Integer Holdings Corporation
Q1 2020 Earnings Call Transcript

Published: 10 May 2020

[Operator:]

Good afternoon. My name is Adrienne, and I will be your conference operator today. At this time, I would like to welcome everyone to the Integer Holdings LLC Q1 2020 Earnings Call. [Operator Instructions]I would now like to turn the call over to your host, Tony Borowicz. Please go ahead, sir.

[Tony Borowicz:]

Good afternoon, everyone. Thank you for joining us, and welcome to Integer's first quarter 2020 earnings conference call. The call is being webcast live, and the replay, along with a copy of the press release and earnings presentation, will be available on the Investor Relations section of our corporate website.The results and data we discuss today reflect the consolidated results of Integer for the periods indicated. During our call, we will discuss some non-GAAP measures. For a reconciliation of these non-GAAP measures, please see the appendix of today's presentation and the notes of the financial statements in today's earnings release.As a reminder, today's presentation includes forward-looking statements. Please refer to the company's SEC filings for a discussion of the risk factors that could cause our actual results to differ materially.Joining me on the call to discuss our first quarter results are Joe Dziedzic, President and Chief Executive Officer; and Jason Garland, Executive Vice President and Chief Financial Officer. On today's call, Joe will provide opening comments and discuss the impact of COVID-19 and Integer's response. Jason will review our financial results for the quarter and talk more about Integer's strong financial position in the context of the COVID-19 environment. Joe will come back on to provide his closing remarks, and then we will open it up for your questions.At this point, I'd like to turn the call over to Joe for his comments.

[Joe Dziedzic:]

Thank you, Tony. These are clearly unprecedented times. And as we operate through the COVID-19 pandemic, our priority is the health and safety of our associates. At the onset of COVID-19, we mobilized our global pandemic team and put in place strict safety measures and protocols to protect our associates and their families. As an essential provider to the medical device industry and, on a much smaller scale, the energy sector, we are ensuring the continuity of our product supply to our customers.I am proud of all of our employees and want to thank them for their extraordinary efforts that enable us to continue to deliver the products that patients rely on every day. The dedication of our associates, especially our manufacturing associates who continue to build products, has been inspiring to all of us within Integer. It has taken a total team effort to manage in this new environment, and I am proud of the agility and the ingenuity the team has demonstrated while we protect our associates and deliver for our customers.To ensure the continuity of our operations, we have implemented many safeguards, including social distancing, disinfecting workstations, quarantining when necessary, restricting travel and having employees work remotely whenever possible. We have also actively engaged with our global suppliers to ensure we have adequate supply chain capacity. We maintain daily monitoring and communication with our suppliers to track and mitigate risk. I'm pleased to report that we have had minimal disruptions within our global supply chain, and I want to thank our suppliers for their cooperation and continued support during these challenging times.We remain in close and constant communication with our customers to respond to their evolving needs as they respond to the temporary decline in medical procedures. Most of the changes have been reductions in demand, but there are some products we build that are now in higher demand, including components and subassemblies for ventilators and patient monitors. We have been ramping production to meet this accelerated demand.Turning to our financial results. Our first quarter was largely unaffected by COVID-19. We had a strong quarter in line with our expectations with sales up 4% and adjusted earnings per share up 25% over last year. Our Medical sales were particularly strong, increasing 5%, whereas our Electrochem sales were negatively impacted by the significant downturn in the energy sector. Jason will provide more color on our product line sales results later in the presentation.Given the significant uncertainty created by COVID-19, we are suspending our financial guidance. We will resume providing financial guidance once we have more certainty that the economic environment has stabilized and we can provide more reliable projections. We will continue to provide as much insight, clarity and transparency in our communications as possible so that you understand how we're managing Integer and the results we are delivering.To provide more perspective on how we are thinking about COVID-19, I'd like to offer commentary on 3 things

[Jason Garland:]

Thank you, Joe. Good afternoon, everyone, and thank you again for joining our call. I'll provide more highlights on our first quarter 2020 adjusted financials and then share our perspectives on why we believe we are well positioned to weather this pandemic as well as offer more clarity and transparency on how we are taking a balanced approach to managing cost during what we believe will be a temporary reduction in our sales.As Joe highlighted, we delivered strong first quarter results that were mostly un-impacted by COVID-19. Sales increased by 4% to $328 million. And consistent with our strategic financial objectives, our profit grew greater than twice the rate of sales with adjusted operating income increasing 10% to $59 million. Adjusted EBITDA increased 8% on a reported basis. New from prior earnings presentations, we have now included adjusted operating income. We believe this metric comprehensively reflects our performance in managing all operating costs in the business. We'll continue to show EBITDA so that you can see both measures. Finally, at $41 million, adjusted net income grew 26%, and adjusted earnings per diluted share grew to $1.25, an increase of $0.25 or 25% on a year-over-year basis.On the next slide, let me offer some more color around the $0.25 of adjusted earnings per diluted share growth. The largest driver, or $0.20, was generated through sales growth and operational improvements in productivity, both of which more than offset price and inflation headwinds. The operational improvements are evidenced by the year-over-year improvement in gross margins of 150 basis points, and the more comprehensive view of adjusted operating income shows a margin rate improvement of 100 basis points year-over-year, building on the progress we achieved in 2019. Our sustained debt reduction and interest rate management lowered interest expense by $3 million and contributed $0.08 of growth. Our strategic tax planning resulted in an adjusted effective tax rate of 16.7%, down 60 basis points versus last year and contributed $0.01 of adjusted earnings per share increase.The first quarter also benefited from favorable foreign exchange impact. As we strive to be transparent in the impact that the COVID-19 pandemic is having on our business, we saw an approximate $0.06 per share drag in the first quarter. Half of this is due to the impact of increased costs and implementing and operating in a social-distanced environment in our manufacturing plants. The other half is due to the decline in Electrochem sales, which includes COVID-19 and the broader impact of the energy market decline.We'll now turn to a review of our product line sales results. As a reminder, Slide 22 reflects trailing 4-quarter organic adjusted sales growth rate. We believe this is a more meaningful indicator of our growth trend and how we are performing in the market versus an individual quarter, which may contain anomalies resulting from the timing of customer purchasing decisions.With Cardio & Vascular being the largest contributor, we finished the first quarter of 2020 with trailing 4-quarter adjusted sales up 3%. Further on Cardio & Vascular, the product line's organic sales were up 17% in the first quarter, led by a strong increase in peripheral vascular demand driven by customers' continued launch of an existing program into a new geography coupled with strong overall growth across most markets. The first quarter also benefited from incremental sales from the start of a new customer contract on existing business, which contributed about one third of the year-over-year growth. Even without this customer contract, Cardio & Vascular delivered double-digit sales growth. As it relates to Cardio & Vascular, the impact of COVID-19 was negligible in the first quarter.On the next slide, you can see that organic sales in the Cardiac & Neuromodulation product line were down 8% in the first quarter, driven entirely by a decline in Neuromodulation. Most of the Neuromodulation decline was caused by a $6 million year-over-year headwind from Nuvectra's bankruptcy as well as other customers' 2019 supply agreement commitments that are reducing demand in 2020. The cardiac rhythm management portion of this product line was up slightly year-over-year as a result of strong growth from product launches and increased battery demand, partially offset by last year's signing of a customer contract on existing business. The first quarter impact of COVID-19 was also negligible for this product line.Slide 25 shows the final part of our Medical segment. You will recall, in July 2018, Viant acquired our AS&O product line. The Advanced Surgical, Orthopedics & Portable Medical product line shown today includes sales under supply agreements with Viant. First quarter sales declined 1% versus the prior year, driven by a decrease in Portable Medical battery demand, partially offset by increased end-market demand for Advanced Surgical & Orthopedics-based products.The first quarter impact of COVID-19 was also negligible for this product line. Portable Medical is working to ramp up production of components and subassemblies to support existing ventilator and patient monitoring customers, which could be a partial offset to the broader impact of COVID-19 on this overall product line.Finally, Slide 26 summarizes Electrochem, our Non-Medical segment. Electrochem sales declined 25% in the first quarter, driven by a severe decline in the energy market due to both an oversupply of oil early in the first quarter and demand reduction from the COVID-19 pandemic through the latter half.We anticipate the market downturn and the reduced demand for our products in this segment could be prolonged, and we have responded with actions to reduce costs. In April, we implemented furloughs and reductions in force in our Electrochem business unit to adjust to this new market environment.So we are suspending guidance because of the uncertainty created by the COVID-19 pandemic. We will continue to provide transparent communication regarding our strong financial position and the actions we are taking to not only protect Integer but to continue to grow Integer. As our philosophy on cash management, leveraging cost management are central to our financial strength, let me offer more details about these in my final three slides.I'll start with our first quarter cash flow, debt and leverage results as the foundation of our financial position. We generated $32 million in cash flow from operating activities and $18 million in free cash flow in the first quarter.Even though the first quarter normally has the lowest cash generation during the year due to the timing of our annual bonus and customer rebate payments, we did see an improvement versus the first quarter of 2019. $16 million of the year-over-year increase in cash flow from operating activities was driven by Integer initiating funding from a customer-sponsored financing program.This program accelerates receivables payments at a discount rate lower than Integer's weighted average interest rate. We also saw $5 million from operational improvement. Free cash flow did not see the same operational year-over-year improvement as CapEx spend was up, given our increased investments in our strategy that Joe referenced earlier. In the first quarter, we lowered our net total debt, which is debt minus cash on hand, to $804 million, which further reduced our debt leverage ratio to 2.8 times adjusted EBITDA.I'll offer four reasons why we believe we are well positioned financially to weather this pandemic. Ample liquidity is the first reason. Instead of making accelerated debt payments in the first quarter like we would normally do, we allowed our cash balance to grow from $14 million to $37 million. Then early in the second quarter, we executed a $160 million drawdown on the remainder of the revolver balance to protect against potential financial market liquidity in the event of a prolonged pandemic.With that, we currently have $198 million of cash on hand. The cost of this revolver drawdown for 6 months is only approximately $0.05 of adjusted EPS. We see this as inexpensive insurance and prudent protection against a prolonged [indiscernible] event. Second, we have established a track record of generating strong cash flows and expect to continue generating positive cash flows for the remainder of 2020. Further, the financial strength of our customer base gives us confidence in our customers' ability to weather this pandemic. Third, our much-improved leverage over the last 2 years has reduced our risk profile, and we finished the first quarter with $124 million of adjusted EBITDA cushion on our bank covenant. And fourth, we have a relatively small fixed debt payment requirement for the remainder of the year, and we have over 2 years before our debt matures.Additionally, our interest expense has been reduced by declining interest rates, positioning us with $190 million of adjusted EBITDA cushion on our interest coverage covenant. Based on these 4 financial metrics, we believe we are well positioned to withstand a prolonged pandemic, and our strong financials afford us the ability to maintain critical investments that will make us stronger post COVID-19.Finally, before I turn the call back to Joe to wrap up our discussion, I wanted to share more about how we are managing costs through an expected but temporary reduction in sales due to COVID-19. We will act to match our variable cost reduction at the same rate of sales reduction, taking necessary labor reductions and working with suppliers to reduce material input. Our indirect labor and overhead are less variable, but we will also take steps to reduce activities that are more closely tied to production while we maintain important support for our continuous improvement programs and maintain our facility infrastructure. We expect fixed costs will remain constant.We are controlling discretionary spending, but we are not reducing SG&A and RD&E commensurate with the temporary sales decline. These resources, including the addition of strategic talent, are crucial to the execution of our long-term strategy. Finally, we also want to ensure that it's clear that given our fixed cost structure and our protection of SG&A resources and RD&E investments, we will see a temporary contraction of margin rates even with the reduction in variable costs. But as we continue to invest in lean manufacturing and business process excellence through the pandemic, we will be well positioned post COVID-19.With that, I'll turn the call back to Joe. Thank you.

[Joe Dziedzic:]

Thank you, Jason. Especially during these uncertain times, it is important that all of our stakeholders understand how we continue to lead Integer. Everything starts with taking care of our associates, our frontline teammates who build the products for our customers and their patients. I want to take this opportunity to once again thank our manufacturing associates and our site leadership teams who continue to put themselves at risk every day for our customers and their patients. They are our Integer heroes, doing their part to support humanity during this crisis. We will continue to implement every social distancing and protective measure available to protect them while they deliver for the patients who need our products. And to all of our nonmanufacturing associates who continue to support our operations mostly from remote locations or managing through the personal aspect of this crisis while also continuing to ensure all of our business processes are performing during this pandemic, I'd like to extend my gratitude for everything they are doing to support our manufacturing operations, our customers and the patients they continue to serve. It is inspiring to witness the teamwork during this pandemic.We believe our strategy is built for managing uncertainty. We have a strong leadership team who is accountable, committed and passionate about what we do. We are clear on how we are leading Integer during these unprecedented times. We will not let COVID-19 and this temporary sales decline impede the execution of our strategy. We see this uncertainty as an opportunity to demonstrate our contribution to an important industry that serves society especially during a crisis. We are confident our journey to excellence will continue during this pandemic, and we will be stronger post COVID-19.Thank you for joining our call this afternoon. I will now turn the call back to the moderator to facilitate the Q&A.

[Operator:]

[Operator Instructions] The first question comes from the line of Matt Mishan with KeyBanc.

[Brett Fishbin:]

Hey, guys. This is Brett Fishbin on for Matt this evening. Congrats on a solid quarter here, and hope everyone is doing well and hanging in there. My first question is around the elevated growth in Cardio & Vascular from the first quarter. Can you provide a little bit more detail on some of the major drivers of the acceleration? That way, it sounds like there's been exciting activity around some new product launches and expansions, which is definitely good to hear.

[Joe Dziedzic:]

Certainly. Brett, it's Joe. Thank you for the greetings, and hope you and Matt are doing well as well. On cardiovascular, we have -- if you look back at the growth rate that we had during 2018 and into the first half of 2019, we were growing solid double digits, high single digit, low double digit. And then we had a couple of quarters in the middle of 2019 where we were flattish during the second and third quarter, and then the momentum picked back up again in the fourth quarter of last year at 6% and now this quarter at 17.5% for the quarter. What we saw last year was we had a couple of phenomena, one in particular being an electrophysiology program that was going end of life that had a fairly meaningful impact on us, and there were a few other items that were causing the second and third quarter decline. Then in the fourth quarter, we started to get beyond that and pick up the momentum again. And in the first quarter, you can see very strong growth. About third of that growth came from signing a contract -- or actually the beginning of a contract that we signed last year that gave us some additional revenue in the first quarter similar to what we had in the first quarter and fourth quarter of last year in a couple of other product lines. But even without that, we still had strong double-digit growth in Cardio & Vascular. It was driven by the acceleration of the peripheral vascular program, which was a customer launch that started last year, and we began to see that in the second half, in particular in the fourth quarter. That continued well into the first quarter. And then broadly across the cardiovascular products, we had very strong growth overall.So we feel that the Cardio & Vascular product line for us is a strong franchise. We've demonstrated very strong growth in that product line over a number of years, and we feel that we're back on that growth trajectory.Now we have COVID, which is obviously going to cause some disruption there, but we feel it's the underlying strength of the products as well as the investments that we've been making in the business to penetrate the faster-growing markets that we've been focusing on, in particular in peripheral vascular and electrophysiology and structural heart.

[Brett Fishbin:]

And then I'm looking a little bit further ahead, and I know you touched on this a bit in the prepared remarks, but for the most part, how are the majority of your largest customers managing their inventory levels with the understanding that it's definitely a little bit different on a case-by-case basis? But like for the most part, are most of them still ordering with the expectation that procedures come back in 2020? Or have you seen like more of a slowdown or a sense of caution around the pace of recovery?

[Joe Dziedzic:]

Yes. It's a great question, and we tried to provide the different perspectives that our customers have provided publicly, and then we tried to paint a picture of how we see the industry in aggregate shaping up. And as I noted in the remarks, there's no one customer and one approach that's going to disproportionately drive our results. We provided the curve as to how we think the industry is going to react.We do absolutely expect that customers will take different approaches with respect to their inventory levels. And we think it's going to even be very tailored to the specific market, specific procedures, where maybe a customer is looking for an opportunity and potentially gain some share during the rebound.Maybe they want to strategically build inventory levels in certain regions, certain geographies so that they can be more aggressive. And each customer is going to decide their own strategy. And what we're going to make sure we do is that we're there to support them and enable their success and enable the execution of their strategy.In aggregate, we think that the second quarter for us is going to have a little bit less of an impact than maybe the whole industry because of the delay in our customers adjusting and developing their strategies and then modifying their manufacturing plants and then translating that into what their suppliers need to do to support that. And that's why we think that potentially, our third quarter and second quarter may look more similar, which we think might be different than the industry.We think the industry is likely to show improvement in the third quarter versus second quarter. And then by the fourth quarter, we think we're on the same trajectory as the industry. Obviously, it will all depend on how our customers decide ultimately to manage their inventory, what that product mix looks like. And it's just too uncertain at this time to have enough understanding of that in order to provide more specific guidance than that.

[Brett Fishbin:]

All right. Thanks. Thanks very much for that detail. And then last one from me. From a longer-term perspective, have you seen any opportunity here to potentially gain market share with either existing or new customers, be it potential challenges other suppliers may be having as a result of the crisis? And if not, is it something that you're really paying active attention to?

[Joe Dziedzic:]

Well, certainly, we're definitely aggressively looking for those opportunities where our customers need additional support. We're reaching out and offering additional help, additional support in areas that maybe we don't have as big of a share as we'd like or maybe areas that we'd like to penetrate more than we have or even areas that are new to us. And so we're being very, very aggressive with our sales team. We continue to add sales leaders. We've added several sales leaders during the last couple of months. We're building, we think, a very strong sales leadership team and the team underneath them, and they're being very, very aggressive and proactive during this time. We think there will be opportunities, I think, from a practical perspective given how early we still are into the pandemic that having those opportunities materialize into anything substantive or tangible at the moment, it's just too early. But we think there will be opportunities.We also think our approach to continuing to invest aggressively during the pandemic, specifically in our strategy and in the capabilities that we've been investing in, we think that's going to play to our advantage when we come out of COVID-19. We've been working with a lot of customers on new product development programs, R&D development programs. That pipeline was strong going into COVID. It hasn't slowed down. Our customers continue to be very focused. In fact, in many cases, they've asked us to accelerate those development programs.We suspect it's because they've had capacity freed up potentially. But we see that strong pipeline of development programs continuing. And we're continuing to add resources in that area. We think this is an opportunity for us to take advantage of this window where others may not be taking the same approach. So we're definitely looking for those opportunities. It's too early in the period of uncertainty that we're all in to point to anything tangible. But hopefully, in a few quarters, we'll be able to share something with you.

[Operator:]

[Operator Instructions] The next question comes from the line of Jim Sidoti with Sidoti & Company.

[Jim Sidoti:]

It's good to hear your voice. Glad everybody is okay there.

[Jason Garland:]

Thanks, Jim.

[Joe Dziedzic:]

Thank you, Jim. Hope you're doing well.

[Jim Sidoti:]

So from a high level, it sounds like the industry is going to see some postponements over the next 2 quarters. But can you give us a sense, the products you manufacture, are those procedures that those products are used in, are those things where people can put them off indefinitely? Or at some point, will those procedures have to get done?

[Joe Dziedzic:]

Jim, it's a great question. I think we share the view with our customers and many others in the industry that it is unlikely that the majority of these procedures can be put off indefinitely. In fact, the harm to patients who don't receive these treatments in a timely manner can only worsen, can significantly worsen their condition. Even in some of the more elective procedures, after some period of time, they shift into more urgent, and that's what we think we're going to see more of. And it's unfortunate and it's why it's so important that we're able to reopen the hospitals and begin to perform these procedures.So we do not see these procedures not being done. The question that I think everyone is wrestling with is over what time period can the procedures that have been delayed be recovered, over what time period can they be caught up. And that gets to, then you have to look at the capacity in the hospitals and the surgery centers, the capacity in the cath labs, the capacity of the health care professionals. The health care professionals, many of them have been through very trying times, although many of those performing these procedures are not as deeply involved in COVID-19. So it's a big question mark, and I don't know that anybody has the clear crystal ball to be able to predict that perfectly. That's why when we portrayed the industry curve, we think there is the possibility by the fourth quarter, we think it's the more optimistic scenarios. But by the fourth quarter, we're seeing some of those procedures not only get back to more normal levels but start to catch up. And then you have the potential then in the fourth quarter to be back above what the run rate was before we were going into the COVID-19. I think everybody believes that by the time we get into 2021, assuming there isn't a meaningful resurgence of the virus in the fall or winter, that we would be able to operate as an industry at above the run rate prior to going into COVID-19. But again, it's -- there are so many variables and it's uncertain at this time. But I think the general view is these procedures will be caught up, will be recovered. The question is at what rate.

[Jim Sidoti:]

All right. And do you expect hospitals to extend hours, extend days? These are profitable procedures for them. Don't you think that they'll do everything they can to get as many procedures in as possible once things have opened up?

[Joe Dziedzic:]

That's absolutely what I think is the -- also the consensus, the need for the hospitals to be able to generate the income in order to be able to support the COVID patients and to operate their hospital. They need these more profitable elective procedures in order to continue to survive. So yes, we absolutely think that there's a strong incentive within the hospitals in order to catch up on these procedures, and we believe they'll be looking for every creative way they can in order to create the capacity to do that. Jim, I think the other big variable is at what rate do patients return, at what point do patients feel comfortable and confident going back into the hospitals and surgery centers to have these elective procedures performed. And that's what the -- I think the -- where the creativity, ingenuity and disciplined rigor of the hospitals and surgery centers is going to come into play and is going to have to create that confidence for patients to return.

[Jim Sidoti:]

All right. And then on the Non-Medical business, obviously, the price of oil is impacting that. Can you give us a sense on what percentage of Electrochem sales are tied to oil production?

[Joe Dziedzic:]

Sure. It's -- about two thirds of that business is tied to oil production. And so our first quarter sales were at about $10 million in the Non-Medical business. We think that's probably the run rate, plus or minus something, but that seems to be the run rate of the business. When we go back to the 2015 time period and the last oil downturn, that looks like about where that business performs in this kind of a cycle, although this is a pretty unprecedented time with the estimated demand of oil has dropped somewhere between 20% and 35% overnight, which is a pretty incredible thing to have happened and the excess supply and the lack of storage capacity for oil. We are planning for and assuming that the oil downturn is prolonged, and that's why we took the actions we did to adjust the cost structure in the Non-Medical business. So we're assuming that continues well into 2021, and we think the run rate that the business is on in the first quarter is probably the run rate for the foreseeable future.

[Jim Sidoti:]

All right. And then last one from me, back on the Medical side. If things do play out the way we discussed and there is an increase in Q4 and into 2021, do you have the capacity to meet your customers' needs? And how quickly can you ramp back up?

[Joe Dziedzic:]

We absolutely feel that we have the capacity. We, it's a big part of the reason why we continue to make the investments that we have been doing. We reported on our earnings call at the end of the fourth quarter or after the first quarter that our capital spending was going to increase up to $60 million to $70 million. That's not the current guidance. We're not giving guidance. But that was up from $48 million in 2019. We're planning to continue to invest aggressively in the business.There is some portion of that planned investment that during this environment, you can't, we can't execute, and there's some portion that the returns get pushed out because of what we're going through. So some portion of that, we'll have to realign with the current environment, but it's realigning because of the environment not because we've chosen to cut it. It's because it's not possible or practical to execute on it.And so we think that we absolutely will have the capacity and the capability. We also think that we're going to have more capabilities, which is part of the investment plans and part of the addition, of additional R&D engineers that we've been adding, and we've been building up our sales force. And we think we've got great traction with our customers and a strong pipeline of opportunities. So we absolutely think that we can meet their increased demand, and we're ready to do so.

[Operator:]

[Operator Instructions] I will now turn the call back over to Tony Borowicz for closing remarks.

[Tony Borowicz:]

Thank you. And I know our prepared remarks were a bit longer this time, but hopefully, you found them informative and transparent. You can listen to the replay of this call on our website. So thank you for your continued interest in Integer, and above all else, please stay safe. Thank you, and that concludes the call.

[Operator:]

You may now disconnect.