Ladies and gentlemen, thank you for standing by and welcome to Integer Holdings LLC Q2 2020 earnings call. At this time, all participants are in a listen-only mode. After the speaker presentation, there will be a question-and-answer session. [Operator Instructions]. Please be advised that today's conference is being recorded. [Operator Instructions]. I would now like to hand the conference over to Tony Borowicz, Senior Vice President of Investor Relations. Thank you. Please go ahead.

Good morning, everyone. Thank you for joining us and welcome to Integer's second quarter 2020 earnings conference call. The 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 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 of the financial statement 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 second 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 and discuss how COVID-19 is impacting our business and how we are managing in this new normal. Jason will review our financial results for the quarter, provide an update on how we are managing costs and discuss our strong cash position. Joe will come back on to provide his final closing remarks and we will open it up for your questions. At this point, I will turn the call over to Joe for his comments.

Thank you Tony and thanks to everyone for joining the call today. I want to start by reiterating what we said at the beginning of our call last quarter, creating a safe environment for our associates who have been coming into our manufacturing operations every day during this pandemic continues to be our top priority. By ensuring pandemic safety protocols are in place, our associates are able to focus on manufacturing the products our customers and their patients need every day. Sounds simple, take care of your associates who take care of your customers. Now that we are operating in this new social distanced environment, we have worked to make it as normal as possible, so we can stay focused on executing our strategy. We have found a cadence and a rhythm that is as normal as one can be during this dynamic period. One step in this process has been increasing our agility to adjust production to the changing needs of our customers and the market demand. We continue to work closely with our customers to meet their needs while also continuing to implement our strategy, with an intense focus on our manufacturing excellence, operational strategic imperative. The team has been very creative in their implementation of the Integer production system during the pandemic, as many of our lean experts are working remotely. We are operating as though this is the new normal and remain focused on the execution of our strategy to achieve excellence in everything we do. On our first quarter earnings call in early May, we disclosed that April sales were down approximately 20% and believed it did not reflect the full impact of COVID-19. We projected our second quarter would be worse than April. And now that the second quarter is complete, sales were down…

Thank you Joe. Good morning everyone and thank you again for joining our call. I will provide more highlights on our second quarter 2020 adjusted financials as well as provide an update on our liquidity and the actions we have taken to enhance our ability to continue investing to execute our strategy throughout the pandemic. As Joe highlighted, our second quarter results were significantly impacted by COVID-19. Sales decreased by 24% to $240 million, adjusted operating income decreased 65% to $22 million and adjusted EBITDA decreased 56% on a reported basis. As a reminder, we now include adjusted operating income, as we believe this metric more comprehensively reflects our performance in managing all operating costs in the business. We will continue to show EBITDA so that you can see those measures. Finally, we reported $10 million of adjusted net income, a decrease of 74% and the adjusted earnings per diluted share declining to $0.32. The profit decline is a direct result of the rapid decline in volume while maintaining infrastructure to support the return of sales post-COVID and continue executing our strategy. We are adjusting variable costs to the new volume levels and working to mitigate COVID related social distancing cost increases. We anticipate the second quarter to be the most challenging from a profitability perspective. The next slide may look familiar, as we showed it in our first quarter earnings call to share the approach we are taking to manage costs during the pandemic and we believe it will help to provide more color on our second quarter income reductions. We are appropriately matching our variable cost reductions to the reduction in sales volume by taking necessary labor reduction and working with suppliers to reduce material input. Our indirect labor and overhead are less variable and in most cases,…

Thank you Jason. We continue to lead Integer with a priority on taking care of our associates during these uncertain times. Our manufacturing associates continue to build products that patients need every day throughout the pandemic. They are delivering for our customers and ensuring they have the highest quality products, where they need them and on time. We continue to experience strong demand in product development and have expanded our engineering team during the pandemic. Our sales pipeline activity also remains robust, including customer outsourcing opportunities. We are approaching each day as the new normal by increasing our agility to respond to the changing needs of our customers and the volume changes in the marketplace. We are remaining focused on executing our strategy. Our lean experts have been extremely creative in implementing the Integer production system, while working remotely and we continue to move forward with a sense of urgency. The sales leadership is accelerating the execution of our sales force excellence, operational strategic imperative despite the pandemic and we continue to make the necessary investments in our capabilities to deliver differentiated products to our customers. The impact of COVID is real and significant, but we remain focused on executing our strategy through the pandemic so that when volumes return to normal, we are back on the growth trajectory we were on pre-COVID. Thank you for joining our call this morning. I will now turn the call back to our operator for the Q&A portion.

[Operator Instructions]. Our first question comes from the line of Matthew Mishan with KeyBanc. Your line is open.

Great. And thank you for taking the questions. Joe, I just want to clarify some of the commentary between market sales and your sales. I think you are very consistent with how you have approached it from last quarter call to this quarter call. What I am not sure about is where you captured for Integer the higher trough of industry sales in 2Q? So it's pretty clear that May, June trends from the customer were stronger than they had anticipated back in April and back when you were communicating your forward outlook. Where did that change apply to Integer?

Well, Matt, it showed up both in our second quarter results as well as in our current view of where we think the third and fourth quarter will land. I think we didn't provide specific revenue guidance or quantitative guidance for the second or third quarter. What we saw on our earnings call, what we conveyed on our earnings call was, we were down about 20% in the month of April. And by all previous communications and now it's been communicated more clearly, the industry appears to have been down in the order of magnitude of 50%, 55% in the month of April. So we knew in the month of April that we weren't down as much as the industry and we expected the lag that we have described. So I think the best way to look at our sales is correlating it to the industry with this lag. And we have tried to portray that as clearly as we could. We didn't know what the second quarter sales were going to be. We knew orders were declining. We were studying our backlog and what customers were communicating to us, but we knew that it would take our customers time to assess the impact of the market and then translate that into changes in their production plans and then translate that into order changes for us. So we fully expected this lag. I wouldn't say that our sales is higher or lower than what we expected because what we expected in the second quarter was dependent upon what happened in the market. But we knew there would be lag and that lag has played out. And we think it's very clear. It's order of magnitude 10 percentage points. We can't be as precise as we would love to be but…

Yes. I think to sum it up, I think what it looks like is, when you communicated 2Q and that down 20%, I had modeled, I think, down 25% for 2Q. I don't think that probably accurately reflected some of what you were thinking 2Q could have actually been down. And then 2Q actually came in better than your internal expectations based upon customer orders.

Yes. If I go back to first quarter, we had said April was down 20% and we knew that did not reflect the full impact of COVID because at that time, there were indications and communications about the industry being down order of magnitude 50% in April. So we knew 20% wasn't the full impact and we tried to convey that that we expected second quarter to be worse than 20% and April being down 20%. And we tried to portray it on the first quarter with our bottom of the curve for Integer sales being in late 2Q, while the industry would be in the mid 2Q. Everything just kind of shifted to the right for us based upon the actual order pattern. But I think the thing I would convey is, relative to the industry, we think our sales in the second quarter were about 10 percentage points. This is a range.- this is an order of magnitude. It's not a precise number. But about 10 percentage points better than the industry volumes which means, in the second half that has to unwind. And what I am confident of is, we continue to win business with customers. We are a reflection of the market during this dynamic, during the pandemic. And as volumes go down and come back up, we are going to be a reflection of the market. We are just going to have this lag based upon the time it takes for customers to absorb the market impact, translate that into changes in their production and translate that into a change in demand on us. So we are a reflection of the market with just a lag.

Okay. I think that's all very fair. When you are talking about the 4Q forecast and moving forward, are your customers just factoring in the Coronavirus at this point? Or are they starting to take into account some other factors, like unemployment? Have you had some broader conversations about how they are seeing the recovery?

Yes. Great question. I think everyone has built in as much as they can project given the high degree of uncertainty. What I am more confident in is the near term and the near term orders that we have with customers recognizing that reaction time that it takes for them. I do believe our customers have factored in some underlying assumption for the impact of unemployment, the impact of what potentially another federal government stimulus or CARES Act package could be. I think that's all factored in. But from a practical perspective, looking six to nine months out, our demand is going to be what our customers see closer to that time period. We really have pretty good visibility for the next two, three months. When you get beyond three months, it's really dependent upon what they see come August, September will determine what they do for fourth quarter demand on us.

Okay. All right. And then the decremental margin, I think, in the quarter was a little steeper than we had modeled. Can you talk through some of the investments that you might have been making in the quarter to help strengthen the relationship with your customers for the long term?

Absolutely. So I will start with, you can't see this because we publish gross profit, which includes the infrastructure in our manufacturing operations. The gross profit includes the fixed cost in every plant, the building itself, the overhead, the maintenance, the equipment. So what we do is, we look at the variable profit which is the variable margin, variable cost and we have worked really hard to match that variable cost to our sales change. Obviously and I think you have seen this in every company that's reported a meaningful drop in sales, you need some amount of time to be able to adjust your variable cost and you need even more time to adjust that fixed cost. When we look at our variable profit or variable margin, we saw a slight deterioration in that. We had some inefficiencies in implementing social distancing and being able to react to the meaningful volume decline. But overall, I think in the quarter, we were pretty effective at matching our variable cost to the sales decline. It's the fixed cost in the plants, the overhead, the infrastructure, is what drove the majority of the gross profit decline. And so that's why you see the decremental margin being as big as it is. The reverse of that is, when sales grow and you get growth on top of that fixed cost, you get leverage on the other side, which is why growth is so important. But to your question about the investments that we have made, we made a conscious decision when we were, like everyone was faced with what to do during the pandemic, that we viewed this as a six to nine, maybe now it's a 12-month decline, temporary decline and that we were going to continue executing our strategy and play…

Excellent. And this is just a follow-up to that and this is the last question. And I will jump back, my apologies to the guys behind me. Are your customers making changes or thinking about changes around business continuity and redundancy coming out of this? And how does that potentially impact the industry? And thanks for taking all my questions.

No worries, Matt. Thank you for the questions. I think it's unquestioned that our customers are looking at the pandemic and asking themselves, how do they take advantage of this? What are the opportunities that this creates? And do believe that they are relooking at what infrastructure they have, what infrastructure investments they want to make in their own manufacturing and they are making those trade offs and we are seeing opportunities. On the last call, I was asked the question, what's COVID done to their in-sourcing, outsourcing decisions? And at that time, I thought it was way too early to have an indication. There are indications that our customers are, in fact, thinking about what is it that they want that's most strategic as we look at it in an environment where cash is important and capital investments are more constrained. There's more opportunity for us and we have seen those opportunities. We think outsourcing will continue to grow and accelerate. Business continuity was important going into COVID. I think in the environment where there's excess capacity, it's less of a concern. But as we ramp back up, it's going to be even more important, especially when we get on the other side and we see the growth and the pent-up demand that's happening in the market at the moment. Thanks for the questions, Matt.

Our next question is from Jim Sidoti with Sidoti & Company. Your line is open.

Good morning. Can you hear me?

Yes, Jim. Good morning.

So you did a pretty good job, I think, explaining how, - basically, you are seeing the same trends as the industry, only your trends are shifted a little bit to the right, lagged a little bit because of the delay in orders. You seem to indicate that Q3 will be your lowest quarter on sales, but not on profitability. Did I hear that correctly? And why would that be?

Jim, we do think that second quarter will be the lowest on profitability. We think third quarter is likely, even if third quarter's are similar, which we expect in the second quarter --

I am sorry. Yes. That's what I meant. I am sorry. Third quarter would be lowest on sales, but not on profitability.

Yes. And so part of that is, in the second quarter, we had inefficiencies related to implementing the social distancing environment. We had some inefficiencies from a variable cost perspective, the ability to react as quick as the volume declined. And we also continue to execute our manufacturing excellence strategy to drive savings and efficiency into the business. So we expect of ourselves to get better every quarter on both the year-over-year and a linear basis. And so we expect the second quarter to be the bottom from a margin rate or a profitability measured by margin rate perspective. We expect it to be a little better in the third quarter. There were inefficiencies in the second quarter, but I think we managed them pretty effectively. So we will get some help there. And then it's just the continuous improvement efforts in the business to drive improvement in the third quarter. And just let me frame, when we say third quarter sales might be a little lower than second quarter, the order of magnitude, we are in low single digit percentages, the single digit dollars of revenue. We are not talking meaningful. At least that's what we see sitting here today. And obviously, July sales are almost complete. And we have got really good visibility into August and September orders and demand from our customers. It's not to say that can't change. But the picture we are looking at today, we feel like we have got pretty good visibility to the third quarter.

Okay. And then you did take on some more debt in the quarter. Can you let us know what you think interest expense will be over the next couple of quarters?

Yes. So we are about an average 3%, 3.6% for 2Q. And again barring any real big changes with LIBOR, we expect to keep that consistent right through the second half, Jim.

So 3.6% on the new balance.

And the debt increase, Jim, was from the revolver drawdown, which we would expect to repay the revolver as the environment continues to stabilize. We actually paid down on the Term Loan A.

Yes. So they are a required debt payment. And then we also paid back within the quarter or by the end of the quarter, $15 million on the revolver. So we drew it early in the quarter in April. And with the cash we generated, we actually paid some of that back even within. But to your point, quarter-over-quarter, you see the net increase from the revolver draw. And again, to that, just to be prudent and prevent against any risk in case the market became illiquid and this thing is prolonged. So we are watching that. We believe that the situation in the credit market is certainly stabilizing and we will continue to look at that balance and likely bring down that through the second half.

Jim, the net debt in the second quarter went down $33 million. So when you look at cash and debt combined, it was down $33 million in the quarter.

Okay. Yes. No, I know Jason is used to running the business with less than $20 million of cash in the bank. So I would expect you to make some changes over the next couple of quarters.

Okay. We will definitely get back to that level when we get to a more normal environment.

All right. Thank you.

Thank you Jim

Thanks Jim.

[Operator Instructions]. And at this time, there are no further questions. So I will now turn the call back over to Tony Borowicz for any closing remarks.

All right. Thank you everyone for joining us on today's second quarter call and for your continued interest in Integer. Note that this conference call is going to be available for replay on our website. So thank you. That concludes the call today and stay safe, everyone.

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