Integer - Q2 2023

Transcript

Operator (participant)

If you would like to withdraw your question, again, just press star one. I would now like to introduce you to your speaker, Andrew Senn, Senior Vice President of Strategy, Business Development, and Investor Relations. Andrew, you may begin.

Andrew Senn (SVP of Strategy, Business Development and Investor Relations)

Good morning, everyone. Thank you for joining us, and welcome to Integer's Q2 2023 earnings conference call. With me today are Joseph Dziedzic, President and Chief Executive Officer, and Diron Smith, Vice President, Financial Planning and Analysis, and Interim Chief Financial Officer. As a reminder, the results and the 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 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 Diron will then review our financial results for the Q2 2023 and provide an update on our full year 2023 guidance. Joe will come back to provide his closing remarks, and then we will open up the call for your questions. With that, I will turn the call over to Joe.

Joseph Dziedzic (President and CEO)

Thank you, Andrew, and thank you to everyone for joining the call today. In addition to KeyBank, Benchmark, Piper Sandler, and Bank of America, we are excited to welcome sell-side analysts from Citi and Wells Fargo, who initiated coverage on Integer during the Q2. We appreciate the coverage from all the sell-side analysts and are excited by the opportunity to reach more potential investors. In the Q2, we delivered another strong quarter of year-over-year results. Sales grew 14% organically from robust customer demand across all product lines. Our adjusted operating income grew 20% while expanding margins by about 80 basis points compared to last year. We were able to deliver more products to our customers than our prior guidance assumed, due to a meaningful improvement in the supply chain environment, as well as a stabilizing labor market. We are encouraged by the significant supply chain improvement.

However, we continue to experience pockets of supply chain risk. Based on continued strong customer demand and the improvements in supply chain and labor, we are raising our full-year outlook. We expect sales to grow 11%-13% and adjusted operating income to grow 17%-21% year-over-year. Free cash flow guidance is now a range of $75 million-$95 million, a strong year-over-year increase. The strategy that we developed in 2017 and began implementing in 2018 is producing above-market sales growth with a pipeline to sustain growth at 200 basis points above the market. In 2023, we expect to grow operating income at 1.6 times the rate of sales growth.

We remain confident we can achieve our strategic financial objective of growing operating income at two times the rate of sales growth through the execution of our manufacturing excellence strategies and when the supply chain and labor environment more fully stabilize. It is an exciting time at Integer because demand remains incredibly strong. We have a robust pipeline of new products concentrated in faster-growing end markets, and we are making the investments needed to deliver sustained growth. I am grateful for our associates around the world that are delivering for our customers and making a difference for patients. I'll now turn the call over to Diron.

Diron Smith (Interim CFO)

Thank you, Joe. Good morning, everyone, thank you again for joining today's discussion. I'll provide more details on our Q2 2023 financial results and provide an update on our 2023 outlook. In the Q2, we continued our strong start to 2023. With sales of $400 million, Integer delivered 14% year-over-year sales growth on both a reported and an organic basis, which excludes the impact of currency fluctuations. Our sales performance reflects the continued strong customer demand across all product lines and the meaningful improvements in supply chain and direct labor. We delivered $76 million of adjusted EBITDA, up $10 million compared to last year, or an increase of 16%. Adjusted operating income was up 20% or $10 million versus last year, as we continue to make progress on our year-over-year margin expansion.

Adjusted operating income as a percent of sales increased by 76 basis points since the prior year to 15%, driven by operational efficiency improvements, offsetting material inflation and annual merit increases. With adjusted net income at $38 million, we delivered $1.14 of adjusted diluted earnings per share, up $0.10 or 10% from the Q2 of 2022, benefiting from the lower fixed interest convertible notes issued in January of this year. I will share a bit more detail on the year-over-year growth and adjusted net income in a few moments. In the Q2 of 2023, sales for all four product lines delivered strong year-over-year growth due to strong customer demand and improvements in the supply chain. The Cardio and Vascular product line delivered 15% sales growth in the Q2 compared to a year ago.

Continued strong demand across all markets, growth in key products such as guidewires, new product ramps in electrophysiology, and supply chain improvements were drivers of this strong performance. Cardiac Rhythm Management and Neuromodulation 2Q sales increased 13% over the Q2 of 2022, with double-digit growth in both Cardiac Rhythm Management and in Neuromodulation. This was driven by strong demand, including double-digit growth from emerging customers with PMA products and supply chain improvements. Advanced Surgical, Orthopedics & Portable Medical saw 17% growth in the Q2 versus a year ago, driven by increased price and demand as a result of the continued execution of the multi-year Portable Medical exit announced in 2022. Additionally, Advanced Surgical and Orthopedics grew low single digit year-over-year.

Lastly, Electrochem, our non-medical segment, grew 7% from a year ago, driven by strong demand in military and environmental market segments, partially offset by a decline in the energy market. Further product line details are included in the appendix of the presentation on our website at integer.net. Q2 2023 adjusted net income increased a total of $4 million compared to Q2 2022, primarily due to strong sales and related operational improvements, partially offset by higher interest and taxes. In this higher interest rate environment, we incurred interest expense of approximately $4 million or $3 million tax affected more than last year. On a sequential basis, compared to the first quarter 2023, we reduced our interest expense by $1 million tax affected, driven by the January convertible note issuance.

The expiration of the 10-year Malaysian tax holiday, under which we have been operating, is the primary driver of a higher adjusted effective tax rate for Q2 2023 compared to the prior year. In the Q2 2023, we generated $56 million in cash flow from operations, up $37 million from a year ago. This strong performance is driven by higher sales volumes, improving margins, our effective management of working capital, and approximately $20 million from our previously discussed accounts receivable factoring program. In the Q2, we generated $23 million in free cash flow, inclusive of $33 million of capital expenditures. With year-to-date capital expenditures of $57 million, we are tracking to our full year guidance of $100-$120 million.

Net total debt in the Q2 improved by $15 million sequentially, and as a result, our net total debt leverage at the end of the Q2 was 3.5 times our trailing four quarter adjusted EBITDA, back within our strategic target range. We will now transition to providing an update on our full year outlook for 2023 sales, profit and cash. As Joe mentioned in his opening remarks, with strong performance through the first half of 2023 and Q2 supply chain improvements, we are raising our full year 2023 outlook.

Starting with sales, we are increasing our outlook to 12% year-over-year growth at midpoint, with a sales range of $1.53 billion to $1.55 billion, an increase of 11%-13% versus last year, up from our previous guidance of 7%-9%. Our outlook for 2023 adjusted EBITDA is 15%-18% growth year-over-year, with a range of $294 million to $302 million, up from our previous guidance of 11%-16% growth. We are increasing our adjusted operating income outlook by $11 million at midpoint and expect 2023 adjusted operating income to be between $224 million and $232 million, reflecting year-over-year growth of 17%-21%.

Adjusted net income is now expected to be between $143 million and $149 million, reflecting a year-over-year growth of 10%-15%, up from our previous guidance of 4%-11%. This delivers an expected adjusted EPS outlook between $4.23 and $4.43, a growth of 9%-14% year over year. Our adjusted effective tax rate remains unchanged from our previous outlook and is projected to be between 17% and 19%. To provide more color into our outlook, our first half 2023 sales averaged $389 million, comprised of an approximately $380 million quarterly run rate, plus the recovery of the prior year supply chain delays, which were discussed in our call in April.

As we enter the second half of 2023, we expect sales similar to the first half run rate of $380 million. We continue to expect adjusted operating income as a % of sales to improve throughout the remainder of 2023 as we continue to improve manufacturing efficiencies and operate in a stabilizing direct labor environment. Moving to our 2023 cash outlook, we expect cash flow from operations between $185-$205 million, an increase of $5 million from our prior outlook, consistent with our increase in adjusted EBITDA. Our cash flow from operations outlook includes an expected full year impact of $35 million from accounts receivable factoring to support our Irish manufacturing facility capacity investments, which we shared during our February earnings call.

Consistent with our strategy, we are maintaining our outlook on capital expenditures of $100-$120 million as we continue to invest in capacity expansion. We expect to generate free cash flow between $75 million and $95 million. The free cash flow generated will be used to reduce our net total debt. We expect to end the year with our leverage ratio within our target range of 2.5 to 3.5 times our trailing four quarter adjusted EBITDA. Thank you for your time. I'll now turn the call back to Joe.

Joseph Dziedzic (President and CEO)

Thanks, Diron. Integer is on track for a strong year, with 22% sales growth in the first quarter and 14% sales growth in the Q2. Adjusted operating income was up 28% in the first quarter and 20% in the Q2. We are raising our 2023 outlook as we continue to execute our strategy to deliver sustained above-market growth with expanding margins. We have a strong pipeline of new products and are investing in the capacity to sustain above-market growth. We remain focused on delivering for our customers and the patients they serve, to generate a premium valuation for our shareholders. Thank you for joining our call this morning. I will now turn the call back to our moderator for the Q&A portion of our call.

Operator (participant)

Awesome. Thank you so much. I would like to remind everyone, if you would like to ask a question, please press star and then the number one on your telephone keypad. All right, it looks like we're ready for our first question. Our first question comes from Matthew Miksic. Matthew, please go ahead.

Matt Miksic (Managing Director and Senior Equity Research Analyst)

Great, thank you for taking the questions. I just wanted to start with the drivers of the revenue beat. Are you guys just experiencing a level of supply chain relief that's enabling you to pull forward some sales into 2023? Are just the procedural volume environment, like, that much better than you thought it would be going into the year? Are some new products ramping, like, faster than expected?

Joseph Dziedzic (President and CEO)

Good morning, Matt. Thank you for the questions. I'll start with the simple answer is, we're meeting the procedural demand and volume that our customers have placed on us. We're in no way pulling anything forward. And I'm not convinced that there was necessarily a meaningful increase in demand. You know, we've got really good visibility to the demand from our customers. You know, we've talked about how our backlog is now approaching, it's right at $1 billion, compared to $300 million pre-pandemic, which is a function of lead times being longer across the industry and everybody placing orders further into the future. The takeaway is that gives us really good visibility in the next six to nine months.

The increase in output in the Q2 was very much a function of supply chain improvement. You know, we've talked about how we track supply chain on a daily, weekly basis. We track the number of issues, we quantify the impact. Throughout the quarter, we saw continued improvement, and that enabled us to meet more of the demand that we've had. We've been communicating now for 6 to 12 months that we have very strong demand in our backlog, and it's really a function of how much of it can we meet. Our focus has been ensuring that procedure volumes have been meeting procedure volumes. We don't see any of this revenue as coming from the future.

We see it as meeting the demand that's been there because supply chain has improved. We did highlight that, you know, we still have pockets of supply chain challenges, which we're managing, and we have factored into our second half outlook. Now, to get to the other things you asked about, we absolutely have new products from the strong product development pipeline that we've talked about and shared some of our in-process metrics. That pipeline of new products, combined with our emerging customers that we've talked about, and we've highlighted the growth that we've been experiencing there, all of that's contributing to the strong demand that we've been experiencing and have visibility to. It's really supply chain that enable us, ultimately, to get more product out the door in the Q2.

We had shared, or have been sharing over the last three months since our last earnings call, the demand is there, and it's really about our ability to continue to improve the supply chain and stabilize direct labor to meet more of it with our customers. What you're seeing is, you're seeing us being able to meet the demand that's been there, and the demand remains strong, and we have confidence in our 12% sales growth at midpoint for the full year.

Operator (participant)

All right, thank you. Our next question comes from the line of Matthew O'Brien. Matthew, please go ahead.

Matthew O'Brien (Managing Director and Senior Research Analyst)

Hey, this is still on for Matt. Congrats on the great quarter, and thanks for taking our questions. Just for starters, Joe, similar vein, but on the updated guide, great to see that it's coming up more than the beat year in Q2. Where's that confidence coming from? What I'm really trying to get at is, you know, taking the guide up to, let's say, 12% at the midpoint, and you've indicated your intentions to grow 200 basis points above the market. Do we think about the underlying market this year growing about 10%, or are you growing above that 200 basis points guidance that you've set?

Joseph Dziedzic (President and CEO)

Yeah, great, great, great question. Thank you. As best we can tell as we look at the industry, we think we're growing more than the 200 basis points above the market this year. We think our ability to meet the strong demand that we've had after working through the supply chain and labor constraints, that we're exceeding that 200 basis points this year. You know, we track our customer sales into the end markets and try to correlate it. What we'll see as the year progresses, whether the industry's growing faster than the mid-single digits, that our weighted average growth rate, based on the markets we sell into, would indicate kind of a historical mid-single-digit growth.

We think we're growing much faster than the market, much faster than the 200 basis points this year. I would point to the strong product development pipeline we've talked a lot about, those products starting now to become therapies being introduced in the market that's driving additional production, manufacturing revenues for us. I'd point to the emerging customers that we've talked a fair amount about, that are growing from, you know, roughly $50 million in 2022 to $80-$100 million in 2024. We've talked about that, that's also fueling this faster than 200 basis points growth in calendar year 2023.

Your next question might be, well, how do I think about this going forward in 2024 and beyond? We still think 200 basis points faster than the markets, which, you know, our estimates, the market's mid-single digit, 4%-6%. We still think that 200 basis points faster, 6%-8% organic growth is the right number to think about looking forward. We've got a really strong year here with tremendous demand that we're fulfilling on, and I do think 12% is well above the 200 basis points in the markets in 2023.

Operator (participant)

All right, thank you. Our next question comes from the line of Craig Bijou. Craig, please go ahead.

Craig Bijeau (Director and Equity Research Analyst covering Medical Supplies and Devices at Bank of America Securities)

Good morning, guys. Thanks for taking the questions, and congrats on a strong quarter. I wanted to start with the debt. Obviously, you guys are getting back to your strategic range. You're going to use cash flow to further reduce the debt, you know, throughout the year. Maybe just talk about kind of your M&A appetite, at this point, and if, you know, with the strong underlying demand that you're seeing, if you think you need to bring on additional capacity, either this year or maybe when you look ahead to 2024, to meet some of this demand.

Joseph Dziedzic (President and CEO)

Great, Craig. Thanks for the question. Maybe the quick answer is we remain very committed to our 2.5x-3.5x leverage. As you noted, we're at 3.5, so we're right at that spot. We think as we continue to grow EBITDA and we continue to pay down debt, which our free cash flow indicates we will continue doing, that creates capacity. We still think we have between $200-$250 million a year on average for acquisition capital.

Obviously, at 3.5, that means in the next, you know, in the near term, we wouldn't be doing anything substantive or meaningful, but certainly as that leverage comes down by year-end and starts to get closer to the midpoint or the bottom half of our range, that creates a lot more capacity to do acquisitions. We continue to be very active in the marketplace. The activity is still high. You can see from the transactions that are... at least have been announced, DuPont acquiring Spectrum at, you know, high teens, maybe closer to maybe 18, trailing EBITDA multiple. Memry, the acquisition of Memry by Resonetics, GTCR is also in that high teens.

You can see that the best assets, premium assets, are still going for, you know, what we would characterize as strong multiples, premium multiples. Below, maybe the low 20s, where a couple of years ago you saw some of the best assets trading at. When you think about valuations, we still think that premium assets are still trading and being acquired at premium values. You know, we're not looking at those size acquisitions. We've been very clear we're staying at our 2.5 to 3.5 times leverage. That puts us in that $250 million, kind of on an annual basis.

We remain very active at looking for acquisitions that fit within our strategy, and we've worked to be very clear about what our strategy is. We have very clear criteria and parameters. We're looking for acquisitions that are more tuck-in in nature. We're looking for acquisitions that bring additional capability that allows us to accelerate our development work and partnership with our customers in those faster-growing end markets. You've heard about them many times: structural heart, electrophysiology, neurovascular, Neuromodulation, peripheral vascular.

That's where our customers are innovating because there's significant patient need, and that's where we're continuing to add capabilities in our manufacturing operations and R&D operations to be able to enable our customer strategy, which we think makes us the partner of choice, because we help them accelerate the execution of their strategy. To your question about capacity, you know, we've been investing. You see our CapEx this year, we're which is heavily driven by two major expansions in Ireland, one in Galway, one in our New Ross guidewire facility, where we're spending about $40 million this year.

When you step back and look at total Integer, you know, we think we've got somewhere in the neighborhood of 400,000-500,000 sq ft of available manufacturing space spread across our network. We're obviously adding 80,000 sq ft in our guidewire facility. In New Ross, we're adding 70,000 sq ft in a new facility. In Galway, Ireland, we've got about 100,000 sq ft in the Dominican Republic that we got as part of our acquisition of Oscor. We've got capacity in our Tijuana facility. We've got capacity in our other U.S. facilities. We feel we have capacity to continue growing and to support the level of growth that we're projecting. 2023 is a year of elevated CapEx spend because of that.

Once we get into 2024 and beyond, we expect that CapEx to come back down because we don't anticipate the magnitude of facility investments like the Irish facility. We feel we've got the capacity to continue growing, but naturally, you do need the equipment, the capital equipment, to build the product. But we've continued to invest in the equipment and feel confident that we've got the capacity to support the growth that not only that we're experiencing this year, but looking forward.

Operator (participant)

Okay, just as a reminder, if you'd like to ask a question, please press star one. Our next question comes from the line of Anthony Petrone. Anthony, please go ahead.

Anthony Petrone (Managing Director, Senior Medical Devices, Diagnostics and Therapeutics Equity Research Analyst)

Hi. Thanks for taking the question. Congrats on a great quarter. In terms of the supply chain improvement, how would you characterize the state of the supply chain and the overall inflation environment relative to Q1 and your expectations for when it normalizes? I'm thinking, like, in terms of your thoughts on getting back to your pre-COVID margins. Thanks.

Joseph Dziedzic (President and CEO)

Anthony, thanks for the question. We did see a meaningful improvement in supply chain in the Q2, and we had tried to convey that the demand was there, and we were being constrained by supply chain. We still have pockets of supply chain challenges. You know, we saw a little bit of an uptick in some, in the number of supply chain issues early in the third quarter. We've assumed in the second half of this year in our guidance, we've assumed no further changes in supply chain. We're not gonna try to predict supply chain changes.

When it happens, if it improves, we think we have the opportunity to ship more, but we're assuming no further changes in supply chain, similar to how we guided to after the first quarter. We are in aggregate seeing that improving trend, and that's enabled us to deliver more in the Q2, and as someone noted earlier, increase the second half forecast as well. In terms of getting back to pre-COVID margins, you know, the way we're looking at it is we see ourselves growing 200 basis points or more above the markets we're serving. As we look to 2024 and beyond, we continue to have confidence in our development pipeline, emerging customers to be able to do that.

We have confidence that we can continue to expand margins. You know, this year we're expanding margins at about 1.6. I'm sorry, growing operating profit about 1.6 times the growth of sales. You know, our target is to grow operating profit twice as fast as the sales growth rate. We're confident when the labor environment and supply chain more fully stabilize, we can get back to growing profit at twice the rate of sales. Because we can't fully predict when supply chain is gonna get back to that level, I can't predict when that is, but know that we're continuing to be aggressive in the actions we're taking to improve supply chain.

You know, we've talked about some of the things we're doing in supply chain, whether it's dual sourcing, whether it's shifting materials, if it's a material constraint. Insourcing is something that we've also done, and sometimes we insource in addition to having an external source, so dual source could be external and internal. There's a number of different ways in which we've been working to manage and mitigate supply chain risk. We're confident we can achieve our financial objectives. We've got the top-line growth, the product development pipeline of new products and emerging customers.

We're expanding margins this year, and what we think is still a challenging environment, and we're confident we can get to our strategic objective of profit growth twice as fast as sales when we get to a more fully stabilized supply chain and labor environment.

Operator (participant)

All right, perfect. At this time, I'm not seeing any more questions. I'd like to turn it back over to Andrew Senn and the team at Integer.

Andrew Senn (SVP of Strategy, Business Development and Investor Relations)

Great. Thank you for joining the call today. As always, you can access the replay of this call on our website, as well as the presentation that was just covered. Thank you for your interest in Integer, and that concludes today's call.

Operator (participant)

Thank you, and you may now all disconnect.