Integer Holdings Corporation (ITGR) Q3 2012 Earnings Report, Transcript and Summary

Welcome everyone to the Third Quarter 2012 Greatbatch Incorporated 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 it 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 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.

Hello, everyone, and thank you for joining us today for our 2012 third 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 third quarter results, and will then provide an overview of our strategic focus going forward. After that, Michael will review our third 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 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, which was a strong quarter for us. During the quarter, we were able to achieve 8% organic constant currency revenue growth by exceeding market growth rates in our cardiac rhythm management and vascular access product lines. Also, cardiac rhythm management comparables were easier versus the prior year. Overall, revenue increased 22% in comparison to the prior year, reflecting the successful acquisition of Micro Power, which continues to perform ahead of our expectations. This increased revenue, the initiatives we began to implement in the second quarter to leverage our operating infrastructure and the optimization of our research and development investments, allowed us to achieve 27% adjusted operating income growth. However, a lot of hard work remains in order to attain our financial targets for the year and to achieve our strategic objectives. Near the top of our priority list is the completion of our consolidation and productivity initiatives, and in particular our Swiss orthopedic consolidation initiative. These initiatives continue to impact our GAAP financial performance and resulted in negative GAAP earnings for the quarter, given the charges taken. As a result of the progress we have made, we increased our estimate for the amount of non-GAAP adjustments we expect for 2012. It is important to note that while we are increasing the 2012 estimate for these costs, our estimate for the overall cost to complete our consolidation initiative remains unchanged, and the impact to our operating cash flows will be significantly less than the charges taken. Even though these charges reduce our GAAP operating results in the near-term, these initiatives will increase operating leverage and profitability as we move forward…

Thanks, Tom. Good afternoon, everyone. I am very pleased to be on the call today and review with you the results in the third quarter. I would like to provide some color commentary on our financial results to help you understand how we view our third quarter performance and updated guidance. For more specific details regarding our financial results in the quarter, we refer you to our press release that we issued earlier today. With that, let's get started. Here are the key highlights about the quarter. CRM neuromodulation, 13% revenue growth, continued high growth portable medical business performance, aggressively addressing our Swiss orthopedic issues, prioritize our R&D investment along with ongoing productivity efforts. We are very aware of the large difference between our GAAP EPS and adjusted EPS, because of the expenses incurred for our numerous productivity and consolidation initiatives. We expect the difference between GAAP and adjusted EPS to be much smaller next year and to realize the productivity from our investments we are making this year. We are confirming our EPS guidance at the lower end of the range and are cautiously optimistic about the fourth quarter given the continued challenges surrounding key CRM players. And finally, our cash flow from operations remains strong and provides the funding we need to execute on all of our strategic objectives. I would now like to provide further details on some of these points. In comparison to the third quarter last year, CRM and neuromodulation sales increased 13%. This growth consisted of various increases and decreases within that product line but, in general, can be attributed to our customers having more level inventory ordering patterns in 2012 in comparison to 2011, as well as easier comparables versus the 2011 period. These results are ahead of our expectations and put us…

[Operator Instructions] And your first question is from the line of Bruce Jackson with Northland Capital Markets.

You mentioned in the press release that you had some new contracts in the quarter, new long-term contracts with some of your OEM suppliers. I was wondering which business units those benefit?

Bruce, thanks for the questions. We've actually been pretty successful with signing long-term agreements across each of the business units. We started this practice in Greatbatch Medical, really, 7, 8 years ago, and we've matured these along. In Electrochem, it's newer where we've been signing long-term agreements and we continued to mature that progress with the integration of Micro Power there as well. So the LTAs we've signed in 2012 have been within both business units, and we expect that that's going to continue to securitize the business on new products as well as the current products we manufacture, so it's a bit of both.

Okay. Then one other question on the CRM neuro business unit. The number there was quite strong. I was wondering if you could just give us a little bit more color on whether it was the CRM or the neurostim component that was driving the growth, and then just a little bit more color on what you are seeing in terms of the current quarter.

It certainly is. I'll let Mike chime in here, but in general our neurostim's product line revenues are very small still and we've been very successful at winning neurostim development agreements, which will start to build in terms of return and results in the 2013 to 2015 time range. But primarily the revenue growth for the quarter was really driven by cardiac rhythm management. We've done a good job over the last 3 plus years, which if you think and remind yourself, we completed our cardiac rhythm management consolidations in the 2008 timeframe, so we've been successful at partnering with OEMs over the past several years and winning projects for them and increasing our share with OEMs in terms of the discrete component technologies we have been selling. It's fair to say, we did have a weak comparable relative to Q3 2011 as well. We're not immune from the slowdown in the cardiac rhythm management markets. But because of the uptick of some of the technologies that we've been selling or winning of development contracts over the past several years with key OEM customers, we still feel confident we can grow above the market, growth rates entirely through the management and our results reflect that for Q3. And we expect that while the percentage, the upper single-digit numbers really aren't sustainable, we do expect that that trend of staying ahead of the market will continue in the current quarter we are in and we plan that also for 2013.

Your next question is from the line of Charles Haff with Craig-Hallum.

I apologize, I had to be on another call, so I may have missed this, but Tom you mentioned that growing faster than the market in CRM. What's your expectation for market growth in the next few periods?

Well, as you know, I over the last several years have been fairly pessimistic about CRM market growth and we have really geared and planned the cardiac rhythm management business to be in synchronization with our customers, and expect their rather stabilization of those markets here over 2012 that it's going to be kind of continuing challenging market dynamics and do for the rest of the year into 2013. So we are not really expecting what I would call growth in the CRM markets, but more stability and relative flatness. But through the partnering initiatives and the development agreements that we have, we think we can have a low single-digit growth rate because of the success we are having there, so we're just as eager to see the results from the OEMs and have been tracking those as they've been reported, as you have and, obviously, monitoring our progress on a share basis with regards to their initiatives and technologies that they are launching. And we know we have got a favorable trend, but we don't expect CRM to ignite into a fast-growing opportunity for us. It's an area where we plan to have progressive growth based on hard one innovation projects and we expect the market to continue to be challenging.

Sure. Then you made a comment about the easier year-over-year comps helped a little bit here, if I heard you right, but it's a pretty similar comp to what you had last quarter. However, this quarter's growth in CRM was dramatically higher than last quarter and I think you had mentioned in the press release about the inventory adjustments, and I apologize if you gave more color earlier in the call, but can you just kind of share with us a little bit more color, which is what led to the big delta since your comps were pretty similar to last quarter?

I'll let Mike answer this one.

Generally speaking, there is a little bit of seasonality to that, so generally in the third quarter last year you should have seen a bump in the third quarter that did not happen. So, even though the comps are flat, in the $70 million range, this year we saw a more general pattern where the third quarter is higher than the second quarter. So, that's the reason why we say it's a leveling of the orders that we get from our CRM customers. They really didn't buy more than this year. They just bought on a pattern more consistent with what we've seen in the past.

I got you, so last year each quarter was kind of in that $77.5 million range, plus or minus $0.5 million, and so because that last quarter a year ago was weaker, you had an easier comp, you're saying.

Yes. That last quarter last year actually dipped down to $71 million, so it actually did go down.

Yes. Okay. I got you. Then last question. On the orthopedic side of the business, I think you mentioned on the last quarterly call that you're positioning with the Swiss facilities was causing you to miss out on some opportunities in ortho. Now that you're kind of moving through the integration and shifting business to Indiana, etcetera, have the business wins or the business development efforts started or restarted now or is it still a little too early for that in ortho?

Well, Charles, that's a great question. If you look at our orthopedic business, and we divide the business up into the pieces that we sell, half the business for us is implants, and we have done a very good job in the implant side of the business out of our Corgemont facility for 2012, and we have been winning and expanding that business quite nicely this year and plan to continue that into 2013 with similar momentum, so on that half of the business we have done very well. In the other half of the business, in our delivery systems or cases and trays business, we've consolidated that business into our newly refurbished Indiana facility and we have launched in 2012. We've added incremental sales and marketing efforts in that delivery systems product line and we've done a very nice job of winning new business and in ramping revenue there. It has mitigated some of the effect of the Swiss operating problems. So, that's a, 75%, really, of the orthopedic business, we've done a good job of getting onto winning programs with customers and expanding the business, and it's mitigated some of the effects on the instrument side of struggling with multiple operating locations, in particular, our Swiss locations. So, our expectations are as we complete the Swiss consolidation projects, we get the product lines fully into Fort Wayne and Tijuana, Mexico, we will be able to pick up more incremental business development wins on the instruments side of the business. In that area, right now, we are struggling obviously through the complexity of the consolidations and we are not winning what I would call our fair share, because we're preoccupied with our key OEM customers working on the transition plans. And our plan is for 2013, once we have the consolidations completed, is to pivot and start working on the new projects so that we can start ramping opportunities with them on that segment of our orthopedic business.

Okay. That's very helpful. Would that be more of a first half 2013 or a second half 2013 kind of event?

I think, what we are looking at for the consolidation on the orthopedic side is to move the project through over the course of 2013. Obviously, you know that we are aggressively moving on this, which is why we reflected some of these costs moving into 2012, so we are making some aggressive progress. My expectation is on the instrument side of the business, we'll be starting to pick up opportunities in the beginning of the year and then building momentum towards the end of 2013.

[Operator Instructions] Your next question is from the line of Mark Cooper with Pacific Ridge.

You mentioned cash flow from operations in the quarter was $16 million. Is that right?

That is correct.

Then what was the CapEx for the quarter?

Give me a second. Give me a second to calculate that for you. Then we'll come back as soon as I calculate -- I have a year-to-date number at $33.6 million, so I got to calculate the current quarter.

Well, that's fine. I can back into it from that.

So year-to-date is $33.6 million.

Your next question from the line of Stan Mann with Mann Family Investors.

First I want to congratulate you on rationalizing our R&D efforts. I think it was an extremely smart business move. Secondly, can we talk about the converts when they are due and how you plan to handle that on the balance sheet?

The convertible notes?

Yes. Converts. Yes.

Okay. I didn't understand what you said. They come due June of next year and our intention is to retire them by using the availability that we have on our revolver.

Okay. In your plan or your vision, will that use up most of our capability of finance or liquidity?

No. It would not. It will still leave us well in excess of $100 million of liquidity and as we use the revolver, we've already entered into a forward contract to fix this so we don’t -- we're not 100% variable, so we'll still have liquidity left and we'll be somewhere in the range of 60% and 40% between variable and fixed, and we think we will still be in good position. Plus as we rebound on our EBITDA performance, it creates even greater liquidity for us to do deals, so unless we are doing some type of huge transformational deal, we'll have more than enough to support our acquisition next year.

Okay. Does this save us any cost of dividends on your converts that really can make a difference?

Did you say the cost of the dividends on the convert?

Yes. What we repay as interest. Is that going to be eliminated?

Well, the coupon rate that would pay down, that converts versus what we are going to be paying on the revolver, there's not much difference between that, maybe 20 basis points higher that we will be paying on the revolver versus the converts. The one thing that is impacting that is that we had used a method where, even though we were paying 2.75% or whatever the number is, on the converts, we were taking a higher percent of that because of equity transition that we thought would happen on our tax reductions. So we do have, in 2013, to repay back to the IRS since the converts did not happen in roughly about $30 million, but we've taken that into consideration on our cash flows and when I said we have enough liquidity to do deals.

Okay. Just staying on the convertibles, will that reduce our diluted or our share count at all once this is done?

No. It will not.

It will not? Okay. Next question, Tom…

Unless you guys raise the cash price of our stock real high real soon.

Tom, you alluded that we grew the Microchem or Electrochem acquisition has brought us great opportunities in portable electronic devices. At least that's what I hear. Is that correct?

That is correct, Stan. I think that Micro Power has done an extremely good job historically, building their portable medical business. We had started, over the last couple of years, in Electrochem to do that, but the Micro Power acquisition gave us the opportunity to combine the resources of our Electrochem initiatives and Micro Power. Susan Bratton and her team that run Electrochem, very quickly integrated the 2 businesses together, and they’ve picked up significant momentum in commercializing Micro Power's product development portfolio and they also won a significant amount of new contracts on new business that they brought into their deal funnel. So the win-win of the Micro Power deal was we've been able to leverage our operating efficiencies and resource space much more effectively than Micro Power could alone. It's accelerated the growth rate and it's an area that we intend to maintain our momentum into 2013 as it's been a really good targeted acquisition and we are ahead of our deal models for the current year and expect to be ahead of them next year as well.

Do you see opportunities to get bolt-on acquisitions in this electronic portable device area? Is there available bolt-ons?

I think there's 3 directions to go here, Stan. One is there's definitely opportunities to look for other similar portable medical product lines that could be of interest to us. We definitely are going to be adding sales and marketing resources and engineering resources to perform on all the customer wins that we are getting and to also grow the business, because it's fertile territory and the market is maturing aggressively due to the mobility aspect that is being driven into medical devices, especially for patient care outside of hospital settings. Also in the surgical suites with powered surgical instruments, so we both organically feel confident we can grow. We also feel that that there's targeted deals out there that could open up other product lines or geographies. And the third piece is that the more we built our capabilities as a company, we can do more work for our strategic OEMs on these portable medical devices to include not just batteries but battery packs, charging systems, electronics and power management and actually some of the actual integration of the product itself and potentially even we could move up towards product sub-assembly stages. All of those are revenue opportunities for us. And of course, when you're performing for your customers and they're happy, they open up more opportunities and that allows us to build the business quicker. So it's an area that we are going to put significant resources into all three of those buckets going forward and have already done that. That's an area where we think that we can significantly have opportunities for growth as a company.

Can you frame for us just approximately your vision on the size of that market opportunity relative to where we are now? It seems to be bigger than the CRM area that we have in Europe. Can you give us a feel? It sounds like it's a large growing market.

Sure. I think if you look at it today, Stan, and drew what I would call tight brackets around it, in other words, battery power, power management of portable medical devices for high value applications, defibrillation, AEDs, surgical instruments. Now you are looking at around slightly less than a $0.5 billion market. Clearly, for us, we've got about an $80 million product line, so there's plenty of room for us to grow. If you draw broader brackets around the market and you include device subassembly and then other product lines that are more mid-value segments, powered carts, etcetera, there you are talking a multibillion dollar market, much higher volumes, more standardization. So there's multiple avenues for us to grow here in this market and this obviously used to be a $5 million to $10 million product line for us, so we've taken a significant jump with the Micro Power deal and we expect to grow very aggressively organically next year and also look for potential on the moving up the food chain from a technology standpoint, and also potentially looking at targeted deals in the space, too.

So, if this is like the striker, power…

It could be. We don't disclose specific deals as you know, but any powered surgical instrument from general surgery to orthopedics or anything, it's the de-cluttering of the OR from a power cord perspective. And, some of these instruments exist today, but there's a lot more instruments that do not exist that are on the drawing board. They all need effective power solutions that are reliable, sterilizable, autoclavable, so we've got a lot of unique technologies that we've developed. Clearly, quality and reliability, FDA registration, ISO 1345, are all pivotal requirements in this space, so we are very well positioned and we are going to take advantage of that.

Just last part of it. You in the CRM area dominate that market segment on the stuff you do with the largest players, Medtronic, St. Jude, Boston Scientific. In this area, are you among the top -– or are you a major supplier to the major medical device companies or powered instruments?

I think the answer to that, Stan, is yes, but there is significant gaps in our customer product matrix. And just like we do in Greatbatch Medical, we map out where we have design wins with current customers and we work hard to get "designed in" to their new applications, so the approach in our portable medical product lines is the same. It's just that the opportunities in portable medical are much greater because we are starting from a smaller base, but we are still a very significant if not the most significant player in the portable medical market, but there's just a lot more room to grow organically, inorganically and through technology. The other important thing to note is while CRM market is not growing, it's stable, but it's flat growth. The portable medical market is growing. As a market, there is a lot of work in this area. OEMs are putting a significant amount of attention and resources and innovation attention on this. So for us the timing is good for us to innovate and partner with them and take advantage of that market and the application growth.

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

Thank you. 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. This concludes today's conference call.