INTEGRA LIFESCIENCES HOLDINGS CORP 10-Q

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion and analysis of the Company's financial condition and results of operations should be read in conjunction with our condensed consolidated financial statements and the related notes thereto appearing elsewhere in this report and our consolidated financial statements for the year ended December 31, 2020 included in our Annual Report on Form 10-K. We have made statements in this report which constitute forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended and Section 21E of the Securities Exchange Act of 1934 (the “Exchange Act”). These forward-looking statements are subject to a number of risks, uncertainties and assumptions about the Company and other matters. These forward-looking statements include, but are not limited to, statements related to the Company's expectations regarding the potential impacts of the COVID-19 pandemic on our business, financial condition, and results of operations. These statements should, therefore, be considered in light of various important factors, including, but not limited to, the following: the Company's ability to recover to normalized procedure volume in the midst of the COVID-19 pandemic; the risk that the COVID-19 pandemic could lead to further material delays and cancellations of, or reduced demand for, procedures; delayed capital spending by the Company's customers; disruption and/or higher costs to the Company’s supply chain; staffing shortages in hospitals; labor impacts in our facilities; delays in gathering clinical evidence; diversion of management and other resources to respond to the COVID-19 outbreak; the impact of global and regional economic and credit market conditions on healthcare spending; the risk that the COVID-19 virus disrupts local economies and causes economies in our key markets to enter prolonged recessions. The Company's actual results could differ materially from those anticipated in these forward-looking statements as a result of many factors, including but not limited to those set forth under the heading “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2020, under the heading "Risk Factors" in this report, and in other filings with the SEC. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, except to the extent required by applicable law. You can identify these forward-looking statements by forward-looking words such as “believe,” “may,” “might,” “could,” “will,” “estimate,” “continue,” “anticipate,” “intend,” “seek,” “plan,” “expect,” “should,” “would” and similar expressions in this report. GENERAL Integra, headquartered in Princeton, New Jersey, is a world leader in medical technology. The Company was founded in 1989 with the acquisition of an engineered collagen technology platform used to repair and regenerate tissue. Since then, Integra has developed numerous product lines from this technology for applications ranging from burn and deep tissue wounds, to the repair of dura mater in the brain, as well as nerves and tendons. The Company has expanded its base regenerative technology business to include surgical instruments, neurosurgical products and advanced wound care through a combination of several global acquisitions and development of products internally to further meet the needs of its customers and impact patient care. Integra manufactures and sells products in two reportable business segments: Codman Specialty Surgical and Tissue Technologies. Following the sale of the Extremity and Orthopedics business in the first quarter of 2021, the Company rebranded the Orthopedics and Tissue Technologies segment as Tissue Technologies. See Note 2. Acquisitions and Divestitures, for details. Our Codman Specialty Surgical products comprise of specialty surgical implants and instrumentation for a broad range of specialties. This segment includes products and solutions for dural access and repair, instruments, advanced energy, cerebral spinal fluid management and neuro monitoring including market leading product portfolios used in neurosurgery operation suites and critical care units. Codman Specialty Surgical products are sold through a combination of directly employed sales representatives, distributors and wholesalers, depending on the customer call point. Our Tissue Technologies product portfolios consist of differentiated regenerative technology products for soft tissue repair and tissue regeneration products, and surgical reconstruction. This business also includes private label sales of a broad set of our regenerative and wound care medicine technologies. Tissue Technologies products are sold through directly employed sales representatives and distributors focused on their respective surgical specialties, and strategic partners. We have key manufacturing and research facilities located in California, Indiana, Maryland, Massachusetts, New Jersey, Ohio, Tennessee, Canada, France, Germany, Ireland, Puerto Rico and Switzerland. We also source most of our handheld surgical instruments, and dural sealant products through specialized third-party vendors. Integra is committed to delivering high quality products that positively impact the lives of millions of patients and their families. We focus on four key pillars of our strategy: 1) enabling an execution-focused culture, 2) optimizing relevant scale, 3) advancing innovation and agility, and 4) leading in customer experience. We believe that by sharpening our focus on these areas through improved planning and communication, optimization of our infrastructure, and strategically aligned tuck-in acquisitions, we can build scale, increase competitiveness and achieve our long-term goals. 35 Table of Contents To this end, the executive leadership team has established the following key priorities aligned to the following areas of focus: Strategic Acquisitions. An important part of the Company's strategy is pursuing strategic transactions and licensing agreements that increase relevant scale in the clinical areas in which Integra competes. In December 2020, Integra entered into a merger agreement to acquire ACell, Inc., an innovative regenerative medicine company specializing in the manufacture of porcine urinary bladder extracellular matrices. This acquisition, which closed on January 20, 2021, expands our product offering of regenerative technology and is complementary to Integra’s existing tissue technologies portfolio. The acquisition also supports our long-term growth and profitability strategy with a financial profile similar to Integra’s tissue products. To date, all critical components of ACell Inc. integrating into our Tissue Technologies business have been completed ahead of schedule. See Note 2, Acquisitions and Divestitures , for details. Portfolio Optimization and New Product Introductions. We are investing in innovative product development to drive a multi-generational pipeline for our key product franchises. Our product development efforts span across our key global franchises focused on potential for significant returns on investment. We continue to advance the development of pioneering technologies from our 2019 acquisitions, Arkis Biosciences, Inc. and Rebound Therapeutics Corporation. In addition to new product development, we are funding studies to gather clinical evidence to support launches, ensure market access and improve reimbursement for existing products. We continue to identify ways of optimizing our portfolio including identifying low-growth, low-margin products and product franchises for discontinuation. In January 2021, we completed the sale of our Extremity Orthopedics business for approximately $240 million in cash. The Company finalized the net working capital and paid an additional $1.3 million to Smith & Nephew as of September 30, 2021. This transaction enables us to increase our investments in our core Neurosurgery and Tissue Technology businesses that will strengthen our existing leadership positions in both areas and fund pipeline opportunities to drive future growth and expand our addressable markets. See Note 2, Acquisitions and Divestitures for details. Commercial Channel Investments. With acquisitions, new product introductions and a broad portfolio of products, investing in our sales channels is a core part of our strategy to create specialization and greater focus on reaching new and existing customers and addressing their needs. To support our commercial efforts in Tissue Technologies, we expanded our two-tier specialist model to increase our presence in focused segments. We created a virtual selling organization to help serve the evolving needs of our customers. Internationally, we have increased our commercial resources significantly in key emerging markets and are making investments to support our sales organization and maximize our commercial opportunities. These investments in our international sales channel position us well for expansion and long-term growth. In addition, we continue to build upon our leadership brands across our product franchises to enable us to engage customers through enterprise-wide contracts. Customer Experience. We aspire to be ranked as a best-in-class provider and are committed to strengthen our relationships with all customers. We continue to invest in technologies, systems and processes to enhance the customer experience. Additionally, we launched new digital tools and programs, resources and virtual product training to drive continued customer familiarity with our growing portfolio of medical technologies globally. Clinical and Product Development Activities We continue to invest in collecting clinical evidence to support the Company's existing products and new product launches, and to ensure that we obtain market access for broader and more cost-effective solutions. In each area, we continue to benefit from products launched over the past several years. Within our Codman Specialty Surgical segment, the Company received U.S. Food and Drug Administration ("FDA") clearance in 2020 to treat malignant and benign tumors, but not limited to meningiomas and gliomas, for its CUSA® Clarity Ultrasonic Surgical Aspirator System, the first and only ultrasonic tissue ablation system with this specific indication. The FDA clearance is based on a wealth of peer-reviewed clinical publications and 40 years of surgical cases involving resection of brain and spinal tumors. Additionally, the Company continued to reap the benefits of our product launches from the prior year from the Codman Specialty Surgical segment, including our new electrosurgery generator and irrigator system, an innovative customer-centric toolkit for our Certas™ Plus Programmable Valve along with additional shunt configurations. In Japan, we are experiencing strong growth as a result of the successful launch of DuraGen® in mid-2019, which is the first and only collagen xenograft approved for use as a dural substitute in the country. We are focused on the development of core clinical applications in our electromechanical technologies portfolio. Also, we updated our CUSA Clarity platform to incorporate a new ultrasonic handpiece, surgical tips and integrated electrosurgical capabilities. We continue to work with several instrument partners to bring new surgical instrument platforms to the market. This enables us to add new instruments with minimal expense and invest in ongoing development, such as our next generation of LED technology with our DUO LED Surgical Headlight System. 36 Table of Contents We advanced the early-stage technology platforms we acquired during 2019. Through the Arkis Acquisition, we added a platform technology, CerebroFlo ® external ventricular drainage catheter with Endexo technology, a permanent additive designed to reduce the potential for catheter obstruction due to thrombus formation. The CerebroFlo ® EVD Catheter has demonstrated an average of 99% less thrombus accumulation onto its surface, in vitro, compared to a market leading EVD catheter. We acquired Rebound Therapeutics, a Company that specialized in single-use medical device, known as Aurora® Surgiscope®, which is the only tubular retractor system designed for cranial surgery with an integrated access channel, camera and lighting. In the third quarter of 2021, we conducted a limited clinical launch of the Aurora® Surgiscope® for use in minimally invasive neurosurgery as well as initiated a registry called MIRROR to collect data on early surgical intervention using Aurora for the treatment of intracerebral hemorrhage (ICH). In the third quarter of 2021, the CereLink ™ ICP Monitor System was launched in the U.S. and Europe to gather user data and feedback. CereLink ™ provides clinicians with uncompromised, advanced continuous ICP monitoring that until now, has not been available when treating patients with traumatic brain injuries. Within our Tissue Technologies segment, we recently completed one of the largest diabetic foot ulcers (DFU) randomized controlled trials (RCTs) of the PriMatrix® Dermal Repair Scaffold for the management of DFU. This multi-center study enrolled more than 225 patients with chronic DFU's over the course of 12-week treatments and 4-week follow-up phases. The results of this study, which was published in the Journal of Wound Care, demonstrated that PriMatrix® plus standard of care (SOC) consisting of sharp debridement, infection elimination, use of dressings and offloading was significantly more likely to achieve complete wound closure compared with SOC alone, with a median number of one application of the product. In 2020, we announced positive clinical and economic data on Integra® Bilayer Wound Matrix ("IBWM") in complex lower extremity reconstruction based on two retrospective studies recently published in Plastic and Reconstructive Surgery, the official journal of the American Society of Plastic Surgeons. As surgeons look for ways to efficiently and effectively repair and close wounds during these challenging times, IBWM helps address the efficiency needed in operating rooms by reducing both the operating time and costs to hospitals and patients. COVID-19 Pandemic During this global crisis, the Company's focus remained on supporting patients, providing customers with life-saving products, and protecting the well-being of our employees. The rapid and evolving spread of the virus has resulted in an unprecedented challenge to the global healthcare industry, as medical resources were reallocated to fight COVID-19. During the first half of 2020, in response to the pandemic, we acted swiftly by implementing protocols to ensure continuity of our manufacturing and distribution sites around the world and to provide for the safety of our employees. During the second half of 2020, the Company's revenues were still impacted due to COVID-19 resurgences, though not to the levels seen in the first half of 2020. During 2021, our business segments have benefited from the improving demand compared to 2020, driven by the ongoing global market recovery. We have seen improving order activity in products used in neurosurgery, instruments, burn and trauma as markets continue to recovery from 2020 levels. However, the COVID-19 Delta variant has impacted the pace of recovery in our business as we experienced regional variability driven in part by vaccination rates and local re-opening policies. The pace of recovery has also been more recently impacted by staffing shortages in hospitals and surgical centers. As a result, the Company has continued to manage its operating costs in this environment. We remain confident that the underlying markets in which the Company competes remain attractive. We also remain focused on managing the business for the long-term, including preserving full time jobs needed to support the rebound in surgical procedure volumes. The Company's adaptability and resiliency in the face of this unprecedented crisis is made possible in part by prior investments in technology infrastructure and operations, as well as our talented and committed global workforce. Capital markets and worldwide economies have also been significantly impacted by the COVID-19 pandemic, and it is possible that it could cause a local and/or global economic recession. Any such economic recession could have a material adverse effect on the Company's long-term business as hospitals curtail and reduce capital as well as overall spending. The COVID-19 pandemic and local actions, such as “shelter-in-place” orders and restrictions on travel and access to our customers or temporary closures of our facilities or the facilities of our suppliers and their contract manufacturers, disruption and/or higher costs to the Company’s supply chain, staffing shortages in hospitals and labor constraints in our facilities, could further impact our sales and our ability to ship our products and supply our customers. Any of these events could negatively impact the number of surgical and medical intervention procedures performed and have a material adverse effect on our business, financial condition, results of operations, or cash flows. FDA Matters We manufacture and distribute products derived from human tissue for which FDA has specific regulations governing human cells, tissues and cellular and tissue-based products, or HCT/Ps. An HCT/P is a product containing or consisting of human cells or tissue intended for transplantation into a human patient. 37 Table of Contents On June 22, 2015, the FDA issued an Untitled Letter (the "Untitled Letter") alleging that BioD's morselized amniotic membrane tissue-based products do not meet the criteria for regulation as HCT/Ps solely under Section 361 of the Public Health Services Act ("Section 361") and that, as a result, BioD would need a biologics license to lawfully market those morselized products. Since the issuance of the Untitled Letter, BioD and the Company have made known to the FDA their disagreement with the FDA’s assertion that certain products are more than minimally manipulated. The FDA has not changed its position that certain of the BioD acquired products are not eligible for marketing solely under Section 361. In July, 2020, the FDA issued the final guidance document related to human tissue titled, “Regulatory Considerations for Human Cells, Tissues, and Cellular and Tissue-Based Products: Minimal Manipulation and Homologous Use” (the “HCT/P Final Guidance”). This Guidance document supersedes the November 2017 guidance by the same title. The HCT/P Final Guidance maintains the FDA’s position that products such as the Company’s morselized amniotic membrane tissue-based products do not meet the criteria for regulation solely as HCT/Ps. In addition, in the November 2017 guidance, the FDA articulated a risk-based approach to enforcement and, while some uses for amniotic membrane tissue-based products would have as much as thirty-six months of enforcement discretion, other high risk uses could be subject to immediate enforcement action. The revised final guidance of July 2020 maintained this approach and extended the discretionary enforcement period to May 31, 2021. Considering the risk of enforcement action, the Company discontinued the manufacturing of all morselized amniotic membrane tissue-based products prior to May 31, 2021. We no longer distribute these products. As of September 30, 2021, the Company has not received any further notice of enforcement action from the FDA regarding its morselized amniotic membrane tissue-based products. Revenues from the now discontinued BioD morselized amniotic membrane-based products for the nine months ended September 30, 2021 were less than 1.0% of consolidated revenues. On March 7, 2019, TEI Biosciences, Inc. ("TEI"), a subsidiary of the Company received a Warning Letter (the “Warning Letter”), dated March 6, 2019, from the FDA. The warning letter relates to quality systems issues at TEI's manufacturing facility located in Boston, Massachusetts. The letter resulted from an inspection held at that facility in October and November 2018 and did not identify any new observations that were not already provided in the Form 483 that followed the inspection. The Company submitted its initial response to the FDA Warning Letter on March 28, 2019 and provides regular progress reports to the FDA as to its corrective actions and, since the conclusion of the inspection, has undertaken significant efforts to remediate the observations and continues to do so. The warning letter does not restrict the Company’s ability to manufacture or ship products or require the recall of any products. Nor does it restrict our ability to seek FDA 510(k) clearance of products. The letter states that requests for Certificates to Foreign Governments would not be granted. However, due to our monthly progress reports, the FDA agreed to issue Certificates to Foreign Governments for the products manufactured at TEI due to substantial progress and the length of time it takes to resolve the Warning Letter. Additionally, premarket approval applications for Class III devices to which the Quality System regulation violations are reasonably related will not be approved until the violations have been corrected. The TEI Boston facility manufactures extracellular bovine matrix products. The Company does not expect to incur material incremental expense for remediation activities. We cannot, however, give any assurances that the FDA will be satisfied with our response to the Warning Letter or as to the expected date of the resolution of the matters included in the letter. Until the issues cited in the letter are resolved to the FDA’s satisfaction, the FDA may initiate additional regulatory action without further notice. Any adverse regulatory action, depending on its magnitude, may restrict us from effectively manufacturing, marketing and selling our products and could have a material adverse effect on our business, financial condition and results of operations. Revenues of products manufactured in the TEI Boston facility for the nine months ended September 30, 2021 were approximately 4.6% of consolidated revenues. ACQUISITIONS & DIVESTITURES Divestiture On January 4, 2021, the Company completed its previously announced sale of its Extremity Orthopedics business to Smith & Nephew USD Limited. The transaction included the sale of the Company's upper and lower Extremity Orthopedics product portfolio, including ankle and shoulder arthroplasty and hand and wrist product lines. The Company received an aggregate purchase price of $240.0 million from Smith and Nephew and concurrently paid $41.5 million to the Consortium of Focused Orthopedists, LLC ("CFO") effectively terminating the licensing agreement between Integra and CFO relating to the development of shoulder arthroplasty products. The Company recognized a gain of $42.0 million in connection with the sale that is presented in Gain from the sale of business in the consolidated statement of operations for the year ended September 30, 2021. See Note 2- Acquisitions and Divestitures for details. 38 Table of Contents Acquisition On January 20, 2021, the Company acquired ACell, Inc. for an acquisition purchase price of $306.9 million plus contingent consideration obligations of up to $100 million, that may be payable upon achieving certain revenue-based performance milestones in 2022, 2023 and 2025 . ACell was a privately-held company that offered a portfolio of regenerative products for complex wound management, including developing and commercializing products based on MatriStem Urinary Bladder Matrix ("UBM"), a technology platform derived from porcine urinary bladder extracellular matrix. See Note 2- Acquisitions and Divestitures for details. OPTIMIZATION AND INTEGRATION ACTIVITIES As a result of our ongoing acquisition strategy and significant growth in recent years, we have undertaken cost-saving initiatives to consolidate manufacturing operations, distribution facilities and transfer activities, implement a common ERP system, eliminate duplicative positions, realign various sales and marketing activities, and expand and upgrade production capacity for our regenerative technology products. These efforts are expected to continue and while we expect a positive impact from ongoing restructuring, integration, and manufacturing transfer and expansion activities, such results remain uncertain. RESULTS OF OPERATIONS Executive Summary Net income for the three months ended September 30, 2021 was $43.2 million, or $0.51 per diluted share, as compared to $32.3 million or $0.38 per diluted share for the three months ended September 30, 2020. The increase in net income for the three months ended September 30, 2021, was primarily driven by higher revenues across most franchises compared to the prior year due to continuing recovery in surgical procedure volumes experienced from the COVID-19 pandemic, partially offset by higher operating expenses as costs continued to normalized after 2020 cost reduction actions. Within non-operating income and expense, the Company benefited from lower interest expense and higher other income. Net income for the nine months ended September 30, 2021 was $123.7 million, or $1.45 per diluted share, as compared to $41.1 million or $0.48 per diluted share for the nine months ended September 30, 2020. The increase in net income for the nine months ended September 30, 2021 was primarily driven by higher revenue relating to surgical procedure recovery and increase in non-operating income due to the gain of $42.0 million recognized in the first quarter of 2021 as a result of the sale of the Extremity Orthopedics business. Special Charges Income before taxes includes the following special charges : Three Months Ended September 30, Nine Months Ended September 30, Dollars in thousands 2021 2020 2021 2020 Acquisition, divestiture and integration-related charges (1) $ 2,637 $ 7,148 $ (13,588) $ 19,856 Structural optimization charges 6,696 4,543 15,051 9,015 EU medical device regulation 7,077 2,399 16,240 5,470 Discontinued product lines charges 23 999 359 5,486 Convertible debt non-cash interest expense — 4,295 — 11,075 Expenses related to debt refinancing — 3,428 — 6,168 COVID-19 pandemic related charges (2) — (192) — 3,644 Total $ 16,433 $ 22,620 $ 18,062 $ 60,714 (1) The Company completed its sale of its Extremity Orthopedics business and recognized a gain of $42.0 million for the nine months ended September 30, 2021 which was partially offset by other acquisition, divestiture and integration-related charges. See Note 2- Acquisitions and Divestitures for details. (2) Charges relate to business interruptions and costs associated with the COVID-19 pandemic which impacted the Company's operations globally, partially offset by Coronavirus government relief programs in the prior year. 39 Table of Contents The items reported above are reflected in the condensed consolidated statements of operations as follows: Three Months Ended September 30, Nine Months Ended September 30, 2021 Dollars in thousands 2021 2020 2021 2020 Cost of goods sold $ 5,854 $ 6,892 $ 26,757 $ 22,500 Research and development 5,517 859 13,140 432 Selling, general and administrative 6,386 7,146 24,443 20,539 Interest expense (1) — 7,723 — 17,243 Gain from the sale of business 230 — (41,967) — Other income (1,554) — (4,311) $ — Total $ 16,433 $ 22,620 $ 18,062 $ 60,714 (1) Upon adoption of ASU No. 2020-06, the Company will no longer incur non-cash interest expense for the amortization of debt discount. See Note 1- Basis of Presentation , for details. We typically define special charges as items for which the amounts and/or timing of such expenses may vary significantly from period to period, depending upon our acquisition, divestiture, integration and restructuring activities, and for which the amounts are non-cash in nature, or for which the amounts are not expected to recur at the same magnitude. We believe that given our ongoing strategy of seeking acquisitions, our continuing focus on rationalizing our existing manufacturing and distribution infrastructure and our continuing review of various product lines in relation to our current business strategy, some of the special charges discussed above could recur with similar materiality in the future. We believe that the separate identification of these special charges provides important supplemental information to investors regarding financial and business trends relating to our financial condition and results of operations. Investors may find this information useful in assessing comparability of our operating performance from period to period, against the business model objectives that management has established, and against other companies in our industry. We provide this information to investors so that they can analyze our operating results in the same way that management does and to use this information in their assessment of our core business and valuation of Integra. Revenues and Gross Margin The Company's revenues and gross margin on product revenues were as follows: Three Months Ended September 30, Nine Months Ended September 30, Dollars in thousands 2021 2020 2021 2020 Segment Net Sales Codman Specialty Surgical $ 256,497 $ 239,323 $ 754,575 $ 640,541 Tissue Technologies 130,364 130,909 382,349 342,680 Total revenues $ 386,861 $ 370,232 $ 1,136,924 983,221 Cost of goods sold 144,468 134,811 441,558 373,765 Gross margin on total revenues $ 242,393 $ 235,421 $ 695,366 $ 609,456 Gross margin as a percentage of total revenues 62.7 % 63.6 % 61.2 % 62.0 % Three Months Ended September 30, 2021 as Compared to Three Months Ended September 30, 2020 Revenues For the three months ended September 30, 2021, total revenues increased by $16.6 million to $386.9 million from $370.2 million for the same period in 2020. Dom estic revenues increased by $9.3 million, or 3.5%, to $275.8 million and were 71.3% of total revenues for the three months ended September 30, 2021 compared to $266.5 million during the same period in the prior year. International revenues increased by $7.3 million or 7.0% to $111.1 million for the three months ended September 30, 2021 compared to $103.8 million during the same period in the prior year. The increase in revenues was primarily driven by the recovery experienced from the COVID-19 pandemic across most franchises due to continuing recovery in surgical procedure volumes compared to the prior period, as well as the launch of the CereLink ™ ICP Monitor which occurred in the third quarter. Foreign exchange fluctuations had a favorable impact of $1.0 million on revenues for the quarter. In the Codman Specialty Surgical segment ("CSS"), revenues were $256.5 million which was an increase of $17.2 million, or 7.2% as compared to the prior-year period. The Company saw growth within our Neurosurgery portfolio primarily with sales in neuromonitoring increasing low double digits due to the launch of the CereLink™ ICP Monitor as well as sales in advanced energy increasing high single digits and dural access and repair increasing mid-single digits. Sales in our instruments portfolio increased low double digits as compared to the same period in the prior year driven by order recovery. 40 Table of Contents In the Tissue Technologies ("TT") segment, revenues were $130.4 million which was a decrease of $0.5 million, or 0.4% from the prior-year period. Within TT, our Extremity Orthopedics business was divested on January 4, 2021. Our Wound Reconstruction business, excluding the impact of acquisitions, increased low single digits and sales in our Private Label business increased low double digits as a result of continuing recovery in order trends from our customers. We continue to closely monitor local, regional, and global COVID-19 surges as well as new variants of the virus for an impact on procedures during Q4 2021 and beyond. The reallocation of hospital resources to treat COVID-19 and staffing shortages may continue to cause a financial strain on healthcare systems and reduce procedural volumes. Additionally, the Company does not expect all markets and product lines to improve at the same rate based on the level of recurrence of COVID-19 and its associated impact on the pace of procedure recovery and economic normalization. Gross Margin Gross margin increased to $242.4 million for the three months ended September 30, 2021, an increase of $7.0 million from $235.4 million for the sa me period in 2020. Gross margin as a percentage of revenues decreased to 62.7% from 63.6% in the same period last year. This decrease was mainly attributable to increased amortization associated with technology-based intangible assets. Operating Expenses The following is a summary of operating expenses as a percent of total revenues: Three Months Ended September 30, 2021 2020 Research and development 6.7 % 5.3 % Selling, general and administrative 40.3 % 40.5 % Intangible asset amortization 1.1 % 2.3 % Total operating expenses 48.1 % 48.1 % Total operating expenses, which consist of research and development, selling, general and administrative, and amortization expenses, increased by $8.1 million, or 4.6% to $186.0 million in the three months ended September 30, 2021, compared to $177.9 million in the same period in 2020. The increase in operating expenses compared to the prior year reflects costs associated with higher employee related costs, increased research and development as well as increased outside spending as revenue recovered. T he Company continues to manage and prioritize it operating costs closely given the continued uncertainty of COVID-19. We also benefited from cost synergies as a result of the acquisition of ACell and the sale of the Extremity Orthopedics business. Research and Development Research and development expenses for the three months ended September 30, 2021 increased by $6.4 million as compared to the same period in the prior year. This increase in spending resulted from additional spending on new product development, clinical studies and additional spending due to the European Union Medical Device Regulation compliance. Selling, General and Administrative Selling, general and administrative costs increased by $5.9 million as compared to the same period in the prior year driven primarily due to costs associated with higher employee related costs as well as increased outside spending as revenue recovered. Intangible Asset Amortization A mortization expense (excludin g amounts reported in cost of product revenues for technology-based intangible assets) for the three months ended September 30, 2021 was $4.1 million compared to $8.3 million for the same period in prior year primarily due to a reduction in amortization expense associated with intangible assets sold in conjunction with the sale of the Extremity Orthopedics business during the current year. 41 Table of Contents Non-Operating Income and Expenses The following is a summary of non-operating income and expenses: Three Months Ended September 30, Dollars in thousands 2021 2020 Interest income $ 1,786 $ 2,273 Interest expense (12,192) (20,796) Gain (loss) from the sale of business (230) — Other income, net 4,985 2,492 Total non-operating income and expense $ (5,651) $ (16,031) Interest Income Interest income for the three months ended September 30, 2021 decreased by $0.5 million as compared to the same period last year. Interest Expense Interest expense for the three months ended September 30, 2021 decreased by $8.6 million as compared to the same period in the prior year primarily due the elimination of the non-cash interest expense as the result of the adoption ASU 2020-06 and the expenses associated with Amended and Restated Senior Credit Agreement which occurred in the prior period. See Note 1- Basis of Presentation for details in relation to the adoption of ASU 2020-06. Other Income, net Other income, net for the three months ended September 30, 2021 increased by $2.5 million compared to the same period in the prior year primarily due to income associated with the transition services agreement from the divestiture of the Extremity Orthopedics business which was partially offset by an unfavorable impact of foreign exchange in the prior year. Income Taxes Three Months Ended September 30, Dollars in thousands 2021 2020 Income before income taxes $ 50,788 $ 41,511 Income tax (benefit) expense 7,559 9,174 Effective tax rate 14.9 % 22.1 % The Company’s effective income tax rates for the three months ended September 30, 2021 and 2020 were 14.9% and 22.1%, respectively. For the three months ended September 30, 2021, the primary drivers of the tax rate is due to the jurisdictional mix of income and a benefit related to excess tax benefits from stock compensation. For the three months ended September 30, 2020, the primary drivers of the tax rate are due to the jurisdictional mix of income and a $4.2 million recognition of a deferred tax liability related to an outside tax basis from the sale of the Extremity Orthopedics business, offset by the reversal of $3.2 million valuation allowance on certain foreign deferred tax assets as the Company determined that it was more likely than not that these foreign deferred tax assets would be realized. The effective tax rate may vary from period to period depending on, among other factors, the geographic and business mix of taxable earnings and losses, tax planning and settlements with various taxing authorities. We consider these factors and others, including the Company's history of generating taxable earnings, in assessing our ability to realize tax assets on a quarterly basis. Additionally, changes to income tax laws and regulations, in any of the tax jurisdictions in which the Company operates, could impact the effective tax rate. Various governments, both U.S. and non-U.S., are increasingly focused on tax reform and revenue-raising legislation. The current U.S. administration has proposed tax reform which, if enacted, would increase the Company’s U.S. federal income tax liability. Further, legislation in foreign jurisdictions may be enacted, in response to the base erosion and profit-shifting (BEPS) project begun by the Organization for Economic Cooperation and Development (OECD). The OECD recently finalized major reform of the international tax system with respect to a minimum tax rate. Such changes in U.S. and Non-U.S. jurisdictions could have an adverse effect on the Company’s effective tax rate. 42 Table of Contents While it is often difficult to predict the outcome or the timing of the resolution of a particular matter with the various federal, state, and foreign tax authorities, we believe that our reserves reflect the most probable outcome of known tax contingencies. Settlement of a particular issue would usually require the use of cash. A favorable resolution would be recognized as a reduction to our annual effective tax rate in the year of resolution. The Company's tax reserves are presented in the balance sheet within other liabilities, except for amounts relating to items that we expect to pay in the coming year, which would be classified as current income taxes payable. Nine Months Ended September 30, 2021 as Compared to Nine Months Ended September 30, 2020 Revenues and Gross Margin For the nine months ended September 30, 2021, total revenues increased by $153.7 million to $1,136.9 million from $983.2 million for the same period in 2020. Domestic revenues increased by $106.6 million, or 15.3%, to $801.8 million and were 70.5% of total revenues for the nine months ended September 30, 2021. International revenues increased by $47.1 million, or 16.4% to $335.2 million for the nine months ended September 30, 2021 compared to $288.0 million during the same period in the prior year. The net increase of $153.7 million was a result of continuing recovery in surgical procedure volumes experienced from the COVID-19 pandemic across all franchises. Foreign exchange fluctuations had a favorable impact of $12.9 million on revenues for the year. Codman Specialty Surgical revenues were $754.6 million, an increase of $114.0 million, or 17.8% from the prior-year period. The Neurosurgery and Instrument portfolios increased low-double digits as a result of the continued recovery experienced from the COVID-19 pandemic. Tissue Technologies revenues were $382.3 million, an increase of $39.7 million, or 11.6% from the prior-year period. Within TT, our Extremity Orthopedics business was divested on January 4, 2021. Sales in our Wound Reconstruction business, excluding the impact of acquisitions, and sales in our Private Label business both increased low double digits as a result of continued recovery experienced from the COVID-19 pandemic. Gross Margin Gross margin was $695.4 million for the nine months period ended September 30, 2021, an increase of $85.9 million from $609.5 million for the same period last year. Gross margin as a percentage of total revenue decreased to 61.2% for the nine months ended September 30, 2021 from 62.0% in the sam e period last year. The decrease in gross margin percentage was due to increased amortization associated with technology-based intangible assets and inventory step-up amortization in connection with the ACell Acquisition. Operating Expenses The following is a summary of operating expenses as a percent of total revenues: Nine Months Ended September 30, 2021 2020 Research and development 6.0 % 5.6 % Selling, general and administrative 41.8 % 44.0 % Intangible asset amortization 1.1 % 2.4 % Total operating expenses 48.9 % 52.0 % Total operating expenses, which consist of selling, general and administrative expenses, research and development expenses, and amortization expenses, increased by $45.6 million, or 8.9% to $556.4 million in the nine months ended September 30, 2021, compared to $510.7 million in the same period in 2020. Research and Development Research and development expenses for the nine months ended September 30, 2021 increased by $13.1 million as compared to the same period in the prior year. This increase in spending resulted from additional spending on new product development, clinical studies and additional spending due to the European Union Medical Device Regulation compliance. Selling, General and Administrative Selling, general and administrative costs increased by $43.1 million as compared to the same period in the prior year driven primarily due to higher employee related costs, higher incentive and stock-based compensation, as well as increased outside spending as revenue recovered. 43 Table of Contents Intangible Asset Amortization A mortization expense (excludin g amounts reported in cost of product revenues for technology-based intangible assets) for the nine months ended September 30, 2021 was $12.8 million compared to $23.4 million for the same period in prior year primarily due to a reduction in amortization expense associated with intangible assets sold in conjunction with the sale of the Extremity Orthopedics business during the current year as well as accelerated amortization expense associated with an intangible asset which was recorded in the prior year. We expect total annual amortization expense to be app roximately $20.2 million for the remainder of 2021, $78.8 million in 2022, $78.1 million in 2023, $77.4 million in 2024, $77.4 million in 2025, $77.2 million in 2026 and $588.9 million thereafter. Non-Operating Income and Expenses The following is a summary of non-operating income and expenses: Nine Months Ended September 30, Dollars in thousands 2021 2020 Interest income $ 5,298 $ 7,124 Interest expense (38,270) (54,230) Gain from the sale of business 41,967 — Other income, net 14,888 2,985 Total non-operating income and expense $ 23,883 $ (44,121) Interest Income In terest income for the nine months ended September 30, 2021 decreased by $1.8 million as compared to the same period last year primarily due to the settlement of cross-currency swaps designated as net investment hedges during Q4 2020. Interest Expense Interest expense for the nine months ended September 30, 2021 decreased by $16.0 million as compared to the same period last year primarily due to the elimination of the non-cash interest expense as the result of the adoption ASU 2020-06 and the expenses associated with Amended and Restated Senior Credit Agreement which occurred in the prior period. See Note 1- Basis of Presentation for details in relation to the adoption of ASU 2020-06. Gain from the sale of business On January 4, 2021, the Company completed its sale of its Extremity Orthopedics business and recognized a gain of $42.0 million in the first quarter of the current year. Other Income, net Other income, net for the nine months ended September 30, 2021, increased by $11.9 million primarily due to income associated with the transition services agreement with Smith and Nephew which was partially offset by an unfavorable impact of foreign exchange in the prior year. Income Taxes Nine Months Ended September 30, Dollars in thousands 2021 2020 Income before income taxes $ 162,890 $ 54,604 Income tax (benefit) expense 39,199 13,456 Effective tax rate 24.1 % 24.6 % The Company’s effective income tax rates for the nine months ended September 30, 2021 and 2020 were 24.1% and 24.6%, r espectively. For the nine months ended September 30, 2021, the primary driver of the tax rate is due to the jurisdictional mix of income and a benefit related to excess tax benefits from stock compensation, offset by the tax impact of the gain on the sale of the Extremity Orthopedics business which was completed during the first quarter of 2021. For the nine months ended September 30, 2020, the primary drivers of the tax rate are the jurisdictional mix of income and a $4.2 million recognition of a deferred tax liability related to an outside tax basis from the sale of the Extremity Orthopedics business. The Company expects its effective income tax rate for the full year to be approximately 24.1%, driven primarily by the jurisdictional mix of income and the tax impact of the gain from the sale of its Extremity Orthopedic business, which closed during the first quarter. 44 Table of Contents The effective tax rate may vary from period to period depending on, among other factors, the geographic and business mix of taxable earnings and losses, tax planning and settlements with various taxing authorities. We consider these factors and others, including the Company's history of generating taxable earnings, in assessing our ability to realize tax assets on a quarterly basis. Additionally, changes to income tax laws and regulations, in any of the tax jurisdictions in which the Company operates, could impact the effective tax rate. Various governments, both U.S. and non-U.S., are increasingly focused on tax reform and revenue-raising legislation. The current U.S. administration has proposed tax reform which, if enacted, would increase the Company’s U.S. federal income tax liability. Further, legislation in foreign jurisdictions may be enacted, in response to the base erosion and profit-shifting (BEPS) project begun by the Organization for Economic Cooperation and Development (OECD). The OECD recently finalized major reform of the international tax system with respect to a minimum tax rate. Such changes in U.S. and Non-U.S. jurisdictions could have an adverse effect on the Company’s effective tax rate. While it is often difficult to predict the outcome or the timing of the resolution of a particular matter with the various federal, state, and foreign tax authorities, we believe that our reserves reflect the most probable outcome of known tax contingencies. Settlement of a particular issue would usually require the use of cash. Favorable resolution would be recognized as a reduction to our annual effective tax rate in the year of resolution. The tax reserves are presented in the balance sheet within other liabilities, except for amounts relating to items we expect to pay in the coming year, which would be classified as current income taxes payable. GEOGRAPHIC PRODUCT REVENUES AND OPERATIONS The Company attributes revenues to geographic areas based on the location of the customer. Total revenue by major geographic area consisted of the following: Three Months Ended September 30, Nine Months Ended September 30, Dollars in thousands 2021 2020 2021 2020 United States $ 275,775 $ 266,477 $ 801,754 $ 695,179 Europe 46,458 45,995 140,714 123,917 Asia Pacific 45,015 40,473 136,616 113,934 Rest of World 19,613 17,287 57,840 50,191 Total Revenues $ 386,861 $ 370,232 $ 1,136,924 $ 983,221 The Company generates significant revenues outside the U.S., a portion of which are U.S. dollar-denominated transactions conducted with customers that generate revenue in currencies other than the U.S. dollar. As a result, currency fluctuations between the U.S. dollar and the currencies in which those customers do business could have an impact on the demand for the Company's products in foreign countries. Local economic conditions, regulatory compliance or political considerations, the effectiveness of our sales representatives and distributors, local competition and changes in local medical practice all may combine to affect our sales into markets outside the U.S. Domestic revenues increased by $9.3 million for the three months ended September 30, 2021 compared to the same period last year. European sales increased by $0.5 million for the three months ended September 30, 2021 compared to the same period last year. Sales to customers in Asia Pacific increased by $4.5 million for the three months ended September 30, 2021. The Rest of World for the three months ended September 30, 2021 increased by $2.3 million compared to the same period last year. The increase in revenues globally was primarily driven by the continued recovery experienced from the COVID-19 pandemic across all franchises compared to the prior year due to rebound in surgical procedure volumes as well as the launch of the CereLink ™ ICP Monitor which occurred in the third quarter. Sales in China and Japan continue to drive international growth, and continue to see improving performance in several key markets in Europe, Canada and our indirect markets. Domestic revenues increased by $106.6 million for the nine months ended September 30, 2021 compared to the same period last year. European sales increased by $16.8 million for the nine months ended September 30, 2021 compared to the same period last year. Sales to customers in Asia Pacific increased by $22.7 million for the nine months ended September 30, 2021. The Rest of World for the nine months ended September 30, 2021 increased by $7.6 million compared to the same period last year. The increase in revenues globally was primarily as a result of the continued recovery experienced from the COVID-19 pandemic across all franchises compared to the prior year due to rebound in surgical procedure volumes. LIQUIDITY AND CAPITAL RESOURCES Working Capital The working capital as of September 30, 2021 and December 31, 2020 was $770.9 million and $836.2 million, respectively. Working capital consists of total current assets less total current liabilities as presented in the consolidated balance sheets. Cash and Marketable Securities 45 Table of Contents The Company had cash and cash equivalents totaling approximately $470.2 million at September 30, 2021 and December 31, 2020 respectively, which are valued based on Level 1 measurements in the fair value hierarchy. At September 30, 2021, our non-U.S. subsidiaries held approximately $265.6 million of cash and cash equivalents that are available for use outside the U.S. The Company asserts that it has the ability and intends to indefinitely reinvest the undistributed earnings from its foreign operations unless there is no material tax cost to remit the earnings into the U.S. The Company does not anticipate the need to repatriate earnings from foreign subsidiaries as a result of the impact of the COVID-19 pandemic. Cash Flows Nine Months Ended September 30, Dollars in thousands 2021 2020 Net cash provided by operating activities $ 243,150 $ 123,570 Net cash used in investing activities (133,958) (32,152) Net cash (used) provided by financing activities (98,747) 100,403 Effect of exchange rate fluctuations on cash (10,380) 5,547 Cash Flows Provided by Operating Activities Operating cash flows for the nine months ended September 30, 2021 increased by $119.6 million compared to the same period in 2020. Net income after removing the impact of the gain on sale of business and non-cash adjustments increased for the nine months ended September 30, 2021 by approximately $25.4 million as compared to the same period in 2020 primarily due to the continuing revenue recovery in the current year as compared to the height of the COVID-19 pandemic in the first half of the 2020. The changes in assets and liabilities, net of business acquisitions, increased cash flows by $43.4 million as compared to the decrease of $50.8 million for the same period in 2020. The improvement in 2021 working capital is attributable to a smaller increase in inventory of $3.6 million due to investments in building safety stock made in the prior year where inventory increased by $45.5 million. Operating cash flows for the nine months ended September 30, 2020 decreased compared to the same period in 2019. For the nine months ended September 30, 2020, net income after non-cash adjustments decreased by approximately $21.3 million to $174.4 million from $195.7 million when compared to the same period in 2019 primarily due to adverse effects of the COVID-19 pandemic. The changes in assets and liabilities, net of business acquisitions, decreased cash flows from operating activities by $50.8 million for the nine months ended September 30, 2020 compared to a decrease of $53.5 million for the same period in 2019. The decrease in 2020 is attributable to an increase in inventory to improve safety stock of select products. In addition, decreases were also driven by reduced payables offset by decreases in accounts receivable due to lower revenue and continued collection efforts. Cash Flows Used in Investing Activities During the nine months ended September 30, 2021, we paid a net cash amount of $303.9 million in relation to the acquisition of ACell and received net proceeds of $190.5 million for the sale of the Extremity Orthopedics business. The Company also paid for $20.6 million capital expenditures to support operations improvement initiatives at a number of our manufacturing facilities and other information technology investments. During the nine months ended September 30, 2020, the Company paid $30.5 million for capital expenditures, most of which were directed to our facilities located in Mansfield, MA; Boston, MA; Memphis, TN; and Princeton, NJ. Cash Flows Used in Financing Activities Uses of cash from financing activities in the nine months ended September 30, 2021 were repayments of $114.3 million under our Senior Credit Facility and Securitization Facility. In addition, the Company had $4.3 million in cash taxes paid in net equity settlements. These uses were offset by $6.6 million proceeds from the exercise of stock options and $13.5 million borrowings under our Senior Credit Facility and Securitization Facility. Sources of cash from financing activities in the nine months ended September 30, 2020 were $515.3 million proceeds from the issuance of Convertible Senior Notes including the call and warrant transactions, $151.3 million borrowing under our Senior Credit Facility and Securitization Facility. These were offset by repayments of $441.0 million on the revolving portion of our Senior Credit Facility and Securitization Facility, $24.3 million debt issuance costs related to the Amended and Restated Senior Credit Agreement and the issuance of the 2025 Notes and $100.0 million purchases of treasury stock. 46 Table of Contents Amended and Restated Senior Credit Agreement, Convertible Senior Notes, Securitization and Related Hedging Activities See Note 6, Debt to the current period’s condensed consolidated financial statements for a discussion of our Amended and Restated Senior Credit Agreement, the 2025 Notes and Securitization Facility and Note 7- Derivative Instruments for discussion of our hedging activities. We are forecasting that sales and earnings for the next twelve months will be sufficient to remain in compliance with our financial covenants under the terms of the February 2020 Amendment and July 2020 Amendment to the Senior Credit Facility. Share Repurchase Plan On December 7, 2020, the Board authorized the Company to repurchase up to $225 million of the Company’s common stock. The program allows the Company to repurchase its shares opportunistically from time to time. The repurchase authorization expires in December 2022. The Company has $225.0 million remaining under the share repurchase of its Common Stock. The price and timing of any future purchases under the share repurchase program will depend on factors such as levels of cash generation from operations, the volume of stock option exercises by employees, cash requirements for acquisitions, dividends, economic and market conditions and stock price. During the year ended December 31, 2020, the Company repurchased 2.1 million shares of Integra’s common stock as a part of our previous share repurchase authorization. The Company utilized $100.0 million of net proceeds from the offering of the 2025 Notes to execute the share repurchase transactions. This included $7.6 million from certain purchasers of the convertible notes in conjunction with the closing of the offering. On February 5, 2020, the Company entered into a $92.4 million accelerated share repurchase ("ASR") to complete the remaining $100.0 million of share repurchase. The Company received 1.3 million shares through the ASR, which represented approximately 80% of the expected total shares. Upon settlement of the ASR in June 2020, the Company received an additional 0.6 million shares determined using the volume-weighted average price of the Company's common stock during the term of the transaction. Dividend Policy The Company has not paid any cash dividends on our common stock since our formation. Our Senior Credit Facility limits the amount of dividends that we may pay. Any future determinations to pay cash dividends on our common stock will be at the discretion of the Board and will depend upon our financial condition, results of operations, cash flows and other factors deemed relevant by the Board. Capital Resources We believe that our cash and available borrowings under the Senior Credit Facility are sufficient to finance our operations and capital expenditures for the foreseeable future. Our future capital requirements will depend on many factors, including the growth of our business, the timing and introduction of new products and investments, strategic plans and acquisitions, among others. Additional sources of liquidity available to us include short term borrowings and the issuance of long term debt and equity securities. Off-Balance Sheet Arrangements We do not have any off–balance sheet financing arrangements during the nine months ended September 30, 2021 that have or are reasonably likely to have, a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that are material to our interests. 47 Table of Contents Contractual Obligations and Commitments As of September 30, 2021, the Company is obligated to pay the following amounts under various agreements: Payments Due by Calendar Year Dollars in millions Total Remaining 2021 2022-2023 2024-2025 Thereafter Revolving Credit Facility (1) $ 20.0 $ — $ — $ 20.0 $ — Term Loan 855.0 11.2 106.9 736.9 — Securitization Facility (1) 111.7 — — 111.7 — Convertible Debt (4) 575.0 — — 575.0 — Interest (2) 36.9 5.7 21.1 10.1 — Employment Agreements (3) 0.3 0.3 — — — Operating Leases 143.6 4.2 32.1 23.8 83.5 Purchase Obligations 3.8 0.5 3.3 — — Other 3.4 0.4 1.0 2.0 — Total $ 1,749.7 $ 22.3 $ 164.4 $ 1,479.5 $ 83.5 (1) The Company may borrow and make payments against the revolving credit portion of its Senior Credit Facility and Securitization Facility from time to time and considers all of the outstanding amounts to be long term based on its current intent and ability to repay the borrowing outside of the next twelve-month period. (2) Interest is calculated on the term loan portion of the Senior Credit Facility based on LIBOR plus the spread paid by the Company. As the revolving credit facility and Securitization Facility can be repaid at any time, no interest has been included in the calculation. (3) Amounts shown under Employment Agreements do not include compensation resulting from a change in control. (4) On February 4, 2020, the Company issued $575.0 million aggregate principal amount of its of 0.5% Convertible Senior Notes due 2025 (the "2025 Notes"). The 2025 Notes will mature on August 15, 2025 and bear interest at a rate of 0.5% per annum payable semi-annually in arrears, unless earlier converted, repurchased or redeemed in accordance with the terms of the Notes. See Note 6- Debt , for the details on the 2025 Notes. The Company has excluded its contingent consideration obligation related to prior and current year acquisitions from the contractual obligations table above; this liability had a total estim ated fair value of $37.8 million at September 30, 2021. This liability has been excluded because the amount to be paid or the potential payment date is not fixed. The Company has excluded its future pension contribution obligations from the table above. This has been excluded because the future amounts to be paid and the potential payment dates are not fixed. The Company has excluded the liability for uncertain tax benefits from the contractual obligations table above, including i nterest and penalties, totaling $0.8 million at September 30, 2021. This liabili ty for uncertain tax benefits has been excluded because we cannot make a reliable estimate of the period in which the uncertain tax benefits may be realized. OTHER MATTERS Critical Accounting Estimates The critical accounting estimates included in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2020 have not materially changed. Recently Issued Accounting Standards Information regarding new accounting pronouncements is included in Note 1 - Basis of Presentation to the current period’s condensed consolidated financial statements. 48 Table of Contents