Integer Holdings Corporation (ITGR) Q2 2012 Earnings Report, Transcript and Summary

Welcome everyone to the Second Quarter 2012 Greatbatch, Inc. Conference Call. Before we begin, I would like to read the Safe Harbor statement. This presentation and our press release contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and involve a number of risks and uncertainties. These risks and uncertainties are described in the company's annual report on the Form 10-K. The statements are based upon Greatbatch, Incorporated current expectations and actual results could differ materially from those stated or implied. The company assumes no obligation to update its 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 now like to turn the call over to today's host, Vice President of Finance and Treasurer, Marco Benedetti. Please go ahead.

Hello, everyone, and thank you for joining us today for our 2012 second quarter earnings call. With us on the call are Thomas J. Hook, President and Chief Executive Officer; and Michael Dinkins, Senior Vice President and Chief Financial Officer. In terms of today's agenda, Tom will start us off with a few brief comments regarding our second quarter results and will then provide an overview of our strategic focus going forward. After that, Mike will review our second quarter financial results and guidance for 2012. 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 now turn the call over to Tom Hook.

Thank you, Marco, and 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 second quarter, which as expect, improved in comparison to the sequential first quarter. This improvement was primarily due to our increased sales, which are being driven by stronger-than-expected growth from our cardiac rhythm management and portable medical markets and 16% growth from our Vascular Access product line, which benefited from the commercialization of our medical device pipeline. In comparison to the second quarter 2011, sales increased 14% to a record $166.5 million. This increase was primarily a result of our acquisition of Micro Power Electronics in December of last year, which added $21.3 million to sales. On an organic constant currency basis, sales for the second quarter increased 1% as our cardiac rhythm management, Vascular Access and portable medical sales growth was partially offset by weakness in our orthopedics product line. Despite the increased sales level, adjusted operating income for the quarter increased only 1% in comparison to the prior year as our higher gross profit was offset by continued operational issues in our Switzerland orthopedic operations and increased investment in our medical device strategy. We are aggressively addressing these operational issues. As indicated in our earnings release today, we expect to see operating income improvements as the year progresses, which will come from the consolidation of our orthopedic operations and optimization of our R&D investment as well from various other measures we have initiated to manage our cost structure. Despite these efforts, we are now expecting that our full-year 2012 adjusted operating income percentage and adjusted diluted earnings per share will be at the lower end of the guidance we provided. Importantly, we are reaffirming our top line guidance…

Thanks, Tom, and good afternoon, everyone. I am very pleased to be on the call today with you to review our results for the second quarter. I also look forward to meeting many of you in my new role as CFO. In a change from prior practice, I would like to provide some color commentary on our financial results to help everyone understand how we view our second performance and updated 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. Here are the key points we would like you to consider about the quarter. Our CRM and portable medical product lines are performing ahead of our expectations. When combined with our strong Vascular Access growth, we are on track to achieve our full-year revenue guidance. Our orthopedic product line is weighing down our operating performance but it is aggressively being addressed. The increase in our other operating expense reflects the multiple consolidation, productivity and optimization initiatives we have in place and will generate future benefits. During the quarter, we made strategic decisions in order to fully optimize our R&D efforts, which will be focused on fewer projects going forward. And finally, our cash flows from operations remains strong and provides the funding we need to execute on all of our strategic objectives. I would like to provide further details on each of these key points. First beginning with CRM, in comparison to the second quarter of last year, CRM and neuromodulation sales increased 3%. This growth consisted of various increases and decreases within that product line that in general can be attributed to our higher level of customer product launches in comparison to last year. These results are much improved…

[Operator Instructions] Your first question comes from the line of Brooks West.

Tom, I wanted to start with CRM, definitely some upside there versus our model and, as you said, ahead of your expectations. Given the contractual nature of that business, I'm curious where you saw the upside and do you think the upside is sustainable certainly going forward into the rest of the year?

A lot of that business we do have locked in, in the CRM side. Those contracts are somewhat variable in nature in that as we have spent years consolidating our operations and signing those agreements, we've won new product lines with customers and as they're in the mode of launching those new product technologies, their component sets that we have won with those are richer than some of the legacies, both in terms of technology as well as in terms of share. So as we transition or as they move to those product lines or those product variations, then it gives us an upside opportunity to both sell from a technology standpoint as well as from a mix standpoint a higher set of products. Obviously there's differences between OEMs, but there's also, more importantly, differences between the product platforms that they have and our content in them in terms of technology. And of course, more recent versions of technology you have better pull through for us. So as a -- from a CRM side, as well, we're still predictive that CRM is going to be a tough market and it's going to have some level of dynamics with it from a unit basis, you can look at the volumes. They're stabilizing across the market. We're anticipating obviously looking at the other OEM's announce results, but when we look over the course in the first half and the second half of the year, we see that we still can have low single digit growth in that business as a company from the wins that we've had historically.

Our next question comes from the line of Glenn Novarro.

Tom, I was hoping if you could provide a little bit more detail on the orthopedic issues. And then as a follow-up, it seems like you are maintaining your current client base but you're not able to win new business and new contracts. So does that mean revenues should stay kind of where they are for the next couple of quarters? Or is there a risk that your current -- you lose business from the current base today? And then I had a follow-up on Algostim.

Sure. We'll just look at the ortho first. As you know, of all the acquisitions that we've done in the company, we've been aggressively consolidating our operations and we have not consolidated our Swiss operations. And we studied this very carefully over the past several years as that business was transitioning from Susan Campbell to Mauricio Arellano and we reached the -- obviously the reality that running 3 smaller Swiss facilities is very costly. Certainly some of the European market turbulence has made the European market more challenging. Obviously in the results also is a significant FX factor which we obviously will provide some information and it's about $3 million that we try to normalize out. But at the end of the day, we know that operating from those smaller, less efficient facilities necessitates us making an operating decision to consolidate. So after a lot of evaluations of many different options, we purposefully made the decision to consolidate into the new facilities we have, which is obviously into Ft. Wayne and also into the Tijuana, Mexico facility to leverage the infrastructure we already have in place. That allows us to have a much more effective overhead structure and cost structure that will improve both the gross margins as well as ultimate operating contribution for them. I think where we stand from a client base, I think we are very good at these transfers. We feel very confident we can hold the client base. I also feel better going forward that because we'll have a better cost structure and we can be more competitive, we'll be able to do a better job at winning new business and that's really where we see a lot of our strategy has been built on investing to win new business. And when our cost structure…

So I think you're saying the transition to Ft. Wayne is 12 to 18 months. So is it going to take 12 to 18 months before orthopedic revenues start to improve or can you get that sooner?

Drawing FX out to the side is that I feel we still can still have a positive trajectory on orthopedics moving forward, but we're going to have to get that positive trajectory out of our U.S. operations where we're going to be more competitive. And because of the nature of transitioning our Swiss operation, it's going to be tougher to grow that base. We're going to be most cost reducing that base as we move it to the U.S. Additionally obviously, as you know, we have our implant facility in Chaumont, France, which is not moving and already is consolidated. We've already made significant investments there. And that's an operation where we still feel we can bring on new customers as well and get some organic growth out of that as well. So I do feel in the U.S. and in France -- in our French operations, in particular, we're positioned to grow. What we have to do is shake the negative effect that the Swiss operations are having on us right now. It's obviously flat growth from the Swiss operations on the instrument side, and it's really negative profit contribution because we're in a very extensive cost structure and we've got to rationalize it out quickly. Hopefully that answers your question, Glenn.

[Operator Instructions] Your next question comes from the line of Charles Croson.

One quick question on guidance here and I think you kind of highlighted it but maybe a little more granular. Lowering the guidance for ortho, that makes sense in terms of the revenue but looking at a higher CRM, why are you now expecting EPS to be on the lower end of guidance, I should say adjusted EPS?

Primarily because of the first half performance that's already behind us and also during the transition period, not expecting a material improvement in the Swiss operations, the contribution to the bottom line we do believe will be better than the first half but not materially different back to where it was last year. Those 2 factors are already built into our numbers, cause us to be conservative on our guidance and say that we are targeting -- we're communicating towards a lower end. However, we as a management team are undertaking numerous actions and are not satisfied with being at the lower end of that guidance. And we hope that we can update you at the end of the third quarter with something better than that. So I do not want to send the message that that is something that we're happy with and not trying to take some additional actions to improve upon.

Our next question comes from the line of Bruce Jackson.

With regard to your strengths in CRM, your customers have just come through some pretty major new product launches. So what gives you the confidence that you're going to be able to maintain that sales trajectory for the rest of the year?

I think the better way to look at it is not so much your trajectory, Bruce, but it's as we come through those product launches it kind of becomes the normalized level. So when you kind of look at how we're going forward, I think we've done a lot of transition on these new product launches. We have a very disciplined supply chain with the OEMs. They can have quarter-to-quarter variations based on the sales we have to them from a -- because we transfer to them large dollar amounts at any one time. But I would not refer to it so much as a ramp as I would that we've achieved through years of product development wins with them a higher level of mix on those products and that is, in turn, putting us on a standpoint where on a comparison basis we have higher levels of sales than we did in the prior year. So I don't want anybody to walk away with the impression that we're accelerating growth in CRM. It's low single digit in comparison to last year. It's much more favorable than we had though it would be. We were planning for a very flat year. And just since the execution of the research and development teams to win these projects and the customers commercializing them that have got this. And as a comparison, we're comparing those levels of sales to last year but it's I'd say favorable. But it's certainly not a trend up.

[Operator Instructions] Your next question comes from the line of Charles Haff.

Two questions that I had; first, you mentioned in the press release that you were increasing strategic focus on sales and marketing to drive core business growth. I wondered if you could kind of elaborate on that. And then my second question is regarding the 10 discrete OEM projects that you're working on in the QIG group, should we expect any launches in the second half of the year?

Is the -- from a strat focus standpoint is I think -- I've been at Greatbatch 8 years and I'm being very objective. I think we've done a very good job from a manufacturing standpoint, manufacturing consolidation, manufacturing investment. We've also done a very good job in terms of R&D rationalization, establishing innovation engines and having those innovation engines work at a very efficient basis with manufacturing. An area that we have not done well on and has not received much investment and focus in the company has been our sales and marketing investments, how we interface and work with customers. Clearly we have had many successes in areas like how we grow the management and signing long-term agreements. But our level of market understanding, market knowledge and how we work with OEMs, whether it be contractually or through partnerships, we have a lot of room for improvement. And I think in areas like the medical device area as well as in areas like orthopedics, we have not had the focus and hence not the success that we should be achieving. In areas where we have put this focus in sales and marketing -- and I'll highlight Electrochem here, both in the energy markets as well as in portable medical, we've had great results come out of those investments. So building off the success of the investments in sales and marketing we've had on Electrochem, we're implementing that type of approach in Greatbatch medical now where we're going to be able to partner with our customers better, be more sensitive and timely to their technical needs as well as their cost targets, be more timely and to be able to, just like we've developed our manufacturing capabilities and our research development capabilities, we're going to also develop our sales and…

Our next question comes from the line of Bruce Jackson.

If we could go back to the Algostim design verification process, exactly what does that entail and why has it slipped? Is it a personnel issue? Is it a design issue, maybe a little bit more color on that particular topic?

Yes, I think I'd best classified it as a testing issue, Bruce, is that we've been surprised -- pleasantly surprised at the level of interest that the investor day last year has created in Algostim. We have multiple OEMs that have engaged us in terms of learning more about the system, which we've been very careful at sharing information with but certainly have engaged in discussions with regards to the commercialization of the product. But since we're in a very delicate stage of securing intellectual property and completing that design verification testing, we're being very selective in terms of the amount of information we provide while we're protecting the investment that we have. The process itself of doing design verification testing, we've laid out a very comprehensive testing program and is, I think, based on the components that have finished design verification testing as well as the portions of the systems, I mean, the system is really a collection of multiple devices. Some of those devices have completed the DDT testing. Some have yet to be completed. We made the decision based on the test data that we've seen to date as well as our customer interfaces and interactions given that we're going to commercialize these via partnership, that we're going to expand the scope of the DDT testing on certain device pieces within that Algostim system. And that is going to give us obviously a little bit more testing expense. It won't necessarily increase the ultimate overall testing cost and product cost of Algostim, but it is going to extent out the submission timeline. Obviously it's our first major product platform. We are being very risk averse and very thorough on the testing plan and being extremely conservative on the interpretation of all the test results which are very comprehensive. We know that going forward in the future that we may have design verification testing processes that we could be more selective. But I'd say for our first system through, we are being err on the side of having a lot more testing than is required and much more testing than we originally had planned. And we feel that's the more prudent thing to do for our first project and that process decision in terms of design verification testing is what's creating the delay.

Our next question comes from the line of Anu Metta [ph].

It's Justin Seriorni [ph] at Tameracq [ph]. I missed your complete medical device sales that you guys reported this quarter within the vascular segment.

We are not -- like I said, we're kind of were on the path last year because we were just starting of just getting our medical device sales on a quarterly basis. Now we've just provided kind of our general guidance of $10 million to $15 million for the year. We're not going to report it on a quarterly basis, quarter-to-quarter. But on a -- we're still confident that we're going to be in that $10 million to $15 million range for 2012 and we're managing the business to that. Obviously some of it's launch dependent. But our approach is going to be as to -- so we don't have to report this kind of every quarter, we're just going to start having it -- providing the guidance with a consistent with what we're doing on a yearly basis.

One follow-up question as it relates to the consolidation costs. You guys expect $20 million to $30 million this year between cash and non-cash charges. Should we be expecting these actions with the consolidations to continue into 2013 with extra costs on top of that as well?

Well, I'd say that the nature of these products is that they will spill from 2012 to 2013. But it is -- the decisions we've made on the consolidation products are made, the scopes are captured within the programs that we have reviewed and particularly big one of the Swiss consolidation and some of the product line transfers that we're making down to our Tijuana facility. But the scope of those has already captured but spending will definitely -- and the expense that we recognize will be part 2012, part 2013, but 2013 is the full scope of those projects. It does not extend beyond 2013.

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

Thank you, everyone. I would like to remind you that both the audio portion of this call and the slide visuals will be archived on our website at greatbatch.com and will be accessible for 30 days. Thank you, everyone, for joining us.

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