Integer Holdings Corp (ITGR) 2013 Q1 法說會逐字稿

Welcome, everyone, to the first-quarter 2013 Greatbatch, Inc earning 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 form 10-K.

The statements are based upon Greatbatch, Inc' s current expectations and actual results that differ materially from those stated or implied. The Company assumes no obligations to update forward-looking information included in this conference call to reflect change assumptions, the current or unanticipated events or changes, and future operating results, financial conditions, or prospects.

I would like to now turn the call over to today's host, Vice President and Corporate Controller, Tom Mazza. Please proceed.

Thank you, Erica. Hello, everyone.

Thank you for joining us today for our 2013 first quarter earning call. With us on the call are Thomas J. Hook, President and Chief Executive Officer; Michael Dinkins, Senior Vice President and Chief Financial Officer; and Betsy Cowell, Vice President of Finance and Treasurer. Going forward, Betsy will be your contact for Investor Relations. Please join me in welcoming Betsy to the Greatbatch team.

In terms of today's agenda, Tom Hook will start off with a few brief comments regarding our first quarter results and provide an update of our strategic objectives. After that, Michael will provide some additional comments on the first quarter performance including comments on our working capital and cash flow, and confirm our 2013 guidance. We will open -- we will then open the call to Q and A. As we have done in the past, we are including slide visuals that go along with this presentation which you can access on our web site at www.greatbatch.com.

With that, let me turn the call over to Tom Hook.

Thank you, Tom. Welcome to all of you who are listening on our call today. We are pleased to be able to share with you our results for the first quarter.

Adjusted diluted EPS increased $0.07 to $0.44 per share which represents a 19% increase over the first quarter 2012. This improvement, as well as our increase in adjusted operating income, was fueled by our improved gross margins and continued focus of our RD&E expenditures.

Michael will discuss our financial results in further detail later in the presentation, but you will notice the following significant improvements in our quarter-over-quarter performance. 340-basis points improvement in gross margin, continued focused net research, development, and engineering spending resulting in a $2.8 million reduction, and adjusted operating margin performance of 13%, up 320-basis points over the prior year.

For the quarter, adjusted EBITDA improved by $3 million to $28 million which represents a 300-basis point improvement to 18.9%. As expected, our CapEx run rate is decreasing as most of our expenditure for plant consolidations are behind us now. CapEx was reduced by $3 million to approximately $7 million for the quarter. Slide 6 outlines our first quarter organic growth by product line.

On the next several slides, we will discuss the quarter results and our outlook for the remaining part of the year. I would like to address our sales performance where adjusting for the sale of our non-core orthopaedic products we saw a 4% sales decline year over year. We experienced lower volume in the cardiac neuromodulation consistent with the underlying market. Due to OEM focus on inventory levels, our first quarter order intake, and thus revenue, was less than expected. For the remainder of the year we expect customer ordering patterns to normalize, and we also have new product launches that are deepening our relationship with our OEM customers to help us grow this product line faster than the underlying market.

Our vascular business was down $1 million year over year. Again, due to customer inventory adjustments. This business will be challenged throughout the year. As you know, we voluntarily recalled several vascular medical device products, and we are diligently executing our plans to have these products back on the market in the second half of this year. With regard to our orthopaedics product line, after adjusting for the sale of certain non-core products during the quarter, of $4.2 million, this product line showed strong double-digit growth which we feel will continue throughout the year. We also launched several new products, specifically cases and trays, in the quarter.

Turning to our Electrochem business, our portable medical business was slightly up 1% in the first quarter. We are experiencing continued strength from our fourth-quarter product launch with one of our largest portable medical customers. We should mention that in the first quarter of last year, we had the upside of new product introductions. For the second half of the year, our customers are launching new products and redesigning existing products which will accelerate our growth.

Rounding out our Electrochem business, we were up against strong comparables in our energy, military, and other product lines. We believe that some of the lighter customer demand was attributable to price increases announced in the fourth quarter 2012 with more customers buying forward. We expect customer ordering patterns to normalize and are already seeing run rates for the first part of the second quarter improving. We will continue to execute on our pricing strategy and rationalize lower-value products throughout the remainder of the year.

This is the same slide that we used at our Investor Day meeting. Because as we continue to execute our plan, I would like to reiterate two important strategic points to everyone on the call. Our core business is well positioned because OEM customers leverage our portfolio of intellectual property and have entered into long-term agreements which secure our core business revenue streams. Second, we are building a healthy pipeline of opportunities as we work with OEM customers on projects. Additionally, we have enhanced our sales and marketing capabilities to take our existing portfolio of intellectual property and manufacturing excellence to new customers and new markets. Combine this with stronger discipline to ensure we have adequate returns for all projects, we expect our bottom line performance will continue to improve.

With these in mind, we wanted to update you on two initiatives, Algostim and orthopaedics. First commercializing Algostim. Slide 13 outlines our development, clinical, and regulatory approval actions. Design verification testing activities are on track. We initiated two animal studies for support of our literature-based PMA submission later this year and are well along on our CE mark submission. Operationally we are identifying and signing up key suppliers. Also, our collaboration with JPMorgan, who as you may recall is assisting us in identifying commercial partners, is progressing well.

Turning to Orthopaedics. As of the end of the first quarter, we have completed the product transfers to our Ft. Wayne, Indiana; and Tijuana, Mexico facilities. Plant and product validations are essentially completed, and we are working off the $2.9 million backlog as our plants staff up to full production. We are experiencing strong growth in orthopaedics and expect this to continue, thus validating our strategic decision to consolidate this Business.

I will now turn the presentation over to Michael Dinkins to provide more detail on our first quarter results and recap our guidance for the year.

Thanks, Tom, and good afternoon, everyone.

I am very pleased to be on the call today and provide a brief update on our first quarter 2013 results and confirm our full-year guidance. For more specific details regarding our financial results for the quarter, we refer you to our press release that we issued earlier today. With that let's get started.

As shown on slide 16, operationally our team delivered strong margins and operating income. This execution resulted in a double-digit adjusted EBITDA growth to $28 million for the quarter, or 11%. The key highlights for the quarter are as follows, sequential gross margin improvements over the last five quarters to 32.9% in the first quarter 2013; planned RD&E rationalization with $2.8 million lower spending year over year; respectable medical growth; and strong double-digit organic growth in orthopaedics, validating our consolidation decisions. Algostim progress continues on schedule, and adjusted diluted EPS up 19% to $0.$0.44 per share. I will address our cash flow later in this presentation.

On slide 17, we provide EPS reconciliation for the quarter compared with first quarter of 2012. The key highlight for the quarter is the positive $0.07, adjusted EPS impact from the plant consolidations, and our ongoing continuous improvement efforts. In addition, we benefited from the focusing of our RD&E efforts. Equally important is that we are investing in the sales and marketing resources [to an eight clause] to build a pipeline of projects with our OEM customers to sustain at least 5% organic growth in the future.

Slide 18 details our balance sheet items for the quarter. Receivables increased $3.6 million as many of our customers held payments until the end of the calendar month. Our balance is now in line with revenues, having received approximately $20 million in the first two weeks of April, with a good portion of our payments coming from our European customers. We have several efforts to try to improve our future performance.

The 10% jump in inventory was caused by several factors. We replenished our safety stock in the quarter to be in compliance with contractual requirements. This represents about 5 million of the increase. We also forward bought several key materials, given the uncertainty of the global supply and suppliers for several key materials such as titanium, we increased our inventory levels by approximately $2 million.

Finally, raw materials increased as a result of the plant consolidations and startup of production at the new site. Now that we have completed the product moves, we have implemented a plan to more tightly tie our purchases to revenue forecasts. Our working capital performance negatively impacted our cash flow by $35 million, which included a $19 million reduction in accounts payables and accrued expenses. The reduction in accounts payable and accrued expenses was primarily due to the annual bonus payments in March and severance payments as a result of the plant consolidations. All of these factors resulted in the use of operating cash flow of $7.6 million for the quarter. We still expect a total year cash flow, excluding the $30 million IRS payment, to be approximately $90 million for 2013. I will be happy to answer any questions on the drivers during our Q and A portion of this call.

We are reaffirming our guidance for 2013. Based upon first-quarter early April indications and our targeted second-half of the year product-line plans, we believe revenue will be closer to the lower end of the revenue guidance. Our operating performance in the first quarter provides comfort in our ability to deliver 12% to 12.5% adjusted operating margin. Because our production facilities continue to deliver productivity and these results should continue as volume leverage for are having greater impacts in the second half of the year, partially offset by our variable compensation expense, and we continue to estimate that our RD&E will be $3 million below prior year. The drivers for the EPS improvement is the same data we shared with you at the Investor Day presentation. But as stated, we continue to be comfortable with our guidance.

Let me now turn the call back over to the moderator so that Tom and I can address your questions.

(Operator Instructions)

Charles Croson with Sidoti & Company. Please proceed.

Hi, guys, how's it going. Can you hear me okay?

Absolutely, Charles.

Great. Thanks. So I want to address two things right here. The top line being below estimates here. And I'm just trying to get your sense what gives you the confidence to maintain guidance in light of that.

Charles, this is Tom Hook. Where we're at in the beginning of the year was obviously finishing up the move on the orthopaedic side of the equation. So we shut down the Swiss facilities, didn't have the ability to ship out of the North American facilities yet. So we expected that we were going to have a shortfall on orthopaedic revenues because of the sale of assets and because of that qualification gap. And in the second and third quarter we would run out more of the backlog. I think we expect the category of management, that there is the market in terms of, obviously we're linked to volume more than the ASPs of OEMs, but the volume is down in those markets. However, we're launching a lot of technology into both CRM and Neuromod applications that allow us to still be relatively flat to slightly up in terms of where we view the market opportunities as we move to the second half of the year.

And we also in vascular feel that we are going to bring the two products that we had removed for the recall back into the market per the plans that have been moving ahead smoothly. And all of those factors together will allow us to continue to execute along with the portable medical opportunities that we see in the funnel that we're progressing per plan in the timeline. When we take and phase out each of those categories in the plans for the year and how we're tracking against them, while we came in below my satisfaction level for the first quarter, we see the progress being made across the board in all those product line revenues from now to the second half of the year. We've already seen the pick-up in the second quarter, and we see that we'll be coming in towards the lower end of the range of guidance but still within the guidance band.

Okay. I see. That's helpful. And then one more question there on the top line, in particular portable medical segment. When do we see that growing, you know, into maybe the high-single digits or so? We were expecting a little bit more growth there. Just trying to get your take on that. Then one quick one on expenses.

Yes. Charles, this is Tom Hook again. The simple answer to that is really second half. We pushed a lot of products through the funnel in 2013. So we have a little bit of a tough comparable -- excuse me, in 2012 we pushed a lot of products through the funnel. In 2013, we're getting some tough comparables in the first half and second half. We're pushing a whole set of additional products through the funnel which start to monetize for us in the second half. And we'll build on, as you remember from Investor Day, that portable medical revenue build slide. As we launch products they tend to add to the replacement market of prior products, and that's what's going to pick the growth rate up for us on a year-over-year basis and a total-year basis.

Okay. That's helpful, thank you, Tom. Then one last quick one on R&D. Looks like you rationalized that a little bit quicker than I was anticipating. Good job there. Is this kind of the level we should expect? I know you said a few million below the prior year, but I'm just trying to get a sense of what a few million actually means.

Yes. I think, Charles, just be careful when you look at RD&E because there's two effects, there's timing, and then there's rationalization. We are rationalizing and focusing on the primary projects that we've already communicated at Investor Day like Algostim. Clearly some of those products are reaching maturity in terms of their product development, so their expenses are starting to curtail anyways, so that there's a focusing type and rationalizing of R&D which still hasn't been fully realized yet. However, what you're also seeing is some of the timing of, and repayments from customers, and the actual expenses for projects coming through, so we do have some favorability. But we still think that for the remainder of the year there's more favorability will get out of the focus and the crescendoing of the Algostim project as that starts to come down to fruition.

Okay. I appreciate the answers there, Tom. I'll hop back in the queue then.

Charles Haff with Craig-Hallam. Please proceed.

Hi, thanks for taking my questions. Had one regarding the DVT expenses in the quarter. Looked like they were about 30% or 40% higher this quarter versus the couple -- previous couple of quarters. I wonder if you could give us insight there. Should we expect this level, similar level in the next couple of quarters, or will we kind of revert back to where we were before?

Charles, I think what you're going to see is about $5 million for the year for the DVT expenditures. You know, we're pushing through the completion of a good chunk of the DVT right now including some -- the start of the animal trials. So it's not going to be a regular expense at a consistent level. It will actually taper off as the various elements are validated and verified.

Okay.

So it won't be consistent. About $5 million for the total year is a good estimate.

Okay.

A [good question] in the second quarter, and then a smaller amount in third and fourth.

Okay. Thank you. Then on inventories, I saw those went up about 11%. You mentioned some things about titanium in the prepared remarks. But will this -- will these inventory levels be reversing in future periods this year, or are these sustained higher levels of safety stock for the remainder of the year or how should we think about that?

In terms of safety stock, roughly $5 million that we have there, that is the compliance level. We pretty much stay close to that throughout the year. That you can expect to continue. We did end up with more work in process than what we would like to have, so we do expect some improvement in our inventory performance going forward relative to our sales levels. And as things calm down and, you know, we're in the plants and running it and giving our forecasts under the new systems and stuff, we should be able to bring that down and do better in the second quarter and get back to more normal levels.

Okay. Great.

And just to be clear, you know, when you look at raw materials, is that you got to be -- you have to always be careful that we do raw material purchasing on a strategic basis to avoid supply chain disruptions downstream. So when we're doing them, it's with a lot of consideration to make those purchases of raw materials, whether it's materials for orthopaedic implants like titanium or tantalum for capacitors. We would do that only when strategically necessary. We don't have to maintain minimum supply levels for that. It's only the finished goods that we have contractual obligations for supply to maintain. So we must contractually have those at certain levels for customers, and they cannot be reduced once we achieve them unless the customer elects to depress the inventory and give us kind of a catch-up time to do it.

Okay. Thanks for the insight there. And then my last question is regarding growth. Kind of along the lines of the previous question, but just wanted to get a little more color in terms of the visibility that you have. I understand, you know, the factors that you believe are going to play out this year. And then, you know, looking at the year-over-year comparisons, it appears as though this first quarter was the easiest year-over-year comparison relative to the remaining quarters of this year. I'm just wondering if you could kind of talk about the visibility just to kind of give us a little bit more comfort in a lot of these things actually occurring this year. Maybe comment on your -- prepared remarks you mentioned revenue growth of at least 5%. I understand that might be aspirational. But if you could talk about that a little bit that would be great.

Sure, Charles, I would say we still remain fairly pessimistic on a lot of the markets, but aggressive in terms of our ability to execute against customer programs. It's the funnel of customer programs that really set the tempo for how we look at our revenue prospects going forward. They're still eagerly adopting technologies that we've worked with them for years across a majority of the product lines. We have defined customer programs for their product developments to feed their regulatory submissions and their revenue streams. We build our revenue picture based off what our OEM customers are executing against in their plans as well as their core product lines. But we still apply a pessimistic picture of what we expect out of a core markets given some of the challenges that our individual customers are facing.

When we add up the picture of core market, you know, growth, which is pretty meager in a lot of the product lines. We add that to technology implementation programs that the customers have running, as well as new product wins that we're qualifying in with existing customers and also new customers. We still see -- and supplanting for second through fourth quarter this year that we'll be back on stream shipping from the North American orthopaedic facilities. We see the combination of that coming in toward the lower end of the revenue guidance, but we still see a growth environment through the execution on all those programs.

We're not expecting a lot of market growth to be able to, you know, float the tides for us. We expect that it's going to be pretty aggressive, and I think as we look forward we're not really projecting that's going to percolate up. We're going to have to earn every percent that we get. For us for the year, it's still going to be a challenge revenue growth, but we do see the opportunities out there. We definitely feel that we'll get growing back with vascular again with the product introductions that we're back in a lot of the market again. In orthopaedics we've been able to percolate right back to a double-digit growth rate following the moves and shutdowns from Switzerland. So, we're bullish in the second half of the year, as well.

I don't expect -- you're not going expect to hear a lot of bullish comments from me about [category] management. But, neurostimulation will begin to build in significance as we get out toward the end of '13 to '14 because of the amount of work we've done over the last three years in product development in those areas. Not a bad landscape for us.

Okay. Just to comment on the year-over-year comparisons, any thoughts there? Does it present any challenges or you feel like you have good visibility on the new product flow that takes care of that?

Always challenges. We got very good visibility in metrics to the programs which gives us confidence. You can imagine that one of the things that you're very used to hearing from us is seasonality out of the European facilities. We obviously still have that in our French facility. However, the Swiss facilities are shut down, and we won't be turning off our North American orthopaedic plants in August like we used to in Europe. So, we'll be shipping consistently through the third quarter, as well. So, some of the seasonality effects even will go away towards the second half.

We've done a very good job across all the businesses of winning new business. I think that also leaves a little bit of bullishness from us even though we're not seeing any market push-through. In terms of volume we are seeing, and have for several years a very healthy funnel of product development initiatives within all the core project areas. And especially in areas like portable medical which tend to be large project volume drivers when they come. And they tend to level off a little bit. We don't launch new projects every single quarter in portable medical. You can see the effect it has in the growth rate when we're not launching a product at a level of growth from that quarter. But we still see a very rich product funnel in portable medical that's going to end up increasing the growth profile of the entire Company in the second half because of the meaningful revenue we have in that product line now, as well.

Okay, thank you for your time.

Glenn Novarro with RBC Capital Markets. Please proceed.

I have a few questions on the orthopaedic side. You called out the asset sale of $4 million. Is that $4 million per quarter? So, how should we think about this from a modelling point of view is the first question?

On an annualized basis it's roughly $15 million, evenly split among the quarters with the one quarter being down a little bit would be the third quarter.

So then my -- my followup to that is, that's a lot to offset, but I'm assuming you do have business and contracts in place to offset it. I think this is why you have confidences. Is that a fair assumption?

We think that, you know, in terms of offsetting, we've obviously called out some non-core, you know, low-margin products that we did not move out of Switzerland. They just didn't have enough volume, and they would be too expensive to move, and there wasn't enough margin to return on that investment. But you're right. Through new product launches, with new customers or existing customers, we're replacing those orthopaedic revenues with other product sales and revenue. And that's what's making us -- the execution on those programs is why the revenue, organic-revenue growth rate for orthopaedics is up in the first quarter and why we expect to -- for the year to be a strong double-digit grower.

I think additionally, you remember we are not moving the implant facility in Chaumont that's been a very steady operational facility for us. We have been growing in that product category, as well. And we intend to, based on execution of the customer programs we have currently implemented in -- we are executing on, we continue to expect the growth in that plant, as well, based on the tremendous execution of the Chaumont operating team and the customer wins that we have. Really in orthopaedics, I think on both sides of the equation, both in instruments, trays, and also in implants, we expect a good growth opportunities and a good deal funnel for us going forward to drive revenues.

And can you remind me, this is the type -- this is a little bit different relative to CRM where you have long customer contracts and long lead times. There's more business that can be picked up quicker in orthopaedics, as well, correct?

That's correct. And the instruments, and the cases and tray side, the product life cycle is much shorter. So, within the course of the year we can pick up revenue and ship revenue. And the implant side, it is more CRM like. As you know, we've owned that business for several years. We've qualified new customers. We've expanded our relationship with our key customer there, which is DePuy. And we've grown the business and the plant output year over year, and we've won a lot of business there. So I think it's more CRM like an implant.

Obviously, we have a long-term agreement that covers that facility with DePuy, and we've executed against it, and we've been rewarded with more business. And the combination of both new customers and expanding the existing and deepening relationship with DePuy has allowed us to grow that. But it's more similar to a CRM type agreement that it takes years and years to get qualified for those products. And then we have long-term agreements that protect the business for the foreseeable future.

Okay. One quick one for Mike. I just want to make sure my math is right. The operating margin, the adjusted operating margin in the quarter came in around 13%?

That is correct.

So that's already trending above your guidance today. So what is it over the next couple of quarters that brings the operating margin back down in that -- you know, the 12%, 12.5% range where guidance is?

Two things that will bring it down slightly. First, we were encouraged that it was higher than what we anticipated in the first quarter. And we obviously hope to hold on to the high gross margin that we have. The two things that will impact it going forward is that, one, as our portable medical business trends from roughly 12% of our revenue to 15% of our revenue in the second half with the new product introductions, they are slightly lower margins than our other product line. So that will give us a little bit of an unfavorable mix.

And we book our variable compensation as we -- in line when our earnings come in. So they'll be a little bit higher variable compensation in those numbers in the second half also. So those two factors will slightly bring the margins down. But obviously we're off to a good start and closer to the 12.5% to the 12.0% in terms of where we might be for the year in terms of operating margin performance.

Okay. great. Thanks, Mike.

(Operator Instructions)

Brooks West with Piper Jaffray. Please proceed.

Hi, Mike, I had a question for you on the timing of OEM customer purchases between Q4 of last year and this quarter. And we saw another OEM supplier into the cardiovascular space come in light on revenues this quarter. And my question is, I know some of your OEM customers who are accounting for the medical device tax in cost of goods sold did buy inventory, and they're actually assigning the tax to work in progress. And so I'm wondering, was that the cause of the kind of bigger purchasing in Q4 versus Q1? And your thoughts on kind of how long it might take them to work through that inventory.

I can't confirm the reason why they did what they did. So I won't speculate there. But that's one logical explanation of why they would have the pattern that they have. But I can't say I've confirmed that with them. But we think it's a combination of that. That they did buy heavier in the fourth quarter. In addition, we are seeing our OEM customers pay more attention to the inventory levels and just trying to bring their inventory levels down. So I think it's a combination that there was some buy forward, reasons -- again, I have not confirmed. But we believe that the medical-device tax along with some other things would be part of the driver. And they are focusing on managing their inventory levels. As we go into the second quarter, we're starting to see a normalization of the ordering pattern from our customers, and that's one of the reasons why we believe we will be at the lower end of the range because we're not seeing the same pattern of -- in volume of orders that we saw in the first quarter.

Okay. And then on the guidance, at what point -- I'm trying to relate the pointing us toward the low end of the revenue guidance to the EPS range. At what point should we start to think about a lower, you know, looking at the lower end of the EPS range in relation to the revenue performance?

I think that we have had and can sustain our margin improvement. So we're not giving guidance to the lower end of the EPS range. We're giving guidance to the lower end of the revenue range.

Fair enough. Thank you.

We have no further questions at this time. I will now turn the call back over to Tom Mazza for any closing remarks.

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

Thank you for your participation in today's conference. This concludes the presentation. Everyone may now disconnect, and have a great day.