Integer Holdings Corporation (NYSE:ITGR) Q4 2022 Earnings Call Transcript

Integer Holdings Corporation (NYSE:ITGR) Q4 2022 Earnings Call Transcript February 18, 2023

Operator: Hello, everyone, and welcome to the Integer Holdings Corporation’s Fourth Quarter 2022 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. At this time, I would like to hand the conference over to Mr. Tony Borowicz, Senior Vice President of Investor Relations. Please go ahead, sir.

Tony Borowicz: Good morning, everyone. Thank you for joining us, and welcome to Integer’s fourth quarter and full year 2022 earnings conference call. With me today are Joe Dziedzic, President and Chief Executive Officer; and Jason Garland, Executive Vice President and Chief Financial Officer. Also joining us on the call is Andrew Senn, Senior Vice President, Strategy and Business Development. Andrew will be adding the title of Investor Relations when I retire at the end of this month. As a reminder, the results and data we discuss today reflect the consolidated results of Integer for the periods indicated. During our call, we will discuss some non-GAAP financial measures. For a reconciliation of these non-GAAP financial measures, please refer to the appendix of today’s presentation, today’s earnings press release, and the trending schedules, which are available on our website at integer.net.

Please note that today’s presentation includes forward-looking statements. Please refer to the company’s SEC filings for a discussion of the risk factors that could cause our actual results to differ materially. On today’s call, Joe will provide his opening comments and an update on the execution of Integer’s strategy. Jason will then review our adjusted financial results for the fourth quarter and full year 2022 and provide our full year 2023 guidance. Joe will come back on to provide his closing remarks, and then we’ll open up the call for your questions. With that, I’ll turn the call over to Joe.

Joe Dziedzic: Thank you, Tony. And as you bring your 21-year career at Integer to a close at the end of this month, I would like to take a moment to recognize your significant contributions to Integer. On behalf of all Integer associates, including our Board of Directors, and I’m confident many investors, we thank you for your leadership in helping to shape the company we have today and wish you the best as you enter the next phase of your journey. After this earnings call, Tony will officially pass the Investor Relations responsibilities to Andrew Senn, who has been leading our corporate development and business strategy for the last year. Integer had a strong finish to 2022 with double-digit sales growth across all product lines in the fourth quarter.

We ended the year with fourth quarter sales up 19% and full-year sales up 13%. In the fourth quarter, we also delivered a 30% improvement in adjusted operating income and a 25% improvement in adjusted EBITDA. Earlier this month, we strategically replaced about half of our variable rate debt with a 2% and 8% fixed coupon convertible bond. This transaction delivers significant interest cost savings and repositions our debt to approximately 60% fixed, and 40% variable. Our 2023 sales outlook is what we believe to be an above-market 7% to 9% organic growth rate. We expect adjusted operating income to grow faster than sales at 10% to 16%. At the midpoint of our guidance, we are expanding adjusted operating income margins by about 70 basis points.

We believe this will be a strong performance in what remains a challenging supply chain environment. We have been executing our product line strategies to accelerate our top line growth and now expect to deliver sustained above-market growth. Our strong product development pipeline in high-growth markets, emerging customer product launches, successful tuck-in acquisitions and underlying strength of existing programs gives us confidence in this outlook. We believe 2023 is the beginning of sustained above-market sales growth for Integer. The Integer investment thesis summarizes why we believe Integer is executing a clear and compelling strategy to sustainably outperform. Our portfolio strategy and product line strategies define how we win in the markets we serve.

Our operational strategy defines how we achieve excellence in everything we do and our values define how we engage with each other. The bottom of the slide articulates the industry and Integer fundamentals that create a resilient business model the elements of our strategy to generate sales growth and the disciplined approach we’ve taken to develop a performance culture. Our financial objectives are clear and measurable. Everything we do in the company is anchored to this strategy, which is why we share it every quarter. So let’s look at some of the important milestones we have achieved in our strategy journey. The first two years of our strategy execution delivered margin expansion and the launch of each element of our strategy. The last three years have been challenging given the macro environment, but we are entering 2023 with a stronger portfolio and a pipeline of new product launches, expanding margins and an unmatched capabilities to serve our customers.

As our sales accelerate, we are investing in capacity to support this growth and to enable sustained above-market growth. We are pleased to report that the acquisitions of Oscor in December 2021 and Aran Biomedical in April 2022 are exceeding our deal models through higher sales and operational efficiencies. The following slides outline how we are accelerating sales growth to sustainably grow 200 basis points above the market. We developed our portfolio strategy in 2017 and formed the growth teams in 2018. These market-focused teams have executed a structured and disciplined approach across the organization to shift our pipeline to high-growth products and markets, expand our capabilities, and ensure our investments are aligned to our strategy.

These product line strategies have generated a strong product development pipeline that are delivering results and position us for sustained above-market growth. This structured and disciplined process has been and will continue to be critical to Integer achieving sustained outperformance. This slide illustrates where the C&V end markets are in their growth curve and how they compare in end market size on a relative basis. The curve represents the growth rate of the end market, which is slower during the emerging and mature phases of the technology maturity time line. Integer is uniquely positioned to serve our customers across all phases of the product life cycle because of our deep technology, breadth of capability and products, global manufacturing footprint and strategic focus.

The blue box represents the most significant near-term growth opportunities for both our customers and Integer, which demonstrates the strong alignment of our strategy with our customers. The products on the bottom of the slide highlight areas of continued investment in capabilities and capacity that we expect to deliver significant growth to Integer. This slide combines the Cardiac Rhythm Management & Neuromodulation end markets and demonstrates that there are growth opportunities beyond conventional CRM products and spinal cord stimulation within neuromodulation. Integer’s historically deep and differentiated component and subassembly technology that has positioned us so well in the large, but mature conventional CRM markets also positions us extremely well to serve our customers in the smaller emerging and growth CRM markets such as leadless pacing and cardiac monitoring.

The emerging and growth markets within neuromodulation have significantly more early-stage companies than the C&V or CRM markets because of the number of companies that are investing to develop therapies for currently unmet or underserved patient conditions. Integer is uniquely positioned to be able to bring full design, development, and high-volume manufacturing to these customers, while also vertically integrating the most technologically advanced components with our own intellectual property from decades of innovation. Very few other companies have the breadth of design and development capabilities and even fewer offer the depth of component technology that Integer offers to our neuromodulation customers. Integer is uniquely positioned to enable emerging companies to bring innovative therapies to market, which brings us to our third annual update on our emerging customers that we are enabling to bring their therapies to market.

We first presented this slide at our earnings call in the third quarter of 2020, and we provided an update on our fourth quarter 2021 conference call. We have been investing in this pipeline of PMA products for many years. and the advancement of these programs is a key leading indicator for accelerating our sales growth. We are proud to report that we have supported the launch of four PMA programs with emerging customers since 2020 and we have five additional programs in what we’ve defined as the product introduction phase. And our first update on these customers during our third quarter 2020 earnings call, we project that we would generate about $40 million in sales in 2022 from the product introduction and launched customers. We actually delivered about $50 million.

Last year, during our fourth quarter 2021 earnings call, we estimated that we would generate between $60 million and $80 million in 2024 sales from these emerging customers. We are now increasing that projection to between $80 million and $100 million. Our strong pipeline of emerging customers in this high-growth end market is a meaningful contributor to our sustained above-market growth. Integer partners with our customers to bring innovative medical technologies to market, and we are paid for this service throughout the development cycle. As these life-saving and life-enhancing products are introduced to the market, and then enter the manufacturing ramp phase, Integer benefits from accelerated sales growth. The amount of product development sales and the growth rate of the products being developed are leading indicators for sustained above-market sales growth.

Our product development sales have increased 230% since we launched our strategy in 2017, and we have added 62% more development resources. This means our pipeline of new programs has grown significantly and as evidence our customers view Integer as a partner of choice for innovative medical technologies. We have also strategically targeted product development opportunities in high-growth markets to accelerate our growth rate on a sustainable basis. 80% of our development sales are currently in high-growth markets with the remaining 20% in more mature markets. We believe the mix of 80% high-growth and 20% mature markets is the appropriate balance to accelerate our sales growth rate, while protecting our mature products for the benefits they deliver to our customers and Integer.

The development cycle in our industry is relatively long. So, it is a meaningful milestone for us to achieve the level of product development sales and program mix necessary to sustain above-market growth. In order to support sustained above-market growth, it is necessary to invest in manufacturing capability and capacity. As shown in the chart on the left side of the slide, we continue to allocate a higher percentage of our capital budget to equipment and facilities needed for growth. The right side of this slide highlights our facility footprint growth since 2018, which has primarily come from acquisitions. The increased spending in 2023 is driven by the previously announced construction of a new facility in Galway, Ireland, as well as a significant expansion of our Guidewire manufacturing facility in New Ross, Ireland.

In 2024, we expect to be back at normal CapEx levels similar to 2022, with some increase in line with our sales growth. We announced the Galway, Ireland greenfield facility investment in September 2021. This new facility will expand our presence in Galway, a global medical device hub by adding 67,000 square feet of manufacturing and importantly, R&D space. This capacity will allow us to better serve our customers and high growth, structural heart and neurovascular products because our new facility is near our customers’ development and manufacturing facilities. We are also expanding our New Ross, Ireland facility in 2023 because of increased demand for guidewires used in minimally-invasive procedures. The demand for our proprietary guidewires has accelerated because of additional new business and higher-growth submarkets like electrophysiology and our ability to grow through our industry-leading product performance and scale.

The New Ross investment will add 80,000 square feet of manufacturing space. We expect the building expansion to be complete by year-end 2023 and generating sales in 2024. We launched our portfolio strategy in 2017 with the strategic objective of sustainably growing sales at least 200 basis points above the market. We implemented a structured and disciplined product line strategy process with our growth teams to develop how we will win in the markets we serve. We are uniquely positioned to serve our customers across all phases of the technology maturity time line because of our breadth of capability and products, deep technology, global manufacturing footprint and strategic focus. The 230% growth in our product development revenues demonstrates the strong pipeline that we expect will deliver above-market growth for years to come.

We believe 2023 is the beginning of sustained above-market growth for Integer and are excited to reach this milestone in our journey to creating a premium valuation for our shareholders. I’ll now turn the call over to Jason.

Jason Garland: Thanks, Joe. Good morning, and thank you again for joining today’s discussion. I’ll provide more details on our fourth quarter and full-year 2022 adjusted financial results and provide our 2023 outlook. We delivered fourth quarter results at the high-end of our October 27, 2022 guidance, reflecting a recovery from the supplier delays we faced in the third quarter. Though it remains challenging, we continue to effectively manage through this environment. In fact, in the fourth quarter, we delivered $11 million of sales above the midpoint of our prior guidance. This resulted in $372 million of fourth quarter sales, up $59 million or 19% over last year. Excluding the impact of acquisitions and currency fluctuations, our organic sales growth was 13% higher than last year.

We delivered $73 million of adjusted EBITDA, up $15 million, compared to last year and an increase of 25%. Adjusted operating income was up 30% versus prior year to $57 million, and with adjusted net income at $37 million, we delivered $1.11 of adjusted diluted earnings per share of $0.12 or 12% from the fourth quarter of 2021. Before we go into detail on the full-year financial results, I wanted to transition to a discussion on our product line sales performance. The detailed product line slides that we have traditionally presented can be found in the appendix of this presentation. But this morning, we wanted to focus and summarize our commentary around the fourth quarter highlights across each of the product lines. As you can see in the fourth quarter 2022, we delivered double-digit year-over-year growth across all product lines.

Our first product line, Cardio & Vascular, delivered 20% sales growth in the fourth quarter 2022, compared to the fourth quarter of 2021. This was driven by strong organic demand across all markets, especially structural heart and key products such as guidewires, as well as incremental sales from Oscor and Aran acquisitions. Additionally, C&V benefited from the improved delivery performance from the complex catheter supplier that negatively impacted the third quarter of 2022. The Cardiac Rhythm Management & Neuromodulation’s fourth quarter 2022 sales increased 14% over the fourth quarter of 2021, driven by sales growth in Oscor, our recent acquisition and improved supplier delivery performance versus prior quarter, particularly for the neuromodulation products.

Advanced Surgical, Orthopedics & Portable Medical fourth quarter 2022 sales increased 32% year-over-year on higher demand and price achievement from the start of the multi-year portable medical exit that we announced in 2021. Advanced Surgical & Orthopedics also grew at low double digit in the fourth quarter. And finally, Electrochem, our non-medical segment, delivered fourth quarter 2022 sales increase of 41% versus fourth quarter 2021, driven by strong demand across all market segments and approximately $2 million of incremental sales recovery from the third quarter supplier delivery issues. And with that, I will now transition to our full-year financial results. With the improvement in fourth quarter, our full year financials delivered at the high-end of our 2022 earnings guidance.

Sales grew $1.376 billion, which is a strong year-over-year increase of 13% or 6% organically. Adjusted EBITDA was $256 million, up 5% versus last year, and adjusted operating income was $192 million, up $5 million or 3% compared to the prior year. We delivered $130 million of adjusted net income and $3.88 of adjusted diluted earnings per share, down $0.20 from the prior year. To provide more color on the full-year 2022 adjusted net income performance, we decreased $6 million compared to 2021, primarily due to increasing interest rates and a slightly higher tax rate. We delivered $4 million of operational improvement as compared to last year, supported by strong sales volume and offset by the challenging supply chain and labor environment. FX was favorable, contributing $1 million in improvement versus 2021.

In the higher interest rate environment, we incurred adjusted interest expense of approximately $11 million or $9 million tax effected higher than last year. Now, I will go into more detailed actions we’re taking to manage interest expense during this high-rate environment in the coming slides. Our adjusted effective tax rate was 16.1% for the full-year 2022 and while this remains a favorable rate, we saw a year-over-year headwind of approximately $2 million, due to the adjusted effective tax rate in 2021 being 15%. 2021 benefited from the impact of certain non-recurring discrete tax benefits, including a favorable settlement of prior year audits. For 2023, we expect our adjusted effective tax rate to be between 17% to 19%. This increase is mostly driven by the expiration of the 10-year Malaysian tax holiday under which we have been operating.

We drove a step-up in the conversion of income to cash in the fourth quarter, generating $52 million in cash flow from operating activities, up 86% sequentially from the third quarter. We generated $20 million in free cash flow, inclusive of $32 million of capital expenditures in the fourth quarter. On a full-year basis, this equates to $116 million of cash flow from operating activities inclusive of approximately $50 million increase in inventory to support our manufacturing execution. Our full-year free cash flow of $42 million reflects the impact of $74 million of CapEx spent in-line with our guidance. As Joe mentioned earlier, we will need to continue making focused investments to fuel and fulfill growth, consistent with our strategy. Net total debt decreased $18 million to $907 million for the fourth quarter, and our net total debt leverage at the end of the fourth quarter was 3.5x trailing fourth quarter adjusted EBITDA back within our strategic target range after stepping slightly above for the last two quarters following the Aran acquisition in April of 2022.

We’ll now transition to provide more detail on our guidance for 2023 sales, profit, and cash. The full-year outlook, as summarized earlier remarks that we expect to be the beginning of sustained above-market sales growth. With that, we are forecasting 2023 sales to be in the range of $1.470 billion to $1.500 billion, an increase of 7% to 9% versus last year, well above the underlying market growth rate of 4% to 6%. We expect 2023 adjusted EBITDA to be between $285 million to $296 million, which is 11% to 16% growth year-over-year. We expect 2023 adjusted operating income to be between $211 million to $222 million, reflecting a growth of 10% to 16%, which is 1.5x to 1.7x our expected sales growth. We expect to be able to achieve our strategic financial objective of growing adjusted operating income 2x our sales growth rate once the supply chain environment fully stabilizes, and we generate more benefits from manufacturing efficiencies.

Adjusted EPS is expected to be between $4 and $4.30, which represents a 3% to 11% growth year-over-year. This assumes an adjusted effective tax rate between 17% to 19%, as mentioned earlier, and assumes our adjusted interest expense will be between $45 million to $50 million. We see this demand continues to remain strong. And as Joe noted, having a robust development pipeline that is converting to sales. The challenging labor and supply chain environment, although improving, continues to have an impact on our sales, and we expect first quarter 2023 sales to be similar to the second half of the 2022 average quarterly sales of $358 million, with sequential growth throughout the remainder of 2023 as we continue to execute on our strategy. Adjusted operating income as a percent of sales is expected to expand through 2023 as sales grow beyond first quarter and our manufacturing efficiencies improved.

Over the last several years, we have continued to make debt and interest expense management a priority. We continue to be committed to maintaining a 2.5x to 3.5x net total debt leverage to trailing fourth quarter adjusted EBITDA by balancing our disciplined M&A strategy with consistent debt repayment. We have managed interest expense by refinancing our debt in September 2021 to reduce our credit spreads, and we have maintained a mostly variable interest rate structure that has allowed Integer to benefit from the low interest rate environment through the beginning of 2022. With these actions, we were able to achieve an average annual effective interest rate of 4.1% in 2022, similar to the last two years. Now, we think the higher interest rate environment and modeled several scenarios using forward rate estimates that projected our effective interest rate for 2023 would reach 7% or higher.

Facing that challenge and the headwind it creates on our projected strong operating performance, we strategically partnered with several leading financial firms to close a well-received $500 million convertible note offering a fixed rate coupon of 2.125% for a five-year term. We used the proceeds to pay down our highest variable rate debt to Term Loan B and paid a portion of our outstanding revolver after covering all fees. The impact of these actions will save approximately $18 million of interest expense or generate approximately $0.44 of adjusted EPS accretion based on today’s outstanding debt balance and current market interest rates. Additionally, with the convertible note term aligned with our previous Term Loan B, we have now secured a fixed rate of 2.125%, while maintaining flexibility through 2028.

With a net share settlement structure, we will repay the $500 million principal with cash, which avoids dilution on the principal repayment. Any premium owed above the principal can be repaid in cash with no dilution or equity at our choice. With the associated capped call, any premium paid with equity would not until the Integer stock reaches approximately or a 65% increase from the closing sale price of Integer common stock on January 31, 2023. At a doubling of the stock price or approximately $132 per share, dilution would be approximately 3% if the premium is paid with equity. Also note, we have included an additional slide in the appendix of the presentation that shows the correlation of dilution with potential stock price growth. In addition to discipline in our interest management, we remain disciplined in our overall capital allocation.

Before summarizing our full cash flow outlook, I wanted to share more details on the strategy we are employing to maintain strong cash flow generation. In addition to generating $39 million of incremental year-over-year cash from operational improvement, we expect to enter into a receivables factoring program that provides a one-time incremental cash benefit of approximately $35 million. This will essentially offset the one-time investment needed to expand the manufacturing capacity in our Irish facilities. And with this, our operational cash improvements fall through to free cash flow and eliminate any pressure on our net total debt to trailing adjusted EBITDA leverage. I’ll also note that in addition to the cash offset to this one-time CapEx increase, the cost of the factoring program will be slightly favorable to our current effective interest rate, providing further earnings benefit.

To close our financial discussion, I would like to pull together the impact of the several actions we are taking and summarize our cash flow generation and our net total debt projections for 2023, inclusive of reduced interest payments, operational growth and the factoring program, we expect to generate cash flow from operations between $180 million to $200 million. As discussed earlier, we expect capital expenditures to temporarily increase in 2023 as we invest in critical capacity expansions in our Irish facility of approximately $37 million. Excluding this temporary increase in spend on building expansions, we estimate our remaining capital expenditures to be between $70 million to $80 million. This will result in a total estimated CapEx investment between $100 million to $120 million and free cash flow between $70 million to $90 million.

The free cash flow we expect to generate will be used to reduce the year-end 2022 net total debt by $2 million to $22 million after reducing the additional debt created in early February from the fees associated with the convertible note and capped call. We expect to end the year at our leverage ratio within our target range of 2.5x to 3.5x adjusted EBITDA. With that, I’ll turn the call back to Joe. Thank you.

Joe Dziedzic: Thanks, Jason. Integer had a strong finish to 2022 with fourth quarter sales up 19% and adjusted operating income up 30%. Our 2023 outlook is to grow sales high single digits and expand margins in what remains a challenging supply chain environment. Looking beyond 2023, we believe our strong product development pipeline in high-growth markets, combined with our demonstrated emerging customer growth positions us well for sustained above-market growth. We remain focused on executing our strategy to create a premium valuation for our shareholders. I will now turn the call over to the operator for the Q&A portion of our call.

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Q&A Session

Operator: Thank you, sir. We will take a question from Matthew Mishan, KeyBanc.

Matthew Mishan: Hey good morning and thank you for taking the question. I guess first, I just wanted to say thank you to Tony for all the help through the years and wish you the very best in retirement. Thank you, Tony.

Tony Borowicz: Thank you, Matt.

Matthew Mishan: And then I’m just going to start off with the market plus to the 6% €“ 6% to 8% growth from here on, on a sustainable basis. Is that including, I mean how are you incorporating the exit from portable medical and kind of Nevro in-sourcing over the next, like 2 to 3 years within that market plus 2? And then does it also include potential contribution from acquisitions?

Joe Dziedzic: Good morning, Matt. Thank you for the question. I’ll start maybe in a reverse order. It does not include acquisition revenues. So any acquisitions would be inorganic on top of our organic growth of 200 basis points above the market. Acquisitions do help when we think about looking forward, Oscor and Aran, the two acquisitions we did at the end of 2021 and in the second quarter of 2022. They are contributing to accelerating our revenue growth because they both grew around 20% on a year-over-year basis pro forma, if you look at the part of the prior year that was not part of Integer. So, they’re strong growers. Now, we expect 20% every year, but those two businesses have performed very well on a year-over-year basis, and we expect strong growth, high single digit, low double digit from those two acquisitions.

So that does contribute to the total company growth rate for sure. Your other question on €“ as we think about looking forward, we definitely see strong growth from the pipeline that we have. When you think about Nevro, we’ve already factored in the Nevro impact of them in-sourcing into our guidance. That’s €“ it’s a couple of three-year transition. And I’ll highlight that we do have a long-term agreement with Nevro. We are their second source for manufacturing, second source for them to their in-source. We also have vertical integration of components that we’re selling to them. So that’s been factored into our longer-term guidance. And we’ve been planning for that for, gosh, it feels like 1.5 years to 2 years since they announced their in-sourcing.

So, that’s in our 2023 guidance. That’s in our outlook for the remainder. And then your question about portable medical, it’s going to take another two to three years for those customers to finish the in-sourcing that they’re doing because from start to finish, it was about four years. And I’ll highlight again, I think that reinforces the sheer stickiness of what we do. The portable medical products that we were manufacturing, we determined we didn’t have meaningful differentiation because it was largely assembly. The portion of that business, there was about 70 million in sales in total, about 40 million of it is what we’re exiting, 30 million of it’s what we’re retaining. We’re retaining the part that serves heart failure and cochlear applications which we do have vertical integration, and we do have points of differentiation.