Business Context and Reporting Period
Integer Holdings Corporation is a medical device outsourcing manufacturer serving cardiac, neuromodulation, vascular, orthopedic, advanced surgical, portable medical, and niche battery markets. It reports Medical and Non-Medical segments. This Form 10-Q covers the 13-week quarter ended March 29, 2019, compared with the quarter ended March 30, 2018. Results exclude the Advanced Surgical and Orthopedic product lines, which were sold to Viant on July 2, 2018 and presented as discontinued operations.
Financial Performance and Position
| Metric | Q1 2019 | Q1 2018 | Change |
|---|---|---|---|
| Sales | $314.7 million | $292.4 million | Up 7.6% |
| Gross profit | $88.6 million | $83.5 million | Up 6.1% |
| Gross margin | 28.2% | 28.6% | Down 0.4 percentage points |
| Operating income | $39.2 million | $30.0 million | Up 30.4% |
| Operating margin | 12.4% | 10.3% | Up 2.1 percentage points |
| Income from continuing operations | $21.4 million | $13.1 million | Up 63.3% |
| Diluted EPS from continuing operations | $0.65 | $0.40 | Up $0.25 |
| Net income | $21.7 million | $8.1 million | Up $13.6 million |
| Adjusted EBITDA | $65.7 million | $53.9 million | Up 21.7% |
Medical sales increased 7.6% to $301.1 million, led by Cardio & Vascular sales of $152.6 million, up 11.5%, and Cardiac & Neuromodulation sales of $116.9 million, up 7.3%. Advanced Surgical, Orthopedics & Portable Medical sales declined 6.9% to $31.6 million. Non-Medical sales increased 7.0% to $13.6 million.
Operating expense declined to $49.4 million from $53.5 million, reflecting lower SG&A, research and development, and other operating expenses. Interest expense declined to $13.8 million from $15.6 million. The prior-year period included a $5.0 million net gain on equity investments, compared with a $0.04 million loss in Q1 2019. The effective tax rate declined to 15.0% from 29.1%, primarily due to $1.7 million of discrete tax benefits.
Cash flow from operations was $11.2 million, down from $46.1 million, primarily because higher accounts receivable and customer rebate payments reduced working-capital cash flow. Capital expenditures were $7.4 million. Financing activities used $16.2 million, including $15.4 million of net debt payments. Cash decreased to $13.5 million from $25.6 million at December 28, 2018.
Total debt was $911.7 million, net of discounts and issuance costs, compared with $925.5 million at year-end 2018. The company had $173.2 million of available revolving-credit capacity after standby letters of credit. Working capital was $265.7 million and the current ratio was 2.55.
Material Changes Versus the Prior Comparable Period
- Sales grew 7.6%, driven by market growth, new business wins, customer share gains, product launches, and an $11.5 million accrual for in-process material under a long-term customer agreement.
- Price concessions to larger OEM customers reduced Q1 2019 sales by approximately $3 million versus the prior-year quarter and reduced gross margin by approximately 0.9 percentage points.
- Operating margin expanded despite the lower gross margin because operating expenses decreased by $4.0 million.
- Income from continuing operations benefited from stronger operating performance, lower interest expense, and a lower tax rate. The improvement was partly offset by the absence of the prior-year equity-investment gain.
- Cash generation was significantly lower because of working-capital usage, while the company continued to reduce debt.
- The adoption of ASC 842 resulted in recognition of operating lease assets and liabilities; March 29, 2019 operating lease assets were $39.1 million and operating lease liabilities totaled $41.5 million.
- Q1 2019 included $1.7 million of transition-services income from Viant. Viant also agreed to pay a $4.8 million net working-capital adjustment by June 14, 2019, to be recognized in the quarter ending June 28, 2019.
Guidance, Outlook, Risks and Unusual Items
Management maintained or improved its 2019 outlook for continuing operations: sales of $1.265 billion to $1.280 billion; GAAP income of $95 million to $101 million; GAAP diluted EPS of $2.87 to $3.07; adjusted income of $137 million to $144 million; adjusted EBITDA of $275 million to $283 million; and adjusted diluted EPS of $4.15 to $4.35. Planned 2019 capital spending is $50 million to $55 million, and the expected full-year effective tax rate, excluding discrete items, is approximately 22%.
Management stated that it was on track to deliver its improved guidance and continued to target sales growth above market growth, profit growth at twice the rate of sales growth, and a valuation premium. Strategic reorganization and manufacturing-alignment initiatives are expected to be substantially complete by the end of 2019. Total 2019 other operating expenses are expected to be approximately $10 million to $15 million.
Debt remains a significant risk. Approximately 78% of principal debt was subject to variable rates at quarter-end. The revolving facility and Term Loan A require a maximum total net leverage ratio of 5.0:1.0, with step-downs beginning in Q3 2019, and minimum interest coverage of 3.0:1.0. The company reported ratios of approximately 3.0:1.0 and 6.0:1.0, respectively, and was in compliance. In April 2019, it entered into an additional $400 million interest-rate swap and extended an existing $200 million swap, which management expects to reduce interest-rate exposure.
Other key risks include customer concentration, pricing pressure, customer ordering patterns, reliance on suppliers, product quality and liability, regulatory approvals or actions, intellectual-property disputes, foreign currency and interest-rate changes, tax-law impacts including GILTI, and execution of restructuring and growth initiatives. In January 2019, a jury awarded Integer $22.2 million in damages in its patent litigation against AVX; the award remained subject to post-trial proceedings, and no gain had been recorded.
Investor Verification Checklist
- Verify that revenue growth is sustainable after the $11.5 million long-term customer agreement accrual and that OEM price concessions do not worsen.
- Assess conversion of earnings into operating cash flow, particularly accounts receivable, rebates, and other working-capital movements.
- Monitor debt repayments, variable-rate exposure, refinancing timelines, covenant headroom, and the impact of the new interest-rate swaps.
- Reconcile GAAP results with adjusted income, adjusted EPS, and adjusted EBITDA, including amortization, litigation, restructuring, debt-extinguishment, and other exclusions.
- Confirm the timing and after-tax impact of the $4.8 million Viant working-capital adjustment and any final tax allocation related to the divestiture.
- Evaluate customer concentration: three Medical customers represented 25%, 19%, and 12% of Medical sales, while one Non-Medical customer represented 24% of Non-Medical sales.
- Track the AVX patent litigation outcome and any potential cash recovery, noting that no gain was recognized as of the filing date.