Earnings Call Transcript - ITGR Q1 2020

Operator, Operator

Good afternoon. My name is Adrienne, and I will be your conference operator today. At this time, I would like to welcome everyone to the Integer Holdings LLC Q1 2020 Earnings Call. I would now like to turn the call over to your host, Tony Borowicz. Please go ahead, sir.

Tony Borowicz, Host

Good afternoon, everyone. Thank you for joining us, and welcome to Integer's first quarter 2020 earnings conference call. The call is being webcast live, and the replay, along with a copy of the press release and 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 a reconciliation of these non-GAAP measures, please see the appendix of today's presentation and the notes of the financial statements in today's earnings release. As a reminder, 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. Joining me on the call to discuss our first quarter results are Joe Dziedzic, President and Chief Executive Officer; and Jason Garland, Executive Vice President and Chief Financial Officer. On today's call, Joe will provide opening comments and discuss the impact of COVID-19 and Integer's response. Jason will review our financial results for the quarter and talk more about Integer's strong financial position in the context of the COVID-19 environment. Joe will come back on to provide his closing remarks, and then we will open it up for your questions. At this point, I'd like to turn the call over to Joe for his comments.

Joe Dziedzic, CEO

Thank you, Tony. These are clearly unprecedented times. As we operate through the COVID-19 pandemic, our priority is the health and safety of our associates. At the onset of COVID-19, we mobilized our global pandemic team and put in place strict safety measures and protocols to protect our associates and their families. As an essential provider to the medical device industry and, on a much smaller scale, the energy sector, we are ensuring the continuity of our product supply to our customers. I am proud of all of our employees and want to thank them for their extraordinary efforts that enable us to continue to deliver the products that patients rely on every day. The dedication of our associates, especially our manufacturing associates who continue to build products, has been inspiring to all of us within Integer. It has taken a total team effort to manage in this new environment, and I am proud of the agility and the ingenuity the team has demonstrated while we protect our associates and deliver for our customers. To ensure the continuity of our operations, we have implemented many safeguards, including social distancing, disinfecting workstations, quarantining when necessary, restricting travel and having employees work remotely whenever possible. We have also actively engaged with our global suppliers to ensure we have adequate supply chain capacity. We maintain daily monitoring and communication with our suppliers to track and mitigate risk. I'm pleased to report that we have had minimal disruptions within our global supply chain, and I want to thank our suppliers for their cooperation and continued support during these challenging times. We remain in close and constant communication with our customers to respond to their evolving needs as they respond to the temporary decline in medical procedures. Most of the changes have been reductions in demand, but there are some products we build that are now in higher demand, including components and subassemblies for ventilators and patient monitors. We have been ramping production to meet this accelerated demand. Turning to our financial results. Our first quarter was largely unaffected by COVID-19. We had a strong quarter in line with our expectations with sales up 4% and adjusted earnings per share up 25% over last year. Our Medical sales were particularly strong, increasing 5%, whereas our Electrochem sales were negatively impacted by the significant downturn in the energy sector. Jason will provide more color on our product line sales results later in the presentation. Given the significant uncertainty created by COVID-19, we are suspending our financial guidance. We will resume providing financial guidance once we have more certainty that the economic environment has stabilized and we can provide more reliable projections. To provide more perspective on how we are thinking about COVID-19, I'd like to offer commentary on three things: our view of how COVID-19 is impacting our industry; how we see it impacting Integer; and the actions we are taking to manage this impact. Given where Integer is in the supply chain and the fact that we touch many medical device markets and almost every OEM in the industry, Integer is in a unique position to provide insights into the industry trends. First, let me give you our perspective on how we see COVID-19 impacting the industry. It is important to clarify that this is our interpretation of the impact compiled from everything we are learning. Though the COVID-19 impact was being felt outside the U.S. earlier in the first quarter, the impact on the medical device industry began to be significantly felt when the U.S. lockdown started on March 16. The industry OEMs have shared during their recent earnings calls that they felt this impact immediately with most experiencing dramatically lower volumes over the last two weeks of March. There seems to be a clear consensus that the second quarter will be the most significantly impacted quarter of the year due to the prevalence of shelter-in-place orders and the ban on elective medical procedures in many locations in the U.S. and other hotspots around the world. The definition of an elective procedure has been difficult to define with clarity at times as ultimately, patients decide whether to go to a hospital or emergency room when an adverse health event occurs. As the U.S. has begun to reopen and allow elective procedures, the recovery is positioned to start, which suggests an improvement in the third quarter on a linear basis. Barring a second wave of the virus in the fall or winter, the industry could begin to approach normal run rates by the end of the year. Turning to Slide 10. We point to some of the public statements that med device companies are making regarding the depth of the sales decline and the possible speed of the market recovery. We have used what we are hearing from our customers to draw conclusions on the direction of the industry. This slide is intended to provide a graphical depiction of the wide range of possible recovery outcomes for the industry. Please note this is our estimation, and the line in the middle of the range is not intended to be a precise prediction or the most probable outcome but simply the midpoint of what is a reasonably wide range of potential outcomes. Generally, this curve supports everything we are hearing and seeing. The second quarter should experience the most severe impact on the industry. The third quarter is better than the second quarter but still down on a year-over-year basis, and the fourth quarter continues to show improvement but is still below the prior year. Only in the most optimistic scenarios does the fourth quarter actually grow on a year-over-year basis. Now let me turn to how the shape of the industry recovery will impact Integer. Note that the impact on Integer will be more than just how medical procedure volumes decline and recover but will also include a blend of how our customers manage this cycle, including their inventory levels. We expect, based on experience to date, that there is a one to two-month delay between the time medical procedures decline, which is when our customers' volume declines, and when we see a corresponding decrease in our sales. The fact that we did not see a change in our orders for the second half of March is evidence of this delay. As you've heard on a number of earnings calls already, we also expect to see a temporary contraction in our margin rates during the quarters we experience a decline in sales. Sudden and sharp volume declines have a greater impact on margins as it takes time to put in place the necessary actions to match less variable or even fixed cost with volume. Jason will cover this topic in more detail in his review of the financials. Let me turn back to the shape of the industry curve and the correlation to Integer. As reported, many of our customer earnings calls stated their volumes began to decline significantly in mid-March when the U.S. shelter-in-place orders began. It takes our customers time to identify the sales decline, determine how they are going to react to the decline, reschedule their manufacturing plans and then communicate to their suppliers. I'll offer some perspective on our preliminary April sales, which is not representative of medical procedure volumes. However, it does provide some indication of what to expect for the second quarter. Our April sales were down about 20% versus last year, which we believe does not yet reflect the full impact of the medical procedure volume decline. With the delayed impact on Integer and the blend of customer responses to COVID-19, we believe our third quarter may be similar to our second quarter. By the fourth quarter, we expect our sales to align more closely with the industry trajectory as the delay in inventory management approaches become less impactful. We estimate that approximately 75% of our sales are tied to either moderately elective or more urgent medical procedures. I know it's stating the obvious, but the elective procedures on the left-hand side of this slide have seen the most dramatic decline in demand from our customers. Our product mix will help us weather this pandemic, and we will be ready to support our customers and their patients as medical procedures return to normal levels. First and foremost, we continue to execute the strategy we launched in 2018. Our strategic focus on customers, cost, and culture has positioned us to withstand the temporary impact of COVID-19. We have a resilient business model and a strong financial position with ample liquidity. It is this financial strength that will allow us to continue to invest in critical capacity and capabilities for growth. We are taking necessary actions to address our variable and discretionary cost related to the temporary volume decline, but it is important to note that we will not take any actions that will impact our ability to grow our business over the long term. Our confidence in our ability to continue our journey to excellence is based on the progress we have made in executing our strategy. Over the last three years, we have significantly reduced our debt leverage and have the liquidity needed to keep investing to drive long-term growth. By continuing to execute our strategy, we are well positioned to successfully navigate these uncertain times.

Jason Garland, CFO

Thank you, Joe. Good afternoon, everyone, and thank you again for joining our call. I'll provide more highlights on our first quarter 2020 adjusted financials and then share our perspectives on why we believe we are well positioned to weather this pandemic as well as offer more clarity and transparency on how we are taking a balanced approach to managing cost during what we believe will be a temporary reduction in our sales. As Joe highlighted, we delivered strong first quarter results that were mostly un-impacted by COVID-19. Sales increased by 4% to $328 million. And consistent with our strategic financial objectives, our profit grew greater than twice the rate of sales with adjusted operating income increasing 10% to $59 million. Adjusted EBITDA increased 8% on a reported basis. New from prior earnings presentations, we have now included adjusted operating income. We believe this metric comprehensively reflects our performance in managing all operating costs in the business. Finally, at $41 million, adjusted net income grew 26%, and adjusted earnings per diluted share grew to $1.25, an increase of $0.25 or 25% on a year-over-year basis. The first quarter also benefited from favorable foreign exchange impact. As we strive to be transparent in the impact that the COVID-19 pandemic is having on our business, we saw an approximate $0.06 per share drag in the first quarter. Half of this is due to the impact of increased costs and implementing and operating in a social-distanced environment in our manufacturing plants. The other half is due to the decline in Electrochem sales, which includes COVID-19 and the broader impact of the energy market decline. As a reminder, Slide 22 reflects trailing 4-quarter organic adjusted sales growth rate. We believe this is a more meaningful indicator of our growth trend and how we are performing in the market versus an individual quarter, which may contain anomalies resulting from the timing of customer purchasing decisions. With Cardio & Vascular being the largest contributor, we finished the first quarter of 2020 with trailing 4-quarter adjusted sales up 3%. Further on Cardio & Vascular, the product line's organic sales were up 17% in the first quarter, led by a strong increase in peripheral vascular demand driven by customers' continued launch of an existing program into a new geography coupled with strong overall growth across most markets. Electrochem sales declined 25% in the first quarter, driven by a severe decline in the energy market due to both an oversupply of oil early in the first quarter and demand reduction from the COVID-19 pandemic through the latter half. We anticipate the market downturn and the reduced demand for our products in this segment could be prolonged, and we have responded with actions to reduce costs. As our philosophy on cash management, leveraging cost management are central to our financial strength, let me offer more details about these in my final three slides. I will start with our first quarter cash flow, debt and leverage results as the foundation of our financial position. We generated $32 million in cash flow from operating activities and $18 million in free cash flow in the first quarter. Even though the first quarter normally has the lowest cash generation during the year due to the timing of our annual bonus and customer rebate payments, we did see an improvement versus the first quarter of 2019.

Joe Dziedzic, CEO

Thank you, Jason. Especially during these uncertain times, it is important that all of our stakeholders understand how we continue to lead Integer. Everything starts with taking care of our associates, our frontline teammates who build the products for our customers and their patients. I want to take this opportunity to once again thank our manufacturing associates and our site leadership teams who continue to put themselves at risk every day for our customers and their patients. They are our Integer heroes, doing their part to support humanity during this crisis. We will continue to implement every social distancing and protective measure available to protect them while they deliver for the patients who need our products. And to all of our non-manufacturing associates who continue to support our operations mostly from remote locations or managing through the personal aspect of this crisis while also continuing to ensure all of our business processes are performing during this pandemic, I'd like to extend my gratitude for everything they are doing to support our manufacturing operations, our customers and the patients they continue to serve.

Tony Borowicz, Host

Thank you. And I know our prepared remarks were a bit longer this time, but hopefully, you found them informative and transparent. You can listen to the replay of this call on our website. So thank you for your continued interest in Integer, and above all else, please stay safe.

Operator, Operator

You may now disconnect.