Integer Holdings Corporation
Q1 2015 Earnings Call Transcript

Published: 1 May 2015

[Operator:]

Welcome, everyone, to the first quarter 2015 Greatbatch Incorporated conference call. Before we begin, I would like to read the Safe Harbor statement. This presentation and our press release contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and involves a number of risks and uncertainties. These risks and uncertainties are described in the company’s annual report on Form 10-K. The statements are based upon Greatbatch Incorporated current expectations, and actual results could differ materially from those stated or implied. The company assumes no obligations to forward-looking statements information included in this conference call to reflect changed assumptions, the occurrence of unanticipated events, or changes in future operating results, financial conditions, or prospects. I would like now to turn the call over to today’s host, Vice President of Finance and Treasurer Betsy Cowell. Please proceed.

[Betsy Cowell:]

Thank you, operator. Hello, everyone, and thank you for joining us today for our first quarter 2015 earnings call. With us on the call are Thomas J. Hook, President and Chief Executive Officer, as well as Michael Dinkins, Executive Vice President and Chief Financial Officer. As we have done in the past, we are including slide visuals to accompany the presentation, which you can access at our website at www.greatbatch.com. Once Tom and Michael have completed their presentations, we will then open up for Q&A session. Both Michael are I available to take questions following the call. Let me turn the call over to Tom Hook.

[Thomas Hook:]

Thank you, Betsy, and good afternoon to all of you who are joining the call today. Slide five is an executive summary of our performance for the quarter, our plans, and expectations going forward. We are confirming our guidance, although the first quarter performance was down versus Q1 2014 on every key measurement

[Michael Dinkins:]

Thanks, Tom, and good afternoon everyone. I’m very pleased to be on the call today to provide insights to our capital deployment and 2015 guidance. Slide 14 shows the key balance sheet metrics. Greatbatch has a strong balance sheet with positive cash flow, increasing 5% when compared with first quarter 2014, and a leverage ratio below 1.5

[Thomas Hook:]

Thank you, Michael. I would like to make a few comments about our neurostimulation strategy as well as the proposed spin. We embarked on a strategy nine years ago to evolve Greatbatch from strictly developing components and subassemblies to also developing complete active, implantable medical device systems for our customers. Algovita continues to move along the regulatory pathway and has received an approvable order from the Food and Drug Administration. This platform and the CCC Medical Devices acquisition are pillars of the strategy enabling Greatbatch to be a leading partner for the development and supply of technology and systems for the neurostimulation market. On slide 18, we show four key segments of the market. What is encouraging about our future is that we have the ability to support all four segments by leveraging CCC Medical Device capabilities, our combined customer relationships, the Algovita platform, and our global manufacturing and supply chain operations. Slide 19 shows a large and expanding market. The U.S. market is approximately $3 billion and growing at various rates, ranging from the mature spinal cord stimulation market in the low to mid-single digits, to sacral nerve stimulation, which is double-digit growth. Suffice it to say, the neurostimulation market is very attractive. Slide 20 is a slide we have shared with you before, because it highlights how Greatbatch is positioned to capture significant market share in the neurostimulation market. We are moving forward on several fronts. We intend to modify the Algovita platform for other established indications and growing and emerging technologies. CCC Medical Devices will be used for early stage technologies. We have a large and growing list of interested partners in this space that we can engage with under our GB Ventures initiative. Additionally, we are leveraging NeuroNexus and CCC Medical Devices for early stage research and development. Lastly, we will continue to advance and incorporate the capabilities from our core Greatbatch medical segment across opportunities in neurostimulation. Today, we announced a proposal of a tax free spinoff of Algostim LLC, which will create a newly publicly traded company focused on commercializing the Algovita Spinal Cord Stimulation system. Greatbatch would have a long term manufacturing agreement with the spun off company. In parallel, Greatbatch will continue to focus on expanding its core business and providing complete medical device systems for our customers. We see several benefits to this strategic decision. First, both companies operate in different markets, with different capital and resource objectives. The spinoff allows efficient capital allocation for each company to grow profitably. Second, this approach provides a clearer investment proposition to attract long term investors best suited for each company. The proposal is subject to the approval of the Greatbatch board of directors, confirmation of the tax free status of the transaction, and the effectiveness of a Form 10 registration statement to be filed with the Securities and Exchange Commission. Over the coming months, we’ll be advancing the activities leading to the filing of the Form 10 and the closing of the transaction. Details and updates will be provided throughout the process. With that, let me turn the call back over to the moderator to take questions.

[Operator:]

[Operator instructions.] And your first question comes from the line of Matthew Mishan with KeyBanc.

[Matthew Mishan:]

I think I’m just going to start off first with, I think previously you were indicating that you were looking for a commercialization partner for Algovita. So maybe just walk through the thinking of what you’re going to do with Algostim. Is Algostim going to go direct to market with the device? Are they still looking for a partner? How are you thinking about that?

[Thomas Hook:]

I can say that right now we’re focused on the process of completing the FDA approval process to complete the PMA application. In parallel with that, we’re considering the option to do the spin, at which time that management team would then articulate its strategy for how it’s going to commercialize the Algovita Spinal Cord Stimulation system and Greatbatch would be the manufacturing partner for it. So the decisions of the mechanisms for how they would go from there, in terms of by country or by either other forms that we’ve talked about before, the distribution agreements or partnerships, would be determined by the spun off company, if we choose to execute the spinoff. But right now, since we’re only considering it, we still have all options available to us, and the spin is just the opportunity we’re evaluating right now to execute on later in the year.

[Matthew Mishan:]

And what is the timeline for the remainder of the FDA process? Your best estimate?

[Thomas Hook:]

We’re continuing on through the approval process now, and we’ve been following those steps. And I think for us, we’re targeting that we’ll have it completed in 2015. We obviously do not set the timeline. We continue to be active in the steps with the FDA in following the preprescribed process and responding to questions. But right now, our thinking is we are confident it will happen in 2015. But couldn’t give a specific date or direction for what it is, because it’s still ongoing and clearly we’re beyond the timeline we originally set, which was at the end of 2014, beginning of 2015. So we’re actively managing it and staying as engaged and as close as we can, but we obviously understand that timeline really is going to get determined by the FDA. And that timeline will affect how we approach this spinoff opportunity here as well, because we’d do those in synchronization with each other.

[Matthew Mishan:]

And are you staying with Greatbatch, or are you thinking about going on with Algostim?

[Thomas Hook:]

I plan on staying as the chief executive officer of Greatbatch.

[Operator:]

[Operator instructions.] And your next question comes from the line of Greg [unintelligible] with CRT Capital.

[Greg [unintelligible]:]

In terms of high frequency, with Algostim, can you talk about how important you think that is going forward? Is it something that you can pursue in the future? I’m just curious on what you thought about that product.

[Thomas Hook:]

Greg, just to clarify your question, you mean high frequency stimulation for spinal cord?

[Greg [unintelligible]:]

Yes, absolutely.

[Thomas Hook:]

As you know, as we embarked on the development of the Algovita platform, we developed the platform as a virtual Swiss Army knife for neurostimulation, which would allow us to do many therapy regimes for neurostimulation, not just for spinal cord, but for other nerve targets that we have actively in development to leverage that platform. We’re taking a similar approach with technologies that are available out of our CCC Medical Devices. So we do feel, based on the positive information that has been shared by other companies for high frequency stimulation, it has a great deal of promise, proving that out in clinical studies. And as a technology, we have the ability to handle our own innovative therapies, but we’ve chosen first to gain approval of the Algovita system using the traditional capabilities or therapies that are used within the neurostimulation market for spinal cord stimulation. And we would then, and have, considered using the Algovita capabilities of that system to do other therapeutic profiles, which could include elevated frequency stimulation. We haven’t communicated what we’re doing for secrecy reasons, but we find the innovation level in neurostimulation as a whole market to be very exciting. And one of the reasons why we have a broad neurostimulation strategy as a company is to tap into it at various points, including areas like you’ve pointed out, the specific innovation area, because we think there’s great promise in neurostimulation going for decades into the future, and we want to be a core player in that, enabling a lot of our key OEMs to be successful. So I project that technologies like high frequency stimulation and others will play a large role in the industry going forward, and we plan to be an enabler and a participant in that work, both at the innovation stage as well as the manufacturing and supply chain stage for OEM customers.

[Greg [unintelligible]:]

I know this is a 2016 issue, but if I look at this potential spinoff, it has the products, the first product is SCS, but it still falls under Algovita for DVS, VNS, and FNS, is that correct?

[Thomas Hook:]

The spinoff is dedicated to spinal cord stimulation, and that is what we’re evaluating at the present time, for the scope of the spin. So it’s dedicated to what we’ve done our PMA submission on, and the followon product developments for spinal cord stimulation.

[Greg [unintelligible]:]

Oh, okay, so any QiG work for DVS, VNS, and so forth, will probably not go with Algovita? Is that correct?

[Thomas Hook:]

That is correct. We will be retaining the QiG group projects that apply to the non-Algovita spin. So those areas dealing with spinal cord stimulation are being evaluated as the scope of the spin. And the work that we’re doing in other areas would be still part of the QiG group, which would include NeuroNexus, it would include CCC Medical Devices, and Greatbatch Ventures. It would be retained.

[Operator:]

[Operator instructions.] And we have a follow up with Mr. Greg.

[Greg [unintelligible]:]

Just another question on CRM and neuromodulation in terms of the Greatbatch medical revenue. You said second half gets a little bit stronger. Did I get that right?

[Thomas Hook:]

That is correct. We will build momentum throughout the course of the year.

[Greg [unintelligible]:]

And is that just based on life of the projects that you’re dealing with, and some of these rolling off, and new things rolling on?

[Thomas Hook:]

We have to obviously work through the end of life product effects that are occurring over clearly kind of a four quarter increment that stretches into the first half of the year. So we have one quarter left of that. And the new product wins are going to drive the momentum for us over the course of the year, but in particular in the second half, a lot of the new product developments that we had won years ago are precipitating out into their launch phases. So we’re very optimistic about those.

[Greg [unintelligible]:]

And do those range in multiple different areas of the components that you sell?

[Thomas Hook:]

Yes, they do. So that would incorporate a variety of product technologies. They’re very broad-based. They’re already under contracts, so we’ve already passed the product development contractual negotiation and qualification stages. And we’re just staying connected with customer launches. And they’re very broad-based.

[Greg [unintelligible]:]

And we’re going to switch gears a little bit here. In terms of with oil prices down and a lot of these projects coming offline, how much do you think that’s hurt you?

[Thomas Hook:]

Great question, Greg. We know it’s a negative effect. In particular the oil and gas services companies have rolled off on projects. However, we’re a critical enabler of that technology for customers. We make both the electrochemical cell, the battery pack, and the integrated solution levels for customers. And we’re a very critical industry player for them all. And obviously their drilling activity remains very high. So while we’ve definitely seen, as I pointed out in my comments, some pressure on the energy side, we’ve been able to supplement the military and environmental pieces of the business to mitigate some of that effect. And despite very heavy pressures in the market, we’ve been able to maintain that from a growth trajectory fairly flat. So we’re challenging the based business leaders in those product segments to manage it despite the headwinds. But certainly, you can see the macro industry having negative double digit effects, so you could certainly project that as the type of headwind we’re facing to be able to be flat in growth.

[Greg [unintelligible]:]

And one last one, in terms of Algostim. Did I hear you correctly? You said it was FDA approvable? Or did I hear something totally different?

[Thomas Hook:]

We received an approvable letter subject to completion of audits, which are still ongoing.

[Greg [unintelligible]:]

And when did you receive that?

[Thomas Hook:]

Actually, we’re just announcing it right now. But we have not divulged the details of the approvable letter, just that we’ve received it.

[Greg [unintelligible]:]

Based on that, it sounds like you’re now talking 2015 and not first half of 2015. Is that correct, and what I’m remembering correctly from last quarter?

[Thomas Hook:]

That’s correct. We’re focused on having it completed this year and you’re right, our original timeline was end of 2014, beginning of 2015. And we did adjust that based on the status at the time of the year-end call, the first half of 2015. And I think now we’re just going to be more generic and say we’re targeting sometime in 2015.

[Greg [unintelligible]:]

Okay, so receiving information from the FDA, plus being conservative, is what you come up with 2015 for an approval?

[Thomas Hook:]

That’s correct. I think that we’re advancing steadily through the process. We’re doing good work. It’s just a very large submission, and we’re staying engaged and obviously we don’t control the timeline. But we’re advancing productively in the right direction, but it’s going to take more time than we originally planned.

[Greg [unintelligible]:]

And based on what I’m hearing from you, it’s not you need to run trials or anything else, it’s just some internal stuff you need to take care of?

[Thomas Hook:]

That’s correct. We have not been asked to run trials.

[Greg [unintelligible]:]

Fantastic. Thanks for answering my other 15 questions. I appreciate it. [laughter]

[Thomas Hook:]

Not a problem.

[Operator:]

And we have another follow up from Mr. Matthew Mishan with KeyBanc.

[Matthew Mishan:]

I’m just trying to understand the strategy of you’re going to still have all these costs with the QiG group, without necessarily any revenue to cover them. Why spin out the device when it’s just about to generate revenues that would be able to start covering those costs?

[Thomas Hook:]

Well, just to correct, obviously, when we do the spinoff of the Algostim LLC subsidiary a team of individuals would obviously be convened to run it. So there would be a cost, and we would retain the manufacturing agreement, so we would actually obtain revenues when we sold the system to that new publicly traded company, and we would recognize revenues that would end up generating margins for us as Greatbatch in that construct. And that’s how we’re evaluating the construct. This is consistent with the original QiG model, where we said that we would entertain selling these, what we call “new cos” which Algostim was the first one and it’s leveraging the Algovita platform. We said that we would potentially joint venture or partner it or sell it or take it public. So we’ve elected to evaluate taking it public via the spin route, and it would then largely function how Greatbatch interfaces with its traditional customers, as a manufacturer partner and a technology supporter at the discreet product level and allow that company to run as an independent company, much like all of our customers run today. So it’s very consistent with the strategy we’ve had since 2008, and obviously, while we’re not executing on the spin yet, we’re just evaluating the possibility, it provides clarity for how we’re going to go forward and monetize the investment for shareholders.

[Matthew Mishan:]

And then what percentage of the QiG operating losses at this point would you say are directly related to Algovita?

[Thomas Hook:]

We haven’t broken that information out yet for you, but will at the appropriate time. But as we’ve said before, the overwhelming majority of what occurs in QiG has been directed toward the Algovita Spinal Cord Stimulation system. And because that system development and qualification was the large up front expense over the course of the last six plus years, that money that’s already been spent and invested can be leveraged for other nerve therapy indications. So we know going forward, based on the capabilities we have now, between CCC Medical Devices and the Algovita platform it can use for other areas, that we have the ability to be more efficient in terms of our investment and spend and hence R&D dollars as we pursue other indications going forward.

[Operator:]

And your next question comes from the line of Gregory Macosko with Montrose Advisors.

[Gregory Macosko:]

Just one question on a different subject. The facility in Mexico, that’s going to take the ortho products as well as vascular? Could you give us a sense of kind of how much of the product line you expect to put in there? And when do you expect that to be up and running and in good order?

[Thomas Hook:]

Our Greatbatch Medical Mexico number one facility is currently in operation, and that does a great deal of product lines for us from cardiac rhythm management, to neuromodulation, and it also does vascular and orthopedic products today. The Greatbatch Medical Mexico number two facility, which is being built adjacent to that facility, is completing construction as we speak. The portable medical product lines are being moved into that facility from our Beaverton, Oregon operations, and that is actually in process qualification stages over the next several months. So we expect by the end of the year, those portable medical product lines will be manufactured in that new facility that we’re constructing. In addition to that, our vascular product lines in our Plymouth, Minnesota operations, are being relocated down to the Greatbatch Medical Mexico facilities, and that move, we’re projecting to be completed around the end of this year as well. And certain product lines will be retained in Plymouth, Minnesota for manufacture, but mostly that relates to the lead wires and Algovita products. And the engineering team for the portable medical group will stay in Beaverton, Oregon to continue to do the product development and product design work that would feed the new Mexico manufacturing facility. So by the end of this year, we expect those transitions to be largely completed and for 2016 to be enjoying a revenue and profitability picture that is post that transition, which increases our revenue opportunity because of capability improvements and increases our margin profile because it’s a low cost manufacturing location.

[Gregory Macosko:]

And so basically, products from Plymouth and products from Beaverton. And obviously some remixing with the portable medical. Overall, if we look at Mexico in 2016, give us a sense of what the potential there from those two facilities is in terms of growth. Are they 40%, 50% utilized? Any sense of that?

[Thomas Hook:]

From an overall capacity standpoint, we have the ability to use more of our capacity in the plant that we’ll have in place and we’ll be able to drive double the amount of throughput through the facilities, through leveraging capacity expansions, shift time that’s not allocated, as well as equipment that doesn’t run 100% of the time. It varies by product line. Some product lines have more capacity, some have less. But we don’t have limits in terms of growth potential out of our Greatbatch Medical Mexico facilities. We plan capacity proactively there. And we will maintain it that way so that it won’t inhibit the high growth rate that we’ll have out of those facilities. We’ve planned it quite effectively.

[Operator:]

Your next question comes from the line of Jim Sidoti with Sidoti & Company.

[Jim Sidoti:]

I just wanted to review just a couple of quick things. The operating loss in the quarter from the QiG group, $5.5 million, are you saying that the majority of that is related to the Algostim business still?

[Thomas Hook:]

The majority of it is related to the Algostim development and qualification of that system through regulatory for specifically Algo via spinal cord stimulation platform. Because that’s the major project that we’re working on. So that’s the bulk of the work that we have ongoing. The other pieces within that operating segment are either out of CCC Medical Devices or NeuroNexus, which those pieces don’t really contribute to the operating loss.

[Jim Sidoti:]

But a year from now, should you spin this division off, you wouldn’t think that number would be down in the $2 million to $3 million range?

[Thomas Hook:]

We haven’t provided guidance on that. We will at the appropriate time. But your thought process is directionally correct.

[Jim Sidoti:]

And what was the pro forma tax rate in the quarter?

[Michael Dinkins:]

18% for the quarter. And the reason for that, and we gave guidance of 25% for the total year, we had a couple of audits that were completed recently, and the benefit of those audits are reflected in the current quarter, as we came out of those audits without any problems, and in one case, a little bit of upside.

[Jim Sidoti:]

And then I know you don’t give quarterly guidance, but can you just give us a little help directionally? Considering you still have some end of life issues in the second quarter, and currency’s still going to be a headwind, do you think the second quarter, again, will be down year over year from the first quarter?

[Michael Dinkins:]

Well, that’s asking for guidance. [laughter] You’re very good at that. We do expect that the second quarter, particularly in our CM market, will still be a challenge for us, because of end of life and the new products have not kicked in. So the pattern for us will be a much stronger third quarter and a stronger fourth quarter, particularly some of the products that start in the third quarter, we’re expecting growth up to the normal run rate. So the fourth quarter is a very strong quarter for us.

[Operator:]

And that concludes today’s question and answer session. I would like to hand the call back over to Ms. Betsy Cowell for closing remarks. Percentage points.

[Betsy Cowell:]

Thank you, operator. I would like to remind you that both the audio portion of the call and the slide visuals will be archived on our website at Greatbatch.com, and will also be accessible for the next 30 days. Thank you again everyone for joining us, and have a great evening.