Greatbatch second quarter 2012 sales increase 14% to $166.5 million

Jul 26 2012

Greatbatch, Inc. (NYSE: GB), today announced results for its second quarter ended June 29, 2012:

“We expect the progress we have made with regards to our financial performance to carry over into the second half of the year as we continue to commercialize our medical device pipeline, aggressively address the operational issues at our Swiss facilities and begin to optimize our RD&E investment”

• Sales increased 14% over the prior year to a record $166.5 million, and included the following:
  • $21.3 million of revenue contributed from the acquisition of Micro Power Electronics, Inc.;
  • 16% Vascular Access growth driven by commercialization of medical devices;
  • 3% increase in CRM/Neuromodulation revenue, ahead of our expectations;
  • 13% decline in Orthopaedics revenue (-5% constant currency) due to lower customer product launches, pricing pressures and poor execution at our Swiss facilities;
  • Organic constant currency growth of 1%.
• Second quarter GAAP diluted EPS decreased 56% versus the prior year primarily due to higher consolidation and optimization activities. On an adjusted basis, diluted EPS was $0.43 per share, consistent with the prior year.
• Similar to GAAP diluted EPS, GAAP operating income decreased 39% in comparison to the prior year. Adjusted operating income increased 1% over the prior year as higher gross profits were offset by increased RD&E investment in the development of medical devices.
• Cash flows from operations were $24 million for the second quarter which enabled the Company to pay down an additional $8 million of long-term debt.

CEO Comments

"As expected, second quarter adjusted operating income increased 20% in comparison to the first quarter of 2012 as sales improved," commented Thomas J. Hook, President & CEO, Greatbatch Inc. "In comparison to the prior year, adjusted operating income increased 1% as current quarter results include the benefit of over 40% Portable Medical pro forma growth driven by our Micro Power acquisition, as well as above market growth in our CRM and Vascular Access markets. During the quarter, we continued to experience operational issues within our Swiss Orthopaedic facilities; however, we have taken action to improve our performance over the next 18 months. In addition to the progress we have made on our current strategic initiatives, during the quarter we announced several new initiatives which included the following:

• Opening of our manufacturing facility in Fort Wayne, Indiana, which will be used to consolidate our Orthopaedic operations;
• Establishing an R&D center in Singapore with the support of the Singapore Economic Development Board, which is the first step of our Asia Pacific strategy;
• Increasing our strategic focus on sales and marketing to drive core business growth; and
• Completing the integration of our Portable Medical product line (Micro Power), which is performing ahead of expectations.

We remain confident these initiatives will improve the long-term growth prospects of our Company and are being undertaken with one goal in mind - to drive shareholder value."

CFO Comments

"We expect the progress we have made with regards to our financial performance to carry over into the second half of the year as we continue to commercialize our medical device pipeline, aggressively address the operational issues at our Swiss facilities and begin to optimize our RD&E investment," commented Michael Dinkins, Senior Vice President & CFO. "Despite these efforts, we now believe that our full year adjusted operating income as a percentage of sales and adjusted diluted EPS will be at the lower end of our guidance provided at the beginning of the year due to lower than expected profitability from our Swiss operations. However, we still expect that revenue will be in line with our original guidance due to stronger than expected performance from our CRM and Portable Medical product lines. We are committed to driving operational improvements in our business to achieve our long-term growth objectives and provide value to our shareholders."

Second Quarter Results

Second quarter 2012 sales increased 14% over the prior year period to a record $166.5 million. This increase was driven by the acquisition of Micro Power, primarily Portable Medical, which added $21.3 million to sales, as well as a 16% increase in Vascular Access revenue and stronger than expected growth in our CRM product line. Second quarter results also included the impact of foreign currency exchange rate fluctuations, which lowered Orthopaedic sales by approximately $3 million in comparison to the prior year. On an organic constant currency basis, sales for the second quarter increased 1% versus the prior year as the benefits described above were partially offset by continued weakness within our Orthopaedics product line.

Gross profit was $51.9 million, or 31.2% of sales, in the second quarter of 2012, compared to $46.6 million, or 31.8% of sales for the comparable 2011 period. The increase in gross profit primarily resulted from the higher sales volumes discussed above. The decrease in gross profit as a percentage of sales from the prior year was primarily due to price concessions made to our larger OEM customers, a higher mix of lower margin revenue, as well as production inefficiencies at our Swiss Orthopaedic facilities. As previously discussed, these operational issues are aggressively being addressed and should improve as the year progresses and into 2013.

Selling, general and administrative ("SG&A") expenses increased to $20.7 million, or 12.5% of sales, for the second quarter of 2012 compared to $17.6 million, or 12.0% of sales, for the same period of 2011. The majority of this increase can be attributed to the Company's recent acquisitions, which added $2.8 million to SG&A.

Net research, development and engineering costs ("RD&E") for the 2012 second quarter were $14.2 million, compared to $11.3 million for the comparable 2011 period. Approximately $0.7 million of this increase was a result of the operations from our recent acquisitions. The remainder of this increase can be attributed to the investment in the development of complete medical devices which totaled $7.0 million for the 2012 second quarter compared to $5.6 million for 2011. These amounts include $1.6 million and $0.6 million, respectively, of design verification testing ("DVT") costs in connection with our development of a neuromodulation platform. For the second half of the year we anticipate that RD&E costs will be slightly lower than the first half as the Company begins to optimize its RD&E investment, which will be partially offset by an increased level of design verification testing.

GAAP operating income for the second quarter of 2012 was $11.1 million, compared to $18.3 million for the 2011 second quarter. This decrease was primarily due to an increased level of consolidation and integration activities, the costs of which are excluded from adjusted amounts. Adjusted operating income was $18.6 million, or 11.2% of sales in the second quarter of 2012, compared to $18.4 million, or 12.6% of sales, for the comparable 2011 period. Refer to Table A at the end of this release for a reconciliation of GAAP operating income to adjusted operating income and the "Use of Non-GAAP Financial Information" section below.

The 2012 second quarter GAAP and adjusted effective tax rates were 43.9% and 38.7%, respectively, compared to 33.0% and 33.3%, respectively, for the same periods of 2011. The 2011 effective tax rates include the benefit of the R&D tax credit, which expired at the end of 2011. Additionally, 2012 amounts include losses from our Swiss operations, which are deducted at a lower effective tax rate, thus increasing the overall effective tax rate of the Company. We currently expect our 2012 annual GAAP effective tax rate to be between 40% and 45%, depending on the timing of expenses incurred in connection with the closure of manufacturing operations in Switzerland. On an adjusted basis, which will exclude the impact of these consolidation costs, we expect our effective tax rate to be more in line with the U.S. statutory rate of 35%.

GAAP and adjusted diluted EPS for the second quarter of 2012 were $0.16 and $0.43 per share, respectively, compared to $0.36 and $0.43 per share, respectively, for the second quarter of 2011. Refer to Table B at the end of this release for a reconciliation of GAAP net income and EPS to adjusted net income and EPS and the "Use of Non-GAAP Financial Information" section below.

Cash flows from operations for the second quarter of 2012 were approximately $24 million compared to $13 million in the 2011 period. During the second quarter of 2012, the Company repaid $8 million of long-term debt. Going forward, cash flows from operations will be used to fund our consolidation and RD&E initiatives, as well as to pay down long-term debt.

Implantable Medical

CRM and Neuromodulation sales for the second quarter of 2012 increased 3% compared to the prior year to a record $80.0 million. CRM and Neuromodulation revenue for the second quarter of 2012 and 2011 both included the benefit of customer product launches. The Company continues to see an increased pace of product development opportunities from its CRM customers. Management believes that this, combined with our increased focus on sales and marketing, will allow the Company to grow this product line faster than the underlying market.

Second quarter 2012 sales for the Vascular Access product line increased 16% to $12.5 million in comparison to the prior year and was primarily driven by the commercialization of new medical devices. We continue to expect 2012 sales of complete medical devices developed by Greatbatch to be in the range of $10 to $15 million for 2012.

Orthopaedic product line sales of $32.9 million for the second quarter of 2012 declined 13% (-5% constant currency) compared to the second quarter of 2011. Foreign currency exchange rate fluctuations decreased Orthopaedic revenue by approximately $3 million in the second quarter of 2012 in comparison to the prior year. The remaining decline in second quarter 2012 Orthopaedic sales was a result of price concessions provided to customers, as well as fewer customer product launches and development opportunities due to operational issues within our Orthopaedic business, which are aggressively being addressed. In comparison to the sequential first quarter, Orthopaedic revenue increased 6%.

Electrochem

Second quarter 2012 sales for Electrochem increased $21.1 million to $41.2 million versus $20.1 million for the comparable 2011 period. Second quarter 2012 Electrochem sales included $21.3 million of revenue related to the acquisition of Micro Power in December 2011. On an organic basis, Electrochem revenue was consistent with the prior year despite tough comparables with the second quarter of 2011, which included the benefit of customer inventory restocking. The Micro Power acquisition continues to exceed our initial expectations, and is being driven by successful product launches into the higher growth, higher value portable medical market. This market is benefiting from the shifting of patient care from clinical settings to the home and an aging population, which is driving the need for lightweight/portable devices for patients and caregivers. Our funnel of portable medical products from this acquisition continues to be full and is expected to drive high single digit revenue growth for the next several years in this product line.

Financial Guidance

At this time, we are reaffirming our sales guidance provided at the beginning of the year. However, based upon our results for the first two quarters and projections for the remainder of the year, we now expect our adjusted operating income as a percentage of sales and adjusted diluted EPS to be at the lower end of the ranges provided. The guidance provided at the beginning of the year was as follows:

Given the softness that we are seeing in our Orthopaedic product line, we will not achieve the revenue growth assumptions previously provided for that product line. With that said, we still expect to achieve our 13% to 17% growth guidance for total sales set at the beginning of the year given stronger than expected performance from our CRM and Portable Medical product lines. Additionally, we expect to see operating income improvements as the year progresses, which will come from the consolidation of our Orthopaedic operations and optimization of RD&E investment, as well as from various other measures management has initiated to manage our cost structure.

Adjusted operating income for 2012 is expected to consist of GAAP operating income minus non-recurring, unusual or infrequently occurring items such as acquisition, consolidation and integration charges, certain RD&E expenditures and asset disposition/write-down charges, totaling approximately $20 million to $30 million, of which approximately $5 million to $10 million will be non-cash expenses. This range has been revised upward from our previous expectations of $15 million to $20 million to reflect the additional costs associated with the announced closure of manufacturing operations in Switzerland.