Ladies and gentlemen, thank you for standing by, and welcome to the Integer Holdings, LLC Q3 2019 Earnings Call. [Operator Instructions]. I would now like to hand the conference over to your speaker today, Tony Borowicz, Senior Vice President, Strategy, Corporate Development and Investor Relations. Thank you. Please go ahead..

Thanks, Rob. Good morning, everyone, and thank you for joining us, and welcome to Integer's Third Quarter 2019 Conference Call. The call is being webcast live and a 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 to 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 third 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 his opening comments.

Jason will then review our financial results for the quarter, and then provide updated full year 2019 guidance. Joe will come back on for his closing remarks, and then we'll open it up to your questions. At this point, I'll turn the call over to Joe..

Thank you, Tony, and good morning, everyone. I'm pleased to report that Integer delivered another strong quarter of earnings and cash as we execute our strategy to win in the markets we serve and achieve excellence in everything we do. We delivered 4% growth in adjusted EBITDA and 14% growth in adjusted net income on flat sales.

We paid down $36 million of debt and we expect our debt leverage to be below 3x by the end of the year. Our third quarter results give us the confidence to once again increase our full year profit guidance.

We have increased the midpoint of our full year adjusted EBITDA guidance by $3 million and the midpoint of our adjusted earnings per share guidance is now $0.25 higher. The midpoint of our new EPS guidance is $0.45 higher than our original guidance at the beginning of the year. We are executing our strategy and it is delivering strong results.

Our full year sales are still within our original 2019 guidance, despite the end of life of our electrophysiology program, the recent decline in the neuromodulation marketplace and the change in our fiscal year-end. Our full year guidance remains unchanged at 4% to 5.5% growth, which is within the growth rate of the market.

Our quarterly sales are not linear, and this variation is our reality as the medical device outsourcer as the timing of our sales do not link directly to the daily flow of medical procedure volumes. Our sales are buffered by the inventory that our customers hold, which can cause quarterly shifts in volume as inventories are adjusted.

We believe it is easier to predict volumes over a long time period than in any single quarter, which is another reason why we emphasized the rolling four quarter view of revenue. I think it's worth taking a moment to reflect on the results through the first 3 quarters of 2019.

On a year-to-date adjusted basis, our sales are up 2%, EBITDA is up 10% and earnings per share is up 24%. This dramatic operating leverage is reflected in the EBITDA margin rate, increasing from 21.1% to 22.6%, which is a 150 basis points increase versus last year.

This margin expansion is a direct result of the more than 8,000 associates executing our manufacturing excellence strategy and managing SG&A.

I've talked on prior calls about how we launched our manufacturing excellence strategy in July of last year and that we have been implementing it across all of our manufacturing sites in a very structured and rigorous manner.

I've talked about how the benefits of this strategy will build and even accelerate over time and ultimately be reflected in profit growing, at least, twice the rate of revenue growth, which is evident both on a year-to-date basis as well as in our full year guidance.

Since our last earnings call, I have visited 11 of our manufacturing sites to spend time with our associates who do the hard work of building the components and devices that improve patients' lives.

I've spent time on the manufacturing floor, observing the implementation of the Integer production system and the lean diagnosis activities that are improving the safety of our operations for our associates that are increasing the quality of our products for our customers and patients.

And that are improving the on-time delivery of the products to our customers, so they can support the physicians and surgeons who perform the medical procedures.

I've spent time with the teams to recognize the tremendous progress they're making and to understand where they need additional help to continue our journey to differentiation in our customers' eyes.

I came away from each site visit energized by the passion and commitment of our associates and how they're executing our manufacturing excellence strategy to better serve our customers and thereby improving patients' lives. Our strategy will enable our customers' success, thereby ensuring our continued success.

I'm confident that the progress we have made in executing our manufacturing imperative, will allow us to sustain our goal of growing profit at twice the rate of sales. I'll turn the call over to Jason now to discuss our financial results in more detail..

Thank you, Joe. Good morning, everyone, and thank you again for joining our call. I'll start with a review of our third quarter adjusted financial results. Third quarter sales were flat to prior year at $304 million. I'll provide more details on our sales results during our product line reviews.

Adjusted EBITDA increased 4% on a reported basis and 1% organically. We delivered $40 million of adjusted net income or $1.20 of adjusted earnings per diluted share, up $0.14 or 13% on a year-over-year reported basis. To provide some additional detail on our adjusted net income growth, let's turn to Slide 9.

Our third quarter adjusted net income increased $5 million year-over-year, up 14% on a reported basis on flat sales.

This growth was generated by operational improvements and productivity, driven by traction in our manufacturing excellence strategic imperatives and strong operating expense management, both continuing to offset price and inflation headwinds.

In fact, our adjusted SG&A was down $600,000 year-over-year, including covering the unfavorable $2 million impact from the expiration of our transition service agreement with Viant. Foreign exchange was favorable due to a currency headwind last year that did not repeat.

And we reduced our interest expense by $2 million through our debt and interest rate management. And though we continue to benefit from strategic tax planning and reported an adjusted effective tax rate of 15.7% in the third quarter of 2019, this was higher than last year's 14.3% that included a discrete benefit from stock compensation.

Year-to-date, our adjusted effective tax rate is 17.6%, and we have lowered our full year guidance to a range of 17.0% to 18.5% from the previous guidance of 17.5% to 19.5%. Now let's turn to a review of our product line sales results. As a reminder, Slide 11 reflects trailing four quarter organic sales.

We believe this is a more meaningful indicator of our growth trend and how we are performing in the market versus any individual quarter that may contain anomalies resulting from the timing of customer purchasing decisions.

Our trailing four quarter sales growth slowed in the third quarter, but is expected to turn upward in the fourth quarter to an outlook of 4% to 5.5% growth, as you can see, in the product line trends, this increase will be driven by a significant increase in the fourth quarter in neuromodulation and growth in the CRM product line, combined with strength in our Advanced Surgical, Orthopedics & Portable Medical and Electrochem product lines.

Cardio & Vascular will level off in the fourth quarter. On the next slide, we'll take a deeper look at Cardio & Vascular. Cardio & Vascular organic sales were down 1% in the third quarter.

The strong growth we continue to see in peripheral vascular and structural heart was offset by the largest quarter of decline to date in an our end of life electrophysiology program.

In fact, you can see that alone this program -- this program's meaningful decline drove approximately 500 basis points of headwind on our total Cardio & Vascular product line.

We expect low to mid single-digit growth for the fourth quarter as the impact of this end of life program lessens, and we see strength in structural heart and peripheral vascular. Excluding the end of life electrophysiology program, the rest of the product line will grow at market for the full year.

On Slide 13, organic sales in our Cardiac & Neuromodulation product line were down 3% in the third quarter on flat CRM sales and a decline in neuromodulation from a shift in customer demand into the fourth quarter.

We expect extremely strong neuromodulation sales in the fourth quarter due to the total year commitments required in our supply agreement. And we expect strong CRM sales in the fourth quarter due to a favorable year-over-year comparison. We anticipate the full product line growth to grow mid-single digits for the full year.

We estimate that our neuromodulation sales in 2019 will benefit approximately $10 million from the supply agreements. And therefore, we will not see the full impact of the neuro market slowdown. This means we could potentially have $10 million lower neuromodulation sales in 2020, thereby creating a $20 million year-over-year headwind.

Slide 14 shows the last part of our Medical segment. You will recall in July 2018 Viant acquired our AS&O product line. the Advanced Surgical, Orthopedics & Portable Medical product line shown today includes sales under supply agreements with Viant.

The third quarter Advanced Surgical, Orthopedics & Portable Medical returned to growth, up 5% organically versus the third quarter prior year, driven by an increase in Advanced Surgical based products and new product launches in Portable Medical.

We expect strong sales in the fourth quarter across all products as a result of increased end market demand. Finally, Slide 15 summarizes Electrochem, our nonmedical segment. As expected, Electrochem sales grew a strong 14% in the third quarter, driven by energy market demand and increased customer market penetration.

We expect strong growth to continue in the fourth quarter from increased military and environmental demand despite a softening energy market. Slide 17, we look at the 4Q 2019 outlook. With 1 quarter left in the year, we have included this additional slide to call out the fourth quarter outlook that aligns with our total year guidance.

As discussed, we expect a strong finish in our fourth quarter sales growing 10% to 15%. Adjusted EBITDA is expected to grow 6% to 12%, with volume offset by a projected increase in SG&A expenses as we continue to selectively add new leadership and resources to execute our strategic imperative.

Adjusted EPS growth follows a 9% to 18%, with added lift from interest expense and tax favorability. Turning to the full year 2019 outlook and following the strong expected fourth quarter we just outlined, our forecasted sales growth of 4% to 5.5% for the full year is unchanged. So as highlighted, we expect to be on the low end of that range.

Traction on our manufacturing excellence strategic imperative and strong operating expense management gives us confidence to again increase our adjusted EBITDA guidance to a range of $282 million to $286 million, which increases our low-end by $5 million and our high-end by $1 million.

At 9% to 10% growth over last year, we will achieve EBITDA growth at approximately 2x our sales growth, consistent with our strategic objectives. In addition to the adjusted EBITDA guidance improvement, our reduction in interest expense and tax planning efforts continue to drive improvement in our adjusted EPS outlook.

Accordingly, we have increased and tightened our adjusted earnings per share guidance to a new range of $4.55 to $4.65, up $0.30 on the low end and up $0.20 on the high end of the range. This new range reflects a growth of 20% to 22% versus 2018. Turning to Slide 19.

Our third quarter cash flow was strong and in line with our expectations as we delivered $44 million in cash flow from operations, bringing the year-to-date total to $112 million. We also paid down $36 million in debt in the third quarter, bringing our year-to-date payments to $102 million, further reducing our leverage to 3x adjusted EBITDA.

We remain on track, and our full year cash flow outlook is unchanged. We expect to generate $160 million to $170 million of cash flow from operations and $110 million to $120 million of free cash flow.

Capital expenditures are still expected to be in the range of $50 million to $55 million, and cash tax payments are now expected to be lower by approximately $5 million. Our projected debt payments remain unchanged for 2019 despite the $15 million acquisition of assets from US BioDesign announced earlier this month.

And with this debt payment outlook, we remain solidly within our debt leverage targeted range of 2.5 to 3.5x adjusted EBITDA, with dry powder to continue our bolt-on acquisition strategy to add critical capabilities in our portfolio. I'll now turn the call back to Joe for his final comments..

Thanks, Jason. This slide summarizes our strategy to win in the markets we serve and achieve excellence in everything we do. We developed this strategy during the second half of 2017, we've built out the multiyear plans during the first half of 2018 and formally launched this strategy in September of 2018.

So we are just now entering the second year of executing our operational strategy. We have been making the necessary investments in both human and financial capital to ensure the successful execution of our strategy.

I told you back in May about the two new business presidents, Joel Becker and Carter Houghton, as well as the internal promotion of Jen Bolt to the leadership role of our Global Operations and manufacturing excellence.

During the third quarter, we made additional investments by adding more lean manufacturing and business process experts to further accelerate our plans.

We've strengthened our manufacturing leadership with several leaders who bring deep experience and expertise in lean manufacturing, strong automation and robotics backgrounds and medical device manufacturing experience.

In addition to the two new leaders, we continue to make the necessary investments in our operations to develop and expand both capability and capacity to support our product line strategies. We anticipate investing approximately $50 million in CapEx this year to support the innovation and growth in our strategy.

Additionally, I'm happy to say that we have hired Elizabeth Giddens as our General Counsel and Chief Ethics and Compliance Officer. Her expertise in the areas of securities law, mergers and acquisitions and corporate governance bring the skills we need to accelerate our strategy. The Integer executive leadership team is now complete.

Our full year guidance is to grow sales 4% to 5.5%, increase adjusted EBITDA at twice the rate of sales and grow adjusted EPS by 20% to 22%. The sales guidance is about in the middle of our original guidance and the adjusted EBITDA and adjusted earnings per share are both above the original guidance.

We expect our debt leverage to be slightly below 3x adjusted EBITDA by year-end. From the first time we introduced the financial objectives of our strategy to grow sales 200 basis points above the market and grow profit at twice the rate of sales. I said we could achieve the profit growth faster than the sales growth.

This is a function of the time to win and transfer new business and the regulatory environment in which we operate.

We are investing in the innovation, the sales team and the product strategies necessary to accelerate our growth beyond the current market growth rate that we've been achieving, but we are a market growth company until we build the pipeline of wins and can achieve growth above the market.

Regarding profit growth, we are now growing at twice the rate of sales and believe that is sustainable. So looking forward, we see market sales growth, pending the potential impact of the neuromodulation market slowdown in 2020 and profit growing at twice the rate of sales.

The acquisition of US BioDesign assets, which we closed earlier this month, is one example of adding capability to our product portfolio. We can now offer our customers complex braiding capability for high-growth Cardio & Vascular markets.

This is a bolt-on acquisition that immediately becomes a technology center of excellence for us, and we expect to deliver revenue synergies when combined with our existing technology and customer relationships. We continue to work a robust pipeline of bolt-on opportunities that would bring additional capabilities for high-growth end markets.

One of the areas we continue to invest heavily in is our customer relationships and sales team. Since our last earnings call, I've spent time with 5 of our largest customers. We've discussed our strategy and our objective to enable their success through innovation and operational excellence.

We're building on our long history together to make Integer their most strategic outsourced partner. I believe we're making significant progress in developing deeper relationships that can lead to Integer participating in their growth in a much more meaningful way as a strategic partner.

In addition to investing time and deepening our customer relationships, we are expanding our reach by adding sales leaders outside the U.S. We have a new cardiac rhythm management and neuromodulation sales leader and have been adding new sales members to both the cardiac rhythm management and neuromodulation and the cardiovascular teams.

I know I speak for all 8,000 plus of my Integer colleagues, when I say I'm excited to serve our customers because it is through our customers that we improve patients' lives.

In summary, I am confident we have the leadership team in place and with the entire organization aligned on executing our long-term strategy, we are well positioned to deliver on our financial objectives and earn a valuation premium for our shareholders. I'll now turn the call back to the moderator, Rob, to facilitate the Q&A..

[Operator Instructions]. Your first question comes from the line of Matt Mishan from KeyBanc..

I get there's inherent volatility in your business, but you're also the largest CDMO. Your customers are booming. And I feel like you and the new management team have made significant positive changes to your business and to your relationships with your customers.

I mean, I guess the question is, are you seeing enough tailwinds to your business and the changes you've made to kind of push through a potential headwind next year from neuromodulation and still deliver that mid- single-digit market growth..

Matt, Matt, it's a great question. So we're absolutely making tremendous strides with our customers to ensure that we are their first choice for outsourcing their medical device manufacturing needs.

And I believe we're beginning to get into the pipeline of those deals and those products that take longer to get designed in to go through clinicals or qualification and then position us to accelerate above the market. Right now, where we see ourselves is we've achieved the goal of growing profit at twice the rate of revenue.

There is still more work to be done to get sales to grow above the market, which we've said all along will take longer. And the reality is with the neuromodulation market, as best we can tell, the spinal cord stem piece of that market has declined mid-single digit in the first half of this year.

We're just looking at what the industry players are reporting, and we have not felt the impact of that this year because of our supply agreement. So we're still growing high single digit, low double-digit in our neuromod business.

We think that's about a $10 million of revenue that's over and above that market growth rate and we do see that as something that is a potential headwind next year. As we look into 2020, we're kind of assuming a flat neuro market, kind of the end markets.

If the market growth rate is faster, that would obviously help us offset some of that $10 million. In the absence of that, we do see about a $20 million year-over-year headwind. The rest of the business is still growing at about the market rate.

And until we can see a pipeline of deals and products that we believe are going to push us to be above the market rate, that's the market rate or extra growth rate that we'll have. So we look at the neuro decline as a market reality, so the market rate, in fact, has declined this year.

And the benefit for us is we won't feel that impact until next year, which maybe, to your point, gives us time to work to address that. But we're not immune to the markets that we serve, and we do see the neuro market decline this year after growing in the strong double-digit range..

Okay. And then you also talked something new here year about sort of the breadth of your neuromodulation customers, which included a lot of -- I don't want to call them early stage companies, but a lot of early commercialization type stage customers.

Have those progressed as you've expected this year, as they expected or has there also been some modest slowdown or moderation in their expectations..

Great question, Matt. We have not seen any change whatsoever in that segment of the market. We've seen most of the decline in the spinal cord stim. The companies we're working with that are early stage all the way through their clinicals and working on commercialization plans, we continue to be extremely excited about the growth prospects.

And we're making the necessary investments in capacity to ensure we can support their growth. And we're working with a number of those customers that we feel have the potential to drive meaningful growth in the market and for us. And we will incorporate that in our future guidance as those plans firm up..

Okay.

And then on the margin side, first off, the EP product that's rolling off, was that a margin-accretive or dilutive product for you? And then as you move forward into 2020 and '21, how durable are some of these improvements you're seeing kind of moving forward?.

So the -- given the size of the EP program, it's not a meaningful impact on the margin rate. It's not meaningfully different from the total enough to have an impact. And it's also not meaningful enough dollars on the $300 million quarterly or $1.3 billion total year revenue to have a mix impact. So it's not really impacting the rate much.

With respect to your question about the durability of our margin expansion, we feel it's very durable. We feel that we sit here today, we're in the sixth quarter of our manufacturing excellence and strategic imperative. We launched it in July of 2018. So we've got 5 quarters under our belt. We're in the sixth quarter.

We feel that's going to continue to be durable. It'll continue to build, and it's going to enable us to continue to expand margins, and we expect to be able to grow profit at twice the rate of revenue going forward.

So we feel as though we've achieved that critical element, the financial element of our strategy in terms of the increased profitability and cash flow that allows us to reinvest more aggressively in the business. So we see ourselves growing at twice the rate of revenue for profit going forward..

Okay. I have two more, and I apologize to the people who are behind me, but I'm going to ask it anyways. First off, how interested are you in another leg of the stool.

And I'm specifically asking a strategic question around potentially building out a diabetes platform, it would seem to align very well with your customers and it's an area of growth in devices?.

Great question, again, Matt. What I can say about our strategy at the moment is we launched our strategy in September of last year. We are very focused on executing this strategy and ensuring that we get revenue to be growing faster than the market by at least 200 basis points.

And when we do that, we create the capacity to make bigger investments and to branch outside potentially of our existing markets that we serve. But to your point, we do think about and explore and contemplate what are some other adjacent products in the medical device industry, where we think we could bring a point of differentiation.

But I can tell you, for the near term, we're very focused on executing this strategy and demonstrating that we're growing 200 basis points or more above the market, growing profit at twice that rate, and then that earns us the right to place bets in other areas..

Okay, got it. And lastly, when you -- in your revenue that's exposed to the energy patch in Electrochem. It seems like some of your customers are -- and it seems like some of the producers are actually kind of manufacturing or producing very productively and not necessarily investing a ton in CapEx here.

How confident are you that the nonmedical piece can sustain at current level and not have a drop-off in 2020..

Yes. One of the interesting developments in the energy market is our customers, they seem to have become much more responsive to changes in market demand. The recent disruption in Saudi Arabia in supply was almost immediately met with additional supply from other parts of the world. And so there really wasn't a sustained price increase in oil.

And it seems as though our customers in that space have adjusted their investment -- their investment strategy to react very quickly, much more quickly than they have in prior cycles. So we expect there to be a much less pronounced -- both decline or growth during the future energy cycles.

And as we look at the market, we see it softening a little bit, but we're also confident given some of the new products that we're introducing in that space and some opportunities that we have that we'll be able to grow above that market.

But we're not seeing, looking for the same magnitude of spike and decline because the customers seem to be reacting much more responsively to the slight changes in that sector. Right..

And your next question comes from the line of Jim Sidoti from Sidoti & Company..

Apologize in advance, I'm trying to listen to two calls at once and that never goes well. But it seems like from what you guys have reported that you're basically on track with a lot of the initiatives that you've put in place over the past couple of years.

The one question I had for you -- two questions I have for you is the revenue guidance for the year implies double-digit growth in the fourth quarter.

What ticks up there so much?.

Yes, if you look at the fourth quarter, number one, we've got -- we still have a couple of extra days versus last year, despite the fiscal year change that we made. So that's a lift for us. The -- we've talked about the end of life electrophysiology program, that drag lessens in the fourth quarter.

We've also highlighted the significant growth that we'll see from neuro. CRM has got a low comp from last year. And then we also highlighted just the strength we see also AS&O and the Electrochem product line. So we really just have a lot of things going in the right direction.

The great news, Jim, is that the plants are -- and factories are geared up to execute the backlog we've got. So we're looking for a strong sales quarter for 4Q..

Okay. That was the one question. The second question is, you've made a lot of progress on the margins.

You made an acquisition in the quarter, do you take a little bit of a step back as you integrate that? Or do you think you keep going with the same momentum that you've had so far?.

Jim, we expect to keep going. It's a small bolt-on acquisition. It really brings deep expertise for us in complex braiding, nitinol heat setting testing, lectropolishing and some other capabilities, but it's really about adding capability.

It's today a small operation with de minimis sales, but they're in the pipeline for a number of products with our customers that are really exciting for us and for US BioDesign.

So we don't expect any impact whatsoever on our ability to continue executing on our manufacturing excellence to drive the margin expansion and keep the momentum that we have going..

[Operator Instructions]. And we have no further questions. I'll turn the call back to Tony Borowicz for closing remarks..

Thank you, Robin, and thanks, everyone, for joining us on today's call and your continued interest in Integer. Please note that this conference call will be available for replay on the website -- Integer website. Thanks again. That concludes the call. Happy Halloween and be safe..

Ladies and gentlemen, thank you for your participation. This concludes today's conference call and you may now disconnect..