Q3 2022 Integer Holdings Corp Earnings Call
Good day and welcome to the integer Holdings Corporation third quarter 2022 earnings release Conference call. Please note today's conference is being recorded all lines have been placed on mute to prevent any background noise.
The speaker's remarks, there will be a question and answer session. If you want to ask a question. During this time simply press star followed by the number one on your telephone keypad. If you would like to withdraw your question Press Star followed by the number one again.
At this time I will turn the conference over to Anthony Borowitz Senior Vice President of Investor Relations. Mr. Borowitz you may begin your conference.
Good morning, everyone. Thank you for joining us and welcome to <unk> third quarter 2022 earnings Conference call with me today are Joe <unk>, 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 engineered 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 the trending schedules, which are available on 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 <unk> strategy. Jason will then review our adjusted financial results for the third quarter 2020 to provide additional insight on our product line performance and review our full year 2022 guidance.
Joe will come back to provide his closing remarks, and then we'll open up the call for your questions with that I'll 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.
We thought it would be appropriate to start by providing an update on the supply chain challenges that we highlighted on our October 5th pre announcement since that time, we have eliminated additional sales risk related to the two medical component suppliers. Because we have received all the material needed to meet our fourth quarter outlook.
For our non medical products, we have line of sight to component supply from more consistent supplier performance and our dual sourcing strategy for critical components.
We continue to intensify our management of the supply chain to reduce operational risk.
We have increased the frequency and depth of managing supplier risks, including more frequent tracking faster escalation of delays and shortages and executive level engagement with suppliers.
We're also accelerating our proactive measures, including executing in sourcing and dual sourcing strategies where appropriate.
So our updated guidance includes an even more cautious risk adjustment based upon existing supplier performance.
And so just third quarter 2022 financial results were in line with the preliminary view that we released on October 5th.
Our third quarter sales grew 12% versus third quarter 2021, and adjusted EBITDA grew 5% year over year.
<unk> 2022 financial outlook remains unchanged from October 5th release, with 11% to 13% year over year revenue growth and adjusted operating income of $180 million to $196 million.
The next slide summarizes why the fundamentals of our growth strategy remains strong despite the sales push out caused by the recent supply chain challenges.
Introduced growth strategy has not changed and we are excited about our growth prospects.
We are well positioned in a recession resilient industry, where demand has returned to pre COVID-19 growth rates.
Customers tell us that we are performing better than our competitors. Despite supply chain challenges and we believe we will benefit from supplier consolidation trends.
We expect above market revenue growth of 7% to 9% in 2023 due to strong customer demand a significant backlog accretive growth from the Oscar and Darren acquisitions, and new product introductions concentrated in electrophysiology structural heart in Neuromodulation.
We expect margin expansion in 2023 from volume leverage higher prices and the $8 million in annualized savings from eliminating SG&A positions.
Our direct labor environment is improving we reduced turnover by approximately 17% in the United States and 9% in Ireland during the third quarter.
We have achieved our targeted direct labor levels in most of our sites and remain focused on fully training our workforce to operate more efficiently and fulfill the strong demand from customers.
Given this progress we anticipate that are fully staffed and trained workforce will deliver productivity in our operations in 2023 and drive our expected margin expansion.
I'll now hand, the call over to Jason.
Thanks, Joe Good morning, and thank you again for joining our call.
I'll provide more details on our third quarter 2022 adjusted financial results.
Arise our product line sales trends and conclude with our 2022 outlook.
And to your third quarter results were consistent with our October 5th preliminary view.
At $343 million, our third quarter sales grew 12% year over year with currency being about 100 basis point drag mostly driven by the euro.
Excluding acquisitions and currency were up 6% year over year.
As a reminder, our third quarter sales would have been approximately $15 million higher if not for the deteriorating delivery performance and Miss commitments from primarily three suppliers.
Our adjusted EBITDA in the quarter was $63 million up $3 million compared to last year, which is an increase of 5% adjusted operating income was $46 million slightly below third quarter 2021.
The supplier delays reduced adjusted operating income by approximately $12 million.
With $8 million of that driven by the lower sales volume and $4 million from higher manufacturing costs manufacturing costs are higher due to increased wages freight and adding 5% more direct labor in the third quarter in an effort to deliver the high end of sales guidance. We had provided in July .
As an offset to higher manufacturing costs and cost of goods. So we saw lower SG&A expense in the third quarter from a year to date benefit to align incentive compensation with our updated guidance.
That said, we expect the fourth quarter SG&A to be higher than the third quarter and similar to second quarter levels through the fourth quarter includes a benefit from the annualized savings from our restructuring actions are fourth quarter is typically the highest quarterly SG&A spend in the year as it includes end of year cost and services.
With adjusted net income at $32 million, we delivered 95 of adjusted diluted earnings per share down 10 from the third quarter of 2021.
I'll give some more color on our adjusted net income on the following slide.
The third quarter, adjusted net income decreased $3 million compared to the third quarter of 2021, primarily driven by higher interest expenses, partially offset by a $1 million benefit from the currency due to the stronger dollar.
The $3 million and higher interest expenses impact is impacted by the increasing U S interest rate environment, but also from an increase in our principal amount of debt outstanding being more than $300 million higher than last year due to the <unk> and <unk> acquisitions.
Although approximately 11% of our debt is fixed through an interest rate swap the rest moves with LIBOR and therefore, we expect interest expense to continue to increase through the rest of the year.
That said, we subscribe to the view that floating with the market produces the best outcome over the long term.
Our adjusted effective tax rate was 13, 6% in the third quarter of 2022 compared to 13% in the third quarter of 2021, creating a year over year headwind of roughly one cent per share.
The third quarter 2022 rate benefited from discrete items in the quarter, We project an increase in the fourth quarter rate and a total year adjusted effective tax rate of 15, 5% to 17%.
In the third quarter of 2022, we generated $28 million in cash flow from operating activities up 47% sequentially from the second quarter.
Inventory has grown $55 million through the first three quarters was $16 million being added in the third quarter with the single biggest driver being the products that we did not ship because of the supplier delays, we expect inventory to reduce in the fourth quarter.
R $22 million of free cash flow third quarter year to date reflects the impact of the $55 million of inventory increase in the $42 million a year to date Capex spend as we continue organic investments in capabilities and capacity for growth.
We still expect to spend between $65 million and $75 million in capital expenditures in 2022.
With our net total debt balance, peaking in the second quarter. Following the acquisition of <unk> biomedical we decreased by $13 million since that time to $925 million at the end of the third quarter.
Our debt leverage at the end of the third quarter was three eight times trailing four quarter adjusted EBITDA down slightly from the second quarter. Although we are still temporarily above our target range of two five to three five times in the third quarter of 2022 due to the <unk> acquisition, we expect to.
Move our leverage again in the fourth quarter and expect to be between three 4% and three seven times leverage.
We will now transition to a discussion of our product line sales.
Trailing four quarter reported sales grew 12% in the third quarter of 2022 with strong growth across all product lines.
Beginning with our first product line cardio and vascular sales were up 14% in the third quarter compared to the third quarter of 2021 as we have previously discussed we continue to face a challenging supply chain environment that ultimately caused sales to be pushed out of the quarter. Despite this.
Impact we grew double digit on strong demand and backlog in the high growth electrophysiology and structural heart markets.
We have also seen strong performance from both the off score and <unk> acquisitions, which continued to accelerate our cardio and vascular sales growth.
Trailing four quarter sales continued strong year over year growth up 18%. We expect this momentum to continue throughout the year.
Moving the cardiac rhythm management and Neuromodulation sales grew 8% in the third quarter with sales growth primarily from our <unk> acquisition. This includes the impact of the supplier delays that affected our neuromodulation products as previously discussed.
Trailing four quarter sales posted year over year growth of 7%.
In our advanced surgical orthopedics and portable medical product line, our third quarter sales were up 17% driven by the beginning of our multiyear portable medical exit plan as we work with our customers to provide the products they need to transition production.
We also generated low double digit growth in the advanced surgical and orthopedics business in the third quarter.
Trailing four quarter sales was roughly flat year over year.
Finally, we will wrap up the product line discussion with electric <unk>, our non medical segment.
Third quarter sales increased 24% driven by strong demand across the environmental energy and military markets, despite sales being lower than they could have been in the energy market due to supplier delays.
Trailing four quarter sales grew 18% year over year, driven by the continued recovering energy market.
I will now transition to our updated expectations for 2022.
The full year outlook is consistent with our October 5th update.
<unk> with sales we are forecasting sales to be in the range of $1 $350 million to $1 $380 million, an increase of 11% to 13% versus last year.
This includes the noteworthy sales performance from our ask or an error in acquisitions.
On an organic basis, considering the $35 million sales gley, we expect sales to grow 4% to 6% compared to 2021 as.
As previously shared our updated adjusted EBITDA and adjusted operating income forecast was impacted by approximately $25 million was $17 million from lower sales volume due to the supplier delay and $8 million as higher manufacturing costs from increased wages.
<unk> and additional direct labor with these impacts we expect 2022, adjusted EBITDA to be between $244 million and $260 million, which is flat to 7% year over year growth.
We expect our 2022 adjusted operating income to be between $180 million and $196 million, reflecting a decline of 4% to a growth of 5%.
Adjusted EPS is expected to be between $3 57.
The $3 97.
Our adjusted EPS outlook includes the impact of the delayed sales higher manufacturing costs higher interest expense and our latest view of adjusted effective tax rate, which as mentioned earlier is projected to be between 15, 5% to 17% for the year.
As I close we now expect cash flow from operations between $110 million to $125 million. This estimate is inclusive of the inventory investment we have made in the third quarter as we continued to execute strong demand and the impact of supplier delayed shipments at all.
Also includes our latest adjusted EBITDA outlook.
Insistent with our strategy, we are maintaining our outlook on capital expenditures as we continue to invest organically in the business to drive growth.
We still expect to spend between $65 million to $75 million of Capex and now expect to generate free cash flow between 40 million to $55 million.
Most of the free cash flow, we expect to generate will be used to reduce net total debt by $35 million to $50 million.
We expect to end the year with our leverage ratio between three four and three seven times adjusted EBITDA close to within our target range of two five to three five times with that I'll turn the call back to Joe. Thank you. Thanks.
Thanks, Jason.
We have intensified our supply chain management to deliver for our customers and patients our financial outlook is unchanged and we expect to end the year with 11% to 13% year over year sales growth despite supply chain challenges.
In 2023, we expect sales growth of 7% to 9%, which is approximately 300 basis points faster than the markets we serve.
We also expect margin expansion in 2023 from volume leverage higher prices and efficiencies from a more fully staffed and trained direct labor workforce.
We remain focused on executing our strategy, we have our largest ever new product development pipeline customer demand is at an all time high.
We have successfully added the direct labor needed to fulfill on this demand we are positioned to deliver strong sales growth in 2023 with margin expansion.
As we stabilized labor and supply chain, we remain confident in our ability to deliver on our financial objectives of our strategy to grow sales 200 basis points faster than the market grow profit twice as fast as sales and maintain that leverage between two and a half and three five times adjusted EBITDA.
Thank you for joining our call. This morning, I will now turn the call back to our moderator for the Q&A portion of our call.
At this time I would like to remind everyone in order to ask a question Press Star then the number one on your telephone keypad, we'll pause for just a moment to compile the Q&A roster.
Your first question comes from the line of Matthew <unk> with Keybanc.
Good morning, Matt.
Matthew Your line is open.
Good morning, sorry about that I was on mute.
I just first wanted to start off on margin, Joe and you guys have given the.
The 7% to 9% revenue growth for next year.
Without without giving initial guidance is how should we think about.
Some of the moving pieces of margins next year.
Headwind and tailwind and maybe some of the company specific initiatives you guys are implementing.
At this point that should help improve.
Certainly thanks, Thanks for the question, Matt So as we look at 2023, we're confident we can expand margins I'll start with.
We're going to go from this year and in our prior years, having priced down with customers to next year, it's going to be price increases.
Thats, an immediate impact that that changes the trajectory.
Kind of a core element of what we've been doing the last five years, so that'll be a positive.
Added significant direct labor this year significantly more than we've been able to increase output.
We're focused right now on training our workforce, we do not anticipate adding increasing our direct labor head count in the fourth quarter. We feel we have the level, we need to run for some period of time into 2023, and our focus is on training the workforce to get the proficiency in the manufacturing.
<unk> to drive the efficiencies. So we believe that's going to be a meaningful contributor to helping us and with 7% to 9% sales you get volume leverage on that direct labor that we do not anticipate needing to increase in the near term. We also get volume leverage on the overhead and the facilities and volume leverage on the operating.
Cost, which we've already taken specific actions to lower our SG&A costs next year by an annualized $8 million, we implemented that at the end of the third quarter. So we see those as positive trends. We also have new products that are introducing.
No new products typically that is the highest price youre going to see in the marketplace.
When you launched Amit so thats going to help also.
<unk> got strong growth and we continue to drive meaningful synergies in our score the acquisition. We did at the end of 2021.
We are performing better than we expected this year and they are driving meaningful efficiencies and the synergies with customers has been significant and we see significant growth and an additional synergies. There. So those are some of the very integer specific things that we expect to drive margin expansion next year the supply chain environment remains.
<unk> challenging that's a fact, but I think we're all on the same boat and you've seen that with with most everyone's earnings announcements this quarter the pressures there.
We feel that we are managing those effectively we need we obviously had some some gaps in the third quarter and we need to improve on those and we have we.
We're getting much deeper with suppliers were getting were escalating issues faster and I am personally engaging with the suppliers that are challenging.
Other leaders other members of the leadership team. So we think there are some very specific entered your actions that we've taken that will ensure we expand margins next year and that will be able to manage in this continued volatile difficult supply chain environment.
Is it is it fair to assume as a starting point for next year that you get back to your two to one.
Income growth too.
So revenue growth or is there or should we view a little bit more cautious to start the year given the supply chain environment.
So we're not we're not prepared to give that level of granularity for 2023, that's absolutely. Our goal is as we look long term and we're confident when we get to a more stable labor and supply chain environment. We're confident that we can continue to grow profit twice as fast as sales.
We're not ready to give 2023 guidance just yet, but we think we've taken some meaningful actions to ensure margin expansion the price increases as opposed to decreases.
Meaningful amounts of direct labor we've added this year, our focus is on training them.
We've got we've got meaning we've increased inventory meaningfully and now we believe we're going to be able to be able to start to reduce some of that inventory, where we built up maybe more safety stock and what we need. So we do expect to be able to expand margins next year. We're just not ready right now to tell you what that guidance is going to be we will provide that on our fourth quarter earnings call.
But how should we be thinking about your 200 to 250 billion dollar target for <unk>.
M&A.
On an annual basis.
That program was implemented.
For some of these supply chain issues before.
Interest rates have gone.
How are you adapting that M&A program to the current environment.
Yeah, Great Great question, Matt We continue to look at the opportunities that are aligned with our strategy. We think we've been very very transparent and we are looking for tuck ins. We are looking for acquisitions that expand our capabilities to enable us to offer more vertically integrated.
<unk> to our customers in those higher growth end markets. So we've been very targeted very specific.
The awkward Eric and <unk> acquisitions are great examples, where we've either added new and differentiated capability to further vertically integrate and serve our customers.
<unk> is an expansion of what we already do that's in our wheelhouse, where we can generate significant synergies and offer more to our customers and so we continue to look at that obviously, we remain very committed to our two five to three five times leverage that doesn't mean that when you do an acquisition you might you might bump up into the high threes.
A very near term plan to get back within two five to three and a half and so we remain very active in looking at opportunities. We we don't get to decide where to sell ourselves. If we were to incentivize them, we probably would require an above market prices. So we're not doing that but we remain very active and also very committed to our Q&A. After.
Three five times leverage we think the results that we've been able to deliver with <unk> and we think Erin will also demonstrates this over time.
We think that demonstrates that our strategy and our ability to both acquire integrate and drive the synergies. We think we demonstrated our capability there and feel that this is an important part of our strategy going forward, but it's tuck ins and it's within the framework of our of our leverage target.
Okay.
And I think it will be helpful for investors to understand.
How are you thinking about your exposure to neuromodulation.
I would probably guess like legacy.
Integer is more.
It was more focused obviously on spinal cord stimulation.
Thats a little more.
Some of them.
Areas that are growing.
Faster.
Outside of that how should we think about where.
Where you're exposed at this point.
Certainly so.
Today, our sales are more lean more towards the spinal cord stem for sure, but our pipeline and our emerging customers leaning much more towards those those are emerging therapy.
Therapies, whether it's sleep apnea or incontinence, or treating epilepsy or hopefully your applications.
Or heart failure, there are a lot of non spinal cord stim therapies that are in development that are part of our pipeline. So although spinal cord stim is getting getting some news today around reimbursements and around the growth rates, maybe it's mid single digits instead of high single digits.
Our pipeline is.
Not only it includes spinal cord Stim force, but it's also much more heavily weighted outside of spinal cord stem. So we're confident in that pipeline and those therapies. We have a number of customers. We shared that are in various stages of the development phase and a number they're launching.
The revenue generation generation phase. So when you think about us in neuro Mod think about the pipeline is heavily weighted towards non spinal cord stim.
Okay.
This last one you mentioned that you've secured the components and supplies.
To meet your guidance in.
In the fourth quarter.
Im assuming youre talking away at that midpoint of the <unk>.
Our guidance given the correct $30 million range, but we'll see we'll see how the supply chain evolves from from from there as far as the debt.
Whether or not that's up or down.
That's absolutely correct, Matt we put the products that we had the supply chain issues with that we discussed during the pre announce we said, let's only include what we have physically on hand, so that we have derisked those those products on the medical side, we're confident on the nonmedical given the.
Dual sourcing and given the performance of those suppliers.
We've been working on ensuring that the pipeline of those products are flowing and committed for 2023 volumes now that we've taken care of in the fourth quarter for those as well as the other suppliers. There's other suppliers, we continue to work with as well to the address the supply chain and most of the issues when we talk to suppliers.
Points back to labor and I can highlight in the U S. Our labor turnover improved by 17%, which is which.
A positive and I think that's some of the actions we've taken and also we've heard that the labor environment.
Say that it is good it still remains challenging but it does show signs of improving we also improved labor turnover and other places around the company as well and we think we're hearing that with some of our suppliers.
Also improving their ability to supply and we think it's pointing to an improving labor environment in some places, but it still remains very challenging I think you've heard that across the board on earnings calls this quarter.
Okay. Thank you very much guys.
Thanks, Matt.
Your next question comes from the line of Jim Sidoti with Sidoti.
Hi, good morning, Thanks for taking good morning, gentlemen.
First thing.
I think you said.
Organic growth was about 6% in the quarter. So I just wanted to confirm that Oscar and air and sales are in that $18 million to $19 million range is that right.
So from a.
Growth right Jim.
Well just where.
What we're asking Erin sales in the quarter.
Yes, we haven't shared all of there isn't a quarterly basis, but yet the organic is 6% and so that would be the difference in that growth rate yes.
Okay Alright.
Alright, and then.
Looking at the annual guidance, just the fourth quarter left with a 40 foot range there.
What are the factors that get you to the <unk>.
High end of that.
Yes so.
We are continuing to certainly manage the supply chain environment and that has been the biggest.
Variable for us obviously as we've looked at the.
The impact in the third and the fourth quarter and so we're certainly driving that.
The team and the sites to deliver more as we've talked about the customer demand is strong.
And so and as much as we can offer continue to get the materials, we need or are more than maybe what we are expecting that we'll deliver in feed a pipeline to help us to be able to deliver more on the on the high side of the sales that's going to be the biggest driver Jim to get on the higher range of the EPS.
So it sounds like you're confident that demand is there the biggest issue.
Being able to supply that.
To meet that demand.
Absolutely absolutely alright.
We've talked.
A fair amount about how strong demand is both in our our backlog as well as in certainly the conversations we're having with customers and forecast that they're giving us.
And so this is about having a material on hand.
And getting that through our shops out to all of our customers.
Alright, and then last one.
Gross margin guidance, but you did indicate that sales.
SG&A expense is going to be up relative to the September quarter. So.
It seems like you are expecting an improvement in gross margin from the third quarter and the fourth quarter compared to the third quarter.
Is that because of these labor issues have improved.
And to improve.
Whats driving that improvement.
Yes, so think about that.
Third quarter most.
We dropped about 100 basis points right from the run rate in the first first happen and that was certainly impacted by the.
The stranded labor, we've talked about right as we lost sales from our suppliers.
Branded labor and then the other costs that we.
We've talked about as well in the fourth quarter as we get volume higher we get the benefit of that leverage.
<unk>.
As well as continuing to really manage our cost the best we can there is certainly again the environment, we're facing and the inherent pressures that we're still that we've talked about it in manufacturing, but we believe that with the higher sales will be able to absorb a bit of that and to your point. The implicit guidance hasnt is increasing in the fourth quarter.
Alright that was it from me thanks again for taking the questions.
Thanks, Jeff.
Again, if you would like to ask a question. Please press Star then the number one on your telephone keypad.
And there are no further questions at this time I will now turn the call back to Anthony Borowitz for any closing remarks.
Great.
Thank you everyone for joining today's call as always to replay. This call is available on our website as well as a presentation that we just covered so thank you again for your interest in <unk> and that does conclude today's call.
Thank you for participating you may disconnect at this time.
Okay.
Okay.