Greatbatch Inc. GB reported adjusted earnings per share of 64 cents in the second quarter of 2015, in line with the Zacks Consensus Estimate and up nearly 5% on a year-over-year basis. The company registered sales increase of 1.6% year over year at $174.9 million, which was marginally higher than the Zacks Consensus Estimate of $174 million.
Revenue Details
Unfavorable foreign exchange rate reduced sales in the quarter by approximately $5.5 million. Organic growth on a constant currency basis was 4% in the reported quarter. Higher organic growth can be attributed to better performance from Greatbatch’s cardiac and neuromodulation as well as orthopedic product lines.
Revenues from Cardiac/Neuromodulation products increased 12.7% to $90.2 million, on the back of double-digit growth rate in medical batteries, shield assemblies and neuromodulation product lines.
Revenues from Orthopedic products grossed $35.5 million, down 6.3% on a reported basis but up 8% on a constant currency basis. Sales of instruments, especially implants, were impressive in the quarter.
Revenues from Portable Medical increased 5.8% to $17.7 million on a year-over-year basis. During the quarter under review, Greatbatch renewed its strategic partnership with an important customer. This transaction is expected to boost organic growth in the long run. Greatbatch is also well on track with the transition of its manufacturing plant to Mexico. Production is set to begin therein in the fourth quarter of 2015.
Vascular product revenues decreased 15.4% to $12.9 million due to customer inventory management and lower customer volumes. The transition of its manufacturing plant to Mexico is expected to better the prospects of this segment by granting Greatbatch a competitive edge over its peers.
Revenues from the Energy, Military and Environmental ("EME") business plunged 22.5% on a year-over-year basis to $16.5 million. The weakness may be attributed to declining energy revenues.
Revenues from QiG, which includes sales from CCC Medical Devices acquired in Aug 2014, surged to $2.7 million from $0.9 million in the year-ago quarter. On an organic constant currency basis, QiG revenues soared 73% on the back of new product launches, including a limited release of the Algovita Spinal Cord Stimulation system in Europe.
Operational Details
Gross margin contracted 90 basis points (bps) year over year to 33.1%. Improved sales volume was offset by pricing pressure and an unfavorable product mix.
Selling, general and administrative expenses (SG&A) increased 10.2% to $24.1 million, primarily attributable to the acquisition of CCC Medical Devices, as well as increased legal fees.
Net research, development & engineering costs increased 2.1% on a year-over-year basis to $13.1 million.
Owing to a lower gross margin and higher operating expenses, adjusted operating margin contracted 140 bps to 12.7% while adjusted earnings before interest, income tax, depreciation & amortization (EBITDA) margin declined 160 bps to 17.9%.
Nuvectra Spin-Off
On Jul 30, Greatbatch announced filing of a Form 10 registration statement with the U.S. Securities and Exchange Commission (SEC) for a proposed spin-off of its neuromodulation device business known as QiG Group. Post spin-off, the new entity will be known as Nuvectra Corp., which will primarily emphasize on the development and marketing of the Algovita spinal cord stimulation system. Greatbatch will, meanwhile, retain its hold on CCC Medical Devices and GB Ventures.
Per management at Greatbatch, the spin-off will allow both the companies to operate more effectively by way of proper allocation of resources.
Financial Position
As of Jul 3, 2015, Greatbatch had cash and cash equivalents of $72.3 million compared with $67 million at the end of the preceding quarter. Long-term debt declined to $168.8 million in the second quarter of 2015 from $172.5 million in the previous quarter.
In the second quarter of 2015, cash flow from operating activities totaled $15.2 million, down 22% from the second quarter of 2014, primarily due to lower working capital levels and reduced cash net income.
Capital expenditure totaled $6.8 million in the recently reported quarter, higher than $6 million in the year-ago period, primarily due to higher level of investments in capacity and capabilities.
Guidance
Greatbatch reiterated its revenue and adjusted EPS guidance for 2015. Adjusted EPS is projected in the band of $2.61–$2.71. The current Zacks Consensus Estimate is at $2.63.
Sales are anticipated in the band of $715 million to $730 million. Unfavorable foreign exchange rate is expected to have a negative impact of approximately $14 million (or 2%) on sales.
Adjusted operating margin is expected in the range of 13.7% to 14%. Meanwhile, Greatbatch anticipates capital expenditure in the range of $40 million to $50 million for 2015.
Adjusted operating cash flow is projected in the range of $80–$100 million, although management expects it to be closer to the lower end of its outlook if Greatbatch goes forward with the spin-off. Management anticipates related expenses for the proposed spin-off in the band of $10–12 million.
Our Take
Sales at Greatbatch during the second quarter were hurt by foreign exchange headwinds, which may continue to put the top line under pressure going ahead.
Higher investments in R&D and unfavorable product mix are expected to impact margins in the near term. Nevertheless, there is scope for expansion in margin and improvement in return on invested capital (ROIC) in the long run, on the back of investments in the new facility in Mexico.
The integration of CCC Medical Devices capabilities and customers into the organization as planned is expected to be accretive, going forward. Despite macroeconomic headwinds, the company has maintained its guidance for 2015, which is commendable.
We also feel that the strategic spin-off of QiG Group will help Greatbatch focus on its core operations and allocate its resources in a more efficient manner. This, in turn, should propel significant organic growth in the long run. Additionally, post spin-off, management expects reduction in operating expenses of $12 million to $16 million on an annualized basis. This will help improve the bottom line in the quarters ahead.
Zacks Rank
Currently, Greatbatch carries a Zacks Rank #4 (Sell).
Better ranked stocks in the broader medical sector include LeMaitre Vascular LMAT, LDR Holding Corp LDRH and Abaxis ABAX. All the stocks sport a Zacks Rank #1 (Strong Buy).
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