Greatbatch, Inc. (now Integer Holdings Corp.) — Form 10-Q Summary
Business context and reporting period
The filing covers the 13-week third quarter and 39-week year-to-date period ended October 2, 2015, compared with periods ended October 3, 2014. The company reported two segments: Greatbatch Medical, which designs and manufactures medical devices and components, and QiG, which develops neurostimulation technologies. The filing predates the company’s later Integer Holdings name.
On October 27, 2015, after the reporting date, Greatbatch acquired Lake Region Medical and announced financing and capital-structure changes that materially affected subsequent periods. The company also planned to spin off a portion of QiG as Nuvectra in the first quarter of 2016.
Key financial metrics
| Metric | Q3 2015 | Q3 2014 | 9M 2015 | 9M 2014 |
|---|---|---|---|---|
| Sales | $146.6 million | $171.7 million | $482.8 million | $518.1 million |
| Gross profit | $51.6 million | $58.1 million | $162.0 million | $174.2 million |
| Gross margin | 35.2% | 33.8% | 33.5% | 33.6% |
| Operating income | $1.2 million | $16.2 million | $23.6 million | $58.2 million |
| Operating margin | 0.8% | 9.4% | 4.9% | 11.2% |
| Net income | $22 thousand | $14.0 million | $17.3 million | $41.3 million |
| Diluted EPS | Less than $0.01 | $0.54 | $0.66 | $1.60 |
| Adjusted diluted EPS | $0.58 | $0.75 | $1.95 | $2.09 |
| Adjusted EBITDA | $31.4 million | $39.8 million | $96.9 million | $111.5 million |
- Q3 gross margin improved 140 basis points, primarily from pricing, production efficiencies, and lower performance-based compensation, but lower volumes drove an $6.5 million gross-profit decline.
- Cash provided by operating activities was $31.0 million for the first nine months, down from $54.7 million in the prior-year period. Capital expenditures were $31.3 million, net cash used in investing was $36.9 million, and ending cash was $68.6 million.
- At October 2, 2015, total debt was $180.0 million, including $15.0 million current debt. The company was in compliance with its pre-acquisition debt covenants.
- Working capital was $246.8 million and the current ratio was 3.10. Inventory increased to $164.2 million from $129.2 million at January 2, 2015, primarily in anticipation of higher fourth-quarter sales.
Material changes versus the prior comparable period
- Sales declined 15% in Q3 and 7% year to date. Management attributed the decline to customer inventory reductions, timing of new product introductions, faster-than-expected runoff of end-of-life products, foreign currency effects, and weakness in energy markets.
- Foreign currency reduced sales by approximately $2.5 million in Q3 and $12.0 million year to date, primarily due to the stronger U.S. dollar.
- Greatbatch Medical sales fell 15% in Q3 and 8% year to date. Energy, Military and Environmental sales declined 37% in Q3 and 21% year to date. QiG sales increased 12% in Q3 and 162% year to date, partly reflecting the CCC acquisition.
- Other operating expenses increased to $13.8 million in Q3 and $29.4 million year to date, compared with $6.2 million and $10.2 million, respectively, in the prior-year periods. The increase included capacity and capability investments, acquisition costs, spin-off costs, and asset disposition and severance expenses.
- Interest expense increased to $5.8 million in Q3 and $8.2 million year to date, including approximately $4.8 million of Lake Region Medical transaction-related debt commitment and interest-rate-swap termination costs.
- The nine-month effective tax rate declined to 20.4% from 30.1%, primarily because a greater proportion of income arose in lower-tax jurisdictions.
Guidance, outlook, risks and unusual items
- Fiscal 2015 guidance was sales of $685 million to $695 million, capital expenditures of $40 million to $50 million, GAAP diluted EPS of $1.32 to $1.42, and adjusted diluted EPS of $2.96 to $3.06. Management expected to be at the low end of adjusted EPS guidance. The guidance excluded the Lake Region Medical acquisition.
- Management expected approximately $25 million of Lake Region Medical transaction costs in Q4 2015 and forecast the acquisition to reduce 2015 adjusted diluted EPS by 5% to 10%.
- Management projected Lake Region Medical synergies of $25 million in 2016, increasing to at least $60 million in 2018, with approximately $69 million of integration investment over three years.
- The acquisition had an approximately $1.77 billion purchase price including assumed debt. Consideration included approximately $478 million cash, 5.0 million Greatbatch shares, and approximately 120 thousand options. New financing included $1.4 billion of variable-rate term facilities and $360 million of 9.125% senior notes, resulting in approximately $1.76 billion of debt.
- Management expected the Nuvectra spin-off in Q1 2016, with $10 million to $12 million of estimated transaction costs and anticipated annual operating-expense reductions of $12 million to $16 million for Greatbatch.
- Key risks include substantial post-acquisition leverage, variable interest rates, integration and synergy execution, customer concentration, pricing pressure, product obsolescence, regulatory approval of Algovita, the proposed spin-off, foreign currency volatility, intellectual-property litigation, product liability and potential recalls.
- The company was defending intellectual-property litigation expected to proceed to trial in Q1 2016; 2015 costs were expected to total $4 million to $5 million. A product corrective action involving Standard Offset Cup Impactors remained a regulatory and product-quality risk, although no adverse events had been reported.
- Three customers represented 50% of nine-month sales. Purchase commitments totaled approximately $35.2 million, and product warranty liabilities were $1.2 million at October 2, 2015.
Facts investors should verify
- Whether the Lake Region Medical integration achieved the projected $25 million 2016 and at least $60 million 2018 synergies.
- The company’s post-acquisition leverage, covenant compliance, refinancing needs, and sensitivity to variable interest rates.
- Actual acquisition, integration, restructuring, and spin-off costs versus the estimates disclosed in the filing.
- Completion and tax treatment of the Nuvectra spin-off and the resulting segment presentation.
- FDA approval and commercialization of Algovita, as well as the revenue contribution from new products and the pace of legacy-product runoff.
- Customer inventory levels, customer concentration, energy-market recovery, foreign currency effects, and progress of manufacturing transfers to Mexico.