Integer Holdings Corporation — Form 10-Q Summary
Business Context and Reporting Period
Integer Holdings Corporation is a medical device outsource manufacturer serving cardiac, neuromodulation, vascular and portable medical markets, with a smaller Non-Medical battery business. The filing covers the 13-week third quarter and nine months ended September 28, 2018, compared with September 29, 2017. Results are presented primarily as continuing operations following the July 2, 2018 sale of the Advanced Surgical and Orthopedic product lines to Viant.
Key Financial Metrics
| Metric | Q3 2018 | Q3 2017 | 9M 2018 | 9M 2017 |
|---|---|---|---|---|
| Sales | $305.1 million | $286.2 million | $912.0 million | $833.8 million |
| Gross profit | $91.9 million | $89.2 million | $274.2 million | $260.4 million |
| Gross margin | 30.1% | 31.2% | 30.1% | 31.2% |
| Operating income | $41.5 million | $35.8 million | $115.9 million | $95.8 million |
| Operating margin | 13.6% | 12.5% | 12.7% | 11.5% |
| Income from continuing operations | $(8.3) million | $19.9 million | $27.8 million | $32.4 million |
| Diluted EPS from continuing operations | $(0.26) | $0.62 | $0.86 | $1.01 |
| Adjusted diluted EPS | $1.06 | $0.91 | $2.75 | $2.21 |
| Adjusted EBITDA | $66.6 million | $60.3 million | $191.9 million | $170.0 million |
Reported third-quarter net income was $114.1 million, or $3.54 diluted EPS, including $122.4 million of income from discontinued operations. Nine-month net income was $142.2 million, or $4.38 diluted EPS, including $114.4 million from discontinued operations.
Operating cash flow was $120.7 million for the first nine months, compared with $115.6 million in the prior-year period. Capital expenditures were $33.3 million. Cash from investing activities was $549.2 million, primarily reflecting approximately $582.4 million of net proceeds from the divestiture. Financing activities used $692.9 million, including $670.1 million of debt repayments. Cash ended the period at $22.9 million versus $37.3 million at year-end 2017.
Total debt was $954.2 million at September 28, 2018, down from $1.609 billion at December 29, 2017. Debt consisted principally of a $314.1 million Term Loan A and a $658.3 million Term Loan B, net of discounts and issuance costs. The company had no revolver borrowings and approximately $191.3 million of available revolver capacity after letters of credit. The current ratio was 2.41, and working capital was $250.7 million.
Material Changes Versus the Prior Comparable Period
- Continuing-operations sales increased 6.6% in the third quarter and 9.4% for the first nine months, driven mainly by Medical market growth and new business wins. Medical sales rose 8.0% and 10.1%, respectively, while Non-Medical sales declined 17.7% and 4.9%.
- Cardio & Vascular sales increased 9.1% in the quarter and 11.2% year to date; Cardiac & Neuromodulation increased 7.9% and 7.4%. Non-Medical sales were pressured by softer North American drilling activity, customer inventory adjustments and a planned product phase-out.
- Gross margin declined 1.1 percentage points to 30.1%, principally because of price concessions to large OEM customers, higher incentive compensation, and a less favorable product mix. Production efficiencies and higher volume partially offset these pressures.
- Operating income increased 15.7% in the quarter and 21.0% year to date. Operating expenses declined as prior-year acquisition and integration spending ended, although 2018 included strategic reorganization and manufacturing-alignment charges.
- Reported continuing-operations earnings declined because interest expense increased $38.7 million in the quarter and $36.1 million year to date. The increase primarily reflected debt extinguishment charges, including a $31.3 million make-whole premium on the redemption of the 9.125% senior notes.
- The company completed the AS&O divestiture for approximately $582 million of net cash proceeds and recognized a pre-tax gain of approximately $194.7 million. The transaction substantially reduced leverage but also removed the divested business from continuing-operations results.
Guidance, Outlook, Risks and Unusual Items
Management revised 2018 continuing-operations guidance to sales of $1.197 billion to $1.212 billion, GAAP net income of $44 million to $49 million, GAAP diluted EPS of $1.34 to $1.49, adjusted net income of $117 million to $122 million, adjusted diluted EPS of $3.55 to $3.70, and adjusted EBITDA of $255 million to $265 million. Management cited continued sales growth, debt reduction and a focus on portfolio and operational execution.
Management expects approximately $15 million to $20 million of 2018 other operating expenses. Strategic reorganization charges are expected to total approximately $28 million to $30 million, manufacturing-alignment charges approximately $9 million to $11 million, and consolidation and optimization charges approximately $18 million to $22 million, including discontinued-operations amounts. These initiatives are expected to generate annual operating benefits over time.
The company was in compliance with its debt covenants at period end. Its total net leverage ratio was approximately 3.4:1 and adjusted EBITDA-to-interest coverage was approximately 5.4:1, compared with covenant limits of 5.75:1 and minimum coverage of 2.75:1, respectively. Management identified higher LIBOR rates, weaker sales or adjusted EBITDA, and the company’s high indebtedness as risks to future covenant compliance and financial flexibility.
The final net working capital adjustment and tax allocation related to the Viant transaction had not been finalized and could change the recorded gain and related tax amounts. The company also had an ongoing patent infringement case against AVX; a prior $37.5 million damage award was vacated and a damages retrial was scheduled for January 2019. No litigation gain had been recognized.
Tax results may remain volatile because of the Tax Cuts and Jobs Act, including GILTI. The company estimated a 2018 worldwide effective tax rate of approximately 32%, excluding discrete items, and had approximately $5.2 million of unrecognized tax benefits at quarter end. It was still evaluating its accounting policy for GILTI.
Most Important Facts for Investors to Verify
- Reconcile GAAP earnings and EPS with adjusted results, particularly the $40.7 million third-quarter debt extinguishment charge and other excluded items.
- Assess sustainable post-divestiture revenue, margins and cash flow, excluding the discontinued AS&O business and the one-time divestiture gain.
- Monitor the company’s $954.2 million debt balance, mandatory amortization, variable-rate exposure, interest-rate swap and covenant headroom.
- Verify the final Viant working-capital adjustment, sale-price tax allocation and any subsequent changes to the divestiture gain.
- Evaluate customer concentration, pricing concessions, product mix, Non-Medical weakness and dependence on large OEM customers.
- Track restructuring and manufacturing-alignment costs, expected savings and execution through the stated completion dates.
- Review developments in the AVX patent litigation and the potential effect of the January 2019 damages retrial.