Integer Holdings Corp (ITGR) 2014 Q1 法說會逐字稿

Welcome, everyone, to the first quarter 2014 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, Inc. current expectations, and actual results could differ materially from those stated or implied. The Company assumes no obligation update forward-looking statement information included in this conference call to reflect change assumptions, the conference or unanticipated events, or changes in future operations results, financial conditions, or prospects.

I would like to turn the call over to your host for today, Vice President, Finance and Treasurer, Betsy Cowell.

Thank you, Brittney, and hello, everyone, and thank you for joining us today for our first quarter 2014 earnings call. With us on the call are Thomas J. Hook, President and Chief Executive Officer, and Michael Dinkins, Executive Vice President and Chief Financial Officer.

In terms of today's agenda, Tom will start us off with an overview of the results of the first quarter, key accomplishments contributing to our financial performance, and remarks on our product lines. Michael will then provide additional comments on the 2014 first quarter financial results and discuss our 2014 guidance. We will then open the call up to Q&A.

As we have done in the past, we are including visual slides to accompany this presentation, which you can access on our website, www.greatbatch.com. Now let me turn the call over to Tom Hook.

Thank you, Betsy, and good afternoon, all of you who are joining our call today.

Today we reported first quarter 2014 revenue of $174.3 million, a 17% organic constant currency sales growth. Three of our Greatbatch medical product lines, cardiac rhythm management/neuromodulation, orthopaedic and vascular, delivered growth in excess of 20% for the quarter versus the first quarter of 2013. I will talk more about the sales performance drivers later in the presentation.

Adjusted operating income increased 16%, and diluted earnings per share totalled $0.54, a 23% improvement when compared to the same period 2013.

Cash flow from operations totaled $7 million, versus the prior-year usage of $7.6 million, driven by our strong operating performance and improved asset management, principally inventory.

We hold firm our commitment to improve shareholder return by growing the top line 5% organically and returning two times that amount to the bottom line.

Greatbatch has delivered year-over-year revenue growth for four consecutive quarters and adjusted diluted EPS growth seven consecutive quarters.

We are creating and professionalizing the Greatbatch sales and marketing organization to a standard commensurate with a global Greatbatch operations and innovation organizations capable of studying markets intensively, driving prioritization of key technologies and product development, and leading OEM customers to product solutions. This highly professional sales and marketing organization will drive a culture of new deals while simultaneously securing our core revenue. We are starting to see the benefit of these investments.

Our global operations have created a competitive advantage to minimize business risk. We maintain a culture of continuous improvement and a network of manufacturing sites that are tightly integrated into category teams and focused on delivering our objective of improved return on invested capital. Through volume and productivity initiatives, we have improved profitability in all product lines.

We aligned our R&D organization closer to our markets, which accelerates execution and launch predictability. Enhanced project management tools and new reporting capabilities will optimize our product development process across all product lines. Today we have in excess of 40 new product development projects in progress.

We continue to efficiently move through the Algostim regulatory approval process, and we believe we'll be in a position to receive CE Mark in the second half of 2014 and PMA approval very early in 2015.

Now I'd like to provide some comments relative to our various product offerings.

Cardiac rhythm management/neuromodulation sales of $86.8 million were 23% higher than the $70.5 million in the comparable quarter 2013, and revenue grew 2% in the sequential quarter-over-quarter comparisons. Several factors contributed to the strong first quarter performance.

First and most importantly, we continued to see strong performance with our core product portfolio of batteries, capacitors, enclosures, feedthroughs and shield assemblies. We also benefitted from successful customer product introductions leveraging our new technologies. We do believe some of our customers increased inventory levels, which we will monitor during the remainder of the year, and we are comparing to a soft quarter in 2013.

On a rolling four-quarter basis Greatbatch continues to see an upward trend. Our customers' results through the most recent reporting period have shown a similar trend in the comparable period. As most of our customers have yet to report quarterly earnings, we will continue to monitor the stability of the market.

Our orthopaedic product line sales of $36.4 million grew 20% on an organic constant currency basis versus the first quarter 2013 revenue of $29.6 million. During the first quarter last year, we were in the final stages of getting our manufacturing sites up to targeted production levels as we completed the Switzerland consolidation, which impacted sales for that quarter.

Our instrument product family continues to strengthen, along with our implant business, which is benefitting from market share gains by one of our primary customers. We expect to see double-digit growth in orthopaedic product line for the remainder of the year.

The portable medical product line first quarter revenue of $19.2 million was comparable to last year's sales of $18.9 million, a 2% expansion. Rechargeable battery assembly application growth was very strong due to a relatively easy 2013 comparable. This product family revenue was slightly ahead of fourth quarter 2013, which gives us confidence in our strategy to service the industry.

Our single-use battery packs lagged the prior year first quarter, which is attributable to our decision to exit certain low-margin applications. We believe repositioning the portable medical product lines is the right strategy for Greatbatch and in the long term for our customers.

Our vascular product line grew 23%, driven primarily by our catheter products such as our steerable sheath catheter. We expect strong double-digit performance of this product line, led by product launches in our introducer and catheter offerings, as a sales force dedicated to deeper customer partnerships and our commitment to product innovation.

The energy/military/environmental product line results are in line with the prior-year quarter, as customer order patterns continue to stabilize.

Michael Dinkins will now take you through a more detailed look at our first quarter results and our 2014 guidance before we take your questions.

Thanks, Tom, and good afternoon, everyone. I am very pleased to be on the call today to provide an overview of our first quarter 2014 performance and our 2014 full-year guidance. For more details regarding our financial results, we refer you to our press release that we issued earlier today.

For 2014 we delivered the following: 18% sales growth; 17% organic constant currency sales growth; gross margins of 33%, slightly ahead of first quarter 2013; 16% adjusted operating income improvement to $22.3 million, and adjusted operating margins representing 12.8% of sales; $0.54 adjusted diluted EPS, a 23% increase; adjusted EBITDA of $31.6 million, up 12%; and operating cash flows totaling $7 million, versus a usage of $7.6 million in the prior year.

Slide 13 provides a reconciliation of our adjusted EPS from the first quarter 2013 to the first quarter 2014. Sales mix and volume increases quarter over quarter contributed approximately $0.23 improvement to our adjusted EPS. Performance-based compensation negatively impacted the quarter when compared to prior year by approximately $0.07, as we have reflected performance-based compensation expense in line with the first quarter 2014 results and last year we had a soft quarter, so our performance-based compensation was much lower.

With regard to operating expenses, RD&E expenditures accounted for a $0.05 dilution for the quarter caused by several items. We had lower customer cost reimbursements for engineering projects in comparison to last year, a matter of timing in the year.

In 2014 design verification testing, DBT, expenses reported in normal operations, where in prior years DBT was adjusted from our adjusted operating income. This expense totaled $0.7 million for the quarter, compared to $1.7 million incurred the first quarter 2013. Lastly, we incurred project costs associated with Greatbatch Medical earlier than planned.

Across Greatbatch, gross RD&E expenditures as a percentage of sales are in line with our expectations.

Selling, general and administrative expenses were in line with prior expectations and above the prior-year quarter largely due to our increased sales and marketing investments, partially offset by our cost savings in connection with our operating unit realignment in the second half of 2013.

Other items explaining the 0.1 adjusted EPS improvements include interest expense, which was lower in the quarter, generating $0.04 adjusted EPS accretion due to reduced debt levels and favorable interest rates. Our outstanding debt is now $195 million, which results in a 1.5 leverage to adjusted EBITDA ratio.

A lower effective adjusted tax rate in the quarter of 34.2% versus 35.3% first quarter 2013. This accounted for $0.01 improvement to adjusted EPS. Offsetting the interest expense and tax rate favorability was the impact of the continued increase in diluted shares outstanding due to our stock-based compensation programs and the increase in our stock price. In the quarter we have a $0.03 unfavorable impact. We expect our adjusted effective tax rate and interest expense for the remainder of the year will be in line with the first quarter 2014.

Now I would like to provide some comments on our operating cash flows. Cash flows generated from operating activities totalled $7 million during the quarter. Net income and improved working capital were the main drivers. Higher raw material consumption drove the inventory improvement, offset partially by higher finished goods supporting customer orders.

We ended with the inventory days at 92, a 16-day improvement when compared with the same period last year. We were very pleased with our supply chain efforts to improve our inventory performance and contribute to our expanding ROIC.

Customer collection activity showed continued improvements, and the increase in receivables are in line with sales.

Our return on invested capital improved 80 basis points when compared with prior year and resulted in an 8.3% in performance.

Turning to our 2014 outlook, we believe we will be at the upper end of our 2014 revenue and adjusted EPS guidance ranges shown on Slide 16.

With that, let me now turn the call back over to the moderator to take questions.

Thank you.

(Operator Instructions)

Matthew Mishan, KeyBanc.

Okay, it looks like Matthew has withdrawn their question.

Charles Haff, Craig-Hallum.

Hi, great quarter. Thanks for taking my questions.

Hey, Charles. Thanks.

Hi. So just a couple housekeeping here. CapEx, did you mention what that was, Mike?

No, I didn't, and offhand I don't remember the exact number, so I'll post that out on the site. But it was in line with our expectations that we have for the total year.

Okay. Thanks.

But I'll get you that number.

Okay. Thanks. And any update, Tom, on the 100-day meeting on Algostim with the FDA? Any updates there?

I won't give any specific update, just that the 100-day meeting event passed. We're still on our timeline as originally stated, and I'm just going to reconfirm our timeline. So you can surmise from that that we've -- we're advancing on schedule.

Okay. Great. Thank you. And one more question and I'll jump back in the queue here. Putting aside the easy comparisons on revenue, historically your first quarter on a dollar basis has been lower than your fourth quarter by most business lines, and this quarter you were up in the first quarter in multiple areas versus the 4Q. Would you say that we've kind of reached a new reset point? I know that you've worked hard to kind of get to this point. Should we kind of view this as a new normal for you guys with advancing sequential growth in 1Q versus 4Q, or how should you -- how would you kind of characterize that?

Charles, great question. As much as I'd like to think that we could smooth out the austerities quarter to quarter we still think that on a rolling 12-month basis is kind of the way to look at what we do in terms of growth. But your point is fair. As we've become a much larger organization and have many more product lines, many more customers, and with each customer many more systems and components, it has certainly smoothed out our variability quarter to quarter.

So as we have implemented the 5% and 2X leverage philosophy and have made investments in sales and marketing, it is definitely raising the quarterly run rates on a regular basis. And we expect to maintain that trajectory going forward, and that's obviously why we've provided the guidance we have for the year, and we're confident that a good start in Q1 is the best way to make the targets that we've laid out for ourselves.

And can you just remind us in terms of new CRM products and neuromodulation products, how long is the sales cycle usually for those products that you manufacture for the large OEMs?

It can range -- I'll say a new product is typically 24 to 36 months from the original development to production. A new technology would actually be 48 to 60 months, because you would have to do several years of technology development and then usually 2 to 3 years of product development. So, as I've said many times before, the trends that we see in cardiac rhythm management and neuromodulation are reflective of successes that have occurred over the last three-plus years, and that is hard work that we've won.

And, just as a reminder, when we win a sale with a customer, we kick off R&D spending for that three- to five-year period before we actually get revenue. So the revenues we're enjoying now are due to R&D expenses we've incurred over the last 36-plus months.

Great. Nice work, guys, thanks.

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

Glenn, this is Betsy, do you have a question?

Can you hear me okay?

Glenn?

Hi, this is Julia Kufman calling in for Glenn. Can you guys hear me okay?

Yes, we can. Please ask your question.

Okay, great. So I wanted to see if you could speak to some of the underlying trends in CRM and orthopaedics this quarter and in terms of what drivers we can think about as we think about the quarterly cadence for the remainder of the year, because I see a little bit of deceleration in the back half, and just in terms of modeling it.

Yes, I'll talk to CRM first, Julia, is we're obviously a very large player with all five cardiac rhythm management companies and we have long-term agreements with each of them for our multiple product lines. We also report, obviously, neuromodulation sales in with CRM. They're similar component technologies. And we're also widely represented in neurostimulation customers from the big players all the way to smaller companies.

When you look at the trends in cardiac rhythm management, the market clearly has stabilized. It's -- in our opinion is recovering. Our biggest wins in cardiac rhythm management really relate to new technologies and new products that we won customers in CRM and neuromodulation.

So from a standpoint of putting ourselves in a position where we can grow with the customers it's to win projects with them, to develop those technologies. And whatever the market growth rate would be, we would take advantage of that market growth rate to the best we can.

But if the trajectory on cardiac rhythm management is slightly negative, I think the position we would take is that we still can grow the category through technology introduction for us. In addition, beyond technology introduction we can win outsourcing of the OEMs' business from their products and manufacture to us, and we've capitalized on each of those three categories: market share growth as CRM has stabilized, new product wins as they convert to our technology, and getting them to outsource their product lines to us that they make internally. And I believe that trend will continue, and we will focus on winning in each of those three categories.

So, while I see CRM market stabilizing for us, I think there's other ways for us to grow beyond just the market contribution even though we're a large player.

On orthopaedics, completely different market. We're a very small player in a very enormous market. And while in general orthopaedic end-market growth for our customers is definitely more favorable today, in the mid-single digit range, which definitely feeds us growth, we have ample opportunity to win new business with orthopaedic customers that we either historically have done no business with or convert product lines that they have outsourced to other third-party competitors in orthopaedic supply chain.

And that's how we're growing at the 20%-plus in -- while we're not immune from the market growth, we certainly like to see the ortho markets healthy, there's other avenues for us to grow there to -- for us to grow much faster than the underlying markets. Hopefully that helps answer your questions, Julia.

Yes, yes, that's good. And on Algostim, was there any sort of progress in finding a commercial partner?

Our commercial partner perspective is we continue to eclipse the milestones in a lot of the heavy lifting in terms of product design in the regulatory process. The partner discussions have definitely heated up. And I would expect that as we approach the CE Marking and the PMA approval they'll probably create a sense of urgency around it.

We're playing our hand very carefully and coolly and intend to do so as we move forward. And as that process reaches more significant milestones we will announce them. So it's still active, along with the regulatory approval process of the project, and we anticipate making other announcements during the course of the year, but nothing new to report right now that we'd feel comfortable sharing.

Okay, great. Congratulations on a good quarter.

(Operator Instructions)

Matt Mishan, KeyBanc.

Hey, congratulations on a great quarter, and thank you for taking my questions.

You're welcome, Matt.

And I apologize, I got knocked off the call, and if these are repeats, just let me know. Can you talk a little bit about the margins, especially at Greatbatch Medical? You guys have had tremendous revenue growth over the last several quarters, but it hasn't necessarily translated through on the margin side. Can you talk a little bit about what's holding that back?

I think from Greatbatch Medical we still continue to have very nice leverage into the business, and we're still committing to 2X our revenue growth in margin expansion. We are, to maintain our revenue growth trajectory, still investing heavily in R&D and sales and marketing, and obviously as we do meet our targets it does drag our compensation expenses, which are variable based on performance, into consideration, as well.

So, while we're -- I don't want to say ever as a CEO and a CFO from Mike Dinkins that we're satisfied with our leverage, but we're confident in our ability to do the 2X leverage argument without creating our research and development or sales and marketing expenses, and, generally, Matt, that's the careful balance here is investing at the same time as we're growing to maintain that revenue growth trajectory and then maintaining the balance on margin expansion at the 2X leverage.

So we feel we've got the right balance right now. We've got the year kicked off the way we want it. And we don't feel that prematurely taking too much profitability in advance is the right thing to do because it'll hurt our revenue growth process back as we get out into the end of the year, 2015 time frame.

Okay, great. And then just on your guidance, I know you said you're going to be towards the upper end, but how do I get from the first quarter growth, which is in the mid- to high teens, to kind of 5% to 6% for the full year?

I think that if you take out the first quarter and look at the balance of the year, that will still give us an overall growth in the 2%, 3%, 4% kind of range, and to get to the high end of the guidance. And last year, second half of the year, you remember fourth quarter of 2013 we had 13% organic growth. So we do have tougher comparables to compare against in the latter half of the year.

As Tom indicated, when we looked at our first quarter number we were partnered with companies that were doing some new product introductions, and we know that when those introductions are coming into the marketplace, although we can't say with certainty, we think some of our customers have then increased their inventory levels in the first quarter, keeping in mind that our first quarter doesn't cut off exactly with the same timing of our large customers. So when they order, could be -- we think favorably impact us into Q1.

So all of those factors allows us to say at this time we think we're at the upper end, but obviously we will continue to try to outperform that and try to do better than that.

And portable medical, can you just expand on your strategy in that group and maybe elaborate a little bit about your exposure in the single-use batteries versus kind of the rechargeable battery assembly?

Certainly. So in portable medical our strategy in entering this market was to move our external battery product lines away from just energy/military/environmental to medical applications, since all implantable medical devices in some way, shape or form are associated with an external medical device, which we call portable medical. Be it a power drill, be it an AD, a unit that would program a pacemaker or a defibrillator, they all require some external device that needs power and power management.

We entered that market through product development as well as several acquisitions. And our strategy is to provide those power solutions that either obviously out of Greatbatch Medical to go in the body with implantable batteries or in portable medical product line for Greatbatch Medical would be the external devices. The regulatory and manufacturing processes are very similar, and the types of compliance, etc. programs that are required are similar, although the technologies that underlie them are very different.

One of the things we did post-acquisition integration for the companies that we acquired is we rationalized out the product line and found several products that we made at very low margins, which is why we rationalized those out, which is why it's not growing. But I can say from a product development standpoint there's more active products in product development for portable medical than any other area of the Company due to the size and the scope of that market opportunity.

So we expect as we've rationalized out the poor-margin revenues that we did not want to perpetuate that we're going to continue to win new business at -- and a quality new business that's going to result in that being a double-digit grower for us over the longer run. And we view that as a critical market for us.

That portable medical power, as it associates with implantable power, is a very important market for us to be represented in, given that systems like our Algostim platform that we're commercializing has five portable medical devices that all require power that we're designing those power management and applications for. And it's a technology we have to have to be successful in the longer run.

Great. And then last question for me on CardiomoniX, I know in your JPMorgan presentation back in early January you were thinking you would submit that for approval maybe in the back half of 2014. Is that still on plan? And are you also working with JPMorgan on CardiomoniX?

We only are working with JPMorgan on Algostim. On CardiomoniX, our plans haven't changed with CardiomoniX. To date we're still in active discussions with partners determining what we're going to do with the project, and in the product development progress of the project is continuing forward as well.

Thank you, and a very good quarter.

(Operator Instructions)

Gregory Macosko, Montrose Advisors.

Yes, thank you. Just one question with regard to the discussion of the final three quarters of growth for 2014. You -- is there any -- can you give us any color or differences between the different product lines, CRM versus ortho? I mean, ortho I sense is going to be stronger, CRM perhaps weaker, and portable, etc. Can you give us any sense there?

Certainly, Greg. Thanks for the question. As I would expect that ortho continues on a strong pace and I expect that vascular continues on a strong pace.

I believe that cardiac rhythm management and neuromodulation will return to its smooth, average quarterly performance as consistent with our guidance that we provided for the year. That tends to be because it's a few customers with large order quantities. It's best to look to the smooth data. So our expectations would be -- fall back into that trend.

I think for portable medical there's two ways to look at this. It's the actual data that we have, but we tend to look at the performance of the business, backing out the business that we harvested, and if we back out the business that we harvested we continue to look at portable medical very healthy grower throughout the course of the year. It will, of course, be winning deals and designing them, but it will not be really achieving revenue out of them in earnest until 2015. So it'll be building in its growth rate over the course of 2013.

So as we look forward we still think we're going to post some nice growth for the year. We've got obviously a healthy start. We're clearly giving an indication by moving to the high end of our guidance ranges -- we're not ready to change guidance yet -- that we're bullish on the year. And, as Mike said, as being aggressive operators we're going to continue to run the business to outperform what milestones and targets we have in front of us and try to outperform the guidance we've put forward on the Street.

Good. Thank you.

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

Thank you, Brittney.

I would like to remind you that both the audio portion of the call as well as the visual slides will be archived on our website at www.greatbatch.com and will also be accessible for the next 30 days.

Thank you, everyone, for joining. We appreciate your questions, and talk to you next time.

Thank you for your participation. That concludes today's conference. You may now disconnect. Have a wonderful day.