Integer Holdings Corp

NYSE:ITGR

Earnings Call Analysis

Revenue Growth and Strategic Focus

Integer Holdings Corporation has recently navigated a significant transformation by divesting its Electrochem business, leading it to focus solely on the medical technology sector. As of the third quarter of 2024, Integer reported sales of $1.267 billion, marking a 10% year-over-year increase and 6% on an organic basis, excluding acquisitions and other adjustments. The commitment to enhancing operational efficiency is evident, with adjusted operating income rising 23%, which is 2.3 times the rate of sales growth. This strategic pivot, alongside effective operational execution, positions Integer to target organic sales growth of 200 basis points above market trends.

Margin Expansion Initiatives

Integer's operations have shown continued improvements in manufacturing efficiency and cost management, resulting in an adjusted operating margin of 16.5% year-to-date, an increase of approximately 177 basis points compared to the previous year. The company anticipates adjusted operating income for 2024 to rise between 18% and 22%, raising the midpoint of their full-year profit guidance by $4 million. This increase stems from the consistent application of Manufacturing Excellence initiatives, which focus on direct labor efficiency and reduced operational costs.

Quarterly Performance Highlights

In the third quarter of 2024, Integer's sales reached $431 million, reflecting a 9% increase compared to the same quarter the prior year. The adjusted net income was $50 million, yielding $1.43 per share, a notable 11% rise from the previous year. The company's expectations moving into the fourth quarter are optimistic, with projected organic sales growth between 11% at midpoint. Despite challenges, such as the impact of Hurricane Helene on operations, the strong pipeline of new products is expected to drive further revenue increases.

Forward Guidance and Expectations

Integer has narrowed its sales outlook for 2024 to between $1.707 billion and $1.727 billion, projected to reflect a 10% to 11% growth compared to last year. The company expects earnings per share in the range of $5.24 to $5.43, implying a 14% to 18% year-over-year growth. Additionally, the estimated cash flow from operations is anticipated to be between $195 million to $205 million, which signifies an 11% increase year-over-year. This emphasis on cash generation alongside sales growth reflects Integer’s commitment to bolstering shareholder value.

Operational Strength and Future Strategy

Integer's strategy remains focused on maintaining a competitive edge within the medical technology market. With an organic growth target that exceeds relevant market trends and enhanced profitability metrics, the company is strategically positioned for long-term growth. The restructuring and strong execution of its operational strategies suggest enhanced scalability and profitability. Looking ahead, the company is optimistic about sustaining momentum, with goals firmly set on achieving a leverage ratio well within its target range and continued shareholder value enhancement.

Earnings Call Transcript 2024-Q3

[Operator]

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

[Andrew Senn, executive]

Good morning everyone, thank you for joining us, and welcome to Integer's third quarter 2024 earnings conference call. With me today are Joseph Dziedzic, President and Chief Executive Officer and Diron Smith, Executive Vice President and Chief Financial Officer.

A reminder, the results and the data we discuss today reflect the consolidated results of Integer for the periods indicated. Except for cash flow measures, prior period amounts have been recast to exclude the Electrochem business, consistent with US GAAP continuing operations presentation. Unless otherwise stated, all results and comparisons are presented on a continuing operations basis.

In the appendix of today's presentation, we have provided supplemental information which will help you update your financial models to reflect the impact of discontinued operations. During our call, we will discuss some non GAAP financial measures, a reconciliation of non GAAP financial measures, please refer to the appendix of today's presentation, today's earnings press release and the trending schedules, which are available on our website at integer.net.

Please note that today's presentation includes forward-looking statements. Please refer to the company's SEC filings for a discussion of the risk factors that could cause our actual results to differ materially.

On today's call, Joe will provide his opening comments, and Diron will then review our adjusted financial results for the third quarter, 2024 and provide an update on full year 2024 outlook. Joe will come back to provide his closing remarks, and then we'll open up the call for your questions.

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

[Joseph Dziedzic, executive]

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

Andrew has been with Integer for the last 18 years in a variety of leadership roles, primarily within our Cardio & Vascular business. You know him currently as our Investor Relations, Business Development & Strategy leader for Integer. Both Payman and Andrew have been integral leaders in the development execution and success of our strategy. Payman and Andrew will transition into their new roles in the first quarter of 2025.

In the third quarter we delivered another quarter of strong year-over-year results. Sales grew 9% and our adjusted operating income grew 17%. On a year-to-date basis, sales have grown 10% and operating income is up 23% or 2.3x the rate of sales growth.

We are narrowing our sales outlook to deliver 10% to 11% growth in 2024. We're confident in our ability to deliver strong sales growth given our high visibility to customer demand, including ramping programs in high growth markets, and additional guidewire capacity in Ireland.

In addition to this above market sales growth, we are driving margin expansion across the business. We are raising the midpoint of our full-year profit and earnings per share outlook. Our Manufacturing Excellence Initiatives are delivering operational improvements in direct labor turnover, direct material scrap reduction, lower overtime and direct labor efficiency. Combined with our strong OpEx leverage, we are confident in our ability to meet our increased full-year profit outlook. At the midpoint of our outlook, we expect 20% adjusted operating income growth, an increase of $4 million over our prior guidance and nearly 2x the rate of sales growth at midpoint.

We are also raising the midpoint of our adjusted earnings per share outlook to 16% year-over-year growth, an increase of $0.07 per share at midpoint over our prior guidance.

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

I'll now turn the call over to Diron.

[Diron Smith, executive]

Thank you, Joe. Good morning, everyone, and thank you again for joining today's call. As a reminder, unless otherwise noted, all results presented are on a continuing operations basis and exclude the Electrochem business, which has been classified as a discontinued operation.

Knowing this is the first time you are seeing our results without the Electrochem business, I will first share our third quarter year-to-date results from continuing operations, followed by the discrete third quarter 2024 financial results. As usual, I will end with an update to our 2024 outlook.

Through 3 quarters of 2024, we have delivered strong financial performance. Sales of $1.267 billion delivered 10% year-over-year growth on a reported basis and 6% on an organic basis, which excludes the impact of our recent InNeuroCo and Pulse acquisitions, the strategic exit of the Portable Medical market and foreign currency fluctuations.

We delivered $266 million of adjusted EBITDA, up $48 million compared to the prior year or an increase of 22%. Adjusted operating income grew 23% versus last year, 2.3x the rate of sales growth as we continue to make progress on our year-over-year margin expansion. Third quarter year-to-date adjusted operating income as a percent of sales was 16.5%, which represents approximately 177 basis points of improvement versus a year ago, reflecting the continued improvement in manufacturing efficiency and operating expense leverage.

Adjusted net income for the third quarter 2024 year-to-date is $133 million, delivering $3.87 of adjusted earnings per share, up $0.67 or 21% from a year ago.

In the third quarter of 2024, we again delivered strong financial results. Sales of $431 million delivered 9% year-over-year growth on a reported basis and 4% on an organic basis. We delivered $96 million of adjusted EBITDA, up $15 million compared to the prior year or an increase of 18%, while adjusted operating income grew 17% versus last year or 2x the rate of sales growth.

As we continue to make progress on our year-over-year margin expansion, third quarter 2024 adjusted operating income as a percent of sales improved by 126 basis points to 17.5%. Adjusted net income for the third quarter of 2024 is $50 million, delivering $1.43 of adjusted earnings per share, up $0.14 or 11% from the third quarter 2023.

Both C&V and CRM&N product lines continue to deliver above-market sales growth on a trailing 4-quarter basis. The Cardio & Vascular product line trailing 4-quarter sales increased 15% year-over-year. C&V growth is driven by above-market growth across all markets, new product ramps in electrophysiology and structural heart and the InNeuroCo and Pulse acquisitions.

Cardiac Rhythm Management & Neuromodulations trailing 4-quarter sales increased 7% year-over-year, driven by double-digit Neuromodulation growth from emerging PMA customers and normalized low single-digit growth in Cardiac Rhythm Management.

Further product line details are included in the appendix of the presentation, which can be found on our website at integer.net.

On a third quarter 2024 year-to-date basis, we delivered $25 million more adjusted net income than we did in the first 3 quarters of 2023. Strong sales, acquisition performance and operational improvements, which include improving manufacturing efficiencies and operating cost leverage delivered $32 million of the increase. This was partially offset by higher interest expense of approximately $7 million. The year-to-date increase in interest expense is primarily due to a higher average debt balance during the period, driven by the previously discussed acquisitions of InNeuroCo and Pulse Technologies.

Our year-to-date adjusted effective tax rate was 18.7% for 2024, consistent with the same period a year ago. Increases in the effective tax rate are primarily due to the Pillar 2, 15% global minimum tax and the impact of the Malaysian tax holiday expiration, fully offset by discrete items such as higher research tax credits and other tax planning initiatives.

Historical GAAP and non-GAAP cash flow measures have not been adjusted to remove Electrochem, consistent with the applicable GAAP presentation on the statement of cash flows. Leverage, also a non-GAAP measure, has similarly not been adjusted.

In the third quarter 2024, we generated $72 million of cash flow from operations, up $9 million from a year ago and up $24 million from the prior quarter. This strong performance was driven by improved operational execution, primarily from higher sales, improved margins and continued management of working capital.

In the third quarter, we generated $46 million of free cash flow, inclusive of $26 million of capital expenditures. On a year-to-date basis, we have generated $142 million in cash flow from operations, a 14% increase versus a year ago. Strong cash flow from operations has supported $86 million of year-to-date investments in capital expenditures, resulting in year-to-date free cash flow of $56 million, an increase of 33% compared to the same period last year.

Net total debt is $1.055 billion at the end of the third quarter 2024, which is a $41 million reduction compared to the second quarter ending balance. As a result, our net total debt leverage at the end of the third quarter was 3.0x trailing 4-quarter adjusted EBITDA, which is at the midpoint of our strategic target range of 2.5 to 3.5x.

As Joe mentioned earlier, we are narrowing our 2024 sales outlook and raising the midpoint of our 2024 profit and earnings per share outlook. With strong year-to-date margin performance from execution on our Manufacturing Excellence Initiatives, we have increased confidence and are raising the adjusted operating income outlook by $4 million at the midpoint.

We expect to deliver sales in the range of $1.707 billion to $1.727 billion, an increase of 10% to 11% versus last year. On an organic basis, we expect sales growth of 7% to 8%, which is approximately 200 basis points above our underlying market growth rate estimate of 4% to 6%.

In addition to our organic growth, we expect the InNeuroCo and Pulse acquisitions, partially offset by the Portable Medical market exit to contribute approximately 3% inorganic growth.

We are raising our adjusted operating income outlook by $4 million at midpoint and expect 2024 adjusted operating income to be between $280 million and $288 million, reflecting year-over-year growth of 18% to 22%. At $284 million, which is the midpoint, adjusted operating income as a percent of sales is expected to grow 133 basis points compared to the full year 2023. Adjusted EBITDA is expected to be between $358 million and $368 million, an increase of 18% to 21% compared to the prior year, similar to the adjusted operating income growth rate. Adjusted net income is expected to be between $181 million and $188 million, reflecting a year-over-year growth of 16% to 21%, up from our previous outlook of 12% to 21%. This delivered an expected adjusted EPS outlook between $5.24 and $5.43, which is growth of 14% to 18% year-over-year.

Our updated adjusted EPS outlook reflects an increase versus our prior outlook of $0.07 per share at midpoint. Our outlook assumes adjusted weighted average shares outstanding of 34.6 million shares, taking into account an estimated dilutive effect of the convertible notes based upon recent stock price performance. This dilution is offset by an improvement in our adjusted operating income and improvements in our expected 2024 effective tax rate, which is projected to be between 18% and 19%, down from our previous outlook of 18% to 20%.

With above-market sales growth and operational improvements from our Manufacturing Excellence Initiatives, we have confidence in tightening our sales outlook and raising the midpoint of our adjusted operating income as a percent of sales. Since our guidance issued in July, which has been revised to exclude the impact from Electrochem, we have increased our adjusted operating income as a percent of sales by 20 basis points to 16.5%, now up 133 basis points versus 2023.

As we begin the fourth quarter of 2024, we expect sales to increase versus the third quarter, driven by new product ramps, increased guidewire capacity and growth from emerging customers with premarket approval products. Full year organic sales of 7% to 8% would imply a fourth quarter organic growth of 11% at the midpoint of our outlook.

Moving to our 2024 cash outlook. We expect cash flow from operations between $195 million to $205 million, which represents an 11% year-over-year increase at midpoint of outlook, up from our previous outlook of 8% at the midpoint. Our outlook for capital expenditures is $100 million to $110 million as we continue to invest in organic capabilities and capacity. As a result, we expect to generate free cash flow between $90 million and $100 million. We expect our 2024 year-end net total debt to be between $970 million and $980 million. Versus our previous outlook, this represents a $45 million reduction at midpoint, which is driven by the expected proceeds from the sale of Electrochem before the end of October.

We expect to end the year with a leverage ratio between 2.6 and 2.7x trailing 4-quarter adjusted EBITDA, well within our target range of 2.5 and 3.5x.

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

[Joseph Dziedzic, executive]

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

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

[Operator]

[Operator Instructions] Your first question comes from the line of Brett Fishbin with KeyBanc.

[Brett Fishbin, analyst]

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

[Joseph Dziedzic, executive]

So I'll start with to your highlight, 6% organic year-to-date, and our guidance is 7% to 8% organic for the full year, which is up slightly from our original guidance at the beginning of the year, where we said 6% to 8%, so the bottom end on the organic has come up a little bit. And we had highlighted what we expected to happen throughout the year and the biggest driver of the third quarter at 4%. The biggest driver is, as we expected, based on our order book and the ordering patterns that we saw at the beginning of the year, CRM was down versus the trend line that we had in the first half of the year. And we expected that because we could see that in the demand based upon the order book that we have. We would have been a little higher. We were 4% for organic for the quarter. It would have been more like 5%, but we had a little bit of an impact from the Hurricane Helene and that happened at the end of the quarter for us. We had to shut down our facility in Florida and the Dominican Republic to protect our associates. That had a little bit of an impact. It wasn't a material or meaningful impact. But we would have been 5% organic growth. The C&V segment would have been about 7%, a little higher than the reported 6% organic growth. So when we look at the quarter, it's really what we expected in terms of all the moving parts.

We had said on our February -- fourth quarter earnings call back in February, beginning of this year that our order patterns showed that CRM would normalize in the second half of the year from an ordering and shipments perspective. And that's what happened. So our Neuromodulation business continued to perform very strongly. We saw continued growth there in the emerging PMA customers. In fact, the $100 million to $120 million that we had guided the year to for those emerging PMA customers are actually tracking to the high end of that range. And we have strong shipments in the fourth quarter for those emerging PMA customers. So we feel great about the fourth quarter outlook and the guidance.

[Brett Fishbin, analyst]

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

[Joseph Dziedzic, executive]

Yes. So it's really about continuing to execute our strategy and to outperform on a sustainable basis as we get bigger and continue to grow the size of the business. So it's really about executing the strategy and continuing to meet or exceed our financial objectives of sales growth above the market organically and operating profit 2x.

Payman and Andrew have been integral parts of the strategy for not only the C&V business, but the whole company because different leaders have ownership over enterprise-wide elements of our strategy, and Andrew and Payman have been here since the beginning of the strategy in 2018. Payman joined the company in early '18. Andrew has been with the company much longer, but he's been in the C&V business. During Payman's tenure leading the Cardio & Vascular business, we've almost doubled the sales for Cardio & Vascular. We're up over 90% since Payman stepped into that leadership role. Andrew has been in the Cardiovascular business for his entire career with Integer. He's done everything from lead R&D to sales to marketing. You know him more recently as the enterprise-wide leader for the Strategy Process for M&A and Investor Relations. They both know our customers and the industry incredibly well. So this is really about accelerating the execution of our strategy and giving 2 highly successful leaders broader responsibilities to help us continue to deliver for our customers and then ultimately for shareholders.

[Operator]

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

[Craig Bijou, analyst]

So I wanted to start, can you guys just go over the growth trends of your EP business over the last couple of quarters. And then when we think about PFA, I guess I want to ask directly if your expected benefit from PFA products, if that's changed at all as of the end of Q3. And I ask because I think investors are looking to see and maybe see some acceleration in that C&V business given the launch of the products today and then the expected launch coming in '25. So maybe if you could just kind of talk about the EP business, PFA and then kind of frame how investors should be thinking about potential contribution from that emerging market?

[Joseph Dziedzic, executive]

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

For us, I'll highlight electrophysiology is an important part of our business, but it's one of many. It's one of our 4 targeted growth markets. And then even then within electrophysiology, I think we've talked a lot about how we play across the full procedure. Everything from access with introducers, guidewires, the transseptal crossing as well as the diagnostic catheters that help perform the mapping and then to the ablation therapy itself where pulse field ablation specifically comes into play. So electrophysiology is an exciting high-growth market. We are highly vertically integrated. We have a very strong position and footprint across the full procedure. And we expect it to continue growing, and we expect to be a strong participant. And so our outlook hasn't changed. Every day, I think, it gets brighter and brighter with the industry's progress. But I'll just highlight, it's one of many growth factors for us, and I would not expect any one product or end market to be the single biggest driver or materially change the company outlook. So it's in our guidance as we continue to work with customers on their new product rollouts, we continue to factor that into our outlook.

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

[Craig Bijou, analyst]

Great. And if I can also ask on the acceleration in organic growth expected in Q4 and understand there's a number of moving pieces. So you're getting rid of Electrochem, Portable Medical is coming out. So maybe if you can just help us understand expectations for acceleration -- organic growth acceleration by segment. So C&V, CRM&N and then even the Advanced Surgical. Just kind of want to get a sense for where that organic growth is going to accelerate.

[Joseph Dziedzic, executive]

Sure. So when you look at fourth quarter, it will be a little different from a split between organic and reported than the first 3 quarters. So in the first 3 quarters, you had roughly 400 basis points of difference between reported and organic. In the fourth quarter, there's very little net inorganic in the quarter. One of the acquisitions rolls off, its rolling 12 months and becomes organic. And then the other acquisition is offset by Portable Medical coming down in the fourth quarter. So when you look at that fourth quarter guidance number, think of that as both reported and organic in the quarter. So that will be a little nuanced there as you stare at organic and inorganic split. So 4Q reported and organic are roughly the same number, same percentage in the fourth quarter. And we do expect to see continued improvement or acceleration in the growth rate in Cardiovascular because of the new products that continue to ramp in that segment.

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

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

[Operator]

Your next question comes from the line of Rich Newitter with Truist Securities.

[Richard Newitter, analyst]

A couple for me. I guess just one, you mentioned the hurricane impact in the third quarter. I guess, is that going to have any lingering impact into the fourth quarter? What divisions, if there were specific ones, were more impacted there? And that segues into just my additional question on CRM and Neuro. Was it that division? And if not, just a little more color on why that was so soft, at least relative to our expectations and seemingly consensus expectations.

[Joseph Dziedzic, executive]

Sure. So thanks for the question, Rich. The first answer is it's mostly Cardio & Vascular coming out of the Florida facility and the Dominican Republic facility. The lingering impact will likely be cost because of having to shut down and then ramp back up and then run some overtime to catch up on the few days, 2 or 3 days that we had to shut down. So in the fourth quarter, we would expect to incur a little bit more cost. It was a small impact, but it was at the end of the quarter. And so you have really no time to react when it was the last few days of the third quarter. So that's on the hurricane impact. Fortunately, all of our associates are safe and that the impact was far less than what was expected from that particular hurricane.

On the Cardiac Rhythm Management Neuromod question, I'll go back to what we said at the beginning of the year on our fourth quarter earnings call back in February. We looked at our order patterns that we saw from customers given our order book, and we could see that the demand for CRM products was less in the second half, which I would not point to or indicate necessarily has anything to do with the broader market trends because you look at the market trends, some of the CRM participants had pretty strong growth. Some had a little bit lower growth. But I don't know that I would point to necessarily a market trend. I would look at this and say, this is how customers were planning to run their facilities and the demand they placed on us across the year. We saw that at the beginning of the year. We said on our earnings call that we expected CRM to normalize in the second half, which meant be at a lower run rate than it had been in the first half and in 2023. That played out like we expected that it would. We've got the fourth quarter expectation out of that order pattern baked into our guidance. I mean we're sitting here now, we're in the end of the fourth week of the quarter. We've got 9 weeks to go, and we've got really good visibility to the rest of the year. So we feel really good about the top line guidance that we've given and the split by segment that we guided to in our product line summary slides in the appendix of the presentation.

[Richard Newitter, analyst]

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

[Joseph Dziedzic, executive]

Nothing significant there. There might be plus or minus. I'd have to ask Diron. Internally, that's not something that we noticed once -- we went to a calendar year back in a calendar year for our reporting back, I think it was 2020. I think it was calendar year -- no, it was actually the end of 2019, we went to a calendar year. So for the year, it all washes out. We had been on a fiscal year, which I think it was every 6 or 7 years, we have an extra week. But we're on a calendar year basis, so there might be a day or 2. But for how our business operates, we don't see that as a meaningful impact.

[Operator]

Your next question comes from the line of Joanne Wuensch with Citi.

[Joanne Wuensch, analyst]

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

[Joseph Dziedzic, executive]

I'd say we continue to focus on executing our strategic objectives, our financial strategic objectives of organic growth, 200 basis points above the market. We had said at the beginning of this year, we thought 2024 was going to be a normal market growth relative to '23, which was above normal. And based upon what we've seen in the market, we think that has played out to be a very normal kind of organic growth year for the industry. I have no reason at this point to believe 2025 is going to be any different than that. So we remain focused on delivering on our strategic objectives. Sales growing at least 200 basis points organically above the market and operating profit growing twice as fast as sales.

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

[Joanne Wuensch, analyst]

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

[Joseph Dziedzic, executive]

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

[Operator]

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

[Matthew O'Brien, analyst]

Maybe just sticking on Q4 for a second. And before I do that, just congratulations to Payman and Andrew. But sticking on Q4, it does look like a little bit of a decel in terms of the 2-year stack. So I'm just curious, is that entirely CRM? Is there any of the hurricane lingering impact there that would cause that slowdown? Or is it just you guys being somewhat conservative?

[Joseph Dziedzic, executive]

Sure. I may not be tracking the 2-year stack. At midpoint, we see sales growth of about 11% operating profit in that same order of magnitude. So we think for the fourth quarter, we see strong sales growth based upon the new products we're rolling out and supporting in C&V and the Neuromod, the acceleration of the emerging customer PMA. And so we feel good about that given that we're sitting here 4 weeks into the quarter with 9 to go. The fourth quarter last year, thinking about the comps, fourth quarter last year was the highest quarter of the year. It was over $400 million of sales and the prior quarters were well below $300 million, and it was also the highest profitability of the year. It was 16.7%. AOI margin rate last year compared to the full year was 15.2%. So you see the quarterly improvement. So on a year-over-year basis, fourth quarter is the toughest comp.

And if you look at our guidance for the fourth quarter, the midpoint from a profitability standpoint is the average operating margin rate for year-to-date. So we think the fourth quarter guidance is very consistent with year-to-date. And I'll take this opportunity to highlight on a year-to-date basis, our operating margin is up 180 basis points year-over-year. We're at 16.5% operating margin rate year-to-date. That compares to 14.7% last year, and that's 100 bps from gross margins. So we're expanding gross margins, which has been a big focus for us this year, in particular, coming out of all of the pandemic disruption, and we're very focused on getting margin expansion and gross margin. But we're also getting 80 basis points of leverage on OpEx. So we're pleased with the progress we're making both in gross margin and getting operating leverage.

So I'm sorry if I didn't answer your question, but I'll take another shot at it.

[Matthew O'Brien, analyst]

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

[Joseph Dziedzic, executive]

So we haven't seen any measurable meaningful shift or change. Obviously, I think everybody believes cryo is going to be impacted over time by pulse field ablation coming out. And so we are assuming and factoring in the kind of the broader industry expectation on cryo decline. But in the other applications, we continue to see strong demand. Our customers continue to be very optimistic about the broader electrophysiology marketplace. And given our broad footprint and participation across the full procedure and given our significant vertical integration, we think we're incredibly well positioned to support the industry during this transition and help our customers bring products to market as fast as we all can on a safe basis. So we remain excited and don't -- haven't seen any meaningful shift beyond what you're hearing and seeing in the broader industry. And as we look at electrophysiology, given our broad footprint and vertical integration, we see it as a net tailwind for the company for sure.

[Matthew O'Brien, analyst]

And sorry, can I sneak in one more?

[Joseph Dziedzic, executive]

Yes.

[Matthew O'Brien, analyst]

The big R&D cut in the quarter, why was that? And is that anything to be cautious about in terms of '25 or '26 in terms of investment there. I don't know if there was an adjustment that I missed in the release.

[Joseph Dziedzic, executive]

Yes. No adjustments. It's a great question. So first off, we didn't cut R&D. Nominally, we continue to spend more in R&D. What you're seeing there is higher levels of reimbursement or maybe a wrong term given your thought -- your understanding of reimbursement for our customers, higher levels of our customers paying us to do development work for them in the discrete third quarter compared to other quarters. I think in the last couple of years, you've heard us talk about how to think about our development revenues. The R&D line is impacted by our development revenues. The cost for our development activity is very flat quarter-to-quarter throughout the year because it's primarily R&D engineers doing work. So they're on the payroll 365 days a year. When we get -- when we generate revenues or get paid by our customers is connected to achieving milestones on those different development programs.

And in previous years, what we saw was a pattern of more revenues later in the year, in particular, in the fourth quarter as we and our customers work to hit milestones within the year and stay on track. We have been very focused on normalizing or leveling that out across the year. And I think I commented on last quarter's call that this year, in particular, we've been seeing a much, much more level-loaded revenues for that kind of work.

And what you're highlighting here is actually in the third quarter, we actually saw more revenues in the third quarter for that kind of work than the other quarters. And so that's the biggest driver of the R&D expense being down. It's because of revenues, not because of reducing cost. And so now we're expecting fourth quarter to be a more normal average for the year as compared to prior years, where fourth quarter might have been a very strong revenue quarter for the development revenues. So thanks for highlighting that because it was important I explained that we didn't lower any costs. We actually just generated more revenues for the work we're doing.

[Operator]

[Operator Instructions] Your next question comes from the line of Kirsten Stewart with CL King.

[Kristen Stewart, analyst]

I was wondering if you could just give a little bit more detail on gross margins in the quarter, what drove kind of the increase? And then how should we think about it going forward just from a sustainability perspective of the increase year-to-year and whether or not you can get back to that 31% pre-COVID level and if there's any time horizon associated with that achievement?

[Joseph Dziedzic, executive]

Great. Thanks for the question. We absolutely expect to get back to the 2019 31% gross margins, and then we expect to build on that. We don't plan to stop at 31%. But we have made tremendous progress year-to-date, up 100 basis points year-over-year. It's really a function of recovering, getting back some of the inefficiencies that we incurred from supply chain disruption and the direct labor turnover. Our supply chain is very, very stable at this point. The team has done a good job of managing that. And then on the direct labor turnover, at the company total, we're below where we were pre-pandemic, which is great. We're very focused on engagement with our direct labor associates, and we're getting really good traction on our Manufacturing Excellence Initiative and the work we're doing with associates to provide them with tools and Kaizen events and lean -- implementing lean processes. And we see continued significant opportunity, whether it's in direct material scrap reduction or reducing overtime because of how we load the plants or in driving greater direct labor efficiency. There's automation opportunities still. And so now that the teams -- the plant management teams can really get back to focusing on driving those individual projects. Many of them are small projects that compound over time. We're starting to see the financial benefits of the hard work the team has been doing. And we expect that to continue and excited for the progress that the team is making. So we absolutely expect to continue growing operating profit twice as fast as sales. The sales growth rate is our objective, and we would expect that to come from both expanding gross margins, while also continuing to get leverage on the operating expense. And so right now, we're 180 basis points at the operating margin rate level above last year on a year-to-date basis, and that's 100 basis points from gross margin, and 80 from OpEx. And it's a good mix that we'll keep driving going forward.

[Kristen Stewart, analyst]

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

[Joseph Dziedzic, executive]

Yes. Well, by the end of the year, we expect to be at the low end of our range, which means we've got the $250 million to $300 million capacity that we've talked about on a kind of a rolling annual basis. And so we continue to have a robust pipeline that we continuously curate. Many of the acquisitions we do, we work with those targets over multiple years, building a relationship, understanding their business so that when they're ready, and we don't get to choose when they're ready to transact. If we did, we would probably be paying a premium, and we'd rather pay a fair price, fair multiple. So that pipeline continues to be curated by Andrew and his team, and we would expect to continue executing our inorganic strategy over time. And the nice thing is we now have the full capacity that we target within our targeted debt leverage range.

[Operator]

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

[Suraj Kalia, analyst]

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

[Diron Smith, executive]

Sure, Suraj. Yes. I mean when you look at our order pattern, there's a couple of different variables that happen. One of them is the normal order pattern is relatively smooth. We do about $33 million a week. And so when you look at the timing of that, most are relatively smooth. You have some that you have sterilization near the end of the quarter where that happens a little bit more in bulk. And when you talk about Hurricane Helene specifically, it all happened right in the last few days of the quarter. So we ended up closing our facility for about 3 days. And that was right when things were already in the process of getting packed, shipped, final sterilization. So you have a little bit of an outsized impact. Again, it's ultimately is about a 1 percentage point impact to our overall organic growth that for that will be caught up in the fourth quarter. And as Joe mentioned earlier, it will be primarily a cost pressure or a cost headwind as we kind of work through getting re-ramped up.

[Suraj Kalia, analyst]

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

[Diron Smith, executive]

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

[Suraj Kalia, analyst]

Joe, one question for you. I do appreciate all the color. Joe, in terms of the comment about new structural heart products, I know you guys are talking of the tricuspid component in structural heart. Maybe if I can push you on TriClip. Remind us, is it based on just minimum volumes? Or are there any adjustments based on price volumes? How should we think about, as we roll out into Q4 and FY '25? Any color you could give us would be great.

[Joseph Dziedzic, executive]

Great. Thanks, Raj. I can't speak to any specific individual program or individual customer. But if I just respond to your question maybe more broadly, our agreements -- some of our agreements will, in fact, have some pricing based upon volume levels. We call it tiered pricing. As we hit certain volume thresholds, we drive additional synergies, efficiencies of scale. And we do, in fact, share some of that with our customers so that we both benefit from growth. Our goal is to enable our customers' success, which means help them grow and treat more patients and grow in the market. And when we get to participate in that, we have to earn that right. When we get to participate in that, there is a sharing on some programs. And so that is -- it is a structure and a function that we have with some customers. It's very common with a new product launch, where pricing may be above average in the early days because you have inefficiencies as you introduce something and ramp, you've got training of associates. Yields are not always optimal at the beginning of a new product launch. And then as you move into kind of a full-scale production, then the pricing comes in line more with kind of the cost that you would expect in a full-scale manufacturing line. And so there is that dynamic. But the end objective of that is really just kind of matching the inefficiencies with the pricing during that ramp phase and then as quickly as possible, getting to a very efficient full-scale production and a price that's very competitive and helps our customers succeed in the market.

[Operator]

This concludes the question-and-answer session. I will turn the call to Andrew for closing remarks.

[Andrew Senn, executive]

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

[Operator]

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