Integer Holdings Corporation — FY2018 Form 10-K Summary
Reporting period: Fiscal year ended December 28, 2018, consisting of 52 weeks. The filing includes fourth-quarter data, but is an annual Form 10-K. Integer is a medical device outsourcing manufacturer serving cardiac, neuromodulation, vascular, surgical, orthopedic and portable medical markets, with a smaller battery business serving energy, military and environmental applications.
Business Context and Major Transaction
- The company reports Medical and Non-Medical segments. FY2018 continuing-operations results exclude the Advanced Surgical and Orthopedic product lines, which were sold to Viant on July 2, 2018.
- The divestiture generated approximately $581 million of net cash proceeds and a pretax gain of approximately $195 million. The proceeds were primarily used to repay debt.
- FY2018 firm backlog was approximately $268 million, with most orders expected to ship within one year.
- Abbott, Medtronic and Boston Scientific each represented more than 10% of total sales and collectively accounted for approximately 52% of FY2018 sales.
Financial Performance
| Metric | FY2018 | FY2017 | Change |
|---|---|---|---|
| Sales | $1.215 billion | $1.136 billion | Up 6.9% |
| Gross profit | $362.7 million | $354.0 million | Up 2.4% |
| Gross margin | 29.8% | 31.2% | Down 1.4 percentage points |
| Operating income | $155.6 million | $125.6 million | Up 23.8% |
| Operating margin | 12.8% | 11.1% | Up 1.7 percentage points |
| Income from continuing operations | $47.0 million | $87.1 million | Down 46.0% |
| Diluted EPS from continuing operations | $1.44 | $2.72 | Down $1.28 |
| Net income | $168.0 million | $66.7 million | Up $101.3 million |
| Diluted EPS | $5.15 | $2.08 | Up $3.07 |
| Adjusted diluted EPS from continuing operations | $3.80 | $3.09 | Up 23% |
| Adjusted EBITDA from continuing operations | $259.4 million | $234.0 million | Up 10.9% |
Medical sales increased 7.7% to $1.162 billion, led by Cardio & Vascular sales growth of 10.3% and Advanced Surgical, Orthopedics & Portable Medical growth of 11.0%. Cardiac & Neuromodulation increased 3.5%. Non-Medical sales declined 7.0% to $53.0 million, reflecting weaker North American drilling activity, customer inventory adjustments and the planned phase-out of certain rechargeable battery products.
Gross margin declined primarily because of customer price concessions, an unfavorable product mix and higher incentive compensation. Price concessions to larger OEM customers reduced FY2018 sales by approximately $15 million. Operating income benefited from lower integration and consolidation costs, partially offset by higher incentive compensation.
Fourth-Quarter Data
| Metric | Q4 FY2018 | Q4 FY2017 |
|---|---|---|
| Sales | $303.0 million | $302.3 million |
| Gross profit | $88.4 million | $93.6 million |
| Net income | $19.2 million | $54.7 million |
| Diluted EPS | $0.58 | $1.69 |
Q4 FY2018 net income included approximately $41 million of pretax debt-extinguishment charges, primarily related to the AS&O divestiture and debt repayment.
Cash Flow, Debt and Liquidity
- Cash provided by operating activities was $167.3 million, compared with $149.4 million in FY2017.
- Investing cash flow was $536.7 million, primarily reflecting the $581.4 million AS&O sale proceeds.
- Financing cash flow was negative $725.1 million, including approximately $700.5 million of net debt repayment and $32.0 million of debt issuance and redemption costs.
- Cash and cash equivalents were $25.6 million at year-end, down from $37.3 million. Working capital from continuing operations was $251.7 million, and the current ratio was 2.53.
- Total debt principal was approximately $942.0 million; debt net of discounts and issuance costs was $925.5 million. The company redeemed its $360 million of 9.125% senior notes and paid a $31.3 million make-whole premium.
- Available borrowing capacity under the $200 million revolving facility was approximately $188.2 million after borrowings and letters of credit.
- Net leverage was approximately 3.3x and adjusted EBITDA-to-interest coverage was approximately 5.4x. The company was in compliance with its debt covenants at year-end.
- Estimated FY2019 principal and interest debt service was approximately $86 million. Management stated that cash, operating cash flow and available revolver capacity should fund working capital, debt service and expected capital expenditures for the next twelve months.
Material Changes, Outlook and Unusual Items
- FY2018 continuing-operations earnings declined despite higher sales and operating income because interest expense increased by $35.3 million, including $42.7 million of debt-extinguishment losses.
- FY2017 benefited from a $39.4 million net tax benefit related to the Tax Reform Act; FY2018 included a $14.1 million tax provision and a 23.0% effective tax rate.
- Management expects FY2019 capital spending for continuing operations of approximately $50 million to $55 million.
- Management expected FY2019 sales growth from new customers and products and renewed military-market government funding, while recognizing continued customer pricing pressure.
- Strategic reorganization and alignment charges are estimated at $28 million to $30 million in total, with $16 million to $20 million expected to be cash costs. Manufacturing-alignment charges are estimated at $9 million to $11 million, plus $4 million to $6 million of capital expenditures. Both initiatives were expected to be substantially completed by the end of 2019.
- The company recorded no gain from the AVX patent litigation as of the filing date. A January 2019 retrial awarded Integer $22.2 million, subject to post-trial proceedings.
- The company reported $1.6 billion of goodwill and other intangible assets, representing approximately 71% of total assets. No goodwill or indefinite-lived intangible impairment was identified at year-end, but future impairment remains a risk.
- The company adopted revenue-recognition guidance in FY2018 without a material financial statement impact and expected the new lease standard to add approximately $40 million to $50 million of right-of-use assets and lease liabilities beginning in FY2019.
Principal Risks and Contingencies
- Customer concentration, limited contractual minimum purchase commitments, customer insourcing, inventory changes and pricing concessions.
- High leverage, variable interest rates, covenant requirements and refinancing or liquidity risk. A 100-basis-point change in LIBOR would affect annual interest expense by approximately $7 million on unhedged variable-rate debt.
- Dependence on limited suppliers of specialized raw materials and potential disruptions, cost inflation or shortages.
- Medical-device regulatory compliance, product liability, recalls, quality failures, intellectual-property disputes and environmental obligations.
- Foreign currency, international operating, tax, healthcare-reimbursement, energy-market and cybersecurity risks.
Investor Verification Checklist
- Verify the recurring earnings power of continuing operations separately from the $195 million divestiture gain, discontinued operations and debt-extinguishment charges.
- Reconcile GAAP EPS of $1.44 from continuing operations with adjusted EPS of $3.80 and assess which adjustments are genuinely nonrecurring.
- Monitor gross-margin trends and the ability of manufacturing efficiencies and supply-chain savings to offset customer price concessions.
- Confirm debt paydown, covenant headroom, revolver availability and the effect of LIBOR or other floating-rate changes.
- Track customer concentration, backlog conversion, customer inventory behavior and the sustainability of Cardio & Vascular and Cardiac & Neuromodulation growth.
- Assess completion costs and cash requirements for the strategic reorganization and manufacturing-alignment programs.
- Follow the AVX litigation, final divestiture working-capital and tax adjustments, and any future goodwill or intangible-asset impairment indicators.