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GB > SEC Filings for GB > Form 10-Q on 6-Aug-2013All Recent SEC Filings

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Form 10-Q for GREATBATCH, INC.


6-Aug-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 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.

As discussed in Note 9 "Other Operating Expenses, Net" of the Notes to Condensed Consolidated Financial Statements in Item 1 of this report, in June 2013, we initiated a plan to realign our operating structure in order to optimize our continued focus on profitable growth. Under this initiative, the sales & marketing and operations groups of our Implantable Medical and Electrochem segments were combined into one sales & marketing and one operations group serving the entire Company. As a result of this realignment initiative, which includes changing the management and reporting structure, we are re-evaluating our operating and reportable segments.

Our Customers

Implantable Medical customers include leading original equipment manufacturers ("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 six months ended June 28, 2013, Johnson & Johnson, Medtronic and St. Jude Medical collectively accounted for 50% 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, in alphabetical order here and throughout this report, Carefusion, Covidien, Ethicon Endo-Surgery, Halliburton, Phillips Healthcare, Physio-Control, and Weatherford International.

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Financial Overview

Second quarter 2013 sales increased $4.8 million or 3% over the prior year period to a record $171.3 million. When adjusting 2012 for the divestiture of certain non-core orthopaedic product lines at the beginning of 2013 ($4.4 million), sales increased $9.2 million or 6% organically. Foreign currency exchange rate fluctuations did not have a material impact on the current quarter in comparison to the prior year period. This 6% organic constant currency growth was primarily due to above market growth (5% growth) from our cardiac/neuromodulation product line, implant market share gains, which helped drive 14% orthopaedics product line organic growth, and strength in our portable medical product line, which is benefitting from new product launches into this higher growth market. This growth was partially offset by the timing of orthopaedic plant validations in connection with the closing of our Swiss facilities. For the first six months of 2013, sales decreased 2% to $319.6 million compared to the prior year period. On an organic constant currency basis, sales for the first half of 2013 increased 1% in comparison to 2012 as the strong second quarter 2013 results were partially offset by slower demand in the first quarter of 2013 due to customer inventory adjustments and the impact of our Swiss consolidation. For the remainder of 2013, we expect revenue to continue to be strong as orthopaedic backlog continues to be relieved, and new product introductions are commercialized in our cardiac and portable medical product lines.

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.

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

                                                                                          Three Months Ended
                                            Implantable Medical               Electrochem                   Unallocated                      Total
                                          June 28,       June 29,       June 28,       June 29,       June 28,       June 29,       June 28,       June 29,
                                            2013           2012           2013           2012           2013           2012           2013           2012
Sales                                     $ 128,604      $ 125,366      $  42,727      $  41,182      $      -       $      -       $ 171,331      $ 166,548

Operating income (loss) as reported       $  16,640      $  11,396      $   5,828      $   6,199      $  (5,333 )    $  (6,504 )    $  17,135      $  11,091
Adjustments:
Medical device DVT expenses (RD&E)            1,235          1,575             -              -              -              -           1,235          1,575
Consolidation and optimization costs          3,065          2,713            126             -             517          1,742          3,708          4,455
Acquisition and integration expenses             41             39             30             72             -               1             71            112
Asset dispositions, severance and other          (7 )          531             50            156             -             669             43          1,356

Adjusted operating income (loss)          $  20,974      $  16,254      $   6,034      $   6,427      $  (4,816 )    $  (4,092 )    $  22,192      $  18,589

Adjusted operating margin                      16.3 %         13.0 %         14.1 %         15.6 %          N/A            N/A           13.0 %         11.2 %

Medical device related adjusted
expenses (excluding DVT)                  $   6,615      $   7,143      $      -       $      -       $      -       $      -       $   6,615      $   7,143

Adjusted operating income excluding
medical device related adjusted
expenses                                  $  27,589      $  23,397      $   6,034      $   6,427      $  (4,816 )    $  (4,092 )    $  28,807      $  25,732

Adjusted operating margin excluding
medical device related adjusted
expenses                                       21.5 %         18.7 %         14.1 %         15.6 %          N/A            N/A           16.8 %         15.5 %

                                                                                           Six Months Ended
                                            Implantable Medical               Electrochem                   Unallocated                      Total
                                          June 28,       June 29,       June 28,       June 29,       June 28,       June 29,       June 28,       June 29,
                                            2013           2012           2013           2012           2013           2012           2013           2012
Sales                                     $ 240,018      $ 243,183      $  79,578      $  82,468      $      -       $      -       $ 319,596      $ 325,651

Operating income (loss) as reported       $  30,983      $  21,508      $  10,644      $  10,670      $ (10,153 )    $  (9,889 )    $  31,474      $  22,289
Adjustments:
Inventory step-up amortization (COS)             -              -              -             532             -              -              -             532
Medical device DVT expenses (RD&E)            2,969          2,615             -              -              -              -           2,969          2,615
Consolidation and optimization costs          5,825          3,463            126             -             819          2,560          6,770          6,023
Acquisition and integration expenses            111            144             70            910              1              1            182          1,055
Asset dispositions, severance and other          53            507             55            411             -             672            108          1,590

Adjusted operating income (loss)          $  39,941      $  28,237      $  10,895      $  12,523      $  (9,333 )    $  (6,656 )    $  41,503      $  34,104


Adjusted operating margin                      16.6 %         11.6 %         13.7 %         15.2 %          N/A            N/A           13.0 %         10.5 %

Medical device related adjusted
expenses (excluding DVT)                  $  12,490      $  14,644      $      -       $      -       $      -       $      -       $  12,490      $  14,644

Adjusted operating income excluding
medical device related adjusted
expenses                                  $  52,431      $  42,881      $  10,895      $  12,523      $  (9,333 )    $  (6,656 )    $  53,993      $  48,748

Adjusted operating margin excluding
medical device related adjusted
expenses                                       21.8 %         17.6 %         13.7 %         15.2 %          N/A            N/A           16.9 %         15.0 %

GAAP operating income for the second quarter and year-to-date periods of 2013 was $17.1 million and $31.5 million, respectively, compared to $11.1 million and $22.3 million, respectively, for the comparable 2012 periods. These increases were primarily due to increased gross profit, lower net research, development and engineering ("RD&E") investment and lower consolidation and optimization expenses partially offset by higher selling, general, and administrative ("SG&A") expenses. Adjusted operating income, which excludes consolidation, optimization and DVT costs, increased 19% and 22%, respectively, for the second quarter and year-to-date periods of 2013 to $22.2 million and $41.5 million, respectively. The increases in gross profit for the quarter and year-to-date periods was driven primarily by our higher sales volumes as well as cost savings and production efficiencies, including savings realized from the consolidation of our Swiss orthopaedic facilities and product line rationalizations, which benefitted our gross margin by approximately $1.3 million and $2.6 million, respectively, in comparison to 2012. The decrease in our RD&E is primarily a result of our efforts, beginning in 2012, to focus on medical RD&E investment and discontinue certain non-core RD&E projects as well as increased customer cost reimbursements in the first quarter of 2013. The increase in SG&A for the second quarter and year-to-date periods was primarily due to the additional cost from our investment in sales and marketing resources to drive future core business growth, as well as increased performance based compensation. These increases were partially offset by synergies realized from our acquisitions and benefits from the Swiss orthopaedic facility consolidation.

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GAAP and adjusted diluted EPS for the second quarter of 2013 were $0.39 and $0.56 per share, respectively, compared to $0.16 and $0.43 per share, respectively, for the second quarter of 2012. For the first six months of 2013, GAAP and adjusted diluted EPS were $0.62 and $0.99 per share, respectively, compared to $0.35 and $0.79 per share, respectively, for the same period of 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                                      Six Months Ended
                                             June 28,                   June 29,                   June 28,                    June 29,
                                               2013                       2012                       2013                        2012
                                                    Impact                     Impact                      Impact                     Impact
                                                      Per                        Per                        Per                         Per
                                        Net         Diluted        Net         Diluted        Net         Diluted         Net         Diluted
                                       Income        Share        Income        Share        Income        Share         Income        Share
Net income as reported                $  9,752     $    0.39     $  3,851     $    0.16     $ 15,415      $   0.62      $  8,318     $    0.35
Adjustments:
Inventory step-up amortization
(COS)                                       -             -            -             -            -             -            346          0.01
Medical device DVT expenses (RD&E)         803          0.03        1,024          0.04        1,930          0.08         1,699          0.07
Consolidation and optimization
costs(a)                                 2,956          0.12        2,896          0.12        5,296          0.21         3,915          0.16
Acquisition and integration
expenses(a)                                 46            -            73            -           118            -            686          0.03
Asset dispositions, severance and
other(a)                                    26            -           881          0.04           91            -          1,033          0.04
Loss on cost and equity method
investments, net(b)                        352          0.01           -             -           398          0.02            -             -
CSN conversion option discount
amortization(c)                             -             -         1,471          0.06        2,906          0.12         2,915          0.12
2012 R&D Tax Credit(d)                      -             -            -             -        (1,500 )       (0.06 )          -             -

Adjusted net income and diluted
EPS(e)                                $ 13,935     $    0.56     $ 10,196     $    0.43     $ 24,654      $   0.99      $ 18,912     $    0.79

Adjusted diluted weighted average
shares                                  24,922                     23,876                     24,818                      23,816

(a) Net of tax amounts computed using a 35% U.S. statutory tax rate for the 2013 and 2012 periods and a 0% and 22.5% Switzerland tax rate for the 2013 and 2012 periods, respectively.

(b) Pre-tax amount is $542 thousand and $612 thousand for the quarter and year-to-date periods, respectively.

(c) Pre-tax amount is $4.5 million for the 2013 year-to-date period and $2.3 million and $4.5 million for the 2012 quarter and year-to-date periods, respectively.

(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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Financial Guidance

We are encouraged by our strong second quarter revenue performance, but continue to believe our full year sales will be at the lower end of our revenue guidance provided at the beginning of the year of $660 to $680 million. If achieved, this would result in organic revenue growth of 5% - 8% after adjusting for the disposition of $15 million of non-core orthopaedic product lines at the end of 2012. Our manufacturing operations continue to perform well. As a result, we now believe our adjusted operating margin will approximate 13.0% for the total year and our effective adjusted tax rate will be around 33%. Because of our current higher stock price we are estimating that our diluted outstanding shares for EPS purposes will be approximately 25.0 million for 2013.

Based upon these expectations and our results for the first half of the year, we now believe that our 2013 adjusted diluted EPS guidance range will be $2.05 to $2.15 per share an increase from the previously disclosed $2.00 to $2.05 per share.

Our CEO's View

We are very pleased with our performance in the second quarter as adjusted diluted EPS increased 30% to $0.56 per share. These improvements were fueled by:

Constant currency organic revenue growth of 6%,

A 220 basis points improvement in gross margin,

A 2% reduction in our operating expenses, and

An effective tax rate of 35% for the quarter.

Additionally, the strategy laid out at our Investor Day earlier this year continues to be implemented aggressively as we establish Greatbatch as a growth company where we have a competitive advantage in the markets we serve, we continue to introduce innovative product offerings into the market place, and where organic growth represents a significant percentage of recurring revenue growth.

Our new organization structure announced in June further enables Greatbatch to accomplish these strategic growth objectives and achieve our goal of 5% organic revenue growth. Our sales and marketing investments are bearing fruit. Additionally, we will maintain a disciplined approach to identifying, executing, and integrating tuck-in acquisitions to enhance our core business. Our approach to commercializing Algostim has not changed, and is proceeding as planned with regulatory submissions.

Greatbatch continues on its evolution and has a profitable core business that is able to adapt to our growth vision. Our core business is well positioned because OEM customers leverage our portfolio of intellectual property, and we are building a healthy pipeline of diverse medical technology opportunities.

Over the last eight years Greatbatch has successfully integrated and consolidated its businesses and facilities. This has led us to an inflection in which we can build upon our strong operations foundation to establish Greatbatch as a growth company. Our new organization structure allows dedicated resources to focus on growth. Combined with our stronger discipline to ensure we have adequate returns for all projects, the new organizational structure will help us to continue to improve our bottom line performance and our return on invested capital. In this new structure we have retained and enhanced the leadership team and the capabilities that have driven our operational excellence. This foundation, which we stand on when working with our OEM partners, will continue to drive our growth strategy.

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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.

Neuromodulation portfolio - With regards to Algostim, our spinal cord stimulator for the treatment of chronic pain in the trunk and limbs, everything is moving along on schedule. We have accelerated our timeline for CE Mark which we now expect to submit in early 2014, and our plans to submit our literature based PMA later this year is on course. Operationally, we are finalizing contracts with key suppliers and collaboration continues with JPMorgan who is assisting us in identifying commercial partners.

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. 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.

In June 2013, the Company initiated a plan to realign its operating structure in order to optimize its continued focus on profitable growth. As part of this initiative, the sales & marketing and operations groups of our Implantable Medical and Electrochem segments were combined into one sales & marketing and one operations group serving the entire Company. Total restructuring charges expected to be incurred in connection with this realignment is between $4.2 million to $5.0 million, of which $0.9 million has been incurred to date. Expenses related to this initiative will be recorded within the applicable segment and corporate cost centers to which the expenditures relate. When fully implemented, this plan is expected to result in annual savings of approximately $7.0 to $7.7 million.

In addition, in 2010, we initiated 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 $21.8 million has been expended to date. Total expense expected to be incurred for these initiatives is between $39 million and $40 million, of which $38.4 . . .

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