Title

Presentation

Integra LifeSciences Holdings Corporation reports earnings inline with expectations. Reported EPS is $0.74 EPS, expectations were $0.74.

Operator: Good day, and thank you for standing by. Welcome to the Integra LifeSciences First Quarter 2023 Financial Results Conference Call. At this time all participants are in a listen-only mode. Please be advised that today’s conference is being recorded. I would now like to hand the conference over to your speaker today, Chris Ward, Senior Director of Investor Relations. Please go ahead, sir.

Chris Ward: Thank you, Norma. Good morning, and thank you for joining the Integra LifeSciences first quarter 2023 earnings conference call. Joining me on the call this morning is Jan De Witte, President and Chief Executive Officer; Mathieu Aussermeier, Vice President of FP&A, Investor Relations and Treasurer; and Jeff Mosebrook, Principal Accounting Officer. Earlier today, we issued a press release announcing our first quarter 2023 financial results. The release and corresponding earnings presentation, which we will reference during the call, are available at integralife.com under Investors, Events and Presentations and a file named First Quarter 2023 Earnings Call Presentation. Before we begin, I would like to remind you that many of the statements made during this call may be considered forward-looking statements.

Factors that could cause actual results to differ materially are discussed in the company’s Exchange Act reports filed with the SEC and in the release. Also in our prepared remarks, we will reference both organic and reported revenue growth. Organic revenue growth excludes the effects of foreign currency, acquisitions, divestitures as well as discontinued products. Unless otherwise stated, all this aggregated and franchise-level revenue growth rates are based on organic performance. And lastly, our comments today will include certain non-GAAP financial measures. Reconciliations of any non-GAAP financial measures can be found in today’s press release, which is an exhibit to Integra’s current report on Form 8-K filed with the SEC. And with that, I will now turn the call over to Jan.

Jan De Witte: Thank you, Chris, and good morning, everyone. Let me start by reviewing our first quarter business highlights on Slide 4. Our first quarter revenue performance reflects solid execution by our teams as a positive trend in market demand and procedure volumes that we see now nearing pre-COVID levels. First quarter revenues finished at around $381 million above our primary guidance range with organic growth of 4.6% comprised of Tissue Technologies at 6.8% and Codman Specialty Surgical at 3.5%. Tissue Technologies enjoyed a strong start to the year, including double-digit growth from a number of our leading products in the wound reconstruction franchise, such as Integra Skin, MicroMatrix, Gentrix and Cytal, along with high single-digit growth from SurgiMend.

We also launched MicroMatrix in Europe where we are seeing positive initial feedback from wounds and reconstructive surgeons. While we are encouraged by the broad strength in demand for our tissue technology products – we are also experiencing the expected revenue pressure from the normalization of private label orders, as we mentioned in our February guidance. Beyond the top-line results in Tissue Technologies, we remain confident in our efforts to obtain a breast reconstruction indication for SurgiMend, and we’re on track to file our PMA update this August, as well as completing related work at our Boston facility to upgrade our quality systems. And FDA inspection in March reinforced the urgency of these quality system upgrades. To maximize focus and efficiency in implementing these changes, we have passed production at the Boston site and accelerated certain project work that was originally planned for later in the year.

We plan to resume production in early June after the system upgrades are substantially complete. And in the meantime, we are continuing to work with our customers and commercial teams to minimize the supply chain impact as they work through existing finished product stock. Turning to CSS now. Here, we also saw a good start to the year with double-digit growth in our CUSA product line and our programmable valves as well as strong performance in instrument sales. We launched CUSA Clarity bone tip in U.S., Canada, Australia and New Zealand, further expanding the global CUSA portfolio. As expected, we also continue to work through several supply headwinds and back order levels remain elevated, particularly in our dural access and repair and neuromonitoring franchises.

Related to CereLink, we’ve made progress on resolving the electrical interference issue in our monitors and now expect to relaunch late third quarter of this year. As we were validating and testing an earlier technical fix, our engineers identify a more robust solution that does not require any change to the monitor. We are currently in verification testing and, in the meantime, have contacted the FDA to discuss the regulatory pathway to return to the market. Also working with regulatory agencies outside U.S. to finalize the plan in our international markets. Our current technical solution allows us to ramp up distribution faster once we’re back in the market. We are excited about the relaunch of CereLink, our customers’ commitment and support during the recall further validates our confidence that CereLink remains an important catalyst to our long-term growth expectations.

Turning to our bottom line now. First quarter adjusted earnings per share came in at $0.74 within our original guidance range. Despite some temporary pressures to our adjusted gross margin during the quarter from product and geographical mix and the Boston quality projects, we were able to meet our profitability targets and continue to make the necessary investments to fuel our long-term growth plans. During the quarter, we also appointed Dr. Stuart Hart as Chief Medical Officer. Dr. Hart has worked at leading medtech organizations and brings a deep and broad experience in global medical affairs and surgical innovation. That will enable him to strengthen our clinical operations and innovation capabilities. Our CFO search continues with a strong slate of candidates.

We’re close to identifying a great leader who has the right skills and fit for the company. On the first quarter, we further solidified our balance sheet and liquidity position by amending and extending our credit facility, providing us ample liquidity as we execute our M&A strategies. We also initiated a $150 million accelerated share repurchase to return additional value to shareholders. Overall, the strength demonstrated by our portfolio at the beginning of this year provides us confidence that we will deliver our 2023 commitments, and we are reaffirming our original full year guidance for revenue, organic growth and adjusted EPS. Consistent with the guidance we provided in February, we expect to see a clear step-up from our first half to second half revenues.

Additionally, we now also expect a larger step-up in gross margin as a result of the Boston quality project cost acceleration from the later part of the year into the first half. So with that, I’d like to turn the call over to Mathieu now to go deeper into our first quarter performance and our guidance.

Mathieu Aussermeier: Thank you, Jan. Let me provide you with a more detailed look at our first quarter financial highlights, starting on Slide 5. As Jan mentioned, first quarter total revenues were approximately $381 million, representing an increase of 1.1% on a reported basis and 4.6% on an organic basis. Total revenues were $5 million, above the high end of the guidance range communicated back in February. First quarter revenue growth was strong across many parts of our business with organic growth of 3.5% in Codman Specialty Surgical and 6.8% in Tissue Technologies. Overall, organic growth was 3.5% in the U.S. and 7.2% in International. Adjusted gross margin for the quarter was 67.3%, up sequentially by a 100 basis points versus the fourth quarter of 2022, but down 40 basis points versus the prior year.

Adjusted EBITDA margin for the quarter was 24.2%, down 60 basis points and adjusted earnings per share were flat at $0.74. Both metrics were largely impacted by gross margin pressures, planned growth investments and year one dilution from the SIA acquisition. If you turn to Slide 6, I will go deeper into the first quarter revenue performance for our CSS segment. Reported Q1 revenues in CSS were $248 million, flat on a reported basis, and up 3.5% on an organic basis from the prior year. Global neurosurgery sales were up 2.9%, driven by low double-digit growth in our CUSA capital and disposable and mid-single-digit growth in CSS management, including continued strength in our Certas Plus Programmable Valves. Neuromonitoring declined low digit – low double digits, primarily because of the lack of CereLink monitor sales in the quarter, following its recall in the third quarter last year.

Our global neurosurgery performance in the quarter was also impacted by continued supply challenges in our dual access and repair as well as neuromonitoring. Overall, excluding CereLink, capital sales within the quarter were strong and grew low double digits driven by CUSA with low single-digit growth in smaller capital. We continue to see strong demand funnels for our capital equipment as customers see value, innovation and additional productivity in these products, particularly our CUSA platform. Instruments grew approximately 6% driven by healthy demand and the timing of orders. This result exceeded our low single-digit long-term growth expectations for this business. Shifting to international. Sales grew high single digits in the quarter, led by double – low double-digit growth in both Japan and China.

Japan growth was led by sales in CUSA capital and disposables as well as DuraGen while China benefited from the recovery of rolling COVID lockdowns and our continued geographic expansion. Moving to our Tissue Technologies segment on Slide 7. Tissue Technologies grew 2.6% on a reported basis and 6.8% on an organic basis compared to the prior year. First quarter sales in wound reconstruction increased 11%, driven by strong demand and commercial execution, led by double-digit growth from Integra Skin, MicroMatrix, Gentrix and Cytal as well as high single-digit growth in SurgiMend. In our private label franchise, sales declined 5% versus last year, as expected, while our partners continue to normalize their inventory levels following strong purchases in the first half of 2022.

And finally, international sales and Tissue Technologies were down mid-single digits due to supply challenges in certain markets. Turning to Slide 8 to review our first quarter P&L metrics. Adjusted gross margin for the quarter was 67.3%, down 40 basis points compared to Q1 of 2022. The decline of our gross margin year-over-year was primarily driven by unfavorable product and geographic mix as well as Boston quality project expenses. These temporary pressures represented a headwind of approximately 120 basis points in the quarter and offset our positive revenue performance and continuous cost improvement activities. Despite these interim pressures, our gross margin improved sequentially by 100 basis points versus Q4 of 2022, primarily driven by continued strength in our higher gross margin Tissue Technology business some improvement in supply and the passing of one-time cost pressures we saw in the fourth quarter of last year, all of which were factored in our February guidance.

We expect the cost of acceleration of the Boston quality projects to continue into the second quarter and impact our first half adjusted gross margin unfavorably by approximately 100 basis points compared to our February guidance. This implies flat to marginal improvement in gross margins in Q2 compared to Q1. Our first quarter adjusted EBITDA margin was down 60 basis points compared to the prior year driven by temporary gross margin pressures highlighted earlier as well as the investments supporting our key strategic priorities discussed during our February call. Our EBITDA margin also reflects the one-year dilution of our SIA acquisition, which closed in December 2022. Our adjusted EPS was $0.74, flat to prior year and includes a negative $0.04 impact as a result of the Boston quality project.

If you turn to Slide 9 for a brief update on our balance sheet, capital structure and cash flow. In the first quarter, we initiated the previously announced $150 million accelerated share repurchase program. We also amended and extended our $2.1 billion credit facility from 2025 to 2028, on favorable terms despite the challenging banking environment, providing us strong liquidity to support our M&A game work. During the quarter, operating cash flow was $26 million and free cash flow was $13 million reflecting both expected increases in capital and EU MDR compliance spending as well as increased inventory levels compared to the fourth quarter of 2022 as we increase our finished goods safety stock levels. Free cash flow conversion was 71% on the trailing 12 months.

Our balance sheet remains strong with ample liquidity to support our short-term and long-term plans. And as of March 31, net debt was $1.1 billion, and our consolidated total leverage ratio was 2.5 times. The company had total liquidity of $1.6 billion, including $307 million in cash and the remaining available under our revolving credit facility. Turning to Slide 10. I will provide an update to our consolidated revenue and adjusted earnings per share guidance for the second quarter and full year 2023. Second quarter revenues are forecasted to be in the range of $396 million to $400 million, representing approximately flat reported growth and organic growth in the range of 1.5% to 2.5%. Our second quarter revenue guidance reflects continued procedure recovery and strong demand for our products but also continuing supply challenges and a modest negative impact of approximately $5 million from the Boston quality project.

Our organic growth guidance also reflects the higher comps from last year in private label and instruments as well as the lack of revenue from selling monitors in the quarter. For the full year 2023, we are reaffirming our revenue and organic growth guidance. Our guidance contemplates the strong demand and portfolio performance we demonstrated in the first quarter, a slight improved FX outlook, updated timing for the relaunch of CereLink, supply and back order challenges and a modest revenue impact from the Boston quality project. We are also holding our organic growth expectations to approximately 3% in the first half and 6% in the second half as shared during our February call. As a reminder, the step-up from first half to second half is driven by gradual supply improvements, the relaunch of CereLink and favorable back half comps in China and private label.

Turning to adjusted earnings per share guidance for the second quarter, we expect adjusted EPS to be in the range of $0.75 to $0.79, up sequentially, but down from the prior year driven by temporary gross margin pressures, including the cost from the Boston quality project as well as our planned strategic investments, including the SIA acquisition. This guidance range reflects an approximate $0.06 headwind from the Boston quality project but will have a benefit in the second half of the year. As we look at the rest of the year, we expect that the acceleration of the project cost, along with other gross margin levers will contribute to a sequential improvement in gross margin from first half to second half of approximately 100 basis points. We will also continue to manage our spending ramp for the remaining of the year while preserving our key growth investments.

In summary, we are holding our full year 2023 adjusted EPS guidance of $3.43 to $3.51 per share. Now I would like to turn the call back over to Jan.

Jan De Witte: Thank you, Mathieu, and please turn to Slide 11 to conclude our prepared remarks. First quarter performance was solid and the results and trends provide confidence that we can deliver on our full year commitments through market recovery and strong demand for our products, while we navigate supply challenges and the acceleration of our quality system project in Boston. In parallel, we continue to progress toward our long-term strategic goals. We strengthened our core business with new product launches in the CUSA platform and in our international Tissue Technologies portfolio with MicroMatrix in Europe. We’re advancing our PMA projects, intending to file the SurgiMend PMA amendment this summer as well as additional modules of the DuraSorb PMA later this year.

This keeps us on track to deliver the first two PMAs for an AGM in the high-growth implant-based breast reconstruction market. The team has also done a tremendous job getting to the root causes on CereLink and developing a robust technical solution to bring the monitor back to the market. In addition, we made continued progress in enhancing our executive leadership team and strengthening our core capabilities in manufacturing, quality assurance, clinical study design and evidence generation. We have also taken the opportunity to fortify our balance sheet by extending our credit facility and we’ll return value to our shareholders through a share repurchase. All of these achievements will enable us to continue to bring innovative and life-saving technologies to market and serve our customers and their patients around the world.

Our full year outlook is balanced reflecting our commercial momentum and our focus on improving execution, but also the pulling forward of the Boston quality project costs. While we push ahead with investments in critical initiatives, that will propel our growth over the long-term. Our second half reflects a clear step-up in organic growth and margin expansion with expected organic growth well above 5%, adjusted gross margins greater than 68% and adjusted EPS growth approaching double digits. I believe these metrics for the second half are much more reflective of where we see the business in the near term as we progress towards our LRP commitments. In that context, we look forward to going into more detail on our exciting growth catalysts and providing more clarity on our plans to achieve our long-term targets next week on Thursday, May 4, at our Investor Day in New York.

That concludes our prepared remarks. Thank you for joining us this morning. And operator, would you please open the lines for questions?

Operator: Thank you. Our first question comes from the line of Steve Lichtman with Oppenheimer. Your line is now open.

Steve Lichtman: Thank you. Good morning guys. I guess just first on CereLink. Can you talk a little bit more about sort of the adjustment in the fixed there. And I think, Jan, you alluded to the fact that on the back end that, that will help. Just any more color you could provide on sort of what the change in the fix is and why it will help on the back end in terms of ramp?

Jan De Witte: Good morning. Yes. So as we were over the past couple of months with our engineers are doing the statistical validation and testing of the initial fixed, they identified a more robust technical solution that is even more capable to shield away the different electrical interference, specifically, in this case, one that came from the patient and the table. It’s a fix in addition that does not require a change to the monitor box, but rather to the sensor connector. It’s a cable type component. So the benefit of the solution other than shielding interferes better is that it does not require a change to the monitor box, which allows us to ramp up faster the moment we’re back in the field. So that’s the change.

That’s also the change that we thought was a better solution in the medium and long-term for the business. It does require us now to restart validation and verification testing with this new solution. And that’s the main driver why essentially, we’re slipping out one quarter with plan in terms of going back to the market.

Steve Lichtman: Okay. Got it. And then on the Boston manufacturing project, can you just maybe provide a little bit more detail there in terms of what’s being done? How far along you are in that process? And then what exactly is being manufactured there? It obviously sounds like SurgiMend and anything else? Thanks.

Jan De Witte: Yes. In short, in Boston, the main product there is SurgiMend. There’s also one private label product that’s being manufactured there. To go back to the Boston production or the quality project there, we’ve been working for the past couple of years to upgrade our Boston facility based on FDA observations in 2018 and 2021, okay? In addition, as we are preparing to have SurgiMend PMA product there, the Boston side requires a quality system that operates at a higher level. So that’s a product that we’ve been a project that’s been ongoing. We had an audit early in March that confirms we’re on the right track with our execution. At the same time, it further ups – our sense of urgency to finish the projects, specifically upgrading a number of testing-related processes and infrastructure, physical layout changes.

In addition, the plan that we have on the table now gets the job finished well before August this summer, which is the timing where we also submit the PMA amendment for the SurgiMend breast product. So in that context, we elected to pause production as it allows us to more quicker and more efficient, make the changes in process and physical layouts that are needed. We can do that because we have ample inventory in the system that allows us to satisfy current customer demand. So this project that’s an eight-week focused project while we keep the factory down, we’re going to be back up and running early June with the factory. And as I said, in the meantime, we’re living off inventories to satisfy customer demand.

Steve Lichtman: Got it. Thanks, Jan.

Operator: Thank you. The question comes from the line of Vik Chopra with Wells Fargo. Your line is now open.

Vik Chopra: Hey good morning and thank you for taking my questions. So I just had one clarification on gross margins. I think you said Q2 is sort of flat to marginal improvement in Q3, and Q4, a step up. You’ve previously talked about mid 100 basis points gross margin improvement. Is that still on the table? And then I had a follow-up.

Mathieu Aussermeier: Good morning, Vik. So yes, we expect to see kind of flat to moderate increase in gross margin from Q1 to Q2 and then from first half to second half, as you mentioned, the 100 basis points of improvement. From a full year perspective, we were talking about this mid- 100 basis point improvement in gross margin. We’re currently looking at more 100 basis points year-over-year of an improvement, so approximately 100 basis points at this point in time. And the drivers that we have discussed during the February call are very much, I would say, alive tempered by, I would say, some kind of residual impact coming from the Boston project that we’re running right now here in the first half. So hopefully, that helps.

Vik Chopra: That does help. Thank you. And then my follow-up was when can we expect to hear an update on the search for a new CFO. Any color on that would also be helpful. Thank you so much.

Jan De Witte: So on the CFO search, very happy with the slate that we’re having. Over the next couple of weeks, we have bought our Board together – we have a little Board committee. That’s part of the selection. So that’s the main step into selecting, yes, the main candidates out of that slate. And so I think on the month of May, that’s where a decision will be made.

Operator: Thank you. Our next question comes from Rohan Patel with JPMorgan Chase. Your line is now open. Rohan Patel, your line is now open.

Jan De Witte: Just we go to the next one, right, and Rohan can come back later on.

Operator: Thank you. Our next question comes from the line of Ryan Zimmerman with BTIG. Your line is now open.

Ryan Zimmerman: Good morning, Jan, and everyone on the call. I had a question. I mean, historically, Integra has generated closer to 48% to 50% of its EPS in the first half. And if I look at kind of – if I look back at kind of years past, now you’re targeting this year about 57% in the second half of the year since you generate about 43% in the first half of this year. And so I can appreciate some of the Boston one-time impact in the first half of the year. But I’m curious if you could kind of help us bridge the dynamic, particularly as revenue increases in the back half of the year, I would imagine that costs are also going up on the OpEx side. And so I just want to get comfortable with the EPS ramp in the second half of the year.

Mathieu Aussermeier: Yes. Good morning, Ryan. So as you look at the first half, we’ve also accelerated certain expenses related to the Boston project right now. So part of this acceleration and some of the costs that we are facing here in the second quarter, we’re going to offset some of this in the second half. And so part of that second half improvement, along with the revenue increase that you’re going to see first half to second half, this will enable us to generate more EPS contribution to the full year. And you’re correct, we’re about 43%, 45% in the first half and about just over 50% in the second half.

Ryan Zimmerman: Yes. Okay. And then organic growth in the second quarter is certainly softer than what you saw this first quarter. Procedure volumes have – were good this first quarter. I’m curious kind of why you think there’s either a slowdown or just that doesn’t continue into the second quarter. And maybe that’s all related to some private label or things like that. But help us understand kind of what you’re seeing in the second quarter that’s maybe tempering your expectations.

Jan De Witte: I’ll hand that to Mathieu to give you some of the movements there.

Mathieu Aussermeier: So again, in the second quarter, the quarter will be facing, I would say, one, the toughest comps. If you think about private label, about instruments. So that’s definitely softening the growth year-over-year. In addition to that, we have this moderate impact coming from Boston, which is about $5 million here in the quarter. So, I would say these are the three or the two big elements that are going to be softening the growth. We believe that demand is going to continue to be strong for the remainder of the year, but it’s, again, this temporary comp year-over-year and the Boston that’s going to temper a little bit of growth here in the second quarter temporarily.

Ryan Zimmerman: And that was – sorry, you called out a $5 million impact on the Boston quality projects in the second quarter. I just want to be clear.

Mathieu Aussermeier: Okay. That is correct.

Ryan Zimmerman: Thank you.

Jan De Witte: And part of that, Ryan will come back in the second half, is linked with a private label shipment, which we think we’re not going to be doing in the second quarter, but it will shift to later second half.

Ryan Zimmerman: Okay. So it sounds like – just to be clear, there’s – private label starts to maybe normalize or at least there’s a lumpy larger order that picks up in the third or fourth quarter that can help.

Jan De Witte: Yes. Correct.

Ryan Zimmerman: Okay. Thanks for taking my questions guys.

Jan De Witte: Thank you, Ryan.

Operator: Thank you. Our next question comes from Matthew O’Brien with Piper Sandler. Your line is now open.

Unidentified Analyst: Hey, good morning. This is Phil on for Matt. Thanks for taking our questions. For starters on the CereLink relaunch, thanks for the color on the recent breakthrough there. And – but given the late Q3 relaunch now, can you let us know what gives you confidence in the steep second half guidance not saying the whole thing was based on CereLink, but certainly, it’s not helping? And just on CereLink, how are those conversations with the FDA going? And do you have high visibility in that Q3 time line at this point?

Jan De Witte: Yes. So we – your second question first. We have exchanged with the FDA our engineering – the early test results on this new solution, which look very robust, are quite binary in terms of pass/fail on several dozens of tests. So that information, we’ve shared with the FDA. We’re going to discuss that next week to further fine-tune how we set up the validation and verification, say the official testing of that solution. We plan to submit that around mid-August. Our time line at this point in time, the time line of end third quarter assumes a special 510(k). And that also is aligned with the high end of our top-line guidance. If this would not end up being a special 510(k) then we’re talking, yes, about two, three months later, which is aligned with the lower end of our guidance.

So our guidance reflects the high and the low scenarios when it comes to selling back to market, and that’s pretty much driven by the uncertainty on what the regulatory path we will have to follow after we submit in mid-August.

Mathieu Aussermeier: So just to add to Jan’s remarks here, if you think about the first half to second half, need to realize that CereLink – maybe the delay represents maybe a couple of million dollars of change. So it was a smaller contributor to the second half ramp. And just as a reminder, as we see kind of supply recovering throughout the year, we’re expecting to have a bigger contribution in the second half. China normalization post-COVID lockdown is also going to be more of a contributor in the second half along with kind of growth in some of our NPIs that are going to continue to ramp here in the second half of the year. And then we’re going to be passed as to some of the tough comps that we’ve had from an instrument and from – and from a private label perspective, sorry, both of which are going to help also the second half growth. So that’s kind of the first – second half log, and the biggest contributors are still very much alive.

Unidentified Analyst: No, that’s helpful. Thank you. And just shifting gears here, can you kind of flesh out what you see on the international front? I know you just mentioned China, but what should we be looking for from Integra here in 2023 and maybe even 2024 as we start to look there as well? Thank you so much.

Jan De Witte: Yes. So, as I think we indicated, the International had a good start of the first quarter with 7% plus growth. China and Japan were double digits. That’s where we pretty much expect them to be where we expect international to be this year in the next couple of years is in the high single digits, driven by mid-single digits, Europe and a couple of double-digit drivers in Asia China.

Operator: Thank you. Our next question comes from the line of Craig Bijou with Bank of America. Your line is now open.

Craig Bijou: Hi, good morning guys. Thanks for taking the question. A couple of follow-ups here. So Jan, I wanted to circle back to CereLink and the change in the solution and your thoughts that you can distribute it faster. So maybe just ask specifically, so if you don’t have to change the monitor, I guess, can components be switched out on site? Can they be sent? I think you mentioned the cable. So can that be sent to sites that can then update the system? Just wanted to understand what exactly the recall consists of now.

Jan De Witte: So your assumption is right. So the monitor does not change. This is about a connector cable, plug-in cable that plugs into the monitor on the other side, plugs into the sensor cable. It’s a cable that can be sent as an accessory into our customers. Of course, it has to be – has to be manufactured, right? And that’s being initiated as we speak to have those cables manufactured by one of our suppliers.

Craig Bijou: Got it. That’s helpful. And then a follow-up on the Boston project. What requirements – and sorry if I missed it, does the FDA have to come back into the facility and inspect? Or are there any other steps once you do finish the project that need approval or sign off or some other step before you can then submit the SurgiMend PMA?

Jan De Witte: So the startup of the plant is up to us, yes, when we have finished the project that we do. We’re sharing that work and that planning with the FDA, but pretty much when we’re done, we start and restart the factory.

Craig Bijou: Okay. Thanks for taking the questions.

Operator: Thank you. Our next question comes from the line of Joanne Wuensch with Citi. Your line is now open.

Unidentified Analyst: Good morning. This is actually Anthony on for Joanne. Thanks for taking our question. In the presentation, you mentioned your M&A game board. So just with FAA and the bad now, can you just maybe refresh us on thoughts around M&A?

Jan De Witte: I think your question is overall thoughts for M&A?

Unidentified Analyst: Yes.

Jan De Witte: So as I mentioned sometime before, the strategic work we’ve done last year has translated into a clear M&A game boards. We definitely have the balance sheet capacity to execute on that. At this point in time, we have several of our targets in process, in discussion. And that’s as far as I can give you any insight in further execution.

Unidentified Analyst: Got it. That’s helpful. On the backlog, I think you said it was elevated, but could you maybe provide any more color on how it trended? Has it gone down materially during the quarter? Has it sort of stayed flat? Just curious if you could provide any more commentary on that?

Jan De Witte: Yes. Back orders are still elevated $10 million to $15 million higher than what we consider as normal. We had not expected over the first half for this to materially come down. That’s playing out as we assumed. The challenges here are twofold: one, we keep dealing with several challenges of suppliers that are either not delivering on time or discontinuing components, which drives us to recertify new components or build up last time buy inventories. So that’s one factor, fiscal factor that’s driving the back orders. And then second, we are in several factories stepping up work on build to keep up with the increased demand with the factory capacity that we have.

Unidentified Analyst: Thank you.

Operator: Thank you. Next question comes from the line of Richard Newitter with Truist. Your line is now open.

Unidentified Analyst: Hi, this is Tim on for Rich. Thanks for taking our questions and appreciate the commentary on the backlog there. But can you just remind us when you think about the second half ramp, does that include realization of that backlog at all? And can you kind of give us any confidence in the dynamic you expect there for the second half?

Mathieu Aussermeier: Yes. So definitely, we expect an improvement, and it’s part of it. I would say, again, as we think overall about all the different elements that contribute to the second half, I talked about NPIs. I talked about the China normalization, about the private label, but the instruments. And the other component, as I mentioned early on, is this kind of supply recovery. We’re definitely seeing more than we would like on the dural access and repair side as well as on the neuromonitoring side, and we hope for this to continue and contribute also in the second half.

Jan De Witte: Just to clarify, Tim, when I mentioned it’s $10 million to $15 million higher than where – what we consider normal. We do not expect in our guidance that this $10 million to $15 million will be fully solved, okay? We count on about half of that. So that’s potential upside or downside in function of how we get over the different supply chains.

Mathieu Aussermeier: And again, if you look at our guidance range, right, these are things that we are contemplating as well, right? So some of those factors between our low end and the high end of the guidance range are elements that we’re factoring in as well.

Unidentified Analyst: Okay. That’s helpful. Thanks. And just one more on the Boston factory change and how that impacted the margin. It sounds like it was more pull-forward than unexpected. So was this the $0.06 impact in 2Q? Was that factored into the full year guide and now it’s just being more realized in 2Q? And then with the lower sort of expansion on GM for the year, can you kind of walk us through the levers on the P&L you have that helps you maintain full year EPS? Thanks.

Jan De Witte: Yes. I’ll give this to Mathieu. I think overall, your assumption is right, but Mathieu can get you one level more detail.

Mathieu Aussermeier: Yes, Tim, so I agree with what you said. So, we need to look at it as a little bit of a shifting in expense, and I would say, impact our gross margin here into the second quarter. So let me take you maybe a step back. So in Q1, we saw about 120 basis points of an impact related to the Boston quality project itself. And we saw some benefit coming from manufacturing efficiencies, favorable FX and product mix as we expected originally, which is resulting in the net-net about 40 basis points down year-over-year. As we shift to Q2, we’re expecting a modest improvement in supply, but still an impact of about 100 basis points I would say in Q2 and for the first half, really driven by the timing, this acceleration of the Boston quality project.

As we turn into the second half, the second half of the year, we’re expecting to offset part of this. Again, the Boston impact has really three components to it. It has the idle capacity, it has the project cost, and it has some revenue impact. So as you go into the second half, we’ll gain back some of the revenue that we lost in the first half, you’re going to gain back some of the gross margin because of the timing of the expenses. And then you asked about leverage. The other lever is that we’re continuously just looking at being good stewards of our P&L and looking at our investments in the second half and prioritizing some of them while really focusing on our key strategic priorities and spending in the second half.

Unidentified Analyst: Got it. Thanks for taking the questions.

Operator: Thank you. . Our next question comes from Eric Fleming with Raymond James. Your line is now open.

Eric Fleming: Yes. It’s Eric on for Jayson Bedford. Just had a couple of quick questions. on the private label with the comps on the private label, were there any account losses in there? Or is that straight down?

Mathieu Aussermeier: No, no account losses. I mean I think a lot of our partners last year built inventory based on certain assumptions around EU MDR. With the change in the EU MDR assumptions and kind of later dates, we just see them actively managing their inventory levels and these are coming down. So this is part of the privatization, I would say, with the kind of normalization, I should say, of inventory levels that we’re seeing. And again, the impact is going to be heavier in the first half than in the second half.

Eric Fleming: Okay. And just one follow-up on CereLink before we were expecting a $6 million to $7 million contribution in the second half. Is that – are we now looking at about half of that now with the delay?

Jan De Witte: Yes. I think that’s roughly correct.

Eric Fleming: Okay, thanks a lot.

Operator: Thank you. Next question comes from Rohan Patel with JPMorgan Chase. Your line is now open.

Rohan Patel: Hi, sorry. Can you hear me?

Operator: Yes.

Mathieu Aussermeier: We can hear you.

Jan De Witte: We can hear you now.

Rohan Patel: Sorry about the early confusion. I’m on for Robbie Marcus. Just a quick one on free cash flow. It definitely looks like conversion looks a little soft in the first quarter. How much of that is related to the Boston manufacturing quality issue? And is there anything else driving that kind of weak conversion? And what should we expect for the balance of the year?

Mathieu Aussermeier: So, we definitely expected from a cash flow perspective a ramp in capital spend as well as EU MDR spend. That’s the first thing. Second of all, we’ve started also building more inventory. And so you’ll see that a portion of our cash flow at this point in time is also driven by higher inventory levels at the end of Q1, some of which would – will continue throughout the year as we’re kind of rebuilding our stock levels and some of it being kind of in WIP and all this that will flush through for the remainder of the year.

Jan De Witte: So Rohan, no connection to the Boston project.

Mathieu Aussermeier: Correct.

Jan De Witte: It’s not in that.

Rohan Patel: Got it. And then just when we look forward to your Analyst Day, what are the main things you’d highlight for us to inspect? What are the most exciting things? Should we think of new products? Should we think of updated LRP? Just kind of a preview of that would be helpful. Thank you.

Jan De Witte: Yes. Thanks. So hope to see you next week Rohan, but the way we’ve set it up is to really give that insights into how we get from where we are today to the long-term parts that we set forth. And many of you over the past years have asked me for where is the plan and how do you get say, what are the contributors. So we’ll spend most of our time making sure that not only do we explain why we feel great about several of our innovations or our markets but how does that translate into top-line, top-line growth acceleration and gross margin acceleration. We also give further insight into when we talk about M&A gain more, what directions are we looking into.

Operator: Thank you. And our last question will come from the line of Drew Ranieri with Morgan Stanley. Your line is now open.

Drew Ranieri: Hi all. A couple of questions on maybe the forward guidance, but I appreciate the second half ramp for revenue and for earnings. But as you are thinking about upside for the year, are you more inclined to drop that through to the bottom line? Or are you looking more to reinvest in the middle of the P&L, just given some of the growth initiatives ahead? And then just as a second question, I was just asking both upfront as you are reaffirming the 2023 guidance, is there any change necessarily in the composition of how you’re thinking about CSS versus tissue technology growth? Thank you.

Jan De Witte: On your first question, in our guidance, we are protecting our key strategic growth investments. So I would say if we have top line upside, a lot of that will flow down to the bottom line, okay, given again, that we are making sure that the projects we want to do, we do. In the case of Boston, we do it earlier than planned. So we’re really determined in 2023 to execute on our growth investments. And so top-line impact should rather translate into bottom line.

Mathieu Aussermeier: And then to your second question around CSS and Tissue Tech growth in our guidance. We expect this very much to be in line with our expectation of the February call. So no change in there. We’re still expecting good growth coming from both CSS and Tissue Tech here in 2023.

Operator: And thank you for your questions. This concludes Integra LifeSciences first quarter earnings conference call. Thank you for your participation. You may now disconnect. Everyone, have a wonderful day.