U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarter ended March 28, 2008
Commission File Number 1-16137
GREATBATCH, INC.
(Exact name of Registrant as specified in its charter)
Delaware
(State of incorporation)
16-1531026
(I.R.S. employer identification no.)
9645 Wehrle Drive
Clarence, New York
14031
(Address of principal executive offices)
(716) 759-5600
(Registrant's telephone number, including area code)
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [_]
Indicate by check mark whether the registrant is a large accelerated
filer, an accelerated filer, 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 Exchange Act Rule 12b-2). Yes [_] No [X]
The number of shares outstanding of the Company's common stock, $0.001 par value
per share, as of May 6, 2008 was: 22,866,233 shares.
GREATBATCH, INC.
TABLE OF CONTENTS FOR FORM 10-Q
AS OF AND FOR THE THREE MONTHS ENDED MARCH 28, 2008
Page
COVER PAGE 1
TABLE OF CONTENTS 2
PART I - FINANCIAL INFORMATION (unaudited)
ITEM 1. Condensed Consolidated Financial Statements
Condensed Consolidated Balance Sheets 3
Condensed Consolidated Statements of Operations and Comprehensive Income 4
Condensed Consolidated Statements of Cash Flows 5
Condensed Consolidated Statement of Stockholders' Equity 6
Notes to Condensed Consolidated Financial Statements 7
ITEM 2. Management's Discussion and Analysis of Financial Condition and 34
Results of Operations
ITEM 3. Quantitative and Qualitative Disclosures About Market Risk 49
ITEM 4. Controls and Procedures 50
PART II - OTHER INFORMATION
ITEM 1. Legal Proceedings 51
ITEM 1A. Risk Factors 51
ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds 51
ITEM 3. Defaults Upon Senior Securities 51
ITEM 4. Submission of Matters to a Vote of Security Holders 51
ITEM 5. Other Information 51
ITEM 6. Exhibits 52
SIGNATURES 52
EXHIBIT INDEX 52
PART I - FINANCIAL INFORMATION
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
GREATBATCH, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS - Unaudited
(in thousands except share and per share data)
---------------------------------------------------------------------------------- ------------------
As of
----------------- ------------------
March 28, December 28,
ASSETS 2008 2007
----------------- ------------------
Current assets:
Cash and cash equivalents $ 14,307 $ 33,473
Short-term investments available for sale 6,455 7,017
Accounts receivable, net of allowance of $970 in 2008
and $758 in 2007 79,499 56,962
Inventories, net of reserve 93,960 71,882
Refundable income taxes 4,249 377
Deferred income taxes 6,715 6,469
Prepaid expenses and other current assets 3,654 5,044
----------------- ------------------
Total current assets 208,839 181,224
Property, plant and equipment, net 158,321 114,946
Amortizing intangible assets, net 99,505 71,268
Trademarks and tradenames 34,863 32,582
Goodwill 298,816 248,540
Other assets 14,242 15,291
----------------- ------------------
Total assets $ 814,586 $ 663,851
================= ==================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 40,794 $ 33,433
Accrued expenses and other current liabilities 33,121 30,975
Current portion of long-term debt 2,101 -
----------------- ------------------
Total current liabilities 76,016 64,408
Long-term debt 358,571 241,198
Deferred income taxes 42,593 35,346
Other long-term liabilities 5,155 228
----------------- ------------------
Total liabilities 482,335 341,180
----------------- ------------------
Stockholders' equity:
Preferred stock, $0.001 par value, authorized 100,000,000
shares; no shares issued or outstanding in 2008 or 2007 - -
Common stock, $0.001 par value, authorized 100,000,000
shares; 22,859,205 shares issued and outstanding in 2008
and 22,477,340 shares issued and 22,470,299 shares
outstanding in 2007 23 22
Additional paid-in capital 244,604 238,574
Treasury stock, at cost, no shares in 2008 and 7,041 shares in
2007 - (140)
Retained earnings 80,841 84,215
Accumulated other comprehensive income 6,783 -
----------------- ------------------
Total stockholders' equity 332,251 322,671
----------------- ------------------
Total liabilities and stockholders' equity $ 814,586 $ 663,851
================= ==================
The accompanying notes are an integral part of these condensed consolidated
financial statements
-3-
GREATBATCH, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE INCOME - Unaudited
(in thousands except per share data)
---------------------------------------------------------------------------------- ----------------
Three months ended
-----------------------------------
March 28, March 30,
2008 2007
------------------ ----------------
Sales $ 122,154 $ 76,860
Costs and expenses:
Cost of sales - excluding amortization
of intangible assets 93,745 47,288
Cost of sales - amortization of intangible assets 1,710 948
Selling, general and administrative expenses 18,347 10,033
Research, development and engineering costs, net 9,224 6,452
Acquired in-process research and development 2,240 -
Other operating expense, net 1,028 1,533
------------------ ----------------
Operating income (loss) (4,140) 10,606
Interest expense 3,431 1,144
Interest income (396) (1,856)
Gain on extinguishment of debt - (4,473)
Other income, net (1,457) (16)
------------------ ----------------
Income (loss) before provision (benefit) for income taxes (5,718) 15,807
Provision (benefit) for income taxes (2,344) 5,138
------------------ ----------------
Net income (loss) $ (3,374) $ 10,669
================== ================
Earnings (loss) per share:
Basic $ (0.15) $ 0.48
Diluted $ (0.15) $ 0.43
Weighted average shares outstanding:
Basic 22,386 22,014
Diluted 22,386 26,470
Comprehensive income:
Net income (loss) $ (3,374) $ 10,669
Foreign currency translation adjustment 7,209 -
Unrealized loss on interest rate swap, net of tax (461) -
Unrealized gain (loss) on short-term investments
available for sale, net of tax 35 (226)
------------------ ----------------
Comprehensive income $ 3,409 $ 10,443
================== ================
The accompanying notes are an integral part of these condensed consolidated
financial statements
-4-
GREATBATCH, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS - Unaudited
(in thousands)
-------------------------------------------------------------------------------------------------------------------
Three months ended
-------------------------------------
March 28, March 30,
2008 2007
------------------ ------------------
Cash flows from operating activities:
------------------------------------------------------------------------------
Net income (loss) $ (3,374) $ 10,669
Adjustments to reconcile net income (loss) to net cash provided
by operating activities:
Depreciation and amortization 15,995 4,989
Stock-based compensation 3,046 2,548
Gain on extinguishment of debt - (4,473)
Acquired in-process research and development 2,240 -
Other non-cash (gains) losses 79 (251)
Deferred income taxes 1,382 (10,369)
Changes in operating assets and liabilities:
Accounts receivable (9,807) (7,220)
Inventories 221 3,184
Prepaid expenses and other current assets 759 820
Accounts payable (6,021) 6,617
Accrued expenses and other current liabilities 2,506 (13,266)
Income taxes refundable/payable (3,972) 15,370
------------------ ------------------
Net cash provided by operating activities 3,054 8,618
------------------ ------------------
Cash flows from investing activities:
------------------------------------------------------------------------------
Purchase of short-term investments (1,988) (22,925)
Proceeds from maturity/disposition of short-term investments 2,550 15,379
Acquisition of property, plant and equipment (7,924) (1,829)
Acquisitions, net of cash acquired (99,745) -
Other investing activities 180 301
------------------ ------------------
Net cash used in investing activities (106,927) (9,074)
------------------ ------------------
Cash flows from financing activities:
------------------------------------------------------------------------------
Borrowings under line of credit 117,000 -
Principal payments of long-term debt (31,682) -
Proceeds from issuance of long-term debt - 76,000
Issuance of common stock - 610
Excess tax benefits from stock-based awards 16 32
Repurchase of treasury stock (793) (205)
------------------ ------------------
Net cash provided by financing activities 84,541 76,437
------------------ ------------------
Effect of foreign currency exchange rates on cash and cash equivalents 166 -
------------------ ------------------
Net increase (decrease) in cash and cash equivalents (19,166) 75,981
Cash and cash equivalents, beginning of year 33,473 71,147
------------------ ------------------
Cash and cash equivalents, end of period $ 14,307 $ 147,128
================== ==================
The accompanying notes are an integral part of these condensed consolidated
financial statements
-5-
GREATBATCH, INC.
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY - Unaudited
(in thousands)
------------------------------------------------------------------------------------------------------------------------------------
Treasury Accumulated
Common Stock Additional Stock Other Total
--------------- Paid-In ------------------ Retained Comprehensive Stockholders'
Shares Amount Capital Shares Amount Earnings Income Equity
------- -------- ------------ -------- --------- ------------ -------------- -------------
Balance, December 28, 2007 22,477 $ 22 $ 238,574 (7) $ (140) $ 84,215 $ - $ 322,671
Stock-based compensation - - 1,928 - - - - 1,928
Grant of restricted stock 103 1 (793) 36 793 - - 1
Vesting of restricted stock units 51 - - - - - - -
Repurchase of shares to settle
employee tax witholding on vested
restricted stock and restricted
stock units - - - (29) (653) - - (653)
Tax impact from vesting of restricted
stock and restricted stock units - - (50) - - - - (50)
Shares issued in connection with the
Quan Emerteq acquisition 60 - 1,473 - - - - 1,473
Shares contributed to 401(k) Plan 168 - 3,472 - - - - 3,472
Net loss - - - - - (3,374) - (3,374)
Total other comprehensive income - - - - - - 6,783 6,783
------- ------- ------------ -------- --------- ------------ -------------- --------------
Balance, March 28, 2008 22,859 $ 23 $ 244,604 - $ - $ 80,841 $ 6,783 $ 332,251
======= ======= ============ ======== ========= ============ ============== ==============
The accompanying notes are an integral part of these condensed consolidated
financial statements
-6-
GREATBATCH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Unaudited
----------------------------------------------------------------
1. BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements have
been prepared in accordance with accounting principles generally accepted
in the United States of America for interim financial information
(Accounting Principles Board Opinion ("APB") No. 28, Interim Financial
Reporting) and with the instructions to Form 10-Q and Article 10 of
Regulation S-X. Accordingly, they do not include all of the information
necessary for a fair presentation of financial position, results of
operations, and cash flows in conformity with accounting principles
generally accepted in the United States of America. Operating results for
interim periods are not necessarily indicative of results that may be
expected for the fiscal year as a whole. In the opinion of management, the
condensed consolidated financial statements reflect all adjustments
(consisting of normal recurring adjustments) considered necessary for a
fair presentation of the results of Greatbatch, Inc. and its wholly-owned
subsidiary Greatbatch Ltd. (collectively "Greatbatch" or the "Company") for
the periods presented. The preparation of financial statements in
conformity with accounting principles generally accepted in the United
States of America requires management to make estimates and assumptions
that affect the reported amounts of assets, liabilities, sales, expenses,
and related disclosures at the date of the financial statements and during
the reporting period. Actual results could differ from these estimates. The
December 28, 2007 condensed consolidated balance sheet data was derived
from audited financial statements but does not include all disclosures
required by accounting principles generally accepted in the United States
of America. For further information, refer to the consolidated financial
statements and notes included in the Company's Annual Report on Form 10-K
for the year ended December 28, 2007. The Company utilizes a fifty-two,
fifty-three week fiscal year ending on the Friday nearest December 31st.
For 52-week years, each quarter contains 13 weeks. The first quarter of
2008 and 2007 each contained 13 weeks and ended on March 28, and March 30,
respectively.
2. ACQUISITIONS
P Medical Holding SA
On January 7, 2008, the Company acquired P Medical Holding SA ("Precimed")
with administrative offices in Orvin, Switzerland and Exton, PA,
manufacturing operations in Switzerland and Indiana and sales offices in
Japan, Asia and the United Kingdom. This transaction diversifies the
Company's revenue and establishes the Company as a leading supplier to the
orthopedics industry.
This transaction was accounted for under the purchase method of accounting
in accordance with Statement of Financial Accounting Standards ("SFAS") No.
141 Business Combinations. Accordingly, the results of Precimed's
operations were included in the condensed consolidated financial statements
from the date of acquisition. The aggregate purchase price was $80.5
million, consisting of the cash issued at closing to Precimed shareholders
($77.5 million), and other direct acquisition-related costs, including
financial advisory, legal and accounting services ($3.0 million).
Additionally, the purchase agreement includes a contingent payment 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
1.0053 CHF per one U.S. dollar as of March 28, 2008 the maximum contingent
payment would be approximately $12.1 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 and
borrowings under the Company's revolving credit agreement.
-7-
GREATBATCH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Unaudited
--------------------------------------------------------------------------------
The cost of the acquisition was allocated to the assets acquired and
liabilities assumed from Precimed based on their preliminary fair values as
of the acquisition date, 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, settlement of the
contingent payment, the finalization of our asset valuation, the final
reconciliation and confirmation of tangible assets, 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. Any changes to
the preliminary valuation may result in material adjustments to the fair
value of the assets and liabilities 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) January 7, 2008
-------------------------------------- ---------------------
Assets acquired
Current assets $ 35,428
Property, plant and equipment 26,491
Acquired IPR&D 2,240
Amortizing intangible assets 28,358
Trademarks and tradenames 2,163
Goodwill 41,227
Other assets 1,624
---------------------
Total assets acquired 137,531
Liabilities assumed
Current liabilities 23,884
Long-term liabilities 33,194
---------------------
Total liabilities assumed 57,078
---------------------
Purchase price $ 80,453
=====================
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 estimates the 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 estimates the 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, trademarks and tradenames, in-process research and
development ("IPR&D") and for the noncompete agreements with employees. The
projected cash flows were discounted at a required rate of return that
reflects the relative risk of the Precimed 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 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.
-8-
GREATBATCH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Unaudited
--------------------------------------------------------------------------------
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 $5.6 million. During the first quarter of 2008,
the Company expensed as cost of sales the step-up value relating to the
acquired Precimed inventory sold during 2008. As of March 28, 2008, there
was no remaining inventory step-up value remaining in inventory to be
expensed. 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):
Fair Value Weighted average Weighted
assigned amortization average
period (years) discount rate
----------- ----------------- --------------
Amortizing intangible assets
---------------------------------
Technology and patents $ 11,772 15 14%
Customer relationships 15,567 20 13%
Noncompete agreements 1,019 5 13%
-----------
$ 28,358 17 13%
Trademarks & tradenames $ 2,163 indefinite 13%
Acquired IPR&D $ 2,240 - 14%
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 Precimed 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 15 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 15
years.
Customer relationships - Customer relationships represent the preliminary
estimated fair value of both the contractual and non-contractual customer
relationships Precimed has with OEMs as of the acquisition date. The
primary customers of Precimed include Johnson & Johnson, Smith & Nephew,
Stryker, Medtronic and Zimmer, 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 20 years. This life was based upon historical customer attrition and
Management's understanding of the industry and regulatory environment. The
expected cash flows associated with these customer relationships were
nominal after 20 years.
-9-
GREATBATCH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Unaudited
--------------------------------------------------------------------------------
Trademarks and tradenames - Trademarks and tradenames represent the
estimated fair value of corporate and product names acquired from Precimed,
which will be utilized by the Company in the future. These included the
"Precimed" corporate tradename as well as 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 associated. 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 $2.2 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 Reamer, Instrument Kit, Locking Plate and Cutting Guide projects. These
projects primarily represent the next generation of products already being
sold by Precimed which incorporate new enhancements and customer
modifications. The Company expects to commercially launch these products in
2008 and 2009 which will replace existing products. For purposes of valuing
the IPR&D, the Company estimated total costs to complete the projects to be
approximately $0.2 million. If the Company is not successful in completing
these projects on a timely basis, future sales 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 Precimed
transaction 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 their fair value at the date
of acquisition and do not exceed the amount an independent third party
would be willing to pay for the projects.
Goodwill - The excess of the purchase price over the preliminary fair value
of net tangible and intangible assets acquired of $41.2 million was
allocated to goodwill. Various factors contributed to the establishment of
goodwill, including: the value of Precimed'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 and diversifying its revenues. The goodwill acquired in
connection with the Precimed acquisition was allocated to the Company's IMC
business segment and is not deductible for tax purposes.
-10-
GREATBATCH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Unaudited
--------------------------------------------------------------------------------
DePuy Orthopedics Chaumont, France Facility
On February 11, 2008, Precimed completed its previously announced
acquisition of DePuy Orthopedics ("DePuy") Chaumont, France manufacturing
facility (the "Chaumont 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.
This transaction was accounted for under the purchase method of accounting.
Accordingly, the results of the Chaumont Facility were included in our
condensed consolidated financial statements from the date of acquisition.
The aggregate purchase price was approximately $27.9 million, consisting of
the cash issued to DePuy ($26.9 million), and other direct
acquisition-related costs, including financial advisory, legal and
accounting services ($1.0 million). The aggregate purchase price was
preliminarily allocated to the assets acquired ($6.2 million inventory,
$13.4 million PP&E) and liability assumed from the Chaumont Facility based
on their fair values as of the close of the acquisition, with the amount
exceeding the fair value recorded as goodwill ($5.5 million). 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 valuation, the final reconciliation
and confirmation of tangible assets, the Company incurring direct
acquisition costs in connection with this transaction and the resolution of
tax positions. Any adjustment to the purchase price will be allocated to
goodwill.
Various factors contributed to the establishment of goodwill, including:
the value of the Chaumont Facility's highly trained assembled work force;
the expected revenue growth over time and the incremental value to the
Company's Orthopedics business from having the capability to manufacture
joint implants; and the strategic partnership established with one of the
largest orthopedic companies in the world. Goodwill resulting from the
Chaumont Facility acquisition was allocated to the Company's IMC business
segment and is not deductible for tax purposes.
Pro Forma Results (Unaudited)
The following unaudited pro forma information presents the consolidated
results of operations of the Company, Precimed, and the Chaumont Facility
as if those acquisitions had occurred as of the beginning of each of the
fiscal periods presented. Additionally, 2007 amounts reflect the Company's
2007 acquisition of Enpath Medical, Inc. (June 2007) ("Enpath"), Quan
Emerteq LLC (November 2007) and Engineered Assemblies Corporation ("EAC")
(November 2007) as if those acquisitions had occurred as of the beginning
of 2007 (in thousands, except per share amounts):
Three Months Ended
-----------------------------------
(Unaudited) March 28, 2008 March 30, 2007
----------------- -----------------
Sales $ 132,630 $ 131,934
Net income 3,114 9,196
Earnings per share:
Basic $ 0.14 $ 0.42
Diluted $ 0.14 $ 0.37
-11-
GREATBATCH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Unaudited
--------------------------------------------------------------------------------
The unaudited pro forma information presents the combined operating results
of Greatbatch, Precimed, the Chaumont Facility, 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 the non-recurring IPR&D charge ($2.2
million) and inventory step-up amortization recorded by Greatbatch in 2008
($6.4 million), the adjustment to interest income/expense reflecting the
cash paid in connection with the acquisition, including acquisition-related
expenses, at Greatbatch's weighted average interest income/expense rate,
and the impact of income taxes on the pro forma adjustments utilizing the
applicable statutory tax rate, 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 acquisitions
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.
3. SUPPLEMENTAL CASH FLOW INFORMATION
Three months ended
-----------------------------------
March 28, March 30,
2008 2007
----------------- -----------------
Noncash investing and financing activities (in thousands):
Net unrealized gain (loss) on available-for-sale securities $ 35 $ (226)
Unrealized loss on interest rate swap, net (461) -
Common stock contributed to 401(k) Plan 3,472 2,956
Property, plant and equipment purchases included
in accounts payable 2,399 695
Deferred financing fees and acquisition costs included in
accrued expenses and other current liabilities 5,801 4,495
Exchange of convertible subordinated notes - 117,782
Shares isued in connection with a business acquisition 1,473 -
Cash paid during the period for:
Interest $ 262 $ 337
Income taxes 225 105
Acquisition of noncash assets and liabilities:
Assets acquired $ 163,262 $ -
Liabilities assumed 57,751 -
-12-
GREATBATCH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Unaudited
--------------------------------------------------------------------------------
4. SHORT-TERM INVESTMENTS AVAILABLE FOR SALE
Short-term investments available for sale are comprised of the following
(in thousands):
Cost Gross Gross Estimated
unrealized unrealized fair value
gains losses
----------- ------------- -------------- -------------
March 28, 2008
--------------------------------------
Commercial Paper $ 1,233 $ 13 $ - $ 1,246
U.S. Government Agencies 1,469 25 - 1,494
Corporate Bonds 3,699 16 - 3,715
----------- ------------- -------------- -------------
Total available for sale securities $ 6,401 $ 54 $ - $ 6,455
=========== ============= ============== =============
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
=========== ============= ============== =============
Short-term investments available-for-sale 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. The fair value of short-term investments available for sale are
based on Level 2 measurements as defined in the fair value hierarchy in
SFAS No. 157 Fair Value Measurements - see Note 9.
5. INVENTORIES
Inventories are comprised of the following (in thousands):
March 28, December 28,
2008 2007
----------------- -----------------
Raw materials $ 39,653 $ 38,561
Work-in-process 33,440 19,603
Finished goods 20,867 13,718
----------------- -----------------
Total $ 93,960 $ 71,882
================= =================
-13-
GREATBATCH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Unaudited
--------------------------------------------------------------------------------
6. INTANGIBLE ASSETS
Amortizing intangible assets are comprised of the following (in thousands):
Gross carrying Accumulated Foreign Net carrying
amount amortization currency amount
translation
--------------- ---------------- --------------- ---------------
March 28, 2008
--------------------------------
Purchased technology and patents $ 81,585 $ (30,678) $ 1,065 $ 51,972
Customer lists 45,550 (1,638) 1,453 45,365
Other 3,679 (1,578) 67 2,168
-------------- --------------- -------------- ---------------
Total amortizing intangible
assets $ 130,814 $ (33,894) $ 2,585 $ 99,505
============== =============== ============== ===============
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
============== =============== ============== ===============
Aggregate amortization expense for the first quarter of 2008 and 2007 was
$2.7 million and $0.9 million, respectively. As of March 28, 2008, annual
amortization expense is estimated to be $8.1 million for the remainder of
2008, $10.1 million for 2009, $9.6 million for 2010, $9.5 million for 2011,
$9.4 million for 2012 and $8.6 million for 2013.
The change in trademarks and tradenames during the first quarter of 2008 is
as follows (in thousands):
Balance at December 28, 2007 $ 32,582
Acquired in 2008 2,163
Foreign currency translation 118
---------------
Balance at March 28, 2008 $ 34,863
===============
The Company is currently performing a review of its market strategy to
determine the best use of its "non-Greatbatch" tradenames, including those
acquired with its recent acquisitions. The outcome of this review, which is
expected to be completed by the end of 2008, may impact the useful life of
the Company's "non-Greatbatch" tradenames which had a value of $17.0
million as of March 28, 2008.
The change in goodwill during the first quarter of 2008 is as follows (in
thousands):
IMC Electrochem Total
---------- ------------- --------------
Balance at December 28, 2007 $ 238,810 $ 9,730 $ 248,540
Goodwill recorded for 2007 acquisitions 52 3 55
Goodwill recorded for 2008 acquisitions 46,744 - 46,744
Foreign currency translation 3,477 - 3,477
---------- ------------- --------------
Balance at March 28, 2008 $ 289,083 $ 9,733 $ 298,816
========== ============= ==============
-14-
GREATBATCH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Unaudited
--------------------------------------------------------------------------------
7. LONG-TERM DEBT
Long-term debt is comprised of the following (in thousands):
March 28, December 28,
2008 2007
--------------- --------------
Revolving line of credit $ 117,000 $ -
3% Mortgage agreement, due 2008 2,101 -
Convertible subordinated notes
2.25% convertible subordinated notes I, due 2013 52,218 52,218
2.25% convertible subordinated notes II, due 2013 197,782 197,782
Unamortized discount (8,429) (8,802)
--------------- --------------
Total convertible subordinated notes 241,571 241,198
--------------- --------------
Less current portion of long-term debt (2,101) -
--------------- --------------
Total long-term debt $ 358,571 $ 241,198
=============== ==============
Revolving Line of Credit - The Company has a senior credit facility (the
"Credit Facility") consisting of a $235 million revolving credit facility,
which can be increased to $335 million upon the Company's request. The
Credit Facility also contains a $15 million letter of credit subfacility
and a $15 million swingline subfacility. The 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 Credit Facility are, at the Company's
option, based upon the current prime rate or the LIBOR rate plus a margin
that varies with the Company's leverage ratio. If interest is paid based
upon the prime rate, the applicable margin is between minus 1.25% and
0.00%. If interest is paid based upon the LIBOR rate, the applicable margin
is between 1.00% and 2.00%. The Company is required to pay a commitment fee
between 0.125% and 0.250% per annum on the unused portion of the Credit
Facility based on the Company's leverage ratio.
The 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 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 addition, the 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 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 Credit Facility immediately due and payable.
-15-
GREATBATCH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Unaudited
--------------------------------------------------------------------------------
In connection with the Company's acquisition of Precimed and the Chaumont
Facility, the Company borrowed $117 million under its revolving line of
credit during the first quarter of 2008. The weighted average interest rate
on these borrowings as of March 28, 2008 was 5.0% which resets based upon
the six-month ($87 million), three-month ($15 million) and one-month ($15
million) LIBOR rate. Based upon current capital needs in connection with
the new Electrochem Solutions, Inc. ("Electrochem") facility as well as the
expansion of the Company's corporate headquarters, Management currently
does not anticipate making principal payments on the revolving line of
credit within the next twelve months. As of March 28, 2008, the Company had
$118 million available under its revolving line of credit.
Interest Rate Swap - During the first quarter of 2008, the Company entered
into an $80 million notional receive floating-pay fixed interest rate swap
indexed to the six-month LIBOR rate that expires on July 7, 2010. The
objective of this swap is to hedge against potential changes in cash flows
on $80 million of the Company's revolving line of credit, which is indexed
to the six-month LIBOR rate. No credit risk was hedged. The receive
variable leg of the swap and the variable rate paid on the revolving line
of credit bear the same rate of interest, excluding the credit spread, and
reset and pay interest on the same dates. The Company intends to continue
electing the six-month LIBOR as the benchmark interest rate on the debt. If
the Company repays the debt it intends to replace the hedged item with
similarly indexed forecast cash flows. The pay fixed leg of the swap bears
an interest rate of 3.09%, which does not include the credit spread.
The Company accounts for this interest rate swap under SFAS No. 133
Accounting for Derivative Instruments and Hedging Activities. SFAS No. 133
requires that all derivatives are recognized as either assets or
liabilities in the condensed consolidated balance sheet at fair value.
Changes in the fair value of the derivatives are recorded each period in
current earnings or other comprehensive income, depending on whether the
derivative is used in a qualifying hedge strategy and, if so, whether the
hedge is a cash flow or fair value hedge. In order to qualify as a hedge,
the Company must document the hedging strategy at its inception, including
the nature of the risk being hedged and how the effectiveness of the hedge
will be measured. The Company evaluates hedge effectiveness at inception
and on an ongoing basis. If a derivative is no longer expected to be highly
effective, hedge accounting is discontinued.
The Company designated the interest rate swap as a cash flow hedge. The
Company recognizes the portion of the change in fair value of the interest
rate swap that is considered effective as a direct charge or credit to
accumulated other comprehensive income (a component of stockholders'
equity), net of tax. The ineffective portion of the change in fair value,
if any, is recorded to earnings. Amounts recorded in accumulated other
comprehensive income are periodically reclassified to interest expense to
offset interest expense on the hedged portion of the revolving line of
credit resulting from fluctuations in the six-month LIBOR interest rate.
The fair value of the interest rate swap is based on Level 2 measurements
in the fair value hierarchy as described in SFAS No. 157 - see Note 9. As
of March 28, 2008, a negative fair value adjustment of $0.5 million was
recorded in accumulated other comprehensive income, net of income taxes of
$0.2 million. No portion of the change in fair value of the interest rate
swap during the first quarter of 2008 was considered ineffective. The
amount recorded as an offset to interest expense during the first quarter
of 2008 related to the interest rate swap was $0.07 million.
-16-
GREATBATCH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Unaudited
--------------------------------------------------------------------------------
Convertible Subordinated Notes - In May 2003, the Company completed a
private placement of $170 million of 2.25% convertible subordinated notes,
due 2013 ("CSN I"). In 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.
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 in the first quarter of 2007. 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 throughout 2007. This amount was previously recorded as a
non-current deferred tax liability on the balance sheet. The following is a
summary of the significant terms of CSN I and CSN II:
CSN I - The notes bear interest at 2.25% per annum, payable semi-annually.
Holders may convert the notes into shares of the Company's common stock at
a conversion price of $40.29 per share, which is equivalent to a conversion
ratio 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.
-17-
GREATBATCH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Unaudited
--------------------------------------------------------------------------------
The notes are convertible at the option of the holders at such time as: (i)
the closing price of the Company's common stock exceeds 150% of the
conversion price of the notes for 20 out of 30 consecutive trading days;
(ii) the trading price per $1,000 of principal is less than 98% of the
product of the closing sale price of common stock for each day during any
five consecutive trading day period and the conversion rate per $1,000 of
principal; (iii) the notes have been called for redemption; (iv) the
Company distributes to all holders of common stock rights or warrants
entitling them to purchase additional shares of common stock at less than
the average closing price of common stock for the ten trading days
immediately preceding the announcement of the distribution; (v) the Company
distributes to all holders of common stock any form of dividend which has a
per share value exceeding 5% of the price of the common stock on the day
prior to such date of distribution; (vi) the Company affects a
consolidation, merger, share exchange or sale of assets pursuant to which
its common stock is converted to cash or other property; (vii) the period
beginning 60 days prior to but excluding June 15, 2013; and (viii) certain
fundamental changes, as defined in the indenture agreement, occur or are
approved by the Board of Directors.
Conversions in connection with corporate transactions that constitute a
fundamental change require the Company to pay a premium make-whole amount
whereby the conversion ratio on the notes may be increased by up to 8.2
shares per $1,000 of principal. The premium make-whole amount will be paid
in shares of common stock upon any such conversion, subject to the net
share settlement feature of the notes described below.
The notes contain a net share settlement feature that requires the Company
to pay cash for each $1,000 of principal to be converted. 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.
Mortgage Agreement - In connection with the Precimed acquisition we assumed
a mortgage agreement, with a former owner, that bears an interest rate of
3% and is due in September 2008. If the mortgage is not paid in full by
that date the interest rate increases to 8%.
Deferred Financing Fees - The following is a reconciliation of deferred
financing fees for the first quarter of 2008, which are included in other
assets (in thousands):
Balance at December 28, 2007 $ 6,411
Financing costs deferred 8
Amortization during the period (338)
-----------------
Balance at March 28, 2008 $ 6,081
=================
-18-
GREATBATCH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Unaudited
--------------------------------------------------------------------------------
8. PENSION PLANS
In connection with the Precimed and Chaumont Facility acquisitions, the
Company recorded a pension liability related to the defined benefit pension
plans provided to the non-U.S. employees of those businesses. Under these
plans, benefits accrue to employees based upon years of service, position,
age and compensation. The liability and corresponding expense related to
these pension plans is based on actuarial computations of current and
future benefits for employees. Pension expense is charged to current
operating expenses. The accumulated benefit obligation, projected benefit
obligation and fair value of plan assets as of the acquisition date, which
was also the measurement date, were $12.3 million, $14.0 million and $10.5
million, respectively.
The change in the net pension liability for the first quarter of 2008 is as
follows (in thousands):
Balance at December 28, 2007 $ -
Acquired in 2008 3,534
Net periodic pension cost 177
Foreign currency translation 368
--------------
Balance at March 28, 2008 $ 4,079
==============
Net pension cost is comprised of the following (in thousands):
Three months ended
March 28, 2008
----------------------
Service cost $ 167
Interest cost 118
Expected return on plan assets (108)
----------------------
Net pension cost $ 177
======================
The principal actuarial assumptions used were as follows:
Discount rate 3.9%
Expected rate of return on plan 4.0%
assets
Salary growth 2.6%
The discount rate used is based on the yields of foreign government bonds
plus 20 to 30 basis points to reflect the risk of investing in corporate
bonds. The expected rate of return on plan assets reflects long-term
earnings expectations on existing plan assets and those contributions
expected to be received during the current plan year. In estimating that
rate, appropriate consideration was given to historical returns earned by
plan assets in the fund and the rates of return expected to be available
for reinvestment. Rates of return were adjusted to reflect current capital
market assumptions and changes in investment allocations. Equity securities
and fixed income securities were assumed to earn a return in the range of
7% to 8% and 3% to 4%, respectively. The long-term inflation rate was
estimated to be 1.8%. When these overall return expectations are applied to
the pension plan's target allocation, the expected rate of return is
determined to be 4.0%.
-19-
GREATBATCH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Unaudited
--------------------------------------------------------------------------------
The weighted average asset allocation was as follows:
Asset Category: Target Actual
----------- ---------------
Bonds 60% 52%
Equity 25% 32%
Other 15% 16%
----------- ---------------
100% 100%
=========== ===============
This allocation is consistent with the Company's goal of diversifying the
pension plans assets in order to preserve capital while achieving
investment results that will contribute to the proper funding of pension
obligations and cash flow requirements.
Estimated benefit payments over the next ten years are as follows (in
thousands):
Estimated benefit payments over the next ten years are as follows (in
thousands):
Remainder 2008 $ 1,060
2009 1,068
2010 958
2011 1,030
2012 1,145
2013-2017 6,292
9. FAIR VALUE MEASUREMENTS
Beginning in fiscal year 2008, the Company adopted the provisions of SFAS
No. 157, Fair Value Measurements for all financial assets and liabilities
and nonfinancial assets and liabilities that are recognized or disclosed at
fair value on a recurring basis (at least annually). Under this standard,
fair value is defined as the price that would be received to sell an asset
or paid to transfer a liability (i.e. the "exit price") in an orderly
transaction between market participants at the measurement date.
SFAS No. 157 establishes a hierarchy for inputs used in measuring fair
value that maximizes the use of observable inputs and minimizes the use of
unobservable inputs by requiring that the most observable inputs be used
when available. Observable inputs are inputs that market participants would
use in pricing the asset or liability developed based on market data
obtained from sources independent of the Company. Unobservable inputs are
inputs that reflect the Company's assumptions about the assumptions market
participants would use in pricing the asset or liability developed based on
the best information available in the circumstances. The hierarchy is
broken down into three levels based on the reliability of inputs as
follows:
Level 1 -- Valuations based on quoted prices in active markets for
identical assets or liabilities that the Company has the ability to access.
Since valuations are based on quoted prices that are readily and regularly
available in an active market, valuation of these products does not entail
a significant degree of judgment.
Level 2 -- Valuations based on quoted prices in markets that are not active
or for which all significant inputs are observable, either directly or
indirectly.
-20-
GREATBATCH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Unaudited
--------------------------------------------------------------------------------
Level 3--Valuations based on inputs that are unobservable and significant
to the overall fair value measurement. The degree of judgment exercised in
determining fair value is greatest for instruments categorized in Level 3.
The availability of observable inputs can vary from asset/liability to
asset/liability and is affected by a wide variety of factors, including,
the type of asset/liability, whether the asset/liability is established in
the marketplace, and other characteristics particular to the transaction.
To the extent that valuation is based on models or inputs that are less
observable or unobservable in the market, the determination of fair value
requires more judgment. In certain cases, the inputs used to measure fair
value may fall into different levels of the fair value hierarchy. In such
cases, for disclosure purposes the level in the fair value hierarchy within
which the fair value measurement in its entirety falls is determined based
on the lowest level input that is significant to the fair value measurement
in its entirety.
Fair value is a market-based measure considered from the perspective of a
market participant rather than an entity-specific measure. Therefore, even
when market assumptions are not readily available, assumptions are required
to reflect those that market participants would use in pricing the asset or
liability at the measurement date.
Valuation Techniques
Short-term investments available for sale - The fair value of short-term
investments available for sale is obtained from an independent pricing
service that utilizes multidimensional relational models with observable
market data inputs to estimate fair value. These observable market data
inputs include benchmark yields, reported trades, broker/dealer quotes,
issuer spreads, benchmark securities, bids, offers and reference data. The
Company's short-term investments available for sale are categorized in
Level 2 of the fair value hierarchy.
Interest rate swap - The fair value of our interest rate swap is obtained
from an independent pricing service that utilizes cash flow models with
observable market data inputs to estimate fair value. These observable
market data inputs include LIBOR and swap rates. The Company's interest
rate swap is categorized in Level 2 of the fair value hierarchy.
The following table provides information regarding financial assets and
liabilities measured at fair value on a recurring basis (in thousands):
Fair value measurements at reporting date using
----------------------------------------------------
Quoted prices
in active Significant
markets for Significant other unobservable
At March 28, identical assets observable inputs inputs
Description 2008 (Level 1) (Level 2) (Level 3)
------------------------------------- ---------------- ------------------ ----------------
Assets
Short-term investments
available for sale $ 6,455 $ - $ 6,455 $ -
Liabilities
Interest rate swap $ (710) $ - $ (710) $ -
As of March 28, 2008, the Company did not have any nonfinancial assets and
liabilities that are recognized or disclosed at fair value on a recurring
basis.
-21-
GREATBATCH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Unaudited
--------------------------------------------------------------------------------
10. STOCK-BASED COMPENSATION
Under SFAS No. 123(R) the Company records compensation costs related to all
stock-based awards. Compensation costs related to share-based payments for
the three months ended March 28, 2008 totaled $1.9 million, $1.2 million
net of tax, or $0.06 per diluted share. This compares to $1.7 million, $1.1
million net of tax, or $0.04 per diluted share for the three months ended
March 30, 2007.
The following table summarizes stock option activity related to the
Company's stock-based incentive plans:
Weighted
average
Weighted remaining Aggregate
average contractual intrinsic
Number of exercise life value(1)
stock options price (in years) (in millions)
----------------- ----------- ------------- -------------
Outstanding at December 28, 2007 1,744,022 $ 25.04
Granted 424,715 20.15
Exercised - -
Forfeited or Expired (1,732) 24.28
-----------------
Outstanding at March 28, 2008 2,167,005 $ 24.08 7.5 $ 0.4
================= =========== ============= =============
Exercisable at March 28, 2008 1,097,850 $ 25.07 6.1 $ 0.4
================= =========== ============= =============
(1) Intrinsic value is calculated for in-the-money options (exercise price less
than market price) outstanding and/or exercisable as the difference between
the market price of our common shares as of March 28, 2008 ($18.79) and the
weighted average exercise price of the underlying options, multiplied by
the number of options outstanding and/or exercisable.
The weighted-average fair value and assumptions used to value options
granted are as follows:
Three months ended
------------------------------
March 28, March 30,
2008 2007
--------------- --------------
Weighted-average fair value $ 7.93 $ 10.33
Risk-free interest rate 2.91% 4.48%
Expected volatility 40% 39%
Expected life (in years) 5 5
Expected dividend yield 0% 0%
-22-
GREATBATCH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Unaudited
--------------------------------------------------------------------------------
The following table summarizes restricted stock and restricted stock unit
activity related to the Company's plans:
Weighted average
Activity fair value
--------------- -----------------
Nonvested at December 28, 2007 282,134 $ 24.96
Shares granted 139,289 20.06
Shares vested (94,221) 23.72
Shares forfeited - -
---------------
Nonvested at March 28, 2008 327,202 $ 23.23
===============
11. OTHER OPERATING EXPENSE
The following were recorded in other operating expense, net in the
Company's Condensed Consolidated Statements of Operations and Comprehensive
Income (in thousands):
Three months ended
------------------------------
March 28, March 30,
2008 2007
------------------------------
(a) Carson City facility shutdown and Tijuana
facility consolidation No. 1 $ - $ 386
(b) Columbia facility shutdown, Tijuana facility
consolidation No. 2 and RD&E consolidation 224 1,303
(c) Electrochem expansion 106 137
(d) Integration and severance costs 660 -
(e) Asset dispositions and other 38 (293)
--------------- --------------
$ 1,028 $ 1,533
=============== ==============
(a) Carson City Facility shutdown and Tijuana Facility consolidation No. 1.
On March 7, 2005, the Company announced its intent to close the Carson City,
NV facility ("Carson City Facility") and consolidate the work performed at
that facility into the Tijuana, Mexico facility ("Tijuana Facility
consolidation No. 1").
This consolidation project was completed in the third quarter of 2007. 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.
-23-
GREATBATCH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (con't) - Unaudited
--------------------------------------------------------------------------------
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 are included in the
IMC business segment.
Accrued liabilities related to the Carson City Facility shutdown are
comprised of the following (in thousands):
Severance and Accelerated Other Total
retention depreciation
------------------ -------------- ------------ -------------
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
Restructuring charges - - - -
Cash payments (65) - - (65)
------------------ -------------- ------------ -------------
Balance, March 28, 2008 $ 85 $ - $ - $ 85
================== ============== ============ =============
Accrued liabilities related to the Tijuana Facility consolidation No. 1 are
comprised of the following (in thousands):
Production Relocation Personnel Other Total
inefficiencies and and moving
revalidation
------------------- -------------- ----------- ---------- -------------
Balance, December 29, 2006 $ - $ - $ - $ - $ -
Restructuring charges 220 - - - 220
Cash payments (220) - - - (220)
------------------- -------------- ----------- ---------- -------------
Balance, December 28, 2007 $ - $ - $ - $ - $ -
Restructuring charges - - - - -
Cash payments - - - - -
------------------- -------------- ----------- ---------- -------------
Balance, March 28, 2008 $ - $ - $ - $ - $ -
=================== ============== =========== ========== =============
-24-
GREATBATCH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (con't) - Unaudited
--------------------------------------------------------------------------------
(b) Columbia Facility shutdown, Tijuana Facility consolidation No. 2 and
RD&E consolidation. On November 16, 2005, the Company announced its intent
to close both the Columbia, MD facility ("Columbia Facility") and the
Fremont, CA Advanced Research Laboratory ("ARL"). The Company also
announced that the manufacturing operations at the Columbia Facility will
be moved into the Tijuana Facility ("Tijuana Facility consolidation No. 2")
and that the research, development and engineering ("RD&E") and product
development functions at the Columbia Facility and at ARL will relocate to
the Technology Center in Clarence, NY.
The total estimated cost for this facility consolidation plan is
anticipated to be between $11.6 million and $12.1 million of which $10.8
million has been incurred through March 28, 2008. The ARL move and closure
portion of this consolidation project is complete. The Company expects to
incur the remaining cost for the other portions of the consolidation
project over the next two 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.
-25-
GREATBATCH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (con't) - Unaudited
--------------------------------------------------------------------------------
Accrued liabilities related to the Columbia Facility and ARL shutdowns and the
RD&E consolidation are comprised of the following (in thousands):
Accelerated
Severance and depreciation /
retention Personnel asset write-offs Other Total
-------------- ----------- ------------------ ----------- ------------
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
Restructuring charges 107 91 - 10 208
Cash payments (642) (91) - (10) (743)
Write-offs - - - - -
-------------- ----------- ------------------ ----------- ------------
Balance, March 28, 2008 $ 1,165 $ - $ - $ - $ 1,165
============== =========== ================== =========== ============
Accrued liabilities related to Tijuana Facility consolidation No. 2 are
comprised of the following (in thousands):
Production
inefficiencies Relocation and
and revalidation moving Personnel Other Total
----------------- ---------------- -------------- -------------- --------------
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 $ - $ - $ - $ - $ -
Restructuring charges - - - 16 16
Cash payments - - - (16) (16)
----------------- ---------------- -------------- -------------- --------------
Balance, March 28, 2008 $ - $ - $ - $ - $ -
================= ================ ============== ============== ==============
(c) Electrochem Solutions, Inc. 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 $3.4 million to $3.8 million, of which $0.6
million has been incurred through March 28, 2008 ($0.1 million in the first
quarter of 2008) and primarily related to accelerated depreciation. Costs
related to this move are included in the Electrochem business segment and
include the following:
o Production inefficiencies and revalidation - $0.9 million;
o Moving and facility closure - $1.3 million to $1.5 million;
o Accelerated depreciation - $0.7 million; and
o Other - $0.5 million to $0.7 million.
-26-
GREATBATCH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (con't) - Unaudited
--------------------------------------------------------------------------------
(d) Integration and severance costs. During the first quarter of 2008, the
Company incurred $0.7 million of integration and severance costs related to
its acquisitions in 2007 and 2008. This included the consolidation of
various general and administrative functions, as well as the conversion of
information technology platforms to one ERP system. The primary costs
incurred associated with these integration efforts are travel, consulting,
personnel and severance and retention in connection with workforce
reductions. The Company expects to continue to incur these costs for the
remainder of 2008 and into the first half of 2009 at a quarterly rate that
exceeds the current quarter amount.
(e) Asset dispositions and other. During the first quarter of 2008, the
Company had various asset dispositions. During the first quarter of 2007,
the Company received $0.3 million of insurance proceeds related to
equipment damaged during transportation to the Tijuana Facility in the
second quarter of 2006.
12. INCOME TAXES
During the first quarter of 2008, the balance of unrecognized tax benefits
decreased approximately $0.5 million as a result of a favorable settlement
with a state taxing authority. The settlement results in a cash refund of
approximately $0.3 million, including interest. The tax portion is
recognized in the quarterly effective tax rate while the interest income is
included as part of pre-tax income. As of March 28, 2008, approximately
$0.3 million of unrecognized tax benefits would impact goodwill if
recognized. Of the remaining approximately $0.8 million of unrecognized tax
benefits, approximately $0.6 million would favorably impact the effective
tax rate (net of federal benefit on state issues), if recognized. We are
still analyzing the impact of Financial Accounting Standards Board ("FASB")
Interpretation No. 48 Accounting for Uncertainty in Income Taxes, an
Interpretation of FASB SFAS No. 109, with respect to the 2008 acquisitions.
The Company anticipates that the total unrecognized tax benefits could
significantly change within the next twelve months due to the settlement of
audits/appeals currently in process, however, quantification of an
estimated range cannot be made at this time.
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.
-27-
GREATBATCH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (con't) - Unaudited
--------------------------------------------------------------------------------
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 expected to go to trial during the
second quarter of 2008, but it is not possible to predict the outcome of
this litigation at this time, including whether it will affect the
Company's ability to sell its FlowGuard products, or to estimate the amount
or range of potential loss.
Product Warranties - The Company generally warrants that its products will
meet customer specifications and will be free from defects in materials and
workmanship. The Company accrues its estimated exposure to warranty claims
based upon recent historical experience and other specific information as
it becomes available.
The change in aggregate product warranty liability for the quarter ended
March 28, 2008 is as follows (in thousands):
Beginning balance at December 28, 2007 $ 1,454
Warranty reserves acquired 142
Additions to warranty reserve 146
Warranty claims paid (539)
------------------
Ending balance at March 28, 2008 $ 1,203
==================
Purchase Commitments - Contractual obligations for purchase of goods or
services are defined as agreements that are enforceable and legally binding
on the Company and that specify all significant terms, including: fixed or
minimum quantities to be purchased; fixed, minimum or variable price
provisions; and the approximate timing of the transaction. Our purchase
orders are normally based on our current manufacturing needs and are
fulfilled by our vendors within short time horizons. We enter into blanket
orders with vendors that have preferred pricing and terms, however these
orders are normally cancelable by us without penalty. As of March 28, 2008,
the total contractual obligation related to such expenditures is
approximately $28.7 million and primarily relate to the construction of our
new Electrochem manufacturing facility and the expansion of our corporate
headquarters as material purchase commitments. These commitments will be
financed by existing cash, short-term investments or cash generated from
operations. We also enter into contracts for outsourced services; however,
the obligations under these contracts were not significant and the
contracts generally contain clauses allowing for cancellation without
significant penalty.
Operating Leases - The Company is a party to various operating lease
agreements for buildings, equipment and software. Minimum future annual
operating lease payments are $1.9 million for the remainder of 2008; $1.9
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.
-28-
GREATBATCH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (con't) - Unaudited
--------------------------------------------------------------------------------
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 purchase price of
Precimed, which 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
purchase price of the Chaumont Facility, which was payable in Euros. The
net result of the above contracts, which were settled upon the funding of
the respective acquisitions, was a gain of $2.4 million, $1.6 million of
which was recorded in 2008 as Other Income, Net.
14. EARNINGS PER SHARE
The following table reflects the calculation of basic and diluted earnings
per share (in thousands, except per share amounts):
Three months ended
------------------------------
March 28, March 30,
2008 2007
-------------- ---------------
Numerator for basic earnings per share:
Net income (loss) $ (3,374) $ 10,669
Effect of dilutive securities:
Interest expense on convertible notes and related deferred
financing fees, net of tax - 727
-------------- ---------------
Numerator for diluted earnings (loss) per share $ (3,374) $ 11,396
============== ===============
Denominator for basic earnings (loss) per share:
Weighted average shares outstanding 22,386 22,014
Effect of dilutive securities:
Convertible subordinated notes - 4,219
Stock options and unvested restricted stock - 237
-------------- ---------------
Dilutive potential common shares - 4,456
-------------- ---------------
Denominator for diluted earnings per share 22,386 26,470
============== ===============
Basic earnings (loss) per share $ (0.15) $ 0.48
============== ===============
Diluted earnings (loss) per share $ (0.15) $ 0.43
============== ===============
The diluted weighted average share calculations do not include 2,218,000
and 787,000 of time based stock options and restricted stock for the 2008
and 2007 periods, respectively, as they are not dilutive to the earnings
per share calculations. The diluted weighted average share calculations for
2008 and 2007 also do not include 276,000 shares and 204,000 shares,
respectively, of performance based stock options and restricted stock units
as the performance criteria for those awards had not been met. The diluted
weighted average share calculation for 2008 excludes the effect of
1,296,000 shares related to the Company's outstanding contingent
convertible notes.
-29-
GREATBATCH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (con't) - Unaudited
--------------------------------------------------------------------------------
15. COMPREHENSIVE INCOME
The Company's comprehensive income as reported in the Condensed
Consolidated Statements of Operations and Comprehensive Income includes net
income (loss), foreign currency translations gains (losses), unrealized
loss on its interest rate swap and the net unrealized gain (loss) on
short-term investments available for sale, adjusted for any realized
gains/losses.
The Company translates all assets and liabilities of the foreign operations
of Precimed and the Chaumont Facility acquired in 2008 at the period-end
exchange rate and translates sales and expenses at the average exchange
rates in effect during the period. The net effect of these translation
adjustments is recorded in the condensed consolidated financial statements
as comprehensive income (loss). The aggregate translation adjustment for
the first quarter of 2008 was $7.2 million. Translation adjustments are not
adjusted for income taxes as they relate to permanent investments in the
Company's foreign subsidiaries. Net foreign currency transaction gains and
losses included in Other Income, Net amounted to a loss of $0.3 million
during the first quarter of 2008.
The Company has designated its interest rate swap - see Note 7 - as a cash
flow hedge under SFAS No. 133. Accordingly, the effective portion of any
change in the fair value of the swap is recorded in comprehensive income
(loss), net of tax. The net unrealized loss on the Company's interest rate
swap recorded in comprehensive income was $0.5 million for the first
quarter of 2008 and is reported net of a deferred income tax benefit of
$0.2 million.
The net unrealized gain (loss) on short-term investments available for sale
- see Note 4 - of $0.04 million and ($0.2 million) is reported in the
condensed consolidated financial statements net of a deferred tax expense
of $0.02 million and benefit of $0.1 million for the three month period of
2008 and 2007, respectively.
16. BUSINESS SEGMENT AND GEOGRAPHIC INFORMATION
The Company operates its business in two reportable segments - Implantable
Medical Components ("IMC") and Electrochem. The IMC segment includes sales
of Cardiac Rhythm Management ("CRM") and Neurostimulation products which
include the design and manufacturing of batteries, capacitors, filtered
feedthroughs, engineered components and enclosures used in Implantable
Medical Devices ("IMDs"). Additionally, the Company offers value-added
assembly and design engineering services for products that incorporate IMD
components. With the acquisitions of Precimed and the Chaumont Facility in
the first quarter of 2008 and Enpath (2nd Qtr.) and Quan Emerteq (4th Qtr.)
in 2007, the IMC business now includes revenue from the design, development
and manufacturing of instrumentation for hip and knee replacement, trauma
and spine as well as hip and shoulder implants and revenue from the design,
development and manufacturing of introducers, catheters, implantable
stimulation leads and microcomponents.
The Electrochem segment includes revenue from the Company's wholly-owned
subsidiary Electrochem Solutions, Inc. Electrochem designs and manufactures
high performance batteries and battery packs for use in the oil and gas
exploration, pipeline inspection, telematics, oceanography equipment,
seismic, communication, military and aerospace applications. With the
acquisitions of EAC and IntelliSensing in the fourth quarter of 2007, the
Electrochem business includes revenue from the design and manufacturing of
rechargeable battery and wireless sensor systems.
-30-
GREATBATCH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (con't) - Unaudited
--------------------------------------------------------------------------------
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. The 2008 results for the IMC segment
include $6.4 million and $2.2 million of inventory step-up amortization and
IPR&D expense, respectively, related to the 2007 and 2008 acquisitions.
An analysis and reconciliation of the Company's business segment
information to the respective information in the condensed consolidated
financial statements is as follows (in thousands):
Three months ended
----------------------------------
March 28, March 30,
Sales: 2008 2007
--------------- ------------------
IMC
ICD batteries $ 10,023 $ 11,651
Pacemaker and other batteries 5,598 5,845
ICD capacitors 6,498 8,514
Feedthroughs 16,312 18,393
Introducers, catheters and leads 16,522 -
Orthopedic 27,786 -
Enclosures 5,128 5,706
Other medical 14,650 15,087
--------------- ------------------
Total IMC 102,517 65,196
Electrochem 19,637 11,664
--------------- ------------------
Total sales $ 122,154 $ 76,860
=============== ==================
Segment income (loss) from operations:
IMC $ (1,223) $ 11,691
Electrochem 2,276 2,722
--------------- ------------------
Total segment income from operations 1,053 14,413
Unallocated operating expenses (5,193) (3,807)
--------------- ------------------
Operating income (loss) as reported (4,140) 10,606
Unallocated other income (expense) (1,578) 5,201
--------------- ------------------
Income (loss) before provision (benefit)
for income taxes as reported $ (5,718) $ 15,807
=============== ==================
-31-
GREATBATCH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (con't) - Unaudited
--------------------------------------------------------------------------------
Sales by geographic area are presented in the following table by allocating
sales from external customers based on where the products are shipped to
(in thousands):
Three months ended
--------------------------------
March 28, March 30,
2008 2007
---------------- ---------------
Sales by geographic area:
United States $ 63,171 $ 37,686
Non-Domestic locations:
United Kingdom 15,394 17,712
France 13,499 2,710
Puerto Rico 12,499 7,139
All other 17,591 11,613
---------------- ---------------
Consolidated sales $ 122,154 $ 76,860
================ ===============
Long-lived tangible assets by geographic area are as follows:
As of
---------------------------------
March 28, December 28,
2008 2007
---------------- ----------------
Long-lived tangible assets:
United States $ 123,312 $ 111,364
Non-Domestic locations 49,251 18,873
---------------- ----------------
Consolidated long-lived assets $ 172,563 $ 130,237
================ ================
Four customers accounted for a significant portion of the Company's sales as
follows:
Three months ended
---------------------------------
March 28, March 30,
2008 2007
--------------- -----------------
Customer A 18% 27%
Customer B 14% 14%
Customer C 13% 28%
Customer D 10% 0%
--------------- -----------------
Total 55% 69%
=============== =================
-32-
GREATBATCH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (con't) - Unaudited
--------------------------------------------------------------------------------
17. IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS
In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative
Instruments and Hedging Activities. SFAS No. 161 amends and expands the
disclosure requirements of SFAS No. 133, and requires entities to provide
enhanced qualitative disclosures about objectives and strategies for using
derivatives, quantitative disclosures about fair values and amounts of
gains and losses on derivative contracts, and disclosures about
credit-risk-related contingent features in derivative agreements. The
Company is still evaluating the impact of SFAS No. 161 on its consolidated
financial statements which will be effective beginning in fiscal year 2009.
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 materially impact the Company's consolidated financial statements if
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 Accounting Research Bulletin No. 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.
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
SFAS No. 157. The provisions of SFAS No. 157 applicable to the Company
beginning in fiscal year 2008 did not have a material effect on its
consolidated financial statements. The Company is still evaluating what
impact the provisions of SFAS No. 157 that were deferred will have on its
consolidated financial statements, which are effective beginning in fiscal
year 2009.
-33-
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
--------------------------------------------------------------------------------
Our Business
------------
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 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.
We operate our business in two reportable segments - Implantable Medical
Components ("IMC") and Electrochem Solutions ("Electrochem"). The IMC segment
includes sales of Cardiac Rhythm Management ("CRM") and Neurostimulation
products which include the design and manufacturing of batteries, capacitors,
filtered feedthroughs, engineered components and enclosures used in Implantable
Medical Devices ("IMDs"). Additionally, the Company offers value-added assembly
and design engineering services for products that incorporate IMD components.
With the acquisitions of Precimed and the Chaumont Facility in the first quarter
of 2008 and Enpath Medical (2nd Qtr.) and Quan Emerteq (4th Qtr.) in 2007, the
IMC business now includes revenue from the design, development and manufacturing
of instrumentation for hip and knee replacement, trauma and spine as well as hip
and shoulder implants and revenue from the design, development and manufacturing
of introducers, catheters, implantable stimulation leads and microcomponents.
The Electrochem segment includes revenue from our wholly-owned subsidiary,
Electrochem Solutions, Inc. Electrochem designs and manufactures high
performance batteries and battery packs for use in the oil and gas exploration,
pipeline inspection, telematics, oceanography equipment, seismic, communication,
military and aerospace applications. With the acquisitions of EAC and
IntelliSensing in the fourth quarter of 2007, the Electrochem business includes
revenue from the design and manufacturing of rechargeable battery and wireless
sensor systems.
Our Customers
-------------
Our IMC customers include leading Original Equipment Manufacturers ("OEM"), in
alphabetical order here and throughout this report, such as Biotronik, Boston
Scientific, Johnson & Johnson, Medtronic, the Sorin Group, Smith & Nephew, St.
Jude Medical and Zimmer Holdings, Inc. 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. During the first quarter of 2008, Boston Scientific,
Johnson & Johnson, Medtronic and St. Jude Medical, collectively accounted for
55% of our total sales, compared to 69% for the first quarter of 2007.
Additionally, for the first quarter of 2008 revenue from the CRM market was
below 50% compared to approximately 85% for the same period in 2007.
-34-
We have entered into long-term supply agreements with some of our customers. Our
previous agreement with Boston Scientific, pursuant to which Boston Scientific
purchased filtered feedthroughs, expired March 31, 2008. We are negotiating a
follow-on agreement with targeted completion during the second quarter of 2008.
Purchases and shipments of filtered feedthroughs continue during contract
negotiations.
Our Electrochem customers are 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.
Our CEO's View
--------------
Twelve months ago we initiated our gap fill acquisition strategy into higher
growth markets. We successfully completed seven acquisitions that diversified
Greatbatch's revenue base and significantly expanded our product offerings to
customers. First quarter sales of $122 million, with CRM market concentration
below 50%, is clear evidence of accomplishing one of the prime objectives of our
long-term strategy.
We are focused on steadily improving operating profitability across Greatbatch
to drive value for our shareholders. This is a straight forward process of
consolidation, integration and optimization that we have successfully
implemented within Greatbatch over the last three years. We will leverage this
experience together with the expertise from the acquired companies to drive core
operating profitability improvement in the combined businesses. We have
organized our improvement plans into a series of major initiatives and we are
aggressively pursuing them. I am pleased the acquisitions have generated more
opportunities than originally contemplated and we are confident in our ability
to deliver the projected financial performance for 2008.
Product Development
-------------------
Currently, we are developing a series of new products for customer applications
in the CRM/neurostimulation, Therapy Delivery, Orthopedics and commercial power
markets. Some of the key development initiatives include:
1. Continue the evolution of our Q series high rate ICD batteries;
2. Continue development of MRI compatible product lines;
3. Integrating Biomimetic coating technology with therapy delivery devices;
4. Complete design of next generation steerable catheters;
5. Further minimally invasive surgical techniques for orthopedics industry;
6. Develop disposable instrumentation;
7. Provide wireless sensing solutions to Electrochem customers; and
8. Develop a charging platform for commercial secondary offering;
Approximately $2.3 million of the BIOMEC, Inc. ("BIOMEC") acquisition purchase
price was allocated to the estimated fair value of acquired in-process research
and development ("IPR&D") projects that had not yet reached technological
feasibility and had no alternative future use as of the acquisition date. The
value assigned to IPR&D relates to projects that incorporate BIOMEC's
novel-polymer coating (biomimetic) technology that mimics the surface of
endothelial cells of blood vessels. The estimated fair value of these projects
was determined using a discounted cash flow model. This model utilized discount
rates that took into consideration the stage of completion and the risks
surrounding the successful development and commercialization of each of the
IPR&D projects of approximately 40% which is consistent with these projects
being in the early development stage. We expect various products that utilize
the biomimetic coatings technology to be commercially launched by OEMs in 2009
once Food and Drug Administration ("FDA") approval is received. With BIOMEC, we
acquired grants that will fund the remaining development costs for these
products. There were no significant changes from our original estimates with
regards to these projects during the first quarter of 2008.
-35-
Approximately $13.8 million of the Enpath acquisition purchase price was
allocated to the estimated fair value of acquired IPR&D projects that had not
yet reached technological feasibility and had no alternative future use. These
projects primarily represent the next generation of products already being sold
by Enpath which incorporate new enhancements and customer modifications. We
expect 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 IPR&D, we estimated total costs to complete the
introducer projects to be approximately $0.3 million and $0.5 million to
complete the catheter projects. If we are not successful in completing these
projects on a timely basis, our future sales from introducers and catheters may
be adversely affected resulting in erosion of our market share. There were no
significant changes from our original estimates with regards to these projects
during the first quarter of 2008.
Approximately $2.2 million of the Precimed acquisition purchase price was
allocated to the preliminary estimated fair value of acquired IPR&D projects
that had not yet reached technological feasibility and had no alternative future
use. The value assigned to IPR&D related to Reamer, Instrument Kit, Locking
Plate and Cutting Guide projects. These projects primarily represent the next
generation of products already being sold by Precimed which incorporate new
enhancements and customer modifications. We expect to commercially launch these
products in 2008 and 2009 which will replace existing products. For purposes of
valuing the IPR&D, we estimated total costs to complete the projects to be
approximately $0.2 million. If we are not successful in completing these
projects on a timely basis, future sales may be adversely affected resulting in
erosion of our market share.
Cost Savings and Consolidation Efforts
--------------------------------------
During 2005, we initiated several significant cost savings and consolidation
efforts, the implementation of which continued during 2006, 2007 and the first
three months of 2008.
Carson City Facility shutdown and Tijuana Facility consolidation No. 1. On March
7, 2005, we announced our intent to close the Carson City, NV facility ("Carson
City Facility") and consolidate the work performed at our Carson City Facility
into our Tijuana, Mexico facility ("Tijuana Facility consolidation No. 1").
We completed this closure in the third quarter of 2007. The total cost for this
consolidation was $7.5 million, which was above the original estimates, as we
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.
-36-
All categories of costs are considered to be cash expenditures, except
accelerated depreciation. We anticipate annual cost savings in the range of $2.5
million to $3.1 million. The expenses for the Carson City Facility shutdown and
the Tijuana Facility consolidation No. 1 are included in the IMC segment.
Columbia Facility & ARL shutdown, Tijuana Facility consolidation No. 2, and RD&E
Consolidation. On November 16, 2005, we announced our intent to close both our
Columbia, MD facility ("Columbia Facility") and our Fremont, CA Advanced
Research Laboratory ("ARL"). The manufacturing operations at our Columbia
Facility will be moved into our Tijuana Facility ("Tijuana Facility
consolidation No. 2"). The research, development and engineering ("RD&E") and
product development functions at our Columbia Facility have begun to relocate to
the Technology Center in Clarence, NY. The ARL relocation to the Technology
Center in Clarence, NY is complete.
The total revised estimated cost for this facility consolidation plan is
anticipated to be between $11.6 million and $12.1 million. To date, we have
expensed $10.8 million related to these projects and expect to incur the
remaining costs over the next two quarters through September 2008, with cash
payments being made through the end of 2008. All categories of costs are
considered to be future cash expenditures, except for accelerated depreciation
and asset write-offs.
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. 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 expansion. In February 2007, we announced that we will close our
manufacturing facility in Canton, MA and construct a new 80,000 square foot
facility in Raynham, MA. The expected completion of this $28 million expansion
project is the fourth quarter of 2008. The total expense to be recognized for
this relocation is estimated to be $3.4 million to $3.8 million of which $0.6
million has been incurred through March 28, 2008 ($0.1 million in the first
quarter of 2008), which were primarily non-cash items. Costs related to this
move are included in the Electrochem business segment.
Integration and severance costs. During the first quarter of 2008, we incurred
$0.7 million of integration and severance costs related to our acquisitions in
2007 and 2008. This included the consolidation of various general and
administrative functions, as well as the conversion of information technology
platforms to one ERP system. The primary costs incurred associated with these
integration efforts are travel, consulting, personnel and severance and
retention in connection with workforce reductions. We expect to continue to
incur these costs for the remainder of 2008 and into the first half of 2009 at a
quarterly run rate that exceeds the amount for the current quarter.
-37-
Our Financial Results
---------------------
We utilize a fifty-two, fifty-three week fiscal year ending on the Friday
nearest December 31st. For 52-week years, each quarter contains 13 weeks. The
first quarter of 2008 and 2007 ended on March 28, and March 30, respectively.
The commentary that follows should be read in conjunction with our condensed
consolidated financial statements and related notes and with the Management's
Discussion and Analysis of Financial Condition and Results of Operations
contained in our Form 10-K for the fiscal year ended December 28, 2007.
Three months ended
-----------------------
March 28, March 30, $ %
In thousands, except per share data 2008 2007 Change Change
-----------------------------------------------------------------------------------------
IMC
ICD batteries $ 10,023 $ 11,651 (1,628) -14%
Pacemaker and other batteries 5,598 5,845 (247) -4%
ICD capacitors 6,498 8,514 (2,016) -24%
Feedthroughs 16,312 18,393 (2,081) -11%
Introducers, catheters and leads 16,522 - 16,522 NA
Orthopedic 27,786 - 27,786 NA
Enclosures 5,128 5,706 (578) -10%
Other medical 14,650 15,087 (437) -3%
---------------------------------------------
Total IMC 102,517 65,196 37,321 57%
Electrochem 19,637 11,664 7,973 68%
---------------------------------------------
Total sales 122,154 76,860 45,294 59%
Cost of sales - excluding amortization
of intangible assets 93,745 47,288 46,457 98%
Cost of sales - amortization
of intangible assets 1,710 948 762 80%
---------------------------------------------
Total Cost of Sales 95,455 48,236 47,219 98%
Cost of sales as a % of sales 78.1% 62.8% 15.3%
Selling, general, and administrative
expenses (SG&A) 18,347 10,033 8,314 83%
SG&A as a % of sales 15.0% 13.1% 1.9%
Research, development and engineering
costs, net (RD&E) 9,224 6,452 2,772 43%
RD&E as a % of sales 7.6% 8.4% -0.8%
Other operating expense, net 3,268 1,533 1,735 113%
---------------------------------------------
Operating income (loss) (4,140) 10,606 (14,746) -139%
Operating margin -3.4% 13.8% -17.2%
Interest expense 3,431 1,144 2,287 200%
Interest income (396) (1,856) 1,460 79%
Other income, net (1,457) (4,489) 3,032 68%
Provision (benefit) for income taxes (2,344) 5,138 (7,482) -146%
Effective tax rate 41.0% 32.5% 8.5%
---------------------------------------------
Net income (loss) $ (3,374)$ 10,669 $ (14,043) -132%
=============================================
Net margin -2.8% 13.9% -16.7%
Diluted earnings (loss) per share $ (0.15)$ 0.43 $ (0.58) -135%
-38-
Sales
IMC. The nature and extent of our selling relationship with each OEM customer is
different in terms of component products purchased, selling prices, product
volumes, ordering patterns and inventory management. We have pricing
arrangements with our customers that at times do not specify minimum order
quantities. Our visibility to customer ordering patterns is over a relatively
short period of time. Our customers may have inventory management programs and
alternate supply arrangements of which we are unaware. Additionally, the
relative market share among the OEM manufacturers changes periodically.
Consequently, these and other factors can significantly impact our sales in any
given period.
Our customers may initiate field actions with respect to market-released
products. These actions may include product recalls or communications with a
significant number of physicians about a product or labeling issue. The scope of
such actions can range from very minor issues affecting a small number of units
to more significant actions. There are a number of factors, both short-term and
long-term, related to these field actions that may impact our results. In the
short-term, if product has to be replaced, or customer inventory levels have to
be restored, this will result in increased component demand. Also, changing
customer order patterns due to market share shifts or accelerated device
replacements may also have a positive impact on our sales results in the
near-term. These same factors may have longer-term implications as well.
Customer inventory levels may ultimately have to be rebalanced to match demand.
IMC sales increased 57% for the three month period of 2008 when compared to the
same period of 2007. This growth included $44.3 million of sales related to our
acquisitions in 2007 and 2008. Excluding these sales, first quarter sales
declined by 11% over the previous year. This decrease was primarily the result
of lower revenue from coated components, feedthroughs and capacitors partially
offset by higher assembly revenue.
The decrease in ICD capacitor sales was primarily the result of a customer
supply issue during the first half of 2007, which has subsequently been
resolved. The decrease in feedthrough sales was primarily due to customer
inventory stocking in the first quarter of 2007 as well as price concessions
provided to some of our larger OEM customers during the first half of 2007 in
exchange for long-term commitments. The decline in coated component sales is
primarily the result of a large OEM customer changing product mix due to
marketplace field actions which is expected to continue for the remainder of
2008. 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 45% over the 2007 period.
Electrochem. 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.
Electrochem sales increased 68% over the prior year first quarter. This included
$7.1 million of sales from the companies acquired in 2007. On an organic basis
Electrochem revenue increased by 7%. The core growth in Electrochem sales
primarily came from oil and gas, pipeline inspection and military markets. Oil
and gas drilling and pipeline inspection activity remains strong. Additionally,
we continue to gain market share across our markets.
-39-
Cost of sales
Changes from the prior year to cost of sales as a percentage of sales were
primarily due to the following:
Three months ended
March 28, 2008
-------------------
Impact of 2008 and 2007 acquisitions (a) 7.8%
Inventory step-up amortization (b) 5.3%
Amortization of intangible assets (c) 0.6%
Lower volume (d) 1.7%
Other -0.1%
-------------------
Total percentage point change to cost of sales as a
percentage of sales 15.3%
===================
(a) We completed seven acquisitions from the second quarter of 2007 to the
first quarter of 2008. The acquired companies are currently operating with
a higher cost of sales percentage than our legacy businesses due to higher
excess capacity and less efficient operations. We are currently in the
process of applying our "Lean" manufacturing processes to their operations
and formalizing plans for plant consolidation in order to lower cost of
sales as a percentage of sales. These initiatives, as well as increased
sales volumes, are expected to help improve our cost of sales percentage
over the next two years.
(b) In connection with our acquisitions in the first quarter of 2008 and fourth
quarter of 2007, 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 $6.4 million. As of March 28, 2008 there was no remaining
inventory step up to be amortized.
(c) In connection with our acquisitions in 2008 and 2007, the value of
technology and patents were recorded on the balance sheet at fair value.
These intangible assets are amortized to cost of sales - amortization of
intangible assets over their estimated useful lives. The 2008 quarter
includes approximately $0.8 million of incremental amortization expense
over the 2007 period related to the amortization of these intangible
assets, which is expected to continue at current levels for the foreseeable
future.
(d) This increase in cost of sales is primarily due to lower production of core
IMC products (mainly capacitors and feedthroughs), which absorb a higher
amount of fixed costs such as plant overhead and depreciation. In the prior
year period, production volume was higher in response to increased sales
and replenishment of safety stock.
We expect our cost of sales as a percentage of sales to decrease over the next
several years as a result of our "Lean" initiatives and consolidation efforts,
the elimination of excess capacity and the elimination of inventory step-up
amortization related to the acquisitions.
-40-
SG&A expenses
Changes from the prior year to SG&A expenses were due to the following (in
thousands):
Three months ended
March 28, 2008
----------------------
Impact of 2008 and 2007 acquisitions (a) $ 5,968
Amortization (b) 996
Litigation fees (c) 945
Director compensation (d) 274
Professional and consulting fees (e) 316
Other (185)
----------------------
Net increase in SG&A $ 8,314
======================
(a) We completed seven acquisitions from the second quarter of 2007 to the
first quarter of 2008. 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. We are currently in the process of consolidating our
administrative operations in order to lower SG&A costs. These initiatives
are expected to be implemented over the next two years.
(b) In connection with our acquisitions in 2008 and 2007, the value of customer
relationships and non-compete agreements were recorded at fair value at the
time of acquisition. These intangible assets are amortized to SG&A over
their estimated useful lives. The 2008 quarter includes approximately $1.0
million of incremental amortization expense over the 2007 period related to
the amortization of these intangible assets, which is expected to continue
at current levels for the foreseeable future.
(c) Amount represents legal fees incurred in connection with the patent
infringement action filed by Pressure Products Medical Supplies, Inc.
against Enpath which continued to be defended during the current quarter.
This lawsuit is expected to go to trial during the second quarter of 2008.
Accordingly, litigation expenses are expected to continue at current levels
into the third quarter of 2008. Enpath believes that the plaintiff's claims
are without merit. However, it is not possible to predict the 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 - See Note 13.
(d) The increase in director fees is consistent with our amended director
compensation plan as discussed in our 2008 proxy statement as well as an
increase in the number of non-employee directors over the prior year.
(e) The increase in professional and consulting fees is due to the overall
growth and increased complexity of the Company due to our recent
acquisitions.
-41-
RD&E expenses
Net research, development and engineering costs are as follows (in thousands):
Three months ended
---------------------------------
March 28, March 30,
2008 2007
----------------- ---------------
Research and development costs $ 5,445 $ 3,631
----------------- ---------------
Engineering costs 5,912 3,131
Less cost reimbursements (2,133) (310)
----------------- ---------------
Engineering costs, net 3,779 2,821
----------------- ---------------
Total research and development and
engineering costs, net $ 9,224 $ 6,452
================= ===============
The increase in total research and development and engineering costs, net for
the first quarter of 2008 was primarily a result of the acquisitions in 2007 and
2008 which added $2.2 million to research and development costs and $1.3 million
to engineering costs, net. We are currently finalizing plans to consolidate our
research and development functions, which we should begin implementing during
the second half of 2008. Reimbursement on product development projects is
dependent upon the timing of the achievement of milestones and are netted
against gross spending.
Other Operating Expenses
Acquired In-Process Research and Development - Approximately $2.2 million of the
Precimed purchase price represents the estimated fair value of IPR&D projects
acquired. 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 valuation of the IPR&D is preliminary
in nature and is subject to adjustment as additional information is obtained.
The valuations will be finalized within 12 months of the close of the
acquisition. Any changes to the preliminary valuation may result in material
adjustments to the IPR&D.
The remaining other operating expenses are comprised of the following costs (in
thousands):
Three months ended
------------------------------
March 28, March 30,
2008 2007
--------------- --------------
(a) Carson City facility shutdown and Tijuana
facility consolidation No. 1 $ - $ 386
(a) Columbia facility shutdown, Tijuana facility
consolidation No. 2 and RD&E consolidation 224 1,303
(a) Electrochem expansion 106 137
(a) Integration and severance costs 660 -
(a) Asset dispositions and other 38 (293)
--------------- --------------
$ 1,028 $ 1,533
=============== ==============
(a) Refer to the "Cost Savings and Consolidation Efforts" discussion for
disclosure related to the timing and level of remaining expenditures for
these items as of March 28, 2008.
-42-
Interest expense and interest income
Interest expense for the three month period ended March 28, 2008 is $2.3 million
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 during the first quarter of 2007, as well as the
additional expense associated with $117 million of debt outstanding used to fund
our acquisitions in 2008. Interest income for the three months ended March 28,
2008 decreased by $1.5 million in comparison to the same period of 2007
primarily due to the cash deployed in connection with our acquisitions in 2008
and 2007. We expect interest expense and income to remain comparable to the
current quarter's level for the next two years.
Other income, net
Gain on foreign currency contracts - 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 the Chaumont 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, $1.6 million of which was recorded in the first quarter of 2008 as
Other Income, Net.
Gain on extinguishment of debt - In March 2007, we entered into separate,
privately negotiated agreements to exchange $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 CSN I. This
exchange was accounted for as an extinguishment of debt and resulted in a net
pre-tax gain of $4.5 million.
Provision for income taxes
The effective tax rate for the first quarter of 2008 was 41.0% compared to 32.5%
for the 2007 first quarter. The current quarter effective tax rate includes the
impact of $2.2 million of acquired IPR&D written off in connection with the
Precimed acquisition which is not deductible for tax purposes as well as the
favorable effect of income tax settlements with a state taxing authority as
discussed in Note 12 to the condensed consolidated financial statements.
Additionally, the 2008 effective tax rate is higher than 2007 due to the
expiration of the federal research and development tax credit at the end of
2007. We expect our effective tax rate to be approximately 39% for 2008.
Liquidity and Capital Resources
-------------------------------
March 28, December 28,
(Dollars in millions) 2008 2007
-------------- -------------
Cash and cash equivalents and short-term investments
(a)(b) $ 20.8 $ 40.5
Working capital (b) $ 132.8 $ 116.8
Current ratio (b) 2.7:1.0 2.8:1.0
(a) Short-term investments consist of investments acquired with maturities that
exceed three months and are less than one year at the time of acquisition.
(b) Cash and cash equivalents and short-term investments decreased primarily
due to the cash used to acquire Precimed and the Chaumont Facility
partially offset by $117.0 million of net cash received from our revolving
line of credit. Our working capital and current ratio remained relatively
consistent with year-end amounts.
-43-
Revolving Line of Credit
We have a senior credit facility (the "Credit Facility") consisting of a $235
million revolving credit facility, which can be increased to $335 million upon
our request. The Credit Facility also contains a $15 million letter of credit
subfacility and a $15 million swingline subfacility. The 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 Credit Facility are, at our option, based upon the current prime rate
or the LIBOR rate 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 rate, 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 Credit Facility based
on our leverage ratio.
The 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 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 our ability to make cash payments upon
conversion of our subordinated notes. These limitations can be waived upon our
request and approval of a simple majority of the lenders. Such waiver was
obtained in order to fund the Precimed acquisition.
In addition, the Credit Facility requires us 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 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 Credit
Facility immediately due and payable.
In connection with our acquisition of Precimed and the Chaumont Facility, we
borrowed $117 million under our revolving line of credit during the first
quarter of 2008. The weighted average interest rate on these borrowings as of
March 28, 2008 was 5.0% which resets based upon the six-month ($87 million),
three-month ($15 million) and one-month ($15 million) LIBOR rate. Based upon
current capital needs in connection with the new Electrochem facility as well as
the expansion of our corporate headquarters, we currently do not anticipate
making principal payments on the revolving line of credit within the next twelve
months.
Interest Rate Swap - During the first quarter of 2008, we entered into an $80
million notional receive floating-pay fixed interest rate swap indexed to the
six-month LIBOR rate that expires on July 7, 2010. The objective of this swap is
to hedge against potential changes in cash flows on $80 million of our revolving
line of credit, which is indexed to the six-month LIBOR rate. No credit risk was
hedged. The receive variable leg of the swap and the variable rate paid on the
revolving line of credit bear the same rate of interest, excluding the credit
spread, and reset and pay interest on the same dates. We intend to keep electing
six-month LIBOR as the benchmark interest rate on the debt. If we repay the debt
we intend to replace the hedged item with similarly indexed forecast cash flows.
The pay fixed leg of the swap bears an interest rate of 3.09%, which does not
include the credit spread.
-44-
As of March 28, 2008, a negative fair value adjustment on the interest rate swap
of $0.5 million was recorded in accumulated other comprehensive income, net of
income taxes of $0.2 million. No portion of the change in fair value of the
interest rate swap during the first quarter of 2008 was considered ineffective.
The amount recorded as an offset to interest expense during the first quarter of
2008 related to the interest rate swap was $0.07 million.
Operating activities
Net cash flows from operating activities for the three months ended March 28,
2008 declined slightly from the comparable period in 2007 as increased net
income excluding non-cash items (i.e. depreciation, amortization, stock-based
compensation, non-cash gains/losses) was more than offset by less cash flow
provided by working capital accounts. The extinguishment of debt in the first
quarter of 2007 resulted in a reclassification of approximately $11.3 million of
current income tax liability, which was paid over the remainder of 2007. This
amount was previously recorded as a non-current deferred tax liability on the
balance sheet. The remaining variances can be attributed to the timing of cash
receipts and payments, including those related to the companies acquired in 2007
and 2008.
Investing activities
Net cash used in investing activities of $106.9 million for the three months
ended March 28, 2008 increased over the comparable period in 2007. This was
primarily the result of the acquisitions of Precimed and the Chaumont Facility
in 2008 which was funded with our revolving line of credit and cash on hand. The
increase in property, plant and equipment purchases during the first quarter of
2008 relates to construction of our new Electrochem manufacturing facility in
Raynham, MA and the expansion of our corporate headquarters initiated in the
third quarter of 2007. The remaining capital expenditures for 2008 are expected
to total approximately $45 million and will be paid throughout the remainder of
2008.
Financing activities
Cash flow provided by financing activities for the first quarter of 2008 was
primarily related to $117.0 million of borrowings on our revolving line of
credit taken in connection with the acquisition of Precimed and the Chaumont
Facility. Additionally, in accordance with the purchase agreement, we repaid
nearly all of the outstanding debt of Precimed on the acquisition date, which
totaled $31.7 million. The 2007 first quarter includes net proceeds of $76.0
million received in connection with the issuance of 2.25% convertible
subordinated notes due 2013 and $6.6 million of financing fees paid related to
that transaction and the new revolving credit agreement discussed above.
Capital structure
At March 28, 2008, our capital structure consisted of $241.6 million of
convertible subordinated notes, $117.0 million of debt under our revolving line
of credit and 22.9 million shares of common stock outstanding. We have $20.8
million in cash, cash equivalents and short-term investments which is sufficient
to meet our short-term operating cash flow needs. If necessary, we have access
to $118 million under our available line of credit and 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 initial public
offering has exceeded our book value; accordingly, we believe that if needed we
can access public markets to raise additional capital.
Our capital structure allows us to support our internal growth and provides
liquidity for corporate development initiatives. Our current expectation for the
remainder of 2008 is that capital spending will be approximately $45.0 million.
-45-
Off-Balance Sheet Arrangements
------------------------------
We have no off-balance sheet arrangements within the meaning of Item 303(a)(4)
of Regulation S-K.
Contractual Obligations
The following table summarizes our contractual obligations at March 28, 2008,
and the effect such obligations are expected to have on our liquidity and cash
flows in future periods, and include the impact of the Precimed and Chaumont
Facility acquisitions.
Payments due by period
------------------------------------------------------------
CONTRACTUAL OBLIGATIONS Remainder
Total of 2008 2009-2010 2011-2012 After 2012
-------------------------------------------- ----------- ------------- ----------- -----------
Long-Term Debt Obligations (a) $ 423,035 $10,734 $ 22,950 $ 136,538 $ 252,813
Operating Lease Obligations (b) 11,171 1,882 3,236 2,684 3,369
Purchase Obligations (b) 28,722 28,722 - - -
Pension Obligations (c) 11,288 795 2,026 2,175 6,292
Acquisitions (d) 5,281 5,281 - - -
---------- ----------- ------------- ----------- -----------
Total $ 479,497 $47,414 $ 28,212 $ 141,397 $ 262,474
========== =========== ============= =========== ===========
(a) Includes the annual interest expense on the convertible debentures of
2.25%, or $5.6 million and our variable-rate revolving line of credit of
$5.9 million based upon the period end weighted average interest rate of
5.0%. 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 and that the amount outstanding on our revolving line of credit is not
repaid until the expiration of the facility in May 2012. These amounts also
do not include the impact of our $80 million notional interest rate swap
entered into to hedge a portion of the outstanding revolving line of
credit. See Note 7 - "Long-Term Debt" of the Notes to the Condensed
Consolidated Financial Statements in this Form 10-Q for additional
information about our long-term debt obligations.
(b) See Note 13 - "Commitments and Contingencies" of the Notes to the Condensed
Consolidated Financial Statements in this Form 10-Q for additional
information about our operating lease and purchase obligations.
(c) See Note 8 - "Pension Plans" of the Notes to the Condensed Consolidated
Financial Statements in this Form 10-Q for additional information about our
pension plan obligations acquired in connection with the Precimed and
Chaumont Facility acquisitions.
(d) Payment for approximately $5.3 million of the Chaumont Facility purchase
price is due 60 days after the transaction date (April 11, 2008).
Litigation
----------
We are 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 the 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.
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 expected to go to trial
during the second quarter of 2008, but it is not possible to predict the 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.
-46-
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 March 2008, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 161, Disclosures about
Derivative Instruments and Hedging Activities. SFAS No. 161 amends and expands
the disclosure requirements of SFAS No. 133, and requires entities to provide
enhanced qualitative disclosures about objectives and strategies for using
derivatives, quantitative disclosures about fair values and amounts of gains and
losses on derivative contracts, and disclosures about credit-risk-related
contingent features in derivative agreements. We are still evaluating the impact
of SFAS No. 161 on our consolidated financial statements which will be effective
beginning in fiscal year 2009.
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 materially impact our consolidated
financial statements if 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 Accounting Research Bulletin No. 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.
-47-
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 SFAS No. 157. The provisions of SFAS No. 157
applicable to us beginning in fiscal year 2008 did 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.
Application of Critical Accounting Estimates
--------------------------------------------
Our unaudited condensed consolidated financial statements are based on the
selection of accounting policies and the application of significant accounting
estimates, some of which require management to make significant assumptions. We
believe that some of the more critical estimates and related assumptions that
affect our financial condition and results of operations are in the areas of
inventories, goodwill and other indefinite lived intangible assets, long-lived
assets, share-based compensation and income taxes. For further information,
refer to Item 7 "Managements Discussion and Analysis of Financial Condition and
Results of Operations" and Item 8 "Financial Statements and Supplementary Data"
in our Annual Report on Form 10-K for the year ended December 28, 2007.
During the three months ended March 28, 2008, we did not change or adopt new
accounting policies that had a material effect on our consolidated financial
condition and results of operations.
Forward-Looking Statements
--------------------------
Some of the statements contained in this Quarterly Report on Form 10-Q and other
written and oral statements made from time to time by us and our representatives
are not statements of historical or current fact. As such, they are
"forward-looking statements" within the meaning of Section 27A of the Securities
Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934,
as amended. We have based these forward-looking statements on our current
expectations, which are subject to known and unknown risks, uncertainties and
assumptions. They include statements relating to:
o future sales, expenses and profitability;
o the future development and expected growth of our business and the
markets we operate in;
o our ability to successfully execute our business model and our
business strategy;
o our ability to identify trends within the implantable medical devices,
medical components, and commercial power sources markets 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.
-48-
Although it is not possible to create a comprehensive list of all factors that
may cause actual results to differ from the results expressed or implied by our
forward-looking statements or that may affect our future results, some of these
factors include the following: dependence upon a limited number of customers,
product obsolescence, inability to market current or future products, pricing
pressure from customers, reliance on third party suppliers for raw materials,
products and subcomponents, fluctuating operating results, inability to maintain
high quality standards for our products, challenges to our intellectual property
rights, product liability claims, inability to successfully consummate and
integrate acquisitions, unsuccessful expansion into new markets, competition,
inability to obtain licenses to key technology, regulatory changes or
consolidation in the healthcare industry, and other risks and uncertainties that
arise from time to time as described in the Company's Annual Report on Form 10-K
and other periodic filings with the Securities and Exchange Commission.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
With our acquisition of Precimed and the Chaumont facility, we significantly
increased our exposure to foreign currency exchange rate fluctuations due to
transactions denominated in Swiss Francs, British Pounds and the Euros. 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. A hypothetical
10% change in the value of the U.S. Dollar in relation to our most significant
foreign currency exposures would have had an impact of approximately $10 million
on our 2008 net sales. This amount is not indicative of the hypothetical net
earnings impact due to partially offsetting impacts on cost of sales and
operating expenses.
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 the Chaumont 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, $1.6 million of which was recorded in 2008 as Other Income.
We translate all assets and liabilities of our foreign operations of Precimed
and the Chaumont Facility acquired in 2008 at the period-end exchange rate and
translates sales and expenses at the average exchange rates in effect during the
period. The net effect of these translation adjustments is recorded in the
condensed consolidated financial statements as comprehensive income (loss). The
aggregate translation adjustment for the first quarter of 2008 was $7.2 million.
Translation adjustments are not adjusted for income taxes as they relate to
permanent investments in our foreign subsidiaries. Foreign currency transaction
gains and losses included in other income, net in the Condensed Consolidated
Statements of Operations and Comprehensive Income amounted to $0.3 million
during the first quarter of 2008. A hypothetical 10% change in the value of the
U.S. Dollar in relation to our most significant foreign currency net assets
would have had an impact of approximately $11 million on our foreign net assets
as of March 28, 2008.
-49-
Borrowings under our revolving line of credit bear interest at fluctuating
market rates based upon the Prime Rate or LIBOR Rate. At March 28, 2008, we had
$117.0 million outstanding debt under our line of credit and thus were subject
to interest rate fluctuations. To help mitigate this risk, during the first
quarter of 2008, we entered into an $80 million notional receive floating-pay
fixed interest rate swap indexed to the six-month LIBOR rate that expires on
July 7, 2010. The objective of this swap is to hedge against potential changes
in cash flows on $80 million of our revolving line of credit, which is indexed
to the six-month LIBOR rate. No credit risk was hedged. The receive variable leg
of the swap and the variable rate paid on the revolving line of credit bear the
same rate of interest, excluding the credit spread, and reset and pay interest
on the same dates. We intend to continue electing six-month LIBOR as the
benchmark interest rate on the debt. If we repay the debt we intend to replace
the hedged item with similarly indexed forecast cash flows. The pay fixed leg of
the swap bears an interest rate of 3.09%, which does not include a credit
spread.
As of March 28, 2008, a negative fair value adjustment on the interest rate swap
of $0.5 million was recorded in accumulated other comprehensive income, net of
income taxes of $0.2 million. No portion of the change in fair value of the
interest rate swap during the first quarter of 2008 was considered ineffective.
The amount recorded as an offset to interest expense during the first quarter of
2008 related to the interest rate swap was $0.07 million.
A hypothetical 10% change in the LIBOR interest rate to the remaining $37
million of floating rate debt would have had an impact of approximately $0.2
million on our 2008 interest expense. This amount is not indicative of the
hypothetical net earnings impact due to partially offsetting impacts on our
short-term investments and cash and cash equivalents to interest income.
ITEM 4. CONTROLS AND PROCEDURES.
a. Evaluation of Disclosure Controls and Procedures.
-------------------------------------------------
Our management, including the principal executive officer and principal
financial officer, evaluated our disclosure controls and procedures (as defined
in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934)
related to the recording, processing, summarization and reporting of information
in our reports that we file with the SEC as of March 28, 2008. 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 March 28, 2008, our principal executive officer
and principal financial officer have concluded that our disclosure controls and
procedures are effective.
b. Changes in Internal Control Over Financial Reporting.
-----------------------------------------------------
We completed the following acquisitions during 2007 and 2008:
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
o P Medical Holding SA on January 7, 2008
o DePuy Orthopedics Chaumont, France manufacturing facility on February
11, 2008
-50-
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 excluded the
2007 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 Quarterly Report on Form
10-Q relates that have materially affected, or are reasonably likely to
materially affect, internal control over financial reporting, other than the
above mentioned acquisitions.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
There have been no other material changes to those legal proceedings as
previously disclosed in the Company's Form 10-K for the year ended December 28,
2007.
ITEM 1A. RISK FACTORS.
There have been no material changes in risk factors as previously disclosed in
the Company's Form 10-K for the year ended December 28, 2007.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
ITEM 5. OTHER INFORMATION.
None.
-51-
ITEM 6. EXHIBITS.
See the Exhibit Index for a list of those exhibits filed herewith.
SIGNATURES
Pursuant to the requirements of Sections 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
Dated: May 6, 2008 GREATBATCH, INC.
By /s/ Thomas J. Hook
---------------------------------------
Thomas J. Hook
President and Chief Executive Officer
(Principal Executive Officer)
By /s/ Thomas J. Mazza
---------------------------------------
Thomas J. Mazza
Senior Vice President and Chief Financial
Officer
(Principal Financial Officer)
By /s/ Marco F. Benedetti
---------------------------------------
Marco F. Benedetti
Corporate Controller
(Principal Accounting Officer)
EXHIBIT INDEX
Exhibit No. Description
----------- -----------
3.1 Amended and Restated Certificate of Incorporation (incorporated
by reference to Exhibit 3.1 to our quarterly report on Form
10-Q ended July 1, 2005).
3.2 Amended and Restated Bylaws (incorporated by reference to
Exhibit 3.2 to our quarterly report on Form 10-Q ended March
29, 2002).
31.1* Certification of Chief Executive Officer pursuant to Rule
13a-14(a) of the Securities Exchange Act.
31.2* Certification of Chief Financial Officer pursuant to Rule
13a-14(a) of the Securities Exchange Act.
32* Certification of Chief Executive Officer and Chief Financial
Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002.
* - Filed herewith.
-52-