Integer Holdings Corp (ITGR) Q1 2024 Earnings Call Transcript

Thank you for joining us. My name is Kathleen, and I will be your conference operator today. I would like to welcome everyone to the First Quarter 2024 Integer Holdings Corporation Earnings Call. I will now hand the call over to Andrew Senn, Senior Vice President of Strategy, Business Development and Investor Relations.

Good morning, everyone. Thank you for joining us, and welcome to Integer's First Quarter 2024 Earnings Conference Call. With me today are Joe Dziedzic, President and Chief Executive Officer; and Diron Smith, Executive Vice President and 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 adjusted financial results for the first quarter of 2024 and provide an update on our full year 2024 outlook. Joe will come back to provide his closing remarks, and then we'll open up the call for questions. With that, I'll turn the call over to Joe.

Thank you, Andrew, and thank you to everyone for joining the call today. We appreciate the sell-side analysts who have initiated coverage on Integer over the past year and welcome Kristen Stewart from CL King, who initiated coverage of Integer last month. We had a strong start to 2024 with sales growing 10% year-over-year and adjusted operating income up 26% or 2.7x the rate of sales growth compared to the first quarter of 2023. In addition, our adjusted earnings per share grew 31% year-over-year and gross margin expanded 120 basis points versus first quarter 2023, primarily due to the execution of our manufacturing excellence initiatives and an improved supply chain and direct labor environment. We are reiterating our full year outlook. We continue to expect sales growth of 9% to 11% and adjusted operating income growth of 13% to 20% versus 2023, a strong year-over-year increase. We are also confirming 2024 adjusted earnings per share of $5.01 to $5.43 and free cash flow of $85 million to $105 million. The strategy that we developed in 2017 and began implementing in 2018 is now producing sustained above-market sales growth and margin expansion. We also continue to manage our debt leverage within the range of 2.5 to 3.5x trailing 4-quarter adjusted EBITDA, while executing our inorganic growth strategy. It is an exciting time at Integer because we have a strong pipeline of new products, concentrated in faster growing end markets. Our margins are expanding as a result of our manufacturing excellence initiatives, and we continue to acquire and integrate tuck-in acquisitions that add or compound differentiated capabilities. 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.

Thank you, Joe. Good morning, everyone, and thank you again for joining our discussion today. I'll provide more details on our first quarter 2024 financial results and provide an update on our 2024 outlook. We started 2024 with a strong first quarter. Sales of $415 million delivered 10% year-over-year growth on a reported basis and 6% on an organic basis, which excludes the impact of our recent InNeuroCo and Pulse acquisitions, the strategic exit of the portable medical market, and foreign currency fluctuations. We delivered $81 million of adjusted EBITDA, up $15 million compared to the prior year or an increase of 22%. Adjusted operating income grew 26% versus last year, more than 2.5x the rate of sales growth. We continue to make progress on our year-over-year margin expansion. First quarter 2024 adjusted operating income as a percent of sales was 15.2%, which represents approximately 200 basis points of improvement versus a year ago. Adjusted net income for the first quarter of 2024 is $39 million, delivering $1.14 of adjusted diluted earnings per share, up $0.27 or 31% from the first quarter of 2023. C&V and CRM&N product line sales, which represent approximately 91% of our total sales, continued strong year-over-year growth on a trailing 4-quarter basis in the first quarter of 2024. For our Cardio and Vascular product line, trailing 4-quarter sales increased 18% year-over-year with double-digit growth across all CMB markets, driven by strong customer demand and sales from the InNeuroCo and Pulse acquisitions. Cardiac Rhythm Management and Neuromodulation trailing 4-quarter sales increased 12% year-over-year, primarily driven by double-digit CRM growth from strong customer demand and double-digit neuromodulation growth from emerging PMA customers. Further product line details are included in the appendix of the presentation on our website at integer.net. To provide more insight into our first quarter 2024 performance, we delivered $39 million of adjusted net income, up $10 million versus a year ago. Operational improvements, which include improved manufacturing efficiencies and operating cost leverage, delivered $10 million versus first quarter 2023. While improvements in our adjusted effective tax rate were more than offset by higher interest expense and slightly unfavorable foreign exchange. On a tax-effected basis, adjusted total interest expense was approximately $1 million higher than last year. This is primarily due to a higher average debt balance during the period, driven by funding for the acquisitions of InNeuroCo and Pulse technologies using our available revolver capacity. Our adjusted effective tax rate was 18.1% for the first quarter of 2024 compared to 19.8% in the prior year. Our lower adjusted effective tax rate compared to the prior year was primarily due to discrete tax benefits recognized upon vesting of restricted stock units during the first quarter of 2024. We continue to expect our adjusted effective tax rate to be between 19% to 21% for 2024, as discussed in our previous earnings call, this is mostly driven by the recent adoption of the OECD Pillar 2 framework by the EU member state establishing a minimum effective tax rate of 15% as well as the residual effect of the Malaysian tax holiday expiration. In the first quarter of 2024, we generated $23 million in cash flow from operations, up $17 million from a year ago. The improvement driven by higher sales volumes, improving margins, and effective management of working capital was partially offset by higher annual bonus payments, which are made in the first quarter of every year. Our CapEx spend of $29 million in the first quarter is on track to our expected full year spend of $90 million to $110 million. As a result, free cash flow in the first quarter was a usage of $6 million. Net total debt ended at $1.1 billion for the first quarter of 2024, an increase of $162 million compared to the fourth quarter 2023 ending balance. This increase was driven by the approximate $140 million acquisition of Pulse Technologies in January of this year. Net total debt leverage at the end of the first quarter 2024 was 3.4x trailing 4-quarter adjusted EBITDA, which is within our strategic target range of 2.5x to 3.5x. As Joe mentioned in his opening remarks, we are reiterating our 2024 outlook for sales, profit, and cash. We expect to deliver sales in the range of $1.735 billion to $1.770 billion, an increase of 9% to 11% versus last year, with organic growth of 6% to 8%, which is 200 basis points above our underlying market growth rate estimate of 4% to 6%. In addition to our organic growth, we expect the InNeuroCo and Pulse acquisitions, partially offset by the portable medical market exit, to contribute 3% inorganic growth. We anticipate adjusted EBITDA between $355 million to $375 million, reflecting growth of 15% to 21%. Similarly, we expect adjusted operating income to grow 13% to 20% to between $272 million and $290 million. At $281 million, which is the midpoint, adjusted operating income as a percent of sales is expected to grow 91 basis points compared to the full year 2023. We expect adjusted net income between $171 million and $185 million, which is growth of 8% to 18% compared to the prior year with adjusted earnings per share of $5.01 to $5.43, which is growth of $0.34 to $0.76 versus 2023. First quarter 2024 results were in line with our expectations. We further expect the first half of 2024 sales to grow high single digits year-over-year with sales continuing to increase throughout 2024 from new product introductions and emerging PMA customer growth. We expect adjusted operating income as a percent of sales to expand throughout the remainder of 2024, driven by continued improvement in manufacturing efficiency and sales growth outpacing our growth in operating costs. Similar to our outlook on profit and loss, we also reiterate our cash flow outlook and net total debt projections for 2024. We expect cash flow from operations between $185 million to $205 million, which represents an 8% year-over-year increase at the midpoint of outlook. Our outlook for capital expenditures remains at $90 million to $110 million as we continue to invest in organic capabilities and capacity. As a result, we expect to generate free cash flow between $85 million and $105 million. Inclusive of our approximate $140 million acquisition of Pulse Technologies in January of this year, we expect our 2024 year-end net total debt to be between $1.010 and $1.030 billion, which is up $60 million to $80 million year-over-year. We expect to end the year with our leverage ratio within our target range of 2.5 to 3.5x trailing 4-quarter adjusted EBITDA. With that, I'll turn the call back to Joe. Thank you.

Thanks, Diron. With our strong start to 2024, we are reiterating our outlook of 9% to 11% sales growth and a 13% to 20% increase in adjusted operating income. The execution of our strategy, both organically and inorganically, is producing results as we continue to demonstrate above-market sales growth with expanding margins. We remain focused on executing our strategy to create a premium valuation for our shareholders. We will now turn the call over to our moderator for the Q&A portion of the call.

Your first question comes from Brett Fishbin of KeyBanc Capital Markets.

Just wanted to start off quickly on revenue growth trend in the March quarter. One topic that came up in your conversation was just the potential impact of some inventory build by customers that they were looking to reduce or take down. So just curious if looking across the different product areas, you might have seen some pockets where customers needed to actually take down their inventory before some of the ordering activity returned more in line with the underlying trends that we're seeing.

Brett, thanks for the question. I guess my immediate answer is we have an order book that's around $900 million. It gives us really good visibility into what our customers' demand is. We have really good visibility, particularly in the second quarter and into the third quarter, and so our guidance is based upon what customers are telling us they need in the near term based on actual orders. We highlighted last year on the third quarter earnings call and the year-end earnings call that last summer, we saw customers adjusting what we thought were adjusting inventory levels. We got some of the dear supplier letters on inventory adjustments that they do for mass adjustments, and we believe what we're seeing and experiencing now is normal inventory management by our customers. Many of them have said that they are working to reduce their inventory levels. We've got all of that factored into our guidance. We think we started off the year with a strong first quarter, up 10%. And for the full year, we're confident of 9% to 11% sales growth.

All right. Certainly, very helpful. And then maybe on the other side in terms of potential tailwinds, a lot of conversations around emerging PSA products. So I'm just curious if there's any way that you could frame maybe the contribution of some of those products to the trends we're seeing in Cardio & Vascular. And then maybe just around the broader electrophysiology subsegments and the contribution to the quarter, and how you're thinking about it for the rest of the year as contemplated in the guidance.

Certainly. We've talked a lot about our strong position in electrophysiology, everything from access devices through diagnostics as well as the ablation therapy itself, where we are highly vertically integrated. We're involved in a number of new programs, and we're excited to support our customers in bringing new and innovative therapies in that space in particular to the marketplace. We've experienced very strong electrophysiology growth. Last year, we had very strong growth in electrophysiology that continued into the first quarter. We expect that to continue throughout the year. We have our best estimate factored into our guidance, based upon our customers' ramp programs and their launch programs. I would highlight our emerging PMA customers. We increased the growth forecast for those customers at the end of last year or beginning of this year, which we had done in the previous year as well. We're excited about those new programs; many of them are in emerging neuromodulation therapies and applications. We have structural heart programs that are launching that we're excited about. So we're excited about last year's strong top-line growth at 16%. And this year, we think 9% to 11% on top of that continues to demonstrate the success of our strategy of partnering with our customers.

Maybe if I can sneak in one more question. Just like one other thing that stood out, you quantified the 2 big segments, now over 90% of sales, but just given the magnitude of the decline in Biomedical, just curious maybe if you could touch on what the key driver of that was? And if we should think about it getting a little bit more towards, I mean, I guess, really how to think about it for the rest of the year, maybe sequentially compared to like the baseline from Q1.

Sure. We've given guidance on Electrochem, a non-medical segment, that we expect $32 million to $36 million of sales for the year, which will be a drag of 50 to 75 basis points for total Integer. You can do the math on a year-over-year basis. In the first quarter, it was a drag of about $7 million, so almost 200 basis points in the non-medical segment. So Medical segment in the first quarter was actually up 8.5% organically. You can see that in our press release, and when we filed the query, we provide that level of detail. In particular, the first quarter and what we expect the first half to be down on a year-over-year basis, Electrochem had a couple of significant supply chain disruptions that suppressed their sales back in the 2021, 2022 time period. We recovered from those supply chain challenges and had a bolus of backlog orders that we fulfilled in late '22 and the early part of '23. What we're seeing is that we're normalizing to what we expect to be a run rate for that business of $32 million to $36 million for 2024. We would expect that to grow mid-single digits going forward.

Your next question comes from the line of Matthew O'Brien from Piper Sandler.

I would like to follow up on the electrophysiology aspect. Joe, would you say that your company has the most exposure compared to your competitors to the growing dynamics in the market? Do you have a broad range of exposure, considering that several companies are developing products in this area? Will you be able to supply everyone, or is your focus limited to just a few companies? Apologies for the lengthy question, but will you be supplying full catheters, or just parts of individual catheters?

Thanks for the question, Matt. Unfortunately, I can't share specific details about our customers or the precise support we're providing. Our customers prefer that we don't publicly discuss their innovative programs and products that contribute to their growth. What I can share is that we are very vertically integrated, handling everything from components to the delivery of finished devices. We don’t have the same content for every device available or in production. However, due to our extensive capabilities, we can serve a wide range of needs, though this varies by customer. The success of our clients impacts us in both the short and long term. Our portfolio is broad; we offer everything from access products like guidewires and guiding sheaths to necessary diagnostic and ablation catheters. We are robust in access and diagnostics, which often allows us to be flexible with the therapy options. As the market expands, we grow in tandem. What we provide to our customers can be significantly influenced by pricing and the composition of the bill of material. We anticipate that as electrophysiology develops, our access, delivery, and diagnostic strengths will lead to success. I’d like to emphasize that we experienced significant growth in electrophysiology last year, and we expect this trend to continue throughout the year.

Got it. And then a follow-up question on C&V specifically, you had a tough comp here in Q1, but still put up pretty good growth. But I think it's maybe just a little bit below what some folks were expecting. So I'm just wondering with all these new PMA products that are coming, do you anticipate a lot more contribution from those products here in the last 3 quarters of the year and really strong performance out of that C&V business for the remainder of '24?

Sure. C&V grew a reported 16% for the first quarter. We think that's a pretty strong result given the broad mix of products and markets that we serve. We saw an 18% increase on a rolling 4-quarter basis. We also have the acquisitions in there that are helping. So that includes the benefit of those acquisitions, but even without it, on an organic basis, we still grew high single digits. So very, very strong results for the C&V business. We would expect C&V to continue growing throughout the year, especially as new programs launch across structural heart and electrophysiology and as we get the commercial synergies from the Pulse and InNeuroCo acquisitions. Although that won't necessarily be organic this year because of the timing of the acquisition, that will fuel organic growth when we get into '25 and beyond.

Your next question comes from the line of Craig Bijou from Bank of America.

So another question on the EP business. I recognize that you guys don't provide a lot of color on customers. But if you look at the business that you have today in the aggregate, I mean is there any way to quantify or directionally give some color on the portion of the business that's components versus full catheters today? And then how does that change with the new PFA launches? I believe you guys have said that you could see more content in the aggregate on PFA devices versus your existing portfolio?

Yes, great question. I would start with we're strong in components assembly, and assembly, you can think of that from a few components to a significant number. We do have finished device capability and currently assemble finished devices. But the majority of our business is going to be in components and subassembly. Our customers often desire final device assembly, but we also have finished devices that we're producing today. As we move into the new programs, we are always working to take advantage of our vertical integration to help customers accelerate their speed to market, giving them the synergies of having more of the device under one company, one roof, and one supplier so that they have fewer partners to work with. That's a competitive advantage of vertical integration. We're always looking to get a higher percentage of the bill of material and incorporate more components into the device. That's our strategy with every next-generation device: to achieve a higher percentage of the bill of material.

Great. That's helpful. And on operating income growth, obviously, it was pretty strong at 26% in Q1, but you didn't change the guide for the year, which implies a bit of a slowdown or less leverage, if you will. So is that simply conservatism or are there other things that we should be considering as you're moving throughout the year that may affect the amount of leverage you guys can deliver?

Sure. Thanks for noting that. 26% is a very strong quarter. Last year, I'll start with 2023, we got progressively better throughout the year on the margin rate. You can see the adjusted operating income grew every quarter on a sequential basis. If you look at 2023 by quarter, you'll find the first quarter was the lowest, and the fourth quarter was the highest. We would expect that pattern to repeat throughout 2024. I’d point out that the supply chain environment has improved significantly compared to where we were last year, with the number of disruptions and their impact greatly reduced. We had significant turnover challenges in direct labor in 2022, but we have improved throughout 2023 and into 2024. Direct labor turnover continues to improve, which has helped us drive margin expansion. We would expect, throughout 2024, to be able to sequentially grow both sales and profit, in line with the pattern last year. The comps will get tougher as the year progresses. I would suggest looking at last year's quarter splits while considering our expectations for growth. At the high end of our guidance, we're growing profit 1.9x the rate of sales; at the midpoint, it's 1.7. We think that 13% to 20% profit growth for the year is very strong, and we're excited about our 26% growth in the first quarter.

Got it. Helpful. And if I could just squeeze one more in on PFA. I think you said that you've included your best estimates in your guidance. What would have to happen from PFA or in PFA for you guys to see upside to your guidance this year?

Yes. Maybe I'll answer that by saying, if you think about what we do for our customers, we manufacture components, subassemblies, and finished devices. If it's a component or sub-assembly, it gets shipped to one of our customers' manufacturing plants. They then build that into a product and put it into their distribution channel for procedures. For us to see upside, our customers would have to place significantly more orders into our order book and increase their manufacturing plans to drive volume on us. When we build a product in the second quarter of 2024, that won’t go into a procedure until the second half of '24 or maybe even early 2025. You need to consider the demand on us relative to procedure volume timing. If customers increase their manufacturing and their orders on us, we'll deliver that for them. Given our primarily sole source nature, we ultimately reponses to their end market demand.

Your next question comes from the line of Kristen Stewart from CL King.

Congratulations on a good quarter. I was wondering if you could just share a little bit more further details on InNeuroCo and Pulse technologies, how they performed in the quarter and expectations for the year? And then any update on your thinking on M&A perspective?

Certainly. InNeuroCo and Pulse are off to a great start. They both had strong first quarters. It's always good when they meet or exceed the plans we have for them in the initial quarters. We're seeing operational synergies; there are benefits and things we've learned from their operations. We believe we've been able to share some insights, and it's a two-way sharing process. We expect to see operational synergies this year. From a commercial standpoint, we have a strong pipeline of conversations and activities with customers that we believe will help us accelerate those businesses, and we're very excited about having them as part of Integer. The integration thought process is well underway, and we expect to see organic growth accelerate from those two businesses when we get into 2025.

And then just thoughts on the M&A landscape?

Yes. Great, great. Sorry, I missed your second part. We continue to curate a number of opportunities in our pipeline. We never stop that process. The variable really is when do we have the debt leverage capacity to be able to do an acquisition. We ended the first quarter at 3.4x leverage after the two acquisitions in October of last year and January of this year. So we're well within our strategic range of 2.5 to 3.5x. Based on cash flow and EBITDA growth, we expect to have more capacity in the second half of the year to continue with tuck-in acquisitions while maintaining that leverage. We believe we have a competitive advantage in curating opportunities for these tuck-ins with founder-led or individually-owned businesses, and we'll continue to execute that strategy, which has been working well for us.

Joe, I have a broad question regarding your long-term outlook of 4% to 6% market growth plus an additional 200 basis points. You mentioned frameworks established a few years ago, and it seems that new industry developments like PSA and tricuspid therapies might impact this. Could this suggest a higher structural growth rate for your business?

That's a great question, Nathan. I would say, absolutely, the ultimate over time as the mix of the business shifts into a higher percentage in the faster-growing end markets that we've been targeting, we absolutely expect the average market growth rate of our sales mix to increase. When we define market growth, we use our sales mix. I absolutely expect over time that as the portion of sales in electrophysiology, structural heart, neuromodulation, and neurovascular increases, our market growth rate also increases. Having 80% of our development programs in those targeted growth markets will absolutely lead to that faster growth. Our ultimate measure of success is, are we growing faster than the market, which is how we know that we're winning.

Okay. And how are you thinking about gross margin in 2024? Can you talk about the cadence relative to the 28% in Q1? You previously talked about pricing being flattish in 2024, but are you able to take price to offset any lingering inflation?

Our pricing for the year is largely established, but there will still be pockets of opportunity as the year progresses. However, we're comfortable with a flattish pricing outlook for 2024. We would expect to see continued gross margin improvement throughout the rest of the year. At midpoint, we're at 91 basis points of operating margin improvement, and we would expect some of that to come from gross margins, but we also work diligently to control operating expense, SG&A, and R&D expenses after recovering some from our customers. We’ll work to achieve operating expense leverage as well. Gross margin improvement is expected to continue throughout the year.

Your next question comes from Joanne Wuensch of Citi Group.

This is Phillip Ilmar on for Joanne. Just quickly, I was wondering if you could touch on how internal and external investments are that you're making to build up the portfolio? I guess how you're seeing consolidation of share across your customers as you expand your portfolio?

Certainly, if the question is about internal and external investment, I'd point to the CapEx investments we're making this year, which is still at a slightly elevated level due to the two Irish facility expansions we discussed. From a CapEx timing, I expect the first half CapEx to be high, with a step down in the second half as we complete the build-out of those two facilities. You can see the first quarter is at a higher than average level. For external investment, if you mean acquisition or inorganic growth, we are very excited about the two recent acquisitions, and expect to have more debt capacity in the second half of the year. Regarding customer or supplier consolidation, we continue to hear from our customers that they want fewer, stronger, more strategic partners. We believe this plays to our advantage. We're incredibly well positioned to help them consolidate their supply chain, whether through acquisitions or continued vertical integration, even if we're not doing a finished device. Integrating components and doing subassemblies enables us to consolidate our capabilities, which we view as a competitive advantage, helping us accelerate our top line while supporting our customers’ strategies.

Great. And then on operating margins, I mean you were able to extend margins about 200 bps in the quarter. I'm just wondering where you had the most success? And where do you see the most room for opportunity for the rest of the year?

Certainly. It was a combination of the improving supply chain and the labor turnover, which enabled us to recover efficiencies while annualizing some of the price pass-through for inflation we implemented last year. As the supply chain and labor environment stabilize, we are working out some of the inefficiencies. I would also point out that we do not expect to have 26% growth in operating profit for the year; the 13% to 20% remains our estimate. Every quarter in 2023, we improved our operating profit and margin rate sequentially, and we expect that continuous improvement to follow throughout 2024 as well.

There are no further questions at this time. I will now turn the conference back over to Andrew Senn for closing remarks.

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

Ladies and gentlemen, that concludes today's call. Thank you all for joining. You may now disconnect.