Integer Holdings Corporation: FY2017 Form 10-K Summary
Business context and reporting period
Integer Holdings Corporation is a global medical device outsource manufacturer serving cardiac, neuromodulation, orthopedic, vascular, advanced surgical and portable medical markets, with a smaller non-medical battery business serving energy, military and environmental applications. The company reports Medical and Non-Medical segments and sells primarily to large multinational medical-device OEMs.
The filing covers the 52-week fiscal year ended December 29, 2017, with comparisons to the 52-week fiscal year ended December 30, 2016. The filing also provides unaudited quarterly data; the fourth quarter ended December 29, 2017.
Financial performance and key metrics
| Metric | FY2017 | FY2016 | Change |
|---|---|---|---|
| Sales | $1.462 billion | $1.387 billion | +5.4% |
| Gross profit | $393.6 million | $378.3 million | +4.0% |
| Gross margin | 26.9% | 27.3% | (0.4) percentage points |
| Operating income | $139.4 million | $108.3 million | +28.8% |
| Operating margin | 9.5% | 7.8% | +1.7 percentage points |
| Net income | $66.7 million | $6.0 million | +$60.7 million |
| Diluted EPS | $2.09 | $0.19 | +$1.90 |
| Adjusted diluted EPS | $2.81 | $2.68 | +4.9% |
| Adjusted EBITDA | $285.6 million | $279.8 million | +2.1% |
- Medical sales increased 4.4% to $1.405 billion. Cardio & Vascular grew 9.4% and Advanced Surgical, Orthopedics & Portable Medical grew 6.1%, while Cardiac & Neuromodulation declined 2.5%.
- Non-Medical sales increased 36.7% to $57.0 million, primarily reflecting recovery in energy markets, new business wins and market-share gains.
- Price concessions to larger OEM customers reduced 2017 sales by approximately $16 million versus 2016 and reduced gross margin by approximately 1.1 percentage points.
- Research, development and engineering expense was $55.2 million, broadly unchanged from $55.0 million in 2016.
- Cash provided by operating activities rose to $149.4 million from $105.5 million. Capital expenditures were approximately $47.3 million, and investing cash outflow was $47.9 million.
- Cash used in financing activities was $111.7 million, including approximately $130.9 million of net debt repayment. Year-end cash was $44.1 million versus $52.1 million in 2016.
Fourth-quarter results
| Metric | Q4 FY2017 | Q4 FY2016 |
|---|---|---|
| Sales | $390.5 million | $359.6 million |
| Gross profit | $104.8 million | $92.9 million |
| Net income | $54.3 million | $7.9 million |
| Diluted EPS | $1.68 | $0.25 |
Fourth-quarter net income included a $39.4 million net tax benefit from the U.S. Tax Cuts and Jobs Act, principally from revaluing deferred tax liabilities, partially offset by a provisional transition tax on undistributed foreign earnings. The tax benefit materially increased reported GAAP earnings and is not representative of recurring operating performance.
Debt, liquidity and financial position
- Total debt principal was approximately $1.64 billion at December 29, 2017; carrying value of total debt was $1.609 billion after discounts and issuance costs.
- Debt consisted principally of a $335 million Term Loan A, an $873 million Term Loan B, $360 million of 9.125% senior notes due 2023 and $74 million drawn on a $200 million revolving facility.
- Available revolver capacity was approximately $116.7 million after outstanding letters of credit.
- Working capital was $322.9 million, with a current ratio of 2.54. Estimated 2018 principal and interest debt service was approximately $123 million.
- The company was in compliance with its debt covenants. Total net leverage was approximately 5.09x and adjusted EBITDA to interest expense was approximately 3.31x. Management stated that adjusted EBITDA could decline by more than $58.8 million, or approximately 19%, before covenant noncompliance would result under the disclosed calculations.
- Management believes operating cash flow, cash on hand and potential revolver borrowings are sufficient for working capital, debt service and capital expenditures over the next twelve months. The company’s stated long-term goal is to reduce leverage to 3x–4x adjusted EBITDA.
Material changes, outlook and unusual items
- Operating results improved from 2016 as sales grew, production efficiencies and integration synergies increased, and consolidation and acquisition-related charges declined. Other operating expenses fell to $37.3 million from $61.7 million.
- Since the Lake Region Medical acquisition, Integer reported approximately $50 million of cumulative annual run-rate synergies, consistent with its original expectations.
- In the fourth quarter, management began a strategic reorganization and alignment program focused on reallocating resources, improving business processes and redirecting investment from lower-opportunity projects. Expected aggregate charges are approximately $10 million to $12 million, with substantial completion expected by the end of the second quarter of 2018.
- For 2018, other operating expenses are expected to be approximately $10 million to $15 million. Capital spending is expected to be approximately $50 million to $55 million, about half of which management characterizes as discretionary.
- Additional manufacturing alignment initiatives are expected to generate future costs and capital expenditures, including approximately $9 million to $11 million of charges and $4 million to $6 million of capital spending through 2019.
- Management expects continued gross-margin improvement from manufacturing rationalization and supply-chain synergies, but cautions that customer pricing pressure could offset these benefits.
Principal risks and contingencies
- Customer concentration is significant: four customers accounted for approximately 55% of 2017 sales, and many customer agreements do not include minimum purchase commitments.
- The company faces pricing pressure, customer inventory changes, customer insourcing or dual sourcing, product obsolescence, regulatory requirements, product liability and recall exposure, and dependence on a limited number of suppliers for critical materials.
- Variable-rate debt creates interest-rate exposure. A 100-basis-point increase in LIBOR on approximately $1.08 billion of unhedged variable-rate debt would increase annual interest expense by approximately $11 million.
- Foreign currency transaction losses were $9.7 million in 2017, compared with a $4.9 million gain in 2016. Management expects these effects to be reduced after eliminating most intercompany balances, but currency volatility remains a risk.
- Goodwill and other intangible assets totaled approximately $1.91 billion, or 67% of total assets. No goodwill impairment was recorded, but impairment charges could be material if operating assumptions deteriorate.
- Integer is pursuing patent litigation against AVX; a jury awarded $37.5 million in damages for infringement, but the matter remained subject to post-trial proceedings and no gain had been recorded because no cash had been received.
- The Collegeville, Pennsylvania facility remains subject to an EPA consent order requiring groundwater treatment and monitoring. The company expects a decision on its post-remediation care plan by the end of 2018 and does not expect a material financial impact.
- The company recognized provisional Tax Reform Act effects and had not completed all related accounting at year-end. The ultimate tax impact could differ materially as additional analysis and guidance become available.
Important facts for investors to verify
- Whether revenue growth and Non-Medical recovery continue after the 2017 rebound, particularly in Cardio & Vascular and Cardiac & Neuromodulation.
- Progress toward the stated 3x–4x adjusted EBITDA leverage objective and the pace of debt repayment.
- Compliance with leverage and interest-coverage covenants as they step down or step up beginning in 2018.
- The recurring earnings impact of customer price concessions, foreign currency movements and the expiration of unusual tax benefits.
- Actual costs, cash outlays and savings from the strategic reorganization and manufacturing-consolidation programs.
- Final accounting for the Tax Reform Act, including GILTI, BEAT and the provisional repatriation-tax calculations.
- Resolution and potential cash proceeds from the AVX patent litigation and the status of the Collegeville and South Plainfield environmental matters.
- Exposure to the four largest customers, supplier concentration and any changes in customer inventory, outsourcing or insourcing decisions.