Integer Holdings Corporation: FY2019 Form 10-K Summary
Business context and reporting period
Integer Holdings is a medical device outsource manufacturer serving cardiac, neuromodulation, vascular, advanced surgical, orthopedic and portable medical markets, with a smaller Non-Medical battery business serving energy, military and environmental markets. The filing covers the fiscal year ended December 31, 2019. The company changed from a 52/53-week fiscal year to a calendar year; fiscal 2019 therefore ran from December 29, 2018 through December 31, 2019, while fiscal 2018 ended December 28, 2018.
Operations are reported in Medical and Non-Medical segments. The Advanced Surgical and Orthopedic product lines were sold to Viant in July 2018 and are presented as discontinued operations for all periods. In October 2019, Integer acquired certain US BioDesign assets for preliminary consideration of $19.2 million, including $15.0 million cash and $4.2 million of contingent consideration.
Key financial metrics
| Metric | FY2019 | FY2018 | Change |
|---|---|---|---|
| Sales | $1,258.1 million | $1,215.0 million | +3.5% |
| Gross profit | $355.0 million | $362.7 million | -2.1% |
| Gross margin | 28.2% | 29.8% | -1.6 percentage points |
| Operating income | $157.6 million | $155.6 million | +1.3% |
| Operating margin | 12.5% | 12.8% | -0.3 percentage points |
| Income from continuing operations | $91.2 million | $47.0 million | +94% |
| Diluted EPS from continuing operations | $2.76 | $1.44 | +92% |
| Net income | $96.3 million | $168.0 million | -42.6% |
| Cash flow from operations | $165.4 million | $167.3 million | -1.2% |
| Capital expenditures | $48.2 million | $44.9 million | +$3.3 million |
Continuing-operations results exclude the sold AS&O product line. Net income in 2018 benefited substantially from the $195.0 million pretax gain on that divestiture; FY2019 included only a $4.8 million final working-capital adjustment from the sale.
Fourth-quarter 2019 sales were $325.6 million, gross profit was $76.0 million, income from continuing operations was $11.0 million, and diluted EPS was $0.33. Fourth-quarter results included approximately $24.2 million of pretax charges related to the Chapter 11 bankruptcy of customer Nuvectra, primarily inventory and receivables write-downs.
Revenue and segment performance
- Medical sales: $1,199.7 million, up 3.2%. Cardio & Vascular sales rose 4.2% to $610.1 million; Cardiac & Neuromodulation rose 3.1% to $457.2 million; Advanced Surgical, Orthopedics & Portable Medical declined 0.6% to $132.4 million.
- Non-Medical sales: $58.4 million, up 10.3%, driven primarily by military demand and growth with energy customers.
- Growth was supported by Cardio & Vascular and CRM demand, a new customer agreement on existing business, peripheral vascular and structural heart growth, and production efficiencies. Price reductions reduced Cardio & Vascular sales by $6.7 million and Cardiac & Neuromodulation sales by approximately $6.9 million.
- Three customers accounted for approximately 50% of FY2019 sales, creating significant customer concentration.
Liquidity, debt and cash flow
- Cash and cash equivalents were $13.5 million at December 31, 2019, compared with $25.6 million at December 28, 2018. Working capital was $236.3 million and the current ratio was 2.32.
- Debt principal outstanding was approximately $825.5 million; debt net of discounts and deferred fees was $814.8 million. Integer repaid $116.5 million of Senior Secured Credit Facility debt during 2019.
- The $200 million revolving facility had $193.2 million of available capacity after letters of credit. Term Loan A and Term Loan B facilities mature October 27, 2022.
- At year-end, the company reported a total net leverage ratio of approximately 2.6:1 and adjusted EBITDA to interest expense of approximately 7.0:1, versus required thresholds of 4.50:1 and 3.00:1, respectively. Management reported compliance with all debt covenants.
- Estimated 2020 debt service was approximately $70 million. Management expected cash, operating cash flow and available revolver capacity to fund working capital, debt service and capital expenditures for the next twelve months.
- Management projected 2020 capital spending of $60 million to $70 million. No formal revenue or earnings guidance was provided in the filing.
Material changes, outlook and unusual items
- Gross margin declined because of customer pricing concessions and $21.4 million of cost-of-sales charges tied to the Nuvectra bankruptcy, partly offset by production efficiencies and volume.
- Interest expense fell $46.8 million to $52.5 million, primarily because of lower debt balances and the absence of the significant 2018 debt-extinguishment costs associated with the AS&O divestiture.
- Operating expenses declined 5%, including lower SG&A, research and development, and other operating expenses. Strategic reorganization and manufacturing-alignment actions were substantially completed by year-end.
- Integer adopted lease accounting under ASC 842 in 2019, recognizing approximately $40.9 million of operating lease right-of-use assets and $43.4 million of lease liabilities at adoption without a material income-statement or cash-flow effect.
- Management emphasized manufacturing excellence, supply-chain savings, market-focused innovation, customer expansion and selective bolt-on acquisitions. The company expects pricing pressure to continue but believes manufacturing and supply-chain initiatives can offset some of that pressure.
- International operations expose Integer to foreign-currency, regulatory, tax, trade and geopolitical risks. Interest-rate exposure was reduced through swaps; approximately 20% of debt principal remained subject to variable rates at year-end.
Principal risks and contingencies
- Customer concentration, pricing pressure, customer vertical integration and limited visibility into future orders.
- Medical-device regulatory requirements, product quality issues, recalls, product liability claims and changing European regulations.
- Reliance on limited suppliers for critical raw materials and exposure to raw-material prices, tariffs and supply disruptions.
- Debt obligations, variable interest rates, LIBOR transition risk and covenant compliance. Contractual obligations totaled approximately $1.06 billion, including $825.5 million of debt principal.
- Goodwill and other intangible assets totaled approximately $1.6 billion, or 69% of total assets, creating impairment risk. No impairment was identified at year-end.
- NJDEP continued investigating possible groundwater contamination associated with a former Lake Region Medical site in New Jersey; management did not expect a material financial effect.
- Integer pursued patent litigation against AVX. A January 2019 jury awarded $22.2 million, but the matter was under appeal and Integer had recorded no gain from the litigation.
Investor verification checklist
- Verify the sustainability of Medical segment growth, particularly Cardio & Vascular and Cardiac & Neuromodulation, after adjusting for customer agreements, pricing concessions and the Nuvectra bankruptcy.
- Assess whether manufacturing efficiencies and supply-chain savings can offset continuing OEM price reductions and margin pressure.
- Reconcile debt principal, net debt, required amortization, interest-rate swaps and the October 2022 maturity concentration.
- Monitor the three largest customers, which represented approximately 50% of 2019 sales, and evaluate renewal, inventory and vertical-integration risks.
- Review goodwill, tradename and customer-list carrying values, including the $70.0 million Lake Region Medical tradename and future amortization expense.
- Confirm the final accounting and integration progress for US BioDesign, including contingent consideration of up to $5.5 million through 2023.
- Track the AVX appeal, the NJDEP environmental investigation, product-liability exposure and regulatory implementation costs.