I see. I work on the MedT ech team at B of A. We'd love to welcome Integra. We have Glenn Coleman, CFO, and Sravan Emany, Treasurer and VP of Investor Relations. Glenn's gonna do a few short slides, and then we'll do Q&A.
Thanks, Travis. Good morning. I'm excited to be here this morning talking to you about Integra LifeSciences. I'm gonna flip through the first couple of charts. This is just our safe harbor statement. I'll be making certain forward-looking statements on the call, and then also non-GAAP financial measures.
I'll be referring to a couple of non-GAAP financial measures. Let me start off by giving an overview of Integra for those that may not be familiar with our company. We're a mid-sized, diversified MedTech company with annual revenues of $1.48 billion based upon the midpoint of our guidance range for 2018. We're headquartered out of Plainsboro, New Jersey, just down the road from Princeton University. We have about 4,400 employees worldwide, and that number's up about 1,000 heads year- over- year, largely due to two acquisitions we did in 2017, Codman Neurosurgery and Derma Sciences.
And we're also adding a significant amount of additional heads in our commercial channels. On the left side of the chart, you can see our enterprise value, a little over $6 billion. We trade on the NASDAQ stock market under the ticker symbol of IART. If you look at our two segments in the breakdown, a little less than two-thirds coming from our Codman Specialty Surgical segment.
That includes a leadership position in neurosurgery as well as specialty instruments. And a little more than one-third coming from Orthopedics and Tissue Technologies. Again, 80% of this segment is really regenerative products, products that regenerate tissue in the body. And 20% or so coming from extremity orthopedics used in small joints. If you look at our 2018 guidance, we're projecting reported revenue growth of 25%, which includes a full-year performance of Codman Neurosurgery.
When you remove acquisitions and divestitures in foreign currency, organic growth is expected to be around 5% for the full year. Our Adjusted EBITDA margins, 23% to 24% for the full year, represents almost 100 basis points improvement over 2017, and we're expecting that trend to continue over the next five years. An adjusted earnings per share growth of greater than 20%, a combination of higher revenue growth, EBITDA margin expansion, and a lower tax rate.
A big part of our company is rolling out new products each and every year, and we expect 25% of our organic growth coming from new product launches or new product registrations each and every year. So think of that as about a point or two of revenue growth from new products. On the lower right side of the chart, you can see 40% of our sales coming from regenerative products.
Why is that important? These are the faster-growing products in our portfolio and carry the highest gross margins. And then finally, our international sales, about 30% of the total company sales. To me, this represents a big opportunity for us. In 2017, we did two transformational acquisitions: Codman Neurosurgery, which was a carve-out from Johnson & Johnson, and Derma Sciences, a regenerative technology company.
You can see how our business mix has changed over the last two years. In the middle of the page, you see neurosurgery now representing 46% of our total sales. And obviously, that was increased with the acquisition. And then in OTT, our regenerative skin and wound platform, now 29% of our total consolidated sales. Internationally, we've gone from 23% to 30%, a lot of that driven by Codman. So over half of Codman revenues are outside the US.
And so obviously, that gave us much greater scale and reach in our international business. On the right side of the slide, you can see we have a good mix of both stable and high-growth markets. Fast-growing areas such as ankle arthroplasty, shoulder arthroplasty, we play in that space. Double-digit growth in outpatient wound care and reconstructive surgery. And then very stable markets in neurosurgery, growing in that low to mid-single-digit range.
And in certain markets outside the US, growing even faster, such as Asia. This is a deeper dive into our Codman Specialty Surgical segment. $3.5 billion addressable market opportunity for us. Our business, based upon our guidance, is $960 million for 2018. About 35% of this segment sales comes from outside the US. And we have a number of leading products in this space. Why is that important?
You really can't go through a neurosurgery procedure without using Integra products. We also have the largest sales force in the world, direct sales force. And we expanded that sales force with the Codman acquisition, increasing our US channel by 30% and outside the US by 50%. We took our channel from 300 commercial reps to 450 outside the US. And you can see on the right side the key growth drivers for this part of our business.
You know, lots of new products being rolled out, especially from the Codman portfolio. You hear more about those in 2019. But it includes an electrosurgical generator, a new ICP monitor, a toolkit for the programmable valves, and a number of other products, as well as new product registrations outside the US. We're really excited. We just announced we got the approval for CUSA Clarity, our tissue ablation device in Japan.
We'll be launching that, obviously, in the next couple of months. And we're expecting our flagship product, DuraGen, product used for dural repair, to be approved later this year. Obviously, those are key growth drivers for us, coupled with the channel expansion I mentioned earlier. This next chart really highlights the breadth and depth of our portfolio.
This is the most comprehensive portfolio in neurosurgery. The boxes in green represent the Integra legacy products, and the boxes in blue represent the Codman products. You can see the complementary nature of the two companies coming together and what now represents the broadest portfolio in the industry. A couple of points to highlight. If you look at Advanced Energy, 15% of the total segment sales, very fast-growing. Why is that?
We just launched CUSA Clarity, our tissue ablation device, in 2017, seeing high single-digit, low double-digit growth for that part of our business. I mentioned the electrosurgical generator we're expecting to launch in 2019. And then VersaTru, which are bipolar forceps that plug into the generator, launched earlier this year. So we're expecting this part of the business to be quite fast-growing, for the next several years with the new product launches.
Neuromonitoring, we had to divest one of our platforms to Natus, as part of our closing of the Codman acquisition to comply with the FTC request. We have a new monitor being launched in 2019 called ICP EXPRESS . And we're quite excited about that. And probably the most transformational part of the portfolio with this acquisition is in cerebrospinal fluid management.
Codman brings us a programmable valve, top two valve in the world, as well as an antimicrobial catheter. And so this has really transformed this part of the portfolio for us. Quickly going to OTT, our faster-growing segment. This is a segment we'd expect to grow in the high single to low double-digit range over the long term. You can see a $6 billion addressable market opportunity for us this year. Our sales guidance is $520 million.
Again, 80% regenerative products, 20% extremities for small joints. Still very underpenetrated outside the US. Most of our sales are just in Europe today. You can see only 13% of the segment sales coming from outside the US. Again, a number of leading positions across the portfolio: burns, skin substitutes, and a medical-grade honey, to name a few. And here we have a number of new products we're launching as well.
So we're expecting to launch our next-generation Panta Nail , which is used for ankle fixation later this year. We have a total ankle revision system we're launching, which can be used not just on our ankle but also competitor ankles. And then outside the US, expecting to launch several regenerative products. So for example, IDRT, our Integra Dermal Regeneration Template, and getting the CE mark for that in the meshed form in Europe later this year, as well as SurgiMend Macroporous .
Again, a big part of this business is expanding our channels. And I'll touch on that in just a minute. So one of the big changes we did in our orthopedics and tissue business this year coming into the year was getting more focused on our inpatient business. If you look at the two gray boxes to the left, this was one channel as we exited 2017.
So we had our rep selling extremity metal and also all the wound reconstruction in the inpatient setting. We split the channels. Now we've got dedicated channels that are just focused on extremity metal and orthopedics for small joints, as well as inpatient skin.
And you can see on the right, we also have a separate channel for outpatient wound care, where we have one of the most, broadest portfolios with three different technology platforms. And then surgical reconstruction, which is a channel focused on hernia, ab wall, and breast reconstruction. Other key point on this chart to highlight is over 200 additional FTEs added in the last two years in our OTT business. And I'll just wrap up with this last chart on international.
We've doubled our business outside the US since 2015, going from a little over $200 million to over $400 million based upon our guidance for this year. Key growth drivers, again, channel expansion. And I obviously, Codman helped to accelerate a lot of that expansion outside the U.S. But a lot of new products being registered. And these are existing products in new markets.
And we'd like to highlight two key markets for us now. Both Japan and China have more than doubled over the past year. We now have over 70 resources in each of these markets. Put this into context, five years ago, we had no presence in essentially either one of these key, key markets for us. So we actually have scale now in each of these two markets.
We're planning on launching new products to the Japan market later this year between CUSA Clarity and DuraGen, as I mentioned earlier. With that, I'm just gonna wrap up on one final chart on capital structure. I think it's important given some of the recent announcements that we just made. You can see what our capital structure looked like as of 31 March .
We had net debt of about $1.66 billion and a bank leverage ratio of four times. We announced two transactions, earlier, excuse me, late last week. Number one was we amended and extended our credit facility. The size of the facility stayed unchanged, $2.2 billion. But we shifted $300 million from the term loan to our revolver. We extended the maturity out by 18 months to 2023. And we got much better pricing, so lower interest rates.
Subsequently, right after that, we announced an equity offering of about $350 million. We issued a little over six million shares to pay down the revolver. And you can see that brought our leverage ratio down to 3.1 times. This was clearly an opportunistic financing for us. Coming off the heels of a very strong Q1, the integration of Codman going well, the OTT channel expansion going well, we took it as an opportunity to go to the markets and pay down some debt.
Another key aspect of this was the deleveraging, so taking our leverage down by a full turn. And the nice thing about this is we were able to do both of these transactions and be net neutral to earnings per share. So the reduced interest expense is fully offset by the equity issuance. So there's no impact on earnings per share in 2018.
Obviously, when people see us do this, they're wondering if we're up to any large acquisitions, and we've been very clear, no big acquisitions are planned for 2018. This is really giving us strategic and financial flexibility to support our plans for tuck-in acquisitions over the next five years, and so that's a key message that I wanted to make sure I also put out there, so with that, Travis, why don't we turn it over to you? We can go to Q&A.
Yeah, great, so I'd like to start with kind of a, a big-picture question, so essentially, every sales rep in the company has undergone some sort of change. You're integrating your largest deal, and you've had some disruption, but it's, you know, gone a lot better than planned and better than most of us expected. Now, how have you been more successful than many of your peers navigating such a large change with a commercial organization?
Yeah, it's a good question. I would say first and foremost, we did a lot of planning coming into these channel changes. And so, you know, planning through the Codman announcement to the actual close, having lots of communications with the sales reps, and then having the territories really laid out as soon as we closed and getting those communicated, I think, was a very important thing for us to start off on a good footing.
As we got into the Q1 , obviously, people had new territories. But for the most part, they're selling into a lot of the same accounts. It was a lot about out of the time selling in terms of training effort that was involved. We had to do training in the US, in Europe, around the globe in local languages.
And so we had a lot of field reps that were out of the field in the Q1 . And so for us, the fact we actually generated organic growth that was, you know, above 2% in that part of our business, we felt quite good about.
But again, this is an area we know really well. We've got a great portfolio, as you saw earlier. I think people are really energized from a compensation point of view, knowing that they can make more money with a combined portfolio going forward. And so I think that's been one of the key contributors to success on the CSS side. On the OTT side, we did a lot of things to plan in 2017 for successfully launching in 2018. So what did we do?
We hired a number of skin specialists and ankle specialists, knowing that when we announced the channel split, we'd actually put those resources into those two areas of our business. And those are key anchors for us. We had to make sure we didn't have any disruption in those two parts of our business when we did the OTT channel split. And so for me, that was a big contributor to the, you know, the success that we're seeing so far in 2018. Sravan, I don't know if you wanna add anything, but that's.
No, I think there was just a lot of groundwork laid down on the CSS side last year. We had a long lead time between the time we had signed the deal with Johnson & Johnson in February of last year and when we closed it in October. And Glenn, Pete, and the rest of the leadership went around, basically met almost every single Codman employee to make sure that those people were retained and felt good about joining Integra. And so we had, I think from the amount of work and legwork that they did last year really paid off this year.
And in terms of the risk, you know, during Q1, you know, that's obviously your highest risk quarter of disruption. You know, how much lower is the risk in Q2? And does that risk kinda go away by Q3 completely?
Yeah, so when I think about the risk in our channels, on the CSS side, you know, we're essentially complete in the US. Pete used a 90% complete overall on the earnings call because we still have some work to do outside the US as we close certain Day 2 countries, we call them. So, you know, once we close those countries, that's really an indirect sales force sold through distributors.
But the vast majority of the commercial integration is behind us on the CSS side of the business. I would say we're a long way through the OTT channel split as well. But we still have to add about 30 resources here in the Q2 . And I would expect that to carry forward into the Q3 . So there's still more work to be done on the OTT channel side. But that's going quite well. That's probably the bigger work effort, if you will, in the Q2 versus CSS.
And it seems like a lot of things that you've done to make this integration go smoothly and that sales force changes to go smoothly is really no real reason why that would change in, you know, in Q2. So I don't know if there's anything that you would like to say in the first few months into Q2 that seems like the integration's still on track. Is there anything you would like to comment on that?
No, listen. I think when we came into the earnings call late April, we said we expect Q2 to be slightly better than the Q1 from an overall organic growth perspective. That contemplated our private label business being down year- over- year in the Q2 . Last year, we had one of the highest quarters we ever had in our private label business. And so it's a tough comp. But the channel changes themselves are going well. And that's reflected in the sequential improvement we're expecting in our Q2 guidance that we put out there.
Okay, and just switching over to the equity offering, so obviously you talked about that a little bit, but equity is usually more expensive than debt, so just trying to think of how you think about your optimal capital structure and how do you decide how much, you know, equity to raise versus debt to pay down?
Sravan , why don't you take a crack at that one?
Sure. So look, it was, from our perspective, truly opportunistic. We were trading at a, I think, from a debt perspective, we were able to work with our banks to really improve our cost of financing. And we got a meaningful improvement in our pricing grid. And that improvement allowed us to absorb the equity deal, right, from a EPS perspective.
And since the two offset, we felt we had this opportunity, this interesting opportunity to basically do one transaction, accelerate our deleveraging target by about two years. And where we would have ended up at the end of 2020, we brought that forward to today. Again, nothing to do with that additional flexibility and capacity this year. But you know, reducing the amount of total leverage that we have and freeing up capacity for you know, future growth, you know, doing that today was pretty meaningful for us.
Was there something about last week's or I guess it was last week's debt restructuring that allowed you to pay down the debt? Because it seems like from our math that most of the savings on the EPS really came from debt pay down versus interest expense.
Yeah, so it's a combination of both. So, the way our pricing grid works, right, so there are breakpoints in the pricing as well. And so we had a benefit of not only just having improved pricing, say we didn't do the equity deal, but the fact that we lowered the amount of total debt that we have. We had a breakpoint in our debt. So it increased the amount of savings that we had overall on our overall total debt, so in the total borrowings. So it was a pretty big savings there.
Okay. So, why decide to do the equity raise now and not wait, you know, a few more quarters when your revenue growth rate's gonna be kinda double what it is today?
It's a good question. So we thought a lot about that. This year is an election year, right? There's a lot of volatility in the markets. We kinda saw where it was the last few weeks and where we were personally. And we just felt from a capital structure perspective that this was a time where we could lock in that neutrality bet or that benefit of the two offsetting each other. And we just thought that now was the time to take it and see what we get out of it.
Is there anything to read about Q2 versus doing the equity raise now? I don't know how much thought went into that.
No, it was more just broader macro.
Yeah, and keep in mind, good, strong start to the year. Q1 , you know, was off and running. Codman integration's going really well. OTT channel expansion going really well. And, you know, the world could look like a very different place in six months. And the fact that we got this done gave us a lot more flexibility over the long term, have no impact on our earnings per share, and delever by almost a full turn, why would you not do it, right?
Yeah, that makes sense. So switching over to margins, Q1 gross margin came in, you know, a little lower than expected. I guess the one thing that was really a surprise was the higher cost in the J&J plant. Just maybe a little more color on what drove that and how much of this contribute to the margin miss in Q1?
Yeah, again, you know, we were a little disappointed on our gross margins in the Q1 . The good news is we expect a nice rebound here in the Q2 . There was a lot of factors that went into the performance in the Q1 . I mean, the higher cost from some of the J&J products, obviously one of the factors. We also just started up our new Mansfield site in Massachusetts.
That's where we're gonna be transferring the manufacturing to. FX always plays a role in this as well. And FX was not so favorable for us. And so, I would just say we're not gonna quantify how much that is, only to say that we expect a nice rebound. I said on the earnings call, at least 100 basis points improvement in the Q2 on gross margins. We've got good line of sight to that.
We're seeing better productivity coming out of our plants, particularly in Puerto Rico, as we're ramping up Puerto Rico post the three hurricanes. And so, I feel quite good about it, along with more of the longer-term plans where we're optimizing our facilities.
So what does that mean? For example, we're putting all robotics in our new collagen manufacturing facility so humans don't touch the product. Those types of initiatives and investments are gonna pay off for us several years from now and should help to drive our gross margins higher to the 70% to 72% range, which is what we gave as a long-term target by 2022.
So 100 basis point improvement in Q2 and then really need 200 basis points kinda by the back half of the year or more to get to your full year guidance of 67.5% to 68.5% for 2018 gross margin. How much of that is mix? And what else kinda gets you there? You know, I guess regenerative revenues improving, you know, anything else to really give us confidence that you can hit those margin targets?
Yeah, so I think, you know, the way we look at the rest of the year, Q2 should be a really strong quarter on gross margins. And then, you know, from there, even if we hold the gross margins pretty consistent, we should get pretty close to our full year guidance even without further improvement. I would just say it's a combination of more volume going through our plants.
The fact we've got a dedicated channel now that's just focused on selling regenerative products and so forth should drive much faster revenue growth. And that should help the overall mix, to use your terms. And again, the improvements we're making across our facilities continue to occur. And we expect more cost benefits later this year associated with that.
Last point, you know, a lot of these new products that we're launching, we've redesigned to be much more cost-effective. So I look at CUSA Clarity as an example where, it's a more expensive piece of capital from a selling price perspective, but the cost is much lower. We've designed that box to be much easier and simpler to make at a much lower cost, and so the gross margins on that, along with a lot of our new products, are gonna help our overall gross margins from a mixed perspective as we go forward.
You're not expecting a really big ramp in second half EPS, although you know, revenue growth's accelerating through the year. You've called out R&D spending and some more marketing on new product launches. Are there any of the headwinds that we should consider as you kinda go through 2018? And how would you quantify the R&D? Is that maybe like $2 to 3 million and $5 to 10 million more for marketing?
Yeah, so listen, I, I think for us, we had a really good start to the year in terms of earnings per share. There's not a big ramp to hit our full year numbers. But keep in mind, one of the key wildcards for us is getting off the transition services agreements with J&J, which is gonna happen in the July timeframe.
So, you know, we're being a little bit cautious until we get past that. And what that means is we're gonna be doing all of the order taking, shipping products to our distribution centers, billing customers, and getting cash. Today, that's all done by J&J. And the cost to do that, putting that through our infrastructure, we've obviously got good estimates in there. But until we get past some of those initial TSAs and get off of those, we're being cautious around, you know, our guidance on EPS.
And so that's factored into some of the numbers that you've quoted. If things go well, there's obviously upside. And we think we've built enough of a cushion in for the unknown where if things go okay, we should have most of that covered. But for us, we're just being cautious until we get past mid-year.
Is the risk with the TSAs really that you would end up costing more money to make those transitions happen? Is that the only risk really or the main risk?
Well, so keep in mind, you could have a customer disruption if you can't ship an order and that type of thing as well from a revenue point of view. We don't expect that to happen. But the cost side of it is the biggest part of the equation. And as you can imagine, you know, we're not getting the best price from J&J on these costs, right?
So they're charging us a pretty sizable fee to do these services for us. So the faster we get off, the better off we should be. And we believe we can do these costs cheaper than what we're being charged as part of these TSAs. But again, until we get off and see what the cost is within our infrastructure, we're gonna continue to be cautious for the remainder of the year.
How big of an impact could it be on your margins if you can do things kind of in line with your plan? And just how much more can you save versus J&J is charging you today?
I don't think we've quantified the impact on our margins. I would just say, as we look forward, a big part of how we go from 23% EBITDA margins today to 30% by 2022 is getting leverage and doing things efficiently within our overall company structure. And so getting G&A leverage is an important one. That's really where these TSAs show up.
If I look back at where we were just a few years ago, 18% of our costs were G&A as a percent of revenue. We exited 2017 at 15%. I'm expecting it to be less than 12% by 2022. And these TSAs and being able to support this business much more efficiently is a big part of the reason how we get to the 30% EBITDA margins.
So kinda TSA is kinda maybe the best case scenario or a good case. They kinda come in line with plan or better than plan. Is that more like a 20 basis point improvement in margin versus your guidance, or is it 100 basis points or some?
Yeah, again, we're not gonna quantify it 'cause there's a lot of unknown around it. I would just say we think we've got adequate costs built into our guidance for some disruption coming off the TSAs. If things go well, there obviously could be upside for us.
What happens at the customer end? Does the customer see any change at all when this TSA moves over to Integra?
Yeah, so obviously, we're doing a lot of communications with the customer now. So I know where to place orders, where orders are gonna be shipped from, all the basic things that go into an actual sale. So all that communication is taking place as we speak. And obviously, the customer will be directly interfacing with our customer service organization instead of J&J, as an example, come July.
How is there like, how would you quantify the risk or think about the risk of what could go wrong in terms of the customer interfaces that having I mean, you think they call a different phone number, would be the same, same service?
Yeah, I mean, customer could be confused about where to send the order, how to order, where the products are being shipped from. But listen, we think in our infrastructure, we've done this before. We've transitioned off of other agreements, not to the extent we're talking about here. But we've done it before. And we have contingency plans put in place. We've thought through these plans quite carefully, and so I'm not expecting to have a lot of disruption or, or issues. But again, those are the types of things that could come up.
Sure, that's very helpful and kinda moving really quickly to new products. So you've talked a lot about new products in CSS. I don't know any more info that you'd wanna share on that today and how should we think about the impact on revenue growth? You've got that business pegged at 3% to 5% long-term. Is that enough to push you over 5% just from the new products?
Yeah, we certainly think getting to 5% has some level of success with new product launches. And again, I would look at new product launches as those we've recently launched where we're seeing a multi-year upgrade cycle such as CUSA Clarity, where we expect to see very good growth coming for the next 3 to 4 years as customers replace the embedded base out of their current network.
Beyond CUSA Clarity, though, Codman, we have probably 4 or 5 products we're expecting to launch in 2019. And the key for us is doing these in a thoughtful, staggered manner so as to not overwhelm the sales force with 5 products at once. And so we're gonna have a regular cadence of new product launches, really starting at the beginning of 2019. And that'll include an electrosurgical generator, new toolkit for the programmable valves, an ICP monitor.
And there's other things we haven't spoken about yet publicly. But there's other products that will come through that portfolio, which we think will drive to the higher end of the 3% to 5% range. And again, another key component is new product registrations outside the US. This is a big one for us. I mean, Japan is a big market for us now.
We just got approval for CUSA Clarity, had our first successful case last week in Japan. And DuraGen we're expecting to launch later this year. These are flagship products in our portfolio that we're gonna be launching through a direct sales force that's over 70 reps. Five years ago, we had nobody in Japan. That's why we're excited about this acquisition. And this really highlights the selling synergies we have between the two teams.
Okay, great. That's all the time we have. Thank you.
Thank you.