Integer Holdings Corp (ITGR) 2013 Q2 法說會逐字稿

Welcome, everyone, to the Second Quarter 2013 Greatbatch, Inc., 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's current expectations, and actual results could differ materially from those stated or implied. The Company assumes no obligations to update forward-looking information included in this conference call to reflect changed assumptions, the occurrence of unanticipated events, or changes in the future operating results, financial conditions, or prospects.

I would like to now turn the call over to today's host, Vice President, Finance and Treasurer, Betsy Cowell.

Thank you, Lisa. Hello, everyone, and thank you for joining us today for our 2013 second quarter earnings call. With us today on the call are Thomas J. Hook, President and Chief Executive Officer, and Michael Dinkins, Executive Vice President and CFO.

In terms of today's agenda, Tom Hook will start us off with a few comments regarding our second quarter results and provide an update of our strategic objectives including our recently announced reorganization. After that, Michael will provide additional comments on the second quarter performance including comments on our working capital, cash flow, and our 2013 guidance.

We will then open up the call to Q&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 website, at www.greatbatch.com. With that, let me turn the call over now to Tom Hook.

Thank you, Betsy, and welcome to all of you who are listening to our call today. We are pleased to be able to share with you our results for the second quarter. We delivered record quarter sales performance growing 3% to $171.3 million. Organically, we grew 6% driven by three product lines -- orthopedics up 14%; portable medical up 9%; and cardiac rhythm management up 5%. I will talk more about the drivers of this performance later in the presentation.

Adjusted diluted earnings per share increased for the second quarter to $0.56 per share, which represents a 30% increase over the second quarter 2012. These improvements were fueled by our organic revenue growth of 6%, 220 basis points improvement in gross margin; 2% reduction in our operating expenses; and an effective tax rate of 35% for the quarter. This resulted in 120 basis points improvement in our return on invested capital performance to 8.7%.

As expected, our CapEx run rate is decreasing as most of our expenditures for plant consolidations are behind us now. CapEx was reduced by $9 million to $5 million for the quarter. Our cash flow from operations of negative $1 million is something we plan to aggressively address. As expected, included in this cash flow are roughly $1 million of severance payments for the Switzerland plant consolidation and then $11 million tax payment for the convertible notes redemption. After adjusting for these two items, our cash flow is a positive $11 million, still approximately $10 million to $15 million below our expectations because of higher receivables and inventories.

Our plans target improvements for the second half of the year. Slide 6 outlines our organic growth by product line for the quarter. As we had planned, orthopedic, portable medical, and cardiac rhythm management drove our performance with softness in vascular and energy, environmental, and military.

On slide 7 I have some insight on the drivers. Cardiac neuromodulation rebounded, consistent with the underlying market from the slow start in Q1. We continue to see normalized customer ordering patterns and a new product launches in the second half that continue to deepen our OEM customer relationships.

Orthopedics is approaching 20% of our revenue mix. After adjusting for the disposition of certain noncore products, which were $4.4 million for the quarter, the product line grew 14%. For the second quarter in a row, we experienced strong demand in hip and shoulder implants and continue to broaden our customer base. Our plants are fully operational and we'll be working down the backlog through the second half of the year. We remain bullish on this product line.

Our battery packs for portable medical applications were very strong in the quarter, as we experienced growth from several key customers, which offsets slower business from a customer rebalancing inventory. For the second half of the year, we expect growth to be driven by over 40 new product introductions but partially offset by changes with one of our customers. Overall, our diverse customer base and product introductions allow Greatbatch to manage through these various transitions.

The energy environmental and military product lines showed modest decline. We continue to rationalize our product offerings in these markets and apply a disciplined pricing model. These actions provide a stronger base from which Greatbatch can leverage its technical strengths as a strategic partner to our customers.

Finally, our vascular product line was down $200,000 in the quarter due to the voluntary recall of our two medical devices in late 2012. As we communicated in the first quarter, these products are scheduled to be back in production the second half of the year. Our view for the year remains unchanged as we plan this product line to be below expectations set forth at the beginning of 2013.

Let's now turn our attention to our strategic update beginning on slide 9. Strategy laid out at our Investor Day continues to be implemented aggressively. We are establishing Greatbatch as a growth company where we have a competitive advantage in the markets we serve, by introducing innovative product offerings into the marketplace, and where organic growth represents a significant percentage of recurring revenues.

Our new organization structure announced in June further enables Greatbatch to accomplish these strategic growth objectives and achieve our goal of 5% organic revenue growth.

Our sales and marketing investments are bearing fruit. Additionally, we will maintain a disciplined approach to identifying, executing, and integrating tuck-in acquisitions to enhance our core.

Our approach to commercializing algostim has not changed and is proceeding as planned with FDA and CE Mark submissions.

Greatbatch continues on its evolution and as a profitable core business that is able to adapt to our growth vision. I again emphasize two of the important strategic points to everyone on the call. First, our core business is well positioned because OEM customers leverage our portfolio of intellectual property. And, second, we are building a healthy pipeline of diverse medical technology opportunities.

Over the last eight years, Greatbatch has successfully integrated and consolidated its businesses and facilities. This has led us to an inflection in which the Company can build upon our strong operations foundation to establish Greatbatch as a growth company. Our new organization structure allows dedicated resources to focus on growth. Combined with stronger discipline to ensure we have adequate returns for our products, our bottom line performance and our return on invested capital will improve.

In this new structure, we have retained and enhanced the leadership team and the capabilities that have driven our operational excellence. This foundation we stand on when working with our OEM partners will continue to drive our growth strategy.

At this time, I will update you on two initiatives -- algostim, and our orthopedics consolidation, and then I'll allow Michael to provide more information on our financial performance and guidance for the year.

First -- commercializing algostim. We have accelerated our timeline for CE Mark, which we now expect to submit in early 2014 and our plans to submit our [literature]-based PMA to the FDA later this year are on course.

Operationally, we are finalizing contracts with key suppliers. Lastly, our JP Morgan collaboration continues. In other words, everything is moving along on schedule.

Turning to orthopedics -- we have executed the transition and are fully operational in our Fort Wayne, Indiana, and Tijuana, Mexico, facilities. Both facilities continue to work off backlog as our plants staff up to full production. The growth we are experiencing and expect to continue validates our strategic decision to consolidate these orthopedic facilities.

I will now turn the presentation over to Mike Dinkins to provide more detail on our second quarter results and update 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 second quarter 2013 results and update you on 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.

The key highlights for the quarter are as follows -- 3% sales growth; 6% organic sales growth; sequential growth margin improvement over the last six quarters to 33.4% in the second quarter 2013; planned funding reallocations to sales and marketing while reducing our other operating expense as we complete our consolidation projects in the ERP upgrade.

We have, in the appendix, page 26, a year-over-year analysis of our other operating expenses.

Adjusted diluted EPS, up 30% to $0.56 per share and 10% adjusted EBITDA improvement to $31.3 million. On slide 14 we provide EPS reconciliation for the second quarter compared to 2012.

Our global operations continue to perform exceptionally well. In the decision to consolidate our orthopedics business has delivered positive results of $0.09 in the quarter. We have funded sales and marketing through reduced spending on our medical device initiatives and lower interest expenses, and our performance-based compensation tracks with our total year revenue and adjusted operating income expectations.

Slide 15 details some selected balance sheet items for the quarter.

Receivables includes $14 million reflected in a strong June shipment volume. We are not seeing any issues with the collectability of our receivables, and have added staffing so we can provide more timely follow-up to reduce our receivable balance in the near term and get back on track for our total year cash flow target.

Although the inventory balance is up versus year-end, inventory days are trending down in line with sales trends. The inventory increase is attributable to pre-buys of clinical materials, safety stock replacement, and support of second-half sales. Having said this, we do not believe -- we do believe there is room for improvement as we work with our customers to agree to lower safety stock levels and improve our inventory turns above our historical performance.

Our working capital performance negatively impacted our cash flow by $12 million, which included a $6 million reduction in accounts payables and accrued expenses. The reduction in accounts payable and accrued expenses was primarily due to incentive compensation for 2012, paid in 2013, and severance payments tied to our Switzerland consolidation. Cash flow from operations for the quarter was a usage of $1 million. Including the expected tax payments of $11.5 million made in connection with the retirement of their convertible notes, excluding the tax payments and the $0.9 million for Switzerland's severance, our cash from operations was $11.4 million.

We remain highly focused on cash flow generation and are working to improve our performance in the third quarter.

Turning now to slide 17 -- we are raising our guidance for 2013 to $2.05 to $2.15 adjusted diluted EPS. We are encouraged by our strong second quarter revenue performance, although we continue to believe we are closer to the lower end of our revenues guidance of $660 million to $680 million for the total year. Our manufacturing operations continue to perform well, and we now believe our operating margin will approximate 13% of the total year. And our effective adjusted tax rate will be around 33%.

Because of our higher stock price, we are estimating that our diluted outstanding shares will be around $25 million. Using these updated factors, our range of adjusted diluted EPS is $2.05 to $2.15. Let me now turn the call back over to the moderator so that Tom and I can address your questions.

(Operator Instructions) Charles Haff, Craig-Hallum.

Hi, thanks for taking my questions and a nice quarter. I had a question for you regarding CRM, so St. Jude, on their last conference call said they launched six new CRM product lines, so far, in 2013, and they said they expect two more in 2013. I understand that St. Jude is a very material customer for you. How impactful were those new product launches on your CRM performance this quarter?

Hey, Charles, it's Tom Hook. We don't, obviously, break out kind of the customer impacts by customer, but I'll say this, is that, in general, the launches didn't drive a lot of our growth, just straight up wins and deepening the relationships with all of our customers that we have progressively over the last multiple sets of years is really what's driving the growth.

And we're also doing a good job of starting to penetrate on the neuro side, even though that's a very small effect for us. It will keep growing in importance. So I think that we're doing a good job more broadly in CRM is with delivering the growth there by increasing our share with each customer. It's not really a launch or transitory increase.

Okay. And I respect that you don't want to mention customer names. I understand that. But, just generally, or would you say that you have other customers with this level of new product launches in the next -- past six months, next upcoming year? Or would this customer be kind of an anomaly in terms of new product launches here?

Actually, in cardiac rhythm management, Charles, I am encouraged by the amount of renewed investment and vigor in innovation and product launches. I think a lot of the last several years where it was kind of -- I'll just call it a "dry spell" in device innovation is changing, and I do think it's on the way back up in multiple customers. And I think that's not just focused on the United States, I think it's focused globally. So we're actually pretty encouraged, and we've seen this trend years ago because we've been in the designs of a lot of these programs and working hard to win them, and that's why we've been a little bit more bullish than the market growth rates that have been posted by our customers because we -- we're projecting that we're going to be able to win deeper relationships with the OEM to do more work with them, and it's going to be a growth segment for us. And, obviously, our objective is to continue to capitalize on that through the partnerships. So -- I don't want to say that I'm bullish, but I'm not as pessimistic as a lot of the end market news has been.

Okay, and then there was just one last follow-up question here, and I'll jump back in the queue. In terms of -- for CRM customers when they launch new products, how early before they launch the product do you tend to start incurring revenues? I know you get paid sometimes for your design work and things like that, but how should we think about the pacing of revenue to Greatbatch around the new product launches for OEM customer?

Certainly, Charles, just to be clear, is we don't recognize any of the reimbursements we get for engineering fees as revenue. They are only recognized for us for CRM customers as reimbursements to our R&D expenses. But for revenues we usually see them shortly before the launches. But every customer launches in a different manner. Some launch with limited geographies and some launch with the express intent of cannibalizing their inventory of an older-generation product.

So some customers actually build up inventory and then use that inventory to push out the old product. Some actually just kind of do it on an orderly transition, and it varies by product line, and it varies by customer. So, for us, because we sell to so many OEMs, it tends to balance out and not be a big factor. But when it is a significant factor, we try to always give the transparency in our comments as to a launch that drove a particular effect, and you'll know historically when we've done that.

(Operator Instructions) Charles Haff.

Oh, hi. I thought there would be some other questioners, so I'll just keep going here. On working cap, Mike, you talked about how that hurt cash flow generation, and I understand there were some items like the accounts receivable and the inventories and such, and I was wondering if you've kind of separated out, let's say, the items where you were more proactive, like, forward buying. You mentioned you did some of that versus some of the things you need to fix like maybe AR or AP. Have you kind of -- I'm just trying to tease out which ones were proactive hits to the working cap and which ones you really need to work on?

The proactive hits to the working capital would all be in inventory. And they would be in the range of about $3 million to $5 million where we have brought forward on certain materials, maybe ahead of what we would normally carry for various reasons, looking at the market, spot pricing availability through suppliers, et cetera, et cetera. So maybe about $3 million to $5 million is in that category. And I say that range because no sooner we buy, we start using some of it. So I don't have the precise number.

But the rest of it is our targeted area where we hope to improve and get our cash flow back to our historical run rates.

Okay, and how long do you think that would take? Is that just a couple of quarters or any estimate how long that would take to get back to those normal run rates?

We're going to try to be back in by year-end, so we think that on the receivable side, that's a much shorter fix. And on the inventory side, it's a matter of going through, and the operations team has identified several projects that they are working on, and we will work with them and systematically make improvement on the inventory side. So it will take a little bit longer on that side, but when we focus in on it, we'll get it done.

Okay, great. And then another question on algostim regarding what's going on with JP Morgan. What are the services that you have going on right now with JP Morgan? I know you've been a little bit vague on that in the past. Could you describe that a little bit more now that some time has passed?

Charles, it's really very simple -- we want JP Morgan to help us screen and identify a commercialization partner for that technology, and they're active in identifying interested parties that we're talking to and just talking. And, obviously, based on the Investor Day presentation, you can appreciate how much information that we need to share with these potential parties. And they're brokering a lot of those conversations and, obviously, helping us narrow down the direction we would like to go strategically in advising the management team and the Board accordingly. And that's exactly what JP Morgan's services encompass.

Okay. And then in terms of your time, Tom, obviously, algostim is a very important product for the Company. How should we think about from your time or the resources of the Company, how much time is being put into algostim versus all the other areas of your business that you have going on? I just wanted to kind of get an understanding of, kind of, prioritization, if you will.

Everything is important and everything is urgent for the CFO and the CEO. So I, obviously, with Mike, divide our time across the board. Algostim is something that is very important, but the urgent and important challenge for us is our core business growing 5% and growing 2x to the bottom line. So we put a lot of energy and prioritization on that urgent and important growth and return to shareholders as a priority. And we're using the targeted M&A in the commercialization of the medical devices like algostim is the enhancers to that.

But given the magnitude of the algostim, and given that it's coming to crunch time for CE Mark and PMA submissions, I do spend considerable time with the algostim R&D, QIG, and the Chief Technology Officer, George Cintra, on making sure that product is on schedule and, accordingly, reviewing it with the Board of Directors to make sure they are aware and comfortable on the path we're pursuing for commercialization.

So -- I think that I would -- I don't really feel comfortable giving a percentage of time, but it gets a fair amount of energy from me and Mike on a weekly basis. And, obviously, it's becoming a very busy timeframe in the second half of this year regarding that product, so it's going to require some extra push from the management team to see it get to the submission points.

Okay, and one last one for me, and I'll jump back in queue -- on Micro Power in portable medical -- a faster growth area of your business. It looks like you had about 9% revenue growth in portable medical this quarter. I thought I recall that Micro Power at the time that you bought it, may have been a little bit faster growth. Correct me if I'm wrong there, but I just want to kind of get a sense for second half acceleration versus deceleration for portable medical. Any help you can give me there, and I realize that the business can be lumpy, so I understand that part.

True, medical device -- clinical medical was a double-digit growth business for us last year, and as we've indicated, there was a lot of heavy introductions for clinical medical in the first half of last year. So when you compare this year to prior year for the first half, you don't get that double-digit growth. We do see a number of new product introductions that our customers are working with us on and telling us about. Obviously, we can't directly control them, so we are more optimistic about the second half of the year for portable medical getting back to a double-digit growth.

And that concludes today's question-and-answer session. I'll turn the call back over to Mr. Tom Hook for closing remarks.

Thank you. Okay, thanks very much, everybody, for participating and have a great day.

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