Integer Holdings Corporation — Q1 2017 Form 10-Q Summary
Business context and reporting period
Integer Holdings is a medical-device outsource manufacturer serving cardiac, neuromodulation, vascular, orthopedic, advanced surgical and portable medical markets, with a smaller Non-Medical battery business. The quarter ended March 31, 2017 and contained 13 weeks; the comparable quarter ended April 1, 2016 and also contained 13 weeks. Reportable segments were Medical and Non-Medical.
The 2016 comparison includes Nuvectra operations through the March 14, 2016 spin-off, which affects comparability. Prior-period product-line and segment information was reclassified to conform to the 2017 presentation.
Financial performance and key metrics
| Metric | Q1 2017 | Q1 2016 | Change |
|---|---|---|---|
| Sales | $345.4 million | $332.2 million | +4% |
| Gross profit / margin | $91.2 million / 26.4% | $91.5 million / 27.5% | Margin down 110 bps |
| Operating income / margin | $26.5 million / 7.7% | $11.1 million / 3.4% | +58%; margin up 430 bps |
| Net loss / diluted EPS | $(4.3) million / $(0.14) | $(12.7) million / $(0.41) | Loss improved by $8.3 million |
| Adjusted diluted EPS | $0.41 | $0.42 | Down $0.01 |
| EBITDA | $49.3 million | $37.3 million | +$12.0 million |
| Adjusted EBITDA | $64.3 million | $65.4 million | Down $1.1 million |
| Operating cash flow | $38.6 million | $29.9 million | +$8.8 million |
Medical sales increased 4% to $334.1 million. Cardio & Vascular sales rose 10% to $125.1 million, Advanced Surgical, Orthopedics & Portable Medical sales rose 7% to $105.1 million, and Cardiac & Neuromodulation sales declined 4% to $103.8 million. Non-Medical sales declined 3% to $11.3 million.
Sales growth reflected market growth and new business wins, while foreign exchange reduced sales by approximately $1.4 million and the prior-year Nuvectra spin-off reduced sales by approximately $1.2 million. Management reported approximately 5% organic sales growth.
Gross margin declined because of price concessions to larger OEM customers in exchange for long-term commitments and a less favorable product mix. Production efficiencies and integration synergies partially offset these pressures.
Operating expenses declined $15.7 million, including lower spin-off-related costs, lower Lake Region Medical acquisition and integration charges, and operating efficiencies. Interest expense increased $1.3 million, primarily because of accelerated amortization and write-off of debt fees and discounts following debt repayment. Other expense included a $0.4 million investment loss and approximately $1.5 million of foreign-currency losses.
Balance sheet, debt and liquidity
- Cash and cash equivalents were $54.9 million at March 31, 2017, compared with $52.1 million at December 30, 2016.
- Working capital was $324.0 million, with a current ratio of 2.59.
- Total debt was $1.70 billion, including $34.2 million classified as current debt. Debt consisted principally of a $351.6 million term loan A, $948.3 million term loan B, $82.0 million revolver borrowings and $360.0 million of 9.125% senior notes due 2023.
- The company repaid approximately $79.2 million of long-term debt and issued $50.0 million of long-term debt during the quarter, for net debt-related payments of approximately $29.2 million. It recognized a $1.6 million loss from debt extinguishment.
- On March 17, 2017, the company amended its credit facilities to reduce term loan B interest-rate margins by 75 basis points. Maturities and financial covenants were unchanged.
- The revolver had $109.1 million of available capacity after outstanding letters of credit. Total net leverage was approximately 5.65x and adjusted EBITDA to interest expense was approximately 2.91x, compared with required thresholds of 6.25x maximum leverage and 2.50x minimum interest coverage. The company was in compliance with its covenants.
- Capital expenditures were $12.3 million in the quarter. Full-year 2017 capital spending was expected to be $50 million to $60 million, approximately half discretionary.
Material changes, outlook and unusual items
- Full-year 2017 guidance was reaffirmed: sales of $1.39 billion to $1.43 billion, GAAP diluted EPS of $1.03 to $1.43, adjusted diluted EPS of $2.70 to $3.10, and operating cash flow of approximately $150 million.
- Other operating expenses were $11.8 million, including $4.8 million of acquisition and integration costs, $4.6 million of asset disposition, severance and other costs, and $2.3 million of consolidation and optimization expenses. Approximately $4.7 million related to CEO and CFO transitions.
- Management expected 2017 other operating expenses of approximately $25 million to $30 million. Remaining restructuring, consolidation and integration programs are expected to continue through 2017 and 2018.
- The 2014 capacity and capability program is expected to incur total expenses of $52 million to $55 million and capital expenditures of $24 million to $25 million; $50.7 million of expense and $23.4 million of capital investment had been incurred through March 31, 2017.
- Lake Region Medical consolidation initiatives are expected to incur total expenses of $20 million to $25 million and capital expenditures of $5 million to $6 million, with completion expected in 2018.
- Management emphasized completing integration, improving operating processes, generating cash flow and accelerating debt repayment. Key pressures include OEM pricing concessions, product mix, customer ordering patterns, currency movements and the remaining facility transfers.
Risks and contingencies
- Four customers—Abbott Labs, Boston Scientific, Johnson & Johnson and Medtronic—represented approximately 55% of total sales. Customer concentration, consolidation and pricing pressure are material risks.
- High leverage may limit financial flexibility. A significant increase in LIBOR or decline in sales or adjusted EBITDA could impair covenant compliance and potentially trigger an event of default.
- The company faces risks from product quality, recalls, regulatory approvals, intellectual-property disputes, supplier dependence, acquisition integration, foreign exchange and interest-rate fluctuations.
- Integer had not recognized any gain from its patent litigation against AVX, despite a $37.5 million jury award. Post-trial proceedings were scheduled for August 2017, and the ultimate outcome remained uncertain.
- The company held approximately $22.6 million of cost and equity method investments whose values may fluctuate materially. It also had approximately $10.9 million of unrecognized tax benefits.
Investor verification checklist
- Verify whether sales growth and new business wins offset continuing OEM price concessions and lower-margin product mix.
- Monitor adjusted EBITDA, operating cash flow and debt repayment against the company’s leverage and interest-coverage covenants.
- Assess progress, cash costs and expected benefits from the Lake Region Medical integration and facility consolidation programs.
- Reconcile GAAP EPS guidance to adjusted EPS guidance, particularly the projected $44 million of intangible amortization and approximately $77 million of excluded pre-tax items.
- Track customer concentration, Cardiac & Neuromodulation recovery, foreign-exchange exposure and the outcome of the AVX litigation.