This conference call transcript was computer generated and almost certianly contains errors. This transcript is provided for information purposes only.EarningsCall, LLC makes no representation about the accuracy of the aforementioned transcript, and you are cautioned not to place undue reliance on the information provided by the transcript.
spk08: Good day, and thank you for standing by. Welcome to the Integra Life Sciences First Quarter 2023 Financial Results Conference Call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question-and-answer session. To ask a question during the session, you'll need to press star 1-1 on your telephone. You will then hear an automated message advising your hand is raised. To remove yourself from the queue, please press star 1-1 again. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Chris Ward, Senior Director of Investor Relations. Please go ahead, sir.
spk14: Thank you, Norma. Good morning, and thank you for joining Integral Life Sciences' first quarter 2023 earnings conference call. Joining me on the call this morning are Jan DeWitt, President and Chief Executive Officer, Matthew Alsemeyer, Vice President of FP&A, Investor Relations and Treasurer, and Jeff Mosbrook, Principal Accounting Officer. Earlier today, we issued a press release announcing our first quarter 2023 financial results. The release and corresponding earnings presentation, which we will reference during the call, are available at IntegraLife.com under Investors, Events, and Presentations, and a file named First Quarter 2023 Earnings Call Presentation. Before we begin, I would 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 filed with the SEC and in the release. Also, in our prepared remarks, we will reference both organic and reported revenue growth. Organic revenue growth excludes the effects of foreign currency, acquisitions, divestitures, as well as discontinued products. Unless otherwise stated, all disaggregated and franchise-level revenue growth rates are based on organic performance. And 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 8-K filed with the SEC. And with that, I will now turn the call over to Jan.
spk05: Thank you, Chris, and good morning, everyone. Let me start by reviewing our first quarter business highlights on slide four. Our first quarter revenue performance reflects solid execution by our teams as well as positive trend in market amounts and procedure volumes that we see now nearing pre-COVID levels. First quarter revenues finished at around $381 million above our February guidance range, with organic growth of 4.6% comprised of tissue technologies at 6.8% and government specialty surgical at 3.5%. Tissue technologies enjoyed a strong start to the year, including double-digit growth from a number of our leading products the wound reconstruction franchise, such as Integra Skin, Micromatrix, Gentrix, and Cytel, along with high single-digit growth from Surgiment. We also launched Micromatrix in Europe, where we are seeing positive initial feedbacks from wound and reconstructive surgeons. While we are encouraged by the broad strength in demand for our tissue technology products, we are also experiencing the expected revenue pressure from the normalization private label orders, as we mentioned in our February guides. Beyond the top-line results in tissue technologies, we remain confident in our efforts to obtain a breast reconstruction indication for surgiment, and we're on track to file our PMA update this August, as well as completing related work at our Boston facility to upgrade our quality systems. An FDA inspection in March reinforced the urgency of these quality system upgrades. To maximize focus and efficiency in implementing these changes, we have paused production at the Boston site and accelerated certain project work that was originally planned for later in the year. We plan to resume production in early June after the system upgrades are substantially complete. And in the meantime, we will continue to work with our customers and commercial teams to minimize the supply chain impact as they work through existing finished product stock. Turning to CSS now, here we also saw a good start to the year, with double-digit growth in our KUSA product line and our programmable files, as well as strong performance in instrument sales. We launched the KUSA Clarity bone tip in the US, Canada, Australia, and New Zealand, further expanding the global KUSA portfolio. As expected, we also continued to work through several supply headwinds and backorder levels remain elevated, particularly in our durable access and repair and neuromonitoring franchises. Related to CERLINK, we've made progress on resolving the electrical interference issue in our monitors and now expect to relaunch late third quarter of this year. As we were validating and testing an earlier technical fix, our engineers identify a more robust solution that does not require any change to the monitor. We are currently in verification testing, and in the meantime have contacted the FDA to discuss the regulatory pathway to return to the market. Also working with regulatory agencies outside U.S. to finalize the plan in our international markets. Our current technical solution allows us to ramp up distribution faster once we're back in the market. We are excited about the relapse of Satellink, our customers' commitment and support during the recall, further validates our confidence that Serolink remains an important catalyst to our long-term growth expectations. Turning to our bottom line now. First quarter adjusted earnings per share came in at 74 cents within our original guidance range. Despite some temporary pressures to our adjusted gross margin during the quarter from product and geographical mix and the Boston Quality Project, we were able to meet our profitability targets and continue to make the necessary investments to fuel our long-term growth plans. During the quarter, we also appointed Dr. Stuart Hart as Chief Medical Officer. Dr. Hart has worked at leading medtech organizations and brings a deep and broad experience in global medical affairs and surgical innovation that will enable him to strengthen our clinical operations and innovations capabilities. Our CFO search continues with a strong slate of candidates. We're close to identifying a great leader who has the right skills and fit for the company. In the first quarter, we further solidified our balance sheet and liquidity position by amending and extending our credit facility, providing us ample liquidity as we execute our M&A strategies. We also initiated a $150 million accelerated share repurchase, to return additional value to shareholders. Overall, the strength demonstrated by our portfolio at the beginning of this year provided us confidence that we will deliver our 2023 commitments, and we are reaffirming our original full-year guidance for revenue, organic growth, and adjusted EPS. Consistent with the guidance we provided in February, we expect to see a clear step up from our first half to second half revenues. Additionally, we now also expect a larger step-up in gross margin as a result of the Boston Quality Project cost acceleration from the later part of the year into the first half. So with that, I'd like to turn the call over to Mathieu now to go deeper into our first quarter performance and our guidance.
spk02: Thank you, Jan. Let me provide you with a more detailed look at our first quarter financial highlights starting on slide five. As Jan mentioned, first quarter total revenues were approximately $381 million, representing an increase of 1.1% on a reported basis and 4.6% on an organic basis. Total revenues were $5 million, above the high end of the guidance range communicated back in February. First quarter revenue growth was strong across many parts of our business, with organic growth of 3.5% in Codman Specialty Surgical and 6.8% in Tissue Technologies. Overall, organic growth was 3.5% in the U.S. and 7.2% in international. Adjusted gross margin for the quarter was 67.3%, up sequentially by 100 basis points versus the fourth quarter of 2022, but down 40 basis points versus the prior year. Adjusted EBITDA margin for the quarter was 24.2%, down 60 basis points, and adjusted earnings per share were flat at 74 cents. Both metrics were largely impacted by gross margin pressures, planned growth investments, and year one dilution from the CA acquisition. If you turn to slide six, I will go deeper into the first quarter revenue performance for our CSS segment. Reported Q1 revenues in CSS were $248 million, flat on a reported basis, and up 3.5% on an organic basis from the prior year. Global neurosurgery sales were up 2.9%, driven by low double-digit growth in Arcusa Capital and Disposable, and mid-single-digit growth in CSS Management, including continued strength in Assertus Plus programmable valves. Neuromonitoring declined low double digits primarily because of the lack of Serilink monitor sales in the quarter following its recall in the third quarter last year. Our global neurosurgery performance in the quarter was also impacted by continued supply challenges in our dual access and repair, as well as neuromonitoring. Overall, excluding Sarah Lane, capital sales within the quarter were strong and grew low double digits driven by KUZA, with low single digit growth in smaller capital. We continue to see strong demand funnels for our capital equipment as customers see value, innovation, and additional productivity in these products particularly our KUZA platform. Instruments grew approximately 6%, driven by healthy demand and the timing of orders. This result exceeded our low single-digit long-term growth expectations for this business. Shifting to international, sales grew high single digits in the quarter, led by low double-digit growth in both Japan and China. Japan growth was led by sales in KUZA Capital and disposables as well as Duragen, while China benefited from the recovery of rolling COVID lockdowns in a continued geographic expansion. Moving to our tissue technology segment on slide seven. Tissue technologies grew 2.6% on a reported basis and 6.8% on an organic basis compared to the prior year. First quarter sales in wood reconstruction increased 11%, driven by strong demand and commercial execution led by double-digit growth from Integra Skin, Micromatrix, Gentrix, and Cytol, as well as high single-digit growth in Surgimen. In our private label franchise, sales declined 5% versus last year, as expected, while our partners continued to normalize their inventory levels following strong purchases in the first half of 2022. And finally, international sales and tissue technologies were down mid-single-digits, due to supply challenges in certain markets. Turning to slide 8 to review our first quarter P&L metrics. Adjusted gross margin for the quarter was 67.3%, down 40 basis points compared to Q1 of 2022. The decline of our gross margin year-over-year was primarily driven by unfavorable product and geographic mix, as well as Boston quality project expenses. These temporary pressures represented a headwind of approximately 120 basis points in the quarter and upset our positive revenue performance and continuous cost improvement activities. Despite these interim pressures, our gross margin improved sequentially by 100 basis points versus Q4 of 2022, primarily driven by continued strength in our higher gross margin tissue technology business, some improvement in supply, and the passing of one-time cost pressures we saw in the fourth quarter of last year, all of which were factored in our February guidance. We expect the costs of acceleration of the Boston Quality Project to continue into the second quarter and impact our first half adjusted gross margin unfavorably by approximately 100 basis points compared to our February guidance. This implies flat to marginal improvement in gross margins in Q2 compared to Q1. Our first quarter adjusted EBITDA margin was down 60 basis points compared to the prior year, driven by temporary gross margin pressures highlighted earlier, as well as the investments supporting our key strategic priorities discussed during our February call. Our EBITDA margin also reflects the one-year dilution of our SEIA acquisition, which closed in December 2022. Our adjusted EPS was $0.74, flat the prior year, and includes a negative $0.04 impact as a result of the Boston Quality Project. If you turn to slide 9 for a brief update on our balance sheet, capital structure, and cash flow. In the first quarter, we initiated the previously announced $150 million accelerated share repurchase program. We also amended and extended our $2.1 billion credit facility from 2025 to 2028 on favorable terms, despite the challenging banking environment, providing us strong liquidity to support our M&A game boards. During the quarter, operating cash flow was $26 million and free cash flow was $13 million, reflecting both expected increases in capital and EUMDR compliance spending, as well as increased inventory levels compared to the fourth quarter of 2022, as we increase our finished good safety stock levels. Free cash flow conversion was 71% on the trailing 12 months. Our balance sheet remained strong with ample liquidity to support our short-term and long-term plans, And as of March 31st, net debt was $1.1 billion, and our consolidated total leverage ratio was 2.5 times. The company had total liquidity of $1.6 billion, including $307 million in cash and the remaining available under a revolving credit facility. Turning to slide 10, I will provide an update to our consolidated revenue and adjusted earnings per share guidance for the second quarter and full year 2023. Second quarter revenues are forecasted to be in the range of $396 to $400 million, representing approximately flat reported growth and organic growth in the range of 1.5 to 2.5%. Our second quarter revenue guidance reflects continued procedural recovery and strong demand for our products, but also continuing supply challenges and a modest negative impact of approximately $5 million from the Boston Quality Project. Organic growth guidance also reflects the higher comps from last year in private label and instruments, as well as the lack of revenue from Serrelink monitors in the quarter. For the full year 2023, we are reaffirming our revenue and organic growth guidance. Our guidance contemplates the strong demand and portfolio performance we demonstrated in the first quarter, a slight improved FX outlook, updated timing for the relaunch of Serrelink, supply and backorder challenges, and a modest revenue impact from the Boston quality project. We are also holding organic growth expectations to approximately 3% in the first half and 6% in the second half as shared during our February call. As a reminder, this step up from first half to second half is driven by gradual supply improvements, the relaunch of SaraLink, and favorable back half comps in China and private label. Turning to adjusted earnings per share guidance for the second quarter, we expect adjusted EPS to be in the range of $0.75 to $0.79, up sequentially but down from the prior year, driven by temporary gross margin pressures, including the cost from the Boston Quality Project, as well as our planned strategic investments, including the SEA acquisition. This guidance range reflects an approximate $0.06 headwind from the Boston Quality Project, but will have a benefit in the second half of the year. As we look at the rest of the year, we expect that the acceleration of the project costs, along with other gross margin levers, will contribute to a sequential improvement in gross margin from first half to second half of approximately 100 basis points. We will also continue to manage our spending ramp for the remaining of the year while preserving our key growth investments. In summary, we are holding our full year 2023 adjusted EPS guidance of $3.43 to $3.51 per share. Now, I would like to turn the call back over to Jan.
spk05: Thank you, Mathieu, and please turn to slide 11 to conclude our prepared remarks. Our first quarter performance was solid, and the results and trends provide confidence that we can deliver on our full-year commitments through market recovery and strong demand for our products while we navigate supply challenges and the acceleration of our quality system project in Boston. In parallel, we continue to progress toward our long-term strategic goals. We strengthened our core business with new protocols in the CUSA platform and in our international tissue technologies portfolio with Micromatrix in Europe. We're advancing our PMA projects, intending to file the Surgiment PMA amendments this summer, as well as additional modules of the Durasorb PMA later this year. This keeps us on track to deliver the first two PMAs for an ADM in the high-growth implant-based breast reconstruction market. The team has also done a tremendous job getting to the root causes on CEROLINK and developing a robust technical solution to bring the monitor back to the market. In addition, we made continued progress in enhancing our executive leadership team and strengthening our core capabilities in manufacturing quality assurance, clinical study design, and evidence generation. We have also taken the opportunity to fortify our balance sheet by extending our credit facility, and we returned value to our shareholders through a share repurchase. All of these achievements will enable us to continue to bring innovative and lifesaving technologies to market and serve our customers and their patients around the world. A full year outlook is balanced reflecting our commercial momentum and our focus on improving execution, but also the pulling forward of the Boston Quality Project costs, while we push ahead with investments in critical initiatives that will propel our growth over the long term. Our second half reflects a clear step up in organic growth and margin expansion. With expected organic growth well above 5%, adjusted gross margins greater than 68%, and adjusted EPS growth approaching double digits. I believe these metrics for the second half are much more reflective of where we see the business in the near term as we progress towards our LRP commitments. In that context, we look forward to going into more detail on our exciting growth catalysts and providing more clarity on our plans to achieve our long-term targets next week. Thursday, May 4th, at our Investor Day in New York. That concludes our prepared remarks. Thank you for joining us this morning. Operator, would you please open the lines for questions?
spk08: Thank you. As a reminder, to ask a question, you'll need to press star 1-1 on your telephone. To withdraw your question, please press star 1-1 again. Please wait for your name to be announced. We ask that you please keep to one question with one follow-up. Please stand by while we compile the Q&A roster. One moment for our first question. Our first question comes from the line of Steve Lichtman with Oppenheimer. Your line is now open.
spk11: Thank you. Good morning, guys. I guess just first on Sara Link, can you talk a little bit more about sort of the adjustment in the fix there? And I think, Jan, you alluded to the fact that on the back end that that will help. Any more color you could provide on sort of what the change in the fix is and why it will help on the back end in terms of RAMP?
spk12: Yeah.
spk05: So good morning. So as we were over the past couple of months with our engineers doing this statistical validation and testing of the initial fix, They identified a more robust technical solution that is even more capable to shield away the different electrical interference, specifically in this case, one that came from the patient and the table. It's a fix, in addition, that does not require a change to the monitor box, but rather to the sensor connector. It's a cable-type component. So the benefit of the solution, other than shielding interferes better, is that it does not require a change to the monitor box, which allows us to ramp up faster the moment we're back in the field. So that's the change. That's also the change that we thought was a better solution in the medium-long term for the business. It does require us now to restart validation and verification testing with this new solution. And that's the main driver why essentially we're slipping out one quarter with the plan in terms of going back to the market.
spk11: Okay, got it. And then on the Boston manufacturing project, can you just maybe provide a little bit more detail there in terms of what's being done, how far along you are in that process, and then What exactly is being manufactured there? It sounds like Surgiment. Anything else? Thanks.
spk05: Yeah, in Boston, the main product there is Surgiment. There's also one private label product that's being manufactured there. To go back to the Boston production or the quality project there, We've been working for the past couple of years to upgrade our Boston facility based on FDA observations in 2018 and 2021. In addition, as we are preparing to have surgiment, a PMA product there, the Boston site requires a quality system that operates at a higher level. So that's a project that we've been – a project that's been – ongoing we had an audit early in march that confirmed we're on the right track with our execution at the same time it further upped our sense of urgency to finish the project specifically upgrading a number of testing related processes and infrastructure physical layout changes in addition The plan that we have on the table now gets the job finished well before August this summer, which is the timing where we also submit the PMA amendments for the surgical breast product. So in that context, we elected to post-production as it allows us to more quicker and more efficient make the changes in process and physical layouts that are needed. We can do that because we have ample inventory in the system that allows us to satisfy current customer demand. So this project, that's an eight-week focused project. While we keep the factory down, we're going to be back up and running early June with the factory. And as I said, in the meantime, we're living off inventories to satisfy customer demand.
spk11: Got it. Thanks, Ron. Thanks, John.
spk08: Thank you. One moment for our next question. Question comes from the line of Vic Chopra with Wells Fargo. Your line is now open.
spk13: Hey, good morning, and thank you for taking my questions. So, I just had one clarification on gross margins. You know, I think you said Q2 sort of flat to marginal improvement, Q3 and Q4 step up. You previously talked about mid-100 basis points of gross margin improvement. Is that still on the table? And then I had a follow-up.
spk02: Good morning, Vic. So, yes, we expect to see and a flat to moderate increase in gross margin from Q1 to Q2, and then from first half to second half, as you mentioned, the 100 basis points of improvement. From the full-year perspective, we were talking about this mid-100 basis point improvement in gross margin. We're currently looking at more 100 basis points year-over-year of an improvement, so approximately 100 basis points at this point in time. And the drivers that we had discussed during the February call are very much, I would say, alive, tempered by, I would say, some kind of residual impact coming from the Boston project that we're running right now here in the first half. So hopefully that helps.
spk13: That does help. Thank you. And then my follow-up was, when can we expect to hear an update on the search for a new CFO? Any color of that would also be helpful. Thank you so much.
spk05: So a setback on the CFO, Serge, very happy with the slate we're having. Over the next couple of weeks, we have our board together. We have a little board committee that's part of the selection. So that's a main step into selecting the main candidates out of that slate.
spk12: And so I think over the month of May, that's where a decision will be made. Thank you. One moment for our next question.
spk08: Our next question comes from Rohan Patel with JPMorgan Chase. Your line is now open. Rohan Patel, your line is now open. Rohan Patel, your line is now open.
spk05: I suggest we go to the next one, right, and Rohan can come back later.
spk08: Thank you. Our next question comes from the line of Ryan Zimmerman with BTIG. Your line is now open.
spk10: Good morning, Jan, and everyone on the call. I had a question. Historically, Integra has generated closer to 48% to 50% of its EPS in the first half. If I look back at years past, now you're targeting this year about 57% of the second half of the year since you generate about 43% in the first half this year. I can appreciate some of the Boston one-time impact in the first half of the year, but But I'm curious if you could kind of help us bridge the dynamic, particularly as revenue increases in the back half of the year. I would imagine that costs are also going up on the OPEX side. And so, you know, just want to get comfortable with the EPS ramp in the second half of the year.
spk02: Good morning, Brian. So, as you look at the first half, we've also accelerated certain expenses related to the Boston project right now. in some of the costs that we're facing here in the second quarter, we're going to offset some of this in the second half. And so part of that second half improvement, along with the revenue increase that you're going to see first half to second half, this will enable us to generate more EPS contribution to the full year. And you're correct. We're about 43%, 45% in the first half and about just over 50% in the second half. Yeah. Okay.
spk10: And then organic growth in the second quarter is certainly softer than what you saw this first quarter. Procedure volumes were good this first quarter. I'm curious kind of why you think there's either a slowdown or just that doesn't continue into the second quarter. And maybe that's all related to some private label or things like that. But help us understand kind of what you're seeing in the second quarter that's maybe tempering your expectations.
spk05: I'll hand that to Mathieu to give you some of the movements there.
spk02: So again, in the second quarter, the second quarter is the quarter we'll be facing, I would say, one, the toughest comps, if you think about private label, about instruments. So that's definitely softening the growth year over year. In addition to that, we have this moderate impact coming from Boston, which is about $5 million here in the quarter. So I would say these are the three or the two big elements that are going to be softening the growth. We believe that demand is going to continue to be strong for the remainder of the years, but it's, again, this temporary comp year over year and the Boston that's going to temper a little bit growth here in the second quarter temporarily.
spk10: And that was, sorry, you called out $5 million impact on the Boston quality project for the second quarter? Correct, Boston. That is correct. Thank you.
spk05: And part of that, Ryan, will come back in the second half. It's linked with a private label shipment, which we think we're not going to be doing in the second quarter, but that will shift to later second half.
spk10: Okay, so it sounds like, just to be clear, private label starts to maybe normalize, or at least there's a lumpy larger order that picks up in the third or fourth quarter that can help? Yeah, correct. Okay. Thanks for taking my questions, guys.
spk08: Thank you, Ryan. One moment for our next question. Our next question comes from Matthew O'Brien with Piper Sandler. Your line is now open.
spk15: Hey, good morning. This is Phil on for Matt. Thanks for taking our questions. For starters, on the Serolink relaunch, you know, thanks for the color on the recent breakthrough there. But given the late Q3 relaunch now, can you let us know what gives you confidence in the steep second half guidance? Not saying the whole thing was based on Serolink, but certainly it's not helping. And just on Serolink, how are those conversations with the FDA going, and do you have high visibility in that Q3 timeline at this point?
spk05: Yes. somebody your second question first we have exchanged with the FDA our engineering early test results on this new solution which look very robust are quite binary in terms of pass fail on several dozens of tests so that information we've shared with the FDA we're going to discuss that next week to further fine-tune how we set up the validation and verification, say, the official testing of that solution. We plan to submit that around mid-August. Our timeline, at this point in time, the timeline of end third quarter assumes a special 510K, and that also is aligned with the high end of our top-line guidance. If this would not end up being a special 510 , then we're talking about two, three months later, which is aligned with the lower end of our guidance. So our guidance reflects the high and the low scenarios when it comes to settling back to market, and that's pretty much driven by the uncertainty on what regulatory path we will have to follow after we submit in mid-August.
spk02: If you think about the first half, the second half, we need to realize that that Sarah Link, maybe the delay represents maybe a couple million dollars of change. So it was a smaller contributor to the second half REM. And just as a reminder, you know, as we see kind of supply recovering throughout the year, we expecting to have a bigger contribution in the second half. China normalization post COVID lockdown is also going to be more of a contributor in the second half. along with kind of growth in some of our NPIs that are going to continue to ramp here in the second half of the year. And then we're going to be past also some of the tough comps that we've had from an instrument and from a private label perspective, sorry, both of which are going to help also the second half growth. So that's kind of the first second half walk, and the biggest contributors are still very much alive.
spk15: No, that's helpful. Thank you. And just shifting gears here, can you kind of flesh out what you see on the international front? I know you just mentioned China, but what should we be looking for from Integra here in 2023 and maybe even 2024 as we start to look there as well? Thank you so much.
spk05: So as I think we indicated, the international had a good start of the first quarter with 7 plus percent growth. China, Japan were double digits. That's where we pretty much expect them to be, where we expect international to be this year and the next couple of years is in the high single digits, driven by mid-single digits, Europe, and a couple of double-digit drivers in Asia, China.
spk12: Thank you.
spk08: One moment for our next question. Our next question comes from the line of Craig Bijou with Bank of America. Your line is now open.
spk04: Good morning, guys. Thanks for taking the question. A couple of follow-ups here. So, Jan, I wanted to circle back to Sarah Link and the change in the solution and your thoughts that you can distributed it faster. So, maybe just ask specifically. So, if you don't have to change the monitor, I guess, you know, can components be switched out on site? Can they be sent? I think you mentioned the cable. So, can that be sent to sites that can then update the system? Just wanted to understand what exactly, you know, the recall consists of now.
spk05: So your assumption is right. So the monitor does not change. This is about a connector cable, a plug-in cable that plugs into the monitor. On the other side, it plugs into the sensor cable. It's a cable that can be sent as an accessory into our customers. Of course, it has to be manufactured, and that's being – initiated as we speak to have those cables manufactured by one of our suppliers.
spk12: Got it. That's helpful.
spk04: And then a follow-up on the Boston project. What requirements, and sorry if I missed it, does the FDA have to come back into the facility and inspect or Are there any other steps once you do finish the project that need approval or sign off or some other step before you can then submit the Surgimen PMA?
spk05: So the startup of the plant is up to us. When we have finished the project that we do, we're sharing. that work and that planning with the FDA, but pretty much when we're done, we start and restart the factory.
spk12: Okay. Thanks for taking the questions. Thank you. One moment for our next question.
spk08: Our next question comes from the line of Joanne Wunsch with Citi. Your line is now open.
spk07: Good morning. This is actually Anthony on for Joanne. Thanks for taking our question. In the presentation, you mentioned your M&A game board. So just with SIA in the bag now, can you just maybe refresh us on thoughts around M&A?
spk12: I think your question is overall thoughts for M&A? Yep.
spk05: So as I mentioned several times before, the strategic work we've done last year has translated into a clear M&A game board. We definitely have the balance sheet capacity to execute on that. At this point in time, we have several of our targets. in process, in discussion, and that's as far as I can give you any insight in further execution.
spk07: That's helpful. On the backlog, I think you said it was elevated, but could you maybe provide any more color on how it trended? Has it gone down materially during the quarter? Has it sort of stayed flat?
spk12: Just curious if you could provide any more commentary on that.
spk05: Yeah, back orders are still elevated, 10 to 15 million higher than what we consider as normal. We had not expected over the first half for this to materially come down. That's playing out as we assumed. The challenges here are twofold. One, we keep... we keep dealing with several challenges of suppliers that are either not delivering on time or discontinuing components, which drives us to recertify new components or build up last time by inventories. So there's one factor, fiscal factor, that's driving the back orders, and then second, We are in several factories stepping up work on builds to keep up with the increased demands with the factory capacity that we have.
spk12: Thank you. Thank you. One moment for our next question.
spk08: Next question comes from the line of Richard Newitter with Truist, your line is now open.
spk09: Hi, this is Sam on for Rich. Thanks for taking our questions and appreciate the commentary on the backlog there. But can you just remind us when you think about the second half, does that include realization of that backlog at all? And can you kind of give us any confidence in the dynamic you expect there for the second half?
spk02: So, yeah, so definitely we expect an improvement, and it's part of it. I would say, again, as we think overall about all the different elements that contribute to the second half, I talked about NPIs, I talked about the China normalization, about the private label, about the instruments. And the other component, as I mentioned early on, is this kind of supply recovery. We're definitely seeing more than we would like on the drill access and repair side as well as on the neuromonitoring side, and we hope for this to continue and contribute also in the second half.
spk05: Just to clarify, Tim, when I mentioned it's 10 to 15 million higher than what we consider normal, we do not expect in our guidance that this 10 to 15 million will be fully solved. We count on about half of that. So that's potential upside or downside in function of how we get over the different supply channels.
spk02: And again, if you look at our guidance range, right, these are things that we're contemplating as well, right? So some of those factors between our low end and our high end of the guidance range are elements that we're factoring in as well.
spk09: Okay, that's helpful. Thanks for that. And just one more on the Boston factory change and... how that impacts the margin. It sounds like this was more pull forward than unexpected. So was this the sixth impact in 2Q? Was that factored into the full year guide and now it's just being more realized in 2Q? And then with the lower sort of expansion on GM for the year, can you kind of walk us through the levers on the P&L you have that help you maintain full year EPS? Thanks.
spk05: Yeah, I'll give this to Mathieu. I think overall your assumption is right, but Mathieu gets you one level more detail.
spk02: Yeah, Tim, so I agree with what you said. So we need to look at it as a little bit of a shifting in expense and I would say impact to gross margin here into the second quarter. So let me take you maybe a step back. So in Q1, we saw about 120 basis points of an impact related to the Boston quality project itself. And we saw some benefit coming from manufacturing efficiency favor originally, which is resulting in the net net about 40 basis points down year over year. As you shift to Q2, we're expecting a modest improvement in supply, but still an impact of about 100 basis points, I would say, in Q2 and for the first half, really driven by the timing, this acceleration of the Boston Quality Project. As we turn into the second half, the second half of the year, we're expecting to offset part of this. Again, the Boston impact has really three components to it. It has the idle capacity, it has the project cost, and it has some revenue impact. So as you go into the second half, we'll gain back some of the revenue that we lost in the first half. You're going to gain back some of the gross margin because of the timing of the expenses. And then you asked about leverage. The other lever is that we're continuously just looking at being good stewards of our P&L. and looking at our investments in the second half and prioritizing some of them while really focusing on our key strategic priorities and spending in the second half.
spk12: Thanks for taking the questions.
spk08: Thank you. One moment for our next question. Our next question comes from Eric Fleming with Raymond James. Your line is now open.
spk03: Hey, guys. It's Eric. I'm on for Jason Bedford. Just had a couple quick questions. On the private label, with the comps on the private label, were there any account losses in there, or is that just straight down?
spk02: No, no account losses. I mean, you know, I think a lot of our partners last year built inventory based on certain assumptions around EUMDR. With the change in the EUMDR assumptions and kind of later dates, We just see them actively managing their inventory levels, and these are coming down. So this is part of the prioritization, I would say, the kind of normalization, I should say, of inventory levels that we're seeing. And again, the impact is going to be heavier in the first half than in the second half.
spk03: Okay. And just one follow-up on SaraLink. Before, we were expecting a $6 million to $7 million contribution in the second half. Are we now looking at about half of that now with the delay?
spk05: Yeah, I think that's roughly correct.
spk03: Okay, thanks a lot.
spk08: Thank you. One moment for our next question. Our next question comes from Rohan Patel with JPMorgan Chase. Your line is now open.
spk06: Hi, sorry, can you hear me?
spk08: Yes.
spk05: Sorry about the earlier confusion.
spk06: I'm on for Robbie Marcus. Just a quick one on free cash flow. Definitely looks like conversion looked a little soft in the first quarter. How much of that is related to the Boston manufacturing quality issue? And is there anything else driving that kind of weak conversion? And what should we expect with the balance of the year?
spk02: So we definitely expected from a cash flow perspective, you know, a ramp in capital spend as well as EMDR spend. That's the first thing. Second of all, we've started also building more inventory. And so you'll see that a portion of our cash flow at this point in time is also driven by higher inventory levels at the end of Q1, some of which will continue throughout the year as we're kind of rebuilding our stock levels and some of it being kind of in WIP and all this that will flush through for the remainder of the year.
spk05: So, Rohan, no connection to the Boston project, right? Got it.
spk06: And then just, you know, when we look forward to your analyst day, what are, you know, the main things you would highlight for us to inspect? What are the most exciting things, you know, should we think of, you know, new products, we think of, you know, updated LRP, just kind of a preview of that would be helpful. Thank you.
spk05: Yeah, thanks. So I hope to see you next week, by the way, Rohin, but the way we've set it up is to really give insights into how we get from where we are today to the long-term parts that we set forward. And many of you over the past years have asked me for where's the plan and how do you get What are the contributors? So we'll spend most of our time making sure that not only do we explain why we feel great about several of our innovations or our markets, but how does that translate into top line, top line growth acceleration and gross margin acceleration. We'll also give further insight into when we talk about M&A game board, what directions are we looking into.
spk12: Thank you.
spk08: And our last question will come from the line of Drew Ranieri with Morgan Stanley. Your line is now open.
spk00: Hi, Dawn. A couple of questions on maybe the forward guidance, but I appreciate the second half ramp for revenue and for earnings. As you are thinking about upside for the year, are you more inclined to drop that through to the bottom line, or are you looking more to reinvest in the middle of the P&L, just given some of the growth initiatives ahead? And then just as a second question, I'll just ask them both up front. As you are reaffirming the 23 guidance, is there any change necessarily in the composition of how you're thinking about CSS versus tissue technology growth?
spk12: Thank you.
spk05: On your first questions, in our guidance, we are protecting our key strategic growth investments. So I would say if we have top line upside, a lot of that will flow down to the bottom line, given, again, that we are making sure that the projects we want to do, we do. In the case of Boston, we do it earlier. So we're really determined in 2023 to execute on our growth investments. And so top line impact should rather translate into bottom line.
spk02: And then to your second question around CSS and tissue tech growth in our guidance, we expect this very much to be in line with our expectation of the February call. So no change in there.
spk12: Tech here in 2023. And thank you for your questions.
spk08: This concludes Integra Life Sciences' first quarter earnings conference call. Thank you for your participation. You may now disconnect. Everyone have a wonderful day.
Disclaimer