Integer Holdings Corporation (ITGR) Q1 2012 Earnings Report, Transcript and Summary

Welcome everyone to the First Quarter 2012 Greatbatch Incorporated Conference Call. Before we begin I’d like to read the Safe Harbor statement. This presentation and our press release contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and involve a number of risk and uncertainty. These risks and uncertainties are described in the company’s Annual Report on Form 10-K. These statements are based upon Greatbatch Incorporated current expectations and actual results could differ materially from those stated or implied. The company assumes no obligations to update forward-looking information included in this conference call to reflect changed assumptions, occurrence of unanticipated events or changes in future operating results, financial conditions or prospects. I’d now like to turn the call over to your host, Corporate Controller and Treasurer, Marco Benedetti.

Hello everyone and thank you for joining us today for our 2012 first quarter earnings call. With us on the call are Thomas J. Hook, President and Chief Executive Officer; and Thomas J. Mazza, Senior Vice President and Chief Financial Officer. In terms of today’s agenda, Tom Hook will start us off with a few brief comments regarding our first quarter result and we will then provide an overview of our strategic focus going forward. After that Tom Mazza will review our first quarter financial result and guidance for 2012. We will then open up the call to Q&A. As we have done in the past we are including slide visuals that go along with this presentation, which you can access on our website at www.Greatbatch.com. With that let me now turn the call over to Tom Hook.

Thank you, Marco, and welcome to all of you who are listening to our call today. We are pleased to be able to share with you our results for the first quarter which is as expected were below the 2011 period due to the tough comparables in the planned increase investment in the development of complete medical devices. Revenue for the quarter was a record $159.1 million and represented a 7% increase over the prior year, this increase was primarily driven by our acquisition of Micro Power which contributed $20.6 million to sales of this quarter and we ahead of our expectation. On an organic constant currency basis revenue declined 6% due to the tough comparables that were created by a lower level of CRM and Orthopaedic customer product launches relative to last year’s first quarter, partially offset by double-digits growth within our Vascular Access product line. Adjusted operating income for the quarter decreased $3.2 million to $15.5 million and reflected lower gross profit and increased investment in the development of medical devices. Gross profit for the quarter includes the impact of lower volumes and production inefficiencies and our European Orthopaedic facilities. Since then we have aggressively begun to right size our cost structure as previously announced we have further plans to enhance optimize and leverage this business which we began implementing in 2011. Even though we are off to a slow start, we are reaffirming our full-year 2012 guidance, as we have indicated in our last call we expect our results to improve as the year progresses driven by moderate growth in our NOI market in the second half of the year, operational improvements is a result of further integration of our recent acquisitions, consolidation of our Orthopaedic operations as well as increased sales from medical devices. Additionally, there…

Thanks Tom, and good afternoon everyone for the call today. I’m pleased to review with you our results of the first quarter beginning on Slide 10. First quarter 2012 sales increased 7% over the prior year period to a record $159.1 million and included the benefit of 20.6 million of sales from the Micro Power acquisition. On an organic constant currency basis, revenue declined 6% due to lower customer product launches in our Orthopaedic and our CRM product lines partially offset by double-digits growth from our Vascular Access product line. Looking at our CRM and neuromodulation product line in comparison to prior year, sales in the first quarter of 2012 decreased 4% as revenue continue to be in impacted by the overall slowdown in the underlying market. Additionally, first quarter 2011 CRM sales included the benefit of customer inventory builds to support the product launches which did not reoccur in 2012 period. As indicated last quarter, we expect CRM and neuromodulation revenue for 2012 to be lower in the first half of 2012 but begin to rebound in the second half of the year as comparisons ease and the CRM market improves. With that said, given the recent negative publicity surrounding CRM devices that has been in the news lately, we thought it prudent to reiterate that our visibility of customer ordering patterns is over a relatively short period of time and that any significant customer field actions or relative market share shifts among OEM manufacturers could have a material impact on our operating results. First quarter 2012 sales for our Vascular Access product line increased 11% over the prior year period, this increase was primarily attributable to growth in the underlying market in new business including sales of complete medical devices. As Tom already mentioned, we currently expect 2012…

(Operator Instructions) Our first question comes from Daniel Garofalo with Piper Jaffray. Please proceed.

Just on the acquisition front, a two part question, can you give us some sense of what you are seeing in terms of the quality of opportunities out there? And then secondly, what’s your appetite capacity for additional acquisitions given your recent activity?

Great question Dan, I might see in terms our growth orientation now. We are looking for quality targets, we got obviously the financing in place, we looked at a lot of companies that align with our current product lines kind of what I’d say was just in scope of our current product technologies. We see a lot of good high quality targets out there. Obviously, valuation and price negotiation are really always the counterbalance quality is you are going to expect obviously, we have to pay a higher value for more quality companies. So, we are looking for strategic alignment. But there is definitely deals out there, we now only think of good quality companies that are very good compliments to us. When I look at for transformal deals at this time we are looking for things that fit GAAPs and product technologies and capabilities that we like to feel that would fit nicely into the operating base, and then also ones that we can consolidate, integrate and take advantage of cost out actions like we have done historically. What’s our appetite, we have plenty of obviously room from the financing standpoint for this, but I think what our appetite really is going to be gauged by our operational appetite given that the work that we are doing with our core customers because of all of these large agreements and product developments we started and Greatbatch Medical and Electrochem side we were very busy. So, we are going to have to really concentrate, really targeted M&A activities, because I don’t think we are really in a position of taking huge vibes on big deals because of the temple being that busy at Greatbatch Medical and Electrochem and of course if you know QiG right now is kind of fully loaded across the board and their projects is well. So, I’d say that we are going to have small to medium appetite on deals going forward. So, to be something it's going to supplement it's not going to be really a transformal one. So, hopefully that those thesis answer your question, Dan.

Yes, that’s very helpful. You had indicated devices commercialized under the Greatbatch name to be about 10 to 15 million this year I think. And I’m just wondering if you are going to update us on where we could see that goal over a multi-year horizon. Have you laid out some goals internally, or otherwise what that number could be that you can share with us?

Sure. We did provide last year some direction at our Investor Day, what it's always going to be overtime, and as we have said we made a tentative commitment to provide in Investor Day around what our projects will be towards the end of this year in the fourth quarter. And we will at that time also kind of provide some updated guidance for 2013 and beyond where we think those programs are going to hit. I think definitely the timelines that we have working on the regulatory clearances is a little bit frustrating given reviewed timeline of lengths has been much longer than we originally had planned or liked. We are not necessarily running into challenges, getting them through or getting running into challenges we have been taking too long which obviously starts the commercialization phase late. So, we are going to be tuning up the guidance we gave for 2012 at our Investor Day and provide some revised guidance later in this year on that, but right now we are targeting 10 to $15 million range and obviously we are aspiring to get to the top of the range or higher.

And just one last quick follow-up if I could. Specifically on the Ortho number, is there a degree of seasonality that affected their number and trend wise do you have a sense for if there has been any stabilization taking place thus far in Q2? Thank you.

Well, I’d say there is seasonality in Ortho, yes, but that’s not what our challenge was, is there is certainly we have a half of our businesses kind of European operation it has a third quarter seasonality dip. Our challenge was in our European operations, we did not execute operationally and it hurt our revenue and profitability and that’s an operational problem. There is plenty of business out there, we want it and we could not operationally completed and ship it on time. And we have to correct those operational issues and as you know Dan, that’s the last consolidation opportunity that we have from the acquisitions we did from the 2007 and ‘08 timeframe. We run our surgical instruments division, our four facilities globally, three of them in Switzerland and we need to consolidate that the projects and plans we started and we need to complete it up and finish it to be able to prevent these profitability challenges from hurting us like they did in Q1.

Our next question comes from Glen Novarro with RBC Capital Markets.

Few questions, one, given the Orthopaedic challenges that you mentioned, you still reiterate your revenue guidance of 13 to 17%. Is it fair to assume that we should be really closer to the low end of that range at this point. That’s my first question?

It's a great question, obviously we got a lot of triggers that we can pull beyond just our Orthopaedics product lines to meet our overall revenue guidance. I mean certainly as you know not untypical but when we break out guidance in terms of ranges that provide the spread we may have some puts and takes. We are very disappointed at the European Ortho give up hat we had in the first quarter. We didn’t plan for it, we can see it coming until it was too late to respond. We made adjustments late in the quarter to fix the balance of the year and we also had a we have got managerial flexibility to reallocate resources to accelerate growth in other areas, and that’s as we still see a signs of stabilization CRM, recovery in Ortho in the larger markets. We definitely see the business out there. I think Ortho for us is operational execution and because we are so deep and tight with our customers and CRM, and we have done such a good job of expanding those strategic partnerships, we have to see them execute on the product development activities to pull the volume from us. And we are seeing that stabilizing it gives us confidence in our full-year guidance at this time. So, while I think we got a little bit challenge in Ortho, I think we got other levers we can pull to, we still be able to deliver the years we originally planned.

Okay. And just a follow-up on Ortho. It seems like in the quarter it was more of a timing issue, and it sounds like what you weren’t able to deliver this in 1Q shouldn’t that just get pushed into 2Q or are you seeing that business tats beneficially lost?

I think it's an operational issue in terms of, [we bit up] more than we can chew, we could not perform and a lot of it stems from that we have very inefficient operations because we are spread amongst four facilities. As you know we have a brand new facility that we have finished completing construction in Fort Wayne, and we are just starting to move into. It's going to address some of the challenges we have in the U.S. operations. We haven’t started that project to consolidate our European operations yet. We are behind schedule we planned it out, to get the project approved through our review process internally, and we missed the quarter because we didn’t execute operationally for customers and that’s the problem that it’s internal. We know how to fix and it wasn’t due to lack of opportunities with customers. So, literally and it wasn’t a timing issue either. We just didn’t perform and we are playing catch up and we have to get more aggressive to meet the objectives that we had set out to be Orthopaedic business in Europe full-year.

So, when you don’t deliver on schedule to a customer, what does that customer do? Are they vulnerable in terms of business, take product elsewhere or was this business that was just going to be more additive to that one customer?

Think of it as kind of fluid, Glen, is that certain (inaudible) is more or less one time opportunities that you keep earning the next phase of business you move forward. When you are late on a project that occupies your resources and ties them up for a longer period of time. And then obviously, you can’t start new projects and of course customer may take in more projects than they outsource or give them to your competition. So, you got to remember is that, it's a combination of mixed revenue opportunities but also cost overruns as well. And so it's a profitability that hurts more even in the lost revenue when you are looking at missed operational execution like we have. And I think what we have to get is we need to consolidate our operations, we need to implement, that’s the only site that we don’t have our Oracle ERP system implemented, and we have got to do better there. So, that for us was an impact that was at the root cause of why we missed the quarter from our internal plans and although the loss consensus was pretty balanced over the course of the year. We still obviously underperformed where we should have been from our internal benchmarks as well as consensus.

One quick on CRM, because in Tom Mazza’s comments he said there is still is a little bit of uncertainty in the CRM market, kind of highlighting to maybe one of your customers having some issues. Let’s just assume that one customer that Tom Mazza was referring to St. Jude, because of their reaudit issue. I know St. Jude is an important customer, but you also do business with Boston Scientific, you also do business with Medtronic. So, if you lose a little business or there is a slowdown in the St. Jude business, doesn’t that business get picked up by Boston and Medtronic, so in the end your CRM business still does well?

Certainly, there is many theories that surround, Glen, I tend to ascribe to the theory that bad news is bad for the market and bad for the adoption of technology. So, it hurts since we are well represented, and have long-term agreements with all of our customers, and partner with them strategically. When there is kind of what I’ll call [sourcing] of share between the customers it tends to be mitigated because one goes down one goes up. If they pass that through to us and buffer it, they affect us on inventory, but over the long run. We will normally get a mitigating effect. However, if it's negative news that weighs down the market which obviously we have seen a lot of negative news come out in the media. It tends to be a drag factor on our CRM business and obviously this is where we diversified revenues in a company, made investments in other areas. We are still reaffirming our investment in CRM, but the bottom line is that we think we have got enough triggers to meet what our guidance was that we set out at the beginning of the year, even though we are going to have some potential loss debunks in the CRM side.

Our next question comes from Jason Mills with Canaccord Genuity. Please proceed.

This is (inaudible) calling in for Jason. My first question is on medical device revenue, can you give me the number for Q2 and then what have you seen that cause you to change your guidance. Last quarter you gave a flat 15 million for the year and this quarter and you have given a range of 10 to 15 million?

Yes, we are just going to stick with what our guidance is on the 10 to 15 million, because we are kind of in this stage we are launching some of the approved products we got at the beginning of the year. And then we will give kind of a more future breakout, the call it will have surrounding attention on Inventor Day that all of the QiG products towards the end of the year, but we are targeting 10 to 15, it's totally driven by really approval time lines that we got in our plan. We definitely see the opportunities to get the 15, there is obviously a lot of review complexicities that occurs when we submit things to the regulatory bodies. The average review times is well documented by (inaudible) and as well as the FDA had been steadily increasing year-over-year. And obviously that just kind of brings revenue opportunities for us going forward. So, it's not a question of whether we will or won’t get the revenue, we will, we just can’t since that kind of ran throughout the year, even there is a 30 or 45 day delay in approvals that tend to spill it over in the first quarter of 2013 which is extremely frustrating for us. But it's realistic to expect that pressure. So, the change between our statements of 15 million of revenue and kind of softening that 10 to 15 million is really driven by that timing aspect of the regulatory clearances. And as soon as we get them we have been very quick to ramp up with customers and drive commercialization. And couple of products that we highlighted, we have been very pleased with how they have been adopted by customers and also get feedback from them on the clinician acceptance has been good and back it's been better than our anticipated plans for the year in terms of the adoption of those. So, we do expect some upside potential to it, totally driven by timeline approvals.

Okay. Is it fair to say that of the product that we launched in Q1, or you did 3 million is being sequential growth over that?

For the year we are planning on doubling top tripling the revenue, but I think we are just going to try to stay in an annual guidance for devices, because now they are kind of out of the gate. We are just going to try to keep the focus on the bigger picture, because we are going to get into too much complexicity with ramping launch (inaudible) and then coming into steady state production and various products and we did we want to pose in a little bit more macro view of device revenue rather than getting down at the individual piece parts. We will still break out the approvals as we get them individually. So, everybody can understand which products are coming on stream, but we are not going to really give much more granularity underneath that in terms of the individual financials.

And so you originally guided Micro Power to be neutral to 2012, is it fair to say because you are maintaining your guidance that perhaps Micro Power could be accretive to 2012 given the performance that we have seen this quarter, the strong performance.

Yes, I think that’s a fair statement, is it that I think the Electrochem and Micro Power teams jumped on the integration initiatives extremely quickly in Q1, and they got some very nice gains. And that’s so much on the cost side but more on the strategic side, and customer pay side. They have unified the management team over there to run at a single business. So, it's going to get a little muddy in terms of kind of what Electrochem and Micro Power were going be rolling out kind of a unified branding, messaging and identity for that combined organization, but they have just done a tremendous job executing operationally and Micro Power was a bright spot as you know and operating teams are crisp and they get on top of those challenges and they execute. We have always been able to show very strong results. Electrochem is a integrated multiple acquisition in multiple locations over the past several years, we are very good at it, the operating team there is very good. And the complement of lot of the leadership that has stayed on board and Micro Power really is picked up the opportunities there and they are combining these skills of Micro Power and Electrochem very effectively. So, it's a significant upside for the year from where original plans are laid out.

Okay. Yes, it's very impressive to see the diversification of your business and even though you had, this big hit in Orthopaedic to see this many lever in your business, that’s very encouraging. I applaud you for the diversification there. I’m sure it's not an easy task. The other question I had was regarding the AF as durable catheter sheet. What kind of stocking patterns which you typically have. I assume that was the, I know you don’t want to name customers, but I saw that VSC had announced an AF steerable catheter. I assume this is there, but what kind of stocking patterns do you typically see when you launch a new innovative product like this?

On any form of products that’s kind of novel is a fair amount (inaudible) around making large ramps, everybody wants to control and get certain amount of data back. Sooner after when the initial feedback from first human work has been done, it generates a lot of excitement and of course everybody wants to increase production demand, so it doesn’t so much ramp up inventory and preparation of a launch like many traditional OEMs do. It tends to just build an intensity and then we in our operation got to keep pace with that increased demand. And that works well with our operational plan. It's a good partnership with customers and do it this way. So we don’t end up with building a massive inventory bubble before we get some good market feedback understand what the true demand is going to be. So, I expect when we look at the sales number for medical devices out of the Greatbatch, it's true demand that we are actually seeing it, it's not push pulling it inventory. It's pretty much a straight pull right out of Greatbatch to meet the raw demand it's coming from the market.

And that concludes today’s question-and-answer session. I’d like to turn the call back over to Marco Benedetti for any closing remarks.

Thank you. I’d like to remind you that both the audio portion of this call and the slide visuals will be archived on our website at Greatbatch.com and will be accessible for 30 days. Thank you everyone for joining us.

Thank you for your participation, that concludes today’s conference call.