The following discussion and analysis of our financial condition and results of operations should be read together with our consolidated financial statements and the related notes appearing in Item 8 of this report. This discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of many factors, including but not limited to those under the heading "Risk Factors" in Item 1A of this report. Our Business •Our business •Impact of COVID-19 •Recent business acquisitions •Discontinued operations •Patent litigation •Financial overview Our Financial Results •Fiscal 2021 compared with fiscal 2020 •Liquidity and capital resources •Cash and other commitments •Impact of recently issued accounting standards
Critical accounting estimates
•Acquisition method of accounting •Inventories •Valuation of goodwill and intangible assets
Integer Holdings Corporationis one of the largest MDO manufacturers in the world serving the cardiac, neuromodulation, orthopedics, vascular and advanced surgical markets. We also develop batteries for high-end niche applications in the non-medical energy, military, and environmental markets. Our vision is to enhance the lives of patients worldwide by being our customers' partner of choice for innovative technologies and services. We organize our business into two reportable segments, Medical and Non-Medical, and derive our revenues from four principle product lines. The Medical segment includes the Cardio & Vascular, Cardiac & Neuromodulation and Advanced Surgical, Orthopedics & Portable Medical product lines and the Non-Medical segment comprises the Electrochem product line. For more information on our segments, please refer to Note 18 "Segment and Geographic Information" of the Notes to Consolidated Financial Statements contained in Item 8 of this report.
Impact of COVID-19
Beginning in early
March 2020, the global spread of the novel coronavirus ("COVID-19") created significant uncertainty and worldwide economic disruption. Specific impacts to our business include labor shortages, disruptions in the supply chain, delayed or reduced customer orders and sales, restrictions on associates' ability to travel or work, and delays in shipments to and from certain countries. The extent to which COVID-19 will continue to impact our operations will depend on future developments, which remain highly uncertain and difficult to predict, including, among others, the duration of the outbreak, the effectiveness and utilization of vaccines for COVID-19 and its variants, new information that may emerge concerning the severity of COVID-19 and the actions, especially those taken by governmental authorities to contain the pandemic or treat its impact. As pandemic-related events continue to evolve, additional impacts may arise or worsen that we are not aware of currently. Any prolonged material disruption of our labor force, suppliers, manufacturing, or customers could materially impact our consolidated financial position, results of operations or cash flows. - 29 -
MANAGEMENT'S DISCUSSION AND ANALYSIS
Recent business acquisitions
December 1, 2021, we acquired 100% of the outstanding equity interests of Oscor, privately-held companies with operations in Florida, the Dominican Republicand Germanythat design, develop, manufacture and market a comprehensive portfolio of highly specialized medical devices, venous access systems and diagnostic catheters and implantable devices. Refer to Note 2 "Business Acquisitions" of the Notes to Consolidated Financial Statements contained in Item 8 of this report for additional information about the acquisition. On February 19, 2020, we acquired certain assets and liabilities of InoMec, a privately-held company based in Israelthat specializes in the research, development and manufacturing of medical devices, including minimally invasive tools, delivery systems, tubing and catheters, surgery tools, drug-device combination, laser combined devices, and tooling and production. The acquisition enabled us to create a research and development center in Israel, closer to the customer base in the region. Refer to Note 2 "Business Acquisitions" of the Notes to Consolidated Financial Statements contained in Item 8 of this report for additional information about the acquisition of Oscorand InoMec.
July 2018, we completed the sale of the AS&O Product Line within our Medical segment to Viant (formerly MedPlast, LLC). For all periods presented, financial results reported as discontinued operations relate to the divested AS&O Product Line. All results and information presented exclude the AS&O Product Line unless otherwise noted. During 2021, we recognized income from discontinued operations of $3.8 millionor $0.11per diluted share. There was no income from discontinued operations during 2020.
Refer to Note 20 “Discontinued Operations” of the Notes to the Consolidated Financial Statements in Section 8 of this report for additional information.
April 2013, we commenced an action against a competitor alleging they had infringed on the our patents by manufacturing and selling filtered feedthrough assemblies used in implantable pacemakers and cardioverter defibrillators that incorporate our patented technology. Following four trials and an appeal, the United States Court of Appeals for the Federal Circuitaffirmed, in all respects, a judgment in our favor. We received proceeds related to the judgment of $28.9 millionin October 2020, and after recognizing certain related expenses, recognized a net gain of $28.2 million, which is recorded in Selling, general and administrative expenses. The proceeds were used to pay down a portion of our Revolving Credit Facility.
Refer to note 13 “Commitments and contingencies” of the notes to the consolidated financial statements appearing in section 8 of this report for additional information on this subject.
Fiscal 2021 vs. Fiscal 2020
Income from continuing operations for 2021 was
•Sales for 2021 increased 14% to
$1.221 billionas we began to see our sales return to pre-pandemic levels as the demand for many of our products continues to recover from the impacts of the COVID-19 pandemic.
• Gross profit for 2021 increased
•Operating expenses for 2021 increased by
$36.2 millioncompared to 2020, primarily due to increases of $32.4 millionin SG&A expenses and $3.5 millionin RD&E expenses. Included in SG&A expenses for 2020 is a net gain of $28.2 millionrecognized in connection with a previously mentioned patent litigation judgment.
• Interest expense for 2021 decreased by
• We recorded a net loss on the equity investments of
•Other (income) loss, net for 2021 was income of
$0.1 millioncompared to a loss of $1.5 millionduring 2020, primarily due to fluctuations in foreign currency gains and losses in the respective periods. •We recorded provisions for income taxes of $8.0 millionand $8.9 millionfor 2021 and 2020, respectively. The changes in income tax were primarily due to relative changes in pre-tax income and the impact of discrete tax items. - 30 -
MANAGEMENT'S DISCUSSION AND ANALYSIS
Fiscal 2020 vs. Fiscal 2019
Income from continuing operations for 2020 was
•Sales from continuing operations for 2020 decreased by 15%, mainly due to the impact of the COVID-19 pandemic.
•Gross profit for 2020 decreased
$69.3 millionor 20%, primarily from a decrease in sales volume, price reductions to our customers, and a loss in volume leverage, which resulted from our sales decrease, partially offset by 2019 charges associated with a customer bankruptcy. Cost of sales for fiscal years 2020 and 2019 included pre-tax charges of $1.1 millionand $21.4 million, respectively, in connection with the customer bankruptcy. •Operating expenses for 2020 decreased by $32.3 millioncompared to 2019, due to decreases of $29.7 millionin SG&A expenses and $4.5 millionin Other operating expenses, partially offset by a $1.9 millionincrease in RD&E expenses. Included in SG&A expenses for 2020 is a net gain of $28.2 millionrecognized in connection with a previously mentioned patent litigation judgment.
• Interest expense for 2020 decreased by
• We recorded a net gain on the equity investments of
•Other loss, net for 2020 was
$1.5 millioncompared to other income, net of $0.6 millionduring 2019, primarily due to fluctuations in foreign currency gains and losses in the respective periods. •We recorded provisions for income taxes of $8.9 millionand $14.0 millionfor 2020 and 2019, respectively. The decrease in provision for income taxes is primarily due to our decrease in pre-tax income and the beneficial impact of the final Treasury Regulations issued in 2020. - 31 -
MANAGEMENT'S DISCUSSION AND ANALYSIS
Our financial results
The following table presents selected financial information derived from our Consolidated Financial Statements, contained in Item 8 of this report, for the periods presented (dollars in thousands, except per share amounts): Change Change 2021 vs. 2020 2020 vs. 2019 2021 2020 2019 $ % $ % Medical Sales: Cardio & Vascular
$ 626,013 $ 569,948 $ 610,056 $ 56,06510 % $ (40,108)(7) % Cardiac & Neuromodulation 446,569 346,242 457,194 100,327 29 % (110,952) (24) % Advanced Surgical, Orthopedics & Portable Medical 110,044 121,788 132,429 (11,744) (10) % (10,641) (8) % Total Medical Sales 1,182,626 1,037,978 1,199,679 144,648 14 % (161,701) (13) % Non-Medical 38,453 35,464 58,415 2,989 8 % (22,951) (39) % Total sales 1,221,079 1,073,442 1,258,094 147,637 14 % (184,652) (15) % Cost of sales 884,109 787,735 903,084 96,374 12 % (115,349) (13) % Gross profit 336,970 285,707 355,010 51,263 18 % (69,303) (20) % Gross profit as a % of sales 27.6 % 26.6 % 28.2 % Operating expenses: Selling, general and administrative ("SG&A") 141,418 109,006 138,695 32,412 30 %
SG&A as a % of sales 11.6 % 10.2 % 11.0 % Research, development and engineering ("RD&E") 51,985 48,468 46,529 3,517 7 % 1,939 4 % RD&E as a % of sales 4.3 % 4.5 % 3.7 % Other operating expenses 7,856 7,621 12,151 235 3 % (4,530) (37) % Total operating expenses 201,259 165,095 197,375 36,164 22 % (32,280) (16) % Operating income 135,711 120,612 157,635 15,099 13 % (37,023) (23) % Operating income as a % of sales 11.1 % 11.2 % 12.5 % Interest expense 31,628 38,220 52,545 (6,592) (17) % (14,325) (27) % (Gain) loss on equity investments, net 3,143 (5,337) 475 8,480 (159) % (5,812) NM Other (income) loss, net (123) 1,522 (578) (1,645) (108) % 2,100 NM
Income from continuing operations
before taxes 101,063 86,207 105,193 14,856 17 % (18,986) (18) % Provision for income taxes 8,043 8,949 13,975 (906) (10) % (5,026) (36) % Effective tax rate 8.0 % 10.4 % 13.3 %
Income from continuing operations
$ 91,218 $ 15,76220 % $
Income from continuing operations as a % of sales 7.6 % 7.2 % 7.3 %
Diluted earnings per share of
$ 2.80 $ 2.33 $ 2.76 $ 0.4720 % $ (0.43)(16) %
NM – Calculated change not significant.
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MANAGEMENT'S DISCUSSION AND ANALYSIS The following discussion is a comparison between fiscal year 2021 and fiscal year 2020 results. For a discussion of our results of operations for fiscal year 2020 compared to fiscal year 2019, please refer to Item 7 of Part II, "Management's Discussion and Analysis of Financial Condition and Results of Operations" in our Annual Report on Form 10-K for the fiscal year ended
December 31, 20 20 , which was filed with the SECon February 18, 2021.
Fiscal 2021 vs. Fiscal 2020
Sales by product line for 2021 and 2020 were as follows (dollars in thousands): Change 2021 2020 $ % Medical Sales: Cardio & Vascular
$ 626,013 $ 569,948 $ 56,0659.8 % Cardiac & Neuromodulation 446,569 346,242 100,327 29.0 % Advanced Surgical, Orthopedics & Portable Medical 110,044 121,788 (11,744) (9.6) % Total Medical Sales 1,182,626 1,037,978 144,648 13.9 % Non-Medical 38,453 35,464 2,989 8.4 % Total sales $ 1,221,079 $ 1,073,442 $ 147,63713.8 %
Total 2021 sales increased 14% to
Cardio & Vascular sales for 2021 increased
$56.1 millionor 10% in comparison to 2020. Cardio & Vascular sales for 2021 reflect the continued recovery from the negative impact of the COVID-19 pandemic, with strong increases across all Cardio & Vascular markets, particularly in the neurovascular market, despite end market demand fluctuations and supply chain constraints. During 2021, price changes reduced Cardio & Vascular sales by $0.4 millionin comparison to 2020. Foreign currency exchange rate fluctuations increased Cardio & Vascular sales for 2021 by $1.5 million. Cardio & Vascular sales for 2021 include Oscorsales since the date of acquisition of $2.9 million. Cardiac & Neuromodulation sales for 2021 increased $100.3 millionor 29% in comparison to 2020. Cardiac & Neuromodulation sales for 2021 reflect the continued recovery from the negative impact of the COVID-19 pandemic and strong sales across all markets, despite end market demand fluctuations and supply chain constraints. Sales in the cardiac rhythm management market and neuromodulation market saw double-digit increases when comparing fiscal year 2021 to fiscal year 2020. During 2021, price changes reduced Cardiac & Neuromodulation sales by approximately $10.8 millionin comparison to 2020. Foreign currency exchange rate fluctuations did not have a material impact on Cardiac & Neuromodulation sales during 2021 in comparison to 2020. Cardiac & Neuromodulation sales for 2021 include Oscorsales since the date of acquisition of $1.8 million. In addition to Portable Medical sales, Advanced Surgical, Orthopedic & Portable Medical includes sales to the acquirer of our former AS&O Product Line, under supply agreements entered into as part of the divestiture in 2018. Advanced Surgical, Orthopedics & Portable Medical sales for 2021 decreased by $11.7 millionin comparison to 2020. The decreases in 2021 sales reflects a double-digit decline in Advanced Surgical and Orthopedics, the divested product line currently under supply agreement, and a low single-digit decline in Portable Medical driven by lower demand for COVID-related ventilators and patient monitoring components. Price changes reduced Advanced Surgical, Orthopedic & Portable Medical sales by $0.4 millionin comparison to 2020. Foreign currency exchange rate fluctuations did not have a material impact on Advanced Surgical, Orthopedic & Portable Medical sales during 2021 in comparison to 2020. Non-Medical sales for 2021 increased $3.0 millionor 8% in comparison to 2020. The sales increase reflects moving from a period of energy market contraction to recovery beginning in the second quarter of 2021. Price and foreign currency exchange rate fluctuations did not have a material impact on Non-Medical sales during 2021 in comparison to 2020. - 33 -
Table of Contents MANAGEMENT'S DISCUSSION AND ANALYSIS Gross Profit
Changes in gross margin as a percentage of sales (“gross margin”) from the prior year are due to the following:
% Change 2021 vs. 2020 Price(a) (0.7) % Mix(b) 0.8 Production efficiencies and volume(c) 0.7 Customer Bankruptcy(d) 0.2
Total percentage point change in gross margin as a percentage of sales
(a) Our gross margin for 2021 was negatively impacted by price reductions granted to our largest OEM customers in exchange for long-term volume commitments.
(b) The amount represents the impact on our gross margin attributable to changes in product sales mix during the period.
(c) Our gross margin for 2021 was positively impacted by increased sales volume and production efficiency, primarily due to our manufacturing excellence imperative.
November 2019, one of our customers, Nuvectra Corporation, filed a voluntary Chapter 11 bankruptcy petition (the "Customer Bankruptcy"). During fiscal year 2021, we recognized benefits from favorable settlements on supplier purchase order termination clauses and utilization of previously reserved inventory. During fiscal year 2020, we incurred costs and recorded charges associated with the Customer Bankruptcy, primarily consisting of charges related to inventory recorded in cost of sales.
General and administrative costs
Changes in general and administrative expenses are mainly due to the following items (in thousands):
$ Change 2021 vs. 2020
Compensation and benefits(a)
Patent litigation gain, net(b) 28,167 All other SG&A, net(c) (824)
Net increase in SG&A fees
(a) Compensation and benefits increased in 2021 compared to 2020, mainly due to higher stock-based compensation expense.
(b)We recognized a net gain of
$28.2 millionduring 2020 related to a patent litigation judgment. See "Patent Litigation" in the Financial Overview section for additional information.
(c) The net decrease in all other SG&A expenses for 2021 compared to 2020 is mainly due to lower travel expenses and amortization expense.
RD&E expenses for 2021 and 2020 were
$52.0 millionand $48.5 million, respectively. The increase in RD&E expenses for 2021 compared to 2020 is primarily attributable to increased compensation and benefits costs, consistent with our strategy to invest in capabilities for growth. RD&E expenses are influenced by the number and timing of in-process projects and labor hours and other costs associated with these projects. Our research and development initiatives continue to emphasize new product development, product improvements, and the development of new technological platform innovations. - 34 -
MANAGEMENT'S DISCUSSION AND ANALYSIS
Other operating expenses
OOE includes the following for 2021 and 2020 (in thousands):
$ 3,893 $ 2,791$
Reorganization and strategic alignment(b) 911,686
Industrial alignment to support growth(c) – 241 (241)
Acquisition and integration costs(d) 2,544 (776) 3,320 Other general expenses(e) 508 4,679 (4,171) Other operating expenses
$ 7,856 $ 7,621 $ 235__________
(a)These projects focus on modifying our organizational structure to align product line growth strategies with customer needs, transitioning our manufacturing process to competitive advantage, and standardizing and optimizing of our business processes. The associated costs for 2021 and 2020 consist mainly of severance pay.
(b)The Company's strategic reorganization and alignment initiatives primarily include those that align resources with market conditions and the Company's strategic direction in order to enhance the profitability of its portfolio of products. Costs related for 2021 primarily consist of termination benefits. Costs related for 2021 primarily consist of termination benefits and fees for professional services.
(c) In 2017, we launched several initiatives aimed at reducing costs, increasing manufacturing capacity to accommodate growth and improving operational efficiency. The plan included relocating some manufacturing operations and expanding some of our facilities. These actions were practically completed at the end of 2020.
(d)Amounts include expenses related to the acquisitions of
Oscorin 2021 and InoMec in 2020. The 2020 amount also includes a $2.0 millionadjustment to reduce the fair value of acquisition-related contingent consideration liabilities. See Note 17 "Financial Instruments and Fair Value Measurements" of the Notes to Consolidated Financial Statements contained in Item 8 of this report for additional information related to the fair value measurement of the contingent consideration. (e)Amounts include expenses related to other initiatives not described above, which relate primarily to integration and operational initiatives to reduce future costs and improve efficiencies. The 2020 amounts primarily include severance, information technology systems conversion expenses, expenses incurred in connection with the Customer Bankruptcy, and expenses related to the restructuring of certain legal entities of the Company.
Refer to note 11 “Other operating expenses” of the notes to the consolidated financial statements in section 8 of this report for additional information regarding these initiatives.
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Table of Contents MANAGEMENT'S DISCUSSION AND ANALYSIS Interest Expense Interest expense consists primarily of cash interest and debt related charges, such as amortization of deferred debt issuance costs and original issue discount. Interest expense decreased
$6.6 millionto $31.6 millionin 2021 from $38.2 millionin 2020, primarily due to lower interest rates and lower average outstanding debt balances. The weighted average interest rates on outstanding borrowings during 2021 and 2020 was 3.50% and 3.79%, respectively. Debt related charges included in interest expense were $7.0 millionfor 2021 compared to $4.8 millionfor 2020. The increase in debt related charges during 2021 compared to 2020 is primarily attributable to write-offs of deferred debt issuance costs and unamortized discount (losses from extinguishment of debt) related to prepayments of portions of our Term Loan B facility and a write off of $3.3 millionof deferred issuance costs and unamortized discount in connection with the refinancing of our credit facilities in September 2021. We recognized losses from extinguishment of debt during 2021 and 2020 of $3.8 millionand $0.5 million, respectively. As of December 31, 2021, approximately 18% of our principal amount of debt outstanding has been effectively converted to fixed-rate borrowings through the use of interest rate swaps, in comparison to approximately 27% as of December 31, 2020. We enter into interest rate swap agreements to reduce our exposure to fluctuations in the LIBOR rate. See Note 17 "Financial Instruments and Fair Value Measurements" of the Notes to the Consolidated Financial Statements contained in Item 8 of this report for additional information pertaining to our interest rate swap agreements. (Gain) Loss on Equity Investments, Net During2021, we recognized a net loss of $3.1 millionon our equity investments compared to net gains of $5.3 millionfor 2020. Gains and losses on equity investments are generally unpredictable in nature. During 2021 and 2020, we recognized impairment charges of $0.1 millionand $0.4 million, respectively, related to investments in our non-marketable equity securities. The residual amounts for 2021 and 2020 relate to our share of equity method investee gains/losses, including unrealized appreciation and depreciation of the underlying interests of the investee. As of December 31, 2021and December 31, 2020, the carrying value of our equity investments was $21.8 millionand $27.2 million, respectively. See Note 17 "Financial Instruments and Fair Value Measurements" of the Notes to Consolidated Financial Statements contained in Item 8 of this report for further details regarding these investments. Other (Income) Loss, Net Other (income) loss, net was income of $0.1 millionduring 2021 compared to a loss of $1.5 millionduring 2020. Other (income) loss, net primarily includes gains/losses from the impact of exchange rates on transactions denominated in foreign currencies. Our foreign currency transaction gains/losses are based primarily on fluctuations of the U.S.dollar relative to the Euro, Mexican peso, Uruguayan peso, Malaysian ringgits, Dominican peso, or Israeli shekel. The impact of foreign currency exchange rates on transactions denominated in foreign currencies included in Other (income) loss, net for 2021 and 2020 were net gains of $0.1 millionand net losses of $1.6 million, respectively. We continually monitor our foreign currency exposures and seek to take steps to mitigate these risks. However, fluctuations in foreign currency exchange rates could have a significant impact, positive or negative, on our financial results in the future. - 36 -
MANAGEMENT'S DISCUSSION AND ANALYSIS
Provision for income taxes
During 2021 and 2020, our provision for income taxes was
$8.0 millionon worldwide pre-tax income of $101.1 million(effective tax rate of 8.0%) and $8.9 millionon worldwide pre-tax income of $86.2 million(effective tax rate of 10.4%), respectively. The stand-alone U.S.component of the effective tax rate for 2021 reflected a $2.0 millionprovision on $48.3 millionof pre-tax book income (effective tax rate of 4.2%) versus a $3.1 millionprovision on $35.3 millionof pre-tax book income (effective tax rate of 8.9%) for 2020. The stand-alone International component of the effective tax rate for 2021 reflected a $6.0 millionprovision on $52.8 millionof pre-tax book income (effective tax rate of 11.4%) versus a $5.8 millionprovision on $50.9 millionof pre-tax book income (effective tax rate of 11.4%) for 2020.
The provision for income taxes for 2021 differs from the
U.S. International Combined $ % $ % $ % Income before provision for income taxes
$ 48,293 $ 52,770 $ 101,063Provision at statutory rate $ 10,14121.0 % $ 11,08221.0 % $ 21,22321.0 % Federal tax credits (including R&D) (11,929) (24.8) - - (11,929) (11.8) Foreign rate differential 1,366 2.8 (6,531) (12.4) (5,165) (5.1) Stock-based compensation (1,084) (2.2) - - (1,084) (1.1) Uncertain tax positions 18 - - - 18 - State taxes, net of federal benefit 1,183 2.4 - - 1,183 1.2 U.S.tax on foreign earnings, net of §250 deduction 1,913 4.0 - - 1,913 1.9 Valuation allowance - - 524 1.0 524 0.5 Other 398 0.8 962 1.8 1,360 1.4 Provision for income taxes $ 2,0064.0 % $ 6,03711.4 % $ 8,0438.0 %
The provision for income taxes for 2020 differs from the
U.S. International Combined $ % $ % $ % Income before provision for income taxes
$ 35,337 $ 50,870 $ 86,207Provision at statutory rate $ 7,42021.0 % $ 10,68321.0 % $ 18,10321.0 % Federal tax credits (including R&D) (7,009) (19.9) - - (7,009) (8.1) Foreign rate differential 339 1.0 (5,672) (11.2) (5,333) (6.2) Stock-based compensation (1,459) (4.1) - - (1,459) (1.7) Uncertain tax positions 1,208 3.4 - - 1,208 1.4 State taxes, net of federal benefit 553 1.6 - - 553 0.6 U.S.tax on foreign earnings, net of §250 deduction 3,216 9.1 - - 3,216 3.7 Valuation allowance (470) (1.3) 125 0.2 (345) (0.4) Other (674) (1.9) 689 1.4 15 0.1 Provision for income taxes $ 3,1248.9 % $ 5,82511.4 % $ 8,94910.4 % Our effective tax rate of 8.0% for 2021 is lower than our effective tax rate of 10.4% for 2020, primarily due to the beneficial impact of a year over year increase in R&D tax credits, an increase in Foreign tax credits and Foreign Derived Intangible Income ("FDII") resulting from an increase in foreign source income in 2021, and the release of Uncertain Tax Positions relating to the tax years 2017 and 2018 as the Internal Revenue Service ("IRS") effectively concluded its examination of those years during 2021. - 37 -
MANAGEMENT'S DISCUSSION AND ANALYSIS The Company's effective tax rate for 2021 differs from the
U.S.federal statutory tax rate of 21% due principally to the estimated impact of Federal Tax Credits (including R&D credits and Foreign tax credits), stock based compensation windfalls, and the impact of the Company's earnings realized in foreign jurisdictions with statutory rates that are different than the U.S.federal statutory rate. These benefits are partially offset by the impact of U.Staxes on foreign earnings, including the GILTI provision which requires the Company to include foreign subsidiary earnings in excess of a deemed return on a foreign subsidiary's tangible assets in its U.S.income tax return. The U.S.tax on foreign earnings is reflected net of a statutory deduction of 50% of the GILTI inclusion (subject to limitations based on U.S.taxable income, if any) and net of FDII that provides a 37.5% deduction to domestic companies for certain foreign sales and services income. The primary foreign jurisdictions in which we operate and the statutory tax rate for each respective jurisdiction include Switzerland(22%), Mexico(30%), Uruguay(25%), Ireland(12.5%) and Malaysia(24%). We currently have a tax holiday in Malaysiathrough April 2023provided certain conditions continue to be met. In addition, we acquired manufacturing operations in the Dominican Republicas part of the acquisition of Oscor, and are operating under a free trade zone agreement in the Dominican Republicthrough March 2034. There is a potential for volatility of our effective tax rate due to several factors, including changes in the mix of pre-tax income and the jurisdictions to which it relates, business acquisitions, settlements with taxing authorities, changes in tax rates, and foreign currency exchange rate fluctuations. In addition, we continue to explore tax planning opportunities that may have a material impact on our effective tax rate. The balance of unrecognized tax benefits is not expected to materially change over the course of the next twelve months as a result of the lapse of the statute of limitations and/or audit settlements. As of December 31, 2021, approximately $5.5 millionof unrecognized tax benefits would favorably impact the effective tax rate (net of federal impact on state issues), if recognized.
Cash and capital resources
December 31, December 31, (dollars in thousands) 2021 2020 Cash and cash equivalents
$ 17,885 $ 49,206Working capital $ 293,353 $ 256,746Current ratio 2.84 2.64 Cash and cash equivalents at December 31, 2021decreased by $31.3 millionfrom December 31, 2020. In 2021, we generated $156.7 millionof cash from operating activities and borrowed a net amount of $95.8 millionunder our Senior Secured Credit Facility, which was more than offset by $218.0 millionof net cash paid for the Oscoracquisition and net purchases of property, plant and equipment of $53.0 million. Working capital increased by $36.6 millionfrom December 31, 2020, primarily from positive working capital fluctuations associated with accounts receivable, contract assets, prepaid expenses and other current assets, and the current portion of long-term debt aggregating to $84.6 million, which were partially offset by fluctuations in cash and cash equivalents and accounts payable aggregating to $56.6 million. During 2021, accounts receivable increased mainly from higher sequential sales, and contract assets increased mainly due to a contract modification to add existing products and extend the contractual term, while the current portion of long-term debt decreased due to the refinancing of our term loan facilities during the third quarter of 2021. Cash and cash equivalents decreased primarily from net cash outflow in connection with the Oscoracquisition, while accounts payable increased mainly from the timing of supplier payments and higher sequential inventory purchases. At December 31, 2021, $13.1 millionof our cash and cash equivalents were held by foreign subsidiaries. We intend to limit our distributions from foreign subsidiaries to previously taxed income or current period earnings. If distributions are made utilizing current period earnings, we will record foreign withholding taxes in the period of the distribution.
Cash flow summary
The following summary cash flow information includes cash flow from discontinued operations (in thousands):
2021 2020 Cash provided by (used in): Operating activities
$ 156,666 $ 181,341Investing activities (270,998) (56,576) Financing activities 81,986 (88,578)
Effect of exchange rates on cash and cash equivalents
1,025 (516) Net change in cash and cash equivalents $
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MANAGEMENT'S DISCUSSION AND ANALYSIS Operating Activities - Cash provided by operating activities decreased
$24.7 millionin 2021 compared to 2020. Net income as adjusted for non-cash items such as depreciation and amortization increased $39.2 millionbut was more than offset by a decrease from fluctuations in operating assets and liabilities, which totaled $63.9 million. The increase in net income adjusted for non-cash items such as depreciation and amortization is primarily from higher sales volume, margin expansion and lower interest expense partially offset by higher SG&A from the aforementioned patent litigation judgement in the prior year. The decrease associated with changes in operating assets and liabilities is primarily related to the impact of declining sales volume in the prior year, which caused a significant prior year benefit to operating cash flow from the collection of accounts receivable in a period of declining sales and a lower investment in inventory. In addition, we deferred payment of the employer portion of Social Securitytaxes during 2020 under the provisions of the CARES Act, which further contributed to the prior year benefit. These unfavorable impacts were partially offset with accounts payable fluctuations based on timing of supplier payments. Investing Activities - The $214.4 millionincrease in net cash used in investing activities was primarily attributable to an increase in net cash paid for business acquisitions of $212.8 millionand increased purchases of property, plant, and equipment of $6.6 million, partially offset by a decrease from the purchase of an intangible asset of $4.6 millionin 2020. Financing Activities - Net cash provided by financing activities during 2021 was $82.0 millioncompared to net cash used of $88.6 millionin 2020. Financing activities during 2021 included net borrowings of $95.8 millioncompared to net payments of $87.5 millionin 2020. The net cash inflow for 2021 included $220.0 millionin borrowings to fund the Oscoracquisition. The payments made during 2020 include the utilization of proceeds received in conjunction with the patent litigation judgment during the fourth quarter of 2020. Capital Structure - As of December 31, 2021, our capital structure consists of $828.1 millionof debt, net of deferred debt issuance costs and unamortized discounts, outstanding under our Senior Secured Credit Facilities and 33 million shares of common stock outstanding. We have access to $375.0 millionof borrowing capacity under our Revolving Credit Facility, available for normal course of business and letters of credit. We are also authorized to issue up to 100 million shares of common stock and 100 million shares of preferred stock. As of December 31, 2021, our contractual debt service obligations for 2022, consisting of principal and interest on our outstanding debt, are estimated to be approximately $33 million. Actual principal and interest payments may be higher if, for instance, the applicable interest rates on our Senior Secured Credit Facilities increase, we borrow additional amounts on our Revolving Credit Facility, or we pay principal amounts in excess of the required minimums reflected in the contractual debt service obligations above. Credit Facilities - On September 2, 2021, we entered into a new credit agreement (the "2021 Credit Agreement") which permits borrowings and other extensions of credit in an initial aggregate principal amount of up to $1 billion(as may be increased from time to time in accordance with the terms). The 2021 Credit Agreement governs the Company's senior secured credit facilities (the "Senior Secured Credit Facilities"), which consist of a five-year $400 millionrevolving credit facility (the "Revolving Credit Facility"), which had available borrowing capacity of $375.0 millionas of December 31, 2021, a five-year "term A" loan (the "TLA Facility") with outstanding principal balance of $467 million, and a seven-year "term B" loan (the "TLB Facility") with outstanding principal balance of $349 million. The Revolving Credit and TLA Facilities mature on September 2, 2026. The TLB Facility matures on September 2, 2028.
Our off-balance sheet commitments related to our outstanding letters of credit
The 2021 Credit Agreement contains customary terms and conditions, including representations and warranties and affirmative and negative covenants, as well as financial covenants for the benefit of the lenders under the Revolving Credit Facility and the TLA Facility, which require that we maintain (i) a total net leverage ratio not to exceed 5.50:1.00 (stepping down to 5.00:1.00 for the third fiscal quarter of 2023 through maturity and subject to increase in certain circumstances following qualified acquisitions, but not to exceed 5.50:1.00) and (ii) an interest coverage ratio of at least 2.50:1.00. As of
December 31, 2021, we were in compliance with these financial covenants. The TLB Facility does not contain any financial maintenance covenants. As of December 31, 2021, our total net leverage ratio, calculated in accordance with our Senior Secured Credit Facilities agreement, was approximately 2.7 to 1.0. For the twelve month period ended December 31, 2021, our ratio of adjusted EBITDA to interest expense, calculated in accordance with our Senior Secured Credit Facilities agreement, was approximately 12.5 to 1.0. Failure to comply with these financial covenants would result in an event of default as defined under the Revolving Credit Facility and TLA Facility unless waived by the lenders. An event of default may result in the acceleration of our indebtedness. As a result, management believes that compliance with these covenants is material to us.
See Note 8 “Debt” in the Notes to the Consolidated Financial Statements in Section 8 of this report for a more detailed description of our outstanding debt.
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MANAGEMENT'S DISCUSSION AND ANALYSIS
Cash and other liabilities
We have significant cash requirements to pay third parties under various contractual obligations described below.
Below is a summary of the contractual obligations and other minimum commitments at
Payments due by period Less than 1 More than 5 Total year 1-3 years 3-5 years years
Principal outstanding debt(a)
Interest on debt(a)
99,758 17,532 34,173 30,780 17,273 Operating lease obligations(b) 80,691 12,423 22,126 20,490 25,652 Finance lease obligations(b) 9,894 876 1,784 1,427 5,807 (a)Interest payments in the table above reflect the contractual interest payments on our outstanding debt based upon the balance outstanding and applicable interest rates at
December 31, 2021, and exclude the impact of the debt issuance cost and discount amortization and the impact of interest rate swap agreements. Refer to Note 8 "Debt" of the Notes to Consolidated Financial Statements contained in Item 8 of this report for additional information regarding long-term debt.
(b) Refer to note 14 “Leases” in the notes to the consolidated financial statements in section 8 of this report for additional information on our operating lease and finance lease obligations.
Capital expenditures for 2021 totaled
$53.5 million, compared to $46.8 millionand $48.2 millionin 2020 and 2019, respectively. Capital expenditures in 2021 related primarily to upgrades of manufacturing facilities and information technology. We expect 2022 capital expenditures to approximate $65 millionto $75 million, with a significant portion related to additional upgrades of manufacturing facilities and information technology, as well as for manufacturing equipment to support productivity initiatives. In addition to debt obligations, lease obligations, and capital expenditures, we enter into a variety of contractual obligations in connection with the execution of our business. As of December 31, 2021, we had purchase obligations for raw materials and other parts of approximately $91 millionwhich we will incur during 2022. We have recorded liabilities for unrecognized tax benefits that, because of their nature, have a high degree of uncertainty regarding the timing of future cash payment and other events that extinguish these liabilities. Refer to Note 12 "Income Taxes" of the Notes to Consolidated Financial Statements in Item 8 of this report for additional information about these unrecognized tax benefits. Based on current expectations, we believe that our projected cash flows provided by operations, available cash and cash equivalents and availability under our Revolving Credit Facility are sufficient to meet our working capital, debt service and capital expenditure requirements for at least the next twelve months. However, such cash flows are dependent upon our future operating performance which, in turn, is subject to prevailing economic conditions, the effects of the COVID-19 pandemic, and to financial, business and other factors, including the conditions of our markets, some of which are beyond our control. If our future financing needs increase, we may need to arrange additional debt or equity financing. We continually evaluate and consider various financing alternatives to enhance or supplement our existing financial resources, including our Senior Secured Credit Facilities. However, we cannot be assured that we will be able to enter into any such arrangements on acceptable terms or at all.
Impact of recently issued accounting standards
In the normal course of business, we evaluate all new accounting pronouncements issued by the
Financial Accounting Standards Board("FASB"), SEC, or other authoritative accounting bodies to determine the potential impact they may have on our Consolidated Financial Statements. Refer to Note 1 "Summary of Significant Accounting Policies" of the Notes to Consolidated Financial Statements contained in Item 8 of this report for additional information about these recently issued accounting standards and their potential impact on our financial condition or results of operations. - 40 -
MANAGEMENT'S DISCUSSION AND ANALYSIS
CRITICAL ACCOUNTING ESTIMATES
Management's discussion and analysis of financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with GAAP. We make estimates and assumptions in the preparation of our consolidated financial statements that affect the reported amounts of assets and liabilities, revenue and expenses and related disclosures of contingent assets and liabilities. We base our estimates and judgments upon historical experience and other factors that are believed to be reasonable under the circumstances. Changes in estimates or assumptions could result in a material adjustment to the consolidated financial statements. We have identified several critical accounting estimates. An accounting estimate is considered critical if both: (a) the nature of the estimates or assumptions is material due to the levels of subjectivity and judgment involved, and (b) the impact of changes in the estimates and assumptions have had or are reasonably likely to have a material effect on the consolidated financial statements. This listing is not a comprehensive list of all of our accounting policies. For further information regarding the application of these and other accounting policies, see Note 1 "Summary of Significant Accounting Policies" of the Notes to Consolidated Financial Statements contained in Item 8 of this report.
Inventories are measured on a first-in, first-out basis at the lower of cost or net realizable value. Net realizable value is the estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. The valuation of inventory requires us to estimate obsolete or excess inventory, as well as inventory that is not of saleable quality. Historically, our inventory adjustment has been adequate to cover our losses. However, variations in methods or assumptions could have a material impact on our results. If our demand forecast for specific products is greater than actual demand and we fail to reduce manufacturing output accordingly, we could be required to record additional inventory write-down or expense a greater amount of overhead costs, which would negatively impact our net income.
Acquisition method of accounting
The Company accounts for business combinations using the acquisition method of accounting. We recognize the identifiable assets acquired, the liabilities assumed and any noncontrolling interest in the acquiree at their estimated fair values on the date of acquisition. Any excess purchase price over the fair value of net assets acquired is recorded to goodwill. Determining the fair value of these items requires management's judgment and more often than not the utilization of independent valuation specialists. The judgments made in the determination of the estimated fair values assigned to the assets acquired, the liabilities assumed and any noncontrolling interest in the investee, as well as the estimated useful life of each asset and the duration of each liability, can materially impact the financial statements in periods after acquisition, such as through depreciation and amortization expense. For more information on our acquisitions and application of the acquisition method, see Note 2 "Business Acquisitions"of the Notes to Consolidated Financial Statements contained in Item 8 of this report.
We make assumptions in establishing the carrying value, fair value and, if applicable, the estimated lives of our intangible and other long-lived assets.
Goodwilland intangible assets determined to have an indefinite useful life are not amortized. Instead, these assets are evaluated for impairment on an annual basis on the last day of our fiscal year and whenever events or business conditions change that could indicate that the asset is impaired. Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset (asset group) may not be recoverable.
Valuation of goodwill for impairment
We test each reporting unit's goodwill for impairment on the last day of our fiscal year and between annual tests if an event occurs or circumstances change that would more-likely-than-not reduce the fair value of a reporting unit below its carrying value. In conducting this annual impairment testing, we may first perform a qualitative assessment of whether it is more-likely-than-not that a reporting unit's fair value is less than its carrying value. If not, no further goodwill impairment testing is required. If it is more-likely-than-not that a reporting unit's fair value is less than its carrying value, or if we elect not to perform a qualitative assessment of a reporting unit, a quantitative analysis is performed, in which the fair value of the reporting unit is compared to its carrying value. If the carrying value of a reporting unit exceeds its fair value, an impairment loss is recognized equal to the excess, limited to the amount of goodwill allocated to that reporting unit. - 41 -
MANAGEMENT'S DISCUSSION AND ANALYSIS We performed a qualitative assessment of our Medical reporting unit as of
December 31, 2021. As part of this analysis, we evaluated factors including, but not limited to, our market capitalization and stock price performance, macro-economic conditions, market and industry conditions, cost factors, the competitive environment, and the operational stability and overall financial performance of the reporting unit. The assessment indicated that it was more likely than not that the fair value of the Medical reporting unit exceeded its carrying value. We elected to bypass the qualitative assessment and performed a quantitative analysis for our Non-Medical reporting unit. Resulting from the quantitative analysis, the fair value exceeded the carrying value of the Non-Medical reporting unit by approximately 184%. We do not believe that any of our reporting units are at risk for impairment. However, changes to the factors considered above could affect the estimated fair value of one or more of our reporting units and could result in a goodwill impairment charge in a future period. We may be unaware of one or more significant factors that, if we had been aware of, would cause our conclusion to change, which could result in a goodwill impairment charge in a future period.
Valuation of indefinite life intangible assets for impairment
Our indefinite-lived intangible assets include the
Greatbatch Medicaland Lake Region Medical tradenames. Similar to goodwill, we perform an annual impairment review of our indefinite-lived intangible assets on the last day of our fiscal year, unless events occur that trigger the need for an interim impairment review. We have the option to first assess qualitative factors in determining whether it is more-likely-than-not that an indefinite-lived intangible asset is impaired. If we elect not to use this option, or we determine that it is more-likely-than-not that the asset is impaired, we perform a quantitative assessment that requires us to estimate the fair value of each indefinite-lived intangible asset and compare that amount to its carrying value. Fair value is estimated using the relief-from-royalty method. Significant assumptions inherent in this methodology include estimates of royalty rates and discount rates. The discount rate applied is based on the risk inherent in the respective intangible assets and royalty rates are based on the rates at which comparable tradenames are being licensed in the marketplace. Impairment, if any, is based on the excess of the carrying value over the fair value of these assets. We performed a quantitative assessment to test our indefinite-lived intangible assets for impairment as of December 31, 2021. For the Greatbatch Medicaltradename, the excess of the estimated fair value over carrying value (expressed as a percentage of carrying value) was in excess of its carrying value of $20 millionby approximately 386% as of December 31, 2021. The Lake Region Medical tradename had an excess of the estimated fair value over carrying value of approximately 78% and a carrying value of $70 millionat December 31, 2021. We do not believe that our indefinite-lived intangible assets are at risk for impairment. However, a significant increase in the discount rate, decrease in the terminal growth rate, increase in tax rates, decrease in the royalty rate or substantial reductions in our end-markets and volume assumptions could have a negative impact on the estimated fair values of either of our tradenames and require us to recognize impairments of these indefinite-lived intangible assets in a future period.
Valuation of long-lived assets for impairment
When impairment indicators exist, we determine if the carrying value of the long-lived asset(s) or definite-lived intangible asset(s) including, but not limited to, PP&E and right-of-use lease assets, exceeds the related undiscounted future cash flows. In cases where the carrying value exceeds the undiscounted future cash flows, the carrying value is written down to fair value. Fair value is generally determined using a discounted cash flow analysis. When it is determined that the useful life of an asset (asset group) is shorter than the originally estimated life, and there are sufficient cash flows to support the carrying value of the asset (asset group), we accelerate the rate of depreciation/amortization in order to fully depreciate/amortize the asset over its shorter useful life. Estimation of the cash flows and useful lives of long-lived assets and definite-lived intangible assets requires significant management judgment. Events could occur that would materially affect our estimates and assumptions. Unforeseen changes, such as the loss of one or more significant customers, technology obsolescence, or significant manufacturing disruption, among other factors, could substantially alter the assumptions regarding the ability to realize the return of our investment in long-lived assets, definite-lived intangible assets or their estimated useful lives. - 42 -
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