Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Greatbatch, Inc. (NYSE:GB)

Q3 2008 Earnings Call Transcript

November 4, 2008 5:00 pm ET

Executives

Marco Benedetti – Corporate Controller

Thomas Hook – President and CEO

Thomas Mazza – SVP and CFO

Analysts

Jamar Ismail – Canaccord Adams

Tim Lee – Piper Jaffray

Keay Nakae – Collins Stewart

Assaf Guterman – Lazard Capital Markets

Stan Manne – Manne Family Investments

Operator

Welcome everyone, to the third quarter Greatbatch Inc. conference call. Before we begin I would like to read the Safe Harbor statement. This presentation and our press release contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, and involve a number of risks and uncertainties. These risks and uncertainties are described in the Company's annual report and Form 10-K.

These statements are based upon Greatbatch Incorporated's current expectations, and actual results could differ materially from those stated or implied. The Company assumes no obligations to update forward-looking information included in this conference call to reflect changed assumptions about the occurrence of unanticipated events or changes in future operating results, financial conditions or prospects.

I would like to now turn the call over to today's host, Corporate Controller, Marco Benedetti. Please proceed, sir.

Marco Benedetti

Thank you. On the call today are Thomas J. Hook, President and Chief Executive Officer, and Thomas J. Mazza, Senior Vice President and Chief Financial Officer.

In terms of today's agenda, Tom Hook will start by providing a few comments regarding our third quarter results and our major strategic initiatives. After that, Tom Mazza will provide a financial overview and further comment on the third quarter results. Afterwards we will then open up the floor to Q&A. As we have done in the past, we are including slide visuals that will go along with this presentation, which you can access on your Web site.

Let me now turn the call over to our President and Chief Executive Officer, Tom Hook.

Thomas Hook

Thank you, Marco. I would like to thank everyone listening for joining our third quarter earnings call. As you will note from this afternoon's release, we are very pleased with our financial results for the quarter.

Furthermore, this quarter provides additional evidence of our execution and progress on our long-term strategic initiatives, which include growing and diversifying our revenue base, driving improved operating performance, and delivering innovative solutions to our customer.

In the third quarter, we delivered solid revenue growth, with sales increasing 72% over the prior year period to $136 million. The benefits of our recent acquisitions were reflected in the diversification of our sales mix and our improved profitability. Our adjusted operating income grew to $19.3 million, an 84% increase over the previous year.

During the quarter, we also showed sequential improvement in our operating margins as we further streamlined operations and achieved efficiencies. We remain committed to ongoing improvements in our operating performance through continued facility consolidation, optimizing our production efficiency and product development activities, which are focused on high value added products. Tom Mazza will provide additional detail on our financial results later in the call.

Given the financial crisis that is currently impacting the global markets, I thought it was important to note that Greatbatch actively monitors its vendors, suppliers and customers for any adverse effects. To-date, we have not seen any significant impact to our suppliers’ ability to deliver materials or customers ordering patterns.

We are in solid financial position as a result of our strong cash flow from operations, access to over $100 million under our existing line of credit, and our decision in March 2007 to extend the maturity of our convertible notes and raise an additional $80 million in funds, which do not mature until 2013.

Based on our diversified product portfolio, our ongoing progress with our integration initiatives, and our ability to continue delivering innovative value-added products and solutions to our customers, we believe that Greatbatch is positioned well to withstand the turbulent markets.

One strategic initiative that we have been working on diligently over the last two years is the diversification of our business, while leveraging our core operational and product development strength. We believe this will significantly enhance our long-term growth and profitability. This diversification strategy has helped expand our opportunities within a variety of new markets.

As part of the acquisitions, we were able to add proprietary technologies and product lines to our portfolio of strategic manufacturing and product development capabilities. In addition, we expanded and diversified our global customer relationships.

While the acquisitions clearly diversified our customer base and reduced our customer concentration, it also created additional opportunities to sell a broader portfolio of products within those key accounts. Instead of simply selling to just the cardiac or the management sector within one of our customers, we can now sell to the orthopedics neuromodulation or therapy delivery divisions.

We have made great strides in diversifying Greatbatch and we will continue to integrate these new businesses and look for ways to drive both near-term and long-term revenue gains.

Another key strategic initiative is focused on streamlining our operational efficiencies and optimizing our production. The Greatbatch team has extensive experience in successfully optimizing and consolidating operations.

We have already identified and implemented several key programs to enhance the operating performance of our new businesses and move them closer to the Greatbatch operating model.

As evidenced by the substantial improvement in our operating margin this quarter, we have begun to realize several of the benefits immediately. We have approached this initiative on several different fronts, and I want to provide an overview of our plan over the next 24 months. First, let's review some of the consolidation initiative accomplishments in both our medical and commercial businesses.

In the third quarter, we finalized the completion of our Columbia, Maryland, and Orchard Park, New York manufacturing facility consolidations. Along those same lines, we ceased manufacturing at our facility in Suzhou, China and initiated the consolidation of one of our Switzerland manufacturing locations. The operations at these facilities are now being relocated to existing facilities that had excess capacity.

During the third quarter, we also successfully completed the expansion of our R&D center in western New York and relocated our corporate offices into that facility. This facility now houses our leadership team as well as our corporate shared services group.

Also noteworthy is that we completed construction and initiated the move into our new 80,000 square foot commercial manufacturing plant in Raynham, Massachusetts. This initiative allows us to improve efficiency, enhance our capacity, and enable us to consolidate our locations into one new state-of-the-art facility.

Finally, to-date, we have made significant progress in moving the Company to a common ERP platform with conversions for five of the seven acquisitions already completed. This will allow us to centralize our back office, finance and IT functions, further streamlining operational efficiencies.

Looking at the companies that we have acquired, we still see an enormous amount of capabilities and opportunity that are yet to be realized. Further consolidations are planned. Just last week, we announced our intention to close our Teterboro, New Jersey, and Exton, Pennsylvania facilities.

We also plan to move our Blaine, Minnesota team and operations into our Plymouth, Minnesota, facility. Additionally, we believe we can align our R&D spending with the right growth market opportunities, implement lean manufacturing initiatives and supply chain improvements to generate immediate gains and provide ground work for future improvement.

Our third strategic initiative is to drive growth through technology and innovation. During the most recent quarter, we spent approximately $9.3 million on research and development, which includes $2.5 million of cost reimbursed by our customers.

On an annualized basis, we intend to spend approximately 8% of our sales revenue on gross research and development spending, as we continue to develop new offerings for our customers.

This investment in R&D will enable us to maintain our leadership position in our core markets, drive new growth opportunities, and potentially provide additional cost savings across our portfolio. We will invest that money at an appropriate level, not only to drive profitability, but obviously to drive future product developments as well. Ultimately, we hope that this will facilitate a more diverse product platform, as we partner with our customers to build innovative new products and technologies.

One recent example of our success is our investment in the wireless sensing product line for our Electrochem business. This new offering is a complete system utilized by our customers in their production processes to help manage their operations more efficiently.

Each system incorporates a combination of pressure, temperature, and flow sensors, along with gateway units and customized end user software. This technology is able to withstand the harsh and sometimes hazardous conditions that our customers operate in, and eliminates the need for traditional wired sensors, which are often impractical or impossible due to the nature of their business.

Our patented wireless technology not only provides real time access to critical data but also conditioned based monitoring and decision making capabilities. The sensors operate remotely, powered by our own Electrochem lithium battery solutions, and are fully tailored to each user's operational requirements.

Our wireless sensing technology is uniquely enabled by a combination of state-of-the-art RF communication links, based on ZigBee technology, high performance embedded data acquisition subsystems and robust power solutions Electrochem is known for. ZigBee is the standards based technology that is driving the wide scale adoption of low power wireless devices across all markets.

Electrochem's wireless sensor platform enables the development of customized end to end solutions that solve complex problems in demanding application. As the single source for all required hardware, software and power, Electrochem is uniquely positioned to be a value solution provider in the larger scale deployments.

There is great opportunity for this technology in many of the current markets we are serving with our battery technology, including the oil and gas sector, where wireless sensor systems are expected to be most widely adopted. We are seeing applications of the product in the current drilling and exploration segment where our batteries are used and more widely in the production and transportation segments of the industry.

This new technology solution also opens up market space for us in new areas such as process markets, where wireless sensing systems are used in applications such as metal fabrication, chemical, food and beverage processing. With multiple end user field tests in progress at various stages, we expect broad market penetration where the technology will be adopted across a platform of applications.

As you can see, our investment in this new wireless technology elevates our technology portfolio from offering components to complete system solutions that customers utilize as part of their infrastructure. Our goal is to continue to develop and deliver innovative solutions for our customers that improve the functionality, safety, and efficiency of their products.

To summarize, based on our current portfolio and research and development activities, we feel we are in a strong competitive position for future growth and profitability. The acquired markets are growing faster than our historical markets and remain confident that our diversification strategy was the right move to make.

We are moving aggressively to ensure we consolidate our operating footprint, to drive profitability and to take advantage of increased market growth across all our product lines. We are evaluating and looking for cross-selling opportunities amongst our customer base, and continue to leverage our technology to work towards partnering with our customers to deliver customized component and complete systems in the future.

I will now turn the call over to Tom Mazza for a review of our financial results.

Thomas Mazza

Thanks, Tom, and good afternoon. Sales for the third quarter were in line with our expectations, and reflected the contributions of our recent acquisitions. We reported $136 million in revenue. Of this amount, acquisitions contributed $49 million.

Third quarter sales for the IMC business segment were $117.3 million, a 75% increase over the prior year quarter, and consistent with the second quarter of 2008.

The cardiac rhythm management and neuromodulation product line reported revenue of $64.9 million, a 14% increase compared to the third quarter 2007 and consistent with revenue from the previous quarter. Compared to the prior year, the third quarter benefited from the increased adoption of our Q series high rate ICD batteries as well as higher feed through and assembly revenue.

However, these benefits were mitigated by lower demand for coded components due to a customer recall near the end of 2007, unrelated to Greatbatch products, lower ICD battery sales and lower capacitor sales.

2008 third quarter revenues for the therapy delivery product line were $14.5 million compared to $10 million for the comparable 2007 quarter, and $15.8 million for the second quarter 2008. This increase over the prior year is primarily due to the Quan Emerteq acquisition in November 2007, which added $5.5 million to revenue. The decrease from the sequential quarter was a result of lower demand for our catheter products.

The orthopedic product line reported $37.9 million in sales for the quarter, compared to $41 million in the second quarter 2008. This quarter's results included the seasonal impact of holiday manufacturing facility shutdowns at our European locations.

Switching to our commercial business, third quarter sales for the Electrochem business segment were $18.9 million compared to $12 million in the third quarter 2007, and $20.1 million in the second quarter of 2008. The increase in sales compared with the prior year is a result of the acquisition of EAC in November 2007, which added $6.2 million to revenue as well as strong demand for the oil and gas market.

The decrease from the sequential quarter was primarily due to the timing of orders from our customers. As intended, our acquisition strategy has enabled us to successfully diversify our revenue mix from a combined concentration of approximately 85% in CRM to below 50%. We believe our revenue growth and diversification has validated our strategic investments in the vascular, commercial and orthopedics markets.

Now turning to our expenses, our selling, general and administrative expenses as a percentage of sales improved to 11.5% and reflect the impacts of various cost cutting initiatives. This compares very favorably to $14.4 in the prior year quarter and $13.2 in the sequential quarter, which included $3 million of incremental legal expenses.

Research, development and engineering costs for the third quarter were $6.8 million, in line with expectations, and lower as a percentage of sales versus the prior year as a result of synergies from the business acquired in 2007 and 2008. R&D costs also decreased as we reorganized this function as part of our overall plan to streamline operations.

Other operating expenses for the third quarter of 2008 were $3.6 million, including costs incurred in connection with our various consolidation initiatives and the integration of our newly acquired businesses. We anticipate that these costs will remain at these levels for the foreseeable future as we continue to integrate and consolidate resources across our entire infrastructure.

Adjusted operating income was $19.3 million, an increase of 84% from the same period in 2007. More meaningful was the expansion in adjusted operating margin to 14.2% from 10% in the second quarter of 2008. While this expansion in operating margin is an indicative of the type of improvements we are trying to achieve, we do not believe that the current quarter's results can be assumed for a full year run rate, given the non-linear nature of our business.

In particular, the timing of customer orders, inventory production and the implementation of our various operating initiatives, can all significantly impact both positively and negatively our operating margins from quarter-to-quarter.

Our strong adjusted operating income translated to adjusted earnings per diluted share of $0.44 in the quarter compared to $0.29 per diluted share in the third quarter 2007 and $0.30 in the second quarter 2008. These results exclude the impact of acquisition-related charges as well as facility consolidation, manufacturing transfer and system integration expenses.

Earnings per share on a US GAAP basis were $0.33 per share in the quarter compared to $0.22 per share in the third quarter 2007, and $0.25 per share in the second quarter of 2008.

Given the results of the first three quarters, the progress made on our strategic initiatives and the passing of the R&D credit in October, which is not reflected in our third quarter results, we are confident that we are in line with our original range of expectations for 2008. We are continuing to guide in the $490 million to $530 million range for revenues and $1.20 to $1.50 per share for adjusted EPS.

We expect our full-year 2008 tax rate on adjusted income to be 32%, which includes the impact of the R&D credit. This would imply a fourth quarter effective tax rate of approximately 30%.

On a GAAP basis, which includes the impact of acquisition-related charges, facility consolidation and integration; we expect our full-year tax rate including the R&D credit to be 35%. This implies a fourth quarter GAAP effective tax rate of approximately 36%.

We are currently in the early stages of our annual budgeting process for next year. Based upon preliminary feedback from our business units, we expect to see revenue between the range of $570 million to $610 million, as we continue to benefit from our diversified revenue stream.

Additionally, preliminary indications are that we remain on track with our stated goal of improving operating margins by an average of 200 basis points per year over the next two years to three years. Working off of our original 2008 baseline of 10% that will put 2009 adjusted operating margin in the 11% to 13% range. We will issue our formal 2009 guidance with our fourth quarter earnings release, once our budgeting process is complete.

We remain confident in our ability to execute on our operating efficiency and sales growth initiatives. We remain excited by the prospects we see for Greatbatch in both the near and long-term, and we look forward to driving growth and profitability for the Company and our shareholders going forward.

Let me now turn the call over to the moderator to take questions.

Question-and-Answer Session

Operator

(Operator instructions) Your first question comes from the line of Jason Mills with Canaccord Adams. Please proceed.

Jamar Ismail – Canaccord Adams

Hi, this is Jamar Ismail for Jason.

Thomas Mazza

Hey, Jim.

Thomas Hook

How is going, Jim?

Jamar Ismail – Canaccord Adams

Hey, Jamar, is the first name. Are you mentioning ordering patterns in your calls? Can you give some color in terms of ordering patterns in your implantable medical component customers, relates to Q4 and going forward?

Thomas Hook

Jamar, we normally don't really give too much information in terms of bookings or ordering patterns going forward. It is, we normally end up having a 12-month rolling forecast with our customers, normally between a month and three months of that is locked in, in terms of the quarterly forecast. And then we obviously agree upon that with our customers individually and ship to that over the course of a quarter. Sometimes, near the end of the quarter, there is, because we have shipped in large releases to our customers, we can have a release go from one quarter to the next fairly easily. So we – but we normally don't provide a lot of information with regards to that. We just provide the kind of the summary guidance, and then and manage it with our individual customers on a case by case basis.

Jamar Ismail – Canaccord Adams

Okay. I was just wondering because you beat our estimate by a fairly large margin this quarter. I was wondering if there was any large order that maybe had got pushed over.

Thomas Hook

I always do caution that it can be a little lumpy from quarter to quarter. Certainly, the results from a lot of our major customers are announced already. We've been doing a good job at growing the Company. The industry obviously is having some success at getting stabilization and recovery in our core markets like cardiac rhythm management. And – but from time to time a few million dollars can go either way. So it's a strong quarter for us, but it what we expected to do and was consistent with our guidance.

Jamar Ismail – Canaccord Adams

Okay. Thanks a lot for the operating margin guidance for '09. I know before you had talked about EBITDA margins around the 21% to 23% range for '08. Given your objectives in optimization and consolidation, what level of EBITDA margin can we see going forward, like one year or two years out?

Thomas Mazza

I think, Jamar, we continue to hold where we are, we think those numbers are reasonable that we gave previously, this time certainly 21% to 22%. We are not going to give specific guidance for 2009, but clearly, I think if you do the math – considering that we have approximately $40 million of depreciation and amortization on a run rate basis, you get pretty close to the numbers we were speaking about previously.

Operator

Your next question comes from the line of Tim Lee with Piper Jaffray. Please proceed.

Tim Lee – Piper Jaffray

Good afternoon. Thanks for taking the question. Just first, in terms of your current year earnings outlook, just based on earnings to-date, the first nine months, that kind of implies what Q4 pro forma EPS in the $0.30 to $0.60 that puts a pretty big range. I was trying to figure out what are some of the variables that make it a $0.30 quarter versus a $0.60 quarter.

Thomas Hook

Well, I think is what we are trying to do is give an annual guidance number and run to it for the year. Obviously, the beginning of the year, we had a $0.11 operating quarter, $0.16 with the one timer. There was a lot of questions with regards to how even going to make $1.20. So we have run the plan as we had laid out at the beginning of the year. It's been the same plan we've executed towards all year long. And we think that we are going to be in that range, so we are not going to narrow down guidance over the course of the year as a course of habit. We feel we are right where we need to be, have felt that way since the beginning of the year following the acquisitions, and we are on track for it. So yes, it does give rise to a large range in the final quarter, no matter what we do, but short of just giving quarterly guidance, which we don't want to do, we're just going to stay with the annual guidance at the beginning of each year and only change it if we don't think we are going to hit that range.

Tim Lee – Piper Jaffray

Okay. I appreciate not giving the quarterly, but I guess in terms of, we are looking at the major factors that can make, deviate from the low end to the upper end, is it more top line driven or is it cost control that are more under your control or is it a little of both I guess?

Thomas Hook

I think it's both. We are doing a good job at working very closely with our customers to satisfy their needs and desires, and to deliver them on time and with high quality level. And I think as we have done a better job with that, both in the core business and the additional product lines we've added through the acquisitions, we've continued to earn new business and that will continue on through the fourth quarter. The consolidations, we have to work cooperatively with each one of our customers for every single product line. It takes a large commitment on the operating teams of Greatbatch and on the customers to make those happen.

So we continue to work closely, and then obviously the consolidation is where we create the savings that we can drive for future investment and we have been largely on track with those all year. Those consolidations also include the consolidation of a lot of the back office stuff, which as we said for the finance and IT pieces, about five of the seven are completed. And we have a couple more that will move on into next year for completion. So, we think it is still on track with our original plan. So we think both the revenue and the consolidations will come in kind of exactly as how we thought at the beginning of the year, and in a few areas, we are ahead of our milestones, a few areas we are a little bit behind, and pushing hard to make sure those remain on track without a lot of bleed on the time line. I think both of those two things, revenue growth as well as consolidation, will both drive profitability.

Tim Lee – Piper Jaffray

Got you. One last one if I may. On the Electrochem segment, how much of that exposure is tied to the oil and gas business, because given where oil prices have come down here, are you seeing that same level of demand from your customers, really from the industrial segment?

Thomas Hook

I think the best way to track the Electrochem business is by tracking, about half of that business is oil and gas roughly, and you can really look at the oil services business, Baker Hughes, the (inaudible), the Haliburtons. There is obviously there is a certain number of tools that they have in service at any number of rigs, even though the price of oil has skyrocketed, there is not as nearly a dramatic change in that service business activity because the number of tools they have is fixed. What they're fluctuating with is really backlog, which they actually give guidance on and disclose. Our business really is tied to their actual production tempo, which doesn't change a lot, since that's linked to the number of tools they have. And when their backlog goes up and down or the price of oil goes up and down, it doesn't have really a direct effect on us, it's kind of indirect. That business has been good. The challenge for us is, our Canton, Massachusetts facility that we're still in the process of transitioning to Raynham, has had a lot of limitations in that facility for us to grow the business. That business is Electrochem, for us, grew 30% for a couple of years running, and we really have struggled a little bit with capacity over the past couple of years, while we're building the new Raynham facility. And I expect in the next three months to six months while we're moving into Raynham and shutting down the Canton plant, and bringing that plant fully on stream and raising its capacity and its efficiency and its effectiveness, it will give us more opportunities to grow, despite that the market in oil and gas is challenging. It's a slower growth market, but we feel we got good technology and a good sales team to outpace the market growth.

Tim Lee – Piper Jaffray

Thank you.

Thomas Hook

Welcome.

Operator

Your next question comes from the line of Keay Nakae with Collins Stewart. Please proceed.

Keay Nakae – Collins Stewart

Yes, good afternoon.

Thomas Hook

Nakae, how are you today?

Keay Nakae – Collins Stewart

I'm doing well, great. Tom, with respect to the ICD batteries, can you give us a sense of what percent of the mix of ICD batteries is now Quasar?

Thomas Hook

I assume you meant that for Tom Hook. We don't really break it out at the higher percentage on a quarterly basis every quarter, over the past two years in particular. There is two configurations of the Q battery, Q medium rate and Q high rate. The effect of the Q high rate is in the numbers, the Q medium rate batteries are really still in kind of the qualification and very early stages of commercialization phase. So these primarily, the batteries we talk to about Q are the high rate versions for ICDs in high rate uses that is increasing. We haven't provided color on it yet, we may be starting in 2009 give a little bit more of a breakdown on the percentage of older technologies like Silver vanadium oxide, both the high temp sheet and press powder versus Q. We have multiple customers ordering Q right now, but on a percentage basis, we don't have plans right now to break it out until we get a little further down the commercialization chain.

Keay Nakae – Collins Stewart

Alright. We will look forward to that breakout when you are ready to provide it. As far as ICD battery sales in general, it would seem that your Q3 numbers are now reflecting the fact that one of your customers has some internally generated batteries that they're using. Is that correct?

Thomas Hook

I don't really kind of, as you know, make a lot of specific comments. We've done a great job at growing a lot of the product lines, some have not faired as well with not the combination of competitive pressure both inside customers and externally. And – but other areas we've been able to pick up the slack, like I said many times before I don't expect to win 100% of the deals. It's a very competitive landscape out there. We feel we have the technology to make exceptionally good products, but we don't expect to see kind of a 100% batting average. And I think there is a lot of pressure on OEMs to have redundant sources of supply, and they intend to execute some of those strategies, sometimes externally and internally depending on which product line. I think some of that effect is in the battery, the ICD battery line, and – but then at the same token, there's areas where we don't have large penetrations on product lines and I expect us to be able to put very competitive offers in front of customers and pick up revenue opportunities on those as well as drive profits.

Keay Nakae – Collins Stewart

Okay. As far as your strategy for product solutions as opposed to components and solutions in the wireless area, how soon will we see these products, number one? Number two, is the wireless sensing that you are providing, and is that only capable due to your battery technology. What's the relationship there? And then third, just a clarification on your plan for R&D spending, I thought you throw out a number of 8%. Is that 8% of total revenue and when does that start, if that's in fact what you said?

Thomas Hook

Yes, in terms of the systems what, I think the best way to look at it is that more and more customers, in particular, for wireless sensors, are kind of looking for an integrated solution. And we have done a very good job of developing these products and pushing the technology along following the acquisition of a company called IntelliSensing. It has been integrated into Greatbatch, in particular, the R&D group. Those technologies, we have certainly patents issued that protect them.

The products have been developed, we are actually more or less in field testing, actually proving out applications with individual customer accounts to demonstrate to them what the technologies can do. These sales tend to be associated with large systems, and integrations, and the process industry, oil and gas industries such as refineries. So it requires actually a larger project to be in progress for us to actually sell the sensor solutions into, and we work with the customers or integrators to actually put those in place. During our, more or less doing the early stages of commercialization of those, as we start to get the test cases out there, build data, and demonstrate the performance. And that will open up doors for us to have larger integrations of those into larger industries and markets. The battery solutions we have in Electrochem definitely give us an added edge. As you know, Electrochem makes very high powered, high rate, severe environment batteries that is an enhancer to the sensor's capability. We feel we have a very broad temperature, pressure and vibration ranges that the batteries at Electrochem make can serve under, which gives us we think a strategic advantage with the sensor technology to provide something that not other customers can.

I think the other nice thing is because they are not as – obviously a wireless solution has no wires associated with it. When it is severe environment proof as well as wireless, it allows the insulation to be a lot more expeditious and easier to debug and get running. The question on R&D spend, we are at about 8% research and development spend on a gross basis. So on revenue is – when you look at our revenue we are about on a gross basis 8% R&D. We do credit some of the non-recurring engineering payments we get from customers against that. We don't, just as a reminder, we don't record those non-recurring engineering payments as revenue, we record them as a (inaudible) against R&D spending. So we are right around the, close to the 8% now, and that's pretty much where we plan on being going forward. There may be a few ups or downs based on driving some efficiencies or individual program, funding, timing, but for the most part on an annual basis, that's will run to.

Keay Nakae – Collins Stewart

Okay. So the credits you expect to receive will continue to offset the spending at the same degree that we have been seeing?

Thomas Mazza

Exactly, Keay, this is Tom Mazza. We're expecting it to be in the 5% to 6% range, as we have in the past.

Keay Nakae – Collins Stewart

Okay, very good. And Tom, not to beat this to death, but I appreciate your guidance that you've given, certainly on the EPS line as you said, the Street has been skeptical that you meet that number, and in fact heading into today, consensus is still below the low end of your range. I appreciate that you don't want to change that, but on the top line certainly you're well within the range, you haven't moved up the bottom of the range. And it really, in my mind, is just a function of the market environment that we're in right now. You are halfway through the quarter. Is there any way you can provide comfort that a $90 million quarter is not on the table, even though that's the low end of your range you are not changing?

Thomas Hook

Yes, I certainly can say that we don't expect the fourth quarter to be dramatically different than what we had planned since the beginning of the year, which is consistent with each of the quarters. It's, yes, we made the decision not to make adjustments to the guidance quarter to quarter. If we are remaining true to our plan from the beginning of the year, I see that, that we are right on track, few milestones we laid on that is been very dissatisfied with. A few milestones we're ahead, but largely the integrations, consolidations, the revenue growth, the things that we've had in the product technologies, the new innovations and the patents we've had all really come in to plan since the beginning of the year.

But duly noted your comments, I spent a lot of the beginning of the year grimacing answering these questions, and smiling a little bit more and feeling a little bit more vindicated near the end of the year. But really it's the team that has done a magnificent job of executing the plan we have scoped out at the end of 2007 with the Board of Directors, and implemented at the beginning of 2008 following the acquisitions. And we have really remained true to that, and on schedule to that, and still to this day and for the forecast for the end of the year, I still think we are going to make exactly where we intended to do. And while I don't want to change those guidance ranges, hopefully, those words will provide you a little bit more comfort, there's nothing surprising coming along in the fourth quarter.

Keay Nakae – Collins Stewart

Alright. Very good. Nice quarter.

Thomas Hook

Thank you.

Thomas Mazza

Thank you.

Operator

Your next question comes from the line of Assaf Guterman with Lazard Capital Markets. Please proceed.

Assaf Guterman – Lazard Capital Markets

Hi, guys.

Thomas Mazza

Assaf, how are you today?

Assaf Guterman – Lazard Capital Markets

Good. How are you? A quick question, which segment of your business do you feel you are the most exposed to the overall financial situation. Is there any specific segment, I don't know if it's orthopedics or maybe the non-medical segment that you feel you are more exposed than in others?

Thomas Hook

I really don't feel exposed directly. I think it would be more by individual customers and more likely because we have a lot of smaller customers in orthopedics and commercial markets, it's more likely where we see the effects. But I will reiterate that we've seen no effects from supply base customers in any segment. Any of the partners we work with in the Company is there has been no direct effects in the last quarter at all, and haven't – don't project any going forward either. So I think, not that we're insulated from it, but we haven't seen any direct ones we could associate with the dynamics at this time.

Assaf Guterman – Lazard Capital Markets

Okay. Now speaking orthopedics, the Shamond facility, is it manufacturing exclusively for J&J right now?

Thomas Hook

Well, I think, yes, pragmatically because at the beginning of year we did that acquisition in the February time frame, and that any other work that we would put in that facility, which is an FDA registered site, would require us to qualify it. So while there is a lot of work going on to increase the capacity and efficiency at that plant, it takes a significant amount of time to actually get things qualified to run it there. So pragmatically, yes, you are correct.

Assaf Guterman – Lazard Capital Markets

Right. But contractually, I mean you are allowed to start manufacturing for other–

Thomas Hook

That's correct. It's – we don't have any restrictions that inhibit our ability to use it for other needs, and we have already done some internal transfer of work there for our own product lines, and we continue to use the facility broadly to build its business base there. We see it as a significant advantage that investment and we plan on growing and expanding its capacity. And have actually in the short time that we have owned it, have worked cooperatively with our customer there to grow capacity in cooperation with them, and also to drive improvements in the plant like any smart operator would be, and we are just going to continue that on. There is no contractual restrictions to prevent that.

Assaf Guterman – Lazard Capital Markets

Okay. Now lastly, could you quantify the impact of the R&D tax credit? You recognized in the fourth quarter. In terms of the –

Thomas Mazza

It's about 2%, Assaf.

Assaf Guterman – Lazard Capital Markets

About 2% in terms of tax rate?

Thomas Mazza

Yes.

Assaf Guterman – Lazard Capital Markets

Which equates to $0.03 or $0.04, something in that area.

Thomas Hook

Correct. Yes.

Assaf Guterman – Lazard Capital Markets

But then that's for the full year. So, we are talking about almost $0.01 per quarter.

Thomas Mazza

Exactly. As we guided, as we put in our release, we basically on an adjusted basis, are seeing the fourth quarter will be at 30% and thereby we'll get an annual rate of 32%, which before we were seeing it was 34.5.

Assaf Guterman – Lazard Capital Markets

Right. And looking into 2009, we should look at about, again about 2% impact in terms of tax rate?

Thomas Mazza

I wouldn't, the more the earnings grow, the less the credit means, so I wouldn't jump to that conclusion. We haven't given guidance on that, but clearly it will be closer to the federal statutory rate than the 32.

Assaf Guterman – Lazard Capital Markets

Okay. Got it. Thank you very much.

Operator

Next question is a follow up from the line of Tim Lee with Piper Jaffray. Please proceed.

Tim Lee – Piper Jaffray

Yes, thanks for taking my follow up. Just in terms of your '09 Op margin goal, I think you had said 11% to 13%.

Thomas Mazza

Correct.

Tim Lee – Piper Jaffray

And is that a GAAP Op margin or is that the more adjusted Op margin?

Thomas Mazza

It's the adjusted margin.

Tim Lee – Piper Jaffray

Then just given the performance that we saw here in the third quarter, the 11% to 13%, how should we think about, is there some conservatism built into that or was there some very strong out performance from the Op margin standpoint here in this quarter?

Thomas Hook

This is Tom Hook. I will answer, it is, I certainly – I think we got a little bit chastised at the beginning of the year when we were talking to a 200 basis point improvement per year for each of the next three years, that was far too aggressive. I think that certainly in third quarter, we demonstrate that we have the capability to drive good operating margins. We do tend to have a little bit of a lumpy business, and the mix can shift quarter-to-quarter. So, we try not to read any one quarter is the annual answer because we have some high points, some low points. We've obviously been on a steady improvement over the course of the year have a very strong Q3. We will wait we see the Q4 results. We got a lot of consolidations moving right now, and a lot of things in the mill. So we feel confident that 200 basis point improvement for '09 is logical, which would take us obviously midpoint from 10% to 12%. We don't want to get too bullish ahead of finishing the year, in understanding where we are for our 2009 plans. So, I think we are just being prudent and not wanting to over-commit. And again, because it is fairly aggressive to improve 200 basis points a year on the margin line from year to year, we have done a nice job in the third quarter, we got a lot to do in the fourth quarter to maintain that type of pace. And in 2009 early, we will adjust and provide in the formal guidance where we think we are based on our 2008 results, but for now we feel good where we're at, and obviously, it could be viewed as conservative but we think it's prudent.

Tim Lee – Piper Jaffray

Okay. Thank you.

Operator

Your next question comes from the line of Stan Manne with Manne Family Investments. Please proceed.

Stan Manne – Manne Family Investments

Good job, gentlemen. I have a couple of questions. One, you are going to be generating really a good amount of cash, and I just want to get a feeling, are we done with these big acquisitions or are we going to start accumulating cash and using it in other ways going down the road the next couple of years?

Thomas Hook

I think that the acquisitions, the major acquisitions have been completed. We had laid out that strategy in 2007 with the Board of Directors and brought that to close at the beginning of 2008. So I don't expect any major acquisitions to come in the foreseeable future. Over the next year or two there could be a deal that we feel is an opportunity for us to grow through acquisition, more likely is probably to make investments, in particular, technologies or product lines that we would like, not so much acquisitions, but more on the investment side that would, that we would kind of either partner with a customer with or early stage company like we've historically done. I think the other priority is certainly going to be make sure that we continue to pay the debt down and use the operating cash flows to fund the consolidations, which in turn, will produce cash to fund more debt repayment.

Stan Manne – Manne Family Investments

So you would consider paying down some of the convertible debt?

Thomas Hook

I think, certainly convertible is possible but right now with the revolver is more likely we would be paying the revolver.

Stan Manne – Manne Family Investments

How big is the revolver, just – ?

Thomas Mazza

110 million as of September.

Stan Manne – Manne Family Investments

And that rate of are you LIBOR plus or something?

Thomas Mazza

It's LIBOR plus, yes.

Thomas Hook

The base rate, LIBOR plus.

Stan Manne – Manne Family Investments

So you would knock that off first, okay. Second question, you talked a lot about this, MRI, MRI-able battery and leads. It seems to me that could be a very big program across your businesses, and I'm wondering where that stands. You were doing some work with I think Sorren [ph] or somebody on that program?

Thomas Hook

That is correct. We are working with all of our customers on qualifying that technology. It is an enormous effort within Greatbatch and it holds great promise. Obviously, in one of the prior calls this year, we highlighted that suite of technologies in terms of our enable BC filter, our non-magnetic material technology and also our EMI filter technology. We are continuing to develop that and we have a very large team, both in Minneapolis as well as in Buffalo, New York, that are working on those technologies, and we definitely plan on cooperating with our customers and incorporating that technology into each of their product designs. We pick it as wide applicability with every implantable medical customer from neuromodulation at cardiac rhythm management. And it's our intention to work on a program by program basis with each customer to commercialize it. The first one we started with was with Sorren, which in May, we announced that we had won and commenced the cooperation agreement with them to do the development. And that's progressed forward as well as other customers at the same time.

Stan Manne – Manne Family Investments

Is that a proprietary technology? In other words is your patent intellectual property pretty strong in that?

Thomas Hook

We feel it is. It's not just a patent, it's a series of patents, both granted and filed. We also have an extensive set of know-how in these areas as well as work that we have done in prior to the MRI field just in energy field filtering. So we feel we got a very compelling approach, it's not the only approach to make a device MRI conditional or enabled. And while the standard setting bodies and any are working cooperatively with the FDA to establish what the requirements would be, we are actively working in conjunction with that to develop products that will meet those requirements. And certainly, there is other competitors in the field. We don't feel that we are going to be alone in this space, but we have spent a lot of very focused investment. We feel we have an extremely strong solution, it's very well protected, and we've done a lot in terms of investing and perfecting it, which includes a lot of work to miniaturize the designs to make them fit into a very small size of six french or smaller size, to make them effective. We have stated that we will start with the low voltage side of cardiac rhythm management on the treatment for bradycardia, and then we will work on the high voltage side in terms of the ICD market next, and we have made good progress.

Stan Manne – Manne Family Investments

Does that include the lead part of the program also? Does this expand to several of your business segments, is what I am trying to get at?

Thomas Hook

It does, it definitely cuts across the entire business. It's three pieces, it's non-magnetic materials, which would be non-magnetic cases, batteries, capacitors, et cetera. So the materials themselves would be non-magnetic. It would be the filtering at the distal tip and the filtering at the proximal tip of the device. One for more or less interference with pulse generator, and the other one for heating of the tip of the lead wire in particular, that can cause tissue damage. So, the three of those suites, we've worked very cooperatively with customers developing, and we are going to continue to do that going forward, and we've made a lot of progress and we will still play it fairly close to the vest strategically, we will talk to what breakthroughs and what patents we have. I will be a little bit quiet in terms of which deals we have with which customers until their time to commercialize and we'll let them advertise the technology.

Stan Manne – Manne Family Investments

But it could have a significant effect on your total business in several segments.

Thomas Hook

That's correct. I will remind everyone that it takes years to qualify these through end devices with customers, but yes, it's a significant technology and it'll be a significant revenue stream for us out two years to three years from now.

Stan Manne – Manne Family Investments

Okay. Last question. It looks to me like the 20% operating margin target is achievable in the near future, from what I can numerically calculate.

Thomas Hook

Thank you for your confidence.

Stan Manne – Manne Family Investments

Thank you.

Operator

Your next question comes from the line of Keay Nakae with Collins Stewart. Please proceed.

Keay Nakae – Collins Stewart

Yes, two follow up questions, one for Tom Hook. Tom, as I recall earlier this year you had hedged your LIBOR exposure with some currency swaps, how far out do those go and what's your exposure there now?

Thomas Hook

Two and a half years.

Keay Nakae – Collins Stewart

Okay. Very good. Alright. And then at what point do you guys anticipate seeing a rebound in coded electrode sales?

Thomas Hook

I think we will find that, that's going to be something that's end of '09, 2010. We have done a lot in terms of commercializing new technologies there, new codings, but it tends to take a while to get those through the approval routes. And I think obviously as the customers that we've had that, one in particular that had a recall issue that's related to this. As they come back on line through their (inaudible), then we will be picking that back up again. But they could give a more precise answer, but we are not being bullish in 2009 in that category right now. It's moved, it's running very well in Tijuana, and more or less we are ready to see that come back but we are waiting patiently and cooperating with our customers until that does.

Keay Nakae – Collins Stewart

Okay. Great. Thanks.

Operator

That concludes today's question-and-answer session. I would like to turn the call back over to Marco Benedetti for any closing remarks.

Marco Benedetti

Thank you. I would like to remind you that both the audio portion of this call and the slide visuals will be archived on our Web site at greatbatch.com and will be accessible for 90 days. Thanks everyone for joining us.

Operator

Thank you for your participation. That concludes today's conference call.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Greatbatch, Inc. Q3 2008 Earnings Call Transcript
This Transcript
All Transcripts