Integer Holdings Corporation: Fiscal 2016 Form 10-K Summary
Business context and reporting period
Integer Holdings Corporation, formerly Greatbatch, Inc., is a global medical-device outsourced manufacturer serving cardiac, neuromodulation, orthopedic, vascular, advanced surgical and portable medical markets. Its Non-Medical segment provides battery solutions for energy, military and environmental applications. The fiscal year ended December 30, 2016 and comprised 52 weeks.
Fiscal 2016 reflected the first full year of operations following the October 2015 acquisition of Lake Region Medical and included Integer’s operations through the March 14, 2016 spin-off of Nuvectra. The Company reorganized its reporting structure into Medical and Non-Medical segments and changed its name to Integer Holdings Corporation effective June 30, 2016.
Financial performance and liquidity
| Metric | 2016 | 2015 | Change |
|---|---|---|---|
| Sales | $1.387 billion | $800.4 million | Up 73% |
| Gross profit / margin | $378.3 million / 27.3% | $235.1 million / 29.4% | Margin down 210 bps |
| Operating income / margin | $108.3 million / 7.8% | $13.1 million / 1.6% | Up $95.1 million |
| Net income (loss) / margin | $6.0 million / 0.4% | $(7.6) million / (0.9)% | Returned to profitability |
| Diluted EPS | $0.19 | $(0.29) | Improved $0.48 |
| Adjusted diluted EPS | $2.59 | $2.90 | Down 11% |
| Adjusted EBITDA | $276.2 million | $165.9 million | Up $110.3 million |
| Cash flow from operations | $105.5 million | $12.5 million | Up $93.1 million |
Medical sales were $1.345 billion, up 82%, primarily from the Lake Region Medical acquisition. Cardio & Vascular sales were $568.5 million, Cardiac & Neuromodulation sales were $389.4 million, and Advanced Surgical, Orthopedics & Portable Medical sales were $392.8 million. Non-Medical sales fell 30% to $41.7 million as energy-market customers reduced drilling and exploration activity.
Interest expense increased to $111.3 million from $33.5 million because of acquisition-related debt. The Company reported a $4.8 million income-tax benefit, producing an unusually negative reported effective tax rate because pretax income was only $1.2 million.
Cash and cash equivalents were $52.1 million at year-end, compared with $82.5 million at the prior year-end. Working capital was $332.1 million and the current ratio was 2.79. Operating cash flow funded $58.6 million of capital expenditures and $46.0 million of debt repayment. The Company expected 2017 capital spending of approximately $50 million to $60 million.
Total debt was $1.730 billion, consisting principally of $356.3 million of term loan A, $1.0148 billion of term loan B, $360.0 million of 9.125% senior notes due 2023 and $40.0 million drawn on the revolving facility. Available revolving capacity was approximately $151.1 million. Net leverage was approximately 5.84x and adjusted EBITDA to interest expense was approximately 2.85x; the Company was in compliance with its debt covenants at year-end.
Material changes versus the prior comparable period
- Lake Region Medical contributed approximately $802.4 million of 2016 revenue and $32.8 million of net income; its 2015 contribution covered only approximately two months.
- Reported sales increased substantially from acquisition-related volume, but organic constant-currency sales declined 8%, excluding acquisitions, divestitures and currency effects.
- Gross margin declined because Lake Region Medical historically had lower margins, contractual price concessions reduced pricing, and product mix was less favorable. The comparison benefited from the absence in 2016 of the $23.0 million Lake Region inventory step-up amortization recorded in 2015.
- Operating income improved materially, aided by acquisition synergies and the Nuvectra spin-off, but the Company continued to incur $61.7 million of other operating expenses, including $28.3 million of acquisition and integration costs.
- Interest expense rose by $77.8 million due to the approximately $1.8 billion of acquisition-related debt. Management made debt reduction and working-capital reduction strategic priorities.
- The Company achieved approximately $34 million of cumulative annual run-rate Lake Region synergies, exceeding its $25 million target, and expected net synergies to reach approximately $60 million by 2018.
- Nuvectra received approximately $76.3 million of cash in the spin-off and contributed a $5.2 million pretax loss to 2016 results before the separation.
Fourth-quarter and outlook information
Fourth-quarter 2016 sales were $359.6 million, gross profit was $92.9 million and net income was $7.9 million, or $0.25 diluted EPS. Fourth-quarter 2015 included $138.6 million of Lake Region Medical revenue and a $24.9 million net loss.
Management’s 2017 outlook was revenue of $1.390 billion to $1.430 billion, GAAP diluted EPS of $1.10 to $1.50 and adjusted diluted EPS of $2.70 to $3.10. Expected 2017 excluded items totaled approximately $72 million pretax, or approximately $50 million after tax. Management expected 2017 other operating expenses of approximately $18 million to $22 million.
Management’s priorities were continued integration of Lake Region Medical, investment in customer growth opportunities, manufacturing consolidation, improved cash generation and debt reduction toward a long-term leverage goal of 3.0x to 3.5x adjusted EBITDA.
Risks, contingencies and unusual items
- Customer concentration is significant: four medical-device customers represented approximately 56% of 2016 sales and 45% of year-end accounts receivable. Many customer agreements do not include minimum purchase commitments.
- Debt and covenant risk is material. Management stated that adjusted EBITDA could decline by more than approximately $19 million, or 7%, before covenant compliance would be jeopardized under the year-end assumptions.
- Variable-rate debt creates interest-rate exposure; a 100-basis-point increase in LIBOR on approximately $1.2 billion of unhedged variable-rate debt was estimated to increase annual interest expense by approximately $9 million.
- Medical-device regulation, product quality, warranty claims, recalls, field actions, product liability and customer validation requirements could delay shipments or increase costs.
- The Company held approximately $1.9 billion of intangible assets, equal to about 67% of total assets, including $967.3 million of goodwill. Management reported no 2016 impairment, but the Non-Medical reporting unit had only an approximately 15% fair-value cushion.
- Non-Medical results remain exposed to volatile energy-market conditions. Foreign sales represented approximately 42% of 2016 sales, and currency movements reduced sales by approximately $1 million during the year.
- The Company is dependent on limited suppliers for technically specialized raw materials and components, including metals and battery materials.
- A jury awarded Integer $37.5 million in damages in patent litigation against AVX. No gain had been recorded because no cash had been received; post-trial proceedings and a possible appeal were pending.
- The Collegeville, Pennsylvania facility remained subject to an EPA consent order requiring groundwater treatment and monitoring. A separate New Jersey environmental matter required additional site investigation.
Most important facts for an investor to verify
- Whether 2017 revenue and adjusted EPS guidance was achieved and whether organic growth resumed after the acquisition-related comparison effects.
- Progress toward the targeted $60 million of Lake Region Medical synergies and the remaining integration, restructuring and capital costs.
- Debt paydown, covenant headroom, interest-rate exposure and progress toward the 3.0x to 3.5x leverage objective.
- Medical segment margin recovery versus ongoing customer price concessions and product-mix pressure.
- Recovery prospects for the Non-Medical energy business and potential goodwill impairment if operating results deteriorate.
- Customer concentration, contract renewal terms and any changes in purchasing, vertical integration or dual-sourcing strategies.
- Resolution of the AVX litigation and the Collegeville and New Jersey environmental matters.
- Reconciliations between GAAP and adjusted results, particularly amortization, integration, consolidation, litigation and other excluded charges.