ITGR

Business Context and Reporting Period

Company: Greatbatch, Inc. (formerly Wilson Greatbatch Technologies, Inc.)
Filing Type: Form 10-Q (Unaudited)
Reporting Period: Quarter and six months ended June 30, 2005
Business Overview: The Company operates two segments: Implantable Medical Components (IMC), manufacturing batteries and components for pacemakers and defibrillators, and Electrochem Commercial Power (ECP), producing high-performance cells for oil/gas, oceanographic, and aerospace applications.

Key Financial Metrics

Material Changes vs. Prior Period

• Sales Growth: Total sales increased 20% in Q2 and 11% YTD. IMC sales rose 19% (Q2) driven by ICD batteries and feedthroughs, while ECP sales surged 30% (Q2) due to volume increases in oil/gas exploration markets.
• Margin Compression: Gross margin declined 550 basis points Q2 and 500 basis points YTD. Primary drivers included excess capacity at wet tantalum capacitor and Tijuana facilities, lower IMC selling prices, and higher platinum costs.
• Operating Expenses: Operating income decreased 21% YTD despite sales growth. This was due to a 101% increase in "Other operating expense" driven by non-recurring restructuring charges totaling $6.4 million YTD (including facility consolidations and severance).
• Net Income: Net income increased 12% in Q2 but declined 18% YTD compared to the prior year.

Guidance, Outlook, and Risks

Management Commentary & Outlook

• Facility Consolidation: The Company is consolidating operations into new facilities in Alden, NY, and Tijuana, Mexico. Total estimated costs for these moves range from $8.0 million to $9.4 million, with remaining expenses expected to be incurred over the next two to four quarters.
• Product Development: Focus is on the Q-Series batteries (High Rate and Medium Rate), which offer smaller size and greater energy density. Nanotechnology applications are in development.
• Capital Expenditures: Expected 2005 capital spending is $30.0 million to $35.0 million, primarily for the Alden and Tijuana facility build-outs.
• Market Dynamics: Sales benefited from field issues surrounding ICD products in the marketplace, though the exact impact is difficult to quantify. Management expects strong underlying growth fundamentals to continue.

Risks and Contingencies

• Legal Proceedings: A 2002 lawsuit regarding proprietary information remains pending with a potential risk of loss between $0 and $1.75 million. A May 2005 complaint regarding an implantable drug delivery device was settled and dismissed without prejudice.
• Accounting Changes: Adoption of SFAS No. 123(R) regarding stock-based compensation is expected on January 1, 2006, which will likely reduce reported net income and EPS.
• Customer Concentration: The Company relies on a limited number of customers in the cardiac rhythm management market, making it susceptible to order pattern changes and market share shifts.

Investor Verification Checklist

• Restructuring Costs: Verify the timing and cash impact of the remaining $8.0M+ in facility consolidation costs (Alden, Tijuana, Carson City) expected in future quarters.
• Margin Recovery: Monitor gross margin trends as excess capacity at new facilities is absorbed and selling price pressures stabilize.
• ICD Field Actions: Assess the sustainability of sales growth driven by ICD field issues versus organic demand.
• Debt Covenants: Confirm compliance with the new $50 million revolving credit facility covenants (EBITDA to Fixed Charges and Leverage ratios).
• Stock-Based Compensation: Review the impact of SFAS 123(R) adoption in 2006 on future earnings per share.