Morning, everybody. Thanks so much for joining us. Matt O'Brien, I cover MedTech here at Piper. We're very, very fortunate to have the Integer company here with us today, and from the management team up here is Joe, who is the Chief Executive Officer of the company. You know, Joe, thanks so much for coming out, first of all. Really do appreciate it, making the trip up here. Maybe start a little bit, you know, with Integer and just the background. It's a big company, lots of sales and market cap. Hasn't been very well-covered historically.
Maybe just talk about you know where things have come from since you've been there the last five or seven years-ish, you know, and where things are gonna go from here versus, you know, kind of where things were when everybody, you know, thought about Greatbatch and more of a battery kind of company.
Great. Well, Matt, thanks for having us, and as a leading MedTech analyst, we appreciate you picking up coverage. It's awesome to see everybody here and look forward to meeting as many of you as we can today, and if not today, we're happy to talk to you after this meeting. So I'll start with a 30-second backdrop. So I stepped in as Chief Executive Officer in 2017. At that time, the company was 18 months into a large acquisition. Greatbatch, a public company, had acquired Lake Region, a privately owned company. Greatbatch was primarily cardiac rhythm management, neuromodulation, a little bit of vascular, a little bit of orthopedic.
Lake Region was a lot of cardiovascular, a lot of orthopedic and two very, very different end markets that they were serving. I think it was a great combination because it broadened the company, deepened the company, but it had been a tough 18 months of integration. The company had gotten through, I'll say, the mechanics of integrating, but the company really wasn't clear on what's the strategy now that you have a $1.5 billion business, two equally sized companies coming together. The acquisition was late 2015. 2015 and 2016 were tough years for the company. I think the distraction of the integration and other things, sales declined, profit declined, and debt leverage was over 6x.
So when I stepped in, it was the perfect time, 2017, to look at the portfolio and decide, well, what, what—who are we gonna be and what's our strategy? And so we did a portfolio review. We looked at the markets we were serving, what are the attractive, unattractive markets? We looked at what's been our strategy in those markets, successful, not successful. What's our point of differentiation in each of those markets? And we concluded the first thing was $400 million of our business in the advanced surgical and ortho space, we divested. We did that in about six months, $600 million sale. We got a great price for the business. Helped us to de-lever. Took us from 25 manufacturing plants down to 15, so we could then focus on running our business more efficiently.
Then we turned to, well, what are we trying to accomplish? And we came up with three clear financial objectives for the company. We want to grow 200 basis points faster than the markets we serve. The markets we serve are growing mid-single digits. We want to grow operating profit twice as fast as sales. We want our debt leverage to be in a range that investors are comfortable with, which we pegged at 2.5-3.5 x leverage. Then we went out and built a strategy around how to accomplish that.
We built what we call our growth teams, which are teams of cross-functional teams that work to understand the markets that we were serving, decide what's our point of differentiation, what should it be, and develop a strategy for how to go to market and grow the business 200 basis points or more faster than the end markets. Then we built a manufacturing excellence strategy, built around the Integer Production System, and this is your traditional lean manufacturing processes, to expand margins and deliver that operating profit growth of twice as fast as sales. So we launched all that in 2018. We divested the business in 2018, went down to $1.1 billion of sales. We've grown back to $1.6 billion, mostly organically, some acquisitions.
From 2017 to 2019, we expanded margins 300 basis points. We had gotten leverage down to right in the middle of the two point five to three point five. Operating profit was growing twice as fast or more than sales. The piece that we hadn't accomplished at that point was growing the business faster than the markets. We knew that would take longer by virtue of the cycle times of winning business and converting that to manufacturing revenues. That's what we've been focused on since 2019 while managing through the pandemic. Right now, we've said publicly we're confident we can grow 200 basis points faster than the markets we serve, based upon our strong development pipeline of new programs with our customers. 2023, our profit is growing 1.6 x the rate of sales.
A strong, strong year this year, and our leverage is right within our range at three point one, middle of the two point five to three point five So we've got one more step to go to finish hitting the three objectives, and that's to get the operating profit to grow twice as fast as sales.
Got it. Okay, very good synopsis there. So results this year have been really good. I think some investors are wondering, like, okay, is this just really surgical backlog? You're really benefiting from all that. So just maybe talk a little bit about the dynamics that you're seeing in the business this year, and then, you know, the surgical backlog, if things start to normalize a little bit, doesn't sound like it's gonna be next year, more like 2025, but what happens to the business if things start to normalize a little bit on the, on the backlog side of things?
Sure. So it's been a strong year for us. Our sales have grown 15% organically, operating profit 25%. That's a midpoint of our guidance. You know, we look at the development pipeline that we have and the new programs that we're launching this year has fueled that growth. We've seen tremendous success in those programs that we won back in 2017, 2018, 2019, 2020. The three- to five- to seven-year cycle time it takes from developing a program to launching it and generating manufacturing revenues, that's what's driven our success this year. Obviously, the market and the industry has been strong. We see that across the board. You know, when you look at the industry, we—the industries and the markets we serve, mid-single digits.
You know, this year it feels like they're probably growing high single digits, so 15% sales is still significant outperformance, and we would point to our new product introductions across that development pipeline that we've built. Inventory corrections, you know, or what's happening with backlogs, without a doubt, there's been a very strong market, but what we see is we see the industry settling back down to what we would call the more normal, predictable, mid-single-digit growth rates across the end markets that we're serving.
Okay. Okay, appreciate that. This that you started mentioning, I just told you before we started I wasn't gonna bounce around, but now I'm gonna bounce around. The conversion rates that you're seeing as far as that new business win, it just seems that I'm looking at your performance. You're gonna grow 15% this year. Your end market's not growing 13%, so you're clearly winning share. What's going on as far as that conversion, you know, that you're seeing in terms of things that are getting bid out and then things that you're winning? Because it seems like you're really disproportionately taking more of that new business that's out there for bid.
Yeah, it's a great question. When we think about the markets we're targeting, the success we're having in the development pipeline, the best way for us to grow is organically, and that's to get designed into programs. When you're designed in, it becomes incredibly sticky. The development process is time-consuming, it's expensive, it requires customer engineering effort. Once you're designed in, it's your business, and then you just have to take care of the customer and serve them incredibly well. Our strategy's been crystal clear. We're focusing on shifting our mix and our capabilities more towards the faster-growing end markets. In the cardiovascular space, that would be Structural Heart, Electrophysiology, and Neurovascular.
If you look at the organic investments we've made to add capability and capacity, they've been very targeted in those end markets. If you look at the acquisitions we've made, they've been very targeted in those end markets. That's helped us to build a very strong development pipeline. On the Cardiac Rhythm Management, even though it's a lower growth, there are pockets of growth, whether it's Leadless Pacing or cardiac monitoring, and so we're also investing and focusing in those markets.
And then neuromodulation, we have full vertical integration for neuromodulation customers, and so the early-stage neuromodulation customers that don't have a supply chain, they don't have manufacturing capability at all, they completely outsource that to us, everything from the design and development, starting with proof of concept, through clinicals, all the way into high-volume manufacturing. And so, we look at conversion rate as, are we winning the business in the targeted high-growth markets with differentiated capability? And we would point to the development work that we're doing. From 2017 to 2022, so 2017 being the year before the implementation of our growth strategy, we've grown our development program work with customers, so think new programs, by 230%.
That's actual data, 2017 to 2022, and in 2023, it's continued to grow. More importantly, we've shifted the mix of those programs. In 2017, when we weren't as structured and focused on those end markets, we had about half of our programs were in faster-growing, targeted end markets, and half were in those slower-growing, more mature markets. That is now 80% in those faster-growing end markets, Structural Heart, Electrophysiology, Neurovascular, Neuromodulation. So we've grown 200%+ on the number of programs we're getting designed into, and more importantly, we've shifted that mix to be 80% those faster-growing end markets, so that when they do launch, there's higher demand. And those faster-growing end markets is where the innovation in the industry is occurring.
So we're really following our customer strategy, which is where's their unmet patient need, which is where the innovation is, and we're following that strategy into those markets.
Got it. And do you have... I mean, as you don't have to get into details, but there are a bunch of other areas that should be rapidly growing over the next several years in neuromod, cardio, and vascular. Are you already bidding on some of that business? And you know, because, you know, and then getting spec'd into that as well, are these areas that people should be excited about continuing to kind of focus you in these faster growth areas? And how do you identify those faster growth areas early on?
Yeah, we study where the innovation and the R&D work is going with our customers. Where are they researching? What are they investing in? Where are the clinical trials? Who's out there innovating? And whether it's the small startups, which we work with, or our large customers, or who our large customers might be looking at acquiring. And we study our customer strategy, and we study the industry and where there's unmet patient need, and that's where we see innovation. So we're following the innovation of the industry.
And then our job is to enable our customers to bring those products to market quickly, and help them with speed to market, bring them vertical integration, and simplifying their supply chain so that they can focus on developing the therapy and then commercializing it, so that they don't have to invest in bricks-and-mortar, which they don't want to do because they prefer to bring the therapy to market first and be that first mover. So we study our customers, follow their strategy, study the industry. We work with the early-stage companies all the way to our larger customers.
Got it. And then you talked about visibility a little bit, Joe. What, what kind of visibility do you have into your business over the next two to three quarters? Because I think that's something else that's missed by investors. Everybody thinks the contract manufacturers and these big swings that go around, but-
Right.
But, I think you have a little bit better visibility as far as your organization goes.
We do. Before the pandemic, we had about $300 million in orders on the book from customers. That was largely within the next six months. We had very few orders that were beyond six months. During the pandemic, with the supply chain disruptions, everybody's lead times in all of manufacturing extended. Customers, including us, everyone throughout the supply chain, started ordering further in advance to give the supply chain better visibility to demand, in hopes that everyone would have a higher probability of meeting that demand. So our order book today is $1.0 billion, compared to $300 million before the pandemic. Clearly, some of that is because of that dynamic of ordering further into the future.
Over $300 million of that $1 billion is for six months or further into the future. And so previously, we would enter a quarter, and we'd have really good visibility to 50%, 60% of the quarter, then we had run rate analysis for the rest. Now, we enter a quarter, and we know what the demand is for the quarter. That doesn't mean that there won't be changes. There are changes within our customers' needs throughout the quarter. But it's pretty good visibility for one to two quarters out based upon a billion-dollar order book. We would expect at some point that the ordering into the future will come back down maybe to more normal levels. We're not sure.
But we won't go back to $300 billion order book, as we've done the analysis around. Some of that is because, some of that growth is because with our new programs, customers give us orders for 12 to 18 months for new program launches so that we can align around what that ramp schedule looks like, and we can make commitments to each other on what we need to build and add into our business to support them. And so a portion of that increase is the new products. We're also a bigger business, a faster-growing business today than we were pre-pandemic, and so that's also increased the backlog. So we've got really good near-term visibility to what our customers' demand is.
Got it. Okay. All right, speaking of your customers, two of the bigger customers that you guys have are Abbott and Boston Scientific. They've publicly said, "Hey, we need to work down inventory levels. We're well above, you know, pre-pandemic levels. We need to work that down." Why wouldn't that be a headwind for Integer?
Yeah, it very well could be, but here's our perspective. You know, in 2022, a lot of customers were saying, "Build, build, and ship whatever you can, whatever you can make.
Yeah.
So clearly, that doesn't take a lot of thinking to realize that they're not that interested in managing inventory. They just don't want to miss a sale. Understand that in that environment. The other dynamic is we're sole source in most of what we do, so we can triangulate the demand for products that customers are putting on us to what they're selling externally, because the segments that they report, we can connect those dots, so we can see if the demand on us is well in excess of the market. So we understand that and have conversations with our customers around that, and then we allocate our capacity to customers that need to meet patient procedures, instead of just building excess inventory.
We entered 2023 believing that inventories were probably higher than they would ever have been, and that at some point, customers would rationalize that. So we baked an assumption, it was our guesstimate, of what that adjustment would be in 2023, recognizing at the beginning of the year, we had $1 billion of orders on the books with $1.006 billion sales for the year. So we put in our estimate. And then in the middle of the year, this past summer, we got some of those dear supplier letters that go out. We're managing our inventories down now, so expect some changes. And so you see the impact of that already in our third quarter results, and it's already in our fourth quarter guidance.
I said on our third quarter earnings call that we were already seeing what we would characterize as normal pre-pandemic, year-end inventory management that some customers do at the end of the year, and that that was factored into our guidance. And so we feel like we've already seen and experienced some amount of that. Doesn't mean that there couldn't be more, but, but again, we, we've got really good order visibility to what our customers are looking for for the next six months at least.
Sure. Some of the areas that they've talked about working down, I'm assuming, are not faster growth areas?
Without a doubt.
Yeah.
On the faster-growing areas, they still want more product.
Right.
I mean, there are still pockets where our customers want more inventory than what we can fulfill.
Okay. Okay, on the other end of it, another one of your big customers, Medtronic, has said publicly, "We are consolidating vendors. Like, we have too many vendors, we need to consolidate it." Is that a dynamic that is... I know it's been going on somewhat. Has it accelerated? And then how beneficial could just Medtronic alone consolidating vendors be for you guys?
Well, we think we're well positioned with particularly all of our large customers, but even more so with our smaller customers, 'cause our ability to vertically integrate and simplify our smaller customer supply chain. We have deep relationships with all of our large customers, and we think that our strategy and the capabilities that we have and continue to add are perfectly aligned with our customers' growth strategy. And that is a fundamental element of our strategy, is to enable our customers' success in bringing markets products, innovative products to market faster. So we think we're well positioned to participate in that. We believe we're strategic partners with our customers.
They tell us repeatedly that we're the only supplier who serves them in most of their manufacturing operations, because most of what we build goes into one of their plants to get incorporated into a finished device. That alone makes us strategic. The fact that we have innovative capabilities and capacity to serve them broadly and with depth is also another point of differentiation. So Medtronic's been very open publicly about their desire to consolidate the supply, their supply base. We believe we're gonna be a winner in that consolidation, but this is a trend that's been going on for a while across the industry, and Medtronic's just probably been the most open and visibly clear about what they're trying to accomplish.
Okay. Last piece on this one, and I think it's important just to talk about, 'cause I get the question sometimes. I don't think people understand this. You're spec'd into a lot of these different products that you sell into the OEMs. That means that if they're gonna move, they've got to run a completely different clinical study, right? They have to do another clinical study. So the likelihood that a Medtronic, a Boston, an Abbott decides to vertically integrate and manufacture things themselves would be what, in your view?
Well, the first question is, what would the-- how would they benefit? What would they get for it? They would be pulling investment dollars away from new therapies, clinical trials, and commercialization, which is clearly where they get the biggest return-
Yeah
... in their business. We also— What we manufacture and what we do, we do for a living across the whole industry, so we learn from trying multiple different approaches to the technologies that we have. And we also have oftentimes greater scale because we're serving the industry, whereas they're just serving the, well, their portion of the market. So there's lots of reasons why, given our scale at $1.6 billion and serving everybody in the industry in some way, that we are focusing on these processes, and for them, it's not their primary focus. Their focus is on the therapy. So we feel like that's not a risk, and we're not seeing that trend.
Yep.
The other piece to the stickiness of what we do, once you're designed in and spec'd in, as long as you take care of your customer with high quality delivery and reasonable cost, it's your business for that generation of the product, and you're the incumbent on the next generation. And then we just keep innovating with them on their next generation and getting designed into that program, and then they focus on developing a new better therapy with better efficacy and safety for patients.
Okay. Okay, got that. What about on the pricing side? I know that's been a net headwind historically for Integer and pretty much all contract manufacturers. How has that dynamic changed, post-pandemic? And, you know, is it an area that you think can be stable going forward, or is it gonna be a headwind in the future?
... Yeah, this is an area where, I'd say the pandemic ended up being a positive, and I can't say many things about the last three years that were a positive for our business. But, what we did was we took all the supplier price increases we were experiencing in direct material, and we pushed them as far into the future as we could. So we're actually experiencing more inflation in 2023 than 2022 because of that. But we did that intentionally so that we would then have time to go to customers and say, "We need to pass some of this inflation through to you, both labor and material," because our customers are experiencing the same thing. We didn't raise price to expand margins. We did it to cover cost.
And we felt that was important as a strategic partner with our customers, because we want to remain in the pipeline of new business and getting designed in. And so our strategy was: delay the price increases as long as we could, pass some of that through to our customers, cover the rest with our own operational efficiencies. And now we have 70% of our business under long-term agreements, multi-year agreements, and the structure of those are more to drive growth incentives. So price down comes with growth. It comes with very little built-in guaranteed price down. So pre-pandemic, we were very consistently 1% to 2% priced down every year, 1% to 2%. Post-pandemic, we expect to be flattish.
We had price increases in 2023 that covers a significant portion of that inflation, but not all of that. And our customers understood that 'cause we took them through the details of that. And then as we look at 2024 and beyond, we expect price to be, I'll call it, neutral-ish, so call it ±0.5%, and that's the structure of our agreements going forward. And we believe that that's one of the advantages for us. But I also think that's what our customers have done, right? They've also talked about how they've now been able to raise prices in certain markets and certain areas, and so I think what we've done is consistent with what they've done, which is why I think it's worked.
Okay. So nice to hear about pricing benefits in med tech for the first time in 20 years. And then, maybe lastly, just on the supply chain issue that you guys ran into earlier this year, just, you know, where is that at this point? And then what kind of muscle have you gotten built around the supply chain, just given some of the challenges you did face?
Certainly. So yeah, last year, we had a couple suppliers that became very problematic at the end of the third quarter. The effect of that was essentially to move some business out of the fourth quarter, some shipments into the first half, but ended up being mostly the first quarter of 2023, so it was really just a delay. But we've worked through those. Supply chain has improved for us significantly in 2023 compared to 2022, particularly in the second quarter. You saw that in our second quarter results. Third quarter, it kind of stayed at about the exit rate of second quarter. It's kind of trending on that level. We still see pockets of supply chain challenges. It's not a specific material or industry. It's really more supplier specific.
We're just operating like that's the way it's gonna be going forward, and we just got to keep getting better at managing it. We've certainly built, I think, a lot of muscles around managing supply base. We're doing dual sourcing, we're doing insourcing, we're qualifying different materials. You know, we're building up safety stocks. I mean, I think we're deploying all of the standard tactics that you would to deal with supply chain challenges. And we're just gonna operate like this is the way it's gonna be going forward and just keep getting better at managing it. Every Tuesday, we have an operations review, where we review sales and orders, we review direct labor, hiring, and turnover.
We review supply chain. We go supplier by supplier that are challenges for us site by site, and we go through what the action plans are, and then we take action. So we've definitely got a pretty rigorous process built around it.
That makes sense. Heading over to the, the operating income side of things, you know, that you said that's the one area that you haven't, you haven't hit yet. 1.6x your top line growth rate is pretty good, 'cause it's much faster than expected. You said you were eating some of that inflationary cost this year. So, I mean, is next year the year where you think you can get to that 2x?
Yeah, it's a great question. We're not in a position to give 2024 guidance, but clearly, our financial objectives are to grow 200 basis points faster than the markets we serve. The markets we serve are growing 4%to 6%, and we've said we're confident we can do that going forward because of that development pipeline that we have that's 200% higher than 2017. 80% of it's in the high-growth markets. Our debt leverage is 3.1, so it's right in that 2.5 to 3.5. And the last piece that we haven't said, "Hey, we can do this next year and going forward," is growing operating profit twice as fast as sales. We'll give guidance on that in February, in our fourth-quarter earnings call, but that's absolutely the goal.
Hitting 1.6 x this year, we think, was a great step in the right direction. You know, and we would expect to be able to get some gross margin improvement over time as we better manage the supply chain, as direct labor efficiency and proficiency and training takes hold, and the turnover continues to improve. So we'll be looking for some improvement in gross margins to help us get to that operating profit twice as fast as sales.
Okay. All right, got that. Well, as I look at the clock, I think we're out of time, so I'll have to go ahead and cap it there. I'm not gonna get to the M&A stuff I wanted to get to, but Joe, really appreciate all the feedback. I think this has been really helpful for everybody in the room and hopefully on the webcast.
Great. Thank you, Matt. Yeah, appreciate it. Thank you.