U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarter ended September 29, 2006
Commission File Number 1-16137
GREATBATCH, INC.
(Exact name of Registrant as specified in its charter)
Delaware
(State of incorporation)
16-1531026
(I.R.S. employer identification no.)
9645 Wehrle Drive
Clarence, New York
14031
(Address of principal executive offices)
(716) 759-5600
(Registrant's telephone number, including area code)
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [ X ] No [ ]
Indicate by check mark whether the Registrant is a large accelerated filer,
an accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer" and "large accelerated filer" in Exchange Act Rule 12b-2 (check one):
----------------------------- ---------------------- ---------------------------
Large accelerated filer [ ] Accelerated filer [X] Non-accelerated filer [ ]
----------------------------- ---------------------- ---------------------------
Indicate by check mark whether the Registrant is a shell company (as
defined in Exchange Act Rule 12b-2). Yes [ ] No [ X ]
The number of shares outstanding of the Company's common stock, $0.001 par value
per share, as of November 7, 2006 was: 22,013,180 shares.
GREATBATCH, INC.
TABLE OF CONTENTS FOR FORM 10-Q
AS OF AND FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 29, 2006
Page
COVER PAGE 1
TABLE OF CONTENTS 2
PART I - FINANCIAL INFORMATION (unaudited)
ITEM 1. Condensed Consolidated Financial Statements
Condensed Consolidated Balance Sheets 3
Condensed Consolidated Statements of Operations and
Comprehensive Income 4
Condensed Consolidated Statements of Cash Flows 5
Notes to Condensed Consolidated Financial Statements 6
ITEM 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 25
ITEM 3. Quantitative and Qualitative Disclosures About Market Risk 41
ITEM 4. Controls and Procedures 41
PART II - OTHER INFORMATION
ITEM 1. Legal Proceedings 42
ITEM 1A. Risk Factors 42
ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds 42
ITEM 3. Defaults Upon Senior Securities 42
ITEM 4. Submission of Matters to a Vote of Security Holders 42
ITEM 5. Other Information 43
ITEM 6. Exhibits 43
SIGNATURES 43
EXHIBIT INDEX 44
PART I - FINANCIAL INFORMATION
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
GREATBATCH, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS - Unaudited
(in thousands except share and per share data)
---------------------------------------------------------------------------------------------
ASSETS September 29, December 30,
2006 2005
--------- ---------
Current assets:
Cash and cash equivalents $ 55,792 $ 46,403
Short-term investments 72,426 65,746
Accounts receivable, net of allowance of $540 in 2006
and $450 in 2005 35,856 29,997
Inventories 54,657 45,184
Refundable income taxes -- 928
Deferred income taxes 5,635 6,257
Prepaid expenses and other current assets 3,074 1,488
--------- ---------
Total current assets 227,440 196,003
Property, plant, and equipment, net 92,090 97,705
Amortizing intangible assets, net 29,027 31,891
Trademark and names 28,252 28,252
Goodwill 155,039 155,039
Other assets 3,449 4,021
--------- ---------
Total assets $ 535,297 $ 512,911
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 13,697 $ 13,678
Accrued expenses and other current liabilities 23,649 29,903
Current portion of long-term debt -- 464
--------- ---------
Total current liabilities 37,346 44,045
Convertible subordinated notes 170,000 170,000
Deferred income taxes 34,468 30,261
--------- ---------
Total liabilities 241,814 244,306
--------- ---------
Stockholders' equity:
Preferred stock, $0.001 par value, authorized 100,000,000
shares; no shares issued or outstanding in 2006 or 2005 -- --
Common stock, $0.001 par value, authorized 100,000,000
shares; 22,013,180 shares issued and outstanding in 2006 and
21,658,134 shares issued and outstanding in 2005 22 22
Additional paid-in capital 223,034 215,614
Retained earnings 67,771 53,039
Accumulated other comprehensive income (loss) 2,656 (70)
--------- ---------
Total stockholders' equity 293,483 268,605
--------- ---------
Total liabilities and stockholders' equity $ 535,297 $ 512,911
========= =========
The accompanying notes are an integral part of these condensed consolidated
financial statements
-3-
GREATBATCH, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE INCOME - Unaudited
(in thousands except per share data)
----------------------------------------------------------------------------------------------------------------
Three months ended Nine months ended
September 29, September 30, September 29, September 30,
2006 2005 2006 2005
------------- ------------- ------------- -------------
Sales $ 69,294 $ 62,358 $ 207,999 $ 182,240
Cost and expenses:
Cost of sales - excluding amortization
of intangible assets 42,709 38,178 125,087 112,154
Cost of sales - amortization of intangible assets 948 967 2,864 2,883
Selling, general and administrative expenses 9,311 8,842 28,191 24,089
Research, development and engineering costs, net 6,022 5,124 18,062 13,182
Other operating expense, net 6,239 7,818 12,551 14,207
------------- ------------- ------------- -------------
Operating income 4,065 1,429 21,244 15,725
Interest expense 1,135 1,154 3,433 3,476
Interest income (1,521) (796) (4,066) (2,024)
Other (income) expense, net 171 (9) 51 (69)
------------- ------------- ------------- -------------
Income before provision for income taxes 4,280 1,080 21,826 14,342
Provision for income taxes 1,041 324 7,094 4,303
------------- ------------- ------------- -------------
Net income $ 3,239 $ 756 $ 14,732 $ 10,039
============= ============= ============= =============
Earnings per share:
Basic $ 0.15 $ 0.03 $ 0.68 $ 0.47
Diluted $ 0.15 $ 0.03 $ 0.65 $ 0.46
Weighted average shares outstanding:
Basic 21,816 21,621 21,788 21,559
Diluted 21,983 21,895 26,176 21,740
Comprehensive income:
Net income $ 3,239 $ 756 $ 14,732 $ 10,039
Net unrealized gain (loss) on
available-for-sale securities (96) 41 2,726 (60)
------------- ------------- ------------- -------------
Comprehensive income $ 3,143 $ 797 $ 17,458 $ 9,979
============= ============= ============= =============
The accompanying notes are an integral part of these condensed consolidated
financial statements
-4-
GREATBATCH, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS - Unaudited
(in thousands)
-----------------------------------------------------------------------------------------
Nine months ended
September 29, September 30,
2006 2005
------------- -------------
Cash flows from operating activities:
Net income $ 14,732 $ 10,039
Adjustments to reconcile net income to
net cash provided by operating activities:
Depreciation and amortization 14,492 14,038
Stock-based compensation 6,603 2,468
Deferred income taxes 4,207 5,934
Loss on disposal of assets 5,273 5,258
Changes in operating assets and liabilities:
Accounts receivable (5,859) (10,312)
Inventories (9,473) (2,130)
Prepaid expenses and other current assets (1,586) (796)
Accounts payable 1,293 3,327
Accrued expenses and other current liabilities (5,048) 6,718
Income taxes 121 (1,712)
------------- -------------
Net cash provided by operating activities 24,755 32,832
------------- -------------
Cash flows from investing activities:
Short-term investments:
Purchases (29,846) (63,178)
Proceeds from dispositions 26,532 58,043
Acquisition of property, plant and equipment (12,060) (22,690)
Proceeds from sale of assets 39 82
Decrease (increase) in other assets 19 (401)
------------- -------------
Net cash used in investing activities (15,316) (28,144)
------------- -------------
Cash flows from financing activities:
Principal payments of long-term debt (464) (890)
Payment of debt issue costs -- (213)
Proceeds from exercise of stock options and stock issued 414 936
------------- -------------
Net cash used in financing activities (50) (167)
------------- -------------
Net increase in cash and cash equivalents 9,389 4,521
Cash and cash equivalents, beginning of year 46,403 34,795
------------- -------------
Cash and cash equivalents, end of period $ 55,792 $ 39,316
============= =============
The accompanying notes are an integral part of these condensed consolidated
financial statements
-5-
GREATBATCH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Unaudited
--------------------------------------------------------------------------------
1. BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements have
been prepared in accordance with accounting principles generally accepted
in the United States of America for interim financial information
(Accounting Principles Board Opinion ("APB") No. 28, Interim Financial
Reporting) and with the instructions to Form 10-Q and Article 10 of
Regulation S-X. Accordingly, they do not include all of the information
necessary for a fair presentation of financial position, results of
operations, and cash flows in conformity with accounting principles
generally accepted in the United States of America. Operating results for
interim periods are not necessarily indicative of results that may be
expected for the fiscal year as a whole. In the opinion of management, the
condensed consolidated financial statements reflect all adjustments
(consisting of normal recurring adjustments) considered necessary for a
fair presentation of the results of Greatbatch, Inc. (the "Company") for
the periods presented. The preparation of financial statements in
conformity with accounting principles generally accepted in the United
States of America requires management to make estimates and assumptions
that affect the reported amounts of assets, liabilities, sales, expenses,
and related disclosures at the date of the financial statements and during
the reporting period. Actual results could differ from these estimates. The
December 30, 2005 condensed consolidated balance sheet data was derived
from audited financial statements but does not include all disclosures
required by accounting principles generally accepted in the United States
of America. For further information, refer to the consolidated financial
statements and notes included in the Company's Annual Report on Form 10-K
for the year ended December 30, 2005.
The Company utilizes 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 third quarter of 2006 and 2005 ended on September 29 and
September 30, respectively. The Company has revised its Condensed
Consolidated Statement of Operations and Comprehensive Income to eliminate
presentation of gross profit effective December 31, 2005. At the same time,
the Company has associated the amortization expense of intangible assets
with cost of sales.
2. STOCK-BASED COMPENSATION
Beginning in fiscal year 2006, the Company adopted the Financial Accounting
Standards Board ("FASB") Statement of Financial Accounting Standards
("SFAS") No. 123 (revised 2004), Share-Based Payment ("SFAS No. 123(R)"),
and related Securities and Exchange Commission ("SEC") rules included in
Staff Accounting Bulletin ("SAB") No. 107, on a modified prospective basis.
Under this method, the Company began recognizing compensation cost,
beginning in fiscal year 2006, related to 1) all share-based payments
(stock options and restricted stock awards) granted prior to but not yet
vested as of the beginning of fiscal year 2006, based on the grant-date
fair value estimated in accordance with the original provisions of SFAS No.
123, Accounting for Stock-Based Compensation, and 2) all share-based
payments (stock options, restricted stock and restricted stock unit awards)
granted subsequent to the beginning of fiscal year 2006 based on the
grant-date fair value estimated in accordance with the provisions of SFAS
No.123(R). SFAS No. 123(R) also amends SFAS No. 95, Statement of Cash
Flows, to require excess tax benefits that had previously been reflected as
cash flows from operating activities be reflected as cash flows from
financing activities.
-6-
GREATBATCH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (con't) - Unaudited
--------------------------------------------------------------------------------
Compensation cost for service-based stock options and restricted stock
awards is recognized ratably over the applicable vesting period.
Compensation cost for performance-based stock options and restricted stock
units is reassessed each period and recognized based upon the probability
that the performance targets will be achieved. The Company utilizes the
Black-Scholes option pricing model to estimate the fair value of stock
options granted.
Compensation costs related to share-based payments for the three months
ended September 29, 2006 totaled $1.6 million ($1.1 million net of tax or
$0.05 per diluted share) and $4.2 million ($2.8 million net of tax or $0.11
per diluted share) for the nine months ended September 29, 2006. These
amounts include $0.6 million and $1.5 million for the three and nine months
ended September 29, 2006, respectively, for accelerated vesting for certain
retirement-eligible employees. The incremental cost of expensing stock
options under SFAS No. 123(R) for the three and nine months ended September
29, 2006 was $1.1 million ($0.7 million net of tax) and $2.9 million ($2.0
million net of tax), respectively. Stock-based compensation expense
included in the Condensed Consolidated Statement of Cash Flows includes
costs recognized for stock options, restricted stock, restricted stock
units and the annual share contribution to the 401(k) Plan.
During the third quarter of 2006, the Board of Directors approved the grant
of 183,648 shares of performance based non-qualified stock options. The
performance metrics for these awards cover a three-year performance period
beginning in 2006 and include the achievement of revenue, operating
earnings per share and operating cash flow targets. Compensation expense
related to these awards amounted to $0.07 million during the third quarter
of 2006.
Stock-based compensation expense is only recorded for those awards that are
expected to vest. Forfeiture estimates for determining appropriate
stock-based compensation expense are estimated at the time of grant based
on historical experience and demographic characteristics. Revisions are
made to those estimates in subsequent periods if actual forfeitures differ
from estimated forfeitures. A 9% annual forfeiture rate estimate was used
for the stock-based compensation expense recorded during 2006 unless it was
certain that the awards would vest (i.e. retirement eligible employees). In
those instances, a 0% forfeiture rate was used.
In November 2005, the FASB issued FSP No. FAS 123(R)-3, Transition Election
Related to Accounting for the Tax Effects of Share-Based Payment Awards.
This FSP provides an elective alternative simplified method for calculating
the pool of excess tax benefits available to absorb tax deficiencies
recognized subsequent to the adoption of SFAS No. 123(R). Companies may
take up to one year from the effective date of the FSP to evaluate the
available transition alternatives and make a one-time election as to which
method to adopt. The Company is currently in the process of evaluating the
alternative methods of calculating the pool of excess tax benefits.
-7-
GREATBATCH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (con't) - Unaudited
--------------------------------------------------------------------------------
Stock Options
Summary of Plans
----------------
The Company has stock option plans that provide for the issuance of
nonqualified and incentive stock options to employees of the Company. The
Company's 1997 Stock Option Plan ("1997 Plan") authorizes the issuance of
up to 480,000 shares of nonqualified and incentive stock options to
purchase the Company's common stock, subject to the terms of the plan. The
stock options granted under the 1997 Plan generally vest over a five-year
period and may vary depending upon the achievement of certain performance
targets as determined by the Board of Directors. The stock options expire
10 years from the date of the grant. Stock options are granted at exercise
prices equal to or greater than the fair market value of the Company's
common stock at the date of grant.
The Company's 1998 Stock Option Plan ("1998 Plan") authorizes the issuance
of up to 1,220,000 shares of nonqualified and incentive stock options to
purchase the Company's common stock, subject to the terms of the plan. The
stock options granted under the 1998 Plan vest over a three to five year
period and may vary depending upon the achievement of certain performance
targets as determined by the Board of Directors. The stock options expire
10 years from the date of grant. Stock options are granted at exercise
prices equal to or greater than the fair value of the Company's common
stock at the date of grant.
The Company has a stock option plan that provides for the issuance of
nonqualified stock options to Non-Employee Directors (the "Director Plan").
The Director Plan authorizes the issuance of up to 100,000 shares of
nonqualified stock options to purchase the Company's common stock from its
treasury, subject to the terms of the plan. The stock options granted under
the Director Plan vest immediately. The stock options expire 10 years from
the date of grant. Stock options are granted at exercise prices equal to or
greater than the fair value of the Company's common stock at the date of
grant.
The Company's 2005 Stock Incentive Plan ("2005 Plan") authorizes the
issuance of up to 1,000,000 shares of equity incentive awards including
nonqualified and incentive stock options to purchase the Company's common
stock, subject to the terms of the plan. The stock options granted under
the 2005 Plan generally vest over a four to five year period and may vary
depending upon the achievement of certain performance targets as determined
by the Board of Directors and the terms of each specific grant. The stock
options expire 10 years from the date of grant. Stock options are granted
at exercise prices equal to or greater than the fair value of the Company's
common stock at the date of grant.
As of September 29, 2006, 431,478 shares were available for future grants
of options under all of the above plans.
-8-
GREATBATCH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (con't) - Unaudited
--------------------------------------------------------------------------------
Fair Value
----------
The Company utilizes the Black-Scholes Option Pricing Model to determine
the fair value of stock options under SFAS No. 123(R), consistent with that
used for pro forma disclosures in prior years. Management is required to
make certain assumptions with respect to selected model inputs, including
anticipated changes in the underlying stock price (i.e., expected
volatility) and option exercise activity (i.e., expected life). Expected
volatility is based on the historical volatility of the Company's stock
over the most recent period commensurate with the estimated expected life
of the stock options and other factors. The expected life of options
granted, which represents the period of time that the options are expected
to be outstanding, is based primarily on historical data. The expected
dividend yield is based on the Company's history and expectation of
dividend payouts. The risk-free rate is based on the U.S. Treasury yield
curve in effect at the time of grant for a period commensurate with the
estimated expected life. If factors change and result in different
assumptions in the application of SFAS No. 123(R) in future periods, the
stock option expense that the Company records for future grants may differ
significantly from what the Company has recorded in the current period.
Stock Option Activity
The following table summarizes stock option activity related to the
Company's plans for the nine months ended September 29, 2006:
Weighted
Average
Weighted Remaining Aggregate
Number of Average Contractual Intrinsic
Stock Exercise Life Value(1)
Options Price (in years) (in millions)
------------ ----------- ------------- -------------
Outstanding at December 30, 2005 1,397,160 $ 23.16
Granted 473,170 23.87
Exercised (45,475) 9.09
Forfeited or Expired (36,485) 25.44
------------
Outstanding at September 29, 2006 1,788,370 $ 23.66 7.4 $ 3.6
============ =========== ============= =============
Exercisable at September 29, 2006 859,552 $ 24.17 7.0 $ 2.6
============ =========== ============= =============
(1) Intrinsic value is calculated for in-the-money options (exercise price
less than market price) outstanding and/or exercisable as the difference
between the market price of our common shares as of September 29, 2006
($22.62) and the weighted average exercise price of the underlying options
($17.42/$13.35), multiplied by the number of options outstanding and/or
exercisable (686,939 shares/284,942 shares).
-9-
GREATBATCH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (con't) - Unaudited
--------------------------------------------------------------------------------
The weighted-average fair value and assumptions used to value options
granted in 2006 and 2005 are as follows:
Nine months ended
September 29, September 30,
2006 2005
-------------------- -------------------
Weighted-average fair value $10.85 $9.85
Risk-free interest rate 4.74% 3.94%
Expected volatility 42.5% 46.2%
Expected life (in years) 5.4 5.0
Expected dividend yield 0% 0%
The total intrinsic value of stock options exercised during the nine months
ended September 29, 2006 was $0.7 million ($0.9 million for 2005). Cash
received from the exercise of those options was $0.4 million ($0.9 million
for 2005). The actual tax benefit realized from stock option exercises for
the nine months ended September 29, 2006 was $0.06 million ($0.2 million
for 2005). Proceeds from the exercise of stock options under stock option
plans are credited to common stock at par value and the excess is credited
to additional paid-in capital.
As of September 29, 2006, $7.2 million of unrecognized compensation cost
related to non-vested stock options is expected to be recognized over a
weighted-average period of approximately 4 years.
Pro Forma Information under SFAS No. 123 for Periods Prior to 2006
------------------------------------------------------------------
Prior to the adoption of SFAS No. 123(R), we accounted for stock options to
employees in accordance with APB No. 25, Accounting for Stock Issued to
Employees, and related interpretations. We also provided the disclosures
required under SFAS No. 123, as amended by SFAS No. 148, Accounting for
Stock-Based Compensation - Transition and Disclosures. As a result, no
expense was reflected in our net income for the three and nine month
periods ended September 30, 2005 for stock options, as all options granted
had an exercise price equal to the market value of the underlying common
stock on the date of grant. However, stock-based compensation expense was
recognized for restricted stock awards.
-10-
GREATBATCH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (con't) - Unaudited
--------------------------------------------------------------------------------
The following table provides the Company's net income and earnings per
share as if the fair value based method had been applied to all outstanding
and unvested awards for the comparable prior year periods (in thousands
except per share data):
September 30, 2005
Three months Nine months
ended ended
------------ -------------
Net income as reported $756 $10,039
Add: Stock-based employee compensation cost
included in net income as reported, net of
related tax effects 714 1,728
Deduct: Stock-based employee compensation cost
determined using the fair value based method, net
of related tax effects 1,259 3,278
------------ -------------
Pro forma net income $211 $8,489
============ =============
Earnings per share:
Basic - as reported $0.03 $0.47
Basic - pro forma $0.01 $0.39
Diluted - as reported $0.03 $0.46
Diluted - pro forma $0.01 $0.39
Restricted Stock and Restricted Stock Units
Summary of Plans
----------------
The Company's 2002 Restricted Stock Plan authorizes the issuance of stock
awards to employees. The number of shares that are reserved and may be
issued under the plan cannot exceed 200,000. Restricted stock awards are
either time-vested or performance-vested based on the terms of each
individual award agreement. Time-vested restricted stock vests 50% on the
first anniversary of the date of the award and 50% on the second
anniversary of the date of the award. Performance-vested restricted stock
vests upon the achievement of certain annual diluted earnings per share
targets by the company, or the seventh anniversary date of the award.
The Company's 2005 Plan authorizes the issuance of restricted stock,
restricted stock units and stock bonuses of up to 400,000 shares, subject
to the terms of the plan with an overall limit on awards of 1,000,000
shares. Time-vested restricted stock granted under the 2005 Plan generally
vest 50% on the second anniversary of the date of the award and 25% on the
third and fourth anniversaries of the date of the award. Performance-vested
restricted stock granted under the 2005 Plan vests upon the achievement of
certain annual diluted earnings per share targets by the company, or the
seventh anniversary date of the award. Performance-vested restricted stock
units granted under the 2005 Plan vest upon the completion of Board
approved strategic initiatives.
-11-
GREATBATCH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (con't) - Unaudited
--------------------------------------------------------------------------------
As of September 29, 2006, there were 349,074 shares available for future
grants of restricted stock, restricted stock units or stock bonuses under
the 2002 and 2005 plans, subject to the overall limit imposed by the 2005
Plan.
Restricted Stock and Restricted Stock Unit Activity
---------------------------------------------------
The following table summarizes restricted stock and restricted stock unit
activity related to the Company's plans for the nine months ended September
29, 2006:
Number of
Restricted Weighted
Stock and Average
Restricted Grant Date
Units Fair Value
-------------- --------------
Nonvested at December 30, 2005 93,956 $ 22.46
Shares granted 145,126 23.25
Shares vested - -
Shares forfeited (3,641) 21.50
--------------
Nonvested at September 29, 2006 235,441 22.96
==============
There were no shares of restricted stock or restricted stock units that
vested during the nine months ended September 29, 2006 or September 30,
2005. As of September 29, 2006, there was $3.7 million of total
unrecognized compensation cost related to the restricted stock and
restricted stock unit awards. That cost is expected to be recognized over a
weighted-average period of approximately 3 years.
3. SUPPLEMENTAL CASH FLOW INFORMATION
Nine months ended
September 29, September 30,
2006 2005
--------------- --------------
Noncash investing and financing activities: (in thousands)
Net unrealized gain (loss) on available-for-sale
securities $ 2,726 $ (60)
Common stock contributed to 401(k) Plan 2,780 2,729
Property, plant and equipment purchases included
in accounts payable 619 2,268
Cash paid during the period for:
Interest $ 1,960 $ 1,955
Income taxes 2,769 60
-12-
GREATBATCH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (con't) - Unaudited
--------------------------------------------------------------------------------
4. SHORT-TERM INVESTMENTS
Short-term investments at September 29, 2006 and December 30, 2005 are
comprised of the following (in thousands):
Gross Gross
unrealized unrealized Estimated
As of September 29, 2006 Cost gains losses fair value
------------------------ -------------- -------------- ------------- -------------
Available-for-sale:
Equity Securities $ 291 $ 3,292 $ (15) $ 3,568
Auction Rate Securities and Other 68,858 - - 68,858
-------------- -------------- ------------- -------------
Total available for sale securities $ 69,149 $ 3,292 $ (15) $ 72,426
============== ============== ============= =============
As of December 30, 2005
-----------------------
Available-for-sale:
Equity Securities $ 276 $ - $ (74) $ 202
Auction Rate Securities and Other 65,544 - - 65,544
-------------- -------------- ------------- -------------
Total available for sale securities $ 65,820 $ - $ (74) $ 65,746
============== ============== ============= =============
As prescribed in SFAS No. 115, Accounting for Certain Investments in Debt
and Equity Securities, during the second quarter of 2006, the Company
classified an equity security investment as available-for-sale, which was
previously accounted for under the cost method in accordance with APB No.
18, The Equity Method of Accounting for Investments in Common Stock, as the
investment now has a readily determinable fair value due to the associated
Company's stock offering. This resulted in an unrealized gain of $3.3
million ($2.7 million net of tax) which was recorded within accumulated
other comprehensive income, net of tax, for the nine month period ended
September 29, 2006.
5. INVENTORIES
Inventories are comprised of the following (in thousands):
September 29, December 30,
2006 2005
----------------- -----------------
Raw materials $ 28,557 $ 24,864
Work-in-process 12,894 11,266
Finished goods 13,206 9,054
----------------- -----------------
Total $ 54,657 $ 45,184
================= =================
-13-
GREATBATCH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (con't) - Unaudited
--------------------------------------------------------------------------------
6. AMORTIZING INTANGIBLE ASSETS
Amortizing intangible assets are comprised of the following (in thousands):
Gross carrying Accumulated Net carrying
As of September 29, 2006 amount amortization amount
--------------------------------- ---------------- -------------- --------------
Amortizing intangible assets:
Patented technology $21,462 $(12,902) $ 8,560
Unpatented technology 30,886 (10,419) 20,467
Other 1,340 (1,340) -
---------------- -------------- --------------
$53,688 $(24,661) $29,027
================ ============== ==============
As of December 30, 2005
---------------------------------
Amortizing intangible assets:
Patented technology $21,462 $(11,738) $ 9,724
Unpatented technology 30,886 (8,750) 22,136
Other 1,340 (1,309) 31
---------------- -------------- --------------
$53,688 $(21,797) $31,891
================ ============== ==============
Aggregate amortization expense for the third quarter of 2006 and 2005 was
$0.9 million and $1.0 million, respectively, and $2.9 million each for the
nine months ended September 29, 2006 and September 30, 2005. Annual
amortization expense is estimated to be $0.9 million for the remainder of
2006, $3.8 million for 2007 and 2008, $3.2 million for 2009, and $2.7
million for 2010 and 2011.
7. DEBT
Long-term debt is comprised of the following (in thousands):
September 29, December 30,
2006 2005
-------------- ---------------
2.25% convertible subordinated notes, due 2013 $170,000 $170,000
Capital lease obligations - 464
-------------- ---------------
170,000 170,464
Less current portion - (464)
-------------- ---------------
Total long-term debt $170,000 $170,000
============== ===============
-14-
GREATBATCH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (con't) - Unaudited
--------------------------------------------------------------------------------
Revolving Line of Credit
The Company maintains a three-year $50.0 million Revolving Credit Facility
(the "Revolver"), which contains a $10.0 million sub-limit for the issuance
of commercial or standby letters of credit. The Revolver is secured by the
Company's non-realty assets including cash, accounts and notes receivable,
and inventories and has an expiration date of May 31, 2008. The Revolver
requires the Company to comply with two quarterly financial covenants, as
defined. The first relates to the ratio of consolidated net earnings or
loss before interest, taxes, depreciation, and amortization ("EBITDA") to
fixed charges. The second is a leverage ratio, which is calculated based on
the ratio of consolidated funded debt less cash, cash equivalent
investments and short-term investments to consolidated EBITDA. Interest
rates under the Revolver vary with the Company's leverage. The Company is
required to pay a commitment fee of between 0.125% and 0.250% per annum on
the unused portion of the Revolver based on the Company's leverage. As of
September 29, 2006, the Company had no balance outstanding on the Revolver.
8. EARNINGS PER SHARE
The following table reflects the calculation of basic and diluted earnings
per share (in thousands, except per share amounts):
Three months ended Nine months ended
September 29, September 30, September 29, September 30,
2006 2005 2006 2005
------------- ------------- ------------- -------------
Numerator for basic earnings per share:
Net Income $ 3,239 $ 756 $ 14,732 $ 10,039
Effect of dilutive securities:
Interest expense on convertible notes and
related deferred financing fees, net of tax - - 2,264 -
------------- ------------- ------------- -------------
Numerator for diluted earnings per share $ 3,239 $ 756 $ 16,996 $ 10,039
============= ============= ============= =============
Denominator for basic earnings per share:
Weighted average shares outstanding 21,816 21,621 21,788 21,559
Effect of dilutive securities:
Convertible notes - - 4,219 -
Stock options and unvested restricted stock 167 274 169 181
------------- ------------- ------------- -------------
Dilutive potential common shares 167 274 4,388 181
------------- ------------- ------------- -------------
Denominator for diluted earnings per share 21,983 21,895 26,176 21,740
============= ============= ============= =============
Basic earnings per share $ 0.15 $ 0.03 $ 0.68 $ 0.47
============= ============= ============= =============
Diluted earnings per share $ 0.15 $ 0.03 $ 0.65 $ 0.46
============= ============= ============= =============
-15-
GREATBATCH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (con't) - Unaudited
--------------------------------------------------------------------------------
The diluted weighted average share calculations do not include 1,193,449
stock options for the three and nine months ended September 29, 2006 and
670,336 and 900,618 stock options for the three and nine months ended
September 30, 2005, respectively, as they are not dilutive to the earnings
per share calculations. Additionally, the diluted weighted average share
calculations for the three months ended September 29, 2006 and the three
and nine months ended September 30, 2005 do not include 4,219,409 shares
related to the convertible subordinated notes, as they are not dilutive to
the earnings per share calculations.
9. COMPREHENSIVE INCOME
The Company's comprehensive income includes net income and the net
unrealized gain (loss) on its available-for-sale securities. The net
unrealized gain (loss) on available-for-sale securities reported on the
Condensed Consolidated Statements of Operations and Comprehensive Income
are shown net of deferred income tax benefit of $0.06 million and tax
expense of $0.6 million for the three and nine month periods of 2006,
respectively, and deferred income tax expense of $0.02 million and tax
benefit of $0.03 million in the three and nine month periods of 2005,
respectively.
10. COMMITMENTS AND CONTINGENCIES
Litigation - During 2002, a former non-medical customer commenced an action
alleging that the Company had used proprietary information of the customer
to develop certain products. The Company believes that it has meritorious
defenses and is vigorously defending the matter. The potential risk of loss
is between $0.0 and $1.7 million.
As reported in the Company's 2005 first quarter Form 10-Q, on May 2, 2005,
a complaint was filed against the Company by a developer of an implantable
drug delivery device in the United States Federal District Court for the
Central District of California. On May 20, 2005, the parties entered into a
settlement agreement under which the Company undertook certain obligations
including the performance of certain additional development tasks for a
limited period of time. On June 2, 2005, the Court ordered the complaint
dismissed without prejudice. During the second quarter of 2006, a letter
was received from the developer claiming that the Company was in breach of
the settlement agreement. The Company asserted a counter-position that the
developer also breached the settlement agreement and initiated the
mandatory arbitration process as allowed for under the settlement
agreement. During the third quarter of 2006, this dispute between the
developer and the Company was settled and each party executed a legally
binding release. All costs and payments associated with this resolution had
been previously accrued under the May 20, 2005 settlement agreement and no
further charges are anticipated.
Product Warranties - The Company generally warrants that its products will
meet customer specifications and will be free from defects in materials and
workmanship. The Company accrues its estimated exposure to warranty claims
based upon recent historical experience and other specific information as
it becomes available.
-16-
GREATBATCH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (con't) - Unaudited
--------------------------------------------------------------------------------
The change in aggregate product warranty liability for the quarter ended
September 29, 2006 is as follows (in thousands):
Beginning balance at June 30, 2006 $ 1,711
Additions to warranty reserve 559
Warranty claims paid (399)
---------------
Ending balance at September 29, 2006 $ 1,871
===============
Purchase Commitments - In the normal course of business, the Company makes
routine purchase commitments (primarily equipment and raw material
purchases) in order to maintain the technological leadership of its
manufacturing facilities and meet the needs of its customers. As of
September 29, 2006, the total contractual obligation related to such
expenditures is $8.6 million and will be financed by existing cash,
short-term investments, or cash generated from operations.
11. BUSINESS SEGMENT INFORMATION
The Company operates its business in two reportable segments: Implantable
Medical Components ("IMC") and Electrochem Commercial Power ("ECP"). The
IMC segment designs and manufactures critical components used in
implantable medical devices. The principal components are batteries,
capacitors, filtered feedthroughs, enclosures and precision components. The
principal medical devices are pacemakers, defibrillators and
neurostimulators. The ECP segment designs and manufactures high performance
batteries and battery packs; principal markets for these products are for
oil and gas exploration, oceanographic equipment, and aerospace.
The Company defines segment income from operations as sales less cost of
sales, including amortization, and expenses attributable to
segment-specific selling, general, administrative, research, development,
engineering and other operating expenses. Segment income also includes a
portion of non-segment specific selling, general, administrative, research,
development and engineering expenses based on allocations appropriate to
the expense categories. The remaining unallocated operating expenses are
primarily corporate headquarters and administrative function expenses. The
unallocated operating expenses along with other income and expense are not
allocated to reportable segments. Transactions between the two segments are
not significant.
-17-
GREATBATCH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (con't) - Unaudited
--------------------------------------------------------------------------------
An analysis and reconciliation of the Company's business segment
information to the respective information in the consolidated financial
statements is as follows (in thousands):
Three months ended Nine months ended
September 29, September 30, September 29, September 30,
Sales: 2006 2005 2006 2005
------------- ------------- ------------- -------------
IMC
ICD batteries $ 11,456 $ 11,345 $ 35,129 $ 34,783
Pacemaker and other batteries 4,439 5,424 16,156 16,917
ICD capacitors 4,499 5,349 13,406 15,600
Feedthroughs 17,355 16,386 47,944 45,927
Enclosures 5,698 6,203 19,143 18,769
Other medical 13,560 9,378 42,565 24,740
------------- ------------- ------------- -------------
Total IMC 57,007 54,085 174,343 156,736
ECP 12,287 8,273 33,656 25,504
------------- ------------- ------------- -------------
Total sales $ 69,294 $ 62,358 $ 207,999 $ 182,240
============= ============= ============= =============
Segment income from operations:
IMC $ 3,476 $ 3,383 $ 23,144 $ 20,744
ECP 3,976 1,992 10,061 6,300
------------- ------------- ------------- -------------
Total segment income from operations 7,452 5,375 33,205 27,044
Unallocated operating expenses (3,387) (3,946) (11,961) (11,319)
------------- ------------- ------------- -------------
Operating income as reported 4,065 1,429 21,244 15,725
Unallocated other income (expense) 215 (349) 582 (1,383)
------------- ------------- ------------- -------------
Income before provision for income
taxes as reported $ 4,280 $ 1,080 $ 21,826 $ 14,342
============= ============= ============= =============
The carrying amount of goodwill at September 29, 2006 and December 30, 2005
for IMC was $152.4 million and $2.6 million for ECP.
-18-
GREATBATCH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (con't) - Unaudited
--------------------------------------------------------------------------------
12. OTHER OPERATING EXPENSE
The following charges were recorded in other operating expense in the
Company's Condensed Consolidated Statement of Operations and Comprehensive
Income (in thousands).
Three months ended Nine months ended
September 29, September 30, September 29, September 30,
2006 2005 2006 2005
------------- ------------- ------------- -------------
(a) Alden facility consolidation $ - $ 1,428 $ 567 $ 2,323
(b) Carson City facility shutdown and
Tijuana facility consolidation No. 1 411 1,595 2,450 2,468
(c) Columbia facility shutdown, Tijuana
facility consolidation No. 2 and RD&E
consolidation 1,225 - 3,546 -
(d) Tijuana start-up - 380 - 865
(e) Asset dispositions and other 4,603 4,415 5,988 7,046
(f) Severance - - - 1,505
------------- ------------- ------------- -------------
$ 6,239 $ 7,818 $ 12,551 $ 14,207
============= ============= ============= =============
(a) Alden Facility Consolidation - Beginning in the first quarter of 2005
and ending in the second quarter of 2006 we consolidated the medical
capacitor manufacturing operations in Cheektowaga, NY, and the implantable
medical battery manufacturing operations in Clarence, NY, into the advanced
power source manufacturing facility in Alden, NY ("Alden Facility"). The
Company also consolidated the capacitor research, development and
engineering operations from the Cheektowaga, NY, facility into the
Technology Center in Clarence, NY.
The total cost for these consolidation efforts was $3.4 million, which was
below the Company's original estimate of $3.5 to $4.0 million. The expenses
for the Alden Facility consolidation are included in the IMC business
segment and included the following:
o Production inefficiencies and revalidation - $0.03 million;
o Moving and facility closures - $2.7 million; and
o Other - $0.4 million.
-19-
GREATBATCH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (con't) - Unaudited
--------------------------------------------------------------------------------
Accrued liabilities related to the Alden Facility consolidation are
comprised of the following (in thousands):
Production Moving and
inefficiencies facility
and revalidation Training closures Other Total
Restructuring charges $ 230 $ 23 $ 2,180 $ 373 $ 2,806
Cash payments (230) (23) (1,144) (373) (1,770)
Accelerated depreciation/
asset write-offs - - (838) - (838)
----------------- --------- ------------ --------- ---------
Balance, December 30, 2005 $ - $ - $ 198 $ - $ 198
Restructuring charges 43 - 524 - 567
Cash payments (43) - (722) - (765)
Accelerated depreciation/
asset write-offs - - - - -
----------------- --------- ------------ --------- ---------
Balance, September 29, 2006 $ - $ - $ - $ - $ -
================= ========= ============ ========= =========
(b) Carson City Facility shutdown and Tijuana Facility consolidation No. 1.
On March 7, 2005, the Company announced its intent to close the Carson
City, NV facility ("Carson City Facility") and consolidate the work
performed at that facility into the Tijuana, Mexico facility ("Tijuana
Facility consolidation No. 1").
The Company has delayed the anticipated final closing of the Carson City
Facility until the end of the first quarter of 2007 in order to accommodate
a customer's pending regulatory approval. If this regulatory approval is
delayed further, additional costs could be incurred. The total revised
estimate for this plan is anticipated to be between $7.2 million and $7.4
million of which $6.9 million has been incurred through September 29, 2006.
The major categories of costs include the following:
o Costs related to the shutdown of the Carson City Facility:
a. Severance and retention - $3.4 million;
b. Accelerated depreciation - $0.6 million; and
c. Other - $0.5 million.
o Costs related to Tijuana Facility consolidation No. 1:
a. Production inefficiencies and revalidation - $0.4 to $0.5 million;
b. Relocation and moving - $0.3 million;
c. Personnel (including travel, training and duplicate wages) - $1.5 to
$1.6 million; and
d. Other - $0.5 million.
-20-
GREATBATCH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (con't) - Unaudited
--------------------------------------------------------------------------------
All categories of costs are considered to be cash expenditures, except
accelerated depreciation. Once the moves are completed, the Company
anticipates annual cost savings in the range of $2.5 to $3.1 million. The
expenses for the Carson City Facility shutdown and the Tijuana Facility
consolidation No. 1 is included in the IMC business segment.
Accrued liabilities at September 29, 2006 related to the Carson City
Facility shutdown are comprised of the following (in thousands):
Severance and Accelerated
retention Depreciation Other Total
Restructuring charges $ 2,096 $ 595 $ 221 $ 2,912
Cash payments - - (221) (221)
Write-offs - (595) - (595)
------------- ------------- ---------- ----------
Balance, December 30, 2005 $ 2,096 $ - $ - $ 2,096
Restructuring charges 1,183 5 43 1,231
Cash payments (2,110) - (43) (2,153)
Write-offs - (5) - (5)
------------- ------------- ---------- ----------
Balance, September 29, 2006 $ 1,169 $ - $ - $ 1,169
============= ============= ========== ==========
Accrued liabilities at September 29, 2006 related to the Tijuana Facility
consolidation No. 1 are comprised of the following (in thousands):
Production
inefficiencies Relocation
and revalidation and moving Personnel Other Total
Restructuring charges $ 5 $ 123 $ 1,050 $ 350 $ 1,528
Cash payments (5) (123) (1,050) (350) (1,528)
Write-offs - - - - -
----------------- ------------ ----------- -------- ---------
Balance, December 30, 2005 $ - $ - $ - $ - $ -
Restructuring charges 288 1 644 286 1,219
Cash payments (288) (1) (644) (286) (1,219)
Write-offs - - - - -
----------------- ------------ ----------- -------- ---------
Balance, September 29, 2006 $ - $ - $ - $ - $ -
================= ============ =========== ======== =========
(c) Columbia Facility shutdown, Tijuana Facility consolidation No. 2 and
RD&E consolidation. On November 16, 2005, the Company announced its intent
to close both the Columbia, MD facility ("Columbia Facility") and the
Fremont, CA Advanced Research Laboratory ("ARL"). The manufacturing
operations at the Columbia Facility will be moved into the Tijuana Facility
("Tijuana Facility consolidation No. 2"). The research, development and
engineering ("RD&E") and product development functions at the Columbia
Facility and at ARL will relocate to the Technology Center in Clarence, NY.
-21-
GREATBATCH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (con't) - Unaudited
--------------------------------------------------------------------------------
The total estimated cost for this facility consolidation plan is
anticipated to be between $7.9 million and $8.3 million of which $4.7
million has been incurred through September 29, 2006. The ARL move and
closure portion of this consolidation project is complete. The Company
expects to incur and pay the remaining cost for the other portions of the
consolidation project over the next three fiscal quarters through June
2007. The major categories of costs include the following:
o Costs related to the shutdown of the Columbia Facility and ARL and the
move and consolidation of the RD&E functions to Clarence, NY:
a. Severance and retention - $2.7 to $2.8 million;
b. Personnel (including travel, training and duplicate wages)
- $1.5 million
c. Accelerated depreciation/asset write-offs - $0.7 million; and
d. Other - $0.3 to $0.4 million.
o Costs related to Tijuana Facility consolidation No. 2:
a. Production inefficiencies and revalidation - $0.4 to $0.5 million;
b. Relocation and moving - $0.2 million;
c. Personnel (including travel, training and duplicate wages) - $2.0 to
$2.1 million; and
d. Other (including asset write-offs) - $0.1 million.
All categories of costs are considered to be cash expenditures, except for
accelerated depreciation and asset write-offs. Once the moves are
completed, the Company anticipates annual cost savings in the range of $5.0
to $6.0 million. The expenses for the Columbia Facility and ARL shutdowns,
the Tijuana Facility consolidation No. 2 and the RD&E consolidation are
included in the IMC business segment.
Accrued liabilities at September 29, 2006 related to the Columbia Facility
and ARL shutdowns and the RD&E consolidation are comprised of the following
(in thousands):
Severance Accelerated
and depreciation /
retention Personnel asset write-offs Other Total
Restructuring charges $ 379 $ - $ 435 $ 310 $ 1,124
Cash payments - - - - -
Write-offs - - (435) - (435)
----------- ----------- ----------------- -------- ---------
Balance, December 30, 2005 $ 379 $ - $ - $ 310 $ 689
Restructuring charges 1,391 518 56 101 2,066
Cash payments (370) (518) - (411) (1,299)
Write-offs - - (56) - (56)
----------- ----------- ----------------- -------- ---------
Balance, September 29, 2006 $ 1,400 $ - $ - $ - $ 1,400
=========== =========== ================= ======== =========
-22-
GREATBATCH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (con't) - Unaudited
--------------------------------------------------------------------------------
Accrued liabilities at September 29, 2006 related to Tijuana Facility
consolidation No. 2 are comprised of the following (in thousands):
Production
inefficiencies Relocation
and revalidation and moving Personnel Other Total
Restructuring charges $ - $ - $ 10 $ - $ 10
Cash payments - - (10) - (10)
----------------- ----------- ----------- -------- ---------
Balance, December 30, 2005 $ - $ - $ - $ - $ -
Restructuring charges - 109 1,127 244 1,480
Cash payments - (109) (1,127) (244) (1,480)
----------------- ----------- ----------- -------- ---------
Balance, September 29, 2006 $ - $ - $ - $ - $ -
================= =========== =========== ======== =========
(d) Tijuana start-up. Other Tijuana start-up expenses (not associated with
the Carson City Facility or Columbia Facility consolidation) during the
three and nine months ended September 30, 2005 amounted to $0.4 million and
$0.9 million, respectively. These expenses are primarily related to the
initial start-up of the value added assembly business.
(e) Asset dispositions and other. During the third quarter of 2006, the
Company recorded a loss of $4.4 million related to the write-off of a
battery test system that was under development. Upon completion of the
Company's engineering and technical evaluation, it was determined that the
system could not meet the required specifications in a cost effective
manner. This charge was included in the IMC business segment. During the
2005 third quarter, a $2.8 million charge was recorded for the write-down
of automated cathode assembly equipment for the IMC segment.
In addition to the quarter variances discussed above, the nine month period
in 2006 includes various asset dispositions and $0.8 million for
professional fees related to a potential acquisition that was no longer
considered probable. The remaining expense for the nine month period in
2005 relates to various asset dispositions and the cost to exit a
development agreement of $1.2 million.
(f) Severance charges. During the first quarter of 2005, the Company
implemented a 4% workforce reduction as a continuation of cost containment
efforts initiated mid-year 2004. As a result, severance charges of $1.5
million were recorded and paid in 2005. Expense of $0.9 million was
recorded in the IMC segment, $0.2 million in the ECP segment, and $0.4
million was recorded in unallocated operating expenses under business
segment information.
13. IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS
In October 2006, the FASB issued SFAS No. 158, Employers' Accounting for
Defined Benefit Pension and Other Postretirement Plans an amendment of FASB
Statements No. 87, 88, 106, and 132(R). This Statement requires companies
to recognize the overfunded or underfunded status of defined benefit
postretirement plans as an asset or liability in the statement of financial
position and to recognize changes in that funded status in the year in
which the changes occur through comprehensive income. For publicly traded
companies, SFAS No. 158 is effective as of the end of the fiscal year
ending after December 15, 2006. Management does not expect this Statement
to have a material impact on its financial statements as the Company
currently does not maintain any benefit plans that fall within the scope of
SFAS No. 158.
-23-
GREATBATCH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (con't) - Unaudited
--------------------------------------------------------------------------------
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements.
This Statement defines fair value, establishes a framework for measuring
fair value while applying generally accepted accounting principles, and
expands disclosures about fair value measurements. SFAS No. 157 establishes
a fair value hierarchy that distinguishes between (1) market participant
assumptions based on market data obtained from independent sources and (2)
the reporting entity's own assumptions developed based on unobservable
inputs. The Company is still evaluating the impact of SFAS No. 157 on its
financial statements, which is effective beginning in fiscal year 2008.
In September 2006, the SEC issued SAB No. 108, Considering the Effects of
Prior Year Misstatements when Quantifying Misstatements in Current Year
Financial Statements. SAB No. 108 provides guidance on the consideration of
the effects of prior year misstatements in quantifying current year
misstatements for the purpose of determining whether the current year's
financial statements are materially misstated. SAB No. 108 is effective for
fiscal years ending after November 15, 2006. The Company does not expect
the adoption of SAB No. 108 to have a material impact on its financial
statements.
In June 2006, the FASB issued Interpretation ("FIN") No. 48, Accounting for
Uncertainty in Income Taxes. FIN No. 48 addresses the noncomparability in
reporting tax assets and liabilities resulting from a lack of specific
guidance in SFAS No. 109, Accounting for Income Taxes, on the uncertainty
in income taxes recognized in an enterprise's financial statements.
Specifically, FIN No. 48 prescribes (a) a consistent recognition threshold
and (b) a measurement attribute for the financial statement recognition and
measurement of a tax position taken or expected to be taken in a tax
return, and provides related guidance on derecognition, classification,
interest and penalties, accounting in interim periods, disclosure, and
transition. The Company is still evaluating the impact of FIN No. 48 on its
financial statements which is effective beginning in fiscal year 2007.
14. SUBSEQUENT EVENT
Subsequent to the end of the third-quarter, on November 3, 2006, the
Company's Chief Executive Officer approved a plan for consolidating the
Company's corporate and business unit organization structure. As a result,
approximately 40 corporate and business unit positions will be eliminated.
The cash severance costs associated with the consolidation plan are
estimated to be $2.1 to $2.3 million. The majority will be expensed in the
4th quarter of 2006 and will be paid out over the next three quarters. The
annual gross savings is estimated to be $8.0 to $10.0 million upon plan
completion and will generate annual net savings of $2.0 to $4.0 million.
Approximately, $6.0 million will be reinvested in critical areas including
Research, Development & Product Engineering.
-24-
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
--------------------------------------------------------------------------------
Our Business
We are a leading developer and manufacturer of batteries, capacitors,
feedthroughs, enclosures, and other components used in implantable medical
devices ("IMDs") through our Implantable Medical Components ("IMC") business. We
offer technologically advanced, highly reliable and long lasting products that
enable our customers to introduce IMDs that are progressively smaller, longer
lasting, more efficient and more functional. We also leverage our core
competencies in technology and manufacturing through our Electrochem Commercial
Power ("ECP") business to develop and produce cells and battery packs for
commercial applications that demand high performance and reliability, including
oil and gas exploration, oceanographic equipment, seismic and aerospace markets.
Most of the IMC products that we sell are utilized by customers in cardiac
rhythm management ("CRM") devices. The CRM market comprises devices utilizing
high-rate batteries and capacitors such as implantable cardioverter
defibrillators ("ICDs") and cardiac resynchronization therapy ("CRT") with
backup defibrillation devices ("CRT-D") and devices utilizing low or medium rate
batteries but no capacitors (pacemakers and CRTs). All CRM devices utilize other
components such as enclosures and feedthroughs, and certain CRM devices utilize
electromagnetic interference ("EMI") filtering technology.
Our Customers
Our products are designed to provide reliable, long lasting solutions that meet
the evolving requirements and needs of our customers and the end users of their
products. Our medical customers include leading IMD manufacturers such as Boston
Scientific, St. Jude Medical, Medtronic, Biotronik, Cyberonics and the Sorin
Group. A substantial part of our business is conducted with a limited number of
customers. For the third quarter and first nine months of 2006, Boston
Scientific, St. Jude Medical, and Medtronic collectively accounted for
approximately 66% of our total sales. The nature and extent of our selling
relationships with each CRM customer are different in terms of breadth of
component products purchased, purchased product volumes, length of contractual
commitment, ordering patterns, inventory management and selling prices. Our ECP
customers are primarily companies involved in oil and gas exploration, military,
oceanography, seismic and aerospace industries.
We have entered into long-term supply agreements with some of our customers. For
each of our products, we recognize revenue when the products are shipped and
title passes.
-25-
Business Highlights
o We achieved our sixth consecutive quarter of double-digit sales growth
which totaled $69.3 million, up 11% from $62.4 million in the third quarter
of 2005.
o Implantable Medical Components sales were $57.0 million, up 5% from
$54.1 million in the third quarter of 2005.
|X| The increase was primarily due to sales of new assembly products
and continued growth in coated electrodes and molded components.
|X| 2005 sales included approximately $3 to $5 million of additional
revenue related to customer field actions, primarily impacting
ICD batteries and capacitors as well as filtered feedthroughs and
medical enclosures.
o Electrochem Commercial Power sales were $12.3 million, up 49%, led by
continued strength in the oil and gas and seismic markets.
Additionally, approximately $2 million of the increase was due to
customer inventory stocking and seasonality.
o Diluted earnings per share for the third quarter of 2006 increased to $0.15
($0.03 for 2005). The 2006 quarter included incremental stock-based
compensation expense of $0.03 per share related to the adoption of
Statement of Financial Accounting Standards ("SFAS") No. 123(R) and
benefited from lower facility move related costs and a lower effective tax
rate.
o Operating margin increased 3.6 percentage points. This was primarily due to
lower costs associated with our consolidation initiatives and higher sales
volume partially offset by our planned increase in spending on research and
development programs and the incremental cost of expensing stock options
under SFAS No. 123(R).
o Facilities update:
o The final closure of the Carson City facility was delayed to
accommodate pending customer regulatory approval;
o The move of the Columbia facility is on-going and is scheduled for
completion in mid-2007, as originally planned.
o The Tijuana facility has been recommended for ISO 13485:2003
certification. This is the internationally recognized standard for
medical device development and manufacturing, which acknowledges that
the facility meets medical device quality standards.
Our CEO's View
Our third quarter results represent the sixth consecutive quarter we have been
able to achieve double-digit sales growth. These results came during an
uncertain period in the ICD market and are indicative of the underlying strength
of our position and the multiple levers we have available to drive our growth.
These include market share penetration, new product introductions, international
expansion, a robust commercial business and an emerging neurostimulation market
opportunity.
Our sales for the third quarter increased by 11% from the prior year, with
implantable medical components up 5%. This growth is positive given that last
year's results included the added ICD related revenue resulting from the
marketplace field actions, which we estimate at approximately $3 to $5 million.
This growth continues to be driven by new products, market share gains and
customer market share shifts, including positive results from our international
customers.
-26-
We continue to experience growth (49%) in our commercial business led by our
core oil and gas markets and favorable seasonality in the seismic market. In
addition to the strong industry economic factors, our commercial sales growth is
being driven by market share gains, increased sales from new products and
increased sales and marketing efforts.
Currently, we are assessing both the strengths and areas for improvement within
our organization and actions to address these issues in the near term. While
advancing our corporate development initiatives remains a priority, we also plan
to address ways in which we can optimize our already strong capital structure.
We remain confident that these initiatives will allow us to achieve our overall
strategic goals and further our competitive position in the marketplace.
Product Development
Our strategy is to maintain technology leadership by providing a fresh pipeline
of next generation core products. Currently, the company is developing a series
of new products for customer applications in the CRM, neurostimulation and
commercial markets.
Some of the key development initiatives are as follows:
1. Continue the evolution of our Q series high rate ICD batteries.
2. Complete the development of a high voltage and high energy density
capacitor system.
3. Develop Q series medium rate battery for neurostimulation and
pacemaker applications.
4. Augment our existing rechargeable battery with a new rechargeable
battery offering for use in neurostimulation applications.
5. Develop rechargeable battery packs for use in commercial applications.
6. Introduce new inductor slab filtered feedthrough technology and molded
headers.
7. Continue development of the batteries and capacitors used in
intravascular ICD devices.
IMC. Our near term focus for growth in the medical battery market, a portion of
our IMC business, is the introduction of our Q-Series batteries. Initially they
will be available in two configurations - QHR (High Rate) and QMR (Medium Rate).
These batteries hold the promise of unparalleled performance in a wide range of
implantable device and neurostimulation applications and allow our customers to
incorporate advanced power-hungry features into these devices. While companies
typically announce new products that have modest improvements in form and/or
function regularly, we believe the Q-Series firmly establishes a new industry
standard. It delivers advanced performance criteria to an industry that
historically embraces new products. We believe the Q-Series will represent a
major breakthrough by combining a smaller size with greater energy density (more
power). We are pleased to report that the first ICD device implant with our new
QHR technology occurred in the third quarter of 2006.
ECP. ECP continues to develop new and innovative power solutions for the world's
most demanding commercial applications. ECP has developed a new high energy
lithium cell for a customer in the telematics market. Due to their exceptional
high energy, two of these new cells are capable of providing power for the
entire 10-year life of the telematics device. ECP also has developed a battery
pack capable of withstanding the customer's harsh operating conditions such as
high vibration, high shock, salt spray, high temperature, low temperature, and
high humidity.
-27-
Finally, ECP has developed a modular battery pack for a customer's fleet of
underwater sonabuoys which measure water characteristics. The long life of ECP
cells, coupled with their ability to withstand harsh conditions, make them
ideally suited for buoys. The customer's expense of commissioning a ship to
replace the batteries in each buoy is reduced when using ECP batteries due to
their long life.
Cost Savings and Consolidation Efforts
During 2005, we initiated several significant cost savings and consolidation
efforts, the implementation of which continued during the first nine months of
2006.
Alden Facility Consolidation. Beginning in the first quarter of 2005 and ending
in the second quarter of 2006 we consolidated our medical capacitor
manufacturing operations in Cheektowaga, NY, and our implantable medical battery
manufacturing operations in Clarence, NY, into our advanced power source
manufacturing facility in Alden, NY ("Alden Facility"). We also consolidated our
capacitor research, development and engineering operations from our Cheektowaga,
NY, facility into our Technology Center in Clarence, NY.
Expenses of $2.8 million were incurred in 2005 and $0.6 million were incurred
during the first two quarters of 2006. In total, $1.8 million was paid in cash
and $0.8 million was for assets written-off in 2005. Approximately $0.8 million
was paid in cash during 2006.
Carson City Facility shutdown and Tijuana Facility consolidation No. 1. On March
7, 2005, we announced our intent to close the Carson City, NV facility ("Carson
City Facility") and consolidate the work performed at our Carson City Facility
into our Tijuana, Mexico facility ("Tijuana Facility consolidation No. 1").
The Company has delayed the anticipated final closing of the Carson City
Facility until the end of the first quarter of 2007 in order to accommodate a
customer's pending regulatory approval. If this regulatory approval is delayed
further, additional costs could be incurred. The total revised estimate for this
consolidation plan is anticipated to be between $7.2 million and $7.4 million,
comprised of $4.5 million for the Carson City Facility shutdown and $2.7 million
to $2.9 million for the Tijuana Facility consolidation No. 1. To date, $6.9
million of expenses has been recorded. All categories of costs are considered to
be cash expenditures, except for accelerated depreciation.
Carson City Facility shutdown expenses of $4.1 million have been incurred to
date, of which $2.9 million were recorded in 2005, and $1.2 million were
incurred in the first nine months of 2006. In 2005, $0.2 million were paid in
cash and $0.6 million were recorded as accelerated depreciation. To date, $2.1
million of the $3.3 million of severance and retention recorded to date was
paid. Tijuana Facility consolidation No. 1 expenses of $1.5 million were
incurred and paid in 2005, and $1.2 million were incurred and paid in 2006.
Once the moves are completed, we anticipate annual cost savings in the range of
$2.5 to $3.1 million. The expenses for the Carson City Facility shutdown and the
Tijuana Facility consolidation No. 1 are included in the IMC business segment.
-28-
Columbia Facility & ARL shutdown, Tijuana Facility consolidation No. 2, and RD&E
Consolidation. On November 16, 2005, we announced our intent to close both our
Columbia, MD facility ("Columbia Facility") and our Fremont, CA Advanced
Research Laboratory ("ARL"). The manufacturing operations at our Columbia
Facility will be moved into our Tijuana Facility ("Tijuana Facility
consolidation No. 2"). The research, development and engineering ("RD&E") and
product development functions at our Columbia Facility have begun to relocate to
the Technology Center in Clarence, NY. The ARL relocation to the Technology
Center in Clarence, NY is complete.
The total estimated cost for this facility consolidation plan is anticipated to
be between $7.9 million and $8.3 million. To date, we have expensed $4.7 million
related to these projects and expect to incur the remaining costs over the next
three fiscal quarters. All categories of costs are considered to be future cash
expenditures, except for accelerated depreciation and asset write-offs.
Approximately $1.1 million of the Columbia Facility and ARL shutdown costs were
incurred in 2005 ($0.4 million for assets written-off), and $2.1 million were
incurred in the first three quarters of 2006. Approximately $1.3 million was
paid in cash during the first three quarters of 2006. Tijuana Facility
consolidation plan No. 2 expenses of $1.5 million were incurred and paid in cash
in 2006.
Once the moves are completed, the Company anticipates annual cost savings in the
range of $5.0 to $6.0 million. The expenses for the Columbia Facility and ARL
shutdowns, the Tijuana Facility consolidation No. 2 and the RD&E consolidation
are included in the IMC business segment.
Severance charges. The Company implemented a 4% workforce reduction during the
first quarter of 2005, which resulted in a severance charge of $1.5 million. All
amounts were paid in 2005.
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
third quarter of 2006 and 2005 ended on September 29, and September 30,
respectively.
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 Form 10-K for the fiscal year ended December 30, 2005.
-29-
Results of Operation
Three months ended Nine months ended
Sept. 29, Sept. 30, $ % Sept. 29, Sept. 30, $ %
In thousands, except per Change Change Change Change
share data 2006 2005 2006 2005
---------------------------------------------------------------------------------------------------------
IMC
ICD batteries $ 11,456 $ 11,345 111 1% $ 35,129 $ 34,783 346 1%
Pacemaker and other
batteries 4,439 5,424 (985) -18% 16,156 16,917 (761) -4%
ICD capacitors 4,499 5,349 (850) -16% 13,406 15,600 (2,194) -14%
Feedthroughs 17,355 16,386 969 6% 47,944 45,927 2,017 4%
Enclosures 5,698 6,203 (505) -8% 19,143 18,769 374 2%
Other medical 13,560 9,378 4,182 45% 42,565 24,740 17,825 72%
-----------------------------------------------------------------------------
Total IMC 57,007 54,085 2,922 5% 174,343 156,736 17,607 11%
ECP 12,287 8,273 4,014 49% 33,656 25,504 8,152 32%
-----------------------------------------------------------------------------
Total sales 69,294 62,358 6,936 11% 207,999 182,240 25,759 14%
Cost of sales - excluding
amortization of intangible
assets 42,709 38,178 4,531 12% 125,087 112,154 12,933 12%
Cost of sales -
amortization of intangible
assets 948 967 (19) -2% 2,864 2,883 (19) -1%
-----------------------------------------------------------------------------
Total Cost of Sales (1) 43,657 39,145 4,512 12% 127,951 115,037 12,914 11%
Cost of sales as a % of
sales 63.0% 62.8% 0.2% 61.5% 63.1% -1.6%
Selling, general, and
administrative expenses
(SG&A) 9,311 8,842 469 5% 28,191 24,089 4,102 17%
SG&A as a % of sales 13.4% 14.2% -0.8% 13.6% 13.2% 0.4%
Research, development and
engineering costs, net
(RD&E) 6,022 5,124 898 18% 18,062 13,182 4,880 37%
RD&E as a % of sales 8.7% 8.2% 0.5% 8.7% 7.2% 1.5%
Other operating expense,
net 6,239 7,818 (1,579) -20% 12,551 14,207 (1,656) -12%
-----------------------------------------------------------------------------
Operating income 4,065 1,429 2,636 184% 21,244 15,725 5,519 35%
Operating margin 5.9% 2.3% 3.6% 10.2% 8.6% 1.6%
Interest expense 1,135 1,154 (19) -2% 3,433 3,476 (43) -1%
Interest income (1,521) (796) (725) 91% (4,066) (2,024) (2,042) 101%
Other (income) expense, net 171 (9) 180 -2000% 51 (69) 120 -174%
Provision for income taxes 1,041 324 717 221% 7,094 4,303 2,791 65%
Effective tax rate 24.3% 30.0% -5.7% 32.5% 30.0% 2.5%
-----------------------------------------------------------------------------
Net income $ 3,239 $ 756 $ 2,483 328% $ 14,732 $ 10,039 $ 4,693 47%
=============================================================================
Net margin 4.7% 1.2% 3.5% 7.1% 5.5% 1.6%
Diluted earnings per share $ 0.15 $ 0.03 $ 0.12 400% $ 0.65 $ 0.46 $ 0.19 41%
(1) Cost of sales includes amortization of intangible assets and has been
reclassified for the previous year periods to conform with the current year
presentation.
-30-
Sales
IMC. The nature and extent of our selling relationship with each CRM customer is
different in terms of component products purchased, selling prices, product
volumes, ordering patterns and inventory management. We have pricing
arrangements with our customers that at times do not specify minimum order
quantities. Our visibility to customer ordering patterns is over a relatively
short period of time. Our customers may have inventory management programs and
alternate supply arrangements of which we are unaware. Additionally, the
relative market share among the CRM device manufacturers changes periodically.
Consequently, these and other factors can significantly impact our sales in any
given period.
Our customers may initiate field actions with respect to market-released
products. These actions may include product recalls or communications with a
significant number of physicians about a product or labeling issue. The scope of
such actions can range from very minor issues affecting a small number of units
to more significant actions. There are a number of factors, both short-term and
long-term related to these field actions that may impact our results. In the
short-term, if product has to be replaced, or customer inventory levels have to
be restored, this will result in increased component demand. Also, changing
customer order patterns due to market share shifts or accelerated device
replacements may also have a positive impact on our sales results in the
near-term. These same factors may have longer-term implications as well.
Customer inventory levels may ultimately have to be rebalanced to match demand.
We believe that the market continues to exhibit strong underlying growth
fundamentals and that we are well positioned to participate in this market
growth.
Driving the increase in IMC sales of 5% and 11% for the three and nine month
periods ending September 29, 2006 were sales related to assembly products,
coated components and machined parts which are included in the other medical
category. The assembly product line was initiated in 2005. We expect this
business to continue to grow for the remainder of 2006 and in 2007. Our machined
parts and coated electrode products are up 35% in the quarter and 32% year to
date as we have benefited from increased adoption of our technology by our
domestic customers.
This growth was partially offset by lower than expected sales from ICD batteries
and capacitors as well as medical enclosures primarily due to the marketplace
field actions in 2005. We estimate that these marketplace field actions added
approximately $3 to $5 million and $6 to $8 million for the three and nine month
periods of 2005, respectively.
ECP. Similar to IMC customers, we have pricing arrangements with our customers
that many times do not specify minimum quantities. Our visibility to customer
ordering patterns is over a relatively short period of time.
-31-
The ECP sales increased 49% and 32%, respectively, for the three and nine month
periods ending September 29, 2006. During the third quarter of 2006, we
benefited from approximately $2 million of customer inventory stocking in the
oil and gas segment, due to marketplace consolidation in prior quarters that
reduced inventory levels, and favorable seasonality in the seismic market.
Looking longer term, the fundamentals in the oil and gas, ocean, seismic and
military markets remain healthy. In addition, we have a highly motivated sales
and management team in place that have effectively positioned our products for
continued growth. We continue to add value for our customers by moving from
providing discrete cells to more complete battery packages.
Cost of Sales
Changes from the prior year to cost of sales as a percentage of sales were
primarily due to the following:
September 29, 2006
Three months Nine months
ended ended
--------------- -------------
Production efficiencies primarily
associated with higher volumes (a) -4.3% -5.4%
Excess capacity at wet tantalum capacitor
facility (b) -0.8% -0.9%
Excess capacity at Tijuana Facility (c) 0.3% 0.6%
Mix change (d) 3.8% 5.2%
Other 1.2% -1.1%
--------------- -------------
Total percentage point change to cost of
sales as a percentage of sales 0.2% -1.6%
=============== =============
(a) This decrease in cost of sales is primarily due to the fact that as
production volumes increase, fixed costs such as plant overhead and
depreciation do not increase at the same rate. The production volume
increase was necessary to accommodate the increased sales and to replenish
safety stocks.
(b) During 2005, the capacitor facility was not being utilized to its full
capacity. The cost associated with the excess capacity was eliminated in
2006 as capacitor manufacturing was consolidated into the Alden Facility.
In accordance with the Company's inventory accounting policy, excess
capacity costs were expensed in 2005.
(c) The Tijuana Facility was new in 2005 and its infrastructure and floor space
were coming on line during the first quarter of 2005 and therefore the full
cost of the capacity was not in place. In accordance with the Company's
inventory accounting policy, excess capacity costs were expensed.
(d) The revenue increase from 2005 was primarily in other medical, which
generally have lower margins.
We expect cost of sales as a percentage of sales to decrease over the next
several years as the result of the consolidation efforts and the elimination of
excess capacity. Excess capacity for the Tijuana Facility is not expected to be
eliminated until mid-2007 when the last announced consolidation effort is
anticipated to be completed (see the "cost savings and consolidation efforts"
section for additional information).
Cost of sales - Amortization of intangible assets
Amortization expense for the three and nine month periods ended September 29,
2006 was consistent with the same periods of 2005.
-32-
SG&A expenses
Changes from the prior year to SG&A expenses were primarily due to the following
(in thousands):
September 29, 2006
Three months Nine months
ended ended
-------------- --------------
SFAS No. 123(R) stock-based compensation expense $ 1,100 $ 2,900
Increased workforce 100 1,300
Incentive compensation (1,100) (900)
Other 400 800
-------------- --------------
Net increase in SG&A $ 500 $ 4,100
============== ==============
As a result of the adoption of SFAS No. 123(R), the Company began expensing
stock options in fiscal year 2006, which had a material impact on SG&A costs.
The increase in stock-based compensation expense is expected to continue into
the future. The increased workforce expense was a result of the Company's
efforts to increase the marketing and sales of its products as well as general
and administrative costs associated with the Tijuana Facility. Incentive
compensation is accrued based upon the achievement of performance goals relative
to planned results.
RD&E expenses
Net research, development and engineering costs are as follows (in thousands):
Three months ended Nine months ended
September 29, September 30, September 29, September 30,
2006 2005 2006 2005
------------- ------------- ------------- -------------
Research and development
costs $ 3,852 $ 4,534 $ 11,800 $ 12,187
------------- ------------- ------------- -------------
Engineering costs 2,521 1,384 7,697 4,250
Less cost reimbursements (351) (794) (1,435) (3,255)
------------- ------------- ------------- -------------
Engineering costs, net 2,170 590 6,262 995
------------- ------------- ------------- -------------
Total research and
development and
engineering costs, net $ 6,022 $ 5,124 $ 18,062 $ 13,182
============= ============= ============= =============
The increase in RD&E expenses for the three and nine month periods ended
September 29, 2006 is primarily due to the planned increase in engineering
personnel costs (headcount), as we continue to invest substantial resources to
develop new products. Reimbursement on product development projects decreased in
the current quarter compared to last year primarily due to the achievement of
significant milestones on one large project in 2005 that did not reoccur in
2006. In terms of the development costs billed, reimbursements were lower due to
lower volume and timing of reimbursable development projects entered into during
the last nine month period. Reimbursements for achieving certain development
milestones are netted against gross spending.
-33-
Other operating expense
Other operating expense for 2006 and 2005 are comprised of the following costs
(in thousands):
Three months ended Nine months ended
September 29, September 30, September 29, September 30,
2006 2005 2006 2005
------------- ------------- ------------- -------------
(a) Alden facility consolidation $ - $ 1,428 $ 567 $ 2,323
(a) Carson City facility shutdown and
Tijuana facility consolidation No. 1 411 1,595 2,450 2,468
(a) Columbia facility shutdown, Tijuana
facility consolidation No. 2 and RD&E
consolidation 1,225 - 3,546 -
(a) Tijuana start-up - 380 - 865
(b) Asset dispositions and other 4,603 4,415 5,988 7,046
(c) Severance - - - 1,505
------------- ------------- ------------- -------------
$ 6,239 $ 7,818 $ 12,551 $ 14,207
============= ============= ============= =============
(a) Refer to the "Cost Savings and Consolidation Efforts" discussion for
disclosure related to the timing and level of remaining expenditures for
these items as of September 29, 2006.
(b) During the third quarter of 2006, the Company recorded a loss of $4.4
million related to the write-off of a battery test system that was under
development. Upon completion of the Company's engineering and technical
evaluation, it was determined that the system could not meet the required
specifications in a cost effective manner. This charge was included in the
IMC business segment. During the 2005 third quarter, a $2.8 million charge
was recorded for the write-down of automated cathode assembly equipment for
the IMC segment.
In addition to the quarter variances discussed above, the nine month period
in 2006 includes various asset dispositions and $0.8 million for
professional fees related to a potential acquisition that was no longer
considered probable. The remaining expense for the nine month period in
2005 relates to various asset dispositions and the cost to exit a
development agreement of $1.2 million.
(c) During the first quarter of 2005, the Company implemented a 4% workforce
reduction as a continuation of cost containment efforts initiated mid-year
2004. As a result, severance charges of $1.5 million were recorded and paid
in 2005. Expense of $0.9 million was recorded in the IMC segment, $0.2
million in the ECP segment, and $0.4 million was recorded in unallocated
operating expenses under business segment information.
Other operating expense for 2006 is expected to be in the range of $14.3 million
and $15.5 million, primarily related to plant consolidations and asset
dispositions. Other operating expenses are expected to be substantially reduced
after the second quarter of 2007 when the last announced consolidation effort is
anticipated to be completed.
Interest expense and interest income
Interest expense for the three and nine months ended September 29, 2006 is
consistent with prior year periods, and is primarily related to the outstanding
convertible notes.
Interest income for the three and nine months ended September 29, 2006 increased
in comparison to the same periods of 2005 due to increased cash, cash
equivalents and short-term investment balances coupled with higher interest
rates on the invested cash.
-34-
Provision for income taxes
During the third quarter of 2006, we adjusted our tax accounts to reflect the
filing of our 2005 tax returns as well as the completion of various tax savings
initiatives. Additionally, our effective tax rate is lower than the United
States statutory rate due to the allowable Extraterritorial Income Exclusion
("ETI") and the Qualified Production Activities Deduction. As a result, our
effective tax rate was reduced to 24.3% in the third quarter of 2006 and 32.5%
for the first three quarters of 2006. In comparison to the prior year, the 2005
effective tax rate for the three month and nine month periods ending September
30, 2005 of 30.0% benefited from federal research and development tax credits
and a higher level of allowable ETI benefits. For the remainder of the year, we
expect our effective tax rate to be 32.5% and approximately 35% over the longer
term.
Subsequent Events
Subsequent to the end of the third-quarter, on November 3, 2006, the Company's
Chief Executive Officer approved a plan for consolidating the Company's
corporate and business unit organization structure. The Company has completed
two-thirds of its three-year plan to consolidate facilities. The Company's
Management determined that it was time to align the Company's organization and
cost structures to be consistent with the revised facilities' footprint and the
way they intend on conducting business in the future. As a result, approximately
40 corporate and business unit positions will be eliminated. This reduction will
enable the Company to better match its human resources with the management and
technical skill sets required to optimize long-term operating performance. A
significant portion of the annual savings will be reinvested into Research &
Development activities and business investment opportunities.
The annual gross savings is estimated to be $8.0 to $10.0 million upon plan
completion and will generate annual net savings of $2.0 to $4.0 million.
Approximately, $6.0 million will be reinvested in critical areas including
Research, Development & Product Engineering. The severance costs associated with
the consolidation plan are estimated to be $2.1 to $2.3 million and the majority
will be incurred in the 4th quarter of 2006. As a result, the Company is
decreasing its full year 2006 diluted earnings per share guidance by $0.06 from
the range of $0.71 - $0.77 per share to $0.65 - $0.71 per share. Final
completion of the plan is expected during 2007.
Liquidity and Capital Resources
September 29, December 30,
(Dollars in millions) 2006 2005
----------------- ----------------
Cash and cash equivalents and short-term
investments (a) $ 128.2 $ 112.1
Working capital (b) $ 190.1 $ 152.0
Current ratio 6.1:1.0 4.5:1.0
(a) Short-term investments consist of investments acquired with maturities that
exceed three months and are less than one year at the time of acquisition,
equity securities classified as available-for-sale, and auction rate
securities.
(b) Working capital increased by approximately $38.1 million. Net earnings of
$14.7 million, depreciation and amortization of $14.4 million, the Company
stock contributed to the 401(k) Plan of $2.8 million and the $2.7 million
increase in accumulated other comprehensive income during the period are
the primary drivers behind this increase.
-35-
Revolving Line of Credit
The Company maintains a three-year $50.0 million Revolving Credit Facility (the
"Revolver"), which contains a $10.0 million sub-limit for the issuance of
commercial or standby letters of credit. The Revolver is secured by the
Company's non-realty assets including cash, accounts and notes receivable, and
inventories and has an expiration date of May 31, 2008. The Revolver requires
the Company to comply with two quarterly financial covenants, as defined. The
first relates to the ratio of consolidated net earnings or loss before interest,
taxes, depreciation, and amortization ("EBITDA") to fixed charges. The second is
a leverage ratio, which is calculated based on the ratio of consolidated funded
debt less cash, cash equivalent investments and short-term investments to
consolidated EBITDA. Interest rates under the Revolver vary with the Company's
leverage. The Company is required to pay a commitment fee of between 0.125% and
0.250% per annum on the unused portion of the Revolver based on the Company's
leverage. As of September 29, 2006, the Company had no balance outstanding on
the Revolver.
Our principal sources of liquidity are our operating cash flow combined with our
working capital of $190.1 million at September 29, 2006 and availability under
the Revolver. Historically we have generated cash from operations sufficient to
meet our capital expenditure and debt service needs, other than for
acquisitions. At September 29, 2006, our current ratio was 6.1:1.0.
The Company regularly engages in discussions relating to potential acquisitions
and may announce an acquisition transaction at any time.
Operating activities
Net cash flows provided by operating activities for the nine months ended
September 29, 2006 decreased by $8.1 million over the comparable period in 2005.
This was primarily the result of an increase in inventory safety stocks and
decreased accrued expenses resulting from the payment of 2005 incentive
compensation and lower accruals in 2006 for incentive compensation as well as
cost saving initiatives and consolidation efforts. These cash outflows were
offset by higher cash inflows resulting from operating income during the period.
Investing activities
The majority of the acquisition of property, plant and equipment for the first
three quarters of 2006 was related to the movement of operations to and build
out of the Tijuana Facility. Additionally, routine purchases are made in order
to support our internal growth and to maintain our technology leadership.
Net cash invested in short-term instruments during the first nine months of 2006
of $3.3 million is comparable to the 2005 period and was primarily a result of
the investment of excess cash flow from operations.
Financing activities
Payments on capital lease obligations and cash received from non-qualified stock
option exercises are the primary financing activities for the first nine months
of 2006 and 2005.
-36-
Capital Structure
At September 29, 2006, our capital structure consisted of $170.0 million of
convertible subordinated notes and our 22.0 million shares of common stock
outstanding. We have in excess of $128.2 million in cash, cash equivalents and
short-term investments and are in a position to facilitate future acquisitions
if necessary. We are also authorized to issue 100 million shares of common stock
and 100 million shares of preferred stock. The market value of our outstanding
common stock since our IPO has exceeded our book value; accordingly, we believe
that if needed we can access public markets to sell additional common or
preferred stock assuming conditions are appropriate.
Our capital structure allows us to support our internal growth and provides
liquidity for corporate development initiatives. Our current expectation for
2006 is that capital spending will be in the range of $16.0 million to $20.0
million, of which $5.0 to $7.0 million is attributable to the Tijuana Facility
build-out.
Off-Balance Sheet Arrangements
We have no off-balance sheet arrangements within the meaning of Item 303(a)(4)
of Regulation S-K.
Contractual Obligations
In the normal course of business, the Company makes routine purchase commitments
(primarily equipment and raw material purchases) in order to maintain the
technological leadership of its manufacturing facilities and meet the needs of
its customers. As of September 29, 2006, total contractual obligations related
to such expenditures are $8.6 million and will be financed by existing cash,
short-term investments, or cash generated from operations.
Inflation
We do not believe that inflation has had a significant effect on our operations.
Impact of Recently Issued Accounting Standards
In October 2006, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 158, Employers' Accounting for Defined Benefit Pension and Other
Postretirement Plans an amendment of FASB Statements No. 87, 88, 106, and
132(R). This Statement requires companies to recognize the overfunded or
underfunded status of defined benefit postretirement plans as an asset or
liability in the statement of financial position and to recognize changes in
that funded status in the year in which the changes occur through comprehensive
income. For publicly traded companies, SFAS No. 158 is effective as of the end
of the fiscal year ending after December 15, 2006. Management does not expect
this Statement to have a material impact on its financial statements as the
Company currently does not maintain any benefit plans that fall within the scope
of SFAS No. 158.
-37-
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements. This
Statement defines fair value, establishes a framework for measuring fair value
while applying generally accepted accounting principles, and expands disclosures
about fair value measurements. SFAS No. 157 establishes a fair value hierarchy
that distinguishes between (1) market participant assumptions based on market
data obtained from independent sources and (2) the reporting entity's own
assumptions developed based on unobservable inputs. The Company is still
evaluating the impact of SFAS No. 157 on its financial statements, which is
effective beginning in fiscal year 2008.
In September 2006, the SEC issued SAB No. 108, Considering the Effects of Prior
Year Misstatements when Quantifying Misstatements in Current Year Financial
Statements. SAB No. 108 provides guidance on the consideration of the effects of
prior year misstatements in quantifying current year misstatements for the
purpose of determining whether the current year's financial statements are
materially misstated. SAB No. 108 is effective for fiscal years ending after
November 15, 2006. The Company does not expect the adoption of SAB No. 108 to
have a material impact on its financial statements.
In June 2006, the FASB issued Interpretation ("FIN") No. 48, Accounting for
Uncertainty in Income Taxes. FIN No. 48 addresses the noncomparability in
reporting tax assets and liabilities resulting from a lack of specific guidance
in SFAS No. 109, Accounting for Income Taxes, on the uncertainty in income taxes
recognized in an enterprise's financial statements. Specifically, FIN No. 48
prescribes (a) a consistent recognition threshold and (b) a measurement
attribute for the financial statement recognition and measurement of a tax
position taken or expected to be taken in a tax return, and provides related
guidance on derecognition, classification, interest and penalties, accounting in
interim periods, disclosure, and transition. The Company is still evaluating the
impact of FIN No. 48 on its financial statements which is effective beginning in
fiscal year 2007.
Application of Critical Accounting Estimates
Our unaudited condensed consolidated financial statements are based on the
selection of accounting policies and the application of significant accounting
estimates, some of which require management to make significant assumptions. We
believe that some of the more critical estimates and related assumptions that
affect our financial condition and results of operations are in the areas of
inventories, goodwill and other indefinite lived intangible assets, long-lived
assets, share-based compensation and income taxes.
During the three months ended September 29, 2006, we did not change or adopt new
accounting policies that had a material effect on our consolidated financial
condition and results of operations.
Effective in fiscal year 2006, we adopted SFAS No. 123 (revised 2004),
Share-Based Payment ("SFAS No. 123(R)"), and related Securities and Exchange
Commission rules included in Staff Accounting Bulletin No. 107, on a modified
prospective basis. Under this method, compensation cost recognized beginning in
fiscal year 2006 includes costs related to 1) all share-based payments (stock
options and restricted stock awards) granted prior to but not yet vested as of
fiscal year 2006, based on the grant-date fair value estimated in accordance
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with the original provisions of SFAS No. 123, Accounting for Stock-Based
Compensation, and 2) all share-based payments (stock options and restricted
stock and unit awards) granted subsequent to the beginning of fiscal year 2006
based on the grant-date fair value estimated in accordance with the provisions
of SFAS No. 123(R). Compensation cost for service-based stock options and
restricted stock awards is recognized ratably over the applicable vesting
period. Compensation cost for performance-based stock options and restricted
stock units is reassessed each period and recognized based upon the probability
that the performance targets will be achieved.
Compensation costs related to share-based payments for the three and nine months
ended September 29, 2006 totaled $1.6 million and $4.2 million, respectively,
and is included in the statement of earnings primarily in selling, general, and
administrative expenses. As of September 29, 2006, $10.9 million of unrecognized
compensation cost related to non-vested share-based payments is expected to be
recognized over a weighted-average period of approximately five years.
We utilize the Black-Scholes Options Pricing Model to determine the fair value
of stock options under SFAS No. 123(R), consistent with that used for pro forma
disclosures in prior years. We are required to make certain assumptions with
respect to selected model inputs, including anticipated changes in the
underlying stock price (i.e., expected volatility) and option exercise activity
(i.e., expected life). Expected volatility is based on the historical volatility
of the Company's stock over the most recent period commensurate with the
estimated expected life of the Company's stock options and other factors. The
expected life of options granted, which represents the period of time that the
options are expected to be outstanding, is based, primarily, on historical data.
The expected dividend yield is based on our Company's history and expectation of
dividend payouts. The risk-free rate is based on the U.S. Treasury yield curve
in effect at the time of grant for a period commensurate with the estimated
expected life. If factors change and result in different assumptions in the
application of SFAS No. 123(R) in future periods, the stock option expense that
we record for future grants may differ significantly from what we have recorded
in the current period.
There is a high degree of subjectivity involved in selecting the option pricing
model assumptions used to estimate share-based compensation expense under SFAS
No. 123(R). Option pricing models were developed for use in estimating the value
of traded options that have no vesting or hedging restrictions, are fully
transferable and do not cause dilution. Because our share-based payments have
characteristics significantly different from those of freely traded options, and
because changes in the subjective input assumptions can materially affect our
estimates of fair values, existing valuation models may not provide reliable
measures of the fair values of our share-based compensation. Consequently, there
is a risk that our estimates of the fair values of our share-based compensation
awards on the grant dates may bear little resemblance to the actual values
realized upon the exercise, expiration or forfeiture of those share-based
payments in the future. Stock options may expire worthless or otherwise result
in zero intrinsic value as compared to the fair values originally estimated on
the grant date and reported in our condensed consolidated financial statements.
Alternatively, value may be realized from these instruments that is
significantly in excess of the fair values originally estimated on the grant
date and reported in our condensed consolidated financial statements.
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There are significant differences among valuation models. This may result in a
lack of comparability with other companies that use different models, methods
and assumptions. There is also a possibility that we will adopt a different
valuation model in the future. This may result in a lack of consistency in
future periods and may materially affect the fair value estimate of share-based
payments.
Compensation cost for performance-based stock options and restricted stock units
is reassessed each period and recognized based upon the probability that the
performance targets will be achieved. Changes could occur that would materially
affect our probability assessment. Changes in performance of the Company or
individuals who have been granted performance-based awards that affect the
likelihood that performance based targets are achieved could materially impact
the amount of stock-based compensation recognized.
Forward-Looking Statements
Some of the statements contained in this Quarterly Report on Form 10-Q and other
written and oral statements made from time to time by us and our representatives
are not statements of historical or current fact. As such, they are
"forward-looking statements" within the meaning of Section 27A of the Securities
Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934,
as amended. We have based these forward-looking statements on our current
expectations, which are subject to known and unknown risks, uncertainties and
assumptions. They include statements relating to:
o future sales, expenses and profitability;
o the future development and expected growth of our business and the
industries we operate in;
o our ability to successfully execute our business model and our
business strategy;
o our ability to identify trends within the implantable medical devices,
medical components, and commercial power sources industries and to
offer products and services that meet the changing needs of those
markets;
o projected capital expenditures; and
o trends in government regulation.
You can identify forward-looking statements by terminology such as "may,"
"will," "should," "could," "expects," "intends," "plans," "anticipates,"
"believes," "estimates," "predicts," "potential" or "continue" or the negative
of these terms or other comparable terminology. These statements are only
predictions. Actual events or results may differ materially from those suggested
by these forward-looking statements. In evaluating these statements and our
prospects generally, you should carefully consider the factors set forth below.
All forward-looking statements attributable to us or persons acting on our
behalf are expressly qualified in their entirety by these cautionary factors and
to others contained throughout this report. We are under no duty to update any
of the forward-looking statements after the date of this report or to conform
these statements to actual results.
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Although it is not possible to create a comprehensive list of all factors that
may cause actual results to differ from the results expressed or implied by our
forward-looking statements or that may affect our future results, some of these
factors include the following: dependence upon a limited number of customers,
product obsolescence, inability to market current or future products, pricing
pressure from customers, reliance on third party suppliers for raw materials,
products and subcomponents, fluctuating operating results, inability to maintain
high quality standards for our products, challenges to our intellectual property
rights, product liability claims, inability to successfully consummate and
integrate acquisitions, unsuccessful expansion into new markets, competition,
inability to obtain licenses to key technology, regulatory changes or
consolidation in the healthcare industry, and other risks and uncertainties that
arise from time to time as described in the Company's Annual Report on Form 10-K
and other periodic filings with the Securities and Exchange Commission.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Under our line of credit any borrowings bear interest at fluctuating market
rates. At September 29, 2006, we did not have any borrowings outstanding under
our line of credit and thus no interest rate sensitive financial instruments
other than short-term investments. We do not believe that the impact of
fluctuations in interest rates on our short-term investments will have a
material effect on our condensed consolidated financial statements.
The company incurs certain expenses related to the Tijuana operations that are
denominated in a foreign currency. We do not believe that the impact of foreign
currency fluctuations will have a material effect on our condensed consolidated
financial statements.
ITEM 4. CONTROLS AND PROCEDURES.
a. Evaluation of Disclosure Controls and Procedures.
During the third quarter of 2006, our management, including the principal
executive officer and principal financial officer, evaluated our disclosure
controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under
the Securities Exchange Act of 1934) related to the recording, processing,
summarization and reporting of information in our reports that we file with
the SEC. These disclosure controls and procedures have been designed to
provide reasonable assurance that material information relating to us,
including our subsidiaries, is made known to our management, including
these officers, by other of our employees, and that this information is
recorded, processed, summarized, evaluated and reported, as applicable,
within the time periods specified in the SEC's rules and forms.
Based on their evaluation, as of September 29, 2006, our principal
executive officer and principal financial officer have concluded that our
disclosure controls and procedures are effective.
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b. Changes in Internal Control Over Financial Reporting.
There have been no changes in our internal control over financial reporting
that occurred during our last fiscal quarter to which this Quarterly Report
on Form 10-Q relates that have materially affected, or are reasonably
likely to materially affect, our internal control over financial reporting.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
As reported in the Company's 2005 first quarter Form 10-Q, on May 2, 2005, a
complaint was filed against the Company by a developer of an implantable drug
delivery device in the United States Federal District Court for the Central
District of California. On May 20, 2005, the parties entered into a settlement
agreement under which the Company undertook certain obligations including the
performance of certain additional development tasks for a limited period of
time. On June 2, 2005, the Court ordered the complaint dismissed without
prejudice. During the second quarter of 2006, a letter was received from the
developer claiming that the Company was in breach of the settlement agreement.
The Company asserted a counter-position that the developer also breached the
settlement agreement and initiated the mandatory arbitration process as allowed
for under the settlement agreement. During the third quarter of 2006, this
dispute between the developer and the Company was settled and each party
executed a legally binding release. All costs and payments associated with this
resolution had been previously accrued under the May 20, 2005 settlement
agreement and no further charges are anticipated.
ITEM 1A. RISK FACTORS.
No material changes from risk factors as previously disclosed in the Company's
Form 10-K for the year ended December 30, 2005.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
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ITEM 5. OTHER INFORMATION.
Subsequent to the end of the third-quarter, on November 3, 2006, the Company's
Chief Executive Officer approved a plan for consolidating the Company's
corporate and business unit organization structure. The Company has completed
two-thirds of its three-year plan to consolidate facilities. The Company's
Management determined that it was time to align the Company's organization and
cost structures to be consistent with the revised facilities' footprint and the
way they intend on conducting business in the future. As a result, approximately
40 corporate and business unit positions will be eliminated. This reduction will
enable the Company to better match its human resources with the management and
technical skill sets required to optimize long-term operating performance. A
significant portion of the annual savings will be reinvested into Research &
Development activities and business investment opportunities.
The annual gross savings is estimated to be $8.0 to $10.0 million upon plan
completion and will generate annual net savings of $2.0 to $4.0 million.
Approximately, $6.0 million will be reinvested in critical areas including
Research, Development & Product Engineering. The severance costs associated with
the consolidation plan are estimated to be $2.1 to $2.3 million and the majority
will be incurred in the 4th quarter of 2006. As a result, the Company is
decreasing its full year 2006 diluted earnings per share guidance by $0.06 from
the range of $0.71 - $0.77 per share to $0.65 - $0.71 per share. Final
completion of the plan is expected during 2007.
ITEM 6. EXHIBITS.
See the Exhibit Index for a list of those exhibits filed herewith.
SIGNATURES
Pursuant to the requirements of Sections 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
Dated: November 7, 2006 GREATBATCH, INC.
By /s/ Thomas J. Hook
-------------------------------------
Thomas J. Hook
President and Chief Executive Officer
(Principal Executive Officer)
By /s/ Thomas J. Mazza
-------------------------------------
Thomas J. Mazza
Senior Vice President
and Chief Financial Officer
(Principal Financial Officer)
By /s/ Marco F. Benedetti
-------------------------------------
Marco F. Benedetti
Corporate Controller
(Principal Accounting Officer)
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EXHIBIT INDEX
Exhibit No. Description
----------- -----------
3.1 Amended and Restated Certificate of Incorporation
(incorporated by reference to Exhibit 3.1 to our quarterly
report on Form 10-Q ended July 1, 2005).
3.2 Amended and Restated Bylaws (incorporated by reference to
Exhibit 3.2 to our quarterly report on Form 10-Q ended March
29, 2002).
10.1 Employment Agreement dated August 8, 2006 between
Greatbatch, Inc. and Thomas J. Hook.
10.2 Employment Agreement dated November 3, 2006 between
Greatbatch, Inc. and Larry T. DeAngelo.
31.1 Certification of Chief Executive Officer pursuant to Rule
13a-14(a) of the Securities Exchange Act.
31.2 Certification of Chief Financial Officer pursuant to Rule
13a-14(a) of the Securities Exchange Act.
32 Certification of Chief Executive Officer and Chief Financial
Officer pursuant to 18 U.S.C. Section 1350 as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
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