Good morning, everyone, and welcome to the Morgan Stanley Healthcare Conference. My name is David Lewis, medical device analyst here at Morgan Stanley. And thanks for being with us here on day one of our five-day virtual event. It's my pleasure here, as we progress through the morning, to have with us Integra LifeSciences and their CEO, Peter Arduini. We're going to jump right into Q&A with Pete. But before I do, make sure you go to the Morgan Stanley website under Research Disclosures and check out fun facts about me. Pete, just I want to start this morning kind of where we've been starting with a lot of companies here, obviously, with the topic du jour, which is COVID. You talked about June being down around 13%.
I just wanted you to just update us here on what kind of improvement you're seeing here in July, August, and September relative to some of your peers.
Hey, David Lewis . Good morning, you, and good morning to everyone listening. And yeah, we communicated on the second quarter call that June was down about 13%, as you mentioned. And we talked about seeing sequential improvement coming out here through the rest of the year, honestly, but particularly in the third quarter, and referenced a range of around 5%-15% down. And I would say we are seeing the sequential improvement that's taken place within the quarter. One of my biggest concerns, as well as many folks, during that time period, I think Arizona, Texas, South Florida were really getting hit pretty hard. And the question is, will that translate into hospital lockdowns, in our case in particular, ICU reductions? And we saw some, but not near what we saw, let's say, in the Northeast in the April, May timeframe.
So we feel pretty good about the sequential improvements that are taking place.
Okay. So you had that down 5%-15% you gave for sort of the third quarter. If I think about the 13% in June, and I think about that sequential improvement, I mean, it certainly feels like if you saw sequential improvement month over month, you should be sort of towards the lower end of that range. It just seems like a pretty conservative, the 15% number certainly seems very conservative, and a lot of 13% getting better. So should we be thinking something that's closer to that down mid-single digits? Is that the better way to think about the third quarter?
Yeah, it's tough to imagine where I can have a discussion about being down 5% or 15% is good, but I would say, look, from the standpoint of the improvements that have taken place, with our midpoint being down 10%, we definitely are more on that trend or leaning a little bit better. We'll see how September ends up. Obviously, we'll have the impact, and our traditional kind of ramp was having a bigger September. August, for us, as many other companies, has a slower international component to it, but in this year, it's a strange year. We don't normally see the same hockey sticks. There's a little bit of different cadence, and the quarter ends have been rather smooth into the beginning of the following months, and we've seen that trend. As we get healthier, we'll probably see more of an uptick towards the end of the quarter.
In our case, that will be probably some pickups of some smaller capital items. I remain reasonably optimistic here that we're probably going to be closer to the mid or lower end of that range and that we are continuing to see sequential growth.
Okay. And you mentioned resurgence, Pete. The resurgence activity, was that most intense in July? Was there any resurgence activity really in August, or was July really the peak resurgence month?
Yeah, I'd say July probably within the quarter was probably the main. Although there were hotspots. I mean, I think as an example, in the Phoenix area and stuff in August, the beginning of the month, there was a lot of the hospitals were actually quite limited. But again, in perspective to the second quarter, we haven't seen anything to the level of the type of pullbacks that we've seen as far as hospital access, ICU lockdowns. And as you know, in many cases within April, a lot of jurisdictions, particularly on the eastern part of the United States and the West Coast, wouldn't even allow elective procedures. And that had a significant impact. And we haven't seen that type of activity in Q3, which is great, and also has led to continued improvements throughout the quarter.
Okay, so it sounds like things are going kind of at expectations, maybe a little better here in the third quarter. You also talked about fourth quarter maybe getting back to kind of flattish trends. Obviously, the big caveat being capital, so let me just start with capital first. I mean, we've heard different things. Some people are very worried about the capital environment still. Other companies feeling that with hospital endowments being healthy, and obviously, the CARES Act capital has actually trended a little better than expected. How are you feeling about capital trends in your business and the ability to kind of do something that's flat or in the positive growth territory in the fourth quarter?
Yeah. I mean, so starting with the fourth quarter, I don't think anything's changed relative to our views that we have scenarios where we don't get back to flat. We have scenarios where we do get back to flat. I would say at this point in time, we feel a little bit better that our odds are increasing. The biggest caveat is what's always been there, which is what happens in the October-November window on seasonal flu coupled with COVID. And I think we're obviously going to see that here pretty soon to understand how that looks. If it's managed more like Q3 has been seen, my confidence is definitely higher that we can get back to flat. If it feels a little bit more like what we saw in Q2 or worse, well, then obviously that changes it.
So again, if you had asked me this question in July and you asked me the question now, my confidence has improved that we're seeing better management of patients, better management of beds, which then translates to increased confidence, our sequential growth. To the point on capital, we don't have the largest dollar amounts of capital. So $200,000, it's about 10% of our total revenues, but traditionally amounts to, at the end of a given quarter, particularly the end of the year, a really nice uptick. And our product that's the largest contributor is called CUSA. It's the top device for removing brain tumors. And we suspect we're having solid sales right now, but we're just not seeing the increases. And what we hear is even though endowments and such are strong, many of our buyers here aren't hospitals with large endowments.
I mean, it's a large swath across the country. And most CFOs are just trying to take a look and saying, "When will I have a window here where we'll have stability?" And back to the same question of if we're going to have some downs here in the fourth quarter because of resurgence, I want to keep my capital reasonably locked down during this time period. Outside the United States, we're seeing a little bit more openness to spend. Now, obviously, how a socialized medicine structure works versus our hospital systems in the U.S., it's different from how they'll manage cash. But that's been a little bit more consistent on at least our size of capital. And then for other components, I mean, we have certain parts of our portfolio that are actually in growth mode.
So internationally, we talked about Japan up 20% for some new product introductions and also how they manage the country, candidly. And then we have certain products within our portfolio, particularly right now within our tissue portfolio, that are starting to show some really nice resurgence here within the third quarter.
Okay. Thanks, Peter Arduini. Last question on recovery here. We'll get into more strategic stuff. Thinking about next year, and obviously, we're not in a position yet to give guidance, but the streets got you kind of 2021 very similar to 2019, maybe kind of 1% above. Does that feel right to you? I mean, based on the commentary today, if things were to continue, that number looks a little conservative. But how are you thinking about how the consensus street estimates kind of are capturing your '21 today?
Yeah. Well, I mean, David Lewis , I mean, we're not obviously in a position to give guidance. But talking about how we feel about things, I mean, it depends on how certain things play out. I would say, let me start with profitability. We've had a lot of focus this year on the profitability of the company. And our plans over the last couple of years, I think we've talked strategically about being a 28%-30% EBITDA margin company. We've done a lot of things with EU MDR as well as with our portfolios to take products out of the portfolio that aren't contributing. And that's caused a little bit of a headwind. But it also, on a go-forward basis, really sets us up to improve in our margins. And I think through this year, you'll see some of those improvements even coming through this year.
As I look into next year, I feel quite good about progress that we'll make, even in a more challenged revenue market, because of some of these critical changes that we've made in the structure of the company. That being said, with revenue, if we are to finish up, say, close to flat at the end of this year, if that's the scenario that plays out, it doesn't necessarily mean that Q1 jumps back to plus 5% growth. And so the question is going to be, what's the Q1 recovery look like? And then you could clearly see Q2, Q3, Q4 getting back to more normative levels. If Q4 doesn't get back to the '19 levels, well, then there's probably a six-month window to kind of get there. If it does, it's probably a three-month window, is kind of how we think about it.
And so do I see scenarios where we obviously put up positive growth in 2021 versus 2019? Absolutely. And optimistically, the scenarios that play out for us well, as we had a challenging 2019 relative to supply. If you think about our tissue business, we were only growing in the mid- to low-single-digit window when we should have been high-single- to low-double-digits, solely tied to supply constraints. I mean, one of the blessings in disguise for COVID for us this year is we were able to, with the reduced demand that was in the marketplace, get all of our safety stocks back to where they need to be on the tissue side, as well as address any particular plant issues. So as we're in the second half, we have no supply constraints.
As we go into next year, we'll be able to start off in a good position. All those bode well for growth. I think the market points that I made probably have the highest bearing, if anything, how that plays out.
Okay. Well, that's a great segue into where I wanted to go next, which is there's one debate on Integra these last six quarters. It's been LRP guidance was 5%-7% organic. Last couple of years, we were sort of stuck below [the] end. Admittedly, you said it was going to be low and then build to high, but you probably didn't expect to sort of miss the low end of the outlook. So everyone's really trying to ask two questions. Number one, what went wrong? You addressed tissue as obviously one of the dynamics in 2019 that obviously impacted growth. But what went wrong? And what can you say to inspire confidence in investors that you can deliver this 5%-7% organic growth as we get into sort of that 2021, 2022 timeframe?
Yeah. Look, it's a very fair question. I think the first question, the first point is that none of our underlying fundamentals via our issues that we had as well as post-COVID change. If you look at neurosurgery, the aging population, the global growth within that core business being roughly in the 3%-4% range, with opportunities where we're expanding into the periphery of vascular and also minimally invasive access could make that market grow even a couple of points faster. And so that business is solid. And we see lots of interesting opportunities, particularly with the acquisitions we made last year to add to that business. Again, getting into intracerebral hemorrhage as well as being really one of the first players to bring minimally invasive techniques into neurosurgery. On the tissue side of the house in orthopedics, we've had some issues relative to supply.
And so if you back up and you say, we laid out guidance in 2017 that said we'd be 5%-7% growth and drive the 28%-30% EBITDA margins out into 2022. And to your point, we were like, well, in 2018, fundamentally, we were finalizing the integration of Codman. We knew that that would have a drag effect. When we bought the Codman business, it was flat, only growing 1%. Now it's growing over 5%. And we also made major significant channel changes on both sides of the house. And then in 2019, Codman did significantly well. We were 5.5% plus growth, but our OTT business was not anywhere near it needed to be. It was below 5% growth. And that was a combination of some of the challenges with ortho and the tissue.
And I think between looking at the portfolio and plans that we have to correct ortho with the shoulder platform and the supply issues that I've talked about, we're actually in as good a position as we've been in the last five years to accelerate growth. And I think also coming out of this, our amniotic platform, which now we have stabilized and new products coming out, we've got actually some new indication opportunities within a broad spread of our portfolio. I feel quite good about how we're teed up for TT growth. And so how do you get there? You get a 4%-6% growth in the neurosurgery business, and you put up high single-digit, low double-digit growth in TT, which we feel in all these scenarios that are playing out this year, we feel that that's definitely doable once we get stabilized here in the markets.
Okay. And a bit of a nitpick. I deal with this a little bit with a company, Hillrom, that has discontinued products. And you have put discontinued products sort of into the LRP, so to speak. That 5%-7% with discontinued products, maybe it's 3%-4%. Why is discontinued products the right way to think about the underlying organic growth for the business? And do you really see a cadence of discontinuations here on a go-forward basis?
So what we do, David Lewis , we put together divested and discontinued in the same bucket because they're either we sold them off. So in some cases, when we did Codman, they went that way. And some of them, if there wasn't a buyer for some lower-end products and it really wasn't worth running a process, we just discontinue them. And so we break them out for all investors to see if they want to add them back into the point, they can do it. But we want to just be very transparent to it to show what the underlying business is. I mean, if you're looking at us as a what's going to happen in the year, I can understand why that metric may be frustrating.
If you're an investor that looks at us at 3%-4% and you really want to see what the underlying business looks like and where it can get to, that's why we choose to do it. I would say the vast majority of all of this, divested as well as discontinued products, we get through a lot of that in 2020. And so in 2021 and beyond, it's a smaller amount of the overall percentage that we've had. And obviously, if you're growing 5% overall reported or, excuse me, organic and 3% reported, it's a lot different if you're growing 7% and 5%. And so I think as the compression came down because of the supply issues, it became more of an acute point. But we feel very good about what we've been able to do as far as clean up the portfolio.
And during this window of time during COVID, between what costs are necessary and what we can do, we've even thought more about it. And I think investors will be happy as they start seeing quarter after quarter our ability to put up and consistently deliver on the numbers, which candidly has been an issue the last 18 months.
Yep. Okay. All right. So a lot of this is behind you heading into 2021. The other thing is, in all the years we've looked at Integra, M&A has always been a significant component of the business. Codman was a very substantial transaction. You still got $200 million of M&A kind of baked into the LRP. I'm just kind of curious. You haven't been as active post-Codman, which just may have been Codman was a very big deal on a relative basis. Do you still think that $200 million-ish of acquired revenue is the right way to think about it? And what does the M&A environment look like for your business kind of post-COVID?
Yeah. I would say when we laid the LRP out, I mean, the more important metrics there were 5%-7% growth, 30% EBITDA, north of 70% gross margins to demonstrate that that could be a $2 billion business by 2022. Obviously, that's interrupted by the COVID world. You needed some acquisitions. I would argue you could see $200 million-$500 million depending on how things play out. It's why we've been very focused on our cash flow and our profitability because we want to be in a very good position to take advantage of the right acquisitions when they come up. I would say you saw it in 2019 with non-revenue, but technology acquisitions for neurosurgery.
Again, a product that can take us into minimally invasive neuro, a product that can take us into intracerebral hemorrhage, and a product platform that can solve one of the biggest issues in neuro, which is all types of clogging of catheters that are used within the neuro procedure area. And so we couldn't have done that without Codman. You're going to see, I think, those products come to light over the next one, two, and three years. On the tissue side, there's still a significant amount of small individual players' products that are out there. And I think we can build a large plastic reconstructive as well as wound care franchise. And so I think you will see from us over the next few years a focus on how we can build that platform out.
I would say if you look at our position right now, we did the convert at the beginning of the year, which was very fortuitous timing-wise for us. We were able to get an extension to kind of take our debt covenants up to 5.5%. We're 3%-4% now. I think with our focus on the cost management, we'll focus on paying debt down. But we definitely want to be in the M&A game. I think you'll hear from us over this next year, still very much active in the M&A market.
Okay. And just size proclivity, I mean, DuraGen is probably a bit of an outlier. So should we think about most of these transactions being on the smaller end, less than several hundred million, or are they all across the spectrum?
I think it's fair to say on the smaller end. But as you know, part of this comes down to if it's an asset with no profitability to it and it's got a three-year tail till you get there, that's very different than a very commercial asset that has strong, if not even above margins that are actually accretive to the company. But I would say in general, we're focused on individual assets or products that may be one or two products that could plug into the platform to give us the breadth and scale. Again, our view of our strategy for the company is to build out this large, strong neurosurgery platform that really puts us in a number one or number two position and be able to expand from there and defend that.
And on the plastic and reconstructive side is to really build out this larger platform as well. And again, as we think there's going to be more consolidation that takes place on the payer-provider side, it's a way for us to be able to be differentiated and also have some level of differentiation within the marketplace.
Okay. So if I try to get to this 5%-7%, it kind of makes sense that you kind of have confidence at around 4% in the base and then some contribution from new products, maybe a point, point and a half, I think is what you've mentioned. But what are the two or three key products, Peter Arduini, heading into 2021 and 2022 that you're most enthusiastic about in terms of moving this kind of organic needle?
Yeah. Well, I think the first part is there's a whole underlying core of business that's been suppressed on the tissue side because of supply. So if you just think about the amniotic portfolio, we were launching AmnioExcel Plus, which is this tri-layer product really viewed as a top-performing product in the marketplace, and we never really could supply it. So that's a big one that's got multi-years in front of us. I think within the SurgiMend portfolio, which is a product used within hernia, it's also used in other abdomen as well as upper pectoral reconstructive procedures. That's got some interesting opportunities as well. And then the whole wound care area, whether it be our Integra platform, which includes OmniGraft as well as the PriMatrix platform.
So that's just one that says, how do you take a year-over-year play and say, move something that was growing 4%-5% and now seeing it growing closer to 8%-9% while the supply is a big part of that? On the products themselves, we actually have some really interesting things going on. So in neurosurgery, the CereLink platform, which is our monitoring platform, will be rolling out in 2021. That will be a new catalyst to drive growth. We've got new products coming out in our nerve platform as well. And nerve, as you know, is not a hugely crowded space, but there's also new activities that are going on there on nerve reanimation. And we think we can be one of the key players in growth in there.
And then I would say specifically back to the Rebound products, which will start coming out at the end of 2021, but real commercial impact in 2022, 2023 is this reach into intracerebral hemorrhage, again, which is our entry into stroke, not intravascularly, but actually intracranial, and then also into minimally invasive access. And the interesting thing about the minimally invasive access is instead of doing a large craniotomy, having a small burr hole and being able then to have a working channel. And so a product like the CUSA, having customized tools that will enable to work through there or even having some opportunities down the road to tie this into with robotics. So it gives us a very good positioning to set the company up with all the different products we have to perform. Those are the key products that I've mentioned.
Okay. And then kind of shifting from growth to margins here for a second, Peter Arduini. I mean, if I think about there's a lot of opportunity for margin expansion next year, obviously from favorable mix and cost rationalization that the company's always had, rolling obviously some of the J&J transitional dynamics. So this was kind of one point of margin expansion that you've done actually very consistently. How are you feeling about the ability to drive sort of one point of expansion going forward in that 28%-30% LRP target? Do you still feel good about that target, or do you feel like that target shifts a bit because of COVID?
I would caveat it this way. If we finish up this year as a marketplace and we start 2021 reasonably solid, the vaccines look good, the distribution chain to do that, and hospitals are stable, I would say I feel quite good about reaching our 28%-30% EBITDA targets in the time range that we talked about, mainly because we've made a lot of the portfolio changes. We've solved a lot of these other challenges with supply that are then going to bear fruit. And as you'd mentioned, we have this transition manufacturing agreement with J&J that beginning next year and finishing fundamentally by the end of 2022, we bring over all those products into our plant. We're paying them cost plus once they go into our facility. That's a gross margin accretive add. So we're in quite good shape there.
And then the second part of this is that with the supply back on the tissue business, keep in mind those products have 15-20 points higher gross margins than what we've been really living on in the last 18 months. So that will have a nice lift to the portfolio as well.
Okay. So when I think about tissue investments you made there, your prior comments about growth, the streets got you in 2021 at very similar margins to 2019. It sounds like you feel pretty good about those numbers as well. Based on some of these revenue and tissue dynamics we've talked about, that 2021 margins in line with 2019 feels a little conservative.
Yeah. I would say all the indications and things we have set up is that margins in 2021, barring prolonged COVID situation, should actually do quite well. And obviously, if we were able to perform even better on the top line, the drop-through because of the mix is richer in 2021 than it is in 2020 or 2019 for the previous points that I made.
The one surprise to us during Codman, Peter Arduini, was just the ability to drive growth there. I think when you first bought Codman, I think everyone said, "It's going to be synergistic over time," but from a growth perspective, I think people were a little concerned. Growth there was actually very good during integration. What was the key to driving growth, greater than 5% in that business during integration? And are there any kind of concerns or headwinds we should be worried about, Stryker's Hyper brands, anything competitively to success that you can't sustain sort of those levels of growth on a go-forward basis?
Yeah. I would say I don't see anything that says we can't sustain that growth if we keep innovating. So one of the key components here is that it's been somewhat of a sleepy market overall. I think the Codman assets that we picked up were very solid-based assets, but there hadn't been a lot of innovation that had come out. There had actually been some very good pipeline plans, but they weren't funded. And as a first step, we funded many of those. And so as an example, this year alone, the Certas valve platform, which has a new programmer and all these different valve configurations, is doing quite well. It's one of the platforms that's actually performing well this year and will continue into the next couple of years. That's a level of focus. And then also the expansion that this represented.
I mean, even under J&J, we now have 40% more people around the world selling that product than it was under Johnson & Johnson. So a combination of new products and getting them out there, really addressing the needs in the marketplace and the expanded coverage that we've been able to put in place have been the key. And again, we're now having folks, particularly in other parts of the world, come to us with single products because of this large channel we have and looking to distribute products for us through our channel. So I think that component with new products will be key. It's why last year, when we bought Rebound, we also did Arkis. Those were some of the largest acquisitions we had ever done without any revenues associated with them, technology deals, if you will.
And the reason we did that is because of the confidence of the infrastructure that we have. And if we can have hits on three of those spectacular, but candidly, if two out of three hit, that will be the type of fuel that will continue to feed that growth.
Any concerns you have as you're managing through the TMAs at J&J on supply disruption?
No. And we've had a great relationship with them. I mean, where we've had our issues, we've been able to work through it. We purposely made a decision to open our plant 30 minutes down the road so we could keep all the employees. And the way we're bringing this up, David Lewis , is we'll bring line one up in Mansfield. Once that's running, passes the quality standards, it'll be shut down in Raynham. And so in that type of a structure, you really risk reduce the probability of an issue. If we have an issue, you keep both of them running until this one's adequate. And we still have multiple years left on the TMA if we needed it. But at this point in time, I don't foresee it. I think the teams are doing a very good job on transfer.
We discussed this many, many years ago, actually, at this conference before you had bought Codman. We talked about you had a couple of big businesses, the tissue business, the orthopedic business, neurosurgical business. You said at the time, maybe we aren't committed to all these businesses over time. Maybe that's not the right way of building a centralized business. Are you still committed to the ortho business? Does it make sense kind of post-Codman, given all the interest there that the ortho business has been a little volatile? Is that a business that makes sense inside Integra anymore?
So I think the key on with the ortho business, particularly with the extremity side, is as you know, we exited spine because we just didn't see the synergies. I think the key, again, as we talk about with extremities orthopedic, is there are synergies with nerve repair. There are synergies with soft tissue repair. The key for us as bigger players come into the market and the market becomes more closer to acting like larger joints, what type of an impact will that have on the business? At this point in time, we think that we can be competitive within the business. It's actually having a good resurgence coming back. But I would say out of COVID, one of the interesting things we're watching is what happens to a lot of the customers that we serve as well.
I mean, if we start seeing more consolidation and larger players where you have to be significantly larger to win, it's probably not a business that we're going to do well in the long run with. As you probably know, unlike hips and knees, still much of these decisions are made in surgery centers and doctor office areas. And so a company like us can be very scrappy and do well. If that changes more, which there is some concern that it could, it may be better in a different location. At this point in time, though, we still think it's a good fit to the company, and we think we can continue to grow it.
Okay. You haven't seen those purchasing patterns change. And have you seen any activity in light of the Stryker-Wright transaction that's worth noting?
It's difficult to say in a COVID year what's driving what. Just to be honest with you. So we haven't really seen any fundamental changes there. If I look at our business that was down plus 70% in April and then coming back, all that isn't really tied to competitive pressures. It's really tied to access and getting patients back into the system.
Okay. I think we are well, I think we're out of time. Unfortunately, we're one minute over. Pete, thanks so much for doing this. Enjoy the meeting for the rest of the day. Thank you all for listening, and we'll be in touch. Thank you, Pete.
Thanks, David Lewis . Thanks, everyone.