Integer Holdings Corp (ITGR) 2013 Q3 法說會逐字稿

Welcome, everyone, to the third quarter 2013 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'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, Bree. Hello, everyone, and thank you for joining us today for our 2013 third quarter earnings call. With us today on the call is 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 third quarter. After that, Michael will provide additional comments on the third quarter performance, including comments on our working capital, cash flow, and 2013 guidance.

We will then open up the call to Q&A. As we've done in the past, we're including slide visuals accompanying 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 third quarter.

Sales for the quarter totaled $167.7 million, growing 5% organically when accounting for the impact of foreign exchange and the divestiture of non-core orthopedic products in 2012. Three product lines contributed to this growth. Orthopedics is up 22%, cardiac rhythm management plus 8%, and energy plus 4%. I will talk more about the sales performance drivers later in the presentation.

Adjusted diluted earnings per share increased for the third quarter to $0.57 per share, a 24% increase over the third quarter 2012, and the fifth consecutive quarter-over-quarter improvement.

These results were fueled by our organic constant currency revenue growth of 5%, 170-basis-point improvement in gross margin, lower medical device spending, and an effective tax rate of 28.8% for the quarter. This resulted in 110-basis-point improvement in our return on invested capital performance to 8.6%.

Our cash flow from operations for the quarter totaled $25 million, bringing our year-to-date cash flow total to $16 million. This quarter's performance was driven by higher operating income.

As expected, we issued an estimated tax payment of $8 million during the quarter in conjunction with the retirement of our convertible subordinated notes. This brings our total estimated tax payment for the debt retirement to $20 million for the year.

Excluding this tax payment, our quarterly operating cash flow totaled $33 million or $36 million year to date. Michael will discuss the changes and programs in place to continue to improve our cash flow performance later in the call.

Slide six shows our constant currency organic growth by product line for the quarter. Most notably were the continued growth in our orthopedic and cardiac rhythm management product lines and a modest improvement in the energy product line during the quarter.

We experienced mixed performance in portable medical, vascular, environmental, and military.

On slide seven, eight, and nine, we have outlined some insight on the drivers. Cardiac/neuromodulation quarterly growth aggregated 8% versus the same period in 2012. Our year-to-date organic growth is 3%. And on a rolling 12-month basis, our organic growth is 1% versus a 1% decline in the market.

Investments into our sales initiatives are driving growth and delivered success in the current quarter. This included an expansion of our sales pipeline through improved leverage of our strong intellectual property portfolio and manufacturing excellence. All this has contributed to outperforming the market.

Lastly, we have received several inquiries about the recently released study conducted by Dr. Saba at the University of Pittsburgh. I will address any questions during the Q&A session. However, we do not see this study impacting Greatbatch directly.

Performance in our orthopedic product line following the disposition of non-core products continues to reap rewards, showing 22% organic growth in the quarter and 15% organic growth year to date, both adjusted for foreign exchange impacts. Our expanded sales and marketing investments have led to new wins in minimally invasive surgical hip arthroplasty combined with 6% market growth in unit sales for large joints.

We have also expanded our customer base and delivery systems. Backlog from our consolidation activities moves along as planned. And we remain bullish on our performance for the remainder of the year.

Our portable medical product line showed mixed results as we continued to reposition the product line for growth with a more acceptable return on invested capital book of business. The loss of low-margin business impacted the quarter and will impact organic growth for the remainder of the year and into 2014.

We believe moving to a higher-margin business model is the right approach, given the strength of our research, development, and engineering teams and strong customer relations.

We lost two programs, which aggregate to approximately $9 million of annualized revenues. In addition, several of our customers are introducing their new products later than anticipated, creating a timing issue and resulted in a negative 4% organic growth for the quarter.

We have a healthy pipeline of products, which we expect our customers to introduce in the next several months. We are not satisfied with our revenue growth performance in portable medical and have refocused resources to drive improvements.

We saw a rebound in our energy business in the third quarter, with sales growth mid-single digits as customer ordering patterns normalized. We expect nominal growth in the fourth quarter because of a slow start in the first half of the year, causing the product line to be flat to slightly positive versus 2012.

Our vascular sales force in targeting underpenetrated markets has seen success with existing products. We expect to reintroduce our voluntarily recalled products in the fourth quarter, although this relaunch will not materially impact 2013 revenue.

Our 2013 initiatives are all progressing as planned. Our approach to commercializing Algostim has not changed and is proceeding as planned with FDA and CE Mark submissions. Our core business is well positioned because OEM customers leverage our portfolio of intellectual property, and we are building a healthy pipeline of diverse medical technology opportunities.

Our new organization structure allows dedicated resources to focus on growth. Combined with stronger discipline to ensure we have adequate returns for all products, our bottom line performance and our return on invested capital continues to 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.

If you have any questions on the consolidation and Algostim, we can address those during the Q&A session.

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

Thanks, Tom, and good afternoon, everyone. I am pleased to be on the call today to provide a brief update on our third 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.

Slide 13, the key highlights for the quarter are as follows, 5% constant currency organic sales growth, gross margin improvement to 33.3%, in line with prior periods of 2013, and 170 basis points up from the third quarter 2012.

Planned funding reallocations to sales and marketing, lower medical device spending, and reduction in our other operating expenses shown in the reconciliation of other operating expenses in the appendix of our presentation.

Adjusted diluted EPS up 24% to $0.57 per share, and 18.4% adjusted EBITDA margin or $30.8 million, up 10% over prior year. Cash flow from operating activities is $24.7 million, up 54% over prior year.

On slide 14, we provide EPS reconciliation for the quarter compared with third quarter 2012.

Our global operations continue to perform exceptionally well. And the decision to consolidate our orthopedic business has delivered positive results of $0.06 in the quarter.

We have funded sales and marketing through reduced spending in our medical device initiatives and lower interest expenses. Our performance-based compensation tracks with our total-year revenue and adjusted operating income expectations.

As our fully diluted share count moves higher with the higher stock price, this also impacted our quarterly EPS.

On slide 15, we have some details of our cash flow performance. Cash flow from operations for the first nine months of the year totaled $16.1 million, including the $20 million tax payments made in connection with the retirement of the convertible notes. Excluding the tax payments, our cash flow from operations was $36 million.

We remain highly focused on cash flow generation and are working to improve our performance. Although there is a net increase in our receivables balance, our days sales outstanding improved two days to 72 days for the period ended September 30th, 2013.

Our inventory balance increased within the period due to timing of European sales. Inventory turns are 3.6 at the end of September. We anticipate inventory to improve for the remainder of the year in line with revenue expectations and our inventory reduction programs.

Capital expenditures for the year totaled approximately $15 million. We remain within our target range of $20 million to $30 million capital spending for the year.

Turning now to slide 17, building on our first half results, coupled with third quarter performance, we believe we are closer to the middle to higher end of our guidance range given for the year of $2.05 to $2.15 adjusted EPS.

Revenues, as discussed previously, are closer to the lower end of our revenue guidance of $660 million to $680 million for the total year. And we expect our operating margin to approximate 13%.

Our adjusted tax rate will approximate 31%. And we expect a fully diluted share count to be around 25 million shares with our higher stock price.

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

(Operator Instructions). And your first question comes from the line of Dan Rutter with Paragon Investment.

Yes, hi. I wonder if you could talk a little bit about the expectations for the headwinds for military over the next couple of quarters. Thank you.

This is Tom Hook, Dan. Military for us is a small product line. We have a couple of key accounts in the product line, especially in the communications space. And those are areas where we have long-term agreements with customers for those product lines on more or less an exclusive basis.

So, it's a small piece of our EME or energy, military, and environmental product line that we report. So, on a consolidated basis, it does not have a big effect. So, we remain cautious on military, given what's happening globally. But, we still have a long-term agreement in place that secures a reasonable portion of that business. And it's been relatively predictable.

The second driver ends up being that we have won some new pieces of military business, which will start coming on stream in 2014, which will also buffer and mitigate some of the volume loss that occurs as the military retracts its purchasing powers. Hopefully that answers your question, Dan.

Yes, it does. Can I follow up with another one?

Certainly.

Great. Can you elaborate a little bit more on the progress around Algostim and partnering?

Right now, I'm going to limit my comments on Algostim partnering specifically to that we even have an engagement that has put ourselves in a position where we're screening partners and have evaluated our alternatives.

We've not made any choices, especially because, as we're approaching the actual submissions for FDA PMA submission as well as the CE mark, we recognize that's a very important milestone. So, they've progressed along in the regulatory submission path and are on schedule with completion of the design verification testing and those submissions.

We have not submitted them yet. But, we will provide information when we do. And the process of finding a commercial partner continues. And we don't have any news to report because we're still in the middle of that process and don't plan any particular updates until we're ready to make a selection on what our strategy's going to be.

Can you give us a little more guidance as to when submissions may be?

We've provided commentary that we intend to make the PMA submission by the end of this year for Algostim. And then early next year, we would plan doing the -- finishing the process for CE marking in Europe. And we're, as you heard in my prepared remarks, we're on schedule with those timelines. And we're progressing forward along those still.

Great. Thank you.

Welcome.

And your next question comes from the line of Chris Sassouni with Eagle Asset Management.

Good afternoon. On the topic of Algostim, if you're going to do the CE mark by the end of -- by next year some time, would you also expect to gain approval next year and actually be able to market that?

Our -- I think the CE marking timeline we project to have a shorter approval length of time than the PMA submission of the FDA.

Yes.

So, yes, Chris, we would be in a position, obviously, there's multiple other things that need to take place, manufacturing preparations as well as precipitation of our partnering discussions. But, it is feasible that CE marking could be received before the end of 2014.

We're not, but we're taking a very conservative approach, as we've said before. We're counting on an early 2015 PMA approval and a late 2014 CE mark approval. But, they could come sooner, to your point.

Okay. And at this point, have any of the -- refresh my memory. This is a literature-based PMA, correct?

It is a PMA that many people call a literature-based PMA, correct, although that's not a technical term that's an informal descriptor.

Okay. Right. Okay. So, can the FDA decide post-submission that they've changed their mind or would want you to do clinicals, or what are the odds on the decision tree? You submit. What are the possible outcomes from FDA? Could they just come back and say during the normal timeline, yes, you're approved? But, is it also possible that they would come back and say, we accept what you have so far, but we want additional clinicals?

So, the PMA process for the Algostim submission, when we give it to the FDA and obviously communicate with them, the FDA can ask for a wide range of information and data up to and including clinical information. So, we're following the guidelines and the path that's been followed by virtually all other neurostimulation companies.

Okay.

And we're going to, and we've already been in communication with regards to our approach. We're, obviously, we'll find out more once we have the submission in the 100-day review, specifically what feedback we'll get. We're taking a very straightforward approach in terms of our submission and plan to, as you call it or it's commonly referred to, literature-based approach, which the last two major systems have been approved under. We plan on taking the exact same approach.

Got it. Okay. And then on the subject of -- I don't know what you would call it, discontinuing or low-margin businesses, at this point, have you -- I missed the early part of your introductory remarks. At this point, have you decided which businesses and/or which customers you would like to discontinue?

I think one of the things that we do as a company very actively now to grow is we're being very conscious and deliberate on growing profitably. And our whole strategy is built around profitable growth.

And one of the investments that we've made as a company under the last 10 years of investing in IT systems has been to be able to look deeply product by product, customer by customer, really platform by platform and stratify which pieces and product lines we do not have profitable growth opportunities.

And we're -- to reallocate those resources to more better opportunities, we are stepping away from those product lines consciously and searching a place to deploy our resources that can grow and grow profitably.

So, it's -- they're conscious decisions, not to, quote, chase price. And most of those opportunities have a common theme. And it's simply our intellectual property portfolio is not strong. So, our base of our business strategy is around profitable growth to leverage our intellectual property portfolio and our manufacturing excellence.

And that's where we want to steer our investments and we are consciously. And in areas where we do not have strong intellectual property, if those margins are not acceptable, we're going to step out of that business and look for better opportunities to grow. And that's as simple as -- .

-- Okay. But, so, how -- when or how are you going to reveal which businesses will stay and which businesses will not stay?

It's not a question of businesses or product lines. It's a question of literally individual components for individual customers and individual platforms. It's very granular deal-by-deal analysis. So, there's -- we're not exiting any wholesale product line. We see great opportunities in all our product categories.

Okay. Okay. Thank you.

You're welcome.

(Operator Instructions). Your next question comes from the line of Charles Haff with Craig-Hallum.

Hi. Thanks for taking my questions. I apologize. I've been toggling in between different earnings calls here. So, if you already answered this and I missed it, I apologize.

But, on CRM and neuro, your previous guidance was for 0% to 2%. And now, that looks to be pretty conservative. Any thoughts on how we should be thinking about this?

I don't think we think of it the same way as low-single digit, Charles. If you look over a rolling 12-month basis, we track ourselves as 1% above the market that we track, while the market is shrinking about 1%. We're tracking about a positive 1% above that.

As you know, that's over 50% of our revenues as a company. So, it's a huge impact for us. So, we think we've pegged the rolling 12-month growth rate correctly in that 0% to 2% range. We know we're growing faster than the market. And we're widely represented in all five cardiac rhythm management companies. And we also serve an ever-increasing number of neurostimulation companies. And of course, we plan on obviously making our components for our own neurostimulators, which haven't achieved revenue yet.

So, from a guidance perspective, I think we're right where we should be. Certainly, for the year, we're a little bit ahead of the pace. But, we track those obviously on a quarterly basis. And we track those on a rolling 12-month basis. So, while the nine months is 3% and we're quite happy with that, a little bit above what we projected, the rolling 12 months is about 1%. And we feel pretty good about that, too.

Okay. And then my other question is regarding portable medical, negative 4% growth. That seems a little bit weaker than you previously expected. Are there some things going on here that we should be aware of, or how we should be thinking about this?

It's weaker because we -- as we -- I said in my prepared remarks, exited $9 million of business that we were not making acceptable returns on the investments that we'd been making, weak intellectual property position.

Okay.

We decided not to decrease our prices and go into a meet price and milestones that were given to us. So, we exited that business and redeployed the resources onto new projects where our profit margins are more acceptable.

So, it's a -- definitely a hit to our revenue growth for the portable medical segment, which we're not satisfied with. But, it allows us to make investments to grow revenue and margins more profitably and other opportunities in the portable medical area.

But, that takes a gestation time to win those businesses and turn them into revenues. So, it's about a three- to six-quarter lag, depending on the opportunities. But, it's the right thing to do for our profitability. But, it does show up as weakness in our revenue growth.

Okay. And is any of this business that came through the Micropower acquisition, or is this kind of outside of the Micropower acquisition that you brought in?

That's all Micropower-acquired product lines that we made -- .

-- Okay -- .

-- Those decisions on.

Okay. Great. Thank you.

Welcome.

Your next question comes from the line of Julia Kufman with RBC Capital Markets.

Hi, this is Julia Kufman calling in for Glenn. So, my first question relates to your base business, if you could speak to -- .

-- Could you speak up, please? We can't hear you.

I'm sorry. Is this better?

Yes, much better.

Okay. So, my first question relates to your base business and if you could speak to some of the underlying trends this quarter and specifically CRM and orthopedics, what's driving you to grow above the market, and if you could also discuss your thinking on long-term agreements and if there's been anything incremental since your last update.

Certainly. From a core business perspective in cardio rhythm management and neuro, we're doing a very good job of working with our customers to get designed into their platforms. And cardiac rhythm management is obviously historically a very significant set of product lines for us. They're secured by long-term agreements, and we have very deep and long-standing relationships with OEMs.

However, the real growth opportunities for us certainly are going to come in neurostimulation. We historically have had much lower revenues in neuro. They're very similar technologies from a discrete product standpoint that are used.

So, combined with winning new CRM products with our current OEM customers and adding incremental wins in the neuromodulation space will continue to allow us to grow slightly faster than the underlying unit growth in that market.

We've got the strategy and the technology underneath that to back it up. And what gives us confidence is our signing of long-term agreements that secure that business for multiple years, sometimes three to five and sometimes as long as eight years in length for both CRM and neurostimulation.

So, on the CRM side, while that's a slower growth market, we've got very deep penetration of the OEMs. And they leverage our intellectual property footprint very heavily. So, we don't expect that to generate the 5% revenue growth target we have as a company. But, we do expect to be able to grow faster than the underlying markets through customer engagement and incremental wins in neuro in particular.

There are multiple long term cardiac rhythm management in neuromodulation. Every year, there's new one that have been renewed. Fortunately, we've successfully renewed all of those that are in the near-term expiration. And we're on track to renew the ones that will be expiring in the near future. And you can see, when we do our investor communications, we periodically update our revenue long-term agreement tracking by year from the percentage basis.

And we have quite a bit of our revenues for 2014 already locked in on those agreements. Those agreements are not as standard in other product categories. But, as we deepen our relationships with OEMs in vascular, orthopedics, portable medical, long-term agreements we think will be more common as we partner deeper with those customers.

What's driving orthopedic revenue performance is the operational excellence investments that we've made over the past three years to consolidate our operations at our Fort Wayne facility, at our Chaumont, France, facility, and at our Indianapolis facility. And our Indianapolis facility in particular, now that it's had several years of stable operation, has seen a tremendous growth in delivery systems based on the improvements it's made and quality lead time performance and milestone performance to customer projects.

We have very little patented intellectual property in orthopedics, but we have a great deal of know-how. And we've produced a very lean manufacturing environment to respond quickly to the OEMs.

And finally, we're a very small player in orthopedics in a tremendous growth opportunity because of the size of the market. So, we're on the other end of the spectrum in orthopedics as compared to our cardiac rhythm management business. We're a very large presence and a very significant piece of the overall market. In orthopedics, we're much smaller, and we have much better revenue growth opportunities to -- in orthopedics in the future. And we're aggressively going after those opportunities. Hopefully, that answers your question.

No, that's a very thorough answer. Thank you very much. I don't know if you touched on this in the call. But, the transition for your manufacturing and the discontinuation of the product lines, is that 100% done and online, meaning the manufacturing online and the divestitures completed?

It's not 100% done. We still have -- the facilities are effectively phased out, except for a handful of people in Switzerland. We have moved completely from our Columbia City operations into our Fort Wayne facility. However, we still have backlog that we're relieving. It was a result of that transition process that we're still completing.

And we still have other regulatory and customer approval processes that have to be done. So, while the overwhelming majority of the transition is completed, we still have pieces to complete between now and the end of the year to finalize it.

Okay. Thank you. And my last question relates to sort of -- you guys mentioned a lot on Algostim. But, I think, in the past, you mentioned that you have a few other medical device -- excuse me, medical device initiatives in the pipeline. Are you ready to disclose any more details on that front, or do you have timing when you are ready?

I'm not prepared to disclose anything more than we've already disclosed. Yes, there's multiple other medical device platforms. One of those, at our Investor Day, we did disclose as a cardiac monitor called Cardiomonics. And other than that, we're not providing any other guidance or information on those programs at this time. But, in the future, as we reach milestones and are prepared to communicate on them, we plan on doing so.

Okay. And sort of back to Algostim, is there an opportunity to see a commercial agreement in advance of a PMA or CE Mark, or is that expected after the two milestones are reached?

We have left our options open. And we've been working with our Board of Directors as well as potential partners along with JPMorgan as our partners to compare an option in which we would sign a partner pre-PMA approval versus waiting for the PMA or the CE mark to be granted and then structuring a deal.

So, we're considering all options. And we're not going to make a choice prematurely because we feel we've still got a lot of work left to go. And we're in a strong position with regards to how we would like to monetize it. So, we're going to not make that choice purposely.

Okay. Thank you very much.

Thank you.

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

Thanks, Bree. I would like to remind you both that both the audio portion of the call as well as the slide visuals will be archived on our Website at greatbatch.com. And they'll also be accessible for the next 30 days.

Thank you, again, for everyone joining us. And have a good afternoon.

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