Greatbatch, Inc. (proposed Integer Holdings Corporation) — Q1 2016 Form 10-Q
Reporting period: 13 weeks ended April 1, 2016, compared with 13 weeks ended April 3, 2015. The filing was dated May 10, 2016. The company completed its acquisition of Lake Region Medical in October 2015 and spun off a portion of QiG as Nuvectra Corporation on March 14, 2016. The proposed name change to Integer Holdings Corporation was subject to shareholder approval.
Business context
The company designs and manufactures medical components, devices and outsourced manufacturing solutions serving cardiac, neuromodulation, vascular, advanced surgical, orthopedic, portable medical and other markets. Q1 2016 reportable segments were Greatbatch Medical, QiG and Lake Region Medical. Lake Region Medical contributed $198.3 million of quarterly revenue.
Key financial metrics
| Metric | Q1 2016 | Q1 2015 | Change |
|---|---|---|---|
| Sales | $332.2 million | $161.3 million | Up 106% |
| Gross profit / margin | $91.5 million / 27.5% | $52.4 million / 32.5% | Margin down 5.0 points |
| Operating income / margin | $11.1 million / 3.4% | $9.4 million / 5.8% | Margin down 2.4 points |
| Interest expense, net | $27.6 million | $1.1 million | Up $26.5 million |
| Net income (loss) | $(12.7) million | $8.0 million | Declined $20.7 million |
| Diluted EPS | $(0.41) | $0.31 | Down $0.72 |
| Adjusted diluted EPS | $0.34 | $0.65 | Down 48% |
| Adjusted EBITDA | $61.7 million | $30.4 million | Margin 18.6% vs. 18.9% |
| Cash flow from operations | $29.9 million | $7.3 million | Up $22.6 million |
Organic constant-currency sales declined 16%, excluding acquisition, divestiture and currency effects. Management attributed the decline to product end-of-life activity, customer inventory reductions, price concessions and the energy-market slowdown. Growth in neuromodulation partially offset these pressures.
Liquidity, debt and capital resources
- Cash and cash equivalents were $54.1 million at April 1, 2016, down from $82.5 million at January 1, 2016.
- Total debt was $1.76 billion, including $370.3 million under Term Loan A, $1.02 billion under Term Loan B, $360 million of 9.125% senior notes and $55 million drawn on the revolving facility.
- Available revolving capacity was $134.1 million after standby letters of credit.
- Total net leverage was approximately 5.5x and adjusted EBITDA to interest expense was approximately 4.1x for the relevant trailing period. The company remained in compliance with its debt covenants.
- Operating cash flow was $29.9 million; capital expenditures were $18.8 million; and cash used in financing activities was $40.1 million.
- Financing cash use included the $76.3 million cash distribution to Nuvectra, $7.25 million of debt principal repayments and $6.8 million to purchase remaining non-controlling interests in certain QiG subsidiaries. The distribution was partially funded by $55 million of revolving borrowings.
- Management expected 2016 maintenance capital spending of $50 million to $60 million and believed cash, operating cash flow and available revolver capacity were adequate to fund needs.
Material changes versus the prior comparable period
- Revenue more than doubled primarily because of the Lake Region Medical acquisition; however, legacy organic sales declined materially.
- Gross margin fell from 32.5% to 27.5%, primarily due to Lake Region Medical’s historically lower margins, lower production volumes and customer price concessions.
- Operating expenses increased substantially, including acquisition and integration costs, consolidation and optimization charges, litigation expenses, Spin-off costs and asset disposition/severance charges.
- Interest expense rose sharply because of the debt used to finance the Lake Region Medical acquisition and related transactions.
- The company moved from $8.0 million of net income to a $12.7 million net loss, despite higher operating income.
- Three customers represented 47% of sales, compared with 54% in the prior-year quarter.
Guidance, outlook and management commentary
- Q2 2016 revenue guidance was $355 million to $360 million.
- Full-year 2016 guidance was reiterated at revenue of $1.425 billion to $1.475 billion, adjusted EBITDA of $320 million to $335 million and adjusted diluted EPS of $3.00 to $3.35.
- Management expected at least $25 million of annual pre-tax operating synergies from the Lake Region Medical acquisition in 2016, increasing to at least $60 million by 2018, with $60 million to $75 million of expected integration investment over three years.
- Management stated that integration was progressing well and that the strategic priorities were integrating the businesses, optimizing the supply chain and global footprint, realizing synergies and reducing leverage toward 3.0x to 3.5x adjusted EBITDA over two to three years.
- Management believed the energy-market downturn had bottomed, but did not expect an Electrochem recovery until at least 2017.
- 2016 other operating expenses were expected to be approximately $55 million to $65 million. Remaining restructuring and integration costs were expected across capacity initiatives, orthopedic optimization, Lake Region Medical consolidations and acquisition integration.
Risks, contingencies and unusual items
- The company had significant post-acquisition leverage, variable-rate debt and no outstanding interest-rate swaps. A 100-basis-point increase in LIBOR was estimated to increase annual interest expense by approximately $10.6 million.
- Customer concentration, pricing pressure, inventory actions, product obsolescence, foreign exchange, regulatory changes, product liability, intellectual property disputes and acquisition integration were identified as key risks.
- A jury awarded Greatbatch $37.5 million in damages in patent litigation against AVX; no gain was recorded because no cash had been received, and post-trial proceedings and a possible appeal remained.
- The company recorded $1.1 million for environmental remediation at a former Lake Region Medical site and was awaiting EPA action on a post-remediation care plan.
- Purchase commitments totaled approximately $60.3 million, and future operating lease expense totaled approximately $87.7 million.
- The company reported no material impairment charges, no off-balance-sheet arrangements and no material changes to previously disclosed risk factors.
- The Lake Region Medical purchase price allocation remained preliminary, although first-quarter measurement-period adjustments were not material.
- Adjusted results excluded substantial items, including intangible amortization, litigation, consolidation and optimization costs, acquisition and integration costs, asset dispositions, severance and Spin-off-related expenses.
Facts investors should verify
- Whether revenue growth and projected synergies translate into sustained organic growth and margin expansion, given the 16% organic constant-currency sales decline.
- Progress toward debt reduction and compliance with leverage and interest-coverage covenants as scheduled covenant step-downs begin.
- The timing and total cost of Lake Region Medical integration, facility consolidations and other restructuring programs.
- The ultimate resolution and collectability of the $37.5 million AVX patent award.
- The impact of customer concentration, inventory normalization, price concessions and the delayed energy-market recovery.
- Final approval and implementation of the Integer Holdings Corporation name and any resulting changes to segment reporting.