Go ahead and get started here. My name is David Lewis, medical device analyst with Morgan Stanley. It's my pleasure to have with us here as we progress through the morning and our first day of our conference, Integra LifeSciences, and we've got two members of management: Peter Arduini, CEO, and Carrie Anderson, recently hired CFO.
Mm-hmm.
So we're gonna jump right into it. Once again, please go to the Morgan Stanley Research Disclosure website to see fun and familiar facts about me. So, Pete, I wanna move right into a tough question. You've talked about this business as a 5%-7% grower for a prolonged period of time. We didn't see that level of growth in 2017, 2018, or the earlier part here of 2019. What, what has held the company back in terms of getting into that sort of 5%-7% profile?
Yeah. Well, I would say, look, David, broadly, you know, prior to the acquisition of Codman, you know, we were growing above that level. The underlying markets that we're in justify that type of growth. But we made that strategic decision to pick up, you know, one of our major competitors, put us in a position to be worldwide the number one player in neurosurgery, and also kind of advance our international strategy by multiple years. I mean, you just can't grow in China and Japan without picking up some of that base. So we have it now. The integration is fundamentally complete. Our last TSA with Japan just took place this quarter and is on track to our expectations. So that's part of it. I think you saw in the first half, you know, 5% growth. We're talking about 5% growth in the second half.
You know, as I communicated on the call, as we exit this year going into next year, we'll accelerate above that level. You know, what gives me confidence, I mean, I see the underlying constructs. I mean, the new products we're bringing out in neurosurgery are growing faster than the company average. The growth that we have within our tissue technologies business is growing, obviously, then faster than the company average. Orthopedics, for the first time since we've realigned the channel structure, we're starting to see positive growth. Not where we fully want it to be yet, but after multiple years of not having growth, the changes we've made in the portfolio are starting to bear fruit.
Okay, and so what you did with Codman was a little sort of antithetical to what we're seeing across broader med tech. Med tech right now has an arms race, whether Boston Scientific, or you name it. Everyone's buying growth. Growth is good for the multiple, PE multiples or, you know, 20-year highs. You buy Codman, you sort of deliberately take down your growth rate. Why, why does that make sense? Why was that the right strategy?
I mean, if you're the two previous named companies, they already have scale. We didn't have scale. And we believe, as many other companies, that being a top three player in a segment in med tech is huge. Obviously, if you can be the number one player, it's a really sustainable position to be in. But this gave us that girth, if you will, to be that. Now, we announced this morning an acquisition called Rebound Therapeutics, which is a good example that we probably wouldn't have done the deal if we didn't have this platform that we have now. And so what this deal is all about is we think it's a really interesting opportunity to actually change the growth profile of some of the fundamental marketplace within neurosurgery. It's a platform that actually has illumination, also image capabilities, and a working channel.
So if you think about neurosurgery, it hasn't really changed that much in a craniotomy in 100 years. Most procedures, it's a wide open access. The reason being, it's a compact space. It's difficult even for robotics, and hence there hasn't been a lot of minimally invasive platforms. This, we think, is gonna be a winner within that space because it allows high-end lighting, imaging, and access of instruments down that port to do tumor resections, actually play into the stroke market from a neurosurgery standpoint, and intracerebral hemorrhage. And it's all a disposable product. So when you bring all that together and say it's on our call point 100%, these are all what neurosurgeons use, and they've been hungry for a device like this, we think it's a great fit. So that's a product that we expect with success would grow in the double-digit range.
And so now, back to your point, we had, you know, we had a high single-digit growth business. We buy a Codman that was growing in the 1%-2%, 1%-2% growth. We focused on it, growing it into the 3%-4%, maybe 5%. Now, with that platform, adding some new technologies, we think we can move it above that. And for long-term sustainability, being number one and moving up the scale, we just think it just made a lot of sense strategically to do that.
Okay. So maybe you spend on Arkis and Rebound. Maybe you spend close to $100 million bucks in recent weeks. What's sort of the revenue opportunity for Rebound? Is this a $100 million dollar product? Is this a $20-$30 million dollar product?
I think, I think there's different shots on goal. I think if you think about ICH area, you know, we think those market areas, it could be a marketplace of a couple million dollars. I think if you think of minimally invasive neurosurgery, it's bigger than that. I mean, it could be twice the size of that, depending on where those procedures go. And then we have rights to other areas within the body, whether it be if you wanted to use this within ENT, you wanted to use it in other areas in the neck or other parts of the body. So the thing we like about it is it's a double-digit play. We've got multiple platform plays. You guys know how all this works. Not every market plays out exactly as the company that bought it says it will.
So when you have a platform technology that has multiple shots on goal, it's pretty good. And then Arkis, David, to your point, we announced this about a month ago, right?
Mm-hmm.
Okay. In that, in that range. And what this is all about in neurosurgery, one of the biggest issues you have, anytime you put something in the brain that is a tube that either is a sensor, a delivery vehicle, or a fluid exciser, it usually gets clogged. It's one of the top issues you have with shunt or whatever. And this is an Endexo technology that is licensed to other parts of the body. We have the exclusivity for neurosurgery. And the ability for this to work in combination with an antimicrobial catheter so that you reduce infections, reduce occlusions on a shunt, on an EVD, on a neural monitor, would be revolutionary for many neurosurgeons and the practice. So we've brought that in.
But again, these are great examples of higher growth platform products that we will bring in, do clinical work, some advanced, additional R&D onto this platform that will help accelerate the growth.
Okay. So you raised guidance in the Q2 after the second quarter. I think you talked about the segment doing 3%-5% in the LRP. You're probably on pace to do about 4% this year. Can this business outpace the LRP in 2020?
So, I would say if you think about our 2022 numbers, where we talked 5% - 7%, $2 billion, getting to our margin targets, which I'll have Carrie comment on here in a few minutes, we feel very good about where we are. I mean, we're right on track to all those things. I think when it comes to the growth piece here, you know, these products I just talked about aren't gonna have any material impact here within the next year. It's really, you know, beyond 2020 is where they're gonna have a substantial impact. The products that we just launched, you know, are gonna have another two to three years of run. We can talk about some of those monitors, the CUSA products, the new shunts, so we feel good.
We have things now in the portfolio that can drive us to the higher end of that range, that 5%-7% organic. Yeah, we're teed up. We've had two years of purposeful disruption, meaning we split channels. We took a carve-out out of the largest medical device company, which can be challenging, and we're successfully folding it in. Now we believe we'll be able to reap the benefits in the years going forward because we have that platform. Profitability-wise.
Yeah. I'll comment on that. In terms of our long-term plan, we talked about double-digit EPS growth. We talked about gross margin in the 70%-72% range by 2022. And there are a number of factors and levers that get us there. Part of that is with the revenue growth. So as we think about the types of products that we're growing, these tend to be faster growth, faster margin type of products. Some of that being our new product innovations, our introductions that we've talked about this year will cause a natural favorable product shift, as well as some capacity, incremental capacity that we're adding into our regenerative tissue portfolio. Again, these are faster growth, higher margin type of products that will also lead to that favorable gross margin shift over time.
I would also say, we have a focus on SKU rationalization and footprint optimization as well. On the SKU rationalization, you've seen a little bit of that, those announcements coming with the closure of a couple of Mexico facilities and one facility in Pennsylvania as we exit some lower margin commodity dental type of instruments. And you'll see with Glenn moving to his new COO role that the focus on footprint manufacturing optimization will continue and that will have an impact as well. And the last piece I would say is, though I would say the Codman integration is largely in our rearview mirror, and we can talk a little bit about that in terms of one of the last remaining TSAs we came off and the Q3.
But the other thing that impacts gross margins longer term is a TMA agreement on manufacturing with the J&J facility. So right now, J&J is manufacturing some of our Codman products, and that will roll off at the end of 2021 into 2022. And obviously, that will have a favorable mix on gross margin too.
Okay. The financial impact for the Japan TSA transition in the third quarter, I'm assuming, is fully baked in.
Yeah. It I would say the financial impact was small, but it had, you know, a sizable or significant risk that we were managing through. We talked about that the Japan TSA was one of the last remaining TSAs, and there was a reason that it was one of the last because of the complexity of that country in terms of standing up the back office functions in terms of customer service, in terms of logistics and order entry. Things that we didn't have there where you think about in Europe, we had some of that base infrastructure already, but for Japan, we did not have that. So I would say as we thought about our guidance and the distraction of the team, that was baked into our Q3 guidance.
We exited that TSA at the end of August, largely in line with our expert expectations. We're in a period of about a 60-day hypercare, as we just continue to watch and make sure that everything, the handoff with customers, is going smoothly.
You know, I would just add, David. I mean, this if you step back for this year, we opened the year saying, you know, at another conference, the discussion about what are our big challenges for the year. We had, going off the number, the largest TSA, which was the European TSA from Johnson & Johnson, making a decision to switch our legacy European platform and move the Codman business to our Oracle platform, and then ending up with the Japanese conversion, which just took place. So the amount of energy focused on that versus selling versus growth was a lot this year. And so this is the point about staying focused on that, executing it. Glenn and his team, with the IT group, with the international team, really did a stellar job.
I won't, you know, kid you that we had our challenges, and there's always issues when it's midnight the next morning. Everything is switched. You're off at J&J. Customer calls. They don't go to their customer service center. It doesn't go to the collection center. Our IT systems for how you get the numbers are all on. All of that was completely done. We did it in the U.S. the year before. We did that now, and then we just did Japan. So behind the scenes, there's clearly been some distraction factor. We get that behind us Q3, and that's why I get more optimistic when I think about Q4 and beyond because we're not integrating a big deal.
And we're gonna do more deals, but there's a clear difference of buying something in your space where every function, every sales territory has to be integrated or otherwise they're competitors against each other. And we made that bet back to your whole your original question because we would see a position where the number two player, us, could buy the number three player, Codman, and become the number one player in the world. And that would build a platform that'll allow us to buy assets like Rebound and Arkis to accelerate the growth faster. And here we are today.
Okay.
So we'll see.
To what, Carrie, to what extent is the J&J TMA for 2022? I mean, how important is that for inflection in margins in 2022?
We haven't quantified the impact of that, but it is part of that path to get there. I mean, J&J is charging us at cost plus. There is a significant cost to that agreement. We obviously think we can do that cheaper, more efficiently, and so that's what we're working on. We've got our Mansfield facility constructed already. It's about 30 miles away. You'll start to see products transition over the next couple of years. It won't be just one big bang. It'll be a slow transition as we move that product over.
Okay.
Yeah. So I think, I mean, to Carrie's point, so we, when we move those over, I mean, we'll bring a lineup in the new site, shut the J&J component down later. So the risk-reward piece, we think is well proportioned. It's a much more conservative move than shutting a TSA off and turn it on.
Yeah.
We have some pretty good predictability about what those savings are. The other side of this for margin accretion is, keep in mind, a third of our business is this transition, or excuse me, this tissue business, which has margins that are significantly more accretive to the company average. We've got quite a few shots on goal there to accelerate growth as well.
Okay. Let's talk about the back half of the year a little bit here. You said 5% in the first half of the year. Comps get two points harder in the back half. So what drives that, that momentum acceleration in the back half of the year? What's giving you that confidence?
Part of that is some of the new product introductions. Certainly, that's adding to that momentum. We do think it's about a point and a half of our growth for the year. So that's really what drives a lot of that. There's some seasonality in fourth quarter as well. But I think that largely is what's fueling some of that growth.
And where your confidence is higher, CUSA, where else are you very, you know, optimistic in the back half of the year?
Yeah. I would say in the product line. So all of the launches that we were just getting out at the end of Q2 substantially are just really now getting fully vetted in Q3. So Q4 is when you start seeing the uptick. So the reason we bought Codman from a product standpoint, if you say, "What was the biggest value driver?" was the shunt business. We had no substantial shunt business. These are the hydrocephalus pressure devices, and we've actually come out with two new products that get us into pediatrics. J&J wasn't there because of the configurations. And in this world, the programmer for how the neurosurgeon programs the device and the device, how well that programmer works can be almost half the value decision of why they go with you.
And I joke with our team, but I mean, ours was kind of like a DOS-based programmer, and now we have a modern GUI iPhone-esque programmer. So people are very enamored with the new programmer. We have new configurations. And the other thing, David, is that we have a claim that one of our big competitors doesn't, that in a magnet, in a 3T magnet, or even with other magnets, the settings will not change. And so we've done some pretty, I would say fair balance, but open marketing around educating the marketplace that didn't happen when it was in previous owners' hands. And we're seeing a very nice uptick because of that. You mentioned CUSA. Look, we think with the new entrants in the market, they've got good products, but we think we've got feature sets that are significantly better.
That being said, we've communicated that the cycle when there's you're the only one and now there's two to shop. Everybody's gonna go to the car dealership and look at the three cars. We think they'll come back and decide ours is the best one. But if you only have one to look at, you can make a sale in 60 days. If you got three to look at, the sales cycle takes a little longer. So those are all baked in, but that's what's on that side. And then on the tissue business, I mean, honestly, we're challenged to keep up with demand on amniotics is doing extremely well. We're growing double digits in the outpatient setting. We see that continuing into the future. On the inpatient side, there are some new competitors coming into certain parts. We're actually still doing quite well.
We see opportunities to expand and grow in that area, and then I think there's some areas within plastic and reconstructive surgery that use technologies that we acquired a few years ago, called SurgiMend, for breast reconstruction and hernia repair that we're starting to see some pretty interesting traction. There's some procedures outside the United States that are starting to drive that. Outside the United States, one is a pre-pectoral breast reconstruction approach that's not approved in the United States but is outside the U.S., and that's an area we plan to invest to go after some U.S. indications on.
In 2Q, few benefits of certain new product launches like CereLink. Any concern that any pull forward or capital exposed orders in the second quarter that decelerated a bit in the third?
No, I don't see that. I think part of our challenges, you know, when you have any new products is making sure that based on the demand, the new manufacturers you have, how much you can bring up. I mean, all of these new launches, by definition, you have some cap of how many you can make until you get over the next level, the hump of the ramp-up. And so that's probably what's gonna limit our growth. I think, you know, the install base of neuromonitoring. So to your point, CereLink, our new neuromonitor, received very well. Most of the J&J install base was 15-20 years old. We think that this monitor, compared to our previous platform, actually has significantly more broader features. So I don't see that being an issue.
Again, in the world of capital, this is a, you know, a $25,000-$40,000 device, not a, you know, a significantly more expensive one.
Okay. And then, Carrie, margins for 25% in the first half of the year, kind of pacing above guidance. What gets worse in the back half of the year? I sort of feel like with Japan TSA, fourth quarter should be kind of a strong margin quarter. So what gets worse in the back half of the year?
Yeah. Our guidance reflected, we did take the full year EPS guidance up a little bit, but not as much as the amount that we beat in the second quarter. But part of that is some additional R&D investments, including clinical work that we're provided for in the second half. We're also doing some investments, again, in that regenerative tissue space and trying to get a capacity to get to the point where we see demand. So you're seeing some of that spending being comprehended in the second half.
Okay. And then back to the LRP, Peter, Carrie, just trying to think about, you know, the 28%-30% sort of margin target. Is that gonna be linear? Should we think of it as this is 150 basis points a year pretty linearly, or should it be more back half loaded tied to, you know, the timing of TMA or?
Yeah. That piece will make it a little bit lumpy. So I wouldn't say that it will be exactly linear-linear, but I would say that we would still expect that double digit growth for the foreseeable future.
So it sounds like you're confident in at least 100 basis points of margin expansion for 2020.
Yeah. And we, we're not in a position to give guidance at this point, but I would say that the long-term double digit growth rate remains intact.
Okay. Hey, Pete, this is always an issue, even when I cover the company, about, you know, you bought so many things. You had sort of disjointed IT systems, and now you have sort of new management to focus just on that.
We have one ERP system now.
Yeah. So that's, you know, that's big, that's big time. So the point is I look at your OM/GM, your operating margin efficiency relative to peers. You're kind of sitting at a 0.32 now. MedTech's kind of at a 0.42. Your LRP takes you up to 0.37. So I guess I'm asking you in sort of a circuitous way, these margin targets still look very conservative. So, you know, are they conservative, or is there just a significant amount of reinvestment you wanna make back in the growth of the business?
I'll take a shot at it, Carrie. I mean, you've obviously looked at this as well as you've joined the company. I wouldn't say they're conservative, but I think they're very realistic. I mean, we've had this discussion before. How can you grow top line 5%-7% and still grow the profit simultaneously? Right. So now I get questions, "Well, gee, it seems like you could do both, you know, a little bit better." Well, the truth is we probably could.
I think the way we've built things into the portfolio, just like the two products that I just talked to you about that we brought in, if we were to hit in ICH and we're to hit minimally invasive surgery, you know, how do you take neurosurgery, which we talk about three to five, and say, "Well, get you to that high end of the range," and if both of them hit, get you to 6%, which on a company average then moves us, you know, from 5% -7% to really pushing 7%. Those are the things, but I think how we think about it is how do you make enough of those bets? Not all of them are gonna play out that you can get there.
The truth be told as well is as we get bigger in concentrated areas, we can run that business with less expense. So part of our issue from the past was we were in spine. We had other areas, broader in dental. We were not that big. And so your leverage, because you just didn't have the scale, hurts you. So the more that we can grow in more of these concentrated areas, which is why we strive very aggressively to be a number one player in neurosurgery, we think there's more margin that can come from.
I would say where we want to protect and grow is in R&D. As a percent of sales, our target is long-term 6%. We're not at 6%. So we understand the importance of R&D, including the clinical work, especially when it comes to some of these new acquisitions. So as we think about our long-term margin and EPS guidance, we want to make sure that we have enough there to fund R&D properly.
Okay. One of the areas that's been a drag on growth, revenue growth, has been ortho extremities. You're kind of growing several points below market. You've talked about some sales force transition issues. You know, I feel like everyone right now in extremities is going through a sales force transition issue or adding or growing. What, how confident are you that you're sort of behind or, or, you know, have moved past some of these decisions to split the sales force and some of the recent reinvestments?
I'm actually quite confident that the decisions we made are gonna make a big difference, but let me kind of frame it. Last 15 years, we had an integrated sales force orthopedics and tissue together. When there weren't that many orthopedic extremity competitors, it worked out great. We kept that together because of cost of sales reasons. If we split them, our previous quarter would've even looked, you know, more challenged. As we've gained scale and the competition has changed, we made the decision to split the channel the same year we did when we bought Codman. I had a lot of people say, "Yeah, you bought the largest acquisition. And on the other side of the business, you split your channel right now." Why would you ever do it in one year? Because you don't wanna do it over two years. It's all done now.
Now we have a dedicated channel, and we clearly had no growth for about two years in ortho. The beginning of this year, we put up growth. Second quarter, we put up a minimal amount. And I would say as we go into the back half, we feel comfortable that we're continuing to accelerate growth. Why? Because we have a dedicated team. Two, we have a number three ankle platform, which we're starting to see lift in. And three, we actually have a shoulder platform that's still small because it's isolated more to trauma cases, but we've got a really nice pipeline that's gonna continue to advance it. And I would say, look, a year from now, we'll talk and see how right I was on this and ultimately decide at that point, do we buy other assets, d o we invest in other things to expand it?
But I think we've made the moves that actually set this up for success. We've got a great shoulder, great ankle. We've got other plating systems in the foot that need work, and we're gonna pick off these one by one. So, we just came out this year with what we call the Panta 2, which is an internal fixation device. It's getting rave reviews. We're doing quite well with it. I think that will be our approach you'll see within orthopedics. But, yes, we'll be mid-single digits. We need to move to high single digits, but it's, you know, from negative growth to now positive growth. It's one step at a time.
It was definitely the right strategic move. I feel like, you know, Wright Medical stumbled in the second quarter. They're now signaling they're gonna reinvest in the back half of the year. Zimmer is signaling they're gonna reinvest in their sets business in the back half of the year. Any concern that the competitive response is mounting and that's gonna, you know?
I mean, it's, as you know, it's always been very competitive within the space. I would say the difference is that when it comes to all the small plating system in the podiatric area, you know, we aren't counting on that to be any type of growth contributor. What we're looking at is when we have the Salto ankle, which has the best data really in the world, the Cadence, which probably has the best instrumentation and positioning product that's actually growing quite well for us, and we now have a new revision, we see it being accepted very well. We're probably limited by we just don't have a broad enough sales force to get it in all those areas.
Then again, with the shoulder, this new CFO deal that we did, which will bring a short stem, no stem-based product into the marketplace, we think is great. Pyrocarbon, we haven't talked about in years. We've kind of been low-key on it. We actually have that technology moving quite well into a design structure that a pyrolytic head could fit onto this existing shoulder platform. So my message is, David, we made the changes. It's gonna be an organic story. We think we've got it. And now, over the next couple of years, we'll see, can we get the kind of growth and competitive differentiation we would expect?
When I think about neurosurgery, tissue, extremities, where do you think your M&A's likely to be most active the next two to three years?
It's been obviously quite active in CSS here, recently. I think both sides of the house, you'll see some stuff. But clearly in the tissue world, there's a lot of things going on. If you follow, obviously, at your conference here, what's going on in regenerative medicine, whether it be stem cells, whether it be matrices, how signals align relative to some of those plays, I think those are all areas that, you know, we're involved in at some level or we have a product that participates in a disease state that works with one of those. So either through a direct position, a private label relationship, I think you'll hear more about some of those in the future.
When it comes to our instruments platform and CSS, I mean, we actually, because of our scale there, have some opportunities to play into some areas where we can bring broader, you know, capabilities to an institution, whether it be with data. So the neuro ICU still really doesn't have aggregated data. It's still a lot of different devices. We're probably a company that's as, as well positioned as anybody to, to take a look at that. So there's a lot of different plays that way. But I would say both will have a, a fair amount. Over the next couple of years, I would expect tissue to, to be right on par with, with CSS as far as acquisition targets.
You mentioned strength in amniotics. There's actually been some disruption in some of the key amniotic players these last, you know, 12 to 15 months. Any sense that they're sort of getting their act together, and that relative tail when you've seen in amniotics, you know, comes to a close?
I would say I don't think the tailwind is any one particular player. I mean, we've come out with some different ply products that competed directly with the number one player that has been accepted, I think, at a higher rate. Our challenge is we gotta get our capacity up so we can meet the demand that's out there. I think they're rightfully so. There's a lot of new regulation and things happening from the agency looking at the market. As you know, most of this has been regulated just as tissues. Even the inspections of facilities has been tissue banks, not FDA. A lot of that's happening. And I think as more of that comes through, someone like us that's done medtech manufacturing, has actually done biologic, has done drug device combos. Longer term, we'll be a player that's here for the long run.
We'll come out ahead of this. But there is a lot going on, and I don't think between any one disruption with a competitor, I think we're beyond that now. We're gonna see continued growth. We're seeing amniotic not just in outpatient, but we're also seeing it in inpatient. We're seeing requests for it in plastics. So it's spread much further than I'd say the traditional views maybe just a few years ago.
So it feels like on both of the fronts, you kind of think, you know, second quarter was really the inflection in getting back to growth here.
So I think second quarter de-risked the second half for us. We knew Q3 was going to be more of a challenging quarter because of the integration. It's why we've kind of set the numbers that we've set, and I think Q4 then is where we actually start seeing no integration, products fully launched, the ramp's beginning, and then we kind of slingshot into 2020, and we're off to the races.
All right. Well, we'll leave it at slingshot.
All right.
Peter, Carrie, thanks so much. Thank you all for listening.
Thanks.