yeah, I'd say, look, the pipeline, any of the critical programs that we deem environmentally we could keep moving. What do I mean by that? A clinical study that doctors weren't doing procedures, obviously we would delay, and in some of those cases, some of those studies might have delayed out a few months based on that. We'll see how that plays out here in the summer. Critical R&D programs, particularly acquisitions that we recently made, technology rebound into the stroke market, as well as different products that we utilize for catheter technologies, monitoring technologies, all those are advancing in a remote approach or with specific engineers on site in select locations to keep them moving forward. Those are areas that we clearly focused on preserving and keeping them going. At this point in time, I don't see any substantial impact to our pipeline plans.
Great. Thanks so much.
Thank you.
Next, we'll hear from Shagun Singh with Wells Fargo. Please go ahead.
Thank you so much for taking the questions. I guess I was just wondering if you guys can share any data with respect to the backlog you may be seeing in neurosurgery versus regen, versus ortho. What % of procedures are being rescheduled, how far or canceled? I guess the second question is, the slide that you gave was pretty helpful with respect to the recovery leaders versus laggards. You know what kind of trends are you seeing in those categories in May, and what % of total sales kind of falls within those three categories? Thank you.
Shagun, I'll comment a little bit on the first part, and then maybe Carrie, you can comment a little bit about how the percentage of the business falls into the category. But I would say, Shagun, at this point, we're not in a position to kind of give any details relative to how we would see what's built up in pent demand. I mean, our discussions with surgeons as well as the sourcing teams at different hospitals, I think they're still trying to decide that question themselves. There's clearly, in neurosurgery, a list of patients that have been deferred in certain areas. That's a little bit more of a clear pathway than, say, when are traumatic brain injuries, burns, or trauma going to come back with the economy opening up. Then it's trickier as well as in things such as chronic wound care.
I'm sure you've seen as well as others about institutions putting out ads and components. It's safe to come back. We have green zones. I would say we are starting to see the sequential uplifts that we had hoped for in May. Why it gives us confidence that we'll continue to see that. I think broader than that, we really don't have a lot of details to share. Carrie, do you want to talk a little bit about the thoughts on the revenue profile and the implications as we lay them out?
Yeah, Shagun, I would say that the slide that we presented, it didn't have the vertical lines on it to clearly indicate that something was in one bucket versus the other. It is very much a sliding scale and will be very much influenced by the factors that we note on slide number 11 that are considerations for the pace of recovery. I would just say our capital is probably about 10% of our revenue, as an indication, there was a question on the capital piece. And then you're going to do a big spectrum. We give you the disaggregated revenue on some of the buckets like ortho. You can get to what that is a % of our sales.
The majority of our portfolio really falls in the middle, in that moderately urgent, and will be very dependent on really key three factors, which is the ICU bed availability, the OR availability, as well as patients' confidence coming back. Really, I guess the fourth factor is essentially the stay-at-home, the shelter-in-place things being lifted. All of that will determine the ICU bed availability, OR, as well as patients' confidence. So I would say the bulk of our portfolio is going to sit there somewhere in the middle. Then you got the two tails that are on the more urgent, on the more deferrable side. Certainly the bulk of the portfolio will sit somewhere in that sliding scale of moderately urgent.
I got it. Thank you so much.
Next we'll hear from Dave Turkaly with JMP Securities. Please go ahead.
Thanks. I love the slide on page 10. I actually tried to create a similar matrix for my coverage universe. I got some right and some really wrong in this new non-elective but deferrable world. That's helpful. When you look at your private label, that might be one that sort of stands out a bit in that moderately urgent category. I'm just curious, how much of the orders there are kind of locked in, or how is the visibility on that part of the business?
Hey, Dave, it's Glenn. I mean, we have good line of sight and visibility into private label. These are long-term partnerships. We usually get the orders.
A quarter or two in advance of when customers need actual product. In the Q1, we held up quite well because we had the orders in hand in Q4. Having said that, some of the demand and the forecasts that we're getting from our larger private label partners will likely modify in the Q2 because things have changed. While we have, I'll say, firm commitments and forecasts for our private label partners, we're looking to be working with them here in the Q2 to adjust to what they're seeing in the marketplace. But we do have good line of sight and visibility to it.
Normally, we would have, I would say, a long-term locked forecast in orders, but just given the unique circumstances we're dealing with, we're going to have to be flexible with our private label partners and make some adjustments based on what they're seeing in the marketplace.
I think it's fair to say, Dave, that it's a diversified portfolio, right? We don't control the end markets, but we have some insights into them from dental procedures that at some point are going to have to pick up and orthopedic procedures probably closer to the more deferable side of things, to products that are used to reduce infection of a central line or a PICC line or being used in other areas of tissue reconstruction. At the end of the day, it positions in that area. This is one that with the rebound that everyone is expecting, we think it's properly positioned. If obviously things lasted a whole lot longer, then probably our private label itches out a little bit more into the deferrable range.
That's not what we're seeing right now, mainly because of the diversification of the procedures that feed into this.
Got it. Thanks for that. One quick financial follow-up, the $4.7 million COVID-19-related charges, I just wondered if you could comment on exactly what that was. Thanks a lot.
Yeah.
Carrie on it.
Absolutely. $4.7 million COVID one-time related charges, and I would say that 80% of that had to do with incremental reserves we took on inventory and accounts receivable, doubtful accounts. Let me give you some context of that. As we work through our balance sheet in our quarter with our auditors, we looked at, given the environment of sales rapidly declining, really understanding our risk of expiry product over the next two to three months. And so taking a look at what additional reserves we would likely need as a result of that kind of environment. The AR reserves, really looking at our aged receivables as of 3/31.
Though I would say we didn't see a dramatic slowdown of customer payments at the end of the quarter, we do expect, again, with the financial strain that is being placed on the economy, that it could create some issues for some of our customers. Taking a different lens on our aged receivables and with particular focus on Europe and certainly some of particular countries in Europe like Italy, looking at those and determining whether or not we needed additional reserves. Obviously, we'll continue to look at those. If sales do continue to pick up and we find ourselves working through a lot of that inventory, then obviously, we'll reverse those, and it'll go through the special charges as well. And the remaining piece, so that was about 80% was those incremental reserves on inventory and AR.
The remaining piece, which is around $900,000, was related to incremental charges for PP&E, cleaning of facilities, expedited freight, cancellation charges. Hopefully, that's helpful to you.
Yeah. Thank you.
We will take our next question from Matt Taylor with UBS. Please go ahead.
Morning.
Hi, this is Xuyang in for Matt. Good morning. Thanks for taking the question. Maybe just the first one, I think your comments on Germany and the Chinese markets stabilizing and recovering, just wondering, how much do you think we can read through for their recovery for the U.S. market? Are you assuming similar recovery curves and trends to the U.S., maybe just a few months later? If you can provide some color, that'd be helpful.
Matt, I think your question is what kind of read-through do we can see from Germany and China and the implications into the United States? I think there's some, in particular, around probably more Germany than China. I think as Glenn commented, and I'll have him comment in a few minutes here, China, we definitely remain optimistic about the recovery. Particularly this point about when you're in lockdown on neurosurgery, what are some of the first procedures to come back that need ICU beds? We're definitely seeing that neurosurgery gets more of a priority view there. Glenn, maybe you want to comment since obviously you run overall international.
I would say as it relates to China, we're probably seeing something close to 80% to 85% of procedures coming back at this point. As you know, pretty much February, March was shut off. That's an encouraging sign. Japan, while I've seen some fall off in procedure, we're still in that 80% to 85% range as well. I would say those two markets are actually holding up quite well along with Canada and Australia. Europe's a mixed bag for us right now. I mean, Germany looks like it's about 80% to 85% of normal procedures. That's doing quite well. Obviously, a very strong healthcare system there.
Other markets like Spain, the U.K., and Italy, we're still lagging. Country by country, it's a mixed bag, and it's largely dependent on how hard they've been hit with the virus. Obviously, even in Italy, though, now it's starting to see some signs of recovery in the southern part of Italy. Things are coming along here. Market by market, country by country, it's different. Overall, we actually held on quite nicely in the Q1. You saw we put up almost 7% organic growth. We were on pace to do double-digit organic growth. Really good momentum in our international business before COVID-19 hit. Obviously, if you look at April results, the international business not down as much as the overall company. That's how we see things outside of the U.S. at the moment.
Okay, great. That's really helpful color. I guess, maybe another question on M&A, because understanding your focus on cash and expense control in the short term, just wondering when do you think you can focus on M&A again and maybe your thoughts on valuation of strategic assets?
I'd say, look, from an M&A standpoint, as we came into this, we had a significant pipeline of opportunities. As we've talked about before, we're primarily focused on tuck-in acquisitions. I would say during this time period, it's given us an opportunity to take a hard look and think about our broader portfolio, which we've spent some time on. It's also a window where we'll see where valuations go. I think it's no secret in public market valuations were quite high. Some of the privates have followed as well. And so we believe we're in a good position. It's one of the reasons that we were aggressive on our cost moves and all of our actions is that we want to obviously keep the company in a very strong position.
One is to take advantage of the rebound that we see coming. Secondly, be in a position to take advantage of the right types of M&A or actually partnership opportunities that may come up around the world. I think I'll leave the comment at that.
Okay. Thank you.
Our next question will come from Ryan Zimmerman with BTIG. Please go ahead.
Morning, Ryan.
Thanks for taking the questions. A couple from me, maybe not related to what's been asked before. Number one, this question gets asked from time to time. I'm just wondering if your outlook on Extremity Ortho has changed a little bit over this time period. You certainly have WMGI being acquired by Stryker, and the business is going to be under pressure because of the pandemic. Does it still make sense in your portfolio right now or over time, I guess, is the question?
Yeah, Ryan, thanks for the question. I think, obviously, when you start taking a look at elective-based procedures in a world where you're debating what is slightly urgent or more emergent, it brings that question up. We still believe that this orthopedic segment of any of the segments in orthopedics is the area where there's the most future growth potential. I'd say that's one, and that hasn't changed. I think secondly, it's really the primary area that has more synergies with some of the tissue products, whether it be tendon repair, nerve repair, and such, which is why that it does make sense. But we believe that continuing to add scale will be important.
I think as other integrations and acquisitions take place, that will be part of us taking a crucial look at where the market's heading and can we add more scale within the business at the right time. I would say that from our time horizons in thinking of the business, nothing in COVID has fundamentally changed how we think about the business at this time.
Okay. That's fair. Then Carrie, on gross margin dynamics, the manufacturing sites have certainly helped gross margins over the past couple quarters, particularly on the regenerative side. I'm just wondering how you're thinking about gross margin going forward with the pandemic impact measured against what you've invested in from a manufacturing perspective. Thank you.
Yeah. A couple of thoughts on that. One, obviously, if I think about the Q1, we ended with a gross margin at 68%, which is really, it was not what we expected. We expected that to be much better. That was really driven by unfavorable mix. We had the international side of the business actually still delivering really nice growth, close to 7% organic growth, and that meant the U.S. basically declined organically in the quarter. So that mix really tempered our gross margin performance, and we didn't see the year-over-year improvement we expected. As I think about the Q2, I don't expect to see that dramatic of a mix issue for us in the Q2. The Q1 international performance really held up quite well because of our indirect model, in particular international markets like China is an example.
And that will balance out probably more in the Q2 as we see some declines both on the international side as well as the U.S. side. But as it relates to Q2 gross margins, given the relatively high fixed cost nature of our business, we would expect a high decrement margin rate on the lost revenue that would impact a gross margin, even with a reduction of labor hours of 20% to 25%. As you compare the 68% gross margin in Q1, you could get to certain revenue scenarios that we've given you some data points on April. You've heard some comments from Peter and Glenn that I think you could get to a gross margin in about the 60% region in Q2. I hope that we'll do better than that. I hope that our revenue comes in a bit stronger.
Given some of the comments that Peter and Glenn have made on the quarter for Q2 and where we landed for April, I think you will see an impact to gross margins for certain in Q2.
Okay. Thank you very much. Appreciate the call.
Our next question will come from Steven Lichtman with Oppenheimer. Please go ahead.
Thank you. Hi, guys. Overall growth in 1Q in neurosurgery looks like it held up versus recent trends, despite the obvious falloff. I'm wondering if the core business was running ahead heading into mid-March. I know you called out Japan, which has held up relatively well, and of course, you got momentum there. Was that a factor in neuro holding up? Just any underlying comments on that business would be helpful.
Carrie, you want to start and then maybe Glenn, you can add some color to it?
Yeah, Glenn, I'll have you start first, if that's okay.
Steve, in terms of Q1, our core business was actually doing quite well up until mid-March. We were actually trending ahead both on the CSS and neuro side, as well as the OTT side of our business. Yeah, you saw one chart that Pete went through during his prepared remarks. Our orders were up, our sales were up very nicely through mid-March. Even though we saw a pretty substantial decline in the back half of the month, the numbers that we put up for the quarter were actually pretty good overall. We look at neuro still growing mid-single digits. Obviously, we saw the impact in our instruments business. Outside the U.S., we held up quite well all the way through the end of the quarter, which would've even been better had things not transpired with COVID-19 outside the U.S.
Yeah, we were in fact trending in our core business ahead of our plans up until mid-March.
Yeah, I would add, as I mentioned before on the international side, it's a combination of Japan really holding up. We continue to see some nice results there in our DuraGen product there that we had launched in mid-2019. The indirect model, as I mentioned, as really some of our distributors were really concerned about borders closing with the spread of COVID-19. Certainly, there was some advanced orders coming in in the Q1 that will obviously correct themselves a little bit in Q2, and that's why we are, in the April performance, you see the international performance is -35% there in the April month there.
I would across the board say that we were trending actually quite well on the wound reconstruction side for the OTT side of the business, seeing a low double-digit growth with some of that supply being corrected out of Memphis and in Boston. Really seeing some nice growth there overall as well.
Thank you. Just one quick product-related question, actually. Does any COVID-19 impact on the regulatory processes impact your thought on CereLink reentry? I know you were thinking a 510K would be needed. Any changes in when you think that product could come back?
Hey, Steve, you broke up. Can you just repeat the question one more time?
Yeah. I'm sorry, Peter. Yeah, just on any product relative to COVID-19 impact on regulatory, does it impact your thought on CereLink reentry? I know you were thinking about a 510K would be needed.
The short answer is we've actually had good response in timely discussions with the agency, and so we haven't had any effects at this point in time with any of our key products. Obviously, even some of the delay of EU MDR is helpful relative to resource management. I would say specifically to CereLink, where we're talking beginning of 2021 launch, no, the dates have not been negatively impacted.
Thank you.
Our next question will come from Matthew O'Brien with Piper Sandler. Please go ahead.
Morning. We're getting a little bit late in the call here, so I'll just stick with one. The commentary on Q2 and Q3 I think are largely as expected with the declines that you're anticipating. I think the Q4 commentary is a little bit different than we're hearing from most other med tech names. I know you talked about this a little bit with Raj's question, but what headwind would really need to happen? Is it a pricing headwind or all the capital being zero in Q4 for you to kind of hit that base case scenario? What would need to happen for you to deliver some upside to numbers or to the growth profile versus what you're laying out in the base case in Q4? Thanks.
Matt, I think relative to our base case, the first part is that we see sequential improvements within obviously primarily neurosurgery, but also across the portfolio, which we believe that that's going to take place. I think from a more societal level of that, as the society opens up that we plan on actually seeing more traumatic brain injury, more fundamental trauma, the things that happen in everyday life that don't happen when majority of people are staying at home. I think the variability between getting to a Q4 level and outperforming a Q4 level is a couple things. One is, how much normalcy is back into the system. I think that's key. Relative to the tissue side of the business, we actually have some really great opportunities in hernia repair, breast reconstruction, the orthopedics we talked about.
I would say we're planning in our models that the recoveries take longer for those areas out into the end of this year. If the businesses open up faster, all of the countries around the world are getting back to a more normal level of procedures, I won't say necessarily of life as we know it, but procedures, then we think there's potential upside. We're trying to be, I'd say, appropriately cautious about how we think about it. By the time we have our next call and we're into July, we'll have a much better view of what that slope looks like. The fact that a large percentage of our revenue is tied to hospitals and ICU beds, that's something that we keep a sharp eye on.
But again, if I compare what took place in March to April to what could happen in the fall, I just think our country, as well as other countries around the world, are going to be much more better prepared to manage what the curve looks like. The need to basically shut down all ICUs, we think that risk is lower. Obviously, we'll see how that plays out, which would bode well for continued neurosurgery procedures and green zone components of hospitals. That's kind of the range as we see it. In the near term, it's about neuro, trauma, TBIs getting back in business. In longer term, it's about adding those things that we talked is more deferrable back into the fold.
Thank you.
Thank you.
We will take our final question from Jayson Bedford with Raymond James. Please go ahead.
Hi, Jayson.
Hey, Peter. Good morning. Just a couple quick questions. The 30% reduction in OpEx sequentially, what percent of your OpEx is variable versus fixed?
Yeah-
Carrie, do you want to answer?
Yeah. It's 60% is fixed and 40%'s variable. Understand that the cost actions we did take actually impacted some of those fixed buckets as well. When we talk about some of the reduced work hour weeks and the pay cuts that we did enact, that would be part of that fixed bucket. That's where the 30% overall of the operating expenses gives you a more complete story in terms of what we targeted.
Right. Okay. That's helpful. And then you mentioned, in answering a question, 60-ish % gross margin in 2Q potentially. Just for clarification, is this based on the down 45% in April, with modest improvement in May or June?
Yeah
Okay. Yep.
I would say if you're in somewhere in the low $200 million for Q2, that's where essentially you're talking about a 60% gross margin. If you can get to mid $200 million, obviously, we would expect gross margins to start to see some improvement. It really depends on your view of what May and June looks like. Again, Glenn and Peter have given you some indications that we do expect some improvement, I would say the 60% is more of a modest recovery in May and June. It doesn't assume a 45% for the entire quarter. I would say, from my perspective, it's a more conservative view of gross margin until I have more experience of what our P&L looks like as we continue to close our books for April.
Okay. That's helpful. Thank you.
And this concludes today's question and answer session, and it also concludes today's call. Thank you for your participation, and you may now disconnect.