Integer Holdings Corporation — Q2 2017 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 battery business serving energy, military and environmental applications. The report covers the 13-week quarter and 26-week year-to-date period ended June 30, 2017, compared with periods ended July 1, 2016.
- Reportable segments: Medical and Non-Medical.
- Four major customers—Abbott Labs, Boston Scientific, Johnson & Johnson and Medtronic—represented approximately 56% of first-half sales.
- Prior-period segment and product-line amounts were reclassified to conform to the current presentation.
Financial performance and key metrics
| Metric | Q2 2017 | Q2 2016 | First six months 2017 | First six months 2016 |
|---|---|---|---|---|
| Sales | $362.7 million | $348.4 million | $708.1 million | $680.6 million |
| Gross profit | $99.3 million | $96.0 million | $190.5 million | $187.5 million |
| Gross margin | 27.4% | 27.6% | 26.9% | 27.5% |
| Operating income | $39.7 million | $29.3 million | $66.3 million | $40.4 million |
| Operating margin | 11.0% | 8.4% | 9.4% | 5.9% |
| Net income (loss) | $3.0 million | $(0.8) million | $(1.3) million | $(13.4) million |
| Diluted EPS | $0.09 | $(0.03) | $(0.04) | $(0.44) |
| Adjusted EBITDA | $70.1 million | $68.9 million | $134.4 million | $134.3 million |
- Q2 sales increased 4.1%; first-half sales increased 4.0%. Management reported organic sales growth of approximately 5% for both periods after currency and divestiture effects.
- Q2 Medical sales rose 2.5%, led by Cardio & Vascular growth of 8.2%; Non-Medical sales increased 60.3%. First-half Medical sales rose 3.3% and Non-Medical sales rose 26.0%.
- First-half operating cash flow was $77.2 million, versus $33.8 million in the prior-year period. Capital expenditures were $22.4 million, and net cash used in investing activities was $22.3 million.
- Cash declined from $52.1 million at year-end 2016 to $46.5 million at June 30, 2017, primarily because operating cash was used for debt repayment.
- Total debt was $1.665 billion, including $82.0 million drawn on the revolving facility. Revolver availability was $109.2 million after outstanding letters of credit.
- Working capital was $328.1 million and the current ratio was 2.67 at June 30, 2017.
Material changes versus the prior comparable period
- Profitability improved substantially because of higher sales, integration efficiencies, lower acquisition and consolidation charges, and lower interest expense.
- Other operating expenses declined to $6.9 million in Q2 and $18.7 million year to date, compared with $15.5 million and $36.6 million, respectively, in 2016.
- Interest expense declined 8.1% in Q2 and 1.8% year to date, reflecting the March 2017 75-basis-point reduction in Term Loan B pricing and debt repayment. These benefits were partly offset by $0.9 million of Q2 and $2.5 million of year-to-date debt extinguishment charges.
- Gross margin contracted by 0.2 percentage points in Q2 and 0.6 percentage points year to date. Price concessions to large OEM customers and incentive compensation were partly offset by production efficiencies, synergies and volume.
- Other loss increased to $10.0 million in Q2 and $11.8 million year to date, driven by foreign-exchange losses and investment losses. The second quarter included a $5.0 million impairment of a cost-method investment.
- Sales in Cardiac & Neuromodulation declined 0.7% in Q2 and 2.5% year to date, including the impact of customer price concessions and a first-quarter supplier delay that management said was resolved in Q2.
Guidance, outlook, commentary and risks
- Full-year 2017 sales guidance: $1.400 billion to $1.430 billion, representing 1% to 3% growth.
- GAAP diluted EPS guidance: $0.60 to $1.00; adjusted diluted EPS guidance: $2.55 to $2.95.
- Operating cash flow guidance: approximately $150 million.
- Expected 2017 capital spending: $50 million to $60 million, approximately half discretionary. Management expects cash, operating cash flow and revolver capacity to fund these requirements.
- Management stated that integration, consolidation and cost-saving initiatives are intended to support margin expansion and debt reduction. Capacity and capability initiatives are expected to be substantially completed in 2017; Lake Region Medical consolidations are expected to be completed in 2018.
- Management expects Other Operating Expenses of approximately $25 million to $35 million in 2017 and a 2017 worldwide effective tax rate of approximately 10%, excluding discrete items.
- At June 30, 2017, the company reported compliance with its financial covenants. Total net leverage was approximately 5.47x versus a 6.25x maximum, and adjusted EBITDA-to-interest coverage was approximately 3.03x versus a 2.50x minimum. Future covenant risk could increase with higher LIBOR, weaker sales or lower adjusted EBITDA.
- Key risks include high leverage, customer concentration, pricing pressure, supply-chain and manufacturing-transfer execution, regulatory approvals and product quality, foreign-exchange volatility, acquisition integration, intellectual-property litigation, and potential product liability or recalls.
- Integer reported a $37.5 million jury award in its patent case against AVX, but has recognized no gain because no cash has been received; post-trial proceedings were scheduled for August 2017.
- The company expects adoption of the new revenue-recognition standard in the first quarter of 2018. Several supply agreements may shift from point-in-time shipment recognition to over-time recognition, but the financial impact had not yet been quantified.
Most important facts to verify
- Reconcile the path from $77.2 million of first-half operating cash flow to $70.6 million of net debt repayment and confirm ongoing deleveraging capacity.
- Test covenant headroom under adverse sales, EBITDA, interest-rate and foreign-exchange scenarios.
- Assess whether the $1.4 billion to $1.43 billion sales outlook and $150 million operating-cash-flow target remain supported by order patterns and customer demand.
- Monitor Cardiac & Neuromodulation recovery, OEM price concessions and customer concentration.
- Verify the remaining costs and expected benefits of manufacturing transfers, Lake Region consolidations and Lake Region Medical integration.
- Evaluate the eventual impact of revenue-recognition adoption on reported sales, earnings timing and disclosures.
- Review the outcome of the AVX litigation and the recoverability and volatility of cost- and equity-method investments.