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 28, 2007
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 6, 2007 was: 22,477,340 shares.
GREATBATCH, INC.
TABLE OF CONTENTS FOR FORM 10-Q
AS OF AND FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 28, 2007
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 29
Results of Operations
ITEM 3. Quantitative and Qualitative Disclosures About Market Risk 43
ITEM 4. Controls and Procedures 43
PART II - OTHER INFORMATION
ITEM 1. Legal Proceedings 44
ITEM 1A. Risk Factors 45
ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds 45
ITEM 3. Defaults Upon Senior Securities 45
ITEM 4. Submission of Matters to a Vote of Security Holders 45
ITEM 5. Other Information 45
ITEM 6. Exhibits 45
SIGNATURES 46
EXHIBIT INDEX 47
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)
------------------------------------------------------------------------------------------------------
As of
-------------------------------
September 28, December 29,
ASSETS 2007 2006
--------------- ---------------
Current assets:
Cash and cash equivalents $ 95,979 $ 71,147
Short-term investments available for sale 19,774 71,416
Accounts receivable, net of allowance of $743 in 2007
and $532 in 2006 44,108 31,285
Inventories 68,565 57,667
Refundable income taxes - 1,569
Deferred income taxes 6,597 5,899
Prepaid expenses and other current assets 3,063 2,343
--------------- ---------------
Total current assets 238,086 241,326
Property, plant and equipment, net 103,208 91,869
Amortizing intangible assets, net 48,595 28,078
Trademarks and tradenames 32,582 28,252
Goodwill 208,786 155,039
Other assets 13,605 3,263
--------------- ---------------
Total assets $ 644,862 $ 547,827
=============== ===============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 24,009 $ 12,657
Accrued expenses and other current liabilities 29,417 29,618
--------------- ---------------
Total current liabilities 53,426 42,275
Convertible subordinated notes 240,902 170,000
Deferred income taxes 31,740 35,859
Other long-term liabilities 127 -
--------------- ---------------
Total liabilities 326,195 248,134
--------------- ---------------
Stockholders' equity:
Preferred stock, $0.001 par value, authorized 100,000,000
shares; no shares issued or outstanding in 2007 or 2006 - -
Common stock, $0.001 par value, authorized 100,000,000
shares; 22,468,840 shares issued and outstanding in 2007 and
22,119,142 shares issued and 22,111,516 shares outstanding in 2006 22 22
Additional paid-in capital 237,210 227,187
Treasury stock, at cost, no shares in 2007 and 7,626 shares in 2006 - (205)
Retained earnings 81,435 69,165
Accumulated other comprehensive income - 3,524
--------------- ---------------
Total stockholders' equity 318,667 299,693
--------------- ---------------
Total liabilities and stockholders' equity $ 644,862 $ 547,827
=============== ===============
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 28, September 29, September 28, September 29,
2007 2006 2007 2006
-------------- -------------- ------------- -------------
Sales $ 79,009 $ 69,294 $ 234,331 $ 207,999
Costs and expenses:
Cost of sales - excluding amortization
of intangible assets 48,647 42,709 141,697 125,087
Cost of sales - amortization of intangible assets 1,222 948 3,164 2,864
Selling, general and administrative expenses 11,362 9,311 32,130 28,191
Research, development and engineering costs, net 8,423 6,022 21,856 18,062
Acquired in-process research and development (2,260) - 16,093 -
Other operating expense, net 1,275 6,239 4,796 12,551
-------------- -------------- ------------- -------------
Operating income 10,340 4,065 14,595 21,244
Interest expense 2,112 1,135 5,345 3,433
Interest income (1,586) (1,521) (6,028) (4,066)
Gain on sale of investment security - - (4,001) -
Gain on extinguishment of debt - - (4,473) -
Other expense, net 70 171 156 51
-------------- -------------- ------------- -------------
Income before provision for income taxes 9,744 4,280 23,596 21,826
Provision for income taxes 4,744 1,041 11,326 7,094
-------------- -------------- ------------- -------------
Net income $ 5,000 $ 3,239 $ 12,270 $ 14,732
============== ============== ============= =============
Earnings per share:
Basic $ 0.23 $ 0.15 $ 0.55 $ 0.68
Diluted $ 0.22 $ 0.15 $ 0.54 $ 0.65
Weighted average shares outstanding:
Basic 22,214 21,816 22,129 21,788
Diluted 23,872 21,983 24,739 26,176
Comprehensive income:
Net income $ 5,000 $ 3,239 $ 12,270 $ 14,732
Net unrealized gain (loss) on short-term investments
available for sale, net of tax - (96) (869) 2,726
Less: reclassification adjustment for net realized gain on
short-term investments available for sale, net of tax - - (2,601) -
-------------- -------------- ------------- -------------
Comprehensive income $ 5,000 $ 3,143 $ 8,800 $ 17,458
============== ============== ============= =============
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 28, September 29,
2007 2006
------------- -------------
Cash flows from operating activities:
--------------------------------------------------------------------------------------
Net income $12,270 $14,732
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization 18,539 14,492
Stock-based compensation 7,092 6,603
Gain on sale of investment security (4,001) -
Gain on extinguishment of debt (4,473) -
Acquired in-process research and development 16,093 -
(Gain) loss on disposal of assets (126) 5,273
Deferred income taxes (8,378) 4,207
Changes in operating assets and liabilities:
Accounts receivable (8,205) (5,859)
Inventories (4,936) (9,473)
Prepaid expenses and other current assets (610) (1,586)
Accounts payable 8,721 1,293
Accrued expenses and other current liabilities (4,090) (5,048)
Income taxes refundable/payable 2,946 121
------------- -------------
Net cash provided by operating activities 30,842 24,755
------------- -------------
Cash flows from investing activities:
--------------------------------------------------------------------------------------
Purchase of short-term investments (59,208) (29,846)
Proceeds from maturity/disposition of short-term investments 109,971 26,532
Acquisition of property, plant and equipment (10,852) (12,060)
Proceeds from sale of property, plant and equipment 14 39
Purchase of cost method investment, net of distributions (1,750) -
Insurance proceeds for replacement of assets 375 -
Acquisitions, net of cash acquired (109,737) -
Increase in other assets 18 19
------------- -------------
Net cash used in investing activities (71,169) (15,316)
------------- -------------
Cash flows from financing activities:
--------------------------------------------------------------------------------------
Repayments under line of credit (1,000) -
Principal payments of long-term debt (6,093) (464)
Proceeds from issuance of long-term debt 76,000 -
Debt issuance costs (6,619) -
Issuance of common stock 2,699 414
Excess tax benefits from stock-based awards 377 -
Repurchase of treasury stock (205) -
------------- -------------
Net cash provided by (used in) financing activities 65,159 (50)
------------- -------------
Net increase in cash and cash equivalents 24,832 9,389
Cash and cash equivalents, beginning of year 71,147 46,403
------------- -------------
Cash and cash equivalents, end of period $95,979 $55,792
============= =============
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. and its indirect
wholly-owned subsidiary Greatbatch Ltd. (collectively "Greatbatch" or 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 29, 2006 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 29, 2006. 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 2007 and 2006 each contained 13 weeks and ended
on September 28, and September 29, respectively.
2. ACQUISITIONS
BIOMEC, Inc. - On April 3, 2007, the Company acquired substantially all of
the assets of BIOMEC, Inc. ("BIOMEC"), a biomedical device company based in
Cleveland, OH with the objective of accelerating technology from major
medical and academic institutions, national laboratories, and from
internally developed proprietary products. With the BIOMEC acquisition, we
acquired an engineering team with diverse capabilities in medical device
development, including mechanical design, software engineering,
biocompatible coatings, and electronics. As a result, we can now offer our
customers device engineering expertise along with full device assembly
utilizing our proprietary components. This will also enable us to work in
conjunction with our customers' design teams to build more sophisticated
devices.
This transaction was accounted for under the purchase method of accounting
in accordance with Statement of Financial Accounting Standards ("SFAS") No.
141 Business Combinations. Accordingly, the results of BIOMEC's operations
were included in our condensed consolidated financial statements from the
date of acquisition. The aggregate purchase price was $11.4 million, which
was paid in cash. This purchase price is preliminary and is subject to
change based upon the Company incurring direct acquisition costs in
connection with this transaction. Any adjustment to the purchase price is
not expected to be material and will be allocated to goodwill, which
totaled $5.2 million. During the third quarter, the Company received a
payment of $0.25 million from the former BIOMEC representing its share of
the purchase price resulting from its 2% ownership interest in the former
BIOMEC. This payment was recorded as a reduction to the carrying amount of
this investment.
- 6-
GREATBATCH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Unaudited
--------------------------------------------------------------------------------
Various factors contributed to the establishment of goodwill, including:
the value of BIOMEC's highly trained assembled work force; the expected
revenue growth over time and the incremental value to the Company's
Implantable Medical Components ("IMC") business from having device
engineering capabilities; and the strategic partnership established with
IntElect Medical, Inc. ("IntElect") an early stage neurostimulation device
company that works in conjunction with the Cleveland Clinic. Goodwill
resulting from the BIOMEC acquisition was allocated to the Company's IMC
segment and is deductible for tax purposes.
Approximately $2.3 million of the purchase price represents the estimated
fair value of acquired in-process research and development ("IPR&D")
projects that had not yet reached technological feasibility and had no
alternative future use as of the acquisition date. Accordingly, the amount
was immediately expensed after the acquisition date. The value assigned to
IPR&D relates to projects that incorporate BIOMEC's novel-polymer coating
(biomimetic) technology that mimics the surface of endothelial cells of
blood vessels. The estimated fair value of these projects was determined
using a discounted cash flow model. This model utilized discount rates that
took into consideration the stage of completion and the risks surrounding
the successful development and commercialization of each of the IPR&D
projects of approximately 40%, which is consistent with the early
development stage of these projects. The Company expects various products
that utilize the biomimetic coatings technology to be commercially launched
by original equipment manufacturers ("OEM") in 2009 once Food and Drug
Administration ("FDA") approval is received. With BIOMEC, the Company
acquired grants that will fund the remaining development costs for these
products. The Company believes that the estimated acquired IPR&D amounts
represent their fair value at the date of acquisition and do not exceed the
amount an independent third party would pay for the projects. Pro forma
amounts are not presented as, excluding the IPR&D charge, BIOMEC did not
materially impact our results of operations.
Approximately $3.7 million of the purchase price was allocated to BIOMEC's
investment in IntElect. Subsequent to the acquisition, the Company made an
additional $2.0 million investment in IntElect, which increased its
ownership percentage to approximately 19%. The IntElect investment is being
accounted for under the cost method of accounting and is included in other
assets.
Enpath Medical, Inc. - On June 15, 2007, the Company completed its
acquisition of Enpath Medical, Inc. ("Enpath"). Enpath is a medical
products company engaged in designing, developing, manufacturing and
marketing single use medical device products for the cardiac rhythm
management, neuromodulation and interventional radiology markets. We
believe that the acquisition will further expand our product and service
offerings to the cardiac rhythm management ("CRM") and neurostimulation
marketplaces, broaden our market reach into the vascular segment through
Enpath's introducer product lines, as well as add several new OEM
customers.
This transaction was accounted for under the purchase method of accounting
in accordance with SFAS No. 141. Accordingly, the results of Enpath's
operations were included in our condensed consolidated financial statements
from the date of acquisition. The aggregate purchase price was $98.4
million, consisting of the cash issued at closing to Enpath shareholders
($91.7 million), the consideration paid to employees in exchange for the
cancellation of their Enpath stock options and restricted stock ($3.9
million) and other direct acquisition-related costs, including financial
advisory, legal and accounting services ($2.8 million). Subsequent to the
acquisition date, the Company repaid the line of credit and term loans
assumed from Enpath of approximately $7.1 million.
- 7 -
GREATBATCH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Unaudited
--------------------------------------------------------------------------------
In accordance with SFAS No. 141, the cost of the acquisition was
preliminarily allocated to the assets acquired and liabilities assumed from
Enpath based on their fair values as of the close of the acquisition, with
the amount exceeding the fair value recorded as goodwill. As the values of
certain assets and liabilities are preliminary in nature, they are subject
to adjustment as additional information is obtained, including, but not
limited to, the finalization of our intangible asset valuation and the
Company incurring direct acquisition costs in connection with this
transaction. The valuations will be finalized within 12 months of the close
of the acquisition. Any adjustment to the valuation is not expected to be
material and will be allocated to goodwill.
The following table summarizes the preliminary allocation of the cost of
the acquisition to the assets acquired and liabilities assumed as of the
close of the acquisition (in thousands):
As of
(in thousands) June 15, 2007
---------------------------------------------- -------------------
Assets acquired
Current assets $ 10,942
Property, plant and equipment 11,623
Acquired IPR&D 13,840
Amortizing intangible assets 24,144
Tradenames 4,330
Goodwill 48,595
-------------------
Total assets acquired 113,474
Liabilities assumed
Current liabilities 5,950
Notes payable 4,379
Deferred income taxes 4,625
Other non-current liabilities 145
-------------------
Total liabilities assumed 15,099
-------------------
Purchase price $ 98,375
===================
The fair values of the assets acquired and liabilities assumed were
preliminarily determined using one or more of three valuation approaches:
market, income and cost. The selection of a particular method for a given
asset depended on the reliability of available data and the nature of the
asset, among other considerations. The market approach, which indicates
value for a subject asset based on available market pricing for comparable
assets, was utilized for certain acquired personal property. The income
approach, which indicates value for a subject asset based on the present
value of risk adjusted cash flows projected to be generated by the asset,
was used for certain intangible assets such as core and developed
technology, acquired IPR&D, customer relationships, corporate tradenames
and for noncompete agreements with employees. The risk adjusted projected
cash flows were discounted at a required rate of return that reflects the
relative risk of the Enpath transaction and the time value of money. The
risk adjusted projected cash flows for each asset considered multiple
factors, including current revenue from existing customers, distinct
analysis of expected price, volume, and attrition trends, reasonable
contract renewal assumptions from the perspective of a marketplace
participant, and expected profit margins giving consideration to historical
and expected margins. The cost approach, which estimates value by
determining the current cost of replacing an asset with another of
equivalent economic utility, was used for the majority of personal
property. The cost to replace a
- 8 -
GREATBATCH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Unaudited
--------------------------------------------------------------------------------
given asset reflects the estimated reproduction or replacement cost for the
property, less an allowance for loss in value due to depreciation or
obsolescence, with specific consideration given to economic obsolescence if
indicated.
Inventory - The fair value of the inventory acquired was estimated by
applying a version of the cost approach called the net realizable value
method. This approach estimates the fair value of the asset by calculating
the potential sales generated from selling the inventory and subtracting
from it the costs related to the sale of that inventory and a reasonable
profit allowance. Based upon this methodology, the Company recorded the
inventory acquired at fair value resulting in an increase in inventory of
$1.3 million. For the three and nine months ended September 28, 2007, the
Company expensed as cost of sales $1.1 million and $1.3 million,
respectively, of the step-up value relating to the acquired Enpath
inventory sold during the respective periods. As of September 28, 2007,
there was no inventory step-up value remaining to be expensed.
Intangible assets - The purchase price was allocated to specific intangible
assets on a preliminary basis as follows (dollars in thousands):
Weighted average
amortization Probability
Amount period (years) assigned to Discount
assigned revenues rate
-------------- ------------------- -------------- --------------
Amortizable intangible assets
Technology - core $ 6,927 11 100% 10%
Technology - developed 2,774 6 100% 10%
Customer relationships 14,133 11 100% 11%
Noncompete agreements 310 1 50% 10%
-------------- -------------------
$24,144 10
Tradenames $ 4,330 indefinite 100% 10%
Acquired IPR&D - Introducers $12,640 - 60% - 90% 10%
Acquired IPR&D - Catheters $ 1,200 - 70% - 75% 10%
Core technology - Core technology consists of technical processes, patented
and unpatented technology, manufacturing know-how and the understanding
with respect to products or processes that have been developed by Enpath
and that will be leveraged in future products or processes and will be
carried forward from one product generation to the next. Approximately 85
percent of the preliminary value assigned to core technology is associated
with Enpath's introducer products. The Company determined that the
estimated useful life of the core technology is 11 years. This life is
based upon management's estimate of the product life cycle associated with
core technology before they will be replaced by new technologies. The
expected cash flows associated with core technology were nominal after 11
years.
Developed technology - Developed technology acquired from Enpath represents
the preliminary value associated with currently marketed products that have
received FDA approval as of the acquisition date. Enpath's currently
marketed products include:
- 9 -
GREATBATCH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Unaudited
--------------------------------------------------------------------------------
o Venous vessel introducers and valved introducers that enable
physicians to create a conduit through which they can insert infusion
catheters, implantable ports and pacemaker leads into a blood vessel;
o Advanced delivery catheters that have a "fixed curve" or articulating
distal tip section that can be manipulated to enable the health care
professional to access parts of the patient's anatomy that cannot be
reached by traditional introducers; and
o Implantable stimulation leads, adaptors and delivery systems for the
cardiac and neuromodulation markets.
The Company determined that the estimated useful life of the developed
technology is 6 years. This life is based upon management's estimate of the
life cycle associated with the above products before they will be replaced
by new technologies or the next generation of products. The expected cash
flows associated with developed technology were nominal after 6 years.
Customer relationships - Customer relationships represent the preliminary
estimated fair value of both the contractual and non-contractual customer
relationships Enpath has with OEMs as of the acquisition date. The primary
customers of Enpath include C.R. Bard, Boston Scientific, Medtronic and St.
Jude Medical, some of which are also customers of Greatbatch. These
relationships were valued separately from goodwill at the amount which an
independent third party would be willing to pay for these OEM
relationships. The Company determined that the estimated useful life of the
intangible assets associated with the existing customer relationships is 11
years. This life was based upon historical customer attrition and
management's understanding of the industry. The customer relationships
valuation was modified during the quarter due to the finalization of
assumptions used in the excess earnings analysis and primarily related to
the allocation of R&D costs between new and existing customers.
Acquired IPR&D - Approximately $13.8 million of the purchase price
represents the preliminary estimated fair value of acquired IPR&D projects
that had not yet reached technological feasibility and had no alternative
future use. Accordingly, the amount was immediately expensed on the
acquisition date. The preliminary value assigned to IPR&D related to
introducer projects ($12.6 million) and catheter projects ($1.2 million).
These projects primarily represent the next generation of products already
being sold by Enpath which incorporate new enhancements and customer
modifications. The Company expects to commercially launch various
introducer products in 2008 and 2009 and various catheter products in 2009
which will replace existing products. For purposes of valuing the acquired
research and development, the Company estimated total costs to complete the
introducer projects to be approximately $0.3 million and approximately $0.5
million to complete the catheter projects. If we are not successful in
completing these projects on a timely basis, our future sales from
introducers and catheters may be adversely affected resulting in erosion of
our market share.
The preliminary fair value of these projects was determined based on the
excess earnings method. This model utilized discount rates that took into
consideration the internal rate of return expected from the Enpath
transaction and applied that rate to risk adjusted revenues. The risk
adjustment assigned to the revenues was based upon the stage of completion
and the risks surrounding the successful development and commercialization
of each of the IPR&D projects. The Company believes that the estimated
acquired IPR&D amounts represent the fair value at the date of acquisition
and do not exceed the amount an independent third party would pay for the
projects. The IPR&D valuation was modified during the quarter due to the
finalization of assumptions used in the excess earnings analysis and
primarily related to the allocation of R&D costs between new and existing
customers.
- 10 -
GREATBATCH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Unaudited
--------------------------------------------------------------------------------
Goodwill - The excess of the purchase price over the preliminary fair value
of net tangible and intangible assets acquired of $48.6 million was
allocated to goodwill. Various factors contributed to the establishment of
goodwill, including: the strategic benefit of entering the neurostimulation
and interventional markets; the value of Enpath's highly trained assembled
work force; the expected revenue growth over time that is attributable to
increased market penetration from future products and customers; and the
incremental value to the Company's IMC business from having a leads
platform. The goodwill acquired in connection with the Enpath acquisition
was allocated to the Company's IMC business segment and is not deductible
for tax purposes.
Pro Forma Results - The following unaudited pro forma information presents
the consolidated results of operations of the Company and Enpath as if the
acquisition of Enpath had occurred as of the beginning of each of the
fiscal periods presented (in thousands, except per share amounts):
Three months ended Nine months ended
-------------------------------- --------------------------------
September 28, September 29, September 28, September 29,
(Unaudited) 2007 2006 2007 2006
-------------------------------- --------------------------------
Sales $79,009 $78,404 $251,949 $235,307
Net income 3,469 2,628 22,868 13,163
Earnings per share:
Basic $0.16 $0.12 $1.03 $0.60
Diluted $0.15 $0.12 $0.97 $0.59
The unaudited pro forma information presents the combined operating results
of Greatbatch and Enpath, with the results prior to the acquisition date
adjusted to include the pro forma impact of the adjustment of amortization
of acquired intangible assets and depreciation of fixed assets based on the
preliminary purchase price allocation, the elimination of acquisition
expenses incurred by Enpath ($5.9 million), the elimination of the
non-recurring IPR&D charge ($13.8 million) and inventory step-up adjustment
related to the Enpath acquisition recorded by Greatbatch in 2007 ($1.1
million/$1.3 million for the three and nine month periods), the adjustment
to interest income reflecting the cash paid in connection with the
acquisition, including acquisition-related expenses, at Greatbatch's
weighted average interest income rate, and the impact of income taxes on
the pro forma adjustments utilizing the federal statutory tax rate of 35%,
except for IPR&D which is not deductible for tax purposes. The unaudited
pro forma consolidated basic and diluted earnings per share are based on
the consolidated basic and diluted weighted average shares of Greatbatch.
The unaudited pro forma results are presented for illustrative purposes
only and do not reflect the realization of potential cost savings, and any
related integration costs. Certain cost savings may result from the
acquisition; however, there can be no assurance that these cost savings
will be achieved. These pro forma results do not purport to be indicative
of the results that would have actually been obtained if the acquisition
occurred as of the beginning of each of the periods presented, nor does the
pro forma data intend to be a projection of results that may be obtained in
the future.
- 11 -
GREATBATCH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Unaudited
--------------------------------------------------------------------------------
3. SUPPLEMENTAL CASH FLOW INFORMATION
Nine months ended
------------------------------
September 28, September 29,
2007 2006
--------------- --------------
Noncash investing and financing activities (in thousands):
Net unrealized gain (loss) on available-for-sale securities $ (869) $ 2,726
Common stock contributed to 401(k) Plan 2,956 2,780
Property, plant and equipment purchases included
in accounts payable 1,958 619
Exchange of convertible subordinated notes (Note 7) 117,782 -
Cash paid during the period for:
Interest $ 2,429 $ 1,960
Income taxes 16,718 2,769
Acquisition of noncash assets and liabilities:
Assets acquired $ 126,182 $ -
Liabilities assumed 15,678 -
4. SHORT-TERM INVESTMENTS
Short-term investments available for sale are comprised of the following
(in thousands):
Gross Gross
unrealized unrealized Estimated fair
Cost gains losses value
----------- ------------ ------------- ---------------
September 28, 2007
------------------
Auction rate securities and other $ 19,774 $ - $ - $ 19,774
----------- ------------ ------------- ---------------
Total available for sale securities $ 19,774 $ - $ - $ 19,774
=========== ============ ============= ===============
December 29, 2006
-----------------
Equity securities $ 291 $ 4,588 $ - $ 4,879
Auction rate securities and other 66,537 4 (4) 66,537
----------- ------------ ------------- ---------------
Total available for sale securities $ 66,828 $ 4,592 $ (4) $ 71,416
=========== ============ ============= ===============
In the second quarter of 2007, the Company sold an equity security
investment which resulted in a pre-tax gain of $4.0 million ($2.6 million
net of tax) or $0.11 per diluted share.
- 12 -
GREATBATCH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (con't) - Unaudited
--------------------------------------------------------------------------------
5. INVENTORIES
Inventories are comprised of the following (in thousands):
September 28, December 29,
2007 2006
----------------- -----------------
Raw materials $ 36,341 $ 28,568
Work-in-process 17,748 13,528
Finished goods 14,476 15,571
----------------- -----------------
Total $ 68,565 $ 57,667
================= =================
6. INTANGIBLE ASSETS
Amortizing intangible assets are comprised of the following (in thousands):
Gross
carrying Accumulated Net carrying
amount amortization amount
------------- -------------- ------------
September 28, 2007
------------------
Customer lists $ 14,133 $ (374) $ 13,759
Patented technology 21,462 (14,472) 6,990
Unpatented technology 40,587 (12,961) 27,626
Other 1,650 (1,430) 220
------------ ------------- ------------
Total amortizing intangible assets $ 77,832 $ (29,237) $ 48,595
============ ============= ============
December 29, 2006
-----------------
Patented technology $ 21,462 $ (13,320) $ 8,142
Unpatented technology 30,886 (10,975) 19,911
Other 1,340 (1,315) 25
------------ ------------- ------------
Total amortizing intangible assets $ 53,688 $ (25,610) $ 28,078
============ ============= ============
Aggregate amortization expense for the third quarter of
2007 and 2006 was $1.6 million and $0.9 million, respectively. Aggregate
amortization expense for the nine months ended September 28, 2007 and
September 29, 2006 was $3.6 million and $2.9 million, respectively. As of
September 29, 2007, annual amortization expense is estimated to be $1.6
million for the remainder of 2007, $6.3 million for 2008, $5.6 million for
2009, $5.1 million for 2010, 2011 and 2012.
The change in the carrying amount of goodwill during 2007 is as follows (in
thousands):
IMC ECP Total
-------------- --------------- --------------
Balance at December 29, 2006 $ 152,473 $ 2,566 $ 155,039
Goodwill recorded for BIOMEC 5,172 - 5,172
Goodwill recorded for Enpath 48,595 - 48,595
Resolution of Enpath tax contingency (20) - (20)
-------------- --------------- --------------
Balance at September 28, 2007 $ 206,220 $ 2,566 $ 208,786
============== =============== ==============
- 13 -
GREATBATCH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (con't) - Unaudited
--------------------------------------------------------------------------------
7. DEBT
Long-term debt is comprised of the following (in thousands):
September 28, December 29,
2007 2006
------------- -------------
2.25% convertible subordinated notes I, due 2013 $ 52,218 $ 170,000
2.25% convertible subordinated notes II, due 2013 197,782 -
Unamortized discount (9,098) -
------------- -------------
Total long-term debt $ 240,902 $ 170,000
============= =============
Convertible Subordinated Notes - In May 2003, the Company completed a
private placement of $170 million of 2.25% convertible subordinated notes,
due 2013 ("CSN I"). In November 2003, the Company had a registration
statement with the Securities and Exchange Commission ("SEC") declared
effective with respect to these notes and the underlying common stock. In
March 2007, the Company entered into separate, privately negotiated
agreements to exchange $117.8 million of CSN I for an equivalent principal
amount of a new series of 2.25% convertible subordinated notes due 2013
("CSN II") (collectively the "Exchange") at a 5% discount.
The primary purpose of the Exchange was to eliminate the June 15, 2010 call
and put option that is included in the terms of CSN I. In connection with
the Exchange, the Company issued an additional $80 million aggregate
principal amount of CSN II at a price of $950 per $1,000 of principal. In
June 2007, the Company had a registration statement with the SEC declared
effective with respect to these notes and the underlying common stock.
The Exchange was accounted for as an extinguishment of debt and resulted in
a pre-tax gain of $4.5 million ($2.9 million net of tax) or $0.12 per
diluted share. As a result of the extinguishment, the Company had to
recapture the tax interest expense that was previously deducted on the
extinguished notes. This resulted in an additional current income tax
liability of approximately $11.3 million, of which approximately $8.5
million has been paid as of September 28, 2007 and the remainder will be
paid by the end of 2007. This amount was previously recorded as a
non-current deferred tax liability on the balance sheet. The following is a
summary of the significant terms of CSN I and CSN II:
CSN I - The notes bear interest at 2.25% per annum, payable semi-annually.
Holders may convert the notes into shares of the Company's common stock at
a conversion rate of 24.8219 shares per $1,000 of principal, subject to
adjustment, before the close of business on June 15, 2013 only under the
following circumstances: (1) during any fiscal quarter commencing after
July 4, 2003, if the closing sale price of the Company's common stock
exceeds 120% of the $40.29 conversion price for at least 20 trading days in
the 30 consecutive trading day period ending on the last trading day of the
preceding fiscal quarter; (2) subject to certain exceptions, during the
five business days after any five consecutive trading day period in which
the trading price per $1,000 of principal for each day of such period was
less than 98% of the product of the closing sale price of the Company's
common stock and the number of shares issuable upon conversion of $1,000 of
principal; (3) if the notes have been called for redemption; or (4) upon
the occurrence of certain corporate events.
- 14 -
GREATBATCH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (con't) - Unaudited
--------------------------------------------------------------------------------
Beginning June 20, 2010, the Company may redeem any of the notes at a
redemption price of 100% of their principal amount, plus accrued interest.
Note holders may require the Company to repurchase their notes on June 15,
2010 or at any time prior to their maturity following a fundamental change,
as defined in the indenture agreement, at a repurchase price of 100% of
their principal amount, plus accrued interest. The notes are subordinated
in right of payment to all of our senior indebtedness and effectively
subordinated to all debts and other liabilities of the Company's
subsidiaries.
Beginning with the six-month interest period commencing June 15, 2010, the
Company will pay additional contingent interest during any six-month
interest period if the trading price of the notes for each of the five
trading days immediately preceding the first day of the interest period
equals or exceeds 120% of the principal amount of the notes.
CSN II - The notes bear interest at 2.25% per annum, payable semi-annually.
The holders may convert the notes into shares of the Company's common stock
at a conversion price of $34.70 per share, which is equivalent to a
conversion ratio of 28.8219 shares per $1,000 of principal. The conversion
price and the conversion ratio will adjust automatically upon certain
changes to the Company's capitalization.
The notes are convertible at the option of the holders at such time as: (i)
the closing price of the Company's common stock exceeds 150% of the
conversion price of the notes for 20 out of 30 consecutive trading days;
(ii) the trading price per $1,000 of principal is less than 98% of the
product of the closing sale price of common stock for each day during any
five consecutive trading day period and the conversion rate per $1,000 of
principal; (iii) the notes have been called for redemption; (iv) the
Company distributes to all holders of common stock rights or warrants
entitling them to purchase additional shares of common stock at less than
the average closing price of common stock for the ten trading days
immediately preceding the announcement of the distribution; (v) the Company
distributes to all holders of common stock any form of dividend which has a
per share value exceeding 5% of the price of the common stock on the day
prior to such date of distribution; (vi) the Company affects a
consolidation, merger, share exchange or sale of assets pursuant to which
its common stock is converted to cash or other property; (vii) the period
beginning 60 days prior to but excluding June 15, 2013; and (viii) certain
fundamental changes, as defined in the indenture agreement, occur or are
approved by the Board of Directors.
Conversions in connection with corporate transactions that constitute a
fundamental change require the Company to pay a premium make-whole amount
whereby the conversion ratio on the notes may be increased by up to 8.2
shares per $1,000 of principal. The premium make-whole amount will be paid
in shares of common stock upon any such conversion, subject to the net
share settlement feature of the notes described below.
The notes contain a net share settlement feature that requires the Company
to pay cash for each $1,000 of principal. Any amounts in excess of $1,000
will be settled in shares of the Company's common stock, or at the
Company's option, cash. The Company has a one-time irrevocable election to
pay the holders in shares of its common stock, which it currently does not
plan to exercise.
- 15 -
GREATBATCH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (con't) - Unaudited
--------------------------------------------------------------------------------
The notes are redeemable by the Company at any time on or after June 20,
2012, or at the option of a holder upon the occurrence of certain
fundamental changes, as defined in the agreement, affecting the Company.
The notes are subordinated in right of payment to all of our senior
indebtedness and effectively subordinated to all debts and other
liabilities of the Company's subsidiaries.
Revolving Line of Credit - In May 2007, the Company entered into a new
senior credit facility (the "New Credit Facility") consisting of a $235
million revolving credit facility, which can be increased to $335 million
upon the Company's request. The New Credit Facility also contains a $15
million letter of credit subfacility and a $15 million swingline
subfacility. This New Credit Facility replaced the Company's previous $50
million revolving credit facility. The New Credit Facility is secured by
the Company's non-realty assets including cash, accounts and notes
receivable, and inventories, and has an expiration date of May 22, 2012
with a one-time option to extend to April 1, 2013 if no default has
occurred. Interest rates under the New Credit Facility are, at the
Company's option, based upon the current prime rate or the LIBOR rate plus
a margin that varies with the Company's leverage ratio. If interest is paid
based upon the prime rate, the applicable margin is between minus 1.25% and
0.00%. If interest is paid based upon the LIBOR rate, the applicable margin
is between 1.00% and 2.00%. The Company is required to pay a commitment fee
between 0.125% and 0.250% per annum on the unused portion of the New Credit
Facility based on the Company's leverage ratio.
The New Credit Facility contains limitations on the incurrence of
indebtedness, limitations on the incurrence of liens and licensing of
intellectual property, limitations on investments and restrictions on
certain payments. Except to the extent paid for by common equity of
Greatbatch or paid for out of cash on hand, the New Credit Facility limits
the amount paid for acquisitions to $100 million. The restrictions on
payments, among other things, limit repurchases of Greatbatch's stock to
$60 million and limits the ability of the Company to make cash payments
upon conversion of CSN II.
In addition, the New Credit Facility requires the Company to maintain a
ratio of adjusted EBITDA, as defined in the credit agreement, to interest
expense of at least 3.00 to 1.00, and a total leverage ratio, as defined in
the credit agreement, of not greater than 5.00 to 1.00 from May 22, 2007
through September 29, 2009 and not greater than 4.50 to 1.00 from September
30, 2009 and thereafter.
The New Credit Facility contains customary events of default. Upon the
occurrence and during the continuance of an event of default, a majority of
the lenders may declare the outstanding advances and all other obligations
under the New Credit Facility immediately due and payable.
There were no borrowings outstanding under the New Credit Facility as of
September 28, 2007.
Deferred Financing Fees - The following is a reconciliation of deferred
financing fees for the third quarter of 2007, which are included in other
assets (in thousands):
Balance at June 29, 2007 $ 7,031
Financing costs deferred 11
Write-off during the period -
Amortization during the period (339)
---------------
Balance at September 28, 2007 $ 6,703
===============
- 16 -
GREATBATCH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (con't) - Unaudited
--------------------------------------------------------------------------------
8. STOCK-BASED COMPENSATION
Beginning in fiscal year 2006, the Company adopted SFAS No. 123 (revised
2004), Share-Based Payment ("SFAS No. 123(R)"), and related SEC rules
included in Staff Accounting Bulletin ("SAB") No. 107. Under SFAS No.
123(R) the Company records compensation costs related to all stock-based
awards. Compensation costs related to share-based payments for the three
and nine months ended September 28, 2007 totaled $1.4 million, $0.9 million
net of tax, or $0.4 per diluted share and $4.3 million, $2.8 million net of
tax, or $0.11 per diluted share, respectively. This compares to $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 three
and nine months ended September 29, 2006, respectively.
The following table summarizes stock option activity related to the
Company's stock-based incentive plans:
Weighted
average
Weighted remaining Aggregate
average contractual intrinsic
Number of exercise life value(1)
stock options price (in years) (in millions)
----------------------------------------------------
Outstanding at January 1, 2006 1,397,160 $ 23.16
Granted(2) 483,265 23.92
Exercised (160,605) 12.97
Forfeited or Expired (93,291) 24.94
--------------
Outstanding at December 29, 2006 1,626,529 $ 24.27 7.4 $6.4
Granted(3) 334,613 27.63
Exercised (141,302) 19.10
Forfeited or Expired (117,576) 27.50
--------------
Outstanding at September 28, 2007 1,702,264 $ 25.17 7.4 $5.0
====================================================
Exercisable at September 28, 2007 788,492 $ 26.04 5.8 $2.4
====================================================
(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 28, 2007 ($26.59) and the weighted average exercise price of
the underlying options, multiplied by the number of options
outstanding and/or exercisable.
(2) Includes 183,648 performance based stock options which had a weighted
average exercise price of $22.38 per share.
(3) Includes 146,231 performance based stock options which had a weighted
average exercise price of $29.65 per share.
- 17 -
GREATBATCH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (con't) - Unaudited
--------------------------------------------------------------------------------
The weighted-average fair value and assumptions used to value options
granted are as follows:
Nine months ended
-----------------------------
September 28, September 29,
2007 2006
-------------- -------------
Weighted-average fair value $12.33 $10.85
Risk-free interest rate 4.62% 4.74%
Expected volatility 41% 43%
Expected life (in years) 5.4 5.4
Expected dividend yield 0% 0%
The following table summarizes restricted stock and restricted stock unit
activity related to the Company's plans:
Weighted average
Activity fair value
------------ ----------------
Nonvested at January 1, 2006 93,956 $ 22.46
Shares granted 145,126 23.25
Shares vested (25,911) 20.00
Shares forfeited (9,015) 22.63
------------
Nonvested at December 29, 2006 204,156 $ 23.32
Shares granted 113,531 27.33
Shares vested (9,436) 25.50
Shares forfeited (7,618) 23.30
------------
Nonvested at September 28, 2007 300,633 $ 24.77
At the Company's 2007 Annual Meeting of Stockholders held on May 22, 2007,
an amendment to the Company's 2005 Stock Incentive Plan was approved by
stockholders which increased the number of shares available for grant by
1,450,000 shares.
9. OTHER OPERATING EXPENSE
The following were recorded in other operating expense, net in the
Company's Consolidated Statements of Operations and Comprehensive Income
(in thousands):
Three months ended Nine months ended
------------------------------ -----------------------------
September 28, September 29, September 28, September 29,
2007 2006 2007 2006
-------------- -------------- ------------- --------------
(a) Alden facility consolidation $ - $ - $ - $ 567
(b) Carson City facility shutdown and Tijuana
facility consolidation No. 1 10 411 584 2,450
(c) Columbia facility shutdown, Tijuana facility
consolidation No. 2 and RD&E consolidation 1,030 1,225 3,705 3,546
(d) ECP expansion 126 - 408 -
(e) Asset dispositions and other 109 4,603 99 5,988
-------------- -------------- ------------- --------------
$ 1,275 $ 6,239 $ 4,796 $ 12,551
============== ============== ============= ==============
- 18 -
GREATBATCH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (con't) - Unaudited
--------------------------------------------------------------------------------
(a) Alden Facility consolidation - Beginning in the first quarter of 2005
and ending in the second quarter of 2006 the Company 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 - $0.3 million;
o Moving and facility closures - $2.7 million; and
o Other - $0.4 million.
(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 ceased operating at the Carson City Facility on July 15, 2007.
The total cost for this consolidation effort was $7.8 million. The major
categories of costs include the following:
o Costs related to the shutdown of the Carson City Facility:
a. Severance and retention - $3.9 million;
b. Accelerated depreciation - $0.6 million; and
c. Other - $0.3 million.
o Costs related to the Tijuana Facility consolidation No. 1:
a. Production inefficiencies and revalidation - $0.5 million;
b. Relocation and moving - $0.1 million;
c. Personnel (including travel, training and duplicate wages) - $1.7
million; and
d. Other - $0.7 million.
All categories of costs are considered to be cash expenditures, except
accelerated depreciation. The Company anticipates annual cost savings in
the range of $2.5 million 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.
- 19 -
GREATBATCH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (con't) - Unaudited
--------------------------------------------------------------------------------
Accrued liabilities related to the Carson City Facility shutdown are
comprised of the following (in thousands):
Severance and Accelerated
retention depreciation Other Total
--------------- ---------------- --------------- ----------------
Restructuring charges $ 3,551 $ 600 $ 278 $ 4,429
Cash payments (2,394) - (278) (2,672)
Write-offs - (600) - (600)
--------------- ---------------- --------------- ----------------
Balance, December 29, 2006 $ 1,157 $ - $ - $ 1,157
Restructuring charges 338 - 26 364
Cash payments (1,020) - (26) (1,046)
--------------- ---------------- --------------- ----------------
Balance, September 28, 2007 $ 475 $ - $ - $ 475
=============== ================ =============== ================
Accrued liabilities related to the Tijuana Facility consolidation No. 1 are
comprised of the following (in thousands):
Production
inefficiencies and Relocation
revalidation and moving Personnel Other Total
------------------ --------------- --------------- -------------- ---------------
Restructuring charges $ 293 $ 124 $ 1,701 $ 636 $ 2,754
Cash payments (293) (124) (1,701) (636) (2,754)
------------------ --------------- --------------- -------------- ---------------
Balance, December 29, 2006 $ - $ - $ - $ - $ -
Restructuring charges 220 - - - 220
Cash payments (220) - - - (220)
------------------ --------------- --------------- -------------- ---------------
Balance, September 28, 2007 $ - $ - $ - $ - $ -
================== =============== =============== ============== ===============
(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 Company also
announced that the manufacturing operations at the Columbia Facility will
be moved into the Tijuana Facility ("Tijuana Facility consolidation No. 2")
and that 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.
The total estimated cost for this facility consolidation plan is
anticipated to be between $11.1 million and $11.6 million of which $10.0
million has been incurred through September 28, 2007. The ARL move and
closure portion of this consolidation project is complete. The Company
expects to incur the remaining cost for the other portions of the
consolidation project in 2007 and the first quarter of 2008, with cash
payments being made through the second quarter of 2008.
- 20 -
GREATBATCH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (con't) - Unaudited
--------------------------------------------------------------------------------
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 - $3.7 to $3.9 million;
b. Personnel (including travel, training and duplicate wages) - $1.4
million ;
c. Accelerated depreciation/asset write-offs - $0.5 million; and d.
Other - $0.4 to $0.5 million.
o Costs related to Tijuana Facility consolidation No. 2:
a. Production inefficiencies and revalidation - $1.0 to $1.1
million;
b. Relocation and moving - $0.3 million;
c. Personnel (including travel, training and duplicate wages) - $2.9
to $3.0 million; and
d. Other (including asset write-offs) - $0.9 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
million 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 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 $ 2,297 $ 701 $ 509 $ 428 $ 3,935
Cash payments (550) (701) - (428) (1,679)
Write-offs - - (509) - (509)
-------------- ---------------- --------------------- ----------------- ------------------
Balance, December 29, 2006 $ 1,747 $ - $ - $ - $ 1,747
Restructuring charges 1,127 363 (54) 15 1,451
Cash payments (990) (363) - (15) (1,368)
Write-offs - - 54 - 54
-------------- ---------------- --------------------- ----------------- ------------------
Balance, September 28, 2007 $ 1,884 $ - $ - $ - $ 1,884
============== ================ ===================== ================= ==================
- 21 -
GREATBATCH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (con't) - Unaudited
--------------------------------------------------------------------------------
Accrued liabilities related to Tijuana Facility consolidation No. 2 are
comprised of the following (in thousands):
Production
inefficiencies and Relocation
revalidation and moving Personnel Other Total
------------------ ---------------- ----------------- ---------------- ----------------
Restructuring charges $ 264 $ 149 $ 1,594 $ 317 $ 2,324
Cash payments (264) (149) (1,594) (317) (2,324)
------------------ ---------------- ----------------- ---------------- ----------------
Balance, December 29, 2006 $ - $ - $ - $ - $ -
Restructuring charges 770 109 880 495 2,254
Cash payments (770) (109) (880) (495) (2,254)
------------------ ---------------- ----------------- ---------------- ----------------
Balance, September 28, 2007 $ - $ - $ - $ - $ -
================== ================ ================= ================ ================
(d) Electrochem Commercial Power ("ECP") expansion. In February 2007, the
Company announced that it will close its current manufacturing facility in
Canton, MA and construct a new 80,000 square foot replacement facility in
the Massachusetts area. The expected completion of this $28 million
expansion project is mid-2008. The total expense to be recognized for this
relocation is estimated to be $2.2 million to $2.4 million, of which $0.4
million has been incurred primarily related to accelerated depreciation.
Costs related to this move are included in the ECP business segment and
include the following:
o Production inefficiencies and revalidation - $0.6 million;
o Moving and facility closure - $0.9 million to $1.0 million;
o Accelerated depreciation - $0.4 million; and
o Other - $0.3 million to $0.4 million.
(e) Asset dispositions and other. During the third quarter of 2007, the
Company had various asset dispositions. 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.
In addition to the quarter disposals discussed above, the nine month period
in 2007 includes $0.3 million of insurance proceeds received related to
equipment damaged during transportation to the Tijuana Facility. The nine
month period of 2006 also includes the loss of $0.5 million related to this
equipment damaged (included in the IMC business segment) and an expense of
$0.8 million for professional fees related to a potential acquisition that
we no longer considered probable.
- 22 -
GREATBATCH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (con't) - Unaudited
--------------------------------------------------------------------------------
10. INCOME TAXES
Effective in the first quarter of 2007, the Company adopted the provisions
of Financial Standards Accounting Board ("FASB") Interpretation ("FIN") No.
48 Accounting for Uncertainty in Income Taxes, an interpretation of SFAS
No. 109. FIN No. 48, clarifies the accounting for uncertainty in income
taxes recognized under SFAS No. 109. Additionally, in May 2007, the FASB
published FASB Staff Position ("FSP") No. FIN No. 48-1, Definition of
Settlement in FASB Interpretation No. 48, which clarifies how an enterprise
should determine whether a tax position is effectively settled for the
purpose of recognizing previously unrecognized tax benefits. As of our
adoption date of FIN No. 48, our accounting is consistent with the guidance
in FSP FIN No. 48-1.
Upon adoption of FIN No. 48, the Company did not recognize any adjustment
to its $1.8 million of unrecognized tax benefits, all of which would
favorably impact the effective tax rate (net of federal benefit on state
issues), if recognized. The Company's unrecognized tax benefits consist of
refund claims which did not meet the more likely than not threshold under
FIN No. 48.
During the third quarter of 2007, the balance of unrecognized tax benefits
increased approximately $0.1 million as a result of filing positions taken
on our 2006 tax returns. As of September 28, 2007, approximately $0.3
million of unrecognized tax benefits would impact goodwill if recognized.
Of the remaining approximately $1.6 million of unrecognized tax benefits,
approximately $1.3 million would favorably impact the effective tax rate
(net of federal benefit on state issues), if recognized. The Company
anticipates that the total unrecognized tax benefits could significantly
change within the next twelve months due to the settlement of
audits/appeals currently in process, however, quantification of an
estimated range cannot be made at this time.
The tax years 2004-2006 remain open to examination by the major taxing
jurisdictions to which we are subject. The 2001 - 2003 tax years remain
open in certain jurisdictions as a result of audits/appeals currently in
process.
The effective tax rate for 2007 includes the impact of the $16.1 million of
acquired IPR&D written off, $13.8 million of which is not deductible for
tax purposes. Excluding this expense, the effective tax rate for the three
and nine months ended September 28, 2007 would have been approximately 32%
compared to 24.3% and 32.5% for the same periods of 2006, respectively.
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 which resulted in the lower effective tax rate for that
period.
Subsequent to the end of the third quarter, Mexico enacted new tax
legislation that will take effect on January 1, 2008. We are currently
evaluating the impact of this tax law change on our financial statements.
- 23 -
GREATBATCH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (con't) - Unaudited
--------------------------------------------------------------------------------
11. COMMITMENTS AND CONTINGENCIES
Litigation - The Company is a party to various legal actions arising in the
normal course of business. While the Company does not believe that the
ultimate resolution of any such pending activities will have a material
adverse effect on its consolidated results of operations, financial
position or cash flows, litigation is subject to inherent uncertainties. If
an unfavorable ruling were to occur, there exists the possibility of a
material adverse impact in the period in which the ruling occurs.
During 2002, a former non-medical customer commenced an action alleging
that Greatbatch had used proprietary information of the customer to develop
certain products. We have meritorious defenses and are vigorously defending
the matter. The potential risk of loss is between $0.0 and $1.7 million.
In connection with our acquisition of Enpath Medical, Inc. ("Enpath"), we
assumed liability in connection with the following proceeding:
On June 12, 2006, Enpath was named as defendant in a patent infringement
action filed by Pressure Products Medical Supplies, Inc. and venued in the
United States District Court in the Eastern District of Texas. On October
2, 2006, Enpath was officially served. Enpath has filed an answer denying
liability and has filed counterclaims against the plaintiff alleging
antitrust violations and patent misuse. The plaintiff has alleged that
Enpath's FlowGuard(TM) valved introducer, which has been on the market for
more than three years, infringes claims in the plaintiff's patents and is
seeking damages and injunctive relief. Enpath believes that the plaintiff's
claims are without merit and intends to pursue its defenses vigorously.
Revenues from products sold that include the FlowGuard valved introducer
were approximately 5% of Enpath's total revenue for 2007 ($29.3 million),
2006 ($36.8 million) and 2005 ($29.4 million). The lawsuit is currently in
the discovery stage. The District Court held a hearing to construe the
claims of the plaintiff's patents in August 2007, but has not yet issued
its decision. It is not possible to predict the timing or outcome of this
litigation at this time, including whether it will affect the Company's
ability to sell its FlowGuard products, or to estimate the amount or range
of potential loss.
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.
The change in aggregate product warranty liability for the quarter ended
September 28, 2007 is as follows (in thousands):
Beginning balance at June 29, 2007 $ 1,817
Reductions to warranty reserve (251)
Warranty claims paid (340)
-------------
Ending balance at September 28, 2007 $ 1,226
=============
- 24 -
GREATBATCH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (con't) - Unaudited
--------------------------------------------------------------------------------
Purchase Commitments - Contractual obligations for purchase of goods or
services are defined as agreements that are enforceable and legally binding
on the Company and that specify all significant terms, including: fixed or
minimum quantities to be purchased; fixed, minimum or variable price
provisions; and the approximate timing of the transaction. Our purchase
orders are normally based on our current manufacturing needs and are
fulfilled by our vendors within short time horizons. We enter into blanket
orders with vendors that have preferred pricing and terms, however these
orders are normally cancelable by us without penalty. As of September 28,
2007, the total contractual obligation related to such expenditures is
approximately $32.9 million and primarily relate to the construction of our
new ECP manufacturing facility and the expansion of our corporate
headquarters. These commitments will be financed by existing cash,
short-term investments or cash generated from operations. We also enter
into contracts for outsourced services; however, the obligations under
these contracts were not significant and the contracts generally contain
clauses allowing for cancellation without significant penalty.
12. 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 28, September 29, September 28, September 29,
2007 2006 2007 2006
------------- ------------- ------------- -------------
Numerator for basic earnings per share:
Net income $ 5,000 $ 3,239 $ 12,270 $ 14,732
Effect of dilutive securities:
Interest expense on convertible notes and related
deferred financing fees, net of tax 223 - 1,175 2,264
------------- ------------- ------------- -------------
Numerator for diluted earnings per share $ 5,223 $ 3,239 $ 13,445 $ 16,996
============= ============= ============= =============
Denominator for basic earnings per share:
Weighted average shares outstanding 22,214 21,816 22,129 21,788
Effect of dilutive securities:
Convertible subordinated notes 1,296 - 2,270 4,219
Stock options and unvested restricted stock 362 167 340 169
------------- ------------- ------------- -------------
Dilutive potential common shares 1,658 167 2,610 4,388
------------- ------------- ------------- -------------
Denominator for diluted earnings per share 23,872 21,983 24,739 26,176
============= ============= ============= =============
Basic earnings per share $ 0.23 $ 0.15 $ 0.55 $ 0.68
============= ============= ============= =============
Diluted earnings per share $ 0.22 $ 0.15 $ 0.54 $ 0.65
============= ============= ============= =============
The 2007 diluted weighted average share calculations do not include stock
options of 319,000 and 600,000 for the three and nine month periods,
respectively, as they are not dilutive to the earnings per share
calculations. The 2006 diluted weighted average share calculations do not
include 1,193,000 stock options for the three and nine month periods and
4,219,000 shares related to the Company's convertible subordinated notes
for the three month period as they are not dilutive to the earnings per
share calculations. The diluted weighted average share calculations for
both periods in 2007 and 2006 also do not include 338,000 shares and
235,000 shares, respectively, of performance based stock options and
restricted stock units as the performance criteria for those awards had not
been met.
- 25 -
GREATBATCH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (con't) - Unaudited
--------------------------------------------------------------------------------
13. COMPREHENSIVE INCOME
The Company's comprehensive income includes net income and the net
unrealized gain (loss) on its short-term investments available for sale
adjusted for any realized gains/losses. The net unrealized gain (loss) on
short-term investments available for sale reported on the Condensed
Consolidated Statements of Operations and Comprehensive Income are shown
net of a deferred income tax benefit of $0.5 million for the nine month
period of 2007 and deferred income tax benefit of $0.06 million and
deferred tax expense of $0.6 million for the three and nine month periods
of 2006, respectively.
14. 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.
Additionally, the IMC business includes value-added assembly of products
that incorporate these components. The principal medical devices are
pacemakers, defibrillators and neurostimulators. The IMC business segment
also includes the operations acquired from Enpath and BIOMEC in 2007 (see
Note 2), from the date of acquisition. The Enpath operations include
revenue from designing, developing, manufacturing and marketing single use
medical device products for the CRM, neuromodulation and interventional
radiology markets including venous vessel and valved introducers, advanced
delivery catheters that have a "fixed curve" or articulating distal tip
section and implantable stimulation leads, adaptors and delivery systems
for the cardiac and neuromodulation markets.
The ECP segment designs and manufactures high performance batteries and
battery packs; principal markets for these products are for oil and gas
exploration, pipeline inspection, telematics, oceanography equipment,
seismic, communication, military and aerospace applications.
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.
The 2007 results for the IMC segment includes a $16.1 million IPR&D charge
related to the BIOMEC and Enpath acquisitions.
- 26 -
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 28, September 29, September 28, September 29,
Sales: 2007 2006 2007 2006
-------------------- -------------------- -------------------- --------------------
IMC
ICD batteries $ 12,265 $ 11,456 $ 37,657 $ 35,129
Pacemaker and other batteries 4,701 4,439 16,449 16,156
ICD capacitors 5,782 4,499 22,188 13,406
Feedthroughs 14,448 17,355 49,851 47,944
Enclosures 4,584 5,698 16,284 19,143
Introducers, catheters and leads 10,047 - 11,632 -
Other medical 15,176 13,560 45,730 42,565
-------------------- -------------------- -------------------- --------------------
Total IMC 67,003 57,007 199,791 174,343
ECP 12,006 12,287 34,540 33,656
-------------------- -------------------- -------------------- --------------------
Total sales $ 79,009 $ 69,294 $ 234,331 $ 207,999
==================== ==================== ==================== ====================
Segment income from operations:
IMC $ 10,930 $ 3,476 $ 18,147 $ 23,144
ECP 2,445 3,976 7,577 10,061
-------------------- -------------------- -------------------- --------------------
Total segment income from operations 13,375 7,452 25,724 33,205
Unallocated operating expenses (3,035) (3,387) (11,129) (11,961)
-------------------- -------------------- -------------------- --------------------
Operating income as reported 10,340 4,065 14,595 21,244
Unallocated other income (expense) (596) 215 9,001 582
-------------------- -------------------- -------------------- --------------------
Income before provision for income
taxes as reported $ 9,744 $ 4,280 $ 23,596 $ 21,826
==================== ==================== ==================== ====================
15. SUBSEQUENT EVENTS
On October 29, 2007, the Company announced that its wholly-owned
subsidiary, Electrochem Commercial Power, acquired substantially all of the
assets of IntelliSensing LLC ("IntelliSensing") for approximately $3.9
million in cash plus/minus any working capital adjustment as defined in the
purchase agreement. IntelliSensing designs and manufactures wireless sensor
solutions that measure temperature, pressure, flow and other critical data.
On October 30, 2007, the Company announced that it has signed a definitive
agreement to acquire substantially all of the assets of Quan Emerteq LLC
("Quan Emerteq") for approximately $55 million in cash plus/minus any
working capital adjustment as defined in the purchase agreement. The
Company expects to close this transaction in November 2007. Quan Emerteq
designs, develops and manufactures single use medical device products for
the vascular, cardiac rhythm management and neurostimulation markets.
- 27 -
GREATBATCH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (con't) - Unaudited
--------------------------------------------------------------------------------
On November 5, 2007, the Company announced that its wholly-owned
subsidiary, Electrochem Commercial Power, signed a definitive agreement to
acquire substantially all of the assets of Engineered Assemblies
Corporation ("EAC") for approximately $12 million in cash plus/minus any
working capital adjustment as defined in the purchase agreement. The
Company expects to close this transaction in November 2007. EAC is a
leading provider of custom battery solutions and electronics integration
focused on rechargeable battery systems.
16. IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for
Financial Assets and Financial Liabilities--Including an amendment of FASB
Statement No. 115. This Statement provides entities with an option to
choose to measure eligible items at fair value at specified election dates.
If elected, an entity must report unrealized gains and losses on the item
in earnings at each subsequent reporting date. The fair value option may be
applied instrument by instrument, with a few exceptions, such as
investments otherwise accounted for by the equity method, is irrevocable
(unless a new election date occurs), and is applied only to entire
instruments and not to portions of instruments. The Company is still
evaluating the impact of SFAS No. 159 on its financial statements, which is
effective beginning in fiscal year 2008.
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.
- 28 -
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. Additionally, through our
manufacturing facility in Tijuana Mexico, our IMC business includes value-added
assembly of products that incorporates the components we manufacture. 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, pipeline inspection, telematics,
oceanographic equipment, seismic, communication, military and aerospace
applications.
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. With the acquisition
of Enpath Medical, Inc. ("Enpath") in 2007, we now develop and manufacture
vascular access devices used primarily in the CRM market. These include venous
vessel and valved introducers, advanced delivery catheters that have a "fixed
curve" or articulating distal tip section, and implantable stimulation leads,
adaptors and delivery systems for the cardiac and neuromodulation markets.
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 first nine months of 2007, Boston Scientific, Medtronic and
St. Jude Medical collectively accounted for approximately 67% of our total
sales. With the acquisition of Enpath in 2007, we were able to deepen our
relationships with many of our larger customers while at the same time
broadening both our market and product reach. 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,
pipeline inspection, telematics, oceanographic equipment, seismic,
communication, military and aerospace applications 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.
- 29 -
Business Highlights
-------------------
Our CEO's View
--------------
This was our third consecutive quarter of record sales, which included the
benefits of our acquisition growth strategy. After adjusting for the acquisition
of Enpath, our organic growth rate for the year is 7%, which exceeds our market
growth rate, and sales were consistent with the prior year quarter due to
customer inventory adjustments. Additionally, our manufacturing initiatives have
led to improvement in our cost of sales as a percentage of sales. Even though we
have been impacted by our customer actions in the short-term, we are positioned
to take advantage of our long-term growth opportunities as we further leverage
our Company.
On a strategic front, the recently announced acquisitions (see Note 15 of the
Condensed Consolidated Financial Statements), combined with the earlier
acquisitions of Enpath and BIOMEC, are enhancing the overall capabilities of
Greatbatch including 1) increasing our CRM, neurostimulation and commercial
market presence, 2) enhancing our product offering by providing new competencies
in the areas of rechargeable cells, wireless sensors, enhanced design and
prototyping capabilities, regulatory expertise and established important
clinical relationships and 3) giving us entree into the therapy delivery
markets, which brings new growth opportunities and several new blue chip
customers allowing for cross selling opportunities. The business model of the
acquired companies is very synergistic with the strategic direction of
Greatbatch - technology leadership through proprietary innovation - and supports
our device field of view of becoming an even more important OEM supplier through
added customer content and capabilities.
Product Development
-------------------
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 MRI compatible technology for our medical components.
6. Develop rechargeable battery packs for use in commercial applications.
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. These batteries
deliver advanced performance 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). The first ICD
device implant with our new QHR technology occurred in the third quarter of
2006. We also released a new, non-proprietary model of medium-rate implantable
"Q" series battery. Our rechargeable battery program also continues to make
progress in qualification and is receiving tremendous interest from
neurostimulation customers.
- 30 -
In addition to our battery programs, we continue to advance our ICD capacitor
technology with the development of a higher energy capacitor expected for
release in 2009. Furthermore, we continue to develop the technology for a next
generation higher voltage capacitor.
Finally, enabling safe MRI device interaction continues to remain a key focus
and represents a potential growth opportunity for the company. We anticipate
unveiling a series of new technologies in this area in the near future.
With the acquisition of BIOMEC, we now offer our customers device engineering
expertise along with full device assembly utilizing our proprietary components.
This enables us to work in conjunction with our customer's design teams to build
more sophisticated devices. Approximately $2.3 million of the BIOMEC purchase
price was allocated to the estimated fair value of acquired in-process research
and development ("IPR&D") projects that had not yet reached technological
feasibility and had no alternative future use as of the acquisition date. The
value assigned to IPR&D relates to projects that incorporate BIOMEC's
novel-polymer coating (biomimetic) technology that mimics the surface of
endothelial cells of blood vessels. The estimated fair value of these projects
was determined using a discounted cash flow model. This model utilized discount
rates that took into consideration the stage of completion and the risks
surrounding the successful development and commercialization of each of the
IPR&D projects of approximately 40% which is consistent with these projects
being in the early development stage. The Company expects various products that
utilize the biomimetic coatings technology to be commercially launched by
original equipment manufacturers ("OEM") in 2009 once Food and Drug
Administration ("FDA") approval is received. With BIOMEC, the Company acquired
grants that will fund the remaining development costs for these products. There
were no significant changes from our original estimates with regards to these
projects during the third quarter of 2007.
With the acquisition of Enpath, we added a complementary business that further
expands our product and service offerings to the CRM and neurostimulation
marketplaces. This acquisition also broadened our market reach into the vascular
segment as well as added several new customers. These factors support our
long-term objective of customer and market diversification. Enpath's currently
marketed products include:
o Venous vessel introducers and valved introducers that enable physicians to
create a conduit through which they can insert infusion catheters,
implantable ports and pacemaker leads into a blood vessel;
o Advanced delivery catheters that have a "fixed curve" or articulating
distal tip section that can be manipulated to enable the health care
professional to access parts of the patient's anatomy that cannot be
reached by traditional introducers; and
o Implantable stimulation leads, adaptors and delivery systems for the
cardiac and neuromodulation markets.
Approximately $13.8 million of the Enpath purchase price was allocated to the
preliminary estimated fair value of acquired IPR&D projects that had not yet
reached technological feasibility and had no alternative future use. These
projects primarily represent the next generation of products already being sold
by Enpath which incorporate new enhancements and customer modifications. The
Company expects to commercially launch various introducer products in 2008 and
2009 and various catheter products in 2009 which will replace existing products.
For purposes of valuing the acquired purchased research and development, the
Company estimated total costs to complete the introducer projects to be
approximately $0.3 million and $0.5 million to complete the catheter projects.
If we are not successful in completing these projects on a timely basis, our
future sales from introducers and catheters may be adversely affected resulting
in erosion of our market share. There were no significant changes from our
original estimates with regards to these projects during the third quarter of
2007.
- 31 -
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 harsh operating conditions such as high vibration,
high shock, salt spray, high temperature, low temperature, and high humidity.
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 2006 and the first nine
months of 2007.
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.
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. Expenses of $0.6
million were incurred during the first two quarters of 2006. In total, $0.8
million was paid in cash during 2006. The expenses for the Alden Facility
consolidation were included in the IMC business segment.
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 ceased operating at the Carson City Facility on July 15, 2007. The
total cost for this consolidation effort was $7.8 million. The Company
anticipates that the $0.5 million of severance accrued as of September 28, 2007
related to this consolidation project will be paid out over the next two
quarters.
The major categories of costs include the following:
o Costs related to the shutdown of the Carson City Facility:
- Severance and retention - $3.9 million;
- Accelerated depreciation - $0.6 million; and
- Other - $0.3 million.
o Costs related to the Tijuana Facility consolidation No. 1:
- Production inefficiencies and revalidation - $0.5 million;
- Relocation and moving - $0.1 million;
- Personnel (including travel, training and duplicate wages) - $1.7
million; and
- Other - $0.7 million.
- 32 -
All categories of costs are considered to be cash expenditures, except
accelerated depreciation. The Company anticipates annual cost savings in the
range of $2.5 million 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.
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 revised estimated cost for this facility consolidation plan is
anticipated to be between $11.1 million and $11.6 million. To date, we have
expensed $10.0 million related to these projects and expect to incur the
remaining costs in 2007 and the first quarter of 2008, with cash payments being
made through the second quarter of 2008. All categories of costs are considered
to be future cash expenditures, except for accelerated depreciation and asset
write-offs.
Approximately $3.9 million of the Columbia Facility and ARL shutdown costs were
incurred in 2005 and 2006 ($0.5 million for assets written-off), and $1.5
million were incurred in the first three quarters of 2007. Approximately $1.4
million was paid in cash during the first nine months of 2007. Tijuana Facility
consolidation plan No. 2 expenses of $2.3 million were incurred and paid in cash
in 2006 and $2.3 million in the first three quarters of 2007.
Once the moves are completed, the Company anticipates annual cost savings in the
range of $5.0 million 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.
ECP Expansion. In February 2007, the Company announced that it will close its
current manufacturing facility in Canton, MA and construct a new 80,000 square
foot replacement facility in the Massachusetts area. The expected completion of
this $28 million expansion project is mid-2008. The total expense to be
recognized for this relocation is estimated to be $2.2 million to $2.4 million.
During the first nine months of 2007, $0.4 million of costs were incurred
related to this project, which were primarily non-cash items. Costs related to
this move are included in the ECP business segment.
- 33 -
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 2007 and 2006 each contained 13 weeks and ended on September
28, and September 29, 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 29, 2006.
Three months ended Nine months ended
---------------------------- ---------------------------
September 28, September 29, $ % September 28, September 29, $ %
In thousands, except per share data 2007 2006 Change Change 2007 2006 Change Change
-----------------------------------------------------------------------------------------------------------------------------------
IMC
ICD batteries $ 12,265 $ 11,456 809 7% $ 37,657 $ 35,129 2,528 7%
Pacemaker and other batteries 4,701 4,439 262 6% 16,449 16,156 293 2%
ICD capacitors 5,782 4,499 1,283 29% 22,188 13,406 8,782 66%
Feedthroughs 14,448 17,355 (2,907) -17% 49,851 47,944 1,907 4%
Enclosures 4,584 5,698 (1,114) -20% 16,284 19,143 (2,859) -15%
Introducers, catheters and
leads 10,047 - 10,047 N/A 11,632 - 11,632 N/A
Other medical 15,176 13,560 1,616 12% 45,730 42,565 3,165 7%
---------------------------------------------------------------------------------------------
Total IMC 67,003 57,007 9,996 18% 199,791 174,343 25,448 15%
ECP 12,006 12,287 (281) -2% 34,540 33,656 884 3%
---------------------------------------------------------------------------------------------
Total sales 79,009 69,294 9,715 14% 234,331 207,999 26,332 13%
Cost of sales - excluding
amortization of intangible assets 48,647 42,709 5,938 14% 141,697 125,087 16,610 13%
Cost of sales - amortization
of intangible assets 1,222 948 274 29% 3,164 2,864 300 10%
---------------------------------------------------------------------------------------------
Total Cost of sales 49,869 43,657 6,212 14% 144,861 127,951 16,910 13%
Cost of sales as a % of sales 63.1% 63.0% 0.1% 61.8% 61.5% 0.3%
Selling, general, and
administrative expenses (SG&A) 11,362 9,311 2,051 22% 32,130 28,191 3,939 14%
SG&A as a % of sales 14.4% 13.4% 1.0% 13.7% 13.6% 0.1%
Research, development and
engineering costs, net (RD&E) 8,423 6,022 2,401 40% 21,856 18,062 3,794 21%
RD&E as a % of sales 10.7% 8.7% 2.0% 9.3% 8.7% 0.6%
Other operating expense, net (985) 6,239 (7,224) -116% 20,889 12,551 8,338 66%
---------------------------------------------------------------------------------------------
Operating income 10,340 4,065 6,275 154% 14,595 21,244 (6,649) -31%
Operating margin 13.1% 5.9% 7.2% 6.2% 10.2% -4.0%
Interest expense 2,112 1,135 977 86% 5,345 3,433 1,912 56%
Interest income (1,586) (1,521) (65) -4% (6,028) (4,066) (1,962) 48%
Other (income) expense, net 70 171 (101) 59% (8,318) 51 (8,369) N/A
Provision for income taxes 4,744 1,041 3,703 356% 11,326 7,094 4,232 60%
Effective tax rate 48.7% 24.3% 24.4% 48.0% 32.5% 15.5%
---------------------------------------------------------------------------------------------
Net income $ 5,000 $ 3,239 $ 1,761 54% $ 12,270 $ 14,732 $ (2,462) -17%
=============================================================================================
Net margin 6.3% 4.7% 1.6% 5.2% 7.1% -1.9%
Diluted earnings per share $ 0.22 $ 0.15 $ 0.07 47% $ 0.54 $ 0.65 $ (0.11) -17%
- 34 -
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.
IMC sales increased 18% and 15% for the three and nine month periods of 2007,
respectively, and includes sales from the former Enpath of $10.0 million and
$11.6 million, respectively. Additionally, sales were driven by growth of ICD
capacitors, ICD batteries and our assembly business offset by decreases in sales
of feedthroughs (QTD) and enclosures.
The increase in ICD capacitor sales was primarily the result of a customer
supply issue during the first half of 2007, which has subsequently been
resolved. For the year, we experienced growth in our feedthrough business, which
was primarily being driven by the continued acceptance of filtered feedthrough
technology and domestic market share penetration. During the third quarter, the
Company received lower demand forecasts from its larger customers. We believe
that these revisions include the impact of inventory adjustments as well as our
customers' revised outlook for the balance of the year. ICD battery sales
increased by 7% over both prior year periods. ICD battery sales softened through
the balance of 2006 reflecting the general slowdown in the ICD market but began
to rebound in the first three quarters of 2007. Based upon the updated demand
forecasts from our larger customers', we expect our lower sales volume to
continue in the fourth quarter. The variances in our enclosure and assembly
revenues are due to both product mix and prices.
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.
ECP sales were consistent with the prior year third quarter and increased 3% for
the nine month period. ECP revenue for the 2006 quarter included approximately
$2 million of customer inventory stocking. The core growth in ECP sales
primarily came from oil and gas, pipeline inspection and military markets. Oil
and gas drilling and pipeline inspection activity remains strong. Additionally,
we continue to gain market share across our markets.
- 35 -
Cost of sales
Changes from the prior year to cost of sales as a percentage of sales were
primarily due to the following:
September 28, 2007
Three months Nine months
ended ended
--------------- --------------
Excess capacity at Tijuana Facility (a) -1.2% -1.1%
Mix change (b) 0.5% 0.8%
Enpath inventory step-up amortization(c) 1.4% 0.6%
Enpath amortization of intangible assets (d) 0.3% 0.1%
Inventory warranty reserves (e) -1.1% -0.1%
Other 0.2% 0.0%
-------------- --------------
Total percentage point change to cost of sales as a
percentage of sales 0.1% 0.3%
============== ==============
(a) The Tijuana Facility was fully operational in 2006 but was not being fully
utilized as it was only producing sub-assemblies. In 2007, primarily in the
second quarter, the facility is producing increased volumes of
sub-assemblies and the majority of our filtered feedthroughs, thus reducing
excess capacity. In accordance with the Company's inventory accounting
policy, excess capacity costs are expensed.
(b) The revenue increase from 2006 was primarily in lower margin products,
which included our assembly business as well as the addition of the lower
margin introducer, catheter and leads operations acquired with Enpath.
(c) The Company completed its acquisition of Enpath on June 15, 2007. The 2007
quarter and year-to-date periods include $1.1 million and $1.3 million,
respectively, of inventory step-up amortization related to the Enpath
acquisition. As of September 28, 2007, there was no additional inventory
step-up adjustment remaining to be amortized.
(d) The Company completed its acquisition of Enpath on June 15, 2007. The 2007
quarter and year-to-date periods include $0.3 million of amortization
related to intangible assets recorded as a result of that acquisition.
(e) Variances relate to a decrease in inventory warranty reserves. The Company
allows customers to return defective or damaged products for credit,
replacement, or exchange. 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 as cost of sales based upon recent historical experience
and other specific information as it becomes available.
We expect our cost of sales as a percentage of sales to decrease over the next
several years as a result of our consolidation efforts, the elimination of
excess capacity and the elimination of inventory step-up amortization related to
the Enpath acquisition. Excess capacity for the Tijuana Facility is not expected
to be fully eliminated until the beginning of 2008 when the last announced
consolidation effort is anticipated to be completed (see "Cost Savings and
Consolidation Efforts" section of this Management Discussion and Analysis).
- 36 -
SG&A expenses
Changes from the prior year to SG&A expenses were due to the following (in
thousands):
September 28, 2007
Three months Nine months
ended ended
------------------- --------------------
SG&A related to Enpath (a) $ 1,935 $ 2,232
Stock-based and incentive compensation (b) (829) (504)
Increased workforce (c) 180 930
Director fees (d) 18 183
Professional and consulting fees (e) 170 442
Other (f) 577 656
------------------- --------------------
Net increase in SG&A $ 2,051 $ 3,939
=================== ====================
(a) The Company completed its acquisition of Enpath on June 15, 2007.
Accordingly, year over year comparisons will continue to be impacted by
this acquisition through the second quarter of 2008.
(b) The decrease in stock-based compensation is related to leadership
transition costs incurred in 2006. Stock-based compensation is expected to
increase in the future which is consistent with the growth in the Company's
workforce. Incentive compensation is accrued based upon the achievement of
performance goals relative to planned results.
(c) The increase in workforce is a result of our planned increase in marketing
and sales personnel.
(d) The increase in director fees is consistent with our amended director
compensation plan as discussed in our 2006 proxy statement.
(e) The increase in professional and consulting fees is consistent with the
increase in corporate development initiatives of the Company as well as
increased contract negotiations.
(f) The increase in other SG&A costs is primarily due to overall growth of the
Company as well as an increase in various corporate development
initiatives.
RD&E expenses
Net research, development and engineering costs are as follows (in thousands):
Three months ended Nine months ended
---------------------------------- -----------------------------------
September 28, September 29, September 28, September 29,
2007 2006 2007 2006
----------------- ---------------- ----------------- -----------------
Research and development costs $ 4,493 $ 3,852 $ 12,035 $ 11,800
----------------- ---------------- ----------------- -----------------
Engineering costs 5,389 2,521 12,511 7,697
Less cost reimbursements (1,459) (351) (2,690) (1,435)
----------------- ---------------- ----------------- -----------------
Engineering costs, net 3,930 2,170 9,821 6,262
----------------- ---------------- ----------------- -----------------
Total research and development and
engineering costs, net $ 8,423 $ 6,022 $ 21,856 $ 18,062
================= ================ ================= =================
The increase in RD&E expenses for the three and nine month periods ended
September 28, 2007 is primarily due to the planned increase in engineering
personnel costs (headcount), as we continue to invest substantial resources to
develop new products. In terms of the development costs billed, reimbursements
were higher due to the timing of reimbursable development projects as well as
higher design engineering services activity which includes operations of the
former BIOMEC. Reimbursements for achieving certain development milestones are
netted against gross spending.
- 37 -
Acquired in-process research and development
Approximately $2.3 million and $13.8 million of the BIOMEC and Enpath purchase
price, respectively, represents the estimated fair value of IPR&D projects
acquired from those companies. These projects had not yet reached technological
feasibility and had no alternative future use as of the acquisition date, thus
were immediately expensed on the date of acquisition. The Enpath IPR&D valuation
was lowered by $2.3 million during the third quarter of 2007 due to the
finalization of assumptions used in the excess earnings analysis. These
assumptions primarily related to the allocation of R&D costs between new and
existing customers.
Other operating expense
Other operating expense for 2007 and 2006 are comprised of the following costs
(in thousands):
Three months ended Nine months ended
--------------------------- ---------------------------
September 28, September 29, September 28, September 29,
2007 2006 2007 2006
------------- ------------- ------------- -------------
(a) Alden facility consolidation $ - $ - $ - $ 567
(a) Carson City facility shutdown and Tijuana
facility consolidation No. 1 10 411 584 2,450
(a) Columbia facility shutdown, Tijuana facility
consolidation No. 2 and RD&E consolidation 1,030 1,225 3,705 3,546
(a) ECP expansion 126 - 408 -
(b) Asset dispositions and other 109 4,603 99 5,988
------------- ------------- ------------- -------------
$ 1,275 $ 6,239 $ 4,796 $ 12,551
============= ============= ============= =============
(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 28, 2007.
(b) During the third quarter of 2007, the Company had various asset
dispositions. 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.
In addition to the quarter variances discussed above, the nine month period
in 2007 includes $0.3 million of insurance proceeds received related to
equipment damaged during transportation to the Tijuana Facility. The nine
month period in 2006 includes the loss of $0.5 million related to this
damaged equipment (included in the IMC business segment) and an expense of
$0.8 million for professional fees related to a potential acquisition that
we no longer considered probable.
Interest expense and interest income
Interest expense for the three and nine month periods ended September 28, 2007
is higher than the prior year periods primarily due to the additional $80
million of 2.25% convertible notes issued at the end of the first quarter of
2007 and additional amortization of deferred fees and discounts associated with
these notes and the notes exchanged during the first quarter (See "Gain on
extinguishment of debt").
Interest income for the nine months ended September 28, 2007 increased in
comparison to the same period of 2006 primarily due to increased cash, cash
equivalents and short-term investment balances. Interest income for the third
quarter of 2007 was consistent with the same period of 2006. In the future,
interest income is expected to be lower as a result of the cash deployed in
connection with the BIOMEC and Enpath acquisitions near the end of the second
quarter of 2007, as well as the cash that will be deployed in connection with
the acquisitions announced subsequent to September 28, 2007. See note 15 of the
condensed consolidated financial statements.
- 38 -
Gain on sale of investment security
In the second quarter of 2007, the Company sold an equity security investment
which resulted in a pre-tax gain of $4.0 million ($2.6 million net of tax) or
$0.11 per diluted share.
Gain on extinguishment of debt
In March 2007, the Company entered into separate, privately negotiated
agreements to exchange $117.8 million of the original $170.0 million of 2.25%
convertible subordinated notes due 2013 ("CSN I") for an equivalent principal
amount of a new series of 2.25% convertible subordinated notes due 2013. The
primary purpose of this transaction was to eliminate the June 15, 2010 call and
put option that is included in the terms of CSN I. This exchange was accounted
for as an extinguishment of debt and resulted in a net pre-tax gain of $4.5
million ($2.9 million net of tax) or $0.12 per diluted share.
Provision for income taxes
The effective tax rate for 2007 includes the impact of the $16.1 million of
acquired IPR&D written off, $13.8 million of which is not deductible for tax
purposes. Excluding the impact of this expense, the effective tax rate for the
three and nine months ended September 28, 2007 would have been approximately 32%
compared to 24.3% and 32.5% for the same periods of 2006. 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 which
resulted in the lower effective tax rate for that period. We expect our
effective tax rate to be approximately 48% for the remainder of 2007.
Subsequent to the end of the third quarter, Mexico enacted new tax legislation
that will take effect on January 1, 2008. We are currently evaluating the impact
of this tax law change on our financial statements.
Liquidity and Capital Resources
-------------------------------
September 28, December 29,
(Dollars in millions) 2007 2006
------------- ------------
Cash and cash equivalents and short-term investments (a)(b) $ 115.8 $ 142.6
Working capital (b) $ 184.7 $ 199.1
Current ratio (b) 4.5:1.0 5.7:1.0
(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) Cash and cash equivalents and short-term investments, working capital and
our current ratio decreased primarily due to the $109.7 million of cash
used to acquire BIOMEC and Enpath partially offset by $69.4 million of net
cash received from the issuance of additional 2.25% convertible
subordinated notes due 2013 in March 2007 and cash provided by operating
activities of $30.8 million.
Revolving line of credit
In May 2007, the Company entered into a new senior credit facility (the "New
Credit Facility") consisting of a $235 million revolving credit facility, which
can be increased to $335 million upon the Company's request. The New Credit
Facility also contains a $15 million letter of credit subfacility and a $15
million swingline subfacility. This New Credit Facility replaced the Company's
prior $50 million revolving credit facility. The New Credit Facility is secured
- 39 -
by the Company's non-realty assets including cash, accounts and notes
receivable, and inventories and has an expiration date of May 22, 2012 with a
one-time option to extend to April 1, 2013 if no default has occurred. Interest
rates under the New Credit Facility are, at the Company's option, based upon the
current prime rate or the LIBOR rate plus a margin that varies with the
Company's leverage ratio. If interest is paid based upon the prime rate, the
applicable margin is between minus 1.25% and 0.00%. If interest is paid based
upon the LIBOR rate, the applicable margin is between 1.00% and 2.00%. The
Company is required to pay a commitment fee between 0.125% and 0.250% per annum
on the unused portion of the New Credit Facility based on the Company's leverage
ratio.
The New Credit Facility contains limitations on the incurrence of indebtedness,
limitations on the incurrence of liens and licensing of intellectual property,
limitations on investments and restrictions on certain payments. Except to the
extent paid for by common equity of Greatbatch or paid for out of cash on hand,
the New Credit Facility limits the amount paid for acquisitions to $100 million.
The restrictions on payments, among other things, limit repurchases of
Greatbatch's stock to $60 million and limits the ability of the Company to make
cash payments upon conversion of our convertible subordinated notes. In
addition, the New Credit Facility requires the Company to maintain a ratio of
adjusted EBITDA, as defined in the agreement, to interest expense of at least
3.00 to 1.00, and a total leverage ratio, as defined in the credit agreement, of
not greater than 5.00 to 1.00 from May 22, 2007 through September 29, 2009 and
not greater than 4.50 to 1.00 from September 30, 2009 and thereafter. The New
Credit Facility contains customary events of default. Upon the occurrence of an
event of default, a majority of the lenders may declare all obligations under
the New Credit Facility immediately due and payable.
There were no borrowings outstanding under the New Credit Facility as of
September 28, 2007. The Company expects to fund the acquisitions announced
subsequent to September 28, 2007 with cash, short-term investments and
borrowings under the New Credit Facility. See note 15 of the condensed
consolidated financial statements.
Operating activities
Net cash flows from operating activities for the nine months ended September 28,
2007 increased $6.1 million over the comparable period in 2006. This increase
was primarily the result of a $4.3 million increase in net income excluding
non-cash items (i.e. depreciation, amortization, stock-based compensation,
gains/loss on investments, disposal of PP&E, and debt extinguishment, and IPR&D
charges). The extinguishment of debt in 2007 resulted in a reclassification of
approximately $11.3 million of current income tax liability, of which
approximately $8.5 million has been paid as of September 28, 2007 and the
remainder will be paid by the end of 2007. This amount was previously recorded
as a non-current deferred tax liability on the balance sheet.
Investing activities
Net cash used in investing activities of $71.2 million for the nine months ended
September 28, 2007 increased over the comparable period in 2006. This was
primarily the result of the acquisitions of BIOMEC and Enpath in 2007 ($109.7
million) which were funded with both short-term investments and cash on hand.
Approximately, $3.5 million of the property, plant and equipment acquired during
the first nine months of 2007 relate to construction of our new ECP
manufacturing facility in the Massachusetts area and the expansion of our
corporate headquarters. Total cash expenditures under these projects is expected
to be approximately $36 million which will be paid throughout the remainder of
2007 and 2008. The remainder of the property, plant and equipment purchases
relate to routine investment in order to support our internal growth and to
maintain our technology leadership. In addition to the above, in 2007 we made an
additional $2.0 million investment in IntElect Medical, Inc., an early stage
neurostimulation device company that works in conjunction with the Cleveland
Clinic.
- 40 -
Financing activities
Cash flow provided by financing activities for the first nine months of 2007 was
primarily related to net proceeds of $76.0 million received in connection with
the issuance of 2.25% convertible subordinated notes due 2013 during the first
quarter. The Company has paid approximately $6.6 million of financing fees
related to this transaction as well as the new revolving credit agreement
discussed above. In connection with the Enpath acquisition, the Company acquired
$7.1 million of debt which it subsequently paid down with short-term investments
and cash on hand. Cash flows from financing activities also include cash
received from stock option exercises for both 2007 and 2006.
Capital structure
At September 28, 2007, our capital structure consisted of $240.9 million of
convertible subordinated notes and our 22.5 million shares of common stock
outstanding. We have $115.8 million in cash, cash equivalents and short-term
investments and are in a position to finance our future acquisitions. 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
2007 is that capital spending will be in the range of $20.0 million to $35.0
million.
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 28, 2007, total contractual obligations related
to such expenditures are approximately $32.9 million and primarily relate to the
construction of our new ECP manufacturing facility and the expansion of our
corporate headquarters. These commitments 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 February 2007, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 159, The Fair Value
Option for Financial Assets and Financial Liabilities--Including an amendment of
FASB Statement No. 115. This Statement provides entities with an option to
choose to measure eligible items at fair value at specified election dates. If
elected, an entity must report unrealized gains and losses on the item in
earnings at each subsequent reporting date. The fair value option: may be
applied instrument by instrument, with a few exceptions, such as investments
otherwise accounted for by the equity method; is irrevocable (unless a new
election date occurs); and is applied only to entire instruments and not to
portions of instruments. The Company is still evaluating the impact of SFAS No.
159 on its financial statements, which is effective beginning in fiscal year
2008.
- 41 -
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.
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. For further information,
refer to Item 7 "Managements Discussion and Analysis of Financial Condition and
Results of Operations" and Item 8 "Financial Statements and Supplementary Data"
in the Company's Annual Report on Form 10-K for the year ended December 29,
2006. During the three months ended September 28, 2007, 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 the first quarter of 2007, the Company adopted the provisions of
FASB Interpretation ("FIN") No. 48 Accounting for Uncertainty in Income Taxes,
an interpretation of FASB SFAS No. 109. FIN No. 48 clarifies the accounting for
uncertainty in income taxes recognized under SFAS No. 109. FIN No. 48 prescribes
a recognition threshold and measurement attribute for financial statement
recognition and measurement of a tax position taken or expected to be taken in a
tax return and also provides guidance on various related matters such as
derecognition, interest and penalties, and disclosure.
Additionally, in May 2007, the FASB published FASB Staff Position ("FSP") No.
FIN 48-1, Definition of Settlement in FASB Interpretation No. 48. FSP FIN No.
48-1 is an amendment to FIN No. 48. It clarifies how an enterprise should
determine whether a tax position is effectively settled for the purpose of
recognizing previously unrecognized tax benefits. As of our adoption date of FIN
No. 48, our accounting is consistent with the guidance in FSP FIN No. 48-1.
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;
- 42 -
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.
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 28, 2007, 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 its Tijuana, Mexico 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.
------------------------------------------------
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 as of September 28, 2007. 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.
- 43 -
Based on their evaluation, as of September 28, 2007, our principal executive
officer and principal financial officer have concluded that our disclosure
controls and procedures are effective.
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.
We completed the acquisition of Enpath on June 15, 2007, at which time Enpath
became a subsidiary of Greatbatch. We believe that the internal controls and
procedures of Enpath are reasonably likely to materially affect our internal
control over financial reporting. We are currently in the process of
incorporating the internal controls and procedures of the former Enpath into our
internal controls over financial reporting. The Company has extended its Section
404 compliance program under the Sarbanes-Oxley Act of 2002 (the "Act") and the
applicable rules and regulations under such Act to include the former Enpath.
The Company will report on its assessment of the internal controls of its
combined operations within the time period provided by the Act and the
applicable SEC rules and regulations concerning business combinations.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
In connection with our acquisition of Enpath Medical, Inc. ("Enpath"), we
assumed liability in connection with the following proceeding:
On June 12, 2006, Enpath was named as defendant in a patent infringement action
filed by Pressure Products Medical Supplies, Inc. and venued in the United
States District Court in the Eastern District of Texas. On October 2, 2006,
Enpath was officially served. Enpath has filed an answer denying liability and
has filed counterclaims against the plaintiff alleging antitrust violations and
patent misuse. The plaintiff has alleged that Enpath's FlowGuard(TM) valved
introducer, which has been on the market for more than three years, infringes
claims in the plaintiff's patents and is seeking damages and injunctive relief.
Enpath believes that the plaintiff's claims are without merit and intends to
pursue its defenses vigorously. Revenues from products sold that include the
FlowGuard valved introducer were approximately 5% of Enpath's total revenue for
2007 ($29.3 million), 2006 ($36.8 million) and 2005 ($29.4 million). The lawsuit
is currently in the discovery stage. The District Court held a hearing to
construe the claims of the plaintiff's patents in August 2007, but has not yet
issued its decision. It is not possible to predict the timing or outcome of this
litigation at this time, including whether it will affect the Company's ability
to sell its FlowGuard products, or to estimate the amount or range of potential
loss.
There have been no other material changes to those legal proceedings as
previously disclosed in the Company's Form 10-K for the year ended December 29,
2006.
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ITEM 1A. RISK FACTORS.
There have been no material changes in risk factors as previously disclosed in
the Company's Form 10-K for the year ended December 29, 2006, except as follows:
We face risks associated with our acquisitions
Our acquisition of BIOMEC, Inc. Enpath Medical, Inc., IntelliSensing LLC, Quan
Emerteq LLC and Engineered Assemblies Corporation presents several risks and
uncertainties, including the following:
o The allocation of the purchase price to the assets acquired, the
amortization of intangible assets resulting from that allocation and
the impact of fair value purchase accounting adjustments may adversely
affect our earnings;
o We may be unsuccessful in integrating these businesses;
o Integrating these businesses may be distractive to our management and
disruptive to our business and the costs of integration may be
significant; and
o We may assume liabilities in the acquisitions that we did not
anticipate that could have a material adverse effect on our operating
results.
Enpath's products are subject to regulatory oversight.
The medical products that Enpath sells and proposes to sell are subject to
regulation by the Food and Drug Administration ("FDA") and by comparable
agencies in certain states and foreign countries. The process of complying with
requirements of the FDA and other agencies can be costly and time consuming.
Enpath has received clearance from the FDA to market its vessel introducer
products, safety needle, steerable catheter, and epicardial lead and implant
tool. There is no assurance that any future additional clearance can be
obtained. In addition, once obtained, these clearances are subject to review and
later discovery of problems may result in restrictions on the marketing of a
product or withdrawal of the product from the market. Enpath's products are also
subject to certain FDA regulations governing manufacturing practices, packaging
and labeling. Non-compliance with these regulations can result in product
recalls or other sanctions which could have a material adverse effect on
Enpath's business and our financial condition.
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.
ITEM 5. OTHER INFORMATION.
None.
ITEM 6. EXHIBITS.
See the Exhibit Index for a list of those exhibits filed herewith.
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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 6, 2007 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).
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.
* - Filed herewith.
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