Business Context and Reporting Period
The source is Greatbatch, Inc.’s Form 10-K for the 53-week fiscal year ended January 3, 2014, not an Integer Holdings Corp. filing. The company designs and manufactures medical-device components and systems through Greatbatch Medical and QiG. Its products serve cardiac and neuromodulation, orthopaedic, portable medical, vascular, energy and related markets.
Beginning in the fourth quarter of 2013, the company reported two segments: Greatbatch Medical and QiG. Prior-period segment information was reclassified. The filing was signed March 4, 2014.
Financial Metrics
| Metric | 2013 | 2012 | Change |
|---|---|---|---|
| Sales | $663.9 million | $646.2 million | +3% |
| Gross profit | $219.3 million | $201.6 million | +9% |
| Gross margin | 33.0% | 31.2% | +180 bps |
| Operating income | $61.3 million | $25.8 million | +138% |
| Operating margin | 9.2% | 4.0% | +520 bps |
| Net income | $36.3 million | $(4.8) million | Improved by $41.1 million |
| Diluted EPS | $1.43 | $(0.20) | Improved by $1.63 |
| Adjusted diluted EPS | $2.10 | $1.77 | +19% |
Greatbatch Medical sales were $660.9 million, up 3%; QiG sales were $3.0 million, up 24%. Cardiac/neuromodulation sales increased 6% to $325.4 million, while orthopaedic sales increased 7% to $130.2 million. Portable medical, vascular, energy and other sales declined.
Adjusted operating income was $82.9 million, or 12.5% of sales, compared with $73.9 million, or 11.4%, in 2012. Reported results included $15.8 million of other operating expenses, principally restructuring, facility optimization, ERP and related items. QiG medical-device investment was $30.5 million, compared with $32.6 million in 2012.
- Cash flow from operations was $56.8 million; excluding $28.8 million of tax payments associated with retiring the convertible notes, management reported adjusted operating cash flow of $85.5 million.
- Net cash used in investing activities was $18.3 million, including $18.6 million of capital expenditures and $4.7 million of proceeds from the sale of orthopaedic product lines.
- Net cash used in financing activities was $23.4 million. The company made $33.3 million of net long-term debt repayments.
- Cash and cash equivalents were $35.5 million, compared with $20.3 million at year-end 2012. Working capital was $190.7 million and the current ratio was 3.08.
- Debt outstanding was $197.5 million, consisting of the term loan. The company reported $300 million of available revolving borrowing capacity.
- Debt covenants were satisfied: adjusted EBITDA to interest expense was 22.4-to-1 versus a 3.0-to-1 minimum, and total leverage was 1.53-to-1 versus a 4.5-to-1 maximum.
- Total assets were $890.7 million, including $443.1 million of goodwill and other intangible assets, or approximately 50% of total assets.
Material Changes Versus the Prior Comparable Period
- Sales increased 3% despite the first-quarter divestiture of approximately $15 million of non-core orthopaedic product lines. Management stated that organic constant-currency sales increased approximately 5% after adjusting for divestitures and a $2 million foreign-exchange benefit.
- Gross margin expanded primarily from higher volume, productivity initiatives, favorable product mix and completion of the Swiss orthopaedic consolidation. The consolidation benefited 2013 gross profit by approximately $2.8 million.
- Other operating expenses declined to $15.8 million from $42.3 million, as major Swiss consolidation and facility initiatives were substantially completed.
- Interest expense declined $6.8 million because the convertible subordinated notes were redeemed in February 2013, debt balances were lower and borrowing rates declined.
- The effective tax rate fell to 25.7% from 171.3%. The 2012 rate was distorted by Swiss restructuring-related tax charges and deferred-tax valuation adjustments; 2013 benefited from reinstated U.S. research tax credits and foreign tax-rate changes.
- The company initiated an operating-unit realignment in 2013, recording $5.6 million of charges and expecting total charges of $6.5 million to $7.0 million. Expected annual savings were approximately $7.0 million to $7.7 million.
- Fourth-quarter 2013 sales were $176.6 million and net income was $9.8 million, compared with fourth-quarter 2012 sales of $159.2 million and a net loss of $5.6 million. The 2013 fourth quarter included an additional fiscal week.
Guidance, Outlook, Commentary and Risks
For 2014, management guided to sales of $685 million to $705 million, GAAP operating margin of 11.0% to 11.5%, adjusted operating margin of 13.0% to 13.3%, capital expenditures of $25 million to $35 million, a GAAP effective tax rate of 34% to 35%, GAAP diluted EPS of $1.94 to $1.99 and adjusted diluted EPS of $2.25 to $2.35. Management also targeted organic sales growth of 3% to 6% and adjusted diluted EPS growth of 7% to 12%.
- QiG’s spinal-cord-stimulation system was submitted for FDA and CE Mark approval near year-end 2013. Approval, commercialization and market acceptance remain uncertain.
- Planned capital investments include orthopaedic and medical-device manufacturing expansion, with remaining expenditures and restructuring costs expected over multiple years.
- Three customers represented 49% of 2013 sales and 35% of year-end accounts receivable. Many customer agreements lack minimum purchase commitments, creating concentration and ordering-pattern risk.
- The company faces pricing pressure, potential customer vertical integration, product obsolescence, recalls, warranty and product-liability exposure, and dependence on regulatory approvals.
- Critical raw materials are sourced from limited suppliers. Disruption, inflation or inability to qualify substitute suppliers could affect production and margins.
- The medical-device tax increased 2013 cost of sales by $0.5 million. Conflict-minerals compliance was expected to create additional costs that the company could not quantify.
- A Texas product-liability and wrongful-death lawsuit was scheduled for trial in the second half of 2014. The company reported indemnification from its customer and insurance coverage, had not recorded a reserve, and stated that the range of loss was not reasonably estimable.
- Foreign exchange and interest-rate exposures remain. A 100-basis-point change in LIBOR on $47.5 million of unhedged floating-rate debt would affect annual interest expense by approximately $0.5 million.
- Management reported effective internal control over financial reporting, and Deloitte issued unqualified audit opinions on the financial statements and internal controls.
Important Facts for Investors to Verify
- Confirm the company identity: the provided filing is for Greatbatch, Inc., while the request identifies Integer Holdings Corp.
- Reconcile reported operating cash flow of $56.8 million with management’s $85.5 million figure excluding the $28.8 million convertible-note-related tax payment.
- Assess the sustainability of the 2013 margin improvement after the completion of major consolidation programs and the expected decline in unusual charges.
- Track progress, regulatory approvals, commercialization partners and additional spending for QiG’s spinal-cord-stimulation and other medical-device systems.
- Evaluate customer concentration, contract minimums, pricing concessions and the effect of the portable-medical program losses and vascular recall.
- Review debt amortization, covenant calculations, interest-rate hedging and the company’s ability to fund $25 million to $35 million of 2014 capital expenditures while pursuing acquisitions.
- Test goodwill and intangible-asset recoverability, given $443.1 million of recorded intangible assets and exposure to customer loss, technology obsolescence and regulatory non-approval.