Integer Holdings Corp (ITGR) 2011 Q1 法說會逐字稿

Welcome, everyone, to the First Quarter 2011 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 obligation to update forward-looking 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, Corporate Controller and Treasurer, Marco Benedetti. Please proceed.

Hello, everyone, and thank you for joining us today for our 2011 First Quarter Earnings Call. With us on the call are Thomas J. Hook, President and Chief Executive Officer, and Thomas J. Mazza, Senior Vice President and Chief Financial Officer.

In terms of today's agenda, Tom Hook will start by providing a few brief comments regarding our first quarter results and strategic accomplishments. After that, Thomas Mazza will provide further comments and our financial results and guidance for 2011. We will then open up the call to Q&A. As we have done in the past, we are including slide visuals to go along with this presentation, which you can access on our website at www.greatbatch.com. With that, let me now turn the call over to our President and CEO, Thomas Hook.

Thank you, Marco, and welcome to all of you who are listening on the call today. I am pleased to report that we are off to a strong start for 2011. Our revenue of $148.8 million for the quarter was a record for our Company and represented a 13% increase over the prior year. This growth was led by our Vascular Access, Orthopedic, and Electrochem product lines, all of which posted double-digit increases.

This quarter demonstrated the benefits of our diversification strategy, especially given the challenging dynamics we are facing in the cardiac rhythm management market.

In March, we held our first-ever Investor Day, where we provided further insight into our strategy of delivering complete medical devices to our customers and how we will raise the growth and profitability profile of our Company. I am pleased to report that during the quarter we began to see the first revenues from this strategy. While nominal in amount, they were significant, and that marks the beginning of what we are expecting to be a continuous incremental revenue addition.

Similar to sales, our operating results were also strong during the quarter, as our adjusted operating income increased 25% to $18.7 million or 12.6% of sales. This improvement reflects the benefit of the higher revenue during the quarter as well as our various lean initiatives, which helped to offset the negotiated price reductions given to some of our larger OEM customers at the end of last year in exchange for long-term contracts.

As expected during the quarter, we continue to make significant investment in the development of complete medical devices for our customers and reached several key milestones. Research, development, and engineering expense this period included design verification testing costs in conjunction with the development of our neuromodulation platform, which includes the [Alviston] Spinal Cord Stimulation System that we introduced during our Investor Day.

We expect to continue to incur these expenses over the next 12 to 18 months with regulatory submissions targeted for the second half of 2012.

Additionally, research, development, and engineering expenses for the period also included the benefit of two OEM customer cost reimbursements received in connection with the development of medical devices providing more positive evidence of our progress in implementing this strategy.

The net result for the quarter is that we achieved adjusted earnings per diluted share of $0.46 per share, which represents a 44% increase over the prior year. More importantly, these results generated an 18% increase in cash flows from operations to $25 million. Given the results for the quarter, we are well on our way to achieving our financial targets for the year. Thomas Mazza will provide additional detail on the financial performance and our outlook later in the call.

As is customary, I would now like to spend a few minutes to highlight for you the progress we made during the quarter on our three strategic initiatives -- growing and diversifying our revenue base, driving operational excellence, and delivering innovative solutions.

With regards to our first long-term strategic initiative of growing and diversifying our revenue base, this quarter provides a good example of the benefits of this strategy. Despite a modest 1% increase in our cardiac rhythm management revenue, which still comprises over half of our business, we were able to report 13% revenue growth. As a direct result of our diversification strategy, today we have a revenue base that extends across multiple product lines, customers, and industries, and provides us a more stable foundation from which to grow over the long run.

More specifically during the quarter, we began to see tangible benefits from the significant investments we have made in our orthopedic business. Over the past two years, we have invested substantial resources in this business to expand our capabilities, reduce lead times, and improve quality and on-time delivery. Among others, this included the opening of our Orthopedic Design Center in Warsaw, Indiana; investments in our Chaumont, France, implant facility to qualify new customers; the establishment of a pilot line at our Columbia City, Indiana, facility; and the refresh of our Indianapolis, Indiana, facility. All of these investments have allowed us to achieve industry-leading, on-time delivery, lead times, and quality levels.

This has also allowed us to capture additional market share and drove the 34% increase of orthopedic product line sales this quarter. We intend to continue to invest in this business to further expand our capabilities and streamline operations including the construction of a state-of-the-art manufacturing facility in Allentown, Indiana, which we announced earlier this year.

With regards to diversification as mentioned earlier, during the quarter we recorded our first revenue from the sale of medical devices that were developed under the Greatbatch name. The sales of these devices will provide incremental growth to our core business and are expected to steadily increase as we push these projects through our pipeline and into commercialization. These projects will also serve to broaden our product portfolio as well as our customer base and further diversify and stabilize our revenue stream.

Driving operating performance is our second strategic initiative and is also a critical part of our long-term plan to create shareholder value. During the quarter, we were able to achieve 120 basis-point improvement in our adjusted operating margin, which was driven by our increased sales as well as the various lean initiatives put in place over the last year, which helped to offset the pricing pressure that we are seeing.

Going forward, we expect these pricing pressures to continue, and we'll work to offset their impact by further leveraging our existing infrastructure and by pursuing continuous facility optimization, especially within our orthopedic operations.

Additionally, as a result of the consolidation and cost control initiatives completed over the last five years, we have a significant amount of manufacturing capacity at our existing facilities to support the launch of our medical device products as well as incremental growth.

Our last key strategic initiative is to drive growth through delivering innovative solutions. In connection with this initiative, we formally reviewed our medical device strategy and provided specific details of our pipeline at our Investor Day meeting in March.

As you can tell, we are very enthusiastic about the work going on within our Company and, more specifically, within the QIG group. Since that time, we also held town hall meetings with all of our associates and visited some of our largest OEM customers communicating the benefits of this strategy to them. At this time, I am happy to report that the response to this strategy has been positive and has created tremendous energy within our Company.

As you may recall from Investor Day, we are expecting to achieve numerous milestones both near term and longer term around the development and commercialization of complete medical devices for our customers. For this quarter, our more significant accomplishments include the following -- first, recognizing our first medical device revenues from our cardiovascular product portfolio; second, beginning the process of design verification testing on our neuromodulation platform; third, receiving CE Mark for our bidirectional guidance sheet in transradial access introducer; fourth, receiving significant customer cost reimbursements due to the achievement of milestones related to two medical device projects; and, fifth, recognizing a $4.5 million gain on the sale of Intellect Medical.

As you may recall from our Investor Day, our device strategy, which is being facilitated by our QIG Group, has three investment mechanisms, which include strategic equity investments in startup companies, OEM customer discrete projects, and incubating new medical devices to be sold and licensed to an OEM partner at a later date. This quarter's accomplishments illustrate our diversified portfolio approach and how we are executing in all three facets of this strategy simultaneously.

From a longer-term standpoint, we intend to achieve a number of additional major development and commercial milestones. We also fully expect to announce additional innovations in the formation of other newcos to serve as vehicles for these device innovations. Our goal is to establish a cadence of medical device announcements, and we'll continue to update you on our progress in the achievement of milestones as they occur.

With that, let me now turn the call over to Thomas Mazza for a more detailed review of our first quarter financial results.

Thanks, Tom, and good afternoon, everyone. For the call today, I am pleased to review with you our results for the first quarter beginning on slide 8.

Consolidated first quarter 2011 sales grew 13% over the prior-year period to a record $148.8 million, reflecting double-digit growth in our vascular, orthopedic, and Electrochem product lines. This strong growth reflects the benefits of our diversified revenue base as well as the investments made over the last several years to add to our capabilities and to implement our medical device strategy.

Looking at our individual product lines, CRM, in neuromodulation sales for the first quarter 2011, increased 1% compared to the prior-year period and were consistent with the sequential 2010 fourth quarter. During the quarter, CRM revenue included the benefit of customer inventory builds to support their product launches and continue to be impacted by pricing pressures as well as the overall slowdown in the underlying market. We expect these pressures on CRM revenue to continue for the foreseeable future and are still expecting 2011 CRM revenue to be flat in comparison to 2010.

First quarter 2011 sales of our vascular product line increased 28% to $10.5 million compared to prior-year sales of $8.2 million, primarily due to increased Introducer sales. First quarter 2010 Introducer sales included the impact of customer inventory reduction programs, which are now complete, and ordering patterns have returned to a more normalized level.

As Thomas discussed earlier, vascular sales for the first quarter of 2011 were significant in that they included our first sales of medical devices that were developed under the Greatbatch name. Although individually they were not material, this is a significant milestone in that we expect revenue from these devices to steadily increase for the remainder of 2011 as commercialization continues to ramp up.

Orthopedic product line sales of $39.6 million for the first quarter of 2011 were 34% above the $29.4 million for the comparable 2010 period and were at their highest level in three years. This increase occurred across all of our product lines, which benefited from moderate orthopedic market growth, customer inventory builds, and customer product launches.

Additionally, the investments we have made in our operations and expanded capabilities continue to deliver new business.

First quarter 2011 orthopedic sales also included the impact of foreign currency exchange rate fluctuations, which increased sales by approximately $1 million compared to the prior period.

First quarter 2011 sales of our Electrochem business segment increased 19% to $20.7 million compared to $17.5 million in the first quarter of 2010. During the quarter, Electrochem sales benefited as customers in our energy markets began to rebuild inventory levels, which were depleted at the end of last year. Additionally, Electrochem sales benefited from the timing of inventory polls by customers in our environmental markets, which received funding earlier than anticipated.

As you can see, on slide 9, gross profit was $47.2 million, or 31.7% of sales in the first quarter of 2011, compared to $41.7 million, or 31.6% of sales for the comparable 2010 period. This improvement resulted primarily from the higher sales volumes discussed above and various lean initiatives put in place over the past year partially offset by a higher mix of lower-margin orthopedic revenues, price concessions made to our larger OEM customers near the end of 2010, and higher profit-sharing expense which was not accrued in 2010, as performance targets were not hit.

Selling, general, and administrative expenses were $18.6 million, or 12.5% of sales for the first quarter of 2011 compared to $15.7 million, or 11.9% of sales for the same period of 2010. The majority of this increase was also due to an increase in performance-based compensation.

Net research development and engineering costs for 2011, first quarter, were $10.4 million compared to $11 million for the comparable 2010 period. As Thomas discussed earlier, first quarter 2011 results include higher-cost reimbursements from the customers of approximately $900,000, which was primarily due to the achievement of contractual milestones on two medical device products. And approximately $600,000 of design verification testing expenses in connection with the QIG Group's neuromodulation platform. Excluding these items, RD&E costs remain consistent with the prior-year quarter as we continue to invest resources in developing complete medical devices for our OEM customers.

As discussed in our Investment Day, over the long term, we expect net RD&E, excluding GBT expenses, to remain around 8.5% to 9% of sales.

GAAP operating income for the first quarter of 2011 was $18 million compared to $14 million for the first quarter of 2010. Similarly, adjusted operating income was $18.7 million, or 12.6% of sales in the first quarter of 2011 compared to $15 million, or 11.4% of sales for the comparable 2010 period.

I would like to refer you to the appendix of today's presentation for a reconciliation of the adjusted amounts to GAAP.

The 2011 first quarter GAAP adjusted effective tax rates were 33% and 32.8%, respectively, compared to 35% for the same periods of 2010. The 2011 rates include the benefit of RD&E credit, which was reinstated in the fourth quarter of 2010 and extends through the end of 2011.

The net results of the above is that our GAAP and adjusted diluted earnings per share for the first quarter 2011 were $0.51 and $0.46 per share, respectively, compared to $0.24 and $0.32 per share, respectively, for the first quarter of 2010.

As previously disclosed, the 2011 GAAP amounts include a $4.5 million, or $3 million net of tax gains, from the sale of our Intellect Medical cost method investment.

Cash flows from operations for the first quarter of 2011 remain strong at $25 million, and represented an 18% increase over the prior year. We currently expect the cash flow operations will be used to support continued RD&E investment, capital expenditures, and to further pay down debt.

With regards to our guidance, as you can see in our release today, at this time we are reaffirming our revenue, adjusted operating income as a percentage of sales, and adjusted diluted earnings per share guidance provided at the beginning of the year. Given the results for the first quarter, as well as our expectations for the remainder of the year, we believe that our results are trending towards the higher end of the ranges provided.

As you can see, during the quarter, we continued to execute on our long-term strategy, which is being enabled by our strong financial performance. The initiatives we have implemented over the last several years have provided us with an efficient manufacturing base, which more than accommodated the increased volume during the current quarter and helped offset continued pricing pressure from our customers.

As a result, we are off to a solid start for 2011. With that said, as we all know, one quarter does not make a year, and we still have a lot of hard work ahead of us, given the market dynamics we are facing. We are cautiously optimistic and are confident that our 2011 will be another successful year both strategically and operationally for Greatbatch.

With that, let me hand the call back to the moderator to take questions.

(Operator Instructions) Tim Lee, Piper Jaffray.

Big numbers here in the quarter, at least relative to what we were thinking. Was there any one-time big inventory stocking, doing any builds by the customers that kind of skewed the numbers upwards? How should we think about the sales going forward for the year? I'm assuming, based on your comments of the full-year guidance, that Q1 could potentially end up being the high-water mark, and we could see revenues for Q2 and -- Q2 to Q4 -- come in from current levels. A lot of questions in there, but any color would be much appreciated.

Sure, Tim. This is Thomas Hook. So -- no big one-timers. I think, as history would always be consistent in going forward is that if we had some big one-time item, we would normally call them out and give you some information regarding them. But, clearly, we've done a good job operationally in the vascular access, orthopedics, and the Electrochem areas. A lot of our investments are paying off. So the kind of growth was broad spread. Obviously, there's some inventory effect in there that is really tough to divorce out of what the effect of our market success and project success is. But I would say that typically, a lot of that inventory rationalization already took place in prior years. So we know we're clear of that effect. And as we've said before, is on a downturn, we tend to have a slower growth rate and some inventory retraction. In an upturn, we typically get some growth and a little bit of inventory build.

So we know there's a little bit of an inventory factor in this. It certainly does not explain all of the overage that we've achieved. I think we've just operationally performed. Really, obviously, given that we only have one quarter under our belts for the year, it's a little bit premature to kind of extend out for the forecast of the year. I think the way Thomas described it was -- we've had a good strong start to the year. We know we're going to be at the upper end of the guidance based on what we've overperformed on in Q1. But right now we're not bullish enough to say that the -- you know, we're going to keep getting a push-through on that for the remaining three quarters of the year. So it's a bit premature to be thinking that way.

Got it. Just two more quick ones, if I can. Just on the gross margin line, it was down a little bit -- it was down sequentially but a little lower than what we were thinking of. Should we expect to see that bounce back here in Q2 for the balance of the year? Just any color on that front.

Obviously, one of the things is that we have a little bit different of a mix in profitability of our product lines because we have not consolidated, really, our orthopedic operations fully yet. We've only really -- we're kind of in the middle of the process.

When we get a higher orthopedic mix, that, really, mix factor kind of provides a little bit of an arithmetic depression. So, kind of, two effects here -- as the mix stabilizes for the out portions of the year, that factor will start to be numerically eliminated. And then, additionally, as we continue to take cost out of the orthopedic operations with the various lean initiatives and consolidation initiatives we're doing, we're going to take hard costs out. So from a training standpoint, as we expect to continue to make gains in that area, much to your point.

Glenn Navarro, RBC Capital Records (ph).

I want to just follow up on Tim's question on orthopedics, because it was an extremely strong quarter. And if you add up the orthopedic numbers from the key players this quarter, a majority of the players missed, and the market came in below expectations, particularly on the knee side.

So -- I understand there were no one-timers, but it sounds like there was clearly inventory build. But I'm also wondering -- have you picked up new partners in orthopedics? Any more color you can provide, and is this the new run rate that we should be modeling for ortho? That's question one, and I'll have a follow-up.

Certainly, Glenn. Again, Thomas Hook here. Ortho is up. Look, there's multiple effects in orthopedics, where we've got a little bit of currency in there, not much. About $1 million on the currency side. Clearly, there is some inventory effect, which does not explain even a majority of the rebound, and orthopedics is. We did a really good job of engaging with customers two ways. One, we definitely won multiple new customers and new projects. We definitely have picked up a significant amount of revenue over the past year by the Design Center and the Pilot Line investments we have in Indiana, as well as the operating teams in Switzerland have done a very nice job for winning business through performance. [Shortly] times high quality and good cost performance.

And although we're not consolidated, the lean center of excellence that we run has improved our operations enough where we're just winning customer business, and that's really at root fundamentally of why orthopedic revenues are up.

Now, different than the cardiac market for us, where we're kind of at a glass ceiling. We have a lot of business, our opportunities are capitated with customers, and they come along very slowly, and they're kind of already comprehended in our numbers and long-term agreements.

Orthopedics is a much more fluid flow market. We are a very small player in a very large market, and there's a lot of greenfield opportunities to go out and grow. And each of the locations has done a nice job with customer relationship and management turning around some of the negative perceptions that we had to endure through the 2008 and 2009 periods. One of the projects in 2010 and, effective, we're shipping them now. So I think is we have to do a couple of things simultaneously in orthopedics. We must complete the consolidation project so we can keep this momentum going and get the cost performance that our customers need and get the operating performance that we require. And simultaneously with that, we have to satisfy our current customers so we hold onto the business over the longer run.

If we do both of those in concert, and we've got a lot of experience doing these in the other businesses. If we grew both of those in concert, we can have a good trajectory on the orthopedic side. We think there's plenty of opportunity there. And we think that that's an area of focus for us because we think cardiac rhythm management is going to be as we guided to -- kind of a low-growth area, and we think orthopedics has got a lot of opportunities for us both from innovation and operating performance.

Hopefully, that's helpful.

It is. Just -- I guess what you're also trying to say is that it's too premature, then, to assume the $40 million in ortho revenues is the new run rate?

I think you've got to -- just look at our -- you know, obviously, we've had a quarter of good performance, but look at the longer guidance that we put down on the guidance slide, and we're consistent with that.

Exactly, Glenn. There was certainly, as Thomas was saying, there was some inventory build that doesn't account for it. But we can always -- part of what we're seeing is product launches from our customers on the instrumentation side and that we're winning, okay?

And just remember, there's a seasonality in the year, Glenn, to the orthopedics business. We tend to drop off pretty significantly in the third quarter when we hit the European vacation months because about three-quarters of our orthopedic business is Europe-based.

Okay. And two housekeeping questions. One, the new product that you alluded to in vascular -- is that OptiSeal? And then the R&D credits that you receive from customers -- could you just remind us what that was from?

I could just say that from the sales perspective, although we had a low amount of sales, it was from the vascular introducer OptiSeal in there. But there's a couple of other projects that you did point to on the vascular side. We really kind of made a kind of strategic decision not to break out what payments were for, but they did relate to the vascular devices that are very close to commercialization and regulatory approval if not having already passed the regulatory hurdles and us receiving payments for those. So we just want to remain a little bit opaque on the precise identity of each of those projects.

It is two vascular access projects.

(Operator Instructions) Stan Mann, Mann Family Investments.

Good job, gentlemen. I have some usual questions. Use of cash and paydown of debt -- you bought back some converts. Where are you now?

Stan, this is Thomas Hook. No, we have not bought any of the converts, and we obviously have just been retiring the revolving credit facility, and that's pretty much what our plans, this year, in the second quarter as well, is just to keep retiring the revolver first. And, obviously, then we'll have to look at the opportunities in terms of going forward, what we're going to do that's going to be different than that.

Stan, what you may be referring to is the old converts, which we retired last year, at the end of last year. So we haven't been retiring any of the new ones.

So where are we in the (inaudible) debt?

We currently have $50 million under the revolver outstanding. And we have the full amount of the convertible debt outstanding on top of that.

Of the new convertible.

Of the new convertible debt, of the 2000 -- convertible debt that's due in 2013.

Okay, net -- then, net debt, when you put your cash in is -- ?

$160 million.

Okay, I'm right. But my next question is my usual question. You're spending $40 million a year in R&D or that area; 20% return on investment brings you $8 million of profit to pay for these. I'm a doubter. Could you kind of give us a frame of how we're going to get that return on investment that we continually are pouring in? I don't see it.

Well, if you go to the Investor Day materials, we said, as a company, we kind of see our way without the systems and device trajectory, about 2% growth. We expect a 5% long-term growth enhancement based on the systems and device projects. And, remember, the systems and device projects not only drive systems and device revenue, it obviously pulls a lot of component manufacturing opportunities from us from our plants.

So it's a nice contribution in terms of component revenues as well as the device integration revenues. Clearly, we've made a lot of investments over the last three years. We've just seen the first of the revenue precipitate off the P&L this quarter. Even though it's not material, it's an important milestone for us to get the first of these 18 projects out. And our expectations, as we said, is that it's going to just start to build from here.

The vast majority of these projects already have customers that have signed agreements to buy and distribute these products. So we have a good deal of comfort in our technical capability to complete the development, as witnessed by the payments from customers for milestone completion. We've gotten many of them through the barrier of getting approvals for the regulatory clearances in multiple countries. And the customers are gearing up their go-to-market strategies to bring those products to market, which will pull revenue from off that they build inventory to launch the technologies.

So it's a story that builds, over time. Which is much what we presented at Investor Day -- that we would continue to enhance as more of those projects continue to move on. And what we'd end up doing is we would take and kind of levelize (ph). In the four R&D areas, we'd spend about $25 million a year, and in the devices areas, we're going to capitate our spending for the time being, around $25 million a year. We're going to let these projects wash through and start to build up momentum to kind of have proof in the pudding. To answer your questions, there are good returns on this financially.

And, effectively, is we're in that proving it in the 2011 to 2013 timeframe is to show that much like when we made the investments on the manufacturing consolidations is initially we were spending a lot of money, and we weren't generating a lot of cash returns on those. Now, because of those investments we made back in '05, '06, and '07, we're generating a lot of return on those investments because at that period of time we toughed it out and stayed committed to those investments, and they're performing for us now. And we're getting a lot of benefit out of them and will for the go-forward time in parallel with the device strategy.

So I hope that answers your question, Stan.

(Operator Instructions) Jason Mills, Cannacord Genuity.

Hi, this is [Chris Wolniak] for Jason. I just want to talk to you a little bit about your operating margin expansion. It was more than we had expected, and I wanted to get any sense for you in terms of this is a level that we should expect throughout the remainder of the year. And the confidence you're feeling just in terms of the initiatives that you have in place.

Again, Chris, this is Thomas Hook talking. As competency in the issues we have in place -- we have very finely articulated our plans for the year. Obviously, with us kind of four months into the year, all the projects are well underway, already producing results, and we've obviously had -- we're ahead of performance in the first quarter. So the confidence level is high that we can continue to make the initiatives stick and count for us throughout the balance of the year.

I'll still go back and just kind of reaffirm that, from a guidance standpoint, obviously, we've got a jumpstart. We'll be at the higher end of the ranges, which is good news for us. That's where we want to be. If we continue to perform in targeted areas like getting better reimbursements from customers on engineering payments and things like that will be a little bit favorable. So, hence, since we're ahead of the game, we said we'd be at the higher end of the ranges regarding some of this performance for the balance of the year.

But, obviously, we've got one quarter of good performance. We've got three quarters to go. We've got to focus on it. If we perform, we'll continue to stay within the high end of the ranges and post some strong results for the year. And, I guess, by definition, that would become the norm as we progress through the year.

Yes, Chris, this is Thomas Mazza. Just so you know, the level of revenue clearly was driving the operating income at this point in time, as well, too. So as our revenues get lower in the out periods and kind of come back to the 560 range we were talking for the year, that will come into consideration as well, too.

And that concludes today's question-and-answer session. And I'd like to turn the call back over to Mr. Marco Benedetti for any closing remarks.

I'd like to remind you that both the audio portion of this call and the slide visuals will be archived in our website at Greatbatch.com and will be accessible for 30 days. Thanks, everyone, for joining us.

Thank you for your participation. That concludes today's conference call.