Integra Lifesciences Holdings Corp Q4 FY2021 Earnings Call

Good day and welcome to the Integra LifeSciences' Fourth Quarter 2021 Financial Results Call. Today's call is recorded. And I'd now like to turn the conference over to Chris Ward, Senior Director of Investor Relations. Please, go ahead, sir. Thank you, Emma. Good morning and thank you for joining the Integra LifeSciences' fourth quarter and full year 2021 earnings conference call. Joining me on the call this morning are, Jan De Witte, 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 2021 financial results. Our corresponding earnings presentation, which will be referenced during the call, is available at integralife.com under Investors and Events and Presentations. Before we begin, I would like to remind you that statements made during this call may be considered forward looking. 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. Also in our prepared remarks, we will make reference to both reported and organic revenue growth for 2021. Organic revenue growth excludes the effects of foreign currency, acquisitions, including ACell, divestitures, including the sale of our Extremity Orthopedics business, as well as discontinued products. Unless otherwise stated, all disaggregated franchise-level revenue growth rates are based on organic performance. And lastly, our comments today will include certain non-GAAP financial measures. Reconciliation of any non-GAAP financial measures can be found in today's press release, which is an exhibit to Integra's current report Form 8-K filed today with the SEC. And with that, I will now turn the call over to Jan.

Thank you, Chris, and good morning, everyone. Thank you for joining us. I would like to make a few brief remarks at the start of this call, my first earnings call with Integra. Let me start by congratulating and thanking our employees. Since I joined the company, our team's dedication and resilience across the globe have been readily apparent to me. I look forward to working alongside this team in the months and years ahead, as we charge on our exciting path forward. Through my first few months on board, I'm quite impressed with and proud of what Integra has achieved in recent years. I'm thrilled to be leading this organization with its strong legacy values and capabilities into the future. Integra has a sound business platform with significant untapped potential. And it will be my focus to lead our team toward reaching our full potential. 2021 was a successful year for the company despite many ongoing challenges from the global pandemic. We've run a steady ship through the rough COVID seas. But while doing so, we've also driven significant changes in the portfolio and strengthened our platform for the future. And throughout this unusual year, our team showed tremendous resilience in serving our customers and patients while continuing to move our growth priorities forward. During today's presentation, Glenn will go into more detail about 2021 performance and our key accomplishments. And then Carrie will provide a deeper look at our financial performance and share our outlook for 2022. Finally, I will conclude with my thoughts on our key initiatives for accelerating growth in the company's areas of focus this year. So with that, let me turn it over to Glenn.

Thanks, Jan, and good morning. Please turn to slide six. As Jan mentioned, we made great strides in 2021 and believe we’re at another inflection point for growth. So let me highlight a few of our key accomplishments. First, we transformed our portfolio through the divestiture of our low-growth non-core Orthopedics business and the acquisition of ACell, a faster-growing and more profitable regenerative tissue business. We also continue to optimize our manufacturing footprint, as one of our key levers to improve our gross margins over time. We have substantially completed the manufacturing transfer of the Codman portfolio from J&J into our Mansfield, Massachusetts facility. And we're on track to close our manufacturing site in France and complete the necessary product transfers to another existing location by the end of this year. We also made meaningful progress on several new innovative products in each of our segments. In CSS, we launched CereLink, our advanced monitoring system for measuring intracranial pressure in both the US and Europe in the third quarter of 2021. We will have the full year benefit of CereLink in these two markets in 2022, plus we're also launching in Japan and several other international markets later this year. We also initiated a phased clinical launch of our Aurora surgiscope, a proprietary surgical solution for minimally invasive neurosurgery or MIS, with integrated visualization designed specifically for use in deep-seated brain lesions. We are gathering clinical evidence using the same technology for early surgical intervention for intracerebral hemorrhages as well. Together, these two opportunities, MIS and ICH are expected to expand our addressable market in neurosurgery by about $1 billion. In Tissue Technologies, we followed the PMA for SurgiMend and participated in an FDA panel meeting regarding a specific indication for breast reconstruction. We also completed a multicenter study regarding the use of PriMatrix in treating diabetic foot ulcers intended to expand commercial coverage. Some of our most important accomplishments in 2021 occurred outside of an R&D or a commercial setting. I'm pleased to share that Integra has been recognized by leading publications as a 2021 Best Company for Diversity and also one of the top 100 healthcare technology companies. These honors serve as external validation of our diversity and inclusion efforts and market leadership. And at the end of last year, we executed a smooth leadership transition, welcoming Jan as our new CEO. Let's turn to slide seven, where I'll provide some 2021 financial highlights and also some initial thoughts on 2022. Despite a challenging external environment once again in 2021, we delivered strong financial results. Our full year revenues were just over $1.5 billion, with organic growth exceeding 14% compared to 2020 and 4.6% compared to 2019. We saw strong recovery across most of our product lines despite COVID setbacks, benefiting from the critical nature of our products as well as the diversity of our portfolio. Our products play a crucial role in improving the quality of patients' lives. As a result, the majority of procedures in which our products are used can only be deferred for short periods of time, which bodes well for continuing revenue recovery as we move beyond the pandemic-related disruptions in 2022. Our full year adjusted EPS was $3.18, representing growth of 30% versus 2020 and 16% compared to 2019. The EBITDA margins also expanded by 160 basis points, and we delivered record operating cash flow of $312 million. As we look to 2022, specifically in the first half of the year, we expect that COVID impacts will linger with staffing challenges at hospitals and production and supply chain disruptions posing the greatest risk. Our current back order levels are about 2.5 times higher than normal, so even as commercial demand is recovering, we are seeing challenges in keeping up with our customers' requirements. These impacts will be felt most acutely in the first quarter and we expect them to continue beyond the first quarter as it will take time for hospitals, our own manufacturing plants and supply chain to return to normal staffing and production levels. Consequently, we expect more modest sales growth to continue in the second quarter with faster growth in the second half of the year. In closing, I want to reiterate our confidence in our long-term plans and the ability of our teams to deliver on our growth targets once COVID pressures subside. And with that I'll now turn the call over to Carrie.

Thanks, Glenn, and good morning, everyone. I'd like to start with a summary of our fourth quarter and full year revenue results on slide 9. Q4, total revenues were $406 million, representing an increase of 4.3% on a reported basis and 8.3% on an organic basis compared to the prior year. Revenues were negatively impacted by approximately $3 million of FX in the quarter. For full year 2021, revenues were just over $1.54 billion, representing reported growth of 12.4% and organic growth of 14.2% compared to 2020. Despite COVID delta impacts in Q3 and Omicron in hospital staffing impacts in Q4, we achieved second half organic growth of 7.5% compared to 2020 and 5.8% compared to 2019. Our strong second half top-line growth was driven in part by a recovery in our capital business, including the benefit of our new CereLink ICP monitor and a recovery in our indirect markets as well as both our instruments and private label businesses. We also continued to benefit from double-digit growth in China and Japan. If you turn to slide 10, we'll take a deeper dive into our CSS revenue highlights for the fourth quarter. Q4 revenues in CSS were $270 million, an increase of 6.4% on a reported basis and 9% on an organic basis over the prior year with equal contribution from both neurosurgery and instruments. Geographically, sales in the US grew high single digits and international sales grew low double digits compared to 2020. The recovery in global neurosurgery sales was broad-based and sales and instruments continue to benefit from pent-up demand. We saw continued growth contribution from the launch of CereLink in the US and Europe. And even excluding sales of CereLink, our capital sales grew approximately 30% compared to 2020 and about 4% compared to 2019. The international sales in CSS increased across all major regions compared to the prior year. Japan and China continued to deliver strong growth in Q4 with both countries delivering low double-digit growth over 2019. Moving to our Tissue Technologies segment on Slide 11. Q4 sales in Tissue Technologies were $135 million, up slightly on a reported basis, and 6.7% on an organic basis from the prior year. Sales in wound reconstruction increased 3.8% on an organic basis compared to 2020, led by Integra Skin and SurgiMend in our burn trauma and surgical reconstruction markets. The ACell business stabilized during the fourth quarter delivering $16.9 million in sales in line with November guidance. Sales in private label increased 15% compared to 2020 driven by continued recovery in customer orders. Turning to slide 12, I'll cover the highlights of the P&L for the fourth quarter and full year. Adjusted gross margin in Q4 was 66.8%. This was lower than what we expected and was impacted by multiple pandemic-related factors, including increased freight costs, supply chain disruption, and unusually high levels of absenteeism in our factories caused by the omicron variant. The disruptions to our factories have continued into the first quarter, causing idle capacity charges and under-absorption costs which will negatively impact our gross margin through the first half of 2022. Our Q4 adjusted EBITDA margin was 26% compared to 26.4% in the prior year, as the benefit from increased revenue was offset by higher operating costs. As we discussed in Q3, operating expenses continue to increase as we lift the spending restrictions put into place in 2020 in response to the global pandemic. Nevertheless, we remain disciplined in our spending while investing in new product innovation, further geographic expansion, and clinical studies. Although full year operating expenses increased year-over-year, the strong recovery in revenue helped us expand EBITDA margins by 160 basis points for the full year 2021. Adjusted earnings per share for the fourth quarter was $0.84 flat versus 2020, while full year adjusted EPS grew 30% compared to 2020. Now if you turn to slide 13, I'll provide a brief update on our balance sheet capital structure and cash flow. Operating cash flow in the quarter was $69 million and free cash flow was $42 million. Free cash flow conversion was 58% in Q4 reflecting higher levels of capital spending. For the full year 2021, both our operating cash flow of $312 million and our free cash flow of $264 million were record highs for the company. As of December 31st, net debt was $1.05 billion and our consolidated total leverage ratio was 2.3 times. The company had total liquidity of $1.78 billion including $513 million in cash and the remainder available under our revolving credit facility. As a result of our strong cash flow and liquidity position at the end of the year, we commenced a $125 million accelerated share repurchase program in January that is expected to be completed in the first half of the year. Turning to slide 14, I'll provide an update to our consolidated revenue and adjusted earnings per share guidance for the full year 2022 and the first quarter. Our guidance for 2022 reflects continuing first half uncertainty around the scope and duration of the pandemic and its related impacts on our business. For the full year 2022, we anticipate less of a direct impact on underlying procedures than in 2021, but we do expect first half variability and uncertainty in sales to continue as a result of the indirect effects of COVID, including staffing challenges and ongoing supply chain disruptions. We expect revenues to be in the range of $1.58 billion to $1.6 billion, representing reported growth of 2.5% to 3.5% and organic growth of 3.5% to 5% compared to 2021. Our revenue range accounts for an 80 basis point headwind from FX. As a reminder, the calculation of organic growth removes the year-to-year fluctuation in FX, the year-over-year change in discontinued products, and revenue from ACell prior to January 20, the one-year anniversary of the acquisition. ACell revenue was included in organic growth as of January 20. Staffing and supply chain challenges are expected to be more pronounced in the first quarter, leading to an expected first quarter revenue of $357 million to $365 million, representing reported growth of negative 1% to positive 1.5% and organic growth of 0% to 2.5% compared to 2021. As we think about quarterly phasing beyond Q1, we anticipate organic growth to exceed 5% in the second half of the year. Turning to adjusted earnings guidance for 2022. We expect first quarter adjusted EPS to be in the range of $0.67 to $0.71 and for the full year we expect adjusted EPS to be in the range of $3.27 to $3.35. This guidance includes the benefit of the accelerated share repurchase and a slightly higher year-over-year adjusted effective tax rate of 18.5%. Given the headwinds discussed earlier and our plans to continue to prioritize OpEx investments to build out our capabilities to activate our growth catalysts, we expect moderate improvements in adjusted gross margin and EBITDA margin in the second half of 2022 compared to 2021 as the pandemic-related challenges abate. We expect to return to greater margin expansion toward our long-term targets once we reach the other side of the macro impacts of the pandemic. With that I'd like to turn the call back over to Jan.

Thank you, Carrie. As was indicated earlier, although we start 2022 feeling confident about our capabilities, we still have very few data points on exactly how COVID and the world will fare now that we're getting over Omicron and how our markets and operations will ease toward the next level of normality, hence the caution in our outlook for 2022. However, our near-term caution should not obscure our ambition and opportunities to continue to invest in our future and to accelerate the business to the next level of performance over the coming years. If you turn to Slide 16, I would like to outline our expected revenue growth trajectory and how we will accelerate this path. The first factor for growth is the momentum we have today in our core portfolio. When we look back into the results over the past four years, we've delivered historic organic growth between 4% and 5%. We expect this to be a range in 2022 as Carrie mentioned in our guidance, acknowledging that our near-term growth will likely continue to be impacted by COVID. We expect to see the pandemic limit the speed with which our customers' staffing returns to normal and worldwide supply chains move back to a steady state. However, looking past the first half of 2022, we should see a return to normal procedure volumes and growth. At the same time, we will begin to see more substantial benefits from our new product introductions and growth initiatives which we have continued to invest in during the past two COVID years and will continue to focus on in 2022. These new product introductions will allow us to expand our total addressable market and strengthen positions in existing segments which will help us to solidly exceed the 5% organic growth mark. The third factor is about expanding our commercial activities along the international access as well as broadening our value-added adjacencies including leveraging digital capabilities. These are mid to long-term opportunity areas we will advance in 2022. Once we see the benefits of our efforts in these areas, we expect to solidly enter a new organic growth rhythm of 5% to 7%, which is our long-term organic growth target. Finally, the fourth factor is executing synergistic M&A to further strengthen our business portfolio, focusing on accretive growth and value-enhancing opportunities. 2022 will be about laser focus on further building the momentum with which we exited 2021 while capturing near-term acceleration opportunities as the markets move past COVID impacts. Simultaneously, we will seed and build the foundation for mid- and long-term acceleration. Let's turn to Slide 17. As we think about the near to mid-term, there are many great catalysts that can drive our performance. This includes capturing our strong international growth opportunities in Japan, China, key European countries, and other markets ramping up commercial success of new product introductions, as well as further expanding our ACell territory coverage. In parallel to capturing the potential of our catalysts, we will drive focus around those initiatives that strengthen our mid- and long-term capabilities and growth potential. We are stepping up as we speak our focus on employee engagement, talent development, and resilience leveraging the lessons learned during the COVID period. With a very full and diversified portfolio of new products and innovation ideas across both of our business segments, we will also strengthen product management capabilities and drive focus on R&D and regulatory execution while in parallel ramping up and optimizing new capacities in our factories. We've started to define a multi-year path to bring our portfolio of products to additional international markets, aiming to leverage and amplify the momentum and lessons learned from our international initiatives over the past years. As I’m working with our division leaders to evaluate our longer-term strategic options, we will translate these into an M&A game board to support a steeper growth curve. Finally, as I communicated earlier this year, we're making ESG an ongoing operational pillar for the company with a three-year ESG road map in development to define our future ambitions and an inaugural ESG report to be published later this year. If you turn to Slide 18, our final slide, I would like to acknowledge the actions we've taken to date that have set us up for long-term success. We have substantially transformed our portfolio, focusing on more profitable differentiated products. COVID has tested us but made us more resilient and agile in our operations as well as commercially. We're stepping up our focus on important growth initiatives, knowing that our financial rigor and strong balance sheet provide us additional optionality to execute our growth strategy. As we focus on our priority initiatives and move past the current pandemic headwinds and distractions, we expect to position Integra into a long-term organic revenue growth framework in the 5% to 7% range, with double-digit adjusted EPS growth, adjusted gross margins between 70% and 72%, adjusted EBITDA margins of 28% to 30%, and free cash conversion above 90%. In conclusion, let me reiterate my excitement about Integra's future and the opportunity to lead our team forward in bringing great outcomes to surgeons, their patients, as well as to our shareholders and colleagues. With that, I would like to open the call for Q&A.

Thank you. We will now take our first question from Steven Lichtman from Oppenheimer & Company. Please go ahead. Your line is open.

Thank you. Good morning. This first question is about your revenue outlook for 2022. Any further granularity you could provide in terms of what your outlook is by segment? And Jan, what do you see as the biggest product growth driver opportunities here in the near term for Integra?

Steve, good morning. I'll start the question, and then Jan can address the back half of your question there. In terms of the segment color, I think, I would say that both Tissue Technologies and CSS will be largely in line for the full year in line with the corporate averages. Obviously, there will be some pluses and minuses there. But generally, I would say you should model the segments for the full year to be somewhere in the range of the corporate ranges. In the second half of the year, I would say you'll probably see more of a pickup in Tissue Technologies, as it should benefit from that ACell acceleration in the back half of the year and some of our other product launches there. And then Jan, if you would like to take that.

Yeah. If you take the building up momentum of the core of our business as we get over COVID as one, if you take additional products on top of that, like CereLink, like ACell, where we are building out our commercial footprint, those specific products will further accelerate over and above this, I would say, normal comeback after COVID.

Yes. And I would also say capital is still an area. Jan mentioned CereLink, but capital in itself still has the opportunity to recover further in 2022. We saw a nice rebound in our smaller sized capital in 2021. However, we saw some nice recovery in Q4, I think compared to 2019 we still have some opportunity to see further bounce back as we move through the COVID headwinds.

And Steve, I would just give a little geography context as well. If I look at the fastest-growing market in 2022, it will be China. We should be putting up over 20% growth organically. We're expanding into Tier 2 and Tier 3 cities. We've got a really good plan in place for China. This is over a $50 million market for us. You'll hear us talk about growth coming out of China consistently in 2022, which will be a key market for us over the next 5 to 10 years as well. But I would highlight that as an exceptional growth market in 2022.

Great. Thank you. Relative to COVID, you spoke about the indirect impact, but concerning the direct impact, I wonder if you could provide a little bit more color in terms of what you've seen in recent weeks and months. Obviously, it's been very dynamic. Any color you could provide on December versus January versus February on that front?

Yes. I'll start and then Carrie and Jan can add to this. The biggest thing we're seeing in our business is the absentee rates at our facilities. We saw a significant spike in absentee rates, which has caused manufacturing disruption. Day by day that's getting better, so the good news is that's coming back to a more normal trend, but we're still not going to be normal probably for the rest of this quarter. That did have an impact certainly in January and early February. We're still struggling with supplies in certain cases, whether it be electronic components, packaging materials, and things used in our products. Our supplier consistency is not what it was three to four months ago. I think we're working through that, but that was part of my comments around this record high number in terms of our back orders. To put it into quantitative terms, having back orders two and a half times higher than normal means we got $10 million to $12 million in incremental back orders that we typically wouldn't see. As I think about COVID on procedures, it looks like everything is trending in a positive direction. ICU bed capacity is improving. All of that looks like it's moving in the right direction as well.

Yes. I would only add that was a pretty comprehensive response. I think that the hospital staffing challenges are still lingering. So when I think about the dynamics that took place last year in the first quarter to the second quarter and compare it to what we're seeing now, the two biggest pieces are the continued hospital staffing issues and continued supply chain disruption as it relates just to the contagious nature of Omicron.

Got it. Thanks everyone. I’ll jump back in the queue.

Thank you. We will now take our next question from Matt Miksic from Credit Suisse. Please go ahead. The line is open.

Great. Thanks so much for taking questions. One follow-up on this transition of staffing and COVID-related pressures in Q1. I think Glenn you mentioned things are starting to get a little bit better. Wondering if you could provide any color as to how this breaks out US and OUS, just because I think some other elective-focused names in our universe are sort of seeing an inflection now? It sounds like you're suggesting that the inflection is beginning but may not be complete until sometime in Q2, and I'd love to understand the nuance. And one quick follow-up.

Yes. The recovery of procedures is clearly happening; that inflection point is happening. I think the challenge we see is the disruptions to the supply chain are not going to be immediately coming back to normal. That's going to take us a bit more time to get through. The two things I mentioned earlier, the absentee rate in our facilities was at very high levels. That's trending in the right direction and day by day getting better, but we're probably still weeks away from normal staffing levels. The other part of the supply chain is going to take us some time to work through, getting components and materials we need to ship product to customers is going to take several more months in my mind to get back to a better rhythm. Geographically, these issues affect the globe. From a procedure perspective, we still have challenges in certain markets like Australia where that has not come back yet. That's more of a March discussion.

Maybe add from a customer perspective, what we see is that our customers, hospitals, are still struggling with staffing constraints or staffing moves and they're working through that but we see a steady improvement not a step change where suddenly everything is going to be back to normal, okay? Hence, Q1 part of Q2, we see it steadily improve but not a step change.

Understood. A follow-up on ACell, which is up slightly from Q3 to Q4, stable as you pointed out, Carrie. Just would love to get an understanding of whether we should expect that business to start growing sequentially again or whether it's going to be stable here in the near term? What are some of the factors that could get it moving upward again?

Yes. First and foremost, we love the ACell portfolio; micro matrix powder product and other offerings. We've made necessary improvements and changes that I think will have significant benefits in 2022. We've added coverage in territories and resources, and we believe this will help our business return to growth during the mid-year timeframe. We're on the right path, and we expect to see continued improvement as we ramp up resources. We like the asset and expect to meet our financial models as we bought this business.

Great. Thank you.

Thank you. We will now take our next question from Robbie Marcus from JPMorgan. Please go ahead. The line is open.

Hi. This is actually Lilia, on for Robbie. Thanks for taking the question. By math, guidance implies something like 1% to 3% growth in the first half of the year and 5% to 7% in the second half, which is a pretty substantial step up. What gives you the confidence in that acceleration in the back half of the year?

Yes, I'll take that, Lilia. In terms of what we see in the first half, obviously it is impacted by COVID-related disruptions which will hinder growth in that time. As those issues abate, we can see more clearly a stronger, faster growth rate in the second half that as I mentioned would be greater than 5%. Looking at some underlying momentum, we have the benefit of the CereLink launch, the ACell recovery that will start to pick up in the second half. We will be launching our nerve product here at the end of Q1 that will add some contribution, as well as capital recovery that still hasn’t fully come back. International growth, particularly in China, is another area where we expect improvement. A combination of these factors leads us to that momentum in the second half.

Don’t forget that we are sitting on significant back orders, and we expect in the second half to return to a normal situation. Our supply chain will catch up with some of the demand that we cannot fulfill at this moment.

Okay. That's helpful. Just a quick follow-up. Can you give us any color on how things have trended on the inflationary side and how much pressure from this do you have included in EPS guidance for the year? Thanks.

Yes. The thing that has changed over the last couple of months is some of the new items we've talked about, which are temporary impacts regarding high absenteeism in our plants creating under-absorption that factors through our P&L over the inventory turns. The inflation trends have not shifted significantly; however, some freight costs have not abated as quickly as we hoped. We incorporate inflationary pressures and have adjusted our pricing strategy as needed. We've aggressively looked to offset these pressures as much as possible, ensuring this is baked into our budget for 2022.

That's helpful. Thanks.

Thank you. We will now take our next question from Ryan Zimmerman from BTIG. Please go ahead.

Good morning. Thanks for taking the questions. I want to ask Jan, I appreciate the cadence of the business. Are there other areas now you've been in the development process to stay in Integra? Are there other areas of slower growth products or regions that you think makes sense for potential divestiture or discontinuation?

The short answer is that I do not see an obvious slow growth area where we should take immediate action. My focus is on looking at how we can accelerate across the board. There’s ongoing discussions on portfolio review and continuous assessment for any changes.

We continuously look at the portfolio. Integra has done well in refining it based on growth perspectives. Jan's right; we’ve gotten the portfolio to where we want but we maintain a continuous review.

Yes, Ryan, the heavy lift was divesting orthopedics, and that's now behind us. Continuous pruning is natural, but as it pertains to the current portfolio, we like what we have.

Okay. Just on the guide, Carrie, I appreciate your comments about some of the new product contributions, like the NeuraGen 3D product. What's assumed in guidance for Surgiscope, SurgiMend, and these other bigger profile growth initiatives for 2022? Can you comment on each of those and their contribution in 2022?

Yes, we see both the Aurora Surgiscope and SurgiMend as part of our near to midterm drivers for us. For the Aurora Surgiscope, we started with a limited clinical-based launch in Q3 2021. It's being placed strategically with KOLs to help inform our hope to initiate a randomized control trial later in the year. Sales from the Aurora Surgiscope will be limited in 2022 due to this clinical launch strategy. For SurgiMend, while the product is already on the market, we operate with restrictions but are seeing traction in other areas where it's allowed to be marketed. The opportunity and contributions from these products will be more significant beyond 2022.

I would highlight that we anticipate new product introductions to contribute about 25% of our organic growth. That translates to about one and a half points of organic growth. This year should be consistent with that when you analyze our new product launches in CereLink, Aurora, and the nerve product. We are projecting no revenue from the breast indication for SurgiMend in 2022. However, we will provide more insight at later points as we advance discussions with the FDA.

Thank you, guys.

Thank you. We will now take our next question from Samuel Brodovsky from Truist. Go ahead, your line is open.

Thanks for taking the question. Just a few on the new products here. Starting with NeuraGen 3D, I'd like to hear more about the go-to-market strategy and potential competitive data readout in this space? How do you plan to position the product if that data comes back positively?

First, keep in mind, we have a nerve product on the market already addressing short gap nerve repair. NeuraGen 3D allows us to extend from short gap to mid-gap nerve repair, expanding our addressable market opportunity. This product utilizes collagen and chondroitin sulfate to support nerve growth. We're excited about it and have a dedicated team ready to move forward with selling our nerve portfolio. Over the longer term, we have additional products in the pipeline that will further expand our nerve portfolio.

Got it. That's helpful.

NeuraGen 3D is the first step in that direction. Just switching to ACell, regarding growth and that second half inflection, we anticipate growth to be heavily reliant on adding reps to the product. The growth has shown promise, and we've already begun ramping up resources in the first quarter, with significant increases expected in the second quarter. Our strategy involves enhancing coverage and revamping our sales compensation structure. We believe, together with this added coverage, we will start to discuss growth around mid-year.

Got it. Thanks.

Thank you. We will now take our next question from Larry Biegelsen from Wells Fargo. Please go ahead.

Good morning. Thanks for taking the question. Carrie, maybe it would be helpful if you could provide a little more color on the gross margin and operating margin for the year that's implied. I thought I heard your comments on gross margin specific to the second half of the year. Any color on just EPS cadence?

Yes, sure, Larry. I think you heard the remarks correctly in that my specifics were a modest level of improvement in margins on gross margin and EBITDA margins in the second half of the year. You should interpret this as flat margins in the first half on gross margins and operating expenses while expecting modest growth in the second half. It's important to note that it will take time to work through some headwinds on high levels of absenteeism and inventory management, along with gradual transitions in operational expenses through the year.

Thanks for taking the questions.

We will now take our next question from Craig Bijou from Bank of America. Please go ahead.

Good morning. Thanks for taking my questions. Carrie, on your comments on the capital markets, I want to confirm whether the smaller capital markets are back to normal levels, while the larger ones may not be. What do you think needs to happen before those get back to a normal level, and when do you foresee that within 2022?

So, first, for context, capital as a percentage of our total sales is only about 6%. In 2021, capital was approximately 6% of revenue. We observed a nice bounce back in smaller capital, as you mentioned. However, larger capital, which includes our CUSA system, has not yet returned to normal. It will take time to see a broader recovery in that area. Q1 started out slower due to staffing and Omicron impacts.

A reminder that with these capital sales, you also receive a recurring revenue stream for disposables. So as procedures recover, you will see a corresponding uptick in our disposable revenue tied to capital sales.

Got it. That's helpful. Next question, just on SurgiMend. Do you have more color or any updates on discussions with the FDA regarding the breast reconstruction indication?

We're continuing to work with the FDA, conducting additional analysis around the data. We've submitted the PMA and had the panel discussion. Progress will take time, with expectations for the approval to move into 2023 rather than being reached in 2022.

Great. Thanks for taking the questions.

Thank you. We will now take our next question from Jayson Bedford from Raymond James. Please go ahead.

Good morning. Thanks for the questions. Getting back to your gross margin commentary, Carrie, did you reference flat in the first half relative to first half 2021 or flat relative to the fourth quarter number?

No, it's first quarter of 2021, Jayson.

Okay. And what's the gross margin implied in your EPS guidance for 2022?

You should think about gross margins as roughly flat compared to the first half of 2021 and slightly improved compared to the second half of 2021.

Okay. That's helpful. What is the net impact of price in 2022 on the top line?

We don’t provide a breakdown at that level but we are actively working on it as a significant factor in our commercial strategy.

In which areas of the business are you seeing the biggest back order? How much of the $10 million to $12 million in back orders is CSS versus TT? Can we assume by the third quarter you've kind of exhausted those back orders?

It's mostly CSS products driving this back order. That impacts our US and international sales significantly. We do expect back orders to improve by the end of Q2 but it may take longer to fully normalize.

In terms of our tissue technologies segment, we see some back order issues in our private label business as well. We continue prioritizing our resources to ensure efficient supply.

Okay. Thank you.

Thank you. We will now take our next question from Matt Taylor from UBS. Please go ahead.

Hi. Thank you for taking the question. I wanted to ask a higher-level strategic question. After some time in your new role, what do you like about Integra's strategy? Are there things you might tweak or change or emphasize differently? What are some key strengths you plan to bring to this role?

Thank you for the question. First, I like the portfolio, as Glenn said earlier, the heavy lifting in terms of shifting the portfolio to higher growth and higher profitability has been done. My primary focus is on building out the portfolio that we have. Despite our successes in the past, there’s much more to be done internationally. We started a project to lay out the roadmap for which products we will sell in more countries, along with requisite investment needs. Secondly, I want to focus on how we represent within care pathways and expand into adjacencies to be more of a solutions player for the health care professionals we serve. This will guide both organic and inorganic investments, adding digital capabilities. It's an acquisitive space with great potential for M&A activities.

Thanks. I’ll leave it there.

Thank you. I will now turn the call back to your host for some closing remarks.

Well, thank you for joining us for the conference call today, discussing our 2021 fourth quarter results. We'll have follow-up questions. If you need to reach us, please feel free to reach out to me directly at investorrelations@integralife.com or you can find my contact information post-release today. Thank you very much.

Thank you very much.

Ladies and gentlemen, that will conclude today's call. You may now all disconnect.