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Good afternoon. My name is Chris, and I'll be your conference operator today. At this time, I would like to welcome everyone to the Integer Holdings Corporation Q1 2018 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question-and-answer session. [Operator Instructions]
Thank you. Ms. Amy Wakeham, Vice President of Investor Relations, you may begin the conference.
Great. Thank you, Chris. Good afternoon, everyone. Thanks for joining us, and welcome to Integer's first quarter 2018 Conference Call. The call is being webcast live, and the replay, along with the copy of the press release and the earnings presentation will be available on the Investor Relations section of our corporate website. 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 measures. For reconciliation of these non-GAAP measures, please see the appendix of today's presentation and the notes to the financial statements in today's earnings release.
As a reminder, today's presentation includes forward-looking statements. Please refer to our SEC filings for a discussion of the risk factors that could cause our actual results to differ materially. Unless otherwise noted, our commentary today refers to our organic results, which adjusts for the impact of foreign exchange and any M&A activity during the relevant period.
Additionally, our full year 2018 outlook discussion does not reflect the potential impact of today's announcement regarding the planned divestiture of our Advanced Surgical and Orthopedic product line.
Joining me on the call today to discuss our quarterly results are President and Chief Executive Officer, Joe Dziedzic; and our Executive Vice President and Chief Financial Officer, Gary Haire. Following our prepared remarks, the call operator will come back on the line for Q&A.
I'd like to turn the call now over to Joe.
Thank you, Amy. Welcome, everyone, and thank you for joining to hear about our first quarter results. We've continued the strong momentum from last year, and 2018 is off to a really good start. I am pleased to report on another quarter of nearly double-digit sales growth.
But first, I want to thank all of our Integer associates who make this happen. The teams and the manufacturing plants and everyone supporting them built on the strong four quarter results from last year and delivered another quarter of significant growth.
Now let's review our first quarter results. Our first quarter results demonstrate strong revenue growth of 9% and net income growth of 48%. We continued to generate strong cash flow from operations and paid down $50 million of debt during the quarter. Our highest quarter of debt pay down since Integer was formed.
The strength of our first quarter gives us the confidence to increase our full year outlook for sales, earnings and cash flow. We are now projecting sales growth of 3% to 6%, and adjusted EBITDA growth of 9% to 12%, about double the sales growth, which is one of our financial goals.
Today, we also announced an important move to create significant value for Integer and position Integer for even faster growth going forward. We are selling our Advanced Surgical and Orthopedics product lines to MedPlast, LLC for $600 million in cash.
During the strategic review process we undertook last year, we identified opportunity to unlock value much faster for Integer through the sale of our AS&O product line to an industry market leader.
I'll review the transaction in more detail later on in the presentation. But I want to highlight, we expect this transaction to result in improved profitability for Integer, reduced leverage and a similar cash flow profile.
After the planned sale of AS&O, Integer will maintain clear market leadership positions with our remaining product lines and will have increased financial flexibility to more aggressively invest for growth.
Gary will now provide more discussion regarding our financial results for the quarter.
Thanks, Joe, and good afternoon. I will start by taking you through our first quarter financial results, and then I will also take you through a few pages on cash flow as well as our updated 2018 full year outlook.
Turning to slide seven. Here is a quick look at our results for the first quarter. For sales, we had a really strong quarter to start the year, continuing with our momentum from the fourth quarter last year.
Sales increased 9% organically, and we saw growth continue to accelerate in our Medical product lines, while we continued double-digit growth in our Electrochem business, but at a more modest rate.
Adjusted EBITDA increased 7% year-over-year. And during the quarter, the FX impact was comparable to the prior year Q1 results at just around $1 million.
Adjusted net income increased 48% organically when you exclude the impact of FX losses in both the prior year and the current year. Adjusted EPS was $0.61 on a reported basis and includes $0.03 related to FX.
Now moving to slide eight. You can see that the first quarter adjusted EBITDA increased about $5 million or 7% versus last year. However, we had approximately $4 million of higher incentive compensation in Q1 this year versus last year. Excluding this impact, adjusted EBITDA would have increased 13%.
Now looking at the right side of the page. Adjusted net income was up 53% versus last year and adjusted EPS was up 49%. And then breaking down to pieces, the impact of the incentive comp that I mentioned is about $3 million on adjusted net income and about $0.08 on adjusted EPS.
To be clear about incentive compensation, we do not expect this to be a material impact on our full year earnings versus last year, but it will be slightly higher in the first half of the year versus last year due to our improved performance.
All other operational improvement would then be about $4 million or $0.14 a share. We also had a benefit of about $0.04 from lower interest expense and $0.12 from a lower tax rate in the quarter this year versus last year.
Overall, we feel really good about our first quarter results and the trajectory this puts us on going forward.
Turning to slide nine. I will take you through our cash flow performance for the first quarter. We generated $46 million of cash flow from operations during the first quarter. The strongest quarter since the merger with Lake Region back in 2015. And this translated into $36 million of free cash flow. We continued to make progress with inventory management, and our inventory turns went up to almost five at the end of the quarter.
In addition, we have reduced our other operating expenses significantly versus the prior year. This strong cash flow, combined with more efficient use of our cash balances, allowed us to continue to accelerate debt payments and paid down $50 million of debt in the quarter, reducing our leverage further to 5.4.
Turning to slide 10. We are taking up our guidance for cash flow and debt payments for the year. And to be clear, this guidance is excluding any impact from the planned divestiture we have announced today.
We are now expecting cash flow from operations to be at least $160 million, up from $150 million, and free cash flow to be at least a $110 million, up from $100 million.
In addition, we are now expecting to pay down at least $115 million of debt during the year. And lastly, we will continue to reduce our leverage, and now expect to be comfortably under 5x EBITDA by the end of 2018.
As I've continued to emphasize, we are committed to generating continued and sustainable operating cash flow as well as reducing leverage. And this quarter demonstrates that we are continuing to deliver in this area.
Now I'd like to talk about our full year outlook for 2018. In addition to cash flow, we are increasing our guidance for sales, adjusted EBITDA and adjusted EPS. And once again for clarity, this guidance does not contemplate the planned divestiture of our AS&O product lines, and we will come back to you with revised guidance once we have closed the transaction.
Given the solid momentum we are seeing and also our first quarter results, we now expect 2018 full year sales growth to be between 3% and 6% for the year.
For adjusted EBITDA, we have increased our range to $310 million to $320 million, which should be a growth rate of approximately 9% to 12%.
For adjusted earnings per share, we now expect to be in the range of $3.20 to $3.50 per share. And in addition to this guidance, I just want to share a few other comments. We still expect capital expenditures to be in a range of $50 million to $55 million for the year, and depreciation and amortization in a range of $106 million to $108 million for the year.
Stock-based compensation is expected to be in the range of $10 million to $20 million for the year. And other operating expenses are expected to be approximately $10 million to $15 million, which is a significant reduction from prior years as the majority of our spending on acquisition integration is now behind us.
And lastly, we have tightened the range a bit for the full year adjusted effective tax rate to be in the range of 21% to 24%.
I will now turn to the product line sales results, and then I will turn it back to Joe to give you an update on our growth strategy and to discuss the transaction announced today.
On slide 13, you can see that Advanced Surgical, Orthopedics and Portable Medical products had a really strong start to the year. Sales growth year-over-year was up 12% in the first quarter. The growth is driven by increases in Portable Medical products, spinal implants, continued ramping up of new products as well as continued tailwind from one customer's accelerating sales as part of an inventory build program.
We expect that we will see solid year-over-year sales growth continue for this business, but at a slower pace as one customer's inventory build plans slow.
Turning to slide 14. The Cardio & Vascular product line has continued to have a strong top line growth and saw strong year-over-year sales growth in the quarter of 9%. This growth was driven by continued strong demand for existing Integer-owned products and increasing demand for contract manufacturing components as the C&V teams successfully execute its growth strategy.
When you look at this product line on a rolling four quarter basis, you can see that the growth trajectory continues to remain strong, consistently staying in the high single digits over the last several quarters, driven by the continued success of our Cardio & Vascular product offering. Market momentum continues to remain solid, and we continue to see solid growth in this product line as we continue to execute on our product line strategy to accelerate growth.
We're focusing our resources in this product line to ensure that we continue to innovate in areas, such as developing faster capabilities with a goal of accelerating our customers' speed to market and overall success.
Looking at slide 15. Sales turned positive in the first quarter for Cardiac & Neuromodulation product line, increasing 5%. For CRM, the market continues to remain relatively flat overall, but we have seen some stabilization with our customers.
In neuromodulation, sales were very strong. And these products and our customers continued to gain strength. And we also resolved a prior year's supply constraint that impacted the first half of 2017.
The rolling four quarter sales trend further reflects the return to growth we saw in the first quarter. We expect to continue to see low to middle single digit growth for the overall product line over the next couple of quarters, driven by strength in neuromodulation.
As we've mentioned before, the neuromodulation market remains a key driver of long-term growth for the product line. And as the market-leading medical device outsourcer, we are focused on accelerating neuromodulation sales through the active support of our customers.
Overall, we continue to execute on our strategy in cardiac rhythm management and neuro, partnering with customers to provide full component design, development and manufacturing capability to enable success and support growth.
Now on slide 16. Electrochem had a solid quarter to start the year, up 12% on a year-over-year basis. The product line continues to win new business in the energy market, and also had a solid growth - had solid growth in the environmental market this quarter. Electrochem's outlook continues to remain positive for 2018 as the team executes on new business wins and continues to drive sales growth and share gain initiatives.
I will now turn the call back to Joe.
Thanks, Gary. We introduced our strategy to drive long-term growth last quarter, and it doesn't change with the planned divestiture of the AS&O product lines.
I'm not going to cover the strategy slide in detail this quarter, but I will highlight that we are executing our portfolio strategy, which includes specific product line strategies to invest to grow, protect and preserve as well as to improve profitability.
On the operational strategy, we are also developing and implementing the multi-year plans with a strategic comparatives to achieve excellence in each of the focused areas.
We are defining excellent with clarity and aligning compensation to incentivize and reward achievement. Our portfolio and operational strategy is how we are running the company, and we will update you on our progress on future calls.
Now let's cover the planned AS&O divestiture. Before I get into the details of this slide, I want to explain how we came to the decision to divest the AS&O product line. The strategic review we performed last year evaluated the markets we serve and assess the competitive and commercial environments. We evaluated our competitive position and compared it to the overall trends in each of these markets. Our realization for AS&O was that the high fragmentation of the suppliers and the high customer concentration would lead to continued supplier consolidation.
We concluded if we didn't participate in this trend either as a buyer or a seller that we would risk losing ground and our business could be disadvantaged.
We assess the benefits of selling, given the consolidation trend, our current debt leverage and the potential for a significant value-creating transaction. It was clear we should divest if we could find a buyer with complementary capabilities and enough synergies to support a strong valuation.
We believe we accomplished this and have unlocked significant value. After the sale, Integer will have increased financial flexibility and will be even better positioned to invest more aggressively in our current market leadership positions.
We believe MedPlast is an ideal fit for AS&O, and when combined, they will be able to realize synergies that support the valuation we received.
I provided color on the decision process and the transaction rational, so now let's move on to the deal summary. The deal was for Integer to receive $600 million in cash and is subject to normal closing conditions as well as U.S. and foreign antitrust clearances with an expected close in the third quarter.
MedPlast is acquiring about $400 million in sales based on 2017 financials, along with 10 manufacturing facilities. Integer sales will only decrease by about $350 million because we will continue to supply MedPlast about $50 million of product that is manufactured in plants that remain with Integer.
Integer's remaining 15 manufacturing facilities will support about $1.2 billion in sales. The AS&O product line had about 13% EBITDA margins in 2017, which is significantly lower than Integer's 20%.
The takeaway is the valuation multiple received for the AS&O product line is slightly higher than Integer's current multiple despite the difference in profitability.
This valuation is supported by the significant synergy potential of combining AS&O and MedPlast. This transaction positions Integer to more aggressively invest to grow our Cardiac & Vascular - Cardio & Vascular and Cardiac & Neuromodulation product lines, where we have clear leadership positions.
We will have greater financial flexibility, and our evaluation metrics improve. After the transaction, we expect our margins to expand by at least 20 basis points. We plan to use the sale of proceeds to repay about $550 million of debt, which will reduce our leverage to less than four times EBITDA.
Also the lower interest expense offsets the net income we are selling, so our EPS should be higher as well. Free cash flow should be about the same as before the sale, and our return on invested capital will increase because we will have higher earnings on lower invested capital.
Overall, we see this as a significant step towards earning a valuation premium for our shareholders.
So 2018 is off to a great start. Sales, earnings and cash are all accelerating. The strength of our first quarter results supports our increased 2018 outlook.
We believe the transaction announced today is very positive for all stakeholders involved, and unlocks significant value for Integer. After the divestiture, Integer will have higher earnings, higher margins, less than four times leverage and about the same free cash flow as before the deal. This transaction improves our valuation metrics.
For the remaining product lines, we are executing on a clear strategy to accelerate growth, both from a portfolio and an operational perspective. The strategic imperatives are clear as are the financial measures of success.
Sales growth above the market and profit growth at least two times sales growth, which we believe will earn valuation premium. I remain confident we have the right strategy and the right team in place to deliver to our customers and to realize our vision of enhancing patients' lives.
Let's open it up for questions.
[Operator Instructions] Your first question comes from Matthew Mishan with KeyBanc. Your line is open.
Great. Thank you for taking my question. And congratulations on the deal.
Thank you.
Thanks, Matt.
Let's just start with the divestiture. If I look at it, and maybe my math is off, so I was just hoping you could help me out. How do you get to EPS accretion from this, because you're losing about $350 million of sales at about - and you said it as 13% EBITDA margin. How are you able to take that back enough - take down enough debt to cover that?
Matt, it's Gary. I'll just give you the big buckets to make it pretty clean. So if you look at the business, you just have $400 million of sales and about 13% EBITDA margin, so you get to around 50, right? And if you think about the interest savings that we're going to have alone on that, we can get there pretty closely, pretty quickly.
Are you including the flexibility you might now have to take down the high yield notes at the end of the quarter at a more reasonable rate as part of that accretion?
We are absolutely considering that in interest savings.
And then on the guidance. First off, congratulations on a great sales quarter. But versus at least our model, EPS and the margins were a little bit off. What's the rational for not only raising the sales guidance, but also bumping up the EBITDA and the EPS guidance, when it looked like it was a little bit of a more challenging quarter as far as margin goes.
Yes. Again, it is Gary, Matt. So I'll cover all the components. So on the sales side, obviously, it's pretty clean. You can see the momentum that we have in the first quarter. It's a little better than we expected and what we can see the foresight to it. On the EBITDA and the earnings on the EPS side, I think, maybe one of the differences is we had higher incentive comp that we have expected ourselves, but maybe wasn't as clear.
And when you think about that several million dollars, $4 million of EBITDA and a few million on the bottom line that had pretty significant impact there. But it doesn't really have an impact on the full year. So from what we can see on a full year basis, we feel really good about taking the outlook up.
So it's the timing of when you recognized the incentive comp rather than kind of the year-over-year headwind from having to realize that?
Yes. That's exactly right. It's just - the right incentive comp works is it's - you're doing it based on projected performance. So if you look at our business early in the year, last year, it wasn't performing as well. And therefore, we're incurring more expense right now.
But on a full year basis, if you remember the fourth quarter, it was a really big number as a headwind, and we wouldn't expect it to be that big this year. So that - as you get to later in the year, it becomes a tailwind.
And just back - the other thing I would add is, although you highlighted the first quarter margin rate on the sales growth that was what we expected when we looked at our budget. We were pretty much right on the profitability. And so as we look at the rest of the year and the sales going up, we do expect the margin to fall through on that.
Okay. Great. And then last question. Joe, what was the initial feedback from your customers as you kind of rolled out your new strategic plan and had initial conversations with them about it?
Well, they love the fact that our focus is on them. They love the fact that we're focused on driving more efficiencies and driving quality and on-time delivery, because that's a huge component of our operational efficiency. That's what resonated with them.
Obviously, our desire to sell more is something that they support as well, as long as we're bringing value for them. So the feedback thus far has been positive, but they're pretty focused on what impacts them most directly.
Thank you very much. And congrats again.
Thank you, Matt.
Thanks, Matt.
Your next question comes from Jim Sidoti with Sidoti & Company. Your line is open.
Good afternoon. Can you hear me?
We can Jim.
All right. Can you just make a real simple for me, what debt are you going to pay down with the $600 million or $550 million?
Jim, its Gary. Yes. Sure. As far as the $550 million. So just to be clear, I mean, we're working with our banks now. So we signed the transaction earlier today. So it's all planned transaction. So we're going to align that up, but obviously, the higher notes will be a primary target. And then we're going to look at our other debt, which is pretty much term debt and revolver, right?
So we're clearly going to look - and we're going to make a good economic decision as well when we're looking at it. So you, obviously, have some early payment fees and things like that, that we're going to evaluate and make sure we're making good decisions and not just quick decisions.
And how much the debt is high-yield? And what's the rate?
$360 million of debt is high-yield at 9% and an 8%. That's $32 million of interest expense just on those notes.
Okay. All right. Looking at the sales from the Orthopedics, it seemed like they were a little bit more heavily weighted in the fourth quarter over the past couple of years. Is that the way we should think about it as we adjust our models - with that business did a little bit better in the fourth quarter than it did in the first 3?
Jim, its Joe. We got pretty good visibility to second quarter and third quarter. The fourth quarter little bit less visibility. That has absolutely been the historical trend. We are not seeing that exactly this year as we get closer to the fourth quarter and the order start to firm up, we'll have better visibility. But we're not quite seeing that same pronounced fourth quarter growth on a year-over-year basis this year than last year.
We can identify a couple of specific things with customer order patterns and year-end shipments that would support like. This year's fourth quarter may not show as the same level of strength as prior years. So at least right now it's understandable to us. But we're not seeing a significant fourth quarter year-over-year growth like we have in the prior years.
Okay. And if you look at the CRM and the neurovascular businesses, that category was up a few percent, a much better performance year-over-year than we've seen in the past than the trend has been. Is the CRM business becoming more stable? Or is the neuro business getting - growing at a better rate - a bigger part of that right now?
The CRM business has been growing at about the same rate that it has over the past three or four quarters. The increase you see in the category is driven by neuromodulator, and it was driven by a particular supply constraint we had in the first half of last year. So we expect the first half of this year to be stronger than the second half because of that. Last year, there were some sales and ended up more heavily in the second half because of the inability to get product in the first half from a particular supplier.
Okay, all right. That's it from me. Thank you.
Great. Thanks, Jim.
This concludes Q&A session for the conference. So now I'd like to turn it back to Amy Wakeham for any closing remarks.
Great. Thanks, Chris. Thanks, everyone, for taking time this evening to join us for our call and for your continued interest in Integer. If you have any follow-up questions, please feel free to reach out to Investor Relations directly. Thank you, and have a great evening.
This concludes today's conference call. You may now disconnect.