Integer Holdings Corporation (ITGR) Earnings Call Transcript & Summary

Good morning. Craig Bijou, one of the medical device analysts here on the research team at BofA. And it's a pleasure to have Integer Holdings. And from the company, Joe Dziedzic, CEO. So Joe, thank you.

Great to be here, Craig. Thank you.

So maybe start with -- we're not too far from Q1 earnings. So maybe just start with the recap with some of the growth dynamics you saw maybe within your segments. You had some tough comps, but you still put up some pretty solid growth. So maybe we can start there and then dive in.

Sure. So first quarter, we had 10% reported growth. The Cardio & Vascular business grew 16% reported. Cardiac Rhythm Management & Neuromodulation grew 8% reported. So on an organic basis, the Medical segment grew 8.6%, so I think we had pretty strong growth in the first quarter, which was a great start to the year, very much in line with what we expected based upon our visibility to customer demand. A little bit of a drag from our Non-Medical segment in the first quarter. There's a couple of hundred basis points drag on a reported basis, organic basis as that business normalizes after working through some of the supply chain challenges that they had back in 2022 and the early part of '23. So 10% reported, right in line with the beginning of the year that we expected, consistent with our full year guidance of 9% to 11% sales growth, 13% to 20% operating profit growth, pretty strong operating profit growth in the first quarter as well.

Got it. And then maybe just thinking about how to look at guidance before kind of digging into some of the business. I think you made some comments on Q2 revenue growth, and I wanted to just kind of clarify how we should be thinking about it. And you said high single-digit revenue growth for the first half. And the Street is modeling 9% reported, which is roughly 6% organic for Q2, so similar growth to Q2 -- or similar growth in Q2 as compared to Q1 despite some easier comps. So just kind of want to understand, is that conservative to start the year? Is there anything else that we should -- any headwinds that we should be thinking about either for -- in Q2 or the rest of the year?

Yes. So I'd say no headwinds per se. I wish everything were up and to the right every quarter in the same consistent amount. But life isn't linear. Business isn't either. And so our guidance on second quarter is very much in line with the demand profile we see from customers. It's consistent with the full year guidance that when you think, to your point about the organic, there's still a drag on the Non-Medical side of the business for the second quarter. That becomes less so of a drag on an organic basis when you get to the second half of the year. So the medical sales will be stronger than the reported organic growth in the second quarter because of that. But the profile for the second quarter is consistent with customer order demand profile, and we look at the visibility that we have, still a very strong order book that gives us great visibility to the next couple of quarters in particular. This is the profile of demand for customers. Just remembering, we're shipping product mostly into our customers' manufacturing facilities, and so the demand we see is based -- not based upon their end market demand in the quarter. It's based upon the product that they're building and the profile that they've given us for the quarter. So again, second quarter is consistent with our outlook for the full year.

Got it. Similar question -- and we'll try to get these out of the way upfront. Similar question on margins. So you grew operating income 26% in Q1, obviously very strong. It was 2.7x revenue growth and your target multiple there is 2x. Operating income growth is 2x what revenue growth is. But you kept guidance unchanged for the year, again, early in the year. But maybe just talk about what drove the stronger margins in Q1. And then why couldn't we see a similar operating income level? Or I guess what is the appropriate operating income level for the rest of the year to think about?

Sure. So maybe the best way to think about it is look at the operating income by quarter in 2023. So the first quarter operating income was $50 million, 5-0 million. Second quarter of '23 stepped up to $60 million, so it's a 20% increase from first to second quarter. So you just think about that when you get to first quarter '24, first quarter -- second quarter '24. The denominator just went up by 20%. And so we view that as the second quarter has a tougher comp compared to the first quarter because last year's income stepped up meaningfully from first quarter '23 to second quarter '23. And the reason it did is we were coming off of the supply chain disruptions that we had in late 2022, and we were still working through that in the first quarter of '23. We were able to work through a lot of those disruptions by the time we got to the second quarter, which is why you saw the meaningful step-up in operating profit from first quarter, second quarter '23. And so it's 20% harder in the second quarter to grow than it was in the first quarter. So the 26% in the first quarter '24 year-over-year growth was in line with what we were expecting it to be. And as we think about the full year at 13% to 20% for the full year, it gives us a great start in the first quarter. But again, given the visibility that we have to the demand from customers, we're able to operate the facilities in a way that delivers on the operating income that we guided to.

Yes. And I believe you said you expect sequential improvements in operating margin throughout '24. And I guess what are some of those drivers that accelerate the operating margin? And then what could drive upside? I know you gave the guidance. But what could drive that upside to be above where you are, where the guidance is?

Sure. I'll start with what could drive the upside is faster -- greater success and faster success at the continuous improvement initiatives that we have across the business. The margin compression that we saw during the pandemic was driven by direct labor turnover. We had significant turnover that peaked in 2022. And then throughout 2023, the direct labor turnover improved literally every month, every quarter on a very, very sequential basis. And that has continued -- that improvement has continued into 2024. For -- where we sit today, all or almost all of our sites are either at or below the levels of turnover that we had pre-pandemic. And so it's really working the inefficiencies out as we get our direct labor workforce better trained and more proficient at what they do. One of the things we experienced in 2022 and throughout '23 as part of that, one of the implications or ramifications of that turnover, our direct labor associates scrapped more material, so they wasted more material. We literally had to throw away more direct material than we had in prior years. And so as we continue to train our workforce and they become more proficient at what they do, we cross train them so that we've got backup when there's vacation times or absenteeism or demand shifts from one product to another. We can work those inefficiencies out. The supply chain was also very disrupted, particularly in late 2022. We worked through a lot of that in the first half of 2023. So it's really just executing lean manufacturing practices as part of the Integer production system and getting the direct labor efficiency and getting the direct material waste out of the system. We were 31% gross margins before the pandemic. We're in the 27%, 28% range now. We're confident we can not only get back to that 31% but continue to grow from there. What would make it better was just faster execution of those -- working those inefficiencies out.

On that last point, given that you are seeing improvements throughout or each year, year-over-year, I mean, how can -- I mean, how should we think about the timing to potentially get back to that 30-plus gross margin or the pre-COVID gross margin? Is that something that could surprise us and happen sooner than expected or...

So our strategy has been, from the beginning, to grow operating profit twice as fast as sales. Last year, we hit 1.7x. I think the high end of our guidance this year is 1.9x. That's the high end. I think midpoint is around 1.7-ish. And so that's still our goal. As we work through the direct labor turnover and working those inefficiencies out, we're going to keep -- we believe we can continue to expand margins. The pace of getting back to 31%, we haven't made a definitive statement or guidance on that, but we're driving for it because we know we can get there because we've been there before. But we also think we can go beyond that because not all of our manufacturing processes are at world-class levels of efficiency, and that's where the lean manufacturing within the Integer production system is driving to get us there.

Got it. And maybe a follow-up on that. Just M&A is obviously a key component of your business strategy, adding more capacity. How does that factor into some of the gross margin expectations? Or what's -- how much of the risk is that when you're bringing in a new facility? I guess how much diligence do you do on that ahead of so you don't go the other way and you're continuously moving towards that 30-plus, let's say, gross margin?

Certainly. So one of our criteria for acquisitions, it starts with how does it fit within our strategy and enable our strategy. So we're looking for capabilities of either compound existing points of differentiation or add new points of differentiation from a technology standpoint. We're looking for businesses that are focused on the 4 targeted growth markets that we're focused on, electrophysiology, neurovascular, neuromodulation, structural heart. You've heard us talk about those. So those are kind of the starting points. And then the diligence aspect that you bring up, there's a cultural element to the diligence. But from a financial profile, we're looking for businesses that have a pipeline in those 4 targeted growth markets because we know the development cycle in the industry is longer, 3 to 5 or 5 to 10 years if you're in premarket approval products. So we're also looking at profitability, contribution margin or gross margin that is either accretive to Integer gross margins or we can see a very clear path through synergies. The nice thing for us is, most of the time, we're doing acquisitions where it's 1 facility, which is an ideal scenario, and it's anywhere from $20 million, $40 million, maybe $60 million of sales. So in the context of $1.7 billion, $1.8 billion, Integer, we have capabilities and practices around the company that we can usually bring to bear on those manufacturing facilities and help them sometimes as procurement synergies. Other times, it might be practices or automation that we've already implemented. We also find that we learn a lot from these smaller and very entrepreneurial companies, too. And so we share and when you're buying a company, you're buying it because they're doing something really well, so we work really hard to understand what that is and then protect that. So the acquisitions we do, they are either already accretive at the gross margin level or we have a very clear path to doing so in a tight time frame.

Got it, that's helpful. So I want to step back and maybe talk about some of your target growth markets and the opportunities that you see there. And it's really, from a higher level, how do you think about these opportunities. Like for example, in electrophysiology, you have a pretty well-established platform. Structural heart, maybe not, maybe under-indexed there relative to the size of the market. So when you think about how you're positioned in each of those, how do you see the growth opportunities? Is it better to be over-levered or in line with the market in terms of the contribution to your -- you? Or if you're under-indexed, that's certainly an opportunity. So how do you see those? And how do you allocate your resources kind of to those growth markets?

Yes, great question. You gave a good summary of kind of how we're positioned from a vertical integration standpoint. Maybe the 4 targeted markets, electrophysiology, we're highly vertically integrated. We're, we believe, the most vertically integrated provider in the space. We manufacture components that are -- even our customers don't do, and we do that at scale. And in addition to maybe the therapeutic device, the ablation device itself, we're also on the access, the delivery as well as the mapping and the diagnostic catheters as well. So we play in the full procedure, and we have for a very long time. And that vertical integration positions us incredibly well. When there's next-generation products coming to market or when there's an innovation and there's a new therapy like pulsed field ablation, it gives us the opportunity to vertically integrate and help our customers accelerate their product getting to market. So electrophysiology, we're highly vertically integrated where we serve the whole industry, and we see the growth in the procedure volumes coming from the anticipated acceptance of pulsed field ablation being a tailwind for us. But I'll also say because we've had a lot of conversations on pulsed field ablation, there's no 1 therapy that's going to be a meaningful impact on total $1.75 billion at midpoint sales for Integer because we're so highly diversified into your other question or to build on that. Neuromodulation is a great example, implantable pulse generators. We're the most vertically integrated provider in the industry. We're the only outsourced option for high-volume implantable batteries and implantable pulse generators, filtered feed-throughs that are critical for implantable pulse generators, the cases themselves and then the design and assembly of those devices and helping support customers through regulatory approval. We can do the entire lead system vertically integrated as well. So neuromodulation is also 1 of the 4 growth focused areas, highly vertically integrated. To your point, structural heart, we were less vertically integrated when aortic was its growth driver. Now with mitral and tricuspid, we've added the capabilities and now can offer the vertical integration there, also moving up the value chain and doing more of the complicated -- more complex delivery systems, which gives us higher dollar value per unit in structural heart. So the vertical integration is a critical component of our strategy, and the technology differentiation is ultimately what enables us to win.

Got it. That's helpful. I do want to touch on PFA. It's obviously a hot topic for investors for me. And I think you've been pretty clear that you are -- you have exposure to the major players in PFA in some fashion. And is there a way to kind of talk about that exposure, whether it's components, whether it's full assembly, partial assembly, access, maybe even just mapping for some of the participants? But I think what investors are really trying to understand is what that actually means when you say you have exposure to all of the players.

Yes. I wish I could give you the details of the programs we're on and the content we have and talk openly like our customers are able to do about their new products and what's rolling out over the next 12, 24, 36 months. But our customers want to control the conversation with investors on their products and their programs. And they know investors are smart and they look for insights anywhere they can get them. So I'll start with pulsed field ablation and for us, we believe, is a tailwind. It's a tailwind because we have a vertically integrated offering. But we also benefit significantly from electrophysiology procedure growth because we do play in the access and the delivery as well as the mapping and the diagnostic catheter. So it's not just the therapeutic ablation catheter that drives growth for us. We participate in the full procedure, which is, we think, one of the strengths of Integer. Our diversification is a strength. I -- you may say, well, I'd rather be indexed to one product and be a moonshot; and I'd say, well, we're highly diversified. We're taking lots of shots on goal with everyone in the industry, where we've been serving the industry very broadly for a very long time, and we think that gives us consistency in our growth trajectory. And we have 4 targeted growth markets. We're taking shots on goal with every customer on all the next-generation and new therapy, new therapies that they're bringing to market. We're excited to help them. But maybe 1 therapy isn't going to be a meaningful driver on the $1.750 billion of sales for Integer, but we're excited about pulsed field ablation because of what it does for patients and for the tailwind that we think it delivers for us.