Earnings Call Transcript - ITGR Q4 2020

Operator, Operator

Ladies and gentlemen, thank you for standing by, and welcome to the Integer Holdings Corporation Q4 2020 Earnings Call. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Tony Borowicz, Senior Vice President of Strategy, Corporate Development and Investor Relations. Thank you; please go ahead.

Tony Borowicz, Senior Vice President of Strategy, Corporate Development and Investor Relations

Good morning, everyone. Thank you for joining us, and welcome to Integer's Fourth Quarter 2020 Earnings Conference Call. With me today are Joe Dziedzic, President and Chief Executive Officer; and Jason Garland, Executive Vice President and Chief Financial Officer. 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 measures. For a 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, which are available on our website at integer.net.

Joe Dziedzic, President and CEO

Thank you, Tony, and thanks to everyone for joining the call today. I'd like to start by recognizing the Integer associates who worked every day during 2020 to produce products for our customers and patients. The dedication and sacrifice they make to deliver for our customers and their patients are the reason I can join this call today with confidence that Integer is well positioned to continue delivering on our commitments. We delivered fourth quarter sales at the high end of our guidance and profit above our guidance. The fourth quarter was the start of the recovery for Integer, and our sales increased 14% from the third quarter. Our profit margin rate increased 350 basis points from the third quarter, recovering with the expected volume increase, and exceeded our guidance by 50 basis points. On our last earnings call, we estimated the industry would grow low single digits year-over-year during the fourth quarter, which would have been an improvement from the third quarter. Our view on the fourth quarter today is that the industry declined low single digits on a year-over-year basis, similar to the third quarter industry results. Since our fourth quarter sales were at the high end of our expectations, we think our customers built some inventory during the fourth quarter. We expect this inventory will be depleted over the first and second quarters of this year, and we have incorporated this impact into our 2021 guidance. Despite the pandemic, we reduced net total debt by 15% last year, a reduction of $123 million, demonstrating our continued strong focus on cash management. During 2020, we remained focused on executing our strategy, and it delivered for both our associates and our customers through improved safety, quality, and on-time delivery. We increased our overall investment in manufacturing capabilities and capacity, additional R&D engineers, and numerous other areas of the business. Our 2021 outlook reflects our view of the trajectory of the industry recovery, including our margins expanding with the volume recovery. Jason will cover this in more detail later.

Jason Garland, Executive Vice President and CFO

Thank you, Joe. Good morning, everyone. Thank you again for joining our call. I'll take this time to provide more details on our fourth quarter and full year 2020 adjusted financials. I'll provide an update on our cash flow and conclude with our expectations for 2021. I'll start with our fourth quarter results, which continued to be meaningfully impacted by the COVID-19 pandemic. Fourth quarter sales were at the high end of our guidance and up $33 million sequentially over the third quarter. At $269 million, this was down 17% versus the prior year. At $38 million, our adjusted operating income exceeded the high end of our guidance and was up $13 million sequentially over the third quarter. This was 38% lower than the prior year. As projected, our fourth quarter profitability improved significantly over the third quarter on the increased sales, combined with the continued focus on manufacturing excellence and cost containment. Having maintained strategic investments throughout the pandemic, we remain confident that Integer, our customers, and the patients we ultimately serve will benefit. Moving to Slide 20. Our full year financials clearly reflect the impact of the pandemic. Sales decreased by 15% to $1,073,000,000. Adjusted operating income decreased 39% to $144 million and we reported $92 million of adjusted net income, a decrease of 41%. Turning to Slide 21. We see the graphical representation of the impact that a 15% year-over-year reduction in sales had on our full year 2020 adjusted net income. Our balanced approach to cost management during a temporary but steep reduction in sales is also included in the operational drivers column. We saw a $76 million reduction in our adjusted net income in 2020 versus the prior year due to the impact COVID had on our volume and deleveraging. Our strength in cash flow generation, continued focus on debt reduction, along with lower LIBOR, all contributed to the reduction of our interest expense by $10 million and contributed $0.31 per share of growth. The impact from our effective tax rate also contributed $5 million of year-over-year income growth. 2020 benefited from discrete items related to the favorable finalization of 2017 tax reform regulations, tax credits that exceeded our original 2019 return provisions and our tax planning strategy to optimize foreign tax credits. These discrete items drove a more pronounced reduction in our effective tax rate as the absolute dollars of tax savings are applied to a greatly reduced income before taxes due to the pandemic. Given this, our full year adjusted effective tax rate was 12.2% for 2020. As the impact of the discrete items will not repeat, we expect our 2021 effective tax rate will increase over 2020, but will be better than 2019 from our ongoing strategic tax planning actions. In the fourth quarter, we continued a strong conversion of income to cash and generated $71 million in cash flow from operating activities and $59 million in free cash flow. This included $29 million of cash collected as a result of the patent litigation judgment being affirmed in Integer's favor by the United States courts of appeal. In the fourth quarter, we reduced our net total debt by $59 million and for the full year by $123 million despite the COVID-19 pandemic. We continued to steadily reduce our net total debt, consistent with our strategy. However, our debt leverage ratio did increase to 3.6x adjusted EBITDA as our trailing 4-quarter adjusted EBITDA is lower given the impact of the COVID-19 pandemic on the second, third and fourth quarter profit. We also continued investing in our strategy with $47 million in primarily growth-related capital expenditures in 2020, a level similar to our investment in 2019. Next, we'll talk about our expectations for 2021. You may recall that we suspended our financial guidance in early 2020 due to the significant uncertainty created by the COVID-19 pandemic. While we remain in the midst of the pandemic and still face considerable uncertainty, we are resuming financial guidance in keeping with our commitment to provide as much clarity and transparency as possible. We will begin with sales on Slide 24. We expect 2021 sales to be in the range of $1,160,000,000 to $1,200,000,000, an increase of 8% to 12% versus 2020. We project sequential improvement for the second consecutive quarter, with the first quarter of 2021 growing over the fourth quarter of 2020. This growth is supported by our current orders backlog and incorporates the slower industry recovery during the fourth quarter of 2020. We expect the second quarter to be similar or slightly better than the first quarter, with improvements in the second half of the year to be largely determined by the pace of market recovery. We also expect that our quarterly year-over-year growth rates will continue to differ from the industry due to the timing differences of the COVID impacts we saw in 2020. Let me now turn to our outlook for the full year 2021. As shared on the prior page, we expect sales for the full year to be in the range of $1,160,000,000 to $1,200,000,000, an increase of 8% to 12%. We expect 2021 adjusted operating profit to be between $170 million to $190 million, reflecting a growth of 18% to 32%. We expect adjusted net income to be between $113 million to $130 million, reflecting a growth of 23% to 41%. Our projected profit growth is driven by the expected volume recovery and strong productivity from our manufacturing excellence imperative, partially offset by an estimated increase in costs from incentive compensation. The stock-based compensation component of this expense is estimated to increase by approximately $9 million from the increased tenure of our leadership team and lower expense in 2020, as the pandemic caused the 2018 organic sales growth equity awards to yield no payout. Turning to Slide 26. I'll provide some color on our first quarter outlook. Because of the unprecedented impact of the pandemic, we suspended guidance in early 2020. We provided fourth quarter 2020 guidance because we felt we had solid near-term visibility and it would help investors interpret the pace of the recovery on Integer. We are providing a full year 2021 view of the recovery with specific guidance for the first quarter of 2021 to provide insight into the pace of the recovery as we entered the new year. We do not intend to provide quarterly guidance as a regular practice, but felt during this period of greater uncertainty, this additional insight would be particularly helpful to investors. With our backlog continuing to improve, we expect continued sequential improvement in sales, and the first quarter will be between $280 million to $290 million, up approximately $10 million to $20 million over the fourth quarter of 2020. It is important to highlight, the year-over-year decline of 12% to 15% versus the first quarter of 2020 is because Integer sales were not impacted by COVID during the first quarter of last year. We expect adjusted operating income margin rates to continue to grow with increased volume, consistent with the two prior quarters, including our strategic investments. As a result, we expect the first quarter 2021 adjusted operating income margins to be 90 to 210 basis points higher than the fourth quarter of 2020. Finally, on Slide 27, we expect to generate cash flow from operations and free cash flow in the range of $145 million to $165 million and $90 million to $110 million, respectively. In 2021, consistent with our strategy to increase our strategic investments in the business to drive growth, we expect to increase capital spending to a range of $50 million to $60 million. Given the free cash flow projection, we anticipate a reduction of net total debt between $90 million to $110 million in 2021 and expect to return to a target debt to adjusted EBITDA leverage range of 2.5x to 3.5x. With that, I'll turn the call back to Joe. Thank you.

Joe Dziedzic, President and CEO

Thank you, Jason. Our journey to excellence slide has been updated to reflect our 2021 outlook that Jason just explained. Our strategic objectives remain the same, and I believe that despite the disruption of last year, we strengthened our company, and we are well positioned to resume our march to our long-term objective of sales growth that is 200 basis points above the market and to deliver sustained operating profit that is double the sales growth rate, all while maintaining a debt leverage ratio between 2.5% and 3.5%. I'll conclude our remarks today by offering our view on why now is a good time to be an Integer shareholder. We believe we have a clear vision, a compelling strategy, and strong values, combined with the most talented associates among all medical device outsourcers. The industry dynamics of mid-single-digit growth and high barriers to entry, combined with Integer's breadth of product portfolio, creates a very resilient business model. Integer's world-class research and development capabilities, our global manufacturing footprint, combined with our deep customer relationships, creates a compelling growth strategy. Our commitment to our associates and investment in their growth, coupled with our focus on building leadership capability to deliver performance excellence, creates a performance culture that is creating a competitive advantage. Finally, our recent track record of delivering on our financial commitments and generating strong cash flow reinforces our financial strength. I am confident in our strategy, in our associates and our ability to earn a valuation premium 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. Thank you.

Operator, Operator

Your first question comes from Jim Sidoti with Sidoti & Company.

Jim Sidoti, Analyst

I hope you all have power and are feeling well. I know it seems like it's a rough week to be in Texas.

Joe Dziedzic, President and CEO

We are managing through, Jim. Thanks for the greetings.

Jim Sidoti, Analyst

Okay. Regarding the guidance, I was pleasantly surprised that you provided both quarterly and annual guidance for 2021, which I consider a positive sign. What assumptions are you making for the nonmedical segment in terms of revenue? Do you anticipate that it will grow at a faster or slower rate? And will there be more growth in the second half of the year?

Joe Dziedzic, President and CEO

Jim, I think you just called it. Good summary. Our expectation for Electrochem on our last earnings call was that we expected no growth in 2021 versus 2020. And as you've seen in the financial results, the business declined from $58 million to $35 million in sales due to the oil and gas energy decline. What we're seeing right now is we really expect the first half to continue in the same trajectory that it's been on throughout 2020, so little to no growth in the first half of 2021. We do anticipate some uptick in the second half of the year. Maybe we get a little bit of growth in that business. But even a 10% growth on a $35 million business is only $3 million, so it's not meaningful to the total company growth rate or sales, but it would be nice to see the beginning of the recovery in the oil and gas industry. So our expectation is the second half; we begin to see some sort of a pickup in volumes. So maybe there's a few million dollars of year-over-year revenue growth for the full year '21 versus '20.

Jim Sidoti, Analyst

And on the medical side, are there any key new products in the industry that you think will help drive the recovery? Maybe the neuromodulation business or one of the other businesses that you think are going to drive the growth for 2021?

Joe Dziedzic, President and CEO

We want to highlight the areas we’ve been focusing on, particularly neuromod, which was significantly affected by the pandemic in 2020. We noticed this right away in March when the pandemic began, as it involves elective surgery. However, we observed a strong recovery in neuromod around June and July of last year, with excellent growth and volume return in the third and early fourth quarters. Unfortunately, mid-fourth quarter saw a decline due to rising hospitalizations and infection rates. This has been echoed by our customers discussing their neuro business, illustrating how elective the surgery remains in the short term. Long-term, there is substantial patient need in this business, and we believe it is highly underpenetrated. There is considerable innovation occurring, not just from emerging players but also from larger companies introducing more advancements this year and next. We expect the neuromod business to rebound with high-single-digit to low-double-digit growth moving forward. We believe we are well-positioned to support both large companies with component technology and smaller emerging players with comprehensive system design and high-volume manufacturing. Neuromod is a sector we anticipate will recover sooner than others. We are excited about 2021 and the prospect of moving past 2020. As heard from others in the industry, we expect to see continuous improvement month-over-month and quarter-over-quarter. For comparison, while the industry bottomed in the second quarter of 2020 with a significant V-shaped recovery, Integer experienced two quarters at the bottom due to our customers managing their inventory differently. The fourth quarter marked the beginning of our recovery, and we anticipate continued sequential improvement in our first quarter of 2021, with the fourth quarter up $33 million from the third. We’re guiding for an additional increase of $10 million to $20 million in the first quarter over the fourth quarter. While we may not see as much improvement in the second quarter, we expect a more significant rebound in the second half. We are enthusiastic about 2021 as we move forward on a growth trajectory similar to where we were before COVID-19.

Jim Sidoti, Analyst

All right. And the last one for me, if you look at your EPS guidance, the non-GAAP versus the GAAP guidance, really the biggest delta there is the amortization expense. And then the other one-time charges really trickled down to less than $0.20 annually. Does that indicate that at this point you're done with the restructuring?

Joe Dziedzic, President and CEO

Jim, we have reduced the non-GAAP adjustments to single-digit millions. You might recall that four or five years ago, that number was between $40 million and $50 million due to the integration of Greatbatch and Lake Region. We have managed to bring it down, as you've pointed out; it's primarily due to amortization and stock-based compensation, which are commonly excluded in industry metrics. Our current restructuring efforts are more selective and focused. I believe you will continue to see it remain in the single-digit millions of dollars.

Operator, Operator

Your next question comes from Matthew Mishan with KeyBanc.

Matthew Mishan, Analyst

Hey, Joe, just bigger picture, after the last couple of very strange years, what kind of changes are your medical device customers thinking through with their supply chain and how they manage that supply chain over the long run after this last couple of years? And how does that benefit you? Or how could that benefit you?

Joe Dziedzic, President and CEO

Thank you for the question, Matt. The pandemic and various national disasters over the past few years have highlighted the importance of the supply chain, emphasizing resiliency, financial stability, and innovation. Our customers expect us to drive innovation and bring advanced technology to support their operations, demonstrating the same level of performance as their own facilities. It is evident that our customers are eager to invest more in developing therapies, clinical trials, and product commercialization rather than manufacturing, despite the relatively high returns that manufacturing investments can generate. They prefer us to provide a comprehensive range of capabilities, which we are prepared to do. Our continued investment in technology is aimed at enabling their strategies while allowing them to focus on therapy development. We observe a growing demand for redundancy and business continuity, which is reflected in our investments in facilities, such as dedicated lines for quick-turn prototyping and specific technologies to accelerate their time to market. Customers are increasingly interested in outsourcing and are seeking partnerships with reliable providers. Recent supply chain disruptions due to the pandemic, suppliers in Asia, and natural disasters have made redundancy and business continuity critical for them. They recognize that if they fail to meet market demand, other industry players will take over. This underscores the foundational importance of our offerings. A company like ours, which possesses redundancy, financial strength, advanced technology, proven quality, and capacity to deliver on time—backed by ongoing investments—places us in a distinguished position. Our strategy is focused on enabling our customers' success, understanding their technology requirements, and being the leading manufacturer in the industry. We believe we are well-prepared to address their needs and align with their future investment decisions.

Matthew Mishan, Analyst

Joe, as you observe this sequential recovery progress for your team, how are you considering commodity prices or potential supply chain shortages in the industry? Do you believe the industry can manage the pace of change?

Joe Dziedzic, President and CEO

I know Integer can. I'm confident we can. I'm confident that we've demonstrated the agility during COVID to address the potential supply chain disruptions, to modify how we've run our business, protected our associates and still delivered for our customers. I think this is a strong industry. It's mid-single-digit tailwinds across the industry. I think the providers like us, who understand our customers are investing in the innovation, investing in manufacturing and being great at manufacturing, while delivering innovation, are the ones who are going to succeed and who are going to be able to enable our customers' growth and deal with whatever challenges that the environment presents to us. So I'm confident that we have the agility. The industry, I think, has proven to be fairly resilient during the pandemic. I think that the hospitals have done a phenomenal job of adapting and adjusting. And I think supply chains overall have held up reasonably well in the med device sector.

Matthew Mishan, Analyst

Okay. I'll combine the last two questions into one. You made two smaller acquisitions in US BioDesign. First, how have those acquisitions contributed to the new product introductions or the backlog of companies under development that you mentioned last quarter? Additionally, I’d like to understand what your pipeline looks like for 2021, and if you’re getting closer to your target debt to EBITDA, does that suggest you might be more open to acquisitions next year?

Joe Dziedzic, President and CEO

The two acquisitions we made have performed as we anticipated, providing unique capabilities that enhance our customers' design development and speed to market. We are investing in both acquisitions to expand their capacity and capabilities, enabling them to better serve our customers and meet increasing demand. Despite being in the midst of a pandemic last year, we added more R&D engineers than planned due to strong customer demand, and we have continued this trend, increasing our R&D team by about 15% since 2018. We feel well positioned in this area, with the acquisitions demonstrating our commitment to enhancing the capabilities our customers require. This not only fills gaps in our capabilities but also addresses industry needs. We have successfully reduced our net debt by 15% during the pandemic, totaling over $120 million. As our EBITDA recovers to pre-COVID or 2021 levels, we expect our leverage to be on the lower end of the range of 2.5x to 3.5x. We are actively exploring acquisitions, focusing on specific capabilities, and as our leverage decreases, we will have the potential to pursue more substantial acquisitions if the right opportunities arise. Our focus remains on ensuring we achieve strong returns, as overpaying for an acquisition can impact long-term profitability. We are prepared to pursue larger acquisitions beyond just tuck-in opportunities if they fit our strategy and are appropriately priced.

Operator, Operator

There are no further questions at this time. I will now turn the call back to Tony Borowicz for closing remarks.

Tony Borowicz, Senior Vice President of Strategy, Corporate Development and Investor Relations

Great, thank you, Mariana, and thanks, everyone, for joining us on today's call and your continued interest in Integer. Please note this conference call is available on our website. Thanks again, and that concludes our call.

Operator, Operator

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.