U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q/A
(Amendment No. 1)
QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarter ended July 1, 2005
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 an accelerated filer (as
defined in Exchange Act Rule 12b-2). Yes [ X ] No [ ]
The number of shares outstanding of the Company's common stock, $.001 par value
per share, as of August 5, 2005 was: 21,613,552 shares.
EXPLANATORY NOTE
Greatbatch, Inc. (the "Company") is filing this Amendment No. 1 on Form 10-Q/A
to amend its Form 10-Q for the three months ended June 30, 2005 as filed with
the Securities and Exchange Commission on August 10, 2005 (the "Original
Filing") to (i) revise Part I, Item 1, Item 2, and Item 4, and Part II, Item 6
to reflect the restatement of its condensed consolidated balance sheet and
condensed consolidated statement of cash flows to correct the classification of
auction rate securities which were previously classified as cash and cash
equivalents, to restate its consolidated statements of cash flows for the impact
of changes in accounts payable related to the acquisition of property, plant and
equipment, and to account for a deferred tax asset related to net operating
losses acquired in the Company's acquisition of NanoGram Devices Corporation in
2004, and (ii) present revised exhibits 31.1, 31.2 and 32.1.
Except for the amendments set forth in this Amendment No. 1, the Original Filing
is not being modified or amended in any way, and the disclosures contained in
the Original Filing are not being updated herein.
GREATBATCH, INC.
TABLE OF CONTENTS FOR FORM 10-Q/A
AS OF AND FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2005
Page
COVER PAGE 1
TABLE OF CONTENTS 3
PART I - FINANCIAL INFORMATION (unaudited)
ITEM 1. Condensed Consolidated Financial Statements
Condensed Consolidated Balance Sheet (As restated) 4
Condensed Consolidated Statement of Operations and Comprehensive
Income 5
Condensed Consolidated Statement of Cash Flows (As restated) 6
Notes to Condensed Consolidated Financial Statements (As restated) 7
ITEM 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations 21
ITEM 4. Controls and Procedures 34
PART II - OTHER INFORMATION
ITEM 6. Exhibits 36
SIGNATURES 37
EXHIBIT INDEX 38
PART I - FINANCIAL INFORMATION
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
GREATBATCH, INC.
CONDENSED CONSOLIDATED BALANCE SHEET - Unaudited
(IN THOUSANDS)
--------------------------------------------------------------------------------
ASSETS June 30, December 31,
2005(1) 2004(1)
Current assets:
Cash and cash equivalents $ 25,721 $ 34,795
Short-term investments 62,422 57,437
Accounts receivable, net 35,515 24,288
Inventories 33,672 34,027
Refundable income taxes 3,783 3,673
Deferred income taxes 3,622 3,622
Prepaid expenses and other current assets 6,094 4,637
---------- ------------
Total current assets 170,829 162,479
Property, plant, and equipment, net 100,901 92,210
Intangible assets, net 62,058 63,984
Goodwill 155,039 155,039
Other assets 4,496 4,493
---------- ------------
Total assets $ 493,323 $ 478,205
========== ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable 7,850 8,971
Accrued expenses and other current liabilities 18,703 18,109
Current portion of long-term debt 1,001 1,000
---------- ------------
Total current liabilities 27,554 28,080
Long-term debt, net of current portion 58 652
Convertible subordinated notes 170,000 170,000
Deferred income taxes 27,222 23,296
---------- ------------
Total liabilities 224,834 222,028
---------- ------------
Stockholders' equity:
Preferred stock - -
Common stock 21 21
Additional paid-in capital 215,912 212,131
Deferred stock-based compensation (1,579) (833)
Treasury stock, at cost - (95)
Retained earnings 54,254 44,971
Accumulated other comprehensive loss (119) (18)
---------- ------------
Total stockholders' equity 268,489 256,177
---------- ------------
Total liabilities and stockholders' equity $ 493,323 $ 478,205
========== ============
(1) As restated, see Note 2.
The accompanying notes are an integral part of these condensed consolidated
financial statements
4
GREATBATCH, INC.
CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
AND COMPREHENSIVE INCOME - Unaudited
(IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
-------------------------------------------------------------------------------------------------------
Three months ended Six months ended
June 30, June 30,
2005 2004 2005 2004
Sales $ 63,524 $ 52,942 $ 119,882 $ 108,467
Cost of sales 38,405 29,124 73,976 61,474
--------- --------- ---------- ----------
Gross profit 25,119 23,818 45,906 46,993
Selling, general and administrative expenses 8,481 6,389 15,247 13,314
Research, development and engineering costs, net 3,657 5,688 8,058 10,569
Amortization of intangible assets 958 1,076 1,916 1,851
Other operating expense, net 4,001 2,957 6,389 3,178
--------- --------- ---------- ----------
Operating income 8,022 7,708 14,296 18,081
Interest expense 1,191 1,144 2,322 2,304
Interest income (652) (245) (1,227) (558)
Other expense, net (60) (2) (60) -
--------- --------- ---------- ----------
Income before provision for income taxes 7,543 6,811 13,261 16,335
Provision for income taxes 2,263 2,078 3,978 4,983
--------- --------- ---------- ----------
Net income $ 5,280 $ 4,733 $ 9,283 $ 11,352
========= ========= ========== ==========
Earnings per share:
Basic $ 0.24 $ 0.22 $ 0.43 $ 0.53
Diluted $ 0.23 $ 0.21 $ 0.42 $ 0.50
Weighted average shares outstanding:
Basic 21,581 21,366 21,527 21,323
Diluted 26,061 25,715 25,862 25,781
Comprehensive income:
Net income $ 5,280 $ 4,733 $ 9,283 $ 11,352
Net unrealized loss on available for sale
securities, net of deferred income tax benefits of $21
and $44 in the three and six month periods in 2005,
respectively (61) - (101) -
--------- --------- ---------- ----------
Comprehensive income $ 5,219 $ 4,733 $ 9,182 $ 11,352
========= ========= ========== ==========
The accompanying notes are an integral part of these condensed consolidated
financial statements
5
GREATBATCH, INC.
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS - Unaudited
(IN THOUSANDS)
--------------------------------------------------------------------------------
Six months ended
June 30,
2005(1) 2004(1)
Cash flows from operating activities:
Net income $ 9,283 $ 11,352
Adjustments to reconcile net income to
net cash provided by operating activities:
Depreciation and amortization 8,744 7,253
Stock-based compensation 1,448 1,511
Deferred income taxes 3,926 3,540
Loss on disposal of assets 1,489 115
Changes in operating assets and liabilities:
Accounts receivable (11,227) (5,628)
Inventories 355 (4,391)
Prepaid expenses and other current assets (2,007) 1,164
Accounts payable 115 725
Accrued expenses and other current liabilities 1,945 (2,915)
Income taxes (88) (1,502)
---------- ----------
Net cash provided by operating activities 13,983 11,224
---------- ----------
Cash flows from investing activities:
Short-term investments
Purchases (38,990) (67,875)
Proceeds from dispositions 34,005 110,584
Acquisition of property, plant and equipment (17,281) (14,475)
Proceeds from sale of assets 23 64
(Increase) decrease in other assets (256) 37
Acquisition of subsidiary, net - (45,604)
---------- ----------
Net cash used in investing activities (22,499) (17,269)
---------- ----------
Cash flows from financing activities:
Principal payments of long-term debt (593) (663)
Payment of debt issue costs (213) -
Issuance of common stock 248 1,114
Issuance of treasury stock - 179
---------- ----------
Net cash (used in) provided by financing activities (558) 630
---------- ----------
Net decrease in cash and cash equivalents (9,074) (5,415)
Cash and cash equivalents, beginning of year 34,795 23,960
---------- ----------
Cash and cash equivalents, end of period $ 25,721 $ 18,545
========== ==========
(1) As restated, see Note 2.
The accompanying notes are an integral part of these condensed consolidated
financial statements
6
GREATBATCH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Unaudited
--------------------------------------------------------------------------------
1. BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements have
been prepared in accordance with accounting principles generally accepted
in the United States of America for interim financial information (APB 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. (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. For further information, refer to the consolidated financial
statements and notes thereto included in the Company's Annual Report on
Form 10-K/A for the year ended December 31, 2004.
The Company officially changed its name to Greatbatch, Inc. from Wilson
Greatbatch Technologies, Inc. during the second quarter.
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. For clarity of presentation, the Company describes all periods as
if each quarter end is March 31st, June 30th and September 30th and as if
the year-end is December 31st. The second quarter of 2005 and 2004 each
contained 13 weeks.
2. RESTATEMENTS
Subsequent to the original filing of the Company's Form 10-Q for the three
and six months ended June 30, 2005, the Company concluded that its
condensed consolidated financial statements should be restated to change
the classification of auction rate securities from cash and cash
equivalents to short-term investments. Auction rate securities are
securities that have stated maturities beyond three months, but are priced
and traded as short-term investments due to the liquidity provided through
the auction mechanism that generally resets interest rates every 7 to 35
days. Although management had determined the risk of failure of an auction
process to be remote, the definition of a cash equivalent in Statement of
Financial Accounting Standards (SFAS) No. 95, Statement of Cash Flows,
requires reclassification to short-term investments. The condensed
consolidated balance sheets as of June 30, 2005 and December 31, 2004, and
condensed consolidated statements of cash flows for the three and six
months ended June 30, 2005 and 2004, have been restated in order to conform
to this change in classification. Due to the short-term nature of the
interest rate resets, the fair market value of the auction rate securities
approximates their recorded value.
7
The Company has also restated its condensed consolidated statement of cash
flows for the periods ended June 30, 2005 and 2004 to reflect the impact of
changes in accounts payable related to the acquisition of property, plant
and equipment as a non-cash activity as required under SFAS No. 95.
In addition, the Company determined that it had not accounted for a
deferred tax asset in purchase accounting related to net operating losses
acquired in the Company's acquisition of NanoGram in 2004. The recording of
this deferred tax asset decreased long-term deferred income tax liabilities
and correspondingly decreased goodwill.
The restatements have been made to the Condensed Consolidated Balance Sheet
and Condensed Consolidated Statement of Cash Flows as follows:
Condensed Consolidated Balance Sheet as of
------------------------------------------
June 30, 2005
-------------
As previously
-------------
reported Adjustment As restated
------------- ---------- -----------
Current assets:
Cash and cash equivalents $ 83,036 $ (57,315) $ 25,721
Short-term investments $ 5,107 $ 57,315 $ 62,422
Goodwill $ 156,772 $ (1,733) $ 155,039
Total assets $ 495,056 $ (1,733) $ 493,323
Long term liabilities
Deferred income taxes $ 28,955 $ (1,733) $ 27,222
Total liabilities $ 226,567 $ (1,733) $ 224,834
Total liabilities and stockholders' equity $ 495,056 $ (1,733) $ 493,323
Condensed Consolidated Balance Sheet as of
------------------------------------------
December 31, 2004
-----------------
As previously
-------------
reported Adjustment As restated
------------- ---------- -----------
Current assets:
Cash and cash equivalents $ 89,473 $ (54,678) $ 34,795
Short-term investments $ 2,759 $ 54,678 $ 57,437
Goodwill $ 156,772 $ (1,733) $ 155,039
Total assets $ 479,938 $ (1,733) $ 478,205
Long term liabilities
Deferred income taxes $ 25,029 $ (1,733) $ 23,296
Total liabilities $ 223,761 $ (1,733) $ 222,028
Total liabilities and stockholders' equity $ 479,938 $ (1,733) $ 478,205
8
Condensed Consolidated Statement of Cash Flows for the three months ended
-------------------------------------------------------------------------
June 30, 2005
-------------
As previously
-------------
reported Adjustment As restated
------------- ---------- -----------
Cash flows from operating activities:
Net cash provided by operating activities $ 12,747 $ 1,236 $ 13,983
Cash flows from investing activities:
Net cash used in investing activities $ (18,626) $ (3,873) $ (22,499)
Net decrease in cash and cash equivalents $ (6,437) $ (2,637) $ (9,074)
Cash and cash equivalents, beginning of year $ 89,473 $ (54,678) $ 34,795
Cash and cash equivalents, end of period $ 83,036 $ (57,315) $ 25,721
Condensed Consolidated Statement of Cash Flows for the three months ended
-------------------------------------------------------------------------
June 30, 2004
-------------
As previously
-------------
reported Adjustment As restated
------------- ---------- -----------
Cash flows from operating activities:
Net cash provided by operating activities $ 11,932 $ (708) $ 11,224
Cash flows from investing activities:
Net cash used in investing activities $ (52,197) $ 34,928 $ (17,269)
Net decrease in cash and cash equivalents $ (39,635) $ 34,220 $ (5,415)
Cash and cash equivalents, beginning of year $ 119,486 $ (95,526) $ 23,960
Cash and cash equivalents, end of period $ 79,851 $ (61,306) $ 18,545
3. STOCK-BASED COMPENSATION
The Company accounts for stock-based compensation in accordance with
Statement of Financial Accounting Standards No. 123, Accounting for
Stock-Based Compensation ("SFAS No. 123"). As permitted in SFAS No. 123,
the Company has chosen to account for stock-based compensation using the
intrinsic value method prescribed in Accounting Principles Board No. 25,
Accounting for Stock Issued to Employees, and related interpretations.
The Company has determined the pro forma information as if the Company had
accounted for stock options granted under the fair value method of SFAS No.
123. The Black-Scholes option-pricing model was used with the following
weighted average assumptions.
9
These pro forma calculations assume the common stock is freely tradable for
all periods presented and, as such, the impact is not necessarily
indicative of the effects on reported net income of future periods.
Three months Six months
ended ended
June 30, June 30,
2005 2004 2005 2004
Risk-free interest rate 3.83% 3.93% 4.03% 3.80%
Expected volatility 52% 50% 52% 50%
Expected life (in years) 5 5 5 5
Expected dividend yield 0% 0% 0% 0%
The Company's net income and earnings per share as if the fair value based
method had been applied to all outstanding and unvested awards in each
period is as follows (in thousands except per share data):
Three months Six months
ended ended
June 30, June 30,
2005 2004 2005 2004
Net income as reported $ 5,280 $ 4,733 $ 9,283 $ 11,352
Stock-based employee compensation cost
included in net income as reported, net
of related tax effects $ 457 $ 438 $ 1,014 $ 1,050
Stock-based employee compensation cost
determined using the fair value based
method, net of related tax effects $ 976 $ 968 $ 2,019 $ 2,104
Pro forma net income $ 4,761 $ 4,203 $ 8,278 $ 10,298
Earnings per share:
Basic - as reported $ 0.24 $ 0.22 $ 0.43 $ 0.53
Basic - pro forma $ 0.22 $ 0.20 $ 0.38 $ 0.48
Diluted - as reported $ 0.23 $ 0.21 $ 0.42 $ 0.52
Diluted - pro forma $ 0.21 $ 0.19 $ 0.38 $ 0.48
10
4. SUPPLEMENTAL CASH FLOW INFORMATION (in thousands):
Six months ended
June 30,
2005 2004
Noncash investing and financing activities:
Acquisition of property utilizing capital leases $ - $ 1,007
Common stock contributed to 401(k) Plan $ 2,729 $ 2,723
Property, plant and equipment purchases included in
accounts payable $ 994 $ 1,232
5. SHORT-TERM INVESTMENTS
Short-term investments at June 30, 2005 and December 31, 2004 consisted of
the following (in thousands):
As of June 30, 2005
Gross Gross Estimated
unrealized unrealized fair
Cost gains losses value
Available-for-sale:
Equity Securities $ 276 $ - $ (81) $ 195
Auction Rate Securities 55,546 - - 55,546
--------- ---------- ---------- ---------
Total available for sale securities 55,822 - (81) 55,741
Held-to-maturity:
Municipal Bonds (1) 6,681 - (13) 6,668
--------- ---------- ---------- ---------
Short-term investments $ 62,503 $ - $ (94) $ 62,409
========= ========== ========== =========
(1) The municipal bonds have maturity dates ranging from July 2005 to November
2005.
As of December 31, 2004
Gross Gross Estimated
unrealized unrealized fair
Cost gains losses value
Available-for-sale:
Equity Securities $ 276 $ - $ (18) $ 258
Auction Rate Securities 54,678 - - 54,678
--------- ---------- ---------- ---------
Total available for sale securities 54,954 - (18) 54,936
Held-to-maturity:
Municipal Bonds 2,501 1 - 2,502
--------- ---------- ---------- ---------
Short-term investments $ 57,455 $ 1 $ (18) $ 57,438
========= ========== ========== =========
11
6. INVENTORIES
Inventories comprised the following (in thousands):
June 30, December 31,
2005 2004
Raw materials $ 16,527 $ 14,053
Work-in-process 10,328 11,275
Finished goods 6,817 8,699
--------- ------------
Total $ 33,672 $ 34,027
========= ============
7. INTANGIBLE ASSETS
Intangible assets comprised the following (in thousands):
As of June 30, 2005
Gross Net
carrying Accumulated carrying
amount amortization Amount
Amortizing intangible assets:
Patented technology $ 21,462 $ (10,938) $ 10,524
Unpatented technology 30,886 (7,638) 23,248
Other 1,340 (1,306) 34
--------- ---------- ---------
53,688 (19,882) 33,806
Non-amortizing intangible assets:
Trademark and names 31,420 (3,168) 28,252
--------- ---------- ---------
Total intangible assets $ 85,108 $ (23,050) $ 62,058
========= ========== =========
As of December 31, 2004
Gross Net
carrying Accumulated carrying
amount amortization Amount
Amortizing intangible assets:
Patented technology $ 21,462 $ (10,137) $ 11,325
Unpatented technology 30,886 (6,525) 24,361
Other 1,340 (1,294) 46
--------- ---------- ---------
53,688 (17,956) 35,732
Non-amortizing intangible assets:
Trademark and names 31,420 (3,168) 28,252
--------- ---------- ---------
Total intangible assets $ 85,108 $ (21,124) $ 63,984
========= ========== =========
Aggregate amortization expense for second quarter 2005 and 2004 was $1.0
million and $1.1 million, respectively. Aggregate amortization expense for
the six months ended June 30, 2005 and 2004 was $1.9 million. Annual
amortization expense is estimated to be $1.9 million for the remainder of
2005, $3.8 million for 2006 to 2008, $3.2 million for 2009, and $2.7
million for 2010.
12
8. DEBT
Long-term debt comprised the following (in thousands):
June 30, December 31,
2005 2004
2.25% convertible subordinated notes, due 2013 $ 170,000 $ 170,000
Capital lease obligations 1,059 1,652
---------- ------------
171,059 171,652
Less current portion (1,001) (1,000)
---------- ------------
Total long-term debt $ 170,058 $ 170,652
========== ============
Revolving Line of Credit
On May 31, 2005, the Company amended its Senior Secured Credit Facility,
which included changes to the underlying covenants. The amended three-year
facility replaced the old $20.0 million revolving credit facility with a
new $50.0 million Revolving Credit Facility ("new revolver"), which
contains a $10.0 million sub-limit for the issuance of commercial or
standby letters of credit. The new revolver is secured by the Company's
non-realty assets including cash, accounts and notes receivable, and
inventories. The new revolver requires the Company to comply with two
quarterly financial covenants, as defined. The first relates to the ratio
of consolidated net earnings or loss before interest, taxes, depreciation,
and amortization ("EBITDA") to Fixed Charges. The second is a Leverage
ratio, which is calculated based on the ratio of Consolidated Funded Debt
less Cash, Cash Equivalent Investments and Short-Term Investments to
Consolidated EBITDA. Interest rates under the new Facility vary with the
Company's leverage. The Company is required to pay a commitment fee of
between .125% and .250% per annum on the unused portion of the revolving
line of credit based on the Company's leverage. As of June 30, 2005, the
Company had no balance outstanding on its $50.0 million committed revolving
line of credit.
Debt issue expenses for the new revolver totaled $0.2 million and are being
amortized using the straight-line method over a three-year term. The
revolver refinancing transaction resulted in the write-off of $0.1 million
of existing deferred financing fees associated with the prior revolving
line of credit.
13
9. 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 30, June 30,
2005 2004 2005 2004
--------- --------- --------- ---------
Numerator for basic earnings per share:
Income from continuing operations $ 5,280 $ 4,733 $ 9,283 $ 11,352
Effect of dilutive securities:
Interest expense on convertible notes and
related deferred financing fees, net of tax 783 769 1,565 1,537
--------- --------- --------- ---------
Numerator for diluted earnings per share $ 6,063 $ 5,502 $ 10,848 $ 12,889
========= ========= ========= =========
Denominator for basic earnings per share:
Weighted average shares outstanding 21,581 21,366 21,527 21,323
Effect of dilutive securities:
Convertible notes 4,219 4,219 4,219 4,219
Stock options and unvested restricted stock 261 130 116 239
--------- --------- --------- ---------
Dilutive potential common shares 4,480 4,349 4,335 4,458
--------- --------- --------- ---------
Denominator for diluted earnings per share 26,061 25,715 25,862 25,781
========= ========= ========= =========
Basic earnings per share $ 0.24 $ 0.22 $ 0.43 $ 0.53
========= ========= ========= =========
Diluted earnings per share $ 0.23 $ 0.21 $ 0.42 $ 0.50
========= ========= ========= =========
10. COMPREHENSIVE INCOME
For the second quarter and six months ended June 30, 2004, the Company's
only component of comprehensive income is its net income. For the second
quarter and six months ended June 30, 2005, the Company's comprehensive
income includes net income and a net unrealized loss on available-for-sale
securities.
11. COMMITMENTS AND CONTINGENCIES
Litigation - During 2002, a former non-medical customer commenced an action
alleging that the Company had used proprietary information of the customer
to develop certain products. We have meritorious defenses and are
vigorously defending the case. No accrual for an adverse judgment has been
made as such outcome is not deemed probable, the potential risk of loss is
between $0.0 and $1.75 million.
As reported in the Company's 2005 first quarter Form 10-Q, on May 2, 2005,
a complaint was filed against the Company by a developer of an implantable
drug delivery device in the United States Federal District Court for the
Central District of California. On May 20, 2005, the parties entered into a
settlement agreement under which the Company undertook certain obligations
including the performance of certain additional development tasks for a
limited period of time. On June 2, 2005, the Court ordered the complaint
dismissed without prejudice.
14
Product Warranties - The change in aggregate product warranty liability for
the quarter ended June 30, 2005, is as follows (in thousands):
Beginning balance $ 948
Additions to warranty reserve 374
Warranty claims paid (57)
--------
Ending balance $ 1,265
========
Capital Expenditures - During 2004, the Company commenced the build out of
its medical battery and capacitor manufacturing facility in Alden, NY and
its value-add manufacturing facility in Tijuana, Mexico. These facilities
will enable the Company to further consolidate its operations and implement
state of the art manufacturing capabilities at both locations. The total
contractual obligation for construction of these facilities at June 30,
2005 is $4.4 million and will be financed by existing or internally
generated cash.
12. BUSINESS SEGMENT INFORMATION
The Company operates its business in two reportable segments: Implantable
Medical Components ("IMC") and Electrochem Commercial Power ("ECP"),
(formerly "Electrochem Power Solutions"). The IMC segment designs and
manufactures critical components used in implantable medical devices. The
principal components are batteries, capacitors, filtered feedthroughs,
coated components, enclosures and machined and molded precision components.
The principal medical devices are pacemakers, defibrillators and
neurostimulators. The ECP segment designs and manufactures high performance
cells and battery packs; principal markets for these products are for oil
and gas exploration, oceanographic equipment, and aerospace.
The Company defines segment income from operations as gross profit less
costs and expenses attributable to segment-specific selling, general and
administrative, research, development and engineering expenses, intangible
amortization and other operating expenses. Segment income also includes a
portion of non-segment specific selling, general and administrative, and
research, development and engineering expenses based on allocations
appropriate to the expense categories. The remaining unallocated operating
expenses along with other income and expense are not allocated to
reportable segments. Transactions between the two segments are not
significant. The accounting policies of the segments are the same as those
described and referenced in Note 1.
15
An analysis and reconciliation of the Company's business segment
information to the respective information in the condensed consolidated
financial statements is as follows (in thousands):
Three months ended Six months ended
June 30, June 30,
Sales: 2005 2004 2005 2004
IMC
ICD batteries $ 12,608 $ 10,119 $ 23,234 $ 19,539
Pacemaker and other batteries 6,315 5,361 11,695 11,050
ICD Capacitors 5,954 6,239 10,251 14,647
Feedthroughs 15,859 12,261 29,541 26,016
Enclosures 6,019 5,142 12,566 10,539
Other 8,031 7,077 15,363 12,686
--------- --------- ---------- ----------
Total IMC 54,786 46,199 102,650 94,477
ECP 8,738 6,743 17,232 13,990
--------- --------- ---------- ----------
Total sales $ 63,524 $ 52,942 $ 119,882 $ 108,467
========= ========= ========== ==========
Segment income from operations:
IMC $ 9,481 $ 8,396 $ 17,361 $ 19,218
ECP 2,430 1,608 4,308 3,903
--------- --------- ---------- ----------
Total segment income from operations 11,911 10,004 21,669 23,121
Unallocated operating expenses (3,889) (2,296) (7,373) (5,040)
--------- --------- ---------- ----------
Operating income as reported 8,022 7,708 14,296 18,081
Unallocated other income and expense (479) (897) (1,035) (1,746)
--------- --------- ---------- ----------
Income before income taxes as reported $ 7,543 $ 6,811 $ 13,261 $ 16,335
========= ========= ========== ==========
The carrying amount of goodwill at December 31, 2004 and June 30, 2005 is
as follows
(in thousands):
IMC ECP Total
$ 152,473 $ 2,566 $ 155,039
========== ======== ==========
16
13. OTHER OPERATING EXPENSE
During the second quarter and six months ended June 30, 2005, the following
non-recurring charges were recorded in other operating expense in the
Company's Condensed Consolidated Statement of Operations.
Costs to exit development agreement. There was a $1.15 million charge
recorded in other operating expenses for the IMC segment during the second
quarter for charges associated with the discontinuation of a drug pump
development agreement.
Severance charges. During the first quarter, the Company implemented a 4%
workforce reduction as a continuation of cost containment efforts initiated
mid-year 2004, which resulted in a severance charge of $1.5 million.
Accrued liabilities at June 30, 2005 related to the severance charges
comprised the following (in thousands):
IMC ECP CORPORATE TOTAL
Severance charges $ 860 $ 210 $ 430 $ 1,500
Cash payments (794) (128) (367) (1,289)
----- ----- ----- -------
Balance, June 30, 2005 $ 66 $ 82 $ 63 $ 211
The severance charges related to corporate employees are included in
unallocated operating expenses. It is expected that the remaining accrued
severance as of June 30, 2005, will be paid within the next three months.
Alden Facility Consolidation - On February 23, 2005, the Company announced
its intent to consolidate the medical capacitor manufacturing operations,
currently in Cheektowaga, NY, and the implantable medical battery
manufacturing operations, currently in Clarence, NY, into the advanced
power source manufacturing facility in Alden, NY ("Alden Facility"). The
Company is also consolidating the capacitor research, development and
engineering operations from the Cheektowaga, NY, facility into the existing
implantable medical battery research, development, and engineering
operations in Clarence, NY.
The total cost estimated for these consolidation efforts is anticipated to
be between $3.5 and $4.0 million. The Company expects to incur the balance
of this additional expense over the next two fiscal quarters. The expenses
for the Alden Facility consolidation are included in the IMC business
segment. The major categories of costs, which will primarily be cash
expenditures, include the following:
o Production inefficiencies and revalidation - $1.5 to $1.7 million;
o Training - $0.6 to $0.7 million;
o Moving and facility closures - $0.9 million to $1.0 million; and
o Infrastructure - $0.5 to $0.6 million.
17
Accrued liabilities at June 30, 2005 related to the Alden Facility
consolidation comprised the following (in thousands):
Production
Inefficiencies Moving and
and Revalidation Training Facility Closures Infrastructure Total
----------------- --------- ----------------- -------------- -----
Restructuring charges $ 135 $ 15 $ 517 $ 188 $ 855
Cash payments (120) (15) (130) (168) (433)
Write-offs -- -- (167) -- (167)
----- ----- ----- ----- -----
Balance, June 30, 2005 $ 15 $ -- $ 220 $ 20 $ 255
===== ===== ===== ===== =====
Carson City Facility shutdown and Tijuana Facility consolidation - 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 the
Carson City Facility into the Tijuana, Mexico facility ("Tijuana
Facility").
The total estimated cost for this facility consolidation plan is
anticipated to be between $4.5 million and $5.4 million. The Company
expects to incur the remaining cost over the next four fiscal quarters. The
major categories of costs include the following:
o Costs related to the shutdown of the Carson City Facility:
a. Severance and retention - $1.4 to $1.6 million;
b. Accelerated depreciation - $0.5 to $0.6 million; and
c. Other - $0.6 to $0.7 million.
o Costs related to the Tijuana Facility consolidation:
a. Production inefficiencies and
revalidation - $0.4 to $0.5 million;
b. Relocation and moving - $0.3 to $0.5 million;
c. Personnel (including travel, training and duplicate wages)
- $1.0 to $1.1 million; and
d. Other - $0.3 to $0.4 million.
All categories of costs are considered to be cash expenditures, except
accelerated depreciation. The expenses for the Carson City facility
shutdown and the Tijuana Facility consolidation are included in the IMC
business segment.
Accrued liabilities at June 30, 2005 related to the Carson City Facility
shutdown comprised the following (in thousands):
Severance Accelerated
and retention Depreciation Other Total
------------- ------------ ----- -----
Restructuring charges $ 620 $ 200 $ 12 $ 832
Cash payments -- -- (12) (12)
Write-offs -- (200) -- (200)
----- ----- ----- -----
Balance, June 30, 2005 $ 620 $ -- $ -- $ 620
===== ===== ===== =====
18
Accrued liabilities at June 30, 2005 related to the Tijuana Facility
consolidation comprised the following (in thousands):
Production
inefficiencies Relocation
and revalidation and moving Personnel Other Total
---------------- ----------- --------- ----- -----
Restructuring charges $ -- $ -- $ 40 $ 40
Cash payments -- -- (40) -- (40)
----- ------ ----- ---- -----
Balance, June 30, 2005 $ -- $ -- $ -- $ -- $ --
===== ====== ===== ==== =====
14. IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS
In July 2005, the Financial Accounting Standards Board ("FASB") published
an Exposure Draft of a proposed Interpretation, Accounting for Uncertain
Tax Positions. The Exposure Draft seeks to reduce the significant diversity
in practice associated with recognition and measurement in the accounting
for income taxes. It would apply to all tax positions accounted for in
accordance with SFAS 109, Accounting for Income Taxes. The Exposure Draft
requires that a tax position meet a "probable recognition threshold" for
the benefit of the uncertain tax position to be recognized in the financial
statements. This threshold is to be met assuming that the tax authorities
will examine the uncertain tax position. The Exposure Draft contains
guidance with respect to the measurement of the benefit that is recognized
for an uncertain tax position, when that benefit should be derecognized,
and other matters. This proposed Interpretation would clarify the
accounting for uncertain tax positions in accordance with SFAS 109. This
Interpretation, once approved, is expected to be effective as of the end of
the first fiscal year ending after December 15, 2005. The Company outlined
its critical accounting policies related to income taxes in its Annual
Report on Form 10-K for the year ended December 31, 2004. Certain tax
accounting and reporting guidelines may change as a result of new
accounting guidance. The Company's accounting and reporting treatment will
be determined at the time of issuance of a final standard.
In June 2005 the issued Statement of Financial Accounting Standards
("SFAS") No. 154, Accounting Changes and Error Corrections, ("SFAS 154") a
replacement of APB Opinion No. 20, Accounting Changes, and Statement No. 3,
Reporting Accounting Changes in Interim Financial Statements. SFAS 154
changes the requirements for the accounting for and the reporting of a
change in accounting principle. Previously, most voluntary changes in
accounting principles required recognition by recording a cumulative effect
adjustment within net income in the period of change. SFAS 154 requires
retrospective application to prior periods' financial statements, unless it
is impracticable to determine either the specific period effects or the
cumulative effect of the change. SFAS 154 is effective for accounting
changes made in fiscal years beginning after December 15, 2005. The Company
does not expect that adoption of SFAS No. 154 will have a material effect
on its consolidated financial position, consolidated results of operations,
or liquidity.
In December 2004, the FASB issued SFAS No. 123 (revised 2004), Share-Based
Payment ("SFAS No. 123(R)"). This statement is a revision of SFAS No. 123,
Accounting for Stock-Based Compensation, and supersedes APB Opinion No. 25,
Accounting for Stock Issued to Employees. This standard requires the
Company to measure the cost of employee services received in exchange for
equity awards based on the grant date fair value of the awards. The cost
will be recognized as compensation expense over the vesting period of the
awards.
19
The Company anticipates adopting the provisions of SFAS No. 123(R) on
January 1, 2006 using the modified prospective application. Accordingly,
compensation expense will be recognized for all newly granted awards and
awards modified, repurchased, or cancelled after January 1, 2006.
Compensation cost for the unvested portion of awards that are outstanding
as of January 1, 2006 will be recognized ratably over the remaining vesting
period. The compensation cost for the unvested portion of awards will be
based on the fair value at date of grant as calculated for the Company's
pro forma disclosure under SFAS 123.
The Company estimates that the effect on net income and earnings per share
in the periods following adoption of SFAS 123(R) will be consistent with
the Company's pro forma disclosure under SFAS No. 123, except that
estimated forfeitures will be considered in the calculation of compensation
expense under SFAS 123(R). Additionally, the actual effect on net income
and earnings per share will vary depending upon the number of options
granted in subsequent periods compared to prior years.
In November 2004, the FASB issued SFAS No. 151, Inventory Costs, an
amendment of ARB No. 43, Chapter 4 ("SFAS No. 151"). SFAS No. 151 amends
the guidance in ARB No. 43, Chapter 4, "Inventory Pricing," to clarify the
accounting for abnormal amounts of idle facility expense, handling costs
and wasted material (spoilage). Among other provisions, the new rule
requires that such items be recognized as current-period charges,
regardless of whether they meet the criterion of "so abnormal" as stated in
ARB No. 43. SFAS No. 151 is effective for fiscal years beginning after June
15, 2005. The company does not expect that adoption of SFAS No. 151 will
have a material effect on its consolidated financial position, consolidated
results of operations, or liquidity.
20
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The condensed consolidated financial statements in Item 1 have been restated as
described in Note 2. -Restatements and the following discussion, analysis and
financial information herein have been revised to reflect the effects of the
restatements.
Introduction
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 for
IMDs and enable our customers to introduce IMDs that are progressively smaller,
longer lasting, more efficient and more functional. We also leverage our core
competencies in technology and manufacturing through our Electrochem Commercial
Power ("ECP") business (formerly "Electrochem Power Solutions") to develop and
produce cells and battery packs for commercial applications that demand high
performance and reliability, including oil and gas exploration, oceanographic
equipment and aerospace.
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.
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. For
clarity of presentation, we describe all periods as if each quarter end is March
31st, June 30th and September 30th and as if the year-end is December 31st. The
second quarter of 2005 and 2004 each contained 13 weeks.
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/A for the fiscal year ended December 31, 2004.
Overview
During and subsequent to the second quarter 2005, there were several
developments affecting our business:
o We reported all-time record sales results of $63.5 million, led by strong
sales of implantable medical components and commercial power sources.
o We changed the name of the Company to Greatbatch, Inc., from the former
name of Wilson Greatbatch Technologies, Inc.
21
o We celebrated the grand opening of the world-class manufacturing facility
in Tijuana, Mexico.
o We appointed Thomas J. Hook as President and Chief Operating Officer.
o The installation of the remaining assembly equipment at the Tijuana
Facility continued to proceed as planned; completion is expected in the
fourth quarter of 2005. The consolidation plan was finalized for the move
of the Carson City plant into the Tijuana Facility. The move is expected to
be completed by first quarter 2006.
o The move of the medical battery manufacturing equipment to Alden, NY, was
substantially completed in accordance with plan. The movement of the
manufacturing equipment from the existing capacitor plant was initiated and
is expected to be complete by the end of the fourth quarter 2005.
o We amended our Senior Secured Credit Facility to replace our existing $20.0
million revolving credit with a new three-year, $50 million revolving
credit facility.
Product Development
As mentioned in our annual report (which is available on our website,
www.greatbatch.com), our near term focus for growth in the medical battery
market 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. While companies
typically announce new products that have modest improvements in form and/or
function regularly, we believe the Q-Series firmly establishes a new industry
standard. 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).
Based on our limited test results to date, batteries incorporating
nanotechnology may demonstrate the potential for generating even further
improvements. While nanotechnology is showing some limited benefits in current
battery designs, we do not anticipate realizing its full potential until it can
be tested in the Q-Series design. As the word implies, "nano" unlocks the
promise of smaller size and offers potential for enhanced product performance
and manufacturability. Additionally, nano applications are not limited to
batteries. The same technology may well be the enabling force behind other new
products now in development such as significantly smaller higher voltage
capacitors, novel form batteries and capacitors that will be used in new, far
less intrusive cardiac therapy applications that represent an entirely new
approach to CRM treatment.
22
Cost savings and consolidation efforts
During second quarter 2005, we recorded non-recurring charges in other operating
expense related to our ongoing cost savings and consolidation efforts.
Severance charges. The Company implemented a 4% workforce reduction during the
first quarter, which resulted in a severance charge of $1.5 million. Of that
amount, $0.8 million and $0.5 million was paid in cash during the first and
second quarters, respectively. The remaining $0.2 million balance is anticipated
to be paid in cash within the next three months.
Alden Facility Consolidation. On February 23, 2005, we announced our intent to
consolidate the medical capacitor manufacturing operations, currently in
Cheektowaga, NY, and the implantable medical battery manufacturing operations,
currently in Clarence, NY, into the advanced power source manufacturing facility
in Alden, NY ("Alden Facility"). We are also consolidating the capacitor
research, development and engineering operations from the Cheektowaga, NY,
facility into the existing implantable medical battery research, development,
and engineering operations in Clarence, NY.
The total cost estimated for these consolidation efforts is anticipated to be
between $3.5 and $4.0 million. Expenses of $0.9 million have been incurred
through the second quarter. Of these, $0.4 million were paid in cash, $0.2
million were for written-off assets, and $0.3 million remain to be paid. We
expect to incur the remaining expense over the next two fiscal quarters.
Carson City Facility shutdown and Tijuana Facility consolidation. On March 7,
2005, we announced our intent to close the Carson City, NV facility ("Carson
City Facility") and consolidate the work performed at the Carson City Facility
into the Tijuana, Mexico facility ("Tijuana Facility").
The total estimated cost for this facility consolidation plan is anticipated to
be between $4.5 million and $5.4 million, comprised of between $2.5 million to
$2.9 million for the Carson City Facility shutdown and $2.0 to $2.5 million for
the Tijuana Facility consolidation. We expect to incur the remaining costs over
the next three fiscal quarters. All categories of costs are considered to be
cash expenditures, except accelerated depreciation.
Carson City Facility shutdown expenses of $0.8 million have been accrued year to
date, of which $0.2 million have been recorded as accelerated depreciation and
$0.6 million remain to be paid. Tijuana Facility consolidation expenses of $0.04
million have been incurred and paid year to date.
23
Results of Operation and Financial Condition
Three months Six months
ended June 30, $ % ended June 30, $ %
In thousands, except per share data 2005 2004 Change Change 2005 2004 Change Change
-----------------------------------------------------------------------------------------------------------------------------
IMC
ICD batteries $12,608 $ 10,119 2,489 25% $ 23,234 $ 19,539 3,695 19%
Pacemaker and other batteries 6,315 5,361 954 18% 11,695 11,050 645 6%
ICD Capacitors 5,954 6,239 (285) -5% 10,251 14,647 (4,396) -30%
Feedthroughs 15,859 12,261 3,598 29% 29,541 26,016 3,525 14%
Enclosures 6,019 5,142 877 17% 12,566 10,539 2,027 19%
Other 8,031 7,077 954 13% 15,363 12,686 2,677 21%
-------------------------------------------------------------------------------
Total IMC 54,786 46,199 8,587 19% 102,650 94,477 8,173 9%
ECP 8,738 6,743 1,995 30% 17,232 13,990 3,242 23%
-------------------------------------------------------------------------------
Total sales 63,524 52,942 10,582 20% 119,882 108,467 11,415 11%
Cost of sales 38,405 29,124 9,281 32% 73,976 61,474 12,502 20%
-------------------------------------------------------------------------------
Gross profit 25,119 23,818 1,301 5% 45,906 46,993 (1,087) -2%
Gross margin 39.5% 45.0% -5.5% 38.3% 43.3% -5.0%
Selling, general, and
administrative expenses (SG&A) 8,481 6,389 2,092 33% 15,247 13,314 1,933 15%
SG&A as a % of sales 13.4% 12.1% 1.3% 12.7% 12.3% 0.4%
Research, development
and engineering costs, net (RD&E) 3,657 5,688 (2,031) -36% 8,058 10,569 (2,511) -24%
RD&E as a % of sales 5.8% 10.7% -4.9% 6.7% 9.7% -3.0%
Intangible amortization 958 1,076 (118) -11% 1,916 1,851 65 4%
Other operating expense, net 4,001 2,957 1,044 35% 6,389 3,178 3,211 101%
-------------------------------------------------------------------------------
Operating income 8,022 7,708 314 4% 14,296 18,081 (3,785) -21%
Operating margin 12.6% 14.6% -2.0% 11.9% 16.7% -4.8%
Interest expense 1,191 1,144 47 4% 2,322 2,304 18 1%
Interest income (652) (245) (407) 166% (1,227) (558) (669) 120%
Other expense (income), net (60) (2) (58) 2900% (60) - (60) 100%
Provision for income taxes 2,263 2,078 185 9% 3,978 4,983 (1,005) -20%
Effective tax rate 30.0% 30.5% -0.5% 30.0% 30.5% -0.5%
-------------------------------------------------------------------------------
Net income $ 5,280 $ 4,733 $ 547 12% $ 9,283 $ 11,352 $(2,069) -18%
===============================================================================
Net margin 8.3% 8.9% -0.6% 7.7% 10.5% -2.8%
Diluted earnings per share $ 0.23 $ 0.21 $ 0.02 10% $ 0.42 $ 0.50 $ (0.08) -16%
24
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.
The results for the quarter did receive benefit from the field issues
surrounding ICD products. However, it is extremely difficult to identify how
much benefit we did receive during the second quarter. We did see a quarterly
sequential increase in CRM related sales in the range of $5 million. We do not
have granularity into the nature of the orders and can only assume that some
percentage of the increase relates to the ICD field actions in the marketplace.
It is very conceivable that the impact on our sales will continue to be
favorably affected by these field issues into the second half of the year.
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. These dynamics should be become clearer in
early 2006 and will have to be carefully considered when we provide our 2006
outlook.
Moving beyond the field actions, the increase in demand is not isolated to any
one customer. We are seeing strength across all of our products and our entire
customer base. We believe that the market continues to exhibit strong underlying
growth fundamentals and that we are well positioned to participate in this
market growth.
The increase in IMC sales of 19% during the second quarter and 9% year to date
were primarily due to increased demand for ICD batteries, filtered feedthroughs,
coated components and medical enclosures offset by an average 2% reduction in
selling prices. Sales of assembly products manufactured in our Tijuana Facility
added incremental sales of $0.8 million to the quarter and year to date.
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.
We recorded our second consecutive record sales performance in our commercial
business segment. The ECP sales increases of 30% in the second quarter and 23%
year to date have been driven by volume increases due to a number of factors.
25
First and foremost, we have expanded our commercial sales force. We are
aggressively pursuing new business opportunities and have been successful on
many of these fronts.
Second, we have significantly reduced our manufacturing lead times at our Canton
facility, which has allowed us to increase shipments in the current year. We
will continue to expand on these efforts from various lean manufacturing
initiatives that are underway in our Canton facility and throughout the Company.
The third factor that has contributed to our positive commercial results has
been favorable market dynamics. The oil and gas exploration market remains
robust due to the increased demand for products used in pipeline inspections,
pressure monitoring and measurement while drilling applications. In addition, we
have seen an increase in demand for power sources used in wave monitoring and
seismic recording, due to increased Tsunami related concerns, mainly in the
international markets.
Gross profit
The basis point decreases in gross margin for the quarter and year to date were
primarily due to the following factors:
Basis point impact
------------------------
Quarter Year to Date
Excess capacity at wet tantalum capacitor and Tijuana facilities 290 230
Lower IMC selling prices 130 170
Profit sharing accruals and incentive compensation 60 30
Higher platinum costs & other items 70 70
--- ---
550 500
=== ===
SG&A expenses
Expenses for the quarter and year to date increased primarily as a result of
$2.0 million of increased incentive compensation accruals recorded during the
second quarter.
RD&E expenses
RD&E expenses, net of development costs reimbursed, decreased by 36% for the
quarter and 24% for the year to date compared to last year. Gross RD&E spending
declined by 12% for the quarter and 8% for the year to date versus last year.
The majority of this decrease is due to the QHR battery product line moving from
the development stage into production. We expect that RD&E costs will increase
in the second half, due to increased investment in future development programs
and the timing of achievement of reimbursement milestones.
In terms of the development costs billed, reimbursements for development
projects were 360% higher in the current quarter, and 101% higher for the year
to date compared to the same period last year. The reimbursements for achieving
certain development milestones are netted against gross spending. The timing of
the achievement of these milestones was the primary reason for the decline in
net RD&E expenses.
26
Amortization expense
Amortization expense for the quarter declined as the result of the completion of
amortization of a noncompete/employment agreement during 2004. The result is a
$0.1 million reduction in amortization expense per quarter in 2005.
Amortization expense for the year to date reflects an incremental $0.3 million
of intangible amortization resulting from the NanoGram acquisition in March 2004
offset by the $0.2 million reduction of expense due to the completion of the
amortization of the noncompete/employment agreement during 2004.
Other operating expense
Other operating expense for the quarter and year to date is comprised of
the following costs (in millions):
Quarter Year to Date
------- ------------
Costs to exit development agreement $ 1.2 $ 1.2
Alden facility consolidation * 0.9 0.9
Severance * - 1.5
Asset dispositions 1.0 1.5
Carson City facility shutdown * 0.6 0.8
Tijuana start-up * 0.3 0.5
----- -----
$ 4.0 $ 6.4
===== =====
The $1.2 million charge for "costs to exit a development agreement" were
recorded in other operating expenses during the second quarter for charges
associated with the discontinuation of a drug pump development agreement.
Refer to "Cost savings and consolidation efforts" discussion for disclosure
related to the timing and level of remaining expenditures for items marked with
"*".
Interest expense and interest income
Interest expense increased during the quarter and year to date due to the
incremental deferred financing fees amortization related to the new revolver.
Interest income increased during the quarter and year to date due to higher
interest rates as well as the movement of investments in mid-2004 from tax
deferred to taxable securities, which bear higher rates of return.
27
Provision for income taxes
The effective tax rate declined due to various state tax planning initiatives
realized in mid-2004. We anticipate the full year effective tax rate will not
exceed 30.0%.
Our effective tax rate is below the United States statutory rate primarily as a
result of federal and state tax credits and the allowable Extraterritorial
Income Exclusion ("ETI") for 2005.
Liquidity and Capital Resources
Revolving Line of Credit
On May 31, 2005, we amended our Senior Secured Credit Facility, which included
changes to the underlying covenants. The amended three-year facility replaced
the old $20.0 million revolving credit facility with a new $50.0 million
Revolving Credit Facility ("new revolver"), which contains a $10.0 million
sub-limit for the issuance of commercial or standby letters of credit. The new
revolver is secured by our non-realty assets including cash, accounts and notes
receivable, and inventories. The new revolver requires us to comply with two
quarterly financial covenants, as defined. The first relates to the ratio of
consolidated net earnings or loss before interest, taxes, depreciation, and
amortization ("EBITDA") to Fixed Charges. The second is a Leverage ratio, which
is calculated based on the ratio of Consolidated Funded Debt less Cash, Cash
Equivalent Investments and Short-Term Investments to Consolidated EBITDA.
Interest rates under the new Facility vary with our leverage. We are required to
pay a commitment fee of between .125% and .250% per annum on the unused portion
of the revolving line of credit based on our leverage. As of June 30, 2005, we
had no balance outstanding on our $50.0 million committed revolving line of
credit.
Our principal sources of liquidity are our operating cash flow combined with our
working capital of $143.3 million at June 30, 2005 and availability under our
line of credit. Historically we have generated cash from operations sufficient
to meet our capital expenditure and debt service needs, other than for
acquisitions. At June 30, 2005, our current ratio was 6.2:1.
The Company regularly engages in discussions relating to potential acquisitions
and may announce an acquisition transaction at any time.
Operating activities
Positive cash flows from operating activities were achieved in both periods
presented. During the second quarter and year to date, increased accounts
receivable utilized approximately $6.9 million and $11.2 million dollars of the
cash provided from operating activities, respectively.
28
Investing activities
The majority of the current year increase in capital spending was for the
following:
a. New medical power manufacturing plant in Alden, NY - $5.6 million; and
b. New assembly plant in Tijuana, Mexico - $6.7 million.
In March 2004, we purchased NanoGram for approximately $45.7 million. The most
significant elements of the purchase price allocation were to patented and
unpatented technology and goodwill. The costs allocated to patented and
unpatented technology are being amortized over the remaining estimated useful
life of 11.5 years. The residual amount of the allocation of $33.4 million went
to goodwill, which is not amortized but rather subject to periodic testing for
impairment. NanoGram is now referred to as our Advanced Research Laboratory.
Since the primary function of this operation is research and development, all
costs are appropriately classified in that category.
Approximately $9.5 million of short-term investments were purchased during the
quarter, net of dispositions. On a year to date basis, short-term investments of
$5.0 million have been purchased, net of dispositions.
Financing activities
Payments on capital lease obligations and non-qualified stock option exercises
are the primary financing activities for both periods presented.
Capital Structure
At June 30, 2005, our capital structure consisted primarily of $170.0 million of
convertible subordinated notes and our 21.6 million shares of common stock
outstanding. We have in excess of $88.0 million in cash, cash equivalents and
short-term investments and are in a position to facilitate future acquisitions
if necessary. 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. The current expectation for
2005 is that capital spending is expected to be in the range of $30.0 million to
$35.0 million, primarily due to the build-out of the Alden Facility ($11.0
million), the Tijuana Facility ($10.0 million), and normal maintenance capital
expenditures.
Off-Balance Sheet Arrangements
We have no off-balance sheet arrangements within the meaning of Item 303(a)(4)
of Regulation S-K.
29
Inflation
We do not believe that inflation has had a significant effect on our operations.
Impact of Recently Issued Accounting Standards
In July 2005, the Financial Accounting Standards Board ("FASB") published an
Exposure Draft of a proposed Interpretation, Accounting for Uncertain Tax
Positions. The Exposure Draft seeks to reduce the significant diversity in
practice associated with recognition and measurement in the accounting for
income taxes. It would apply to all tax positions accounted for in accordance
with SFAS 109, Accounting for Income Taxes. The Exposure Draft requires that a
tax position meet a "probable recognition threshold" for the benefit of the
uncertain tax position to be recognized in the financial statements. This
threshold is to be met assuming that the tax authorities will examine the
uncertain tax position. The Exposure Draft contains guidance with respect to the
measurement of the benefit that is recognized for an uncertain tax position,
when that benefit should be derecognized, and other matters. This proposed
Interpretation would clarify the accounting for uncertain tax positions in
accordance with SFAS 109. This Interpretation, once approved, is expected to be
effective as of the end of the first fiscal year ending after December 15, 2005.
We outlined our critical accounting policies related to income taxes in our
Annual Report on Form 10-K for the year ended December 31, 2004. Certain tax
accounting and reporting guidelines may change as a result of new accounting
guidance. Our accounting and reporting treatment will be determined at the time
of issuance of a final standard.
In June 2005 the issued Statement of Financial Accounting Standards ("SFAS") No.
154, Accounting Changes and Error Corrections, ("SFAS 154") a replacement of APB
Opinion No. 20, Accounting Changes, and Statement No. 3, Reporting Accounting
Changes in Interim Financial Statements. SFAS 154 changes the requirements for
the accounting for and the reporting of a change in accounting principle.
Previously, most voluntary changes in accounting principles required recognition
by recording a cumulative effect adjustment within net income in the period of
change. SFAS 154 requires retrospective application to prior periods' financial
statements, unless it is impracticable to determine either the specific period
effects or the cumulative effect of the change. SFAS 154 is effective for
accounting changes made in fiscal years beginning after December 15, 2005. We do
not expect that adoption of SFAS No. 154 will have a material effect on our
consolidated financial position, consolidated results of operations, or
liquidity.
In December 2004, the FASB issued SFAS No. 123 (revised 2004), Share-Based
Payment ("SFAS No. 123(R)"). This statement is a revision of SFAS No. 123,
Accounting for Stock-Based Compensation, and supercedes APB Opinion No. 25,
Accounting for Stock Issued to Employees. This standard requires the Company to
measure the cost of employee services received in exchange for equity awards
based on the grant date fair value of the awards. The cost will be recognized as
compensation expense over the vesting period of the awards.
30
We anticipate adopting the provisions of SFAS No. 123(R) on January 1, 2006
using the modified prospective application. Accordingly, compensation expense
will be recognized for all newly granted awards and awards modified,
repurchased, or cancelled after January 1, 2006. Compensation cost for the
unvested portion of awards that are outstanding as of January 1, 2006 will be
recognized ratably over the remaining vesting period. The compensation cost for
the unvested portion of awards will be based on the fair value at date of grant
as calculated for our pro forma disclosure under SFAS 123.
We estimate that the effect on net income and earnings per share in the periods
following adoption of SFAS 123(R) will be consistent with the our pro forma
disclosure under SFAS No. 123, except that estimated forfeitures will be
considered in the calculation of compensation expense under SFAS 123(R).
Additionally, the actual effect on net income and earnings per share will vary
depending upon the number of options granted in subsequent periods compared to
prior years.
In November 2004, the FASB issued SFAS No. 151, Inventory Costs, an amendment of
ARB No. 43, Chapter 4 ("SFAS No. 151"). SFAS No. 151 amends the guidance in ARB
No. 43, Chapter 4, "Inventory Pricing," to clarify the accounting for abnormal
amounts of idle facility expense, handling costs and wasted material (spoilage).
Among other provisions, the new rule requires that such items be recognized as
current-period charges, regardless of whether they meet the criterion of "so
abnormal" as stated in ARB No. 43. SFAS No. 151 is effective for fiscal years
beginning after June 15, 2005. We do not expect that adoption of SFAS No. 151
will have a material effect on our consolidated financial position, consolidated
results of operations, or liquidity.
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 and income taxes.
During the three months ended June 30, 2005, we did not change or adopt new
accounting policies that had a material effect on our consolidated financial
condition and results of operations.
Contractual Obligations
During 2004, we commenced the build out of our Alden Facility and our Tijuana
Facility. These facilities will enable the Company to further consolidate its
operations and implement state of the art manufacturing capabilities at both
locations. The contractual obligations for construction of these facilities is
$4.4 million and will be financed by existing, or internally generated cash.
Litigation
During 2002, a former non-medical customer commenced an action alleging that we
used proprietary information of the customer to develop certain products. We
have meritorious defenses and are vigorously defending the case. No accrual for
an adverse judgment has been made as such outcome is not deemed probable, the
potential risk of loss is between $0.0 and $1.75 million.
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As reported in our 2005 first quarter Form 10-Q, on May 2, 2005, a complaint was
filed against us by a developer of an implantable drug delivery device in the
United States Federal District Court for the Central District of California. On
May 20, 2005, the parties entered into a settlement agreement under which the
Company undertook certain obligations including the performance of certain
additional development tasks for a limited period of time. On June 2, 2005, the
Court ordered the complaint dismissed without prejudice.
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Forward-Looking Statements
Some of the statements contained in this Quarterly Report on Form 10-Q/A 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 implantable medical device industry;
o our ability to successfully execute our business model and
our business strategy;
o our ability to identify trends within the for 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.
33
ITEM 4. Controls and Procedures.
a. Evaluation of Disclosure Controls and Procedures. During the second quarter
of 2005, our management, including the principal executive officer and
principal financial officer, evaluated our disclosure controls and
procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the
Securities Exchange Act of 1934) related to the recording, processing,
summarization and reporting of information in our reports that we file with
the SEC. These disclosure controls and procedures have been designed to
ensure 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. Due to the inherent limitations of
control systems, not all misstatements may be detected. These inherent
limitations include the realities that judgments in decision-making can be
faulty and that breakdowns can occur because of simple error or mistake.
Additionally, controls can be circumvented by the individual acts of some
persons, by collusion of two or more people, or by management override of
the control. Our controls and procedures can only provide reasonable, not
absolute, assurance that the above objectives have been met.
As a result of the restatement of the Company's consolidated balance sheet
and consolidated statement of cash flows as of December 31, 2004 as
described in Amendment 1 to Form 10-K for the year ended December 31, 2004,
the Company's management, including the principal executive officer and
principal financial officer, have concluded that there was a material
weakness in internal control over financial reporting. Specifically, the
Company's review of the financial statements utilizing a financial
statement presentation and disclosure checklist to ensure that the
financial statements were fairly presented in accordance with generally
accepted accounting principles did not operate effectively as it relates to
the misstatements identified above. Solely as a result of this material
weakness, our Management has revised its earlier assessment and has now
concluded that our internal control over financial reporting was not
effective as of June 30, 2005.
b. Changes in Internal Control Over Financial Reporting.
Since March 31, 2005, except as disclosed below, there have been no changes
in our internal control over financial reporting that have materially
affected, or are reasonably likely to materially affect, our internal
controls over financial reporting.
As of the date of this filing, we have remediated the material weakness in
our internal controls over financial reporting. The remedial actions
included:
1. Enhancing the financial reporting process to include the formal review
of all auction rate securities for proper classification, as well as
the appropriate cash flow presentation of liabilities related to the
acquisition of property, plant and equipment.
2. Establishing formal quarterly disclosure meetings which will include
our third party tax advisors to review significant transactions during
the period as well as to review and discuss new accounting
presentation and disclosure guidelines. Our outside accountants,
although not part of our control structure, will participate in these
meetings.
34
3. Enhancing our financial reporting practices to include the use of
multiple third-party financial reporting technical alerts that we
utilize to evaluate our accounting policies and financial statement
disclosures.
While we have not completed all of our Sarbanes-Oxley testing for 2005, we
believe that after putting into effect the remedial actions described above,
our Company's system of internal controls over financial reporting is
effective, which should enable us to arrive at the 2005 assessment that our
system of internal controls over financial reporting are adequate and
operating effectively.
35
PART II - OTHER INFORMATION
ITEM 6. Exhibits.
See the Exhibit Index for a list of those exhibits filed herewith.
36
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: December 16, 2005 GREATBATCH, INC.
By /s/ Edward F. Voboril
-------------------------------------------------
Edward F. Voboril
Chairman of the Board 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)
37
EXHIBIT INDEX
Exhibit No. Description
----------- -----------
31.1 Certification of Chief Executive Officer pursuant to Rule
13a-14(a) of the Securities Exchange Act.
31.2 Certification of Chief Financial Officer pursuant to Rule
13a-14(a) of the Securities Exchange Act.
32.1 Certification of Chief Executive Officer and Chief Financial
Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002.
38