Integer Holdings Corporation — Q3 2019 Form 10-Q Summary
Business context and reporting period
Integer 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 nine months ended September 27, 2019, compared with September 28, 2018. Results exclude the Advanced Surgical and Orthopedic product lines sold in July 2018, which are presented as discontinued operations.
The Board approved changing the fiscal year-end from the Friday nearest December 31 to December 31, subject to lender approval. The change did not affect the periods reported in this filing.
Key financial metrics
| Metric | Q3 2019 | Q3 2018 | 9M 2019 | 9M 2018 |
|---|---|---|---|---|
| Sales | $303.6 million | $305.1 million | $932.5 million | $912.0 million |
| Gross profit | $93.4 million | $91.9 million | $279.0 million | $274.2 million |
| Gross margin | 30.8% | 30.1% | 29.9% | 30.1% |
| Operating income | $46.5 million | $41.5 million | $135.0 million | $115.9 million |
| Operating margin | 15.3% | 13.6% | 14.5% | 12.7% |
| Income from continuing operations | $30.6 million | $(8.3) million | $80.2 million | $27.8 million |
| Diluted EPS from continuing operations | $0.92 | $(0.26) | $2.43 | $0.86 |
| Adjusted diluted EPS | $1.20 | $1.06 | $3.42 | $2.75 |
| Adjusted EBITDA | $69.4 million | $66.6 million | $210.5 million | $191.9 million |
Net income was $30.6 million in Q3 2019 and $85.3 million for the first nine months. Prior-year net income included $122.4 million of Q3 income and $114.4 million of nine-month income from discontinued operations, primarily reflecting the gain on the AS&O divestiture; therefore, total net income comparisons are not representative of continuing business performance.
- Q3 sales declined 0.5%; nine-month sales increased 2.2%.
- Q3 gross margin expanded 70 basis points, primarily from production efficiencies and volume leverage, despite customer price reductions.
- Nine-month gross margin declined 20 basis points because of pricing and inflation, partly offset by efficiencies and higher volume.
- Operating expenses declined $3.6 million in Q3 and $14.4 million year to date.
- Interest expense fell to $12.3 million in Q3 and $39.8 million year to date, versus $54.5 million and $85.4 million, respectively, in the comparable periods.
Revenue and segment developments
- Q3 Medical sales decreased 1.1% to $289.4 million; Non-Medical sales increased 13.8% to $14.2 million.
- For nine months, Medical sales increased 1.9% to $888.0 million and Non-Medical sales increased 10.6% to $44.4 million.
- Nine-month Cardio & Vascular sales increased 3.6% and Cardiac & Neuromodulation sales increased 1.0%, while Advanced Surgical, Orthopedics & Portable Medical sales decreased 2.9%.
- Customer price reductions reduced Q3 sales by approximately $3.2 million and nine-month sales by approximately $9.6 million. Foreign exchange reduced sales by approximately $0.6 million and $2.2 million, respectively.
Cash flow, debt and liquidity
| Metric at or for 9M 2019 | Amount |
|---|---|
| Cash flow from operations | $112.0 million |
| Capital expenditures | $24.7 million |
| Net cash used in financing | $102.4 million |
| Cash and cash equivalents at September 27, 2019 | $14.7 million |
| Total debt, net of discounts and issuance costs | $827.9 million |
| Available revolving credit capacity | $193.2 million |
Operating cash flow decreased from $120.7 million in the prior-year period, primarily because of working-capital usage, including higher receivables and inventory. The Company used excess cash to repay approximately $102.1 million of debt during the first nine months, including $36.3 million in Q3. Debt declined from $925.5 million at December 28, 2018 to $827.9 million at September 27, 2019.
The term loan A and term loan B carried interest rates of 4.31% and 5.05%, respectively. Approximately 20% of principal debt was subject to variable rates at quarter-end, compared with approximately 79% at year-end 2018, following interest-rate swap transactions. The Company reported a total net leverage ratio of approximately 2.7x and adjusted EBITDA-to-interest coverage of approximately 6.5x, versus covenants of 4.75x maximum leverage, subject to step-downs, and 3.0x minimum interest coverage. Management stated that all covenants were satisfied.
Working capital was $264.1 million and the current ratio was 2.40 at September 27, 2019. Management expects 2019 capital expenditures of $50 million to $55 million and believes cash, operating cash flow and available revolver capacity will fund requirements for the next twelve months.
Guidance, outlook and management commentary
Management raised its full-year 2019 profit outlook while maintaining sales expectations:
| 2019 continuing operations | GAAP outlook | Non-GAAP outlook |
|---|---|---|
| Sales | $1.265–$1.280 billion | $1.265–$1.280 billion |
| Income | $106–$110 million | $150–$154 million |
| EBITDA | Not provided | $282–$286 million |
| Diluted EPS | $3.22–$3.32 | $4.55–$4.65 |
Management attributed the stronger outlook to operational execution, production efficiencies, cost actions and debt reduction. It expects 2019 other operating expenses of approximately $10 million to $13 million. Strategic reorganization and manufacturing-alignment actions are expected to be substantially completed by year-end 2019.
On October 7, 2019, after quarter-end, Integer acquired certain US BioDesign assets for $15 million in cash, with up to an additional $5.5 million contingent earn-out over four years. The acquisition adds complex braided biomedical-structure capabilities for disposable and implantable devices.
Material changes, unusual items and risks
- The major year-over-year improvement in GAAP earnings reflects substantially lower debt-related charges and interest expense following the 2018 AS&O divestiture and debt repayment. The 2018 periods included significant debt extinguishment costs and the AS&O sale gain.
- 2019 included $8.2 million of other operating expenses through nine months, including strategic reorganization, manufacturing alignment, asset dispositions and severance.
- A $1.6 million impairment was recorded on a non-marketable equity investment in Q2 2019.
- The AVX patent litigation jury awarded Integer $22.2 million in a January 2019 damages retrial. AVX appealed in August, and Integer filed a cross-appeal in September. No gain has been recognized.
- Risks include high leverage and refinancing needs, customer concentration and pricing pressure, dependence on third-party suppliers, product quality and regulatory matters, intellectual-property and product-liability claims, foreign currency and interest-rate exposure, execution of restructuring and acquisitions, and healthcare-industry changes.
- The Company adopted the new lease standard, recognizing operating lease assets of $43.7 million and operating lease liabilities of $38.7 million at September 27, 2019. Adoption did not materially affect operations or cash flow.
Investor verification checklist
- Reconcile GAAP results with management’s adjusted income, EPS and EBITDA measures, including the adjustments excluded from non-GAAP guidance.
- Assess whether sales growth can offset continuing OEM price reductions, customer concentration and demand timing shifts.
- Monitor debt repayment, the October 2020 revolver maturity, term-loan maturities and compliance with tightening leverage covenants.
- Evaluate execution and remaining cash costs for restructuring and manufacturing-alignment programs.
- Track the AVX appeal and any eventual recognition or non-recognition of damages.
- Assess the integration, purchase accounting and contingent consideration associated with the US BioDesign acquisition.
- Confirm the lender approval and implementation details of the fiscal year-end change.