Earnings Call Transcript - IART Q3 2021

Operator, Operator

Good day, and welcome to the Integra LifeSciences Third Quarter 2021 Financial Results Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Mike Beaulieu, Director of Investor Relations. Please go ahead, sir.

Mike Beaulieu, Director of Investor Relations

Thank you, Cecilia. Good morning and thank you for joining the Integra LifeSciences third quarter 2021 earnings conference call. Joining me on the call are Peter Arduini, 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 third quarter 2021 financial results. Along with the release, a corresponding earnings presentation, which we will reference during the call, is available at integralife.com under Investors, Events and Presentations with the file name Third Quarter 2021 Earnings Call Presentation. Before we begin, I'd like to remind you that the 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. 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 and franchise-level revenue growth rates are based on organic performance. 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 today with the SEC. With that, I'll now turn the call over to Pete.

Peter Arduini, CEO

Thank you, Mike, and good morning, everyone. If you please turn to Slide 5, I'd like to make a few brief remarks regarding the CEO transition. Last Thursday, we issued a press release announcing that after a comprehensive search of candidates, our board has appointed Jan De Witte as its next President and Chief Executive Officer. Jan brings significant leadership experience and capabilities, including digital innovation and new product development, commercial acceleration, and international market expertise and operational excellence as well as a global mindset. As I noted on the second quarter earnings call, Integra has an outstanding leadership team capable of executing our strategic plan with a robust pipeline of innovative new products to drive global growth and market expansion for years to come. I have every confidence that Jan will build on Integra's strong foundation to drive the next phase of our profitable growth strategy and I'll work closely with him over the coming months to ensure a seamless transition. Jan will be joining us prior to the end of the year as we work through the logistics of moving him and his family to the United States from Belgium. I'd also like to extend my sincere thanks to Stuart Essig and the board of directors, Integra's exceptional management team and the more than 3,700 employees around the world. It's been an amazing 11 years at Integra and I remain a huge supporter and look forward to Jan's many contributions as Integra's next CEO. Now, I'd like to turn the call over to Glenn to discuss our accomplishments and performance in the third quarter. Glenn?

Glenn Coleman, CFO

Thanks, Pete, and good morning. Please turn to Slide 7. Our third quarter operating performance was strong despite the challenging environment. I'll highlight a few of the factors that drove our results and provide an update on several of the key catalysts that positioned the company to achieve its near and longer-term financial targets. Third quarter sales were $387 million, near the high end of the guidance we provided in July, adjusted earnings per share were $0.86 compared to $0.80 in the prior year and were $0.13 above the midpoint of the guidance. We're pleased with our continued sales recovery across geographies and product lines during the quarter. Despite the impact of the Delta variant and hospital staffing shortages, that resulted in procedural referrals in parts of the U.S., Europe, and Australia. Sales performance in July was strong, continuing the recovery trends seen in the second quarter with the most pronounced COVID impact in August, followed by a gradual improvement towards the end of September. We experienced a strong recovery during the quarter in our indirect markets and benefited from pent-up demand in our instruments business. Despite the variability in deferral and procedures, third quarter organic revenue growth was 6.7%, demonstrating the benefits of our diverse portfolio with products and market-leading positions. In the third quarter, we achieved positive organic growth in each of our businesses, including neurosurgery, instruments, wound reconstruction, and private label when compared to both 2020 and 2019. Geographically, sales in the U.S. increased mid-single digits and sales outside the U.S. increased approximately 10% compared to 2020 with strong growth in Japan and China. We believe there is a significant opportunity in these markets as we continue to introduce new products and expand our commercial presence. Moving to new product updates, we launched Cerelink in the U.S. and Europe in the third quarter. As a reminder, Cerelink raises the bar in ICP monitoring through enhanced accuracy, usability, and advanced data presentation. Our third quarter sales of Cerelink benefited by $5 million in initial orders, part of the reason we laid it near the high end of our July guidance range. The U.S. and Europe make up approximately half of the global market for neurocritical care monitors and will drive growth for Cerelink over the next several years. During the third quarter, we began a phase market release of the Aurora Surgiscope to a select group of key opinion leaders for clinical evaluation. As a reminder, Aurora is a novel and proprietary minimally invasive surgical solution with integrated visualization and capabilities designed specifically for use in neurosurgery. These key opinion leaders have begun to perform cases using the Aurora Surgiscope to remove different types of brain lesions. Initial feedback has been encouraging and reinforces our excitement about the value of this product offering. We plan to expand our clinical evaluations to a wider group of KOLs during the fourth quarter. Also, during the third quarter, we continued to expand our MIRROR registry, which is designed to collect data on the use of Aurora for early surgical intervention in the treatment of intracerebral hemorrhage or ICH. We look forward to updating you on that progress over the coming months. Turning to ASL, we were encouraged to see sequential improvement in the sales of MicroMatrix, the powder formulation of our UBM technology. Growth in accounts where we have strong existing relationships with providers who already use Integra’s portfolio of products. Despite these improvements, the ASL business was slightly below our expectations in the quarter, but we put in place a plan to drive better performance moving forward. This includes adding sales resources to select territories and expanding our training and surgeon education programs. I'll wrap up my discussion of growth catalysts with our takeaways following the recent FDA advisory committee meeting for our SurgiMend PMA and post-mastectomy breast reconstruction. This panel meeting was held on October 20 and was an important review of the clinical section of our PMA in the broader FDA product review and approval process. To provide some context, Integra worked with the FDA to design a statistical analysis plan for MROC, the Mastectomy Reconstruction Outcomes Consortium, which was a large multicenter study that examined outcomes for thousands of breast reconstruction patients. This analysis demonstrated that results with SurgiMend PRS and post-mastectomy implant-based breast reconstruction are superior to the results in such procedures when no acellular dermal matrix is used. Nevertheless, we've always recognized that there are limitations in the MROC study data, and this was reflected in divided voting results from the panel regarding safety, efficacy, and whether the benefits outweigh the risks. We appreciate the FDA panel members’ insights and discussions regarding our PMA. We continue to believe there is an urgent clinical need for an FDA-approved acellular dermal matrix to help restore quality of life for women following breast reconstruction. As of today, there are no FDA-approved products on the market. We look forward to working with the FDA in the coming months as the agency completes its review of our PMA submission, and we believe the real-world clinical evidence supports approval. In summary, our third quarter organic growth was strong, and we're on track with our growth initiatives, which will keep us on the path towards achieving our long-term targets. Finally, I'd like to thank Pete for his 11 years of leadership at Integra and the incredibly positive difference he has made for me, the thousands of employees here at the company, as well as our customers and patients around the world. Pete, you will certainly be missed, and we wish you well at GE Healthcare. Now I'll turn the call over to Carrie to provide a detailed review of our third quarter financial performance. Carrie?

Carrie Anderson, CFO

Thanks, Glenn. And good morning, everyone. I'd like to start with a summary of our third quarter highlights on Slide 9. Third quarter total revenues were $387 million, representing an increase of 4.5% on a reported basis and 6.7% on an organic basis compared to the prior year. With our strong performance in the third quarter and our outlook for the remainder of the year, we expect our organic growth in the second half of 2021 to be approximately 5% over 2019. Adjusted gross margins in the third quarter were 68.3%, down slightly compared to the prior year, but in line with expectations and up slightly when compared to the first half of 2021. As we discussed on our July earnings call, we continue to monitor material inflationary pressures closely, and impacts in the third quarter were largely related to increased freight and packaging costs and some supply chain disruption. We have supply contracts that help to mitigate near-term exposure to these issues, and we have an opportunity to recoup a portion of increased costs through pricing adjustments as we move into 2022. Our Q3 adjusted EBITDA margin was 27% compared to 27.9% in the prior year, as the benefit from higher revenue was offset by higher operating costs as our expenses continued to normalize. As we discussed last quarter, operating expenses are gradually increasing following the reduced levels of spending we put in place last year in response to the global pandemic. We continue to prioritize our spend in the second half, investing in new product growth strategies, further geographic expansion and clinical studies. Given our year-to-date spending and outlook for Q4, we now expect full-year adjusted EBITDA margins to be above 25%, which was the high end of the range we provided in July. Adjusted earnings per share for the third quarter were $0.86 compared to $0.80 a year ago. The growth in adjusted EPS was largely driven by increased operating leverage on higher revenues and includes a small benefit from a lower tax rate in the quarter. I'll provide an update on our full-year adjusted EPS in a moment. And finally, third quarter operating cash flow was $83 million, representing an increase of 19% from the prior year. If you turn to Slide 10, I'll review the third quarter performance of our CSS segment. Q3 revenues in CSS were $257 million, an increase of 7% on a reported basis and 8% on an organic basis from the prior year. Global neurosurgery sales increased 6%, while instrument sales increased over 15% on an organic basis compared to 2020. Geographically, sales in both the U.S. and outside the U.S. increased approximately 8% compared to the prior year. Recovering global neurosurgery sales were generally broad-based, and sales in instruments benefited from pent-up demand. As Glenn discussed, the launch of Cerelink in the third quarter resulted in a $5 million benefit from early adopters. With this order backlog largely met, we expect a more modest benefit from Cerelink in the fourth quarter and remain excited about a multi-year growth trajectory. Excluding Cerelink, sales of capital grew low double digits compared to 2020, but sales are not yet back at 2019 levels. Sales trends of capital are encouraging, and we expect further improvement in the fourth quarter and a return to normalization in 2022, given our very strong order funnel. International sales in CSS increased across all major regions compared to the prior year. The comparison to 2019 is more mixed, with variability across Europe and growth in Asia-Pac. As Glenn discussed earlier, growth in Japan and China were standouts in the quarter, with both countries delivering low double-digit growth compared to 2019. Moving to our Tissue Technologies segment on Slide 11. Q3 sales in Tissue Technologies were $130 million, approximately flat on a reported basis and increased 3.7% on an organic basis from the prior year. Sales in Wound Reconstruction increased 1.7% organically compared to 2020, led by Integra Skin and SurgiMend in our burn trauma and surgical reconstruction markets. Compared to 2019, sales in Wound Reconstruction increased 1.5%, driven by strong growth in Integra Skin, partially offset by declines in our plastic and reconstructive surgery franchise, which as a reminder grew double digits in Q3 of 2019. Sales in Private Label increased 9% compared to 2020, driven by continued recovery in customer orders, and increased 26% compared to 2019, driven by a favorable comparison related to order timing. If you turn to Slide 12, I'll provide a brief update on our balance sheet, capital structure, and cash flow. Operating cash flow in the quarter was $83 million and free cash was $75 million. Adjusted free cash flow conversion was 103% in the third quarter, reflecting higher earnings in a more gradual recovering capital spending driven by extended timelines on key manufacturing and construction projects. On a trailing 12-month basis, both our operating cash flow of $323 million and our free cash of $294 million were record highs. Net debt at the end of the quarter was $1.1 billion, and our consolidated total leverage ratio was 2.3 times. As of September 30, the company had total liquidity of approximately $1.75 billion, including $470 million in cash and the remainder available under the revolving credit facility. Turning to Slide 13, I'll provide an update to our consolidated revenue and adjusted earnings per share guidance for the full year 2021 and fourth quarter. We are reaffirming our previous full-year 2021 revenue guidance of $1.54 billion to $1.55 billion, with an expectation to be at the low end of the range, representing reported growth of approximately 12% and organic growth of approximately 13% compared to the full year 2020. Embedded in this guidance is an expectation for a sequential quarterly improvement in sales from ACell, resulting in slightly more than $65 million in revenue for the partial year of ownership. We are pleased to report that even at the low end of our full-year 2021 revenue guidance range, organic growth for the second half of the year is expected to be approximately 7% compared to 2020 and 5% compared to 2019. Based on our expectation for the full year, we are targeting fourth quarter revenue of $403 million, which takes into account the risk of ongoing effects of the pandemic and changes in foreign currency. This target corresponds to reported growth of approximately 3.5% and organic growth of approximately 6.5% compared to 2020. Turning to adjusted earnings guidance for 2021, we expect fourth quarter adjusted EPS to be in the range of $0.82 to $0.86. For the full year, we are increasing adjusted EPS to a new range of $3.16 to $3.20, representing 30% growth at the midpoint compared to 2020 and 16% compared to 2019. Our full-year tax rate is now expected at 18.25%. Now I'd like to turn the call back over to Pete for some closing remarks. Pete?

Peter Arduini, CEO

Thanks, Carrie. If you all turn to Slide 14, I'd like to wrap up our prepared remarks with a few key messages. We're pleased with our performance in the third quarter, despite the lingering effects of COVID and as growth in many of our businesses exceeded 2019 pre-pandemic levels. We expect these positive revenue trends to continue into the fourth quarter and into 2022 and remain confident in achieving our long-term growth targets. We're focused on executing our strategies, which is about leveraging our optimized portfolio, penetrating deeper into our existing markets, and expanding into higher growth geographies and market adjacencies. The global launch of CereLink, our investments in the development of the Aurora Surgiscope, nerve 3D, and the pursuit of a PMA for SurgiMend in breast reconstruction are just a few of the examples of our progress in 2021. In closing, on my last evening earnings call here at Integra, I'm incredibly humbled by what we've accomplished over the last decade and the positive impact we've had on patients’ lives. And that's really what matters, doing well by doing good. The company is in a position of strength with an outstanding leadership team and a deep pipeline of new products. And with the appointment of Jan, a proven global business executive with deep experience in healthcare and technology, I have no doubt that the company will continue to excel for many years to come. That concludes our prepared remarks. Thank you for listening. And operator, if you would now open up our lines for questions.

Matt Miksic, Analyst

Great. Thanks so much. Good morning, and congrats on the quarter. Congrats Pete on the new position; it's been a pleasure working with you, and looking forward to keeping in touch.

Peter Arduini, CEO

Thanks, Matt.

Matt Miksic, Analyst

You bet. So, a couple things, I guess I wanted to highlight, heading into the quarter, I think for everyone, the expectation was for tough trends, particularly in the U.S. And I think what is surprising folks to the upside here a little bit in your results is sort of the performance in the U.S., despite I think what everybody understands is the reliance of the business to a large degree on availability of ICUs. And then the outperformance OUS and look to get your additional color on those areas of sort of you held in there and outperformed as I just mentioned then I have one follow-up on Q4 if I could.

Carrie Anderson, CFO

Yes, Matt. I’ll take a stab at that and then if Glenn wants to add color. But I would say, as we went through the quarter, as Glenn made in his prepared remarks, the COVID impact that we saw certainly peaked in August and we saw some nice recovery. I think as we think about the path that gave us the final result of $387 million. We certainly benefited from a late quarter launch of CereLink about $5 million worth of benefit coming from CereLink in the quarter that was towards the end of the quarter. And I would say the pent-up demand that we talked about with instruments certainly helped us achieve the near the high end of our guidance range. There was still a COVID impact in the quarter. So, as I think about procedural deferrals, plastics and reconstruction and surgical reconstruction did see procedural deferrals, and even in some of our neural procedures had some deferrals, but overall, I think there was enough diversity in our portfolio that pushed us there. And then capital, as I mentioned earlier, certainly capital benefitted from CereLink, but even when you exclude capital, we even saw double-digit growth compared to 2020, but when compared to 2019 still not at those same levels. So, we still have some full normalization of capital to go that will help us as we move into Q4 and into 2022. So, with that, Glenn anything else that you would want to add?

Glenn Coleman, COO

Just in terms of the international business, and obviously, we saw some of the COVID impacts in Europe and in Australia, New Zealand. But even with that, we put up a really strong quarter outside the U.S. double-digit organic growth for the international team. So, that was outstanding. A lot of that coming from Japan and China, I mentioned both of those markets doing exceptionally well, but even Europe put up mid-single digit growth organically versus 2020 despite some of the challenges. And we did see a bit of a bounce back with our indirect markets as well. So, on the whole, the international performance was quite good and could have been better had we not seen some of the COVID headwinds. Pete, anything else…

Peter Arduini, CEO

Yes. Just to reinforce what you guys said, I think this is the beauty of the Integra model, a diversified mid-cap. I think you saw some of the benefits of it this quarter, as Carrie mentioned. And the fact that life-sustaining, life-supporting products, such as neurosurgery get prioritized to the top of the list even when ICUs are under pressure. And so, I think we benefited from that as well.

Matt Miksic, Analyst

That’s great. And then if I could just on Q4, you’ve raised on the bottom line for the beat mostly. And – but it– I think the Street was looking for maybe a little shallower Q3 and a little steeper increase into Q4 and you’ve sort of leveled that. I’m just wondering, what kinds of things are you contemplating in your Q4 guide? Given that there’s still some concerns over hospital staffing and some other issues, I guess what goes into that assumption for organic growth in Q4?

Carrie Anderson, CFO

Well, Matt, I think you said it exactly in terms of what we’re thinking about. So, as we digest our Q3 results certainly, there was some impact of COVID in there and that uncertainty still exists in the fourth quarter. So, a bit of caution as we move into the fourth quarter. Like what we’re seeing in terms of October, it came in as expected first month of a quarter typically is the lowest of the three months. So, October came in as expected, but I would say just wanting to reflect fact of a more cautious view of continued COVID uncertainty with flu season. Staffing challenges are still persistent and likely will persist even into 2022. And then just supply chain disruption, certainly managing through expedited freight and getting product where it needs to be all those things factor in, and a little bit of FX headwinds as we think about where the dollar has strengthened against some of those European currencies reflecting some FX headwinds there as well. So, all those things kind of mix into the lower end of our guidance range.

Glenn Coleman, COO

Hey Matt, I would just add to that. We feel quite good about how the second half of the year has played out. I mean if you think about the organic growth versus 2020 in the third quarter, 6.7% that’s a good number. We expect Q4 based upon our guidance to be above 6%. So, we feel like that’s going to bode well as we go into next year. So, I just wanted to highlight that as well.

Matt Miksic, Analyst

Terrific. Thank you.

Glenn Coleman, COO

Yes, thanks.

Steven Lichtman, Analyst

Thank you. Hi guys, and best of luck, Pete. Just a couple of questions for me. First on CereLink outlook, certainly understand your comments about the Q3, Q4 dynamics here. But just bigger picture, what are you seeing in the early days of the reintroduction as you talked to the field, and how are you thinking about CereLink as a driver in 2022, now that we’ve been out on the market again?

Glenn Coleman, COO

Yes, thanks, Steve. I’ll take this one. This is Glenn. Again, just why we’re excited about CereLink, a few things. One, the new monitor is more accurate than other monitors on the market. It has less drift. It’s more compatible. It’s got this waveform that enables continuous monitoring and better clinical decisions and better patient outcomes. And so, we’re real excited about that along with the flexible microcenter that goes with it. We did see some pent-up demand when we launched here in the third quarter in the U.S. and Europe, so we mentioned $5 million. We’ll see obviously more revenues coming in in the fourth quarter, but not to the extent of the third quarter revenues because of some of those initial orders. But as we go into next year, in the next couple of years, this should be a nice growth driver for us in many markets outside the U.S. as well. Longer-term China is a big opportunity for us, but that’s still a few years down the road, I’ll say, but certainly for 2022, this is going to be one of the growth drivers for us and even into 2023. But we’re launched, we’re moving forward, and we feel like we’ve got differentiated capabilities with our monitor versus others on the market.

Steven Lichtman, Analyst

Great. Thanks, Glenn. And then just, secondly, obviously, the organic business is offsetting ACell coming in light of your initial expectations. As you look at that business and how it can be a stronger driver ahead, can you talk about what you’ve identified as potential fixes and what your outlook for ACell is overall over the next say 12 months to 18 months?

Glenn Coleman, COO

Sure. Just a couple of things I want to highlight in terms of the positives around ACell. We still think this is going to be a great asset and a synergistic fit to our business. If you just look at the third quarter, I called out in my prepared remarks, MicroMatrix, the powder formulation is actually growing sequentially – that was a good positive sign. We did grow ACell sales in a number of our existing accounts where we already have relationships established. And so that was a big positive. We still have some COVID challenges in terms of getting account access, especially to the newer surgeons, but we have put plans in place to get better performance moving forward. And a big part of those plans is putting in more resources and getting better coverage, especially around the top 250 accounts across the portfolio. And so those plans are underway. We’re hiring more people. I think as we get more access in the fourth quarter here, you’ll see more product trialing taking place. We’ll do more with the value assessment committees. So, we feel like we’re on a good path there. And then more education, and just to give you some context around this, we completed 13 specific ACell education events alone in the third quarter, and that’s obviously going to have a positive impact as we go forward. So, we’re going to be adding more resources, getting better account coverage. I think access will open up for us better in the fourth quarter. And this is going to take us a few months to get to where we want to be, but certainly, expecting to see an improvement in the business, and we’re already starting to see some positive signs, which I’m encouraged by.

Steven Lichtman, Analyst

Great. Thanks, Glenn. Thanks, everyone.

Anthony Petrone, Analyst

Thank you. And I want to congratulate you, Peter, as well on the role at GE, good luck, and we hope to stay in touch going forward. And of course, good luck to the Integra team as the transition is finalized here into the end of the year. A couple of questions just on COVID and then I’ll have a follow-up on SurgiMend. So just on COVID in the quarter on two specific areas related to Delta, hospital access, and then maybe even an impact to trauma cases. Is there sort of a way to quantify your sort of lowering ACell here, for instance, and other $6 million or so versus or $7 million versus the lower end of the range? How much is actually linked to limitations on hospital access and then just going into tissue technology specifically, did the company see a lower incidence rate of trauma that led to the Q-over-Q downtick? And then I’ll have a follow-up on SurgiMend. Thanks.

Carrie Anderson, CFO

Yeah, Anthony, I’ll take that. If you recall, our original guidance for the third quarter was $382 million to $389 million. And I would say that $389 million, which was about sequentially flat from where we ended up in Q2 really represented very little COVID impact, essentially, continued recovery from COVID trends. So, I would say that as where we landed, certainly, we saw a COVID impact, it pushed us closer to the mid to slightly higher than the midpoint, and then we have the CereLink benefit. So, if you kind of look at that, we probably would have been more closer to the lower end of our guidance had it not been for the successful launch of CereLink, but all in all, as I go back to my comment and Pete’s comment, the diversity of the portfolio really showing through the third quarter and overall producing a really balanced result of $387 million. But I would largely say that if the COVID headwinds had not been there, we certainly would have been at the high end of that range, for sure. And so, I’d quantify that as the headwind from COVID. As it relates to the areas that were more impacted, certainly the surgical and reconstruction area of our tissue technologies business is probably the area that sees the largest impact. These are breast reconstruction, and these are complex hernia repair procedures that can be deferred for a period of time. So, as I mentioned in my prepared remarks, against 2019 surgical plastics and surgical reconstruction was still down compared to 2019 levels. So, I would say, within one reconstruction that was probably the area that was more COVID impacted within tissue. Anything else, Glenn, if you want to add?

Glenn Coleman, COO

No. I think that was well said.

Anthony Petrone, Analyst

Just a quick follow-up on SurgiMend, I know one of the nuances here was the company was not able to see the real-world evidence heading into the ADCOM Meeting. Just wondering if – I believe now the company has actually been able to see that real-world evidence. So maybe just a comment on those data and how you think it influenced the outcome of the panel and any early thoughts here on how the path forward in breast reconstruction may change. Thanks.

Glenn Coleman, COO

Thanks, Anthony. I’ll start, and then Pete feel free to add some comments. Let me just give you some context. So maybe start off. So, you have the right frame and framing out of the situation and then go through a little bit of the MROC data in the FDA panel discussion. Just for context purposes, the FDA has stated that all ADMs, including human ADMs require PMA, and that was actually reiterated last week at the American Society of Plastic Surgeons. So, I think that’s an important point. And today, as I mentioned earlier, there are currently no FDA-approved ADMs with a specific indication for breast, and we are the only company to file a PMA for a breast reconstruction indication. So, I want to make sure that that context as well understood. As it relates to the MROC data, the clinical data that’s part of our PMA is partially based off of MROC. And as I mentioned earlier, it’s best-in-class multi-site study that’s been done looking at the outcomes from thousands of breast reconstruction procedures. This is high quality real-world data. The FDA has stated to us that it can be used to support our PMA. I also indicated that the FDA has worked with us to design a statistical analysis that’s based upon this MROC data. The data demonstrates that the results from SurgiMend PRS surgery are superior to the results in such procedures where no acellular dermal matrix is being used. And as I mentioned earlier, we recognize that there are some limitations to the data, and we’re working with the FDA to design a post-approval study to supplement the existing safety and effectiveness data. So, there’s a lot of work going on. We’re still moving forward with it. The FDA panel itself is a milestone in the process. Obviously, the panel’s decision is important, but the FDA is not bound by the committee. Their recommendation is really advisory. And so, we’re going to continue to move forward with the work that’s going on here. The vote from this panel, obviously does not change any current practices that are going on among surgeons, and there is still an urgent clinical need for an FDA-approved acellular dermal matrix to help restore the quality of life for women following breast reconstruction. So, we’re confident that the existing clinical evidence supports approval, and obviously we remain focused on the mission to improve outcomes for breast cancer patients. Pete, I don’t know if you want to add anything else to it.

Peter Arduini, CEO

Just to emphasize three points. So, I think we have had access with the submission to the MROC data knowing what I said, and we know that there are certain limitations to it and have been open and interacting with the agency on it, so there’s no surprise here. And I think always expecting coming through a PMA of having some type of data follow-up was part of our plan. And so that doesn’t change. I just want to make that point. I think the other aspect here that is really important is the fact that we believe strongly that SurgiMend has unique characteristics no other product has, including a human-based category product. And that is two things. It’s unbelievable strength that it has, and as the procedure volume changes to new procedures with wider coverage, we believe it’s going to bear out to be the leading product. Secondly, our process for how we actually cellularize, its acceptance and its low rejection rate is second to none. And the third is its characteristic on revascularization, which again becomes very, very important if you want this to be actually an integrated part of the body. And so those are the three things that we keep as the beacon tied to what Glenn said, which is fighting for women to have the right to have a product and reconstruction post-mastectomy. And so, it’s a really important part of the plan and the journey’s long, but we think we’re on the right path here.

Anthony Petrone, Analyst

Thanks again. Good luck, Pete. Thank you.

Peter Arduini, CEO

Thanks.

Sam Brodovsky, Analyst

Hey, thanks for taking the questions. Just I wanted to touch on the supply chain issues that you talked about. And I know you’ve highlighted certainly on the freight side some cost issues. But at this point, are you seeing anything that’s leading to the company not being able to fulfill demand or any restraints there to that point yet?

Carrie Anderson, CFO

Yes, I’ll take that. And certainly, as we think about the third quarter impacts that we saw, I would characterize it as some freight expense increases that was probably the majority, some packaging, particularly in the corrugated side of packaging, and then other supply chain disruption. So, our ability to get product in and get it to where we need to be, yes, there have been some challenges. I would say not to a level in the third quarter where it interrupted our sales performance, but something that we want to continue to watch very closely. And we’re continuing to manage that very closely. But I would say, supply chain disruptions are factoring into our thought process, as we think about Q4 and even as we move into 2022. Glenn, anything you wanted to add on that?

Glenn Coleman, COO

Yes. I just want to recognize the incredible work that our global operations team and logistics teams have done as well as procurement. I mean, it’s a challenging environment, but we’ve pushed our way through it. And have had some disruption, but it’s been very manageable. And so, I want to recognize our colleagues that are in these areas because it’s certainly a challenging environment, but we’re managing through it.

Sam Brodovsky, Analyst

Got it. Thanks. That’s helpful. And then just quickly, on the capital market. You talked about getting back to more normalized levels next year. How should we think about the cadence there? Is it maybe first half is still below historical levels and then the second half was above that or is it going to be more of a uniform sort of steadily improving over 2019? Thanks.

Carrie Anderson, CFO

Yes. Sam, I would say that I would expect continued gradual improvement. In the fourth quarter, we are expecting sequential improvement in capital from third quarter to fourth quarter. Fourth quarter normally tends to be higher capital because it’s the end of the most fiscal year hospital budget. So hopefully, some of that capital – some of that cash will be let loose and into some capital purchases. So that’s figuring into our thoughts for the fourth quarter. But as we move into 2022, I think it’ll be a continued gradual recovery back to 2019 levels. So, I think you’re probably thinking about that correctly that it’s more normalization, but when that will happen, not for certain, but certainly, I would expect it to be more gradual.

Glenn Coleman, COO

Yes. And I would just add to that. A big part of our capital business is outside the U.S. I’m very encouraged by what I’m seeing in certain markets like Japan, even in the fourth quarter here in terms of what the capital funnel looks like. The customers are willing to move forward. So, I’m expecting in places like Japan, as an example, to see maybe even a faster recovery and hopefully some good news as we exit the year relative to our capital business. You may remember, this part of our business used to be sold through a distributor, and now we’re selling through our direct sales force. We have a dedicated channel, specifically selling capital, and we’re seeing some really good benefits as a result of that change we made about 12 to 15 months ago.

Carrie Anderson, CFO

Yes. And I would say that the smaller capital, small to mid-sized capital is seeing a faster recovery relative to the larger capital. And for us larger capital is a couple hundred thousand dollars. It’s our CUSA. So, that’s the one that’s probably slower to come back, even though we had a good – again, even if you excluded CereLink, which is our new ICP monitor, our capital did see low double-digit growth in the third quarter. So, some nice recovery even on the larger capital, but certainly smaller and mid-sized capital bouncing back even stronger. And as one mentioned, a really strong funnel that we have good visibility on. And so, our view is the capital competitive landscape has not changed. It’s more of just an extended selling cycle.

Peter Arduini, CEO

Next question operator.

Robbie Marcus, Analyst

Oh, great. Thanks for taking the question and congrats on a good quarter. And Pete, I’ll add – we’ll miss you and best of luck.

Peter Arduini, CEO

Thanks, Robbie.

Robbie Marcus, Analyst

Maybe to start off, I was hoping you could spend a minute on ACell. It looks like the guidance is moving down again would just love to hear sort of what’s going on there? Why the step down? And also, if you could touch on just quickly, what’s assumed for some of the one-time items in fourth quarter? Is there, any further CereLink purchases, and in bulk or restocking, or just, how do we think about what’s assumed in the guidance there?

Peter Arduini, CEO

Robbie, in terms of ACell, as I mentioned, we are seeing some positives here as we exit the third quarter, it’s just going to take us a little bit more time to make more progress on the ACell business, a big part of that is getting better account coverage that I mentioned earlier and getting better access as COVID hopefully dissipates a bit here as we get towards the end of the year. So, it’s going to take us a little bit more time, but we should see a sequential improvement in the ACell business in the fourth quarter. And we do expect that we’ll see much better results as we go into 2022. As it relates to kind of new one-time items in Q4. So, we’re still expecting to see more CereLink purchases in the fourth quarter, but not to the same extent as we saw in the third quarter, because of the initial orders that we received. So that would be one that I would call out. Carrie, you want to call out?

Carrie Anderson, CFO

Yes, I would say obviously instruments at 15.5% growth in the third quarter was a bit of a step up. So, I wouldn’t expect instruments to be as strong in the fourth quarter. But as I mentioned earlier sequentially capital should be stronger than the third quarter. But I don’t think there’s much lumpiness other than just continued gradual recovery. I think our fourth quarter guidance at the low end at $403 million basically reflects the back that we would expect continued gradual revenue from Q3 to Q4.

Anthony Petrone, Analyst

Thank you. And I want to congratulate you, Peter, as well on the role at GE. Good luck, and we hope to stay in touch going forward.

Peter Arduini, CEO

Thanks.

Larry Biegelsen, Analyst

Hey guys. Good morning. Thanks for taking the question. I had to ask a question just so I could wish Pete well in his new job. Just one question the Codman TSA or TMA expires I think at the end of Q4, you guys have said it’s material. Is there any chance maybe Pete is a parting gift? You'll give us a little bit of quantification of how beneficial that might be. Thanks for taking the question.

Peter Arduini, CEO

Larry. It's above my pay grade, but I'll let the team here comment just about how they're thinking about the TMA exits?

Glenn Coleman, COO

I would just say, Larry, at a point where I’m probably a year ahead of schedule from our initial plans, and the CMA transfer is all going to be complete here shortly. So, the quantification, we haven’t said specifically what it means, other than it’s one of the key drivers of our gross margin story over the next several years. So, plan optimization, plan transfers. This is one of them. We have another one in France as well that we’re working on. So, it’s all part of our gross margin improvement plans for the next couple of years.

Operator, Operator

That will conclude today's conference call. Ladies and gentlemen, thank you for connecting. You may now disconnect.