Business Context and Reporting Period
This filing is Greatbatch, Inc.’s unaudited Form 10-Q for the 13-week quarter and six months ended July 1, 2011; the filing does not identify Integer Holdings Corp. as the registrant. Greatbatch operated through Greatbatch Medical, which served cardiac rhythm management, neuromodulation, vascular access and orthopaedic markets, and Electrochem Solutions, which supplied batteries and wireless sensing systems.
The comparable periods ended July 2, 2010. The report was filed August 9, 2011, and reported 23.4 million common shares outstanding as of August 9, 2011.
Financial Performance and Position
| Metric | Q2 2011 | Q2 2010 | Six Months 2011 | Six Months 2010 |
|---|---|---|---|---|
| Sales | $146.5 million | $140.8 million | $295.4 million | $272.8 million |
| Gross profit | $46.6 million | $45.5 million | $93.8 million | $87.1 million |
| Gross margin | 31.8% | 32.3% | 31.7% | 31.9% |
| Operating income | $18.3 million | $17.3 million | $36.3 million | $31.3 million |
| Operating margin | 12.5% | 12.3% | 12.3% | 11.5% |
| Net income | $8.6 million | $7.8 million | $20.5 million | $13.3 million |
| Diluted EPS | $0.36 | $0.33 | $0.86 | $0.57 |
| Operating cash flow | Not separately provided | Not separately provided | $37.8 million | $44.2 million |
- Q2 sales increased 4%, operating income increased 6%, net income increased 10% and diluted EPS increased 9% year over year.
- First-half sales increased 8%, operating income increased 16%, net income increased 54% and diluted EPS increased 51%. The first-half net income comparison benefited from the prior-year period not having the 2011 $4.5 million pretax gain on the sale of the IntElect investment.
- Adjusted Q2 operating income was $18.4 million, or 12.6% of sales, versus $17.8 million, or 12.7%, in the prior year. Adjusted diluted EPS was $0.43 versus $0.40.
- Q2 and first-half effective tax rates were 33%, compared with 35% in the comparable periods, primarily due to reinstatement of the research and development tax credit.
Liquidity, Debt and Capital Spending
- Cash and equivalents were $36.9 million at July 1, 2011, compared with $22.9 million at December 31, 2010. Working capital was $176.1 million, and the current ratio was 3.35.
- Long-term debt was $205.7 million, consisting primarily of $30.0 million drawn on the revolving facility and $197.8 million of 2.25% convertible subordinated notes, net of discount.
- The company repaid $20.0 million of long-term debt during the first six months. Interest expense declined 16% year over year to $8.7 million.
- On June 24, 2011, Greatbatch entered into a secured $400 million revolving credit facility, expandable to $600 million with lender approval, maturing June 24, 2016. The facility had $370 million of borrowing capacity available at July 1, 2011.
- The company was in compliance with all debt covenants. Its adjusted EBITDA-to-interest ratio was 17.5 to 1.0 versus a minimum of 3.0 to 1.0, and its total leverage ratio was 1.98 to 1.0 versus a maximum of 4.5 to 1.0.
- First-half capital expenditures were $11.5 million. Expected remaining 2011 capital spending was $20 million to $30 million, including construction of an approximately $17 million, 80,000-square-foot Indiana facility expected to be operational by mid-2012.
Material Changes Versus the Prior Comparable Period
- Orthopaedic sales rose 24% in Q2 and 29% for the first half; constant-currency growth was 8% and 19%, respectively. Customer product launches and market-share gains contributed to growth.
- CRM and neuromodulation sales declined 1% in Q2 and were essentially flat for the first half. Pricing pressure, a contracting CRM market and the completion of customer inventory builds created headwinds.
- Vascular access sales declined 2% in Q2 but increased 11% for the first half. Electrochem sales declined 2% in Q2 but increased 8% year to date.
- Foreign currency movements increased Q2 sales by approximately $5 million and first-half sales by approximately $6 million, while largely offsetting operating costs.
- Gross margin declined 50 basis points in Q2 and 20 basis points for the first half. Productivity and capacity benefits were offset by performance-based compensation, customer price concessions and product mix.
- SG&A increased 7% in Q2 and 13% for the first half, driven primarily by professional and consulting costs, performance-based compensation and corporate development activities.
- Operating cash flow declined to $37.8 million from $44.2 million, primarily because of timing and working-capital changes, including increased accounts receivable and inventory.
- Other operating income of $0.5 million in Q2 and $0.4 million for the first half contrasted with prior-year operating charges, mainly because of asset disposition gains and reduced consolidation costs.
Guidance, Outlook, Commentary and Risks
- Management revised 2011 sales guidance upward from $540 million-$560 million to $550 million-$570 million.
- Adjusted operating margin guidance remained 12.0%-13.0%; adjusted diluted EPS guidance increased from $1.55-$1.65 to $1.60-$1.70.
- Management expected CRM revenue pressure to intensify in the second half because customer inventory builds were considered complete. It also expected Electrochem revenue to fall below the first-half run rate because of energy-market seasonality and environmental-monitoring inventory timing.
- Orthopaedic revenue was expected to continue benefiting from market-share gains, although third-quarter seasonality was expected to partially offset growth. Gross margin was expected to remain near the current level through the remainder of 2011.
- Management cited significant customer concentration: four customers represented 59% of first-half sales. Risks include pricing pressure, customer vertical integration, short ordering visibility, market contraction, product obsolescence, competition, regulatory changes, product liability and dependence on third-party suppliers.
- Health-care reform could increase industry taxes and alter reimbursement and product-development economics. Proposed lithium-battery transportation rules could adversely affect both segments.
- The company had approximately $32.4 million of purchase obligations, $14.5 million of operating lease obligations and $12.5 million of pension obligations. It also had a $3.7 million accrued self-insured medical liability and a $2.2 million product warranty liability.
- Litigation was described as arising in the ordinary course, with no expected material adverse effect; however, an unfavorable ruling could materially affect the period of resolution. Management reported no material changes to previously disclosed risk factors or legal proceedings.
- Facility optimization expenses were expected to total approximately $2 million, with $0.5 million incurred through July 1, 2011. A $3.0 million contingent liability related to purchased technology was payable only if specified sales targets were achieved.
Important Facts for Investors to Verify
- Confirm the registrant identity: the supplied filing is for Greatbatch, Inc., not Integer Holdings Corp.
- Reconcile reported GAAP results with adjusted measures, particularly the $4.5 million IntElect investment gain, convertible-debt discount amortization and other excluded items.
- Assess the sustainability of revenue growth excluding the approximately $6 million first-half foreign-currency benefit and considering expected CRM and Electrochem pressure.
- Review debt maturities and the provision that the revolving facility may mature March 1, 2013 if the convertible notes are not repaid, modified or refinanced before that date.
- Monitor customer concentration, pricing concessions, inventory levels, gross-margin trends and the company’s ability to convert orthopaedic and complete-device investments into recurring growth.
- Verify planned capital spending, the Indiana facility timeline and the effect of working-capital requirements on operating cash flow.