Integer Holdings Corporation: Q2 2018 Form 10-Q Summary
Business context and reporting period
Integer Holdings is a medical device outsourcing manufacturer serving cardiac, neuromodulation, vascular and portable medical markets, with a smaller Non-Medical business focused on specialty batteries. The filing covers the 13-week quarter and 26-week year-to-date period ended June 29, 2018, compared with periods ended June 30, 2017.
Results exclude the Advanced Surgical and Orthopedic product line, which was classified as discontinued operations after the May 2018 sale agreement. Integer completed the sale to Viant on July 2, 2018 for $600 million in cash, subject to post-closing adjustments.
Financial performance and liquidity
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Continuing-operations sales | $314.5 million | $280.9 million | $606.9 million | $547.7 million |
| Gross profit | $98.8 million | $89.2 million | $182.3 million | $171.2 million |
| Gross margin | 31.4% | 31.7% | 30.0% | 31.3% |
| Operating income | $44.4 million | $36.1 million | $74.4 million | $60.0 million |
| Operating margin | 14.1% | 12.8% | 12.3% | 10.9% |
| Income from continuing operations | $23.1 million | $9.6 million | $36.1 million | $12.5 million |
| Diluted EPS from continuing operations | $0.70 | $0.30 | $1.11 | $0.39 |
| Net income | $20.0 million | $3.0 million | $28.1 million | $(1.3) million |
| Adjusted diluted EPS | $1.06 | $0.74 | $1.69 | $1.29 |
Sales increased 11.9% in the quarter and 10.8% year to date, driven principally by Medical segment growth, market expansion and new business wins. Q2 Medical sales rose 12.9%, led by Cardio & Vascular growth of 13.8%, Cardiac & Neuromodulation growth of 9.2%, and Advanced Surgical, Orthopedics & Portable Medical growth of 22.9%. Non-Medical sales declined 4.7% in the quarter because of military-customer order timing.
Gross margin declined 30 basis points in Q2 and 130 basis points year to date. Management attributed the pressure to price concessions for long-term OEM volume commitments, product mix and higher incentive compensation, partly offset by production efficiencies, synergies and volume. Operating income benefited from higher sales and lower other operating expenses, including the completion of prior acquisition-integration spending.
Cash provided by operating activities was $67.2 million for the first six months, compared with $77.2 million in the prior-year period. Capital expenditures were $19.2 million, and cash used in financing activities was $74.5 million, including $75.1 million of debt repayments. Cash and cash equivalents were $18.9 million at June 29, 2018, excluding $1.2 million classified within discontinued operations.
Total debt was $1.539 billion at June 29, 2018, consisting principally of term loans, $74 million drawn on the revolving facility and $360 million of 9.125% senior notes. Revolving-facility availability was $116.8 million after outstanding letters of credit. The company was in compliance with its debt covenants; reported leverage and interest-coverage ratios, calculated after giving effect to the divestiture and debt repayment, were approximately 3.8x and 5.1x, respectively.
Material changes versus the prior comparable period
- Continuing-operations sales increased $33.5 million in Q2 and $59.2 million year to date.
- Operating income increased 23.0% in Q2 and 24.1% year to date.
- Income from continuing operations nearly doubled in Q2 and increased 189.0% year to date.
- Interest expense declined $2.6 million year to date because of lower debt balances, although Q2 interest expense was slightly higher due to increased interest rates.
- Net investment results improved from losses of $4.4 million in Q2 2017 and $4.8 million year to date to gains of $0.3 million and $5.3 million, respectively, in 2018.
- Other income improved primarily because a prior-year non-cash foreign-currency loss on intercompany loans did not recur.
- Discontinued operations generated net losses of $3.0 million in Q2 and $8.0 million year to date, compared with losses of $6.6 million and $13.9 million in the prior-year periods.
- Foreign-currency translation reduced comprehensive income by $25.9 million in Q2 and $12.4 million year to date.
Guidance, outlook, commentary and unusual items
Management revised 2018 continuing-operations guidance to sales of $1.170 billion to $1.195 billion, GAAP net income of $30 million to $40 million, and GAAP diluted EPS of $0.95 to $1.25. Non-GAAP guidance includes adjusted sales of $1.175 billion to $1.200 billion, adjusted net income of $110 million to $120 million, adjusted EBITDA of $255 million to $265 million, and adjusted diluted EPS of $3.35 to $3.65.
Management stated that the divestiture is expected to create a higher-margin business with lower leverage and greater financial flexibility. Approximately $580 million of cash was expected after deal costs, and the company subsequently used $548 million to repay debt. On July 10, 2018, Integer redeemed the $360 million senior notes, paid a $31.3 million make-whole premium, and used remaining proceeds to repay $188 million of additional debt, including $114 million of Term Loan B and $74 million of revolving borrowings. Moody’s upgraded the corporate family rating to B2 on July 11, 2018, triggering a 25-basis-point reduction in the Term Loan B margin.
Integer expects 2018 capital spending of $35 million to $40 million and other operating expenses of approximately $15 million to $20 million. Strategic reorganization charges are expected to total $28 million to $30 million, manufacturing-alignment charges $9 million to $11 million, and consolidation and optimization charges $18 million to $22 million. The company expects approximately $8 million to $12 million of annual savings from strategic reorganization, $2 million to $3 million from manufacturing alignment and $12 million to $13 million from consolidation and optimization initiatives.
Key risks include high leverage and covenant compliance, rising interest rates, customer concentration and pricing pressure, reliance on suppliers, product quality and liability exposure, regulatory and intellectual-property matters, foreign-currency volatility, tax-rate uncertainty related to GILTI, execution of restructuring programs and the realization of benefits from the divestiture.
The company is defending patent litigation against AVX. A prior $37.5 million damages award was vacated, and a damages retrial was scheduled for January 2019. Integer has recognized no gain from the matter.
Important facts for investors to verify
- Final cash proceeds and post-closing adjustments from the AS&O divestiture.
- Post-divestiture debt balances, interest expense, leverage and revolving-credit availability.
- Whether the company achieves the revised 2018 sales, GAAP EPS, adjusted EPS and EBITDA ranges.
- Actual gross-margin performance after OEM pricing concessions, mix changes and restructuring benefits.
- Cash costs and completion timing for strategic reorganization, manufacturing alignment and consolidation initiatives.
- Effective tax-rate developments, including the final accounting treatment and impact of GILTI.
- Outcome and potential financial effect of the AVX patent damages retrial.
- Customer concentration, particularly the Medical segment’s dependence on several large OEM customers.