Integer Holdings Corporation — Form 10-Q Summary
Business context and reporting period
Integer Holdings Corporation, formerly Greatbatch, Inc., is a medical device outsourcing manufacturer serving cardiac, neuromodulation, vascular, advanced surgical, orthopedic, portable medical and power-solution markets. The filing covers the 13-week quarter and 39 weeks ended September 30, 2016, compared with periods ended October 2, 2015.
- Lake Region Medical, acquired October 27, 2015, contributed $203.9 million of third-quarter sales and $607.1 million of nine-month sales.
- Integer completed the tax-free spin-off of a portion of QiG as Nuvectra Corporation on March 14, 2016.
- The company changed its name from Greatbatch, Inc. to Integer Holdings Corporation effective June 30, 2016.
Key financial metrics
| Metric | Q3 2016 | Q3 2015 | First 9 months 2016 | First 9 months 2015 |
|---|---|---|---|---|
| Sales | $346.6 million | $146.6 million | $1,027.2 million | $482.8 million |
| Gross profit | $97.9 million | $51.6 million | $285.4 million | $162.0 million |
| Gross margin | 28.3% | 35.2% | 27.8% | 33.5% |
| Operating income | $36.9 million | $1.2 million | $77.3 million | $23.6 million |
| Operating margin | 10.6% | 0.8% | 7.5% | 4.9% |
| Net income (loss) | $11.5 million | $0.02 million | $(2.0) million | $17.3 million |
| Diluted EPS | $0.37 | $0.00 | $(0.06) | $0.66 |
| Adjusted EBITDA | $75.0 million | $31.4 million | $205.6 million | $96.9 million |
| Adjusted EBITDA margin | 21.6% | 21.4% | 20.0% | 20.1% |
Operating cash flow for the first nine months was $71.8 million, versus $31.0 million in the prior-year period. Capital expenditures were $47.0 million, and investing cash flow was $(50.9) million. Financing cash flow was $(58.9) million, including $76.3 million of cash distributed with the Nuvectra spin-off, $28.8 million of debt repayments, $57.0 million of new debt proceeds and $6.8 million used to purchase non-controlling interests.
Cash and cash equivalents were $45.0 million at September 30, 2016, down from $82.5 million at January 1, 2016. Working capital was $325.2 million and the current ratio was 2.63.
Debt and liquidity
- Total debt was $1.746 billion, including $360.9 million of term loan A, $1.017 billion of term loan B, $360.0 million of 9.125% senior notes due 2023 and $50.0 million drawn on the revolving credit facility.
- The company had $141.1 million of available revolver capacity after outstanding letters of credit.
- Weighted-average interest on outstanding borrowings was 5.69%; interest expense increased to $83.4 million for the first nine months from $8.2 million in the prior-year period.
- At September 30, the company reported a total net leverage ratio of approximately 5.55x and adjusted EBITDA-to-interest coverage of approximately 3.11x, versus a minimum interest coverage requirement of 3.00x.
- Management warned that current expectations for 2016 adjusted EBITDA create a potential year-end failure to meet the minimum interest coverage covenant. The company was seeking an amendment or waiver before year-end; failure to obtain one could result in an event of default and acceleration of debt.
Material changes versus the prior comparable period
- Reported sales increased 136% in the quarter and 113% year to date, primarily because of the Lake Region Medical acquisition. Excluding acquisition, divestiture and currency effects, organic constant-currency sales declined 4% in the quarter and 13% year to date.
- Reported gross margin declined 6.9 percentage points in the quarter and 5.7 points year to date. Management attributed the decline to Lake Region Medical’s lower historical margins, lower production volumes, unfavorable mix and customer price concessions.
- Operating income improved substantially, but the nine-month period produced a GAAP loss because interest expense increased by $75.2 million and acquisition, integration and spin-off costs increased by $20.6 million.
- Q3 GAAP net income was $11.5 million, compared with essentially break-even income in the prior-year quarter. Nine-month GAAP results declined to a $2.0 million loss from $17.3 million of net income.
- Adjusted diluted EPS was $0.83 in Q3, up from $0.58, but $1.72 for the first nine months, down from $1.95.
- Three customers represented 46% of nine-month sales, compared with 50% in the prior-year period; the filing identifies them as Johnson & Johnson, Medtronic and St. Jude Medical.
Guidance, outlook, commentary and unusual items
| 2016 outlook | GAAP high | GAAP low | Adjusted comparable high | Adjusted comparable low |
|---|---|---|---|---|
| Revenue | $1.396 billion | $1.376 billion | $1.395 billion | $1.375 billion |
| Net income | $13 million | $9 million | $86 million | $82 million |
| Diluted EPS | $0.42 | $0.27 | $2.75 | $2.60 |
| Adjusted EBITDA | N/A | N/A | $295 million | $285 million |
- Management said third-quarter results showed initial stabilization from cost reduction, working-capital improvements and process optimization, but acknowledged that predictable revenue growth had not yet returned.
- Lake Region Medical integration synergies were approximately $11 million in Q3 and $25 million year to date. Full-year 2016 net synergies were expected at $30 million to $35 million, with a target of $60 million by 2018.
- Expected 2016 capital spending was $55 million to $60 million. Management expected cash on hand, operating cash flow and revolver capacity to fund capital requirements for the next twelve months.
- Consolidation, optimization, acquisition and integration charges remained significant. Other operating expenses were expected to total approximately $55 million to $65 million in 2016.
- The company announced closure of its Clarence, New York facility, with product transfers expected to run through the first quarter of 2018 and estimated annual synergies of approximately $4 million beginning in 2018.
- Integer recorded no gain from a $37.5 million jury award in its patent litigation against AVX because no cash had been received and post-trial proceedings, including a possible appeal, remained.
- Goodwill and indefinite-lived intangible assets totaled approximately $1.068 billion. No impairment was recorded, but management noted that weaker operating results, cash flows or stock price could lead to future impairment.
Principal risks and contingencies
- High leverage, rising interest expense, variable-rate debt and potential covenant noncompliance.
- Dependence on a limited number of large OEM customers, customer inventory reductions, product-launch delays, pricing pressure and customer program changes.
- Execution risk related to Lake Region Medical integration, manufacturing transfers, facility closures and realization of expected synergies.
- Foreign currency exposure, particularly to the euro, Mexican peso and Malaysian ringgit; a hypothetical 100-basis-point increase in LIBOR was estimated to increase annual interest expense by approximately $7 million on unhedged variable-rate debt.
- Environmental matters at acquired facilities, including groundwater remediation at Collegeville, Pennsylvania, and additional investigation requested by the New Jersey Department of Environmental Protection for a former South Plainfield site. The company did not expect either matter to be material and had recorded $1.1 million of related liabilities.
- Product warranty, regulatory, product-liability, intellectual-property and potential field-action risks. The filing states that no material new legal proceedings or material risk-factor changes occurred during the quarter.
Investor verification checklist
- Confirm whether the company obtained the requested year-end covenant amendment or waiver and whether interest coverage remained compliant.
- Reconcile GAAP results to adjusted net income, adjusted EPS and adjusted EBITDA, particularly the substantial amortization, integration, consolidation and other excluded charges.
- Assess organic revenue trends separately from Lake Region Medical’s acquired revenue, including CRM customer programs, cardio and vascular inventory reductions, portable medical transfers and energy-market weakness.
- Track gross-margin recovery, synergy realization, restructuring spending and the pace of debt reduction.
- Review subsequent developments in the AVX patent litigation, environmental matters, goodwill impairment testing and customer concentration.