ITEM 2.02 RESULTS OF OPERATIONS AND FINANCIAL CONDITION
On January 10, 2017, the Company issued a press release announcing its preliminary financial results on revenues, organic revenues, earnings per share,
adjusted earnings per share, operating cash flows and free cash flows for the fourth quarter and year ended December 31, 2016 and preliminary financial guidance for 2017 (the Press Release). A copy of the Press Release is attached
as Exhibit 99.1 to this Current Report on Form 8-K and is incorporated by reference into this Item.
The Company will hold a conference call for analysts
and investors at 9:00 am ET on Wednesday, January 11, 2017, to discuss the preliminary financial results for 2016 and preliminary expectations for 2017 and to answer questions. Further information about the call appears in the Press Release.
The information contained in Item 2.02 of this Current Report on Form 8-K (including the Press Release and selected historical financial
information) is being furnished and shall not be deemed filed for the purposes of Section 18 of the Securities Exchange Act of 1934, as amended (the Exchange Act), or otherwise subject to the liabilities of that Section.
The information contained in Item 2.02 of this Current Report on Form 8-K (including the Press Release and selected historical financial information) shall not be incorporated by reference into any registration statement or other document
pursuant to the Securities Act of 1933, as amended, or the Exchange Act, except as shall be expressly set forth by specific reference in any such filing.
Discussion of Adjusted Financial Measures
In addition to our GAAP results, which we regularly report on a quarterly basis, we provide organic revenues, adjusted EBITDA, adjusted net income, adjusted
earnings per diluted share, adjusted diluted weighted average shares outstanding, free cash flow, and adjusted free cash flow conversion. Organic revenues consist of total revenues excluding the effects of currency exchange rates, acquired revenues,
and product discontinuances. The various measures of adjusted EBITDA consist of GAAP net income, excluding: (i) depreciation and amortization, (ii) other income (expense), (iii) interest income and expense, (iv) income taxes,
(v) and those operating expenses also excluded from adjusted net income. The measure of adjusted net income consists of GAAP net income, excluding: (i) global enterprise resource planning (ERP) implementation charges;
(ii) structural optimization charges; (iii) post-spin SeaSpine separation related charges (iv) certain employee severance charges; (v) acquisition-related charges; (vi) convertible debt non-cash interest;
(vii) intangible asset amortization expense; and (viii) income tax impact from adjustments and other items. The measure of adjusted diluted weighted average shares outstanding is calculated by adding the economic benefit of the convertible
note hedge transactions relating to Integras 2016 convertible notes. The adjusted earnings per diluted share measure is calculated by dividing adjusted net income attributable to diluted shares by adjusted diluted weighted average shares
outstanding. The measure of free cash flow consists of GAAP net cash provided by operating activities less purchases of property and equipment. The measure of adjusted free cash flow consists of free cash flow adjusted for certain one-time unusual
items. The adjusted free cash flow conversion measure is calculated by dividing free cash flow by adjusted net income.
The Company believes that the
presentation of organic revenues and the various adjusted EBITDA, adjusted net income, adjusted earnings per diluted share, adjusted diluted weighted average shares outstanding, free cash flow and adjusted free cash flow conversion measures provides
important supplemental information to management and investors regarding financial and business trends relating to the Companys financial condition and results of operations. Management uses non-GAAP financial measures in the form of organic
revenues, adjusted EBITDA, adjusted net income, adjusted earnings per diluted share, adjusted diluted weighted average shares outstanding, free cash flow and adjusted free cash flow conversion when evaluating operating performance because we believe
that the inclusion or exclusion of the items described below, for which the amounts and/or timing may vary significantly depending upon the Companys acquisition, integration, and restructuring activities, for which the amounts are non-cash in
nature, or for which the amounts are not expected to recur at the same magnitude, provides a supplemental measure of our operating results that facilitates comparability of our financial condition and operating performance from period to period,
against our business model objectives, and against other companies in our industry. We have chosen to provide this information to investors so they can analyze our operating results in the same way that management does and use this information in
their assessment of our core business and the valuation of our Company.
Organic revenues, adjusted EBITDA, adjusted net income, adjusted earnings per
diluted share, adjusted diluted weighted average shares outstanding, free cash flow and adjusted free cash flow conversion are significant measures used by management for purposes of:
|
|
|
supplementing the financial results and forecasts reported to the Companys board of directors;
|
|
|
|
evaluating, managing and benchmarking the operating performance of the Company;
|
|
|
|
establishing internal operating budgets;
|
|
|
|
determining compensation under bonus or other incentive programs;
|
|
|
|
enhancing comparability from period to period;
|
|
|
|
comparing performance with internal forecasts and targeted business models; and
|
|
|
|
evaluating and valuing potential acquisition candidates.
|
The measure of organic revenues that we report
reflects the increase in total revenues for the quarter ended December 31, 2016 adjusted for the effects of currency exchange rates, acquired revenues, and product discontinuations on current period revenues. We provide this measure because
changes in foreign currency exchange rates can distort our revenue reduction favorably or unfavorably, depending upon the strength of the U.S. dollar in relation to the various foreign currencies in which we generate revenues. We generate
significant revenues outside the United States in multiple foreign currencies including euros, British pounds, Swiss francs and Australian and Canadian dollars. We believe this measure provides useful information to determine the success of our
international selling organizations in increasing sales of products in their local currencies without regard to fluctuations in currency exchanges rates, for which we do not control. Additionally, significant acquisitions and discontinued product
lines can distort our current period revenues when compared to prior periods.
The measure of adjusted net income reflects GAAP net income adjusted for one or more of the following items, as
applicable:
|
|
|
Global ERP implementation charges
. Global ERP implementation charges consist of the non-capitalizable portion of internal labor and outside consulting costs related to the implementation of a global ERP system.
We have inherited many diverse business processes and different information systems through our numerous acquisitions. Accordingly, we are undertaking this initiative in order to standardize business processes globally and to better integrate all of
our existing and acquired operations using one information system. Although recurring in nature given the expected timeframe to complete the implementation for our existing operations and our expectation to continue to acquire new businesses and
operations, management excludes these charges when evaluating the operating performance of the Company because the frequency and amount of such charges vary significantly based on the timing and magnitude of the Companys implementation
activities.
|
|
|
|
Structural optimization charges
. These charges, which include employee severance and other costs associated with exit or disposal of facilities, costs related to acquisition integration, costs related to
transferring manufacturing and/or distribution activities to different locations, and rationalization or enhancement of our organization, existing manufacturing, distribution, administrative, functional and commercial infrastructure. Some of these
cost-saving and efficiency-driven activities are identified as opportunities in connection with acquisitions that provide the Company with additional capacity or economies of scale. Although recurring in nature given managements ongoing review
of the efficiency of our organization and structure, including manufacturing, distribution and administrative facilities and operations, management excludes these items when evaluating the operating performance of the Company because the frequency
and amount of such charges vary significantly based on the timing and magnitude of the Companys rationalization activities and are, in some cases, dependent upon opportunities identified in acquisitions, which also vary in frequency and
magnitude.
|
|
|
|
Certain employee severance charges
. Certain employee severance and related charges consist of charges related to senior management level terminations and certain significant reductions in force that are not
initiated in connection with restructuring. Management excludes these items when evaluating the Companys operating performance because these amounts do not affect our core operations and because of the infrequent and/or large scale nature of
these activities.
|
|
|
|
Acquisition-related charges
. Acquisition-related charges include (i) up-front fees and milestone payments that are expensed as incurred in connection with acquiring licenses or rights to technology for which
no product has been approved for sale by regulatory authorities and such approval is not reasonably assured at the time such up-front fees or milestone payments are made, (ii) inventory fair value purchase accounting adjustments,
(iii) changes in the fair value of contingent consideration after the acquisition date, and (iv) legal, accounting and other outside consultants expenses directly related to acquisitions or divestitures. Inventory fair value purchase
accounting adjustments consist of the increase to cost of goods sold that occur as a result of expensing the step up in the fair value of inventory that we purchased in connection with acquisitions as that inventory is sold during the
financial period. Although recurring given the ongoing character of our development and acquisition programs, these acquisition, divestiture and in-licensing related charges are not factored into the evaluation of our performance by management after
completion of development programs or acquisitions because they are of a temporary nature, they are not related to our core operating performance and the frequency and amount of such charges vary significantly based on the timing and magnitude of
our development, acquisition and divestiture transactions as well as the level of inventory on hand at the time of acquisition.
|
|
|
|
Post-spin SeaSpine separation related charges
. These charges include legal expenses and adjustments to stock based compensation incurred as part of the spin-off.
|
|
|
|
Intangible asset amortization expense
. Management excludes this item when evaluating the Companys operating performance because it is a non-cash expense.
|
|
|
|
Convertible debt non-cash interest
. The convertible debt accounting requires separate accounting for the liability and equity components of the Companys convertible debt instruments, which may be settled in
cash upon conversion, in a manner that reflects an applicable non-convertible debt borrowing rate at the time that we issued such convertible debt instruments. Management excludes this item when evaluating the Companys operating performance
because of the non-cash nature of the expense.
|
|
|
|
Income tax impact from adjustments and other items
. Estimated impact on income tax expense related to the following:
|
|
(i)
|
Adjustments to income tax expense for the amount of additional tax expense that the Company estimates that it would record if it used non-GAAP results instead of GAAP results in the calculation of its tax provision,
based on the statutory rate applicable to jurisdictions in which the above non-GAAP adjustments relate.
|
|
(ii)
|
When we calculate the adjusted tax rate, we include a full year estimate for all discrete items. We then apply that full year rate to the year-to-date results and calculate the current quarters rate to arrive at
the year-to-date adjusted tax rate. We believe this removes significant variability in our results and creates a more operationally consistent result for our investors to use for comparability purposes. Specifically, the adoption of the FASB Update
No. 2016-09 accounting standard has the effect of generating a significant tax expense benefit in each of the four quarters of 2016. For the adjusted tax rate, we are treating this as a rate item, which is consistent with how other discrete tax
expense items are handled in our current adjusted tax expense measure.
|
Weighted average shares used to calculate GAAP diluted EPS includes
the convertible notes and warrant transactions because they are dilutive. The measure of adjusted diluted weighted average shares outstanding used to calculate adjusted diluted EPS includes the effect of the convertible notes hedge transactions,
which is anti-dilutive. Integra believes the non-GAAP measure is useful for understanding the economic benefit of the convertible notes hedge transactions.
Organic revenues, adjusted EBITDA, adjusted net income, adjusted earnings per diluted share, adjusted diluted weighted average shares outstanding, free cash
flow and adjusted free cash flow conversion are not calculated in accordance with GAAP, and should be considered supplemental to, and not as a substitute for, or superior to, financial measures calculated in accordance with GAAP. Non-GAAP financial
measures have limitations in that they do not reflect all of the revenues, costs or benefits associated with the operations of the Companys business as determined in accordance with GAAP. As a result, you should not consider these measures in
isolation or as a substitute for analysis of the Companys results as reported under GAAP. The Company expects to continue to acquire businesses and product lines and to incur expenses of a nature similar to many of the non-GAAP adjustments
described above, and exclusion of these items from its adjusted financial measures should not be construed as an inference that all of these revenue adjustments or costs are unusual, infrequent or non-recurring. Some of the limitations in relying on
the adjusted financial measures are:
|
|
|
The Company periodically acquires other companies or businesses, and we expect to continue to incur acquisition-related expenses and charges in the future. These costs can directly impact the amount of the
Companys available funds or could include costs for aborted deals which may be significant and reduce GAAP net income.
|
|
|
|
The Company has initiated a long term effort to implement a global ERP system, and we expect to continue to incur significant systems implementation charges until that effort is completed. These costs can directly
impact the amount of the Companys available funds and reduce GAAP net income.
|
|
|
|
All of the adjustments to GAAP net income have been tax affected at the Companys actual tax rates. Depending on the nature of the adjustments and the tax treatment of the underlying items, the effective tax rate
related to adjusted net income could differ significantly from the effective tax rate related to GAAP net income.
|