Filing Overview
Filing identity: The supplied Form 10-Q is for Greatbatch, Inc., not Integer Holdings Corp. Investors should verify the company and filing reference before relying on these figures. The report covers the 13-week third quarter and 39-week year-to-date periods ended October 3, 2014, compared with periods ended September 27, 2013. The balance sheet compares October 3, 2014 with January 3, 2014.
Business Context
Greatbatch reported two segments: Greatbatch Medical, which designs and manufactures medical devices and components, and QiG, which develops medical device systems, collaborates with OEMs and makes strategic investments. On August 12, 2014, the company acquired CCC, a Uruguay-based active implantable neuromodulation device developer and manufacturer, for approximately $19.6 million in cash. CCC contributed approximately $1.6 million of third-quarter revenue and $0.4 million of net income.
Financial Performance
| Metric | Q3 2014 | Q3 2013 | 9M 2014 | 9M 2013 |
|---|---|---|---|---|
| Sales | $171.7 million | $167.7 million | $518.1 million | $487.3 million |
| Gross profit | $58.1 million | $55.9 million | $174.2 million | $161.9 million |
| Gross margin | 33.8% | 33.3% | 33.6% | 33.2% |
| Operating income | $16.2 million | $17.0 million | $58.2 million | $48.5 million |
| Operating margin | 9.4% | 10.1% | 11.2% | 9.9% |
| Net income | $14.0 million | $11.1 million | $41.3 million | $26.5 million |
| Diluted EPS | $0.54 | $0.44 | $1.60 | $1.06 |
Third-quarter sales increased 2%, while nine-month sales increased 6%. Third-quarter net income rose 27%, and nine-month net income rose 56%. Gross margin improved by 50 basis points in the quarter and 40 basis points year to date, primarily from production efficiencies, volume and favorable mix, partly offset by customer price concessions. Third-quarter GAAP operating income declined 5% because of higher restructuring and other operating expenses; nine-month operating income increased 20%.
- Greatbatch Medical sales increased 1% in Q3 and 6% year to date.
- Orthopaedic sales increased 8% in Q3 and 16% year to date.
- Vascular sales increased 21% in Q3 and 23% year to date.
- Portable Medical sales decreased 11% in Q3 and 12% year to date as the company reduced lower-margin products.
- QiG sales increased to $2.5 million in Q3 from $0.7 million, primarily reflecting CCC and increased adoption of thin-film electrode technology.
Cash Flow, Liquidity and Debt
| Metric | October 3, 2014 | January 3, 2014 |
|---|---|---|
| Cash and equivalents | $61.6 million | $35.5 million |
| Working capital | $237.0 million | $190.7 million |
| Current ratio | 3.63 | 3.08 |
| Long-term debt | $190.0 million | $197.5 million |
- Nine-month operating cash flow was $54.7 million, compared with $16.1 million in 2013.
- Investing cash outflow was $24.9 million, including $15.8 million for CCC and $16.0 million of capital expenditures.
- Financing cash outflow was $2.9 million, including $7.5 million of term-loan principal repayments, partially offset by $5.7 million from stock issuances.
- The company had $300 million of undrawn revolving-credit capacity and was in compliance with all debt covenants. The adjusted EBITDA-to-interest ratio was 31.0 to 1.0 versus a 3.0 minimum; total leverage was 1.4 to 1.0 versus a maximum of 4.5 to 1.0.
- Approximately $10.3 million of cash was held at foreign subsidiaries and considered permanently reinvested.
Material Changes and Unusual Items
- Other operating expenses were $6.2 million in Q3 and $10.2 million year to date, including capacity and capability investments, facility optimization, asset dispositions, severance and acquisition-related costs.
- The company expects $29 million to $34 million of total restructuring charges and $25 million to $27 million of capital investment for its 2014 capacity and capability initiatives. These programs are expected to generate more than $20 million of annualized savings beginning in 2016, with full benefit in 2017.
- A third-quarter sale of a cost-method investment generated a pre-tax gain of approximately $3.2 million. Year-to-date investment income was approximately $3.9 million.
- The company reversed $3.0 million of contingent technology-related liabilities after performance targets were not achieved.
- Foreign-currency translation reduced nine-month comprehensive income by $2.4 million. Management expects a stronger U.S. dollar to pressure fourth-quarter sales.
- There were no goodwill or indefinite-lived intangible-asset impairment charges in the first nine months of 2014.
Guidance, Outlook and Risks
Management updated 2014 guidance to sales of $695 million to $705 million, GAAP operating margin of approximately 11.0%, adjusted operating margin of approximately 13.0%, GAAP diluted EPS of $2.10 to $2.18 and adjusted diluted EPS of $2.32 to $2.38. The company expects a 2014 effective tax rate of 30% to 32%, excluding any benefit from a potential reinstatement of the federal R&D tax credit.
Management continues to target approximately 5% year-over-year revenue growth and intends to leverage growth into stronger profitability. Algovita, the company’s spinal cord stimulation system, received European CE Mark approval in June 2014 and remained on track for U.S. regulatory review and early European commercialization planning.
- Key risks include customer concentration, pricing pressure, product obsolescence, dependence on suppliers, regulatory changes, product liability, recalls or field actions, intellectual-property challenges, currency and interest-rate exposure, and execution risk related to acquisitions and facility transfers.
- Three customers represented 45% of Q3 sales and 47% of nine-month sales.
- A voluntary field corrective action affected Standard Offset Cup Impactors manufactured and distributed from 2004 through 2013. Three potentially related complaints had been received, with no reported adverse events.
- A Texas product-liability case was scheduled for trial in the first quarter of 2015. No reserve was recorded because a loss was not considered probable or reasonably estimable; the company had customer indemnification and insurance coverage subject to stated limits and retentions.
- Foreign-currency exposure remained material: management estimated that a hypothetical 10% dollar movement would affect annual sales by approximately $7 million.
- The acquisition of CCC was still being integrated into internal controls, and management expected to exclude CCC from its 2014 internal-control effectiveness assessment as permitted by SEC guidance.
Investor Verification Checklist
- Confirm that the intended issuer is Greatbatch, Inc. rather than Integer Holdings Corp.
- Reconcile reported sales, EPS and guidance with the company’s 2014 earnings release and subsequent filings.
- Assess the sustainability of margin gains after excluding investment gains, restructuring items and other adjusted metrics.
- Monitor CCC integration, preliminary purchase-price allocations and the effect of acquired intangible-asset amortization.
- Track restructuring cash costs, capital spending and the timing of expected savings from facility transfers.
- Evaluate customer concentration, portable-medical declines, legacy product end-of-life exposure and the stronger-dollar headwind.
- Review the Algovita regulatory pathway and potential effects of the Standard Offset Cup Impactor corrective action.
- Verify debt covenant headroom, variable-rate exposure and the subsequent November 2014 interest-rate swap.