Integer Holdings Corporation — 2019 Q2 Form 10-Q Summary
Business context and reporting period
Integer Holdings is a medical device outsource manufacturer serving cardiac, neuromodulation, vascular, orthopedics, advanced surgical and portable medical markets, with a smaller Non-Medical battery business. The report covers the 13-week quarter and six months ended June 28, 2019, compared with June 29, 2018. Results exclude the Advanced Surgical and Orthopedic product lines sold to Viant on July 2, 2018, which are reported as discontinued operations.
Financial performance and liquidity
| Metric | Q2 2019 | Q2 2018 | Six months 2019 | Six months 2018 |
|---|---|---|---|---|
| Sales | $314.2 million | $314.5 million | $628.9 million | $606.9 million |
| Gross profit | $97.0 million | $98.8 million | $185.6 million | $182.3 million |
| Gross margin | 30.9% | 31.4% | 29.5% | 30.0% |
| Operating income | $49.3 million | $44.4 million | $88.5 million | $74.4 million |
| Operating margin | 15.7% | 14.1% | 14.1% | 12.3% |
| Income from continuing operations | $28.2 million | $23.1 million | $49.6 million | $36.1 million |
| Diluted EPS from continuing operations | $0.85 | $0.70 | $1.50 | $1.11 |
| Net income | $33.1 million | $20.0 million | $54.7 million | $28.1 million |
| Adjusted EBITDA | $75.4 million | $71.4 million | $141.1 million | $125.3 million |
- Q2 sales were essentially flat year over year, while six-month sales increased 3.6%. Six-month growth was led by Cardio & Vascular, Cardiac & Neuromodulation and Non-Medical sales.
- Q2 operating income increased 11.2%, and six-month operating income increased 19.0%, primarily from lower SG&A, research and development, and other operating expenses.
- Gross margin declined 50 basis points in both comparison periods, mainly because of customer price reductions and inflation, partly offset by production efficiencies, volume leverage and product mix.
- Cash provided by operations was $67.6 million for the six months, compared with $67.2 million in 2018. Capital expenditures were $15.5 million.
- Cash declined to $15.9 million from $25.6 million at year-end 2018 as the Company used excess cash to reduce debt. Working capital was $261.8 million and the current ratio was 2.42.
- Total debt, net of discounts and issuance costs, was $862.9 million at June 28, 2019, down from $925.5 million at December 28, 2018. The Company paid down $65.8 million of debt during the first six months.
- The revolving facility had $183.2 million of available capacity after outstanding borrowings and letters of credit. The Company reported a total net leverage ratio of approximately 2.9x and adjusted EBITDA-to-interest coverage of approximately 6.2x, and was in compliance with its covenants.
Material changes versus the prior comparable period
- Continuing-operations income increased 22.4% in Q2 and 37.2% for the first six months; diluted EPS increased 21.4% and 35.1%, respectively.
- Operating expense reductions were $6.8 million in Q2 and $10.8 million year to date. Transition-service income from Viant reduced SG&A by $1.2 million in Q2 and $2.8 million year to date; the transition services agreement ended during Q2.
- Interest expense decreased $1.6 million in Q2 and $3.4 million year to date because of lower debt balances.
- Equity-investment results deteriorated from gains of $0.3 million in Q2 2018 and $5.3 million year to date to losses of $1.6 million and $1.7 million, respectively. The 2019 Q2 result included a $1.6 million impairment charge.
- Discontinued operations contributed $4.8 million in Q2 and $5.1 million year to date, including a $4.8 million gain from the final working-capital adjustment related to the Viant divestiture. The prior-year periods included operating losses from the divested business.
- The Company adopted ASC 842 lease accounting, recording operating lease assets of $44.8 million and operating lease liabilities of $39.8 million at June 28, 2019. The adoption did not materially affect reported earnings or cash flow.
Guidance, outlook, commentary and risks
Management stated that strong organic profit growth, debt reduction and operational execution supported an improved full-year outlook. For continuing operations, 2019 guidance was sales of $1.265 billion to $1.280 billion, GAAP income of $95 million to $102 million, GAAP diluted EPS of $2.89 to $3.09, adjusted EBITDA of $277 million to $285 million, adjusted income of $140 million to $147 million and adjusted diluted EPS of $4.25 to $4.45. Planned 2019 capital spending was $50 million to $55 million.
- Restructuring and manufacturing-alignment initiatives are expected to be substantially completed by year-end 2019. Other operating expenses are expected to be approximately $10 million to $15 million for 2019.
- Management believes cash, operating cash flow and available revolver capacity are sufficient for working capital, debt service and capital expenditures for the next twelve months.
- Key risks include substantial indebtedness, refinancing and covenant compliance, customer concentration and ordering patterns, pricing pressure, supplier and quality issues, product liability or recalls, regulatory approvals, intellectual-property disputes, foreign exchange and interest-rate volatility, tax-rate changes, and execution of cost and manufacturing initiatives.
- The AVX patent litigation jury awarded Integer $22.2 million in damages in January 2019. No gain had been recorded as of the quarter-end; on July 31, 2019, the court denied AVX’s post-trial motion to overturn the verdict.
- Strategic reorganization, manufacturing alignment, severance and other charges totaled $6.0 million during the first six months. The Company also had approximately $5.4 million of unrecognized tax benefits, with up to $0.9 million potentially resolving within twelve months.
Facts investors should verify
- Whether sales growth and improved operating margins can offset ongoing OEM price reductions and inflation.
- The sustainability of operating-expense reductions after Viant transition services ended.
- Debt paydown, refinancing plans and compliance as leverage covenant thresholds step down beginning in the third quarter of 2019.
- Execution of the $50 million to $55 million capital-spending plan and its effect on free cash flow.
- The final outcome and collectability of the AVX damages award.
- Whether the Viant divestiture and related supply agreements create continuing concentration, pricing or operational dependencies.
- Future equity-investment valuations, tax-rate volatility, foreign exchange effects and restructuring costs.