Q2 2022 Integer Holdings Corp Earnings Call
Ladies and gentlemen, thank you for standing by my name is Brent.
And I will be your conference operator today.
At this time I would like to welcome everyone to the integer Holdings Corporation second quarter earnings call.
All lines have been placed on mute to prevent any background noise.
After the Speakers' remarks, there will be a question and answer session.
I would like to ask a question at that time simply press star followed by the number one on your telephone keypad.
If you'd like to withdraw your question again press Star one thank you.
My pleasure to turn today's call over to Tony Borowicz Senior Vice President of Investor Relations. Sir. Please go ahead.
Good morning, everyone. Thank you for joining us and welcome to entered your second quarter 2022 earnings Conference call with me today are Joe Dziedzic, President and Chief Executive Officer, and Jason Garland, Our 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 refer to the appendix of today's presentation today's earnings press release and trending schedules.
Which are available at our website at <unk> Dot net please.
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 an update on the execution of integer strategy Jason.
Jason will then review our adjusted financial results for the second quarter 2022.
Any additional insight on our product line performance and review our full year 2022 guidance.
Joe will come back on to provide his closing remarks, and then we'll open up the call for your questions with that let me turn the call over to Joe.
Thank you Tony and thanks to everyone for joining the call today, especially the integer associates, who have continued to execute our strategy through these dynamic times.
In the second quarter, we delivered financial results in line with our expectations shared during our last earnings call sales.
Sales grew double digits versus last year, and the first quarter of this year.
Our adjusted operating profit grew 28% versus the first quarter that was about flat versus last year as the current labor and supply chain environment had minimal impact on our second quarter results last year.
We have increased our full year sales outlook by $14 million to deliver 12% to 14% growth year over year.
We expect adjusted operating profit to grow 10% to 16% year over year as gross margin improves through the second half of this year.
We continue to make progress in executing our strategy to accelerate our topline growth.
We are executing structured and disciplined product line strategies to deliver faster sales growth.
<unk> is uniquely positioned to serve our customers across the full continuum of the product technology lifecycle from emerging technology to high growth and finishing with the mature phase.
We offer differentiated technology for the emerging phase can scale production during high growth and can vertically integrate and simplify our customer supply chain during the mature cycle.
Our organic and inorganic investments are focused on adding capabilities and capacity concentrated in the higher growth end markets of electrophysiology structural heart neurovascular and Neuromodulation.
We are delivering faster organic growth this year now 6% to 8% as a result of these strategies, we expect faster second half organic growth from the new product introductions that continue to ramp the rest of this year and into next year.
Our acquisitions are delivering as Oscar's sales are ahead of plan by $5 million and the integration of Aaron is on track.
Oscar has a strong pipeline of opportunities and has partnered extremely well with our operations and supply chain teams to deliver more than planned at the beginning of the year we.
We are generating strong engagement from strategic customers on the combined capabilities of Erin and integer and are excited about these new opportunities as well as aaron's existing strong pipeline.
We remain focused on executing our strategy to deliver on our financial objectives.
I'll now hand, the call over to Jason.
Thank you Joe Good morning, and thank you again for joining our call.
I'll provide more details on our second quarter 2022, adjusted financial results summarize our product line sales trends and conclude with our updated 2022 outlook.
<unk> second quarter results were consistent with our expectations to increase meaningfully over the first quarter sequentially versus the first quarter of 2022 sales grew 13% and adjusted operating income grew 28% at.
At $350 million of our second quarter sales grew 12% year over year on a reported basis and 5% on a year over year organic basis, which excludes the impact from acquisitions and currency differences.
Our adjusted EBITDA in the quarter was $66 million up $12 million sequentially versus the first quarter of 2022 and up $2 million compared to last year or an increase of 3%.
Adjusted operating income was $50 million, which sequentially grew $11 million versus the first quarter and is down slightly versus the second quarter 2021.
As the key driver to the adjusted operating income results.
Most margin also improved in the second quarter compared to the first quarter of 2022 and in the second half of 2021, but it is lower on a year over year basis.
Last year, we did not see a meaningful amount of incremental costs and inefficiencies from supply chain and labor constraints until the third quarter and therefore these costs were not impactful in the second quarter of 2021 comparison period.
These constraints have continued for the last four quarters and we remain committed to managing through these challenges to provide our customers and the patients they serve with the products they need even at higher costs. These higher costs have caused approximately 300 basis points of gross margin headwind and our most.
Driven by direct labor from higher than normal overtime inefficiencies from delayed material as well as high training costs and the incremental salaries per associates, we are hiring to support accelerating growth through the rest of 2022.
We continue to believe that the majority of these costs are temporary in nature, and they're reducing they're likely to remain through the rest of 2022 and into 2023.
Outside of production costs, our total operating expense, including SG&A and R&D grew year over year on a reported basis, primarily due to the addition of our score and Erin.
They were also impacted by an increase in the annual salaries and higher expenses and stock compensation incentives.
We expect SG&A expense to continue to be higher for the remainder of the year due to the same items and the timing of spend we expect second half R&D spend to continue at a similar run rate as the first half of 2022, but there may be lumpiness across the remaining two quarters due to the timing of key programs.
With adjusted net income at $35 million, we delivered $1 <unk> of adjusted diluted earnings per share down <unk> <unk> from the second quarter of 2021.
Ordinarily I would discuss our year over year adjusted net income bridge next however, since there are no meaningful year over year changes in any of the elements. We have moved this slide to the appendix for reference.
In the second quarter of 2022, we generated $19 million in cash flow from operating activities and generated $7 million in free cash flow inclusive of $12 million of capital expenditures in the quarter.
You may recall during the first quarter earnings conference call. We highlighted that we grew inventory by $20 million in the first quarter versus the end of 2021 to support our double digit sales growth in the second quarter and the second quarter, we increased inventory another $20 million. So a total of $40 million in the first half of the year.
To provide more color there are four key drivers to this $40 million increase.
First we have been rebuilding general inventory positions from the low point, we achieved during the pandemic when we closely preserved our working capital.
We continue to increase our raw materials start to match, our increasing product demand and sales.
We continue to proactively increase our safety stock levels to protect material availability for critical components and see this as an investment to ensure delivery of product to our customers and finally, we have been impacted by an increase in work in process inventory related to products that are partially built but waiting on delay compare.
We believe our aggregate inventory levels are where we need them to support growth in the business and expect improvement in our inventory efficiency.
Fly chain environment improves.
Net total debt increased $127 million to $938 million as we borrowed $129 million from our revolver in the first week of April 2022 to fund the acquisition of <unk>, excluding the new borrowings we reduced our net total debt by $2 million in the second quarter.
Our debt leverage at the end of the second quarter was three nine times trailing four quarter. Adjusted EBITDA. This leverage ratio includes the impact of the new borrowings to fund the <unk> acquisition.
Although we are temporarily above our target range of two five times to three five times in the second quarter due to the <unk> acquisition, we expect to be back within our targeted leverage range by year end.
We will now transition to a discussion of our product line sales.
Trailing four quarter reported sales grew 16% in the second quarter of 2022 with strong growth across our cardio and vascular CRM and N and electrical cab product lines.
Beginning with our first product line cardio and vascular sales were up 25% in the second quarter compared to the second quarter of 2021, though we still face supply chain constraints. The second quarter growth was driven by our ability to deliver on strong demand and the neurovascular electrophysiology.
<unk> and structural heart market and also benefited from the acquisition of Haas score and Erin.
Trailing four quarter sales continued strong year over year growth up 21% with strong double digit growth across all cardio and vascular markets.
Moving to the cardiac rhythm management and Neuromodulation product line sales.
Sales grew 2% in the second quarter with sales growth from our <unk> acquisition offset by labor and supply chain constraints, primarily related to long lead time components.
Trailing four quarter sales continued strong year over year growth up 13%.
In our advanced surgical orthopedic and portable medical product line, our second quarter sales were flat versus the prior year with a low single digit decline in advanced surgical and orthopedics and flat year over year sales for portable medical trailing.
Trailing four quarter sales declined 6% year over year due to a decline in the port of medical driven by lower demand for Covid related ventilator, and patient monitoring components versus last year and from advanced surgical and orthopedic sales being flat.
Finally, we will wrap up the product line discussion with electric our nonmedical segment.
So we see strength in our customer demand our ability to fulfill was constrained by specific supplier shortages impacting approximately $3 million of sales in the second quarter. We continue to work with our suppliers and are addressing these constraints trailing.
Trailing four quarter sales grew 15% year over year, driven by the recovering energy market.
We will now transition to our updated expectations for 2022.
Starting with sales, we are increasing our outlook by $14 million and now expect sales to be in the range of $1 $370 million to $1 $395 million, an increase of 12% to 14% compared to 2021.
On an organic basis, we now expect sales to grow 6% to 8% compared to 2020 months.
Our expectations for 2022, adjusted EBITDA are unchanged, we still expect to be between $273 million and $285 million, which is 13% to 17% year over year growth.
We are increasing our adjusted operating income outlook by $3 million and we expect 2022, adjusted operating income to be between $206 million and $218 million, reflecting growth of 10% to 16%.
Our updated adjusted operating income forecast incorporates the cost of headwinds from the supply chain and labor environment.
Adjusted EPS is now expected to be between $4 20 to $4 50.
Reflecting a growth of 3% to 10%, but down 12% from our prior outlook on both ends of the range.
Our adjusted effective tax rate remains unchanged from our previous outlook and is projected to be between 16% to 17, 5%. The lower adjusted EPS guidance is driven by an increase forecast in our interest expense, which we have increased by $7 million across our outlook range and now expect.
<unk> to spend between $35 million to $40 million. This is primarily driven by the increasing U S interest rate environment, and it's estimated by using a projected one month LIBOR forward rate curve the underlying index for our interest payments. The low end of our range assumes the one month LIBOR rate will rise to about two.
9% by year end and the high end of the range assumes that rate reaches nearly four 3% up from june's average of approximately one 5%.
16% of our debt has a fixed rate through the through an interest rate swap and the rest will move with LIBOR, we subscribe to the view that floating with the market produces the best outcome over the long term while at the same time, we continue to evaluate approaches to reduce interest expense.
As I close we expect cash flow from operations between $151 million to $166 million, which is $7 million lower than our previous guidance, reflecting the higher interest expense payments just discussed.
It is also inclusive of the inventory investment we have made in the first half of the year to prepare for increased sales and continuity of supply.
Consistent with our strategy, we are maintaining our outlook on capital expenditures as we continue to invest organically in the business to drive growth.
Still expect to spend between $65 million and $75 million on Capex and now expect to generate free cash flow between $81 million and $96 million.
Most of the free cash flow, we expect to generate will be used to reduce net total debt by 76% to $91 million. We expect to end the year with our leverage ratio between 3.0 at three two times adjusted EBITDA down from our second quarter leverage ratio, which had increased due to the <unk> acquisition.
This will put us in the middle of our target range of two five to three five times adjusted EBITDA with that I'll turn the call back to Joe. Thank you. Thanks, Jason our second quarter results were in line with our expectations, including the double digit sales growth, we increased our full year sales guidance by $14 million and our adjusted.
Operating income guidance by $3 million full year sales are now expected to grow 12% to 14% from faster organic growth and our recent acquisitions of <unk> and Aaron we continue to execute our structured and disciplined strategy to achieve our financial objectives I remain confident in our strategy and 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.
At this time I would like to remind everyone in order to ask a question press star followed by the number one on your telephone keypad.
For just a moment to compile our Q&A roster.
Okay.
Your first question comes from the line of Matthew <unk> with Keybanc. Your line is open.
Hey, good morning, guys and congratulations on a really nice quarter.
Good morning, Matt and Matt. Thank you.
I just want to start off.
Sure.
Number of times throughout some of the early.
Our reporters.
<unk> to consolidate the number of suppliers.
Reduce the complexity of the supply chain going forward.
Are you seeing any kind of movement from from some of your customers and starting to execute on those strategies.
And I know we've talked about.
From a longer term perspective of winning on the new platforms and new products.
How long it takes to kind of move business over is that really the plan or are they are they looking at shortening that cycle.
That's great Great question and that trend has been there.
What is I think very apparent during the challenges that have been.
Happening in supply chain is there isn't even stronger movement to consolidate to suppliers, who have the resiliency and the operating practices the financial strength and then quite frankly honor their commitments under existing agreements to ship product at the prices that have been agreed to.
Unfortunately, there are a number of suppliers, who are not doing that they're not able to fulfill and theyre not honoring the prices that they've committed to and that is clearly, creating a list of suppliers I think throughout the industry that they're going to be individual companies that want to move away from and I think that's just accelerating the trend towards moving to.
Stronger more reliable suppliers and more strategic partners.
We continue to have a high level discussions with our customers around the resiliency that we've been able to demonstrate in meeting their needs and we havent been perfect. It that we are not immune to the challenges in the industry and in the broader economy, but we feel that we've made the necessary investments we've made the necessary.
Gerry moves in hiring labor, adding inventory to the business and incurring the cost to fulfill our commitments to help our customers continue to take care of patients and that's been our prior priority throughout the pandemic and so I absolutely believe that we have demonstrated to our customers our commitment to.
Their success in serving patients and that that's going to differentiate us over time and in the long run and so we do see the interest in continuing to consolidate continuing to partner with the most strategic suppliers and we know where we are in that category with with most of our customers. They tell.
We are.
To your question about is that happening right now I think the reality is in this environment right now everyone's working to deal with the labor and supply chain issues.
There are keeping track of who is able to deliver and who is making the investments and whose honoring their commitments and who's not.
To think that in this environment that they can put meaningful resources towards making that changes. It is very challenging and their focus is on meeting the immediate need of near term demand and serving patients.
Im confident that they do know who's who is delivering for them and who are serving them today and who is not and I am confident that that's to our advantage because we're making those investments we're incurring the necessary costs were making taking the actions to serve them in the first half we've added 10% more direct labor.
<unk> to our business and Thats on an organic basis, although sales in the first half have only grown two 5% organically second half theyre going to grow double digit organically in that labor that we've added once we get them fully trained and fully proficient there is going to allow us to deliver on the second half we've added $40 million of inventory in the first half.
Specifically to work to minimize and reduce the supply chain disruption from suppliers, who are unable to ship on their committed delivery day and thats going to help us and these are examples of the kinds of investments that we're able to make given our financial strength demonstrated our resiliency and being able to serve our customers and enable them.
To meet the patient need and I think that's the point of differentiation.
That's going to enable us to continue to grow.
On a strategic partnership way with our customers.
Okay.
Excellent and thank you for that.
Really good answer.
On the margins if I'm looking at my model correctly.
And that's a that's a big edge.
Second half it looks as if the gross margin should be at the midpoint of your guidance should be somewhere in the low <unk>.
Which would be which would mark a big improvement.
<unk> over where <unk> been.
In the first half first off is that sort of how youre looking at the second half ramp in EBIT.
Gross margins and like what's driving the level of improvement <unk> already seen.
The manufacturing environment become a little bit easier for you.
Yeah, Matt your model is accurate in your math on the second half margin rate is correct.
As we look at and think about the second half.
We see the significant sales growth, that's coming from new product introductions, thats, giving us additional volume in the second half and Thats going to help drive drive the sales into that.
Mid mid mid to high double digit teens, when you look at the year over year growth rate and you look at that on an organic basis, it's going to be high single digit low double digit on an organic basis.
The top line.
Would point to what enables us and helps us to improve the margins are that we've added 10% more direct labor in the first half that's versus year end and getting getting those new associates trained and fully proficient and building product there is going to allow us to reduce some of the inefficiencies that we've been incurring we've been incurring lots of overtime.
Lots of training cost.
Incurred already in the first half.
Incentives for sign on bonuses as well as incentives to work overtime incentives for training so that cost of bringing on that much labor is going to help us drive greater efficiencies in the manufacturing plant in the second half. Additionally, in the first half we've added $40 million of inventory and Thats all.
All in raw and work in process. The finished goods inventory is basically flat with with where we were at the end of the year and we've done that on purpose to help minimize some of the disruptions from suppliers and so you've heard a lot of companies talk about manufacturing inefficiencies from the suppliers' inability to meet delivery dates or meet the.
Our committed delivery date, and having to reschedule the factories. So the inventory we've added helps us to mitigate it.
It won't eliminate it because there is still critical components that we werent able to build inventory with and we're working to close those gaps, but that extra inventory is going to help us manage the facilities at a more efficient way and the second half of the year.
Third thing I'd point to is some of the long lead materials that we've struggled to get enough of in the first half we're getting more of those in the second half.
And some of those products are higher margin than the average and so we do get some favorable mix in the products. We're shipping in the second half compared to the first half and that will give us favorable margin mix. So there is a combination of variables that drive the margin improvement.
The additional head count that gets get them fully trained to be able to reduce overtime and some of the other inefficiencies.
Final inventory helps with scheduling and running the plants more efficiently and to a schedule and then the favorable sales mix.
And quite frankly, we think we've made a a reasonable.
Judging on what our suppliers delivery commitments are for the second half we feel really good about the top line. In fact, we if we can get even get our associates, even more proficient or faster, we can get a little more be proficient faster in the second half and we can get some help from.
Supplier deliveries, we could even exceed the high end of our sales range because the demand is there.
Dialed back the sales forecast to match, what we think we can ship in the materials, we can get but if we can get some help from supplier delivery and get training faster, we could ship more than the high end that is going to probably comment at lower margins. So if we get to the higher end of the sales or even exceed the sales because of the cost.
To get there, but our patients our customers and their patients. They are looking for the products. The demand is there. So we're going to be working to get as much product to our customers as we can but it will be dependent upon on that on all of those factors and variables I mentioned, so we feel great about the demand in the top line and possibly get into the high end or even higher.
<unk>.
It likely will come at lower margins, but but on balance it will it will meet what our customers need and that's ultimately our goal.
Okay.
Do you feel comfortable that as you exit.
'twenty two is at 30% plus gross margin.
The composition of business you have in the new acquisitions.
That's a good run rate going forward.
Okay.
Assuming we're in a more normalized market growth kind of environment.
Yeah I'll qualify to what you just did a key point you just said if we're in a more normal stable environment, absolutely 30, 30% gross margins.
And then continuing from there to.
To grow operating profit at twice the rate of sales and a more normal environment.
I don't know when we're going to get to that more normal environment, but we're confident when we get to a more normal environment. We can grow profit twice as fast as sales given the pipeline of new products, we have given the the integer production system that we're executing.
And the investments that we've made and some driving some of the efficiencies and theyre, adding the capacity the lab the operating leverage we will get so in a more normal environment. We absolutely are confident 30% gross margins and growing profit twice as fast as sales I just can't predict when we get to that more normal environment.
Thank you very much guys.
Thanks, Matt.
Again, if you would like to ask a question press star followed by the number one on your telephone keypad Youre.
Your next question comes from the line of Jim Sidoti with Sidoti <unk> Company. Your line is open.
Good morning, and thanks for taking the question.
Alright.
You beat my top line estimate you raised top line guidance, but I heard the word supply constraint come up on several of the.
Product lines.
So sales have been.
Higher.
If you didn't have these constraints and.
Are they starting to improve at all.
Jim absolutely sales could have been higher we quantified it somewhere in the range of about $15 million, we we highlighted about $3 million in our electric Kim battery business in the.
The neighborhood of $10 million to $12 million in the cardiac rhythm management Neuromodulation business. So yes, we could have shipped more than and quite frankly that was could have shipped more of what we had scheduled there is even more demand in that but we weren't planning to shift more and more than that given the material availability.
I can't say that things are getting better.
They're at about the same level I think we're getting better at being able to manage some of the challenges. The inventory addition helps a lot because now we've got we've got a lot of inventory that helps us. The challenge becomes as you know you can't ship a product until you have all the components and so we have a lot of the components for most of us.
The product, but we're still missing some critical items or where we're hand to mouth on some critical items that allow us to finish finished shipments, which we think could potentially drive higher sales, particularly in the fourth quarter as some of our suppliers are able to ramp up and deliver more of those products and so when you look at our sales outlook.
We think the third quarter is going to grow a little bit over the second quarter.
A relatively small amount, but then the fourth quarters, where we would expect to see even stronger growth in a range that we have a $25 million sales range. We would expect that range that very variability to be in the fourth quarter and thats because as we fully train our new associates and get them fully.
Some of our suppliers are able to ramp and gives us more product. We think the fourth quarter could be a really strong fourth quarter and in that range of ours that we gave in the guidance. Good is going to be reflected in the fourth quarter.
But I wish I could say.
Getting better I think the actions, we've taking taken are helping by adding more and more resources and adding more inventory that helps but the environment still remains very very challenging.
And it's consistent with what we're hearing from talking to others in the industry and customers I think <unk> heard that fairly clearly in the industry earnings calls this week and last week.
Alright.
Looking at the balance sheet.
Yes.
The inventory issue, but your accounts receivable went up.
And I think around $20 million.
But as well is that related to the acquisitions.
That's a piece of the GM, but we also just see.
Quarter over quarter sales jumped right in.
And with a lot of that in our as it normally would coming towards the end of.
The period, so thats more driven by the timing of sales.
But the acquisition and development of that.
Alright, and then last one for me now that you have Asgard Aaron in the mix.
What impact do you think that will have on your organic growth rate in 2023 and 2024.
I think it absolutely helps the organic growth can be recognized.
$71 million of Alaska sales this year and on an annualized basis, we've got about 21 or $22 million of Aaron's sales. So call. It round numbers $90 million to $95 million of sales. So even if 95 million of sales is growing 3% to 500 basis points above above kind of the <unk>.
<unk> or the industry average and add $3 million to $5 million of organic sales due to a $1 four and so.
Maybe to add.
20 bps of faster organic growth, but as those businesses grow and continue to grow at faster rates. It. It helps it absolutely helps and Thats part of what we're looking for from those acquisitions is they have very strong pipelines of growth and pipeline development pipelines and we would expect them to continue to grow at above average.
Rates so it definitely helps.
<unk> performing incredibly well.
Raised our sales forecast for Oscar by $5 million over what we had beginning of the year. The teams are collaborating incredibly well there is a great Sherri and teamwork and we've been able to help them and we've been able to learn from from Oscar as well the margins are getting better as well and we're also super excited about Aaron.
Some of the early strategic discussions, we're having with customers we see strong interests exactly where we thought we would which is hey integer brings the ability to scale and vertically integrate.
Across a number of products and therapies and Aaron's differentiated technology really really kind of helps finish out the capability round out the capabilities that we have so the early discussions with customers on air and the growth opportunities are exciting.
Alright Thats it from me thank you.
Thank you Jim next year.
Sir no further questions at this time I will now turn the call back over to Mr. Tony Horowitz.
Great. Thank you every one for joining today's call.
Always you can access a replay of today's call on our website.
We appreciate again your interest in integer and we look forward to answering any follow up questions. You may have thank you.
Okay.
Ladies and gentlemen, thank you for participating. This concludes today's conference call you may now disconnect.
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