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 June 29, 2007
Commission File Number 1-16137
GREATBATCH, INC.
(Exact name of Registrant as specified in its charter)
Delaware
(State of incorporation)
16-1531026
(I.R.S. employer identification no.)
9645 Wehrle Drive
Clarence, New York
14031
(Address of principal executive offices)
(716) 759-5600
(Registrant's telephone number, including area code)
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [ X ] No [ ]
Indicate by check mark whether the Registrant is a large accelerated filer,
an accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer" and "large accelerated filer" in Exchange Act Rule 12b-2 (check one):
--------------------------------------------------------------------------------
Large accelerated filer [ ] Accelerated filer [ X ] Non-accelerated filer [ ]
--------------------------------------------------------------------------------
Indicate by check mark whether the Registrant is a shell company (as
defined in Exchange Act Rule 12b-2). Yes [ ] No [ X ]
The number of shares outstanding of the Company's common stock, $0.001 par
value per share, as of August 7, 2007 was: 22,464,150 shares.
GREATBATCH, INC.
TABLE OF CONTENTS FOR FORM 10-Q
AS OF AND FOR THE THREE AND SIX MONTHS ENDED JUNE 29, 2007
Page
COVER PAGE 1
TABLE OF CONTENTS 2
PART I - FINANCIAL INFORMATION (unaudited)
ITEM 1. Condensed Consolidated Financial Statements
Condensed Consolidated Balance Sheets 3
Condensed Consolidated Statements of Operations and Comprehensive Income (Loss) 4
Condensed Consolidated Statements of Cash Flows 5
Notes to Condensed Consolidated Financial Statements 6
ITEM 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations 28
ITEM 3. Quantitative and Qualitative Disclosures About Market Risk 42
ITEM 4. Controls and Procedures 42
PART II - OTHER INFORMATION
ITEM 1. Legal Proceedings 43
ITEM 1A. Risk Factors 43
ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds 44
ITEM 3. Defaults Upon Senior Securities 44
ITEM 4. Submission of Matters to a Vote of Security Holders 44
ITEM 5. Other Information 45
ITEM 6. Exhibits 45
SIGNATURES 45
EXHIBIT INDEX 46
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
-------------------------
June 29, December 29,
ASSETS 2007 2006
------------ ------------
Current assets:
Cash and cash equivalents $ 81,509 $ 71,147
Short-term investments available for sale 39,290 71,416
Accounts receivable, net of allowance of $624 in 2007 and
$532 in 2006 34,980 31,285
Inventories 63,953 57,667
Refundable income taxes - 1,569
Deferred income taxes 6,948 5,899
Prepaid expenses and other current assets 3,473 2,343
------------ ------------
Total current assets 230,153 241,326
Property, plant and equipment, net 101,003 91,869
Amortizing intangible assets, net 48,710 28,078
Trademarks and tradenames 32,582 28,252
Goodwill 207,378 155,039
Other assets 13,671 3,263
------------ ------------
Total assets $ 633,497 $ 547,827
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 22,898 $ 12,657
Accrued expenses and other current liabilities 27,658 29,618
------------ ------------
Total current liabilities 50,556 42,275
Convertible subordinated notes 240,506 170,000
Deferred income taxes 30,193 35,859
Other long-term liabilities 141 -
------------ ------------
Total liabilities 321,396 248,134
------------ ------------
Stockholders' equity:
Preferred stock, $0.001 par value, authorized 100,000,000
shares; no shares issued or outstanding in 2007 or 2006 - -
Common stock, $0.001 par value, authorized 100,000,000
shares; 22,463,758 shares issued and outstanding in 2007
and 22,119,142 shares issued and 22,111,516 shares
outstanding in 2006 22 22
Additional paid-in capital 235,644 227,187
Treasury stock, at cost, no shares in 2007 and 7,626 shares
in 2006 - (205)
Retained earnings 76,435 69,165
Accumulated other comprehensive income - 3,524
------------ ------------
Total stockholders' equity 312,101 299,693
------------ ------------
Total liabilities and stockholders' equity $ 633,497 $ 547,827
============ ============
The accompanying notes are an integral part of these condensed consolidated
financial statements
- 3 -
GREATBATCH, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE INCOME (LOSS) - Unaudited
(in thousands except per share data)
---------------------------------------------------------------------------------------------------------
Three months ended Six months ended
--------------------- ---------------------
June 29, June 30, June 29, June 30,
2007 2006 2007 2006
---------- ---------- ---------- ----------
Sales $ 78,462 $ 70,598 $ 155,322 $ 138,705
Costs and expenses:
Cost of sales - excluding amortization of intangible assets 45,762 42,863 93,050 82,378
Cost of sales - amortization of intangible assets 994 958 1,942 1,916
Selling, general and administrative expenses 10,735 9,865 20,768 18,880
Research, development and engineering costs, net 6,981 6,142 13,433 12,040
Acquired in-process research and development 18,353 - 18,353 -
Other operating expense, net 1,988 3,643 3,521 6,312
---------- ---------- ---------- ----------
Operating income (loss) (6,351) 7,127 4,255 17,179
Interest expense 2,089 1,163 3,233 2,298
Interest income (2,586) (1,353) (4,442) (2,545)
Gain on sale of investment security (4,001) - (4,001) -
Gain on extinguishment of debt - - (4,473) -
Other (income) expense, net 102 (76) 86 (120)
---------- ---------- ---------- ----------
Income (loss) before provision for income taxes (1,955) 7,393 13,852 17,546
Provision for income taxes 1,444 2,550 6,582 6,053
---------- ---------- ---------- ----------
Net income (loss) $ (3,399) $ 4,843 $ 7,270 $ 11,493
========== ========== ========== ==========
Earnings (loss) per share:
Basic $ (0.15) $ 0.22 $ 0.33 $ 0.53
Diluted $ (0.15) $ 0.21 $ 0.33 $ 0.50
Weighted average shares outstanding:
Basic 22,160 21,809 22,087 21,774
Diluted 22,160 26,178 22,367 26,160
Comprehensive income:
Net income (loss) $ (3,399) $ 4,843 $ 7,270 $ 11,493
Net unrealized gain (loss) on short-term investments
available for sale, net of tax (643) 2,796 (869) 2,822
Less: reclassification adjustment for net realized gain on
short-term investments available for sale, net of tax (2,601) - (2,601) -
---------- ---------- ========== ==========
Comprehensive income (loss) $ (6,643) $ 7,639 $ 3,800 $ 14,315
========== ========== ========== ==========
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)
----------------------------------------------------------------------
Six months ended
--------------------
June 29, June 30,
2007 2006
---------- ---------
Cash flows from operating activities:
-------------------------------------
Net income $ 7,270 $ 11,493
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 10,878 9,748
Stock-based compensation 4,877 4,201
Gain on sale of investment security (4,001) -
Gain on extinguishment of debt (4,473) -
Acquired in-process research and
development 18,353 -
Deferred income taxes (9,841) 2,329
(Gain) loss on disposal of assets (82) 532
Changes in operating assets and liabilities:
Accounts receivable 1,225 (10,857)
Inventories 798 (6,428)
Prepaid expenses and other current assets (1,020) (1,441)
Accounts payable 6,818 2,763
Accrued expenses and other current
liabilities (7,070) (6,582)
Income taxes 5,158 2,507
---------- ---------
Net cash provided by operating
activities 28,890 8,265
---------- ---------
Cash flows from investing activities:
-------------------------------------
Purchase of short-term investments (47,713) (21,589)
Proceeds from maturity/disposition of short-
term investments 78,960 19,182
Acquisition of property, plant and equipment (5,183) (8,006)
Proceeds from sale of property, plant and
equipment 7 28
Purchase of cost method investment (2,000) -
Insurance proceeds for replacement of assets 300 -
Acquisitions, net of cash acquired (108,054) -
Increase in other assets 8 12
---------- ---------
Net cash used in investing activities (83,675) (10,373)
---------- ---------
Cash flows from financing activities:
-------------------------------------
Repayments under line of credit (1,000) -
Principal payments of long-term debt (6,093) (464)
Proceeds from issuance of long-term debt 76,000 -
Debt issuance costs (6,445) -
Issuance of common stock 2,550 349
Excess tax benefits from stock-based awards 340 -
Repurchase of treasury stock (205) -
---------- ---------
Net cash provided by (used in)
financing activities 65,147 (115)
---------- ---------
Net increase (decrease) in cash and cash
equivalents 10,362 (2,223)
Cash and cash equivalents, beginning of year 71,147 46,403
---------- ---------
Cash and cash equivalents, end of period $ 81,509 $ 44,180
========== =========
The accompanying notes are an integral part of these condensed consolidated
financial statements
- 5 -
GREATBATCH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Unaudited
--------------------------------------------------------------------------------
1. BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with accounting principles generally accepted in the
United States of America for interim financial information (Accounting
Principles Board Opinion ("APB") No. 28, Interim Financial Reporting) and with
the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly,
they do not include all of the information necessary for a fair presentation of
financial position, results of operations, and cash flows in conformity with
accounting principles generally accepted in the United States of America.
Operating results for interim periods are not necessarily indicative of results
that may be expected for the fiscal year as a whole. In the opinion of
management, the condensed consolidated financial statements reflect all
adjustments (consisting of normal recurring adjustments) considered necessary
for a fair presentation of the results of Greatbatch, Inc. and its indirect
wholly-owned subsidiary Greatbatch, Ltd. (collectively "Greatbatch" or the
"Company") for the periods presented. The preparation of financial statements in
conformity with accounting principles generally accepted in the United States of
America requires management to make estimates and assumptions that affect the
reported amounts of assets, liabilities, sales, expenses, and related
disclosures at the date of the financial statements and during the reporting
period. Actual results could differ from these estimates. The December 29, 2006
condensed consolidated balance sheet data was derived from audited financial
statements but does not include all disclosures required by accounting
principles generally accepted in the United States of America. For further
information, refer to the consolidated financial statements and notes included
in the Company's Annual Report on Form 10-K for the year ended December 29,
2006. The Company utilizes a fifty-two, fifty-three week fiscal year ending on
the Friday nearest December 31st. For 52-week years, each quarter contains 13
weeks. The second quarter of 2007 and 2006 each contained 13 weeks and ended on
June 29 and June 30, respectively.
2. ACQUISITIONS
BIOMEC, Inc. - On April 3, 2007, the Company acquired substantially all of the
assets of BIOMEC, Inc. ("BIOMEC"), a biomedical device company based in
Cleveland, OH with the objective of accelerating technology from major medical
and academic institutions, national laboratories, and from internally developed
proprietary products. With the BIOMEC acquisition, we acquired an engineering
team with diverse capabilities in medical device development, including
mechanical design, software engineering, biocompatible coatings, and
electronics. As a result, we can now offer our customers device engineering
expertise along with full device assembly utilizing our proprietary components.
This will also enable us to work in conjunction with our customers' design teams
to build more sophisticated devices.
This transaction was accounted for under the purchase method of accounting in
accordance with Statement of Financial Accounting Standards ("SFAS") No. 141
Business Combinations. Accordingly, the results of BIOMEC's operations were
included in our condensed consolidated financial statements from the date of
acquisition. The aggregate purchase price was $11.4 million, which was paid in
cash. This purchase price is preliminary and is subject to change based upon the
final resolution of the post-closing adjustment as defined in the purchase
agreement. Any adjustment to the purchase price is not expected to be material
and will be allocated to goodwill which totaled $5.2 million.
- 6 -
GREATBATCH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Unaudited
--------------------------------------------------------------------------------
Various factors contributed to the establishment of goodwill, including: the
value of BIOMEC's highly trained assembled work force; the expected revenue
growth over time and the incremental value to the Company's Implantable Medical
Components ("IMC") business from having device engineering capabilities; and the
strategic partnership established with IntElect Medical, Inc. ("IntElect") an
early stage neurostimulation device company that works in conjunction with the
Cleveland Clinic. Goodwill resulting from the BIOMEC acquisition was allocated
to the Company's IMC segment and is deductible for tax purposes.
Approximately $2.3 million of the purchase price represents the estimated fair
value of acquired in-process research and development ("IPR&D") projects that
had not yet reached technological feasibility and had no alternative future use
as of the acquisition date. Accordingly, the amount was immediately expensed
after the acquisition date. The value assigned to IPR&D relates to projects that
incorporate BIOMEC's novel-polymer coating (biomimetic) technology that mimics
the surface of endothelial cells of blood vessels. The estimated fair value of
these projects was determined using a discounted cash flow model. This model
utilized discount rates that took into consideration the stage of completion and
the risks surrounding the successful development and commercialization of each
of the IPR&D projects of approximately 40%, which is consistent with the early
development stage of these projects. The Company expects various products that
utilize the biomimetic coatings technology to be commercially launched by
original equipment manufacturers ("OEM") in 2009 once Food and Drug
Administration ("FDA") approval is received. With BIOMEC the Company acquired
grants that will fund the remaining development costs for these products. The
Company believes that the estimated acquired IPR&D amounts represent their fair
value at the date of acquisition and do not exceed the amount an independent
third party would pay for the projects. Pro forma amounts are not presented as,
excluding the IPR&D charge, BIOMEC did not materially impact our results of
operations.
Approximately $3.7 million of the purchase price was allocated to BIOMEC's
investment in IntElect. Subsequent to the acquisition, the Company made an
additional $2.0 million investment in IntElect, which increased its ownership
percentage to approximately 19%. The IntElect investment is being accounted for
under the cost method of accounting and is included in other assets.
Enpath Medical, Inc. - On June 15, 2007, the Company completed its acquisition
of Enpath Medical, Inc. ("Enpath"). Enpath is a medical products company engaged
in designing, developing, manufacturing and marketing single use medical device
products for the cardiac rhythm management, neuromodulation and interventional
radiology markets. We believe that the acquisition will further expand our
product and service offerings to the cardiac rhythm management ("CRM") and
neurostimulation marketplaces, broaden our market reach into the vascular
segment through Enpath's introducer product lines, as well as add several new
OEM customers.
This transaction was accounted for under the purchase method of accounting in
accordance with SFAS No. 141. Accordingly, the results of Enpath's operations
were included in our condensed consolidated financial statements from the date
of acquisition. The aggregate purchase price was $98.2 million, consisting of
the cash issued at closing to Enpath shareholders ($91.7 million), the
consideration paid to employees in exchange for the cancellation of their Enpath
stock options and restricted stock ($3.9 million) and other direct
acquisition-related costs, including financial advisory, legal and accounting
services ($2.6 million). Subsequent to the acquisition date, the Company repaid
the line of credit and term loans assumed from Enpath of approximately $7.1
million.
- 7 -
GREATBATCH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Unaudited
--------------------------------------------------------------------------------
In accordance with SFAS No. 141, the cost of the acquisition was preliminarily
allocated to the assets acquired and liabilities assumed from Enpath based on
their fair values as of the close of the acquisition, with the amount exceeding
the fair value recorded as goodwill. As the values of certain assets and
liabilities are preliminary in nature, they are subject to adjustment as
additional information is obtained, including, but not limited to, the
finalization of our intangible asset valuation and the resolution of
pre-acquisition tax positions. The valuations will be finalized within 12 months
of the close of the acquisition. When the valuations are finalized, any changes
to the preliminary valuation of assets acquired or liabilities assumed may
result in material adjustments to the fair value of the identifiable tangible
and intangible assets acquired, including IPR&D, 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) June 15, 2007
------------------------------------ --------------------
Assets acquired
Current assets $ 10,966
Property, plant and equipment 11,737
Acquired IPR&D 16,100
Amortizing intangible assets 22,634
Tradenames 4,330
Goodwill 47,114
--------------------
Total assets acquired 112,881
Liabilities assumed
Current liabilities 6,015
Notes payable 4,379
Deferred income taxes 4,175
Other non-current liabilities 145
--------------------
Total liabilities assumed 14,714
--------------------
Purchase price $ 98,167
====================
The fair values of the assets acquired and liabilities assumed were
preliminarily determined using one or more of three valuation approaches:
market, income and cost. The selection of a particular method for a given asset
depended on the reliability of available data and the nature of the asset, among
other considerations. The market approach, which indicates value for a subject
asset based on available market pricing for comparable assets, was utilized for
certain acquired personal property. The income approach, which indicates value
for a subject asset based on the present value of risk adjusted cash flows
projected to be generated by the asset, was used for certain intangible assets
such as core and developed technology, acquired IPR&D, customer relationships,
corporate tradenames and for noncompete agreements with employees. The risk
adjusted projected cash flows were discounted at a required rate of return that
reflects the relative risk of the Enpath transaction and the time value of
money. The risk adjusted projected cash flows for each asset considered multiple
factors, including current revenue from existing customers; distinct analysis of
expected price, volume, and attrition trends; reasonable contract renewal
assumptions from the perspective of a marketplace participant; and expected
profit margins giving consideration to historical and expected margins. The cost
approach, which estimates value by determining the current cost of replacing an
asset with another of equivalent economic utility, was used for the majority of
personal property. The cost to replace a given asset reflects the estimated
- 8 -
GREATBATCH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Unaudited
--------------------------------------------------------------------------------
reproduction or replacement cost for the property, less an allowance for loss in
value due to depreciation or obsolescence, with specific consideration given to
economic obsolescence if indicated.
Inventory - The fair value of the inventory acquired was estimated by applying a
version of the cost approach called the net realizable value method. This
approach estimates the fair value of the asset by calculating the potential
sales generated from selling the inventory and subtracting from it the costs
related to the disposal of that inventory and a reasonable profit allowance for
our completing and selling effort. Based upon this methodology, the Company
recorded the inventory acquired at fair value resulting in an increase in
inventory of $1.3 million. During the second quarter of 2007, the Company
expensed $0.2 million of the step-up value relating to the acquired Enpath
inventory sold during the quarter. As of June 29, 2007, the Company had
approximately $1.1 million of inventory step-up value remaining and expects to
recognize this step-up value as cost of sales during the third quarter of 2007.
Intangible assets - The purchase price was allocated to specific intangible
assets on a preliminary basis as follows (dollars in thousands):
Weighted
average Probability
Amount amortization assigned to Discount
assigned period (years) revenues rate
---------- -------------- ------------- --------
Amortizable intangible assets
Technology - core $ 6,938 11 100% 10%
Technology - developed 2,683 6 100% 10%
Customer relationships 12,703 11 100% 11%
Noncompete agreements 310 1 50% 10%
---------- --------------
$ 22,634 10
Tradenames 4,330 indefinite 100% 10%
Acquired IPR&D - Introducers $ 14,280 - 60% - 90% 10%
Acquired IPR&D - Catheters $ 1,820 - 70% - 75% 10%
Core technology - Core technology consists of technical processes, patented and
unpatented technology, manufacturing know-how and the understanding with respect
to products or processes that have been developed by Enpath and that will be
leveraged in future products or processes and will be carried forward from one
product generation to the next. Approximately 85 percent of the preliminary
value assigned to core technology is associated with Enpath's introducer
products. The Company determined that the estimated useful life of the core
technology is 11 years. This life is based upon management's estimate of the
product life cycle associated with core technology before they will be replaced
by new technologies. The expected cash flows associated with core technology was
nominal after 11 years.
Developed technology - Developed technology acquired from Enpath represents the
preliminary value associated with currently marketed products that have received
FDA approval as of the acquisition date. Enpath's currently marketed products
include:
- 9 -
GREATBATCH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Unaudited
--------------------------------------------------------------------------------
o Venous vessel introducers and valved introducers that enable physicians to
create a conduit through which they can insert infusion catheters,
implantable ports and pacemaker leads into a blood vessel;
o Advanced delivery catheters that have a "fixed curve" or articulating
distal tip section that can be manipulated to enable the health care
professional to access parts of the patient's anatomy that cannot be
reached by traditional introducers; and
o Implantable stimulation leads, adaptors and delivery systems for the
cardiac and neuromodulation markets.
The Company determined that the estimated useful life of the developed
technology is 6 years. This life is based upon management's estimate of the life
cycle associated with the above products before they will be replaced by new
technologies or the next generation of products. The expected cash flows
associated with developed technology was nominal after 6 years.
Customer relationships - Customer relationships represent the preliminary
estimated fair value of both the contractual and non-contractual customer
relationships Enpath has with OEMs as of the acquisition date. The primary
customers of Enpath include C.R. Bard, Boston Scientific, Medtronic and St. Jude
Medical, some of which are also customers of Greatbatch. These relationships
were valued separately from goodwill at the amount which an independent third
party would be willing to pay for these OEM relationships. The Company
determined that the estimated useful life of the intangible assets associated
with the existing customer relationships is 11 years. This life was based upon
historical customer attrition and management's understanding of the industry.
Acquired IPR&D - Approximately $16.1 million of the purchase price represents
the preliminary estimated fair value of acquired IPR&D projects that had not yet
reached technological feasibility and had no alternative future use.
Accordingly, the amount was immediately expensed on the acquisition date. The
preliminary value assigned to IPR&D related to introducer projects ($14.3
million) and catheter projects ($1.8 million). These projects primarily
represent the next generation of products already being sold by Enpath which
incorporate new enhancements and customer modifications. The Company expects to
commercially launch various introducer products in 2008 and 2009 and various
catheter products in 2009 which will replace existing products. For purposes of
valuing the acquired research and development, the Company estimated total costs
to complete the introducer projects to be approximately $0.3 million and $0.5
million to complete the catheter projects. If we are not successful in
completing these projects on a timely basis, our future sales from introducers
and catheters may be adversely affected resulting in erosion of our market
share.
The preliminary fair value of these projects was determined based on the excess
earnings method. This model utilized discount rates that took into consideration
the internal rate of return expected from the Enpath transaction and applied
that rate to risk adjusted revenues. The risk adjustment assigned to the
revenues was based upon the stage of completion and the risks surrounding the
successful development and commercialization of each of the IPR&D projects. The
Company believes that the estimated acquired IPR&D amounts represent the fair
value at the date of acquisition and do not exceed the amount an independent
third party would pay for the projects.
- 10 -
GREATBATCH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Unaudited
--------------------------------------------------------------------------------
Goodwill - The excess of the purchase price over the preliminary fair value of
net tangible and intangible assets acquired of $47.1 million was allocated to
goodwill. Various factors contributed to the establishment of goodwill,
including: the strategic benefit of entering the neurostimulation and
interventional markets; the value of Enpath's highly trained assembled work
force; the expected revenue growth over time that is attributable to increased
market penetration from future products and customers; and the incremental value
to the Company's IMC business from having a leads platform. The goodwill
acquired in connection with the Enpath acquisition was allocated to the
Company's IMC business segment and is not deductible for tax purposes.
Pro Forma Results - The following unaudited pro forma information presents the
consolidated results of operations of the Company and Enpath as if the
acquisition of Enpath had occurred as of the beginning of each of the fiscal
periods presented (in thousands, except per share amounts):
Three months ended Six months ended
--------------------- ---------------------
(Unaudited) June 29, June 30, June 29, June 30,
2007 2006 2007 2006
--------------------- ---------------------
Sales $86,386 $79,877 $172,940 $156,902
Net income 9,441 4,242 19,448 10,586
Earnings per share:
Basic $0.43 $0.19 $0.88 $0.49
Diluted $0.41 $0.19 $0.81 $0.46
The unaudited pro forma information presents the combined operating results of
Greatbatch and Enpath, with the results prior to the acquisition date adjusted
to include the pro forma impact of: the adjustment of amortization of acquired
intangible assets and depreciation of fixed assets based on the preliminary
purchase price allocation; the elimination of acquisition expenses incurred by
Enpath ($5.9 million); the elimination of the non-recurring IPR&D charge and
inventory step-up adjustment related to the Enpath acquisition recorded by
Greatbatch in the second quarter of 2007 ($16.3 million); the adjustment to
interest income reflecting the cash paid in connection with the acquisition,
including acquisition-related expenses, at Greatbatch's weighted average
interest income rate; and the impact of income taxes on the pro forma
adjustments utilizing the federal statutory tax rate of 35%. The unaudited pro
forma consolidated basic and diluted earnings per share are based on the
consolidated basic and diluted weighted average shares of Greatbatch.
The unaudited pro forma results are presented for illustrative purposes only and
do not reflect the realization of potential cost savings, and any related
integration costs. Certain cost savings may result from the acquisition;
however, there can be no assurance that these cost savings will be achieved.
These pro forma results do not purport to be indicative of the results that
would have actually been obtained if the acquisition occurred as of the
beginning of each of the periods presented, nor does the pro forma data intend
to be a projection of results that may be obtained in the future.
- 11 -
GREATBATCH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Unaudited
--------------------------------------------------------------------------------
3. SUPPLEMENTAL CASH FLOW INFORMATION
Six months ended
----------------------
June 29, June 30,
2007 2006
----------- ----------
Noncash investing and financing activities: (in thousands)
Net unrealized gain (loss) on available-for-
sale securities $ (869) $ 2,822
Common stock contributed to 401(k) Plan 2,956 2,780
Property, plant and equipment purchases
included in accounts payable 1,016 931
Deferred acquisition costs included in
accounts payable 2,023 -
Exchange of convertible subordinated notes
(Note 7) 117,782 -
Cash paid during the period for:
Interest $ 2,354 $ 1,944
Income taxes 11,003 1,247
Acquisition of noncash assets and liabilities:
Assets acquired $ 120,363 $ -
Liabilities assumed 15,294 -
4. SHORT-TERM INVESTMENTS
Short-term investments available for sale at June 29, 2007 and December 29, 2006
are comprised of the following (in thousands):
Gross Gross
unrealized unrealized Estimated
Cost gains losses fair value
---- ----- ------ ----------
June 29, 2007
-------------
Auction rate securities and other $ 39,290 $ - $ - $ 39,290
----------- ----------- ----------- -----------
Total available for sale securities $ 39,290 $ - $ - $ 39,290
=========== =========== =========== ===========
December 29, 2006
-----------------
Equity securities $ 291 $ 4,588 $ - $ 4,879
Auction rate securities and other 66,537 4 (4) 66,537
----------- ----------- ----------- -----------
Total available for sale securities $ 66,828 $ 4,592 $ (4) $ 71,416
=========== =========== =========== ===========
In the second quarter of 2007, the Company sold an equity security investment
which resulted in a pre-tax gain of $4.0 million ($2.6 million net of tax) or
$0.12 per diluted share.
- 12 -
GREATBATCH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (con't) - Unaudited
--------------------------------------------------------------------------------
5. INVENTORIES
Inventories are comprised of the following (in thousands):
June 29, December 29,
2007 2006
------------ ------------
Raw materials $ 33,053 $ 28,568
Work-in-process 16,309 13,528
Finished goods 14,591 15,571
------------ ------------
Total $ 63,953 $ 57,667
============ ============
6. INTANGIBLE ASSETS
Amortizing intangible assets are comprised of the following (in thousands):
Gross
carrying Accumulated Net carrying
amount amortization amount
------------- ------------- -------------
June 29, 2007
-------------
Customer lists $ 12,703 $ (48) $ 12,655
Patented technology 21,462 (14,101) 7,361
Unpatented technology 40,507 (12,132) 28,375
Other 1,650 (1,331) 319
------------- ------------- -------------
Total amortizing intangible assets $ 76,322 $ (27,612) $ 48,710
============= ============= =============
December 29, 2006
-----------------
Patented technology $ 21,462 $ (13,320) $ 8,142
Unpatented technology 30,886 (10,975) 19,911
Other 1,340 (1,315) 25
------------- ------------- -------------
Total amortizing intangible assets $ 53,688 $ (25,610) $ 28,078
============= ============= =============
Aggregate amortization expense for the second quarter of 2007 and 2006 was $1.1
million and $1.0 million, respectively. Aggregate amortization expense for the
six months ended June 29, 2007 and June 30, 2006 was $2.0 million and $1.9
million, respectively. As of June 29, 2007, annual amortization expense is
estimated to be $3.2 million for the remainder of 2007, $6.2 million for 2008,
$5.5 million for 2009 and $4.9 million for each of 2010, 2011 and 2012.
The change in the carrying amount of goodwill during 2007 is as follows (in
thousands):
IMC ECP Total
--- --- -----
Balance at December 29, 2006 $ 152,473 $ 2,566 $ 155,039
Goodwill recorded for BIOMEC 5,225 - 5,225
Goodwill recorded for Enpath 47,114 - 47,114
---------- ---------- ----------
Balance at June 29, 2007 $ 204,812 $ 2,566 $ 207,378
========== ========== ==========
- 13 -
GREATBATCH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (con't) - Unaudited
--------------------------------------------------------------------------------
7. DEBT
Long-term debt is comprised of the following (in thousands):
June 29, December 29,
2007 2006
------------- -------------
2.25% convertible subordinated notes I, due 2013 $ 52,218 $ 170,000
2.25% convertible subordinated notes II, due 2013 197,782 -
Unamortized discount (9,494) -
------------- -------------
Total long-term debt $ 240,506 $ 170,000
============= =============
Convertible Subordinated Notes - In May 2003, the Company completed a private
placement of $170 million of 2.25% convertible subordinated notes, due 2013
("CSN I"). In November 2003 the Company had a registration statement with the
Securities and Exchange Commission ("SEC") declared effective with respect to
these notes and the underlying common stock. In March 2007, the Company entered
into separate, privately negotiated agreements to exchange $117.8 million of CSN
I for an equivalent principal amount of a new series of 2.25% convertible
subordinated notes due 2013 ("CSN II") (collectively the "Exchange").
The primary purpose of the Exchange was to eliminate the June 15, 2010 call and
put option that is included in the terms of CSN I. In connection with the
Exchange, the Company issued an additional $80 million aggregate principal
amount of CSN II at a price of $950 per $1,000 of principal. In June 2007, the
Company had a registration statement with the SEC declared effective with
respect to these notes and the underlying common stock.
The Exchange was accounted for as an extinguishment of debt and resulted in a
pre-tax gain of $4.5 million ($2.9 million net of tax) or $0.13 per diluted
share. As a result of the extinguishment, the Company had to recapture the tax
interest expense that was previously deducted on the extinguished debentures.
This resulted in an additional current income tax liability of approximately
$11.3 million, which will be paid by the end of 2007. This amount was previously
recorded as a non-current deferred tax liability on the balance sheet. The
following is a summary of the significant terms of CSN I and CSN II:
CSN I - The notes bear interest at 2.25% per annum, payable semi-annually.
Holders may convert the notes into shares of the Company's common stock at a
conversion rate of 24.8219 shares per $1,000 of principal, subject to
adjustment, before the close of business on June 15, 2013 only under the
following circumstances: (1) during any fiscal quarter commencing after July 4,
2003, if the closing sale price of the Company's common stock exceeds 120% of
the $40.29 conversion price for at least 20 trading days in the 30 consecutive
trading day period ending on the last trading day of the preceding fiscal
quarter; (2) subject to certain exceptions, during the five business days after
any five consecutive trading day period in which the trading price per $1,000 of
principal for each day of such period was less than 98% of the product of the
closing sale price of the Company's common stock and the number of shares
issuable upon conversion of $1,000 of principal; (3) if the notes have been
called for redemption; or (4) upon the occurrence of certain corporate events.
- 14 -
GREATBATCH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (con't) - Unaudited
--------------------------------------------------------------------------------
Beginning June 20, 2010, the Company may redeem any of the notes at a redemption
price of 100% of their principal amount, plus accrued interest. Note holders may
require the Company to repurchase their notes on June 15, 2010 or at any time
prior to their maturity following a fundamental change, as defined in the
agreement, at a repurchase price of 100% of their principal amount, plus accrued
interest. The notes are subordinated in right of payment to all of our senior
indebtedness and effectively subordinated to all debts and other liabilities of
the Company's subsidiaries.
Beginning with the six-month interest period commencing June 15, 2010, the
Company will pay additional contingent interest during any six-month interest
period if the trading price of the notes for each of the five trading days
immediately preceding the first day of the interest period equals or exceeds
120% of the principal amount of the notes.
CSN II - The notes bear interest at 2.25% per annum, payable semi-annually. The
holders may convert the notes into shares of the Company's common stock at a
conversion price of $34.70 per share, which is equivalent to a conversion ratio
of 28.8219 shares per $1,000 of principal. The conversion price and the
conversion ratio will adjust automatically upon certain changes to the Company's
capitalization.
The notes are convertible at the option of the holders at such time as: (i) the
closing price of the Company's common stock exceeds 150% of the conversion price
of the notes for 20 out of 30 consecutive trading days; (ii) the trading price
per $1,000 of principal is less than 98% of the product of the closing sale
price of common stock for each day during any five consecutive trading day
period and the conversion rate per $1,000 of principal; (iii) the notes have
been called for redemption; (iv) the Company distributes to all holders of
common stock rights or warrants entitling them to purchase additional shares of
common stock at less than the average closing price of common stock for the ten
trading days immediately preceding the announcement of the distribution; (v) the
Company distributes to all holders of common stock any form of dividend which
has a per share value exceeding 5% of the price of the common stock on the day
prior to such date of distribution; (vi) the Company affects a consolidation,
merger, share exchange or sale of assets pursuant to which its common stock is
converted to cash or other property; (vii) the period beginning 60 days prior to
but excluding June 15, 2013; and (viii) certain fundamental changes, as defined
in the agreement, occur or are approved by the Board of Directors.
Conversions in connection with corporate transactions that constitute a
fundamental change require the Company to pay a premium make-whole amount
whereby the conversion ratio on the notes may be increased by up to 8.2 shares
per $1,000 of principal. The premium make-whole amount will be paid in shares of
common stock upon any such conversion, subject to the net share settlement
feature of the notes described below.
The notes contain a net share settlement feature that requires the Company to
pay cash for each $1,000 of principal. Any amounts in excess of $1,000 will be
settled in shares of the Company's common stock, or at the Company's option,
cash. The Company has a one-time irrevocable election to pay the holders in
shares of its common stock, which it currently does not plan to exercise.
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.
- 15 -
GREATBATCH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (con't) - Unaudited
--------------------------------------------------------------------------------
Revolving Line of Credit - In May 2007, the Company entered into a new senior
credit facility (the "New Credit Facility") consisting of a $235 million
revolving credit facility, which can be increased to $335 million upon the
Company's request. The New Credit Facility also contains a $15 million letter of
credit subfacility and a $15 million swingline subfacility. This New Credit
Facility replaced the Company's previous $50 million revolving credit facility.
The New Credit Facility is secured by the Company's non-realty assets including
cash, accounts and notes receivable, and inventories, and has an expiration date
of May 22, 2012 with a one-time option to extend to April 1, 2013 if no default
has occurred. Interest rates under the New Credit Facility are, at the Company's
option, based upon the current prime rate or the LIBOR rate plus a margin that
varies with the Company's leverage ratio. If interest is paid based upon the
prime rate, the applicable margin is between minus 1.25% and 0.00%. If interest
is paid based upon the LIBOR rate, the applicable margin is between 1.00% and
2.00%. The Company is required to pay a commitment fee between 0.125% and 0.250%
per annum on the unused portion of the New Credit Facility based on the
Company's leverage ratio.
The New Credit Facility contains limitations on the incurrence of indebtedness,
limitations on the incurrence of liens and licensing of intellectual property,
limitations on investments and restrictions on certain payments. Except to the
extent paid for by common equity of Greatbatch or paid for out of cash on hand,
the New Credit Facility limits the amount paid for acquisitions to $100 million.
The restrictions on payments, among other things, limit repurchases of
Greatbatch's stock to $60 million and limits the ability of the Company to make
cash payments upon conversion of CSN II.
In addition, the New Credit Facility requires the Company to maintain a ratio of
adjusted EBITDA, as defined in the agreement, to interest expense of at least
3.00 to 1.00, and a total leverage ratio, as defined in the agreement, of not
greater than 5.00 to 1.00 from May 22, 2007 through September 29, 2009 and not
greater than 4.50 to 1.00 from September 30, 2009 and thereafter.
The New Credit Facility contains customary events of default. Upon the
occurrence and during the continuance of an event of default, a majority of the
lenders may declare the outstanding advances and all other obligations under the
New Credit Facility immediately due and payable.
There were no borrowings outstanding under the New Credit Facility as of June
29, 2007.
Deferred Financing Fees - The following is a reconciliation of deferred
financing fees for the second quarter of 2007, which are included in other
assets (in thousands):
Balance at March 30, 2007 $ 5,040
Financing costs deferred 2,283
Write-off during the period (14)
Amortization during the period (278)
-----------
Balance at June 29, 2007 $ 7,031
===========
- 16 -
GREATBATCH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (con't) - Unaudited
--------------------------------------------------------------------------------
8. STOCK-BASED COMPENSATION
Compensation costs related to share-based payments for the three and six months
ended June 29, 2007 totaled $1.2 million, $0.8 million net of tax, or $0.03 per
diluted share and $2.9 million, $1.9 million net of tax, or $0.08 per diluted
share, respectively. This compares to $1.2 million, $0.8 million net of tax, or
$0.03 per diluted share and $2.6 million, $1.7 million net of tax, or $0.07 per
diluted share for the three and six months ended June 30, 2006, respectively.
The following table summarizes stock option activity related to the Company's
stock-based incentive plans:
Weighted
average
Weighted remaining Aggregate
average contractual intrinsic
Number of exercise life value(1)
stock options price (in years) (in millions)
-----------------------------------------------------
Outstanding at January 1, 2006 1,397,160 $ 23.16
Granted(2) 483,265 23.92
Exercised (160,605) 12.97
Forfeited or Expired (93,291) 24.94
--------------
Outstanding at December 29, 2006 1,626,529 $ 24.27 7.4 $ 6.4
Granted(3) 327,359 27.52
Exercised (132,260) 19.28
Forfeited or Expired (44,167) 29.93
--------------
Outstanding at June 29, 2007 1,777,461 $ 25.10 7.6 $ 13.7
=====================================================
Exercisable at June 29, 2007 805,252 $ 26.01 6.0 $ 5.9
=====================================================
(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 June 29, 2007 ($32.40) and the
weighted average exercise price of the underlying options, multiplied by
the number of options outstanding and/or exercisable.
(2) Includes 183,648 performance based stock options which had a weighted
average exercise price of $22.38 per share.
(3) Includes 146,231 performance based stock options which had a weighted
average exercise price of $29.65 per share.
The weighted-average fair value and assumptions used to value options granted
are as follows:
Six months ended
--------------------
June 29, June 30,
2007 2006
-------- --------
Weighted-average fair value $12.34 $10.45
Risk-free interest rate 4.62% 4.65%
Expected volatility 41% 40%
Expected life (in years) 5.4 4.9
Expected dividend yield 0% 0%
- 17 -
GREATBATCH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (con't) - 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 January 1, 2006 93,956 $ 22.46
Shares granted 145,126 23.25
Shares vested (25,911) 20.00
Shares forfeited (9,015) 22.63
-----------
Nonvested at December 29, 2006 204,156 $ 23.32
Shares granted 113,531 27.33
Shares vested (9,436) 25.50
Shares forfeited (3,658) 21.76
-----------
Nonvested at June 29, 2007 304,593 $ 24.77
===========
At the Company's 2007 Annual Meeting of Stockholders held on May 22, 2007, an
amendment to the Company's 2005 Stock Incentive Plan was approved by
stockholders which increased the number of shares available for grant by
1,450,000 shares.
9. OTHER OPERATING EXPENSE
The following were recorded in other operating expense, net in the Company's
Consolidated Statements of Operations and Comprehensive Income (in thousands):
Three months ended Six months ended
-------------------- --------------------
June 29, June 30, June 29, June 30,
2007 2006 2007 2006
--------- --------- --------- ---------
(a) Alden facility consolidation $ - $ 52 $ - $ 567
(b) Carson City facility shutdown and Tijuana
facility consolidation No. 1 188 850 574 2,078
(c) Columbia facility shutdown, Tijuana facility
consolidation No. 2 and RD&E consolidation 1,372 1,410 2,675 2,333
(d) ECP expansion 145 - 282 -
(e) Asset dispositions and other 283 1,331 (10) 1,334
--------- --------- --------- ---------
$ 1,988 $ 3,643 $ 3,521 $ 6,312
========= ========= ========= =========
(a) Alden Facility consolidation - Beginning in the first quarter of 2005 and
ending in the second quarter of 2006 the Company consolidated the medical
capacitor manufacturing operations in Cheektowaga, NY, and the implantable
medical battery manufacturing operations in Clarence, NY, into the advanced
power source manufacturing facility in Alden, NY ("Alden Facility"). The Company
also consolidated the capacitor research, development and engineering operations
from the Cheektowaga, NY facility into the Technology Center in Clarence, NY.
- 18 -
GREATBATCH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (con't) - Unaudited
--------------------------------------------------------------------------------
The total cost for these consolidation efforts was $3.4 million, which was below
the Company's original estimate of $3.5 to $4.0 million. The expenses for the
Alden Facility consolidation are included in the IMC business segment and
included the following:
o Production inefficiencies and revalidation - $0.3 million;
o Moving and facility closures - $2.7 million; and
o Other - $0.4 million.
(b) Carson City Facility shutdown and Tijuana Facility consolidation No. 1. On
March 7, 2005, the Company announced its intent to close the Carson City, NV
facility ("Carson City Facility") and consolidate the work performed at that
facility into the Tijuana, Mexico facility ("Tijuana Facility consolidation No.
1").
The Company ceased operating at the Carson City Facility on July 15, 2007. The
total cost for this consolidation effort was $7.8 million, which has been
incurred through June 29, 2007. The major categories of costs include the
following:
o Costs related to the shutdown of the Carson City Facility:
a. Severance and retention - $4.0 million;
b. Accelerated depreciation - $0.6 million; and
c. Other - $0.5 million.
o Costs related to the Tijuana Facility consolidation No. 1:
a. Production inefficiencies and revalidation - $0.4 million;
b. Relocation and moving - $0.2 million;
c. Personnel (including travel, training and duplicate wages) - $1.5
million; and
d. Other - $0.6 million.
All categories of costs are considered to be cash expenditures, except
accelerated depreciation. The Company anticipates annual cost savings in the
range of $2.5 million to $3.1 million. The expenses for the Carson City Facility
shutdown and the Tijuana Facility consolidation No. 1 are included in the IMC
business segment.
- 19 -
GREATBATCH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (con't) - Unaudited
--------------------------------------------------------------------------------
Accrued liabilities related to the Carson City Facility shutdown are comprised
of the following (in thousands):
Severance and Accelerated
retention depreciation Other Total
-------------- -------------- -------------- --------------
Restructuring charges $ 3,551 $ 600 $ 278 $ 4,429
Cash payments (2,394) - (278) (2,672)
Write-offs - (600) - (600)
-------------- -------------- -------------- --------------
Balance, December 29, 2006 $ 1,157 $ - $ - $ 1,157
Restructuring charges 338 - 16 354
Cash payments (406) - (16) (422)
-------------- -------------- -------------- --------------
Balance, June 29, 2007 $ 1,089 $ - $ - $ 1,089
============== ============== ============== ==============
Accrued liabilities related to the Tijuana Facility consolidation No. 1 are
comprised of the following (in thousands):
Production
inefficiencies and Relocation
revalidation and moving Personnel Other Total
------------------ --------------- -------------- -------------- --------------
Restructuring charges $ 293 $ 124 $ 1,701 $ 636 $ 2,754
Cash payments (293) (124) (1,701) (636) (2,754)
------------------ --------------- -------------- -------------- --------------
Balance, December 29, 2006 $ - $ - $ - $ - $ -
Restructuring charges 220 - - - 220
Cash payments (220) - - - (220)
------------------ --------------- -------------- -------------- --------------
Balance, June 29, 2007 $ - $ - $ - $ - $ -
================== =============== ============== ============== ==============
(c) Columbia Facility shutdown, Tijuana Facility consolidation No. 2 and RD&E
consolidation. On November 16, 2005, the Company announced its intent to close
both the Columbia, MD facility ("Columbia Facility") and the Fremont, CA
Advanced Research Laboratory ("ARL"). The Company also announced that the
manufacturing operations at the Columbia Facility will be moved into the Tijuana
Facility ("Tijuana Facility consolidation No. 2") and that the research,
development and engineering ("RD&E") and product development functions at the
Columbia Facility and at ARL will relocate to the Technology Center in Clarence,
NY.
The total estimated cost for this facility consolidation plan is anticipated to
be between $10.6 million and $11.1 million of which $8.9 million has been
incurred through June 29, 2007. The ARL move and closure portion of this
consolidation project is complete. The Company expects to incur the remaining
cost for the other portions of the consolidation project in 2007, with cash
payments being made through the second quarter of 2008.
- 20 -
GREATBATCH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (con't) - Unaudited
--------------------------------------------------------------------------------
The major categories of costs include the following:
o Costs related to the shutdown of the Columbia Facility and ARL and the move
and consolidation of the RD&E functions to Clarence, NY:
a. Severance and retention - $3.5 to $3.7 million;
b. Personnel (including travel, training and duplicate wages) - $1.7
million;
c. Accelerated depreciation/asset write-offs - $0.5 million; and
d. Other - $0.3 to $0.4 million.
o Costs related to Tijuana Facility consolidation No. 2:
a. Production inefficiencies and revalidation - $0.9 to $1.0 million;
b. Relocation and moving - $0.2 million;
c. Personnel (including travel, training and duplicate wages) - $2.9 to
$3.0 million; and
d. Other (including asset write-offs) - $0.6 million.
All categories of costs are considered to be cash expenditures, except for
accelerated depreciation and asset write-offs. Once the moves are completed, the
Company anticipates annual cost savings in the range of $5.0 million to $6.0
million. The expenses for the Columbia Facility and ARL shutdowns, the Tijuana
Facility consolidation No. 2 and the RD&E consolidation are included in the IMC
business segment.
Accrued liabilities related to the Columbia Facility and ARL shutdowns and the
RD&E consolidation are comprised of the following (in thousands):
Severance Accelerated
and depreciation /
retention Personnel asset write-offs Other Total
----------- ----------- ------------------ ---------- ----------
Restructuring charges $ 2,297 $ 701 $ 509 $ 428 $ 3,935
Cash payments (550) (701) - (428) (1,679)
Write-offs - - (509) - (509)
----------- ----------- ------------------ ---------- ----------
Balance, December 29, 2006 $ 1,747 $ - $ - $ - $ 1,747
Restructuring charges 807 248 - 15 1,070
Cash payments (671) (248) - (15) (934)
----------- ----------- ------------------ ---------- ----------
Balance, June 29, 2007 $ 1,883 $ - $ - $ - $ 1,883
=========== =========== ================== ========== ==========
- 21 -
GREATBATCH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (con't) - Unaudited
--------------------------------------------------------------------------------
Accrued liabilities related to Tijuana Facility consolidation No. 2 are
comprised of the following (in thousands):
Production
inefficiencies and Relocation
revalidation and moving Personnel Other Total
-------------------- ------------- ------------- ------------- -------------
Restructuring charges $ 264 $ 149 $ 1,594 $ 317 $ 2,324
Cash payments (264) (149) (1,594) (317) (2,324)
-------------------- ------------- ------------- ------------- -------------
Balance, December 29, 2006 $ - $ - $ - $ - $ -
Restructuring charges 283 6 880 436 1,605
Cash payments (283) (6) (880) (436) (1,605)
-------------------- ------------- ------------- ------------- -------------
Balance, June 29, 2007 $ - $ - $ - $ - $ -
==================== ============= ============= ============= =============
(d) Electrochem Commercial Power ("ECP") expansion. In February 2007, the
Company announced that it will close its current manufacturing facility in
Canton, MA and construct a new 80,000 square foot replacement facility in the
Massachusetts area. The expected completion of this $28 million expansion
project is mid-2008. The total expense to be recognized for this relocation is
estimated to be $2.2 million to $2.4 million, of which $0.3 million has been
incurred primarily related to accelerated depreciation. Costs related to this
move are included in the ECP business segment and include the following:
o Production inefficiencies and revalidation - $0.6 million;
o Moving and facility closure - $0.9 million to $1.0 million;
o Accelerated depreciation - $0.4 million; and
o Other - $0.3 million to $0.4 million.
(e) Asset dispositions and other. During the second quarter of 2007, the Company
had various asset dispositions and wrote-off professional fees in connection
with an unsuccessful acquisition. 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. During the
second quarter of 2006, the Company recorded a loss of $0.5 million related to
this equipment damaged (included in the IMC business segment) and an expense of
$0.8 million for professional fees related to a potential acquisition that we no
longer considered probable.
10. INCOME TAXES
Effective in the first quarter of 2007, the Company adopted the provisions of
Financial Standards Accounting Board ("FASB") Interpretation ("FIN") No. 48
Accounting for Uncertainty in Income Taxes, an interpretation of SFAS No. 109.
FIN No. 48, clarifies the accounting for uncertainty in income taxes recognized
under SFAS No. 109. Additionally, in May 2007, the FASB published FASB Staff
Position ("FSP") No. FIN 48-1, Definition of Settlement in FASB Interpretation
No. 48. FSP FIN 48-1 is an amendment to FIN 48. It clarifies how an enterprise
should determine whether a tax position is effectively settled for the purpose
of recognizing previously unrecognized tax benefits. As of our adoption date of
FIN 48, our accounting is consistent with the guidance in FSP FIN 48-1.
- 22 -
GREATBATCH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (con't) - Unaudited
--------------------------------------------------------------------------------
Upon adoption of FIN No. 48, the Company did not recognize any adjustment to its
$1.8 million of unrecognized tax benefits, all of which would favorably impact
the effective tax rate (net of federal benefit on state issues), if recognized.
The Company's unrecognized tax benefits consist of refund claims which did not
meet the more likely than not threshold under FIN No. 48. At the end of the
first quarter, there was no change in the balance of unrecognized tax benefits.
During the second quarter of 2007, the balance of unrecognized tax benefits
decreased approximately $0.2 million as a result of a state refund claim being
withdrawn, offset by additional unrecognized tax benefits acquired as part of
the Enpath acquisition. As of June 29, 2007, approximately $0.3 million of
unrecognized tax benefits would impact goodwill if recognized. The remaining
approximately $1.3 million of unrecognized tax benefits would favorably impact
the effective tax rate (net of federal benefit on state issues), if recognized.
The Company anticipates that the total unrecognized tax benefits could
significantly change within the next twelve months due to the settlement of
audits/appeals currently in process, however, quantification of an estimated
range cannot be made at this time.
The Company will recognize interest expense related to uncertain tax positions
as Interest Expense. Penalties, if incurred, would be recognized as a component
of Selling, General and Administrative Expenses. At the end of the second
quarter, the interest or penalties related to uncertain tax positions was not
material.
The tax years 2003-2006 remain open to examination by the major taxing
jurisdictions to which we are subject. The 2001 and 2002 tax years remain open
in certain jurisdictions as a result of audits/appeals currently in process.
The effective tax rate for 2007 includes the impact of the $18.4 million of
acquired IPR&D written off during the quarter, $16.1 million of which is not
deductible for tax purposes. Excluding the impact of this expense, the effective
tax rate for the three and six months ended June 29, 2007 would have been 32.5%
compared to 34.5% for the same periods of 2006. This decrease was primarily a
result of the estimated increase in research and development tax credits and the
Qualified Production Activities Deduction for 2007.
11. COMMITMENTS AND CONTINGENCIES
Litigation - The Company is a party to various legal actions arising in the
normal course of business. While the Company does not believe that the ultimate
resolution of any such pending activities will have a material adverse effect on
its consolidated results of operations, financial position or cash flows,
litigation is subject to inherent uncertainties. If an unfavorable ruling were
to occur, there exists the possibility of a material adverse impact in the
period in which the ruling occurs.
During 2002, a former non-medical customer commenced an action alleging that
Greatbatch had used proprietary information of the customer to develop certain
products. We have meritorious defenses and are vigorously defending the matter.
The potential risk of loss is between $0.0 and $1.7 million.
- 23 -
GREATBATCH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (con't) - Unaudited
--------------------------------------------------------------------------------
In connection with our acquisition of Enpath Medical, Inc. ("Enpath"), we
assumed liability in connection with the following proceeding:
On June 12, 2006, Enpath was named as defendant in a patent infringement action
filed by Pressure Products Medical Supplies, Inc. and venued in the United
States District Court in the Eastern District of Texas. On October 2, 2006,
Enpath was officially served. Enpath has filed an answer denying liability and
has filed counterclaims against the plaintiff alleging antitrust violations and
patent misuse. The plaintiff has alleged that Enpath's FlowGuard(TM) valved
introducer, which has been on the market for more than three years, infringes
claims in the plaintiff's patents and is seeking damages and injunctive relief.
Enpath believes that the plaintiff's claims are without merit and intends to
pursue its defenses vigorously. Revenues from products sold that include the
FlowGuard valved introducer were approximately 5% of Enpath's total revenue for
2006 ($36.8 million) and 2005 ($29.4 million). The lawsuit is currently in the
discovery stage. We anticipate that the Court will hold a hearing to construe
the claims of the plaintiff's patents in August 2007. It is not possible to
predict the timing or outcome of this litigation at this time, including whether
it will affect the Company's ability to sell its FlowGuard products, or to
estimate the amount or range of potential loss.
Product Warranties - The Company generally warrants that its products will meet
customer specifications and will be free from defects in materials and
workmanship. The Company accrues its estimated exposure to warranty claims based
upon recent historical experience and other specific information as it becomes
available.
The change in aggregate product warranty liability for the quarter ended June
29, 2007 is as follows (in thousands):
Beginning balance at March 30, 2007 $ 1,724
Warranty reserve acquired 54
Additions to warranty reserve 428
Warranty claims paid (389)
----------
Ending balance at June 29, 2007 $ 1,817
==========
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 June 29, 2007, the total contractual obligation related to such
expenditures is approximately $9.5 million and will be financed by existing
cash, short-term investments or cash generated from operations. We also enter
into contracts for outsourced services; however, the obligations under these
contracts were not significant and the contracts generally contain clauses
allowing for cancellation without significant penalty.
- 24 -
GREATBATCH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (con't) - Unaudited
--------------------------------------------------------------------------------
12. EARNINGS PER SHARE
The following table reflects the calculation of basic and diluted earnings per
share (in thousands, except per share amounts):
Three months ended Six months ended
--------------------- ---------------------
June 29, June 30, June 29, June 30,
2007 2006 2007 2006
---------- ---------- ---------- ----------
Numerator for basic earnings per share:
Net income (loss) $ (3,399) $ 4,843 $ 7,270 $ 11,493
Effect of dilutive securities:
Interest expense on convertible notes and
related deferred financing fees, net of tax - 732 - 1,465
---------- ---------- ---------- ----------
Numerator for diluted earnings per share $ (3,399) $ 5,575 $ 7,270 $ 12,958
========== ========== ========== ==========
Denominator for basic earnings per share:
Weighted average shares outstanding 22,160 21,809 22,087 21,774
Effect of dilutive securities:
Convertible subordinated notes - 4,219 - 4,219
Stock options and unvested restricted stock - 150 280 167
---------- ---------- ---------- ----------
Dilutive potential common shares - 4,369 280 4,386
---------- ---------- ---------- ----------
Denominator for diluted earnings per share 22,160 26,178 22,367 26,160
========== ========== ========== ==========
Basic earnings (loss) per share $ (0.15) $ 0.22 $ 0.33 $ 0.53
========== ========== ========== ==========
Diluted earnings (loss) per share $ (0.15) $ 0.21 $ 0.33 $ 0.50
========== ========== ========== ==========
The diluted weighted average share calculations do not include stock options and
restricted stock of 1,720,000 and 513,000 for the three and six months ended
June 29, 2007, respectively, as they are not dilutive to the earnings per share
calculations. Additionally, the calculations for the three and six month periods
ended June 29, 2007 do not include 1,296,000 and 2,758,000 shares, respectively,
related to the Company's convertible subordinated notes (see Note 7) outstanding
as they are not dilutive to the earnings per share calculations. The
calculations for the three and six months ended June 29, 2007 also do not
include 362,000 shares of performance based stock options and restricted stock
units as the performance criteria for these awards has not been met as of June
29, 2007. The diluted weighted average share calculations for the three and six
months ended June 30, 2006 do not include 1,400,000 stock options as they are
not dilutive to the earnings per share calculations.
13. COMPREHENSIVE INCOME (LOSS)
The Company's comprehensive income (loss) includes net income (loss) and the net
unrealized gain (loss) on its short-term investments available for sale adjusted
for any realized gains/losses realized. The net unrealized gain (loss) on
short-term investments available for sale reported on the Condensed Consolidated
Statements of Operations and Comprehensive Income are shown net of a income tax
benefit of $0.3 million and $0.5 million for the three and six month periods
ended June 29, 2007, respectively, and tax expense of $0.7 million for the three
and six month periods ended June 30, 2006.
- 25 -
GREATBATCH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (con't) - Unaudited
--------------------------------------------------------------------------------
14. BUSINESS SEGMENT INFORMATION
The Company operates its business in two reportable segments: Implantable
Medical Components ("IMC") and Electrochem Commercial Power ("ECP"). The IMC
segment designs and manufactures critical components used in implantable medical
devices. The principal components are batteries, capacitors, filtered
feedthroughs, enclosures and precision components. Additionally, the IMC
business includes value-added assembly of products that incorporate these
components. The principal medical devices are pacemakers, defibrillators and
neurostimulators. The IMC business segment also includes the operations acquired
from Enpath and BIOMEC in the second quarter of 2007 (see Note 2), from the date
of acquisition. The Enpath operations include revenue from designing,
developing, manufacturing and marketing single use medical device products for
the CRM, neuromodulation and interventional radiology markets including venous
vessel and valved introducers, advanced delivery catheters that have a "fixed
curve" or articulating distal tip section and implantable stimulation leads,
adaptors and delivery systems for the cardiac and neuromodulation markets.
The ECP segment designs and manufactures high performance batteries and battery
packs; principal markets for these products are for oil and gas exploration,
pipeline inspection, telematics, oceanography equipment, seismic, communication,
military and aerospace applications.
The Company defines segment income from operations as sales less cost of sales,
including amortization, and expenses attributable to segment-specific selling,
general, administrative, research, development, engineering and other operating
expenses. Segment income also includes a portion of non-segment specific
selling, general, administrative, research, development and engineering expenses
based on allocations appropriate to the expense categories. The remaining
unallocated operating expenses are primarily corporate headquarters and
administrative function expenses. The unallocated operating expenses along with
other income and expense are not allocated to reportable segments. Transactions
between the two segments are not significant.
The 2007 results for the IMC segment includes the $18.4 million IPR&D charge
related to the BIOMEC and Enpath acquisitions.
- 26 -
GREATBATCH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (con't) - Unaudited
--------------------------------------------------------------------------------
An analysis and reconciliation of the Company's business segment information to
the respective information in the consolidated financial statements is as
follows (in thousands):
Three months ended Six months ended
------------------- -------------------
June 29, June 30, June 29, June 30,
Sales: 2007 2006 2007 2006
--------- --------- --------- ---------
IMC
ICD batteries $ 13,741 $ 10,994 $ 25,392 $ 23,673
Pacemaker and other batteries 5,903 5,930 11,748 11,717
ICD capacitors 7,892 5,339 16,406 8,907
Feedthroughs 17,010 14,301 35,403 30,589
Enclosures 5,994 7,105 11,700 13,445
Introducers, catheters and leads 1,585 - 1,585 -
Other medical 15,467 16,087 30,554 29,006
--------- --------- --------- ---------
Total IMC 67,592 59,756 132,788 117,337
ECP 10,870 10,842 22,534 21,368
--------- --------- --------- ---------
Total sales $ 78,462 $ 70,598 $ 155,322 $ 138,705
========= ========= ========= =========
Segment income (loss) from operations:
IMC $ (4,504) $ 8,768 $ 7,217 $ 19,668
ECP 2,410 3,242 5,132 6,085
--------- --------- --------- ---------
Total segment income (loss) from operations (2,094) 12,010 12,349 25,753
Unallocated operating expenses (4,257) (4,883) (8,094) (8,574)
--------- --------- --------- ---------
Operating income (loss) as reported (6,351) 7,127 4,255 17,179
Unallocated other income 4,396 266 9,597 367
--------- --------- --------- ---------
Income (loss) before provision for income taxes as reported
$ (1,955) $ 7,393 $ 13,852 $ 17,546
========= ========= ========= =========
15. IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for
Financial Assets and Financial Liabilities--Including an amendment of FASB
Statement No. 115. This Statement provides entities with an option to choose to
measure eligible items at fair value at specified election dates. If elected, an
entity must report unrealized gains and losses on the item in earnings at each
subsequent reporting date. The fair value option: may be applied instrument by
instrument, with a few exceptions, such as investments otherwise accounted for
by the equity method; is irrevocable (unless a new election date occurs); and is
applied only to entire instruments and not to portions of instruments. The
Company is still evaluating the impact of SFAS No. 159 on its financial
statements, which is effective beginning in fiscal year 2008.
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements. This
Statement defines fair value, establishes a framework for measuring fair value
while applying generally accepted accounting principles, and expands disclosures
about fair value measurements. SFAS No. 157 establishes a fair value hierarchy
that distinguishes between (1) market participant assumptions based on market
data obtained from independent sources and (2) the reporting entity's own
assumptions developed based on unobservable inputs. The Company is still
evaluating the impact of SFAS No. 157 on its financial statements, which is
effective beginning in fiscal year 2008.
- 27 -
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
--------------------------------------------------------------------------------
Our Business
------------
We are a leading developer and manufacturer of batteries, capacitors,
feedthroughs, enclosures, and other components used in implantable medical
devices ("IMDs") through our Implantable Medical Components ("IMC") business. We
offer technologically advanced, highly reliable and long lasting products that
enable our customers to introduce IMDs that are progressively smaller, longer
lasting, more efficient and more functional. Additionally, through our
manufacturing facility in Tijuana Mexico, our IMC business includes value-added
assembly of products that incorporates the components we manufacture. We also
leverage our core competencies in technology and manufacturing through our
Electrochem Commercial Power ("ECP") business to develop and produce cells and
battery packs for commercial applications that demand high performance and
reliability, including oil and gas exploration, pipeline inspection, telematics,
oceanographic equipment, seismic, communication, military and aerospace
applications.
Most of the IMC products that we sell are utilized by customers in cardiac
rhythm management ("CRM") devices. The CRM market comprises devices utilizing
high-rate batteries and capacitors such as implantable cardioverter
defibrillators ("ICDs") and cardiac resynchronization therapy ("CRT") with
backup defibrillation devices ("CRT-D") and devices utilizing low or medium rate
batteries but no capacitors (pacemakers and CRTs). All CRM devices utilize other
components such as enclosures and feedthroughs, and certain CRM devices utilize
electromagnetic interference ("EMI") filtering technology. With the acquisition
of Enpath Medical, Inc. ("Enpath") in the second quarter of 2007, we now develop
and manufacture vascular access devices used primarily in the CRM market. These
include venous vessel and valved introducers, advanced delivery catheters that
have a "fixed curve" or articulating distal tip section, and implantable
stimulation leads, adaptors and delivery systems for the cardiac and
neuromodulation markets.
Our Customers
-------------
Our products are designed to provide reliable, long lasting solutions that meet
the evolving requirements and needs of our customers and the end users of their
products. Our medical customers include leading IMD manufacturers such as Boston
Scientific, St. Jude Medical, Medtronic, Biotronik, Cyberonics and the Sorin
Group. A substantial part of our business is conducted with a limited number of
customers. For the first six months of 2007, Boston Scientific, Medtronic and
St. Jude Medical collectively accounted for approximately 69% of our total
sales. With the acquisition of Enpath in the second quarter of 2007, we were
able to deepen our relationships with many of our larger customers while at the
same time broadening both our market and product reach. The nature and extent of
our selling relationships with each CRM customer are different in terms of
breadth of component products purchased, purchased product volumes, length of
contractual commitment, ordering patterns, inventory management and selling
prices.
Our ECP customers are primarily companies involved in oil and gas exploration,
pipeline inspection, telematics, oceanographic equipment, seismic,
communication, military and aerospace applications industries.
We have entered into long-term supply agreements with some of our customers. For
each of our products, we recognize revenue when the products are shipped and
title passes.
- 28 -
Business Highlights
-------------------
o Total Company - sales of $78.5 million in the second quarter of 2007, an
increase of 11% compared to $70.6 million in 2006.
o IMC - sales of $67.6 million, an increase of 13% compared to $59.8
million in 2006, driven by growth of ICD batteries, ICD capacitors and
feedthroughs.
o ECP - sales of $10.9 million, which were consistent with last year.
o Acquired BIOMEC, Inc. ("BIOMEC") for $11.4 million.
o BIOMEC is a medical device design and engineering company, located in
Cleveland, Ohio.
o Acquired Enpath for approximately $98.2 million in cash and assumed $7.1
million of long-term debt.
o Enpath is a medical products company engaged in designing, developing,
manufacturing and marketing single use medical device products for the
CRM, neuromodulation and interventional radiology markets. Annual
sales for 2006 were approximately $37 million.
o Carson City, Nevada plant ceased operations on July 15, 2007.
o Columbia, Maryland shutdown scheduled to be completed by the end of 2007.
o ECP facility expansion initiated and scheduled for completion in mid -
2008.
o Realized pretax gain of $4.0 million on sale of non-strategic investment.
o Finalized Boston Scientific supply agreement for batteries, capacitors and
enclosures through 2010.
Our CEO's View
--------------
I'm very pleased with the results for the first half of 2007. We had two
consecutive quarters of record sales. This increased sales volume combined with
our manufacturing initiatives have led to increased operating margins.
On a strategic front, we completed two key acquisitions in the quarter. The
BIOMEC acquisition gives us design capabilities and establishes some key
clinical relationships in the emerging neurostimulation market. Enpath
represents an exciting opportunity that further expands our product and service
offerings to the CRM and neurostimulation marketplaces. This acquisition
broadens our market reach into the vascular segment with the introducer product
lines as well as adding several new OEM customers. These acquisitions are key
steps in our long-term growth strategy.
Product Development
-------------------
Currently, the company is developing a series of new products for customer
applications in the CRM, neurostimulation and commercial markets.
Some of the key development initiatives are as follows:
1. Continue the evolution of our Q series high rate ICD batteries.
2. Complete the development of a high voltage and high energy density
capacitor system.
3. Develop Q series medium rate battery for neurostimulation and
pacemaker applications.
4. Augment our existing rechargeable battery with a new rechargeable
battery offering for use in neurostimulation applications.
5. Develop rechargeable battery packs for use in commercial applications.
6. Continue development of the batteries and capacitors used in
intravascular ICD devices.
- 29 -
IMC. Our near term focus for growth in the medical battery market, a portion of
our IMC business, is the introduction of our Q-Series batteries. Initially they
will be available in two configurations - QHR (High Rate) and QMR (Medium Rate).
These batteries hold the promise of unparalleled performance in a wide range of
implantable device and neurostimulation applications and allow our customers to
incorporate advanced power-hungry features into these devices. It delivers
advanced performance criteria to an industry that historically embraces new
products. We believe the Q-Series will represent a major breakthrough by
combining a smaller size with greater energy density (more power). The first ICD
device implant with our new QHR technology occurred in the third quarter of
2006. We expect a second customer to begin implanting our QHR technology in the
near term. We also released a new, non-proprietary model of medium-rate
implantable "Q" series battery. Our rechargeable battery program also continues
to make progress in qualification and is receiving tremendous interest from
neurostimulation customers.
In addition to our battery programs, we continue to advance our ICD capacitor
technology with the development of a higher energy capacitor expected for
release in 2008. Furthermore, we continue to develop the technology for a next
generation higher voltage capacitor.
Finally, enabling safe MRI device interaction continues to remain a key focus
and represents a potential growth opportunity for the company. We anticipate
unveiling a series of new technologies in this area in the near future.
With the acquisition of BIOMEC, we can now offer our customers device
engineering expertise along with full device assembly utilizing our proprietary
components. This will enable us to work in conjunction with our customer's
design teams to build more sophisticated devices. Approximately $2.3 million of
the BIOMEC purchase price was allocated to the estimated fair value of acquired
in-process research and development ("IPR&D") projects that had not yet reached
technological feasibility and had no alternative future use as of the
acquisition date. The value assigned to IPR&D relates to projects that
incorporate BIOMEC's novel-polymer coating (biomimetic) technology that mimics
the surface of endothelial cells of blood vessels. The estimated fair value of
these projects was determined using a discounted cash flow model. This model
utilized discount rates that took into consideration the stage of completion and
the risks surrounding the successful development and commercialization of each
of the IPR&D projects of approximately 40% which is consistent with these
projects being in the early development stage. The Company expects various
products that utilize the biomimetic coatings technology to be commercially
launched by original equipment manufacturers ("OEM") in 2009 once Food and Drug
Administration ("FDA") approval is received. With BIOMEC the Company acquired
grants that will fund the remaining development costs for these products.
With the acquisition of Enpath we have added a complementary business that
further expands our product and service offerings to the CRM and
neurostimulation marketplaces. This acquisition also broadened our market reach
into the vascular segment as well as added several new customers. These factors
support our long-term objective of customer and market diversification. Enpath's
currently marketed products include:
o Venous vessel introducers and valved introducers that enable physicians to
create a conduit through which they can insert infusion catheters,
implantable ports and pacemaker leads into a blood vessel;
o Advanced delivery catheters that have a "fixed curve" or articulating
distal tip section that can be manipulated to enable the health care
professional to access parts of the patient's anatomy that cannot be
reached by traditional introducers; and
o Implantable stimulation leads, adaptors and delivery systems for the
cardiac and neuromodulation markets.
- 30 -
Approximately $16.1 million of the Enpath purchase price was allocated to the
preliminary estimated fair value of acquired IPR&D projects that had not yet
reached technological feasibility and had no alternative future use. These
projects primarily represent the next generation of products already being sold
by Enpath which incorporate new enhancements and customer modifications. The
Company expects to commercially launch various introducer products in 2008 and
2009 and various catheter products in 2009 which will replace existing products.
For purposes of valuing the acquired purchased research and development, the
Company estimated total costs to complete the introducer projects to be
approximately $0.3 million and $0.5 million to complete the catheter projects.
If we are not successful in completing these projects on a timely basis, our
future sales from introducers and catheters may be adversely affected resulting
in erosion of our market share.
ECP. ECP continues to develop new and innovative power solutions for the world's
most demanding commercial applications. ECP has developed a new high energy
lithium cell for a customer in the telematics market. Due to their exceptional
high energy, two of these new cells are capable of providing power for the
entire 10-year life of the telematics device. ECP also has developed a battery
pack capable of withstanding the customer's harsh operating conditions such as
high vibration, high shock, salt spray, high temperature, low temperature, and
high humidity.
Finally, ECP has developed a modular battery pack for a customer's fleet of
underwater sonabuoys which measure water characteristics. The long life of ECP
cells, coupled with their ability to withstand harsh conditions, make them
ideally suited for buoys. The customer's expense of commissioning a ship to
replace the batteries in each buoy is reduced when using ECP batteries due to
their long life.
Cost Savings and Consolidation Efforts
--------------------------------------
During 2005, we initiated several significant cost savings and consolidation
efforts, the implementation of which continued during 2006 and the first six
months of 2007.
Alden Facility Consolidation. Beginning in the first quarter of 2005 and ending
in the second quarter of 2006 we consolidated our medical capacitor
manufacturing operations in Cheektowaga, NY, and our implantable medical battery
manufacturing operations in Clarence, NY, into our advanced power source
manufacturing facility in Alden, NY ("Alden Facility"). We also consolidated our
capacitor research, development and engineering operations from our Cheektowaga,
NY facility into our Technology Center in Clarence, NY.
The total cost for these consolidation efforts was $3.4 million, which was below
the Company's original estimate of $3.5 to $4.0 million. Expenses of $0.6
million were incurred during the first two quarters of 2006. In total, $0.8
million was paid in cash during 2006. The expenses for the Alden Facility
consolidation were included in the IMC business segment.
Carson City Facility shutdown and Tijuana Facility consolidation No. 1. On March
7, 2005, we announced our intent to close the Carson City, NV facility ("Carson
City Facility") and consolidate the work performed at our Carson City Facility
into our Tijuana, Mexico facility ("Tijuana Facility consolidation No. 1").
The Company ceased operating at the Carson City Facility on July 15, 2007. The
total cost for this consolidation effort was $7.8 million. The Company
anticipates that the $1.1 million of severance accrued as of June 29, 2007
related to this consolidation project will be paid out over the next two
quarters. The major categories of costs include the following:
- 31 -
o Costs related to the shutdown of the Carson City Facility:
- Severance and retention - $4.0 million;
- Accelerated depreciation - $0.6 million; and
- Other - $0.5 million.
o Costs related to the Tijuana Facility consolidation No. 1:
- Production inefficiencies and revalidation - $0.4 million;
- Relocation and moving - $0.2 million;
- Personnel (including travel, training and duplicate wages) - $1.5
million; and
- Other - $0.6 million.
All categories of costs are considered to be cash expenditures, except
accelerated depreciation. The Company anticipates annual cost savings in the
range of $2.5 million to $3.1 million. The expenses for the Carson City Facility
shutdown and the Tijuana Facility consolidation No. 1 are included in the IMC
business segment.
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 $10.6 million and $11.1 million. To date, we have
expensed $8.9 million related to these projects and expect to incur the
remaining costs in 2007, with cash payments being made through the second
quarter of 2008. All categories of costs are considered to be future cash
expenditures, except for accelerated depreciation and asset write-offs.
Approximately $3.9 million of the Columbia Facility and ARL shutdown costs were
incurred in 2005 and 2006 ($0.5 million for assets written-off), and $1.1
million were incurred in the first two quarters of 2007. Approximately $0.9
million was paid in cash during the first six months of 2007. Tijuana Facility
consolidation plan No. 2 expenses of $2.3 million were incurred and paid in cash
in 2006 and $1.6 million in the first two quarters of 2007.
Once the moves are completed, the Company anticipates annual cost savings in the
range of $5.0 to $6.0 million. The expenses for the Columbia Facility and ARL
shutdowns, the Tijuana Facility consolidation No. 2 and the RD&E consolidation
are included in the IMC business segment.
ECP Expansion. In February 2007, the Company announced that it will close its
current manufacturing facility in Canton, MA and construct a new 80,000 square
foot replacement facility in the Massachusetts area. The expected completion of
this $28 million expansion project is mid-2008. The total expense to be
recognized for this relocation is estimated to be $2.2 million to $2.4 million.
During the first six months of 2007, $0.3 million of costs were incurred related
to this project, which were primarily non-cash items. Costs related to this move
are included in the ECP business segment.
- 32 -
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
second quarter of 2007 and 2006 each contained 13 weeks and ended on June 29,
and June 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 29, 2006.
Results of Operation
Three months ended Six months ended
--------------------- ---------------------
June 29, June 30, $ % June 29, June 30, $ %
In thousands, except per share data 2007 2006 Change Change 2007 2006 Change Change
------------------------------------------------------------------------------------------------------------------------------------
IMC
ICD batteries $ 13,741 $ 10,994 2,747 25% $ 25,392 $ 23,673 1,719 7%
Pacemaker and other batteries 5,903 5,930 (27) 0% 11,748 11,717 31 0%
ICD capacitors 7,892 5,339 2,553 48% 16,406 8,907 7,499 84%
Feedthroughs 17,010 14,301 2,709 19% 35,403 30,589 4,814 16%
Enclosures 5,994 7,105 (1,111) -16% 11,700 13,445 (1,745) -13%
Introducers, catheters and leads 1,585 - 1,585 N/A 1,585 - 1,585 N/A
Other medical 15,467 16,087 (620) -4% 30,554 29,006 1,548 5%
---------------------------------------------------------------------------------------
Total IMC 67,592 59,756 7,836 13% 132,788 117,337 15,451 13%
ECP 10,870 10,842 28 0% 22,534 21,368 1,166 5%
---------------------------------------------------------------------------------------
Total sales 78,462 70,598 7,864 11% 155,322 138,705 16,617 12%
Cost of sales - excluding amortization of
intangible assets 45,762 42,863 2,899 7% 93,050 82,378 10,672 13%
Cost of sales - amortization of intangible
assets 994 958 36 4% 1,942 1,916 26 1%
---------------------------------------------------------------------------------------
Total Cost of sales 46,756 43,821 2,935 7% 94,992 84,294 10,698 13%
Cost of sales as a % of sales 59.6% 62.1% -2.5% 61.2% 60.8% 0.4%
Selling, general, and administrative
expenses (SG&A) 10,735 9,865 870 9% 20,768 18,880 1,888 10%
SG&A as a % of sales 13.7% 14.0% -0.3% 13.4% 13.6% -0.2%
Research, development and engineering costs,
net (RD&E) 6,981 6,142 839 14% 13,433 12,040 1,393 12%
RD&E as a % of sales 8.9% 8.7% 0.2% 8.6% 8.7% -0.1%
Other operating expense, net 20,341 3,643 16,698 458% 21,874 6,312 15,562 247%
---------------------------------------------------------------------------------------
Operating income (loss) (6,351) 7,127 (13,478) -189% 4,255 17,179 (12,924) -75%
Operating margin -8.1% 10.1% -18.2% 2.7% 12.4% -9.7%
Interest expense 2,089 1,163 926 80% 3,233 2,298 935 41%
Interest income (2,586) (1,353) (1,233) -91% (4,442) (2,545) (1,897) 75%
Other (income) expense, net (3,899) (76) (3,823) N/A (8,388) (120) (8,268) N/A
Provision for income taxes 1,444 2,550 (1,106) -43% 6,582 6,053 529 9%
Effective tax rate N/A 34.5% N/A 47.5% 34.5% 13.0%
---------------------------------------------------------------------------------------
Net income (loss) $ (3,399) $ 4,843 $ (8,242) -170% $ 7,270 $ 11,493 $ (4,223) -37%
=======================================================================================
Net margin -4.3% 6.9% -11.2% 4.7% 8.3% -3.6%
Diluted earnings (loss) per share $ (0.15) $ 0.21 $ (0.36) -171% $ 0.33 $ 0.50 $ (0.17) -34%
- 33 -
Sales
IMC. The nature and extent of our selling relationship with each CRM customer is
different in terms of component products purchased, selling prices, product
volumes, ordering patterns and inventory management. We have pricing
arrangements with our customers that at times do not specify minimum order
quantities. Our visibility to customer ordering patterns is over a relatively
short period of time. Our customers may have inventory management programs and
alternate supply arrangements of which we are unaware. Additionally, the
relative market share among the CRM device manufacturers changes periodically.
Consequently, these and other factors can significantly impact our sales in any
given period.
Our customers may initiate field actions with respect to market-released
products. These actions may include product recalls or communications with a
significant number of physicians about a product or labeling issue. The scope of
such actions can range from very minor issues affecting a small number of units
to more significant actions. There are a number of factors, both short-term and
long-term related to these field actions that may impact our results. In the
short-term, if product has to be replaced, or customer inventory levels have to
be restored, this will result in increased component demand. Also, changing
customer order patterns due to market share shifts or accelerated device
replacements may also have a positive impact on our sales results in the
near-term. These same factors may have longer-term implications as well.
Customer inventory levels may ultimately have to be rebalanced to match demand.
On June 29, 2007, the Company entered into a supply agreement with Cardiac
Pacemakers, Inc., a subsidiary of Boston Scientific Corporation ("BSC"). Under
the terms of the supply agreement, BSC has agreed to purchase a certain
percentage of the batteries, capacitors, and case halves it uses in its
implantable medical devices at prices stated in the supply agreement. The supply
agreement is effective as of July 1, 2007, and the initial term of the supply
agreement ends on December 31, 2010. The agreement may be renewed for one or
more four year renewal terms upon mutual agreement of the parties. The prices
stated in the supply agreement are subject to adjustment for changes in cost,
and the prices of certain batteries and capacitors stated in the supply
agreement are subject to adjustment for changes in volume.
The increase in IMC sales of 13% for the three and six month periods ended June
29, 2007 was driven by growth of ICD capacitors, feedthroughs and ICD batteries.
Additionally, the acquisition of Enpath added $1.6 million to sales. The
increase in ICD capacitor sales was primarily the result of a customer supply
issue, which we anticipate will subside over the next three months. We also
experienced growth in our feedthrough business, which is primarily being driven
by the continued acceptance of filtered feedthrough technology and domestic
market share penetration. ICD battery sales increased by 25% over the prior year
second quarter. ICD battery sales softened through the balance of 2006
reflecting the general slowdown in the ICD market but began to rebound in the
first two quarters of 2007.
ECP. Similar to IMC customers, we have pricing arrangements with our customers
that many times do not specify minimum quantities. Our visibility to customer
ordering patterns is over a relatively short period of time.
ECP sales were consistent with the prior year second quarter and increased 5%
for the six month period. The growth primarily came from oil and gas, pipeline
inspection and military markets. Oil and gas drilling activity remains strong
and continues to drive the core growth of the business.
- 34 -
Cost of sales
Changes from the prior year to cost of sales as a percentage of sales were
primarily due to the following:
June 29, 2007
Three months ended Six months ended
-------------------- --------------------
Production efficiencies primarily associated with
higher volumes (a) -0.8% -0.1%
Excess capacity at Tijuana Facility (b) -2.2% -1.0%
Mix change (c) 0.9% 1.0%
Other -0.4% 0.5%
-------------------- --------------------
Total percentage point change to cost of sales as a
percentage of sales -2.5% 0.4%
==================== ====================
(a) This decrease in cost of sales is primarily due to increased sales volume
which leverages the fixed cost structure of our manufacturing facilities.
(b) The Tijuana Facility was fully operational in 2006 but was not being fully
utilized as it was only producing sub-assemblies. In 2007, primarily in the
second quarter, the facility is producing increased volumes of
sub-assemblies and the majority of our filtered feedthroughs, thus reducing
excess capacity. In accordance with the Company's inventory accounting
policy, excess capacity costs are expensed.
(c) The revenue increase from 2006 was primarily in lower margin products,
which included capacitors as well as the addition of the lower margin
introducer, catheter and leads operations acquired with Enpath.
As the results from Enpath were only included in our financial statements from
the date of acquisition (June 15, 2007), we would expect pressure on our cost of
sales percentage for the remainder of 2007. However, we expect cost of sales as
a percentage of sales to decrease over the next several years as a result of our
consolidation efforts and the elimination of excess capacity. Excess capacity
for the Tijuana Facility is not expected to be fully eliminated until the end of
2007 when the last announced consolidation effort is anticipated to be completed
(see "Cost Savings and Consolidation Efforts" section).
SG&A expenses
Changes from the prior year to SG&A expenses were due to the following (in
thousands):
June 29, 2007
Three months Six months
ended ended
-------------- --------------
Stock-based compensation expense (a) $ 75 $ 325
Increased workforce (b) 520 750
Director fees (c) 15 165
Legal fees (d) 110 240
Other 150 408
-------------- --------------
Net increase in SG&A $ 870 $ 1,888
============== ==============
(a) Increase in stock-based compensation for the six month period is related to
leadership transition costs incurred in the first quarter of 2007.
Stock-based compensation is expected to continue to increase which is
consistent with the growth in the Company's workforce.
(b) Increase in workforce is a result of our planned increase in marketing and
sales personnel as well as costs related to finance personnel additions in
2006 who were hired in order to help facilitate our acquisition strategy.
(c) Increase in director fees is consistent with our amended director
compensation plan as discussed in our 2006 proxy statement.
(d) Increase in legal fees is due to customer contract negotiations and our
various financing transactions.
- 35 -
We expect SG&A costs will increase in the third quarter of 2007 given the
inclusion of Enpath's operating results for a full quarter versus two weeks in
the second quarter of 2007.
RD&E expenses
Net research, development and engineering costs are as follows (in thousands):
Three months ended Six months ended
------------------------- ------------------------
June 29, June 30, June 29, June 30,
2007 2006 2007 2006
------------ ------------ ------------ -----------
Research and development costs $ 3,911 $ 3,975 $ 7,542 $ 7,948
------------ ------------ ------------ -----------
Engineering costs 3,991 2,821 7,122 5,177
Less cost reimbursements (921) (654) (1,231) (1,085)
------------ ------------ ------------ -----------
Engineering costs, net 3,070 2,167 5,891 4,092
------------ ------------ ------------ -----------
Total research and development and engineering costs, net $ 6,981 $ 6,142 $ 13,433 $ 12,040
============ ============ ============ ===========
The increase in RD&E expenses for the three and six month periods ended June 29,
2007 is primarily due to the planned increase in engineering personnel costs
(headcount), as we continue to invest substantial resources to develop new
products. In terms of the development costs billed, reimbursements were higher
due to the timing of reimbursable development projects as well as the
acquisition of Enpath and BIOMEC. Reimbursements for achieving certain
development milestones are netted against gross spending.
Acquired in-process research and development
Approximately $2.3 million and $16.1 million of the BIOMEC and Enpath purchase
price, respectively, represents the estimated fair value of IPR&D projects
acquired from those companies. These projects had not yet reached technological
feasibility and had no alternative future use as of the acquisition date, thus
were immediately expensed on the date of acquisition.
- 36 -
Other operating expense
Other operating expense for 2007 and 2006 are comprised of the following costs
(in thousands):
Three months ended Six months ended
------------------------- -------------------------
June 29, June 30, June 29, June 30,
2007 2006 2007 2006
------------ ------------ ------------ ------------
(a) Alden facility consolidation $ - $ 52 $ - $ 567
(a) Carson City facility shutdown and Tijuana
facility consolidation No. 1 188 850 574 2,078
(a) Columbia facility shutdown, Tijuana
facility consolidation No. 2 and RD&E
consolidation 1,372 1,410 2,675 2,333
(a) ECP expansion 145 - 282 -
(b) Asset dispositions and other 283 1,331 (10) 1,334
------------ ------------ ------------ ------------
$ 1,988 $ 3,643 $ 3,521 $ 6,312
============ ============ ============ ============
(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 June 29, 2007.
(b) During the second quarter of 2007, the Company had various asset
dispositions and wrote-off professional fees in connection with an
unsuccessful acquisition. 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. During the second quarter of 2006, the Company recorded a loss of
$0.5 million related to this equipment damaged (included in the IMC
business segment) and an expense of $0.8 million for professional fees
related to a potential acquisition that we no longer considered probable.
Interest expense and interest income
Interest expense for the three and six month periods ended June 29, 2007 is
higher than the prior year periods primarily due to the additional $80 million
of 2.25% convertible notes issued at the end of the first quarter of 2007 and
additional amortization of deferred fees and discounts associated with these
notes and the notes exchanged during the first quarter (See "Gain on
extinguishment of debt").
Interest income for the three and six months ended June 29, 2007 increased in
comparison to the same periods of 2006 primarily due to increased cash, cash
equivalents and short-term investment balances. Interest income is expected to
be lower for the remainder of the year as a result of the $108 million of cash
deployed for the BIOMEC and Enpath acquisitions near the end of the second
quarter of 2007.
Gain on sale of investment security
In the second quarter of 2007, the Company sold an available-for-sale equity
security investment which resulted in a pre-tax gain of $4.0 million ($2.6
million net of tax) or $0.12 per diluted share.
Gain on extinguishment of debt
In March 2007, the Company entered into separate, privately negotiated
agreements to exchange $117.8 million of the original $170.0 million of 2.25%
convertible subordinated notes due 2013 ("CSN I") for an equivalent principal
amount of a new series of 2.25% convertible subordinated notes due 2013. The
primary purpose of this transaction was to eliminate the June 15, 2010 call and
put option that is included in the terms of CSN I. This exchange was accounted
for as an extinguishment of debt and resulted in a net pre-tax gain of $4.5
million ($2.9 million net of tax) or $0.13 per diluted share.
- 37 -
Provision for income taxes
Our effective tax rate for 2007 includes the impact of the $18.4 million of
acquired IPR&D written off during the quarter, $16.1 million of which is not
deductible for tax purposes. Excluding the impact of this expense, our effective
tax rate for the three and six months ended June 29, 2007 would have been 32.5%
compared to 34.5% for the same periods of 2006. This decrease was primarily a
result of our estimated increase in research and development tax credits and the
Qualified Production Activities Deduction for 2007. We expect our effective tax
rate to be approximately 47.5% for 2007.
Liquidity and Capital Resources
-------------------------------
June 29, December 29,
(Dollars in millions) 2007 2006
---- ----
Cash and cash equivalents and short-term investments (a)(b) $ 120.8 $ 142.6
Working capital (b) $ 179.6 $ 199.1
Current ratio 4.6:1.0 5.7:1.0
(a) Short-term investments consist of investments acquired with maturities that
exceed three months and are less than one year at the time of acquisition,
equity securities classified as available-for-sale and auction rate
securities.
(b) Cash and cash equivalents and short-term investments, working capital and
our current ratio decreased primarily due to the $108.1 million of cash
used to acquire BIOMEC and Enpath partially offset by $76.0 million of net
cash received from the issuance of additional 2.25% convertible
subordinated notes due 2013 in March 2007.
Revolving line of credit
In May 2007, the Company entered into a new senior credit facility (the "New
Credit Facility") consisting of a $235 million revolving credit facility, which
can be increased to $335 million upon the Company's request. The New Credit
Facility also contains a $15 million letter of credit subfacility and a $15
million swingline subfacility. This New Credit Facility replaced the Company's
prior $50 million revolving credit facility. The New Credit Facility is secured
by the Company's non-realty assets including cash, accounts and notes
receivable, and inventories and has an expiration date of May 22, 2012 with a
one-time option to extend to April 1, 2013 if no default has occurred. Interest
rates under the New Credit Facility are, at the Company's option, based upon the
current prime rate or the LIBOR rate plus a margin that varies with the
Company's leverage ratio. If interest is paid based upon the prime rate, the
applicable margin is between minus 1.25% and 0.00%. If interest is paid based
upon the LIBOR rate, the applicable margin is between 1.00% and 2.00%. The
Company is required to pay a commitment fee between 0.125% and 0.250% per annum
on the unused portion of the New Credit Facility based on the Company's leverage
ratio.
The New Credit Facility contains limitations on the incurrence of indebtedness,
limitations on the incurrence of liens and licensing of intellectual property,
limitations on investments and restrictions on certain payments. Except to the
extent paid for by common equity of Greatbatch or paid for out of cash on hand,
the New Credit Facility limits the amount paid for acquisitions to $100 million.
The restrictions on payments, among other things, limit repurchases of
Greatbatch's stock to $60 million and limits the ability of the Company to make
payments upon conversion of our convertible subordinated notes. In addition, the
New Credit Facility requires the Company to maintain a ratio of adjusted EBITDA,
as defined in the agreement, to interest expense of at least 3.00 to 1.00, and a
total leverage ratio, as defined in the agreement, of not greater than 5.00 to
1.00 from May 22, 2007 through September 29, 2009 and not greater than 4.50 to
1.00 from September 30, 2009 and thereafter. The New Credit Facility contains
customary events of default. Upon the occurrence of an event of default, a
majority of the lenders may declare the outstanding advances and all other
obligations under the New Credit Facility immediately due and payable.
- 38 -
Operating activities
Net cash flows from operating activities for the six months ended June 29, 2007
increased $20.6 million over the comparable period in 2006. This was primarily
the result of a decrease in accounts receivable and inventory during the first
two quarters of 2007, compared to an increase in 2006, due to management efforts
to reduce receivable and safety stock levels. The gain on the extinguishment of
debt recorded during the first quarter of 2007 resulted in a reclassification of
approximately $11.3 million of income tax liability, which will be paid by the
end of 2007. This amount was previously recorded as a non-current deferred tax
liability on the balance sheet.
Investing activities
Net cash used in investing activities for the six months ended June 29, 2007
increased over the comparable period in 2006. This was primarily the result of
the acquisitions of BIOMEC and Enpath during the second quarter of 2007 which
were funded with both short-term investments and cash on hand. The majority of
the acquisition of property, plant and equipment for the first six months of
2007 was related to routine purchases made in order to support our internal
growth and to maintain our technology leadership. We expect these purchases to
increase in the future as we begin construction of a new 80,000 square foot
manufacturing facility in the Massachusetts area. In addition to a new facility,
we will also be investing in semi-automation equipment. The expected completion
of this $28 million expansion project is mid-2008. In addition to the above, in
the second quarter of 2007 we made a $2.0 million investment in IntElect
Medical, Inc., an early stage neurostimulation device company that works in
conjunction with the Cleveland Clinic.
Financing activities
Cash flow from financing activities for the first six months of 2007 was
primarily related to the issuance of $80.0 million of additional 2.25%
convertible subordinated notes due 2013 at a price of $950 per $1,000 of
principal during the first quarter. The Company has paid approximately $6.4
million of financing fees related to this transaction as well as the new
revolving credit agreement discussed above. Cash flows from financing activities
also includes cash received from non-qualified stock option exercises for both
2007 and 2006.
Capital Structure
At June 29, 2007, our capital structure consisted of $240.5 million of
convertible subordinated notes and our 22.5 million shares of common stock
outstanding. We have $120.8 million in cash, cash equivalents and short-term
investments and are in a position to finance our future acquisitions. We are
also authorized to issue 100 million shares of common stock and 100 million
shares of preferred stock. The market value of our outstanding common stock
since our IPO has exceeded our book value; accordingly, we believe that if
needed we can access public markets to sell additional common or preferred stock
assuming conditions are appropriate.
Our capital structure allows us to support our internal growth and provides
liquidity for corporate development initiatives. Our current expectation for
2007 is that capital spending will be in the range of $35.0 million to $45.0
million, of which $20.0 million is attributable to the ECP expansion.
Off-Balance Sheet Arrangements
------------------------------
We have no off-balance sheet arrangements within the meaning of Item 303(a)(4)
of Regulation S-K.
- 39 -
Contractual Obligations
-----------------------
In the normal course of business, the Company makes routine purchase commitments
(primarily equipment and raw material purchases) in order to maintain the
technological leadership of its manufacturing facilities and meet the needs of
its customers. As of June 29, 2007, total contractual obligations related to
such expenditures are approximately $9.5 million and will be financed by
existing cash, short-term investments, or cash generated from operations.
Inflation
---------
We do not believe that inflation has had a significant effect on our operations.
Impact of Recently Issued Accounting Standards
----------------------------------------------
In February 2007, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 159, The Fair Value
Option for Financial Assets and Financial Liabilities--Including an amendment of
FASB Statement No. 115. This Statement provides entities with an option to
choose to measure eligible items at fair value at specified election dates. If
elected, an entity must report unrealized gains and losses on the item in
earnings at each subsequent reporting date. The fair value option: may be
applied instrument by instrument, with a few exceptions, such as investments
otherwise accounted for by the equity method; is irrevocable (unless a new
election date occurs); and is applied only to entire instruments and not to
portions of instruments. The Company is still evaluating the impact of SFAS No.
159 on its financial statements, which is effective beginning in fiscal year
2008.
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements. This
Statement defines fair value, establishes a framework for measuring fair value
while applying generally accepted accounting principles, and expands disclosures
about fair value measurements. SFAS No. 157 establishes a fair value hierarchy
that distinguishes between (1) market participant assumptions based on market
data obtained from independent sources and (2) the reporting entity's own
assumptions developed based on unobservable inputs. The Company is still
evaluating the impact of SFAS No. 157 on its financial statements, which is
effective beginning in fiscal year 2008.
Application of Critical Accounting Estimates
--------------------------------------------
Our unaudited condensed consolidated financial statements are based on the
selection of accounting policies and the application of significant accounting
estimates, some of which require management to make significant assumptions. We
believe that some of the more critical estimates and related assumptions that
affect our financial condition and results of operations are in the areas of
inventories, goodwill and other indefinite lived intangible assets, long-lived
assets, share-based compensation and income taxes. For further information,
refer to Item 7 "Managements Discussion and Analysis of Financial Condition and
Results of Operations" and Item 8 "Financial Statements and Supplementary Data"
in the Company's Annual Report on Form 10-K for the year ended December 29,
2006.
During the three months ended June 29, 2007, we did not change or adopt new
accounting policies that had a material effect on our consolidated financial
condition and results of operations.
Effective in the first quarter of 2007, the Company adopted the provisions of
FASB Interpretation ("FIN") No. 48 Accounting for Uncertainty in Income Taxes,
an interpretation of FASB SFAS No. 109. FIN No. 48 clarifies the accounting for
uncertainty in income taxes recognized under SFAS 109. FIN No. 48 prescribes a
recognition threshold and measurement attribute for financial statement
recognition and measurement of a tax position taken or expected to be taken in a
tax return and also provides guidance on various related matters such as
derecognition, interest and penalties, and disclosure.
- 40 -
Additionally, in May 2007, the FASB published FASB Staff Position No. FIN 48-1,
Definition of Settlement in FASB Interpretation No. 48 (FSP FIN 48-1). FSP FIN
48-1 is an amendment to FIN 48. It clarifies how an enterprise should determine
whether a tax position is effectively settled for the purpose of recognizing
previously unrecognized tax benefits. As of our adoption date of FIN 48, our
accounting is consistent with the guidance in FSP FIN 48-1.
Forward-Looking Statements
--------------------------
Some of the statements contained in this Quarterly Report on Form 10-Q and other
written and oral statements made from time to time by us and our representatives
are not statements of historical or current fact. As such, they are
"forward-looking statements" within the meaning of Section 27A of the Securities
Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934,
as amended. We have based these forward-looking statements on our current
expectations, which are subject to known and unknown risks, uncertainties and
assumptions. They include statements relating to:
o future sales, expenses and profitability;
o the future development and expected growth of our business and the
industries we operate in;
o our ability to successfully execute our business model and our
business strategy;
o our ability to identify trends within the implantable medical devices,
medical components, and commercial power sources industries and to
offer products and services that meet the changing needs of those
markets;
o projected capital expenditures; and
o trends in government regulation.
You can identify forward-looking statements by terminology such as "may,"
"will," "should," "could," "expects," "intends," "plans," "anticipates,"
"believes," "estimates," "predicts," "potential" or "continue" or the negative
of these terms or other comparable terminology. These statements are only
predictions. Actual events or results may differ materially from those suggested
by these forward-looking statements. In evaluating these statements and our
prospects generally, you should carefully consider the factors set forth below.
All forward-looking statements attributable to us or persons acting on our
behalf are expressly qualified in their entirety by these cautionary factors and
to others contained throughout this report. We are under no duty to update any
of the forward-looking statements after the date of this report or to conform
these statements to actual results.
Although it is not possible to create a comprehensive list of all factors that
may cause actual results to differ from the results expressed or implied by our
forward-looking statements or that may affect our future results, some of these
factors include the following: dependence upon a limited number of customers,
product obsolescence, inability to market current or future products, pricing
pressure from customers, reliance on third party suppliers for raw materials,
products and subcomponents, fluctuating operating results, inability to maintain
high quality standards for our products, challenges to our intellectual property
rights, product liability claims, inability to successfully consummate and
integrate acquisitions, unsuccessful expansion into new markets, competition,
inability to obtain licenses to key technology, regulatory changes or
consolidation in the healthcare industry, and other risks and uncertainties that
arise from time to time as described in the Company's Annual Report on Form 10-K
and other periodic filings with the Securities and Exchange Commission.
- 41 -
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Under our line of credit any borrowings bear interest at fluctuating market
rates. At June 29, 2007, we did not have any borrowings outstanding under our
line of credit and thus no interest rate sensitive financial instruments other
than short-term investments. We do not believe that the impact of fluctuations
in interest rates on our short-term investments will have a material effect on
our condensed consolidated financial statements.
The company incurs certain expenses related to its Tijuana Mexico operations
that are denominated in a foreign currency. We do not believe that the impact of
foreign currency fluctuations will have a material effect on our condensed
consolidated financial statements.
ITEM 4. CONTROLS AND PROCEDURES.
a. Evaluation of Disclosure Controls and Procedures.
-------------------------------------------------
Our management, including the principal executive officer and principal
financial officer, evaluated our disclosure controls and procedures (as defined
in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934)
related to the recording, processing, summarization and reporting of information
in our reports that we file with the SEC as of June 29, 2007. These disclosure
controls and procedures have been designed to provide reasonable assurance that
material information relating to us, including our subsidiaries, is made known
to our management, including these officers, by other of our employees, and that
this information is recorded, processed, summarized, evaluated and reported, as
applicable, within the time periods specified in the SEC's rules and forms.
Based on their evaluation, as of June 29, 2007, our principal executive officer
and principal financial officer have concluded that our disclosure controls and
procedures are effective.
b. Changes in Internal Control Over Financial Reporting.
-----------------------------------------------------
We completed the acquisition of Enpath on June 15, 2007, at which time Enpath
became a subsidiary of Greatbatch. We believe that the internal controls and
procedures of Enpath are reasonably likely to materially affect our internal
control over financial reporting. We are currently in the process of
incorporating the internal controls and procedures of the former Enpath into our
internal controls over financial reporting. The Company has extended its Section
404 compliance program under the Sarbanes-Oxley Act of 2002 (the "Act") and the
applicable rules and regulations under such Act to include the former Enpath.
The Company will report on its assessment of the internal controls of its
combined operations within the time period provided by the Act and the
applicable SEC rules and regulations concerning business combinations.
There were no other changes in the registrant's internal control over financial
reporting during the period covered by this quarterly report that have
materially affected, or are reasonably likely to materially affect, internal
control over financial reporting, other than the acquisition of Enpath.
- 42 -
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
In connection with our acquisition of Enpath Medical, Inc. ("Enpath"), we
assumed liability in connection with the following proceeding:
On June 12, 2006, Enpath was named as defendant in a patent infringement action
filed by Pressure Products Medical Supplies, Inc, and venued in the United
States District Court in the Eastern District of Texas. On October 2, 2006,
Enpath was officially served. Enpath has filed an answer denying liability and
has filed counterclaims against the plaintiff alleging antitrust violations and
patent misuse. The plaintiff has alleged that Enpath's FlowGuard(TM) valved
introducer, which has been on the market for more than three years, infringes
claims in the plaintiff's patents and is seeking damages and injunctive relief.
Enpath believes that the plaintiff's claims are without merit and intends to
pursue its defenses vigorously. Revenues from products sold that include the
FlowGuard valved introducer were approximately 5% of Enpath's total revenue for
2006 ($36.8 million) and 2005 ($29.4 million). The lawsuit is currently in the
discovery stage. We anticipate that the Court will hold a hearing to construe
the claims of the plaintiff's patents in August 2007. It is not possible to
predict the timing or outcome of this litigation at this time, including whether
it will affect the Company's ability to sell its FlowGuard products, or to
estimate the amount or range of potential loss.
There have been no other material changes to those legal proceedings as
previously disclosed in the Company's Form 10-K for the year ended December 29,
2006.
ITEM 1A. RISK FACTORS.
There have been no material changes in risk factors as previously disclosed in
the Company's Form 10-K for the year ended December 29, 2006, except as follows:
We face risks associated with our acquisition of Enpath Medical, Inc.
Our acquisition of Enpath Medical, Inc. ("Enpath") presents several risks and
uncertainties, including the following:
o The allocation of the purchase price to Enpath's assets, the
amortization of intangible assets resulting from that allocation and
the impact of fair value purchase accounting adjustments may adversely
affect our earnings;
o We may be unsuccessful in integrating Enpath's business;
o Integrating Enpath's business may be distractive to our management and
disruptive to our business and the costs of integration may be
significant; and
o We may assume liabilities in the Enpath acquisition that we did not
anticipate that could have a material adverse effect on our operating
results.
Enpath's products are subject to regulatory oversight.
The medical products that Enpath sells and proposes to sell are subject to
regulation by the Food and Drug Administration ("FDA") and by comparable
agencies in certain states and foreign countries. The process of complying with
requirements of the FDA and other agencies can be costly and time consuming.
Enpath has received clearance from the FDA to market its vessel introducer
products, safety needle, steerable catheter, and epicardial lead and implant
tool. There is no assurance that any future additional clearance can be
obtained. In addition, once obtained, these clearances are subject to review and
later discovery of problems may result in restrictions on the marketing of a
product or withdrawal of the product from the market. Enpath was also subject to
- 43 -
certain FDA regulations governing manufacturing practices, packaging and
labeling. Non-compliance with these regulations can result in product recalls or
other sanctions which could have a material adverse effect on our business and
financial condition.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
At the Company's Annual Meeting of Stockholders held on May 22, 2007, the
stockholders approved the following:
1. A proposal to elect nine directors of the Company to serve until the next
annual meeting of stockholders or until their successors are duly elected
and qualified as follows:
Votes For Authority For Individual Withheld
---------- ---------------------------------
Thomas J. Hook 18,632,217 2,459,792
Edward F. Voboril 18,541,343 2,550,666
Pamela G. Bailey 18,627,106 2,464,903
Joseph A. Miller, Jr. 18,636,429 2,455,580
Bill R. Sanford 18,636,529 2,455,480
Peter H. Soderberg 18,478,613 2,613,396
Thomas S. Summer 18,485,200 2,606,809
William B. Summers, Jr. 17,171,763 3,920,246
John P. Wareham 18,637,129 2,454,880
2. A proposal for the adoption of the Greatbatch, Inc. Executive Short-Term
Incentive Compensation Plan. The proposal received at least 19,674,757
shares voted in favor of the resolution, 1,364,159 shares voted against,
and 53,093 shares abstained from voting.
3. A proposal for the amendment to Greatbatch, Inc. 2005 Stock Incentive Plan.
The proposal received at least 15,870,141 shares voted in favor of the
resolution, 3,539,585 shares voted against, and 486,906 shares abstained
from voting.
- 44 -
4. A proposal for the ratification of the Appointment of Deloitte and Touche
LLP as our Independent Registered Public Accounting Firm. The proposal
received at least 20,992,591 shares voted in favor of the resolution,
34,944 shares voted against, and 64,474 shares abstained from voting.
ITEM 5. OTHER INFORMATION.
None.
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: August 7, 2007 GREATBATCH, INC.
By /s/ Thomas J. Hook
----------------------------------
Thomas J. Hook
President and Chief Executive Officer
(Principal Executive Officer)
By /s/ Thomas J. Mazza
----------------------------------
Thomas J. Mazza
Senior Vice President and Chief Financial Officer
(Principal Financial Officer)
By /s/ Marco F. Benedetti
-------------------------------------
Marco F. Benedetti
Corporate Controller
(Principal Accounting Officer)
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EXHIBIT INDEX
Exhibit No. Description
----------- -----------
3.1 Amended and Restated Certificate of Incorporation (incorporated
by reference to Exhibit 3.1 to our quarterly report on Form 10-Q
ended July 1, 2005).
3.2 Amended and Restated Bylaws (incorporated by reference to Exhibit
3.2 to our quarterly report on Form 10-Q ended March 29, 2002).
10.1*+ Supply Agreement between Cardiac Pacemakers, Inc. (d/b/a Boston
Scientific) and Greatbatch Ltd.
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.
+ - Portions of this exhibit has been omitted and filed separately with the
Securities and Exchange Commission pursuant to a request for confidential
treatment.
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