Monro Q3 2024 Earnings Call Transcript

Quartr
Provided by Quartr
October 24, 2024

There are 11 speakers on the call.

Operator

Hello, and welcome to the Integer Holdings Corporation Third Quarter 2024 Earnings 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. I would now like to turn the conference over to Andrew Sen, Senior Vice President of Strategy, Business Development and Investor Relations. You may begin.

Speaker 1

Good morning, everyone. Thank you for joining us, and welcome to Anadur's Q3 2024 earnings conference call. With me today are Joe Dzic, President and Chief Executive Officer and Dyrin Smith, Executive Vice President and Chief Financial Officer. As a reminder, the results and the data we discuss today reflect the consolidated results of Integer for the periods indicated. Except for cash flow measures, prior period amounts have been recast to exclude the Electrochem business, consistent with U.

Speaker 1

S. GAAP continuing operations presentation. Unless otherwise stated, all results and comparisons are presented on a continuing operations basis. In the appendix of today's presentation, we have provided supplemental information, which will help you update your financial models to reflect the impact of discontinued operations. During our call, we will discuss some non GAAP financial measures.

Speaker 1

For reconciliation of non GAAP financial measures, please refer to the appendix of today's presentation, today's earnings press release and in the trending schedules, which are available on our website at integer.net. Please note that 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. On today's call, Joe will provide his opening comments and Diren will then review our adjusted financial results for the Q3 2024 and provide an update on full year 2024 outlook. Joe will come back to provide his closing remarks and then we'll open up the call for your questions.

Speaker 1

With that, I will turn the call over to Joe.

Speaker 2

Thank you, Andrew, and congrats on the new role. And thank you to everyone for joining the call today. This morning, in addition to our strong earnings announcement, we also announced the promotion of Payman Kales into the newly created role of Chief Operating Officer for Integer. Payman joined Integer in 2018 as President of our Cardio and Vascular business. I'm also excited to announce that Andrew Sin will become the President of the Cardio and Vascular Business, succeeding payment.

Speaker 2

Andrew has been with Integer for the last 18 years in a variety of leadership roles, primarily within our Cardio and Vascular Business. You know him currently as our Investor Relations, Business Development and Strategy leader for Integer. Both Payment and Andrew have been integral leaders in the development, execution and success of our strategy. David and Andrew will transition into their new roles in the Q1 of 2025. In the Q3, we delivered another quarter of strong year over year results.

Speaker 2

Sales grew 9% and our adjusted operating income grew 17%. On a year to date basis, sales have grown 10% and operating income is up 23% or 2.3 times the rate of sales growth. We are narrowing our sales outlook to deliver 10% to 11% growth in 2024. We are confident in our ability to deliver strong sales growth given our high visibility to customer demand, including ramping programs in high growth markets and additional Guidewire capacity in Ireland. In addition to this above market sales growth, we are driving margin expansion across the business.

Speaker 2

We are raising the midpoint of our full year profit and earnings per share outlook. Our manufacturing excellence initiatives are delivering operational improvements in direct labor turnover, direct material scrap reduction, lower overtime and direct labor efficiency. Combined with our strong OpEx leverage, we are confident in our ability to meet our increased full year profit outlook. At the midpoint of our outlook, we expect 20% adjusted operating income growth, an increase of $4,000,000 over our prior guidance and nearly 2 times the rate of sales growth at midpoint. We are also raising the midpoint of our adjusted earnings per share outlook to 16% year over year growth, an increase of $0.07 per share at midpoint over our prior guidance.

Speaker 2

On September 30, we announced our entry into a definitive agreement to divest Electrochem. The divestiture of our non medical segment makes Integer a pure play medical technology company. The transaction is expected to be EPS neutral and generate $50,000,000 in cash to support execution of our strategy. The strong execution of our strategy by all Integer associates is enabling us to meet or exceed our strategic financial targets of growing sales at 200 basis points above the market, expanding adjusted operating income at 2 times the rate of sales growth and maintaining a debt leverage between 2.5 times and 3.5 times adjusted EBITDA. We believe our strategic financial objectives demonstrate differentiated results that will drive a valuation premium for our shareholders.

Speaker 2

I'll now turn the call over to Diren.

Speaker 3

Thank you, Joe. Good morning, everyone, and thank you again for joining today's call. As a reminder, unless otherwise noted, all results presented are on a continuing operations basis and exclude the Electrochem business, which has been classified as a discontinued operation. Knowing this is the first time you are seeing our results without the Electrochem business, I will first share our Q3 year to date results from continuing operations, followed by the discrete Q3 2024 financial results. As usual, I will end with an update to our 2024 outlook.

Speaker 3

Through 3 quarters of 2024, we have delivered strong financial performance. Sales of $1,267,000,000 delivered 10% year over year growth on a reported basis and 6% on an organic basis, which excludes the impact of our recent Inuraco and Pulse acquisitions, the strategic exit of the portable medical market and foreign currency fluctuations. We delivered $266,000,000 of adjusted EBITDA, up $48,000,000 compared to the prior year or an increase of 22%. Adjusted operating income grew 23% versus last year, 2.3 times the rate of sales growth as we continue to make progress on our year over year margin expansion. 3rd quarter year to date adjusted operating income as a percent of sales was 16.5%, which represents approximately 177 basis points of improvement versus a year ago, reflecting the continued improvement in manufacturing efficiency and operating expense leverage.

Speaker 3

Adjusted net income for the Q3 2024 year to date is $133,000,000 delivering $3.87 of adjusted earnings per share, up $0.67 or 21% from a year ago. In the Q3 of 2024, we again delivered strong financial results. Sales of $431,000,000 delivered 9% year over year growth on a reported basis and 4% on an organic basis. We delivered $96,000,000 of adjusted EBITDA, up $15,000,000 compared to the prior year or an increase of 18%, while adjusted operating income grew 17% versus last year or 2 times the rate of sales growth. As we continue to make progress on our year over year margin expansion, Q3 2024 adjusted operating income as a percent of sales improved by 126 basis points to 17.5%.

Speaker 3

Adjusted net income for the Q3 of 2024 is $50,000,000 delivering $1.43 of adjusted earnings per share, up $0.14 or 11% from the Q3 2023. Both CMD and CRM and N product lines continue to deliver above market sales growth on a trailing 4 quarter basis. The cardio and vascular product line trailing 4 quarter sales increased 15% year over year. CMD growth is driven by above market growth across all markets, new product ramps in electrophysiology and structural heart and the Inuraco and Pulse acquisitions. Cardiac rhythm management and neuromodulation's trailing 4 quarter sales increased 7% year over year, driven by double digit neuromodulation growth from emerging PMA customers and normalized low single digit growth in cardiacrhythmmanagement.

Speaker 3

Further product line details are included in the appendix of the presentation, which can be found on our website at $1,000,000 more adjusted net income than we did in the 1st 3 quarters of 2023. Strong sales, acquisition performance and operational improvements, which include improving manufacturing efficiencies and operating cost leverage, delivered $32,000,000 of the increase. This was partially offset by higher interest expense of approximately $7,000,000 The year to date increase in interest expense is primarily due to a higher average debt balance during the period, driven by the previously discussed acquisitions of Inuraco and Pulse Technologies. Our year to date adjusted effective tax rate was 18.7% for 20.24, consistent with the same period a year ago. Increases in the effective tax rate are primarily due to the Pillar 2 15 percent global minimum tax and impact of the Malaysian tax holiday expiration, fully offset by discrete items such as higher research tax credits and other tax planning initiatives.

Speaker 3

Historical GAAP and non GAAP cash flow measures have not been adjusted to remove Electrochem consistent with the applicable GAAP presentation on the statement of cash flows. Leverage, also a non GAAP measure, has similarly not been adjusted. In the Q3 2024, we generated $72,000,000 of cash flow from operations, up $9,000,000 from a year ago and up $24,000,000 from the prior quarter. This strong performance was driven by improved operational execution, primarily from higher sales, improved margins and continued management of working capital. In the Q3, we generated $46,000,000 of free cash flow, inclusive of $26,000,000 of capital expenditures.

Speaker 3

On a year to date basis, we have generated $142,000,000 in cash flow from operations, a 14% increase versus a year ago. Strong cash flow from operations has supported $86,000,000 of year to date investments in capital expenditures, resulting in year to date free cash flow of $56,000,000 an increase of 33% compared to the same period last year. Net total debt is $1,055,000,000 at the end of the Q3 2024, which is a $41,000,000 reduction compared to the 2nd quarter ending balance. As a result, our net total debt leverage at the end of the 3rd quarter was 3.0x trailing 4 quarter adjusted EBITDA, which is at the midpoint of our strategic target range of 2.5x to 3.5x. As Joe mentioned earlier, we are narrowing our 2024 sales outlook and raising the midpoint of our 2024 profit and earnings per share outlook.

Speaker 3

With strong year to date margin performance from execution on our manufacturing excellence initiatives, we have increased confidence and are raising the adjusted operating income outlook by $4,000,000 at the midpoint. We expect to deliver sales in the range of $1,707,000,000 to $1,727,000,000 an increase of 10% to 11% versus last year. On an organic basis, we expect sales growth of 7% to 8%, which is approximately 200 basis points above our underlying market growth rate estimate of 4% to 6%. In addition to our organic growth, we expect the Neuroco and Pulse acquisitions, partially offset by the Portable Medical market exit, to contribute approximately 3% inorganic growth. We are raising our adjusted operating income outlook by $4,000,000 at midpoint and expect 2024 adjusted operating income to be between $280,000,000 $288,000,000 reflecting year over year growth of 18% to 22%.

Speaker 3

At $284,000,000 which is the midpoint, adjusted operating income as a percent of sales is expected to grow 133 basis points compared to the full year 2023. Adjusted EBITDA is expected to be between $358,000,000 3 $68,000,000 an increase of 18% to 21% compared to the prior year, similar to the adjusted operating income growth rate. Adjusted net income is expected to be between $181,000,000 $188,000,000 reflecting a year over year growth of 16% to 21%, up from our previous outlook of 12% to 21%. This delivers an expected adjusted EPS outlook between $5.24 $5.43 which is growth of 14% to 18% year over year. Our updated adjusted EPS outlook reflects an increase versus our prior outlook of $0.07 per share at midpoint.

Speaker 3

Our outlook assumes adjusted weighted average shares outstanding of 34,600,000 shares, taking into account estimated dilutive effect of the convertible notes based upon recent stock price performance. This dilution is offset by an improvement in our adjusted operating income and improvements in our expected 2024 effective tax rate, which is projected to be between 18% 19%, down from our previous outlook of 18% to 20%. With above market sales growth and operational improvements from our manufacturing excellence initiatives, we have confidence in tightening our sales outlook and raising the midpoint of our adjusted operating income as a percent of sales. Since our guidance issued in July, which has been revised to exclude the impact from Electrochem, we have increased our adjusted operating income as a percent of sales by 20 basis points to 16.5%, now up 133 basis points versus 2023. As we begin the Q4 of 2024, we expect sales to increase versus the Q3 driven by new product ramps, increased Guidewire capacity and growth from emerging customers with premarket approval products.

Speaker 3

Full year organic sales of 7% to 8% would imply a 4th quarter organic growth of 11% in midpoint of our outlook. Moving to our 2024 cash outlook, we expect cash flow from operations between $195,000,000 to $205,000,000 which represents an 11% year over year increase at midpoint of outlook, up from our previous outlook of 8% at the midpoint. Our outlook for capital expenditures is $100,000,000 to $110,000,000 as we continue to invest in organic capabilities and capacity. As a result, we expect to generate free cash flow between $90,000,000 $100,000,000 We expect our 2024 year end net total debt to be between $970,000,000 $980,000,000 Versus our previous outlook, this represents a $45,000,000 reduction at midpoint, which is driven by the expected proceeds from the sale of Electrochem before the end of October. We expect to end the year with a leverage ratio between 2.6 and 2.7 times trailing 4 quarter adjusted EBITDA well within our target range of 2.5 times and 3.5 times.

Speaker 3

With that, I'll turn the call back to Joe and thank you.

Speaker 2

Thanks, Darren. We are successfully executing our strategy to deliver a very strong 2024 outlook after a strong 2023. Over these 2 years combined, we expect to grow sales 29% and grow adjusted operating income 56% at the midpoint of outlook. We are successfully executing our growth strategy both organically and inorganically to meet our strategic financial objectives for sales growth, margin expansion and debt leverage. We are confident this sustained level of performance will produce a premium valuation for our shareholders.

Speaker 2

We will now turn the call over to our moderator for the Q and A portion of the call. Thank

Speaker 3

Thank

Operator

you. Your first question comes from the line of Brett Fishman with KeyBanc. Your line is open.

Speaker 4

Hey, guys. Good morning and thanks so much for taking the questions. Just wanted to start off briefly on the organic growth trend. And I was just wondering, you talked a lot about some of the year to date trends and then the implied 4Q exit rate. But maybe just specifically for the Q3, if you could just touch on a little bit of the deceleration that we saw to 4.3% relative to the 7% year to date, and what you think might have drove that?

Speaker 4

Thank you.

Speaker 2

Great. Good morning, Brett. Thanks for the question. So I'll start with to your highlights, 6% organic year to date, and our guidance is 7% to 8% organic for the full year, which is up slightly from our original guidance at the beginning of the year where we said 6% to 8%. So the bottom end on the organic has come up a little bit.

Speaker 2

And we had highlighted what we expected to happen throughout the year and the biggest driver of the Q3 at 4%. The biggest driver is as we expected based on our order book and the ordering patterns that we saw at the beginning of the year CRM CRM was down versus the trend line that we had had in the first half of the year. And we expected that because we could see that in the demand based upon the order book that we have. We would have been a little higher. We were 4% organic for the quarter.

Speaker 2

It would have been more like 5%, but we had a little bit of an impact from the Hurricane Helene in that happened at the end of the quarter for us. We had to shut down our facility in Florida and the Dominican Republic to protect our associates. That had a little bit of an impact. It wasn't a material or meaningful impact, but we would have been 5% organic growth. The CMV segment would have been about 7%, a little higher than the reported 6% organic growth.

Speaker 2

So when we look at the quarter, it's really what we expected in terms of all the moving parts. We had said on our February Q4 earnings call back in February beginning of this year that our order pattern showed that CRM would normalize in the second half of the year from an ordering and shipments perspective, and that's what happened. So our neuromodulation business continued to perform very strongly. We saw continued growth there in the emerging PMA customers. In fact, the $100,000,000 to $120,000,000 that we had guided the year to for those emerging PMA customers are actually tracking to the high end of that range.

Speaker 2

And we have strong shipments in the Q4 for those emerging PMA customers. So we feel great about the 4th quarter outlook and the guidance.

Speaker 4

All right. Thanks for the color. And then just wanted to ask one quick follow-up and congratulations to Andrew and Taymon on the new roles. And was just curious if you can maybe give a little bit more background around maybe the impetus for some of those changes and how you think the new team can build on some of the existing initiatives under this new structure? Thanks again.

Speaker 2

Yes. So it's really about continuing to execute our strategy and to outperform on a sustainable basis as we get bigger and continue to grow the size of the business. So it's really about executing the strategy and continuing to meet or exceed our financial objectives of sales growth above the market organically, operating profit 2x. Payment and Andrew have been integral parts of the strategy for not only the C and D business, but the whole company because different leaders have ownership over enterprise wide elements of our strategy. And Andrew and Payment have been here since the beginning of the strategy in 2018.

Speaker 2

Payman joined the company in early 2018. Andrew has been with the company much longer, but he's been in the CME business. During Payman's tenure leading the cardio and vascular business, we've almost doubled the sales for cardio and vascular. We're up over 90% since Payment stepped into that leadership role. Andrew's been in the cardiovascular business for his entire career with Integer.

Speaker 2

He's done everything from lead R and D to sales to marketing. You know him more recently as the enterprise wide leader for the strategy process for M and A and Investor Relations. They both know our customers in the industry incredibly well. So, this is really about accelerating the execution of our strategy and giving 2 highly successful leaders, broader responsibilities to help us continue to deliver for our customers and then ultimately for shareholders.

Operator

Your next question comes from the line of Craig Bijou with Bank of America. Please go ahead.

Speaker 5

Good morning, guys. Thanks for taking the questions. So I wanted to start, can you guys just go over the growth trends of your EP business over the last couple of quarters? And then when we think about PFA, I guess, I want to ask directly if your expected benefit from PFA products, if that's changed at all as of the end of Q3? And I asked because I think investors are looking to see and maybe see some acceleration in that CMV business given the launch of the products today and then the expected launch in coming in 2025.

Speaker 5

So maybe if you could just kind of talk about the EP business, PFA and then kind of frame how investors should be thinking about potential contribution from that emerging market?

Speaker 2

Thanks for the question, Craig. I'll start with we remain incredibly excited about PFA as a therapy and a technology and what it can do for patients and we're excited to be part of what's happening in the industry with this growth of PFA. Our view and outlook hasn't changed. In fact, it continues to get better with every passing new clinical study and announcement of progress across the industry on it seems like every participant coming out with another evolution of their therapy and getting closer and closer to having more and more products in the market to deliver this new innovative therapy. For us, I'll highlight electrophysiology is an important part of our business, but it's one of many.

Speaker 2

It's one of our 4 targeted growth markets. And then even then within electrophysiology, I think we've talked a lot about how we play across the full procedure, everything from access with guide introducers, guide wires, the transseptal crossing as well as the diagnostic catheters that help perform the mapping and then to the ablation therapy itself where pulse field ablation specifically comes into play. So electrophysiology is an exciting high growth market. We are highly vertically integrated. We have a very strong position and footprint across the full procedure.

Speaker 2

And we expect it to continue growing and we expect it to be a strong participant. And so our outlook hasn't changed every day. I think it just gets brighter and brighter with the industry's progress. But I'll just highlight, it's one of many growth factors for us and I would not expect any one product or end market to be the single biggest driver or materially change the company outlook. So it's in our guidance.

Speaker 2

As we continue to work with customers on their new products rollouts, we continue to factor that into our outlook. Our electrophysiology business continues to outperform the market. We track our customers' reported sales by end market. We then look at our sales by those end markets. We're still growing 1.5 ish times the end market growth rate on a trailing 4 quarter basis, and we expect that to continue to accelerate as more and more products come to market.

Speaker 5

Great. Thanks, Joe. And if I can also ask on the acceleration in organic growth expected in Q4 and understand there's a number of moving pieces. So you're getting rid of Electrochem, portable medical is coming out. So maybe if you can just help us understand expectations for acceleration organic growth acceleration by segment, so CMV, CRM and N and then even the Advanced Surgical?

Speaker 5

Just kind of want to get a sense for where that organic growth is going to accelerate?

Speaker 2

Sure. So when you look at Q4, it will be a little different from a split between organic and reported than the 1st 3 quarters. So in the 1st 3 quarters, you had roughly 400 basis points of difference between reported and organic. In the Q4, there's very little net inorganic in the quarter. 1 of the acquisitions rolls off its rolling 12 months and becomes organic.

Speaker 2

And then the other action is offset by Portable Medical coming down in the 4th quarter. So when you look at that 4th quarter guidance number, think of that as both reported and organic in the quarter. So that will be a little nuance there as you stare at organic and inorganic split. So 4Q reported and organic are roughly the same number, same percentage in the 4th quarter. And we do expect to see continued improvement or acceleration in the growth rate in cardiovascular because of the new products that continue to ramp in that segment.

Speaker 2

And then on the CRM and neuro, we do expect the neuro sales to be stronger in the Q4, in particular from the emerging customer PMA. I commented earlier that $100,000,000 to $120,000,000 range of emerging PMA customers, we expect to be at the high end of that. And there's a slightly higher percentage of those sales in the 4th quarter relative to a normal 25% for any given quarter because of the ramp plans and the commercialization plans of those customers. These are orders that we had visibility to at the beginning of the year because neuromod in particular, we have very long order patterns and very good visibility multiple quarters out. So we've seen this all year and this was our expectation for the flow of that demand.

Speaker 2

So and to your question on the Advanced Surgical and Ortho, we do have Portable Medical coming down, which will be an inorganic decline. And on an organic basis, that's a very small piece of our business that function is more flattish in the trend line.

Speaker 5

Got it. Thanks for taking the questions, guys.

Speaker 2

Thank you.

Operator

Thank you. My apologies. Your next question comes from the line of Rich Newitter with Truist Securities. Please go ahead.

Speaker 6

Hi, excuse me. Thanks for taking my questions. A couple for me. I guess just one, you mentioned the hurricane impact in the Q3. I guess, is that going to have any lingering impact into the Q4?

Speaker 6

What divisions, if there were specific ones, were more impacted there? And that segues into just my additional question on CRM and neuro. Was it that division? And if not, just a little more color on why that is so soft at least relative to our expectations and seemingly consensus expectations? Thanks.

Speaker 2

Sure. So thanks for the question, Rich. The first answer is, it's mostly cardiovascular coming out of the Florida facility and the Dominican Republic facility. The lingering impact will likely be cost because of having to shut down and then ramp back up and then run some overtime to catch up on the few days, 2 or 3 days that we had to shut down. So in the Q4, we would expect to incur a little bit more cost.

Speaker 2

It was a small impact, but it was at the end of the quarter. And so you have really no time to react when it was the last few days of Q3. So that's on the hurricane impact. Fortunately, all of our associates are safe and that the impact was far less than what was expected from that particular hurricane. On this cardiac rhythm management neuromod question, I'll go back to what we said at the beginning of the year on our Q4 earnings call back in February.

Speaker 2

We looked at our order patterns that we saw from customers given our order book and we could see that the demand for CRM products was less than the second half, which I would not point to or indicate necessarily has anything to do with the broader market trends because you look at the market trends, some of the CRM participants had pretty strong growth, some had a little bit lower growth. But I don't know what I would point to necessarily a market trend. I would look at this and say, this is how customers were planning to run their facilities and the demand they placed on us across the year. We saw that at the beginning of the year. We said on our earnings call that we expected CRM to normalize in the second half, which meant be at a lower run rate than it had been in the first half and in 2023.

Speaker 2

That played out like we expected that it would. We've got the 4th quarter baked expectation out of that order pattern baked into our guidance. I mean, we're sitting here now. We're in the end of the 4th week of the quarter. We've got 9 weeks to go, and we've got really good visibility to the rest of the year.

Speaker 2

So we feel really good about the top line guidance that we've given and the split by segment that we guided to in our product line summary slides in the appendix of the presentation.

Speaker 6

Great. Maybe just one last one. Joe, any selling day considerations we should be thinking about in 3Q and or coming up in 4Q?

Speaker 2

Nothing significant there. There might be plus or minus. I'd have to ask Diren. Internally, that's not something that we noticed once. We went to a calendar year back in a calendar year for our reporting back, I think it was 2020.

Speaker 2

I think it was calendar year 2019. No, it was actually the end of 2019 we went to a calendar year. So for the year, it all washes out. We had been on a fiscal year, which I think it was every 6 or 7 years we have an extra week. But we're on a calendar year basis, so there might be a day or 2.

Speaker 2

But for how our business operates, we don't see that as a meaningful impact.

Speaker 7

Thank you.

Speaker 2

Next question

Operator

comes from the line of Joanne Wuensch with Citi. Please go ahead. Good morning and thank you for taking the question. I know we're a

Speaker 8

little early on this, but can you provide any commentary for how you're thinking about 2025?

Speaker 2

I'd say we continue to focus on executing our strategic objectives, financial strategic objectives of organic growth. 200 basis points above the market, we had said at the beginning of this year, we thought 2024 was going to be a normal market growth relative to 2023, which was above normal. And based upon what we've seen in the market, we think that has played out to be a very normal kind of organic growth year for the industry. I have no reason at this point to believe 2025 is going to be any different than that. So we remain focused on delivering on our strategic objectives, Sales growing at least 200 basis points organically above the market and operating profit twice as fast growing twice as fast as sales.

Speaker 2

I'll just highlight, we'll also be down at the low end of our leverage range. By the end of this year, we shared that on our cash flow update where leverage at the end of the year is expected to be 2.6 times to 2.7 times EBITDA.

Operator

Thank you. And just to confirm

Speaker 8

what you're currently seeing in terms of your market growth that you think you'll be growing 200 basis points faster?

Speaker 2

That's not our guidance. That's our objective. We'll provide formal guidance in February on our Q4 earnings call.

Operator

Okeydokey. Thank you so much.

Speaker 2

Thanks, Joanne.

Operator

Your next question comes from the line of Matthew O'Brien with Piper Sandler. Please go ahead.

Speaker 7

Good morning. Thanks for taking the questions. Maybe just sticking on Q4 for a second and before I do that, just congratulations to Payson and Andrew. But sticking on Q4, it does look like a little bit of a decel in terms of the 2 year stack. So I'm just curious, is that entirely CRM?

Speaker 7

Is there any of the hurricane lingering impact there that would cause that slowdown? Or is it just you guys being somewhat conservative?

Speaker 2

Sure. I may not be tracking the 2 year stack. At midpoint, we see sales growth of about 11% operating profit in that same order of magnitude. So we think for the Q4, we see strong sales growth based upon the new products we're rolling out and supporting in CMV and the neuromod acceleration of the emerging customer PMA. And so we feel good about that given that we're sitting here 4 weeks into the quarter with 9 to go.

Speaker 2

In the Q4 last year, thinking about the comps, Q4 last year was the highest quarter of the year. It was over $400,000,000 of sales and the prior quarters were well below $300,000,000 and it was also the highest Profitability of the year, it was 16.7%. AOI margin rate last year compared to the full year was 15.2%. So you see the quarterly improvement. So on a year over year basis, 4th quarter is the toughest comp.

Speaker 2

And if you look at our guidance for the Q4, the midpoint from a profitability standpoint is the average operating margin rate for year to date. So we think the Q4 guidance is very consistent with year to date. And I'll take this opportunity to highlight on a year to date basis, our operating margin is up 180 basis points year over year. We're at 16.5% operating margin rate year to date. That compares to 14.7% last year, and that's 100 bps from gross margins.

Speaker 2

So we're expanding gross margins, which has been a big focus for us this year in particular coming out of all of the pandemic disruption and we're very focused on getting margin expansion in gross margin. But we're also getting 80 basis of leverage on OpEx. So we're pleased with the progress we're making both in gross margin and in getting operating leverage. So I'm sorry if I didn't answer your questions, but I'll take another shot at it.

Speaker 7

No, Joe. That was perfect. Appreciate that. And then in the just to continue to follow-up on Craig's questions, but in the electrophysiology business, I'm just curious, just given the shift we've seen so quickly to PSA, are you guys feeling any kind of inventory work down on the traditional energy product, be it cryo or RF that's kind of even weighing a little bit on that part of your business? And then at some point, is that really, I guess, moves to the side, you start to really see some of the PFA contribution to the business?

Speaker 7

Is that a dynamic that we should consider at all? Thank you.

Speaker 2

So we haven't seen any measurable meaningful shift or change. Obviously, I think everybody believes cryo is going to be impacted over time by pulse field ablation coming out. And so we are assuming and factoring in the kind of the broader industry expectation on cryo decline. But in the other applications, we continue to see strong demand. Our customers continue to be very optimistic about the broader electrophysiology marketplace.

Speaker 2

And given our broad footprint and participation across the full procedure and given our significant vertical integration, we think we're incredibly well positioned to support the industry during this transition and help our customers bring products to market as fast as we all can on a safe basis. So, we remain excited and don't haven't seen any meaningful shift beyond what you're hearing and seeing in the broader industry. And as we look at electrophysiology, given our broad footprint and vertical integration, we see it as a net tailwind for the company for sure.

Speaker 7

Got it. And sorry, can I sneak in one more? Yes. Just the big R and D cut in the quarter, why was that? And is that anything to be cautious about in terms of 25% or 26% in terms of investment there?

Speaker 7

I don't know if there was an adjustment that I missed in the release. Thanks.

Speaker 2

Yes. No adjustments. It's a great question. So, first off, we didn't cut R and D. But nominally, we continue to spend more in R and D.

Speaker 2

What you're seeing there is higher levels of reimbursement or maybe wrong term given your thought your understanding of reimbursement for our customers, higher levels of our customers paying us to do development work for them in the discrete Q3 compared to other quarters. I think in the last couple of years, you've heard us talk about how to think about our development revenues. The R and D line is impacted by our development revenues. The cost for our development activity is very flat quarter to quarter throughout the year because it's primarily R and D engineers doing work. So, they're on the payroll 365 days a year.

Speaker 2

When we generate revenues or get paid by our customers is connected to achieving milestones on those different development programs. And in previous years, what we saw was a pattern of more revenues later in the year, in particular in Q4, as we and our customers work to hit milestones within the year and stay on track. We have been very focused on levelized normalizing or leveling that out across the year. And I think I commented on last quarter's call that this year in particular, we've been seeing a much, much more level loaded revenues for that kind of work. And what you're highlighting here is actually in the Q3, we actually saw more revenues in the Q3 for that kind of work than the other quarters.

Speaker 2

And so that's the biggest driver of the R and D expense being down. It's because of revenues, not because of reducing costs. And so now we're expecting 4th quarter to be a more normal average for the year as compared to prior years where 4th quarter might have been a very strong revenue quarter for the development revenue. So thanks for highlighting that because it was important I explained that we didn't lower any costs. We actually just generated more revenues for the work we're doing.

Speaker 7

Very helpful. Thank

Operator

Your next question comes from the line of Kristen Stewart with CL King. Please go ahead. Hi, thanks for taking the question. I was wondering if you could just give a little bit more detail on gross margins in the quarter, what drove kind of the increase and then how should we think about it going forward just from a sustainability perspective of the increase year to year and whether or not you can get back to that 31% pre COVID level and if there's any time horizon associated with that achievement?

Speaker 2

Great. Thanks for the question. We absolutely expect to get back to the 2019 31% gross margins and then we expect to build on that. We don't plan to stop at 31%. But we have made tremendous progress year to date, up 100 basis points year over year.

Speaker 2

It's really a function of recovering getting back some of the inefficiencies that we incurred from supply chain disruption and the direct labor turnover. Our supply chain is very stable at this point. The team has done a good job of managing that. And then on the direct labor turnover, at the company, company total, we're below where we were pre pandemic, which is great. We're very focused on engagement with our direct labor associates, and we're getting really good traction on our manufacturing excellence initiative and the work we're doing with associates to provide them with tools and kaizen events and lean implementing lean processes.

Speaker 2

And we see continued significant opportunity, whether it's in direct material scrap reduction or reducing over time because of how we load the plants or in driving greater direct labor efficiency. There's automation opportunities still. And so now that the teams the plant management teams can really get back to focusing on driving those individual projects, many of them are small projects that compound over time, We're starting to see the financial benefits of the hard work the team has been doing. And we expect that to continue and excited for the progress that the team is making. So, we absolutely expect to continue growing operating profit twice as fast as sales.

Speaker 2

The sales growth rate is our objective, and we would expect that to come from both, expanding gross margins while also continuing to get leverage on the operating expense. And so right now, we're 180 basis points at the operating margin rate level above last year on a year to date basis. And that's 100 basis points from gross margin, 80 basis points from OpEx. And that's a it's a good mix, that we'll keep driving going forward.

Operator

And then as your leverage is coming down, I was wondering if you could give us an update on how you're thinking about M and A?

Speaker 2

Yes. Well, by the end of the year, we expect to be at the low end of our range, which means we've got the $250,000,000 to $300,000,000 of capacity that we've talked about on a kind of a rolling annual basis. And so we continue to have a robust pipeline that we continuously curate. Many of the acquisitions we do, we work with those targets over multiple years, building a relationship, understanding their business, so that when they're ready and we don't get to choose when they're ready to transact. If we did, we would probably be paying a premium and we'd rather pay a fair price, fair multiple.

Speaker 2

So that pipeline continues to be curated by Andrew and his team and we would expect to continue executing our inorganic strategy over time. And the nice thing is we now have the full capacity that we target within our targeted debt leverage range.

Operator

Okay. Thanks very much.

Speaker 2

Thank you.

Operator

Your final question comes from the line of Suraj Kalia with Oppenheimer. Please go ahead.

Speaker 9

Good morning, Joe. Darren, can you hear me all right?

Speaker 2

Yes. Good morning, Suraj.

Speaker 9

So, Darren, one question for you and Joe, one question for you. Darren, let me start out with you. So the 1% shortfall in organic growth because of Hurricane Helene, I guess I want to ask the question a slightly different way. Given the visibility of your customer orders from long term contracts, should we start thinking about a relative concentration in the last week of a quarter also? I mean logic would have dictated it would be a relatively steady cadence throughout the quarter.

Speaker 9

Maybe you can help us reconcile Helene in the last week of September and just tie it into how you'll see customer orders throughout the quarter?

Speaker 3

Sure, Suraj. Yes. I mean, when you look at our order pattern, there's a couple

Speaker 10

of different variables that happen. One of them is the normal order patterning is relatively smooth. We do about $30,000,000 $33,000,000 a week. And so when you look at the timing of that, most are relatively smooth. You have some that you have sterilization near the end of the quarter where that happens a little bit more in bulk.

Speaker 10

And when you talk about Hurricane Helene specifically, it all happened right

Speaker 3

in the last few days of

Speaker 10

the quarter. So we ended up closing our facility for about 3 days. And that was right when things were in the process of getting packed, shipped, final sterilization. So you have a little bit of an outsized impact. Again, it ultimately is about a 1 percentage point impact to our overall organic growth that for that will be caught up in the Q4.

Speaker 10

And as Joe mentioned earlier, it'd be primarily a cost pressure or a cost headwind as we kind of work through getting re ramped up.

Speaker 9

So we shouldn't think about besides the hurricane impact, normal cadence and we shouldn't start thinking about concentration towards the end of the quarter. Is that a fair way to look at it?

Speaker 7

Yes, correct. Not from a

Speaker 10

kind of an ongoing basis. Yes, you should not think of kind of last couple of days concentration.

Speaker 9

Fair enough. Joe, one question for you. I do appreciate all the color. Joe, in terms of the comment about new structural heart products, I know you guys are talking of the tricuspid component and structural heart. Maybe if I can push you on TriClip, remind us, is it based on just minimum volumes or are there any adjustments based on price volumes?

Speaker 9

How should we think about as we roll out into Q4 and FY 2025? Any color you could give us would be great. Gentlemen, thank you for taking my questions.

Speaker 2

Great. Thanks, Suraj. I can't speak to any specific individual program or individual customer, but if I just respond to your question maybe more broadly, our agreements some of our agreements will in fact have some pricing based upon volume levels. We call that tiered pricing. As we hit certain volume thresholds, we drive additional synergies, efficiencies of scale.

Speaker 2

And we do, in fact, share some of that with our customers so that we both benefit from growth. Our goal is to enable our customers' success, which means help them grow and treat more patients and grow in the market. And when we get to participate in that, we have to earn that right. When we get to participate in that, there is a sharing on some programs. And so, it is a structure and a function that we have with some customers.

Speaker 2

It's very common with a new product launch where pricing may be above average in the early days because you have inefficiencies as you introduce something and ramp. You've got training of associates. Yields are not always optimal at the beginning of a new product launch. And then as you move into kind of a full scale production, then the pricing comes in line more with kind of the cost that you would expect in a full scale manufacturing line. And so there is that dynamic, but the end objective of that is really just kind of matching the inefficiencies with the pricing during that ramp phase and then as quickly as possible getting to a very efficient full scale production and a price that's very competitive and helps our customers succeed in the market.

Speaker 9

Thank you.

Operator

Sir, this concludes the question and answer session. I will turn the call to Andrew for closing remarks.

Speaker 1

Great. Thank you everyone for joining the call today. As always, you can access the replay of this call on our website as well as the presentation that we covered. Thank you for your interest in Integer and that concludes today's call.

Operator

This concludes today's conference call. We thank you for joining. You may now disconnect.

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Earnings Conference Call
Monro Q3 2024
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