Integer Holdings Corp

NYSE:ITGR

Earnings Call Transcript 2020-Q3

[Operator]

Ladies and gentlemen, thank you for standing by and welcome to the Integer Holdings Corporation Q3 2020 Earnings Conference Call. [Operator Instructions] Please be advised that today’s conference is being recorded. I would now like to turn the call over to Anthony Borowicz, Senior Vice President of Strategy, Corporate Development and Investor Relations. Please go ahead.

[Anthony Borowicz]

Good morning, everyone. Thank you for joining us and welcome to Integer’s third quarter 2020 earnings conference call. With me today are Joe Dziedzic, President and Chief Executive Officer and Jason Garland, Executive Vice President and Chief Financial Officer.

As a reminder, the results and data we discuss today reflect the consolidated results of Integer for the periods indicated. During our call, we will discuss some non-GAAP measures. For reconciliation of these non-GAAP measures, please see the appendix of today’s presentation and the notes of the financial statements in today’s earnings release, 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 filing 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 on the third quarter. Jason will then review our financial results and provide an update on the fourth quarter outlook. Joe will come back on to discuss the impacts of COVID on Integer sales and provide a review of our emerging customer portfolio. He will then provide his closing comments and we will take your questions.

At this point, I will turn the call over to Joe for his comments.

[Joe Dziedzic, President and Chief Executive Officer]

Thank you, Tony, and thanks to everyone for joining the call today. Throughout the pandemic, we have remained focused on executing our strategy. And one of the best examples of this is our manufacturing excellence strategic imperative, which has positioned us incredibly well to be able to navigate the uncertainty that COVID created. The agility of the manufacturing team has displayed by being able to adjust to the fluctuating demand throughout our manufacturing footprint has been impressive and our associates continue to deliver for our customers and the patients they serve. Our associates that come into our manufacturing plants every day during this pandemic to deliver the products patients need are inspiring and enabling us to realize our vision of enhancing patients’ lives. We have also been very focused on protecting the investments in our strategy, whether it’s by adding more R&D resources to continue developing new products for our customers or adding additional capabilities that allow us to penetrate faster growing segments. We continue to add strategic talent to the organization that bring with them the skills necessary for us to accelerate our top line growth.

From a third quarter perspective, what we communicated on our earnings call back at the end of July is fundamentally what we delivered. We said that our sales would be down slightly from the second quarter and they were $4 million right in line with what we expected internally. We also expected and communicated that the margin rate would improve in the third quarter versus the second quarter even though sales were down slightly and that is exactly what happened. We expanded margins by 150 basis points versus the second quarter.

We have remained incredibly focused on working capital and driving cash flow. Despite the suppressed sales due to the pandemic, we were still able to reduce net total debt by $23 million within the quarter. The team has done a great job of reducing inventory levels and managing overall working capital. We are providing a high level outlook for the fourth quarter because we believe we have sufficient visibility and stability in our near-term sales to do so. We expect the fourth quarter to be the start of our sales recovery from the pandemic. Our margin rate improved in the third quarter versus the second quarter and we expect the fourth quarter to continue this trend.

We fully expect that as the volume recovers, our profit margin rate will recover and that is evident in our fourth quarter outlook. We have already made a significant debt reduction during the fourth quarter as we recently paid down about 4% of our net debt with the cash we received from our successful patent lawsuit. Through the middle of October this year, we have reduced our net total debt by over $90 million despite the significant sales reduction from the pandemic. Our focus on cash flow and debt reduction continues to deliver results.

I will now turn it over to Jason to provide an update on the financials.

[Jason Garland]

Thanks, Joe. Good morning, everyone, and thank you again for joining us today. I’ll provide more details on our third quarter 2020 adjusted financials, provide an update on our cash flow and liquidity, and conclude with a high level view of our expectations for the fourth quarter and some preliminary thoughts on our 2021 sales. I’ll start with our third quarter results, which as expected were meaningfully impacted by the COVID-19 pandemic.

Sales decreased by 22% to $236 million. Adjusted operating income decreased 57% to $25 million, and adjusted EBITDA decreased 47%. We reported $17 million of adjusted net income, a decrease of 58%, and adjusted earnings per diluted share declines of $0.50. Though the profitability of the third quarter reflected the rapid decline in volume together with our decision to continue executing our strategy and maintaining the infrastructure to support the return of sales post COVID, it was improved over the second quarter.

Consistent with our prior communication, the second quarter saw our lowest level of profitability. Following the third quarter, our focus on manufacturing excellence improved our ability to adjust favorable costs to lower sales volume and better manage the challenges of operating with social distancing. We are confident that having maintained strategic and often long-term investments throughout the pandemic, our customers and the patients we ultimately serve will benefit.

Turning to the next slide, we see the graphical representation of the impact of 22% year-over-year reduction in sales had on our income. While improved over the second quarter, our balanced approach to cost management during a temporary but steep reduction in sales is seen in the operational drivers’ column and contributes a $29 million reduction in our adjusted net income in the third quarter versus last year. Our continued focus on debt and interest rate management as well as lower LIBOR reduced our interest expense by $2 million and contributed $0.07 per share of growth. The impact from our effective tax rate was significant in the third quarter and contributed $5 million of year-over-year income growth.

We benefited from discrete items recorded in the third quarter related to the favorable impact of final tax reform regulation, the benefit of our tax planning strategy of optimizing foreign tax credits and R&D tax credits on our 2019 return exceeding our original provision. This resulted in a negative 15% adjusted effective tax rate in the third quarter and 11% for the third quarter year-to-date. We expect our total year 2020 adjusted effective tax rate to be between 12% and 14%, which will likely increase in 2021 back to 2019 levels without the significant benefits and discrete items seen this year. And finally, foreign exchange was unfavorable $1 million in the third quarter, primarily related to the euro.

I will now transition to providing an update on our third quarter cash flow and continued financial strength as our liquidity continue to increase. In the third quarter, we continued the strong conversion of income to cash and generated $32 million in cash flow from operating activities and $24 million in free cash flow despite the impact of COVID on our sales. We reduced our net total debt, which is our total debt minus cash on hand, by $23 million. We continue to steadily reduce our net total debt consistent with our strategy. However, our debt leverage ratio increased to 3.5x adjusted EBITDA as our trailing 4-quarter adjusted EBITDA is lower given the impact of the COVID-19 pandemic on the second and third quarter. In addition to the strength of our operational cash generation, I am pleased to share that following a patent litigation judgment being affirmed by the United States courts of appeal in Integer’s favor, we received $28 million of cash early in the fourth quarter on October 15. The following day, we repaid our outstanding debt by an equal amount and our net total debt reduced to $719 million, down from $770 million at the end of the second quarter. Despite the pandemic, we have reduced our net total debt this year by over $90 million.

In the context of the cash generation and debt payments we just discussed, the next slide provides a holistic view of our financial strength we have maintained during the pandemic. As mentioned earlier, we increased our liquidity again in the third quarter. At quarter close, we had $100 million in cash on hand with $243 million in total liquidity, up $13 million from the second quarter. During the quarter, we paid down $120 million on our revolver as the liquidity markets have remained stable. This is consistent with our expectation to pay the revolver by year-end. With the patent judgment cash receipt, our liquidity increased an additional $28 million in the beginning of the fourth quarter. We continue to manage our working capital, and we expect to continue generating positive cash flows for the remainder of 2020. We believe we have ample EBITDA cushion on our leverage and interest coverage covenants, and we continue to meaningfully reduce our debt. Integer has not only proven its ability to withstand the challenges of the pandemic, but to also maintain critical investments to execute the company’s strategy and make Integer stronger.

I’d now like to give you additional detail and context on the fourth quarter outlook that Joe summarized in the opening slide. First, you may recall earlier this year, we suspended our financial guidance due to the significant uncertainty created by the COVID-19 pandemic. We remain in the midst of the pandemic, and we still see considerable uncertainty, and therefore, we are not resuming full financial guidance. However, in keeping with our commitment to provide as much clarity and transparency as possible, we want to provide more insight into our fourth quarter expectations.

Our backlog has improved, which gives us confidence in our expectation of fourth quarter sales being between $255 million and $270 million. We expect the fourth quarter to be the beginning of the sales recovery for Integer due to the industry inventory build in the first half of 2020 and its depletion in the second half. This anticipated sequential improvement of $20 million to $35 million in sales from the third to fourth quarter is in line with our prior communication. We expect adjusted operating income margin rates to recover as volume recovers, which is also consistent with our prior communications. In fact, we expect the fourth quarter adjusted operating income margins to be 200 to 300 basis points higher than the third quarter.

As it relates to the fourth quarter, sales still being down 17% to 22% versus prior year, I’d like to draw your attention to two items that fall outside of the recovery of the medical device industry. As compared to the prior year, the fourth quarter of 2020 has 5% fewer days and it is also impacted by the downturn in the energy market and in turn on our Electrochem sales. Excluding these differences, we are getting closer to converging with the medical device industry as our customers deplete the inventory they built in the first half of the year when our sales growth outpaced the industry. Joe will discuss this dynamic in greater detail when he provides a COVID-19 update in the next section.

We have heard a lot of conversation in the industry and for a lot of investors ask us how to think about 2021 from a growth rate perspective. It’s the best comparison for 2021 against the COVID impacted 2020? Or should we compare 2021 against 2019? So we have thought about this, and we have begun to build our 2021 budget for planning purposes. We started to look at what 2021 will look like, assuming it was the exact same volume – unit volumes at 2019. What’s the same and what’s different. There were four items that jumped out to us that would yield a different dollar amount of sales in 2021, even with the same unit volume in 2019.

The first two items were the same headwinds we discussed when we shared our 2020 pre-COVID outlook in February, and they still apply in the comparison to 2019. The first one is Nuvectra. We are very clear about the impact of Nuvectra’s bankruptcy in the fourth quarter of 2019 when we spoke about our 2020 outlook. We had $17 million of sales in 2019 that would not repeat in 2020, and nor will it repeat in 2021. So when compared to 2019, this becomes the first adjustment for our comparable 2021 baseline. The second item relates to fewer calendar days versus 2019 that we also discussed when we shared our pre-COVID 2020 outlook. This creates approximately $10 million of headwinds. The third item is the contraction of the energy market in 2020 due to excess supply in oil, coupled with the reduced demand from the pandemic. This impacts our non-medical business, Electrochem, which we expect to be approximately $23 million down in 2020 sales versus 2019. Though we cannot make the claim that we know exactly how the energy markets will look in 2021, it is our operating assumption that there will be no recovery in the energy market or in our Electrochem sales until 2022. So again, this creates an additional adjustment to our 2021 baseline as we compare to 2019.

And last we know that we give 1% to 2% of price reductions to our customers every year. These are built into our long-term supply agreements, which cover roughly two-thirds of our sales to customers. So we have to consider that in 2021 on the same exact production and shipment unit volume in 2019. The cumulative reduction in selling prices for 2 years will reduce our sales approximately $38 million in 2021. The sum of these four items yields $1.17 billion as comparable 2021 versus 2019. As we continue our budget process, we will apply our industry growth rate assumptions as a starting point against this $1.17 billion. In February, we expect to share our guidance using this framework.

With that, I will turn the call back to Joe. Thank you.

[Joe Dziedzic, President and Chief Executive Officer]

Thanks, Jason. Now, let’s talk about COVID and the impact that it had on Integer and the industry sales. We believe that whatever impact COVID has on our customer sales, it will ultimately flow through to Integer. But there will be a difference in timing because of where we are in the supply chain and in how the hospitals and our customers build and reduce inventory. We have talked about this dynamic on our last two earnings calls and this quarter will be no different. What is different is our improved understanding of the timing difference between Integer and the industry sales.

As we have studied the demand from our customers, it has become clearer to us that during the first quarter of this year there was more inventory built in the industry than we initially realized. This became very evident as we analyze the demand from our customers for the third and fourth quarters. This caused us to look back at the first quarter when the pandemic had a much smaller impact on the industry sales. We estimate that the industry declined about 6% and Integer grew about 4% creating a 10 percentage point difference in the first quarter. This wasn’t as evident to us as we entered the second quarter as we were managing through the immediate impacts of the pandemic.

As we studied the demand from our customers and began to better understand the impact that industry inventory levels we’re having on our third and fourth quarter sales, the impact from the first quarter became more evident. We believe the industry inventory build during the first half of 2020 is being depleted, potentially to lower levels than pre-COVID. This could be better inventory management or an overcorrection. It’s hard to know at this time. One of the improvements we made as a result of COVID is we have meaningfully increased our understanding of near-term demand from our customers. I will define near term is somewhere in the 90 to 120-day range.

Most of our orders flow like a short cycle business, even though our products have a quality and regulatory cycle that behaves more like a long cycle business. On our second quarter earnings call at the end of July, we had about 30 days of sales already shipped and 60 days in our third quarter estimate. We finished the third quarter very close to our internal sales estimate. Our current outlook for the fourth quarter is currently within 2% of our internal estimate from back in late July. This improved understanding of near-term demand and the stabilization of our customer orders has given us confidence in providing a fourth quarter outlook.

This is a slide that we have developed the past two quarters that shows our view of the impact of COVID on both the industry and Integer. The dark blue line in the graph represents the industry sales, and the orange line represents Integer’s sales. We have added a table at the bottom of this slide to more clearly quantify the difference in the year-over-year sales change of Integer compared to our estimate of the industry. The first row in the table reflects our estimate of the industry year-over-year sales growth or decline.

I want to highlight that the industry numbers represent our aggregation of public companies reported sales in the markets we serve. We try to correlate our customers’ reported sales that would match our sales. The bottom row in the Orange Color is Integer’s reported an estimated year-over-year sales growth or decline by quarter. The second and third rows labeled COVID timing difference and non-COVID are provided to reconcile the industry sales change to the Integer’s sales change. We have provided this view for each quarter and the full year to share our view of what caused the difference between our sales change year-over-year compared to the estimate of the industry.

The second row labeled COVID timing difference is our estimate of the impact on Integer’s sales caused by the industry building inventory during the first half of 2020 and depleting that inventory during the second half of the year. The third row, labeled non-COVID explains the impact that these 3 items are having on Integer’s year-over-year reported sales. Jason explained these 3 items in his 2021 to 2019 sales comparison, and they also apply to 2020 when comparing to 2019. These three items represent about 4 percentage points of sales decline for the full year 2020 versus 2019.

The industry and Integer lines on the graph match the numbers in the table below the graph. The industry row in the table at the bottom of the slide shows a 6% decline in the first quarter and a 34% decline in the second quarter. We are estimating an industry decline of 2% to 7% in the third quarter, an improvement in the fourth quarter of flat to up 5% on a year-over-year basis. The third quarter industry estimate is based on the earnings announcements thus far, and we estimate the full year to be down between 10% and 12%. We estimate that during the first quarter Integer’s sales were 10 percentage points higher on a year-over-year basis than the industry. This reconciles the first quarter industry decline of 6% to Integer’s growth of 4%. During the second quarter, we estimate that Integer’s sales were 15% higher than the industry due to the industry inventory build. Integer’s sales declined 5% year-over-year due to the non-COVID items and this reconciles the industry decline of 34% to the Integer decline of 24%.

The third quarter shows the industry declining between 7% and 2%. The impact of the COVID timing difference is now a negative to Integer as the industry is depleting inventory instead of ordering more product. This caused an estimated unfavorable impact of 12% to 17% on Integer’s sales. The non-COVID items had a 3% unfavorable impact. This reconciles the industry decline of 7% to 2% to the Integer decline of 22%. The fourth quarter follows a similar pattern.

I would like to focus on the full year 2020 column now. Our estimate of the industry decline in 2020 is 10% to 12%. We estimate that the impact of the industry inventory build and depletion for the full year will be 0 or slightly negative. We estimate a 4% decline in year-over-year sales from the non-COVID items, which represents the difference between Integer’s 2020 year-over-year sales decline and the industry’s decline. I appreciate this slide covers a lot of ground and introduces some new data points. Hopefully, the takeaway is clear. For the full year 2020, we expect the Integer’s sales decline to match the industry decline except for the 3 non-COVID items, two of which were communicated as part of our original 2020 guidance at the beginning of the year.

The next topic I want to cover is our comprehensive capability that enables our emerging customers to develop and bring to market a wide range of innovative therapies across a number of clinical indications. Part of the reason we think that this is an important topic to cover now is that last month, one of our neuromodulation customers, Nevro announced that they were in-sourcing a portion of their finished device assembly. We have had a very successful long standing relationship and supporting them through the entire cycle of development, clinicals and regulatory approval to high volume manufacturing.

Nevro has built one of the most successful neuromodulation start-ups in the last 15 years, and we believe our partnership has helped them to reach this level of growth. We will continue to work with Nevro to support and enable their success and will work to be their second source for future generation products and to continue to provide them with our vertically integrated component technologies. Our success in enabling a customer like Nevro to reach this level of maturity demonstrates the capability we have to support emerging companies along their journey from ideation through product design, development, regulatory approval and to launch stage and ultimately, to scale to high volume manufacturing and revenue.

We have proven our capability with Nevro, which has created more product development opportunities for us. As a result, today, we have a strong portfolio of customers that we are working with that are in pursuit of the same success Nevro has experienced. We think it is important to give visibility to and for investors to understand that there is a pipeline of companies that we have been working with for many years. Customers that are leveraging our unique and comprehensive capabilities to enable their therapies to be developed to meet unmet patient needs and enhance patients’ lives.

An important point of differentiation for Integer is a set of comprehensive, vertically integrated capabilities to help our customers to simplify their supply chain and accelerate time to market for their innovative therapies across a wide range of clinical indications. The left side of this slide lays out a high level view of the product development through product launch process. The time from product development, clinical trials, regulatory approval and to large and high volume manufacturing is long anywhere from 6 to 10 years or more. Not every concept delivers a therapy. So, it’s important to have a pipeline of opportunities, which we do. We have 15 different companies in our pipeline we are working with to develop a device to trial their therapy. We have three customers who are in the clinical trial stage, 3 customers that are seeking regulatory approval and five customers who are in the product introduction launch phase, where we are producing products for them to now introduce into the market.

I want to focus on the five emerging customers in the product introduction phase. These five customers generated $10 million of sales for Integer in 2018. And in 2020, we are on track to generate about $20 million. In 2022, we expect our sales to these five customers to double again to about $40 million in sales. We expect continued growth beyond 2022, and the trajectory of that growth will depend on the success of those therapies in the marketplace. The important message we want to convey to investors is that there is a pipeline of companies we have been working with for a long time and that there are six more companies coming behind the 5 companies that are launching now. We want investors to see the magnitude of the sales expected between 2018 and 2022. We are not providing outlook beyond 2022, but the growth rates can be quite significant as those companies get to market and gain traction.

We continue to lead Integer with a priority on taking care of our associates who take care of our customers and ultimately their patients. We remain focused on executing our strategy, so that we continue to build sustainable competitive advantages that will deliver on our strategic objectives. We have protected these strategic investments during the COVID and due sales downturn and do so with high confidence that we will be stronger when the volume recovers to pre-COVID levels. Our profit margin rate began to recover in the third quarter from the lower point of the second quarter, and we expect sales to begin the recovery during the fourth quarter. We have reduced our net total debt by more than $90 million year-to-date, including the October debt payment. We possess a unique set of capabilities in our business that enables emerging customers to develop innovative therapies across a wide range of indications to enhance patients’ lives, which allows us to fulfill our vision. We have 5 customers in the product launch phase on a trajectory to double revenues in 2020 and again in 2022. We are executing our strategy to create long-term value and the pandemic will not deter us.

Thank you for joining our call this morning. I will now turn the call back to our moderator for the Q&A portion of our call.

[Operator]

[Operator Instructions] Your first question comes from Matthew Mishan with KeyBanc. Your line is open.

[Matthew Mishan, KeyBanc]

Hey, good morning guys. A lot to take in here. I just first, once we reset in ‘21, are we still holding you accountable to a market plus 2% growth? Is that still the metric you’re looking to achieve, especially with a customer that’s insourcing in the out years now kind of creating an additional headwind?

[Joe Dziedzic, President and Chief Executive Officer]

Good morning, Matt. Thanks for the question. And the answer is yes, absolutely. Our strategic goal is still to accelerate revenue growth to be 200 basis points faster than whatever the end markets that we serve are growing. And yes, Nevro is planning to insource a portion of their finished device assembly. And we have a strong pipeline of customers that we believe is going to help us offset – more than offset that growth we thought it was important on this call to lay out some of the pipeline of customers and where they are in their evolution. Also, I’ll point out with the customer that’s going to insource. We also have vertical integration with components with that customer. They’re still planning to have a second source for doing finished device assembly. So we’ll still have vertically integrated components as well as, hopefully, some portion of the finished device assembly. So we remain confident that we can still achieve the 200 basis points above the end markets that we serve. We have not declared when that will happen. And we have a number of strategic imperatives underway and actions we’ve been taking to achieve that. But it does remain the goal, absolutely.

[Matthew Mishan, KeyBanc]

Okay. And then besides the emerging companies, so I think it’s good to see a pipeline there. What’s your understanding of your ability to win business with your largest customers moving forward? Is there still a level of increased outsourcing in the industry post this? And are they still consolidating to the largest, most strategic vendors? I mean just kind of can you give us confidence in the underlying fundamental positives of your business here?

[Joe Dziedzic, President and Chief Executive Officer]

We absolutely see continued growth. In fact, during the pandemic, we have not seen any slowdown in the amount of development work that we’re doing with both the emerging customers or our larger OEM customers. We’ve talked about how we’ve added more R&D engineers this year than what we had in the budget. So despite the pandemic, we’ve continued to add more engineers than what we had even planned for this year. The development work and the activity level is still very high. And in fact, we’ve actually had several customers come to us to accelerate programs during the pandemic. I presume it’s – they’ve had capacity to accelerate the work – the development work. And they also want to try to take advantage of this period where there is lower volumes. So we’re seeing very strong development work. The quote activity that we see across the whole spectrum of our customer base continues to be very strong. We are improving our sales force excellence, our sales force capability. We’ve talked about the changes we’ve made with our sales leadership. We have entirely new sales leadership in all of our business units. And over the past 18 to 24 months, a little more than a third of our sales team has changed, as we’ve gone out and recruited additional talent capability, industry knowledge, product knowledge, customer knowledge that we believe is going to be very helpful to us achieving our goal of accelerating revenue growth to be 200 basis points above the market. And I would also highlight, we shared earlier this year that a little more than two-thirds of our revenue is under some point of a long-term agreement. And with the 3 largest customers representing about half of our revenues, that means that they have to be participating in that. So we feel very good about the position that we’re in across the full continuum of OEMs in the marketplace, whether they’re the emerging players that we provide very unique capability to where we accelerate their time to market, we reduce the risk of their ability to bring therapies to the market as well as the large OEMs who might be looking for something different. They may be looking for the deep component technology that we have or the scale or the redundancy that we have or the ability to drive efficiencies and to partner with them to collaborate on innovation.

So we are very confident in where we are with all of the players in the industry. And the outsourcing, the direction of outsourcing continues. We see continued desire to outsource for a multitude of factors. One is the efficiency in the scale that we can bring relative to what some of our customers have. Another is the desire for redundancy and for business continuity planning that’s becoming ever more important. And we continue to see our customers want to invest more in the development of innovative therapies and less in their physical footprint and manufacturing capability. So we believe all indications remain very positive for our ability to achieve our objective, and we think we have an unique set of capabilities to capitalize on that.

[Matthew Mishan, KeyBanc]

Okay, that was very helpful. And thank you for that answer. Could you go a little bit more in detail on the minus 8% non-COVID impact in 4Q ‘20 and what – and walk us through how you get there?

[Joe Dziedzic, President and Chief Executive Officer]

Absolutely, the single biggest driver. So let’s just summarize. It’s 4% for the full year. Two of those three items we talked about when we gave our guidance this year. We explained that we had $17 million of new vector sales in ‘19 that obviously don’t repeat in ‘20 because of their bankruptcy. That impact was primarily first, second, a little bit in the third, not as much in the fourth. We talked about the fewer calendar days. We went to a calendar year for our fiscal year. Previously, we were on a rotation where every 6 or 7 years, we would have 53 weeks. We made that transition at the end of ‘19 in the full year of ‘20. So we highlighted that for the full year, we had about $10 million in lower sales in 2020 compared to ‘19, driven by fewer calendar days. And the way that works out by quarter is the first quarter actually had a little bit of a lift, and the fourth quarter has actually a bigger than $10 million negative impact. So the biggest driver of that 8% is the calendar days on a year-over-year basis. Those are the two items we talked about at the beginning of the year. And the third item that we weren’t aware of at that time was the energy market contraction. And so that’s fairly even throughout each of the quarters when you look at the non-medical business and the year-over-year sales for non-medical. So the biggest driver of the fourth quarter is the number of calendar days. And I would just point to, in summary on a full year basis we expect the impact of COVID on Integer to be the same as the industry. And we think the industry will have depleted the inventory that built in the first half. We think it will be depleted by year-end, maybe even a little more than depleted below pre-COVID levels because the inventory levels seem to be aggressively coming down, which is a good thing. It also could be because the industry seemed to have better sales in the third quarter than what they were projecting, which accelerated the inventory depletion. So that for the full year, we think that the difference between us and the industry are these three items that we’ve laid out.

[Matthew Mishan, KeyBanc]

Okay, understood. And then just two more, first, are your customers managing their inventory differently than they have been in the past, are they running at lower – are they planning to lower levels of inventory given the uncertainty that they are seeing over the next couple of quarters?

[Joe Dziedzic, President and Chief Executive Officer]

It’s hard to tell, Matt. I wish we had very – I wish we had clarity on that to give you a direct answer. What is clear is our customers reacted to the pandemic in different ways. Some shut down their manufacturing plants very quickly, very deeply. We all know in April, customers were talking about a 50% reduction in sales due to the shutdown in the U.S. Well, most of our customers did not shut their manufacturing down or reduced manufacturing by 50%. They chose to run at higher levels to maintain some level of efficiency. Well, that was building inventory. That was a very conscious decision we believe they made, which is a trade-off between operational manufacturing efficiencies and building inventory. And so our customers are – they’re in different positions from a financial strength, cash flow liquidity perspective, and they made different decisions on that trade-off of cash flow and operational efficiencies. But what was very clear to us, there was inventory built in the first and second quarter. You see it in their external reported inventory balances. And then it’s also clear to us in the third and fourth quarter, they’re depleting that. In some instances, what we are seeing is a rapid depletion of that inventory, which will either be a new level of inventory or it will be an overcorrection and it may – inventory levels may come back up. This is not across the entire industry. It’s pockets. But it’s why we show on our slide explaining the potential impact on industry and Integer. It’s why we show 0% to negative 1% for the impact of COVID because inventory levels might be going a little bit below. I wish I had a direct answer for you. I don’t know that they’ve articulated their strategies in that way. I know everybody wants to reduce inventory control inventory. But I also know that none of our customers want to miss an opportunity to ship a product or to support a patient in need. And so that’s why they have inventory turns of 2x to 3x. So like times will tell. But in the end, it’s rounding noise when you look at it on an annual basis and on a multiyear basis.

[Matthew Mishan, KeyBanc]

Okay. And last question, I think you are starting to see some long-term fundamental changes in how people view the oil and gas industry. Do you still consider the energy business and the non-medical business is core to Integer?

[Joe Dziedzic, President and Chief Executive Officer]

I like the business because even when it’s down, it has a strong margin rate in returns. And when it’s up, it has great returns and great margin rates and cash flow. One of the things that we need to do a better job of is we need to better diversify the markets and the regions that we participate in, which would help to mute some of the volatility that we see when there are meaningful changes in that very cyclical industry. That’s part of what we’re doing internally is we’re looking for ways to diversify. Two-thirds of that business serves the energy market and then the other third serves a multitude of other applications, government and environmental applications and we think there is opportunities to grow there. So I love the profitability and the technology and the position we have in that market. We need to work to diversify it to mute some of the cyclicality of it.

[Matthew Mishan, KeyBanc]

Alright. Thank you for taking all the questions.

[Joe Dziedzic, President and Chief Executive Officer]

Thank you, Matt.

[Operator]

[Operator Instructions] Your next question comes from Jim Sidoti with Sidoti & Company. Your line is open.

[Jim Sidoti, Sidoti & Company]

Good morning. Can you hear me?

[Joe Dziedzic, President and Chief Executive Officer]

Yes, Jim. Good morning.

[Jim Sidoti, Sidoti & Company]

Great. Well, first off, you seem to be right on the forecast you put out 3 months ago and even with the pandemic, you’ve been able to hit the numbers that you put out, which is a big change from 2 or 3 years ago. What’s responsible for that?

[Joe Dziedzic, President and Chief Executive Officer]

Jim, I’d start with – I believe we’ve done a really good job of getting our arms around what our customers’ needs are and then meeting those needs, and better understanding those needs on both a short and a long-term basis. And I think we’re partnering with our customers really well to understand those needs and be able to meet them. I would say very specifically in the last 3 to 6 months – or the last 3 months with the pandemic, what we’ve seen is a stabilization of our customers’ short-term needs. We’ve done, I think a really good job of getting our arms around the next 90 to 120 days, and what our customers need in understanding that. There is fluctuation in that window. But outside of a pandemic like event, we think that visibility is pretty good, and we think our customers’ manufacturing plants, which ultimately drive the demand on us is pretty good. And we’ve been able to dial that in the last 3 or 4 months. I also think that the amount of inventory our customers have had has given them a buffer to not need to make meaningful changes in the third quarter or even maybe the fourth quarter of this year when they get back to maybe more normal levels of inventory in a steady state, we may go back to seeing a little more of the previous normal variation that we had. But I think it gets down to how we’re running our business. The manufacturing excellence strategic imperative has helped us to develop that predictability. And I think the closeness with our customers has also improved dramatically and is also helping us.

[Jim Sidoti, Sidoti & Company]

Right. And then a couple of questions on Nevro, does that announcement affect anything you’re doing for them right now or is that future generation products that they have decided to build in house?

[Joe Dziedzic, President and Chief Executive Officer]

Great question. Great point. It’s future generation product. The current generation is still under contract with us. And they also were clear that they plan to have a second source for the future generations. We are working to ensure that we are vertically integrated with our high technology components on that – those future generation devices and we are also working to ensure that we’re the second source doing the finished device assembly.

[Jim Sidoti, Sidoti & Company]

So even if they start to build some of those products themselves, you still expect Nevro to be a customer in 2022, 2023?

[Joe Dziedzic, President and Chief Executive Officer]

Jim, we’ll be their primary provider probably ‘22 and beyond for a number of years. They communicated their plant should be qualified in 2022, which means they will start to ramp some time in 2022 and 2023 and recognize they don’t – they don’t do any manufacturing or assembly today. And so there will be a ramp period. So 2023 and 2024 is when we think we will see the impact of that. But at the same time, it’s future generation product and the future generation product isn’t in the market yet. So we believe we still got a nice runway here. We’re also partnering with [indiscernible] on the vertical integration of components and being the second source. So, we think it’s 2023 and beyond, Jim. We also thought it was important to highlight the pipeline of customers that we have that are now entering the product launch phase and the revenues that we think they will generate in 2022. And then the success of those therapies will dictate how much they grow beyond that.

[Jim Sidoti, Sidoti & Company]

Alright. And then the last one for me, you are obviously not the only company affected by the pandemic, and you’ve – there is a lot of smaller private suppliers that probably been on the balance sheet you have and the flexibility you have. Are you able to pick up some of that business or maybe even pick up, do some acquisitions as a result of COVID?

[Joe Dziedzic, President and Chief Executive Officer]

Great question, Jim. I can’t say that we’ve seen any acquisitions given that our focus has been very clearly on differentiated technology that fits into our portfolio and helps us accelerate growth and penetration into the faster growing end markets. So because we’re so maybe laser focused on the technologies that we want, I think those other companies that might have been negatively impacted by the pandemic are less within our scope. And so I think that hasn’t been a focus area for us. In terms of the pandemic, our financial strength I believe has absolutely helped us. The customers look at the landscape, and they see the differentiation of a player like us that’s got the breadth and the scale, the capability across multiple end markets and the breadth of technologies we have. We all know every one of our big customers has said they want to reduce the number of suppliers. They want strategic partners. They want people that can do development work for them that they can rely on as their primary outsourced partner that gives them – it makes it easier for them to manage their supply chain. We think that’s a strength of ours is managing the supply chain, and our vertical integration we think differentiates us. So we think this just reinforces what we believe is our strength, and it just accelerates what’s been a long-term trend to consolidate the supply base into your stronger, more capable partners and we think that represents us.

[Jim Sidoti, Sidoti & Company]

Alright. Thank you.

[Joe Dziedzic, President and Chief Executive Officer]

Thank you, Jim. Nice judge.

[Operator]

There are no further questions come up at this time. I’ll turn the call back over to Anthony Borowicz.

[Anthony Borowicz]

Great. Thank you, everyone for joining us on today’s call and your continued interest in Integer. As always, this conference call will be available for replay on our website. Again, thank you, and that concludes our call.

[Operator]

This concludes today’s conference call. You may now disconnect.