Integer Holdings Corporation: Q3 2017 Form 10-Q Summary
Business Context and Reporting Period
Integer Holdings is a medical device outsourcing manufacturer serving cardiac, neuromodulation, vascular, orthopedic, advanced surgical and portable medical markets, with a smaller Non-Medical battery business serving energy, military and environmental applications. The report covers the 13-week third quarter and 39-week year-to-date period ended September 29, 2017, compared with periods ended September 30, 2016. Results include Medical and Non-Medical reportable segments. The financial statements are unaudited.
Key Financial Metrics
| Metric | Q3 2017 | Q3 2016 | YTD 2017 | YTD 2016 |
|---|---|---|---|---|
| Sales | $363.3 million | $346.6 million | $1,071.4 million | $1,027.2 million |
| Gross profit | $98.2 million | $97.9 million | $288.7 million | $285.4 million |
| Gross margin | 27.0% | 28.3% | 26.9% | 27.8% |
| Operating income | $38.6 million | $36.9 million | $104.9 million | $77.3 million |
| Operating margin | 10.6% | 10.6% | 9.8% | 7.5% |
| Net income (loss) | $13.7 million | $11.5 million | $12.3 million | $(2.0) million |
| Diluted EPS | $0.43 | $0.37 | $0.39 | $(0.06) |
| Operating cash flow | Not separately provided | Not separately provided | $115.6 million | $71.8 million |
| Adjusted EBITDA | $72.8 million | $75.0 million | $207.1 million | $209.3 million |
Q3 sales increased 4.8% and year-to-date sales increased 4.3%. Organic sales growth, excluding currency and divestiture effects, was approximately 4.4% in Q3 and 4.5% year to date. Medical sales increased 3.1% in Q3 and 3.2% year to date, while Non-Medical sales increased 70.6% and 39.1%, respectively.
- Q3 product-line sales growth: Cardio & Vascular 7.4%; Advanced Surgical, Orthopedics & Portable Medical 7.4%; Cardiac & Neuromodulation decreased 6.0%.
- Year-to-date product-line sales growth: Cardio & Vascular 8.5%; Advanced Surgical, Orthopedics & Portable Medical 4.3%; Cardiac & Neuromodulation decreased 3.7%.
- Gross margin declined due primarily to customer price concessions, unfavorable product mix and higher incentive compensation, partly offset by production efficiencies and volume.
- SG&A was $39.7 million in Q3 and $119.0 million year to date. Research, development and engineering expense was $13.6 million in Q3 and $39.9 million year to date.
- Interest expense declined to $26.5 million in Q3 and $81.0 million year to date, helped by lower debt balances and the March 2017 Term Loan B repricing.
Liquidity, Debt and Capital Resources
- Cash and cash equivalents were $43.6 million at September 29, 2017, down from $52.1 million at December 30, 2016.
- Total debt was $1.630 billion, including $28.1 million current debt and $1.602 billion long-term debt, compared with $1.730 billion at year-end 2016.
- The company repaid $106.5 million of debt during the first nine months, including $37.7 million in Q3, and repaid an additional $10 million on the Term Loan B in October 2017.
- The $200 million revolving facility had $79.0 million drawn and $111.7 million of available capacity after outstanding letters of credit.
- Working capital was $323.2 million and the current ratio was 2.58 at September 29, 2017.
- Capital expenditures were $34.1 million year to date; expected 2017 capital spending was $50 million to $55 million.
- Total net leverage was approximately 5.40x and adjusted EBITDA to interest expense was approximately 3.08x. The company was in compliance with its debt covenants at quarter-end.
Material Changes Versus the Prior Comparable Period
- Year-to-date net income improved by $14.3 million, from a $2.0 million loss to $12.3 million of income.
- Year-to-date operating income increased $27.7 million, driven by higher sales, operating efficiencies and materially lower consolidation and acquisition-related costs.
- Other operating expenses declined $25.0 million year to date, to $25.0 million, primarily due to lower Lake Region Medical integration and consolidation costs and the absence of certain 2016 Spin-off-related expenses.
- Year-to-date other loss increased by $14.8 million, primarily due to foreign-exchange losses of approximately $9.0 million, investment losses and $5.3 million of investment impairment charges.
- Gross margin declined 0.9 percentage point year to date despite higher gross profit.
- Operating cash flow increased $43.8 million year to date, although receivables and inventories consumed $34.2 million of cash in aggregate.
- Accumulated other comprehensive income increased to $43.6 million from a $16.0 million accumulated loss at year-end, largely because of foreign-currency translation gains.
Guidance, Outlook, Commentary and Risks
Management maintained its 2017 outlook for sales of $1.420 billion to $1.435 billion, GAAP diluted EPS of $0.60 to $0.80, adjusted diluted EPS of $2.55 to $2.75, and operating cash flow of approximately $150 million. Other operating expenses were expected to total approximately $30 million to $35 million. Management stated that the company remained on track for its original guidance after adjusting for foreign exchange and that cash generation supported continued debt reduction.
- Capacity and capability initiatives were expected to be substantially completed in 2017, with total expected expenses of $54 million to $56 million and capital investment of $24 million to $25 million. Expected annual operating-income benefit was greater than $20 million.
- Lake Region Medical consolidation initiatives were expected to be completed in 2018, with total expected expenses of $20 million to $25 million and expected annual operating-income benefit of $12 million to $13 million.
- Remaining risks include high leverage, covenant compliance, interest-rate and foreign-currency volatility, customer concentration, pricing pressure, customer ordering and inventory patterns, dependence on suppliers, product quality and liability, regulatory approvals, intellectual-property litigation, product obsolescence, acquisitions and execution of consolidation initiatives.
- Four customers—Abbott Labs, Boston Scientific, Johnson & Johnson and Medtronic—represented approximately 55% of year-to-date sales.
- The AVX patent litigation remained unresolved. A 2016 jury awarded Integer $37.5 million, and a second jury found additional patent infringement in August 2017; no gain had been recognized because no cash had been received.
- The company expects volatility in its effective tax rate; management estimated a 2017 worldwide effective tax rate of approximately negative 9%, excluding discrete items.
- Adoption of the new revenue-recognition standard was expected in the first quarter of 2018 using a modified retrospective method, but the company could not yet quantify the impact on reported revenue.
Investor Verification Checklist
- Verify the company’s ability to reduce leverage while funding $50 million to $55 million of 2017 capital expenditures and ongoing restructuring programs.
- Reconcile GAAP EPS guidance with adjusted EPS guidance, including approximately $90 million of expected excluded charges and their estimated $1.95 per-share after-tax impact.
- Monitor Cardiac & Neuromodulation demand, customer inventory management and the effect of continuing OEM price concessions.
- Assess covenant headroom as debt maturities, LIBOR rates and the required leverage and interest-coverage thresholds change in 2018.
- Track completion, customer validation and regulatory approval of manufacturing transfers and consolidation projects.
- Evaluate potential outcomes and timing of the AVX litigation and the recoverability of cost and equity method investments.
- Review the eventual quantitative impact of the 2018 revenue-recognition adoption and the company’s high concentration among major OEM customers.