Good morning. My name is Casey and I will be your conference operator today. At this time, I would like to welcome everyone to the Integer Holdings Second Quarter 2018 Earnings Conference 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.

[Operator Instructions] Thank you. Tony Borowicz, Vice President of Strategy, Business Development and Investor Relations, please go ahead..

Thank you, Casey, and good morning and thanks to everyone for joining us, and welcome to Integer's second quarter 2018 conference call. This 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 Web-site.

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 the press release we issued earlier this morning. 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 today to discuss our quarterly results is our President and Executive Officer, Joe Dziedzic; and our Executive Vice President and Interim Chief Financial Officer, Jeremy Friedman.

Following our prepared remarks, the call operator will come back on the line to direct the Q&A. Now let me turn the call over to Joe..

Thanks, Tony. Welcome everyone and thank you for joining to hear about our second quarter results. We've built on the strong momentum from the first quarter and I'm pleased to report that we delivered double-digit sales and earnings growth in the second quarter.

We successfully completed the divestiture of the Advanced Surgical and Orthopedic business at the end of the quarter, which would not have been possible without the tremendous effort from all of the Integer employees involved who worked so diligently to make this happen.

It took the entire organization pulling in the same direction to deliver such strong results, while concurrently completing the AS&O divestiture. The Integer organization is actively embracing and driving a long-term strategy that we introduced earlier this year.

The entire organization is aligned on the portfolio strategy which defines how we win in the markets we serve, and the operational strategy which defines how we achieve excellence in everything we do. I'm confident that with this type of commitment, we will be successful in earning a valuation premium for our shareholders.

I'm very pleased to report – now let me provide an overview of the second quarter results, and I'm very pleased to report that both sales and earnings increased by double digits and we continued to pay down debt within the quarter.

Shortly after the quarter ended, we completed the AS&O divestiture and we repaid an additional $548 million of debt from the deal proceeds. This had significantly reduced our financial leverage and we are now at 4x EBITDA leverage and expect to be closer to 3.5x by the end of this year.

The AS&O divestiture is one of the outcomes of our disciplined portfolio strategy. Post the divestiture, we will have higher margins, increased net earnings, greater returns on invested capital, and improved financial flexibility.

As a direct result of this divestiture, we are raising our full year guidance by $0.15, to $3.35 to $3.65, on a full year pro forma basis, that is as if we had sold the business at the beginning of the year. Jeremy will now provide more discussion regarding our financial results for the second quarter.

He will start with the review of our pre-divestiture results. This is how shareholders were analyzing Integer coming into the quarter. Afterwards, I will provide more insight into resetting the business post divestiture and discuss our outlook in more detail..

Thank you, Joe. Good morning, everyone, and thank you again for joining our call. As Joe mentioned, I will be reviewing our second quarter consolidated financial results, which include the full quarter of our recently divested Advanced Surgical and Orthopedic business. I will also take you through the performance of each product line.

All of my comments will be on a pre-divestiture results basis. Let's begin with Slide 7. Our strong growth trajectory continued again this quarter as we delivered a record $403 million in sales, which is up 10% versus last year. Adjusted EBITDA of $89 million increased 15% organically.

On a reported basis, we grew 27%, higher than the 15% organic growth, due to a favorable foreign exchange impact of $8 million. Adjusted net income grew to $35 million or $1.06 of adjusted earnings per share. This was a 37% organic year-over-year improvement.

Moving to Slide 8, trailing four-quarter organic sales continue a solidly positive growth trend. For Integer, trailing four-quarter growth was 8% in the second quarter, led by our Medical product lines and builds on strong growth in the first quarter and prior quarters.

As we have stated previously, we believe that a rolling four-quarter view is a better indicator of our growth trend than any one individual quarter.

These trailing four-quarter views provide a better sense of how we are performing in the market compared to any individual quarter that can contain anomalies resulting from the timing of customer purchasing decision.

Turning to the left hand side of Slide 9, you can see that second quarter adjusted EBITDA increased $19 million or 27% versus last year on a reported basis. $16 million of this growth was driven by improved leverage on increased sales.

We also had $8 million of favorable foreign exchange impact, which was partially offset by a $5 million headwind from higher incentive compensation expense. We expect 2018 incentive compensation expense to be slightly higher than 2017, with the first half being unfavorable and the second half being slightly favorable to 2017.

Turning to Slide 10, I will now take you through our cash flow performance in the second quarter. As we have been doing for more than a year, we continue to pay down debt in excess of our required repayments. Leverage was reduced to 5.1x by the end of the quarter.

After the quarter closed, on July 10 we reduced debt an additional $548 million from the proceeds of the Advanced Surgical and Orthopedic sale. This additional paydown of debt took our leverage ratio down to 4x, further strengthening our financial position significantly.

We generated $21 million of cash flow from operations during the second quarter, which translated into $13 million of free cash flow. These amounts were below our recent levels and were primarily impacted by working capital needs and accounts receivable and inventory to support our increased revenue, particularly in our Cardio & Vascular business.

We remain highly focused on driving strong operating cash flow to pay down debt. Now let's turn to review of our product line sales results. Moving to Slide 12, the Cardio & Vascular product line continued to drive strong top line growth with a 13% year-over-year sales growth in the second quarter.

This growth was driven by particularly strong revenue in our peripheral vascular, neurovascular and electrophysiology markets. Catheter revenue in electrophysiology and both catheter and guidewire revenue in the peripheral vascular and neurovascular markets were particularly strong.

On a rolling four-quarter basis, the Cardio & Vascular product line continues to show consistent and strong growth with solid market dynamics, helping as we experienced solid growth from all our major customers. We expect second half growth rates to be slower due to strong 2017 second half sales.

Turning to Slide 13, sales in our Cardiac & Neuromodulation product line were up 9% in the second quarter, which was the strongest year-over-year growth we have seen in more than two years. Neuromodulation revenue experienced year-over-year growth of approximately 30%, with double-digit increases in nearly all products.

Cardiac rhythm management grew low single digits from the ramping of new lead components and assembly business, along with capacitors. The rolling four-quarter sales trend turned to slight growth for the first time in five quarters.

We anticipate continued strong growth in neuromodulation but we expect the fourth quarter to be challenging for cardiac rhythm management, as Q4 in 2017 was 13% higher than the average of the other three quarters. As we have mentioned before, the neuromodulation market remains a key driver of our long-term growth for this product line.

We are focused on accelerating neuromodulation sales through the active support of our customers. The last portion of our Medical segment, Advanced Surgical and Orthopedic, is shown on Slide 14.

While the Advanced Surgical and Orthopedics group had a very solid second quarter, as a result of the sale of this business at the end of the second quarter, this will be the last time where we will show you the results for the business this way.

The Portable Medical business has been reported as part of this group and was not sold with the Advanced Surgical business. Portable Medical has had a very strong first half with double-digit increases in both the first and the second quarter.

We will continue to serve the Advanced Surgical and Orthopedic markets through our long-term supply agreements with Viant, formally MedPlast, and look forward to their continued growth. Finally, on Slide 15, our Non-Medical business, Electrochem, experienced a year-over-year decline in sales in quarter two.

Revenue in the energy market remained strong with an 8% sales increase compared to the same quarter in 2017. However, this was offset by the timing of government-funded military orders that had been delayed.

Electrochem continues to execute on its strategy and has a number of exciting initiatives expanding its product offering, executing on new business wins, and further penetrating the environmental and military markets. I will now turn the call back to Joe to help you reset Integer on a post-divestiture basis..

Thanks, Jeremy. I'd like to take a second and just review the strategic rationale for the divestiture. The divestiture of the Advanced Surgical and Orthopedics business is an outcome of our long-term portfolio strategy we introduced earlier this year. Our strategic review identified the divestiture as an opportunity to unlock significant value.

During our strategic assessment, we concluded that the AS&O medical device outsourced market was poised for consolidation, and the market was going to benefit from having fewer and larger suppliers.

As we opportunistically reviewed strategic options, it was important to find a buyer who could emerge as a market leader in the AS&O space, and thus provide ongoing benefits for customers, associates, and the patients we serve. The divestiture to Viant meets this criteria, creating one of the largest MDOs serving this market.

The divestiture positions Integer as the market leader in the product lines we serve by bringing differentiated technology to partner with our customers, to drive continued innovation and growth. With the divestiture, we have a stronger financial profile and greater financial flexibility to accelerate growth.

It's also important to note that there was very little overlap between our AS&O customer base and the rest of Integer, with most customers being unique to AS&O. From this perspective, the divestiture has little to no impact on our ongoing customer relationships.

Our manufacturing footprint has also improved, with larger manufacturing facilities to have ample room for growth. I provided color on the transaction rationale. Now let's move on to the financial impact.

We developed 2017 pro forma financials as though we had already sold the AS&O business to Viant, and we have summarized the change for 2017 and first half of 2018 on this slide. For the full year of 2017, Integer pro forma sales would have been lower by $331 million, and pro forma operating profit would have been lower by $31 million.

And we used the proceeds to pay down debt, pro forma interest expense would have been lower by $42 million. The pro forma earnings per share for 2017 would have increased by $0.27 as the interest expense savings would have more than offset the loss of the operating profit. Looking at the first half 2018 impact, EPS increased by $0.02.

Based upon our prior estimated AS&O operating profit and interest expense savings, our full-year 2018 earnings per share estimate increases by $0.15. The reduced EPS impact compared to last year reflects the improved AS&O performance in 2018 compared to 2017. Earlier, Jeremy reviewed our second quarter results on a pre-divestiture basis.

Looking at our results on a post-divestiture basis, both sales and earnings per share increased double digits, growing 11% and 14% respectively. Additionally, our EBITDA margins improved to 22% from 20% the prior year, reflecting the divestiture of the significantly lower EBITDA margin AS&O business.

This slide covers the full-year post-divestiture outlook. Given the solid momentum we are seeing, we now expect 2018 full-year sales growth to be between 4% and 6% for the year. This compares to our previous growth estimates of 3% to 6%.

For adjusted EBITDA, we expect a range of $255 million to $265 million, an increase of 9% to 13% on a comparable basis to last year.

We are increasing our full-year earnings per share guidance by $0.15 as a direct result of the lower interest expense due to the divestiture, and now expect to be in the range of $3.35 to $3.65 per share, which is a growth of 9% to 19%.

Our cash flow outlook remains the same as prior to the deal, with cash flow from operations of $160 million-plus and free cash flow of $110 million-plus. Our estimated debt payments before the divestiture remain the same as well at $115 million-plus.

Adding in the $548 million attributable to the proceeds from the divestiture, we expect to pay down at least $665 million by the end of the year. We expect this will reduce our leverage to about 3.6x. We have already received an upgrade to our credit rating from Moody's as a result of our improved financial profile.

We continue to execute on our long-term strategy that we introduced earlier this year. The divestiture is an outcome of that strategy.

Our portfolio strategy, which define how we win in the markets we serve, we've focused our sales efforts on increasing our market penetration in the higher growth Cardio & Vascular, Neuromodulation and Non-Medical Electrochem markets, while preserving our strong cardiac rhythm management market leadership.

On the operational strategy, we continue developing and implementing the multiyear plans to achieve excellence in everything we do, from safety to quality to on-time delivery to how we manage every business process.

We will run the Company based on this portfolio and operational strategy, which we believe will drive a valuation premium for our shareholders. In summary, we have delivered strong first half results that are consistent with our full year guidance.

We have completed the Advanced Surgical and Orthopedic divestiture, paid down more debt, and increased our earnings per share outlook by $0.15. Our clear strategy, ultimate portfolio, and an operational perspective is gaining momentum within Integer and positions us to deliver on our growth objectives.

We will continue to measure our financial success through two key metrics; sales growth above the market, and profit growth at least 2x sales growth. I remain confident we have the right strategy and the right team in place to deliver for our customers and to realize our vision of enhancing patients' lives. Casey, let's open it up for questions..

[Operator Instructions] Your first question comes from Matthew Mishan with KeyBanc. Please go ahead. Your line is open..

I'm just trying to understand the sustainability of the growth here, because the last couple of quarters have been very strong. Overall volumes for your customers are kind of very good.

Are they having a tough time keeping up with their own manufacturing and are you getting overflow from what they can't keep up with, or is this really truly business and you're going to be able to [indiscernible] stick with for a while?.

I wouldn't characterize our growth as overflow from our customers. We feel we're incredibly well positioned to serve them and support their growth, and we are capitalizing on that. We've had a strong sustained growth over the last six quarters. Last year we were 5%, this year we're looking at 4% to 6%.

We believe it's very sustainable when you look at it on an annualized basis. No business is perfectly linear.

So, any given quarter may be stronger or weaker than the rolling four-quarter average, but we believe we're solidly in mid single digits trajectory and we're working to accelerate that to be sustainably above what we think the end markets are growing, which is below the mid single digits..

Then how should we be thinking about the quoting activity from your customers, as it's kind of progressed through last year? Has anything changed as far as kind of size of contracts, length of contracts, and how they're looking at Integer?.

Matt, I'd frame that in the context of the last two to three years where we have dramatically – the management team, i.e., the Presidents of the businesses, have dramatically improved our customer relations, and we feel we are competing for all opportunities, whether they're small or big, and we do have a number of opportunities in the pipeline across the full continuum of size of opportunities and we're very excited about the pipeline of deals.

And a lot of our customers are looking to consolidate their manufacturing operations.

As they grow, they are looking at what they want to continue manufacturing and they consider core compared to what they feel they should be outsourcing, and we're continuing to see a lot of activity on that front, and we think we're incredibly well-positioned to support their strategy to reduce their manufacturing operations, and we're working to be an extension of not only their manufacturing, but also their growth, their innovation, and their technology roadmaps..

Okay. That's helpful. And then I wanted to dig into the operational excellence. This was a fantastic quarter as far as the volume lift and the contribution down to margins.

Can you talk through the confidence moving forward for like operating margin or EBITDA margin lift on increasing sales versus especially just on volumes, and then maybe breakout what you can control as far as margin improvement from programs that you're implementing around operational excellence?.

Matt, thanks for asking the question about manufacturing excellence, because that is what I think is one of the keys to success for Integer. It's been a bed-rock of who we've been historically, our ability to manufacture and deliver for our customers.

But I see tremendous opportunity in this area because we have a potential to drive even higher quality, greater on-time delivery in our operations, and I'm confident that as we improve in those areas, we're going to drive increased efficiencies in our business. We're working.

We launched two weeks ago our manufacturing excellence strategic comparative with the manufacturing leadership team and the operating leadership team.

We had a couple of days session kicking this off and laying out what the multiyear plan is to go across the business and do lean diagnosis of our operations, developing and fully implementing the Integer production system that's going to leverage things like Kaizen practices and ocean planning that's going to drive sustainable improvement in our operations.

I think we're good today, but I think there's tremendous opportunity to further differentiate in this area. It starts with safety and having an incredibly safe work environment for our associates, and then it goes to having the highest quality in the industry that differentiates us, and then it goes to on-time delivery.

If we do all of those things in an excellent manner, it's going to drive significant efficiency and productivity in the business, and we see tremendous opportunity to improve off of what's already a good position, but we want to be differentiated in the area and use that to drive the growth with our customers.

Just following up on that, over a multiyear period, what do you think on an operating margin or EBITDA margin basis, what do you think those programs can do for your margins, if you can quantify the impact of that? And how much of that do you think you're going to be able to keep versus give back to your customers?.

That is a great question, Matt. We have historically experienced 1% to 2% selling price decrease. Looking backwards over many years, we expect that to continue. As we think about margin expansion, big, big picture macro, here's how we think about it. We look at the selling price pressure that we know exists.

It exists with the doctors in the hospitals, as pressure from the government payors as well as companies putting pressure on the healthcare providers, they in turn put pressure on the medical device OEMs, which then in turn translates to us and trickles down to our supply chain as well.

So, we're looking at it and planning for the historical 1% to 2% price pressure. We know in order to maintain a competitive offering for our associates that we have to give wage increases competitive with the market. So we know those two variables are going to drive margins down every year.

We have to generate enough productivity and efficiency through our two cost strategic comparatives, manufacturing excellence and business process excellence. Business process excellence focuses on everything outside of manufacturing operations, all business processes.

We have to drive enough productivity to at least offset the selling price pressure and the wage inflation that exists. If we do that, and then grow at sustainably above the market averages, the contribution margin that falls through on that revenue growth will yield operating profit growth at twice the rate of the sales growth.

That gives us the margin expansion. So, we know what we're trying to solve for in terms of the level of productivity required to allow us to expand margins on a sustainable basis going forward. Productivity must meet or exceed selling price and wage inflation.

We have to grow revenue sustainably above the market average, which is low to mid single digits. We do that, we'll get, we'll achieve our financial objective, which is operating margins growing, operating dollars growing at twice the rate of revenue, that will give us our margin expansion..

And your next question here comes from the line of Glen Novarro with RBC Capital Markets. Please go ahead. Your line is open..

Joe, two questions. One, on the revenue for the quarter, the Cardio beat our number by $11 million, Cardio Modulation by $9 million. I'm just wondering, were there any timers or chunky orders in the quarter that you can discuss? And then I had a question on strategy..

I would not characterize our continued strong growth in Cardio & Vascular to be driven by any individual product or customer driving an aberration. We've been experiencing very strong growth in this segment. Our catheters and guidewires continue to perform incredibly well. We're seeing growth across most of our product groups.

If you look at our rolling four-quarter average, it continues to accelerate into the high single digit. Now we've been in the low double-digit for the last couple of quarters. We think we're performing very well in Cardio & Vascular. Our long-term objective in Cardio & Vascular is to continue to deliver double-digit growth on a sustainable basis.

We feel we're well-positioned to do that. So, it's continued strength in our end markets and penetration in the higher growth submarkets. We do expect, Glen, as we look at the second half of 2018, we do expect the growth rates to slow simply because the second half of 2017 was so much stronger than the first half of 2017.

So, looking at the second half, third and fourth quarter discrete, we'd expect to see lower rates. But we think it's important to look at all of our product lines on a rolling four-quarter basis.

It gives you a good indication of the trajectory of the business, because we're not running the Company on a three-month basis, we're running it to deliver sustained outperformance over time..

And then follow-up is on strategy. So you've paid down a significant amount of debt. In the slide deck, you talked about investing in faster growing market.

So, you're in neuromodulation, you're in electrophysiology, can you talk to us about market that you're interested that's currently outside of where you are [indiscernible], and would that require internal investment or external investment or both? Thanks..

Thanks, Glen. I wouldn't characterize our investment today is looking at markets that we're not in. We see ample opportunity to accelerate growth for the markets that we're already in. Where we do have an opportunity in certain areas is to expand our capability, whether it's with a specific technology or a manufacturing capability.

We do see opportunity to invest. We may do that organically in some cases where we think that's the better approach, it's going to deliver better returns over time. There could be some opportunities, smaller in nature, where we could acquire some capability.

Any acquisitions that we would do would be very targeted and very specific to manufacturing capability or technology that continues to build out our capability and our portfolio. But right now, we're very focused on the higher-growth submarkets, particularly structural heart, electrophysiology that you referenced, peripheral vascular, neurovascular.

We still see significant opportunities to grow in the markets we're already in.

And our focus over the next couple of years is to execute our strategy to penetrate those higher-growth submarkets faster, organic and inorganic as well as to drive the operational strategic comparatives, which we believe we can bring even greater differentiation in our quality, in our delivery for our customers that leads to increased innovation and ability to hit our financial objectives..

Your next question comes from Jim Sidoti with Sidoti & Company. Please go ahead. Your line is open..

Great. Just want to confirm, based on the guidance you provided today and factoring in the divestiture, you're looking for revenue of about $580 million for the back half of the year.

Is that right?.

If that lands in our mid-point, yes, within our range..

Right. So, I mean if we look at Q1 which was around $290 million and then the guidance at the back half of the year, it looks like Q3 and Q4 will be roughly like Q1 was. Q2 came in about $20 million ahead of that.

What was responsible for that?.

So, we saw very strong growth across all of our end markets in the Cardio & Vascular segment, and you saw a strong growth in Cardiac & Neuromodulation as well. When we look at our quarter splits, we really began to get meaningful traction in the second half of last year.

Our fourth quarter last year was the strongest of the year by a significant amount. We were $35 million higher sales in the fourth quarter last year versus the third quarter last year. So, we think we've got a really good trajectory running around the $300 million level every quarter this year, which gets us to the $1.2 billion forecast.

So, no business is perfectly linear and we think the rolling four-quarter is the right way to look at the business, and any given quarter can be moved a few percentage points in either direction by one customer managing inventory or dealing with their variability and their forecast and then their demands.

So, we think we're on a very good trajectory to hit the $1.2 billion range of our outlook for revenue for the year..

Okay. And in terms of interest expense, you reported about $15 million in the quarter. So, I assume that factors in the debt paydown.

Or what it will look like going forward, is that a good number for Q3 and Q4?.

Absolutely. The only variable there would be how quickly we can continue to pay down more debt, which we do expect continued debt paydown in excess of the required payment, and then what happens with interest rates as well..

Okay. And then last question, in the neuromodulation space, there's been some patent litigation news recently.

Does any of that impact you or do you care who wins that?.

Naturally we do have higher share of wallet with certain customers. So, it does have an impact on us. When we look at the market, we're here to serve all of our customers in the market and we continue to work to increase our share of wallet with all of our customers.

We feel we're incredibly well-positioned to serve both the well-established OEMs on a component basis and the early-stage companies on a complete device basis, from idea all the way to full-scale manufacturing.

We think the recent news with some of the players in that space does not impact or change our outlook in that space or our outlook for the year at all..

All right, thank you..

[Operator Instructions] And there are no further questions coming into the queue at this time. Ladies and gentlemen, thank you very much for joining the call today. This concludes today's conference call and you may now disconnect..