Integra Lifesciences Holdings Corp Q4 FY2022 Earnings Call

Thank you for being here and welcome to Integra LifeSciences Fourth Quarter and Full Year 2022 Financial Results Call. At this moment, all participants are in listen-only mode. I will now turn the call over to Chris Ward, Senior Director of Investor Relations. Please proceed.

Thank you, Lateef. Good morning and thank you for joining the Integra LifeSciences fourth quarter and full year 2022 earnings conference call. Joining me on the call this morning are Jan De Witte, President and Chief Executive Officer; Jeff Mosebrook, Chief Accounting Officer; and Mathieu Aussermeier, Vice President, Corporate FP&A, Investor Relations & Treasurer. Earlier today, we issued a press release announcing our fourth quarter 2022 and full year 2022 financial results. The release and corresponding earnings presentation, which we will feature during the call, are available at integralife.com under Investors, Events & Presentations and the file named Fourth Quarter 2022 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 are discussed in the Company's Exchange Act Report filed with the SEC and in the release. Also, in our prepared remarks, we will refer to both reported and organic 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.

Thank you, Chris, and good morning to all of you joining us today. We will take you through our accomplishments and financial results for 2022 as well as our plans and financial guidance for 2023. Please turn to Slide 4. 2022 was a year of many challenges for all of us, especially from the macro environment. I'm proud of our colleagues for having demonstrated themselves to be responsible stewards of our business and the challenging economic and supply environment. We remain focused on doing right by our customers and patients while delivering on our financial commitments to our shareholders. We met our full-year organic growth targets, exceeded our original adjusted EPS guidance, advanced our strategic initiatives, and bolstered key capabilities. So let me start by highlighting several of these accomplishments in 2022, including key new product introductions, commercial optimization, and strategic M&A that not only expanded our portfolio but also strengthened our capabilities to capitalize on growth. In our Codman Specialty Surgical division, we added important line extensions to our CUSA portfolio with a recent launch of a laparoscopic tip, and with clearance of our bone tip in late Q4. Although its direct contribution to our revenues in 2023 from these products will be modest, they illustrate continued differentiation of our CUSA product line with new functionalities that enhance the utility of this technology platform. We also launched the Aurora Evacuator plus coagulation tip in the U.S as we continue to partner with surgeons to address their needs and expand the Aurora platform. In our Tissue Technologies division, we launched NeuraGen 3D, a unique mid-cap nerve repair product. We also successfully completed the integration of the ACell portfolio through the expansion of our wound reconstruction sales team. As planned a year ago, we returned the ACell portfolio to growth and grew double digits in the second half of 2022. Now that MicroMatrix, Cytal, and Gentrix are fully integrated into our wound care business, we are well-positioned for strong sales growth and to deliver on our long-term expectations for that business. We made substantial progress on our PMA for the use of SurgiMend in implant-based breast reconstruction, and we remain on track with the approval timeline we discussed during the last earnings call and at the recent JPMorgan Health Care Conference. In December, we acquired Surgical Innovation Associates or SIA, makers of DuraSorb, an innovative resorbable synthetic mesh. The DuraSorb will strengthen our strategy for the high-growth breast reconstruction market. Now with DuraSorb and SurgiMend, we have a path to securing the first and second PMA products in the markets. By offering two distinct product solutions to plastic and reconstructive surgeons, Integra can build a leading position by addressing various clinical contracting and economic needs across different sites of care. SIA was the first deal that came from our new M&A gameboard, which we completed in connection with our in-depth reviews of our divisional product market strategies. With our gameboard, we’ve laid out clear roadmaps for where and how M&A will contribute to our growth strategy. Finally, in line with our focus on differentiated regenerative technologies, we divested our non-core traditional wound care business or TWC, in the third quarter of last year. By listening to our portfolio and commercial properties, we continued to build out capabilities and our operations and organization. We closed a high-cost manufacturing facility in France and outsourced select back-office activities, which enabled us to increase profitability and redeploy resources to our strategic imperatives. We strengthened our organization with key executive leadership additions, including the appointments of Mark Jesser, the company's first Chief Digital Officer as well as Harvinder Singh, who is heading up our International Business and is the first executive VP located outside the U.S. We also added talent more broadly, particularly within our strategic marketing, manufacturing, and quality organizations with the ambition to strengthen our innovation capabilities and operational efficiency. We continue to invest in talent development across the organization, focused on further stepping up engagement and inclusion to maximize the potential of our organization. Within our culture, we have embraced sustainability as a guiding principle in how we produce and deliver life-saving technologies to surgeons and patients while providing financial returns to our shareholders. We formalized our sustainability roadmap last year when we issued our inaugural ESG reports. Our commitment to our culture was once again called out by several external organizations recognizing Integra for being a great place to work. Clearly, we accomplished a lot for the year and believe positions us well for 2023 and beyond. Let’s turn now to Slide 6 with the highlights of our 2022 financial performance. Despite the challenging environment, we delivered solid results for the year, and as I stated before, I'm proud of our colleagues for skillfully navigating through these hurdles in 2022. Our full year revenues were $1.56 billion, approximately 1% growth on a reported basis, inclusive of the TWC divestiture, and a $38 million or 260 basis points unfavorable impact from foreign exchange compared to last year. We delivered 4.2% organic growth for the year. Excluding CereLink, organic growth across the remainder of our business was approximately 4.7%, demonstrating the strength of our diverse portfolio. Throughout the year, we saw consistent demand recovery in our markets and procedures ended the year at near pre-COVID levels. This provides a solid foundation for 2023 as we further mitigate supply challenges and prepare for the relaunch of CereLink by the end of the second quarter. We delivered above our February guidance range. Full year adjusted earnings per share of $3.36, representing growth of 5.7%. We overcame both higher-than-expected FX headwinds as well as the second half CereLink recall impacts. We increased our EBITDA margin by 40 basis points while continuing to invest in both our operations and key strategic growth priorities. We also delivered solid cash flows for the year with $264 million in operating cash flow and 79% free cash flow conversion. Please turn to Slide 7 now for additional insights into our fourth quarter revenue performance. Fourth quarter total revenues were $398 million, representing a decrease of 1.8% on a reported basis, inclusive of the $11 million unfavorable impact from FX and the impact of the TWC divestiture. On an organic basis, we delivered 2.9% growth compared to the prior year. Overall, we saw solid demand recovery across our various segments and key product lines, including double-digit growth from ACell. However, the growth across our business in the quarter was tempered by supply challenges, the CereLink recall, and normalization of private label orders. If you turn to Slide 8, we'll take a deeper dive into our CSS revenue highlights for the fourth quarter. Reported fourth quarter revenues in CSS were $265 million, an increase of 1.8% on an organic basis from the prior year. Excluding CereLink, organic growth was 3.5% across the remaining parts of the CSS portfolio, led by CSF management and advanced energy product lines. Global Neurosurgery sales were up 1.8%. The CSS management grew low double digits driven by growth in our programmable valves. Advanced energy grew low single digits driven by CUSA capital and small capital sales. Dural access and repair was down low single digits as a result of supply challenges, including packaging material availability, and neuro monitoring declined mid-single digits due to CereLink. Sales of Instruments grew low single digits in line with our long-term growth expectations for this franchise. And international sales in CSS increased low single digits with mid-single-digit growth coming from Japan, China, and our indirect markets. Moving to our Tissue Technologies segment on Slide 9. Reported Q4 sales in Tissue Tech were $133 million, an increase of 5% on an organic basis from the prior year. Wound Reconstruction grew 8.2% on an organic basis compared to 2021, a solid performance across the portfolio, led by Integra Skin, PriMatrix, MicroMatrix, and Cytal. We're pleased with the accelerated momentum of ACell delivering double-digit growth in the quarter and for the second half of the year as we finalized the integration of ACell and benefited from the increased capacity and productivity of the combined sales team. Sales in private label were down 4% for the quarter compared to 2021. You may recall that we saw double-digit growth in private label through the first half of the year as our partners increased their safety stocks to address their supply chains. We have since seen these inventory levels begin to normalize, resulting in lower sales versus the prior year. Turning to Slide 10, I will cover the highlights of the P&L for the fourth quarter and the full year. Adjusted gross margin in Q4 was 66.3%, down 50 basis points compared to 2021, more than expected, as our supply chain challenges impacted some of our higher gross margin products. We also saw impacts from the CereLink recall and inflation. Our Q4 adjusted EBITDA margin was 27.6% compared to 26% in the prior year, a significant improvement of 160 basis points. We carefully managed our operating expenses by restructuring and redeploying overhead costs to investments in our key strategic growth drivers. Our disciplined spending management allowed us to improve our full year adjusted EBITDA margin by 40 basis points. Adjusted earnings per share for the fourth quarter were $0.94, up $0.10 versus 2021. Our full year adjusted EPS grew by 5.7%. The careful spending allowed us to offset full year FX as well as the CereLink recall headwinds and also enabled us to deliver full year EPS above the high end of our original guidance. If you turn to Slide 11 for a brief update on our balance sheet and cash items. Operating cash flow in the quarter was $85 million; and free cash flow was $71 million with 90% free cash flow conversion. On a full year basis, operating cash flow was $264 million and free cash flow was $222 million. As of December 31, our net debt was approximately $1 billion and total leverage ratio was 2.2x, below our target range of 2.5x to 3x. The company had total liquidity of $1.76 billion, including $457 million in cash and the remainder available under our revolving credit facility. With the strong cash flow, we’ve been able to pay down debt and return additional value to shareholders as we executed a $125 million share repurchase at the beginning of 2022 and commenced a $150 million share repurchase in 2023. With 2022 behind us, let us now go to 2023 and turn to Slide 11. What will drive Integra in 2023 is a further acceleration of growth, strengthened margin accretion, and stepped-up investment in strategic initiatives to support future growth. On the revenue side, as I mentioned earlier, we exited the year with procedures near pre-COVID levels, providing us a solid foundation for growth in 2023. Our outlook reflects this procedural demand, along with a gradual improvement of supply, including sourcing reliability of components and packaging. We also expect overall demand for our products to further grow, and we are excited at the prospect of relaunching CereLink at the end of the second quarter. Our new products are expected to contribute to the company's growth along with DuraSorb, the offering from SIA, our most recent acquisition. We intend to drive profitable growth in 2023 with strong gross margin improvements driven by favorable product mix, a focus on price capture, and increased efficiencies within our manufacturing sites. We will also benefit from the full-year impact of our TWC divestiture and the closure of our high-cost manufacturing site in France. With that profitable growth, we will reinvest in our business by stepping up our strategic investments and strengthening our core capabilities to position ourselves well for future growth. These key growth accelerators include: first, PMA readiness for SurgiMend and DuraSorb, which means execution on the clinical studies, delivery of the PMA submissions, and preparation of our relevant manufacturing sites to produce PMA-level products; second, further advancements of our Aurora platform; and lastly, enhanced generation of clinical evidence to support regulatory approval and strong reimbursement of our portfolio. We will also invest in the expansion of our international business and our first digital pilots. Turning to Slide 13 to translate these drivers into financial expectations for 2023. For the full year, we expect revenues to be in the range of $1.602 billion to $1.620 billion, representing reported growth of 2.9% to 4% and organic growth of 4% to 5.2%. Our revenue range accounts for 40 basis points headwind from FX, which reflects the lower impact compared to 2022 as a result of the strengthening of major foreign currencies versus the U.S. dollar over the past few months. If we look in more detail at full year revenue, we expect to see higher growth contribution in the second half of the year compared to the first half mainly as a result of a number of 2022 timing items. First, as mentioned previously, we expect a gradual improvement in supply, which will contribute more heavily to the second half of the year. Next, we have the year-over-year impact of the CereLink recall on the third quarter of 2022, and we anticipate relaunching at the end of the second quarter 2023. Third, we expect private label to continue to normalize in 2023, resulting in tougher comps in the first half of the year. Lastly, we expect a larger contribution from our China business in the second half, given the end of rolling lockdowns late last year. Overall, at the midpoint of guidance, we expect organic growth of approximately 3% in the first half and approximately 6% in the second half of 2023. On a reported basis, you will see the timing from the TWC divestiture to create an unfavorable comp in the first eight months of 2023. Turning to our profit outlook for the year, we expect adjusted earnings per share to be in the range of $3.43 to $3.51. If you turn to Slide 14 for a look at our guidance for the first quarter of 2023. For the first quarter, we expect revenues to be in the range of $370 million to $376 million, representing reported growth of approximately negative 1.5% to flat and organic growth of 2% to 3.5%. We expect the first quarter to be most impacted by the year-over-year comps I highlighted before. Turning to adjusted earnings guidance for the first quarter 2023, we expect adjusted EPS to be in the range of $0.72 to $0.76, flat year-over-year at the midpoint of the guidance. If you turn to Slide 15, I will conclude with a brief look at our strategic pillars and the summary of our prepared remarks. As we outlined earlier this year, we've rolled the business around five strategic pillars from 2023 and beyond. The first three pillars are our biggest growth levers: driving stronger innovation for outcomes, catching up on our growth potential in international markets, and broadening our impact across the care pathways in the therapeutic areas on which we focus. The last two pillars are key enablers: driving operations and customer excellence and cultivating a high-performance culture. These five pillars are a great way to understand how and where we're prioritizing our investments to achieve our 2023 results and build towards our long-range plan. We look forward to going deeper into our strategy and how we will execute at our May 4 Investor Day. So let's move now to the last slide, Slide 16, to conclude our prepared remarks. In 2022, we were able to capitalize on the recovering markets with our resilient and diverse global portfolio of products and great brands. We delivered about 4% organic growth for the full year in what was still a tough operating environment. Our execution in 2022 points towards a clear path of organic growth within the range of our long-range plan. Utilizing a broad set of operating levers, including price capture, operational efficiencies, careful restructuring, and cost management, we exceeded our profitability commitment for the year and delivered additional value to shareholders in the form of share repurchases, a more focused portfolio, and a strategic acquisition expected to strengthen our position in one of the most exciting growth markets: implant-based breast reconstruction. We are positioned in 2023 and beyond to accelerate our organic growth rates and improve our gross margins. For 2023, a portion of that margin improvement will be redeployed to investments in our growth catalysts, which will temper our EBITDA and EPS growth. However, these investments will further strengthen our core capabilities and operational resilience while building capability to develop and deliver life-saving technologies and products for our customers, providing the fuel to enable us to meet our long-range plan targets. So that brings us to the end of the prepared remarks. I will hand it back now to Chris, and the operator. Mathieu Aussermeier and Jeff Mosebrook are going to join me for the Q&A.

Thank you. Lateef, we can open the line up for Q&A, please.

Our first question comes from Vik Chopra of Wells Fargo. Please go ahead with your question, Vik.

Hey, good morning and thanks for taking the question. Just a couple for me. I guess the first one is can you provide an update on the CFO search? What's the criteria for the candidates and any timeline, that will be helpful? And my second question is on margins. Jan, thanks for the comments, they were helpful. But how should we think about growth and EBITDA margins in 2023? Thank you.

Okay. So let me pick the first one, and I will ask Jeff to go a bit deeper into the margin question. So on the CFO search, we started late January with the search with an executive search company. Looking for the CFO who provides a good balance between operational capabilities – I mean Integra is a heavy operational business, many dimensions of operational excellence and complexity – but also on the other end of the balance there, strong strategic capability and capability to engage in M&A. It's clear that at this point in time, we are an acquisitive firm company, and we will continue to be an acquisitive company. So we are looking for a CFO that has that balance. At this point in time, we are with the executive search company making a list of candidates. I expect that I'm going to be busy interviewing during the month of March. How that translates into a candidate being on the ground can take between 3 to 4 months. So that's on the CFO. I'll hand it to Jeff to give a bit of a view on the margin evolution in 2023.

Thanks, Jan. And Vik, to kind of walk through your question, maybe start first on the gross margin. So, Jan, in his prepared remarks, highlighted a lot of positive things we see across gross margins. So when you start first on the revenue side, you see the benefits that we are going to drop through in 2023 with the product mix and the price capture. You couple that with the benefit that we will see for the full year for the TWC divestiture driving benefits there, along with what we are seeing with manufacturing efficiencies that we hope to gain in 2023. Some of which was mentioned around the closure of a high-cost facility in France as well. So overall, when we look at gross margin, we see that improvement being around 100 bps mid of improvement there. So that's going to be the capture that we're expecting going into 2023. Now if you move to the operating expenses, as Jan had mentioned, we are really trying to apply that and make sure that we are redeploying, and we are looking at our strategic investments. And we mentioned a couple of key areas there: the SurgiMend and DuraSorb PMAs, new products, R&D, and clinical, international expansion along with some R&D along the digital pilot study. So what you're going to see from an EBITDA is really modest EBITDA margin expansion as the offset related to the gross margin expansion will be within the operating expense as we continue to invest into the growth drivers of our business.

Thank you. Our next question comes from the line of Robbie Marcus of JPMorgan. Your question please, Robbie.

Hi. This is Alan filling in for Robbie. I have a quick question about the quarter and the outlook for 2023. Regarding the quarter, we discussed gross margin, and from our view, it appears to have come in a bit softer than anticipated. This is especially notable given that it declined year-over-year and sequentially, even though the macroeconomic conditions, particularly currency, were under pressure but not as severe as expected. Could you explain what contributed to that softness and whether there is potential for improvement beyond the 100 basis points you mentioned?

So let me provide a quick answer regarding the gross margin for the fourth quarter, Robbie.

Yes, that's correct.

Yes. The supply shortages, particularly in packaging materials, have affected our product mix. We are experiencing higher backorders than anticipated on our dural access and repair products, which carry higher profitability. This mix has influenced our performance. Additionally, we faced some impact from the CereLink recall and customer dynamics during the quarter. Furthermore, we are dealing with inflation affecting our gross margins and costs at our factories throughout the year. These are the three main factors that impacted the fourth quarter.

Yes. Jan, I'd probably add there. Again, you had mentioned about the FX. We still look at the FX in a year-over-year, and it was significantly worse versus Q4 from the prior year. As Jan mentioned, relative to some of our costs, what we see is some of the inefficiency with our manufacturing that happened in the earlier part of the year; those amounts get deferred and then expensed in Q4. So the gross margins came in lighter in Q4, but that was within our guidance and within our expectations.

Got it. In 2023, when we examine your organic growth range of 4 to 5.2, at the top end, you’re landing at the very low end of the long-range plan. I understand there are still some variables to consider throughout the year. However, with CereLink making a return in the first half, you have challenging comparisons in that period balanced by easier comparisons in the latter half, while also acknowledging that it will take time to ramp that up. Additionally, you'll be focusing on the integration of SIA. What gives you the confidence to drive that reacceleration and return to sustainable growth within your long-range plan, while aiming for the higher end of the range? Thank you.

Yes, I can provide a brief answer, and if you want more detail, I'm happy to elaborate. As I mentioned earlier, we have two portfolios in different markets. In Tissue Technology, 2022 clearly demonstrated a growth rate of 7% to 9%, with ACell starting to gain traction in the heart sector, while the rest of the portfolio performed well. We anticipate a normalization of our private label offerings, which significantly outperformed in 2022 but will stabilize in 2023. Overall, this portfolio is meeting our expectations. The neuro portfolio is expected to achieve a 3% to 5% growth rate; excluding CereLink in 2022, it performed within that range. With CereLink's return, it will reinstate its importance in the portfolio. Combining these two portfolios, we aim for over 5% growth as we move into 2023. Some year-over-year comparisons may present challenges due to fluctuations in 2022, but I am confident in our portfolio, which aligns with the 5% to 7% growth range we have set for our long-term plan. Additionally, there were several new product introductions launched in 2022 that are set to contribute more throughout 2023, specifically Aurora and NeuraGen, both of which are 2022 launches expected to impact our performance positively in 2023.

It is important also to note that from a CereLink perspective, we are really counting on revenue in the second half as we are looking at our guidance range.

Question please.

Thank you. Our next question comes from the line of Steven Lichtman of Oppenheimer. Your line is open, Steven.

Great. Thank you. Good morning, everyone. I wanted to ask about a couple of topics. First, can you provide an update on the product pipeline, particularly regarding SurgiMend and Aurora? What key milestones should we expect for both, especially in relation to your discussions with SurgiMend and the rollout of Aurora? And Jan, could you elaborate on the international opportunity you see? What should we anticipate from Integra in 2023 as you continue to develop that area? Thanks.

So first, regarding the product pipeline, SurgiMend is on track for our submission in August of this year. We plan to submit further data that we have been working on with the FDA, and we feel optimistic about receiving PMA sometime in 2024. As for Aurora, our focus now is on deploying additional instruments in the field to enhance utilization and experience for surgeons. In 2022, our revenues were lower than expected, but we anticipate that Aurora will contribute significant revenue to our top line in 2023. On the international front, the market has historically been a strong growth driver with high-single-digit growth, particularly in Asia, Japan, and China. Additionally, our indirect markets such as the Middle East, Latin America, and Canada are also performing well. We are making investments in international opportunities, including increasing our presence in underrepresented regions relative to our current portfolio. We've recently launched the ACell portfolio in Europe, introducing existing products to new markets to boost international growth. We are also exploring opportunities in tissue technologies across Europe and selected Asian countries. From a neurosurgery standpoint, we are well-positioned in Europe and looking for opportunities in Asia, especially in China, to introduce more of our new surgical products. Therefore, we are focusing on existing markets with our current products and introducing new products in both Europe and Asia, while also considering M&A opportunities to expand our international presence.

That’s helpful. Thanks, Jan.

Thank you. Our next question comes from the line of Matt Taylor of Jefferies. Your line is open, Matt.

Matt Taylor: Thank you. I wanted to ask about the factors that will contribute to your performance in the second half of the year. Could you provide an estimate of the expected contribution from CereLink? I understand you're anticipating a 6% growth in the second half of the year, which aligns with your long-range plan targets. Do you see this as a solid foundation for consistent growth in that range moving into 2024?

Yes. So Matt, this is Mathieu here. So again, when you look at our first half, second half and kind of the ramp from the 3% to 6%, CereLink, we are not banking on any revenue in the first half and coming back in the second half. If you look at what we have seen historically in terms of sales coming back from CereLink, we think we’re going to be gradually coming back to this in the second half and then entering 2024 with, again, a stronger base growth in that year. In general, in terms of trends into 2024, I think we will continue to make progress towards our long-term plan, which is really that 3% to 5% on the CSS side. It's that 7% to 9% on tissue tech, and we expect to make strides going forward, '23, '24 and onward to achieve those long-term targets.

Okay, great. And maybe just one follow-up. You talked about the private label normalization a few times. Can you be more specific about how you expect private label to grow in '23 because of the tough comps in the first half?

I will give this again to Mathieu.

Yes. So first half, when you look at private label, I mean, we definitely expect a year-over-year comp that's going to be down. First half 2022 was really our strong half, I would say, of 2022. As you go into the second half, we expect it to be slightly down to flattish, bringing the year on a year-over-year comparison to down low single to mid-single-digit on the private label segment.

But overall, Matt, private label is a mid-single-digit growth business. And that's where we will be back at those levels. As of 2023, we will continue in the out years.

Thank you. Let's move to our next question.

Thank you. Our next question comes from the line of Ryan Zimmerman of BTIG. Please go ahead, Ryan.

Good morning. Thank you for taking my questions. I would like to get more clarity on the margin line regarding the long-range plan. When can we expect to achieve that low teens or double-digit EPS growth? Is the 100 basis points of margin expansion you expect for 2023 absolute? I'm curious if this includes any inflation headwinds or foreign exchange factors you mentioned. Should we expect 100 basis points of margin expansion in 2023 on an absolute basis? Additionally, when do you think we'll return to low double-digit EPS growth? Based on the current margins and the sales and marketing structure, it seems unlikely we'll see a double-digit figure in 2024 as well, considering where margins are currently.

Okay. I'm going to hand it back to Ryan and Jeff, but I also want to clarify a couple of things regarding the gross margin, which I think you covered. Jeff?

Yes, Ryan, so going back to that 100 bps, that was a discussion around the gross margin side. So where we see gross margin improving 100 bps mid relative to kind of those drivers we mentioned before. Now when we talk about modest EBITDA improvement, keep in mind within our OpEx, the redeployment that Jan was speaking of, which is a reset kind of coming out of our expense management that we had in the second half of the year, you also have to couple that with the SIA acquisition we did at the end of December. So that acquisition brought within operating expense, and we mentioned within that deal that it would be dilutive. So it's adding the additional R&D and commercial with that business to make sure that we support it going forward, both from the PMA perspective and commercial execution there as well. So I think relative to 2023, you got to keep in mind, there's a lot of moving parts on the top line with timing, and that has created some noise in the first half and the second half, and then also on the operating expense side the investments that we're making along with SIA that are making our EBITDA growth more on the modest side. But again, gross margin growing at 100 mid basis points offset on the operating expense with those investments that we talked about.

So maybe, Ryan, just to add to that, because I mean Jeff used the term 100 bps mids, which means well above 100.

Correct, yes.

So that's one. Yes, we definitely, for 2023, are driving strong gross margin accretion as a result of – yes, on the one hand, yes, some of the mix portfolio changes we've done and focus on operational efficiencies, okay? So that's one. Second, in terms of what I flagged as we are investing in growth. If you look back at our OpEx pattern first half, second half last year, you'll see that second half were significantly lower on OpEx. At that point in time, I told our investors that this is preparing not just to compensate for CereLink, but also preparing to redeploy which we're doing. So you will see that OpEx come back and more, part is the SIA acquisition. But part is that we're reinvesting the money we redeployed last year. And I would say, in total, there's about $35 million of redeployed money that we're reinvesting in 2023. Okay? So that brings our OpEx level back to a bit more normal level, we would say, like the first half of '22 plus the SIA acquisition and some labor inflation.

Okay. Let me ask about market growth, and I'm going to ask a little bit away from the P&L for a second. As you think about the puts and takes of the business, and I know CereLink is coming back and so forth, what are you assuming for overall market growth, be it Neurosurgery or Tissue Tech? Are those markets at depressed levels right now, in your view? Because if they're not, then you are losing share, I guess, relative to your market in the first half of this year. And if they are at depressed levels, when are you assuming they come back? And is that in coordination with the product drivers you're talking about? And why not get more of a boost, I guess, in the back half of the year?

So we see the markets pretty much back at their normal levels. We've seen Q4 except for a couple of countries, but yes, we are pretty much back to normal. The growth that you see, we don't think we're losing share. Then there's definitely with CereLink not in the market, growing that market. But the other parts of the portfolio are doing as we expect them to do. Even in several areas, when I look at our capital, when I look at our CSS, I mean, we are definitely capturing share. I think the numbers you see may have several elements of year-over-year comparison that may make you think differently, but that's definitely not the case. We see the market sitting back and good, we see our position strong in the markets.

Okay. Thank you.

Thank you. Our next question comes from the line of Rich Newitter of Truist. Your line is open, Rich.

Thank you for taking my questions. I want to follow up on the margin outlook. You mentioned earlier a modest expansion in EBITDA margins. For the full year, I'm trying to understand how you plan to achieve that. Earnings growth seems to align closely with the revenue, and there's a repo in there. Could you clarify if there are any non-operating items and tax interest considerations that could contribute to this modest expansion? I’m leaning more towards flat margins or possibly slight deleveraging. Additionally, regarding the pace of margin improvement, it seems you're anticipating a return to 'normalized' spending levels soon, starting in the first half of the year. Given that revenue growth appears to be lower in the first half compared to the second half, should we expect different margin trends in the two halves? Any insights on the margin progression throughout the year would be appreciated.

Thank you, Rich. As we go through the details below EBITDA, it's important to consider the EPS modeling range we provided, especially in relation to the tax rate. In 2022, we benefited from stock compensation, which we do not expect to recur in 2023. Therefore, we are estimating our tax rate to be around 19% for the year, reflecting a year-over-year increase of just over 100 basis points. You mentioned the share count, which is also crucial, as we started a $150 million share repurchase in early Q1. This will need to be considered when updating the share count for the remainder of the year, significantly influencing our EPS guidance. Additionally, regarding operating expenses, we are incorporating the extra investments that Jan highlighted, along with the costs associated with the SIA acquisition made in December, which are both contributing to a modest improvement in EBITDA.

Thank you. Regarding CereLink, as we consider the product's return to market, should we expect that its revenue contribution in 2023 will primarily focus on restoring supply for existing customers? Or is your guidance based on the assumption that you will also be opening new accounts and generating revenue beyond the usual baseline?

We definitely count on opening new accounts. As I communicated before, our manufacturing capability is ready. We have different parts yet ready to start manufacturing. So the capacity is not really going to be a bottleneck. At this point in time, on CereLink, we are running the validation, verification of the new technical fix generating statistically significant data that we then take to the FDA and get back into the market after submission.

Thank you. Our next question comes from the line of Jayson Bedford of Raymond James. Your line is open, Jayson.

Hi. Good morning. Just maybe a couple of quick ones. You mentioned price capture as part of the stronger margin profile. Can you just provide a little bit more detail as to price discussions, any pushback you're getting? And what's the contribution to revenue growth in '23?

So thanks for the question, Jayson. In terms of price, we communicated last year that typically, we've always gotten some price in the range of 1 percentage. Last year, we aimed at four more, and we succeeded in getting more this year, given the realities of inflation that we saw last year and some of the inflation that is hanging. We are aiming a next step higher. As far as we see customers understand we are not the only company that is adding price to deal with inflationary prices. So we are on a path to get more than last year, which definitely is significantly more than what we would get in a typical year.

And Jan, that's on a net basis, meaning if I just look at kind of your $1.5 billion in revenue in '22, you expect to get north of 1% in price in '23 across the portfolio?

Yes.

Okay. Okay. And then just quickly, second one. The mid-single-digit decline in dural access repair, it sounds like much of it is supply chain-related. Are there any demand issues? Or are there any competitive market share dynamics at play as well? Thanks.

No, no, this is all supply and then primarily packaging material, unpredictable availability, let's call it that way. So we are losing some manufacturing capacity as a result.

And when is this expected to be alleviated, the supply chain dynamics?

We will definitely expect it to take all the first half to get better, bit by bit. This is about the supply chain getting back to its capacity. We are developing and have developed parallel suppliers of some of these packaging materials. So we are alleviating some of the root cause. But for some, we will have to continue working with suppliers a bit longer to get back to capacity of material supply.

And Jason, this is Mathieu. This is also, I would say, kind of a good example of what we are going to see throughout 2023 in terms of gradual supply recovery, right? What you mentioned here from a dural access and repair perspective is really in line with how we kind of look at 2023 and the step-up of supply recovery.

Got it. Thank you.

Thank you. Our next question comes from the line of Joanne Wuensch of Citi. Your question please, Joanne.

Hi. This is Anthony standing in for Joanne. Thank you for taking our questions. First, I want to note that in China, growth was in the mid-single digits this quarter, even with the recent changes due to reopening. Can you elaborate on the factors driving this growth, and what your expectations for growth in China are this year? Additionally, I would like to know about the current interest from hospitals regarding new capital investments. Thank you.

I understood your second question. As for the first one, I'm not quite sure, Anthony. Could you please repeat it?

Yes. Sorry, just asking about the Codman growth in the quarter, I believe you said it was mid-single digits in China. So just curious maybe what specifically you're seeing in China, what's driving the growth there and then your expectations for China growth in 2023?

Yes. So what we saw in China over the fourth quarter, still some impact from the rolling lockdowns. However, what we still saw in the fourth quarter was mid-single-digit growth, but that's compared to the double-digit growth we are expected to see from China. So we expect, as of the second quarter this year, to be back to that double-digit growth rhythm. The first quarter is still going to be a bit of a mixed bag with some of the January COVID wave that passed through the country. We definitely saw impact. Although coming out of the Chinese New Year, I think most people are pleasantly surprised at how the ripples flattened out quite quickly. So yes, in the first quarter, do not expect double-digit yet, but as of the second quarter, I see China back into a normal rhythm, which is driven by the further growth of health care in that country, but also our drive to move from Tier 1 to Tier 2 and 3 hospitals. So we are spreading our geographic coverage in China. Okay? And that's the second big growth driver for our Codman portfolio there. The question on capital. Capital in the fourth quarter has been solid, remains solid. We ended the year with very healthy funnels. We pretty much have seen this healthy capital all over 2023. The only thing that we've seen a bit different over the years is that decision timings have become longer, primarily driven by just the administrative processes that seem to run or turn a bit slower. We do not expect that to accelerate quite rapidly. But we consider we are at a new steady state where decisions will take longer. But the pipeline is well filled, and we will get the deals out of that pipeline at a steady growth phase that we've seen last year.

Thank you. Our next question comes from the line of Dave Turkaly of JMP Securities. Your question please, Dave.

Yes. Great. Jan, I'd just like to get your thoughts on sort of valuations out there. It seems like a lot of the private companies are compressed. And if that's true, I'll just add the second part in here. And you're a little below the LRP on top line and you're under leveraged. Why do you think the $150 million buyback is the right allocation choice right now? Thank you.

So I think you know as a discipline with our balance sheet, when we initiated the $150 million buyback, there were two drivers. One, given what we have in our M&A objectives, what we also have on the balance sheet, we felt that we both could give the capital back and still not impact our M&A planning. And then second, from a timing perspective, when we did the SIA acquisition, we knew first year $0.06 dilutive. And with that buyback, we wanted to isolate our shareholders from that impact. So I see it more as a strength of our balance sheet that we can both do M&As, but at the same time, also if we have excess capital, not let it linger on the balance sheet, but bring it back. What do you say on the depressed valuations, we are very aware of that. Yes, we definitely know what are the targets that we want to master for this year and the next years.

Thank you. Our next question comes from the line of Matthew O'Brien of Piper Sandler. Your line is open, Matthew.

Thank you for taking my question. Following up on Dave's inquiry, Jan, you have your game plan in place and you're not heavily leveraged, but you are making significant investments in your organic business this year, along with the acquisition from last year. Given all that you have going on, should we assume that the chances of a larger deal this year are lower, and instead focus more on technology or smaller acquisitions rather than pursuing something substantial? I also have a quick follow-up.

So I would not make that translation to all these smaller deals yet. Definitely, on our gameboard, which is driven by strategy, there are deals that are more tuck-in, like there's also more significant objectives. Our balance sheet is not keeping us from having to make a selection on which we can afford. Okay? So the timing is mainly driven by whether on both sides of the table, there's the willingness to transact.

Okay. Thanks for that. And then ACell was an acquisition that was done that was challenging to start with, but based on the results here recently has been really perking up. So can you just maybe deconstruct a little bit of some of where that growth is coming from? And then the confidence level and the durability that you're seeing there on the low double-digit growth side of things? Thanks.

The situation with ACell is straightforward. Following the acquisition, we had to downsize the sales force due to the SIA agreement related to this business that we chose not to pursue. Consequently, we had to rebuild aspects of the ACell sales team, which required time and investment in hiring new staff starting at the end of 2021. As we communicated in the first and second quarters, we were in the process of onboarding new personnel, and we anticipated it would take six months for them to be fully operational. This timeline unfolded as expected, and we observed the results in the latter half of the year. Today, this product has a clear role in addressing acute wounds and reconstruction, particularly for deep wounds. Additionally, we've noticed a synergistic effect where some ACell products are enhancing the appeal of other tissue technology offerings. Reflecting on this, I believe our strategy for the product was sound, and its contributions align well with our portfolio. While the initial performance was weak, it rebounded as we worked on rebuilding the sales force, and our sales teams have demonstrated their capability in managing and developing the sales organization effectively.

Okay. Thank you.

Thank you. This concludes Integra LifeSciences fourth quarter and full year 2022 financial results call. Thank you for participating. You may now disconnect.

Thank you, Lateef.