Integra LifeSciences - Earnings Call - Q4 2020

Transcript

Speaker 0

Good day, and welcome to the Integra Life Sciences Fourth Quarter and Full Year twenty twenty Financial Results Call. Today's conference is being recorded. And at this time, I'd like to turn the conference over to Mike Boulier, Director of Investor Relations. Please go ahead, sir.

Speaker 1

Thank you, Catherine. Good morning, and thank you for joining the Integra Life Sciences fourth quarter and full year twenty twenty earnings conference call. Joining me on the call are Peter Ardoini, President and Chief Executive Officer Glenn Coleman, Chief Operating Officer and Carrie Anderson, Chief Financial Officer. Earlier today, we issued a press release announcing our fourth quarter and full year twenty twenty financial results. The release and corresponding earnings presentation, which we'll reference during the call, are available at integrlife.com under Investors, Events and Presentations in the file named Fourth Quarter and Full Year twenty twenty Earnings Call Presentation.

Before we begin, I'd like to remind you that many of the statements made during this call may be considered forward looking statements. Factors that could cause actual results to differ materially are discussed in the company's Exchange Act reports filed with the SEC and in the release. Lastly, our comments today will include certain non GAAP financial measures. Reconciliations of any non GAAP financial measures can be found in today's press release, which is an exhibit to Integra's current report on Form eight ks filed today with the SEC. With that, I'll now turn the call over to Pete.

Speaker 2

Thank you, Mike, and good morning, everyone. If you'll turn to Slide four, I'll begin with a review of our performance in 2020. Full year 2020 revenue declined 8.7% on an organic basis to $1,370,000,000 and adjusted earnings declined 11% to $2.45 These declines were a direct result of COVID related surgical procedure deferrals and capital spending delays at hospitals. To put our 2020 performance in perspective and illustrate the impact of the pandemic, we've included a side by side comparison of revenue and profitability in the first and second halves of the year. The biggest impact from COVID was felt during April and May.

And as a result, first half organic revenues were down 16% and earnings were down 40% compared to the 2019. As we've discussed on prior calls, we reacted swiftly to the pandemic prioritizing the safety of our employees while implementing protocols to ensure continuity of our supply chain and key R and D and clinical programs. We also protected our financial position by managing costs down sharply. As the recovery began to take hold, we saw the benefit of our balanced pandemic response. In the second half, we continued to methodically manage expenses while allocating additional funds towards growth and productivity related projects.

We generated $150,000,000 in operating cash flow, invested in inventory and improved our leverage ratio from 3.4x in June to 3x at the end of the year. We reshaped our portfolio with the divestiture of Orthopaedics and the acquisition of Acell. Our second half revenues increased $146,000,000 compared to the first half and organic revenues declined only 1.5 year over year. In the second half, EBITDA sequentially increased $77,000,000 and earnings per share increased 20% year over year. Our sales recovery persisted despite localized COVID surges and lockdowns in the fourth quarter, driven by market leading products such as Integra Skin, Duragen, as well as our service portfolio of programmable valves, all of which returned to growth in the fourth quarter.

If you turn to Slide five, you can see that we used 2020 as an opportunity to reinvent the company. In addition to the strong financial recovery in the second half of the year, we took action that positioned us to accelerate growth in 2021 and beyond. So throughout the pandemic, our focus has always been on our employees and patients, making sure we could supply critical products while keeping our employees safe. We have a one team mindset coming together to do the right things to shore up the business. As a management team, when the pandemic first hit, we acted quickly to prioritize the most important asset, our people.

At the same time, we challenged our employees to reimagine how they would do their jobs in a virtual environment. We provided tools and resources and they rose to the occasion. Our people made our strong recovery possible. Moving to global operations, we completed investments solidifying our tissue supply and also adapted to numerous logistical challenges posed by the pandemic. We quickly implemented rigorous and consistent protocols across our sites to ensure both the safety of employees and continuity of product supply.

In 2020, we closed five sites as part of our optimization program that will help us reach our long term profitability targets. COVID challenged, but it did not impede the progress within our R and D organization. On previous earning calls, we've discussed how we maintain investments in critical growth programs such as the AURORA Surgioscope, keeping them on track with their original development timelines in spite of the pandemic. Moving to the Salesforce capabilities, our commercial organizations rapidly adopted a variety of virtual collaboration and digital marketing mechanisms to stay connected with our customers and to ensure adequate support for patients. Turning to portfolio optimization.

As I mentioned, our two most transformative actions were the divestiture of our orthopedics business and the acquisition of Acell. The combination of the two of these creates a highly focused tissue technology segment that will be accretive to growth and profitability and will advance our leadership positions across

Speaker 3

the portfolio.

Speaker 2

We achieved all of these accomplishments while strengthening our balance sheet and increasing our financial agility. And finally, during 2020, we benefited greatly from prior investments in our information systems infrastructure and accelerate our digital transformation within many parts of the company. So as you can see, we did not sit still during the pandemic. We utilized the time to position the company for success in 2021 and beyond. And I'm proud of the way our colleagues responded.

We are a stronger, more focused company today than when we entered 2020. Now I'd like to turn the call over to Carrie for a more detailed review of our fourth quarter performance and guidance for 2021. Carrie?

Speaker 4

Thanks Pete and good morning everyone. I'd like to start with a brief summary of our fourth quarter highlights on Slide six. Fourth quarter total revenues were $388,600,000 representing decline of 1.6% on a reported basis and a decline of 1.5% on an organic basis. Our revenue performance was at the high end of our preliminary range communicated on January 14. During the quarter, COVID surges occurred in many of our markets resulting in tight ICU bed capacity, but we still managed a 5% improvement in our fourth quarter sales compared to the third quarter.

Most of our franchises are products that returned to growth in the third quarter sustained that growth into Q4. Sales of capital equipment improved sequentially by over 40%, but we're still down on a year over year basis. As we have discussed on prior earnings calls, recovery of capital was expected to lag the rest of the portfolio. So if we exclude capital, total organic growth was flat in Q4 compared to the prior year. Fourth quarter performance in The U.

S. Was also flat on an organic basis compared to 2019. By segment, S. CSS organic growth increased about 2% if we exclude capital and U. S.

OTT organic growth was about flat excluding orthopedics. We were also quite pleased with our profitability performance in Q4 showing improvement year over year as we continue to manage our spending. Adjusted EBITDA margins in Q4 increased by three twenty basis points to 26.4% and adjusted earnings per share increased 24% to $0.84 If you turn to Slide seven, I'll now review the fourth quarter performance of our CSS segment. Reported Q4 revenues were $254,000,000 a decrease of 1.6% on an organic basis from the prior year. Global neurosurgery sales improved sequentially from the third quarter and were down 1.3% on an organic basis year over year.

Sales in Dural Access and Repair and CSF Management increased low single digits and mid single digits respectively. Sales in Neuromonitoring increased low double digits in Q4. All three franchises benefited from strong sales of market leading products including DuraGen, antimicrobial catheters and Certus programmable valve. Sales in Advanced Energy, includes our CUSA capital sales were down mid teens in the fourth quarter in line with expectations. Importantly, sales of consumables directly tied to our CUSA equipment increased low single digits in Q4, a sequential improvement from the third quarter.

Our sales funnel of capital opportunities is strong and we remain confident in our competitive positioning. However, we do expect capital budgets will continue to be constrained through the 2021 until hospitals have more certainty around COVID. Q4 sales in our instruments franchise increased sequentially high single digits from Q3, but still saw a slight 2% decline on an organic basis year over year. International sales in CSS were down low single digits in the quarter with mixed performance. In Q4, we saw a return to growth in several European countries.

Revenues in both China and Japan increased low double digits. However, this was offset by a slower recovery in our indirect markets. Moving to the OTT segment slide on Slide eight. Revenues were $134,000,000 representing a decline of 1% on a reported basis and a decline of 1.3% on an organic basis. Q4 sales in Wound Reconstruction declined 1.5% versus the prior year, but sales of Surgivon, Nerve and Amniotic all increased double digits and sales of EntegraSkin increased low single digits.

Fourth quarter sales in Private Label increased 2% in line with expectations. Orthopedic sales declined mid single digits in the fourth quarter. And as a reminder, we closed the divestiture of the Ortho business on January 4. Turning to Slide nine, I will now show you our fourth quarter performance of the key P and L components. Adjusted gross margin was 68.2% compared to 67.2% in the 2019.

Gross margins benefited from cost management, stronger performance in The U. S. And favorable product mix. Our adjusted EBITDA margin was 26.4% compared to 23.2% in 2019, driven by improved gross margins and ongoing cost management measures. Operating expenses were approximately $12,000,000 below prior year levels.

Fourth quarter GAAP EPS was $1.9 compared to $0.18 in the prior year. The increase was largely driven by a $59,000,000 one time benefit driven by tax restructuring completed during the quarter. Adjusted EPS was $0.84 in the fourth quarter compared to $0.68 in the prior year, reflecting an increase of over 23%. Diluted shares outstanding were down slightly in the fourth quarter as a result of the accelerated share repurchase program completed earlier this year. Turning to Slide 10, I'll now review cash flow performance.

Operating cash flow was approximately $80,000,000 in the fourth quarter and just over $200,000,000 for the full year. Free cash flow conversion for the full year reached almost 80% driven by strong second half EBITDA performance, improved receivable collection efforts and prioritization of capital expenditures. If you turn to Slide 11, I'll provide a brief update on our capital structure. We ended the year with a strong balance sheet. Our cash balance was $470,000,000 with an improvement of $140,000,000 in our net debt position from 2019 pro form a levels inclusive of the convertible note.

This translated into a leverage ratio of three point zero times, basically flat with 2019 on a pro form a basis. Our targeted leverage ratio range is 2.5 to 3.5 times. So we were right in the middle of this window. Recall that in the 2020, we reached our peak ratio for the year at 3.4 times. So our second half cash flow moved us squarely within the range by year end.

Turning to Slide 12, I'll provide an overview of our consolidated revenue and adjusted earnings per share guidance for the first quarter and full year 2021. We are providing guidance today, but recognize that the course of the pandemic remains uncertain. And as a result, the rate of recovery in surgical procedures and capital equipment sales remains variable. In our full year guidance, we assume a gradual improvement in procedures in the first half with no further setbacks from new surges or new COVID variants. And as mentioned earlier, we believe capital budgets will continue to be constrained through the 2021.

We will continue to assess the current environment and provide updates on our quarterly calls. First quarter revenues are forecasted to be in the range of $345,000,000 to $355,000,000 representing our normal seasonality in Q1. This represents reported growth of approximately minus 3% to flat and organic growth of flat to up 3% over 2020. For the full year 2021, we expect revenues to be in the range of $1,520,000,000 to $1,535,000,000 representing reported growth of 11% to 12% and organic growth of 12% to 13% over 2020. Reported revenues include a first quarter estimate for Acel in the range of 14,000,000 to $15,000,000 and a full year estimate in the range of 83,000,000 to $88,000,000 This estimate is based on 2020 Acel revenues of $95,000,000 and the late January closing.

We also assume a continuing COVID impact for Acel similar to our existing tissue business as well as typical short term sales disruptions as we integrate the business. As a reminder, 2021 organic growth excludes the impact of foreign currency fluctuations, acquired revenues including HCEL, divested revenues including Orthopedics and discontinued products. And consistent with previous practice, we will include a reconciliation between reported and organic growth. The impact from discontinued products is expected to continue to decline and will have a negative impact of approximately 1.3% on full year 2021 reported revenue. As a reminder, 2021 should be the last year of any significant impact for product discontinuation.

SKU rationalization has been an important part of how we are simplifying the portfolio and improving overall gross margin. Turning to the earnings guidance for 2021 and based on the revenue ranges I just provided, we expect first quarter adjusted EPS to be in the range of $0.54 to $0.58 which represents double digit year over year growth. Full year 2021 adjusted EPS is expected to be in the range of $2.86 to $2.93 With that, I'd like to turn the call over to Glenn.

Speaker 5

Thanks, Carrie, and good morning. If turn to Slide 13, I'll provide an update on the Acel integration. Immediately following the January 20 closing, we began the implementation of our integration plans and onboarded conveying Acel colleagues. The first three weeks of the integration have largely been focused on the transition of the commercial organization. We've already taken steps to assign sales reps to their territories, formalize quotas and establish and roll out compensation plans.

Integra and ASL sales reps also completed initial product training and are beginning to cross sell our expanded portfolio. Last week, the Tissue Technologies team held their annual national sales training meeting with in-depth product training. While it's still early, the addition of the ASIL portfolio and the expansion of our tissue technology platform is generating positive customer feedback. The unique characteristics of Poresign products, like the MicroMatrix powder and the Gentrix Surgical Matrix, help fill gaps in our portfolio and offer clinicians additional tools to treat the most challenging reconstructive interventions. It's only been a few weeks since we closed ASL, but we remain confident in the positive financial impact and the returns on investment that will come from this acquisition.

We expect this to be a quick integration with all critical activities completed by the end of the second quarter, including our ERP conversion to handle invoicing and distribution. We are excited to welcome new ASIL colleagues to Integra and look forward to providing an integration update on our next quarterly call. Turning to Slide 14, I'd like to provide a summary of our 2021 growth drivers, starting with new product introductions. Over the past two years, we launched about seven new products in CSS, which are expected to take several years to reach peak sales. Performance of all these products was negatively impacted by COVID during 2020.

As the recovery takes hold, many of these launches, like our Certus portfolio of programmable valves and DuraGen in Japan, should contribute to growth for CSS in 2021. In addition, during the 2021, we're planning the global relaunch of Serrelink, our next generation ICP monitor, which should immediately benefit our neuromonitoring franchise. Later in the year, we'll be launching our new AURORA Surgiscope for minimally invasive treatment of brain tumors, an important part of our long term growth plans. In our Tissue Technology segment, we completed investments that were necessary to increase our product supply and expand capacity at several of our regenerative plants in 2020. These investments will enable us to not only support our existing customers, but actively pursue new business.

Turning to our international markets. Japan, our largest country by revenue outside The U. S, has achieved six consecutive quarters of double digit revenue growth despite the impact of COVID. This growth has been driven by our leading neurosurgery portfolio. And as an example, DuraGen is rapidly becoming the standard of care in dural grafting procedures.

In 2020, during the height of the first wave of COVID, we also successfully launched a new surgical sales team and took our CUSIP business direct in the general surgery market, where we have a leadership position in liver surgery. With this transition, we've now converted nearly all of our business in Japan from a distributed model to a direct selling model. During 2021, we'll be launching a number of new products, including programmable valves that are specific to the Japan market, a generator, irrigator and reusable bipolar forceps. We're also adding hydro specialists and leveraging clinical studies for BACTOCIL. Taken together, these channel investments, new product introductions and our broad portfolio of leading products will drive further penetration into the neurosurgery market in Japan in 2021.

Turning to China. After the initial COVID lockdowns in February and March, neurosurgery procedures have steadily recovered. During 2020, we invested in professional education and market access for key products, which helped drive low double digit organic growth in the fourth quarter, giving us momentum as we begin 2021. We're expanding our commercial presence in China and recently entered into our first exclusive licensing and distribution deal with a local Chinese partner, which will result in a launch of new complementary products later this year. This partnership represents a great example of how we can fill a gap in our product portfolio while leveraging our large commercial channel.

On a global basis, we accelerate investments in digital capabilities that will enable our commercial teams to reach a broader customer base. We've added specialists in neuromonitoring, hydrocephalus and certain regenerative areas. In 2020, we created an inside sales team within our OTT segment, which is a virtual selling organization focused on driving further growth. And finally, with Acel, we're bringing together two sales and R and D organizations with deep knowledge and broad experience in regenerative medicine. The A Cell portfolio is a strong fit with our existing commercial infrastructure and call points.

If you turn to Slide 15, I'd like to make some closing remarks. Despite the challenges of 2020 that Pete outlined at the beginning of the call, we took advantage of the current environment to strengthen the company's position and advance towards our long term goals. COVID forced us to reimagine how we do our jobs, and as a result, we optimized many of the functions and operations within the company. We also accelerated investments in critical programs to drive future growth. And with the divestiture of orthopedics and the addition of Acell, we have a more focused product portfolio.

One of our key objectives last year was to emerge from the pandemic as a stronger company. And following our fourth quarter and full year results, we believe we have succeeded. We remain confident in our long term goals of 5% to 7% organic growth, greater than 70% gross margins, 28% to 30% EBITDA margins and double digit adjusted earnings per share growth. Before opening the line to Q and A, I'd like to close by announcing an exciting event we have planned, so please turn to Slide 16. We'll be hosting a virtual Investor Day on May 20.

The half day event will feature a thorough review of our strategies for both the Cognitive Specialty Surgical and Tissue Technology segments and our path to generating 5% to 7% organic growth. We'll provide more information as we get closer to the date, and we hope you'll be able to join us. That concludes our prepared remarks. We look forward to providing you with another update on our first quarter earnings call in April. Thank you for listening.

Operator, would you please open the line for

Speaker 0

We'll now take the first question from Matt Miksic from Credit Suisse. Please go ahead.

Speaker 2

Good morning, Matt.

Speaker 6

Good morning. Thanks for taking good morning. Can you hear me okay?

Speaker 2

We can.

Speaker 6

Terrific. Thanks so much for taking our questions. One on just a sort of bigger picture question on the RegenMed businesses that's coming together and a bigger business for you now and the other on some of the trends you talked about in your guidance and outlook. So from a bigger picture perspective, can you talk a little bit about the sort of how you see the RegenNet platform that you have now with a cell, what you see as some of the competitive advantages or opportunities there and maybe some of the synergies that you're that you may be able to enjoy. It's just putting more things, running more things across that bigger platform?

And then I have one follow-up, as I mentioned.

Speaker 2

Yes, Matt, I'll comment and then Glenn, if you want to jump in after. I would say, I mean, the first piece is I think you know regenerative medicine is not a precise science, right? It's a little bit of art and it's a lot of science. Having multiple tools or different technologies in that toolkit we believe is a big deal primarily because our clinicians tell us so. So a wound that's caused from a pressure ulcer or caused from a vascular related issue or one that's caused by surgical intervention or one that's caused by trauma, all of those may have very different approaches.

And so today, most of these reconstructive surgeons, plastics as well, use different platforms already from different companies. But there really hasn't been a company that's had all of these together. I think today at point in time, we have the most comprehensive portfolio. We may not have the largest share positions in all of them, but I think that's the opportunity that exists. Particularly in The United States with a consolidating healthcare system, ASCs and such, offices, more people becoming part of bigger systems, we believe that contracting with world class technologies will differentiate.

And so we have this large matrices structure. I think then as we go further upstream, we're well positioned to add on to this portfolio with other products that play in potentially into the epidermis, other accelerants to help actually healing. And so we thought Acell, particularly because of its fit within the acute space but also growing area outside of that, was a great fit, particularly for the granulated product that we had no version thereof. And I think that combined with what we think will be able to evolve in the portfolio with porcine is also there. Our new head of R and D previously was at Acel years back and has very good insight into that technology.

He actually did some of the original work from the University of Pittsburgh. So we've got some very good retained knowledge as well and investment capabilities to not just have the current products, but to evolve those into a new portfolio. Glenn, you may want to talk a little bit more even about trends and stuff that we see.

Speaker 5

Yes. I would just say that, first and foremost, when we think about our regenerative platform, it's broader than wound care, right? So it's hitting other parts of the body as well. And one nice thing about the ASIL addition is it did add additional capability in Wound Care, but also in our plastic or reconstructive business with the Gentrex product. So we are thinking broader in terms of regenerative medicines outside of Wound Care.

And I think as we look forward, we'll be doing more in other adjacent areas of the body. Trending wise, obviously, our business has been impacted by COVID, and we'll probably see an additional impact here in the first quarter and maybe first half of the year. But we feel quite good about a few things. Number one, you remember last year, we struggled with supply before COVID hit. I think we're in really good shape relative to our plants.

And we've now built adequate safety stock to support our existing customers, as I mentioned in the prepared remarks, going after new accounts. And so I I think we're in a good position to capitalize a lot around that. Listen, I think once we bring this business together with ASL, we are expecting to see synergies. We'll talk more about what that looks like as we get further into the year. But on the commercial front, all the heavy lifting has been done.

And I think that's really good news that we've got that behind us. We're moving forward. The teams have been trained on the combined product portfolio and are really excited about this broader bag and toolkit that we now have to provide to our customers and ultimately to patients.

Speaker 6

Great. Thanks so much. And the follow-up to say great segue to the follow-up question I have on Acell. It's just the guide that you've given includes obviously a partial Q1 and it sounded like some expectation as we'd expect for some sales disruption during integration, if I heard Carrie's comments correctly. Just I hate to say exiting this year because nobody wants to talk about 2022 outlook at the moment.

But just as an underlying business, net of those kinds of effects as we get into the back half of the year and into the following year, how should we think about underlying growth for that Acel business as we fold it into the portfolio?

Speaker 2

Carrie, do you want to since you commented in the prepared remarks, you want to frame it up a little bit?

Speaker 4

Yes. I think in terms of growth expectations for Acel, I think we would expect it to be growing at the same level that we would expect the rest of our tissue business to be growing at. So I think the high single digits definitely is the expectation that we should all have. As we get more confident with our 5% to 7% with ortho out and A cell coming in to tissue technologies as well as what Glenn mentioned on the supply. I think that entire segment has the ability to get back to high single digits, low double digits for sure.

And so that's what would be my same expectation for Acell.

Speaker 3

Thanks, Matt.

Speaker 6

Great. Thanks so much.

Speaker 0

We'll now take the question from Dave Turkaly from JMP Securities. Please go ahead.

Speaker 7

Thanks. I was beginning to forget what guidance was like and we got a quarter here and a full year. So thank you for that. Maybe one for Pete, just on the heels of that. I mean, obviously, things are changing.

It's a fluid world, but you mentioned some of your confidence. I'd love to get your thoughts on what's happening out there, whether you want to talk domestically or internationally as well with the virus and sort of your confidence level maybe compared to what it was in 2019 looking forward.

Speaker 2

Yes. Maybe we start off, Glenn, maybe you can frame it up globally. I think you've got a really good handle on it, I'll add some other comments on how we see COVID right now.

Speaker 5

Yes. I mean, I would say, first and foremost, our first quarter is going to be impacted by COVID. You saw that in January and early February. If we look at some of the hotspots right now, I'd say Central Southern California is probably the biggest area of impact at the moment. Texas has been an impact, Arizona.

Those are some of the states in The U. S. Outside The U. S, the biggest impact has really been to The UK. There was a significant decline in procedures in the month of January that were actually down and even greater than the levels in terms of procedure deferrals versus April and May.

So The UK got hit pretty hard. For us, it's not a big market, but one that has been impacted. And I think for the most part, the rest of Europe, well, there's been some spots of impact, nothing of concern from our perspective. We are seeing an impact too in Asia Pacific. Japan is going through a third wave of the virus.

But as you heard me in my prepared remarks, we have so many good things going on there. We're generating consistent double digit growth in the face of even some headwinds from the pandemic. But I would just say that the biggest watch out for us is really The U. K. And then a lot of our indirect markets.

That's being impacted the most right now. And that would include markets like Spain, Portugal, Russia and South Africa. And those are the areas that we're keeping a watch out and where we've seen probably the greatest impact outside The U. S.

Speaker 2

And Dave, I would say, Kerry mentioned this in our kind of caveats to the guidance. Look, we're optimistic that obviously the vaccines are having a very positive effect. We believe something like the J and J in addition to other vaccines are going to have a big effect as well. But customers are clearly a little skittish and holding back some reserves relative to these added South African and UK variants and others that may arise. And so that's why we think this is not going to be a big step up.

We think it's going to be linear in the first half. As I've reminded others before, we don't need to be at herd immunity in our business to start seeing a pickup. We just need to have the ICUs not heavily burdened. And that's either a combination of people holding reserve beds back or them fully opening up. And we are seeing those beds to begin opening up and that has a direct correlation with neurosurgery and in many cases some of our more invasive procedures on the tissue technology side.

But we're cautiously optimistic. We don't see a significant amount of business pent up. I think the only caveat to that would be carry probably on our capital business, which is Coosa is still under 6% of the business. You can add on probably a few points or so of our instruments business. But again, when capital budgets free up, I think that's still kind of a question that's beyond just COVID.

It's also what's the cash flow looking like for the different institutions.

Speaker 7

Great. Thank you for that. Maybe just a quick follow-up for Carey. Obviously, performance on the growth and gross margin EBITDA side, the three twenty bps improvement. I'm just curious how sustainable some of those increases are.

I know your long term targets are still higher, but that's an impressive bump in a tough time. So I know some of the spending might come back, but just your thoughts on that level given the environment we're in today and what we should sort of expect moving ahead would be great. Thank you.

Speaker 4

Yes. I would say that as you think about 2021, certainly our operating expenses are going to trend up. They were obviously very low in 2020 as we responded to COVID. And as I mentioned in my prepared remarks, our fourth quarter operating expenses were still about $12,000,000 lower than they were last year. So I do expect to for OpEx to move up in 2021, just as we get back to more run rate levels.

So but I would say that net net, if you use the fourth quarter twenty nineteen as a good run rate level. So fourth quarter twenty nineteen still had obviously had ortho in it, but it had Arcus and rebounded in as well. And you annualize that fourth quarter OpEx spend, it's essentially about $735,000,000 of annual OpEx spend. I think we'll beat that. I don't think you'll see that level of spend in the business in 2021.

I think we're obviously applying more smart spend and prioritizing as we bring spending back. So I would say that we'll be lower than that. I also think that we'll see some gross margin improvement between 2020 and 2021. I think some of the levers that you saw benefiting us in 2021, even though revenue was down 10%, is still going to produce a nice gross margin benefit as we move into 2021. And those are things like tissue supply with Acell in there now and supply addressed and as tissue comes back into a growth mode that will help our gross margins.

The continued leaning out of discontinued products will continue to help our gross margin. And don't forget about this is the year that at the end of the year we'll move off the PMA agreement with J and J. So I would expect some gross margin improvement year over year as well as some modest EBITDA improvement with OpEx still coming back a little bit higher, but with the gross margin line kind of helping to offset that.

Speaker 7

Thank you.

Speaker 0

We'll now take the next question from Tyler Krum at Truist Securities. Please go ahead.

Speaker 8

Great. Hi, guys. Thanks for taking our questions. So 2021 guidance basically assumes revenue will be flat with 2019 levels just on a dollar basis. And obviously, you guys are swapping out the ortho extremity business for a cell, they're about equal sized businesses.

So I guess, can you just help us understand what your assumptions are for the rest of the business this year? And it seems like you guys are considering that COVID will continue to impact things in the first half, just any more additional detail you could provide would be helpful.

Speaker 4

Sure. I'll take that one. Yes. Thanks, Kayla. I would say that as you think about your comparison to 2019, you're right, it's about flat to 2019.

The organic growth is about 3% to 4% compared to 2019 when you remove the impact of ortho divestiture and add in Acell and remove that. It's about an organic growth of 3% to 4%. And if you go back to the remarks that I said when I described our expectations for the year, we talked about a gradual first half recovery, which implies that the second half is going to be stronger than the first half. So we'll be able to give you a bit more color on first half versus second as we get when we get to April, our Q1 earnings call, because we'll be giving some guidance around Q2 at that time. But Caleb, I would expect that you should be thinking about a second half stronger than first half in line with the comments of a first half gradual recovery and COVID impacts assuming to be largely behind us in the second half.

And then in terms of just any segment color, I would expect that the segments would largely be will perform around the same on an organic basis. So not a lot of difference in the segment performance at the midpoint on an organic basis.

Speaker 8

Great. Okay. That makes a lot of sense. Thanks, Carrie. And then just in terms of new product launches coming this year with CereLink and Aurora, I mean, meaningful can those new products be?

And how are you thinking about those contributing in the second half? Thank you.

Speaker 2

Glenn, do you want to take a shot at it?

Speaker 5

Sure. So clearly, biggest impact from a new product launch point of view as it relates to 2021 is going to be CERELINK. It's a global launch that will be the most meaningful contributor to NPIs in 2021. AURORA is really going to be a controlled market release for tumor probably around the third quarter and then some other areas that we'll be launching in the fourth quarter. But won't contribute a lot to revenues in 2021.

That's more of a 2022 and 2023 revenue growth driver for us. Having said that, I think it's important to reflect on the new products we've launched the last few years. So you think about the Certus Programmable Valve enhancements, new sizes, the toolkit we've rolled out, additional tips we've put on Coosa, our surgical headlamp duo, there's a lot of new products that were launched before COVID, and we never saw the ramp and the demand for that. And I think you're going to see a bigger contribution coming from those products in 2021. So it's not a new product we're launching in 2021.

It's definitely going to be a contributor to growth. And then a new product we are actually launching this year is a lumbar shunt that's very specific to the Japan market along with some other products there. So we do have a nice cadence of new products we're launching this year, coupled with the fact we have other products launched the last couple of years that will ramp in 2021. And again, that's going to be a big part of our growth story for 2021 when we move past these COVID headwinds.

Speaker 2

I would just add, Taylor, to Glenn's comments that we clearly had addressed the tissue technology supply issue in 2020. But if you think about it, 'nineteen, we struggled to bring on new customers because we wouldn't have enough ongoing supply. 2020, obviously, because of COVID, we didn't reach a lot of customers. I would argue 'twenty one and 'twenty two with one of the larger growth opportunities is just the ability to expand that base of products. And now with something interesting and new in the portfolio such as the Acell product line, that's going to be also a nice driver for us here over the next couple of years.

Speaker 8

Great. Thank you, guys.

Speaker 5

Thanks. Thanks, Kevin.

Speaker 0

We'll now take the next question from Robbie Marcus at So

Speaker 9

Carrie, you guys had a really good free cash flow conversion in fourth quarter here. I noticed that CapEx was probably a bit lower than you normally would have and I didn't hear guidance for 2021 on free cash flow. So I was just wondering if you could give us thoughts around how that will trend over the coming year?

Speaker 4

Sure, Robbie. Let me start with operating cash flow and then I'll work my way to free cash flow. For 2020, we did just over $200,000,000 in operating cash flow. So a nice robust cash flow even despite again a COVID impacted year. I would expect that our operating cash flow will increase into 2021.

So I do expect a modest improvement in operating cash flow. Free cash flow is going to be a little bit lower though than 2020 just because of the fact that CapEx as you mentioned is going to normalize. So CapEx in 2020 was $39,000,000 and that was the result of us really taking prioritized view of CapEx and really trying to preserve cash as much as we could in 2020 as we weather COVID. So I would expect that our capital expenditures for 2021 will float up. They'll probably be in the neighborhood of where 2019 was.

So 2019 was around $70,000,000 of CapEx spend. So I think you can peg it around that or maybe a little bit higher just because there's some pent up demand. So I would say operating cash flow year over year higher, free cash flow a little bit lower just because of the differential in the CapEx spend.

Speaker 9

Great. And maybe a quick follow-up just staying on free cash flow. The old guidance was for greater than 95% free cash flow conversion. I'm guessing we'll get an update at the May Analyst Day. But how are you thinking about we have a couple, I'd say more impactful acquisitions in the short term.

How are you thinking about that over just the course of the long term and where the business sits right now? Thanks.

Speaker 4

Yes. I mean, Robbie, you're correct in that. As we do additional acquisitions, that's going to take a little bit of cash to do some integration work that will ultimately benefit and drive our top line faster for us. So we think it's a good trade off in terms of making those right investments to integrate the businesses. So certainly from a 2021 perspective, I don't expect to see a free cash flow conversion of 80% like I got in 2020 because again the normalization of some of the numbers including CapEx.

But I do think in normal type of environment where we're steady state, I think those types of cash flow conversions can be there. But in the years where we're going to do an acquisition, and you're going to see us obviously go into that dip into the 60s and maybe be in the 70%, 80% range. But I think in a year where we're in steady state mode, I think a 90% cash flow conversion is possible.

Speaker 9

Great. I appreciate the thoughts.

Speaker 0

We'll now take the next question from Matthew O'Brien at Piper Sandler. Please go ahead.

Speaker 3

Good morning. Thanks for taking the questions. I guess one for Glenn and one for Terry. Sorry, Pete. Glenn, as far as ASIL goes, they did $101,000,000 in 2019.

They did 95,000,000 last year. And now on a pro form a full year basis, you're looking for something like 92,000,000 this year. And I guess there's some COVID impact, some disruption from the integration impact. But why wouldn't that full year pro form a number this year, just given that all the heavy lifting is kind of behind you, not be really conservative? And then when do you think the real big synergistic opportunity from a contracting and cross selling perspective really kicks in?

Is it more like 2022, 2023? Or is it even later this year?

Speaker 5

Just as we think about the guidance for ASIL that Carey had outlined, obviously, we've got eleven months versus a full year as part of our guidance. We've considered COVID impact that's similar to the rest of our tissue business. And anytime you go through an integration like this, you have some typical disruption that takes place with respect to the sales force. And so that's all factored into our guidance of 83,000,000 to 88,000,000 for this year. And so that's how we've looked at our guidance.

Hopefully, we can outperform that number. And to your point around cross selling, when do we start to see some of the opportunities materialize, I think it's probably late this year, early twenty twenty two. It will take us a couple of quarters to get these products fully rolled out, continuing to cross sell the entire bag. So I think it's going to take us a couple of quarters to get through that. So we're probably looking at seeing some upside late this year and then moving into 2022.

Speaker 3

Glenn, just I mean, it feels like

Speaker 7

the 83,000,000 to 88,000,000

Speaker 3

is really kind of a floor as far as that business goes in your view.

Speaker 5

We have uncertainty with respect to how long COVID is going to last, and we've got to get through the rest of the integration. So I would just say, hopefully, it is conservative, and that's kind of how we've outlined it.

Speaker 3

Okay. Fair enough. And then, Carey, I understand Q1 I think all my tech companies are talking about a big ramp throughout the course of the year. But historically, you've done 75% -ish of your earnings in the last three quarters. And this time around, you're looking for 80%, 81% of your earnings in the last three quarters with Q1 being impacted by a lot of things.

What gives you guys the confidence that you can get that level of earnings power in the last three quarters of the year? Can you just give us some levers that you have to pull on in case some of these other issues, COVID related or whatnot pop up? Thanks.

Speaker 4

Sure. Well, COVID is an impact in Q1 for sure. That factors into part of our EPS guide for Q1 just given where the revenue range is. But the other thing I would say is that as I think about Q1 gross margins, they're going to be a little bit lower than 2020 just because of the whole portfolio timing change. So you have ortho coming out, which is higher gross margins than the corporate average that comes out for the full three months.

You have ASIL going in for only two thirds of the quarter. That's going to create a little bit of margin mix there in Q1 that will take margins down a little bit compared to 2020. But I do expect that you'll see some lower OpEx spend year over year in Q1 because of the fact that again you have the ortho out which was heavy burdened in the OpEx line and then replacing it with Acel that comes in. But realize that A Cell, we're not going to realize all of the synergies there until kind of by the time we get to the fourth quarter. So part of Q1 also is reflecting this portfolio timing change and the fact that A Cell synergies, cost synergies will be realized gradually over the course of the year.

So that will be part of the build as well as I mentioned is that we expect that certainly second half most of the COVID impact should be behind us at that point. So we would see a heavier contribution of our revenue in the second half versus first half.

Speaker 0

Thank you. We'll now take the next question from Matt Taylor at UBS. Please go ahead.

Speaker 3

Hi. Thank you for taking the question. Yes. So the first one I wanted to ask was just a follow-up on Acel. You've made a number of comments on the integration here.

I just wanted to know, now that you brought it in house, is there anything that surprised you positively or negatively? And have you thought about the outlook for that longer term in any different material way given some

Speaker 6

of these opportunities for synergies?

Speaker 5

Yes. I would just say we haven't really seen any surprises. I think the good news is we've got the commercial integration well underway. And so from my perspective, we've been impressed with the product portfolio that came over. It's what we thought it was.

We've added a number of A cell specialists that are focused in the wound reconstruction space. So that would be around the Micromatrix powder and the Cytel products. And so I think the specialization that they bring, the team is really high caliber team that we were bringing over. The product portfolio is what we thought it was. So really no surprises, I would say.

And we're really happy. We're getting great feedback from customers already. So we feel really good about it. Great.

Speaker 2

And my two add to it would be the fact that they did do a lot of contracting. And so I think that's going to

Speaker 7

be nice addition in what we do with our enterprise team.

Speaker 2

And the second part would be, as I mentioned in some of the comments before, wherewith on the scientific side, I think in their last few years, there wasn't a significant focus on new derivative products for a lot of reasons. And with the leadership team we have on the R and D side and clinical, we clearly think there's some opportunities with other derivative products that aren't a significant lead to bring out to the market. Stay tuned on that as well.

Speaker 3

Okay. Okay, great. And then I have one follow-up on capital. I know you've been talking about the ongoing capital pressure. It's not too surprising.

I was wondering if you could characterize that anymore precisely in terms of the trends that you've seen over time. How are hospitals starting to open up their wallets? And now that there's kind of a light at the end of the

Speaker 6

tunnel, how would you predict that that's going to progress over the next couple of quarters?

Speaker 2

Carrie, do you want to take a shot at it? Glenn and I can add any color after you comment.

Speaker 4

Yes. I mean and again, would say that we've seen sequential improvement in capital as we've gone. So as I think about Q3 to Q4 capital, that was about a 40% sequential improvement in our capital sales, so really nice. But still capital was still about 18% down year over year in the fourth quarter. So it certainly still lags.

It's all of the portfolio was only down 1.5% in Q4 and capital was down 18%. It's still obviously quite a lag in the recovery piece. And so we think it's going to take some time. We are encouraged by the discussions we're having. The pipeline remains really strong.

We have brought to the table different options to start those conversations back up, financing options, rent to own type of models and things like that to get those discussions going. I would say in the smaller capital, I mean, I don't think of us as very large capital. I mean, our largest price of a capital is our CUSA. You're talking about a couple 100,000. And then we have smaller capital units like Mayfield or our dual lighting headset.

Those the smaller pieces of capital are responding better or coming back a little bit stronger. And even our instruments business that can be capital light was only 2% down in the fourth quarter. So the good news is some of the smaller capital pieces are coming back. It's the larger ones that will continue to expect that they lag. But it's not a competitive issue.

It's more of just when the budgets will kind of free up. So we're still encouraged by the discussions we're having that we think that we'll continue to see some capital sales. They'll just continue to be a little bit lighter than the rest of the portfolio at this point. Okay, great.

Speaker 3

Thanks. That's really The helpful

Speaker 5

only thing I would just add is we talked about it in the past. It's only 6% to 7% of our revenue, so it's not a big part of our business. And the bright silver lining here is the funnel is really strong with our capital business. So when it does come back, we actually feel like we'll turn the corner pretty quickly, but it's probably going to be in the second half of this year.

Speaker 6

Got it. Thanks so much.

Speaker 0

We'll now take the next question from Shagun Singh of Wells Fargo. Please go ahead.

Speaker 10

Thank you so much for taking the questions. A couple here on guidance. What have you assumed for backlog in your 2021 guidance? By our estimate, it could be about 9% of sales. And then also, what are you assuming for normalized region supply coming back?

Are you assuming that the full 15,000,000 to $30,000,000 I think you had indicated 100 to 200 basis points of 2019 sales. Are you expecting all of that to be dialed in? Is that in your guidance? And then also what are you assuming in your guidance for Arcus and Rebound growth contribution?

Speaker 2

Carrie?

Speaker 4

Yes. Shugan, I would say that overall, whether or not we have backlog, I think it's going to be highly dependent on just the course of COVID here. We are assuming gradual recovery in the first half. So I would say that we don't see a big bolus impact of pent up demand, a big bubble coming through. I think it's going to be a slow and steady gradual improvement over the course of the first half with an expectation that largely COVID is behind us in the second half.

So don't have a calculation for backlog to provide you that says this is what we've assumed in our numbers. Certainly, I hope there is a little bit of backlog help in 2021. But again, at this point, we're assuming kind of slow and steady improvement over the course of first half. And I don't have the specific breakdowns of ARKUS and REBOUND at this point. I think REBOUND, we do have some contribution of rebound in Arcus in our 2021 numbers.

I still think the larger impact certainly for rebound of the two is going to be a larger opportunity for us in 2022 and beyond.

Speaker 10

I got it. And what about the region supply? Do you expect all of it to return there? What's included in your guidance?

Speaker 4

I'm sorry. I can't hear what you're saying there. What kind of supply?

Speaker 10

So given the normalized region supply, I think the impact of that was about 100 to 200 basis points.

Speaker 4

Oh, yes, the regenerative tissue. Yes, Shaden. Yes, I mean, at this point, I would say, certainly, our expectations is that the supply issues have been addressed and that we are at a point where we can meet any unconstrained demand as the business recovers. So as I think through the opportunities in 2021, I would assume that Tissue Technologies will be contributing very similar to what we expect for CSS. As I mentioned before in one of the questions that somebody asked, Kayla asked was about, I don't expect to be big differences in the segment performance at this point as I look at the year.

So I think Tissue Technology will be an equal contributor to our growth, growth back to in 2021. And certainly as I think about our gross margin story year over year between 2020 to 2021 that benefit of tissue technologies and restoration of the regenerative tissue supply certainly will help my gross margins year over year as well.

Speaker 10

Thank you so much. I'll leave it there.

Speaker 0

We'll now take the next question from Raj Denhoy at Jefferies. Please go ahead.

Speaker 11

Hi, great. This is Anthony for Raj. I hope everyone is doing well. My question is on margin progression, specifically adjusted margin progression. And so the company ends last fiscal year at 24.4%, but it has ortho in there and it does not have a cell.

So I'm sort of looking to the 1Q adjusted EBITDA margin sort of blended number and it looks like that settles out in the 25% range. So I want to make sure that we're thinking about that correctly. And then when we think about the bridge from 25% to the 28% to 30% range, how do we think about that in terms of progression? It seems that you can actually get there faster now with the mix, meaning that ASIL has a higher margin than ortho. So how do we think about margin progression from where we are today to the 28% to 30% range?

And I'll have one quick follow-up.

Speaker 4

Yes, I think you're thinking about that really in line with what I would say as well. I think where we finished in 2020, we'll see a little bit of EBITDA margin improvement in 2021. And just a couple of factors as you think about that. In 2021, obviously, my expectation is we'll still be able to deliver some nice gross margin improvement year over year. That's going to be moderated back by our operating expenditures coming back up and coming from a pretty low year in 2020 gradually moving up.

But net net, I think we'll still be able to deliver a little bit of EBITDA margin improvement year over year. And I think you pegged it right in that 25% type of range. And but remember, I want to draw you back to one of the slides that Glenn had in his deck. And we've shown this slide before when we announced the Acel acquisition, where we did a pro form a look back at 2019 said if you took 2019 and you took ortho out and you added a cell in, in the first year, the impact to EBITDA margins would be about neutral. And so I still think we can squeak out some margin improvement between 2020 and 2021 with Acel in.

But your real pop is going to be into the next year in 2022 when you realize the full synergies of Acel and you've got ortho out and that swap there will really show a nice benefit in 2022. So I think we'll make some really nice inroads in 2022 along our path to get to 28% EBITDA margin.

Speaker 11

The follow-up there would be, I guess, you mentioned synergies. And so I guess to quantify the synergies, I mean, the cost side specifically, is there a number out there we should be thinking about? And then when we think about synergies and cross sell, I mean, just wondering if Acel, is it all complementary to the nerve repair channel you spoke about last quarter? Are those still going to be two separate dedicated selling efforts? Thanks again.

Speaker 4

Yes. I'll talk about the synergies of ASIL and then maybe ask Glenn to talk a little bit about your second question on NERV. On the ASIL synergies, you can go back to their 2019 public statements and they had about $80,000,000 of operating expenditures in their business that was $100,000,000 of revenue. So essentially the business was at breakeven. So our opportunity is to bring that revenue into Integra and to really synergize And we certainly think we have a lot of opportunity because it's the same call point and we think there's some nice synergies on the infrastructure side there.

So as I think about that, I think our goal was to get about 40% of that OpEx out by the end of the year. And so there's some nice synergies there, as I mentioned, as I think about full run rate realization of those synergies going into 2022. And then Glenn, you want to tackle the nerve question?

Speaker 5

Yes. I just think if you look at the A cell portfolio, it really impacts the wound reconstruction business and the surgical reconstruction business and those channels. Now keep in mind, we have nerve being sold by the wound reconstruction team today, but we have a specialist group that focuses on it. So I don't see a lot of synergies per se as it relates to the nerve business.

Speaker 11

That's helpful. Thanks.

Speaker 0

We'll now take the next question from Jason Bedford at Raymond James. Please go ahead.

Speaker 2

Hi, good morning. Just a couple of modeling questions to keep discussion moving here. On 2020 revenue, what was the incremental revenue contribution from the increase in tissue supply and the move from distributor to direct in Japan?

Speaker 5

So the tissue business was not the business that was moved. It was the general surgical business. So think of that as Kusa XL and other instruments. We haven't specifically quantified how much that is, but it's one of the contributors to Japan driving double digit growth. And keep in mind Japan today, just to put it into context, is a market that's above $60,000,000 of annual revenue.

Sorry. It

Speaker 2

was two items that you helped me with the Japan Dynamics. The other one was just you had your supply constraint on in the tissue 2019. And I'm just wondering what was the incremental

Speaker 4

step It's up in '20 hard to know in 2020 because it was a COVID impacted year overall. Our business was down because of COVID. So it's how I would look at 2020 is a year that we recalibrated and put safety stock back into a supply chain that really was below where we wanted to be. So in 2019, it was missed opportunity. So the demand was there.

We just didn't have the supply to go and chase that demand. In 2020, while COVID was impacting our overall top line, we took the approach that we're going to have a couple of our factories continue to build and bring inventory levels up on some of these critical SKUs such that when the recovery happens that we can then take advantage of it. So not a there's no way I could quantify the impact because overall 2020 was still down across the board in our businesses because of COVID.

Speaker 2

Okay. Is there any way to quantify the delta between demand and supply in 2019 or is that just too far back?

Speaker 4

Well, the what that's what I think Shagrin was getting after in her question. We had talked about that it probably was a point to two points of growth that, that cost us by not having the supply in 2019 to meet the demand. So it certainly, we missed an opportunity to grow revenue in OTT because of the fact that we didn't have the supply. So we talked about it being about a one to two percentage points of our growth in 2019 that it cost us.

Speaker 0

It appears there are no further questions at this time. Mr. Bouley, I'd like to turn the conference back to you, sir.

Speaker 5

Thank you. Thank

Speaker 2

you, everyone, for listening in today. And we look forward to updating you up on our calls and please make sure that you take note of our Investor Day coming up on May 20. Thanks everyone.

Speaker 5

Thank you.

Speaker 0

That concludes today's call. Thank you for your participation. You may now disconnect.