Integer Holdings Corporation — Q2 2020 Form 10-Q Summary
Business context and reporting period
Integer is a medical device outsource manufacturer serving cardiac, neuromodulation, vascular, orthopedic, advanced surgical and portable medical markets, with a smaller Non-Medical segment focused primarily on specialized batteries. The quarter ended July 3, 2020 and comprised 91 days; the comparable quarter ended June 28, 2019. The first six months comprised 185 days in 2020 versus 182 days in 2019. Results exclude the Advanced Surgical and Orthopedic product lines sold in 2018, which are presented as discontinued operations.
Key financial metrics
| Metric | Q2 2020 | Q2 2019 | Six months 2020 | Six months 2019 |
|---|---|---|---|---|
| Sales | $240.1 million | $314.2 million | $568.5 million | $628.9 million |
| Gross profit / margin | $57.9 million / 24.1% | $97.0 million / 30.9% | $154.6 million / 27.2% | $185.6 million / 29.5% |
| Operating income / margin | $9.2 million / 3.8% | $49.3 million / 15.7% | $53.3 million / 9.4% | $88.5 million / 14.1% |
| Income from continuing operations | $0.4 million | $28.2 million | $31.5 million | $49.6 million |
| Diluted EPS from continuing operations | $0.01 | $0.85 | $0.95 | $1.50 |
| Net income | $0.4 million | $33.1 million | $31.5 million | $54.7 million |
| Cash flow from operations | Not separately provided | Not separately provided | $78.0 million | $67.6 million |
Q2 sales declined 23.6%, while gross profit declined 40.3% and operating income declined 81.4%. Six-month sales declined 9.6%, and continuing-operations income declined 36.5%. Interest expense decreased to $9.3 million in Q2 and $19.6 million for the six months, primarily because of lower interest rates. The Q2 effective tax rate was negative 135.8% on minimal pretax income; the six-month rate was 14.4%.
- Medical sales declined 22.2% in Q2 and 8.2% year to date. Cardiac & Neuromodulation declined 37.4% in Q2 and 22.4% year to date.
- Cardio & Vascular sales declined 14.2% in Q2 but increased 1.8% year to date.
- Non-Medical sales declined 47.6% in Q2 and 37.6% year to date, primarily because of the energy-market downturn and COVID-19 effects.
- SG&A increased 2.3% in Q2 and 3.3% year to date; research, development and engineering costs increased 11.8% and 13.0%, respectively.
Balance sheet, debt and liquidity
- Cash and cash equivalents were $206.2 million at July 3, 2020, versus $13.5 million at December 31, 2019. Approximately $90.0 million was held in short-term time deposits and $9.9 million was held by foreign subsidiaries.
- Working capital was $425.9 million and the current ratio was 3.77, compared with $236.3 million and 2.32 at year-end 2019.
- Total debt was $967.9 million, including $170.0 million drawn on the revolving facility, versus $814.8 million at year-end 2019. Approximately 75% of principal debt was variable-rate at quarter-end.
- The $200 million revolving facility had $23.3 million of available capacity after borrowings and letters of credit. The credit facilities mature October 27, 2022.
- The company reported a total net leverage ratio of approximately 3.5:1 and adjusted EBITDA-to-interest coverage of approximately 7.0:1 for the applicable trailing period. It was in compliance with its covenants at July 3, 2020.
- On July 13, 2020, after quarter-end, the company amended its facilities to increase the permitted total net leverage ratio to 4.75:1 through the second quarter of 2021, stepping down thereafter to 4.0:1 beginning in the fourth quarter of 2021.
Material changes versus the prior comparable period
- COVID-19 delayed or reduced customer orders, particularly as elective medical procedures declined, and disrupted travel, shipments, staffing and supply chains.
- Gross margin fell 6.8 percentage points in Q2 and 2.3 points for the first six months. Management attributed the decline to customer price reductions, product mix, lower volume leverage and, year to date, $0.8 million of charges related to the Nuvectra bankruptcy.
- Management drew $160.0 million on the revolving facility on April 10, 2020 to preserve liquidity during pandemic-related market uncertainty.
- Operating cash flow increased $10.4 million year to date, supported by working-capital changes, lower sales and $30.9 million of non-recourse accounts receivable sales under a supplier-financing program.
- Investing cash use increased to $36.0 million from $11.1 million, reflecting higher capital expenditures, a $4.1 million intangible-asset purchase and the InoMec acquisition.
- Integer acquired InoMec in February 2020 for $7.0 million of estimated consideration and finalized the USB acquisition purchase-price allocation during Q2. Combined revenue from InoMec and USB was $1.8 million in Q2 and $3.2 million year to date.
- Prior-year results benefited from $4.8 million of discontinued-operation income related to a working-capital adjustment on the 2018 divestiture and transition-services income; no comparable discontinued-operation income was recorded in 2020.
Outlook, commentary, risks and unusual items
Management did not provide specific sales or earnings guidance in the filing. It expects COVID-19-related uncertainty and customer demand volatility to continue, with potential lagging effects because of customer inventory practices. The company implemented cost reductions, reductions-in-force, furloughs and temporary shutdowns, while continuing investments in manufacturing, business-process and sales-force excellence.
- Management expects the 2020 restructuring plan to generate approximately $2 million to $3 million of pretax charges, with actions substantially complete by year-end 2020. $1.4 million had been incurred through July 3.
- The company believes cash flows from operations, cash on hand and revolver availability are sufficient for working capital, debt service and capital expenditures for the next twelve months, but additional financing could become more difficult or expensive.
- Key risks include prolonged COVID-19 disruption, dependence on a limited number of OEM customers, pricing pressure, supply-chain interruptions, product quality or regulatory issues, international currency and tax exposure, cyber and information-technology risks, substantial indebtedness and covenant compliance.
- The company expects approximately $36 million of principal and interest payments during the remainder of 2020, based on contractual obligations at July 3.
- The company was awarded approximately $27 million in damages in patent litigation against AVX; the Federal Circuit affirmed the judgment in July 2020. No gain had been recorded as of the filing.
- Cash-flow hedge losses of approximately $5.3 million were expected to be reclassified from accumulated other comprehensive income into earnings over the following twelve months.
Investor verification checklist
- Verify the pace and durability of recovery in elective medical procedures, Cardiac & Neuromodulation demand and customer inventory levels.
- Assess whether the $160 million revolver draw and amended leverage covenant provide adequate liquidity through the October 2022 debt maturity.
- Monitor variable-rate debt exposure, interest-rate swaps and the company’s ability to maintain covenant compliance if EBITDA declines.
- Evaluate whether price concessions and lower volume leverage have permanently affected gross margins.
- Reconcile operating cash flow with supplier-financing proceeds and determine the sustainability of working-capital benefits.
- Track restructuring costs, acquisition integration, contingent consideration and the potential timing or amount of the AVX litigation recovery.