UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For The Fiscal Year Ended December 28, 2007
Commission File Number 1-16137
GREATBATCH, INC.
(Exact name of Registrant as specified in its charter)
Delaware 16-1531026
(State of Incorporation) (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)
Securities Registered Pursuant to Section 12(b) of the Act:
Title of Each Class: Name of Each Exchange on Which Registered:
Common Stock, Par Value $.001 Per Share New York Stock Exchange
Preferred Stock Purchase Rights New York Stock Exchange
Securities Registered Pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer,
as defined in Rule 405 of the Securities Act. Yes [ ] No [X]
Indicate by check mark if the registrant is not required to file reports
pursuant to Section 13 or Section 15(d) of the Act. Yes [ ] No [X]
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 if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
Indicate by check mark whether the registrant is a large accelerated filer,
an accelerated filer, a non-accelerated filer, or a smaller reporting company.
See the definitions of "large accelerated filer," "accelerated filer" and
"smaller reporting company" in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer [ ] Accelerated filer [ X ]
Non-accelerated filer [ ] Smaller reporting company [ ]
Indicate by check mark whether the Registrant is a shell company (as
defined in Rule 12b-2 of the Act). Yes [ ] No [X]
The aggregate market value of common stock of Greatbatch, Inc. held by
nonaffiliates as of June 29, 2007, based on the last sale price of $32.40, as
reported on the New York Stock Exchange: $638.0 million. Solely for the purpose
of this calculation, shares held by directors and officers and 10 percent
shareholders of the Registrant have been excluded. Such exclusion should not be
deemed a determination by or an admission by the Registrant that these
individuals are, in fact, affiliates of the Registrant.
Shares of common stock outstanding on February 26, 2008: 22,588,219
DOCUMENTS INCORPORATED BY REFERENCE
The following documents, in whole or in part, are specifically incorporated by
reference in the indicated part of the Company's Proxy Statement:
Document Part
----------------------------------- ----------------------------------------
Proxy Statement for the 2008 Annual Part III, Item 10
Meeting of Stockholders "Directors, Executive Officers and
Corporate Governance"
Part III, Item 11
"Executive Compensation"
Part III, Item 12
"Security Ownership of Certain
Beneficial Owners and Management and
Related Stockholder Matters"
Part III, Item 13
"Certain Relationships and Related
Transactions, and Director Independence"
Part III, Item 14
"Principal Accounting Fees and Services"
TABLE OF CONTENTS
ITEM PAGE
NUMBER NUMBER
------ ------
PART I
1 Business..................................................................................................... 4
1A Risk Factors................................................................................................. 18
1B Unresolved Staff Comments.................................................................................... 27
2 Properties................................................................................................... 27
3 Legal Proceedings............................................................................................ 28
4 Submission of Matters to a Vote of Security Holders.......................................................... 28
PART II
5 Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities. 29
6 Selected Financial Data...................................................................................... 31
7 Management's Discussion and Analysis of Financial Condition and Results of Operation......................... 32
7A Quantitative and Qualitative Disclosures About Market Risk................................................... 57
8 Financial Statements and Supplementary Data.................................................................. 58
9 Changes in and Disagreements With Accountants on Accounting and Financial Disclosure......................... 115
9A Controls and Procedures...................................................................................... 115
9B Other Information............................................................................................ 116
PART III
10 Directors, Executive Officers and Corporate Governance....................................................... 116
11 Executive Compensation....................................................................................... 117
12 Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters............... 117
13 Certain Relationships and Related Transactions, and Director Independence.................................... 117
14 Principal Accounting Fees and Services....................................................................... 117
PART IV
15 Exhibits, Financial Statement Schedules...................................................................... 117
Signatures................................................................................................... 119
3
PART I
ITEM 1. BUSINESS
OVERVIEW
Greatbatch, Inc. is a leading developer and manufacturer of critical products
used in medical devices for the cardiac rhythm management, neurostimulation,
vascular, orthopedic and interventional radiology markets. Additionally,
Greatbatch, Inc. is a world leader in the design, manufacture and distribution
of electrochemical cells, battery packs and wireless sensors for demanding
applications such as oil and gas exploration, pipeline inspection, military,
asset tracking, oceanography, external medical and seismic surveying. When used
in this report, the terms "we," "us," "our" and the "Company" mean Greatbatch,
Inc. and its subsidiaries. We believe that our proprietary technology, close
customer relationships, multiple product offerings, market leadership and
dedication to quality provide us with competitive advantages and create a
barrier to entry for potential market entrants.
The Company is a Delaware corporation that was incorporated in 1997 and since
that time has completed the following acquisitions:
Acquisition date Acquired company Business at time of acquisition
---------------- ---------------- -------------------------------
July 1997 Wilson Greatbatch Ltd. Founded in 1970, the company designed
("WGL") and manufactured batteries for
implantable medical devices ("IMD") and
commercial applications including oil
and gas, aerospace, and oceanographic.
August 1998 Hittman Materials and Founded in 1962, the company designed
Medical Components, and manufactured ceramic and glass
Inc. ("Hittman") feedthroughs and specialized porous
coatings for electrodes used in IMDs.
August 2000 Battery Engineering, Founded in 1983, the company designed
Inc. ("BEI") and manufactured high-energy density
batteries for industrial, commercial,
military and medical applications.
June 2001 Sierra-KD Components Founded in 1986, the company designed
division of Maxwell and manufactured ceramic
Technologies, Inc. electromagnetic filtering capacitors
("Sierra") and integrated them with wire
feedthroughs for use in IMDs. Sierra
also designed and manufactured ceramic
capacitors for military, aerospace and
commercial applications.
July 2002 Globe Tool and Founded in 1954, the company designed
Manufacturing and manufactured precision enclosures
Company, Inc. used in IMDs and commercial products
("Globe") used in the aerospace, electronic, and
automotive sectors.
4
March 2004 NanoGram Devices Founded in 1996, the company developed
Corporation nanoscale materials for battery and
("NanoGram") medical device applications.
April 2007 BIOMEC, Inc. Established in 1998, the company
("BIOMEC") provided medical device design and
component integration to early-stage
and established customers.
June 2007 Enpath Medical, Inc. Founded in 1981, the company designed,
("Enpath") developed, and manufactured venous
introducers and dilators, implantable
leadwires, steerable sheaths and
steerable catheters.
October 2007 IntelliSensing LLC Established in 2005, the company
("IntelliSensing") designed and manufactured battery-
powered wireless sensing solutions for
demanding commercial applications.
November 2007 Quan Emerteq LLC Founded in 1998, the company designed,
("Quan Emerteq") developed, and manufactured single use
medical device products and components
including delivery systems, catheters,
stimulation leadwires and
microcomponents and assemblies.
November 2007 Engineered Assemblies Founded in 1984, the company designed
Corporation ("EAC") and integrated custom battery solutions
and electronics focused on rechargeable
systems.
January 2008 P Medical Holding SA Founded in 1994, the company designed,
("Precimed") manufactured and supplied trays,
instruments and implants for orthopedic
original equipment manufacturers
("OEM").
February 2008 DePuy Orthopaedics' The facility manufactured hip, shoulder
Chaumont, France trauma and knee implants for DePuy.
manufacturing
facility
FINANCIAL STATEMENT YEAR END
The Company utilizes a fifty-two, fifty-three week fiscal year ending on the
Friday nearest December 31st. Fiscal years 2007, 2006 and 2005 ended on December
28, December 29 and December 30, respectively.
5
SEGMENT INFORMATION
We operate our business in two reportable segments - Implantable Medical
Components ("IMC") and Electrochem Commercial Power ("ECP"). Segment information
including sales from external customers, profit or loss, and assets by segment
as well as sales from external customers and long-lived assets by geographic
area are set forth at Note 14 - "Business Segment Information" of the Notes to
the Consolidated Financial Statements contained at Item 8 of this report.
IMPLANTABLE MEDICAL DEVICE INDUSTRY
An IMD is an instrument that is surgically inserted into the body to provide
diagnosis or therapy.
One sector of the IMD market is cardiac rhythm management ("CRM"), which is
comprised of devices such as implantable pacemakers, implantable cardioverter
defibrillators ("ICDs"), cardiac resynchronization therapy ("CRT") devices, and
cardiac resynchronization therapy with backup defibrillation devices ("CRT-D").
A new emerging opportunity sector of the IMD market is the neurostimulation
("Neuro") market, which is comprised of pacemaker-type devices that stimulate
various nerves for the treatment of various conditions. Beyond pain control,
nerve stimulation for the treatment of movement disabilities such as Parkinson's
disease, epilepsy, migraines, obesity and depression has shown promising
results.
The following table sets forth the main categories of battery-powered IMDs and
the principal illness or symptom treated by each device:
Device Principal Illness or Symptom
------ ----------------------------
Pacemakers................................. Abnormally slow heartbeat
(Bradycardia)
ICDs....................................... Rapid and irregular heartbeat
(Tachycardia)
CRT/CRT-Ds................................. Congestive heart failure
Neurostimulators........................... Chronic pain, movement disorders,
epilepsy, obesity or depression
Left ventricular assist devices (LVADs).... Heart failure
Drug pumps................................. Diabetes or chronic pain
We believe that the CRM and Neuro markets continue to exhibit strong underlying
growth fundamentals and that we are well positioned to participate in this
market growth. Increased demand is being driven by the following factors:
o Advances in medical technology - new therapies will allow physicians
to use IMDs to treat a wider range of heart diseases.
o New, more sophisticated implantable devices - device manufacturers are
developing new CRM devices and adding new features to existing
products.
o New indications for CRM devices - the patient groups that are eligible
for CRM devices have increased. Insurance guidelines may allow device
reimbursements for these expanding patient populations.
o Expansion of neurostimulator applications - therapies expected to
expand as new therapeutic applications for pulse generators are
identified.
6
o An aging population - the number of people in the US that are over age
65 is expected to double in the next 30 years.
o New performance requirements - government regulators are increasingly
requiring that IMDs be protected from electromagnetic interference
("EMI").
o Global markets - increased market penetration worldwide.
With the acquisition of Enpath and Quan Emerteq during 2007, we obtained new
product offerings for therapy delivery. These offerings include products that
deliver therapies for coronary/neurovascular disease, peripheral vascular
disease, neurostimulation, CRM, as well as products for medical imaging and drug
and pharmaceutical delivery. These products seek to capitalize on the growth in
the Neuro and CRM markets, specifically with new indications for
Neurostimulation devices. In addition, we continue to see strong growth in the
vascular markets because of stent delivery procedures, peripheral-vascular
disease therapies, and new indications for tissue extraction or ablation.
In early 2008, with the acquisition of Precimed and the DePuy Chaumont
manufacturing facility, we entered the orthopedic sector of the IMD market. Many
of the factors affecting the orthopedic market segment are similar to the CRM
market. These factors include aging population, new implant and surgical
technology, rising rates of obesity, a growing replacements market and emerging
affluence in developing nations. As a result, we believe that the orthopedic
market will also continue to exhibit strong growth fundamentals.
COMMERCIAL BATTERY INDUSTRY
Our commercial primary lithium batteries are used in demanding applications such
as oil and gas exploration, pipeline inspection, oceanographic and seismic
surveying, communication devices, and military and aerospace equipment. These
applications use a variety of battery-powered systems including
measurement-while-drilling tools, pipeline inspection gauges, oceanography
buoys, and hand-held military communication equipment. Commercial primary
batteries are used with these systems because of extreme operating conditions
and long life requirements. ECP commercial primary batteries are capable of
operating reliably and safely at extremely high and low temperatures, as well as
with high shock and vibration.
Our new line of rechargeable commercial batteries, acquired from EAC, provides
ongoing power for portable equipment, devices and tools used in the market
segments where our commercial primary batteries are widely used. The new
rechargeable batteries complement our non-rechargeable primary batteries. This
new product line enables us to expand into new market segments where
rechargeable batteries may be better suited, such as external medical devices.
Our new line of wireless sensor solutions, acquired from IntelliSensing, further
complements our traditional offerings. Many customers in our existing markets
are seeking a means of sensing and controlling equipment wirelessly. Our next
generation products offer vertically integrated solutions built on wireless
sensor networks.
We expect the demand for reliable portable power and integrated wireless sensing
solutions to continue to rise with the increase in oil and gas exploration,
pipeline inspection, seismic surveying, and military and aerospace activity.
7
PRODUCTS
The following table provides information about our principal products:
IMPLANTABLE MEDICAL COMPONENTS:
-------------------------------
PRODUCT DESCRIPTION PRINCIPAL PRODUCT ATTRIBUTES
------- ----------- ----------------------------
Batteries Power sources include:
-- Lithium iodine ("Li Iodine") High reliability and predictability
-- Lithium silver vanadium oxide ("Li SVO") Long service life
-- Lithium carbon monoflouride ("Li CFx") Customized configuration
-- Lithium ion rechargeable ("Li Ion") Light weight
-- Lithium SVO/CFx ("QHR" & "QMR") Compact and less intrusive
Capacitors Storage for energy generated by a battery before delivery to Stores more energy per unit volume (energy
the heart. Used in ICDs and CRT-Ds. density) than other existing technologies
Customized configuration
EMI filters Filters electromagnetic interference to limit undesirable High reliability attenuation of EMI RF over wide
response, malfunctioning or degradation in the performance frequency ranges
of electronic equipment Customized design
Feedthroughs Allow electrical signals to be brought from inside Ceramic to metal seal is substantially more
hermetically sealed IMD to an electrode durable than traditional seals
Multifunctional
Coated electrodes Deliver electric signal from the feedthrough to a body part High quality coated surface
undergoing stimulation Flexible in utilizing any combination of
biocompatible coating surfaces
Customized offering of surfaces and tips
Precision -- Machined High level of manufacturing precision
components -- Molded and over molded products Broad manufacturing flexibility
Enclosures and -- Titanium Precision manufacturing, flexibility in
related -- Stainless steel configurations and materials.
components
Value-added Combination of multiple components in a single package/unit Leveraging products and capabilities to provide
assemblies subassemblies and assemblies
Provides synergies in component technology and
procurement systems
Leads Cardiac, neurostim and hearing restoration stimulation leads Unique configurations that increase effectiveness
Introducers Creates a conduit to insert infusion catheters, guidewires, Variety of sizes and materials that facilitate
implantable ports, pacemaker leads and other therapeutic problem-free access in a variety of clinical
devices into a blood vessel applications
Catheters Delivers therapeutic devices to specific sites in the body Enable safe, simple delivery of therapeutic and
diagnostic devices, soft tip and steerability
Implants Orthopedic implants for reconstructive hip, shoulder, knee, Precision manufacturing, leveraging capabilities
trauma and spine procedures and products, complete processes including
sterile packaging and coatings
8
PRODUCT DESCRIPTION PRINCIPAL PRODUCT ATTRIBUTES
------- ----------- ----------------------------
Instruments Orthopedic instruments for reconstructive and trauma Designed to improve surgical techniques, reduce
procedures surgery time, increase surgical precision and
decrease risk of contamination
Trays Delivery systems for cleaning and sterilizing orthopedic Deliver turn-key full service kits
instruments and implants
ELECTROCHEM COMMERCIAL POWER:
----------------------------
Cells Moderate-rate Optimized rate capability, shock and vibration
High energy density
Spiral (high rate)
Primary and rechargeable Bundling of commercial batteries in a customer Increased power and recharging capabilities
battery packs specific configuration and ease of integration into customer
applications
Wireless sensors Operates where wired sensors are undesirable Measures pressure and temperature at the same
or impractical time, withstanding harsh environments
RESEARCH AND DEVELOPMENT
Our position as a leading developer and manufacturer of components for IMDs and
commercial batteries is largely the result of our long history of technological
innovation. We invest substantial resources in research, development and
engineering. Our scientists, engineers and technicians focus on improving
existing products, expanding the use of our products and developing new
products. In addition to our internal technology and product development
efforts, we at times engage outside research institutions for special projects.
PATENTS AND PROPRIETARY TECHNOLOGY
We rely on a combination of patents, license, trade secrets and know-how to
establish and protect our proprietary rights to our technologies and products.
We have 387 active U.S. patents and 203 active foreign patents. We also have 213
U.S. and 233 foreign pending patent applications at various stages of approval.
During the past three years, we have been granted 91 new U.S. patents, of which
17 were granted in 2007. Corresponding foreign patents have been issued or are
expected to be issued in the near future. Often, several patents covering
various aspects of the design protect a single product. We believe this provides
broad protection of the inventions employed.
Our active battery patents relate to process improvements and design
modifications to the original technology that was developed either by our
Company or others. As part of our current technology strategy, we plan to expand
the purchased patents and licensed technology acquired with the NanoGram
acquisition through continued development of advanced cathode materials for our
implantable battery product lines. Nano-SVO cathode material is part of this
plan and is expected to become the standard technology broadly adopted by all
SVO battery applications.
We are also a party to several license agreements with third parties under which
we have obtained, on varying terms, the exclusive or non-exclusive rights to
patents held by them. One of these agreements is for the basic technology used
in our wet tantalum capacitors. We have also granted rights in our patents to
others under license agreements.
9
It is our policy to require our management and technical employees, consultants
and other parties having access to our confidential information to execute
confidentiality agreements. These agreements prohibit disclosure of confidential
information to third parties except in specified circumstances. In the case of
employees and consultants, the agreements generally provide that all
confidential information relating to our business is the exclusive property of
the Company.
MANUFACTURING AND QUALITY CONTROL
We primarily manufacture small lot sizes, as most customer orders range from a
few hundred to a few thousand units. As a result, our ability to remain flexible
is an important factor in maintaining high levels of productivity. Each of our
production teams receives assistance from a manufacturing support team, which
typically consists of representatives from our quality control, engineering,
manufacturing, materials and procurement departments. Our quality systems are
compliant with and certified to various recognized international standards.
Our commercial battery facility in Canton, MA and our facilities in Alden, NY
and Minneapolis, MN (enclosure manufacturing and engineering) are ISO 9001-2000
registered, which requires compliance with regulations regarding quality systems
of product design (where applicable), supplier control, manufacturing processes
and management review. This certification can only be achieved after completion
of an audit conducted by an independent authority.
Our facilities in Tijuana, Mexico, Minneapolis, MN (Quan Emerteq), Clarence, NY
(machining and assembly of components), and several of the Orvin, Switzerland
(Precimed) sites are ISO 13485 certified in the design (where applicable) and
manufacture of components and performance of assembly operations. This level of
certification additionally allows for the manufacture and distribution of
devices outside of the US. This certification gives us the ability to serve as a
manufacturing partner to medical device manufacturers, which we believe will
improve our competitive position in the Therapy Delivery, CRM and emerging
neurostimulation and Orthopedic markets. Our Enpath facility (Minneapolis, MN)
and several of our Precimed facilities (Switzerland and France) are also
registered with the FDA, thus enabling the manufacture and distribution of
registered medical devices both inside and outside the US.
We are currently working with several neurostimulation companies that can
benefit from our expanded capabilities. Providing device level manufacturing
capability allows us to move up our customers' supply-chain and helps to drive
both component and sub-assembly growth.
Our existing manufacturing plants are audited by several notified bodies (TUV,
G-Med, QMI, BSI, and the National Standards Authority of Ireland). To maintain
certification, all facilities must be reexamined routinely by their respective
notified body.
SALES AND MARKETING
Products from our IMC business are sold directly to our customers. In our ECP
business, we utilize a combination of direct and indirect sales methods,
depending on the particular product. In 2007, approximately 48% of our products
were sold in the US. Sales to countries outside of the US are primarily to
customers whose corporate offices are located and headquartered in the US.
Information regarding our sales by geographic area is set forth at Note 14 -
"Business Segment Information" of the Notes to the Consolidated Financial
Statements contained at Item 8 of this report.
10
The majority of our medical customers contract with us to develop custom
components and assemblies to fit their specific product specifications. As a
result, we have established close working relationships between our internal
program managers and our customers. We market our products and technologies at
industry meetings and trade shows domestically and internationally.
Internal sales managers support all activity and involve engineers and
technology professionals in the sales process to address customer requests
appropriately.
We sell our commercial cells and battery packs directly to the end user,
directly to manufacturers that incorporate our products into other devices for
resale, or to distributors who sell our products to manufacturers and end users.
Our sales managers are trained to assist our customers in selecting appropriate
chemistries and configurations. We market our ECP products at various technical
trade meetings. We also place print advertisements in relevant trade
publications.
Firm backlog orders at December 31, 2007 and 2006 were approximately $107.2
million and $76.6 million, respectively. Most of these orders are expected to be
shipped within one year. See Customers section below for further discussion.
CUSTOMERS
Our IMC customers include leading IMD manufacturers, in alphabetical order here
and throughout this report, such as Biotronik, Boston Scientific, Medtronic, the
Sorin Group and St. Jude Medical. In 2007, Boston Scientific, Medtronic and St.
Jude Medical, collectively accounted for 67% of our total sales, compared to 67%
in 2006 and 70% in 2005. The nature and extent of our selling relationships with
each IMC 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. During 2007 and in the first
quarter of 2008, we completed seven acquisitions consistent with our strategic
objective to diversify our customer base and market concentration. We anticipate
that in 2008, we will reduce our concentration in the CRM market from
approximately 80% to approximately 50%.
Our ECP customers are primarily companies involved in the oil and gas
exploration, pipeline inspection, telematics, oceanography equipment, seismic,
communication, military and aerospace markets including Halliburton Company,
Weatherford International, General Electric and PathFinder Energy Services.
We entered into an agreement with Boston Scientific in June 2007 pursuant to
which Boston Scientific will purchase a minimum percentage of batteries, wet
tantalum capacitors and formed metal components at prices specified in the
agreement. The period of the agreement is July 1, 2007 through December 31,
2010. Our previous agreement with Boston Scientific pursuant to which Boston
Scientific purchased filtered feedthroughs scheduled to expire December 31, 2007
was extended through March 31, 2008. We are negotiating a follow-on agreement
with targeted completion during the first quarter of 2008. Purchases and
shipments of filtered feedthroughs continue during contract negotiations.
11
We have a supply agreement with St. Jude Medical pursuant to which St. Jude
Medical purchases batteries, wet tantalum capacitors, filtered feedthroughs,
molded components and enclosures under specified price and volume terms. A
contract amendment effective March 1, 2007 extended the contract term to
December 31, 2013
We have a supply agreement with Medtronic pursuant to which Medtronic will
purchase implantable device shield sub-assemblies and other products under
specified price and volume terms. The contract term is seven years, commencing
August 2, 2004 and ending August 2, 2011. In October 2005, we entered into a
license agreement which grants Medtronic the right to use certain of our
intellectual property relating to tantalum capacitors. The license is perpetual
and is exclusive to Medtronic, except for our right to make and sell tantalum
capacitors.
SUPPLIERS AND RAW MATERIALS
We purchase certain critical raw materials from a limited number of suppliers
due to the technically challenging requirements of the supplied product and/or
the lengthy process required to qualify these materials with our customers. We
cannot quickly establish additional or replacement suppliers for these materials
because of these requirements. In the past, we have not experienced any
significant interruptions or delays in obtaining these raw materials. We
maintain minimum safety stock levels of critical raw materials.
For other raw material purchases, we utilize competitive pricing methods such as
bulk purchases, precious metal pool buys, blanket orders, and long-term
contracts to secure supply. We believe that there are alternative suppliers or
substitute products available at competitive prices for all of the materials we
purchase.
COMPETITION
Existing and potential competitors in our IMC business includes leading IMD
manufacturers such as Biotronik, Boston Scientific, Medtronic, the Sorin Group
and St. Jude Medical that currently have vertically integrated operations and
may expand their vertical integration capability in the future. Competitors also
include independent suppliers who typically specialize in one type of component.
Our known non-vertically integrated competitors include the following:
Product Line Competitors
------------ -----------
Medical batteries Litronik (a subsidiary of Biotronik)
Eagle-Picher
Capacitors Critical Medical Components
Feedthroughs Alberox (subsidiary of The Morgan
Crucible Co. PLC)
EMI filtering AVX (subsidiary of Kyocera)
Eurofarad
Enclosures Heraeus
Hudson
12
Commercial batteries/battery Eagle-Picher
packs Engineered Power
Saft
Tadiran
Tracer Technologies
Ultralife
Nexergy
Micro-power
Machined and molded Numerous
components
Value added assembly Numerous
Orthopedic trays, Symmetry
instruments and implants Paragon
Accelent
Teleflex
Viasys
Orchid
Catheters Teleflex
Leadwires Oscor
GOVERNMENT REGULATION
Except as described below, our business is not subject to direct governmental
regulation other than the laws and regulations generally applicable to
businesses in the jurisdictions in which we operate. We are subject to federal,
state and local environmental laws and regulations governing the emission,
discharge, use, storage and disposal of hazardous materials and the remediation
of contamination associated with the release of these materials at our
facilities and at off-site disposal locations. Our manufacturing and research,
development and engineering activities may involve the controlled use of small
amounts of hazardous materials. Liabilities associated with hazardous material
releases arise principally under the federal Comprehensive Environmental
Response, Compensation and Liability Act and analogous state laws that impose
strict, joint and several liability on owners and operators of contaminated
facilities and parties that arrange for the off-site disposal of hazardous
materials. We are not aware of any material noncompliance with the environmental
laws currently applicable to our business and we are not subject to any material
claim for liability with respect to contamination at any company facility or any
off-site location. We cannot assure you that we will not become subject to such
environmental liabilities in the future as a result of historic or current
operations.
13
To varying degrees, our products are subject to regulation by numerous
government agencies, including the US Food and Drug Administration ("FDA") and
comparable foreign agencies. The medical product components we manufacture are
not subject to regulation by the FDA. However, the FDA and related state and
foreign governmental agencies regulate the devices we manufacture and our
customers' products as medical devices.
We have "master files" on record with the FDA. Master files may be used to
provide confidential detailed information about facilities, processes, or
articles used in the manufacturing, processing, packaging and storing of one or
more medical device components. These submissions may be used by device
manufacturers to support the premarket notification process required by Section
510(k) of the federal Food Drug & Cosmetic Act. This notification process is
necessary to obtain clearance from the FDA to market a device for human use in
the US.
The medical devices we manufacture and market are subject to regulation by the
FDA and, in some instances, by state and foreign authorities. Pursuant to the
Medical Device Amendments of 1976 to the Federal Food, Drug and Cosmetic Act and
related regulations, medical devices intended for human use are classified into
three categories (Classes I, II and III), depending upon the degree of
regulatory control to which they will be subject. In the U.S. our introducer and
delivery catheter products are considered Class II devices.
If a Class II device is substantially equivalent to an existing (predicate)
device that has been continuously marketed since the effective date of the 1976
Amendments, FDA requirements may be satisfied through a Pre-market Notification
Submission or 510(k) under which the applicant provides product information
supporting its claim of substantial equivalence. In a 510(k) Submission, the FDA
may also require that we provide clinical test results demonstrating the safety
and efficacy of the device. Generally, Class III devices are typically
life-sustaining, life supporting, or implantable devices that must receive
Pre-Market Approval ("PMA") by the FDA to ensure their safety and effectiveness.
A PMA is a more rigorous approval process typically requiring human clinical
studies. Certain leads that we manufacture and market are Class III devices, but
any required PMA is submitted and received by our customers.
As a manufacturer of medical devices, we are also subject to certain other FDA
regulations and our device manufacturing processes and facilities are subject to
on-going review by the FDA in order to ensure compliance with current Good
Manufacturing Practices. We believe that our manufacturing and quality
procedures conform to the requirements of FDA regulations. Our sales and
marketing practices are subject to regulation by the U.S. Department of Health
and Human Services pursuant to federal anti-kickback laws, and are also subject
to similar state laws.
We are also subject to various other environmental, transportation and labor
laws as well as various other directives and regulations both in the U.S. and
abroad. We believe that compliance with these laws will not have a material
impact on our capital expenditures, earnings or competitive position. Given the
scope and nature of these laws, however, there can be no assurance that they
will not have a material impact on our results of operations. We assess
potential contingent liabilities on a quarterly basis. At present, we are not
aware of any such liabilities that would have a material impact on our business.
14
RECRUITING AND TRAINING
We invest substantial resources in our recruiting efforts that focus on
supplying quality personnel to support our business objectives. We have
established a number of programs that are designed to challenge and motivate our
employees. All staff are encouraged to be proactive in contributing ideas.
Feedback surveys are used to collect suggestions on ways that our business and
operations can be improved. We further meet our hiring needs through outside
sources as required.
We provide a training program for our new employees that is designed to educate
them on safety, quality, business strategy, corporate culture, and the
methodologies and technical competencies that are required for our business. Our
safety training programs focus on such areas as basic industrial safety
practices and emergency response procedures to deal with any potential fires or
chemical spills. All of our employees are required to participate in a
specialized training program that is designed to provide an understanding of our
quality objectives. Supporting our lifelong learning environment, we offer our
employees a tuition reimbursement program and encourage them to continue their
education at accredited colleges and universities. Many of our professionals
attend seminars on topics that are related to our corporate objectives and
strategies. We believe that comprehensive training is necessary to ensure that
our employees have state of the art skills, utilize best practices, and have a
common understanding of work practices.
EMPLOYEES
The following table provides a breakdown of employees as of December 28, 2007:
Manufacturing 1,401
General and administrative 122
Sales and marketing 44
Research and development 114
Engineering 97
Tijuana, Mexico facility 613
Suzhou, China facility 54
-----------
Total 2,445
===========
We also employ a number of temporary employees to assist us with various
projects and service functions and address peaks in staff requirements. Our
employees are not represented by any union. The positions at our Tijuana, Mexico
facility and our Suzhou, China facility are primarily manufacturing in nature.
We added approximately 600 employees with our acquisition of Precimed and the
DePuy Chaumont, France manufacturing facility. We believe that we have a good
relationship with our employees.
EXECUTIVE OFFICERS OF THE COMPANY
Information concerning our executive officers is presented below as of February
26, 2008. The officers' terms of office run until the first meeting of the board
of directors after our annual meeting, which takes place immediately following
our Annual Meeting of Stockholders and until their successors are elected and
qualified, except in the case of earlier death, retirement, resignation or
removal.
15
Mauricio Arellano, age 41, is Senior Vice President and the Business Leader
for our CRM and Neuromodulation Group. He served as the Senior Vice President
and Business Leader of the Medical Solutions Group from November 2006 to
January 2008 and as Vice President of Greatbatch Mexico from January 2005 to
November 2006. Mr. Arellano joined our Company in October 2003 as the Plant
Manager of our former Carson City, NV facility. Prior to joining our Company he
served in a variety of human resources and operational roles with Tyco
Healthcare - Especialidades Medicas Kenmex and with Sony de Tijuana Este.
John Ayliffe, age 40, is Vice President, Europe. He is responsible for European
business development and sales for our Company. Mr. Ayliffe joined our Company
in January 2008 upon our acquisition of Precimed. He had served as the Chief
Operating Officer of Precimed since 1998.
Patrick Berdoz, age 47, is Senior Vice President and the Business Leader
for our Orthopedic Group. Mr. Berdoz joined our Company in January 2008 upon
acquisition of Precimed. He had served as President of Precimed since 1998.
Susan M. Bratton, age 51, is Senior Vice President and Business Leader for
our Commercial Group. She served as Vice President of Corporate Quality from
March 2001 to January 2005, as General Manager of our Electrochem Division from
July 1998 to March 2001 and as Director of Procurement from June 1991 to July
1998. Ms. Bratton has held various other positions with our Company since
joining us in 1976.
Susan H. Campbell, age 43, is Senior Vice President for Global Manufacturing and
Supply Chain. She is responsible for all manufacturing operations. Ms. Campbell
had served as the Business Leader for our Medical Power Group from January
2005 until January 2008. She joined our Company in April 2003 as the Plant
Manger for our Clarence, NY facility. Prior to that time, Ms. Campbell was a
plant manager for Delphi Corporation and General Motors Corporation.
Barbara M. Davis, age 57, is Vice President for Human Resources, a position she
has held since April 2004. She joined our Company in October 1998 as Director of
Human Resources and Organization Development.
John T. Farrell, age 47, is Vice President and Business Leader for our
Therapy Delivery Group, a position to which he was appointed following our
acquisition of Quan Emerteq in November 2007. He had been employed from August
2006 to November 2007 as President of Quan Emerteq. Prior to that, he had been
employed for eight years by Kodak, most recently as Vice President and General
Manager of its Healthcare Laser Imaging business.
Richard M. Farrell, age 45, is Vice President for Business Development, a
position to which he was appointed following our acquisition of Quan Emerteq in
November 2007. He was a founder of and had been employed by Quan Emerteq in a
variety of roles, since 1998, most recently as its Vice President of Business
Development.
Thomas J. Hook, age 45, is our President and Chief Executive Officer. Prior to
August 2006, he was our Chief Operating Officer, a position he accepted upon
joining our Company in September 2004. From August 2002 until September 2004,
Mr. Hook was employed by CTI Molecular Imaging where he had served as President,
CTI Solutions Group.
16
Thomas J. Mazza, age 54, is Senior Vice President and Chief Financial Officer, a
position he has held since August 2005. He joined our Company in November 2003
as Vice President and Corporate Controller. Prior to that, Mr. Mazza served in a
variety of financial roles with Foster Wheeler Ltd., most recently as Vice
President and Corporate Controller.
Timothy G. McEvoy, age 50, is Vice President, General Counsel and Secretary, a
position he has held since joining our Company in February 2007. From 1992 until
January 2007, he was employed in a variety of legal roles by Manufacturers and
Traders Trust Company, most recently as Administrative Vice President and Deputy
General Counsel.
AVAILABLE INFORMATION
We make available free of charge on or through our internet website our annual
report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K
and amendments to those reports filed or furnished pursuant to Section 13(a) or
15(d) of the Securities Exchange Act of 1934 as soon as reasonably practicable
after we electronically file those reports with, or furnish them to, the
Securities and Exchange Commission. Our Internet address is www.greatbatch.com.
The information contained on our website is not incorporated by reference in
this annual report on Form 10-K and should not be considered a part of this
report.
CAUTIONARY FACTORS THAT MAY AFFECT FUTURE RESULTS
Some of the statements contained in this annual report on Form 10-K 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 IMD
industry;
o our ability to execute our business model and our business strategy;
o our ability to identify trends within the IMD, medical component, and
commercial power source industries and to offer products and services
that meet the changing needs of those markets;
o projected capital expenditures; and
o trends in government regulation.
You can identify forward-looking statements by terminology such as "may,"
"will," "should," "could," "expects," "intends," "plans," "anticipates,"
"believes," "estimates," "predicts," "potential" or "continue" or the negative
of these terms or other comparable terminology. These statements are only
predictions. Actual events or results may differ materially from those suggested
by these forward-looking statements. In evaluating these statements and our
prospects generally, you should carefully consider the factors set forth below.
All forward-looking statements attributable to us or persons acting on our
behalf are expressly qualified in their entirety by these cautionary factors and
to others contained throughout this report. We are under no duty to update any
of the forward-looking statements after the date of this report or to conform
these statements to actual results.
17
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 and are described in the Company's periodic filings with
the Securities and Exchange Commission and in Item 1A of this report.
ITEM 1A. RISK FACTORS
Our business faces many risks. Any of the risks discussed below, or elsewhere in
this report or in our other SEC filings, could have a material impact on our
business, financial condition or results of operations. Additional risks and
uncertainties not presently known to us or that we currently believe to be
immaterial may also impair our business operations.
Risks Related To Our Business
We depend heavily on a limited number of customers, and if we lose any of them
or they reduce their business with us, we would lose a substantial portion of
our revenues.
A substantial portion of our business is conducted with a limited number of
customers, including Biotronik, Boston Scientific, Medtronic, the Sorin Group
and St. Jude Medical. In 2007, Boston Scientific, Medtronic and St. Jude
Medical, collectively accounted for approximately 67% of our revenues. Our
supply agreements with these customers might not be renewed. Furthermore, many
of our supply agreements do not contain minimum purchase level requirements and
therefore there is no guaranteed source of revenue that we can depend upon under
these agreements. The loss of any large customer or a reduction of business with
that customer for any reason would harm our business, financial condition and
results of operations.
If we do not respond to changes in technology, our products may become obsolete
and we may experience a loss of customers and lower revenues.
We sell our products to customers in several industries that are characterized
by rapid technological changes, frequent new product introductions and evolving
industry standards. Without the timely introduction of new products and
enhancements, our products and services will likely become technologically
obsolete over time and we may lose a significant number of our customers. In
addition, other new products introduced by our customers may require fewer of
our batteries or components. We dedicate a significant amount of resources to
the development of our products and technologies and we would be harmed if we
did not meet customer requirements and expectations. Our inability, for
technological or other reasons, to successfully develop and introduce new and
innovative products could result in a loss of customers and lower revenues.
18
If we are unable to successfully market our current or future products, our
business will be harmed and our revenues and operating results will be reduced.
The market for our medical products has been growing in recent years. If the
market for our products does not grow as rapidly as forecasted by industry
experts, our revenues could be less than expected. In addition, it is difficult
to predict the rate at which the market for our products will grow or at which
new and increased competition will result in market saturation. Slower growth in
the pacemaker, ICD and CRT markets in particular would negatively impact our
revenues. In addition, we face the risk that our products will lose widespread
market acceptance. Our customers may not continue to utilize the products we
offer and a market may not develop for our future products. We may at times
determine that it is not technically or economically feasible for us to continue
to manufacture certain products and we may not be successful in developing or
marketing them. Additionally, new technologies that we develop may not be
rapidly accepted because of industry-specific factors, including the need for
regulatory clearance, entrenched patterns of clinical practice and uncertainty
over third party reimbursement. If this occurs, our business will be harmed and
our operating results will be negatively affected.
We are subject to pricing pressures from customers, which could harm operating
results.
We have made price reductions to some of our large customers in recent years and
we expect customer pressure for price reductions will continue. Price
concessions or reductions may cause our operating results to suffer. In
addition, any delay or failure by a large customer to make payments due to us
would harm our operating results and financial condition.
We rely on third party suppliers for raw materials, key products and
subcomponents and if we are unable to obtain these materials, products and
subcomponents on a timely basis or on terms acceptable to us, our ability to
manufacture products will suffer.
Our business depends on a continuous supply of raw materials. The principal raw
materials used in our business include lithium, iodine, tantalum, platinum,
ruthenium, gallium trichloride, tantalum pellets, vanadium pentoxide, iridium,
and titanium. Raw materials needed for our business are susceptible to
fluctuations due to transportation, government regulations, price controls,
economic climate or other unforeseen circumstances. Increasing global demand for
some of the raw materials we need for our business, including platinum, iridium,
gallium trichloride, tantalum and titanium, has caused the prices of these
materials to increase significantly. In addition, there are a limited number of
worldwide suppliers of several raw materials needed to manufacture our products,
including lithium, gallium trichloride, carbon monofluoride, and tantalum. We
may not be able to continue to procure raw materials critical to our business or
to procure them at acceptable price levels.
We rely on third party manufacturers to supply many of our products and
subcomponents. Manufacturing problems may occur with these and other outside
sources, as a supplier may fail to develop and supply products and subcomponents
to us on a timely basis, or may supply us with products and subcomponents that
do not meet our quality, quantity and cost requirements. If any of these
problems occur, we may be unable to obtain substitute sources for these products
and subcomponents on a timely basis or on terms acceptable to us, which could
harm our ability to manufacture our own products and components profitably or on
time. In addition, to the extent the processes that our suppliers use to
manufacture products and subcomponents are proprietary, we may be unable to
obtain comparable subcomponents from alternative suppliers.
19
We may never realize the full value of our intangible assets, which represent a
significant portion of our total assets.
At December 28, 2007, we had $352.4 million of intangible assets, representing
53% of our total assets. These intangible assets consist primarily of goodwill,
trademarks, tradenames, customer lists and patented technology arising from our
acquisitions. Goodwill and other intangible assets with indefinite lives are not
amortized, but are tested annually or upon the occurrence of certain events that
indicate that the assets may be impaired. We may not receive the recorded value
for our intangible assets if we sell or liquidate our business or assets. In
addition, the material concentration of intangible assets increases the risk of
a large charge to earnings in the event that the recoverability of these
intangible assets is impaired, and in the event of such a charge to earnings,
the market price of our common stock could be adversely affected. In addition,
intangible assets with definite lives, which represent $71.3 million of our net
intangible assets at December 28, 2007, will continue to be amortized. We
incurred total amortization expenses relating to these intangible assets of $5.6
million in 2007. These expenses will reduce our future earnings or increase our
future losses.
Quality problems with our products could harm our reputation for producing high
quality products, erode our competitive advantage and result in claims against
us.
Our products are held to high quality and performance standards. In the event
that our products fail to meet these standards, our reputation for producing
high quality products could be harmed, which would damage our competitive
advantage and could result in lower revenues. Product quality or performance
issues may also result in product liability or other legal claims against us,
which could harm our operating results or financial condition.
Quality problems with our products could result in warranty claims and
additional costs.
We generally allow customers to return defective or damaged products for credit,
replacement, or exchange. We generally warrant that our products will meet
customer specifications and will be free from defects in materials and
workmanship. Additionally, we carry a safety stock of inventory for our
customers which may be impacted by warranty claims. We accrue for our exposure
to warranty claims based upon recent historical experience and other specific
information as it becomes available. However, such reserves may not be adequate
to cover future warranty claims and additional warranty costs and/or inventory
write-offs may be incurred which could harm our operating results or financial
condition.
If we become subject to product liability claims, our operating results and
financial condition could suffer.
The manufacturing and sale of our products expose us to potential product
liability claims and product recalls, including those that may arise from
failure to meet product specifications, misuse or malfunction of, or design
flaws in our products, or use of our products with components or systems not
manufactured or sold by us. Many of our products are components and function in
interaction with our customers' medical devices. For example, our batteries are
produced to meet various electrical performance, longevity and other
specifications, but the actual performance of those products is dependent on how
they are in fact utilized as part of the customers' devices over the lifetime of
the products. Product performance and device interaction from time to time have
been, and may in the future be, different than expected for a number of reasons.
20
Consequently, it is possible that customers may experience problems with their
medical devices that could require device recall or other corrective action,
where our batteries met the specification at delivery, and for reasons that are
not related primarily or at all to any failure by our product to perform in
accordance with specifications. It is possible that our customers (or end-users)
may in the future assert that our products caused or contributed to device
failure where our product was not the primary cause of the device performance
issue. Even if these assertions do not lead to product liability or contract
claims, they could harm our reputation and our customer relationships.
Provisions contained in our agreements with key customers attempting to limit
our damages, including provisions to limit damages to liability for gross
negligence, may not be enforceable in all instances or may otherwise fail to
protect us from liability for damages. Product liability claims or product
recalls, regardless of their ultimate outcome, could require us to spend
significant time and money in litigation or require us to pay significant
damages. The occurrence of product liability claims or product recalls could
adversely affect our operating results and financial condition.
We carry liability insurance coverage that is limited in scope and amount. We
may not be able to maintain this insurance at a reasonable cost or on reasonable
terms, or at all. This insurance may not be adequate to protect us against a
product liability claim that arises in the future.
Our operating results may fluctuate, which may make it difficult to forecast our
future performance and may result in volatility in our stock price.
Our operating results have fluctuated in the past and are likely to fluctuate
significantly from quarter to quarter due to a variety of factors, including but
not limited to the following:
o the fixed nature of a substantial percentage of our costs, which
results in our operations being particularly sensitive to fluctuations
in revenue;
o changes in the relative portion of our revenue represented by our
various products and customers, which could result in reductions in
our profits if the relative portion of our revenue represented by
lower margin products increases;
o timing of orders placed by our principal customers who account for a
significant portion of our revenues; and
o increased costs of raw materials or supplies.
If we are unable to protect our intellectual property and proprietary rights,
our business could be adversely affected.
We rely on a combination of patents, licenses, trade secrets and know-how to
establish and protect our proprietary rights to our technologies and products.
As of December 28, 2007, we held 387 active U.S. patents. However, the steps we
have taken or will take to protect our proprietary rights may not be adequate to
deter misappropriation of our intellectual property. In addition to seeking
formal patent protection whenever possible, we attempt to protect our
proprietary rights and trade secrets by entering into confidentiality and
non-compete agreements with employees, consultants and third parties with which
we do business. However, these agreements can be breached and, if they are,
there may not be an adequate remedy available to us and we may be unable to
prevent the unauthorized disclosure or use of our technical knowledge, practices
or procedures. If our trade secrets become known, we may lose our competitive
advantages.
21
If third parties infringe or misappropriate our patents or other proprietary
rights, our business could be seriously harmed. We may be required to spend
significant resources to monitor our intellectual property rights, we may not be
able to detect infringement of these rights and may lose our competitive
advantages associated with our intellectual property rights before we do so. In
addition, competitors may design around our technology or develop competing
technologies that do not infringe on our proprietary rights.
We may be subject to intellectual property claims, which could be costly and
time consuming and could divert our management from our business operations.
In producing our products, third parties may claim that we are infringing on
their intellectual property rights, and we may be found to have infringed those
intellectual property rights. We may be unaware of intellectual property rights
of others that may be used in our technology and products. In addition, third
parties may claim that our patents have been improperly granted and may seek to
invalidate our existing or future patents. If any claim for invalidation
prevailed, the result could be greatly expanded opportunities for third parties
to manufacture and sell products that compete with our products and our revenues
from any related license agreements would decrease accordingly. We also
typically do not receive significant indemnification from parties which license
technology to us against third party claims of intellectual property
infringement.
Any litigation or other challenges regarding our patents or other intellectual
property could be costly and time consuming and could divert our management and
key personnel from our business operations. The complexity of the technology
involved in producing our products, and the uncertainty of intellectual property
litigation increases these risks. Claims of intellectual property infringement
might also require us to enter into costly royalty or license agreements.
However, we may not be able to obtain royalty or license agreements on terms
acceptable to us, or at all. We also may be subject to significant damages or
injunctions against development and sale of our products. Infringement claims,
even if not substantiated, could result in significant legal and other costs and
may be a distraction to management.
We are dependent upon our senior management team and key personnel and the loss
of any of them could significantly harm us.
Our future performance depends to a significant degree upon the continued
contributions of our senior management team and key technical personnel. Our
products are highly technical in nature. In general, only highly qualified and
trained scientists have the necessary skills to develop our products. The loss
or unavailability to us of any member of our senior management team or a key
technical employee could significantly harm us. We face intense competition for
these professionals from our competitors, customers and companies operating in
our industry. To the extent that the services of members of our senior
management team and key technical personnel would be unavailable to us for any
reason, we would be required to hire other personnel to manage and operate our
company and to develop our products and technology. We may not be able to locate
or employ such qualified personnel on acceptable terms.
22
We may not be able to attract, train and retain a sufficient number of qualified
employees to maintain and grow our business.
Our success will depend in large part upon our ability to attract, train, retain
and motivate highly skilled employees and management. There is currently
aggressive competition for employees who have experience in technology and
engineering. We compete intensely with other companies to recruit and hire from
this limited pool. The industries in which we compete for employees are
characterized by high levels of employee attrition. Although we believe we offer
competitive salaries and benefits, we may have to increase spending in order to
attract, train and retain personnel.
We may make acquisitions that could subject us to a number of operational risks
and we may not be successful in integrating companies we acquire into our
existing operations.
We have made and expect to make in the future acquisitions that complement our
core competencies in technology and manufacturing to enable us to manufacture
and sell additional products to our existing customers and to expand our
business into related markets. Implementation of our acquisition strategy
entails a number of risks, including:
o inaccurate assessments of potential liabilities associated with the
acquired businesses;
o the existence of unknown and/or undisclosed liabilities associated
with the acquired businesses;
o diversion of our management's attention from our core businesses;
o potential loss of key employees or customers of the acquired
businesses;
o difficulties in integrating the operations and products of an acquired
business or in realizing projected revenue growth, efficiencies and
cost savings; and
o increases in our indebtedness and a limitation in our ability to
access additional capital when needed.
Since the end of 2006, we have made seven acquisitions: BIOMEC in April 2007;
Enpath in June 2007; IntelliSensing in October 2007; Quan Emerteq in November
2007; EAC in November 2007; and most recently Precimed in January 2008 and DePuy
in February 2008. These acquisitions have increased the size and scope of our
operations, and may place a strain on our managerial, operational and financial
resources and systems. Any failure by us to manage this growth and successfully
integrate these acquisitions could harm our business and our financial condition
and results.
If we are not successful in making acquisitions to expand and develop our
business, our operating results may suffer.
A component of our strategy is to make acquisitions that complement our core
competencies in technology and manufacturing to enable us to manufacture and
sell additional products to our existing customers and to expand our business
into related markets. Our continued growth will depend on our ability to
identify and acquire companies that complement or enhance our business on
acceptable terms. We may not be able to identify or complete future
acquisitions. Some of the risks that we may encounter include expenses
associated with and difficulties in identifying potential targets, the costs
associated with unsuccessful acquisitions, and higher prices for acquired
companies because of competition for attractive acquisition targets. Our failure
to acquire additional companies could cause our operating results to suffer.
We may face competition from our principal medical customers that could harm our
business and we may be unable to compete successfully against new entrants and
established companies with greater resources.
23
Competition in connection with the manufacturing of our products may intensify
in the future. One or more of our customers may undertake additional vertical
integration initiatives and begin to manufacture some or all of their components
that we currently supply them which could cause our operating results to suffer.
The market for commercial power sources is competitive, fragmented and subject
to rapid technological change. Many other commercial power source suppliers are
larger and have greater financial, operational, personnel, sales, technical and
marketing resources than our company. These and other companies may develop
products that are superior to ours, which could result in lower revenues and
operating results.
Accidents at one of our facilities could delay production and adversely affect
our operations.
Our business involves complex manufacturing processes and hazardous materials
that can be dangerous to our employees. Although we employ safety procedures in
the design and operation of our facilities, there is a risk that an accident or
death could occur in one of our facilities. Any accident, such as a chemical
spill, could result in significant manufacturing delays or claims for damages
resulting from injuries, which would harm our operations and financial
condition. The potential liability resulting from any such accident or death, to
the extent not covered by insurance, could cause our business to suffer. Any
disruption of operations at any of our facilities could harm our business.
We intend to expand into new markets and our proposed expansion plans may not be
successful, which could harm our operating results.
We intend to expand into new markets through the development of new product
applications based on our existing component technologies. These efforts have
required and will continue to require us to make substantial investments,
including significant research, development and engineering expenditures and
capital expenditures for new, expanded or improved manufacturing facilities. We
may not be able to successfully manage expansion into new markets and products
and these efforts may harm our operating results. Specific risks in connection
with expanding into new markets include the inability to transfer our quality
standards into new products, the failure of customers in new markets to accept
our products, and competition.
Our failure to obtain licenses from third parties for new technologies or the
loss of these licenses could impair our ability to design and manufacture new
products and reduce our revenues.
We occasionally license technologies from third parties rather than depending
exclusively on our own proprietary technology and developments. For example, we
license a capacitor patent from another company. Our ability to license new
technologies from third parties is and will continue to be critical to our
ability to offer new and improved products. We may not be able to continue to
identify new technologies developed by others and even if we are able to
identify new technologies, we may not be able to negotiate licenses on favorable
terms, or at all.
24
Additionally, we could lose rights granted under licenses for reasons beyond our
control. For example, the licensor could lose patent protection for a number of
reasons, including invalidity of the licensed patent.
Our international operations and sales are subject to a variety of risks and
costs that could adversely affect our profitability and operating results.
Our sales to countries outside the U.S., which accounted for 52% of net sales
for the year ended December 28, 2007, our Tijuana, Mexico operations and our
Suzhou, China facility are subject to certain foreign country risks. In 2008, we
acquired European subsidiaries and manufacturing facilities. Our international
operations are, and will continue to be, subject to a number of risks and
potential costs, including:
o changes in foreign medical reimbursement programs and policies;
o changes in foreign regulatory requirements;
o local product preferences and product requirements;
o longer-term receivables than are typical in the U.S.;
o difficulties in enforcing agreements through certain foreign legal
systems;
o less protection of intellectual property in some countries outside of
the U.S.;
o trade protection measures and import and export licensing
requirements;
o work force instability;
o political and economic instability; and
o complex tax and cash management issues.
Our sales to countries outside of the U.S. are primarily to customers whose
corporate offices are located and headquartered in the U.S. All supply contracts
to customers outside the U.S. are denominated in U.S. dollars. We incur certain
expenses related to our Tijuana and Suzhou operations that are denominated in a
foreign currency. Historically, foreign currency fluctuations have not had a
material effect on our consolidated financial statements. However, fluctuations
in foreign currency exchange rates could have a significant negative impact on
our profitability and operating results if the volume of transactions
denominated in foreign currencies increases.
Risks Related To Our Industries
The healthcare industry is subject to various political, economic and regulatory
changes that could force us to modify how we develop and price our products.
The healthcare industry is highly regulated and is influenced by changing
political, economic and regulatory factors. Several of our product lines are
subject to international, federal, state and local health and safety, packaging
and product content regulations. In addition, IMDs produced by our medical
customers are subject to regulation by the U.S. Food and Drug Administration and
similar governmental agencies. These regulations govern a wide variety of
product activities from design and development to labeling, manufacturing,
promotion, sales and distribution. Compliance with these regulations may be time
consuming, burdensome and expensive and could negatively affect our customers'
abilities to sell their products, which in turn would adversely affect our
ability to sell our products. This may result in higher than anticipated costs
or lower than anticipated revenues.
25
These regulations are also complex, change frequently and have tended to become
more stringent over time. Federal and state legislatures have periodically
considered programs to reform or amend the U.S. healthcare system at both the
federal and state levels. In addition, these regulations may contain proposals
to increase governmental involvement in healthcare, lower reimbursement rates or
otherwise change the environment in which healthcare industry participants
operate. We may be required to incur significant expenses to comply with these
regulations or remedy past violations of these regulations. Any failure by our
company to comply with applicable government regulations could also result in
cessation of portions or all of our operations, impositions of fines and
restrictions on our ability to carry on or expand our operations. In addition,
because many of our products are sold into regulated industries, we must comply
with additional regulations in marketing our products.
Our business is subject to environmental regulations that could be costly to
comply with.
Federal, state and local regulations impose various environmental controls on
the manufacturing, transportation, storage, use and disposal of batteries and
hazardous chemicals and other materials used in, and hazardous waste produced
by, the manufacturing of power sources and components. Conditions relating to
our historical operations may require expenditures for clean-up in the future
and changes in environmental laws and regulations may impose costly compliance
requirements on us or otherwise subject us to future liabilities. Additional or
modified regulations relating to the manufacture, transportation, storage, use
and disposal of materials used to manufacture our batteries and components or
restricting disposal of batteries may be imposed. In addition, we cannot predict
the effect that additional or modified regulations may have on us or our
customers.
Consolidation in the healthcare industry could result in greater competition and
reduce our IMC revenues and harm our business.
Many healthcare industry companies are consolidating to create new companies
with greater market power. As the healthcare industry consolidates, competition
to provide products and services to industry participants will become more
intense. These industry participants may try to use their market power to
negotiate price concessions or reductions for our products. If we are forced to
reduce our prices because of consolidation in the healthcare industry, our
revenues would decrease and our operating results would suffer.
Our IMC business is indirectly subject to healthcare industry cost containment
measures that could result in reduced sales of our products.
Several of our customers rely on third party payors, such as government programs
and private health insurance plans, to reimburse some or all of the cost of the
procedures in which our products are used. The continuing efforts of government,
insurance companies and other payors of healthcare costs to contain or reduce
those costs could lead to patients being unable to obtain approval for payment
from these third party payors. If that occurred, sales of IMDs may decline
significantly, and our customers may reduce or eliminate purchases of our
products. The cost containment measures that healthcare payors are instituting,
both in the U.S. and internationally, could reduce our revenues and harm our
operating results.
26
Our ECP revenues are dependent on conditions in the oil and natural gas
industry, which historically have been volatile.
Sales of our commercial products depend to a great extent upon the condition of
the oil and gas industry and, specifically, the exploration and production
expenditures of oil and gas companies, which comprise approximately 10% of our
total company sales. In the past, oil and natural gas prices have been volatile
and the oil and gas exploration and production industry has been cyclical, and
it is likely that oil and natural gas prices will continue to fluctuate in the
future. The current and anticipated prices of oil and natural gas influence the
oil and gas exploration and production business and are affected by a variety of
political and economic factors beyond our control, including worldwide demand
for oil and natural gas, worldwide and domestic supplies of oil and natural gas,
the ability of the Organization of Petroleum Exporting Countries ("OPEC") to set
and maintain production levels and pricing, the level of production of non-OPEC
countries, the price and availability of alternative fuels, political stability
in oil producing regions and the policies of the various governments regarding
exploration and development of their oil and natural gas reserves. An adverse
change in the oil and gas exploration and production industry or a reduction in
the exploration and production expenditures of oil and gas companies could cause
our revenues from ECP product sales to decline.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
ITEM 2. PROPERTIES
Our executive offices are located in Clarence, New York. The following table
sets forth information about all of our significant facilities as of December
28, 2007:
Location Sq. Ft. Own/Lease Principal Use
-------- ------- --------- -------------
Alden, NY............... 125,000 Own Medical battery and capacitor manufacturing
Clarence, NY............ 82,800 Own Research, development and engineering ("RD&E")
Clarence, NY............ 20,800 Own Machining and assembly of components
Clarence, NY............ 18,600 Lease Machining and assembly of components
Clarence, NY............ 45,300 Lease Executive offices
Canton, MA.............. 32,000 Own Commercial battery manufacturing and RD&E
Columbia, MD............ 30,000 Lease Feedthrough and electrode manufacturing
Minneapolis, MN......... 72,000 Own Enclosure manufacturing and engineering
Plymouth, MN............ 95,700 Lease Introducers, catheters and leads manufacturing and engineering (formerly Enpath)
Blaine, MN.............. 32,400 Own Medical device manufacturing and engineering (formerly Quan Emerteq)
Teterboro, NJ........... 23,500 Lease Office, warehousing and manufacturing (formerly EAC)
Tijuana, Mexico......... 144,000 Lease Value-added assembly and EMI filtering manufacturing
Suzhou, China........... 27,100 Lease Office, warehousing and manufacturing (formerly EAC)
27
We believe these facilities are suitable and adequate for our current business.
In February 2007, we announced that we will close our manufacturing facility in
Canton, MA and construct a new 80,000 square foot replacement facility in
Raynham, MA. The expected completion of this $28 million expansion project is
in the fourth quarter of 2008. Additionally, in 2007 we began construction
on the expansion of our research and development location in Clarence, NY. This
additional 35,000 square feet of space will serve as our new corporate
headquarters when finished in mid-2008.
ITEM 3. LEGAL PROCEEDINGS
We are involved in various legal actions arising in the normal course of
business. While we do not believe that the ultimate resolution of any such
pending activities will have a material adverse effect on our 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 the
Company had used proprietary information of the customer to develop certain
products. The Company believes that it has meritorious defenses and is
vigorously defending the matter. The potential risk of loss is between $0.0 and
$1.7 million.
In connection with our acquisition of 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 US 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 is vigorously
pursuing its defense. Revenues from products sold that include the FlowGuard
valved introducer were approximately $3.0 million, $2.0 million and $1.5 million
for 2007, 2006 and 2005, respectively. 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.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of the Company's security holders during the
fourth quarter of 2007.
28
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
ISSUER PURCHASES OF EQUITY SECURITIES.
The Company's common stock trades on the New York Stock Exchange ("NYSE") under
the symbol "GB." The following table sets forth for the periods indicated the
high, low and closing sales prices per share for the common stock as reported by
the NYSE:
2006 High Low Close
---- ---- ----- -----
First Quarter $28.02 $20.49 $21.91
Second Quarter 24.92 19.10 23.60
Third Quarter 25.24 20.36 22.62
Fourth Quarter 27.78 21.40 26.92
2007
----
First Quarter $30.05 $25.04 $25.50
Second Quarter 33.17 25.31 32.40
Third Quarter 34.96 26.00 26.59
Fourth Quarter 27.50 18.52 19.91
As of February 26, 2008 there were 245 record holders of the Company's common
stock. The Company stock account included in our 401(k) plan is considered one
record holder for the purposes of this calculation. There are approximately
1,300 holders of Company stock in the 401(k) including active and former
employees.
We have not paid cash dividends and currently intend to retain any earnings to
further develop and grow our business. During the fourth quarter of 2007, the
Company repurchased 7,041 shares from employees of the Company at an average
cost of $19.91 per share to satisfy minimum tax withholding requirements on
vested restricted stock awards as allowed under the Company's 2002 and 2005
stock incentive plans. The price of these repurchases was based upon the closing
market price of the Company's stock on the date of vesting.
29
EQUITY COMPENSATION PLAN INFORMATION
The following table provides information regarding the Company's equity
compensation plans as of December 28, 2007:
Number of securities to be Weighted-average exervise Number of securities
issued upon exercise of price of outstanding remaining available for
outstanding options, options, warrants and future issuance under
warrants and rights or upon rights; Weighted-average equity compensation plans
vesting of shares granted share price of restricted (excluding securities
Plan Category under restricted stock plan stock shares granted reflected in column (a))
------------- --------------------------- -------------------------- -------------------------
(a) (b) (c)
Equity compensation plans
approved by security holders (1) 1,744,022 $ 25.04 1,317,904
Equity compensation plan
approved by security holders (2) 282,134 $ 24.96 575,767
Equity compensation plans not
approved by security holders - - -
--------------------------- --------------------------
Total 2,026,156 $ 25.03 1,317,904
--------------------------- --------------------------
(1) Consists of stock options issued under the 1997 Stock Option Plan, 1998
Stock Option Plan, Non-Employee Director Stock Incentive Plan and the
2005 Stock Incentive Plan. Future shares will only be issued from the
2005 Stock Incentive Plan.
(2) Consists of shares of restricted stock granted pursuant to the 2002
Restricted Stock Plan and 2005 Stock Incentive Plan. Future shares will
only be issued from the 2005 Stock Incentive Plan and is included in the
1,317,904 remaining shares available under that plan.
PERFORMANCE GRAPH
The following graph compares for the five year period ended December 28, 2007,
the cumulative total stockholder return for Greatbatch, Inc., the S&P SmallCap
600 Index, and the Hemscott Peer Group Index. The Hemscott Peer Group Index
includes approximately 200 comparable companies included in the Hemscott
Industry Group 520 Medical Instruments & Supplies and 521 Medical Appliances &
Equipment. The graph assumes that $100 was invested on January 3, 2003 and
assumes reinvestment of dividends. The stock price performance shown on the
following graph is not necessarily indicative of future price performance:
(Please see attached pdf for corresponding graph)
1/03/03 1/02/04 12/31/04 12/30/05 12/29/06 12/28/07
GREATBATCH, INC. 100.00 149.30 78.12 90.63 93.80 69.37
HEMSCOTT PEER GROUP INDEX 100.00 133.47 153.72 165.24 165.43 185.30
S&P SMALLCAP 600 INDEX 100.00 138.79 170.22 183.30 211.01 210.38
30
ITEM 6. SELECTED FINANCIAL DATA
The following table provides selected financial data of our Company for the
periods indicated. You should read this data along with Item 7, "Management's
Discussion and Analysis of Financial Condition and Results of Operations," and
Item 8, "Financial Statements and Supplementary Data" appearing elsewhere in
this report. The consolidated statement of operations data and the consolidated
balance sheet data for the fiscal years indicated have been derived from our
consolidated financial statements and related notes.
Dec. 28, Dec. 29, Dec. 30, Dec. 31, Jan. 2,
Years ended 2007 (5) 2006 2005 2004 (1) 2004
------------------------------------------------------------------------------------------------------------------
(in thousands, except per share data)
Consolidated Statement of Operations Data:
------------------------------------------
Sales $318,746 $271,142 $241,097 $200,119 $ 216,365
Income before income taxes $ 28,688 (3) $ 23,534 (3)(4) $ 15,464 (3) $ 23,732 $ 33,316
Income per share
Basic $ 0.68 $ 0.74 $ 0.47 $ 0.67 $ 1.10
Diluted $ 0.67 $ 0.73 $ 0.46 $ 0.66 $ 1.05 (2)
--------------------------------------- -------- -------- -------- ---------
Consolidated Balance Sheet Data:
--------------------------------
Working capital $116,816 $199,051 $151,958 $132,360 $ 170,455
Total assets $663,851 $547,827 $512,911 $476,166 $ 438,243
Long-term obligations $276,772 $205,859 $200,261 $193,948 $ 178,994
(1) In March 2004, we acquired the capital stock of NanoGram. These amounts
include the results of operations of NanoGram subsequent to its
acquisition.
(2) We adopted Emerging Issues Task Force ("EITF") Issue 04-08, The Effect
of Contingently Convertible Instruments on Diluted Earnings Per Share,
in the fourth quarter of 2004. Under EITF 04-08, we must include the
effect of the conversion of our convertible subordinated notes in the
calculation of diluted earnings per share using the if-converted method
as long as the effect is dilutive. The impact of adopting EITF 04-08 was
a $0.03 reduction in diluted earnings per share for 2003 from $1.08 to
$1.05. Diluted earnings per share for 2003 are restated to reflect the
adoption of EITF 04-08.
(3) During 2007, 2006 and 2005, we recorded charges in other operating
expenses related to our ongoing cost savings and consolidation efforts.
Additional information is set forth at Note 11 - "Other Operating
Expenses" of the Notes to the Consolidated Financial Statements
contained in Item 8 of this report.
(4) Beginning in fiscal year 2006, we adopted Financial Accounting Standards
Board, Statement of Financial Accounting Standards No. 123 (revised
2004), Share-Based Payment ("SFAS No. 123(R)"), and related Securities
and Exchange Commission rules included in Staff Accounting Bulletin No.
107. Under SFAS No. 123(R) we are now required to record compensation
costs related to all stock-based awards. Compensation costs related to
share-based payments for 2007 totaled $5.7 million, $3.8 million net of
tax, or $0.17 per diluted share and for 2006 totaled $6.4 million, $4.4
million net of tax, or $0.17 per diluted share. The incremental cost of
expensing stock options under SFAS No. 123(R) for 2007 was $3.5 million,
$2.4 million net of tax or $0.11 per diluted share and for 2006 was $4.5
million, $3.1 million net of tax or $0.12 per diluted share.
(5) During 2007, we acquired BIOMEC, Inc., Enpath Medical, Inc.,
IntelliSensing, LLC, Quan Emerteq, LLC, and Engineered Assemblies
Corporation. These amounts include the results of operation of these
companies subsequent to their acquisitions.
31
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
YOU SHOULD READ THE FOLLOWING DISCUSSION AND ANALYSIS OF OUR FINANCIAL CONDITION
AND RESULTS OF OPERATIONS IN CONJUNCTION WITH OUR FINANCIAL STATEMENTS AND
RELATED NOTES INCLUDED ELSEWHERE IN THIS REPORT.
INDEX
Our Business
------------
o Our business
o Our acquisitions
o Our customers
o Financial overview
o CEO message
Cost Savings and Consolidation Efforts
--------------------------------------
o Alden facility consolidation
o Carson City facility shutdown and Tijuana facility consolidation No. 1
o Columbia facility and ARL shutdown, Tijuana facility consolidation
No. 2 and RD&E consolidation
o Electrochem Commercial Power expansion
o Severance
Our Critical Accounting Estimates
---------------------------------
o Valuation of goodwill, other identifiable intangible assets and IPR&D
o Stock-based compensation
o Inventories
o Long-lived assets
o Provision for income taxes
Our Financial Results
---------------------
o Results of operations table
o Fiscal 2007 compared with fiscal 2006
o Fiscal 2006 compared with fiscal 2005
o Liquidity and capital resources
o Off-balance sheet arrangements
o Litigation
o Contractual obligations
o Inflation
o Impact of recently issued accounting standards
32
Our Business
------------
We operate our business in two reportable segments - Implantable Medical
Components ("IMC") and Electrochem Commercial Power ("ECP"). The IMC segment
designs and manufactures batteries, capacitors, filtered feedthroughs,
engineered components and enclosures used in Implantable Medical Devices
("IMD"). Additionally, the IMC business offers value-added assembly and design
engineering services for products that incorporate IMD components. As a result
of our acquisitions in 2007, the IMC business now designs, develops and
manufactures introducers, catheters, implantable stimulation leads and
microcomponents for the vascular, cardiac rhythm management and neurostimulation
markets.
The ECP segment designs and manufactures high performance batteries and battery
packs for use in oil and gas exploration, pipeline inspection, telematics,
oceanography equipment, seismic, communication, military and aerospace
applications. As a result of our acquisitions, the ECP business can now design
and provide our customers rechargeable battery and wireless sensor systems.
Our Acquisitions
----------------
On April 3, 2007, we acquired substantially all of the assets of BIOMEC, Inc.
("BIOMEC"). BIOMEC was a biomedical device company based in Cleveland, OH. The
results of BIOMEC's operations were included in our IMC business from the date
of acquisition. The purchase price and other direct costs of BIOMEC totaled
$11.4 million, which we paid in cash. Total assets acquired from BIOMEC were
$12.0 million, of which $7.4 million were intangible assets, including $2.3
million of in-process research and development ("IPR&D"), which we immediately
expensed, and $5.2 million of goodwill.
On June 15, 2007, we completed our acquisition of Enpath Medical, Inc.
("Enpath"). Enpath designs, develops, manufactures and markets single use
medical device products for the cardiac rhythm management, neuromodulation and
interventional radiology markets. The results of Enpath's operations were
included in our IMC business from the date of acquisition. The purchase price
and other direct costs of Enpath totaled $98.4 million, which we paid in cash.
Total assets acquired from Enpath were $113.8 million, of which $91.3 million
were intangible assets, including $13.8 million of IPR&D which we immediately
expensed, and $48.9 million of goodwill.
On October 26, 2007 we acquired substantially all of the assets of
IntelliSensing, LLC ("IntelliSensing"). IntelliSensing designs and manufactures
wireless sensor solutions that measure temperature, pressure, flow and other
critical data. The results of IntelliSensing's operations were included in our
ECP business from the date of acquisition. The purchase price and other direct
costs of IntelliSensing totaled $3.9 million, which we paid in cash. Total
assets acquired from IntelliSensing were $4.0 million, of which $3.8 million
were intangible assets, including $1.8 million of goodwill.
On November 16, 2007, we acquired substantially all of the assets of Quan
Emerteq, LLC ("Quan Emerteq"). Quan Emerteq designs, develops and manufactures
single use medical device products for the vascular, cardiac rhythm management
("CRM") and neurostimulation markets. The results of Quan's operations were
included in our IMC business from the date of acquisition. The purchase price
and other direct costs of Quan Emerteq totaled $60.1 million, which we primarily
paid in cash. Total assets acquired from Quan Emerteq were $62.8 million, of
which $52.4 million were intangible assets, including $32.2 million of goodwill.
33
On November 16, 2007, we acquired substantially all of the assets of Engineered
Assemblies Corporation ("EAC"). EAC is a leading provider of custom battery
solutions and electronics integration focused on rechargeable battery systems.
The results of EAC's operations were included in our ECP business from the date
of acquisition. The purchase price and other direct costs of EAC totaled $15.1
million, which we paid in cash. Total assets acquired from EAC were $16.7
million, of which $7.7 million were intangible assets, including $5.4 million of
goodwill.
On January 4, 2008, we acquired P Medical Holding SA ("Precimed") located in
Orvin, Switzerland and Exton, PA, with manufacturing operations throughout
Switzerland and Indiana and sales offices in Japan, Asia and the United Kingdom.
Precimed is a leading technology-driven supplier to the orthopedic industry.
On February 11, 2008, Precimed completed its previously announced acquisition of
DePuy Orthopaedic's ("DePuy") Chaumont, France manufacturing facility. The
Chaumont Facility produces hip and shoulder implants for DePuy Ireland who
distributes them worldwide through various DePuy selling entities. This
transaction included a new four year supply agreement with DePuy.
We acquired Precimed and the DePuy facility for approximately $130 million in
cash, and a contingent payment based upon Precimed's 2008 earnings performance.
These acquisitions were funded with cash on hand and availability under our
revolving credit agreement (approximately $117 million). The results from the
Precimed and DePuy acquisitions will be included in our 2008 results from the
date of acquisition.
Going forward, we expect the pace of acquisitions to be less than the 2007
level. However, we will continue to pursue strategically targeted and
opportunistic acquisitions.
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. The nature and extent of our selling relationships with each customer
are different in terms of breadth of products purchased, purchased product
volumes, length of contractual commitment, ordering patterns, inventory
management and selling prices.
Our IMC customers include leading IMD manufacturers, in alphabetical order here
and throughout this report, such as Biotronik, Boston Scientific, Medtronic, the
Sorin Group and St. Jude Medical. In 2007, Boston Scientific, Medtronic and St.
Jude Medical collectively accounted for 67% of our total sales, compared to 67%
in 2006 and 70% 2005. During 2007 and in the first quarter of 2008, we completed
seven acquisitions, consistent with our strategic objective to diversify our
customer base and market concentration. We anticipate in 2008 that we will
reduce our concentration in the CRM market to approximately 50% of our total
sales.
We entered into an agreement with Boston Scientific in June 2007 pursuant to
which Boston Scientific will purchase a minimum percentage of batteries, wet
tantalum capacitors and formed metal components at prices specified in the
agreement. The period of the agreement is July 1, 2007 through December 31,
2010. Our previous agreement with Boston Scientific pursuant to which Boston
Scientific purchased filtered feedthroughs scheduled to expire December 31, 2007
was extended through March 31, 2008. We are negotiating a follow-on agreement
with targeted completion during the first quarter of 2008. Purchases and
shipments of filtered feedthroughs continue during contract negotiations.
34
We have a supply agreement with St. Jude Medical pursuant to which St. Jude
Medical purchases batteries, filtered feedthroughs, molded components and
enclosures under specified price and volume terms. A contract amendment signed
in 2007 extended the contract term to December 31, 2013.
We have a supply agreement with Medtronic pursuant to which Medtronic will
purchase implantable device shield sub-assemblies and other products under
specified price and volume terms. The contract term is seven years, commencing
August 2, 2004 and ending August 2, 2011.
Our ECP customers are primarily companies involved in oil and gas exploration,
pipeline inspection, telematics, oceanographic equipment, seismic,
communication, military and aerospace applications. We have entered into
long-term supply agreements with some of those customers. Some of these
customers include, General Electric, Halliburton Company, PathFinder Energy
Services and Weatherford International.
Financial Overview
------------------
2007 was an extraordinary year in many respects and difficult in others. Despite
a sluggish CRM market, we achieved record sales of $318.7 million for the year,
an increase of 18% over last year. Excluding the $26.4 million of revenue that
was contributed by our 2007 acquisitions, we achieved an 8% growth rate year
over year.
Our earnings per share for 2007 totaled $0.67, which included $0.69 per share
for IPR&D charges, $0.07 per share for other non-recurring acquisition related
charges and $0.16 per share related to our cost savings and consolidation
initiatives. 2007 results benefited from a $0.13 per share gain related to the
exchange of a portion of our long-term debt during the year and a $0.12 per
share gain from the sale of an investment security. Earnings per share for 2006
amounted to $0.73 and included $0.43 per share related to our cost savings and
consolidation initiatives.
We completed five acquisitions in 2007 and two in the first two months of 2008.
These acquisitions were enabled by our strong cash position and financing
activities in the first half of 2007. We conducted an exchange offering for
approximately $120 million of our old convertible notes, which extended the
effective maturity from 2010 to 2013. At the same time, we issued an additional
$80 million in new convertible notes. Additionally, in May 2007 we entered into
a new credit facility which included a $235 million revolving line of credit,
which can be increased to $335 million upon our request.
As of year-end our cash and short-term investments totaled $40.5 million,
compared to $142.6 million at the end of 2006. During 2007, we spent
approximately $190 million on the five acquisitions mentioned above. Our cash on
hand and our availability under our line of credit are sufficient to meet our
operating and investment activities for the foreseeable future, including our
investment of approximately $130 million on the orthopedics' acquisitions
completed in the beginning of 2008.
CEO Message
-----------
Over the past year, we have focused our strategic initiatives on creating a
platform that can support additional growth. We remain steadfast in our mission
of being a leader in the comprehensive design and manufacturing of technology
based custom products for the commercial and implantable medical markets. We are
poised to continue growing through innovation and strategic acquisitions that
broaden our technology and market base.
35
In 2006, we operated primarily in the CRM and commercial power markets. As we
moved into 2007, our focus shifted to the diversification and globalization of
Greatbatch. Early in the year, we put in place over $400 million of available
financing to facilitate this growth. This facilitated our acquisition of five
companies in 2007 and two in early 2008, each complementing our existing
business model and adding to our capabilities. These investments helped move us
into new vertical markets while expanding our presence geographically.
To enhance our technological prowess and complement our growing medical
operations, we purchased BIOMEC in April 2007. With specialties in infection and
clotting control, BIOMEC provides us with enhanced design service capability and
extends our customer reach from device concept through commercial manufacturing.
With BIOMEC, we obtained a minority ownership in Intellect Medical, which has
provided us with the important clinical relationships that improve our presence
in the neurostimulation market.
In June 2007, we acquired Enpath. Enpath enhances our current IMC business by
providing a platform to enter into the vascular market and broaden our
neurostimulation markets. It also allows us to expand our current product
offerings to existing customers and leverage a proprietary product portfolio.
With Quan Emerteq, we added substantial critical mass to the vascular product
offerings acquired from Enpath. In addition, approximately 50% of Quan Emerteq's
sales come from CRM and neurostimulation products, which further strengthen our
position with current customers in these markets. Quan Emerteq also helps us
enter the growing peripheral, coronary and neurovascular markets. Together, Quan
Emerteq's and Enpath's capabilities create the basis for our Therapy Delivery
product line. With the inception of our Therapy Delivery business we are now
developing new products such as leadwires for the CRM and neurostimulation
markets, and introducers, catheters and delivery systems for the vascular
market.
We also entered the orthopedics market in early 2008 by acquiring Precimed and
the follow-on acquisition of DePuy's Chaumont, France manufacturing facility.
These acquisitions provided us with a major European manufacturing presence and
multiple product offerings including trays, instruments and implants.
Electrochem, our commercial subsidiary, showed significant growth in 2006. To
build on that momentum, we expanded Electrochem's capabilities to include
battery-powered wireless sensing solutions, with the acquisition of
IntelliSensing. This acquisition works well with our current oil and gas product
offering and enables us to better serve our customers through a more
comprehensive solution. In addition, we plan to leverage our wireless sensor
capabilities into the medical market in the near future.
EAC was added to complement our commercial division as well. EAC designs and
manufactures rechargeable battery pack solutions for customers in the external
medical, communication, automatic data collection, and environmental and safety
markets. EAC allows us to increase product offerings to our existing commercial
customers and allows for expansion into the growing external medical market. It
also increases our primary cell capabilities to include rechargeable batteries
and design solutions.
While diversifying our markets, we simultaneously expanded geographically.
Through our acquisitions, we added eleven new locations throughout the world.
Our newly developed presence in six U.S. cities, Switzerland, France, China,
Japan and the United Kingdom better equips us to serve existing customers while
pursuing untapped markets.
36
I consider the positive impact our growth has had on our customers to be a
significant accomplishment. With new vertical markets and expanded offerings in
CRM and commercial, we are able not only to develop new customers but also to
offer current customers a more comprehensive product portfolio.
Our measures to diversify has brought many new faces to Greatbatch over the past
year and helped to reposition the responsibilities of several long-standing
leadership team members. Our organizational restructuring has led to the
creation of a strong management team, one that will be responsible for leading
Greatbatch into 2008 and beyond. With a platform focused on integration, our
business leaders will not only work to strengthen their units, but together,
work to improve the overall strength of Greatbatch.
Cost Savings and Consolidation Efforts
--------------------------------------
During 2007, 2006 and 2005, we recorded charges in other operating expenses
related to our ongoing cost savings and consolidation efforts. Additional
information is set forth in Note 11 - "Other Operating Expenses" of the Notes to
the Consolidated Financial Statements contained in Item 8 of this report.
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 the
capacitor research, development and engineering operations from our Cheektowaga,
NY facility into our Technology Center in Clarence, NY.
The total expense for these consolidation efforts was $3.4 million, which was
below our original estimate of $3.5 million to $4.0 million. The expenses for
the Alden Facility consolidation are included in the IMC business segment.
Approximately $2.6 million of these charges were paid in cash and $0.8 million
were for assets written-off.
Carson City Facility Shutdown and Tijuana Facility Consolidation No. 1.
Beginning in the first quarter of 2005 and ending in the third quarter of 2007
we consolidated our Carson City, NV facility ("Carson City Facility") into our
Tijuana, Mexico facility ("Tijuana Facility consolidation No. 1").
The total cost for this consolidation was $7.5 million, which was above our
original estimates as we delayed the closing of this facility in order to
accommodate a customer's regulatory approval. All categories of costs are
considered to be cash expenditures, except for $0.6 million of accelerated
depreciation.
We anticipate annual cost savings in the range of $2.5 million to $3.1 million.
The expenses for our Carson City Facility shutdown and the Tijuana Facility
consolidation No. 1 are included in our 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 the Columbia Facility and at ARL were relocated
to our Technology Center in Clarence, NY. The Columbia Facility shutdown, which
was previously scheduled to be completed in the first quarter of 2008, is now
expected to be finalized in mid-2008 based on customer qualification activities.
37
The total estimated cost for this facility consolidation plan is anticipated to
be between $11.6 million and $12.1 million of which $10.6 million has been
incurred through December 28, 2007. The ARL move and closure portion of this
consolidation project is complete. We expect to incur and pay the remaining
costs of the consolidation project over the next three fiscal quarters through
September 2008. All categories of costs are considered to be cash expenditures,
except for $0.5 million of accelerated depreciation and asset write-offs. Once
the moves are completed, we anticipate 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.
Electrochem Commercial Power expansion. In February 2007, we announced that we
will close our current manufacturing facility in Canton, MA and construct a new
80,000 square foot replacement facility in Raynham, MA. The expected completion
of this $28 million expansion project is in the fourth quarter of 2008. The
total expense to be recognized for this relocation is estimated to be $2.4
million to $2.6 million, of which $0.5 million has been incurred, and primarily
related to accelerated depreciation. All categories of costs are considered to
be cash expenditures, except for $0.6 million of accelerated depreciation. Costs
related to this move are included in the ECP business segment.
Severance. During the fourth quarter of 2006, we implemented a plan for
consolidating our corporate and business unit organization structure. As a
result, severance charges of $2.49 million were recorded in the fourth quarter
of 2006. Expense of $1.42 million was recorded in our IMC segment, $0.04 million
in the ECP segment and $1.03 million was recorded in unallocated operating
expenses. Accrued severance related to this consolidation plan was $0.3 million
as of December 28, 2007 and was paid in the first quarter of 2008.
During the first quarter of 2005, we implemented a 4% workforce reduction as a
continuation of cost containment efforts initiated mid-year 2004. As a result,
severance charges of $1.5 million were recorded and paid in 2005. Expense of
$0.9 million was recorded in our IMC segment, $0.2 million in our ECP segment
and $0.4 million was recorded in unallocated operating expenses.
Our Critical Accounting Estimates
---------------------------------
The preparation of our consolidated financial statements in accordance with
generally accepted accounting principles in the United States of America
("GAAP") requires us to make estimates and assumptions that affect reported
amounts and related disclosures. The methods, estimates and judgments we use in
applying our accounting policies have a significant impact on the results we
report in our financial statements. Management considers an accounting estimate
to be critical if:
o It requires assumptions to be made that were uncertain at the time the
estimate was made; and
o Changes in the estimate or different estimates that could have been
selected could have a material impact on our consolidated results of
operations, financial position or cash flows.
Our most critical accounting estimates are described below. We also have other
policies that we consider key accounting policies, such as our policies for
revenue recognition; however, these policies do not meet the definition of
critical accounting estimates, because they do not generally require us to make
estimates or judgments that are difficult or subjective.
38
---------------------------------------------------------------------------------------------------------------------------------
Balance Sheet Caption /
Nature of Critical Assumptions / Approach Used Effect of Variations of Key Assumptions Used
Estimate Item
---------------------------------------------------------------------------------------------------------------------------------
Valuation of Goodwill, We base the fair value of identifiable The use of alternative valuation assumptions,
other identifiable intangible tangible and intangible assets including estimated cash flows and discount
assets and IPR&D (including IPR&D) on detailed valuations rates, and alternative estimated useful life
that use information and assumptions assumptions could result in different
When we acquire a provided by management. The fair values purchase price allocations. In arriving at
company, we allocate the of the assets acquired and liabilities the value of the IPR&D, we additionally
purchase price to the assets assumed are determined using one of consider among other factors: the in-process
we acquire and liabilities we three valuation approaches: market, projects stage of completion; the complexity
assume based on their fair income and cost. The selection of a of the work completed as of the acquisition
value at the date of particular method for a given asset date; the projected costs to complete; the
acquisition. depends on the reliability of available expected introduction date and the estimated
data and the nature of the asset, among useful life of the technology. Significant
We then allocate the other considerations. The market approach changes in these estimates and assumptions
purchase price in excess of values the subject asset based on could impact the value of the assets and
net tangible assets acquired available market pricing for comparable liabilities recorded which would change the
to identifiable intangible assets. The income approach values the amount and timing of future intangible asset
assets, including IPR&D. subject asset based on the present value amortization expense.
Other indefinite lived of risk adjusted cash flows projected to
intangible assets such as be generated by the asset. The projected We make certain estimates and assumptions
trademarks and tradenames cash flows for each asset considers that affect the determination of the expected
are considered non-amortizing multiple factors, including current future cash flows from our reporting units
intangible assets revenue from existing customers, for our goodwill impairment testing. These
as they are expected to attrition trends, reasonable contract estimates and assumptions include sales
generate cash flows renewal assumptions from the perspective growth, cost of capital, and other key
indefinitely. of a marketplace participant, and projections of future cash flows. Significant
expected profit margins giving changes in these estimates and assumptions
Goodwill is recorded when consideration to historical and expected could create future impairment losses to our
the purchase price paid for margins. The cost approach values the goodwill.
an acquisition exceeds the subject asset by determining the current
estimated fair value of the cost of replacing that asset with another For indefinite lived assets such as
net identified tangible and of equivalent economic utility. The cost trademarks and tradenames, we make certain
intangible assets acquired. to replace a given asset reflects the estimates of revenue streams, royalty rates
estimated reproduction or replacement and other future benefits accruing to us.
Indefinite lived intangibles cost for the asset, less an allowance for Significant changes in these estimates could
and goodwill are required to loss in value due to depreciation or create future impairments of these indefinite
be assessed for impairment obsolescence, with specific consideration lived intangible assets.
on an annual basis or more given to economic obsolescence if
frequent if certain indicators indicated. A 1% change in the amortization of our
are present. intangible assets would increase/decrease
We perform an annual review on the last current year net income by approximately
day of each fiscal year, or more $0.04 million, or approximately $0.002 per
frequently if indicators of potential diluted share. As of December 28, 2007 we
impairment exist, to determine if the have $352.4 million of intangible assets
recorded goodwill and other indefinite recorded on our balance sheet representing
lived intangible assets are impaired. We 53% of total assets. This includes
assess goodwill for impairment by $71.3 million of amortizing intangible
comparing the fair value of our assets, $32.6 million of indefinite lived
reporting units to their carrying value intangible assets and $248.5 million of
to determine if there is potential goodwill.
impairment. If the fair value of a
reporting unit is less than its carrying
value, an impairment loss is recorded to
the extent that the implied fair value of
the goodwill within the reporting unit is
less than its carrying value. Fair values
for reporting units are determined based
primarily on the income approach, however
where appropriate, the market approach or
appraised values are also used.
Identifiable intangible assets such as
purchased technology, patents and
customer lists are reviewed at least
annually to determine if any adverse
conditions exist or a change in
circumstances has occurred that would
indicate impairment or a change in their
remaining useful life indefinite lived
intangible assets such as trademarks and
tradenames are evaluated for impairment
by using the income approach.
---------------------------------------------------------------------------------------------------------------------------------
39
---------------------------------------------------------------------------------------------------------------------------------
Balance Sheet Caption /
Nature of Critical Assumptions / Approach Used Effect of Variations of Key Assumptions Used
Estimate Item
---------------------------------------------------------------------------------------------------------------------------------
Stock-based compensation We utilize the Black-Scholes Options Option pricing models were developed for use
Pricing Model to determine the fair in estimating the value of traded options
Prior to fiscal year 2006, we value of stock options under that have no vesting restrictions and are
accounted for stock options SFAS No. 123(R), consistent with that fully transferable. Because our share-based
following the requirements of used for pro forma disclosures prior to payments have characteristics significantly
Accounting Principles Board Opinion 2006. We are required to make certain different from those of freely traded
No. 25, Accounting for Stock Issued assumptions with respect to selected options, and because changes in the
to Employees, and related model inputs, including expected subjective input assumptions can materially
interpretations, which did not volatility, expected life, expected affect out estimates of fair values, existing
require us to record compensation dividend yield and the risk-free valuation models may not provide reliable
expense for fixed stock options if interest rate. Expected volatility is measures of the fair values of our
the exercise price of the option based on the historical volatility of shared-based compensation. Consequently,
equaled or exceeded the fair market our stock over the most recent period there is a risk that our estimates of the
value of our stock at the grant commensurate with the estimated fair values of our shared-based compensation
date. For restricted stock awards, expected life of the stock options. The awards may bear little resemblance to the
the fair market value of the award expected life of options granted, actual values realized upon the exercise,
was recorded to compensation which represents the period of time expiration or forfeiture of those
expense on a straight-line that the options are expected to be shared-based payments in the future. Stock
basis over the vesting period. outstanding, is based, primarily, on options may expire worthless or otherwise
historical data. The expected dividend result in zero intrinsic value as compared to
Beginning in fiscal year 2006, we yield is based on our history and the fair values originally estimated on the
adopted Financial Accounting expectation dividend payouts. The grant date and reported in our consolidated
Standards Board ("FASB") Statement risk-free interest rate is based on the financial statements. Alternatively, value
of Financial Accounting Standards U.S. Treasury yield curve in effect at may be realized from these instruments that
("SFAS") No. 123 (revised 2004), the time of grant for a period is significantly in excess of the fair values
Share-Based Payment commensurate with the estimated originally estimated on the grant date and
("SFAS No. 123(R)"), and related expected life. reported in our consolidated financial
Securities and Exchange Commission statements. There are siginificant
rules included in Staff Accounting For restricted stock awards, the fair differences among valuation models. This may
Bulletin No. 107. Under market value of the award is determined result in a lack of comparability with other
SFAS No. 123(R) we are now required based upon the closing value of our companies that use different models, methods
to record compensation costs stock price on the grant date. and assumptions. There is also a possibility
related to all stock-based awards. that we will adopt a different valuation
Compensation cost for performance-based model in the future. This may result in a
Compensation cost for service-based stock options and restricted stock lack of consistency in future periods and may
stock options and restricted stock units is reassessed each period and materially affect the fair value estimate of
awards is recognized ratably over recognized based upon the probability share-based payments.
the applicable vesting period. that the performance targets will be
Compensation cost for achieved. That assessment is based upon There is a high degree of subjectivity
performance-based stock options and our actual and expected future involved in selecting assumptions to be
restricted stock units is performance as well as that of the utilized to determine fair value and
reassessed each period and individuals who have been granted forfeiture assumptions. If factors change and
recognized based upon the performance-based awards. Stock-based result in different assumptions in the
probability that the performance compensation expense is only recorded application of SFAS No.123(R) in future
targets will be achieved. for those awards that are expected to periods, the expense that we record for
vest. Forfeiture estimates for future grants may differ significantly from
determining appropriate stock-based what we have recorded in the current period.
compensation expense are estimated at Additionally, changes in performance of the
the time of grant based on historical Company or individuals who have been granted
experience and demographic performance-based awards that affect the
characteristics. Revisions are made to likelihood that performance based targets are
those estimates in subsequent periods achieved could materially impact the amount
if actual forfeitures differ from of stock-based compensation expense
estimated forfeitures. recognized.
A 1% change in our stock based compensation
expense would increase/decrease current year
net income by approximately $0.04 million,
or approximately $0.002 per diluted share.
---------------------------------------------------------------------------------------------------------------------------------
40
---------------------------------------------------------------------------------------------------------------------------------
Balance Sheet Caption /
Nature of Critical Assumptions / Approach Used Effect of Variations of Key Assumptions Used
Estimate Item
---------------------------------------------------------------------------------------------------------------------------------
Inventories Inventory standard costing requires Variations in methods or assumptions could
complex calculations that include have a material impact on our results. If our
Inventories are stated at the lower assumptions for overhead absorption, demand forecast for specific products is
of cost, determined using the scrap, sample calculations, greater than actual demand and we fail to
first-in, first-out method, or manufacturing yield estimates and the reduce manufacturing output accordingly, we
market. determination of which costs are could be required to record additional
capitalizable. The valuation of inventory reserves, which would have a
inventory requires us to estimate negative impact on our net income.
obsolete or excess inventory as well
as inventory that is not of saleable A 1% change in our cost of sales, excluding
quality. amortization of intangible assets, would
increase/decrease current year net income by
approximately $1.3 million, or approximately
$0.06 per diluted share. As of December 28,
2007 we have $71.9 million of inventory
recorded on our balance sheet representing
11% of total assets.
---------------------------------------------------------------------------------------------------------------------------------
Long-lived assets We assess the impairment of long-lived Estimation of the useful lives of assets
assets when events or changes in that are long-lived requires significant
Property, plant and equipment, circumstances indicate that the management judgment. Events could occur,
definite-lived intangible assets, carrying value of the assets may not be including changes in cash flow that would
and other long-lived assets are recoverable. Factors that we consider materially affect our estimates and
carried at cost. This cost is in deciding when to perform an assumptions related to depreciation and
charged to depreciation or impairment review include significant amortization. Unforeseen changes in
amortization expense over the under-performance of a business or operations or technology could substantially
estimated life of the operating product line in relation to alter the assumptions regarding the ability
assets primarily using expectations, significant negative to realize the return of our investment
straight-line rates. Long-lived industry or economic trends, and in long-lived assets and therefore the amount
assets acquired through acquisition significant changes or planned changes of depreciation expense to charge against
are subject to the estimation in our use of the assets. both current and future sales. Also, as we
risks related to the initial Recoverability potential is measured by make manufacturing process conversions and
purchase price allocation and the comparing the carrying amount of the other factory planning decisions, we must
on-going impairment assessment. asset group to the related total future make subjective judgments regarding the
Long-lived assets acquired in the undiscounted cash flows. If an asset remaining useful lives of our assets,
ordinary course of business are group's carrying value is not primarily manufacturing equipment and
also subject to impairment recoverable through related cash flows, building improvements. Significant changes in
assessment. the asset group is considered to be these estimates and assumptions could change
impaired. Impairment is measured by the amount of future depreciation and
comparing the asset group's carrying amortization expense or could create future
amount to its fair value, based on the impairments of these long-lived assets.
best information available, including
market prices or discounted cash flow A 1% change in our long-lived asset
analyses. When it is determined that depreciation/amortization expense would
useful lives of assets are shorter than increase/decrease current year net income by
originally estimated, and there are approximately $0.14 million, or approximately
sufficient cash flows to support the $0.01 per diluted share. As of December 28,
carrying value of the asset group, we 2007 we have $201.5 million of long-lived
accelerate the rate of depreciation in assets recorded on our balance sheet
order to fully depreciate the assets representing 30% of total assets.
over their new shorter useful lives.
---------------------------------------------------------------------------------------------------------------------------------
41
---------------------------------------------------------------------------------------------------------------------------------
Balance Sheet Caption /
Nature of Critical Assumptions / Approach Used Effect of Variations of Key Assumptions Used
Estimate Item
---------------------------------------------------------------------------------------------------------------------------------
Provision for income taxes In relation to recording the provision Changes could occur that would materially
for income taxes, management must affect our estimates and assumptions
In accordance with the liability estimate the future tax rates regarding deferred taxes. Changes in current
method of accounting for income applicable to the reversal of tax laws and tax rates could affect the
taxes specified in SFAS No. 109, temporary differences, make certain valuation of deferred tax assets and
Accounting for Income Taxes, the assumptions regarding whether book/tax liabilities, thereby changing the income
provision for income taxes is the differences are permanent or temporary tax provision. Also, significant declines in
sum of income taxes both and if temporary, the related timing of taxable income could materially impact the
currently payable and deferred. expected reversal. Also, estimates are realizable value of deferred tax assets.
The changes in deferred tax made as to whether taxable operating At December 28, 2007, we had $16.5 million of
assets and liabilities are income in future periods will be deferred tax assets on our balance sheet and
determined based upon the changes sufficient to fully recognize any gross a valuation allowance of $4.0 million has
in differences between the bases deferred tax assets. If recovery is not been established for certain deferred tax
of assets and liabilities for likely, we must increase our provision assets as it is more likely than not that
financial reporting purposes and for taxes by recording a valuation they will not be realized.
the tax bases of assets and allowance against the deferred tax
liabilities as measured by the assets that we estimate will not A 1% increase in the effective tax rate would
enacted tax rates that management ultimately be recoverable. increase the current year provision by
estimates will be in effect when Alternatively, we may make estimates $0.3 million, reducing diluted earnings per
the differences reverse. about the potential usage of deferred share by $0.01 based on shares outstanding at
tax assets that decrease our valuation December 28, 2007.
Beginning in 2007, we allowances.
adopted FASB Interpretation
No. 48, Accounting for Uncertainty The calculation of our tax liabilities
in Income Taxes--an involves dealing with uncertainties in
interpretation of the application of complex tax
FASB Statement No. 109 regulations. Significant judgment is
("FIN No. 48"), to assess and required in evaluating our tax
record income tax uncertainties. positions and determining our provision
FIN No. 48 prescribes a for income taxes. During the ordinary
recognition threshold and course of business, there are many
measurement attribute for transactions and calculations for which
financial statement recognition the ultimate tax determination is
and measurement of a tax uncertain. We establish reserves for
position taken or expected to uncertain tax positions when we believe
be taken in a tax return and that certain tax positions do not meet
also provides guidance on the more likely than not threshold. We
various related matters such adjust these reserves in light of
as derecognition, interest changing facts and circumstances, such
and penalties, and disclosure. as the outcome of a tax audit or the
lapse of the statute of limitations.
The provision for income taxes includes
the impact of reserve provisions and
changes to the reserves that are
considered appropriate. We follow
FIN No. 48 for accounting for our
uncertain tax positions.
---------------------------------------------------------------------------------------------------------------------------------
42
Our Financial Results
---------------------
The commentary that follows should be read in conjunction with our consolidated
financial statements and related notes. We utilize a fifty-two, fifty-three week
fiscal year ending on the Friday nearest December 31st. Fiscal years 2007, 2006
and 2005 ended on December 28, December 29 and December 30, respectively.
Results of Operations Table
Yead ended 2007-2006 2006-2005
------------------------------------------ -------------------- ------------------
Dollars in thousands, Dec.28, Dec. 29, Dec.30,
except per share data 2007 2006 2005 $ Change % Change $ Change % Change
-------------------------------------------------------------------------------- -------------------- ------------------
IMC
ICD batteries $ 48,946 $ 45,140 $ 45,803 $ 3,806 8% $ (663) -1%
Pacemaker and other batteries 20,964 21,090 21,708 (126) -1% (618) -3%
ICD capacitors 26,466 16,780 20,709 9,686 58% (3,929) -19%
Feedthroughs 64,999 64,578 59,210 421 1% 5,368 9%
Introducers, catheters and leads 23,287 - - 23,287 NA - -
Enclosures 20,777 23,904 23,866 (3,127) -13% 38 -
Other 64,383 55,915 36,618 8,468 15% 19,297 53%
------------------------------------------ -------------------- ------------------
Total IMC 269,822 227,407 207,914 42,415 19% 19,493 9%
ECP 48,924 43,735 33,183 5,189 12% 10,552 32%
------------------------------------------ -------------------- ------------------
Total sales 318,746 271,142 241,097 47,604 18% 30,045 12%
Cost of sales - excluding amortizaton
of intangible assets 198,184 164,885 151,543 33,299 20% 13,342 9%
Cost of sales - amortization of
intangible assets 4,537 3,813 3,841 724 19% (28) -1%
------------------------------------------ -------------------- ------------------
Total cost of sales 202,721 168,698 155,384 34,023 20% 13,314 9%
Cost of sales as a % of sales 63.6% 62.2% 64.4% 1.4% -2.2%
Selling, general, and administrative
expenses 44,674 38,785 31,528 5,889 15% 7,257 23%
SG&A as a % of sales 14.0% 14.3% 13.1% -0.3% 1.2%
Research, development and engineering
costs, net 29,914 24,225 18,725 5,689 23% 5,500 29%
RD&E as a % of sales 9.4% 8.9% 7.8% 0.5% 1.1%
Other operating expense 21,417 17,058 18,574 4,359 26% (1,516) -8%
------------------------------------------ -------------------- ------------------
Operating income 20, 020 22,376 16,886 (2.356) -11% 5,490 33%
Operating margin 6.3% 8.3% 7.0% -2.0% 1.3%
Interest expense 7,303 4,605 4,613 2,698 59% (8) -
Interest income (7,050) (5,775) (3,113) (1,275) 22% (2,662) 86%
Gain on sale of investment security (4,001) - - (4,001) NA - -
Gain on extinguishment of debt (4,473) - - (4,473) NA - -
Other (income) expense, net (447) 12 (78) (459) NA 90 -115%
Provision for income taxes 13,638 7,408 5,357 6,230 84% 2,051 38%
Effective tax rate 47.5% 31.5% 34.6% 16.0% -3.1%
------------------------------------------ -------------------- ------------------
Net income $ 15,050 $ 16,126 $ 10,107 $ (1,076) -7% $ 6,019 60%
========================================== ==================== ==================
Net margin 4.7% 5.9% 4.2% -1.2% 1.7%
Diluted earnings per share $ 0.67 $ 0.73 $ 0.46 $ (0.06) -8% $ 0.27 59%
43
Fiscal 2007 Compared with Fiscal 2006
Sales
We achieved sales growth of 18% in 2007 compared to 2006. This growth was
achieved through acquisitions and organic growth of 8%. This growth came during
a period in which the CRM industry continued to recover from a difficult 2006.
Our acquisitions which expanded our product lines and diversified our customer
base represented a 10% increase in revenue.
IMC. The nature and extent of our selling relationship with our customers is
different in terms of 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 OEM device manufacturers changes periodically. Consequently, these and
other factors can significantly impact our sales in any given period.
We achieved year-over-year growth of 19% in our IMC business despite our
underlying markets growing at a low-single digit pace and an approximate 1% net
reduction in selling prices. Our acquisitions represented a 10% increase in IMC
revenue. ICD capacitors, ICD batteries, assembly products and coated electrodes
were the primary growth drivers. ICD capacitor sales increased due to a
non-recurring customer supply issue in the first half of the year. Growth in ICD
batteries was primarily due to increased sales of our "Q" technology battery
which was introduced near the end of 2006, partially offset by lower prices.
This growth represents increased adoption of our high rate battery technology.
We expect pricing pressure from our larger customers to continue in the future.
Consistent with our strategy to increase the integration of our component
products (including enclosures) into our assembly business, assembly revenues,
which are included in Other IMC revenue, increased by 48% in 2007.
Correspondingly, revenues from enclosures decreased by 13% over the same period.
In addition to the above, the increase in assembly sales reflected an increase
in price due to contractual agreements related to material price increases.
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 as most customers
utilize short term purchase orders as opposed to long-term contracts.
ECP sales grew by 12% in 2007 through a combination of increased market
penetration, new product introductions, greater value-added pack assembly and
acquisitions. Our acquisitions represented a 7% increase in ECP revenue. The
core growth rate slowed from the prior year partially due to the favorable
benefit of approximately $1.5 to $2.5 million in customer inventory stocking in
2006 as it consolidated operations.
44
The oil and gas exploration market remains robust due to the increased demand
for products used in pipeline inspections, pressure monitoring and measurement
while drilling applications. In addition, our presence in the rechargeable cells
market will provide incremental sales opportunities.
2008 Sales Outlook
Including the acquisitions in 2007 and early 2008, we expect our full year 2008
sales will be in the range of $490 million to $530 million. Our newly acquired
therapy delivery and orthopedic companies are forecasting 10% to 12% growth over
their previous year results, respectively. We have assumed an underlying CRM
market growth rate of 5% for next year.
Cost of Sales - Excluding Amortization of Intangible Assets
Changes from the prior year to cost of sales as a percentage of sales, excluding
the amortization of intangible assets, were primarily due to the following:
2007-2006
% Increase
----------
Price reduction (a) 0.5%
Inventory step-up (b) 0.5%
Excess capacity at Columbia Facility (c) 0.4%
----
Total percentage point change to cost of sales as a
percentage of sales 1.4%
====
a. This increase was primarily due to contractual price concessions negotiated
with our larger customers. Price reductions were negotiated in exchange for
longer term commitments, primarily in the IMC segment.
b. In connection with our acquisitions, the value of inventory on hand was
stepped-up to reflect the fair value at the time of acquisition. The
inventory step-up amortization, which is recorded as cost of sales -
excluding intangible amortization, was $1.7 million. As of December 28,
2007, $0.4 million of inventory step up is remaining to be amortized, which
does not include the value of the inventory step-up related to the
acquisitions in early 2008.
c. The Columbia Facility was operating with excess capacity during 2007 as its
production transitioned to our Tijuana, Mexico Facility. The excess
capacity cost is approximately $1.2 million. In accordance with our
inventory accounting policy, excess capacity costs are expensed.
We expect cost of sales as a percentage of sales to benefit in future years due
to our consolidation efforts and the elimination of excess capacity, partially
offset by a continuing shift in product mix towards lower margin products.
Cost of Sales - Amortization of Intangible Assets
Amortization expense for 2007 increased from 2006 due to an increase in
intangible assets acquired as part of the Enpath, Quan Emerteq and EAC
acquisitions. The increase represents a partial year of amortization related to
our 2007 acquisitions. In 2008, cost of sales - amortization of intangible
assets is expected to increase to $6.0 million, due to the full year impact of
the acquisitions in 2007 and does not include intangible assets that will be
recorded in connection with our acquisitions in early 2008.
45
SG&A Expenses
Changes from the prior year to SG&A expenses were primarily due to the following
(in millions):
2007-2006
$ Increase
----------
Headcount increases associated with acquisitions (a) $ 3.8
Amortization (b) 1.0
Increased sales and marketing workforce (c) 0.9
Increased legal expense (d) 0.5
Other (0.3)
----------
Net increase in SG&A $ 5.9
==========
a. Personnel working for the acquired companies in functional areas such as
Finance, Human Resources and Information Technology were the primary
drivers of this increase. The remaining increase was for consulting, travel
and other administrative expenses to operate these areas.
b. Relates to the amortization of customer relationships and non-compete
agreements recorded as a result of our acquisitions in 2007.
c. The increase in sales and marketing workforce was primarily a result of our
planned efforts to increase the marketing and sales of our products.
d. The increase in legal expense is primarily due to increased staffing levels
and activity related to customer contract renewals during the year.
SG&A expenses as a percentage of sales are expected to remain constant in the
near term and improve over the long-term as synergies from our acquisitions are
realized.
RD&E Expenses
Net research, development and engineering costs were as follows (in millions):
Year ended
---------------------------------
December 28, December 29,
2007 2006
------------ ------------
Research and development costs $ 16.1 $ 16.1
------------ ------------
Engineering costs 18.9 9.9
Less cost reimbursements (5.1) (1.8)
------------ ------------
Engineering costs, net 13.8 8.1
------------ ------------
Total research and development
and engineering costs, net $ 29.9 $ 24.2
============ ============
The increase in RD&E expenses for 2007 was primarily due to the planned
headcount increase in engineering personnel as we continue to invest substantial
resources in product technologies. Additionally, $4.8 million of engineering
costs were a result of the Enpath and BIOMEC acquisitions. Reimbursement on
product development projects increased compared to last year primarily due to
the timing of the achievement of milestones, as well as the Enpath and BIOMEC
acquisitions, which added $2.6 million of cost reimbursements. Reimbursements
for achieving certain development milestones are netted against gross spending.
46
RD&E expenses as a percentage of sales are expected to remain constant,
reflecting our continued development of and investment in core product
technologies. In the future, cost reimbursements generated from various
government grants will be lower as the grants acquired from BIOMEC are scheduled
to expire in 2008.
Other Operating Expenses
Acquired In-Process Research and Development - Approximately $2.3 million and
$13.8 million of the BIOMEC and Enpath purchase prices, respectively, represent
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 IPR&D written off in connection with the Enpath
acquisition is not deductible for tax purposes. Additional information regarding
these projects is set forth in Note 2 -- "Acquisitions" of the Notes to the
Consolidated Financial Statements contained in Item 8 of this report.
We are currently in the process of performing a valuation of the assets and
liabilities of the Companies acquired in 2008. At this time, we have not
determined if any IPR&D charge will result from this valuation.
The remaining other operating expenses are as follows (in millions):
Year Ended
----------------------------------
December 28, December 29,
2007 2006
---------------- ---------------
Alden facility consolidation (a) $ - $ 0.6
Carson City facility shutdown and Tijuana
facility consolidation No. 1 (a) 0.3 2.7
Columbia facility shutdown, Tijuana facility
consolidation No. 2 and RD&E consolidation (a) 4.4 5.1
Electrochem Commercial Power ("ECP") expansion (a) 0.5 -
Asset dispositions and other (b) 0.1 6.2
Severance (a) - 2.5
---------------- ---------------
$ 5.3 $ 17.1
================ ===============
(a) Refer to the "Cost Savings and Consolidation Efforts" section of this Item
for disclosure related to the timing and level of remaining expenditures
for these items as of December 28, 2007.
(b) During 2007, we had various asset disposals which were offset by $0.5
million of insurance proceeds on previously disposed assets. During 2006,
we recorded a loss of $4.4 million related to the write-off of a battery
test system that was under development. Upon completion of our 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. The remaining expense for 2006
includes charges for various asset dispositions and $0.8 million for
professional fees related to a potential acquisition that was no longer
considered probable.
In 2008 plant relocation and asset disposition expenses are expected to be
approximately $4.5 million to $5.2 million.
47
Interest Expense and Interest Income
Interest expense for 2007 is higher than the prior year period 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 at that time. See Note 8 -
"Debt" of the Notes to the Consolidated Financial Statements in this Form 10-K
for additional information about our long-term debt obligations. Going forward,
interest expense will be higher as a result of the $117 million we borrowed in
connection with our acquisitions in early 2008.
Interest income for 2007 increased in comparison to 2006 primarily due to
increased cash, cash equivalents and short-term investment balances, as well as
higher rates earned. In the future, interest income will be lower as a result of
the cash deployed in connection with our 2007 acquisitions and acquisitions in
early 2008.
Gain on sale of investment security
In the second quarter of 2007, we sold an investment security which resulted in
a pre-tax gain of $4.0 million ($2.6 million net of tax) or $0.12 per diluted
share.
Gain on extinguishment of debt
In the first quarter of 2007, we exchanged $117.8 million of our 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 the exchanged
CSN I. We accounted for this exchange as an extinguishment of debt, which
resulted in a net pre-tax gain of $4.5 million ($2.9 million net of tax) or
$0.13 per diluted share.
Other (income) expense, net
In December 2007, we entered into a forward contract to purchase 80,000,000
Swiss Francs ("CHF"), at an exchange rate of 1.1389 CHF per one U.S. dollar, in
order to partially fund our acquisition of Precimed, which closed in January
2008 and was payable in Swiss Francs. In January 2008, we entered into an
additional forward contract to purchase 20,000,000 CHF at an exchange rate of
1.1156 per one U.S. dollar. We entered into a similar foreign exchange contract
in January 2008 in order to fund our acquisition of DePuy's Chaumont, France
facility, which closed in February 2008 and was payable in Euros. The net result
of the above transactions was a gain of $2.4 million, $0.8 million of which was
recorded in 2007 (based upon the fair value of the forward contract at December
28, 2007) as Other Income and the remainder will be recorded in the first
quarter of 2008.
Provision for Income Taxes
Our effective tax rate is higher than the U.S. statutory rate primarily as a
result of the IPR&D charge from the acquisition of Enpath, which is
non-deductible for income tax purposes. As a result, our effective tax rate was
47.5% in 2007. Excluding this IPR&D charge, our effective tax rate was
consistent with 2006. We expect our effective tax rate in 2008 to be more in
line with the 35% U.S. statutory rate. This excludes the impact of any IPR&D
charges which may result from our 2008 acquisitions.
48
Fiscal 2006 Compared with Fiscal 2005
Sales
We achieved sales growth of 12% in 2006 compared to 2005. This growth was
accomplished during a period in which the underlying CRM market, which
represents over 80% of our total sales, was in decline. This growth is even more
favorable considering that 2005 results include the favorable benefit of
approximately $10.0 million to $15.0 million in ICD marketplace field actions.
Another sales highlight for 2006 was our ECP business, which grew 32% through a
combination of increased market penetration, new product introductions and
greater value-added pack assembly.
IMC. We achieved year-over-year growth of 9% from our medical business. This
growth was accomplished despite the underlying CRM market being down compared to
the prior year and an approximate 2% reduction in selling prices. Assembly
products, feedthroughs, coated electrodes and machined components were the
primary growth drivers. The assembly business was a new opportunity that was
launched in the second half of 2005. Growth in feedthroughs, coated products and
machined components represents market share penetration with both our domestic
and international customers.
Our ICD battery product line declined by 1% during 2006, commensurate with the
market and the market share shifts among our customers. The decline in sales was
primarily due to lower volume with U.S. based customers and the approximate 2%
reduction in selling prices, partially offset by strong European customer sales.
This growth represents increased adoption of our high rate battery technology.
The capacitor business also experienced a decline in sales. Capacitor sales
declined by $4 million or 19%, primarily attributable to the actions taken by a
single customer in late 2005 to further vertically integrate its operations.
ECP. ECP sales grew by 32% in 2006 through a combination of increased market
penetration, new product introductions and greater value-added pack assembly.
The oil and gas exploration was robust in 2006 due to the increased demand for
products used in pipeline inspections, pressure monitoring and measurement while
drilling applications. In addition, our presence in the telematics market
provided incremental sales opportunities.
Cost of Sales
Changes from the prior year to cost of sales as a percentage of sales were due
to the following:
2006-2005
% Increase
-------------
Production efficiencies primarily associated with
higher volumes (a) -6.5%
Excess capacity at wet tantalum capacitor facility (b) -0.8%
Excess capacity at Tijuana, Mexico facility (c) 0.4%
Mix change (d) 4.2%
Other 0.5%
-------------
Total percentage point change to cost of sales as a
percentage of sales -2.2%
=============
49
a. This decrease in cost of sales was primarily due to the fact that as
production volumes increase, fixed costs such as plant overhead and
depreciation do not increase at the same rate. The production volume
increase was necessary to accommodate the increased sales and to replenish
safety stocks.
b. During 2005, the capacitor facility was not being utilized to its full
capacity. The cost associated with the excess capacity was eliminated in
2006 as capacitor manufacturing was consolidated into the Alden Facility.
c. The Tijuana, Mexico facility was new in 2005 and its infrastructure and
floor space were coming on line during 2005 and therefore the full cost of
the capacity was not in place. In 2006, the Tijuana facility was on-line
for the entire year and excess capacity costs in 2006 exceeded those in
2005.
d. The revenue increase from 2005 was primarily in other IMC sales, which
generally have lower margins.
Cost of Sales - Amortization of Intangible Assets
Amortization expense for 2006 was consistent with 2005.
SG&A Expenses
Changes from the prior year to SG&A expenses were primarily due to the following
(in millions):
December 29,
2006
--------------
SFAS No. 123(R) stock-based compensation expense (a) $ 3.2
CEO transition and retirement expenses (b) 1.2
Information technology (c) 1.2
Increased sales and marketing workforce (d) 0.5
Director fees (e) 0.4
Other 0.8
--------------
Net increase in SG&A $ 7.3
==============
a. As a result of the adoption of SFAS No. 123(R), we began expensing stock
options in 2006, which had a material impact on SG&A costs.
b. Amounts relate to the additional stock-based compensation costs recorded in
connection with the retirement and replacement of our former CEO and former
Senior Vice President of Administration. These costs were recorded due to
acceleration provisions in our executive retirement guidelines as well as
costs associated with additional grants awarded to facilitate the
transition.
c. The increase in information technology costs was a result of our continuing
investment in the infrastructure of our Company in order to support our
growth.
d. The increased workforce expense was primarily a result of our efforts to
increase the marketing and sales of our products.
e. The increase in Director fees primarily relates to the adoption of a new
Director compensation program in 2006. This program was designed and
approved by the Corporate Governance Committee of the Board of Directors.
50
RD&E Expenses
Net research, development and engineering costs were as follows (in millions):
Year ended
----------------------------------
December 29, December 30,
2006 2005
---------------- ----------------
Research and development costs $ 16.1 $ 17.1
---------------- ----------------
Engineering costs 9.9 5.5
Less cost reimbursements (1.8) (3.9)
---------------- ----------------
Engineering costs, net 8.1 1.6
---------------- ----------------
Total research and development and
engineering costs, net $ 24.2 $ 18.7
================ ================
The increase in RD&E expenses for 2006 was primarily due to the planned
headcount increase in engineering personnel costs, as we continue to invest
substantial resources to develop new products. Reimbursement on product
development projects decreased compared to last year primarily due to the
achievement of significant milestones on one large project in 2005 that did not
reoccur in 2006.
Other Operating Expenses
Other operating expenses are as follows (in millions):
Year Ended
-----------------------------
December 29, December 30,
2006 2005
------------- -------------
Alden facility consolidation (a) $ 0.6 $ 2.8
Carson City facility shutdown and Tijuana
facility consolidation No. 1 (a) 2.7 4.5
Columbia facility shutdown, Tijuana facility
consolidation No. 2 and RD&E consolidation (a) 5.1 1.1
Tijuana facility start-up (b) - 1.4
Asset dispositions and other (c) 6.2 7.3
Severance (a) 2.5 1.5
------------- -------------
$ 17.1 $ 18.6
============= =============
(a) Refer to "Cost Savings and Consolidation Efforts" of this Item for
disclosure related to the timing and level of remaining expenditures for
these items as of December 29, 2006.
(b) Other Tijuana facility start-up expenses (not associated with the Carson
City facility or Columbia Facility consolidations) during 2005 amounted to
$1.4 million. These expenses are primarily related to the initial start-up
of the value-added assembly business.
(c) During 2006, we recorded a loss of $4.4 million related to the write-off of
a battery test system that was under development. Upon completion of our
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. The remaining expense for
2006 includes charges for various asset dispositions and $0.8 million for
professional fees related to a potential acquisition that was no longer
considered probable.
51
During 2005, a $2.8 million charge was recorded for the write-down of
automated cathode assembly equipment for the IMC segment. The remaining
expense for 2005 relates to various asset dispositions of approximately
$3.3 million and the cost to exit a development agreement of $1.2 million.
Interest Expense and Interest Income
Interest expense was consistent with 2005, and is primarily related to the
contingent convertible notes. Interest income increased during 2006 in
comparison to 2005 due to higher interest rates on higher cash and short-term
investment balances.
Provision for Income Taxes
Our effective tax rate is lower than the U.S. statutory rate due to the
allowable Extraterritorial Income Exclusion ("ETI"), the Qualified Production
Activities Deduction and the Federal Research and Development Credit.
In 2006, the net ETI benefits had a greater impact on the effective tax rate
than in 2005. As a result, our effective tax rate was reduced to 31.5% in 2006
compared to 34.6% in 2005.
Liquidity and Capital Resources
As of
December 28, December 29,
(Dollars in millions) 2007 2006
------------- -------------
Cash and cash equivalents and
short-term investments (a) $ 40.5 $ 142.6
Working capital(b) $ 116.8 $ 199.1
Current ratio 2.8:1.0 5.7:1.0
a. Short-term investments in 2007 consist of municipal, U.S. Government Agency
and corporate notes and bonds acquired with maturities that exceed three
months. Short-term investments in 2006 also included auction rate
securities and equity securities.
b. Working capital decreased by approximately $82.3 million primarily due to a
$102.1 million decrease in cash and cash equivalents and short-term
investments. Net cash provided by operating activities of $43.0 and
financing activities of $65.2 million were offset by $208.1 million of
expenditures related to our acquisition activity in 2007 and capital
purchases.
Revolving line of credit
In May 2007, we 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 our request and approval of a simple majority of
the lenders. The New Credit Facility also contains a $15 million letter of
credit subfacility and a $15 million swingline subfacility. This New Credit
Facility replaced our previous $50 million revolving credit facility. The New
Credit Facility is secured by our 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 our option, based upon the
current prime rate or the LIBOR plus a margin that varies with our 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, the
applicable margin is between 1.00% and 2.00%. We are 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 our leverage ratio.
52
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, limits repurchases of
Greatbatch's stock to $60 million and limits our ability to make cash payments
upon conversion of our convertible subordinated notes. These limitations can be
waived upon the Company's request and approval of a simple majority of the
lenders. Such waiver was obtained in order to fund the Precimed acquisition.
In addition, the New Credit Facility requires us 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
December 28, 2007. In connection with our acquisitions that closed in early
2008, we borrowed approximately $117 million under the New Credit Facility. We
anticipate that cash flow from operations will be sufficient to meet our
operating, capital expenditure and debt service needs for the foreseeable
future, other than for acquisitions.
Operating Activities
In total, net cash flows provided by operating activities for 2007 increased by
$3.8 million from 2006. This increase was primarily the result of a $6.2 million
increase in net income excluding non-cash items (i.e. depreciation,
amortization, stock-based compensation, gains/loss on investments, disposal of
PP&E, foreign currency contract 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 which was paid in 2007. This
amount was previously recorded as a non-current deferred tax liability on the
balance sheet. The remainder of the variance relates to the net change in
working capital accounts due to the timing of the receipt/payment of accounts
receivable, accounts payable and inventory levels.
We anticipate that cash flow from operations will be sufficient to meet our
operating, capital expenditure and debt service needs, other than for
acquisitions.
53
Investing Activities
Net cash used in investing activities of $145.8 million 2007 was primarily the
result of our acquisitions in 2007 ($188.1 million) which were funded with both
short-term investments and cash on hand. Expenditures for property, plant and
equipment increased $4.5 million over 2006. The majority of this increase
relates to our new ECP manufacturing facility in Raynham, MA and the expansion
of our corporate headquarters in Clarence, NY which will be completed in 2008.
The remainder of the property, plant and equipment purchases relate to routine
investments 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.
Our current expectation for 2008 is that capital spending will be in the range
of $50.0 million to $55.0 million, of which $28 million relates to the
construction of our new ECP manufacturing facility and the expansion of our
corporate headquarters.
We regularly engage in discussions relating to potential acquisitions and may
announce an acquisition transaction at any time. We continually assess our
financing facilities and capital structure to ensure liquidity and capital
levels are sufficient to meet our strategic objectives. Going forward, we expect
the pace of acquisitions to be less than the 2007 level. However, we will
continue to pursue strategically targeted and opportunistic acquisitions.
Financing Activities
Cash flow provided by financing activities for 2007 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. We paid
approximately $6.6 million of financing fees related to this transaction as well
as the New Credit Facility discussed above. In connection with the Enpath
acquisition, we acquired $7.1 million of debt which we subsequently paid down
with short-term investments and cash on hand. Cash flows from financing
activities also include cash received from stock option exercises.
Capital Structure
At December 28, 2007, our capital structure consisted of $241.2 million of
convertible subordinated notes and our 22.5 million shares of common stock
outstanding. We are 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.
Off-Balance Sheet Arrangements
We have no off-balance sheet arrangements within the meaning of Item 303(a)(4)
of Regulation S-K.
54
Litigation
We are a party to various legal actions arising in the normal course of
business. While we do not believe that the ultimate resolution of any such
pending activities will have a material adverse effect on our 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 we
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, 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 US 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 $3.0 million, $2.0 million and $1.5 million
for 2007, 2006 and 2005, respectively. 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 our ability to sell our FlowGuard products, or
to estimate the amount or range of potential loss.
Contractual Obligations
The following table summarizes our significant contractual obligations at
December 28, 2007, and the effect such obligations are expected to have on our
liquidity and cash flows in future periods.
Payments due by period
-----------------------------------------------------------------
CONTRACTUAL OBLIGATIONS Total Less than 1-3 years 3-5 years More than 5
1 year years
-------------------------------------- -----------------------------------------------------------------
Long-Term Debt Obligations (a) $ 280,938 $ 5,625 $ 11,250 $ 11,250 $ 252,813
Operating Lease Obligations (b) 11,212 2,104 3,055 2,684 3,369
Purchase Obligations (c) 32,483 32,483 - - -
Acquisitions (d) 140,744 130,000 10,744 - -
----------- ---------- ---------- ----------- -----------
Total $ 465,377 $170,212 $ 25,049 $ 13,934 $ 256,182
=========== ========== ========== =========== ===========
55
a. Includes the annual interest expense on the convertible debentures of
2.25%, or $5.6 million, which is paid semi-annually. These amounts assume
the 2010 conversion feature is not exercised on the $52.2 million of 2.25%
convertible subordinated notes issued in May 2003. See Note 8 - "Debt" of
the Notes to the Consolidated Financial Statements in this Form 10-K for
additional information about our long-term debt obligations.
b. See Note 13 - "Commitments and Contingencies" of the Notes to the
Consolidated Financial Statements in this Form 10-K for additional
information about our operating lease obligations.
c. For the purposes of this table, contractual obligations for purchases of
goods or services are defined as agreements that are enforceable and
legally binding 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.
d. In November 2007, we signed a definitive agreement to acquire Precimed
which included its right to purchase the DePuy Chaumont, France
manufacturing facility. These transactions closed in 2008 in exchange for
approximately $130 million in cash, and a contingent payment, as defined in
the Precimed purchase agreement, which can range from 0 CHF to 12,000,000
CHF depending on Precimed's 2008 earnings performance. The 1-3 years amount
was based upon the exchange ratio of 1.1169 CHF per one U.S. dollar as of
December 28, 2007 and is subject to change due to foreign currency
fluctuations and the final calculation of the contingent payment. The
purchase price was funded with cash on hand (approximately $13 million) and
availability under our revolving credit agreement (approximately $117
million) and is an interest only obligation until the expiration of the
revolving credit agreement in May 2012.
Inflation
We utilize certain critical raw materials (including precious metals) in our
products that we obtain from a limited number of suppliers due to the
technically challenging requirements of the supplied product and/or the lengthy
process required to qualify these materials with our customers. We cannot
quickly establish additional or replacement suppliers for these materials
because of these requirements. Additionally, increasing global demand for some
of the critical raw materials we need for our business has caused the prices of
these materials to increase significantly. Our results may be negatively
impacted from an increase in the prices of these critical raw materials. This
risk is partially mitigated as many of the supply agreements that we have with
our customers allow us to partially adjust prices for the impact of any raw
material price increases. Historically, raw material price increases have not
materially impacted our results of operations.
Impact of Recently Issued Accounting Standards
In December 2007, the FASB issued Statement SFAS No. 141(R), Business
Combinations. This Statement replaces FASB Statement No. 141, Business
Combinations but retains the fundamental requirements in SFAS No. 141 that the
acquisition method of accounting (which SFAS No. 141 called the purchase method)
be used for all business combinations. This Statement also retains the guidance
in SFAS No. 141 for identifying and recognizing intangible assets separately
from goodwill. However, SFAS No. 141(R) significantly changed the accounting for
business combinations with regards to the number of assets and liabilities
assumed that are to be measured at fair value, the accounting for contingent
consideration and acquired contingencies as well as the accounting for direct
acquisition costs and IPR&D. SFAS No. 141(R) is effective for acquisitions
consummated beginning in fiscal year 2009 and will not materially impact our
consolidated financial statements unless an acquisition is consummated after the
date of adoption.
56
In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in
Consolidated Financial Statements--an amendment of ARB No. 51. This Statement
amends ARB 51 to establish accounting and reporting standards for the
noncontrolling interest in a subsidiary and for the deconsolidation of a
subsidiary. We are still evaluating the impact of SFAS No. 160 on our
consolidated financial statements, which is effective beginning in fiscal year
2009.
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. SFAS No.
159 is effective beginning in fiscal year 2008 and will not materially impact
our consolidated financial statements unless we make a fair value election for a
financial asset or liability after the date of adoption. Currently, we have not
made such an election.
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. In February 2008, the FASB
issued FSP FAS 157-b--Effective Date of FASB Statement No. 157. This FSP (1)
partially defers the effective date of SFAS No. 157 for one year for certain
nonfinancial assets and nonfinancial liabilities and (2) removes certain leasing
transactions from the scope of FAS 157. We believe that the provisions of SFAS
No. 157 applicable to us beginning in fiscal year 2008 will not have a material
effect on our consolidated financial statements. We are still evaluating what
impact the provisions of SFAS No. 157 that were deferred will have on our
consolidated financial statements, which are effective beginning in fiscal year
2009.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Under our revolving line of credit any borrowings bear interest at fluctuating
market rates. At December 29, 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 consolidated financial statements. In the first quarter
of 2008, we borrowed in excess of $100 million under our $235 million revolving
credit agreement to fund the previously disclosed acquisitions. This borrowing
bears interest at variable rates and thereby will subject us to interest rate
risk in the future.
We incur certain expenses related to our Mexican and China operations that are
denominated in a foreign currency. Given the size of these operations in
relation to the overall Company, they did not have a material effect on our
consolidated financial statements. In 2008, we completed two acquisitions that
had operations in Europe. Correspondingly foreign currency fluctuations are
anticipated to have a greater impact on our future results. We are currently in
the process of evaluating our foreign currency risk as a result of these
transactions in order to develop a plan to best mitigate these risks, which
could include the use of various derivative instruments.
57
In December 2007, we entered into a forward contract to purchase 80,000,000 CHF,
at an exchange rate of 1.1389 CHF per one U.S. dollar, in order to partially
fund the acquisition of Precimed, which closed in January 2008 and was payable
in Swiss Francs. In January 2008, we entered into an additional forward contract
to purchase 20,000,000 CHF at an exchange rate of 1.1156 per one U.S. dollar. We
entered into a similar foreign exchange contract in January 2008 in order to
fund the acquisition of DePuy's Chaumont France facility, which closed in
February 2008 and was payable in Euros. The net result of the above transactions
was a gain of $2.4 million, $0.8 million of which was recorded in 2007 (based
upon the fair value of the forward contract at December 28, 2007) as Other
Income and the remainder will be recorded in the first quarter of 2008.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The following are set forth below:
Management's Report on Internal Control Over Financial Reporting
Reports of Independent Registered Public Accounting Firm
Consolidated Balance Sheets as of December 28, 2007 and December
29, 2006.
Consolidated Statements of Operations and Comprehensive Income
for the years ended December 28, 2007, December 29, 2006 and
December 30, 2005.
Consolidated Statements of Cash Flows for the years ended
December 28, 2007, December 29, 2006 and December 30, 2005.
Consolidated Statements of Stockholders' Equity for the years
ended December 28, 2007, December 29, 2006 and December 30,
2005.
Notes to Consolidated Financial Statements.
58
MANAGEMENT'S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
The Company's certifying officers are responsible for establishing and
maintaining adequate internal control over financial reporting. The Company's
internal control over financial reporting is designed and maintained under the
supervision of its certifying officers to provide reasonable assurance regarding
the reliability of financial reporting and the preparation of the Company's
financial statements for external reporting purposes in accordance with
accounting principles generally accepted in the United States of America.
As of December 28, 2007, management conducted an assessment of the effectiveness
of the Company's internal control over financial reporting based on the
framework established in Internal Control - Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission. Based on this
assessment, management has determined that the Company's internal control over
financial reporting as of December 28, 2007 is effective.
In conducting the evaluation of the effectiveness of internal control over
financial reporting as of December 28, 2007, as permitted by the guidance issued
by the Office of the Chief Accountant of the Securities and Exchange Commission,
management excluded the following 2007 acquisitions:
o Enpath Medical, Inc. on June 15, 2007
o IntelliSensing, LLC on October 26, 2007
o Quan Emerteq, LLC on November 16, 2007
o Engineered Assemblies Corporation on November 16, 2007
See Note 2-"Acquisitions" for a discussion of these acquisitions and their
impact on the Company's Consolidated Financial Statements.
The effectiveness of internal control over financial reporting as of December
28, 2007 has been audited by Deloitte & Touche LLP, the Company's independent
registered public accounting firm.
Dated: February 26, 2008
/s/ Thomas J. Hook /s/ Thomas J. Mazza
-------------------------------------------- -----------------------------------
Thomas J. Hook Thomas J. Mazza
President & Chief Executive Officer Senior Vice President & Chief Financial Officer
59
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Stockholders
Greatbatch, Inc.
Clarence, New York
We have audited the internal control over financial reporting of Greatbatch,
Inc. and subsidiaries (the "Company") as of December 28, 2007, based on criteria
established in Internal Control -- Integrated Framework issued by the Committee
of Sponsoring Organizations of the Treadway Commission. As described in
Management's Report on Internal Control Over Financial Reporting, management
excluded from its assessment the internal control over financial reporting at
Enpath Medical, Inc., IntelliSensing, LLC, Quan Emerteq, LLC, and Engineered
Assemblies Corporation, which were acquired on June 15, 2007, October 26, 2007,
November 16, 2007, and November 16, 2007, respectively, and whose financial
statements constitute 50% and 30% of net and total assets, respectively, and 10%
of revenues of the consolidated financial statement amounts as of and for the
year ended December 28, 2007. Accordingly, our audit did not include the
internal control over financial reporting at Enpath Medical, Inc.,
IntelliSensing, LLC, Quan Emerteq, LLC, and Engineered Assemblies Corporation.
The Company's management is responsible for maintaining effective internal
control over financial reporting and for its assessment of the effectiveness of
internal control over financial reporting, included in the accompanying
Management's Report on Internal Control Over Financial Reporting. Our
responsibility is to express an opinion on the Company's internal control over
financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we
plan and perform the audit to obtain reasonable assurance about whether
effective internal control over financial reporting was maintained in all
material respects. Our audit included obtaining an understanding of internal
control over financial reporting, assessing the risk that a material weakness
exists, testing and evaluating the design and operating effectiveness of
internal control based on the assessed risk, and performing such other
procedures as we considered necessary in the circumstances. We believe that
our audit provides a reasonable basis for our opinion.
A company's internal control over financial reporting is a process designed by,
or under the supervision of, the company's principal executive and principal
financial officers, or persons performing similar functions, and effected by the
company's board of directors, management, and other personnel to provide
reasonable assurance regarding the reliability of financial reporting and the
preparation of financial statements for external purposes in accordance with
generally accepted accounting principles. A company's internal control over
financial reporting includes those policies and procedures that (1) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (2)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company's
assets that could have a material effect on the financial statements.
60
Because of the inherent limitations of internal control over financial
reporting, including the possibility of collusion or improper management
override of controls, material misstatements due to error or fraud may not be
prevented or detected on a timely basis. Also, projections of any evaluation of
the effectiveness of the internal control over financial reporting to future
periods are subject to the risk that the controls may become inadequate because
of changes in conditions, or that the degree of compliance with the policies or
procedures may deteriorate.
In our opinion, the Company maintained, in all material respects, effective
internal control over financial reporting as of December 28, 2007, based on the
criteria established in Internal Control -- Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission.
We have also audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the consolidated financial
statements and financial statement schedule as of and for the year ended
December 28, 2007 of the Company and our report dated February 26, 2008
expressed an unqualified opinion on those financial statements and financial
statement schedule and included an explanatory paragraph relating to the
Company's adoption of Statement of Financial Accounting Standard No. 123
(revised 2004), Share-Based Payment.
/s/ Deloitte & Touche LLP
Buffalo, New York
February 26 2008
61
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Stockholders
Greatbatch, Inc.
Clarence, New York
We have audited the accompanying consolidated balance sheets of Greatbatch, Inc.
and subsidiaries (the "Company") as of December 28, 2007 and December 29, 2006,
and the related consolidated statements of operations and comprehensive income,
stockholders' equity, and cash flows for each of the three years in the period
ended December 28, 2007. Our audits also included the consolidated financial
statement schedule listed in the Index at Item 15(a)(2). These financial
statements and financial statement schedule are the responsibility of the
Company's management. Our responsibility is to express an opinion on the
financial statements and financial statement schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of the Company as of December 28, 2007
and December 29, 2006, and the results of its operations and its cash flows for
each of the three years in the period ended December 28, 2007, in conformity
with accounting principles generally accepted in the United States of America.
Also, in our opinion, such consolidated financial statement schedule, when
considered in relation to the basic consolidated financial statements taken as a
whole, presents fairly, in all material respects, the information set forth
therein.
As discussed in Note 1 to the consolidated financial statements, on January 1,
2006, the Company changed its method of accounting for stock-based compensation
to conform to Statement of Financial Accounting Standard No. 123 (revised 2004),
Share-Based Payment.
We have also audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the Company's internal control over
financial reporting as of December 28, 2007, based on the criteria established
in Internal Control--Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission and our report dated February 26, 2008
expressed an unqualified opinion on the Company's internal control over
financial reporting.
/s/ Deloitte & Touche LLP
Buffalo, New York
February 26, 2008
62
GREATBATCH, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands except share and per share data)
------------------------------------------------------------------------------------------------------
December 28, December 29,
ASSETS 2007 2006
------------------- ------------------
Current assets:
Cash and cash equivalents $ 33,473 $ 71,147
Short-term investments available for sale 7,017 71,416
Accounts receivable, net of allowance of $758 in 2007
and $532 in 2006 56,962 31,285
Inventories, net 71,882 57,667
Refundable income taxes 377 1,569
Deferred income taxes 6,469 5,899
Prepaid expenses and other current assets 5,044 2,343
------------------- ------------------
Total current assets 181,224 241,326
Property, plant and equipment, net 114,946 91,869
Amortizing intangible assets, net 71,268 28,078
Trademarks and tradenames 32,582 28,252
Goodwill 248,540 155,039
Other assets 15,291 3,263
------------------- ------------------
Total assets $ 663,851 $ 547,827
=================== ==================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 33,433 $ 12,657
Accrued expenses and other current liabilities 30,975 29,618
------------------- ------------------
Total current liabilities 64,408 42,275
Convertible subordinated notes 241,198 170,000
Deferred income taxes 35,346 35,859
Other long-term liabilities 228 -
------------------- ------------------
Total liabilities 341,180 248,134
------------------- ------------------
Commitments and contingencies (Note 13)
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; 22,477,340 shares issued and 22,470,299 shares
outstanding in 2007
and 22,119,142 shares issued and 22,111,516 shares
outstanding in 2006 22 22
Additional paid-in capital 238,574 227,187
Treasury stock, at cost, 7,041 shares in 2007 and 7,626
shares in 2006 (140) (205)
Retained earnings 84,215 69,165
Accumulated other comprehensive income - 3,524
------------------- ------------------
Total stockholders' equity 322,671 299,693
------------------- ------------------
Total liabilities and stockholders' equity $ 663,851 $ 547,827
=================== ==================
The accompanying notes are an integral part of these consolidated financial statements
63
GREATBATCH, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE INCOME
(in thousands except per share amounts)
------------------------------------------------------------------------------------------------------------
Year Ended
--------------------------------------------------------
December 28, December 29, December 30,
2007 2006 2005
------------------ ------------------- -----------------
Sales $ 318,746 $ 271,142 $ 241,097
Costs and expenses:
Cost of sales - excluding amortization of
intangible assets 198,184 164,885 151,543
Cost of sales - amortization of intangible assets 4,537 3,813 3,841
Selling, general and administrative expenses 44,674 38,785 31,528
Research, development and engineering costs, net 29,914 24,225 18,725
Acquired in-process research and development 16,093 - -
Other operating expenses, net 5,324 17,058 18,574
------------------ ------------------- -----------------
Operating income 20,020 22,376 16,886
Interest expense 7,303 4,605 4,613
Interest income (7,050) (5,775) (3,113)
Gain on extinguishment of debt (4,473) - -
Gain on sale of investment security (4,001) - -
Other (income) expense, net (447) 12 (78)
------------------ ------------------- -----------------
Income before provision for income taxes 28,688 23,534 15,464
Provision for income taxes 13,638 7,408 5,357
------------------ ------------------- -----------------
Net income $ 15,050 $ 16,126 $ 10,107
================== =================== =================
Earnings per share:
Basic $ 0.68 $ 0.74 $ 0.47
Diluted $ 0.67 $ 0.73 $ 0.46
Weighted average shares outstanding:
Basic 22,152 21,803 21,582
Diluted 22,422 26,334 21,810
Comprehensive income:
Net income $ 15,050 $ 16,126 $ 10,107
Net unrealized gain (loss) on short-term
investments available for sale, net of tax (923) 3,594 (52)
Less: reclassification adjustment for net
realized gain on short-term investments
available for sale,
net of tax (2,601) - -
------------------ ------------------- -----------------
Comprehensive income $ 11,526 $ 19,720 $ 10,055
================== =================== =================
The accompanying notes are an integral part of these consolidated financial statements
64
GREATBATCH, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
------------------------------------------------------------------------------------------------------------------------
Year Ended
------------------------------------------------------------
December 28, December 29, December 30,
2007 2006 2005
------------------ ------------------ ------------------
Cash flows from operating activities:
Net income $ 15,050 $ 16,126 $ 10,107
Adjustments to reconcile net income to
net cash provided by operating activities:
Depreciation and amortization 25,842 19,309 19,718
Stock-based compensation 9,252 9,717 3,327
Gain on extinguishment of debt (4,473) - -
Gain on sale of investment secruity (4,001) - -
Gain on foreign currency contract (778) - -
Acquired in-process research and development 16,093 - -
(Gain) loss on disposal of assets (194) 5,379 5,851
Deferred income taxes (4,935) 4,888 4,330
Changes in operating assets and liabilities:
Accounts receivable (14,523) (1,288) (5,709)
Inventories (1,969) (12,483) (11,157)
Prepaid expenses and other current assets (238) (855) (451)
Accounts payable 11,138 64 5,044
Accrued expenses and other current liabilities (4,581) (1,011) 11,317
Income taxes 1,282 (641) 958
------------------ ------------------ ------------------
Net cash provided by operating activities 42,965 39,205 43,335
------------------ ------------------ ------------------
Cash flows from investing activities:
Short-term investments:
Purchases (70,058) (54,800) (82,851)
Proceeds from dispositions 133,578 53,808 74,743
Acquisition of property, plant and equipment (19,993) (15,445) (28,183)
Proceeds from sale of property, plant and equipment
and other assets 16 39 5,158
Purchase of cost method investment, net of distributions (1,750) - -
Acquisitions, net of cash acquired (188,148) - -
Other investing activities 551 25 (261)
------------------ ------------------ ------------------
Net cash used in investing activities (145,804) (16,373) (31,394)
------------------ ------------------ ------------------
Cash flows from financing activities:
Repayments under line of credit, net (1,000) - -
Principal payments of long-term debt (6,093) - -
Proceeds from issuance of long-term debt 76,000 - -
Payment of debt issuance costs (6,628) - (213)
Principal payments of capital lease obligations - (464) (1,188)
Issuance of common stock 2,699 2,082 1,068
Excess tax benefits from stock-based awards 392 294 -
Repurchase of treasury stock (205) - -
------------------ ------------------ ------------------
Net cash provided by (used in) financing
activities 65,165 1,912 (333)
------------------ ------------------ ------------------
Net increase (decrease) in cash and cash equivalents (37,674) 24,744 11,608
Cash and cash equivalents, beginning of year 71,147 46,403 34,795
------------------ ------------------ ------------------
Cash and cash equivalents, end of year $ 33,473 $ 71,147 $ 46,403
================== ================== ==================
The accompanying notes are an integral part of these consolidated financial statements
65
GREATBATCH, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(in thousands)
------------------------------------------------------------------------------------------------------------------------------------
Accumulated
Additional Deferred Treasury Other Total
Common Stock Paid-In Stock-Based Stock Retained Comprehensive Stockholders'
-------------------- --------------
Shares Amount Capital Compensation Shares Amount Earnings Income (Loss) Equity
--------------------------------- ------------ -------------- --------- ------------- -------------
Balance, January 1, 2005 21,451 $ 21 $212,131 $ (833) 5 $ (95) $ 42,932 $ (18) $ 254,138
Stock-based compensation - - 3 333 (1) 27 - - 363
Exercise of stock options 98 1 1,067 - - - - - 1,068
Grant of restricted stock 68 - 1,260 (1,260) - - - - -
Forfeitures of restricted stock (14) - (270) 270 - - - - -
Income tax benefit from stock
options - - 252 - - - - - 252
Shares contributed to 401(k) 149 - 2,661 - (4) 68 - - 2,729
Net income - - - - - - 10,107 - 10,107
Total other comprehensive loss,
net - - - - - - - (52) (52)
-------------------- ------------ ------------ -------------- --------- ------------- -------------
Balance, December 30, 2005 21,752 22 217,104 (1,490) - - 53,039 (70) 268,605
Adoption of SFAS No. 123(R) - - (1,490) 1,490 - - - - -
Stock-based compensation 11 - 6,417 - - - - - 6,417
Exercise of stock options 161 - 2,082 - - - - - 2,082
Grant of restricted stock 94 - - - - - - - -
Forfeitures of restricted stock (9) - - - - - - - -
Repurchase of shares to settle
employee tax
withholding on vested
restricted stock - - - - (8) (205) - - (205)
Income tax benefit from stock
options -
and restricted stock - - 294 - - - - - 294
Shares contributed to 401(k) 110 - 2,780 - - - - - 2,780
Net income - - - - - - 16,126 - 16,126
Total other comprehensive gain,
net - - - - - - - 3,594 3,594
-------------------- ------------ ------------ -------------- --------- ------------- -------------
Balance, December 29, 2006 22,119 22 227,187 - (8) (205) 69,165 3,524 299,693
Stock-based compensation 9 - 5,673 - - - - - 5,673
Exercise of stock options 141 - 2,699 - - - - - 2,699
Grant of restricted stock 106 - (205) - 8 205 - - -
Forfeitures of restricted stock (8) - - - - - - - -
Repurchase of shares to settle
employee tax
witholding on vested restricted
stock - - - - (7) (140) - - (140)
Income tax benefit from stock
options and
restricted stock - - 264 - - - - - 264
Shares contributed to 401(k) 110 - 2,956 - - - - - 2,956
Net income - - - - - - 15,050 - 15,050
Total other comprehensive loss,
net - - - - - - - (3,524) (3,524)
-------------------- ------------ ------------ -------------- --------- ------------- -------------
Balance, December 28, 2007 22,477 $ 22 $238,574 $ - (7) $(140) $ 84,215 $ - $ 322,671
==================== ========================= ============== ========= ============= =============
The accompanying notes are an integral part of these consolidated financial statements
66
GREATBATCH, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation - The consolidated financial statements include
the accounts of Greatbatch, Inc. and its wholly owned subsidiaries
(collectively, the "Company" or "Greatbatch". All significant intercompany
balances and transactions have been eliminated in consolidation.
Nature of Operations - The Company operates its business in two reportable
segments - Implantable Medical Components ("IMC") and Electrochem
Commercial Power ("ECP"). The IMC segment designs and manufactures
batteries, capacitors, filtered feedthroughs, engineered components and
enclosures used in Implantable Medical Devices ("IMDs"). Additionally, the
IMC business offers value-added assembly and design engineering services
for products that incorporate IMD components. With the acquisitions of
Enpath Medical, Inc. and Quan Emerteq, LLC in 2007, the IMC business now
designs, develops and manufactures introducers, catheters, implantable
stimulation leads and microcomponents for the vascular, cardiac rhythm
management and neurostimulation markets.
The ECP segment designs and manufactures high performance batteries and
battery packs for use in oil and gas exploration, pipeline inspection,
telematics, oceanography equipment, seismic, communication, military and
aerospace applications. With the acquisitions of Engineered Assemblies
Corporation and IntelliSensing, LLC, the ECP business can now design and
provide its customers rechargeable battery and wireless sensor systems.
Fiscal Year End - The Company utilizes a fifty-two, fifty-three week fiscal
year ending on the Friday nearest December 31st. Fiscal years 2007, 2006
and 2005 ended on December 28, December 29 and December 30, respectively.
Cash and Cash Equivalents - Cash and cash equivalents consist of cash and
highly liquid, short-term investments with maturities at the time of
purchase of three months or less.
Short-term Investments - Short-term investments in 2007 are comprised of
municipal, U.S. Government Agency and corporate notes and bonds acquired
with maturities that exceed three months. Short-term investments in 2006
also included auction rate securities and equity securities. All short-term
investments as of December 28, 2007 and December 29, 2006 are classified as
available-for-sale and have a maturity of less than one year at the time of
acquisition. Available-for-sale securities are carried at fair value with
the unrealized gain or loss, net of tax, reported in accumulated other
comprehensive income (loss) as a separate component of stockholders'
equity. Fair value is based on quoted market prices as of the end of the
reporting period. Realized gains and losses and investment income are
included in net income. Due to the short-term nature of the interest rate
resets, the fair market value of the auction rate securities in 2006
approximates their recorded value. The cost of securities sold is based on
the specific identification method. Unrealized losses considered to be
other than temporary during the period are recognized in net income.
67
Fair Value of Financial Instruments - The carrying amount of financial
instruments, including cash and cash equivalents, trade receivables and
accounts payable, approximated their fair value as of December 28, 2007 and
December 29, 2006 because of the relatively short maturity of these
instruments.
Inventories - Inventories are stated at the lower of cost, determined using
the first-in first-out method, or market.
Property, Plant and Equipment - Property, plant and equipment is carried at
cost. Depreciation is computed primarily by the straight-line method over
the estimated useful lives of the assets, as follows: buildings and
building improvements 7-40 years; machinery and equipment 3-8 years; office
equipment 3-10 years; and leasehold improvements over the remaining lives
of the improvements or the lease term, if less.
The cost of repairs and maintenance is expensed as incurred; renewals and
betterments are capitalized. Upon retirement or sale of an asset, its cost
and related accumulated depreciation or amortization is removed from the
accounts and any gain or loss is recorded in operating income or expense.
Business Combinations - The Company records its business combinations under
the purchase method of accounting. Under the purchase method of accounting,
the Company allocates the purchase price of each acquisition to the
tangible and identifiable intangible assets acquired and liabilities
assumed based on their respective fair values at the date of acquisition.
The fair value of identifiable intangible assets is based upon detailed
valuations that use various assumptions made by management. Any excess of
the purchase price over the fair value of the net tangible and intangible
assets acquired is allocated to goodwill.
Amortizing Intangible Assets - Acquired intangible assets other than
goodwill and trademark and tradenames consist primarily of purchased
technology, patents and customer lists. The Company amortizes its
definite-lived intangible assets on a straight-line basis over their
estimated useful lives as follows: purchased technology and patents 5-15
years; customer lists 11-15 years and other intangible assets, 1-10 years.
Purchased In-Process Research and Development ("IPR&D") - When the Company
acquires another entity, the purchase price is allocated, as applicable,
between IPR&D, other identifiable intangible assets, net tangible assets,
and goodwill. The Company defines IPR&D as the value assigned to those
projects for which the related products have not received regulatory
approval and have no alternative future use. Determining the portion of the
purchase price allocated to IPR&D requires the Company to make significant
estimates. The amount of the purchase price allocated to IPR&D is
determined by estimating the future cash flows of each project or
technology and discounting the net cash flows back to their present values.
The discount rate used is determined at the time of acquisition in
accordance with accepted valuation methods. These methodologies include
consideration of the risk of the project not achieving commercial
feasibility.
68
Impairment of Long-lived Assets - The Company assesses the impairment of
definite lived long-lived assets when events or changes in circumstances
indicate that the carrying value of the assets may not be recoverable.
Factors that are considered in deciding when to perform an impairment
review include significant under-performance of a business or product line
in relation to expectations, significant negative industry or economic
trends, and significant changes or planned changes in the use of the
assets. Recoverability potential is measured by comparing the carrying
amount of the asset group to the related total future undiscounted cash
flows. If an asset group's carrying value is not recoverable through
related cash flows, the asset group is considered to be impaired.
Impairment is measured by comparing the asset group's carrying amount to
its fair value, based on the best information available, including market
prices or discounted cash flow analyses. When it is determined that useful
lives of assets are shorter than originally estimated, and there are
sufficient cash flows to support the carrying value of the assets, the rate
of depreciation is accelerated in order to fully depreciate the assets over
their new shorter useful lives.
Goodwill and trademarks and tradenames are not amortized but are
periodically tested for impairment. The Company assesses goodwill for
impairment by comparing the fair value of its reporting units to their
carrying amounts on the last day of each fiscal year, or more frequently if
certain events occur or circumstances change, to determine if there is
potential impairment. If the fair value of a reporting unit is less than
its carrying value, an impairment loss is recorded to the extent that the
implied fair value of the goodwill within the reporting unit is less than
its carrying value. Fair values for reporting units are determined based on
discounted cash flows, market multiples or appraised values as appropriate.
Indefinite lived intangible assets such as trademarks and tradenames are
assessed for impairment on the last day of each fiscal year, or more
frequently if certain events occur or circumstances change, by comparing
the fair value of the asset to their carrying value. The fair value is
determined by using a relief-from-royalty approach. The Company has
determined that, based on the impairment tests performed, no impairment of
goodwill or trademarks and tradenames has occurred during 2007 or 2006.
Other Assets - Other assets includes deferred costs incurred in connection
with the Company's issuance of its convertible subordinated notes and
revolving line of credit. These costs are being amortized using the
effective yield method over the period from the date of issuance to the put
option date (if applicable) or the contractual maturity date, whichever is
earlier. Total net deferred financing fees amounted to $6.4 million at
December 28, 2007 and $2.3 million at December 29, 2006.
Other assets also include long-term investments in equity securities that
do not have readily available market values and are accounted for using the
cost method. The Company assesses impairment of these securities whenever
events or changes in circumstances indicate that carrying amounts may
not be recoverable. If impairment is considered other than temporary, an
impairment loss is recognized and the fair value of the investment becomes
its new cost basis. The aggregate recorded amount of cost method
investments at December 28, 2007 and December 29, 2006 was $6.8 million and
$0.8 million, respectively. The Company has determined that these
investments are not considered variable interest entities as defined in
Financial Accounting Standards Board ("FASB") Interpretation ("FIN") 46(R),
Consolidation of Variable Interest Entities, an interpretation of ARB No.
51. The Company's exposure related to these entities is limited to its
recorded investment. These investments are in research and development
companies where the fair value may be subject to future fluctuations, which
could be significant.
69
Concentration of Credit Risk - Financial instruments that potentially
subject the Company to concentration of credit risk consist principally of
trade receivables. A significant portion of the Company's sales are to
three customers, all in the medical device industry, and, as such, the
Company is directly affected by the condition of those customers and that
industry. However, the credit risk associated with trade receivables is
minimal due to the Company's stable customer base. Note 14 - "Business
Segment Information" contains information on sales and accounts receivable
for the Company's significant customers. The Company maintains cash
deposits with major banks, which from time to time may exceed federally
insured limits.
Allowance for Doubtful Accounts - The Company provides credit, in the
normal course of business, to its customers. The Company also maintains an
allowance for doubtful customer accounts and charges actual losses against
this allowance when incurred.
Income Taxes - The consolidated financial statements of the Company have
been prepared using the asset and liability approach in accounting for
income taxes which requires the recognition of deferred tax assets and
liabilities for the expected future tax consequences of net operating
losses, credits, and temporary differences between the financial statement
carrying amounts and the tax bases of assets and liabilities. A valuation
allowance is provided on deferred tax assets if it is determined that it is
more likely than not that the asset will not be realized.
The Company and its domestic subsidiaries file a consolidated federal
income tax return. State tax returns are filed on a combined or separate
basis depending on the applicable laws relating to the Company and its
domestic subsidiaries.
Revenue Recognition - Revenue from the sale of products is recognized at
the time the product is shipped and title passes to our customers. The
Company includes shipping and handling fees billed to customers in sales.
Shipping and handling costs associated with inbound freight are generally
recorded in cost of sales. In certain instances the Company obtains
component parts for sub-assemblies from its customers that are included in
the final product. The cost of these customer supplied component parts
amounted to $35.1 million, $18.8 million and $7.8 million in 2007, 2006 and
2005, respectively. These amounts were excluded from sales and cost of
sales recognized by the Company.
Product Warranties - 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 based upon recent historical
experience and other specific information as it becomes available.
70
Research and Development and Engineering Costs - Research and development
costs are expensed as incurred. The primary costs are salary and benefits
for personnel. Engineering costs are expensed as incurred. Cost
reimbursements for engineering services from customers for whom the Company
designs products are recorded as an offset to engineering costs upon
achieving development milestones specified in the contracts.
Net research, development and engineering costs are comprised of the
following (in thousands):
Year Ended
-----------------------------------------------------
December 28, December 29, December 30,
2007 2006 2005
----------------- ----------------- -----------------
Research and development costs $ 16,141 $ 16,096 $ 17,069
----------------- ----------------- -----------------
Engineering costs 18,929 9,888 5,500
Less: cost reimbursements (5,156) (1,759) (3,844)
----------------- ----------------- -----------------
Engineering costs, net 13,773 8,129 1,656
----------------- ----------------- -----------------
Total research, development and
engineering costs, net $ 29,914 $ 24,225 $ 18,725
================= ================= =================
Stock-Based Compensation - Beginning in fiscal year 2006, the Company
adopted FASB Statement of Financial Accounting Standards ("SFAS") No. 123
(revised 2004), Share-Based Payment ("SFAS No. 123(R)"), and related
Securities and Exchange Commission ("SEC") rules included in Staff
Accounting Bulletin ("SAB") No. 107. Under SFAS No. 123(R) the Company is
now required to record compensation costs related to all stock-based
awards.
Prior to fiscal year 2006, the Company accounted for stock options
following the requirements of Accounting Principles Board Opinion No. 25,
Accounting for Stock Issued to Employees, and related interpretations,
which did not require the Company to record compensation expense for fixed
stock options if the exercise price of the option equaled or exceeded the
fair market value of the Company's stock at the grant date. For restricted
stock awards, the fair market value of the award, determined based upon the
closing value of the Company's stock price on the grant date, was recorded
to compensation expense on a straight-line basis over the vesting period.
The Company applied the modified prospective approach in adopting SFAS No.
123(R), which allows the requirements of SFAS No. 123(R) to be applied to
new awards (stock options, restricted stock and restricted stock unit
awards) and to awards modified, repurchased, or cancelled beginning in
2006. Additionally, any unvested awards granted prior to 2006 are expensed
as service is performed based on the grant-date fair value calculated in
accordance with SFAS No. 123. Compensation cost for service-based stock
options and restricted stock awards is recognized ratably over the
applicable vesting period. Compensation cost for performance-based stock
options and restricted stock units is reassessed each period and recognized
based upon the probability that the performance targets will be achieved.
The Company utilizes the Black-Scholes option pricing model to estimate the
fair value of stock options granted. For restricted stock and restricted
stock unit awards, the fair market value of the award, determined based
upon the closing value of the Company's stock price on the grant date, is
recorded to compensation expense on a straight-line basis over the vesting
period.
71
The Company's net income and earnings per share for fiscal year 2005 as if
the fair value based method of SFAS No. 123 had been applied to all
outstanding and unvested awards is as follows (in thousands except per
share data):
Year Ended
--------------------
December 30,
2005
--------------------
Net income as reported $ 10,107
Add: stock-based compensation cost included in
net income as reported, net of related tax
effects 2,176
Less: stock-based compensation cost determined
using the fair value based method, net of
related tax effects 4,409
--------------------
Pro forma net income $ 7,874
====================
Net earnings per share:
Basic - as reported $ 0.47
Basic - pro forma $ 0.36
Diluted - as reported $ 0.46
Diluted - pro forma $ 0.36
Net earnings per diluted share for 2005 exclude the effect of 4,219,000
shares related to our outstanding contingent convertible notes, as the
effect is anti-dilutive. Included in stock-based compensation is the cost
of company stock contributed to the 401(k) plan.
In November 2005, the FASB issued FASB Staff Position ("FSP") FAS 123(R)-3,
Transition Election Related to Accounting for the Tax Effects of
Share-Based Payment Awards. FSP FAS 123(R)-3 provides an alternative
transition method for establishing the beginning balance of the pool of
excess tax benefits available to absorb tax deficiencies recognized
subsequent to the adoption of SFAS No. 123(R) (the "APIC Pool"). Effective
in the fourth quarter of 2006, the Company elected to adopt the alternative
transition method provided in FSP FAS 123(R)-3 for establishing the
beginning balance of the APIC Pool. The impact of this election on the
prior quarters of 2006 was immaterial. This method consists of a
computational component that establishes a beginning balance of the APIC
Pool related to employee compensation and a simplified method ("short-cut
method") to determine the subsequent impact on the APIC Pool of employee
awards that are fully vested and outstanding upon the adoption of SFAS No.
123(R).
72
Earnings Per Share - Basic earnings per share is calculated by dividing net
income by the weighted average number of shares outstanding during the
period. Diluted earnings per share is calculated by adjusting for potential
common shares, which consist of stock options, unvested restricted stock
and restricted stock units and contingently convertible instruments.
Holders of the Company's convertible notes may convert them into shares of
the Company's common stock under certain circumstances (see Note 8 -
"Debt").
The Company includes the effect of the conversion of its convertible
subordinated notes in the calculation of diluted earnings per share using
the if-converted method or the net share settlement method for instruments
that may be settled in cash at the Company's election and which the Company
has the ability and intent to settle them in cash, as long as the effect is
dilutive. For computation of earnings per share under conversion
conditions, the number of diluted shares outstanding increases by the
amount of shares that are potentially convertible during that period. Also,
net income is adjusted for the calculation to add back interest expense on
the convertible notes as well as unamortized discount and deferred
financing fees amortization recorded during the period.
The following table reflects the calculation of basic and diluted earnings
per share (in thousands, except per share amounts):
Year Ended
-----------------------------------------------
December 28, December 29, December 30,
2007 2006 2005
--------------- --------------- ---------------
Numerator for basic earnings per share:
Income from continuing operations $ 15,050 $ 16,126 $ 10,107
Effect of dilutive securities:
Interest expense on convertible notes and
related deferred financing fees, net of
tax - 3,064 -
--------------- --------------- ---------------
Numerator for diluted earnings per share $ 15,050 $ 19,190 $ 10,107
=============== =============== ===============
Denominator for basic earnings per share:
Weighted average shares outstanding 22,152 21,803 21,582
Effect of dilutive securities:
Convertible notes - 4,219 -
Stock options and unvested restricted
stock 270 312 228
--------------- --------------- ---------------
Dilutive potential common shares 270 4,531 228
--------------- --------------- ---------------
Denominator for diluted earnings per share 22,422 26,334 21,810
=============== =============== ===============
Basic earnings per share $ 0.68 $ 0.74 $ 0.47
=============== =============== ===============
Diluted earnings per share $ 0.67 $ 0.73 $ 0.46
=============== =============== ===============
73
Earnings per diluted share for 2007 excludes the effect of 6,302,000 shares
related to the Company's outstanding contingent convertible notes, of which
5,700,000 shares relate to notes that may be settled in cash at the option
of the Company, as the effect is anti-dilutive. Earnings per diluted share
for 2005 excludes the effect of 4,219,000 shares related to outstanding
contingent convertible notes, as the effect is anti-dilutive. The diluted
weighted average share calculations do not include options and restricted
stock for 2007, 2006 and 2005 of 664,000, 1,084,000 and 908,000,
respectively, as they are not dilutive to the earnings per share
calculations. The diluted weighted average share calculations for the 2007
and 2006 periods also do not include 287,000 shares and 215,000 shares,
respectively, of performance based stock options and restricted stock units
as the performance criteria for those awards had not been met as of the end
of the respective periods.
As of December 28, 2007, there were 60,000 shares of Greatbatch stock which
were issuable in connection with the acquisition of Quan Emerteq, LLC.
Pursuant to the purchase agreement, these shares were issuable within 60
days of the acquisition date (November 16, 2007). These shares were issued
in January 2008. See Note 2 - "Acquisitions."
Comprehensive Income - The Company's accumulated other comprehensive income
includes the unrealized gains on short-term investments available-for-sale,
net of applicable taxes. The effect of this item was $0 and an increase in
stockholders' equity on a cumulative basis by $3.5 million at December 28,
2007 and December 29, 2006, respectively. The Company's gain on available
for sale securities is included in accumulated other comprehensive income
net of deferred taxes of $1.1 million at December 29, 2006.
Use of Estimates - 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 and liabilities and disclosure of contingent
assets and liabilities at the date of the financial statements and reported
amounts of sales and expenses during the reporting period. Actual results
could differ materially from those estimates.
74
Supplemental Cash Flow Information (in thousands):
Year Ended
--------------------------------------------------
December 28, December 29, December 30,
2007 2006 2005
--------------------------------------------------
Cash paid during the year for:
Interest $ 5,325 $ 3,888 $ 3,971
Income taxes 17,341 2,867 52
Noncash investing and financing activities:
Net unrealized gain (loss) on available-for-
sale securities $ (923) $ 3,594 $ (52)
Common stock contributed to 401(k) Plan 2,956 2,780 2,729
Property, plant and equipment purchases
included in accounts payable 3,307 808 1,893
Unsettled purchase of treasury stock 140 205 -
Exchange of convertible subordinated notes 117,782 - -
Shares to be issued in connection with business
acquisition 1,473 - -
Acquisition of non-cash assets and liabilities:
Assets acquired $ 209,946 $ - $ -
Liabilities assumed 20,395 - -
Recent Accounting Pronouncements -- In December 2007, the FASB issued SFAS
No. 141(R), Business Combinations. This Statement replaces FASB Statement
No. 141, Business Combinations but retains the fundamental requirements in
SFAS No. 141 that the acquisition method of accounting (which SFAS No. 141
called the purchase method) be used for all business combinations. This
Statement also retains the guidance in SFAS No. 141 for identifying and
recognizing intangible assets separately from goodwill. However, SFAS No.
141(R) significantly changed the accounting for business combinations with
regards to the number of assets and liabilities assumed that are to be
measured at fair value, the accounting for contingent consideration and
acquired contingencies as well as the accounting for direct acquisition
costs and IPR&D. SFAS No. 141(R) is effective for acquisitions consummated
beginning in fiscal year 2009 and will not materially impact the Company's
consolidated financial statements unless an acquisition is consummated
after the date of adoption.
In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in
Consolidated Financial Statements--an amendment of ARB No. 51. This
Statement amends ARB 51 to establish accounting and reporting standards for
the noncontrolling interest in a subsidiary and for the deconsolidation of
a subsidiary. The Company is still evaluating the impact of SFAS No. 160 on
its consolidated financial statements, which is effective beginning in
fiscal year 2009.
75
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. SFAS No. 159 is effective
beginning in fiscal year 2008 and will not materially impact our
consolidated financial statements unless we make a fair value election for
a financial asset or liability after the date of adoption. Currently, we
have not made such an election.
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. In February 2008, the FASB issued FSP FAS 157-b--Effective Date of
FASB Statement No. 157. This FSP (1) partially defers the effective date of
SFAS No. 157 for one year for certain nonfinancial assets and nonfinancial
liabilities and (2) removes certain leasing transactions from the scope of
FAS 157. The Company believes that the provisions of SFAS No. 157
applicable to the Company beginning in fiscal year 2008 will not have a
material effect on its consolidated financial statements. We are still
evaluating what impact the provisions of SFAS No. 157 that were deferred
will have on our consolidated financial statements, which are effective
beginning in fiscal year 2009.
2. ACQUISITIONS
BIOMEC, Inc.
On April 3, 2007, the Company acquired substantially all of the assets of
BIOMEC, Inc. ("BIOMEC"). BIOMEC is a biomedical device company based in
Cleveland, OH. With the BIOMEC acquisition, the Company retained an
engineering team with diverse capabilities in medical device development,
including mechanical design, software engineering, biocompatible coatings,
and electronics. As a result, the Company can now offer device design
engineering expertise to its customers.
This transaction was accounted for under the purchase method of accounting.
Accordingly, the results of BIOMEC's operations were included in the
consolidated financial statements from the date of acquisition. The
aggregate purchase price was $11.4 million, which was paid in cash. In
connection with this transaction, which was structured as an asset
purchase, the Company received a payment of $0.25 million from the former
BIOMEC representing the Company's share of the purchase price resulting
from the Company's 2% ownership interest in the former BIOMEC. This payment
was recorded as a reduction to the carrying amount of this investment.
The excess of the purchase price over the fair value of the net tangible
and intangible assets acquired of $5.2 million was allocated to goodwill.
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 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.
76
Approximately $2.3 million of the purchase price represents the estimated
fair value of acquired 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 of approximately 40%, which
represented the stage of completion and the risks surrounding the
successful development and commercialization of each of the IPR&D projects,
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 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.
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 designs, develops, manufactures and markets single
use medical device products for the cardiac rhythm management,
neuromodulation and interventional radiology markets. The acquisition
further expanded the Company's product and service offerings to the cardiac
rhythm management ("CRM") and neurostimulation marketplaces, broadened its
market reach into the vascular segment, and added several new OEM
customers.
This transaction was accounted for under the purchase method of accounting.
Accordingly, the results of Enpath's operations were included in the
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 ($91.6 million), the consideration paid
to employees in exchange for the cancellation of their Enpath stock options
and restricted stock ($3.8 million) and other direct acquisition-related
costs, including financial advisory, legal and accounting services ($3.0
million). Subsequent to the acquisition date, the Company repaid the line
of credit and term loans assumed from Enpath of approximately $7.1 million.
77
The cost of the acquisition was 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. The following table summarizes the 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 48,941
-------------------
Total assets acquired 113,820
Liabilities assumed
Current liabilities 5,950
Notes payable 4,379
Deferred income taxes 4,915
Other non-current liabilities 145
-------------------
Total liabilities assumed 15,389
-------------------
Purchase price $ 98,431
===================
The fair values of the assets acquired and liabilities assumed were
determined using one 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 in-process and finished inventory. 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 technology and patents, acquired IPR&D, customer
relationships, trademarks and tradenames and for the 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, 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 and raw materials inventory. The cost
to replace a 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.
78
Inventory - The fair value of the in-process and finished inventory
acquired was estimated by applying a version of the market approach called
the comparable sales 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 which was fully expensed in 2007 as
the inventory acquired from Enpath was sold and was included in cost of
sales. Raw materials inventory was valued at replacement cost.
Intangible assets - The purchase price was allocated to specific intangible
assets as follows (dollars in thousands):
Weighted average
amortization Probability
Amount period (years) assigned to Discount
assigned revenues rate
-------------- -------------------- --------------- -------------
Amortizable intangible assets
Technology and patents $ 9,701 10 100% 10%
Customer relationships 14,133 11 100% 11%
Noncompete agreements 310 1 50% 10%
-------------- --------------------
$24,144 10
Trademarks and Tradenames $ 4,330 indefinite 100% 10%
Acquired IPR&D - Introducers $12,640 - 60% - 90% 10%
Acquired IPR&D - Catheters $ 1,200 - 70% - 75% 10%
Technology and patents - Technology and patents 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 current and future
products. Approximately 85 percent of the value assigned to technology and
patents is associated with Enpath's introducer products. The Company
determined that the weighted average estimated useful life of the
technology and patents is 10 years. This life is based upon management's
estimate of the product life cycle associated with technology and patents
before they will be replaced by new technologies. The expected cash flows
associated with technology and patents were nominal after 10 years.
Customer relationships - Customer relationships represent the 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.
79
Trademarks and tradenames - Trademarks and tradenames represent the
estimated fair value of registered and unregistered corporate and product
names acquired from Enpath, which will be utilized by the Company in the
future. These included the "Enpath" corporate tradename as well as twelve
other registered product names. These tradenames were valued separately
from goodwill at the amount which an independent third party would be
willing to pay for use of these names. The tradenames are inherently
valuable as the Company believes they convey favorable perceptions about
the products with which they are affiliated. This in turn generates
consistent and increased demand for the products, which provides the
Company with greater revenues, as well as greater production and operating
efficiencies. Thus, the Company will realize larger profit margins than
companies without the tradenames. The Company currently intends to utilize
these trademarks and tradenames for an indefinite period of time, thus
these intangible assets are not being amortized but are tested for
impairment on an annual basis.
Acquired IPR&D - Approximately $13.8 million of the purchase price
represents the 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
and is not deductible for tax purposes. The 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 the
Company is not successful in completing these projects on a timely basis,
future sales from introducers and catheters may be adversely affected
resulting in erosion of the Company's market share.
The 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.
Goodwill - The excess of the purchase price over the fair value of net
tangible and intangible assets acquired of $48.9 million was allocated to
goodwill. Various factors contributed to the establishment of goodwill,
including: the strategic benefit of further penetrating the
neurostimulation market and entering the interventional market; 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.
80
IntelliSensing, LLC
On October 26, 2007, the Company's wholly-owned subsidiary, Electrochem
Commercial Power, Inc. ("Electrochem") acquired substantially all of the
assets of IntelliSensing, LLC ("IntelliSensing"). IntelliSensing designs
and manufactures wireless sensor solutions that measure temperature,
pressure, flow and other critical data. The acquisition expanded the
Company's product and service offerings into the wireless sensing market
which allows it to provide comprehensive solutions to its existing OEM
customers.
This transaction was accounted for under the purchase method of accounting.
Accordingly, the results of IntelliSensing's operations were included in
the consolidated financial statements from the date of acquisition. The
aggregate purchase price was $3.9 million, which was paid in cash. The
excess of the purchase price over the fair value of the net tangible and
intangible assets acquired of $1.8 million was preliminarily allocated to
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, the finalization of the working capital adjustment as
defined in the purchase agreement, the Company incurring direct acquisition
costs in connection with this transaction and the resolution of
pre-acquisition tax positions. The valuations will be finalized within 12
months of the close of the acquisition. When the valuations are finalized,
any changes to the preliminary valuation of assets acquired or liabilities
assumed may result in material adjustments to the fair value of the
intangible assets acquired, as well as goodwill. Various factors
contributed to the establishment of goodwill, including: the value of
IntelliSensing's highly trained assembled work force and management team;
the expected revenue growth over time and the incremental synergies to the
Company's ECP business from having wireless sensing capabilities. Goodwill
resulting from the IntelliSensing acquisition was allocated to the
Company's ECP segment and is deductible for tax purposes.
Approximately $1.5 million and $0.6 million of the purchase price
represents the preliminary estimated fair value of acquired technology and
patents, and a non-compete agreement with the previous owner of
IntelliSensing, respectively.
Technology and patents consist of technical processes, patented and
unpatented technology, manufacturing know-how and the understanding with
respect to products or processes that have been developed by IntelliSensing
and that will be leveraged in current and future products. The estimated
fair value of these projects was determined using relief-from-royalty form
of the income approach. This approach estimates what an independent third
party would be willing to pay for use of the technology, and discounts
those royalty streams in order to determine the fair value of the asset.
The Company determined that the weighted average estimated useful life of
the technology and patents is 8 years. This life is based upon management's
estimate of the product life cycle associated with technology and patents
before they will be replaced by new technologies. The expected cash flows
associated with technology and patents were nominal after 8 years.
81
Quan Emerteq, LLC
On November 16, 2007, the Company acquired substantially all of the assets
of Quan Emerteq, LLC ("Quan Emerteq"). Quan Emerteq designs, develops and
manufactures single use medical device products for the vascular, CRM and
neurostimulation markets. The acquisition further expanded the Company's
product and service offerings to the CRM, neurostimulation and vascular
marketplaces and added several new OEM customers.
This transaction was accounted for under the purchase method of accounting.
Accordingly, the results of Quan Emerteq's operations were included in the
consolidated financial statements from the date of acquisition. The
aggregate purchase price was $60.1 million, consisting of the cash issued
at closing to Quan Emerteq shareholders ($58.2 million), 60,000 shares of
Greatbatch stock (valued at $24.55 per share) issued to Quan Emerteq
shareholders and certain employees of Quan Emerteq ($1.5 million) and other
direct acquisition-related costs, including financial advisory, legal and
accounting services ($0.4 million).
The cost of the acquisition was preliminarily allocated to the assets
acquired and liabilities assumed from Quan Emerteq 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, the finalization of the
working capital adjustment as defined in the purchase agreement, the
Company incurring direct acquisition costs in connection with this
transaction and the resolution of pre-acquisition tax positions. The
valuations will be finalized within 12 months of the close of the
acquisition. When the valuations are finalized, any changes to the
preliminary valuation of assets acquired or liabilities assumed may result
in material adjustments to the fair value of the intangible assets
acquired, as well as 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) November 16, 2007
------------------------------------------------- ---------------------------
Assets acquired
Current assets $ 5,483
Property, plant and equipment 4,675
Amortizing intangible assets 20,200
Goodwill 32,243
Other Assets 200
---------------------------
Total assets acquired 62,801
Liabilities assumed
Current liabilities 2,737
---------------------------
Total liabilities assumed 2,737
---------------------------
Purchase price $ 60,064
===========================
82
The fair values of the assets acquired and liabilities assumed were
preliminarily determined using one 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 in-process and finished inventory. The income approach,
which indicates value for a subject asset based on the present value of
cash flows projected to be generated by the asset, was used for certain
intangible assets such as technology and patents, customer relationships,
and for the noncompete agreement with an employee. The projected cash flows
were discounted at a required rate of return that reflects the relative
risk of the Quan Emerteq transaction and the time value of money. The
projected cash flows for each asset considered multiple factors, including
current revenue from existing customers, 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 raw materials inventory. The cost
to replace a given asset reflects the estimated reproduction or replacement
cost for the asset.
Inventory - The fair value of the in-process and finished inventory
acquired was estimated by applying a version of the market approach called
the comparable sales 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 $0.32 million. For 2007, the Company expensed as
cost of sales $0.16 million of the step-up value relating to the acquired
Quan Emerteq inventory sold during 2007. As of December 28, 2007, there was
$0.16 million of inventory step-up value remaining in inventory to be
expensed as the inventory is sold. Raw materials inventory was valued at
replacement cost.
Intangible assets - The purchase price was allocated to specific intangible
assets on a preliminary basis as follows (dollars in thousands):
Weighted
average
Amount amortization Discount
assigned period (years) rate
------------- -------------------- --------------
Amortizable intangible assets
Technology and patents $ 5,100 7 15%
Customer relationships 14,600 15 15%
Noncompete agreements 500 5 15%
------------- --------------------
$20,200 13
83
Technology and patents - Technology and patents 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 Quan Emerteq and that will be leveraged in current and future
products. The Company determined that the weighted average estimated useful
life of the technology and patents is 7 years. This life is based upon
management's estimate of the product life cycle associated with technology
and patents before they will be replaced by new technologies. The expected
cash flows associated with technology and patents were nominal after 7
years.
Customer relationships - Customer relationships represent the preliminary
estimated fair value of both the contractual and non-contractual customer
relationships Quan Emerteq has with OEMs as of the acquisition date. The
primary customers of Quan Emerteq include Abbott Laboratories, Fox Hollow
Technologies, Medtronic and Siemens Medical Solutions, 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 15 years. This life was based upon historical
customer attrition and management's understanding of the industry.
Goodwill - The excess of the purchase price over the preliminary fair value
of net tangible and intangible assets acquired of $32.2 million was
allocated to goodwill. Various factors contributed to the establishment of
goodwill, including: the value of Quan Emerteq's highly trained assembled
work force and management team; 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
expanding its vascular, CRM and neurostimulation businesses. The goodwill
acquired in connection with the Quan Emerteq acquisition was allocated to
the Company's IMC business segment and is deductible for tax purposes.
Engineered Assemblies Corporation
On November 16, 2007, Electrochem acquired substantially all of the assets
of Engineered Assemblies Corporation ("EAC") based in Teterboro, New
Jersey, with operations in Suzhou, China. EAC is a leading provider of
custom battery solutions and electronics integration focused on
rechargeable battery systems. With the acquisition of EAC, the Company now
can provide a range of rechargeable technology solutions and expanded into
the external medical battery market.
This transaction was accounted for under the purchase method of accounting.
Accordingly, the results of EAC's operations were included in the
consolidated financial statements from the date of acquisition. The
aggregate purchase price was $15.1 million, consisting of the cash issued
at closing to EAC shareholders ($14.9 million), and other direct
acquisition-related costs, including financial advisory, legal and
accounting services ($0.2 million).
84
The cost of the acquisition was preliminarily allocated to the assets
acquired and liabilities assumed from EAC 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, the finalization of the working capital
adjustment as defined in the purchase agreement, the Company incurring
direct acquisition costs in connection with this transaction and the
resolution of pre-acquisition tax positions. The valuations will be
finalized within 12 months of the close of the acquisition. When the
valuations are finalized, any changes to the preliminary valuation of
assets acquired or liabilities assumed may result in material adjustments
to the fair value of the intangible assets acquired, as well as 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) November 16, 2007
------------------------------------------------- ---------------------------
Assets acquired
Current assets $ 7,880
Property, plant and equipment 940
Amortizing intangible assets 2,336
Goodwill 5,409
Other Assets 87
---------------------------
Total assets acquired 16,652
Liabilities assumed
Current liabilities 1,585
---------------------------
Total liabilities assumed 1,585
---------------------------
Purchase price $ 15,067
===========================
The fair values of the assets acquired and liabilities assumed were
preliminarily determined using one 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 in-process and finished inventory. The income approach,
which indicates value for a subject asset based on the present value of
cash flows projected to be generated by the asset, was used for certain
intangible assets such as technology and patents, customer relationships,
and for the noncompete agreement with an employee. The projected cash flows
were discounted at a required rate of return that reflects the relative
risk of the EAC transaction and the time value of money. The projected cash
flows for each asset considered multiple factors, including current revenue
from existing customers, 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 raw materials inventory. The cost to replace a given asset reflects the
estimated reproduction or replacement cost for the asset.
85
Inventory - The fair value of the in-process and finished inventory
acquired was estimated by applying a version of the market approach called
the comparable sales 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 $0.42 million. For 2007, the Company expensed as
cost of sales $0.21 million of the step-up value relating to the acquired
EAC inventory sold during 2007. As of December 28, 2007, there was $0.21
million of inventory step-up value remaining in inventory to be expensed as
the inventory is sold. Raw materials inventory was valued at replacement
cost.
Intangible assets - The purchase price was allocated to specific intangible
assets on a preliminary basis as follows (dollars in thousands):
Weighted
average
Amount amortization Discount
assigned period (years) rate
------------- -------------------- --------------
Amortizable intangible assets
Technology and patents $ 1,031 5 22%
Customer relationships 1,250 7 19%
Noncompete agreements 55 3 15%
------------- --------------------
$2,336 6
Technology and patents - Technology and patents consist of technical
processes, patented and unpatented technology, manufacturing know-how and
the understanding with respect to products or processes that have been
developed by EAC and that will be leveraged in current and future products.
The Company determined that the weighted average estimated useful life of
the technology and patents is 5 years. This life is based upon management's
estimate of the product life cycle associated with technology and patents
before they will be replaced by new technologies. The expected cash flows
associated with technology and patents were nominal after 5 years.
Customer relationships - Customer relationships represent the preliminary
estimated fair value of both the contractual and non-contractual customer
relationships EAC has with OEMs as of the acquisition date. The primary
customers of EAC include 3M, IBM, Thales Communications and ZOLL 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 7 years. This life
was based upon historical customer attrition and management's understanding
of the industry.
86
Goodwill - The excess of the purchase price over the preliminary fair value
of net tangible and intangible assets acquired of $5.4 million was
allocated to goodwill. Various factors contributed to the establishment of
goodwill, including: the value of EAC's highly trained assembled work force
and Management team; 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 ECP business from
expanding into the rechargeable battery market. The goodwill acquired in
connection with the EAC acquisition was allocated to the Company's ECP
business segment and is deductible for tax purposes.
Pro Forma Results
The following unaudited pro forma information presents the consolidated
results of operations of the Company, Enpath, Quan Emerteq and EAC as if
those acquisitions had occurred as of the beginning of each of the fiscal
periods presented. Pro forma amounts do not reflect the acquisitions of
BIOMEC and IntelliSensing as, excluding the IPR&D charge of $2.3 million
related to the BIOMEC acquisition, these acquisitions did not materially
impact the Company's results of operations (in thousands, except per share
amounts):
Year-ended
-----------------------------------------
(Unaudited) December 28, 2007 December 29, 2006
--------------------- -------------------
Sales $375,567 $342,136
Net income 23,909 12,026
Earnings per share:
Basic $ 1.08 $ 0.55
Diluted $ 1.03 $ 0.54
The unaudited pro forma information presents the combined operating results
of Greatbatch, Enpath, Quan Emerteq and EAC, 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 the acquired companies ($5.9 million),
the elimination of the non-recurring IPR&D charge ($13.8 million) and
inventory step-up adjustment recorded by Greatbatch in 2007 ($1.7 million),
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.
87
Subsequent Events
P Medical Holding SA & DePuy Orthopaedics' Chaumont, France Facility
On January 4, 2008, the Company acquired P Medical Holding SA ("Precimed")
with offices in Orvin, Switzerland and Exton, PA, manufacturing operations
in Switzerland and Indiana and sales offices in Japan, Asia and the United
Kingdom. Precimed is a leading technology-driven supplier to the orthopedic
industry. This transaction significantly diversifies the Company's business
into the orthopedic market and establishes the Company as a leading OEM
supplier to multiple market verticals.
On February 11, 2008, Precimed completed its previously announced
acquisition of DePuy Orthopaedic's ("DePuy") Chaumont, France manufacturing
facility. The Chaumont facility produces hip and shoulder implants for
DePuy Ireland which distributes them worldwide through various DePuy
selling entities. This transaction, which included a new four year supply
agreement with DePuy, enhances Greatbatch's and Precimed's strategic
relationship with one of the largest orthopedic companies in the world. The
addition of this facility will align Precimed closer to its orthopedic OEM
customers and further extends its offerings to a full range of orthopedic
implants.
The Company acquired all of the outstanding shares of Precimed and the
assets of the Chaumont facility in exchange for approximately $130 million
in cash, and a contingent payment, as defined in the Precimed purchase
agreement, which can range from 0 Swiss Francs ("CHF") to 12,000,000 CHF
depending on Precimed's 2008 earnings performance. Based upon the exchange
ratio of 1.1169 CHF per one U.S. dollar as of December 28, 2007 the maximum
contingent payment would be approximately $10.7 million and is subject to
change due to foreign currency fluctuations and the final calculation of
the contingent payment. The purchase price was funded with cash on hand
(approximately $13 million) and borrowings under the Company's revolving
credit agreement (approximately $117 million). These transactions will be
accounted for under the purchase method of accounting.
88
3. 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
-------------- ------------- --------------- ----------------
December 28, 2007
--------------------------------------
Commercial Paper $ 1,087 $ 5 $ - $ 1,092
U.S. Government Agencies 1,469 4 - 1,473
Corporate Bonds 4,452 4 (4) 4,452
-------------- ------------- --------------- ----------------
Total available-for-sale
securities $ 7,008 $ 13 $ (4) $ 7,017
============== ============= =============== ================
December 29, 2006
--------------------------------------
Equity Security $ 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
============== ============= =============== ================
During 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 $0.12 per
diluted share.
4. INVENTORIES
Inventories are comprised of the following (in thousands):
December 28, December 29,
2007 2006
---------------- ---------------
Raw material $ 38,561 $ 28,568
Work-in-process 19,603 13,528
Finished goods 13,718 15,571
---------------- ---------------
Total $ 71,882 $ 57,667
================ ===============
89
5. PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment are comprised of the following (in
thousands):
December 28, December 29,
2007 2006
------------------- -------------------
Manufacturing machinery and equipment $ 80,447 $ 69,453
Buildings and building improvements 35,611 32,793
Construction work in process 23,115 11,295
Information technology hardware and software 21,671 19,787
Leasehold improvements 19,957 12,142
Land and land improvements 6,024 5,328
Furniture and fixtures 5,345 4,230
Other 210 129
------------------- -------------------
192,380 155,157
Accumulated depreciation (77,434) (63,288)
------------------- -------------------
Total $ 114,946 $ 91,869
=================== ===================
Depreciation expense for property, plant and equipment during 2007, 2006
and 2005 was approximately $16.4 million, $14.8 million and $15.1 million,
respectively.
6. AMORTIZING INTANGIBLE ASSETS
Amortizing intangible assets are comprised of the following (in thousands):
Gross
carrying Accumulated Net carrying
amount amortization amount
--------------- ---------------- ------------
December 28, 2007
Purchased technology and patents $ 69,813 $ (28,968) $ 40,845
Customer lists 29,983 (840) 29,143
Other 2,660 (1,380) 1,280
-------------- --------------- ------------
Total amortizing intangible
assets $ 102,456 $ (31,188) $ 71,268
============== =============== ============
December 29, 2006
Purchased technology and patents $ 52,511 $ (24,433) $ 28,078
Other 1,177 (1,177) -
-------------- --------------- ------------
Total amortizing intangible
assets $ 53,688 $ (25,610) $ 28,078
============== =============== ============
Intangible amortization expense was $5.6 million, $3.8 million and $3.8
million for 2007, 2006 and 2005, respectively. Prior to 2007, all
intangible amortization expense was included in Cost of Sales. For 2007,
$1.0 million of intangible amortization expense was included in Selling,
General and Administrative Expenses and related to the customer lists and
non-compete agreements acquired in 2007. Annual intangible amortization
expense is estimated to be $8.9 million for 2008, $8.2 million for 2009,
and $7.6 million in 2010 and 2011 and $7.5 million in 2012. These amounts
do not include the amortization expense that will be recorded in connection
with our 2008 acquisitions - See Note 2 "Acquisitions."
90
7. ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES
Accrued expenses and other current liabilities are comprised of the
following (in thousands):
December 28, December 29,
2007 2006
---------------- ---------------
Salaries and benefits $ 10,655 $ 11,055
Profit sharing and bonuses 13,669 13,928
Warranty 1,453 1,993
Other 5,198 2,642
---------------- ---------------
Total $ 30,975 $ 29,618
================ ===============
8. DEBT
Convertible subordinated notes is comprised of the following (in
thousands):
December 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 (8,802) -
----------------- ----------------
Total long-term debt $ 241,198 $ 170,000
================= ================
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 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 $0.13 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, which was paid in 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:
91
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.
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. CSN II notes were issued at a
price of $950 per $1,000 of principal. The effective interest rate of CSN
II notes, which takes into consideration the amortization of the discount
and deferred fees related to the issuance of those notes, was 3.55%.
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.
92
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.
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.
The fair-value of the convertible subordinated notes based on recent sales
prices as of December 28, 2007 and December 29, 2006 was approximately $220
million and $160 million, respectively.
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 and approval of a simple majority of the
lenders. 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 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,
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.
93
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. These limitations can be waived upon the
Company's request and approval of a simple majority of the lenders. Such
waiver was obtained in order to fund the Precimed acquisition in 2008.
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.
As of December 28, 2007 and December 29, 2006 the Company had no balance
outstanding on its revolving line of credit. In connection with the
Company's acquisitions that closed in January and February of 2008, the
Company borrowed approximately $117 million under the New Credit Facility
(see Note 2 "Acquisitions").
Deferred Financing Fees - The following is a reconciliation of deferred
financing fees for 2007 and 2006, which are included in other assets (in
thousands):
Balance at December 31, 2005 $ 2,953
Amortization during the year (648)
-----------------
Balance at December 29, 2006 2,305
Financing costs deferred 6,632
Write-off during the year (1,416)
Amortization during the year (1,110)
-----------------
Balance at December 28, 2007 $ 6,411
=================
9. EMPLOYEE BENEFIT PLANS
Savings Plan - The Company sponsors a defined contribution 401(k) plan,
which covers substantially all of its employees. The plan provides for the
deferral of employee compensation under Section 401(k) and a discretionary
Company match. In 2007, 2006 and 2005, this match was $0.35 per dollar of
participant deferral, up to 6% of the total compensation for each
participant. Net costs related to this defined contribution plan were $1.0
million in 2007 and $0.9 million in 2006 and 2005.
In addition to the above, under the terms of the 401(k) plan document there
is an annual discretionary defined contribution equal to five percent of
each employee's eligible compensation. This amount is contributed to the
401(k) plan in the form of Company stock. Compensation cost recognized
related to the defined contribution was approximately $3.6 million in 2007,
$3.3 million in 2006 and $2.8 million in 2005. As of December 28, 2007, the
401(k) Plan held 473,927 shares of Company stock and there were 174,434
committed-to-be released shares for the plan, which equals the estimated
number of shares to settle the liability based on the closing market price
of the Company's stock at December 28, 2007 of $19.91.
94
Education Assistance Program - The Company reimburses tuition, textbooks
and laboratory fees for college or other job related programs for all of
its employees. The Company also reimburses college tuition for the
dependent children of its full-time employees. For certain employees, the
dependent children benefit vests on a straight-line basis over ten years.
Minimum academic achievement is required in order to receive reimbursement
under both programs. Aggregate expenses under the programs were
approximately $1.5 million, $1.2 million and $0.9 million in 2007, 2006 and
2005, respectively.
10. STOCK-BASED COMPENSATION
Compensation costs related to share-based payments for 2007 totaled $5.7
million, $3.8 million net of tax, or $0.17 per diluted and basic share.
This compares to $6.4 million, $4.4 million net of tax, or $0.17 per
diluted and $0.20 per basic share for 2006. The 2007 and 2006 expense
amounts include $0.1 million and $2.4 million, respectively, for the
accelerated vesting for certain retirement-eligible employees and $0.6
million and $0.3 million for modifications, respectively. This modification
expense relates to the Company's adoption of executive retirement
guidelines in 2005 for senior level executives and the extension of the
exercise period after termination for all outstanding stock options of its
former Chief Executive Officer in 2006. Stock-based compensation expense
included in the Consolidated Statements of Cash Flows includes costs
recognized for stock options, restricted stock, restricted stock units and
the annual share contribution to the 401(k) Plan. See Note 9 - "Employee
Benefit Plans."
Proceeds from the exercise of stock options under stock option plans are
credited to common stock at par value and the excess is credited to
additional paid-in capital. A portion of the Company's granted options
qualify as incentive stock options ("ISO") for income tax purposes. As
such, a tax benefit is not recorded at the time the compensation cost
related to the options is recorded for book purposes due to the fact that
an ISO does not ordinarily result in a tax benefit unless there is a
disqualifying disposition. Stock option grants of non-qualified options
result in the creation of a deferred tax asset, which is a temporary
difference, until the time that the option in exercised. Due to the
treatment of incentive stock options for tax purposes, the Company's
effective tax rate from year to year is subject to variability.
During 2007, the Board of Directors approved the grant of 146,231 shares of
performance based non-qualified stock options. As of December 28, 2007,
138,161 shares of the original award remain outstanding due to forfeitures.
The performance metrics for these awards cover a three-year performance
period beginning in 2007 and include the achievement of revenue, operating
earnings and operating cash flow targets. Compensation expense related to
these awards amounted to $0.3 million during 2007.
95
During 2006, the Board of Directors approved the grant of 183,648 shares of
performance based non-qualified stock options. As of December 28, 2007,
149,236 shares of the original award remain outstanding due to forfeitures.
The performance metrics for these awards cover a three-year performance
period beginning in 2006 and include the achievement of revenue, operating
earnings and operating cash flow targets. Compensation expense related to
these awards amounted to $0.5 million and $0.2 million during 2007 and
2006, respectively.
Stock-based compensation expense is only recorded for those awards that are
expected to vest. Forfeiture estimates for determining appropriate
stock-based compensation expense are estimated at the time of grant based
on historical experience and demographic characteristics. Revisions are
made to those estimates in subsequent periods if actual forfeitures differ
from estimated forfeitures. A 9% annual forfeiture rate estimate was used
for the stock-based compensation expense recorded during 2007 and 2006
unless it was certain that the awards would vest (i.e. retirement eligible
employees, awards that immediately vest). In those instances, a 0%
forfeiture rate was used.
Stock Options
Summary of Plans
The Company's 1997 Stock Option Plan ("1997 Plan") authorized the issuance
of up to 480,000 shares of nonqualified and incentive stock options to
purchase the Company's common stock, subject to the terms of the plan. The
stock options granted under the 1997 Plan generally vest over a five-year
period and may vary depending upon the achievement of certain performance
targets as determined by the Board of Directors. The stock options expire
10 years from the date of the grant. Stock options were granted at exercise
prices equal to or greater than the fair market value of the Company's
common stock on the date of grant.
The Company's 1998 Stock Option Plan ("1998 Plan") authorized the issuance
of up to 1,220,000 shares of nonqualified and incentive stock options to
purchase the Company's common stock, subject to the terms of the plan. The
stock options granted under the 1998 Plan vest over a three to five year
period and may vary depending upon the achievement of certain performance
targets as determined by the Board of Directors. The stock options expire
10 years from the date of grant. Stock options were granted at exercise
prices equal to or greater than the fair value of the Company's common
stock on the date of grant.
The Company has a stock option plan that provides for the issuance of
nonqualified stock options to Non-Employee Directors ("Director Plan"). The
Director Plan authorized the issuance of up to 100,000 shares of
nonqualified stock options to purchase the Company's common stock from its
treasury, subject to the terms of the plan. The stock options granted under
the Director Plan vest immediately. The stock options expire 10 years from
the date of grant. Stock options were granted at exercise prices equal to
or greater than the fair value of the Company's common stock on the date of
grant.
96
The Company's 2005 Stock Incentive Plan ("2005 Plan"), as amended and
approved by stockholders at the 2007 Annual Meeting of Stockholders,
authorizes the issuance of up to 2,450,000 shares of equity incentive
awards including nonqualified and incentive stock options to purchase the
Company's common stock, subject to the terms of the plan. Upon adoption of
the amendment to the 2005 Plan at the 2007 Annual Meeting of Stockholders,
any new stock option issuances are required to be issued from the 2005 Plan
and all previous plans have been frozen for new share issuances. The stock
options granted under the 2005 Plan generally vest over a four to five year
period and may vary depending upon the achievement of certain performance
targets as determined by the Board of Directors and the terms of each
specific grant. The stock options expire 10 years from the date of grant.
Stock options are granted at exercise prices equal to or greater than the
fair value of the Company's common stock on the date of grant.
As of December 28, 2007, 1,317,904 shares were available for future grants
of options under the 2005 Plan.
The following table summarizes stock option activity related to the
Company's plans:
Weighted
Weighted average
average remaining Aggregate
Number of exercise contractual intrinsic
stock options price life value(1)
(in years) (in millions)
----------------------------------------------------------
Outstanding at January 1, 2005 1,249,854 $ 23.68
Granted 477,906 20.95
Exercised (97,888) 10.91
Forfeited or Expired (232,712) 26.90
----------------
Outstanding at December 30, 2005 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
Granted(3) 376,708 26.87
Exercised (141,302) 19.10
Forfeited or Expired (117,913) 27.50
----------------
Outstanding at December 28, 2007 1,744,022 $ 25.04 7.1 $ 0.9
==========================================================
Expected to Vest at December 28, 2007 1,665,266 $ 25.04 7.1 $ 0.8
==========================================================
Exercisable at December 28, 2007 903,368 $ 25.56 5.9 $ 0.7
==========================================================
(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 December 28, 2007 ($19.91) 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.
97
The following table provides certain information relating to the exercise
of stock options (in thousands):
Year Ended
-------------------------------------------------------------
December 28, December 29, December 30,
2007 2006 2005
------------------------ ------------------ -----------------
Stock Options Exercised
Intrinsic value $ 1,338 $ 2,120 $ 1,209
Cash received 2,699 2,082 1,068
Tax benefit realized 292 236 252
As of December 28, 2007, $5.2 million of unrecognized compensation
cost related to non-vested stock options is expected to be recognized
over a weighted-average period of approximately 3 years. Shares are
distributed from the Company's authorized but unissued reserve upon
the exercise of stock options or treasury stock if available. The
Company does not intend to purchase treasury shares to fund the future
exercises of stock options.
Fair Value
----------
The Company utilizes the Black-Scholes Option Pricing Model to determine
the fair value of stock options under SFAS No. 123(R), consistent with that
used for pro forma disclosures in prior years. Management is required to
make certain assumptions with respect to selected model inputs, including
anticipated changes in the underlying stock price (i.e. expected
volatility) and option exercise activity (i.e. expected life). Expected
volatility is based on the historical volatility of the Company's stock
over the most recent period commensurate with the estimated expected life
of the stock options. The expected life of options granted, which
represents the period of time that the options are expected to be
outstanding, is based primarily on historical data. The expected dividend
yield is based on the Company's history and expectation of dividend
payouts. The risk-free interest rate is based on the U.S. Treasury yield
curve in effect at the time of grant for a period commensurate with the
estimated expected life. If factors change and result in different
assumptions in the application of SFAS No. 123(R) in future periods, the
stock option expense that the Company records for future grants may differ
significantly from what the Company has recorded in the current period.
The weighted-average fair value and assumptions used to value options
granted are as follows:
December 28, December 29, December 30,
2007 2006 2005
--------------------- ---------------- ------------------
Weighted-average fair value $ 11.84 $ 10.85 $ 9.89
Risk-free interest rate 4.52% 4.74% 3.95%
Expected volatility 40% 42% 46%
Expected life (in years) 5 5 5
Expected dividend yield 0% 0% 0%
98
Restricted Stock and Restricted Stock Units
Summary of Plans
----------------
The Company's 2002 Restricted Stock Plan authorized the issuance of stock
awards to employees. The number of shares that were reserved for issuance
under the plan could not exceed 200,000. Under this plan, restricted stock
awards are either time-vested or performance-vested based on the terms of
each individual award agreement. Time-vested restricted stock vests 50% on
the second fiscal year-end from the date of the award and 25% on the third
and fourth fiscal year-end from the date of the award. Performance-vested
restricted stock vests upon the achievement of certain annual diluted
earnings per share targets by the company, or the seventh anniversary date
of the award.
The Company's 2005 Plan, as amended and approved by stockholders at the
2007 Annual Meeting of Stockholders, authorizes the issuance of restricted
stock, restricted stock units and stock bonuses of up to 850,000 shares,
subject to the terms of the plan. Upon adoption of the amendment to the
2005 Plan at the 2007 Annual Meeting of Stockholders, any new restricted
stock, restricted stock units and stock bonus issuances are required to be
issued from the 2005 Plan and all previous plans have been frozen for new
share issuances. Time-vested restricted stock granted under the 2005 Plan
generally vest 50% on the second fiscal year-end from the date of the award
and 25% on the third and fourth fiscal year-end from the date of the award.
Performance-vested restricted stock granted under the 2005 Plan vests upon
the achievement of certain annual diluted earnings per share targets by the
company, or the seventh anniversary date of the award. Performance-vested
restricted stock units granted under the 2005 Plan vest upon the completion
of Board approved strategic initiatives.
As of December 28, 2007, there were 575,767 shares available for future
grants of restricted stock, restricted stock units or stock bonuses under
the 2005 Plan, subject to the overall limit imposed by the 2005 Plan.
Restricted Stock and Restricted Stock Unit Activity
---------------------------------------------------
The following table summarizes restricted stock and restricted stock unit
activity related to the Company's plans:
Weighted average
Activity fair value
----------------------- -----------------------
Nonvested at January 1, 2005 40,300 $ 27.79
Shares granted 67,891 19.75
Shares vested - -
Shares forfeited (14,235) 24.66
-----------------------
Nonvested at December 30, 2005 93,956 22.46
Shares granted (1) 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 122,031 27.17
Shares vested (36,435) 23.56
Shares forfeited (7,618) 23.30
-----------------------
Nonvested at December 28, 2007 282,134 $ 24.96
=======================
(1) Includes 50,879 performance based restricted stock units which vested
in January 2008.
99
The fair value of restricted stock and restricted stock units is equal to
the fair value of the Company's stock on the date of grant. The realized
tax benefit from the vesting of restricted stock was $0.03 million, $0.05
million and $0 for 2007, 2006 and 2005, respectively. As of December 28,
2007, there was $4.0 million of total unrecognized compensation cost
related to the restricted stock and restricted stock unit awards. That cost
is expected to be recognized over a weighted-average period of
approximately 3 years.
11. OTHER OPERATING EXPENSES
The following charges were recorded in other operating expenses in the
Company's Consolidated Statement of Operations and Comprehensive Income (in
thousands).
Year Ended
--------------------------------------------------
December 28, December 29, December 30,
2007 2006 2005
---------------- ---------------- ----------------
(a) Alden Facility consolidation $ - $ 623 $ 2,806
(b) Carson City Facility shutdown and Tijuana
Facility consolidation No. 1 331 2,743 4,440
(c) Columbia Facility shutdown, Tijuana Facility
consolidation No. 2 and RD&E consolidation 4,366 5,125 1,134
(d) Electrochem Commercial Power expansion 531 - -
(e) Tijuana Facility start-up - - 1,402
(f) Asset dispositions and other 96 6,073 7,287
(g) Severance - 2,494 1,505
---------------- ---------------- ----------------
$ 5,324 $ 17,058 $ 18,574
================ ================ ================
(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.
100
Accrued liabilities related to the Alden Facility consolidation are
comprised of the following (in thousands):
Production Moving and
inefficiencies and facility
revalidation Training closures Other Total
Balance, December 31, 2005 $ - $ - $ 198 $ - $ 198
Restructuring charges 99 - 524 623
Cash payments (99) - (722 ) - (821)
Accelerated depreciation/
asset write-offs - - - - -
--------------------- ---------- ------------ ----------- --------
Balance, December 29, 2006 $ - $ - $ - $ - $ -
===================== ========== ============ =========== ========
(b) Carson City Facility shutdown and Tijuana Facility consolidation No.
1. Beginning in the first quarter of 2005 and ending in the third
quarter of 2007 the Company consolidated its Carson City, NV facility
("Carson City Facility") into its Tijuana, Mexico facility ("Tijuana
Facility consolidation No. 1").
The total cost for this consolidation was $7.5 million which, was above the
original estimates, as the Company delayed the closing of this facility in
order to accommodate a customer's regulatory approval. The major categories
of costs include the following:
o Costs related to the shutdown of the Carson City Facility:
a. Severance and retention - $3.6 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 - $0.2 million;
c. Personnel (including travel, training and duplicate wages) - $1.7
million; and
d. Other - $0.6 million.
All categories of costs are considered to be cash expenditures, except
accelerated depreciation. The expenses for the Carson City Facility
shutdown and the Tijuana Facility consolidation No. 1 is included in the
IMC business segment.
101
Accrued liabilities related to the Carson City Facility shutdown are
comprised of the following (in thousands):
Severance and Accelerated
retention depreciation Other Total
Balance, December 31, 2005 $ 2,096 $ - $ - $ 2,096
Restructuring charges 1,455 5 57 1,517
Cash payments (2,394) - (57) (2,451)
Write-offs - (5) - (5)
-------------------- --------------- --------- -----------
Balance, December 29, 2006 $ 1,157 $ - $ - $ 1,157
Restructuring charges 85 - 26 111
Cash payments (1,092) - (26) (1,118)
Write-offs - - - -
-------------------- --------------- --------- -----------
Balance, December 28, 2007 $ 150 $ - $ - $ 150
==================== =============== ========= ===========
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
Balance, December 31, 2005 $ - $ - $ - $ - $ -
Restructuring charges 288 1 651 286 1,226
Cash payments (288) (1) (651) (286) (1,226)
Write-offs - - - - -
--------------------------- --------------- ------------- --------- --------
Balance, December 29, 2006 $ - $ - $ - $ - $ -
Restructuring charges 220 - - - 220
Cash payments (220) - - - (220)
Write-offs - - - - -
--------------------------- --------------- ------------- --------- --------
Balance, December 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 its Columbia, MD facility ("Columbia Facility") and its
Fremont, CA Advanced Research Laboratory ("ARL"). The manufacturing
operations at the Columbia Facility will be moved into the Tijuana Facility
("Tijuana Facility consolidation No. 2"). The research, development and
engineering ("RD&E") and product development functions at the Columbia
Facility and at ARL was relocated to the Technology Center in Clarence, NY.
The Columbia Facility shutdown, which was previously scheduled to be
completed in the first quarter of 2008, is now expected to be finalized in
mid-2008 based on customer's qualification activities.
102
The total estimated cost for this facility consolidation plan is
anticipated to be between $11.6 million and $12.1 million of which $10.6
million has been incurred through December 28, 2007. The ARL move and
closure portion of this consolidation project is complete. The Company
expects to incur and pay the remaining cost for the other portions of the
consolidation project over the next three fiscal quarters through September
2008.
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 - $3.8 to $4.0 million;
b. Personnel (including travel, training and duplicate wages) - $1.6
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 - $0.4 million;
c. Personnel (including travel, training and duplicate wages) - $3.0
to $3.1 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. 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
Balance, December 31, 2005 $ 379 $ - $ - $ 310 $ 689
Restructuring charges 1,918 701 74 118 2,811
Cash payments (550) (701) - (428) (1,679)
Write-offs - - (74) - (74)
-------------------- ----------- ----------------- --------- -------------
Balance, December 29, 2006 $ 1,747 $ - $ - $ - $ 1,747
Restructuring charges 1,320 574 - 18 1,912
Cash payments (1,367) (574) - (18) (1,959)
Write-offs - - - - -
-------------------- ----------- ----------------- --------- -------------
Balance, December 28, 2007 $ 1,700 $ - $ - $ - $ 1,700
==================== =========== ================= ========= =============
103
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
Balance, December 31, 2005 $ - $ - $ - $ - $ -
Restructuring charges 264 149 1,584 317 2,314
Cash payments (264) (149) (1,584) (317) (2,314)
----------------------- ------------ ----------- -------- --------
Balance, December 29, 2006 $ - $ - $ - $ - $ -
Restructuring charges 817 6 1,098 533 2,454
Cash payments (817) (6) (1,098) (533) (2,454)
----------------------- ------------ ----------- -------- --------
Balance, December 28, 2007 $ - $ - $ - $ - $ -
======================= ============ =========== ======== ========
(d) Electrochem 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 Raynham, MA. The expected
completion of this $28 million expansion project is in the fourth quarter
of 2008. The total expense to be recognized for this relocation is
estimated to be $2.4 million to $2.6 million, of which $0.5 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 - $0.6 million; and
o Other - $0.3 million to $0.4 million.
(e) Tijuana Facility start-up. Other Tijuana start-up expenses (not
associated with the Carson City Facility or Columbia Facility
consolidations) during 2005 amounted to $1.4 million. These expenses are
primarily related to the initial start-up of the value-added assembly
business.
(f) Asset dispositions and other. During 2007, the Company had various
asset disposals offset by a $0.5 million of insurance proceeds on
previously disposed assets.
104
During 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. The remaining expense for 2006 includes charges for various asset
dispositions and $0.8 million for professional fees related to a potential
acquisition that was no longer considered probable.
During 2005, a $2.8 million charge was recorded for the write-down of
automated cathode assembly equipment for the IMC segment. The remaining
expense for 2005 relates to various asset dispositions of approximately
$3.3 million and the cost to exit a development agreement of $1.2 million.
(g) Severance charges. During the fourth quarter of 2006, the Company
implemented a plan for consolidating its corporate and business unit
organization structure. As a result, severance charges of $2.49 million
were recorded in 2006. Expense of $1.42 million was recorded in the IMC
segment, $0.04 million in the ECP segment and $1.3 million was recorded in
unallocated operating expenses under business segment information. Accrued
severance related to this consolidation plan was $0.3 million and $1.8
million as of December 28, 2007 and December 29, 2006, respectively.
During the first quarter of 2005, the Company implemented a 4% workforce
reduction as a continuation of cost containment efforts initiated mid-year
2004. As a result, severance charges of $1.5 million were recorded and paid
in 2005. Expense of $0.9 million was recorded in the IMC segment, $0.2
million in the ECP segment and $0.4 million was recorded in unallocated
operating expenses under business segment information.
12. INCOME TAXES
The provision for income taxes was comprised of the following (in
thousands):
Year Ended
---------------------------------------------------
December 28, December 29, December 30,
2007 2006 2005
-------------------- --------------- --------------
Current:
Federal $ 17,981 $ 2,378 $ 931
State 592 142 96
-------------------- --------------- --------------
18,573 2,520 1,027
-------------------- --------------- --------------
Deferred:
Federal (4,910) 4,831 4,243
State (25) 57 87
-------------------- --------------- --------------
(4,935) 4,888 4,330
-------------------- --------------- --------------
Provision for income taxes $ 13,638 $ 7,408 $ 5,357
==================== =============== ==============
105
The provision for income taxes differs from the federal statutory rate due
to the following:
Year Ended
--------------------------------------------------
December 28, December 29, December 30,
2007 2006 2005
--------------------- -------------- -------------
Statutory rate 35.0% 35.0% 35.0%
State taxes, net of federal benefit 1.3 0.5 0.8
Extraterritorial income exclusion (0.2) (3.8) (0.9)
Permanent items (1.3) 1.9 0.4
In-process research and development 16.9 0.0 0.0
Federal and state tax credits (4.3) (2.4) (9.5)
Valuation allowance (0.6) 0.7 7.4
Other 0.7 (0.4) 1.4
--------------------- -------------- -------------
Effective tax rate 47.5% 31.5% 34.6%
===================== ============== =============
In 2007, 2006 and 2005, 141,302, 92,693, and 75,887 shares of common stock,
respectively, were issued through the exercise of non-qualified stock
options or through the disqualifying disposition of ISO's. The total tax
benefit to the Company from these transactions, which is credited to
additional paid-in capital rather than recognized as a reduction of income
tax expense, was $0.3 million, $0.2 million, and $0.3 million in 2007, 2006
and 2005, respectively. These tax benefits have also been recognized in the
consolidated balance sheet as a reduction of current income taxes payable.
Deferred tax assets (liabilities) consist of the following (in thousands):
December 28, December 29,
2007 2006
--------------------- -----------------
Property, plant and equipment depreciation $ (3,129) $ (3,574)
Investments - (1,064)
Convertible subordinated notes (9,129) (15,269)
Intangible assets (28,976) (19,317)
Other (190) (19)
--------------------- -----------------
Gross deferred tax liabilities (41,424) (39,243)
--------------------- -----------------
Tax credits 5,090 4,372
Accrued expenses and deferred compensation 2,636 3,340
Inventories 3,634 3,824
Stock-based compensation 3,465 1,992
Net operating loss carryforwards 1,691 97
--------------------- -----------------
Gross deferred tax assets 16,516 13,625
Less valuation allowance (3,969) (4,342)
--------------------- -----------------
12,547 9,283
--------------------- -----------------
Net deferred tax liability $ (28,877) $ (29,960)
===================== =================
Net current deferred tax asset $ 6,469 $ 5,899
Net noncurrent deferred tax liability (35,346) (35,859)
--------------------- -----------------
Total net deferred tax liability $ (28,877) $ (29,960)
===================== =================
106
As of December 28, 2007, the Company has the following carryforwards
available:
Tax Remaining
Jurisdiction Attribute Amount Years
------------ ------------------------ --------------------------- ------------------------------
Federal Net Operating Loss $4.5 million (1) 19
State Net Operating Loss $0.1 million Various
Federal R&D Credit $0.7 million (1) 19
State R&D Credit $0.3 million (1) 19
State Investment Tax Credit $4.0 million Various
(1) These tax attributes were acquired as part of the Enpath acquisition in
2007 and the utilization is subject to an annual limitation under Internal
Revenue Code Section 382.
In assessing the realizability of deferred tax assets, management
considers, within each taxing jurisdiction, whether it is more likely than
not that some portion or all of the deferred tax assets will not be
realized. Management considers the scheduled reversal of deferred tax
liabilities, projected future taxable income and tax planning strategies in
making this assessment. Based on the consideration of the weight of both
positive and negative evidence, management has determined that it is more
likely than not that a portion of the deferred tax asset as of December 28,
2007 related to certain state investment tax credits and net operating
losses will not be realized.
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.
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. At adoption, the Company's unrecognized tax
benefits consisted of refund claims which did not meet the more likely than
not threshold under FIN No. 48. The Company will recognize interest expense
related to uncertain tax positions as Interest Expense. Penalties, if
incurred, would be recognized as a component of Selling, General and
Administrative Expenses. The Company recognized interest expense and
penalties of $0.1 million and $0.05 million, respectively, during 2007.
The Company files annual income tax returns in the U.S., various U.S. state
and local jurisdictions, and in various foreign jurisdictions. A number of
years may elapse before an uncertain tax position, for which we have
unrecognized tax benefits, is audited and finally resolved. While it is
often difficult to predict the final outcome or the timing of resolution of
any particular uncertain tax position, we believe that our unrecognized tax
benefits reflect the most probable outcome. We adjust these unrecognized
tax benefits, as well as the related interest, in light of changing facts
and circumstances. Settlement of any particular uncertain tax position
would usually require the use of cash. The resolution of a matter could be
recognized as an adjustment to our provision for income taxes and our
effective tax rate in the period of resolution.
107
Below is a summary of changes to the unrecognized tax benefit (in
thousands):
Balance, beginning of year $1,787
Additions based upon tax positions related to the current year 110
Additions recorded as part of purchase accounting 280
Reductions relating to settlements with tax authorities (481)
Reductions as a result of a lapse of the applicable
statute of limitations (18)
-------
Balance, end of year $1,678
=======
The number of tax years that remain open and subject to tax audits varies
depending on the tax jurisdiction. During 2007, the IRS completed their
review of our 2003 and 2004 amended U.S. income tax returns and we have
received the respective refunds. In order for the IRS to complete their
review, the statute of limitations for the 2003 tax year had been extended
until June 30, 2008. During 2006, the IRS had completed their examination
of the 2003 and 2004 tax years. The 2005 and 2006 tax years remain open for
examination.
It is reasonably possible that a reduction in the range of $0.06 million to
$0.6 million of the balance of unrecognized tax benefits may occur within
the next 12 months as a result of potential settlements with taxing
authorities and the lapse of the statute of limitations.
13. 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, 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
US 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 $3.0 million, $2.0 million and $1.5 million for 2007, 2006
and 2005, respectively. 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.
108
License agreements - The Company is a party to various license agreements
through 2018 for technology that is utilized in certain of its products.
The most significant of these is an agreement to license the basic
technology used for wet tantalum capacitors in the IMC segment. The Company
is required to pay royalties based on agreed upon terms through August
2014. Expenses related to license agreements were $2.1 million, $1.5
million and $1.6 million, for 2007, 2006 and 2005, respectively.
Product Warranties - The change in the aggregate product warranty liability
was comprised of the following (in thousands):
Year Ended
-------------------------------------------------
December 28, December 29,
2007 2006
------------------------- -----------------------
Beginning balance $ 1,993 $ 2,443
Warranty reserves acquired 158 -
Additions to warranty reserve 945 1,744
Warranty claims paid (1,642) (2,194)
------------------------- -----------------------
Ending balance $ 1,454 $ 1,993
========================= =======================
Operating Leases - The Company is a party to various operating lease
agreements for buildings, equipment and software. The Company incurred
operating lease expense of $2.2 million, $2.3 million, and $2.7 million, in
2007, 2006 and 2005, respectively. Minimum future annual operating lease
payments are $2.1 million in 2008; $1.7 million in 2009; $1.4 million in
2010; $1.3 million in 2011; $1.4 million in 2012 and $3.4 million
thereafter. The Company primarily leases buildings, which accounts for the
majority of the future lease payments. Lease expense includes the effect of
escalation clauses and leasehold improvement incentives which are accounted
for ratably over the lease term.
Workers' Compensation Trust - In Western New York, the Company is a member
of a group self-insurance trust that provides workers' compensation
benefits to eligible employees of the Company and other group member
employers. For locations outside of Western New York, the Company utilizes
traditional insurance relationships to provide workers' compensation
benefits. Under the terms of the Trust, the Company makes annual
contributions to the Trust based on reported salaries paid to the employees
using a rate based formula. Based on actual experience, the Company could
receive a refund or be assessed additional contributions. For financial
statement purposes, no amounts have been recorded for any refund or
additional assessment since the Trust has not informed the Company of any
such adjustments. Under the trust agreement, each participating
organization has joint and several liability for trust obligations if the
assets of the trust are not sufficient to cover its obligation. The Company
does not believe that it has any current obligations under the joint and
several liability.
109
Purchase Commitments - Contractual obligations for the 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 December 28,
2007, the total contractual obligation related to such expenditures is $9.1
million and 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.
Foreign Currency Contract - In December 2007, the Company entered into a
forward contract to purchase 80,000,000 CHF, at an exchange rate of 1.1389
CHF per one U.S. dollar, in order to partially fund the acquisition of
Precimed, which closed in January 2008 and was payable in Swiss Francs. In
January 2008, the Company entered into an additional forward contract to
purchase 20,000,000 CHF at an exchange rate of 1.1156 per one U.S. dollar.
The Company entered into a similar foreign exchange contract in January
2008 in order to fund the acquisition of DePuy's Chaumont France facility,
which closed in February 2008 and was payable in Euros. The net result of
the above transactions was a gain of $2.4 million, $0.8 million of which
was recorded in 2007 (based upon the fair value of the forward contract at
December 28, 2007) as Other Income and the remainder will be recorded in
the first quarter of 2008. See Note 2 - "Acquisitions" for further
discussion of the 2008 acquisitions.
Capital Expenditures - During 2007, the Company commenced the construction
of a new 80,000 square foot facility in Raynham, MA related to the ECP
expansion. Once completed, the Company will close its facility in Canton,
MA. Additionally, in 2007, construction began on the expansion of our
corporate headquarters. The contractual obligations at December 28, 2007
for continuing construction of these facilities and other miscellaneous
capital projects are $23.4 million and will be financed by cash, cash
equivalents, and short-term investments on hand, or from cash flows from
operations.
110
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 batteries, capacitors, filtered
feedthroughs, engineered components and enclosures used in Implantable
Medical Devices ("IMDs"). Additionally, the IMC business offers value-added
assembly and design engineering services for products that incorporate IMD
components. With the acquisitions of Enpath and Quan Emerteq in 2007, the
IMC business now designs, develops and manufactures introducers, catheters,
implantable stimulation leads and microcomponents for the vascular, cardiac
rhythm management and neurostimulation markets.
The ECP segment designs and manufactures high performance batteries and
battery packs for use in oil and gas exploration, pipeline inspection,
telematics, oceanography equipment, seismic, communication, military and
aerospace applications. With the acquisitions of EAC and IntelliSensing,
the ECP business can now design and provide its customers rechargeable
battery and wireless sensor systems.
The Company defines segment income from operations as sales less cost of
sales including amortization and expenses attributable to segment-specific
selling, general and administrative, research, development and engineering
expenses, and other operating expenses. Segment income also includes a
portion of non-segment specific selling, general and administrative, and
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. Segment assets are intended to correlate
with invested capital. The amounts include accounts receivable,
inventories, net property, plant and equipment, amortizing intangible
assets, trademark and tradenames, and goodwill. Corporate assets consist
primarily of cash, short-term investments available for sale, deferred
income taxes and net property, plant and equipment for corporate
headquarters. The accounting policies of the segments are the same as those
described and referenced in Note 1 "Summary of Significant Accounting
Policies." Sales by geographic area are presented by attributing sales from
external customers based on where the products are shipped. 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):
111
Year Ended
--------------------------------------------------
December 28, December 29, December 30,
2007 2006 2005
------------------ ------------- -----------------
Sales:
IMC
Medical batteries:
ICD batteries $ 48,946 $ 45,140 $ 45,803
Pacemakers and other batteries 20,964 21,090 21,708
ICD capacitors 26,466 16,780 20,709
Feedthroughs 64,999 64,578 59,210
Introducers, catheters and leads 23,287 - -
Enclosures 20,777 23,904 23,866
Other 64,383 55,915 36,618
------------------ ------------- -----------------
Total IMC sales 269,822 227,407 207,914
ECP 48,924 43,735 33,183
------------------ ------------- -----------------
Total sales $ 318,746 $ 271,142 $ 241,097
================== ============= =================
Year Ended
--------------------------------------------------
December 28, December 29, December 30,
2007 2006 2005
-------------------- --------------- -------------
Segment income from operations:
IMC $ 25,367 $ 27,860 $ 23,136
ECP 9,378 12,359 7,303
-------------------- --------------- -------------
Total segment income from operations 34,745 40,219 30,439
Unallocated operating expenses (14,725) (17,843) (13,553)
-------------------- --------------- -------------
Operating income as reported 20,020 22,376 16,886
Unallocated other income (expense) 8,668 1,158 (1,422)
-------------------- --------------- -------------
Income before provision for income
taxes as reported $ 28,688 $ 23,534 $ 15,464
==================== =============== =============
Included in the 2007 IMC income from operations is $16.1 million of
acquired in-process research and development from the acquisitions of
BIOMEC and Enpath which was expensed in the current year.
112
Year Ended
--------------------------------------------------
December 28, December 29, December 30,
2007 2006 2005
------------------- ------------- ----------------
Depreciation and amortization:
IMC $ 19,166 $ 15,068 $ 15,749
ECP 1,632 833 851
------------------- ------------- ----------------
Total depreciation and amortization included
in segment income from operations 20,798 15,901 16,600
Unallocated depreciation and amortization 5,044 3,408 3,118
------------------- ------------- ----------------
Total depreciation and amortization $ 25,842 $ 19,309 $ 19,718
=================== ============= ================
The changes in the carrying amount of goodwill:
IMC ECP Total
-------- ------ --------
Balance at December 29, 2006 $152,473 $2,566 $155,039
Goodwill recorded during the year 86,337 7,164 93,501
-------- ------ --------
Balance at December 28, 2007 $238,810 $9,730 $248,540
======== ====== ========
Year Ended
--------------------------------------------------
December 28, December 29, December 30,
2007 2006 2005
-------------------- --------------- -------------
Expenditures for tangible long-lived assets,
excluding acquisitions:
IMC $ 12,847 $ 12,154 $ 25,259
ECP 7,558 1,351 183
-------------------- --------------- -------------
Total reportable segments 20,405 13,505 25,442
Unallocated long-lived tangible assets 2,087 855 2,404
-------------------- --------------- -------------
Total expenditures $ 22,492 $ 14,360 $ 27,846
==================== =============== =============
As of
--------------------------------------------------
December 28, December 29, December 30,
2007 2006 2005
-------------------- --------------- -------------
Identifiable assets, net:
IMC $ 526,699 $ 379,250 $ 355,568
ECP 44,667 25,061 21,881
-------------------- --------------- -------------
Total reportable segments 571,366 404,311 377,449
Unallocated assets 92,485 143,516 135,462
-------------------- --------------- -------------
Total assets $ 663,851 $ 547,827 $ 512,911
==================== =============== =============
113
Year Ended
--------------------------------------------------
December 28, December 29, December 30,
2007 2006 2005
-------------------- --------------- -------------
Sales by geographic area:
United States $ 153,708 $ 137,138 $ 126,832
Foreign countries:
Ireland 63,800 57,208 53,399
Puerto Rico 42,132 26,221 6,722
All other 59,106 50,575 54,144
-------------------- --------------- -------------
Consolidated sales $ 318,746 $ 271,142 $ 241,097
==================== =============== =============
As of
--------------------------------------------------
December 28, December 29,
2007 2006
----------------------- -------------------------
Long-lived tangible assets:
United States $ 111,364 $ 76,440
Foreign countries 18,873 18,692
----------------------- -------------------------
Consolidated long-lived assets $ 130,237 $ 95,132
======================= =========================
Three customers accounted for a significant portion of the Company's sales
and accounts receivable as follows:
Sales Accounts Receivable
----------------------------------------- -------------------------
Year Ended As of
----------------------------------------- -------------------------
December 28, December 29, December 30, December 28, December 29,
2007 2006 2005 2007 2006
------------- ------------- ------------- ------------ ------------
Customer A 25% 25% 35% 16% 18%
Customer B 25% 26% 23% 17% 16%
Customer C 17% 16% 12% 17% 16%
------------- ------------- ------------- ------------ ------------
Total 67% 67% 70% 50% 50%
============= ============= ============= ============ ============
114
15. QUARTERLY SALES AND EARNINGS DATA - UNAUDITED
4th Qtr. 3rd Qtr. 2nd Qtr. 1st Qtr.
-------------------------- --------------- ------------------- ----------------------
2007 (in thousands, except per share data)
----
Sales $ 84,415 $ 79,009 $ 78,462 $ 76,860
Gross profit (1) 26,555 29,140 31,706 28,624
Net income (loss) (2) 2,780 5,000 (3,399) 10,669
Earnings per share - basic 0.13 0.23 (0.15) 0.48
Earnings per share - diluted 0.12 0.22 (0.15) 0.43
2006
----
Sales $ 63,143 $ 69,294 $ 70,598 $ 68,107
Gross profit (1) 22,396 25,637 26,777 27,634
Net income 1,394 3,239 4,843 6,650
Earnings per share - basic 0.06 0.15 0.22 0.31
Earnings per share - diluted 0.06 0.15 0.21 0.28
(1) Gross profit equals total sales minus cost of sales including amortization
of intangibles.
(2) Net loss in the second quarter of 2007 was a result of an IPR&D Charge. See
Note 2 "Acquisitions."
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
ITEM 9A. CONTROLS AND PROCEDURES
Management's Report on Internal Control Over Financial Reporting - Appears
under Part II, Item 8, "Financial Statements and Supplementary Data."
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. These disclosure
controls and procedures have been designed to provide reasonable assurance
that material information relating to us, including our subsidiaries, is
made known to our management, including these officers, by other of our
employees, and that this information is recorded, processed, summarized,
evaluated and reported, as applicable, within the time periods specified in
the SEC's rules and forms.
Based on their evaluation, as of December 28, 2007, our principal executive
officer and principal financial officer have concluded that our disclosure
controls and procedures are effective.
115
b. Changes in Internal Control Over Financial Reporting.
-----------------------------------------------------
We completed the following acquisitions during 2007:
o Enpath Medical, Inc. on June 15, 2007
o IntelliSensing, LLC on October 26, 2007
o Quan Emerteq, LLC on November 16, 2007
o Engineered Assemblies Corporation on November 16, 2007
We believe that the internal controls and procedures of the above mentioned
acquisitions 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 these acquisitions
into our internal controls over financial reporting.
The Company has begun to extend 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 these acquisitions. However, the
Company has excluded the acquisitions listed above from Management's
assessment of the effectiveness of internal control over financial
reporting as of December 28, 2007, as permitted by the guidance issued by
the Office of the Chief Accountant of the Securities and Exchange
Commission. 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.
There were no other changes in the registrant's internal control over
financial reporting during our last fiscal quarter to which this Annual
Report on Form 10-K relates that have materially affected, or are
reasonably likely to materially affect, internal control over financial
reporting, other than the above mentioned acquisitions.
ITEM 9B. OTHER INFORMATION
None.
PART III
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
Except as set forth below, the identification of each of the Registrant's
directors is incorporated by reference to the caption "Election of Directors"
contained in the Company's definitive Proxy Statement for its 2008 Annual
Meeting of Stockholders, which will be filed with the Securities and Exchange
Commission on or about April 18, 2008.
Thomas S. Summer, age 54, has served as director since November 2003. He was
re-elected to a one-year term at the Company's 2007 Annual Meeting of
Stockholders. Mr. Summer had been Executive Vice President and Chief
Financial Officer of Constellation Brands, Inc. from April 1997 until his
retirement from that position on May 15, 2007. Because of responsibilities
associated with his acceptance of a position as Chief Financial Officer of
Advance Publications, Inc. in January 2008, Mr. Summer has decided that he
will not stand for re-election at the Company's 2008 Annual Meeting of
Stockholders.
116
The identification of the Company's executive officers is presented under the
caption "Executive Officers of the Company" contained in Part I of this
Annual Report on Form 10-K.
The other information required by Item 10 is incorporated by reference to the
Company's definitive Proxy Statement for its 2008 Annual Meeting of
Stockholders, which will be filed with the Securities and Exchange Commission
on or about April 18, 2008.
ITEM 11. EXECUTIVE COMPENSATION
Information regarding executive compensation in the Proxy Statement for the
2008 Annual Meeting of Stockholders is incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
Information regarding security ownership of certain beneficial owners in the
Proxy Statement for the 2008 Annual Meeting of Stockholders is incorporated
herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR
INDEPENDENCE
Information regarding certain relationships and related transactions, and
director independence in the Proxy Statement for the 2008 Annual Meeting of
Stockholders is incorporated herein by reference.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
Information regarding the fees paid to and services provided by Deloitte &
Touche LLP, the Company's independent registered public accounting firm, in
the Proxy Statement for the 2008 Annual Meeting of Stockholders is
incorporated herein by reference.
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
(a) LIST OF DOCUMENTS FILED AS PART OF THIS REPORT
(1) Financial statements and financial statement schedules filed
as part of this Annual Report on Form 10-K. See Part II, Item
8. "Financial Statements and Supplementary Data."
117
(2) FINANCIAL STATEMENT SCHEDULES
The following financial statement schedule is included in this report
on Form 10-K: Schedule II - Valuation and Qualifying Accounts.
Schedule II - Valuation and Qualifying Accounts
Additions
-------------------------
Col. B Col. E
Balance at Charged Col. D Balance at
to
Col. A Beginning Charged Other Deductions - End of
to Accounts-
Description of Period Costs & Describe Describe Period
Expenses
(in thousands)
December 28, 2007
Allowance for
doubtful accounts $ 532 $ 151 $ 173(4) $ (98)(2) $ 758
Valuation allowance
for deferred income
tax assets $ 4,342 $ - $ - $ (373)(1) $3,969
December 29, 2006
Allowance for
doubtful accounts $ 450 $ 179 $ - $ (97)(2) $ 532
Valuation allowance
for deferred income
tax assets $ 4,843 $ 40(1) $ - $ (541)(3) $4,342
December 30, 2005
Allowance for
doubtful accounts $ 405 $ 66 $ - $ (21)(2) $ 450
Valuation allowance
for deferred income
tax assets $ 3,701 $ 1,142(1) $ - $ - $4,843
(1) Valuation allowance recorded in the provision for income taxes for certain
net operating losses and tax credits.
(2) Accounts written off, net of collections on accounts receivable previously
written off.
(3) Reversal of valuation allowance related to available for sale investments.
(4) Balances recorded as a part of our 2007 acquisitions of Enpath Medical,
Quan Emerteq and EAC.
Schedules not listed above have been omitted because the information required to
be set forth therein is not applicable or is shown in the financial statements
or notes thereto.
(3) Exhibits required by Item 601 of Regulation S-K. The exhibits listed on the
Exhibit Index of this Annual Report on Form 10-K have been previously
filed, are filed herewith or are incorporated herein by reference to other
filings.
118
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: February 26, 2008 GREATBATCH, INC.
By /s/ Thomas J. Hook
-----------------------------------
Thomas J. Hook
President & Chief Executive Officer
(Principal Executive Officer)
By /s/ Thomas J. Mazza
----------------------------------
Thomas J. Mazza
Senior Vice President & Chief Financial
Officer
(Principal Financial Officer)
By /s/ Marco F. Benedetti
-----------------------------------
Marco F. Benedetti
Corporate Controller
(Principal Accounting Officer)
119
Pursuant to the requirements of the Securities Exchange Act of
1934, this report has been signed below by the following persons on behalf of
the Registrant and in the capacities and on the date indicated.
Signature Title Date
--------- ----- ----
By /s/ Thomas J. Hook President & Chief Executive Officer February 26, 2008
----------------------- & Director
Thomas J. Hook
/s/ Bill R. Sanford Chairman February 26, 2008
------------------------------------
Bill R. Sanford
/s/ Pamela G. Bailey Director February 26, 2008
------------------------------------
Pamela G. Bailey
/s/Kevin C. Melia Director February 26, 2008
---------------------------
Kevin C. Melia
/s/Dr. Joseph A. Miller, Jr. Director February 26, 2008
------------------------------------
Dr. Joseph A. Miller, Jr.
Director
------------------------------------
Peter H. Soderberg
/s/ Thomas S. Summer Director February 26, 2008
---------------------------
Thomas S. Summer
/s/ William B. Summers, Jr. Director February 26, 2008
------------------------------------
William B. Summers, Jr.
/s/ John P. Wareham Director February 26, 2008
------------------------------------
John P. Wareham
120
EXHIBIT INDEX
EXHIBIT
NUMBER DESCRIPTION
------ -----------
2.1 Agreement and Plan of Merger dated as of April 28, 2007 by and among Greatbatch Ltd. and Enpath
Medical, Inc. (incorporated by reference to Exhibit 2.1 to our Current Report on Form 8-K filed on
April 30, 2007).
2.2 Tender and Support Agreement dated as of April 28, 2007 by and among Greatbatch Ltd. and Chestnut
Acquisition Corporation (incorporated by reference to Exhibit 2.2 to our Current Report on Form 8-K
filed on April 30, 2007).
2.3 Asset Purchase Agreement dated October 29, 2007, by and between Greatbatch Ltd. and its wholly owned
subsidiary, Cardinal Acquisition Corporation, and Quan Emerteq, LLC (incorporated by reference to
Exhibit 2.1 to our Current Report on Form 8-K filed on November 2, 2007).
2.4 Share Purchase Agreement dated as of November 21, 2007, by and among the persons named on the signature
page, P Medical Holding SA, Greatbatch, Inc. and Greatbatch Ltd. (incorporated by reference to Exhibit 2.1
to our Current Report on Form 8-K filed on January 8, 2008).
3.1 Amended and Restated Certificate of Incorporation (incorporated by reference to Exhibit 3.1 to our
Registration Statement on Form S-1 (File No. 333-37554)).
3.2 Amended and Restated Bylaws (incorporated by reference to Exhibit 3.2 to our Quarterly Report on Form
10-Q for the quarterly period ended March 29, 2002).
4.1 Indenture for 2 1/4 % Convertible Subordinated Debentures Due 2013 dated May 28, 2003 (incorporated by
reference to Exhibit 4.2 to our Registration Statement on Form S-3 (File No. 333-107667) filed on
August 5, 2003).
4.2 Registration Rights Agreement dated May 28, 2003 by among us and the initial purchasers of the
Debentures described above (incorporated by reference to Exhibit 4.2 to our Registration Statement on
Form S-3 (File No. 333-107667) filed on August 5, 2003).
4.3 Indenture for 2 1/4% Convertible Subordinated Debentures Due 2013 dated as of March 28, 2007
(incorporated by reference to Exhibit 10.3 to our Current Report on Form 8-K filed on March 29, 2007).
4.4 First Supplemental Indenture dated April 2, 2007 (incorporated by reference to Exhibit 10.3 to our
Current Report on Form 8-K filed on April 4, 2007).
4.5 Registration Rights Agreement dated as of March 28, 2007 by and among us and the initial purchasers of
the Debentures described above (incorporated by reference to Exhibit 10.2 to our Current Report on Form
8-K filed on March 29, 2007).
121
10.1# 1997 Stock Option Plan (including form of "standard" option agreement and form of "special" option agreement)
(incorporated by reference to Exhibit 10.1 to our Registration Statement on Form S-1 (File No. 333-37554)).
10.2# 1998 Stock Option Plan (including form of "standard" option agreement, form of "special" option agreement
and form of "non-standard" option agreement) (incorporated by reference to Exhibit 10.2 to our Registration
Statement on Form S-1 (File No. 333-37554)).
10.3# Greatbatch Ltd. Equity Plus Plan Money Purchase Plan (incorporated by reference to Exhibit 10.3 to our
Registration Statement on Form S-1 (File No. 333-37554)).
10.4# Greatbatch Ltd. Equity Plus Plan Stock Bonus Plan (incorporated by reference to Exhibit 10.4 to our
Registration Statement on Form S-1 (File No. 333-37554)).
10.5# Non-Employee Director Stock Incentive Plan (incorporated by reference to Exhibit A to our Definitive
Proxy Statement on Schedule 14-A filed on April 22, 2002).
10.6# Greatbatch, Inc. Executive Short Term Incentive Compensation Plan (incorporated by reference to Exhibit B to
our Definitive Proxy Statement on Schedule 14A filed on April 20, 2007).
10.7 Credit Agreement dated as of May 22, 2007 by and among Greatbatch Ltd., the lenders party thereto and
Manufacturers and Traders Trust Company, as administrative agent (incorporated by reference to Exhibit
10.1 of our Current Report on Form 8-K filed on May 25, 2007).
10.8# 2002 Restricted Stock Plan (incorporated by reference to Appendix B to our Definitive Proxy Statement
on Schedule 14A filed on April 9, 2003).
10.9+ Supply Agreement dated February 22, 2005 between Greatbatch Ltd and Cardiac Pacemakers, Inc.,
(d/b/a Boston Scientific) for the purchase of filtered feedthrough materials and components. (incorporated by
reference to Exhibit 10.1 to our Quarterly Report on Form 10-Q for the quarter ended April 1, 2005).
10.10 License Agreement dated August 8, 1996, between Greatbatch Ltd. and Evans Capacitor Company
(incorporated by reference to Exhibit 10.23 to our Registration Statement on Form S-1 (File No.
333-37554)).
10.11+ Amendment No. 2 dated December 6, 2002, between Greatbatch Technologies, Ltd. and Evans Capacitor
Company (incorporated by reference to Exhibit 10.18 to our Annual Report on Form 10-K for the year
ended January 3, 2003).
10.12+ Supplier Partnering Agreement dated as of October 23, 2003, between Greatbatch, Inc. and Pacesetter,
Inc., a St. Jude Medical Company (incorporated by reference to Exhibit 10.20 to our Annual Report on
Form 10-K for the year ended January 2, 2004).
122
10.13+ Amendment No. 1 dated October 8, 2004, to Supplier Partnering Agreement dated as of October 23, 2003,
between Greatbatch, Inc. and Pacesetter, Inc., d/b/a St. Jude Medical CRMD (incorporated by reference
to Exhibit 10.14 to our Annual Report on Form 10-K for the fiscal year ended December 31, 2004).
10.14+ License Agreement dated October 25, 2005 between Greatbatch, Inc. and Medtronic, Inc. (incorporated by
reference to Exhibit 10.16 to our Annual Report on Form 10-K
for the fiscal year ended December 30, 2005).
10.15# Form of Change of Control Agreement, dated August 14, 2006, between Greatbatch, Inc. and our executive
officers (Thomas J. Hook, Thomas J. Mazza, Mauricio Arellano, Susan M. Bratton, Susan Campbell, Barbara
Davis, Timothy McEvoy, Marco F. Benedetti, Edward F. Voboril and Larry T. DeAngelo).
10.16# Employment Agreement dated August 8, 2006 between Greatbatch, Inc. and Thomas J. Hook (incorporated by
reference to Exhibit 10.1 to our Quarterly Report on Form 10-Q for the quarterly period ended September
29, 2006).
10.17 2005 Stock Incentive Plan (incorporated by reference to Exhibit B to our Definitive Proxy Statement on
Schedule 14A filed on April 20, 2007).
10.18 Form of Restricted Stock Award Letter (incorporated by reference to Exhibit 10.22 to our Annual Report
on Form 10-K for the fiscal year ended December 30, 2005).
10.19 Form of Incentive Stock Option Award Letter (incorporated by reference to Exhibit 10.23 to our Annual
Report on Form 10-K for the fiscal year ended December 30, 2005).
10.20 Form of Nonqualified Option Award Letter (incorporated by reference to Exhibit 10.24 to our Annual
Report on Form 10-K for the fiscal year ended December 30, 2005).
10.21 Form of Stock Option Award Letter (incorporated by reference to Exhibit 10.25 to our Annual Report on
Form 10-K for the fiscal year ended December 30, 2005).
10.22+ Supply Agreement for medical device components dated March 31, 2006, between Greatbatch, Inc. and
SORIN/ELA BIOMEDICA CRM and ELA MEDICAL SAS (incorporated by reference to Exhibit 10.1 to our Quarterly
Report on Form 10-Q for the quarterly period ended March 31, 2006).
10.23 Form of Exchange and Purchase Agreement dated March 22, 2007, by and between Greatbatch, Inc. and
certain other parties thereto. Incorporated by reference to Exhibit 10.1 to our Current Report on Form
8-K filed on March 29, 2007).
10.24+ Amendment No. 2 to Supplier Partnering Agreement, effective as of July 27, 2005, between Greatbatch,
Inc. and Pacesetter, Inc. d/b/a St. Jude Medical CRMD (incorporated by reference to Exhibit 10.1 to our
Quarterly Report on Form 10-Q for the quarter ended March 30, 2007).
123
10.25+ Amendment No. 2 to Supplier Partnering Agreement, effective as of January 1, 2006, between Greatbatch,
Inc. and Pacesetter, Inc. d/b/a St. Jude Medical CRMD (incorporated by reference to Exhibit 10.2 to our
Quarterly Report on Form 10-Q for the quarter ended March 30, 2007).
10.26+ Amendment No. 4 to Supplier Partnering Agreement, effective as of January 1, 2006, between Greatbatch,
Inc. and Pacesetter, Inc. d/b/a St. Jude Medical CRMD (incorporated by reference to Exhibit 10.3 to our
Quarterly Report on Form 10-Q for the quarter ended March 30, 2007).
10.27+ Amendment No. 5 to Supplier Partnering Agreement, effective as of March 1, 2007, between Greatbatch,
Inc. and Pacesetter, Inc. d/b/a St. Jude Medical CRMD (incorporated by reference to Exhibit 10.4 to our
Quarterly Report on Form 10-Q for the quarter ended March 30, 2007).
10.28+ Amendment No. 6 to Supplier Partnering Agreement, effective as of March 1, 2007, between Greatbatch,
Inc. and Pacesetter, Inc. d/b/a St. Jude Medical CRMD (incorporated by reference to Exhibit 10.5 to our
Quarterly Report on Form 10-Q for the quarter ended March 30, 2007).
10.29+ Supply Agreement between Cardiac Pacemakers, Inc. (d/b/a Boston Scientific) and Greatbatch, Ltd., 2007
- 2010, effective July 1, 2007 (incorporated by reference to Exhibit 10.1 to our Quarterly Report on
Form 10-Q for the quarter ended June 29, 2007).
12.1* Ratio of Earnings to Fixed Charges (Unaudited)
21.1* Subsidiaries of Greatbatch, Inc.
23.1* Consent of Independent Registered Public Accounting Firm
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.
32.1* 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.
Portions of those exhibits marked "+" have been omitted and filed separately
with the Securities and Exchange Commission pursuant to a request for
confidential treatment.
* - Filed herewith.
# - Indicates exhibits that are management contracts or compensation plans
or arrangements required to be filed pursuant to Item 14(c) of Form 10-K.
124