Integra Lifesciences Holdings Corp (IART) 2020 Q4 法說會逐字稿

Good day, and welcome to the Integra LifeSciences Fourth Quarter and Full Year 2020 Financial Results Call. Today's conference is being recorded. (Operator Instructions). like to turn the conference over to Mike Beaulieu, Director of Investor Relations. Please go ahead, Sir.

Thank you, Catherine. Good morning, and thank you for joining the Integra LifeSciences Fourth Quarter and Full Year 2020 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 fourth quarter and full year 2020 financial results. The release and corresponding earnings presentation, which we'll reference during the call, are available@integralife.com under investors, events and presentations in the file named Fourth Quarter and Full Year 2020 earnings call presentation.

Before we begin, I'd 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 reports filed with the SEC and in the release. 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.

Thank you, Mike, and good morning, everyone. If you'll turn to Slide 4, I'll begin with a review of our performance in 2020.

Full year 2020 revenue declined 8.7% on an organic basis to $1.37 billion, and adjusted earnings declined 11% to $2.45. And These declines were a direct result of COVID-related surgical procedure deferrals and capital spending delays at hospitals. To put our 2020 performance in perspective and illustrate the impact of the pandemic, we've included a side-by-side comparison of revenue and profitability in the first and second half of the year.

The biggest impact on COVID was felt during April and May. And as a result, first half organic revenues were down 16%, and earnings were down 40% compared to the first half of 2019. As we've discussed on prior calls, we reacted swiftly to the pandemic, prioritizing the safety of our employees while implementing protocols to ensure continuity of our supply chain and key R&D and clinical programs. We also protected our financial position by managing cost down sharply.

As the recovery began to take hold, we saw the benefit of our balanced pandemic response. In the second half, we continue to methodically manage expenses while allocating additional funds towards growth and productivity related projects. We generated $150 million in operating cash flow, invested in inventory and improved our leverage ratio from 3.4x in June to 3x at the end of the year. We reshaped our portfolio with the divestiture of Orthopedics and the acquisition of ACell.

Our second half revenues increased $146 million compared to the first half, and organic revenues declined only 1.5% year-over-year. In the second half, EBITDA sequentially increased $77 million, and earnings per share increased 20% year-over-year. Our sales recovery persisted despite localized COVID surges and lockdowns in the fourth quarter. Driven by market-leading products such as Integra Skin, DuraGen as well as our CERTAS portfolio of program valves, all of which returned to growth in the fourth quarter.

If you turn to Slide 5. You can see that we use 2020 as an opportunity to reinvent the company. In addition to the strong financial recovery in the second half of the year, we took actions that positioned us to accelerate growth in 2021 and beyond. So throughout the pandemic, our focus has always been on our employees and patients. Making sure we could supply critical products while keeping our employees safe.

We have a one-team mindset coming together to do the right things to shore up the business. As a management team when the pandemic first hit, we acted quickly to prioritize the most important asset, our people. At the same time, we challenged our employees to reimagine how they would do their jobs in a virtual environment. We provided tools and resources, and they rose to the occasion, our people made our strong recovery possible.

Moving to global operations. We completed investments, solidifying our tissue supply and also adapted to numerous logistical challenges posed by the pandemic. We quickly implemented rigorous and consistent protocols across our sites to ensure both the safety of the employees and continuity of product supply. In 2020, we closed 5-sites as part of our optimization program. That will help us reach our long-term profitability targets.

COVID challenged, but it did not impede the progress within our R&D organization. On previous earnings calls, we've discussed how we maintain investments in critical growth programs, such as the Aurora surgiscope, keeping them on track with their original development time lines in spite of the pandemic.

Moving to the sales force capabilities. Our commercial organization rapidly adopted a variety of virtual collaboration and digital marketing mechanisms to stay connected with our customers and to ensure adequate support for patients.

Turning to portfolio optimization. As I mentioned, our 2 most transformative actions were the divestiture of our Orthopedics business and the acquisition of ACell. The combination of the 2 of these creates a highly focused tissue technology segment. That will be accretive to growth and profitability and will advance our leadership positions across the portfolio. We achieved all of these accomplishments while strengthening our balance sheet and increasing our financial agility.

And finally, during 2020, we benefited greatly from prior investments in our information systems infrastructure and accelerate our digital transformation within many parts of the company. So as you can see, we did not sit still during the pandemic. We utilized the time to position the company for success in '21 and beyond. And I'm proud of the way our colleagues responded, we are a stronger, more focused company today than when we entered 2020.

Now I'd like to turn the call over to Carrie for a more detailed preview of our fourth quarter performance and guidance for 2021. Carrie?

Thanks, Pete, and good morning, everyone. I'd like to start with a brief summary of our fourth quarter highlights on Slide 6. Fourth quarter total revenues were $388.6 million, representing a decline of 1.6% on a reported basis and a decline of 1.5% on an organic basis. Our revenue performance was at the high end of our preliminary range communicated on January 14.

During the quarter, COVID surges occurred in many of our markets, resulting in tight ICU Bed capacity, but we still managed a 5% improvement in our fourth quarter sales compared to the third quarter. Most of our franchises are products that return to growth in the third quarter, sustain that growth into Q4. Sales of capital equipment improved sequentially by over 40%, but was still down on a year-over-year basis.

As we have discussed on prior earnings calls, recovery of capital was expected to lag the rest of the portfolio. So if we exclude capital, total organic growth was flat in Q4 compared to the prior year. Fourth quarter performance in the U.S. was also flat on an organic basis compared to 2019. My segment U.S. CSS organic growth increased about 2% if we exclude capital and U.S. OTT organic growth was about flat, excluding orthopedics. We were also quite pleased with our profitability performance in Q4, showing improvement year-over-year as we continue to manage our spending.

Adjusted EBITDA margin in Q4 increased by 320 basis points to 26.4%, and adjusted earnings per share increased 24% to $0.84.

If you turn to Slide 7, I'll now review the fourth quarter performance of our CSS segment. Reported Q4 revenues were $254 million a decrease of 1.6% on an organic basis from the prior year. Global neurosurgery sales improved sequentially from the third quarter and were down 1.3% on an organic basis year-over-year.

Sales in dural access and repair and CSF Management increased low single digits and mid-single digits, respectively. Sales in neuromonitoring increased low double digits in Q4. All 3 franchises benefited from strong sales of market-leading products, including DuraGen, antimicrobial catheters and CERTAS programmable valve.

Sales in Advanced Energy, which includes our CUSA capital sales were down mid-teens in the fourth quarter, in line with expectations. Importantly, sales of consumables directly tied to our CUSA equipment increased low single digits in Q4, a sequential improvement from the third quarter. Our sales funnel of capital opportunities is strong, and we remain confident in our competitive positioning. However, we do expect capital budgets will continue to be constrained through the first half of 2021 until hospitals have more certainty around COVID.

Q4 sales in our Instruments franchise increased sequentially high single digits from Q3, but still saw a slight 2% decline on an organic basis year-over-year. International sales in CSS were down low single digits in the quarter with mixed performance. In Q4, we saw a return to growth in several European countries. Revenues in both China and Japan increased low double digits. However, this was offset by a slower recovery in our indirect market.

Moving to the OTT segment on Slide 8. Revenues were $134 million, representing a decline of 1% on a reported basis and a decline of 1.3% on an organic basis. Q4 sales in wound reconstruction declined 1.5% versus the prior year. The sales of SurgiMend, Nerve and Amniotic all increased double digits, and sales of Integra Skin increased low single digits.

Fourth quarter sales in private label increased 2%, in line with expectations. Orthopedic sales declined mid-single digits in the fourth quarter. And as a reminder, we closed the divestiture of the ortho business on January 4 this year.

Turning to Slide 9. I will now show you our fourth quarter performance of the key P&L components. Adjusted gross margins was 68.2% compared to 67.2% in the fourth quarter of 2019. Gross margins benefited from cost management, stronger performance in the U.S. and favorable product mix. Our adjusted EBITDA margin was 26.4% compared to 23.2% in Q4 of 2019, driven by improved gross margins and ongoing cost management measures.

Operating expenses were approximately $12 million below prior year levels. Fourth quarter GAAP EPS was $1.09 compared to $0.18 in the prior year. The increase was largely driven by a $59 million onetime benefit driven by tax restructuring completed during the quarter. Adjusted EPS was $0.84 in the fourth quarter compared to $0.68 in the prior year, reflecting an increase of over 23%. Diluted shares outstanding were down slightly in the fourth quarter, as a result of the accelerated share repurchase program completed earlier this year.

Turning to Slide 10. I'll now review cash flow performance. Operating cash flow was approximately $80 million in the fourth quarter and just over $200 million for the full year. Free cash flow conversion for the full year reached almost 80% driven by strong second half EBITDA performance, improved receivable collection efforts and prioritization of capital expenditures.

And if you turn to Slide 11, I'll provide a brief update on our capital structure. We ended the year with a strong balance sheet. Our cash balance was $470 million, with an improvement of $140 million in our net debt position from 2019 pro forma levels inclusive of the convertible note. This translated into a leverage ratio of 3.0x, basically flat with 2019 on a pro forma basis.

Our targeted leverage ratio range of 2.5 to 3.5x, so we were right in the middle of this window. Recall that in the second quarter of 2020, we reached our peak ratio for the year at 3.4x. So our second half cash flow moved us squarely within the range by year-end.

Turning to Slide 12, I'll provide you overview of our consolidated revenue and adjusted earnings per share guidance for the first quarter and full year 2021. We are providing guidance today, but recognize that the course of the pandemic remains uncertain. And as a result, the rate of recovery in surgical procedures and capital equipment sales remains variable.

In our full year guidance, we assume a gradual improvement in procedures in the first half with no further setbacks from new surges or new COVID variants. And as mentioned earlier, we believe capital budgets will continue to be constrained through the first half of 2021. We will continue to assess the current environment and provide updates on our quarterly calls.

First quarter revenues are forecasted to be in the range of $345 million to $355 million, representing our normal seasonality in Q1. This represents reported growth of approximately minus 3% to flat and organic growth of flat to up 3% over 2020. For the full year 2021, we expect revenues to be in the range of $1.520 billion to $1.535 billion, representing reported growth of 11% to 12% and organic growth of 12% to 13% over 2020.

Reported revenues including first quarter estimate for ACell in the range of $14 million to $15 million and a full year estimate in the range of $83 million to $88 million. This estimate is based on 2020 ACell revenues of $95 million and a late January closing. We also look from the continuing COVID impact for ACell similar to our existing tissue business as well as focal short-term sales disruptions as we integrate the business.

As a reminder, 2021 organic growth excludes the impact of foreign currency fluctuations. Acquired revenues, including ACell, divested revenues, including orthopedic and discontinued product. In consistent with previous practice we will include a reconciliation between reported and organic growth. The impact of discontinued products is expected to continue to decline and will have a negative impact of approximately 1.3% on full year 2021 reported revenues.

As a reminder, 2021 should be the last year of any significant impact for product discontinuation. SKU rationalization has been an important part of how we are simplifying the portfolio and improving overall gross margin. Turning to the earnings guidance for 2021. And based on the revenue ranges I just provided, we expect first quarter adjusted EPS to be in the range of $0.54 to $0.58, which represents double-digit year-over-year growth. Full year 2021 adjusted EPS is expected to be in the range of $2.86 to $2.93.

With that, I'd like to turn the call over to Glenn.

Thanks, Carrie, and good morning. If you turn to Slide 13, I'll provide an update on the ACell integration. Immediately following the January 20 closing, we began the implementation of our integration plans and onboarded conveying ACell colleagues. The first 3-weeks of the integration have are even focused on the tradition of the commercial organization. We've already taken steps to assign sales reps to their territories, formalize quotas and establishing overall compensation plans. Integrated sales reps also completed initial product training and are beginning to cross-sell our expanded portfolio.

Last week, the Tissue Technologies team held their annual national sales training meeting with in-depth product training. While it's still early, the addition of the ACell portfolio and the expansion of our Tissue Technology platform is generating positive customer feedback. The unique characteristics of core signed products, like the MicroMatrix powder and the Gentrix Surgical Matrix, help fill gaps in our portfolio and offer clinicians additional tools to treat the most challenging reconstructive interventions.

It's only been a few weeks since we closed ACell but we remain confident in the positive financial impact and returns on investments that will come from this acquisition. We expect this to be a quick integration with all critical activities completed by the end of the second quarter, including our ERP conversion to handle invoicing and distribution. We are excited to welcome new ACell colleagues to Integra and look forward to providing an integration update on our next quarterly call.

Turning to Slide 14. I'd like to provide a summary of our 2021 growth drivers, starting with new product introductions. Over the past 2 years, we launched about 7-new products in CSS, which are expected to take several years to reach peak sales. Performance of all these products was negatively impacted by COVID during 2020. And as the recovery takes hold, many of these launches, like our CERTAS portfolio of programmable valves, and DuraGen in Japan should contribute to growth for CSS in 2021.

In addition, during the second half of 2021, we're planning the global relaunch of CereLink, our next-generation ICP monitor, which should immediately benefit our neuromonitoring franchise. Later in the year, we'll be launching our new Aurora surgiscope for minimally invasive treatment of brain tumors, an important part of our long-term growth plans.

In our Tissue Technology segment we completed investments that were necessary to increase our product supply and expand capacity at several of our regenerative plants in 2020. These investments will enable us to not only support our existing customers, but actively pursue new business.

Turning to our International markets. Japan, our largest country by revenue outside the U.S., has achieved 6 consecutive quarters of double-digit revenue growth despite the impact of COVID. This growth has been driven by our leading neurosurgery portfolio. And as an example, DuraGen is rapidly becoming the standard of care in dural grafting procedures. In 2020, during the height of the first wave of COVID, we also successfully launched a new surgical sales team and took our CUSA business direct in the general surgery market, where we have a leadership position in liver surgery.

With this transition, we've now converted nearly all of our business in Japan from a distributed model to a direct selling model. During 2021, we'll be launching a number of new products, including programmable valves that are specific to the Japan market, a generator irrigator and reusable bipolar forceps. We're also adding hydro specialists and leveraging clinical studies through BactiSeal. Taken together, these channel investments, new product introductions and our broad portfolio of leading products, will drive further penetration into the neurosurgery market in Japan in 2021.

Turning to China. After the initial COVID lockdown in February and March, neurosurgery procedures have steadily recovered. During 2020, we invested in professional education and market access for key products, which helped drive low double-digit organic growth in the fourth quarter, giving us momentum as we begin in 2021. We're expanding our commercial presence in China and recently entered into our first exclusive licensing and distribution deal with a local Chinese partner, which will result in the launch of new complementary products later this year.

This partnership represents a great example of how we can fill a gap in our product portfolio while leveraging our large commercial channel. On a global basis, we accelerate investments in digital capabilities that will enable our commercial teams to reach a broader customer base. We've added specialists in neuromonitoring, hydrocephalus and certain regenerative areas. In 2020, we created an inside sales team within our OTT segment, which is a virtual selling organization focused on driving further growth.

And finally, with ACell, we're bringing together 2 sales and R&D organizations with deep knowledge and broad experience in regenerative medicine. The ACell portfolio is a strong fit with our existing commercial infrastructure and call points.

If you turn to Slide 15, I'd like to make some closing remarks. Despite the challenges of 2020 that Pete outlined at the beginning of the call, we took advantage of the current environment to strengthen the company's position and advance towards our long-term goals. COVID forced us to reimagine how we do our jobs. And as a result, we optimized many of the functions and operations within the company.

We also accelerated investments in critical programs to drive future growth. And with the divestiture of Orthopedics and the addition of ACell, we have a more focused product portfolio. One of our key objectives last year was to emerge from the pandemic as a stronger company and following our fourth quarter and full year results, we believe we have succeeded.

We remain confident in our long-term goals of 5% to 7% organic growth, greater than 70% gross margins, 28% to 30% EBITDA margins and double-digit adjusted earnings per share growth. Before opening the line to Q&A, I'd like to close by announcing an exciting event we have planed. So please turn to Slide 16.

We'll be hosting a virtual Investor Day on May 20. The half day event will feature a thorough review of our strategies for both the Codman Specialty Surgical and Tissue Technologies segments, and our path to generating 5% to 7% organic growth. We'll provide more information as we get closer to the date, and we hope you'll be able to join us.

That concludes our prepared remarks. We look forward to providing you with another update on our first quarter earnings call in April. Thank you for listening. Operator, would you please open the line for questions?

(Operator Instructions). We'll now take the first question from Matt Miksic from Crédit Suisse.

One on just a bigger picture question on regen med business that's come together in a bigger business for you now and the other on some of the trends you talked about in your initial guidance and outlook.

So from a bigger picture perspective, can you talk a little bit about the sort of how you see regen platform that you have now with ACell. What you see as some of the competitive advantages or opportunities there and maybe some of the synergies that you're -- that you may be able to enjoy. It's just putting more things, running more things across that bigger platform? And then I have one follow-up, as I mentioned.

Yes, Matt, I'll comment and then, Glenn, if you want to jump in after. I would say, I mean, the first piece is, as you know, regenerative medicine is not a precise science, right? It's a little bit of art, and it's a lot of science. And having multiple tools for different technologies in that toolkit, we believe, is a big deal, primarily because our clinicians tell it so. So a wound that's caused from a pressure ulcer or caused from a vascular related issue or one that's caused by surgical intervention or one that's caused by trauma all of those may have very different approaches.

And so today, most of these reconstructive surgeons, plastics as well, use different platforms already from different companies. But there really hasn't been a company that's had all of these together. And I think today, at this point in time, we have the most comprehensive portfolio. We may not have the largest share position at all of them. But I think that's the opportunity that exists.

And particularly in the United States with a consolidating health care system, ASC's and such offices, more people becoming part of bigger systems. We believe that contracting with world-class technologies will differentiate. And so we have this large matrices structure. I think then as we go further upstream, we're well positioned to add on to this portfolio with other products that play in potentially into the epidermis, other accelerants to help actually healing.

And so we've got ACell, particularly because of its fit within the acute space, but also a growing area outside that was a great fit. Particularly for the granulated product that we had no version thereof. And I think that, combined with what we think will be able to evolve in the portfolio with porcine is also there. Our new Head of R&D previously was at ACell years back and has very good insight into that technology, actually did some of the original work, from the University of Pittsburgh.

So we've got some very good retained knowledge as well and investment capabilities to not just have the current products, but to evolve those into a new portfolio. Glenn, you may want to talk a little bit more even about trends and stuff that we see.

Yes. I would just say that, first and foremost, when we think about our regenerative platform, it's broader than wound care, right? So it's hitting other parts of the body as well. And one nice thing about the ACell addition is it did add additional capability in wound care, but also in our plastic and reconstructive business with the Gentrix product. So we are thinking broader in terms of regenerative medicines outside of wound care. And I think as we look forward, we'll be doing more in other adjacent areas of the body.

Trending wise, obviously, our business has been impacted by COVID, and we'll probably see the additional impact here in the first quarter, maybe first half of the year. But we feel quite good about a few things. Number one, you remember last year, we struggled with supply before COVID hit. I think we're in really good shape relative to our plants. And we've now built adequate safety stock to support our existing customers. As I mentioned in the prepared remarks, going after new accounts. And so I think we're in a good position to capitalize a lot around that.

And listen, I think once we bring this business together with ACell, we are expecting to see synergies. We'll talk more about what that looks like as we get further into the year. But on the commercial front, all the heavy lifting has been done. And I think that's really good news that we've got that behind us. We're moving forward. The teams have been trained on the combined product portfolio, and we're really excited about this broader bag and toolkit that we now have to provide to our customers and ultimately to patients.

Great. And the follow-up is a great segue to the follow-up question I had on ACell, it's just the guide that you've given includes obviously a partied Q1, and it sounded like some expectation as we'd expect for some sales disruption during integration, if I heard Carrie's comments correctly.

Just -- I hate to say exiting this year because nobody wants to talk about '22 outlook at the moment. But just with an underlying business, net of those kinds of effects as we get into the back half of the year and into the following year. How should we think about underlying growth for that ACell business as we pull that into the portfolio?

Carrie, do you want to -- since you commented on the preprepared remarks, you want to frame it up a little bit?

Yes. I think in terms of growth expectations for ACell, I think we would expect it to be growing at the same level that we really expect. The rest of our tissue business be going up. So I think the high single digits, definitely is the expectation that we should all have. As we get more confident with our 5% to 7% with ortho out and ACell coming into Tissue Technologies as well as what Glenn mentioned on the supply. I think that entire segment has the ability to get back to high single digits, low double digits, for sure. And so that's what would be my same expectation for ACell.

(Operator Instructions). We'll now take the next question from Dave Turkaly from JMP Securities.

I was beginning to forget what guidance was like, and we got a quarter here and the full year. So thank you for that. Maybe one for Pete, just on the heels of that. I mean obviously, things are changing with the fluid world, but you mentioned some of your confidence. I'd love to get your thoughts on what's happening out there, whether you want to talk domestically or internationally as well with the virus and sort of your confidence level maybe compared to what it was in 2019 looking forward?

Yes. Let me start off, Glenn, maybe you can frame it up globally. I think you've got a really good handle on it, and I'll add some other comments on how we see COVID right now.

Yes. I mean, I would say, first and foremost, our fourth quarter is going to be impacted by COVID. You saw that in January and early February. If we look at some of the hot spots right now, I'd say, Central Southern California is probably the biggest area of impact at the moment. Texas has been an impact, Arizona. Those are some of the states in the U.S.

Outside the U.S., the biggest impact has really been to the U.K. there was a significant decline in procedures in the month of January that were actually down and even greater than the levels in terms of procedure deferrals versus April and May of last year. So U.K. got hit pretty hard. For us it's not a big market, but one that has been impacted.

And I think for the most part, the rest of Europe, well, there's been some spots of impact, nothing of concern from our perspective. We are seeing an impact, too, in Asia Pacific. Japan is going through a third wave of the virus. But as you heard me in my prepared remarks, we have so many good things going on there. We're generating consistent double-digit growth in the face of even some headwinds from the pandemic.

But I would just say that the biggest watch out for us is really the U.K. and then a lot of our indirect markets. That's being impacted the most right now. And that would include markets like Spain, Portugal, Russia and South Africa. And those are the areas that we're keeping a watch out and where we've seen probably the greatest impact outside the U.S.

And Dave, I would say, Carrie mentioned this in our kind of caveats to the guidance. Look, we're optimistic that, obviously, the vaccines are having a very positive effect. We believe something like the J&J and additions of other vaccines are going to have a big effect as well. But customers are clearly a little skittish in holding back some reserves relative to these added South African and U.K. variants and others that may arise. And so that's why we think this is not going to be a big step-up. We think it's going to be linear in the first half.

As I've reminded others before, I mean, we don't need to be a herd immunity in our business to start seeing a pickup we just need to have the ICUs not heavily burdened, and that's either a combination of people holding reserve bed back or then fully opening up. And we are seeing those beds to begin opening up and that has a direct correlation with neurosurgery. And in many cases, some of our more invasive procedures on the tissue technology side.

But we're cautiously optimistic. We don't see a significant amount of business pent up. I think the only caveat with that would be carrying probably in our capital business, which is -- CUSA is still under 6% of the business. You can add on probably a few points or so of our Instruments business. But again, when capital budgets free up, I think that's still kind of a question that's beyond just COVID, it's also what's the cash flow looking like for the different institutions.

Great. Maybe just a quick follow-up for Carrie. Obviously, great performance on the growth and even gross margin EBITDA side, the 320 bps improvement. I'm just curious how sustainable some of those increases are? I know your long-term targets are still higher, but that's an impressive bump in a tough time. So I know some of the spending might come back, but just your thoughts on that level, given the environment we're in today and what we should sort of expect moving ahead would be great.

Yes. I would say that as you think about 2021, certainly, our operating expenses are going to trend up. They were obviously very low in 2020 as we responded to COVID. And as I mentioned in my prepared remarks, our fourth quarter operating expenses were still about $12 million lower than we were last year. So I do expect to -- for OpEx to move up in 2021. Just as we get back to more run rate levels.

So -- but I would say that net-net, if you use the fourth quarter 2019 as a good run rate level. So fourth quarter 2019 still had -- obviously had ortho in it but it had Arkis and Rebound in it as well. And you annualize that fourth quarter OpEx spend is essentially about $735 million of annual OpEx spend. I think we'll beat that. I don't think you'll see that level of spend in the business in 2021. I think we're obviously applying more smart spend and prioritizing as we bring spending back.

So I would say that we'll be lower than that. I also think that we'll see some gross margin improvement between 2020 and 2021. I think some of the levers that you saw benefiting us in 2021, even though revenue was down 10%. It Is still going to produce some high gross margin benefits as we move into 2021. And those are things like tissue supply, with ACell in there now and supply addressed, and as tissue comes back into a growth mode, that will help our gross margins.

The continued leaning out of discontinued products will continue to help our gross margin. And don't forget about this is the year that at the end of the year, we'll move off the TMA agreement with J&J. So I would expect some gross margin improvement year-over-year as well as some modest EBITDA improvement with OpEx still coming back a little bit higher, but with the gross margin line kind of helping to offset that.

We'll now take the next question from Kaila Krum with Truist Securities.

So 2021 guidance basically assumes revenue will be flat with 2019 levels, just on a dollar basis. And obviously, you guys are swapping out the ortho extremity business for ACell, but they're about equal sized businesses. So I guess, can you just help us understand what your assumptions are for the rest of the business this year?

And it seems like you guys are considering that COVID will continue to impact things in the first half. So just any more additional detail you could provide would be helpful.

Carrie, why don't you?

Sure. I'll take that one. I would say that as you think about comparison to 2019, you're right, it's about flat to 2019. The organic growth is about 3% to 4% compared to 2019 when you remove the impact of other divestiture and add in ACell and remove that. It's about an organic growth of 3% to 4%. And if you go back to the remarks that I said when I described our expectations for the year, we talked about a gradual first half recovery, which implies that the second half is going to be stronger than the first half.

So we'll be able to give you a bit more color on first half versus second half and get -- when we get through April, our Q1 earnings call because we'll be getting some guidance around Q2 at that time. But, Kaila, I would expect that you should be thinking about a second half stronger than first half in line with the comments of a first half gradual recovery and COVID impact assuming to be largely behind us in the second half.

And then in terms of just any segment color, I would expect that the segment would largely be -- will perform around the same on an organic basis. So not a lot of difference in the segment performance at the midpoint on an organic basis.

Great. Okay. That makes a lot of sense. And then just in terms of new product launches coming this year with CereLink and Aurora? I mean how meaningful can those new products be? And how are you thinking about those contributing in the second half?

Glenn, do you want to take a shot at them?

Sure. So clearly, the biggest impact from a new product launch point of view as it relates to 2021 is going to be CereLink. It's a global launch. That will be the most meaningful contributor to NPIs in 2021. And Aurora is really going to be a controlled market release for tumor, probably around the third quarter and then some other areas that we'll be launching in the fourth quarter. But won't contribute a lot to revenues in 2021. That's more of a 2022 and 2023 revenue growth driver for us.

Having said that, I think it's important to reflect on the new products we've launched the last few years. So you think about the CERTAS programmable valve, enhancements, new sizes, the toolkit we rolled out, additional tips we've put on CUSA, our Surgical Headlamp Duo. There's a lot of new products that were launched before COVID and we never saw the ramp and the demand for that. And I think you're going to see a bigger contribution coming from those products in 2021. So while it's not a new product we're launching in 2021, it's definitely going to be a contributor to growth.

And then a new product we are actually launching this year is a lot more shunt that's very specific to the Japan market, along with some other products there. So we do have a nice cadence of new products we're launching this year, coupled with the fact we have other products launched in last couple of years that will ramp in 2021. And again, that's going to be a big part of our growth story for 2021, when we pass these COVID headwinds.

And I would just add to Glenn comments that we clearly had that we've addressed the tissue technology supply issue in 2020. But if you think about it, '19, we struggled to bring on new customers because we wouldn't have enough ongoing supply. 2020, obviously because of COVID we didn't reach lot new customers.

So I would argue, '21 and '22, one of the larger growth opportunities is just the ability to expand that base of products. And now with something interesting and new in the portfolio such as the ACell product line, that's going to be also a nice driver for us here over the next couple of years.

We'll now take the next question from Robbie Marcus at JPMorgan.

Great. So Carrie, you guys had a really good free cash flow conversion in fourth quarter here. I noticed that CapEx was probably a bit lower than you normally would have. And I didn't hear guidance for '21 on free cash flow. So I was just wondering if you could give us thoughts around how that will trend over the coming year.

Sure, Robbie. Let me start with operating cash flow, and then I'll work my way to free cash flow. For 2020, we did just over $200 million in operating cash flow. So a nice robust cash flow even despite again a COVID impacted year. I would expect that our operating cash flow will increase into 2021. So I do expect a modest improvement in operating cash flow.

Free cash flow is going to be a little bit lower though than 2020 just because of the fact that CapEx, as you mentioned, is going to normalize. So CapEx in 2020 was $39 million. And that was the result of us really taking prioritized view of CapEx and really trying to preserve cash as much as we could in 2020 as we weather COVID. So I would expect that our capital expenditures for 2021 will float up, but probably be in the neighborhood of where 2019 was.

So 2019 was around $70 million of CapEx spend. So I think you can peg it around that or maybe a little bit higher just because there's some pent-up demand. So I would say operating cash flow year-over-year higher, free cash flow a little bit lower just because of the differential in the CapEx spend.

Great. And maybe a quick follow-up, just an on free cash flow. The old guidance was for greater than 95% free cash flow conversion. I'm guessing we'll get an update at the May Analyst Day. But how are you thinking about -- we have a couple, I'd say, more impactful acquisitions in the short term. How are you thinking about that over just the course of the long-term and where the business sits right now?

Yes. I mean, Robbie, you're correct in that as we do additional acquisitions, that's going to take a little bit of cash to do some integration work, that will ultimately benefit and drive our top line faster for us. So we think it's a good trade-off in terms of making those right investments to integrate the businesses. So certainly, from a 2021 perspective, I don't expect to see a free cash flow conversion of 80% like I got in 2020. Because, again, the normalization of some of the numbers, including CapEx.

But I do think in a normal type of environment where we're steady state. I think those types of cash flow conversions can be there, but in years where we're going to do an acquisition. And you're going to see us obviously go into that dip into the 60s and maybe be in the 70%, 80% range. But I think in a year where we're in steady state mode, I think a 90% cash flow conversion is possible.

We will now take the next question from Matthew O'Brien at Piper Sandler.

I guess one for Glenn and one for Carrie, sorry, Pete.

Glenn, as far as ACell goes, they did $101 million in '19, they did $95 million last year. And now on a pro forma full year basis, you're looking for something like $92 million this year, and I get there's some COVID impact some disruption from the integration impact. But why wouldn't that full year pro forma number this year, just given that all the heavy lifting, is kind of behind you, not be really conservative. And then when do you think the real big synergistic opportunity from a contracting and cross-selling perspective really kicks in? Is it more like '22, '23? Or is it even later this year?

Just as we think about the guidance for ACell that Carrie had outlined, obviously, we've got 11-months versus a full year. As part of our guidance we've considered COVID impact that's similar to the rest of our tissue business. And any time you go both through an integration like this, you have some typical disruption that takes place with respect to the sales force.

And so that's all factored into our guidance, so $83 million to $88 million for quarter this year. And so that's how we've looked at our guidance. Hopefully, we can outperform that number. And to your point around cross-selling, when do we start to see some of the opportunities materialize, I think it's probably late this year, early 2022.

It will take us a couple of core quarters to get these products fully rolled out continuing to cross-sell the entire bag. So I think it's going to take us a couple of quarters to get through that. So we're probably looking at seeing some upside late this year and then moving into 2022.

Okay. Glenn, it feels like the $83 million to $88 million is really kind of a floor as far as that business goes in our view.

We have uncertainty with respect to how long COVID is going to last. And we've got to get through the rest of the integration. So I'd just say, hopefully, it is conservative, and that's kind of how we've outlined it.

Okay. Fair enough. And then, Carrie, I understand Q1, I think all medtech companies are talking about a big ramp throughout the course of the year. But historically, you've done a 75%-ish of your earnings in the last 3 quarters. And this time around, you're looking for 80%, 81% of your earnings in the last 3 quarters, with Q1 being impacted by a lot of things.

So what gives you guys the confidence that you can get that level of earnings power in the last 3 quarters of the year? Can you just give us some levers that you have to pull on in case some of these other issues COVId-related or whatnot pop up?

Sure. Well, certainly, COVID is an impact in Q1 for sure. So that factors into part of our EPS guide for Q1, just given where the revenue range is. But the other thing I would say is that as I think about Q1 gross margins, they're going to be a little bit lower than Q1 of 2020 just because of the whole portfolio timing change. So you have ortho coming out, which is higher gross margins than a corporate average that comes after full 3 months, you have ACell going in for only 2/3 of the quarter. That's going to create a little bit of margin mix there in Q1 that will take margins down a little bit compared to Q1 of 2020.

But I do expect that you'll see some lower OpEx spend year-over-year in Q1 because of the fact that, again, you have the ortho out, which was heavy burdened in the OpEx line and then replacing it with ACell that comes in. But realize that ACell, we're not going to realize all of the synergies there until kind of by the time you get to the fourth quarter.

So part of Q1 also is reflecting this portfolio timing change and the fact that ACell synergies -- cost synergies will be realized gradually over the course of the year. So that will be part of the build as well as, as I mentioned, is that we expect that certainly second half, most of the COVID impact should be behind us at that point. So we would see a heavier contribution of our revenue in the second half versus first half.

We'll now take the next question from Matt Taylor at UBS.

Yes. So the first one I wanted to ask was just a follow-up on ACell. You've made a number of comments on the integration here. I just wanted to know, now you brought it in-house. Is there anything that surprised you positively or negatively? And have you thought about the outlook for that longer-term in different material way given some of these opportunities for synergies?

Glenn, who don't you start?

Yes. I would say, we haven't really seen any surprises. I think the good news is we've got the commercial integration well underway. And so from my perspective, we've been impressed with the product portfolio that came over. It's what we thought it was. We've added a number of ACell specialists that are focused in the Wound Reconstruction space, and that would be around the MicroMatrix powder and the Cytal products.

And so I think the specialization that they bring, the team is really high-caliber team that we were bringing over, the product portfolio is what we thought it was. So really no surprises, I would say. And we're really happy. We're getting great feedback from customers already. So we feel really good about it.

My 2 adds to it would be, in fact, that they did do a lot of contracting. And so I think that's going to be a nice addition in what we do with our enterprise team and the second part would be, as I mentioned, in some of the comments before were with on the scientific side.

I think in their last few years, there wasn't a significant focus on new derivative products for a lot of reasons. And with the leadership team we have on the R&D side and clinical, we clearly think there's some opportunities with other derivative products that aren't a significant lead to bring out to the market. So stay tuned on that as well.

Okay. Great. And then I have one follow-up on capital. I know you've been talking about the ongoing capital pressure. It's not too surprising. I was wondering if you could characterize that any more precisely in terms of the trends that you've seen over time, how our hospitals started to open up their wallets and now there's kind of light at the end of the tunnel. How would you predict that that's going to progress over the next couple of quarters?

Carrie, do you want to take a shot at it and then Glenn and I can add any color after you comment.

Yes. I mean -- and again, I would say that we've seen sequential improvement in capital as we've gone. So as I think about Q3 to Q4 capital, that was about a 40% sequential improvement in our capital sales. So really nice, but still capital is still about 18% down year-over-year in the fourth quarter. So it certainly still lags. If all of the portfolio was only down 1.5% in Q4 and capital is down 18%. It's still obviously quite a lag in the recovery piece.

And so we think it's going to take some time. We are encouraged by the discussions we're having. The pipeline remains really strong. We have brought to the table different options to start those conversations back up, financing options, rent-to-own type of models or things like that. To get those discussions going.

I would say in the smaller capital, I mean, I don't think of us as very large capital. I mean, our largest price of a capital is our CUSA, you're talking about a couple hundred thousand. And then we have smaller capital units like Mayfield or our Duo Lighting Headset. Those -- the smaller pieces of capital are responding better are coming back a little bit stronger. And even our Instruments business that can be capital-light was only 2% down in the fourth quarter.

So the good news is some of the smaller capital pieces are coming back. It's the larger ones that we'll continue to expect that they lag. But it's not a competitive issue. It's more of just when the budgets will kind of free up. So we're still encouraged by the discussions we're having, that we think that we'll continue to see some capital sales will just continue to be a little bit lighter than the rest of the portfolio at this point.

So the only thing I would just add is we talked about it in the past, it's only 6% to 7% of our revenue. So it's not a big part of our business. And the bright silver lining here is the funnel is really strong with our capital business. So when it does come back, we actually feel like we'll turn the corner pretty quickly, but it's probably going to be in the second half of this year.

We'll now take the next question from Shagun Singh at Wells Fargo.

A couple here on guidance. What have you assumed for backlog in your 2021 guidance? By our estimate, it could be about 9% of sales. And then also, what are you assuming for normalized regen supply coming back? Are you assuming that the full $15 million to $30 million, I think you had communicated 100 to 200 basis points of 2019 sales. Are you expecting all of that to be dialed in? Is that in your guidance? And then also, what are you assuming in your guidance for Arkis and Rebound growth contribution?

Carrie?

Yes. Shagun, I would say that overall, whether or not we have backlog, I think it's going to be highly dependent on just the course of COVID here. We are assuming gradual recovery in the first half. So I would say that we don't see a big bolus impact of pent-up demand, a big bubble coming through. I think it's going to be a slow and steady gradual improvement over the course of the first half. With an expectation that largely COVID is behind us in the second half.

So I don't have a calculation for backlog to provide you this is what we've assumed in our numbers. Certainly, I hope there is a little bit of backlog help in 2021. But again, at this point, we're assuming kind of slow and steady improvement over the course of first half.

And I don't have the specific breakdowns of Arkis and Rebound at this point. I think Rebound, we do have some contribution of Rebound and Arkis in our 2021 numbers. I still think the larger impact, certainly for Rebound of the 2 is going to be a larger opportunity for us in 2022 and beyond.

Got it. And what about the regen supply, do you expect all of it to return there, what's included in your guidance?

I'm sorry, I can't hear what you're saying there. What kind of supply?

So given the normalized regen supply, I think the impact of that was about 100 to 200 basis points?

Oh, yes. The regenerative tissue. Yes, Shagun. I mean, at this point, I would say, certainly, our expectations is that the supply issues have been addressed and that we are at a point where we can meet any unconstrained demand as the business recovers. So as I think through the opportunities in 2021, I would assume that Tissue Technologies will be contributing very similar to what we expect for CSS, as I mentioned before in one of the questions that somebody asked, Kaila asked, was about I don't expect to be -- big differences in the segment performance at this point as I look at the year.

So I think Tissue Technology will be an equal contributor to our growth. Grow back to -- in 2021. And certainly, as I think about our gross margin story year-over-year between '20 to 2021 that benefit of Tissue Technologies and restoration of the regenerative tissue supply certainly will help my gross margins year-over-year as well.

We'll now take the next question from Raj Denhoy of Jefferies.

Great. This is Anthony for Raj. My question is on margin progression, specifically adjusted margin progression. And so the company ends last fiscal year at 24.4%, but it has ortho in there and it does not have ACell. So sort of looking to the 1Q adjusted EBITDA margin sort of blended number. And it looks like that settles out in the 25% range. So I want to make sure that we're thinking about that correctly.

And then when we think about the bridge from a 25% to the 28% to 30% range. So how do we think about that in terms of progression? It seems like you can actually get there faster now with the mix, meaning that ACell has a higher-margin than ortho. So how do we think about margin progression from where we are today to the 28% to 30% range? And I'll have one quick follow-up.

Yes. I think you're thinking about that really in line with what I would say as well. I think where we finished in 2020, we'll see a little bit of EBITDA margin improvement in 2021 and just a couple of factors as you think about that. In 2021, obviously, my expectation is we'll still be able to deliver some nice gross margin improvement year-over-year. That's going to be moderated back by our operating expenditures coming back up and coming through a pretty low year of 2020 gradually moving up. But net-net, I think we'll still be able to deliver a little bit of EBITDA margin improvement year-over-year. And I think you pegged it right in that 25% type of range.

And -- but remember, I want to draw you back to one of the slides that Glenn had in his deck, and we've shown this slide before when we announced the ACell acquisition. Where we did a pro forma look back at 2019 and said, if you took 2019 and you took ortho out and you added ACell in. In the first year, the impact to EBITDA margins would be about neutral.

And so I still think we can tweak out some margin improvement between 2020 and 2021 with ACell in. But your real pop is going to be into the next year in 2022. When you realize the full synergies of ACell, and you've got ortho out, and that swap there will really show a nice benefit in 2022. So I think we'll make some really nice inroads in 2022 along our path to get to 28% EBITDA margin.

The follow-up there would be, I guess, you mentioned synergies. And so I guess, to quantify the synergies, I mean, on the cost side specifically, is there a number out there we should be thinking about? And then when we think about synergies in cross-sell. I'm just wondering if ACell, is it all complementary to the Nerve repair channel you spoke about last quarter? Are those still going to be 2 separate and dedicated selling efforts?

Yes. I'll talk about the synergies at ACell and then maybe ask Glenn to talk a little bit about your second question on Nerve. On the ACell synergies, you could go back to their 2019 public statements. And they had about $80 million of operating expenditures in their business that was $100 million of revenue.

So essentially, the business was at breakeven. So our opportunity is to bring that revenue into Integra and to really synergize. And we certainly think we have a lot of opportunity because it's the same call point. And we think there's some nice synergies on the infrastructure side there.

So as I think about that, I think our goal was to get about 40% of that OpEx out. By the end of the year. And so there's some nice synergies there, as I mentioned, as I think about full run rate realization of those synergies going into 2022. And then, Glenn, you want to tackle the Nerve question?

Yes. I just think if you look at the ACell portfolio, it really impacts the Wound reconstruction business and the Surgical reconstruction business in those channels. Now keep in mind, we have Nerve being sold by the Wound Reconstruction team today, but we have a specialist group that focuses on it. So I don't see a lot of synergies per se as it relates to the Nerve business.

We'll now take the next question from Jayson Bedford at Raymond James.

Just a couple of modeling questions to keep the discussion moving here. On 2020 revenue, what was the incremental revenue contribution from the increase in tissue supply and the move from distributors to direct in Japan.

So the tissue business was not the business that was moved. It was the general Surgical business. So think of that as CUSA Excel and other instruments. We haven't specifically quantified how much that is, but it's one of the contributors to Japan, driving double-digit growth. And keep in mind, Japan today, just to put it into context, is a market that's about $60 million of annual revenue.

(inaudible)

Sorry, it was 2 items. You helped me with the Japan dynamics. But the other one was just -- you had your supply constraint side in tissue side in '19. And I'm just wondering what was the incremental in '20?

Yes. It's hard to know in 2020 because it was a COVID impacted year. Overall, our business was down because of COVID. So it's -- how I would look at 2020 is a year that we recalibrated and put safety stock back into a supply chain that really was below where we wanted to be. So in 2019, it was missed opportunity. So the demand was there, we just didn't have the supply to go and chase that demand.

In 2020, while COVID was impacting our overall top line. We took the approach that we're going to have a couple of our factories continue to build and bring inventory levels up on some of these critical SKUs such that when the recovery happens. That we can then take advantage of it. So it's not a -- there's not a way I could quantify the impact, overall 2020 was still down across the board in our businesses because of COVID.

Okay. Is there any way to quantify the delta between demand and supply in '19? Or is that just too far back?

We what that's what I think Shagun was getting after her question. We had talked about that it probably was 1 point to 2 points of growth that, that cost us by not having the supply in 2019 to meet the demand. So certainly, we missed an opportunity to grow revenue in OTT because of the fact that we didn't have the supply. So we talked about it being about 1 to 2 percentage points of our growth in '19 that it cost us.

It appears there are no further questions at this time. Mr. Beaulieu, I'd like to turn the conference back to you, Sir.

Okay. Thank you. Thank you, everyone, for listening in today, and we look forward to updating you calls. And please make sure that you take note of our Investor Day coming up on May 20. Thanks, everyone.

That concludes today's call. Thank you for your participation. You may now disconnect.