Integer Holdings Corporation — Q3 2020 Form 10-Q Summary
Business Context and Reporting Period
Integer Holdings is a medical device outsource manufacturer serving cardiac, neuromodulation, vascular, orthopedics, advanced surgical and portable medical markets, with a smaller Non-Medical battery business serving energy, military and environmental applications. Reportable segments are Medical and Non-Medical.
The filing covers the 91-day third quarter ended October 2, 2020 and the first nine months of 2020. Comparisons are to the quarter ended September 27, 2019 and the nine months ended September 27, 2019. Results exclude the Advanced Surgical and Orthopedic product lines sold in 2018, which are reported as discontinued operations.
Financial Performance and Key Metrics
| Metric | Q3 2020 | Q3 2019 | 9M 2020 | 9M 2019 |
|---|---|---|---|---|
| Sales | $235.9 million | $303.6 million | $804.5 million | $932.5 million |
| Gross profit | $57.9 million | $93.4 million | $212.5 million | $279.0 million |
| Gross margin | 24.6% | 30.8% | 26.4% | 29.9% |
| Operating income | $39.8 million | $46.5 million | $93.0 million | $135.0 million |
| Operating margin | 16.9% | 15.3% | 11.6% | 14.5% |
| Income from continuing operations | $30.3 million | $30.6 million | $61.8 million | $80.2 million |
| Diluted EPS from continuing operations | $0.92 | $0.92 | $1.87 | $2.43 |
| Net cash from operating activities | Not separately reported | Not separately reported | $110.2 million | $112.0 million |
Q3 sales declined 22.3%, while nine-month sales declined 13.7%. Q3 gross profit fell 38.0%, and nine-month gross profit fell 23.8%. The company attributed the declines primarily to COVID-19-related reductions and delays in customer demand, lower procedure volumes, price reductions, unfavorable volume leverage and the Nuvectra bankruptcy.
Q3 SG&A was $3.6 million, including a $28.2 million net gain from patent litigation. Excluding this unusual gain, reported operating profitability would have been materially lower. Research, development and engineering expense increased 1.4% in Q3 and 9.1% for the first nine months as the company continued investing in growth capabilities.
- Medical sales decreased 21.3% in Q3 and 12.5% for the first nine months.
- Non-Medical sales decreased 41.7% in Q3 and 38.9% for the first nine months, reflecting severe weakness in the energy market and COVID-19 effects.
- Cardiac & Neuromodulation was the largest Medical decline, down 31.6% in Q3 and 25.3% for the first nine months.
- Interest expense declined to $9.4 million in Q3 and $29.0 million for the first nine months, primarily because of lower interest rates.
- Effective tax rates were 3.4% in Q3 and 9.3% for the first nine months, compared with 13.8% and 16.0%, respectively, in the prior-year periods. Discrete tax benefits were $4.9 million in Q3 and $5.9 million year to date.
Liquidity, Cash Flow and Debt
- Cash and cash equivalents were $99.9 million at October 2, 2020, compared with $13.5 million at December 31, 2019.
- Working capital was $345.2 million and the current ratio was 3.25, compared with $236.3 million and 2.32, respectively, at year-end 2019.
- Operating cash flow was $110.2 million for the first nine months. Investing cash outflows were $44.9 million, including $35.2 million of capital expenditures, $4.6 million for an intangible asset and $5.2 million for the InoMec acquisition.
- Total debt, net of discounts and issuance costs, was $839.1 million at October 2, 2020, compared with $814.8 million at December 31, 2019. Principal debt included $239.1 million of Term Loan A, $558.3 million of Term Loan B and $50.0 million drawn on the revolving facility.
- The $200 million revolving facility had $143.3 million of available borrowing capacity after borrowings and letters of credit. Senior secured facilities mature on October 27, 2022.
- Approximately 76% of principal debt was subject to variable rates at October 2, 2020, versus approximately 20% at year-end 2019. The company uses interest-rate swaps to reduce exposure to LIBOR fluctuations.
- The company reported a total net leverage ratio of approximately 3.3x and adjusted EBITDA-to-interest coverage of approximately 6.8x, remaining in compliance with its covenants. Management estimated adjusted EBITDA could decline approximately 30%, or $74 million, before covenant noncompliance.
- Supplier financing arrangements accelerated $47.1 million of accounts receivable cash collections during the first nine months. The company stated that it expects cash, operating cash flow and available borrowing capacity to fund working capital, debt service and capital expenditures for the next twelve months.
Material Changes, Outlook and Unusual Items
- COVID-19: Delayed or reduced customer orders, postponed medical procedures, supply-chain constraints and workforce disruptions materially reduced sales. Management implemented cost reductions, furloughs, reductions-in-force and temporary shutdowns to align labor with demand.
- Patent litigation gain: Following appellate affirmation of its judgment against AVX, the company recorded a $28.2 million net gain in Q3. It received $28.3 million on October 15, 2020 and the remaining $0.6 million on October 26, 2020, using the proceeds to repay revolving debt.
- Restructuring: The 2020 restructuring plan generated $2.3 million of charges through October 2, 2020, with total expected charges of approximately $2 million to $3 million. The actions were expected to be substantially complete by year-end.
- Acquisitions: The company acquired InoMec in February 2020 for consideration valued at $7.0 million and completed purchase accounting for the prior-year US BioDesign acquisition. Combined sales from the acquired operations were $2.2 million in Q3 and $5.4 million for the first nine months; earnings were not material.
- Non-Medical impairment risk: The company performed a quantitative goodwill analysis for the Non-Medical reporting unit in April 2020. Fair value exceeded carrying value, and no further impairment indicators had been identified through October 2, 2020.
- No formal sales or earnings guidance is presented in the filing. Management expressed confidence in the long-term medical device outsourcing opportunity but emphasized that the duration and effects of COVID-19 remain uncertain.
- Other risks include customer concentration, pricing pressure, supplier dependence, product quality and regulatory exposure, intellectual-property protection, leverage and covenant compliance, acquisitions, cybersecurity, foreign exchange and interest rates, international tax matters, and continued weakness in energy-related demand.
- An environmental investigation involving a New Jersey property was ongoing. The New Jersey Department of Environmental Protection sought approximately $0.3 million for related work; management did not expect the matter to be material, but noted that the outcome remains uncertain.
Most Important Facts to Verify
- Whether medical procedure volumes and customer orders recover sufficiently to restore sales and gross-margin leverage.
- The sustainability of reported earnings after removing the $28.2 million patent litigation gain and discrete tax benefits.
- Post-quarter debt balances and leverage after applying the patent proceeds to the revolving facility.
- Progress toward the October 2022 debt maturities and compliance with tightening leverage covenants beginning in 2021.
- The effect of supplier receivable financing on reported operating cash flow and future liquidity.
- Potential impairment of Non-Medical goodwill if energy-market weakness persists.
- Customer concentration, including three customers representing 16%, 17% and 17% of Medical segment Q3 sales.
- Resolution and potential cost escalation of the New Jersey environmental matter and other contingent obligations.