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GB > SEC Filings for GB > Form 10-Q on 7-May-2013All Recent SEC Filings

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Form 10-Q for GREATBATCH, INC.


7-May-2013

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Our Business

We operate our business in two reportable segments - Implantable Medical and Electrochem Solutions ("Electrochem"). The Company's customers include large multi-national original equipment manufacturers ("OEMs"). The Implantable Medical segment is comprised of our Greatbatch Medical and QiG Group and designs and manufactures medical devices and components for the cardiac, neuromodulation, vascular and orthopaedic markets. The Implantable Medical segment offers complete medical devices including design, development, manufacturing, regulatory submission and supporting worldwide distribution, which is facilitated through the QiG Group and leverages the component technology of Greatbatch Medical. The devices designed and developed by the QiG Group are manufactured by Greatbatch Medical. The Implantable Medical segment also offers individual components for implantable medical devices as well as value-added assembly and design engineering services for its component products. Examples of these components include batteries, capacitors, filtered and unfiltered feedthroughs, machined components, enclosures, leads, introducers, catheters, as well as orthopaedic implants, instruments and cases and trays.

Electrochem is an industry leader in designing and manufacturing total power solutions for critical applications with market-leading OEMs, largely in the portable medical and energy space. Electrochem offers its customers components, consultation, design, development and testing for medical device applications in high-value markets, including those that support the transition of delivery of health care from clinical to outpatient and home settings, as well as those that enhance the quality of life for an aging population. Examples of these devices include powered surgical tools, automated external defibrillators, portable ultrasound devices, portable oxygen concentrators, and ventilators, among others. Electrochem provides cell and battery pack configurations for rechargeable and non-rechargeable battery power systems, charging and docking stations, and power supplies, for devices where failure is not an option.

Our Customers

Implantable Medical customers include leading OEMs, in alphabetical order here and throughout this report, such as Biotronik, Boston Scientific, Johnson & Johnson, Medtronic, Smith & Nephew, Sorin Group, St. Jude Medical, Stryker and Zimmer. The nature and extent of our selling relationships with each OEM varies in terms of breadth of products purchased, purchased product volumes, length of contractual commitment, ordering patterns, inventory management and selling prices. During the three months ended March 29, 2013, Johnson & Johnson, Medtronic and St. Jude Medical collectively accounted for 52% of our total Company sales.

Electrochem's customers are primarily companies involved in demanding markets with sophisticated total power solutions needs, such as in the portable medical and energy markets. Some of Electrochem's larger OEM customers are Phillips Healthcare, Physio-Control, Covidien, Ethicon Endo-Surgery, Carefusion, Halliburton and Weatherford International.

Strategic and Financial Overview

As expected, first quarter 2013 revenue was lower than the prior year period. First quarter 2013 sales decreased $10.8 million or 7% over the prior year period to $148.3 million. This decrease was partially due to the sale of certain non-core orthopaedic product lines at the beginning of 2013, which caused orthopaedic revenue to decline by approximately $4.2 million. Foreign currency exchange rate fluctuations did not have a material impact on the current quarter in comparison to the prior year period. When adjusting for the sale of non-core product lines, 2013 first quarter revenue declined 4% compared to the prior year first quarter. This decline was primarily due to continued cardiac rhythm management ("CRM") market headwinds, customer market share shifts, as well as customer inventory builds in the fourth quarter of 2012 for all product lines except orthopaedics. We saw the impact of fourth quarter 2012 inventory builds in lower first quarter 2013 orders. Orthopaedic revenue in the first quarter 2013, on a constant currency organic basis, grew 11% for the first quarter of 2013 due to implant market share gains and cases and tray product launches. This growth was partially offset by the timing of plant validations in connection with the closing of our Swiss facilities. For the remainder of 2013, we expect revenue to improve as customer ordering patterns normalize, orthopaedic backlog begins to be relieved, and new product introductions are commercialized in our cardiac and portable medical product lines.

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We prepare our consolidated financial statements in accordance with generally accepted accounting principles in the United States of America ("GAAP"). Additionally, we consistently report and discuss in our quarterly earnings releases and investor presentations adjusted operating income and margin, adjusted net income and adjusted earnings per diluted share. These adjusted amounts consist of GAAP amounts excluding the following adjustments to the extent they occur during the period: (i) acquisition-related charges,
(ii) facility consolidation, optimization, manufacturing transfer and system integration charges, (iii) asset write-down and disposition charges,
(iv) severance charges in connection with corporate realignments or a reduction in force, (v) litigation charges and gains, (vi) the impact of non-cash charges to interest expense due to the accounting change for convertible debt, (vii) unusual or infrequently occurring items, (viii) certain R&D expenditures (such as medical device design verification ("DVT") expenses in connection with developing our neuromodulation platform), (ix) gain/loss on the sale of investments, (x) the income tax (benefit) related to these adjustments and
(xi) certain tax charges related to the consolidation of our Swiss Orthopaedic facility. We believe that reporting these amounts provides important supplemental information to our investors and creditors seeking to understand the financial and business trends relating to our financial condition and results of operations. Additionally, certain performance-based compensation incentives provided to our executives are determined utilizing these adjusted amounts.

A reconciliation of GAAP operating income to adjusted amounts is as follows (in thousands):

                                                                                     Three Months Ended
                                       Implantable Medical               Electrochem                   Unallocated                      Total
                                     Mar. 29,       Mar. 30,       Mar. 29,       Mar. 30,       Mar. 29,       Mar. 30,        Mar. 29        Mar. 30
                                       2013           2012           2013           2012           2013           2012           2013           2012
Sales                                $ 111,414      $ 117,817      $  36,851      $  41,286      $      -       $      -       $ 148,265      $ 159,103

Operating income (loss) as
reported                             $  14,343      $  10,112      $   4,816      $   4,471      $  (4,820 )    $  (3,385 )    $  14,339      $  11,198
Adjustments:
Inventory step-up amortization
(COS)                                       -              -              -             532             -              -              -             532
Medical device DVT expenses (RD&E)       1,734          1,040             -              -              -              -           1,734          1,040
Consolidation and optimization
costs                                    2,760            750             -              -             302            818          3,062          1,568
Acquisition and integration
expenses                                    70            105             40            838              1             -             111            943
Asset dispositions, severance and
other                                       60            (24 )            5            255             -               3             65            234

Adjusted operating income (loss)     $  18,967      $  11,983      $   4,861      $   6,096      $  (4,517 )    $  (2,564 )    $  19,311      $  15,515

Adjusted operating margin                 17.0 %         10.2 %         13.2 %         14.8 %          N/A            N/A           13.0 %          9.8 %

Medical device related adjusted
expenses (excluding DVT)             $   5,875      $   7,501      $      -       $      -       $      -       $      -       $   5,875      $   7,501

Adjusted operating income
excluding medical device related
adjusted expenses                    $  24,842      $  19,484      $   4,861      $   6,096      $  (4,517 )    $  (2,564 )    $  25,186      $  23,016

Adjusted operating margin
excluding medical device related
adjusted expenses                         22.3 %         16.5 %         13.2 %         14.8 %          N/A            N/A           17.0 %         14.5 %

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GAAP operating income for the first quarter 2013 was $14.3 million compared to $11.2 million for the comparable 2012 period. This increase was primarily due to increased gross profit and lower net research, development and engineering ("RD&E") investments, partially offset by higher selling, general, and administrative ("SG&A") expenses and consolidation and optimization expenses. Adjusted operating income, which excludes consolidation, optimization and DVT costs, increased 24% to $19.3 million compared to $15.5 million in first quarter 2012. The increase in gross profit was driven primarily by cost savings and production efficiencies, including savings realized from the consolidation of our Swiss orthopaedic facilities and product line rationalizations, which totaled approximately $1.3 million. The improvement in RD&E is primarily a result of our efforts, beginning in 2012, to focus medical device research and development ("R&D") investments and discontinue certain non-core R&D projects as well as a higher level of customer cost reimbursements. The increase in SG&A was primarily due to the additional cost from our investment in sales and marketing resources to drive future core business growth. The increase was partially offset by synergies realized from our acquisitions and benefits from the Swiss orthopaedic facility consolidation.

GAAP and adjusted diluted EPS for the first quarter of 2013 were $0.23 and $0.44 per share, respectively, compared to $0.19 and $0.37 per share, respectively, for the first quarter 2012.

A reconciliation of GAAP net income and diluted EPS to adjusted amounts is as follows (in thousands, except per share amounts):

                                                                Three Months Ended
                                                     March  29,                    March  30,
                                                        2013                          2012
                                                               Impact                       Impact
                                                 Net            Per            Net            Per
                                                Income        Diluted         Income        Diluted
                                                (Loss)         Share          (Loss)         Share
Net income as reported                         $  5,663       $   0.23       $  4,467      $    0.19
Adjustments:
Inventory step-up amortization (COS)                 -              -             346           0.01
Medical device DVT expenses (RD&E)                1,127           0.05            676           0.03
Consolidation and optimization costs(a)           2,340           0.10          1,019           0.04
Acquisition and integration expenses                 72             -             613           0.03
Asset dispositions, severance and other              65             -             152           0.01
Loss on cost and equity method investments,
net(b)                                               46             -              -              -
CSN conversion option discount
amortization(c)                                   2,906           0.12          1,444           0.06
2012 R&D Tax Credit(d)                           (1,500 )        (0.06 )           -              -

Adjusted net income and diluted EPS(e)         $ 10,719       $   0.44       $  8,717      $    0.37

Adjusted diluted weighted average shares         24,415                        23,848

(a) Net of tax amounts computed using U.S. and foreign tax rates of 35% and 0%, respectively, for items incurred in those geographic locations for 2013 amounts and 35% and 22.5%, respectively for 2012 amounts.

(b) Pre-tax amount is $70 thousand for 2013.

(c) Pre-tax amount is $4.5 million for the 2013 period and $2.2 million for the 2012 period.

(d) Relates to the 2012 portion of the R&D tax credit which was reinstated in the first quarter of 2013 retroactive back to the beginning of 2012. As required, the full year impact of the R&D tax credit relating to 2012 was recognized in the first quarter of 2013.

(e) The per share data in this table has been rounded to the nearest $0.01 and therefore may not sum to the total.

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2013 Financial Guidance

We are reaffirming our adjusted operating income as a percentage of sales and adjusted diluted EPS guidance ranges provided at the beginning of the year as follows:

Adjusted Operating Income as a % of Sales 12.0% - 12.5% Adjusted Diluted EPS $1.90 - $2.00

However, based on the actual results for the first quarter and our current expectations for the remainder of the year, we see a general trend towards the lower end of our original sales guidance of $660 million to $680 million provided at the beginning of the year. If achieved, this would result in organic revenue growth of 5% - 8% due to the disposition of $15 million of non-core orthopaedic product lines at the end of 2012.

As previously disclosed, adjusted operating income for 2013 includes GAAP operating income minus non-recurring, unusual or infrequently occurring items such as acquisition, consolidation and integration charges, certain RD&E expenditures, and asset disposition/write-down charges, totaling approximately $11.5 million to $14.0 million for 2013. These adjustments are significantly lower than the 2012 level as we have essentially completed our consolidation initiatives. Included in the above range are residual DVT costs in the range of $4.8 to $5.8 million to complete our Algostim project.

Our CEO's View

As expected, our first quarter 2013 revenue was lower than the prior year period, however, the magnitude of the decline in our sales was more than we anticipated. We are pleased with the performance of our orthopaedics product line, which had 11% organic growth. Additionally, we continue to expect new product introductions to drive second half 2013 portable medical growth and to sustain or slightly outperform the CRM market.

Despite the decrease in sales, we were able to achieve a 19% increase in our adjusted diluted EPS as a result of a 320 basis point improvement in our adjusted operating margin to 13.0%. This improvement reflects our plant consolidations and more focused RD&E investment, partially offset by our continued investment in sales and marketing resources. Our core business, which excludes $5.9 million of incremental medical device development expenses, posted a 17.0% adjusted operating margin performance.

We continue to make good progress on our key strategic initiatives which include:

Successfully transferring orthopaedic manufacturing to our Fort Wayne and Tijuana facilities;

Prioritizing and focusing our RD&E investment and discontinuing non-core projects;

Continued milestone progress on our Algostim spinal cord stimulator positioning us for a second half 2013 PMA submission;

On-going discussions with potential OEM partners for the commercialization of Algostim; and

Maintaining and deepening our relationship with our OEM customers.

Product Development

Implantable Medical - We provide our Implantable Medical customers with complete medical devices. This medical device strategy is being facilitated through the QiG Group and includes strategic equity investments and medical devices developed independently as well as in conjunction with our OEM partners. While we do not intend to discuss each of these projects individually each quarter, we will discuss significant milestones as they occur. Some of the medical device projects that we currently are working on include:

Cardiovascular portfolio - As previously disclosed, near the end of 2012, Greatbatch Medical voluntarily decided to perform a field action on two of its cardiovascular medical devices as a result of manufacturing irregularities observed during inspection. This problem was identified after implementing a new inspection tool for use in performing inspections. Revenue on these medical devices, which totaled $3.3 million in 2012, is expected to be temporarily delayed until the second half of 2013.

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Neuromodulation portfolio - With regards to Algostim, our spinal cord stimulator for the treatment of chronic pain in the trunk and limbs, DVT activities remain on track. During the first quarter of fiscal 2013, we initiated two animal studies for support of our literature-based PMA submission, which is anticipated later this year and we are well along on our CE mark submission with having completed the first three phases of a five phase modular submission with the TUV. Operationally, we are identifying and signing up key suppliers. Also, our collaboration with J.P. Morgan, who is assisting us in identifying commercial partners, is progressing well.

Approximately $0.5 million of the NeuroNexus Technologies, Inc. ("NeuroNexus") acquisition purchase price in February 2012 was allocated to the estimated fair value of acquired in process research and development ("IPR&D"). These projects are expected to generate cash flows but have not yet reached technological feasibility, and thus were classified as an indefinite-lived intangible asset until the completion or abandonment of the associated projects. The value assigned to IPR&D related to the development of micro-electrodes for deep brain mapping and electrocorticography. There have been no significant changes from our original estimates with regards to these projects.

Electrochem - Electrochem continues to win new customers, new applications and next generation products. Our core competencies enable us to be well-positioned to win existing share and additional new product introductions based on our experience in providing solutions, our customer relationships, our investment in technology and facilities to further expand our capabilities, our capacity to service our customers, and our legacy of delivering highly reliable and innovative solutions to the medical marketplace.

The 2012 growth in Electrochem was driven by successful product launches into the higher growth, higher value portable medical market. Gaining better access to this attractive market is one of our strategic priorities as it provides us with a significant opportunity for growth given its $1 billion market size. Projections for growth in portable medical are expected to be double digit in 2013 with additional product launches with existing and new customers. Additionally, this market is benefiting from favorable market trends as patient care shifts from clinical settings to the home and as an aging population drives the need for lightweight and portable devices for patients and caregivers. These favorable trends are expected to allow this market to grow faster than our legacy markets over the next several years. Finally, this market is also attractive to us given that it has long product life cycles that should provide stability and diversification to our revenue base.

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Cost Savings and Consolidation Efforts

In 2013 and 2012, we recorded charges in Other Operating Expenses, Net related to cost savings and consolidation efforts. These initiatives were undertaken to improve our operational efficiencies and profitability. Additional information regarding the timing, cash flow impact and amount of future expenditures is set forth in Note 9 "Other Operating Expenses, Net" of the Notes to the Condensed Consolidated Financial Statements contained in Item 1 of this report, as well as the "Liquidity and Capital Resources" section of this Item.

Over the last three years, we have been implementing a multi-faceted plan to further enhance, optimize and leverage our orthopaedics operations. This plan includes the construction of an orthopaedic manufacturing facility in Fort Wayne, IN, updating our Indianapolis, IN facility to streamline operations, increase capacity, and further expand capabilities, and the transfer of most major functions performed at our facilities in Orvin and Corgemont, Switzerland into our Fort Wayne, IN and Tijuana, Mexico facilities. The total capital investment expected for these initiatives is between $25 million and $30 million, of which $21.2 million has been expended to date. Total expense expected to be incurred for these initiatives is between $36 million and $40 million, of which $35.8 million has been incurred to date.

Near the end of 2011, we initiated plans to optimize and expand our manufacturing infrastructure in order to support our medical device strategy. This included the transfer of certain product lines to lower cost facilities, expansion of two of our existing facilities, as well as the purchase of equipment to create additional capacity for the manufacture of medical devices and create additional cost savings. Total capital investment under these initiatives is expected to be between $15 million to $20 million, of which approximately $10.3 million has been expended to date. Total expenses expected to be incurred on these projects is between $2.0 million to $3.0 million, of which $1.6 million has been incurred to date.

These orthopaedic and medical device initiatives are expected to be completed over the next year and are expected to generate approximately $10 million to $15 million of annual cost savings and increase our capacity in order to support our growth and the manufacturing of complete medical devices.

In 2011, we initiated plans to upgrade our existing global ERP system. This initiative is expected to be completed over the next year. Total capital investment under this initiative is expected to be approximately $4 million to $5 million, of which approximately $3.0 million has been expended to date. Total expenses expected to be incurred on this initiative is between $6 million to $7 million, of which $5.3 million has been incurred to date.

Our Financial Results

We utilize a fifty-two, fifty-three week fiscal year ending on the Friday nearest December 31st. For 52-week years, each quarter contains 13 weeks. The first quarter of 2013 and 2012 ended on March 29, and March 30, respectively, and each contained 13 weeks. The commentary that follows should be read in conjunction with our Condensed Consolidated Financial Statements and related notes and with the Management's Discussion and Analysis of Financial Condition and Results of Operations contained in our Annual Report on Form 10-K for the fiscal year ended December 28, 2012.

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The following table presents certain financial information derived from our Condensed Consolidated Financial Statements for the periods presented (dollars in thousands, except per share data):

                                                  Three Months Ended
                                              March 29,        March 30,               Change
                                                 2013             2012              $             %
Sales:
Implantable Medical
Cardiac/Neuromodulation                       $   71,167       $   75,135       $  (3,968 )        -5 %
Vascular                                          10,624           11,636          (1,012 )        -9 %
Orthopaedic                                       29,623           31,046          (1,423 )        -5 %

Total Implantable Medical                        111,414          117,817          (6,403 )        -5 %
Electrochem
Portable Medical                                  18,889           18,720             169           1 %
Energy                                            12,293           14,771          (2,478 )       -17 %
Other                                              5,669            7,795          (2,126 )       -27 %

Total Electrochem                                 36,851           41,286          (4,435 )       -11 %

Total sales                                      148,265          159,103         (10,838 )        -7 %
Cost of sales                                     99,516          112,215         (12,699 )       -11 %

Gross profit                                      48,749           46,888           1,861           4 %
Gross profit as a % of sales                        32.9 %           29.5 %
Selling, general and administrative
expenses (SG&A)                                   20,092           19,034           1,058           6 %
SG&A as a % of sales                                13.6 %           12.0 %
Research, development and engineering
costs, net (RD&E)                                 11,080           13,911          (2,831 )       -20 %
RD&E as a % of sales                                 7.5 %            8.7 %
Other operating expense, net                       3,238            2,745             493          18 %

Operating income                                  14,339           11,198           3,141          28 %
Operating margin                                     9.7 %            7.0 %
Interest expense                                   6,988            4,359           2,629          60 %
Other expense, net                                   285              720            (435 )       -60 %
Provision for income taxes                         1,403            1,652            (249 )       -15 %
Effective tax rate                                  19.9 %           27.0 %

Net income                                    $    5,663       $    4,467       $   1,196          27 %

Net margin                                           3.8 %            2.8 %
Diluted earnings per share                    $     0.23       $     0.19       $    0.04          21 %

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Sales

Implantable Medical - Cardiac and neuromodulation sales for the first quarter of . . .

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