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GREATBATCH, INC. - 10-K - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Edgar Glimpses Via Acquire Media NewsEdge) YOU SHOULD READ THE FOLLOWING DISCUSSION AND ANALYSIS OF OUR FINANCIAL CONDITION
AND RESULTS OF OPERATIONS IN CONJUNCTION WITH OUR FINANCIAL STATEMENTS AND
RELATED NOTES INCLUDED ELSEWHERE IN THIS REPORT.
Our Business
• Our business
• Our acquisitions
• Our customers
• Strategic and financial overview
• 2013 financial guidance
• Cost savings and consolidation efforts
• Product development
• Government regulation
Our Critical Accounting Estimates
• Valuation of goodwill and other identifiable intangible assets
• Stock-based compensation
• Inventories
• Tangible long-lived assets
• Provision for income taxes
Our Financial Results
• Results of operations table
• Fiscal 2012 compared with fiscal 2011
• Fiscal 2011 compared with fiscal 2010
• Liquidity and capital resources
• Off-balance sheet arrangements
• Litigation
• Contractual obligations
• Inflation
• Impact of recently issued accounting standards
Our Business
We operate our business in two reportable segments - Implantable Medical and
Electrochem Solutions ("Electrochem"). The Company's customers include large
multi-national original equipment manufacturers ("OEMs"). The Implantable
Medical segment is comprised of our Greatbatch Medical and QiG Group brands and
designs and manufactures medical devices and components for the cardiac,
neuromodulation, vascular and orthopaedic markets. The Implantable Medical
segment offers complete medical devices including design, development,
manufacturing, regulatory submission and supporting worldwide distribution,
which is facilitated through the QiG Group and leverages the component
technology of Greatbatch Medical. The devices designed and developed by the QiG
Group are manufactured by Greatbatch Medical. The Implantable Medical segment
also offers value-added assembly and design engineering services for its
component products.
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Electrochem provides industry-leading total power solutions for rechargeable and
non-rechargeable battery power systems, charging and docking stations, and power
supplies, for critical applications in the portable medical and energy markets,
where safety, reliability, quality and innovation are critical. Electrochem's
product lines cover a number of highly-customized battery-powered applications
in remote and demanding environments, including down hole drilling tools and in
life-saving and life-enhancing applications, including automated external
defibrillators, portable oxygen concentrators, ventilators and powered surgical
tools, among others.
Our Acquisitions
On December 15, 2011, Electrochem acquired all of the outstanding stock of Micro
Power Electronics, Inc. ("Micro Power") headquartered in Beaverton, OR. Micro
Power is a leading supplier of custom battery solutions, serving the portable
medical, military and handheld automatic identification and data collection
markets. Micro Power's commercial portfolio is highly complementary to the
products and services offered by Electrochem. The results of Micro Power were
included in our Electrochem segment from the date of acquisition. The aggregate
purchase price of Micro Power was $71.8 million, which we funded with cash on
hand and $45 million borrowed under our revolving credit facility. Total assets
acquired from Micro Power were $88.2 million. Total liabilities assumed from
Micro Power were $16.4 million. For 2012, Micro Power added approximately $82.4
million to our revenue.
On February 16, 2012, Greatbatch purchased all of the outstanding common stock
of NeuroNexus Technologies, Inc. ("NeuroNexus") headquartered in Ann Arbor, MI.
NeuroNexus is an active implantable medical device design firm specializing in
developing and commercializing neural interface technology, components and
systems for neuroscience and clinical markets. NeuroNexus has an extensive
intellectual property portfolio, core technologies and capabilities to support
the development and manufacturing of innovative neural interface devices across
a wide range of functions including neuromodulation, sensing, optical
stimulation and targeted drug delivery applications. The results of NeuroNexus
were included in our Implantable Medical segment from the date of acquisition.
The aggregate purchase price of NeuroNexus was $13.2 million, which we funded
with cash on hand and $10 million borrowed under our revolving credit facility.
Total assets acquired from NeuroNexus were $14.6 million. Total liabilities
assumed from NeuroNexus were $1.4 million. For 2012, NeuroNexus added
approximately $2.5 million to our revenue.
Going forward, we will continue to pursue potential acquisitions.
Our Customers
Our products are designed to provide reliable, long-lasting solutions that meet
the evolving requirements and needs of our customers and the end users of their
products. The nature and extent of our selling relationships with each customer
are different in terms of breadth of products purchased, purchased product
volumes, length of contractual commitment, ordering patterns, inventory
management and selling prices.
Our Implantable Medical customers include large multi-national OEMs, such as
Biotronik, Boston Scientific, Johnson & Johnson, Medtronic, Smith & Nephew,
Sorin Group, St. Jude Medical, Stryker and Zimmer. During 2012, Boston
Scientific, Johnson & Johnson, Medtronic and St. Jude Medical collectively
accounted for 52% of our total sales.
Our Electrochem customers are primarily companies involved in demanding markets
where highly sophisticated power solutions needs exist, such as energy, portable
medical, military and environmental. Some of our larger OEM customers include
General Electric, Halliburton Company, Scripps Institution of Oceanography,
Thales, Weatherford International and Zoll Medical Corp.
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Strategic and Financial Overview
Since 2007, we have been implementing a strategy centered on continually
strengthening three aspects of our business that can most affect profitable
growth: our top line, our bottom line and our pipeline. This strategy includes
three facets; growth in our core business, growth through acquisitions and
growth through the development and commercialization of complete medical
devices. As a result of this strategy, sales increased 14% for 2012 and 7% for
2011. Sales growth for 2012 and 2011 included the benefit from our acquisitions
of $84.8 million and $2.5 million, respectively. Additionally, sales include the
impact from foreign currency exchange rate fluctuations, which decreased 2012
sales by $6 million in comparison to 2011 and increased 2011 sales by $8 million
in comparison to 2010. On a constant currency, organic basis sales were
consistent from 2011 to 2012 and increased 5% from 2010 to 2011 as growth from
our vascular and portable medical product lines more than offset the impact the
declining cardiac rhythm management ("CRM") market had on our cardiac and
neuromodulation product line. Our portable medical product line is benefiting
from new product introductions and market shift in patient care from clinical
settings to the home, and an aging population, which is driving the need for
lightweight and portable devices for patients and caregivers. Our vascular
product line growth is being driven by growth in the underlying market, market
share gains and the commercialization of our medical devices. Despite the
declining CRM market, we were able to grow our cardiac business faster than the
underlying market through innovation as well as deepening customer
relationships. For 2013, we expect revenue, after adjusting for the sale of a
portion of our orthopaedic product line, to organically grow 5-8% driven
primarily by our portable medical, vascular and orthopaedic product lines along
with above market growth in cardiac and neuromodulation.
Simultaneous with the initiation of our growth strategy, we began evolving our
product offerings to include the development of complete medical devices in
order to raise the growth and profitability profile of the Company. This medical
device strategy is being facilitated through our QiG Group and leverages the
component technology of Greatbatch Medical. More specifically, this strategy
includes the development of a neuromodulation platform that can be used to
support several devices most notably of which is our spinal cord stimulator for
the treatment of chronic pain in the trunk and limbs, which we call Algostim. We
currently expect to submit this device to regulatory authorities in the second
half of 2013. Incremental investments in all of our medical device products,
including Algostim, totaled $33.9 million, $27.3 million and $21.9 million for
2012, 2011 and 2010, respectively, and included charges to selling, general and
administrative expenses ("SG&A") and research, development and engineering, net
("RD&E"). As a result of this strategy, as well as our acquisitions, SG&A
increased 12% during both 2012 and 2011 while RD&E increased 15% and 1%,
respectively, for the same periods.
During the second half of 2012, we began a process to more fully optimize our
research and development efforts. This included the reallocation of research and
development resources to higher priority projects, the postponement of some
research and development projects, and the decision to pursue various
alternatives to monetize our existing non-core intellectual property and
entering into more co-development arrangements with our customers. As a result,
RD&E for the second half of 2012 was $3.7 million lower than the first half of
2012. These reductions are also expected to benefit 2013.
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We have a longstanding history of operational excellence, which is one of our
core competencies. As we move forward, investing in our operations will continue
to be critical to the success of our growth and medical device strategies. Since
2007, we have invested substantial resources in integrating our acquisitions and
streamlining our operations. This strategy continued during 2012 as we worked
diligently to resolve the operational issues we were experiencing at our Swiss
orthopaedic facilities, expanded our manufacturing infrastructure to support the
commercialization of our medical devices and upgraded our global ERP system in
order to support our future growth. As a result of these initiatives, our other
operating expense totaled $47.5 million over the last three years, $42.3 million
of which was incurred during 2012. These expenses are expected to be reduced
significantly in 2013 and to range from $6.7 million to $8.2 million, which will
improve the overall earnings of Greatbatch. While we continually identify and
implement cost improvement initiatives, we have now completed all of our major
plant consolidations, which began in 2007, so our leadership team can focus on
achieving sustainable organic growth to leverage our available capacity.
We prepare our consolidated financial statements in accordance with generally
accepted accounting principles in the United States of America ("GAAP").
Additionally, we consistently report and discuss in our quarterly earnings
releases and investor presentations adjusted operating income and margin,
adjusted net income and adjusted earnings per diluted share, which are non-GAAP
measures. These adjusted amounts consist of GAAP amounts and, to the extent
occurring during a period, excludes (i) acquisition-related charges,
(ii) facility consolidation, optimization, manufacturing transfer and system
integration charges, (iii) asset write-down and disposition charges,
(iv) severance charges in connection with corporate realignments or a reduction
in force (v) litigation charges and gains, (vi) the impact of non-cash charges
to interest expense due to the accounting change governing convertible
debt, (vii) unusual or infrequently occurring items, (viii) certain RD&E
expenditures, such as design verification testing ("DVT") expenses incurred in
connection with the development of our neuromodulation platform, (ix) gain/loss
on the sale of investments, (x) the income tax (benefit) related to these
adjustments and (xi) certain tax charges related to the consolidation of our
Swiss Orthopaedic facility. We believe that reporting these amounts provides
important supplemental information to our investors and creditors seeking to
understand the financial and business trends relating to our financial condition
and results of operations. Additionally, the performance based compensation of
our executive management is determined utilizing these adjusted amounts.
A reconciliation of GAAP operating income (loss) to adjusted amounts is as
follows (dollars in thousands):
Implantable Medical Electrochem Unallocated Total
Dec. 28, Dec. 30, Dec. 28, Dec. 30, Dec. 28, Dec. 30, Dec. 28, Dec. 30,
2012 2011 2012 2011 2012 2011 2012 2011
Total sales $ 483,165 $ 489,065 $ 163,012 $ 79,757 $ - $ - $ 646,177 $ 568,822
Operating income (loss) as reported $ 24,908 $ 62,461 $ 21,631 $ 14,965 $ (20,718 ) $ (15,727 ) $ 25,821 $ 61,699
Adjustments:
Inventory step-up amortization (COS) - - 532 177 - - 532 177
Medical device DVT expenses (RD&E) 5,190 5,133 - - - - 5,190 5,133
Consolidation and optimization costs 34,378 425 - - 4,670 - 39,048 425
Integration expenses 167 - 1,287 - 6 - 1,460 -
Asset dispositions, severance and
other 247 51 883 117 708 - 1,838 168
Adjusted operating income (loss) $ 64,890 $ 68,070 $ 24,333 $ 15,259 $ (15,334 ) $ (15,727 ) $ 73,889 $ 67,602
Adjusted operating margin 13.4 % 13.9 % 14.9 % 19.1 % N/A N/A 11.4 % 11.9 %
Medical device related adjusted
expenses (excluding DVT) $ 28,453 $ 22,080 $ - $ - $ - $ - $ 28,453 $ 22,080
Adjusted operating income excluding
medical device initiatives $ 93,343 $ 90,150 $ 24,333 $ 15,259 $ (15,334 ) $ (15,727 ) $ 102,342 $ 89,682
Adjusted operating margin excluding
medical device initiatives 19.3 % 18.4 % 14.9 % 19.1 % N/A N/A 15.8 % 15.8 %
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Implantable Medical Electrochem Unallocated Total
Dec. 30, Dec. 31, Dec. 30, Dec. 31, Dec. 30, Dec. 31, Dec. 30, Dec. 31,
2011 2010 2011 2010 2011 2010 2011 2010
Total sales $ 489,065 $ 460,269 $ 79,757 $ 73,156 $ - $ - $ 568,822 $ 533,425
Operating income (loss) as reported $ 62,461 $ 62,477 $ 14,965 $ 22,195 $ (15,727 ) $ (15,678 ) $ 61,699 $ 68,994
Adjustments:
Inventory step-up amortization (COS) - - 177 - - - 177 -
Executive death benefits (SG&A) - 885 - - - - - 885
Medical device DVT expenses (RD&E) 5,133 - - - - - 5,133 -
Electrochem litigation gain - - - (9,500 ) - - - (9,500 )
Consolidation and optimization costs 425 573 - 1,000 - - 425 1,573
Integration expenses - (4 ) - - - 46 - 42
Asset dispositions, severance and
other 51 2,517 117 100 - 326 168 2,943
Adjusted operating income (loss) $ 68,070 $ 66,448 $ 15,259 $ 13,795 $ (15,727 ) $ (15,306 ) $ 67,602 $ 64,937
Adjusted operating margin 13.9 % 14.4 % 19.1 % 18.9 % N/A N/A 11.9 % 12.2 %
Medical device related adjusted
expenses (excluding DVT) $ 22,080 $ 21,878 $ - $ - $ - $ - $ 22,080 $ 21,878
Adjusted operating income excluding
medical device initiatives $ 90,150 $ 88,326 $ 15,259 $ 13,795 $ (15,727 ) $ (15,306 ) $ 89,682 $ 86,815
Adjusted operating margin excluding
medical device initiatives 18.4 % 19.2 % 19.1 % 18.9 % N/A N/A 15.8 % 16.3 %
GAAP operating income for 2012 was $25.8 million compared to $61.7 million for
2011 and $69.0 million for 2010. These decreases were primarily due to the costs
incurred in connection with our medical device and consolidation and
productivity initiatives discussed above, as well as the litigation settlement
gain recorded in 2010. Adjusted operating income, which excludes these items,
was $73.9 million for 2012, compared to $67.6 million for 2011 and $64.9 million
for 2010. This represents an increase of 9% for 2012 and 4% for 2011 as the
Company continues to leverage its operating infrastructure and is beginning to
see the benefits of its productivity and consolidation initiatives.
Beginning in 2012, we are showing adjusted operating income excluding the
incremental costs from our medical device initiatives. This information is
provided in order to enhance the reader's understanding of our core business,
which is being impacted by these medical device investments and has not
meaningfully impacted our revenue or gross margins. Sales of complete medical
devices developed under the Greatbatch name were $6.6 million during 2012
compared to $4.5 million for 2011, an increase of 47%.
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A reconciliation of GAAP net income (loss) and diluted earnings (loss) per share
("EPS") to adjusted amounts is as follows (in thousands, except per share
amounts):
Year Ended
December 28, December 30, December 31,
2012 2011 2010
Impact Impact Impact
Net Per Net Per Net Per
Income Diluted Income Diluted Income Diluted
(Loss) Share (Loss) Share (Loss) Share
Net income (loss) as reported $ (4,799 ) $ (0.20 ) $ 33,122 $ 1.40 $ 33,138 $ 1.40
Adjustments:(a)
Inventory step-up amortization (COS) 346 0.01 115 - - -
Executive death benefits (SG&A) - - - - 575 0.02
Medical device DVT expenses (RD&E) 3,374 0.14 3,336 0.14
- -
Electrochem litigation gain - - - - (6,175 ) (0.26 )
Consolidation and optimization costs 28,934 1.21 276 0.01 1,022 0.04
Integration expenses
949 0.04 - - 27 -
Asset dispositions, severance and
other 1,186 0.05 109 - 1,913 0.08
(Gain) loss on cost and equity method
investments, net(b ) 69 - (2,751 ) (0.12 ) 98 -
CSN conversion option discount
amortization(c ) 6,234 0.26 5,515 0.23 5,119 0.22
Swiss tax impact(d) 6,190 0.26 - - - -
Adjusted net income and diluted
EPS(e) $ 42,483 $ 1.77 $ 39,722 $ 1.68 $ 35,718 $ 1.51
Adjusted diluted weighted average
shares (f) 23,947 23,636 23,802
(a) Net of tax amounts computed using the applicable U.S. and foreign statutory
tax rates of 35% and 22.5%, respectively, for items incurred in those
geographic locations.
(b) Pre-tax amount is a loss of $106 thousand, gain of $4.2 million and loss of
$150 thousand for 2012, 2011 and 2010, respectively.
(c) Pre-tax amount is $9.6 million, $8.5 million and $7.9 million for 2012, 2011
and 2010, respectively.
(d) Relates to the loss of our Swiss tax holiday due to our decision to transfer
manufacturing out of Switzerland, as well as the establishment of a valuation
allowance on our Swiss deferred tax assets as it is more likely than not that
they will not be fully realized.
(e) The per share data in this table has been rounded to the nearest $0.01 and
therefore may not sum to the total.
(f) Adjusted diluted weighted average shares for 2012 include 363 thousand shares
of dilution related to outstanding stock incentive awards that were not
dilutive for GAAP diluted EPS purposes.
GAAP net income (loss) and diluted EPS include the impact of costs incurred in
connection with our medical device and consolidation and productivity
initiatives, as well as the litigation settlement gain recorded in 2010.
Excluding these items, adjusted diluted EPS increased 5% in 2012 and 11% in
2011. In aggregate we estimate that our Swiss operational issues had a negative
$0.16 per share of adjusted diluted earnings impact for 2012.
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For 2013, we expect our performance to improve as we progress through the year,
as the first quarter of 2013 will be impacted by the startup of our recently
transferred orthopaedic production lines. The second half of the year is
expected to improve as the orthopaedic backlog is relieved and new product
introductions in our portable medical business commercialize. As a result of our
consolidation initiatives and refocused medical device RD&E investment, we
expect improved performance each quarter when compared to the prior year and
expect to achieve adjusted diluted EPS growth of 7-13% for 2013.
2013 Financial Guidance
For 2013, we estimate annual revenue growth rates for our product lines as
follows:
Estimated 2013 Annual 2013 Estimated Revenue
Product Line Growth Rate (%) (millions)
Cardiac & Neuromodulation 0% - 2% $309 - $315
Vascular 7% - 13% $55 - $59
Orthopaedic(1) (5%) - 0% $116 - $122
Portable Medical 15% - 20% $94 - $98
Energy & Other 6% $86 - $86
Total Sales(1) 2% - 5% $660 - $680
(1) Organic revenue growth for orthopaedic product line is 8%-14% due to
disposition of approximately $15 million of non-core product lines at the end
of 2012. Total consolidated organic revenue growth is expected to be 5%-8%.
Adjusted Operating Income as a % of Sales 12.0% - 12.5%
Adjusted Diluted EPS $1.90 - $2.00
Adjusted operating income for 2013 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 $11.5 million
to $14.0 million. This range has been significantly reduced from the 2012 level
as we have essentially completed our current productivity and consolidation
initiatives. Included in the above range are residual DVT costs in the range of
$4.8 to $5.8 million to complete our Algostim project.
Cost Savings and Consolidation Efforts
In 2012, 2011 and 2010, we recorded charges in Other Operating Expenses, Net
related to cost savings and consolidation efforts. These initiatives were
undertaken to improve our operational efficiencies and profitability. Additional
information regarding the timing, cash flow impact and amount of future
expenditures is set forth in Note 13 "Other Operating Expenses, Net" of the
Notes to the Consolidated Financial Statements contained in Item 8 of this
report, as well as the "Liquidity and Capital Resources" section of this Item.
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Over the last two years, we have been implementing a multi-faceted plan to
further enhance, optimize and leverage our orthopaedics operations. This plan
includes the construction of an orthopaedic manufacturing facility in Fort
Wayne, IN, updating our Indianapolis, IN facility to streamline operations,
increase capacity, and further expand capabilities, and the transfer of most
major functions currently performed at our facilities in Orvin and Corgemont,
Switzerland into our Fort Wayne, IN and Tijuana, Mexico facilities. The total
capital investment expected for these initiatives is between $25 million and $35
million, of which $21 million has been expended to date. Total expense expected
to be incurred for these initiatives is between $30 million and $36 million, of
which $33.1 million has been incurred to date.
Near the end of 2011, we initiated plans to optimize and expand our
manufacturing infrastructure in order to support our medical device strategy.
This included the transfer of certain product lines to lower cost facilities,
expansion of two of our existing facilities, as well as the purchase of
equipment to create additional capacity for the manufacture of medical devices
and create additional cost savings. Total capital investment under these
initiatives is expected to be between $15 million to $20 million of which
approximately $9.9 million has been expended to date. Total expenses expected to
be incurred on these projects is between $2 million to $3 million of which $1.5
million has been incurred to date.
These orthopaedic and medical device initiatives are expected to be completed
over the next year and are expected to generate approximately $10 million to $15
million of annual cost savings and increase our capacity in order to support our
growth and the manufacturing of complete medical devices.
In 2011, we initiated plans to upgrade our existing global ERP system. This
initiative is expected to be completed over the next year. Total capital
investment under this initiative is expected to be approximately $4 million to
$5 million of which approximately $3.0 million has been expended to date. Total
expenses expected to be incurred on this initiative is between $5 million to $7
million of which $5.0 million has been incurred to date.
Product Development
Implantable Medical-As a result of the investments we have made, we are able to
provide our Implantable Medical customers with complete medical devices. This
medical device strategy is being facilitated through the QiG Group and includes
strategic equity investments and medical devices developed independently as well
as in conjunction with our OEM partners. Today we have four medical devices that
we are independently working on that are in various stages of development. While
we do not intend to discuss each of these projects individually each quarter, we
will discuss significant milestones as they occur. Some of the medical device
projects that we currently are working on include:
Cardiovascular portfolio-Venous and arterial introducers, anti-microbial
coatings, steerable delivery systems, and MRI conditional brady, gastric
stimulation and sleep apnea leads. During 2012, we received U.S. Food and Drug
Administration ("FDA") 510(k) clearance on our transradial catheter sheath
introducer and steerable delivery sheath for atrial fibrillation ablation and
received the CE mark for distribution of our transseptal needle that supports
access and delivery of ablation therapies for atrial fibrillation.
During 2012, Greatbatch Medical observed manufacturing irregularities during
inspection of its bi-directional guiding sheath. This problem was identified
after implementing a new inspection tool for use in performing inspections. As a
result, Greatbatch Medical decided to perform a field action on this product in
late 2012. Revenue on this product, which totaled $3.0 million in 2012, is
expected to be temporarily delayed until the second half of 2013.
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Neuromodulation portfolio - With regards to Algostim, our spinal cord stimulator
for the treatment of chronic pain in the trunk and limbs, we continue to make
strong technical progress on the development of this device and continue to
retire critical milestones needed for program completion and the ultimate
submission to regulatory authorities, which we expect in the second half of
2013. Additionally, we continue to receive strong interest from numerous
world-class medical device companies, who appreciate the unique opportunity to
market and distribute Algostim to interventional pain physicians, neurosurgeons
and orthopaedic spine surgeons around the world. We believe Algostim's unique
features and benefits will allow the right commercial partner to capture
significant market share in today's $1.3 billion spinal cord stimulation market,
which continues to see double digit market growth. We look forward to sharing
more details regarding Algostim and our commercial partner progress at our next
investor day in March 2013.
Approximately $0.5 million of the NeuroNexus purchase price in February 2012 was
allocated to the estimated fair value of acquired in process research and
development ("IPR&D"). These projects are expected to generate cash flows but
have not yet reached technological feasibility, and thus were classified as an
indefinite-lived intangible asset until the completion or abandonment of the
associated projects. The value assigned to IPR&D related to the development of
micro-electrodes for deep brain mapping and electrocorticography. There have
been no significant changes from our original estimates with regards to these
projects.
Electrochem-Electrochem continues to win new customers, new applications and
next generation products. Our core competencies enable us to be well-positioned
to win existing share and additional new product introductions based on our
experience in packaging solutions, our customer relationships, our investment in
technology and facilities, our capacity to service our customers, and our legacy
of delivering highly reliable and innovative solutions to the medical
marketplace.
The growth in Electrochem is being driven by successful product launches into
the higher growth, higher value portable medical market. Gaining better access
to this attractive market was one of the main drivers behind our acquisition of
Micro Power as it provides us with a significant opportunity for growth given
its $400 million market size.
Additionally, this market is benefiting from favorable market trends as patient
care shifts from clinical settings to the home and as an aging population drives
the need for lightweight and portable devices for patients and caregivers. These
favorable trends are expected to allow this market to grow faster than our
legacy markets over the next several years. Finally, this market is also
attractive to us given that it has long product life cycles that should provide
stability and diversification to our revenue base.
Government Regulation
The Patient Protection and Affordable Care Act and the Health Care and Education
Affordability Reconciliation Act (collectively "Health Care Reform") legislated
broad-based changes to the U.S. health care system that could significantly
impact our business operations and financial results, including higher or lower
revenue, as well as higher employee medical costs and taxes. Health Care Reform
imposes significant new taxes on medical device OEMs, which will result in a
significant increase in the tax burden on our industry and which could have a
material negative impact on our financial condition, results of operations and
our cash flows. Other elements of Health Care Reform such as comparative
effectiveness research, an independent payment advisory board, payment system
reforms including shared savings pilots and other provisions could meaningfully
change the way healthcare is developed and delivered, and may materially impact
numerous aspects of our business, results of operations and financial condition.
Many significant parts of Health Care Reform will be phased in over the next
several years and require further guidance and clarification in the form of
regulations. Management is currently evaluating the impact that the new medical
device tax will have on our results from operations beginning in 2013, and has
preliminarily estimated that it will reduce gross profit by $1.5 million to $2.5
million. This amount assumes that this tax applies to the first medical device
sale in the U.S. and is based upon a wholesale price.
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On August 22, 2012, the U.S. Securities and Exchange Commission ("SEC") issued a
rule under Section 1502 of the Dodd-Frank Wall Street Reform and Consumer
Protection Act requiring companies to publicly disclose their use of conflict
minerals that originated in the Democratic Republic of the Congo ("DRC") or an
adjoining country. Under the adopted rule, issuers are required to conduct a
"reasonable" due-diligence process to ascertain the source of conflict minerals,
defined as tantalum, tin, gold or tungsten, that are necessary to the
functionality or production of their manufactured or contracted to be
manufactured products. Companies are required to provide this disclosure on a
new form to be filed with the SEC called Form SD. Companies are required to file
Form SD on May 31, 2014 for the 2013 calendar period and annually on May 31
every year thereafter. We anticipate additional, new compliance costs to be
incurred since our Implantable Medical business utilizes all of the minerals
specified in the rule, which we are unable to quantify at this time.
Our Critical Accounting Estimates
The preparation of our consolidated financial statements in accordance with GAAP
requires us to make estimates and assumptions that affect reported amounts and
related disclosures. The methods, estimates and judgments we use in applying our
accounting policies have a significant impact on the results we report in our
consolidated financial statements. Management considers an accounting estimate
to be critical if (1) it requires assumptions to be made that were uncertain at
the time the estimate was made; and (2) changes in the estimate or different
estimates that could have been selected could have a material impact on our
consolidated results of operations, financial position or cash flows. Our most
critical accounting estimates are described below. We also have other policies
that we consider key accounting policies, such as our policies for revenue
recognition; however, these policies do not meet the definition of critical
accounting estimates, because they do not generally require us to make estimates
or judgments that are difficult or subjective.
Valuation of goodwill and other identifiable intangible assets
When we acquire a company, we allocate the purchase price to the tangible and
intangible assets we acquire and liabilities we assume based on their fair value
at the date of acquisition. Some of our intangible assets are considered
non-amortizing intangible assets as they are expected to generate cash flows
indefinitely. Goodwill is recorded when the purchase price paid for an
acquisition exceeds the estimated fair value of the net identified tangible and
intangible assets acquired. Indefinite-lived intangibles and goodwill are not
amortized but are required to be assessed for impairment on an annual basis or
more frequent if certain indicators are present. Definite-lived intangible
assets are amortized over their estimated useful lives and are assessed for
impairment if certain indicators are present.
Assumptions/Approach Used
We base the fair value of identifiable tangible and intangible assets on
detailed valuations that use information and assumptions provided by management.
The fair values of the assets acquired are determined using one of three
valuation approaches: market, income or cost. The selection of a particular
method depends on the reliability of available data and the nature of the asset.
The market approach values the asset based on available market pricing for
comparable assets. The income approach values the asset based on the present
value of risk adjusted cash flows projected to be generated by that asset. The
projected cash flows for each asset considers multiple factors, including
current revenue from existing customers, attrition trends, reasonable contract
renewal assumptions from the perspective of a marketplace participant, and
expected profit margins giving consideration to historical and expected margins.
The cost approach values the asset by determining the current cost of replacing
that asset with another of equivalent economic utility. The cost to replace the
asset reflects the estimated reproduction or replacement cost, less an allowance
for loss in value due to depreciation or obsolescence, with specific
consideration given to economic obsolescence if indicated.
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We perform an annual review on the last day of each fiscal year, or more
frequently if indicators of potential impairment exist, to determine if the
recorded goodwill and other indefinite-lived intangible assets are impaired. We
assess goodwill for impairment by comparing the fair value of our reporting
units to their carrying value to determine if there is potential impairment. If
the fair value of a reporting unit is less than its carrying value, an
impairment loss is recorded to the extent that the implied fair value of the
goodwill within the reporting unit is less than its carrying value. Fair values
for reporting units are determined based on the income and market approaches.
Indefinite-lived intangible assets are evaluated for impairment by using the
income approach. Definite-lived intangible assets are reviewed at least
quarterly to determine if any conditions exist or a change in circumstances has
occurred that would indicate impairment or a change in their remaining useful
life.
We do not believe that the indefinite-lived intangible assets or goodwill
allocated to our Implantable Medical or Electrochem segments are at risk of
failing step one of future annual impairment tests unless operating conditions
significantly deteriorate, given the significant amount that our estimated fair
value for these assets was in excess of their respective book values as of
December 28, 2012, or if there is a change in our reporting units.
Effect of Variation of Key Assumptions Used
The use of alternative valuation assumptions, including estimated cash flows and
discount rates, and alternative estimated useful life assumptions could result
in different purchase price allocations. Significant changes in these estimates
and assumptions could impact the value of the assets and liabilities recorded,
which would change the amount and timing of future intangible asset amortization
expense.
We make certain estimates and assumptions that affect the expected future cash
flows of our reporting units for our goodwill impairment testing. These include
discount rates, terminal values and projections of future revenues and expenses.
Significant changes in these estimates and assumptions could create future
impairment losses to our goodwill. The assumptions used in our 2012 impairment
test incorporate the information disclosed in "2013 Financial Guidance" of this
section as well as other forward-looking statements made in this Management
Discussion and Analysis of Financial Condition and Results of Operations
section.
For our indefinite-lived intangible assets, we make estimates of royalty rates,
future revenues and discount rates. Significant changes in these estimates could
create future impairments of these assets.
Estimation of the useful lives of indefinite- and definite-lived intangible
assets is based upon the estimated cash flows of the respective intangible asset
and requires significant management judgment. Events could occur that would
materially affect our estimates of the useful lives. Significant changes in
these estimates and assumptions could change the amount of future amortization
expense or could create future impairments of these intangible assets.
The way the Company's management allocates resources and evaluates its
businesses determines the reporting unit level which goodwill is tested for
impairment. Significant changes to these reporting units could create future
impairments of goodwill.
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As of December 28, 2012, we have $457.2 million of intangible assets recorded on
our consolidated balance sheet representing 51% of total assets. This includes
$87.3 million of amortizing intangible assets, $20.8 million of indefinite-lived
intangible assets and $349.0 million of goodwill. A 1% change in the
amortization of our intangible assets would change 2012 net income (loss) by
approximately $0.09 million, or approximately $0.004 per diluted share.
Stock-based compensation
We record compensation costs related to our stock-based awards which include
stock options, restricted stock and restricted stock units. We measure
stock-based compensation cost at the grant date based on the fair value of the
award.
Compensation cost for service-based awards is recognized ratably over the
applicable vesting period. Compensation cost for performance awards based on
Company financial metrics is reassessed each period and recognized based upon
the probability that the performance targets will be achieved. Compensation cost
for performance awards based on market metrics (such as total shareholder
return) is expensed each period whether the performance metrics are achieved or
not. The amount of stock-based compensation expense recognized during a period
is based on the portion of the awards that are ultimately expected to vest, as
well as market and nonmarket performance award considerations. The total expense
recognized over the vesting period will only be for those awards that ultimately
vest, as well as market and nonmarket performance award considerations.
Assumptions/Approach Used
We utilize the Black-Scholes Option Pricing Model to determine the fair value of
stock options. We are required to make certain assumptions with respect to
selected Black-Scholes model inputs, including expected volatility, expected
life, expected dividend yield and the risk-free interest rate. Expected
volatility is based on the historical volatility of our stock over the most
recent period commensurate with the estimated expected life of the stock
options. The expected life of stock options granted, which represents the period
of time that the stock options are expected to be outstanding, is based,
primarily, on historical data. The expected dividend yield is based on our
history and expectation of dividend payouts. The risk-free interest rate is
based on the U.S. Treasury yield curve in effect at the time of grant for a
period commensurate with the estimated expected life.
The fair value of time-based as well as nonmarket-based performance restricted
stock and restricted stock unit awards is equal to the fair value of the
Company's stock on the date of grant. The fair value of market-based performance
restricted stock unit awards is determined by utilizing a Monte Carlo simulation
model, which projects the value of Greatbatch stock versus our peer group under
numerous scenarios and determines the value of the award based upon the present
value of these projected outcomes.
Compensation cost for nonmarket-based performance awards is reassessed each
period and recognized based upon the probability that the performance targets
will be achieved. That assessment is based upon actual and expected future
performance.
Stock-based compensation expense is recorded for those awards that are expected
to vest, as well as market and nonmarket performance award considerations.
Forfeiture estimates for determining appropriate stock-based compensation
expense are estimated at the time of grant based on historical experience and
demographic characteristics. Revisions are made to those estimates in subsequent
periods if actual forfeitures differ from estimated forfeitures.
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Effect of Variation of Key Assumptions Used
Option pricing models were developed for use in estimating the value of traded
options that have no vesting restrictions and are fully transferable. Because
our share-based payments have characteristics significantly different from those
of freely traded options, and because changes in the subjective input
assumptions can materially affect our estimates of fair values, existing
valuation models may not provide reliable measures of the fair values of our
share-based compensation. Consequently, there is a risk that our estimates of
the fair values of our share-based compensation awards may bear little
resemblance to the actual values realized upon the exercise, expiration or
forfeiture of those share-based payments in the future. Stock options may expire
worthless or otherwise result in zero intrinsic value as compared to the fair
values originally estimated on the grant date and reported in our consolidated
financial statements. Alternatively, value may be realized from these
instruments that are significantly in excess of the fair values originally
estimated on the grant date and reported in our consolidated financial
statements. There are significant differences among valuation models. This may
result in a lack of comparability with other companies that use different
models, methods and assumptions.
There is a high degree of subjectivity involved in selecting assumptions to be
utilized to determine fair value and forfeiture assumptions. If factors change
and result in different assumptions in future periods, the expense that we
record for future grants may differ significantly from what we have recorded in
the current period. Additionally, changes in performance of the Company and its
stock price will affect the likelihood that performance-based targets are
achieved and could materially impact the amount of stock-based compensation
expense recognized.
A 1% change in our stock-based compensation expense would change 2012 net income
(loss) by approximately $0.07 million, or approximately $0.003 per diluted
share.
Inventories
Inventories are stated at the lower of cost, determined using the first-in,
first-out method, or market.
Assumptions/Approach Used
Inventory costing requires complex calculations that include assumptions for
overhead absorption, scrap, sample calculations, manufacturing yield estimates
and the determination of which costs may be capitalized. The valuation of
inventory requires us to estimate obsolete or excess inventory, as well as
inventory that is not of saleable quality.
Effect of Variation of Key Assumptions Used
Variations in methods or assumptions could have a material impact on our
results. If our demand forecast for specific products is greater than actual
demand and we fail to reduce manufacturing output accordingly, we could be
required to record additional inventory write-downs or expense a greater amount
of overhead costs, which would have a negative impact on our net income. As of
December 28, 2012, we have $106.6 million of inventory recorded on our
consolidated balance sheet representing 12% of total assets. A 1% write-down of
our inventory would change 2012 net income (loss) by approximately $0.7 million,
or approximately $0.03 per diluted share.
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Tangible long-lived assets
Property, plant and equipment and other tangible long-lived assets are carried
at cost. The cost of property, plant and equipment is charged to depreciation
expense over the estimated life of the operating assets primarily using
straight-line rates. Tangible long-lived assets are subject to impairment
assessment if certain indicators are present.
Assumptions/Approach Used
We assess the impairment of tangible long-lived assets when events or changes in
circumstances indicate that the carrying value of the asset (asset group) may
not be recoverable. Factors that we consider in deciding when to perform an
impairment review include, but are not limited to: a significant decrease in the
market price of the asset (asset group); a significant change in the extent or
manner in which a long-lived asset (asset group) is being used or in its
physical condition; a significant change in legal factors or in the business
climate that could affect the value of a long-lived asset (asset group),
including an action or assessment by a regulator; an accumulation of costs
significantly in excess of the amount originally expected for the acquisition or
construction; a current-period operating or cash flow loss combined with a
history of operating or cash flow losses or a projection or forecast that
demonstrates continuing losses associated with the use of a long-lived asset
(asset group); or a current expectation that, more likely than not, a long-lived
asset (asset group) will be sold or otherwise disposed of significantly before
the end of its previously estimated useful life. Recoverability potential is
measured by comparing the carrying amount of the asset (asset group) to the
related total future undiscounted cash flows. The projected cash flows for each
asset (asset group) considers multiple factors, including current revenue from
existing customers, proceeds from the sale of the asset (asset group),
reasonable contract renewal assumptions, and expected profit margins giving
consideration to historical and expected margins. If an asset's (assets group's)
carrying value is not recoverable through related cash flows, the asset (asset
group) is considered to be impaired. Impairment is measured by comparing the
asset's (asset group's) carrying amount to its fair value. When it is determined
that useful lives of assets are shorter than originally estimated, and there are
sufficient cash flows to support the carrying value of the assets, we accelerate
the rate of depreciation in order to fully depreciate the assets over their
shorter useful lives.
Effect of Variation of Key Assumptions Used
Estimation of the cash flows and useful lives of tangible assets that are
long-lived requires significant management judgment. Events could occur that
would materially affect our estimates and assumptions. Unforeseen changes in
operations or technology could substantially alter the assumptions regarding the
ability to realize the return of our investment in long-lived assets or the
useful lives. Also, as we make manufacturing process conversions and other
facility consolidation decisions, we must make subjective judgments regarding
the remaining cash flows and useful lives of our assets, primarily manufacturing
equipment and buildings. Significant changes in these estimates and assumptions
could change the amount of future depreciation expense or could create future
impairments of these long-lived assets (asset groups).
As of December 28, 2012 we have $150.9 million of tangible long-lived assets
recorded on our consolidated balance sheet representing 17% of total assets. A
1% write-down in our tangible long-lived assets would change 2012 net income
(loss) by approximately $1.0 million, or approximately $0.04 per diluted share.
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Provision for income taxes
Our consolidated financial statements have been prepared using the asset and
liability approach in accounting for income taxes, which requires the
recognition of deferred income taxes for the expected future tax consequences of
net operating losses, credits, and temporary differences between the financial
statement carrying amounts and the tax bases of assets and liabilities. A
valuation allowance is provided on deferred tax assets if it is determined that
it is more likely than not that the asset will not be realized.
Assumptions/Approach Used
In recording the provision for income taxes, management must estimate the future
tax rates applicable to the reversal of temporary differences based upon the
timing of expected reversal. Also, estimates are made as to whether taxable
operating income in future periods will be sufficient to fully recognize any
gross deferred tax assets. If recovery is not likely, we must increase our
provision for income taxes by recording a valuation allowance against the
deferred tax assets that we estimate will not ultimately be recoverable.
Alternatively, we may make estimates about the potential usage of deferred tax
assets that decrease our valuation allowances.
The calculation of our tax liabilities involves dealing with uncertainties in
the application of complex tax regulations. Significant judgment is required in
evaluating our tax positions and determining our provision for income taxes.
During the ordinary course of business, there are many transactions and
calculations for which the ultimate tax determination is uncertain. We establish
reserves for uncertain tax positions when we believe that certain tax positions
do not meet the more likely than not threshold. We adjust these reserves in
light of changing facts and circumstances, such as the outcome of a tax audit or
the lapse of statutes of limitations. The provision for income taxes includes
the impact of reserve provisions and changes to the reserves that are considered
appropriate.
Effect of Variation of Key Assumptions Used
Changes could occur that would materially affect our estimates and assumptions
regarding deferred taxes. Changes in current tax laws and tax rates could affect
the valuation of deferred tax assets and liabilities, thereby changing the
income tax provision. Also, significant declines in taxable income could
materially impact the realizable value of deferred tax assets. At December 28,
2012, we had $38.5 million of gross deferred tax assets on our consolidated
balance sheet and a valuation allowance of $12.8 million has been established
for certain deferred tax assets as it is more likely than not that they will not
be realized. A 1% change in the effective tax rate would impact the current year
provision for income taxes by $0.07 million, and 2012 diluted earnings (loss)
per share by $0.003 per diluted share.
Our Financial Results
We utilize a fifty-two, fifty-three week fiscal year ending on the Friday
nearest December 31st. Fiscal years 2012, 2011 and 2010 ended on December 28,
2012, December 30, 2011 and December 31, 2010, respectively. Fiscal years 2012,
2011 and 2010 all contained fifty-two weeks.
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Results of Operations Table
Year Ended 2012 vs. 2011 2011 vs. 2010
Dec. 28, Dec. 30, Dec. 31, $ % $ %
2012 2011 2010 Change Change Change Change
Dollars in thousands, except per share
data
Implantable Medical Sales
Cardiac/Neuromodulation $ 309,124 $ 303,690 $ 303,521 $ 5,434 2 % $ 169 0 %
Vascular 51,980 45,098 38,000 6,882 15 % 7,098 19 %
Orthopaedic 122,061 140,277 118,748 (18,216 ) -13 % 21,529 18 %
Total Implantable Medical 483,165 489,065 460,269 (5,900 ) -1 % 28,796 6 %
Electrochem Sales
Portable medical 81,659 9,609 8,432 72,050 NA 1,177 14 %
Energy/Environmental 67,046 58,934 54,668 8,112 14 % 4,266 8 %
Other 14,307 11,214 10,056 3,093 28 % 1,158 12 %
Total Electrochem 163,012 79,757 73,156 83,255 104 % 6,601 9 %
Total sales 646,177 568,822 533,425 77,355 14 % 35,397 7 %
Cost of sales 444,528 388,469 359,844 56,059 14 % 28,625 8 %
Gross profit 201,649 180,353 173,581 21,296 12 % 6,772 4 %
Gross profit as a % of sales 31.2 % 31.7 % 32.5 %
Selling, general and administrative
expenses (SG&A) 80,992 72,548 64,510 8,444 12 % 8,038 12 %
SG&A as a % of sales 12.5 % 12.8 % 12.1 %
Research, development and engineering
costs, net (RD&E) 52,490 45,513 45,019 6,977 15 % 494 1 %
RD&E as a % of sales 8.1 % 8.0 % 8.4 %
Electrochem litigation gain - - (9,500 ) - NA 9,500 -100 %
Other operating expenses, net 42,346 593 4,558 41,753 NA (3,965 ) -87 %
Operating income 25,821 61,699 68,994 (35,878 ) -58 % (7,295 ) -11 %
Operating margin 4.0 % 10.8 % 12.9 %
Interest expense 18,055 16,928 18,519 1,127 7 % (1,591 ) -9 %
Interest income (1 ) (21 ) (10 ) 20 -95 % (11 ) 110 %
(Gain) loss on cost and equity method
investments, net 106 (4,232 ) 150 4,338 -103 % (4,382 ) NA
Other expense, net
931 632 1,010 299 47 % (378 ) -37 %
Provision for income taxes 11,529 15,270 16,187 (3,741 ) -24 % (917 ) -6 %
Effective tax rate 171.3 % 31.6 % 32.8 %
Net income (loss) $ (4,799 ) $ 33,122 $ 33,138 $ (37,921 ) -114 % $ (16 ) 0 %
Net margin -0.7 % 5.8 % 6.2 %
Diluted earnings (loss) per share $ (0.20 ) $ 1.40 $ 1.40 $ (2 ) -114 % $ - 0 %
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Fiscal 2012 Compared with Fiscal 2011
Sales
Changes to sales by major product lines were as follows (in thousands):
Year Ended 2012 vs. 2011
December 28, December 30, $ %
2012 2011 Change Change
Sales:
Implantable Medical
Cardiac/Neuromodulation $ 309,124 $ 303,690 $ 5,434 2 %
Vascular 51,980 45,098 6,882 15 %
Orthopaedic 122,061 140,277 (18,216 ) -13 %
Total Implantable Medical 483,165 489,065 (5,900 ) -1 %
Portable Medical 81,659 9,609 72,050 N/A
Energy/Environmental 67,046 58,934 8,112 14 %
Other 14,307 11,214 3,093 28 %
Electrochem 163,012 79,757 83,255 104 %
Total sales $ 646,177 $ 568,822 $ 77,355 14 %
Implantable Medical - For 2012, our cardiac/neuromodulation sales increased 2%
to $309.1 million which exceeded our expectations. During 2012, cardiac and
neuromodulation sales benefited from further adoption of our Q series batteries
partially offset by the timing of customer inventory builds and product launches
between 2011 and 2012. Management remains cautiously optimistic over the
short-term prospects of this product line given the continued ongoing challenges
surrounding some of our key cardiac customers. It is important to note that our
visibility to customer ordering patterns is over a short period of time and that
any significant customer field actions or relative market share shifts among OEM
manufacturers could impact our results. We believe that the impact of these
factors is somewhat muted by the fact that we have business with all of the key
cardiac OEMs and have significantly diversified our revenue base. Additionally,
we continue to see an increased pace of product development opportunities from
our 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.
For 2012, our vascular product line sales increased 15% to $52.0 million. This
increase was primarily attributable to growth in the underlying market and
market share gains. Additionally, vascular revenue for the year included $6.6
million from sales of medical devices that were developed under the Greatbatch
name compared to $4.5 million for 2011, an increase of 47%.
Orthopaedic product line sales for 2012 declined 13% compared to the same period
of 2011. On a constant currency basis, orthopaedic sales declined 8% for 2012 as
foreign currency exchange rate fluctuations decreased orthopaedic revenue by
approximately $6 million. The remaining decline in 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 at our
Swiss orthopaedic facilities, which were aggressively addressed in 2012. In
addition to the consolidation of manufacturing, during 2012, we also streamlined
our Swiss orthopaedic product line offerings. This included the sale of several
non-core product lines to an independent third party near the end of the year,
which closed in early 2013. Our current estimate is that the sale of these
products will reduce our 2013 orthopaedic revenue by approximately $15 million
in comparison to 2012. For 2013, we expect our performance to improve as we
progress through the year, as the first quarter of 2013 will be impacted by the
startup of these recently transferred orthopaedic production lines. The second
half of the year is expected to improve as this orthopaedic backlog is relieved.
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Our Implantable Medical customers have various inventory management, dual
sourcing, and vertical integration initiatives in place, and the relative market
share among OEM manufacturers' changes continuously. Additionally, we face
pricing pressures from our customers and in particular our four largest OEM
customers upon which a significant portion of our sales is dependent. These
pressures have increased over the last several years due to the downturn in the
global economy, and more specifically, the contracting CRM market. Consequently,
these and other factors will continue to significantly impact our sales.
Electrochem - 2012 sales for Electrochem increased $83.3 million to $163.0
million. 2012 Electrochem sales included $82.4 million of incremental revenue
related to the acquisition of Micro Power in December 2011. On an organic basis,
Electrochem revenue was consistent with the prior year. During 2012, the Micro
Power acquisition exceeded our expectations, which is benefitting from
successful product launches into the higher growth, higher value portable
medical market. The market shift in patient care from clinical settings to the
home, and an aging population, is driving the need for lightweight and portable
devices for patients and caregivers. Electrochem's technology, customer
relationships, and legacy of delivering highly reliable and innovative solutions
has enabled it to win in this evolving market and continues to position
Electrochem to capture market share. Electrochem continues to secure long-term
agreements in this space and our funnel of portable medical products from this
acquisition continues to be full, which is expected to drive revenue growth for
this product line for the next several years.
Gross Profit
Changes to gross profit as a percentage of sales were primarily due to the
following:
2012-2011
% Point Change
Impact of acquisitions(a) -1.2 %
Excess capacity & Swiss production inefficiencies(b) -1.6 %
Volume and productivity(c) 2.2 %
Performance-based compensation(d) 0.4 %
Selling price(e) -0.5 %
Other 0.2 %
Total percentage point change to gross profit as a
percentage of sales -0.5 %
(a) Our gross profit percentage was impacted by the acquisition of Micro Power in
December 2011, which had a lower gross margin percentage due to its higher
percentage of material costs in comparison to our legacy businesses.
Additionally, during 2012 we recognized $0.5 million of inventory step-up
amortization in connection with this acquisition, which will not recur in
subsequent periods.
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(b) Our gross profit percentage was negatively impacted during 2012 due to
production inefficiencies at our Swiss orthopaedic facilities. Additionally,
as a result of the addition of our Fort Wayne facility in the second quarter
of 2012, we experienced excess capacity costs in comparison to 2011. In
accordance with our inventory accounting policy, excess capacity costs are
expensed in the period they occur. In 2012, we aggressively right-sized our
orthopaedic cost structure, which is expected to help improve our gross
margin percentage starting in the first quarter of 2013.
(c) Our gross profit percentage benefitted from higher sales volumes, primarily
cardiac and vascular, as well as production efficiencies gained at our
manufacturing facilities as a result of our various lean and supply chain
initiatives.
(d) Amount represents lower performance-based compensation expense recorded based
upon the results for 2012 compared to 2011. Performance-based compensation is
accrued based upon the level of performance achieved relative to targets set
at the beginning of the year.
(e) Our gross profit percentage has been negatively impacted in comparison to the
prior year by price concessions made to our larger OEM customers, which were
given in exchange for long-term contracts.
Over the long-term, we expect to see gross margin improvements as a result of
the consolidation of our orthopaedic operations and from various other
productivity improvement initiatives that are being implemented (See "Cost
Savings and Consolidation Efforts" section of this item). Additionally, we
expect our gross profit margin to improve as more system and device level
products are introduced, which typically earn a higher margin. Management is
currently evaluating the impact that the new medical device tax will have on our
results from operations beginning in 2013, and has preliminarily estimated that
it will reduce gross profit by $1.5 million to $2.5 million. This amount assumes
that this tax applies to the first medical device sale in the U.S. and is based
upon a wholesale price.
SG&A Expenses
Changes to SG&A expenses were primarily due to the following (in thousands):
2012-2011
$ Change
Impact of acquisitions(a) $ 9,552
Professional and consulting expense(b) 743
Medical device strategy communication(c) (501 )
Other(d) (1,350 )
Net increase in SG&A $ 8,444
(a) Amount represents the incremental SG&A expenses in 2012 versus 2011 related
to the acquisition of Micro Power and NeuroNexus.
(b) Amount represents the change in professional and consulting expense from 2011
and reflects a higher level of costs incurred in connection with our medical
device strategy and our increased investment in sales and marketing to drive
core business growth.
(c) Amount represents the costs incurred during 2011 in connection with the
communication of our medical device strategy to shareholders, customers and
associates including costs incurred for our Investor Day held in the first
quarter of 2011, which did not recur in 2012.
(d) Amount represents various decreases in SG&A expenses during 2012 and reflects
the cost control initiatives being implemented by the Company including cost
reductions in connection with our Swiss orthopaedic consolidations.
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RD&E Expenses, Net
Net RD&E costs were as follows (in thousands):
Year Ended
December 28, December 30,
2012 2011 Change Research and development costs $ 24,071 $ 19,014
$ 5,057
Engineering costs 38,777 35,472 3,305
Less cost reimbursements (10,358 ) (8,973 ) (1,385 )
Total RD&E, net $ 52,490 $ 45,513 $ 6,977
Net RD&E for 2012 increased $7.0 million to $52.5 million. Approximately $2.6
million of this increase was a result of the operations from our recent
acquisitions. Additionally, $3.2 million of this increase can be attributed to
the investment in the development of complete medical devices, which totaled
$24.8 million for 2012 compared to $21.6 million for 2011. These amounts include
$5.2 million and $5.1 million, respectively, of DVT costs in connection with our
development of a neuromodulation platform. When combined with SG&A expenses,
total costs incurred in connection with our medical device initiatives totaled
$33.9 million for 2012 versus $27.3 million for 2011.
During the second half of 2012, we began to implement an initiative to optimize
our RD&E investment. This included the reallocation of RD&E resources to higher
priority projects, the postponement of some RD&E projects, as well as the
decision to pursue various alternatives to monetize some of our existing
intellectual property that are outside our core business. As a result of this
initiative, RD&E for the second half of 2012 was $3.7 million lower than the
first half of 2012. These reductions are also expected to benefit 2013.
The increase in cost reimbursements in 2012 was a result of our NeuroNexus
acquisition. These cost reimbursements can vary significantly from year to year
due to the timing of the achievement of milestones on development projects.
Other Operating Expenses, Net
Other operating expenses, net were comprised of the following (in thousands):
Year Ended
December 28, December 30,
2012 2011 Change
Orthopaedic facility optimization(a) $ 32,482 $ 425 $ 32,057
Medical device facility optimization(a) 1,525 - 1,525
ERP system upgrade(a) 5,041 - 5,041
Integration costs(b) 1,460 - 1,460
Asset dispositions, severance and other(c) 1,838 168 1,670
Total other operating expenses, net $ 42,346 $ 593 $ 41,753
(a) Refer to "Cost Savings and Consolidation Efforts" section of this Item and
Note 13 "Other Operating Expenses, Net" of the Notes to Consolidated
Financial Statements contained in Item 8 of this report for disclosures
related to the timing and level of remaining expenditures for these
initiatives.
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(b) During 2012, we incurred costs related to the integration of Micro Power and
NeuroNexus. These expenses were primarily for retention bonuses, travel costs
in connection with integration efforts, and severance, which will not be
required in 2013 as these integrations are completed.
(c) During 2012 and 2011, we recorded write-downs in connection with various
asset disposals, net of insurance proceeds received, if any. Additionally,
during 2012, we incurred $1.2 million of costs related to the relocation of
our global headquarters to Frisco, Texas. During 2011, we incurred $0.6
million of acquisition related costs in connection with our purchase of Micro
Power.
Other operating expenses will be reduced significantly in 2013 and are expected
to range from $6.7 million-$8.2 million, which will improve the overall earnings
of Greatbatch. While we continually identify and implement cost improvement
initiatives, we have now completed all of our major plant consolidations, so our
leadership team can focus on achieving sustainable organic growth and leverage
our available capacity.
Interest Expense and Interest Income
Interest expense for 2012 increased $1.1 million over 2011 due to the increased
discount amortization related to our convertible notes, which is being amortized
utilizing the effective interest method. See Note 9 "Debt" of the Notes to
Consolidated Financial Statements contained in Item 8 of this report. Interest
income for 2012 was relatively consistent with 2011.
Gain (Loss) on Cost and Equity Method Investments, Net
In 2011, we sold our cost method investment in IntElect Medical, Inc.
("IntElect") in conjunction with Boston Scientific's acquisition of IntElect. We
obtained our ownership interest in IntElect through our acquisition of BIOMEC,
Inc. in 2007 and two subsequent additional investments. This transaction
resulted in a pre-tax gain of $4.5 million. During 2012 and 2011, we recognized
impairment charges related to our cost and equity method investments of $0.1
million and $0.3 million, respectively. The aggregate recorded amount of our
cost and equity method investments at December 28, 2012 was $9.1 million. These
investments are in start-up research and development companies whose fair value
is highly subjective in nature and subject to future fluctuations, which could
be significant. Our exposure related to these entities is limited to our
recorded investment.
Other Expense, Net
Other expense, net primarily includes the impact of foreign currency exchange
rate fluctuations on transactions denominated in foreign currencies. We
generally do not expect foreign currency exchange rate fluctuations to have a
material impact on our results of operations.
Provision for Income Taxes
The effective tax rate for the year ended December 28, 2012 was 171.3%, versus
31.6% for 2011. The stand-alone U.S. component of the effective tax rate for the
year ended December 28, 2012 was 33.1% versus 31.5% for 2011.
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The provision for income taxes for 2012 differs from the U.S. statutory rate due
to the following (dollars in thousands):
U.S. International Combined
$ % $ % $ %
Income (loss) before provision for
income taxes $ 36,057 $ (29,327 ) $ 6,730
Provision at statutory rate $ 12,620 35.0 % $ (10,265 ) 35.0 % $ 2,355 35.0 %
Foreign rate differential - - 3,414 (11.6 ) 3,414 50.7
Change in tax rate-loss of Swiss tax
holiday - - 1,721 (5.9 ) 1,721 25.6
Uncertain tax positions (681 ) (1.9 ) - - (681 ) (10.1 )
State taxes, net of federal benefit 329 0.9 - - 329 4.9
Valuation allowance - - 4,552 (15.5 ) 4,552 67.6
Other (350 ) (0.9 ) 189 (0.6 ) (161 ) (2.4 )
Provision (benefit) for income
taxes/effective tax rate $ 11,918 33.1 % $ (389 ) 1.4 % $ 11,529 171.3 %
The fluctuation between the overall rate of 171.3% in 2012 and the 31.6% in 2011
is primarily attributable to approximately $6.2 million of tax charges
(approximately 92% increase in our effective tax rate) recorded in connection
with our Swiss orthopaedic restructuring. These charges relate to the loss of
our Swiss tax holiday, due to our 2012 decision to transfer manufacturing out of
Switzerland, as well as the establishment of a valuation allowance on a portion
of our Swiss deferred tax assets as it is more likely than not that they will
not be fully realized. Additionally, our 2012 effective tax rate reflects the
impact of approximately $31.3 million of losses resulting from our Swiss
restructuring, the benefit of which are recorded at the lower Swiss effective
tax rate, thus giving rise to an approximate 57% increase in the overall
effective tax rate of the Company.
The fluctuation of the effective tax rate for the U.S. between 2012 (33.1%) and
2011 (31.5%) is primarily attributable to the expiration of the U.S. R&D tax
credit at the end of 2011. On January 2, 2013, the President signed into law the
American Taxpayer Relief Act of 2012, which includes a retroactive extension of
the section 41 R&D tax credit that had expired on December 31, 2011. Under the
American Taxpayer Relief Act of 2012, the tax R&D credit is extended for two
years retroactively from January 1, 2012 through December 31, 2013. As the R&D
tax credit was signed into law on January 2, 2013, as required by GAAP, the
benefit for the R&D tax credits earned in 2012 will be recognized in the first
quarter of fiscal 2013. R&D tax credits earned in 2013 will be recorded through
the fiscal 2013 effective tax rate. We estimate that the benefit related to the
2012 R&D tax credits will be approximately $1.5 million.
There is a potential for volatility of the effective tax rate due to several
factors, including changes in the mix of pre-tax income and the jurisdictions to
which it relates, business acquisitions, settlements with taxing authorities and
foreign currency exchange rate fluctuations.
We believe it is reasonably possible that a reduction of up to $0.1 million of
the balance of our unrecognized tax benefits may occur within the next twelve
months as a result of the expiration of applicable statutes of limitation and
potential audit settlements, which would positively impact the effective tax
rate in the period of reduction.
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Fiscal 2011 Compared with Fiscal 2010
Sales
Changes to sales by major product lines were as follows (in thousands):
Year Ended 2011 vs. 2010
December 30, December 31, $ %
2011 2010 Change Change
Sales:
Implantable Medical
Cardiac/Neuromodulation $ 303,690 $ 303,521 $ 169 0 %
Vascular 45,098 38,000 7,098 19 %
Orthopaedic 140,277 118,748 21,529 18 %
Total Implantable Medical 489,065 460,269 28,796 6 %
Portable Medical 9,609 8,432 1,177 14 %
Energy/Environmental 58,934 54,668 4,266 8 %
Other 11,214 10,056 1,158 12 %
Electrochem 79,757 73,156 6,601 9 %
Total sales $ 568,822 $ 533,425 $ 35,397 7 %
Implantable Medical - For the year, cardiac/neuromodulation sales were
consistent with 2010. During the first half of 2011, cardiac revenue included
the benefit of customer inventory builds and product launches, which did not
recur in the second half of 2011. Additionally, cardiac/neuromodulation sales
were impacted by pricing pressures and a slowdown in the underlying market.
Full year 2011 vascular sales increased 19% over 2010. This increase was
primarily attributable to growth in the underlying market and market share
gains. Additionally, vascular revenue for 2011 included approximately $4.5
million from sales of medical devices that were developed under the Greatbatch
name, including sales of our OptiSeal Valved Peelable Introducer which received
FDA clearance in 2010.
Orthopaedic sales of $140.3 million for 2011 were 18% above 2010, and included
approximately $8 million of favorable foreign currency exchange rate benefit.
Excluding this benefit, sales increased 11% organically over 2010 despite slower
than expected underlying market growth. These increases occurred across all of
our orthopaedic products, which benefitted from customer product launches, as
well as from market share gains during 2011.
Electrochem - For 2011, sales for the Electrochem business segment increased 9%
in comparison to 2010. Fourth quarter 2011 sales for Electrochem included $2.5
million of additional revenue from the Micro Power acquisition. Excluding the
additional revenue provided by Micro Power, sales for 2011 increased 6% on an
organic basis. During 2011, Electrochem revenue varied from quarter to quarter
due to the timing of various customer inventory pulls. For the full year, the
increase in Electrochem revenue was a result of an increased investment in sales
and marketing, which resulted in market share gains and several new customer
contracts, as well as continued strength in the energy markets.
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Gross Profit
Changes to gross profit as a percentage of sales were primarily due to the
following:
2011-2010
% Point Change
Capacity & productivity(a) 0.9 %
Performance-based compensation(b) -0.9 %
Mix change(c) -0.5 %
Selling price(d) -0.8 %
Other 0.5 %
Total percentage point change to gross profit as a
percentage of sales -0.8 %
(a) Our gross profit percentage for 2011 benefitted from higher sales volumes,
which absorbed excess capacity, as well as productivity gains from our
various lean initiatives.
(b) Amount represents higher performance-based compensation expense recorded
based upon the results for 2011 compared to 2010. Performance-based
compensation is accrued based upon the level of performance achieved relative
to targets set at the beginning of the year.
(c) Our gross profit percentage for 2011 was negatively impacted by a lower mix
of higher-margin cardiac/neuromodulation sales as a percentage of total sales
compared to 2010.
(d) Our gross profit percentage throughout 2011 was negatively impacted, in
comparison to 2010, by price concessions made to our larger OEM customers
near the end of 2010, which were given in exchange for long-term contracts.
SG&A Expenses
Changes to SG&A expenses were primarily due to the following (in thousands):
2011-2010
$ Change
Performance-based compensation(a) $ 3,935
Professional and consulting expense(b) 5,224
Litigation related fees and charges(c) (808 )
Executive death benefits(d) (885 )
Micro Power SG&A costs(e) 358
Other 214
Net increase in SG&A $ 8,038
(a) SG&A costs for 2011 include a higher level of performance-based compensation
expense due to achieving a higher percentage of our targets in 2011 in
comparison to 2010. Performance-based compensation is accrued based upon
management's expectation of performance relative to targets set.
(b) Amount represents the change in professional and consulting expense from 2010
and reflects a higher level of costs incurred in connection with our medical
device strategy, which impacted SG&A by $4.0 million. These costs included
consulting fees paid to outside contractors who are providing technical
expertise on our device projects, as well as legal fees incurred in
connection with the numerous patent filings that we are making.
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(c) During 2010, the Company incurred fees and charges in connection with two
litigation matters that were subsequently settled near the end of 2010.
Accordingly, litigation related fees and charges were lower during 2011 in
comparison to the prior year.
(d) SG&A expenses for 2010 include death benefits provided to the family of the
Company's former Senior Vice President-Orthopaedics.
(e) Amount represents the SG&A costs related to the operations of Micro Power,
which was acquired on December 15, 2011.
RD&E Expenses, Net
Net RD&E costs were as follows (in thousands):
Year Ended
December 30, December 31,
2011 2010 Change Research and development costs $ 19,014 $ 17,378
$ 1,636
Engineering costs 35,472 34,208 1,264
Less cost reimbursements (8,973 ) (6,567 ) (2,406 )
Total RD&E, net $ 45,513 $ 45,019 $ 494
Net RD&E costs for 2011 totaled $45.5 million, or 8.0% of sales, versus $45.0
million, or 8.4% of sales for 2010. During 2011, we continued to invest
resources in developing complete medical devices for our OEM customers. Total
RD&E costs incurred in connection with our medical device initiatives were $21.6
million during 2011 compared to $20.3 million in 2010. This included $5.1
million of design verification testing costs expensed in 2011 related to the QiG
Group's development of a neuromodulation platform. When combined with the SG&A
expenses discussed above, total costs incurred in connection with our medical
device initiatives totaled $27.3 million in 2011 versus $21.9 million in 2010.
Partially offsetting these RD&E increases was a higher level of customer cost
reimbursements of $2.4 million for 2011. These cost reimbursements can vary
significantly from period to period due to the timing of the achievement of
milestones on development projects.
Electrochem Litigation Charge (Gain)
In 2009, a Louisiana jury found in favor of a former Electrochem customer on
their claims made in connection with a failed business transaction dating back
to 1997. During 2009, we accrued $34.5 million in connection with this
litigation after the unfavorable jury verdict. In the fourth quarter of 2010, we
settled this litigation for $25 million and accordingly recognized a $9.5
million gain. See Note 15 "Commitments and Contingencies" of the Notes to
Consolidated Financial Statements contained in Item 8 of this report.
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Other Operating Expenses, Net
Other operating expenses, net were comprised of the following (in thousands):
Year Ended
December 30, December 31,
2011 2010 Change
Orthopaedic facility optimization(a) $ 425 $ 225 $ 200
2007 & 2008 facility shutdowns and
consolidations(b) - 1,348 (1,348 )
Integration costs(c) - 42 (42 )
Asset dispositions, severance and
other(d) 168 2,943 (2,775 )
Total other operating expenses, net $ 593 $ 4,558 $ (3,965 )
(a) During the third quarter of 2010, we began to incur costs in connection with
the optimization of our orthopaedic operations in order to increase capacity,
further expand our capabilities and reduce dependence on outside suppliers.
(b) In 2010, we recorded charges related to our various cost savings and
consolidation efforts initiated in 2007 and 2008.
(c) During 2010, we incurred costs related to the integration of the companies
acquired in 2007 and 2008.
(d) During 2011 and 2010, we recorded write-downs in connection with various
asset disposals, net of insurance proceeds received, if any. Additionally,
during 2011 we incurred $0.6 million of acquisition related costs in
connection with our purchase of Micro Power. During 2010, we consolidated our
Implantable Medical segment, which included the elimination of certain
positions globally. Severance charges associated with this realignment were
$2.3 million.
Interest Expense and Interest Income
Interest expense for 2011 decreased $1.6 million from 2010 primarily due to the
repayment of $118.5 million of long-term debt during 2011 and 2010 as well as
the impact of lower interest rates, partially offset by increased discount
amortization on our convertible notes. Interest income for 2011 was relatively
consistent with 2010.
Gain (Loss) on Cost and Equity Method Investments
In 2011, we sold our cost method investment in IntElect in conjunction with
Boston Scientific's acquisition of IntElect. This transaction resulted in a
pre-tax gain of $4.5 million. During 2011 and 2010, we recognized impairment
charges related to our cost method investments of $0.3 million and $0.2 million,
respectively, based upon recent stock offerings by those companies.
Other Expense, Net
Other expense, net primarily includes the impact of foreign currency exchange
rate fluctuations on transactions denominated in foreign currencies.
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Provision for Income Taxes
The effective tax rate for 2011 was 31.6% versus 32.8% for 2010. The effective
tax rates for 2011 and 2010 are lower than the U.S. statutory rate primarily due
to the R&D tax credit, as well as the favorable impact of the resolution of tax
audits and the lapse of statutes of limitation on certain tax items. See Note 14
"Income Taxes" of the Notes to Consolidated Financial Statements contained in
Item 8 of this report for a reconciliation of the U.S. statutory rate to our
effective tax rate.
Liquidity and Capital Resources
At
December 28, December 30,
(Dollars in thousands) 2012 2011
Cash and cash equivalents $ 20,284 $ 36,508
Working capital $ 176,376 $ 170,907
Current ratio 2.92 2.82
The decrease in cash and cash equivalents from the end of 2011 was primarily due
to the cash used in connection with our acquisitions ($17.2 million), the
purchase of property, plant and equipment ($41.1 million) in connection with our
various cost savings and consolidation initiatives, and the net repayment of
long-term debt ($22 million) during the year partially offset by cash flows from
operations ($64.8 million). Our working capital and current ratio remained
consistent with the prior year. Of the $20.3 million of cash on hand as of
December 28, 2012, $4.5 million is being held at our foreign subsidiaries.
Revolving Line of Credit - We have a senior credit facility (the "Credit
Facility") consisting of a $400 million revolving line of credit, which can be
increased to $600 million upon our request and approval by a majority of the
lenders. The Credit Facility also contains a $15 million letter of credit
subfacility and a $15 million swingline subfacility. The Credit Facility has a
maturity date of June 24, 2016; provided, however, if our convertible
subordinated notes ("CSN") are not repaid in full, modified or refinanced before
March 1, 2013, the maturity date of the Credit Facility is March 1, 2013. On
February 20, 2013, we redeemed all outstanding CSN, which was funded with
availability under the Credit Facility.
The Credit Facility is supported by a consortium of fourteen banks with no bank
controlling more than 19% of the facility. As of December 28, 2012, each bank
supporting the Credit Facility has an S&P credit rating of at least BBB or
better, which is considered investment grade.
The Credit Facility requires us to maintain a rolling four quarter ratio of
adjusted EBITDA to interest expense of at least 3.0 to 1.0. For the twelve month
period ended December 28, 2012, our ratio of adjusted EBITDA to interest
expense, calculated in accordance with our credit agreement, was 17.3 to 1.00,
well above the required limit. The Credit Facility also requires us to maintain
a total leverage ratio of not greater than 4.0 to 1.0. As of December 28, 2012,
our total leverage ratio, calculated in accordance with our credit agreement,
was 2.2 to 1.00, well below the required limit.
The Credit Facility contains customary events of default. Upon the occurrence
and during the continuance of an event of default, a majority of the lenders may
declare the outstanding advances and all other obligations under the Credit
Facility immediately due and payable. See Note 9 "Debt" of the Notes to
Consolidated Financial Statements contained in Item 8 of this report.
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As of December 28, 2012, we had $367 million of borrowing capacity available
under the Credit Facility. As of February 27, 2013, we had available $174
million of borrowing capacity available under the Credit Facility as a result of
the redemption of all CSN in February 2013. This amount may vary from period to
period based upon our debt and EBITDA levels, which impacts the covenant
calculations discussed above. We believe that our cash flow from operations and
the Credit Facility provide adequate liquidity to meet our short and long term
funding needs.
Operating activities - Cash flows from operating activities for 2012 were $64.8
million compared to $89.9 million for 2011. The decrease in cash flows from
operating activities from the prior year is primarily due to our lower net
income as well as a slight increase in working capital balances.
Investing activities - Net cash used in investing activities for 2012 was $59.8
million compared to $80.4 million for 2011. This decrease was primarily related
to the cash payments made in 2011 for the acquisition of Micro Power of $66.5
million, partially offset by $18.6 million of additional investments made in
property, plant and equipment primarily in connection with the consolidation and
optimization initiatives discussed in the "Cost Savings and Consolidation
Efforts" section of this Item (primarily the construction of our Fort Wayne
facility which was completed in 2012) and routine capital expenditures. Our
current expectation is that capital spending for 2013 will be in the range of
$20 million to $30 million, of which approximately half is discretionary in
nature. We anticipate that cash on hand, cash flow from operations and
availability under our Credit Facility will be sufficient to fund these capital
expenditures. As part of our growth strategy, we have and will continue to
consider targeted and opportunistic acquisitions.
Financing activities - Net cash used in financing activities for 2012 was $21.5
million compared to cash provided of $3.7 million for the prior year period.
During 2012, we repaid $32 million of long-term debt which was partially offset
by $10 million borrowed at the beginning of the year to help fund the NeuroNexus
acquisition. On February 20, 2013, we redeemed all of our outstanding CSN, which
was funded with availability under the Credit Facility. See Note 9 "Debt" of the
Notes to the Consolidated Financial Statements contained at Item 8 of this
report for further discussion. Going forward, we expect excess cash flow from
operations to primarily be used to pay down outstanding debt as well as to fund
our various capital projects.
Capital Structure - As of December 28, 2012, our capital structure consisted of
$197.8 million of convertible subordinated notes, $33.0 million of debt under
our revolving line of credit and 23.7 million shares of common stock
outstanding. Additionally, we had $20.3 million in cash and cash equivalents,
which we believe is sufficient to meet our short-term operating cash needs. If
necessary, we have available borrowing capacity under our Credit Facility and
are authorized to issue 100 million shares of common stock and 100 million
shares of preferred stock. As of February 27, 2013, we had available $174
million of borrowing capacity available under the Credit Facility as a result of
the redemption of all CSN in February 2013. We believe that if needed we can
access public markets to raise additional capital. We believe that our capital
structure provides adequate funding to meet our growth objectives. We
continuously evaluate our capital structure as it relates to our anticipated
long-term funding needs. Changes to our capital structure may occur as a result
of this analysis, or changes in market conditions.
Off-Balance Sheet Arrangements
We have no off-balance sheet arrangements within the meaning of Item 303(a)(4)
of Regulation S-K.
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Litigation
We are party to various legal actions arising in the normal course of business.
A description of pending legal actions against the Company is set forth at Note
15 "Commitments and Contingencies" of the Notes to Consolidated Financial
Statements contained at Item 8 of this report. We do not believe that the
ultimate resolution of any individual pending legal action will have a material
effect on our consolidated results of operations, financial position or cash
flows. However, litigation is subject to inherent uncertainties and there can be
no assurance that any pending legal action, which we currently believe to be
immaterial, does not become material in the future.
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Contractual Obligations
The following table summarizes our contractual obligations at December 28, 2012:
Payments due by period
Less than 1 More than 5
CONTRACTUAL OBLIGATIONS Total year 1-3 years 3-5 years years
Debt obligations(a) $ 270,469 $ 229,676 $ 3,800 $ 35,776 $ 1,217
Operating lease obligations(b) 19,044 4,601 8,134 4,379 1,930
Purchase obligations(b) 24,710 12,914 5,378 6,298 120
Foreign currency contracts(b) 12,000 12,000 - - -
Defined benefit plan obligations(c) 11,783 8,813 561 671 1,738
Total contractual obligations $ 338,006 $ 268,004 $ 17,873 $ 47,124 $ 5,005
(a) Includes the annual interest expense on our convertible subordinated notes of
2.25%, which is paid semi-annually, and the $33.0 million outstanding on our
Credit Facility based upon the period end weighted average interest rate of
2.07%. Also includes $36.6 million of deferred federal and state taxes on the
Company's convertible subordinated notes that will be due between 2013 and
2018. This table does not reflect the redemption of all outstanding CSN on
February 20, 2013, which was funded with availability under the Credit
Facility. CSN were classified as long-term in the December 28, 2012
Consolidated Balance Sheet in accordance with ASC 470. See Note 9 "Debt" of
the Notes to Consolidated Financial Statements contained in Item 8 of this
report.
(b) See Note 15 "Commitments and Contingencies" of the Notes to Consolidated
Financial Statements contained in Item 8 of this report for additional
information about our operating leases, purchase obligations and foreign
currency contracts.
(c) See Note 10 "Defined Benefit Plans" of the Notes to Consolidated Financial
Statements contained in Item 8 of this report for additional information
about our defined benefit plan obligations. During 2012, we transferred most
major functions performed at our facilities in Switzerland into existing
facilities. As a result, we curtailed our defined benefit plan provided to
employees at those facilities in 2012. As nearly all of the Swiss pension
liability is expected to be paid off in the next year, the Company moved all
Swiss pension plan investments into cash accounts during the quarter. Plan
assets are expected to be sufficient to cover plan liabilities.
This table does not reflect $1.0 million of unrecognized tax benefits as we are
uncertain as to if or when such amounts may be settled. Refer to Note 14 "Income
Taxes" of the Notes to Consolidated Financial Statements in Item 8 of this
report for additional information about these unrecognized tax benefits.
We self-fund the medical insurance coverage provided to our U.S. based
employees. We limit our risk through the use of stop loss insurance. As of
December 28, 2012, we had $1.4 million accrued, related to our self-insurance
obligations under our medical plan. This accrual is recorded in Accrued Expenses
in the Consolidated Balance Sheet, and is primarily based upon claim history.
For 2013, we have specific stop loss coverage per associate for claims in the
year exceeding $225 thousand per associate with no annual maximum aggregate stop
loss coverage. This table does not reflect any potential future payments for
self-insured medical claims.
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We were a member of a group self-insurance trust that provided workers'
compensation benefits to our employees in Western New York (the "Trust"). Based
on actual experience, we could receive a refund or be assessed additional
contributions for workers' compensation claims. Under the Trust agreement, each
participating organization has joint and several liability for Trust obligations
if the assets of the Trust are not sufficient to cover those obligations. During
2011, we were notified by the Trust of its intention to cease operations at the
end of 2011 and were assessed $0.6 million as an estimate of our pro-rata share
of future costs related to the Trust. This amount was accrued and paid in 2011.
Beginning in 2012, we utilized traditional insurance to provide workers'
compensation benefits to our employees.
Inflation
We utilize certain critical raw materials (including precious metals) in our
products that we obtain from a limited number of suppliers due to the
technically challenging requirements of the supplied product and/or the lengthy
process required to qualify these materials with our customers. We cannot
quickly establish additional or replacement suppliers for these materials
because of these requirements. Our results may be negatively impacted by an
increase in the price of these critical raw materials. This risk is partially
mitigated as many of the supply agreements with our customers allow us to
partially adjust prices for the impact of any raw material price increases and
the supply agreements with our vendors have final one-time buy clauses to meet a
long-term need. Historically, raw material price increases have not materially
impacted our results of operations.
Impact of Recently Issued Accounting Standards
In the normal course of business, we evaluate all new accounting pronouncements
issued by the Financial Accounting Standards Board ("FASB"), SEC, Emerging
Issues Task Force ("EITF"), American Institute of Certified Public Accountants
("AICPA") or other authoritative accounting body to determine the potential
impact they may have on our Consolidated Financial Statements. See Note 1
"Summary of Significant Accounting Policies" of the Notes to Consolidated
Financial Statements contained in Item 8 of this report for additional
information about these recently issued accounting standards and their potential
impact on our financial condition or results of operations.
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