<DOCUMENT>
<TYPE>10-K
<SEQUENCE>1
<FILENAME>a5100172_10k.txt
<DESCRIPTION>GREATBATCH 10-K
<TEXT>
U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For The Fiscal Year Ended December 30, 2005
Commission File Number 1-16137
GREATBATCH, INC.
(Exact name of Registrant as specified in its charter)
Delaware
(State of incorporation)
16-1531026
(I.R.S. employer identification no.)
9645 Wehrle Drive
Clarence, New York
14031
(Address of principal executive offices)
(716) 759-5600
(Registrant's telephone number, including area code)
Securities Registered Pursuant to Section 12(b) of the Act:
Name of Each Exchange
Title of Each Class: on Which Registered:
Common Stock, Par Value $.001 Per Share New York Stock Exchange
Preferred Stock Purchase Rights New York Stock Exchange
Securities Registered Pursuant to Section 12(g) of the Act:
None
<PAGE>
Indicate by check mark if the registrant is a well-known seasoned issuer
(as defined in Exchange Act Rule 405). Yes [_] No [X]
Indicate by check mark if the registrant is not required to file reports
pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes [_] No [X]
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. [X]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [_]
Indicate by check mark whether the Registrant is a large accelerated filer,
an accelerated filer, or a non-accelerated filer (as defined in Exchange Act
Rule 12b-2).
--------------------------------------------------------------------------------
Large accelerated filer [ ] Accelerated filer [X] Non-accelerated filer [ ]
--------------------------------------------------------------------------------
Indicate by check mark whether the Registrant is a shell company (as
defined in Exchange Act Rule 12b-2). Yes [_] No [X]
Aggregate market value of common stock of Greatbatch, Inc. held by
nonaffiliates as of July 1, 2005, based on the last sale price of $24.01, as
reported on the New York Stock Exchange: $518.2 million. Solely for the purpose
of this calculation, shares held by directors and officers and 10 percent
shareholders of the Registrant have been excluded. Such exclusion should not be
deemed a determination by or an admission by the Registrant that these
individuals are, in fact, affiliates of the Registrant.
Shares of common stock outstanding on March 10, 2006: 21,693,214
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the company's definitive Proxy Statement for its 2005 Annual Meeting
of Stockholders are incorporated by reference into Part III of this report.
<PAGE>
PART I
ITEM 1. BUSINESS
OVERVIEW
We are a leading developer and manufacturer of batteries, capacitors,
feedthroughs, enclosures, and other components used in implantable medical
devices ("IMDs") through our Implantable Medical Components ("IMC") business. We
offer technologically advanced, highly reliable and long lasting products for
IMDs and enable our customers to introduce IMDs that are progressively smaller,
longer lasting, more efficient and more functional. We also leverage our core
competencies in technology and manufacturing through our Electrochem Commercial
Power ("ECP") business, formerly known as Electrochem Power Solutions, business
to develop and produce batteries and battery packs for commercial applications
that demand high performance and reliability, including oil and gas,
oceanographic and aerospace applications. We believe that our proprietary
technology, close customer relationships, multiple product offerings, market
leadership and dedication to quality provide us with competitive advantages and
create a barrier to entry for potential market entrants.
In 2005, we expanded our business into value-added assembly of products that
incorporate components. With this in mind, we designed and built a state of the
art manufacturing facility in Tijuana Mexico, incorporating two class 100,000
clean rooms, 90,000 square feet of manufacturing space, engineering, metrology
and quality laboratories, and led by a management team with diverse medical
device and contract manufacturing backgrounds. We began operations at this
facility in the 2nd quarter of 2005.
Our company, a Delaware corporation, was incorporated in 1997 and since that
time has completed the following acquisitions:
<TABLE>
<CAPTION>
Acquisition date Acquired company Business at time of acquisition
---------------- ---------------- -------------------------------
<S> <C> <C>
July 10, 1997 Wilson Greatbatch Ltd. Founded in 1970, the company designed and manufactured
("WGL") batteries for IMDs and commercial applications including
oil and gas, aerospace, and oceanographic.
August 7, 1998 Hittman Materials and Founded in 1962, the company designed and manufactured
Medical Components, Inc. ceramic and glass feedthroughs and specialized porous
("Hittman") coatings for electrodes used in IMDs.
August 4, 2000 Battery Engineering, Inc. Founded in 1983, the company designed and manufactured
("BEI") high-energy density batteries for industrial, commercial,
military and medical applications.
</TABLE>
-3-
<PAGE>
<TABLE>
<CAPTION>
Acquisition date Acquired company Business at time of acquisition
---------------- ---------------- -------------------------------
<S> <C> <C>
June 18, 2001 Sierra-KD Components Founded in 1986, the company designed and manufactured
division of Maxwell ceramic electromagnetic filtering capacitors and
Technologies, Inc. integrated them with wire feedthroughs for use in IMDs.
("Sierra") Sierra also designed and manufactured ceramic capacitors
for military, aerospace and commercial applications.
July 9, 2002 Globe Tool and Founded in 1954, the company designed and manufactured
Manufacturing Company, Inc. precision enclosures used in IMDs and commercial products
("Globe") used within the aerospace, electronic, and automotive
sectors.
March 16, 2004 NanoGram Devices Founded in 1996, the company developed nanoscale
Corporation ("NanoGram") materials for battery and medical device applications.
</TABLE>
FINANCIAL STATEMENT YEAR END
The Company utilizes a fifty-two, fifty-three week fiscal year ending on the
Friday nearest December 31st. Fiscal 2005, 2004, and 2003 ended on December 30,
2005, December 31, 2004, and January 2, 2004, respectively. For clarity of
presentation, the Company describes all fiscal years as if the year-end is
December 31st.
SEGMENT INFORMATION
Segment information including sales from external customers, profit or loss, and
assets by segment as well as sales from external customers and long-lived assets
by geographic area are set forth at Note 17 - Business Segment Information of
the Notes to the Consolidated Financial Statements contained at Item 8 of this
report.
IMPLANTABLE MEDICAL DEVICES
An IMD is an instrument that is surgically inserted into the body to provide
diagnosis or therapy. One sector of the IMD market is cardiac rhythm management
("CRM"), which is comprised of devices such as implantable pacemakers,
implantable cardioverter defibrillators ("ICDs"), cardiac resynchronization
therapy ("CRT") devices, and cardiac resynchronization therapy with backup
defibrillation devices ("CRT-D").
A new emerging opportunity sector of the IMD market is the neurostimulation
("Neuro") market, which is comprised of pacemaker-type devices that stimulate
various nerves for the treatment of various conditions. Beyond pain control,
nerve stimulation for the treatment of movement disabilities such as Parkinson's
disease, epilepsy, migraines, obesity and depression has shown promising
results.
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<PAGE>
The following table sets forth the main categories of battery-powered IMDs and
the principal illness or symptom treated by each device:
<TABLE>
<CAPTION>
Device Principal Illness or Symptom
------ ----------------------------
<S> <C>
Pacemakers.................................. Abnormally slow heartbeat (Bradycardia)
ICDs........................................ Rapid and irregular heartbeat (Tachycardia)
CRT/CRT-Ds.................................. Congestive heart failure
Neurostimulators............................ Chronic pain, movement disabilities, epilepsy, obesity or
depression
Left ventricular assist devices (LVADs)..... Heart failure
Drug pumps.................................. Diabetes or chronic pain
</TABLE>
CRM and Neuro markets are expected to experience double-digit growth for the
next three to five years. Increased demand is being driven by the following
factors:
o Advances in medical technology - new therapies will allow physicians
to use IMDs to treat a wider range of heart diseases.
o New, more sophisticated implantable devices - device manufacturers are
developing new CRM devices and adding new features to existing
products.
o New indications for CRM devices - the patient groups that are eligible
for CRM devices have increased. Insurance guidelines may allow device
reimbursements for these expanding patient populations.
o Expansion of Neurostimulator applications - therapies expected to
expand as new therapeutic applications for pulse generators are
identified.
o An aging population - the number of people in the United States that
are over age 65 is expected to double in the next 30 years.
o New indications for other devices - there is an increased use of
recently developed IMDs.
o New performance requirements - government regulators are increasingly
requiring that IMDs be protected from Electro Magnetic Interference
(EMI).
o Global markets - increased market penetration worldwide.
COMMERCIAL BATTERY INDUSTRY
Commercial batteries are used in demanding applications such as oil and gas
exploration and production as well as oceanographic and aerospace applications.
High performance batteries and battery packs are used in drilling tools,
pipeline inspection systems, lightning detectors and seismic applications in the
oil and gas markets.
High quality, reliable products that can deliver increased performance in severe
environments are the drivers for demand in the commercial battery industry. It
is expected that applications in new technologies used for reworking existing
wells will increase. Natural gas exploration is increasing at a rapid pace as
natural gas powered power plants increase in number. Pipeline inspection gauge
usage is increasing due to new US legislation. Military and aerospace trends
show increasing demand for reliable power sources, including rechargeable cells.
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<PAGE>
PRODUCTS
The following table provides information about our principal products:
IMPLANTABLE MEDICAL COMPONENTS:
The following implantable medical products are used in IMDs unless otherwise
noted.
<TABLE>
<CAPTION>
PRODUCT DESCRIPTION PRINCIPAL PRODUCT ATTRIBUTES
------- ----------- ----------------------------
<S> <C> <C>
Batteries Power sources include: High reliability and predictability
Lithium Iodine ("Li Iodine") Long service life
Lithium silver vanadium oxide ("Li SVO") Customized configuration
Lithium carbon monoflouride ("Li Light weight
CFx") Compact and less intrusive
Lithium ion rechargeable ("Li Ion")
Lithium SVO/CFx ("QHR" & "QMR")
Capacitors Storage for energy generated by a Stores more energy per unit volume
battery before delivery to the heart. (energy density) than other existing
Used in ICDs and CRT-Ds. technologies
Customized configuration
EMI filters Filters electromagnetic interference to High reliability attenuation of EMI RF
limit undesirable response, over wide frequency ranges
malfunctioning or degradation in the Customized design
performance of electronic equipment
Feedthroughs Allow electrical signals to be brought Ceramic to metal seal is substantially
from inside hermetically sealed IMD to an more durable than traditional seals
electrode Multifunctional
Coated electrodes Deliver electric signal from the High quality coated surface
feedthrough to a body part undergoing Flexible in utilizing any combination
stimulation of biocompatible coating surfaces
Customized offering of surfaces and tips
Precision components Machined High level of manufacturing precision
Molded and over molded products Broad manufacturing flexibility
Enclosures and related Titanium Precision manufacturing, flexibility in
components Stainless steel configurations and materials.
Value-add assemblies Combination of multiple components in a Leveraging products and capabilities to
single package/unit provide subassemblies and assemblies
Provides synergies in component
technology and procurement systems
ELECTROCHEM COMMERCIAL POWER:
The following commercial products are used in oil and gas exploration, military and oceanographic equipment
PRODUCT DESCRIPTION PRINCIPAL PRODUCT ATTRIBUTES
------- ----------- ----------------------------
Batteries Mid-rate Long-life dependability
Spiral (high rate) High energy density
Battery packs Bundling of commercial batteries in a customer Increased power capabilities and ease
specific configuration of integration into customer
applications
</TABLE>
4
<PAGE>
RESEARCH AND DEVELOPMENT
Our position as a leading developer and manufacturer of components for IMDs and
commercial batteries is largely the result of our long history of technological
innovation. We invest substantial resources in research, development and
engineering. Our scientists, engineers and technicians focus on improving
existing products, expanding the use of our products and developing new
products. In addition to our internal technology and product development
efforts, we at times engage outside research institutions for special projects.
PATENTS AND PROPRIETARY TECHNOLOGY
We rely on a combination of patents, licenses, trade secrets and know-how to
establish and protect our proprietary rights to our technologies and products.
As of December 31, 2005, we have 266 active U.S. patents and 130 active foreign
patents. We also have 138 U.S. and 306 foreign pending patent applications at
various stages of approval. During the past three years, we have received 106
new U.S. patents, of which 20 were received in 2005. Corresponding foreign
patents have been issued or are expected to be issued in the near future. Often,
several patents covering various aspects of the design protect a single product.
We believe this provides broad protection of the inventions employed.
Our active battery patents relate to process improvements and modifications to
the original technology that was developed either by our Company, or others.
As part of the NanoGram acquisition, we purchased six patents and the license
agreements for 24 others. This gives us access to a proprietary technology to
manufacture advanced materials for a broad array of applications. As part of our
technology strategy, we plan to continue development of advanced cathode
materials for our implantable battery product lines. `Nano-SVO' cathode material
is part of this plan, and will eventually become the standard technology broadly
adopted by all SVO battery applications.
In addition, we are also a party to several license agreements with third
parties pursuant under which we have obtained, on varying terms, the exclusive
or non-exclusive rights to patents held by them. One of these agreements is for
the basic technology used in our wet tantalum capacitors, which we license from
Evans Capacitor Company. We have also granted rights in our own patents to
others under license agreements.
It is our policy to require our executive and technical employees, consultants
and other parties having access to our confidential information to execute
confidentiality agreements. These agreements prohibit disclosure of confidential
information to third parties except in specified circumstances. In the case of
employees and consultants, the agreements generally provide that all
confidential information relating to our business is the exclusive property of
our Company.
5
<PAGE>
MANUFACTURING AND QUALITY CONTROL
We primarily manufacture small lot sizes, as most customer orders range from a
few hundred to thousands of units. As a result, our ability to remain flexible
is an important factor in maintaining high levels of productivity. Each of our
production teams receives assistance from a manufacturing support team, which
typically consists of representatives from our quality control, engineering,
manufacturing, materials and procurement departments.
Our quality system is based upon an ISO documentation system and is driven by a
master validation plan that requires rigorous testing and validation of all new
processes or process changes that directly impact our products. All of our
existing manufacturing plants are ISO 9001-2000 registered, which requires
compliance with regulations regarding quality systems of product design (where
applicable), supplier control, manufacturing processes and management review.
This certification can only be achieved after completion of an audit conducted
by an independent authority. Our existing manufacturing plants are audited by
the National Standards Authority of Ireland, an independent auditing firm and
notified body that specializes in evaluating quality standards. To maintain
certification, all facilities must be reexamined routinely by our certifying
body.
SALES AND MARKETING
Products from our IMC business are sold directly to our customers. In our ECP
business, we utilize a combination of direct and indirect sales methods,
depending on the particular product. In 2005, approximately 53% of our products
were sold in the United States. Information regarding our sales by geographic
area is set forth at Note 17 of the Notes to the Consolidated Financial
Statements contained at Item 8 of this report.
The majority of our medical customers contract with us to develop custom
components and assemblies to fit their specific product specifications. As a
result, we have established close working relationships between our internal
program managers and our customers. We market our products and technologies at
industry meetings and trade shows domestically and internationally, including
Heart Rhythm Society's Annual Scientific Sessions, the Annual World Congress in
Cardiac Electrophysiology and Cardiac Techniques, known as CardioStim, and the
American Society for Artificial Internal Organs.
Internal sales managers support all activity, and involve engineers and
technology professionals in the sales process to address customer requests
appropriately.
We sell our commercial batteries and battery packs either directly to the end
user, directly to manufacturers that incorporate our products into other devices
for resale, or to distributors who sell our products to manufacturers and end
users. Our sales managers are trained to assist our customers in selecting
appropriate battery chemistries and configurations. We market our ECP products
at various technical trade meetings. We also place print advertisements in
relevant trade publications.
Firm backlog orders at December 31, 2005 and 2004, were $92.2 million and $89.5
million, respectively. Most of these orders are expected to be shipped within
one year.
6
<PAGE>
CUSTOMERS
Our medical customers include leading IMD manufacturers such as Guidant, St.
Jude Medical, Medtronic, Biotronik, Cyberonics and the Sorin Group ("Sorin /
ELA"). In 2005, Guidant, St. Jude Medical, and Medtronic collectively accounted
for approximately 70% of our total sales. The nature and extent of our selling
relationships with each CRM customer are different in terms of breadth of
component products purchased, purchased product volumes, length of contractual
commitment, ordering patterns, inventory management and selling prices.
Our ECP customers are primarily companies involved in oil and gas exploration,
oceanography, aerospace, and defense including Halliburton, Computalog, PII and
Pathfinder.
We have entered into a supply agreement with Guidant pursuant to which Guidant
purchases batteries from us for use in its IMDs. The agreement secures pricing
and volumes for Li Iodine batteries, and establishes pricing at defined volume
levels for Li SVO and CFx batteries. A contract amendment effective August 16,
2004 adds QHR Frontier Cell pricing to the original agreement. The contract
period for the agreement is April 1, 2003 to December 31, 2006 and can be
renewed for additional one-year periods upon mutual agreement.
We entered into an agreement with Guidant during April 2005 pursuant to which
Guidant will purchase a minimum quantity of wet tantalum capacitors at prices
specified in the agreement. The period of the agreement is April 7, 2005 to
March 31, 2006. We entered into an agreement with Guidant during February 2005
pursuant to which Guidant will purchase a minimum quantity of filtered
feedthroughs at prices specified in the agreement. The period of the agreement
is February 10, 2005 to December 31, 2007.
We have entered into a supply agreement with St. Jude Medical pursuant to which
St. Jude Medical purchases batteries, wet tantalum capacitors, filtered
feedthroughs, molded components and enclosures under specified price and volume
terms. A contract amendment effective January 1, 2005 extended the contract term
to December 31, 2008 and added QHR high rate, QMR medium rate, and Nano battery
technologies to the Agreement. A contract amendment effective January 1, 2006
added molded header assemblies to the Agreement.
We have entered into a supply agreement with Medtronic pursuant to which
Medtronic will purchase implantable device shield sub-assemblies and other
products under specified price and volume terms. The contract term is seven
years, commencing August 2, 2004 and ending August 2, 2011. In October 2005, we
entered into a license agreement which grants Medtronic the right to use certain
intellectual property relating to tantalum capacitors. The license is perpetual
and except for our right to make and sell capacitors exclusive to Medtronic.
SUPPLIERS AND RAW MATERIALS
We purchase certain critical raw materials 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. In the past, we have not
7
<PAGE>
experienced any significant interruptions or delays in obtaining these raw
materials. We maintain minimum safety stock levels of critical raw materials.
For other raw material purchases, we utilize competitive pricing methods to
secure supply such as bulk purchases, precious metal pool buys, blanket orders,
and long term contracts. We believe that there are alternative suppliers or
substitute products available for each of the materials we purchase at
competitive prices.
COMPETITION
Our existing or potential competitors in our IMC business includes leading IMD
manufacturers, such as Guidant, St. Jude Medical, Medtronic, Sorin / ELA and
Biotronik that currently have vertically integrated operations and may expand
their vertical integration capability in the future. Competitors also include
independent suppliers who typically specialize in one type of component.
Our known non-vertically integrated competitors include the following:
Product Line Competitors
------------ -----------
Medical batteries Litronik (a subsidiary of Biotronik)
Eagle-Picher
Quallion
Capacitors Critical Medical Components
Feedthroughs Alberox (subsidiary of The Morgan
Crucible Co. PLC)
EMI filtering AVX (subsidiary of Kyocera)
Eurofarad
Enclosures Heraeus
Hudson
National Manufacturing
Commercial batteries/battery Eagle-Picher
packs Engineered Power
Saft
Tadiran
Tracer Technologies
Ultralife
Machined and molded Numerous
components
Value added assembly Numerous
8
<PAGE>
GOVERNMENT REGULATION
Except as described below, our business is not subject to direct governmental
regulation other than the laws and regulations generally applicable to
businesses in the jurisdictions in which we operate. We are subject to federal,
state and local environmental laws and regulations governing the emission,
discharge, use, storage and disposal of hazardous materials and the remediation
of contamination associated with the release of these materials at our
facilities and at off-site disposal locations. Our manufacturing and research,
development and engineering activities involve the controlled use of, and our
products contain, small amounts of hazardous materials. Liabilities associated
with hazardous material releases arise principally under the federal
Comprehensive Environmental Response, Compensation and Liability Act and
analogous state laws which impose strict, joint and several liability on owners
and operators of contaminated facilities and parties that arrange for the
off-site disposal of hazardous materials. We are not aware of any material
noncompliance with the environmental laws currently applicable to our business
and we are not subject to any material claim for liability with respect to
contamination at any company facility or any off-site location. We cannot assure
you, however, that we will not be subject to such environmental liabilities in
the future as a result of historic or current operations.
As a component manufacturer, our medical products are not subject to regulation
by the Food and Drug Administration ("FDA"). However, the FDA and related state
and foreign governmental agencies regulate many of our customers' products as
medical devices. In many cases, the FDA must approve those products prior to
commercialization. We believe that our existing medical manufacturing plants
comply with current Good Manufacturing Practices ("cGMP") as applicable.
We have five "master files" on record with the FDA. Master files may be used to
provide confidential detailed information about facilities, processes, or
articles used in the manufacturing, processing, packaging, and storing of one or
more medical device components. These submissions may be used by device
manufacturers to support the premarket notification process required by Section
510(k) of the federal Food Drug & Cosmetic Act. This notification process is
necessary to obtain clearance from the FDA to market a device for human use in
the United States.
RECRUITING AND TRAINING
We invest substantial resources in our recruiting efforts that focus on
supplying quality personnel to support our business objectives. We have
established a number of programs that are designed to challenge and motivate our
employees. All staff is encouraged to be proactive in contributing ideas.
Feedback surveys are used to collect suggestions on ways that our business and
operations can be improved. We further meet our hiring needs through outside
sources as required.
We provide an intensive training program for our new employees that is designed
to educate them on safety, quality, business strategy, corporate culture, and
the methodologies and technical competencies that are required for our business.
Our safety training programs focus on such areas as basic industrial safety
practices and emergency response procedures to deal with any
9
<PAGE>
potential fires or chemical spills. All of our employees are required to
participate in a 20 hour specialized training program that is designed to
provide an understanding of our quality objectives. Supporting our lifelong
learning environment, we offer our employees a tuition reimbursement program and
encourage them to continue their education at accredited colleges and
universities. Many of our professionals attend seminars on topics that are
related to our corporate objectives and strategies. We believe that
comprehensive training is necessary to ensure that our employees have state of
the art skills, utilize best practices, and have a common understanding of work
practices.
EMPLOYEES
The following table provides a breakdown of employees by primary function as of
December 31, 2005:
Manufacturing 1,020
Research and development 108
General and administrative 91
Engineering 96
Sales and marketing 23
-------
Total 1,338
=======
We also employ a number of temporary employees to assist us with various
projects and service functions and address peaks in staff requirements. Our
employees are not represented by any union. We believe that we have a good
relationship with our employees.
AVAILABLE INFORMATION
The Company makes available free of charge on or through its internet website
its annual report on Form 10-K, quarterly reports on Form 10-Q, current reports
on Form 8-K and amendments to those reports filed or furnished pursuant to
Section 13(a) or 15(d) of the Securities Exchange Act of 1934 as soon as
reasonably practicable after it electronically files such material with, or
furnishes it to, the Securities and Exchange Commission. Our Internet address is
http://www.greatbatch.com. The information contained on the Company's website is
not incorporated by reference in this annual report on Form 10-K and should not
be considered a part of this report.
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<PAGE>
CAUTIONARY FACTORS THAT MAY AFFECT FUTURE RESULTS
Some of the statements contained in this Annual Report on Form 10-K and other
written and oral statements made from time to time by us and our
representatives, are not statements of historical or current fact. As such, they
are "forward-looking statements" within the meaning of Section 27A of the
Securities Act of 1933, as amended, and Section 21E of the Securities Exchange
Act of 1934, as amended. We have based these forward-looking statements on our
current expectations, which are subject to known and unknown risks,
uncertainties and assumptions. They include statements relating to:
o future sales, expenses and profitability;
o the future development and expected growth of our business and the IMD
industry;
o our ability to execute our business model and our business strategy;
o our ability to identify trends within the IMD, medical component, and
commercial power source industries and to offer products and services
that meet the changing needs of those markets;
o projected capital expenditures; and
o trends in government regulation.
You can identify forward-looking statements by terminology such as "may,"
"will," "should," "could," "expects," "intends," "plans," "anticipates,"
"believes," "estimates," "predicts," "potential" or "continue" or the negative
of these terms or other comparable terminology. These statements are only
predictions. Actual events or results may differ materially from those suggested
by these forward-looking statements. In evaluating these statements and our
prospects generally, you should carefully consider the factors set forth below.
All forward-looking statements attributable to us or persons acting on our
behalf are expressly qualified in their entirety by these cautionary factors and
to others contained throughout this report. We are under no duty to update any
of the forward-looking statements after the date of this report or to conform
these statements to actual results.
Although it is not possible to create a comprehensive list of all factors that
may cause actual results to differ from the results expressed or implied by our
forward-looking statements or that may affect our future results, some of these
factors include the following: dependence upon a limited number of customers,
product obsolescence, inability to market current or future products, pricing
pressure from customers, reliance on third party suppliers for raw materials,
products and subcomponents, fluctuating operating results, inability to maintain
high quality standards for our products, challenges to our intellectual property
rights, product liability claims, inability to successfully consummate and
integrate acquisitions, unsuccessful expansion into new markets, competition,
inability to obtain licenses to key technology, regulatory changes or
consolidation in the healthcare industry, and other risks and uncertainties that
arise from time to time and are described in the Company's periodic filings with
the Securities and Exchange Commission and in Item 1A of this report.
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ITEM 1A. RISK FACTORS
Risks Related To Our Business
We depend heavily on a limited number of customers, and if we lose any of them
or they reduce their business with us, we would lose a substantial portion of
our revenues.
A substantial portion of our business is conducted with a limited number of
customers, including Guidant, St. Jude Medical, Medtronic, Sorin / ELA,
Biotronik and Halliburton. In 2005, Guidant, St. Jude Medical, and Medtronic
collectively accounted for approximately 70% of our revenues. Our supply
agreements might not be renewed. Furthermore, many of our supply agreements do
not contain minimum purchase level requirements and therefore there is no
guaranteed source of revenue that we can depend upon under these agreements. The
loss of any large customer or a reduction of business with that customer for any
reason would harm our business, financial condition and results of operations.
If we do not respond to changes in technology, our products may become obsolete
and we may experience a loss of customers and lower revenues.
We sell our products to customers in several industries that are characterized
by rapid technological changes, frequent new product introductions and evolving
industry standards. Without the timely introduction of new products and
enhancements, our products and services will likely become technologically
obsolete over time and we may lose a significant number of our customers. In
addition, other new products introduced by our customers may require fewer of
our batteries or components. We dedicate a significant amount of resources to
the development of our products and technologies and we would be harmed if we
did not meet customer requirements and expectations. Our inability, for
technological or other reasons, to successfully develop and introduce new and
innovative products could result in a loss of customers and lower revenues.
If we are unable to successfully market our current or future products, our
business will be harmed and our revenues and operating results will be reduced.
The market for our medical products has been growing in recent years. If the
market for our products does not grow as rapidly as forecasted by industry
experts, our revenues could be less than expected. In addition, it is difficult
to predict the rate at which the market for our products will grow or at which
new and increased competition will result in market saturation. Slower growth in
the pacemaker, ICD and CRT markets in particular would negatively impact our
revenues. In addition, we face the risk that our products will lose widespread
market acceptance. Our customers may not continue to utilize the products we
offer and a market may not develop for our future products. We may at times
determine that it is not technically or economically feasible for us to continue
to manufacture certain products and we may not be successful in developing or
marketing them. Additionally, new technologies that we develop may not be
rapidly accepted because of industry-specific factors, including the need for
regulatory clearance, entrenched patterns of clinical practice and uncertainty
over third party reimbursement. If this occurs, our business will be harmed and
our revenues and operating results will be negatively affected.
12
<PAGE>
We are subject to pricing pressures from customers, which could harm our
operating results.
We have made price reductions to some of our large customers in recent years and
we expect customer pressure for pricing reductions will continue. Further, price
concessions or reductions may cause our operating results to suffer. In
addition, any delay or failure by a large customer to make payments due to us
also could harm our operating results or financial condition.
We rely on third party suppliers for raw materials, key products and
subcomponents and if we are unable to obtain these materials, products and
subcomponents on a timely basis or on terms acceptable to us, our ability to
manufacture products will suffer.
Our business depends on a continuous supply of raw materials. The principal raw
materials used in our business include lithium, iodine, tantalum, platinum,
ruthenium, gallium trichloride, tantalum pellets, vanadium pentoxide, iridium,
and titanium. Raw materials needed for our business are susceptible to
fluctuations due to transportation, government regulations, price controls,
economic climate or other unforeseen circumstances. Increasing global demand for
some of the raw materials we need for our business, including platinum, iridium,
gallium trichloride, tantalum and titanium, has caused the prices of these
materials to increase significantly. In addition, there are a limited number of
worldwide suppliers of several raw materials needed to manufacture our products,
including lithium, gallium trichloride, carbon monofluoride, and tantalum. We
may not be able to continue to procure raw materials critical to our business or
to procure them at acceptable price levels.
We rely on third party manufacturers to supply many of our raw materials.
Manufacturing problems may occur with these and other outside sources, as a
supplier may fail to develop and supply products and subcomponents to us on a
timely basis, or may supply us with products and subcomponents that do not meet
our quality, quantity and cost requirements. If any of these problems occur, we
may be unable to obtain substitute sources of these products and subcomponents
on a timely basis or on terms acceptable to us, which could harm our ability to
manufacture our own products and components profitably or on time. In addition,
to the extent the processes that our suppliers use to manufacture products and
subcomponents are proprietary, we may be unable to obtain comparable
subcomponents from alternative suppliers.
We may never realize the full value of our intangible assets, which represent a
significant portion of our total assets.
At December 31, 2005, we had $215.2 million of intangible assets, representing
42% of our total assets. These intangible assets consist primarily of goodwill,
trademarks, tradenames and patented technology arising from our acquisitions.
Goodwill and other intangible assets with indefinite lives are no longer
amortized, they are tested annually or upon the occurrence of certain events
that indicate that the assets may be impaired. We may not receive the recorded
value for our intangible assets if we sell or liquidate our business or assets.
In addition, the material concentration of intangible assets increases the risk
of a large charge to earnings in the event that the recoverability of these
intangible assets is impaired, and in the event of such a charge to earnings,
the market price of our common stock could be adversely affected. In addition,
intangible assets with definite lives, which represent $60.1 million of our net
intangible
13
<PAGE>
assets at December 31, 2005, will continue to be amortized. We incurred total
amortization expenses relating to these intangible assets of $3.8 million in
2005. These expenses will reduce our future earnings or increase our future
losses.
Quality problems with our products could harm our reputation for producing high
quality products, erode our competitive advantage and result in claims against
us.
Our products are held to high quality standards. In the event that our products
fail to meet these standards, our reputation for producing high quality products
could be harmed, which would damage our competitive advantage and could result
in lower revenues. From time to time quality or performance issues have arisen
regarding our products. Product quality or performance issues, however, may
arise in the future that could have a significant adverse impact on us, either
because they harm our reputation for high quality, result in a product liability
or other legal claim against us, harm our reputation with our customers or
result in a decline in our stock price.
If we become subject to product liability claims, our operating results and
financial condition could suffer.
The manufacture and sale of our products expose us to potential product
liability claims and product recalls, including those that may arise from
failure to meet product specifications, misuse or malfunction of, or design
flaws in, our products, or use of our products with components or systems not
manufactured or sold by us. Many of our products are components and function in
interaction with our customers' medical devices. For example, our batteries are
produced to meet various electrical performance, longevity and other
specifications, but the actual performance of those products is dependent on how
they are in fact utilized as part of the customers' devices over the lifetime of
the products. Product performance and device interaction from time to time have
been, and may in the future be, different than expected for a number of reasons.
Consequently, it is possible that customers may experience problems with their
medical devices that could require device recall or other corrective action,
where our batteries met the specification at delivery, and for reasons that are
not related primarily or at all to any failure by our product to perform in
accordance with specifications. It is possible that customers (or patients) may
in the future assert that our products caused or contributed to device failure
where our product was not the primary cause of the device performance issue.
Even if these assertions do not lead to product liability or contract claims,
they could harm our reputation and our customer relationships.
Provisions contained in our agreements with key customers attempting to limit
our damages, including provisions to limit damages to liability for gross
negligence, may not be enforceable in all instances or may otherwise fail to
protect us from liability for damages. Product liability claims or product
recalls, regardless of their ultimate outcome, could require us to spend
significant time and money in litigation or require us to pay significant
damages. The occurrence of product liability claims or product recalls could
adversely affect our operating results and financial condition.
We carry product liability insurance coverage that is limited in scope and
amount. We may not be able to maintain this insurance or to do so at a
reasonable cost or on reasonable terms. This
14
<PAGE>
insurance may not be adequate to protect us against a product liability claim
that arises in the future.
Our operating results may fluctuate, which may make it difficult to forecast our
future performance and may result in volatility in our stock price.
Our operating results have fluctuated in the past and are likely to fluctuate
significantly from quarter to quarter due to a variety of factors, including:
o the fixed nature of a substantial percentage of our costs, which
results in our operations being particularly sensitive to fluctuations
in revenue;
o changes in the relative portion of our revenue represented by our
various products and customers, which could result in reductions in
our profits if the relative portion of our revenue represented by
lower margin products increases;
o timing of orders placed by our principal customers who account for a
significant portion of our revenues; and
o increased costs of raw materials or supplies.
If we are unable to protect our intellectual property and proprietary rights,
our business could be adversely affected.
We rely on a combination of patents, licenses, trade secrets and know-how to
establish and protect our proprietary rights to our technologies and products.
As of December 31, 2005, we held 266 active U.S. patents. However, the steps we
have taken or will take to protect our proprietary rights may not be adequate to
deter misappropriation of our intellectual property. In addition to seeking
formal patent protection whenever possible, we attempt to protect our
proprietary rights and trade secrets by entering into confidentiality and
non-compete agreements with employees, consultants and third parties with which
we do business. However, these agreements can be breached and, if they are,
there may not be an adequate remedy available to us and we may be unable to
prevent the unauthorized disclosure or use of our technical knowledge, practices
or procedures. If our trade secrets become known, we may lose our competitive
advantages.
In addition, we may not be able to detect unauthorized use of our intellectual
property and take appropriate steps to enforce our rights. If third parties
infringe or misappropriate our patents or other proprietary rights, our business
could be seriously harmed. We may be required to spend significant resources to
monitor our intellectual property rights, we may not be able to detect
infringement of these rights and may lose our competitive advantages associated
with our intellectual property rights before we do so. In addition, competitors
may design around our technology or develop competing technologies that do not
infringe on our proprietary rights.
15
<PAGE>
We may be subject to intellectual property claims, which could be costly and
time consuming and could divert our management and key personnel from our
business operations.
In producing our batteries and other components for IMDs, third parties may
claim that we are infringing their intellectual property rights, and we may be
found to have infringed those intellectual property rights. We may be unaware of
intellectual property rights of others that may be used in our technology and
products. In addition, third parties may claim that our patents have been
improperly granted and may seek to invalidate our existing or future patents. If
any claim for invalidation prevailed, the result could be greatly expanded
opportunities for third parties to manufacture and sell products that compete
with our products and our revenues from any related license agreements would
decrease accordingly. We also typically do not receive significant
indemnification from parties which license technology to us against third party
claims of intellectual property infringement. Any litigation or other challenges
regarding our patents or other intellectual property could be costly and time
consuming and could divert our management and key personnel from our business
operations. The complexity of the technology involved in producing our power
sources and other components for IMDs, and the uncertainty of intellectual
property litigation increase these risks. Claims of intellectual property
infringement might also require us to enter into costly royalty or license
agreements. However, we may not be able to obtain royalty or license agreements
on terms acceptable to us, or at all. We also may be subject to significant
damages or injunctions against development and sale of our products.
Infringement claims, even if not substantiated, could result in significant
legal and other costs and may be a distraction to management.
We are dependent upon our senior management team and key personnel and the loss
of any of them could significantly harm us.
Our future performance depends to a significant degree upon the continued
contributions of our senior management team and key technical personnel. Our
products are highly technical in nature. In general, only highly qualified and
trained scientists have the necessary skills to develop our products. The loss
or unavailability to us of any member of our senior management team or a key
technical employee could significantly harm us. We face intense competition for
these professionals from our competitors, our customers and other companies
operating in our industry. To the extent that the services of members of our
senior management team and key technical personnel would be unavailable to us
for any reason, we would be required to hire other personnel to manage and
operate our company and to develop our products and technology. We may not be
able to locate or employ such qualified personnel on acceptable terms.
We may not be able to attract, train and retain a sufficient number of qualified
professionals to maintain and grow our business.
Our success will depend in large part upon our ability to attract, train, retain
and motivate highly skilled employees and management. There is currently
aggressive competition for employees who have experience in technology and
engineering. We compete intensely with other companies to recruit and hire from
this limited pool. The industries in which we compete for
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<PAGE>
employees are characterized by high levels of employee attrition. Although we
believe we offer competitive salaries and benefits, we may have to increase
spending in order to retain personnel.
We may make acquisitions that could subject us to a number of operational risks
and we may not be successful in integrating companies we acquire into our
existing operations.
We have made and expect to make in the future acquisitions that complement our
core competencies in technology and manufacturing to enable us to manufacture
and sell additional products to our existing customers and to expand our
business into related markets. Implementation of our acquisition strategy
entails a number of risks, including:
o inaccurate assessments of potential liabilities associated with the
acquired businesses;
o the existence of unknown and/or undisclosed liabilities associated
with the acquired businesses;
o diversion of our management's attention from our core businesses;
o potential loss of key employees or customers of the acquired
businesses;
o difficulties in integrating the operations and products of an acquired
business or in realizing projected efficiencies and cost savings; and
o increases in our indebtedness and a limitation in our ability to
access additional capital when needed.
If we are not successful in making acquisitions to expand and develop our
business, our operating results may suffer.
A component of our strategy is to make acquisitions that complement our core
competencies in technology and manufacturing to enable us to manufacture and
sell additional products to our existing customers and to expand our business
into related markets. Our continued growth will depend on our ability to
identify and acquire companies that complement or enhance our business on
acceptable terms. We may not be able to identify or complete future
acquisitions. Some of the risks that we may encounter include expenses
associated with and difficulties in identifying potential targets, the costs
associated with uncompleted acquisitions, and higher prices for acquired
companies because of competition for attractive acquisition targets. Our failure
to acquire additional companies could cause our operating results to suffer.
We may face competition from our principal medical customers that could harm our
business and we may be unable to compete successfully against new entrants and
established companies with greater resources.
Competition in connection with the manufacturing of products may intensify in
the future. One or more of our customers may undertake additional vertical
integration initiatives and begin to manufacture some or all of their
components.
17
<PAGE>
The market for commercial power sources is competitive, fragmented and subject
to rapid technological change. Many other commercial power source suppliers are
larger and have greater financial, operational, personnel, sales, technical and
marketing resources than our company. These and other companies may develop
products that are superior to ours, which could cause our results of operations
to suffer.
Accidents at one of our facilities could delay production and adversely affect
our operations.
Our business involves complex manufacturing processes and hazardous materials
that can be dangerous to our employees. Although we employ safety procedures in
the design and operation of our facilities, there is a risk that an accident or
death could occur in one of our facilities. Any accident, such as a chemical
spill, could result in significant manufacturing delays or claims for damages
resulting from injuries, which would harm our operations and financial
condition. The potential liability resulting from any such accident or death, to
the extent not covered by insurance, could cause our business to suffer. Any
disruption of operations at any of our facilities could harm our business.
We intend to expand into new markets and our proposed expansion plans may not be
successful, which could harm our operating results.
We intend to expand into new markets through the development of new product
applications based on our existing component technologies. These efforts have
required, and will continue to require us to make substantial investments,
including significant research, development and engineering expenditures and
capital expenditures for new, expanded or improved manufacturing facilities. We
may not be able to successfully manage expansion into new markets and products
and these efforts may harm our operating results. Specific risks in connection
with expanding into new markets include the inability to transfer our quality
standards into new products, the failure of customers in new markets to accept
our products and price competition.
Our failure to obtain licenses from third parties for new technologies or the
loss of these licenses could impair our ability to design and manufacture new
products and reduce our revenues.
We occasionally license technologies from third parties rather than depending
exclusively on our own proprietary technology and developments. For example, we
license a capacitor patent from the Evans Capacitor Company. Our ability to
license new technologies from third parties is and will continue to be critical
to our ability to offer new and improved products. We may not be able to
continue to identify new technologies developed by others and even if we are
able to identify new technologies, we may not be able to negotiate licenses on
favorable terms, or at all. Additionally, we could lose rights granted under
licenses for reasons beyond our control. For example, the licensor could lose
patent protection for a number of reasons, including invalidity of the licensed
patent.
18
<PAGE>
Risks Related To Our Industries
We and our customers are subject to various political, economic and regulatory
changes in the healthcare industry which could force us to modify how we develop
and price our products.
The healthcare industry is highly regulated and is influenced by changing
political, economic and regulatory factors. Several of our product lines are
subject to international, federal, state and local health and safety, packaging
and product content regulations. In addition, IMDs produced by our medical
customers are subject to regulation by the U.S. Food and Drug Administration and
similar governmental agencies. These regulations govern a wide variety of
product activities from design and development to labeling, manufacturing,
promotion, sales and distribution. Compliance with these regulations may be time
consuming, burdensome and expensive and could negatively affect our customers'
abilities to sell their products, which in turn would adversely affect our
ability to sell our products. This may result in higher than anticipated costs
or lower than anticipated revenues.
These regulations are also complex, change frequently and have tended to become
more stringent over time. Federal and state legislatures have periodically
considered programs to reform or amend the U.S. healthcare system at both the
federal and state levels. In addition, these regulations may contain proposals
to increase governmental involvement in healthcare, lower reimbursement rates or
otherwise change the environment in which healthcare industry participants
operate. We may be required to incur significant expenses to comply with these
regulations or remedy past violations of these regulations. Any failure by our
company to comply with applicable government regulations could also result in
cessation of portions or all of our operations, impositions of fines and
restrictions on our ability to carry on or expand our operations. In addition,
because many of our products are sold into regulated industries, we must comply
with additional regulations in marketing our products.
Our business is subject to environmental regulations that could be costly for
our company to comply with.
Federal, state and local regulations impose various environmental controls on
the manufacturing, transportation, storage, use and disposal of batteries and
hazardous chemicals and other materials used in, and hazardous waste produced
by, the manufacturing of power sources and components. Conditions relating to
our historical operations may require expenditures for clean-up in the future
and changes in environmental laws and regulations may impose costly compliance
requirements on us or otherwise subject us to future liabilities. Additional or
modified regulations relating to the manufacture, transportation, storage, use
and disposal of materials used to manufacture our batteries and components or
restricting disposal of batteries may be imposed. In addition, we cannot predict
the effect that additional or modified regulations may have on us or our
customers.
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<PAGE>
Consolidation in the healthcare industry could result in greater competition and
reduce our medical component revenues and harm our business.
Many healthcare industry companies are consolidating to create new companies
with greater market power. As the healthcare industry consolidates, competition
to provide products and services to industry participants will become more
intense. These industry participants may try to use their market power to
negotiate price concessions or reductions for our products. If we are forced to
reduce our prices because of consolidation in the healthcare industry, our
revenues would decrease and our operating results would suffer.
Our IMC business is indirectly subject to healthcare industry cost containment
measures that could result in reduced sales of our products.
Our healthcare customers rely on third party payors, such as government programs
and private health insurance plans, to reimburse some or all of the cost of the
procedures in which our products are used. The continuing efforts of government,
insurance companies and other payors of healthcare costs to contain or reduce
those costs could lead to patients being unable to obtain approval for payment
from these third party payors. If that occurred, sales of IMDs may decline
significantly, and our customers may reduce or eliminate purchases of our
products. The cost containment measures that healthcare providers are
instituting, both in the United States and internationally, could reduce our
revenues and earnings.
Our non-medical power source revenues are dependent on conditions in the oil and
natural gas industry, which historically have been volatile.
Sales of our commercial products depend to a great extent upon the condition of
the oil and gas industry and, specifically, the exploration and production
expenditures of oil and gas companies. In the past, oil and natural gas prices
have been volatile and the oil and gas exploration and production industry has
been cyclical, and it is likely that oil and natural gas prices will continue to
fluctuate in the future. The current and anticipated prices of oil and natural
gas influence the oil and gas exploration and production business and are
affected by a variety of political and economic factors beyond our control,
including worldwide demand for oil and natural gas, worldwide and domestic
supplies of oil and natural gas, the ability of the Organization of Petroleum
Exporting Countries, or OPEC, to set and maintain production levels and pricing,
the level of production of non-OPEC countries, the price and availability of
alternative fuels, political stability in oil producing regions and the policies
of the various governments regarding exploration and development of their oil
and natural gas reserves. An adverse change in the oil and gas exploration and
production industry or a reduction in the exploration and production
expenditures of oil and gas companies could cause our revenues from commercial
products to suffer.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
20
<PAGE>
ITEM 2. PROPERTIES
Our executive offices are located in Clarence, New York.
The following table sets forth information about all of our significant
facilities as of December 31, 2005:
<TABLE>
<CAPTION>
Location Sq. Ft. Own/Lease Principal Use
-------- ------- --------- -------------
<S> <C> <C> <C>
Alden, NY................ 125,000 Own Medical battery and capacitor manufacturing
Clarence, NY............. 82,766 Own Medical battery manufacturing and research,
development and engineering ("RD&E")
Clarence, NY............. 20,800 Own Machining and assembly of components
Clarence, NY............. 18,550 Lease Machining and assembly of components
Clarence, NY............. 45,306 Lease Executive offices and warehouse
Cheektowaga, NY.......... 35,509 Lease Unused manufacturing space
Canton, MA............... 32,000 Own Commercial battery manufacturing and RD&E
Columbia, MD............. 30,000 Lease Feedthrough and electrode manufacturing and RD&E
Carson City, NV.......... 23,840 Lease EMI filtering manufacturing and RD&E
Minneapolis, MN.......... 72,000 Own Enclosure manufacturing and engineering
Tijuana, Mexico.......... 144,000 Lease Value-add assembly
</TABLE>
We believe these facilities are suitable and adequate for our current business.
ITEM 3. LEGAL PROCEEDINGS
We are involved in various legal actions arising in the normal course of
business. While we do not believe that the ultimate resolution of any such
pending activities will have a material adverse effect on our consolidated
results of operations, financial position, or cash flows, litigation is subject
to inherent uncertainties. If an unfavorable ruling were to occur, there exists
the possibility of a material adverse impact in the period in which the ruling
occurs.
During 2002, a former non-medical customer commenced an action alleging that the
Company had used proprietary information of the customer to develop certain
products. We have meritorious defenses and are vigorously defending the matter.
The potential range of loss is between $0.0 and $1.7 million.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
21
<PAGE>
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED SHAREHOLDER MATTERS AND
ISSUER PURCHASES OF EQUITY SECURITIES.
The Company's common stock trades on the New York Stock Exchange ("NYSE") under
the symbol "GB." The following table sets forth, for the periods indicated, the
high and low sales prices per share for the common stock as reported on the NYSE
Composite Tape.
2004 High Low
---- ---- ---
First Quarter $45.15 $34.60
Second Quarter 37.42 23.10
Third Quarter 27.10 14.41
Fourth Quarter 22.94 15.30
2005
First Quarter $22.43 $15.76
Second Quarter 25.19 17.30
Third Quarter 27.45 21.96
Fourth Quarter 30.40 24.03
As of March 10, 2006 there were 214 record holders of the Company's common stock
and the stock price was $21.39. The Company stock account included in our 401(k)
Plan is considered one record holder for the purposes of this calculation. There
are approximately 1,500 holders of Company stock in the 401(k) including active
and former employees.
We have not paid cash dividends and currently intend to retain any earnings to
further develop and grow our business.
There were no transactions required to be reported under Item 703 of Regulation
S-K for purchases of the Company's equity securities by the Company or any
affiliated purchasers, as defined in Rule 10b-18(a)(3) under the Securities
Exchange Act, during the Company's fourth quarter.
22
<PAGE>
EQUITY COMPENSATION PLAN INFORMATION
The following table provides information regarding the Company's equity
compensation plans as of December 31, 2005.
<TABLE>
<CAPTION>
(a) (b) (c)
------------------------------- ------------------------------ -------------------------------
Number of securities Weighted-average exercise Number of securities
to be issued upon exercise of price of outstanding remaining available for
outstanding options, options, warrants and future issuance under
warrants and rights or upon rights; Weighted-average equity compensation plans
vesting of shares granted share price of restricted (excluding securities
Plan Category under restricted stock plan stock shares granted reflected in column (a))
------------- ------------------------------- ------------------------------ -------------------------------
<S> <C> <C> <C>
Equity compensation plans
approved by security holders (1) 1,397,160 $ 23.16 1,128,685
Equity compensation plans
approved by security holders (2) 93,956 $ 25.17 579,044
Equity compensation plans
not approved by security holders -- $ - -
------------------------------- ------------------------------ -------------------------------
Total 1,491,116 $ 23.29 1,707,729
=============================== ============================== ===============================
</TABLE>
(1) Consists of the Company's 1997 Stock Option Plan, 1998 Stock Option Plan,
Non-Employee Director Stock Incentive Plan and the 2005 Stock Incentive
Plan (as it relates to stock options).
(2) Consists of the Company's 2002 Restricted Stock Plan and the 2005 Stock
Incentive Plan (as it relates to restricted stock).
23
<PAGE>
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The following table provides selected financial data of our Company for the
periods indicated. You should read the selected consolidated financial data set
forth below in conjunction with Item 7, "Management's Discussion and Analysis of
Financial Condition and Results of Operations," and with our consolidated
financial statements and related notes appearing elsewhere in this report. The
consolidated statement of operations data and the consolidated balance sheet
data for the fiscal years indicated have been derived from our consolidated
financial statements and related notes.
<TABLE>
<CAPTION>
December 31, (4)
Years ended 2005 2004(3)(7) 2003 2002(2) 2001(1)(5)
----------------------------------------------------------------------------------------------
(in thousands, except per share data)
<S> <C> <C> <C> <C> <C>
Consolidated Statement of Operations Data:
Sales $241,097 $200,119 $216,365 $167,296 $135,575
Income before income taxes $ 15,464 (8) $ 23,732 $ 33,316 $ 20,965 $ 13,778
Income per share
Basic $ 0.47 $ 0.67 $ 1.10 $ 0.69 $ 0.44
Diluted $ 0.46 (6) $ 0.66 (6) $ 1.05 (6) $ 0.68 $ 0.43
Consolidated Balance Sheet Data:
Working capital $151,958 $132,360 $170,455 $ 40,204 $ 61,596
Total assets $512,911 $476,166 $438,243 $312,251 $283,520
Long-term obligations $200,261 $193,948 $178,994 $ 77,040 $ 61,397
</TABLE>
(1) In June 2001, we acquired substantially all of the assets and liabilities
of Sierra. These amounts include the results of operations of Sierra
subsequent to its acquisition.
(2) In July 2002, we acquired the capital stock of Globe. These amounts include
the results of operations of Globe subsequent to its acquisition.
(3) In March 2004, we acquired the capital stock of NanoGram. These amounts
include the results of operations of NanoGram subsequent to its
acquisition.
(4) The Company's fiscal year ends on the Friday closest to December 31. For
clarity of presentation, the Company describes fiscal years as if the
year-end is December 31. Fiscal 2002 contained 53 weeks.
(5) We adopted Statement of Financial Accounting Standards (SFAS) No. 145,
Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB 13, and
Technical Corrections, at the beginning of fiscal year 2003. Under SFAS No.
145, we are no longer allowed to classify debt extinguishments as
extraordinary items in our consolidated financial statements, subject to
limited exceptions. Accordingly, amounts previously classified as
extraordinary related to debt extinguishments in fiscal 2001 have been
reclassified as components of income before income taxes.
(6) We adopted Emerging Issues Task Force (EITF) Issue 04-08, The Effect of
Contingently Convertible Instruments on Diluted Earnings Per Share, in the
fourth quarter of 2004. Under EITF 04-08, we must include the effect of the
conversion of our convertible subordinated notes in the calculation of
diluted earnings per share using the if-converted method as long as the
effect is dilutive. The impact on the full year 2003 was a $0.03 reduction
in earnings per share from $1.08 to $1.05. There was no impact on the full
year 2004. Diluted earnings per share for 2003 are restated to reflect the
adoption of EITF 04-08.
(7) The financial information has been amended to reflect the restatements
described in Note 2. Restatements to the consolidated financial statements
in Item 8.
(8) During 2005, we recorded charges in other operating expense related to our
ongoing cost savings and consolidation efforts. Additional information is
set forth at Note 14 of the Notes to the Consolidated Financial Statements
contained at Item 8 of this report.
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<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
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.
The Company's 2004 consolidated financial statements have been restated as
described in Note 2, Restatement to the consolidated financial statements in
Item 8, and the following discussion and analysis and related financial
information contained herein have been revised to reflect the effects of the
restatement.
Index
Our Business
o Our business
o Our customers
o Our CEO's view
Cost Savings and Consolidation Efforts
o Severance
o Alden Facility
o Carson City shutdown & Tijuana consolidation No. 1
o Columbia and ARL shutdown, Tijuana consolidation No. 2 and RD&E
consolidation
Our Critical Accounting Estimates
o Inventories
o Goodwill and other indefinite lived assets
o Long-lived assets
o Provision for income taxes
Our Financial Results
o Results of operations table
o Fiscal 2005 compared to 2004
o Fiscal 2004 compared to 2003
o Liquidity and capital resources
o Off-balance sheet arrangements
o Contractual obligations
o Inflation
o Impact of recently issued accounting standards
25
<PAGE>
Our Business
We are a leading developer and manufacturer of batteries, capacitors,
feedthroughs, enclosures, and other components used in implantable medical
devices ("IMDs") through our Implantable Medical Components ("IMC") business. We
offer technologically advanced, highly reliable and long lasting products for
IMDs and enable our customers to introduce IMDs that are progressively smaller,
longer lasting, more efficient and more functional. We also leverage our core
competencies in technology and manufacturing through our Electrochem Commercial
Power ("ECP") business to develop and produce batteries and battery packs for
commercial applications that demand high performance and reliability, including
oil and gas exploration, oceanographic equipment and aerospace.
Most of the IMC products that we sell are utilized by customers in cardiac
rhythm management ("CRM") devices. The CRM market comprises devices utilizing
high-rate batteries and capacitors such as implantable cardioverter
defibrillators ("ICDs") and cardiac resynchronization therapy with backup
defibrillation devices ("CRT-D") and devices utilizing low or medium rate
batteries but no capacitors (pacemakers and CRTs). All CRM devices utilize other
components such as enclosures and feedthroughs, and certain CRM devices utilize
electromagnetic interference ("EMI") filtering technology.
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. Our medical customers include leading IMD manufacturers such as
Guidant, St. Jude Medical, Medtronic, Biotronik, Cyberonics and the Sorin Group.
A substantial part of our business is conducted with a limited number of
customers. In 2005, Guidant, St. Jude Medical, and Medtronic collectively
accounted for approximately 70% of our total sales. The nature and extent of our
selling relationships with each CRM customer are different in terms of breadth
of component products purchased, purchased product volumes, length of
contractual commitment, ordering patterns, inventory management and selling
prices. Our ECP customers are primarily companies involved in oil and gas
exploration, military, oceanography and aerospace.
We have entered into long-term supply agreements with some of our customers. For
each of our products, we recognize revenue when the products are shipped and
title passes.
Our CEO's View
We are very pleased with our financial performance in 2005. We achieved sales
growth of 20%, and increased operating cash flow by $43.0 million. 2005 marked a
year of considerable change in the industry. A factor in this year's performance
has been the ability of our team to recognize this change, look for the
opportunities that always accompany any changes and then, most importantly,
capitalize on that new dynamic. We are pleased with our accomplishments and the
commitment to the continued growth for our company, its associates and its
shareholders. 2005 was an event filled year in our markets with significant
merger and acquisition activity and marketplace customer field actions.
26
<PAGE>
In the case of Greatbatch, we reacted quickly and decisively and were ultimately
rewarded by our performance. Not all of the change this past year was initiated
externally however, and there is much to report regarding our own "dynamic" news
for 2005. First and foremost, we were pleased to bring two new production
facilities on-line with the opening of Alden, NY and Tijuana, Mexico. The
facility in Alden incorporates state-of-the-art capability for precise and
efficient manufacture of implantable medical batteries and capacitors. This
125,000 square foot plant puts us in position to respond to our customers in a
more timely and effective manner.
We were honored to have Mexico's President, Vicente Fox, as our guest at the
dedication of our new 144,000 square foot facility in Tijuana. At that location
we are, in part, concentrating on an aspect of the implantable device industry
that represents, for us, the opportunity for both growth and diversification. It
is there that we are providing sophisticated assembly services to existing and
new customers both within, and outside, the CRM market in which we're so well
established.
The Alden and Tijuana stories do not end there. Those sites are now, and will
continue to be, critical elements in our strategic facilities consolidation
plan. Capacitor production has been integrated into the Alden facility and the
filtered feedthrough assembly operations have been relocated to the Tijuana
facility. We are also consolidating all of our medical research and development
operations into Clarence, NY. Additionally, feedthrough manufacturing operations
will be transferred to Tijuana by mid-2007. These consolidations not only
provide increased efficiencies and economies of operation, but also provide a
unique synergy between product groups that never before existed with discrete
locations.
With the ICD market expected to grow 20% over the next three to five years and
with the further expansion of our commercial market presence into the
telematics, oceanographic, military and core oil and gas industries, we feel
confident that our consolidation and current manufacturing philosophy lays the
foundation for supporting new and increasing manufacturing demands. In 2005, our
commercial business revenues increased by 21%, resulting from an expansion of
our sales presence in the marketplace. Seismic applications for our products in
the areas of wave and ocean bottom research and exploration, along with military
use in remote sensing and communications technology, are examples of our
expansion beyond our traditional strength in the oil and gas industries. We are
looking ahead to new markets, such as telematics and the possible introduction
of rechargeable battery packs, which offer potential for sustained growth.
2005 marked the first production of the Greatbatch QHR (high rate) battery for
the implantable medical device industry. This new technology further reinforces
the reputation of Greatbatch as innovator, developer and manufacturer of
implantable, medical power sources. At the same time, we are making progress in
the development of a revolutionary high voltage capacitor solution to meet the
demands of the next generation of CRM devices and are expecting release of that
product in 2007. New inductor slab and molded header designs for devices are
also in the development pipeline and offer opportunities for increased growth.
In addition to the aforementioned market opportunities, the neurostimulation
market represents another growth opportunity for Greatbatch. The technology
offers advanced therapy for relief from chronic pain, obesity, Parkinson's
disease, depression, epilepsy, stroke, tremor and other
27
<PAGE>
conditions. Because of the diverse conditions for which it provides treatment,
the neurostimulation market could easily rival the CRM market in size over the
long term. Primary batteries are ultimately expected to be the power source of
choice in more than half of the neurostimulation applications. These devices are
similar in technology to pacemakers and we are currently developing our QMR
(medium rate) power source technology to specifically meet the requirements of
these new devices. We believe our QMR battery has some significant and critical
advantages such as high energy in a small package, high power capabilities to
drive advanced telemetry features, MRI enabled and stable discharge
characteristics over life, with availability in proprietary and non-proprietary
designs. We currently anticipate initial deliveries of the QMR technology to
customers in the fourth quarter of 2006.
For the remainder of the neurostimulation market that has a higher power
requirement that cannot be met by primary batteries, the answer lies with
secondary power sources (rechargeable). We are presently investing in advancing
our own rechargeable battery program. We expect that these high power and high
energy cells will be available by the first half of 2007. With power solutions
in position for our neurostimulation customers, we are poised for a logical and
natural entry into selling our complete line of components (feedthroughs,
coatings, enclosures and precision machined parts) to those same customers. Most
of those products are very mature and will require little, if any,
re-engineering to be valuable to neurostimulation manufacturers.
Beyond neurostimulation there is another therapy with which we've been
integrally involved - the intravascular ICD. As with the benefits of traditional
CRM therapies the new technology has been enabled by Greatbatch battery,
capacitor and filtered feedthrough designs and capabilities. We are currently
collaborating with a leader in the field to bring this new device category to
market.
The foundation for the growth in our Company is dependant on successfully
executing on our corporate strategy. This strategy is based on four key
principles:
1. maintaining our technology leadership;
2. optimizing our operational capabilities;
3. delivering customer focused growth; and
4. pursuing business development opportunities.
Maintaining our technology leadership will require us to maintain a fresh
pipeline of next generation core components, and to transition from supplying
discrete products to providing integrated solutions by bundling our proprietary
technology. Working closely with our customers to understand their product
design changes will be important to minimize the threat of alternative and
replacement technologies.
Optimizing our operational capabilities involves not only successfully executing
on our facility consolidation plan, but is also predicated on maintaining a
robust quality system to ensure product reliability and efficient internal
business practices. In order to maintain a market leadership position, we must
reduce the time to market and design products for manufacturability.
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<PAGE>
In order to deliver customer focused growth, we must understand our customer
needs and design solutions into applications early in the end-product life
cycle. Providing our customers with comprehensive solutions should allow us to
better protect our market share position and reduce competitive threats.
Our biggest risk rests with the heavy concentration of sales with our three
largest customers, which comprise approximately 70% of our total revenues. In
order to establish a platform for growth, we must strengthen our competencies
and broaden the Greatbatch customer base. As part of our growth strategy, we
will continue to look for acquisitions that will allow us to diversify the
customer base while maintaining our focus on proprietary growth products.
In summary, we've maintained our focus despite turbulence in the industry and
actually leveraged those changes to our benefit. We've celebrated our 35 year
anniversary. We are launching important new products that enhance an already
enviable reputation for releasing innovative, high quality, safe and reliable
technologies. We maintain a strong financial position and have in place an
equally strong management team - both of which are essential for our future. All
of these factors are critical in providing stability and growth during changing
times.
Cost savings and consolidation efforts
During 2005, we recorded charges in other operating expense related to our
ongoing cost savings and consolidation efforts. Additional information is set
forth at Note 14 of the Notes to the Consolidated Financial Statements contained
at Item 8 of this report.
Severance charges. The Company implemented a 4% workforce reduction during the
first quarter of 2005, which resulted in a severance charge of $1.5 million. Of
that amount, $0.8 million, $0.5 million, and $0.2 million were paid in cash
during the first, second and third quarters, respectively.
Alden Facility Consolidation. On February 23, 2005, we announced our intent to
consolidate the medical capacitor manufacturing operations, currently in
Cheektowaga, NY, and the implantable medical battery manufacturing operations,
currently in Clarence, NY, into the advanced power source manufacturing facility
in Alden, NY ("Alden Facility"). We are also consolidating the capacitor
research, development and engineering operations from the Cheektowaga, NY,
facility into the existing implantable medical battery research, development,
and engineering operations in Clarence, NY.
The total cost estimated for these consolidation efforts is anticipated to be
between $3.5 million and $4.0 million. Expenses of $2.8 million were incurred in
2005. Of these, $1.8 million were paid in cash, $0.8 million were for assets
written-off, and $0.2 million remain to be paid. We expect to incur the
remaining expense during the first quarter of 2006.
Carson City Facility shutdown and Tijuana Facility consolidation No. 1. On March
7, 2005, we announced our intent to close the Carson City, NV facility ("Carson
City Facility") and consolidate the work performed at the Carson City Facility
into the Tijuana, Mexico facility ("Tijuana Facility consolidation No. 1").
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<PAGE>
The total estimated cost for this facility consolidation plan is anticipated to
be between $5.2 million and $5.5 million, comprised of $3.2 million for the
Carson City Facility shutdown and $2.0 million to $2.3 million for Tijuana
Facility consolidation No. 1. We expect to incur the remaining costs over the
next three fiscal quarters. All categories of costs are considered to be cash
expenditures, except for accelerated depreciation.
Carson City Facility shutdown expenses of $2.9 million were incurred in 2005, of
which $0.2 million were paid in cash, $0.6 million have been recorded as
accelerated depreciation and $2.1 million remain to be paid. Tijuana Facility
consolidation No. 1 expenses of $1.5 million have been incurred and paid year to
date.
Columbia Facility & ARL shutdown, Tijuana Facility consolidation No. 2, and RD&E
Consolidation. On November 16, 2005, we announced our intent to close both the
Columbia, MD facility ("Columbia Facility") and the Fremont, CA Advanced
Research Laboratory ("ARL"). The manufacturing operations at the Columbia
Facility will be moved into the Tijuana Facility ("Tijuana Facility
consolidation No. 2"). The research, development and engineering ("RD&E") and
product development functions at the Columbia Facility and at ARL have begun to
relocate to the Technology Center in Clarence, NY.
The total estimated cost for this facility consolidation plan is anticipated to
be between $7.9 million and $8.3 million. We expect to incur this additional
cost over the next 6 quarters. All categories of costs are considered to be
future cash expenditures, except for accelerated depreciation and asset
write-offs.
Columbia Facility and ARL shutdown expenses of $1.1 million have been incurred
year to date, of which $0.4 million have been recorded for assets written-off,
and $0.7 million remain to be paid. Tijuana Facility consolidation plan No. 2
expenses of $0.01 million have been incurred and paid in cash in 2005.
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<PAGE>
Our Critical Accounting Estimates
The preparation of financial statements in accordance with generally accepted
accounting principles in the United States of America ("GAAP") requires
management 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
financial statements. Management considers an accounting estimate to be critical
if:
o It requires assumptions to be made that were uncertain at the time the
estimate was made; and
o 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.
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<PAGE>
<TABLE>
-----------------------------------------------------------------------------------------------------------------------------------
Balance Sheet Caption / Nature of Effect of Variations on Key
Critical Estimate Item Assumptions / Approach Used Assumptions Used
-----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Inventories Inventory standard costing requires complex Variations in methods or assumptions
calculations that include assumptions for overhead could have a material impact on the
Inventories are stated at the lower absorption, scrap and sample calculations, results. If our demand forecast for
of cost, determined using the manufacturing yield estimates and the specific products is greater than
first-in, first-out method, or determination of which costs are capitalizable. actual demand and we fail to reduce
market. The valuation of inventory requires us to estimate manufacturing output accordingly, we
obsolete or excess inventory as well as inventory could be required to record
that is not of saleable quality. additional inventory reserves, which
would have a negative impact on our
income from operations.
-----------------------------------------------------------------------------------------------------------------------------------
Goodwill and other indefinite lived We perform an annual review, or more frequently if We make certain estimates and
assets indicators of potential impairment exist, to assumptions that affect the
determine if the recorded goodwill and other determination of the expected future
Goodwill is initially recorded when indefinite lived assets are impaired. We assess cash flows from our reporting units.
the purchase price paid for an goodwill for impairment by comparing the fair These estimates and assumptions
acquisition exceeds the estimated value of the reporting units to their carrying include sales growth projections,
fair value of the net identified value to determine if there is potential cost of capital projections, and
tangible and intangible assets impairment. If the fair value of a reporting unit other key indications of future cash
acquired. Other indefinite lived is less than its carrying value, an impairment flows. Significant changes in these
assets such as trademark & names are loss is recorded to the extent that the implied estimates and assumptions could
considered non-amortizing intangible fair value of the goodwill within the reporting create future impairment losses in
assets as they are expected to unit is less than its carrying value. Fair values either reporting unit.
generate cash flows indefinitely. for goodwill are determined based primarily on
These assets are subject to the discounted cash flows, however where appropriate, For indefinite lived assets such as
estimation risks related to the market multiples or appraised values may also be trademark and names, we make certain
purchase price allocation conducted used. Indefinite lived assets such as trademarks estimates of the revenue streams and
at acquisition. and names are evaluated for impairment by using the other future benefits accruing to
the income approach. This method is used to us. Significant changes in these
estimate the value of intangibles by considering estimates could create future
the present worth of the stream of future benefits impairments of these indefinite lived
accruing to the owner of these assets. These assets.
future benefits are quantified by assuming a
"Relief from Royalty." The concept underlying the
method is that the user realizes an enhanced
earnings capacity from ownership of the intangible
asset, equal to the royalty they would have to pay
a third party for use of the name.
-----------------------------------------------------------------------------------------------------------------------------------
Long-lived assets We assess the impairment of long-lived assets when Estimation of the useful lives of
events or changes in circumstances indicate that assets that are long-lived requires
Property, plant and equipment, the carrying value of the assets may not be significant management judgment.
definite-lived intangible assets, recoverable. Factors that we consider in deciding Events could occur, including changes
and other long-lived assets are when to perform an impairment review include in cash flow that would materially
carried at cost. This cost is significant under-performance of a business or affect our estimates and assumptions
charged to depreciation or product line in relation to expectations, related to depreciation. Unforeseen
amortization expense over the significant negative industry or economic trends, changes in operations or technology
estimated life of the operating and significant changes or planned changes in our could substantially alter the
assets primarily using straight-line use of the assets. Recoverability potential is assumptions regarding the ability to
rates. Long-lived assets acquired measured by comparing the carrying amount of the realize the return of our investment
through acquisition are subject to asset group to the related total future in operating assets and therefore the
the estimation risks related to the undiscounted cash flows. If an asset group's amount of depreciation expense to
initial purchase price allocation carrying value is not recoverable through related charge against both current and
and the on-going impairment cash flows, the asset group is considered to be future sales. Also, as we make
assessment. Long-lived assets impaired. Impairment is measured by comparing the manufacturing process conversions and
</TABLE>
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<PAGE>
<TABLE>
-----------------------------------------------------------------------------------------------------------------------------------
Balance Sheet Caption / Nature of Effect of Variations on Key
Critical Estimate Item Assumptions / Approach Used Assumptions Used
-----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
acquired in the ordinary course of asset group's carrying amount to its fair value, other factory planning decisions, we
business are also subject to based on the best information available, including must make subjective judgments
impairment assessment. market prices or discounted cash flow analysis. regarding the remaining useful lives
When it is determined that useful lives of assets of assets, primarily manufacturing
are shorter than originally estimated, and there equipment and building improvements.
are sufficient cash flows to support the carrying
value of the asset group, we accelerate the rate
of depreciation in order to fully depreciate the
assets over their new shorter useful lives.
-----------------------------------------------------------------------------------------------------------------------------------
Provision for Income Taxes In relation to recording the provision for income Changes could occur that would
taxes, management must estimate the future tax materially affect our estimates and
In accordance with the liability rates applicable to the reversal of tax assumptions regarding deferred
method of accounting for income differences, make certain assumptions regarding taxes. Changes in current tax laws
taxes specified in Statement of whether tax differences are permanent or temporary and tax rates could affect the
Financial Accounting Standards No. and the related timing of expected reversal. valuation of deferred tax assets and
109, Accounting for Income Taxes, Also, estimates are made as to whether taxable liabilities, thereby changing the
the provision for income taxes is operating income in future periods will be income tax provision. Also,
the sum of income taxes both sufficient to fully recognize any gross deferred significant declines in taxable
currently payable and deferred. The tax assets. If recovery is not likely, we must income could materially impact the
changes in deferred tax assets and increase our provision for taxes by recording a realizable value of deferred tax
liabilities are determined based valuation allowance against the deferred tax assets. At December 31, 2005 we had
upon the changes in differences assets that we estimate will not ultimately be $6.3 million of deferred tax assets
between the basis of assets and recoverable. Alternatively, we may make estimates on our balance sheet. A 1% increase
liabilities for financial reporting about the potential usage of deferred tax assets in the effective tax rate would
purposes and the basis of assets and that decrease our valuation allowances. As of increase the current year provision
liabilities as measured by the December 31, 2005, the Company has recorded a by $155,000, reducing fully diluted
enacted tax rates that management valuation allowance of $4.8 million against earnings per share by $0.01 based on
estimates will be in effect when the potential non-utilizable deferred tax assets. shares outstanding at December 31,
differences reverse. 2005.
In addition, the calculation of our tax
liabilities involves dealing with uncertainties in
the application of complex tax regulations. We
recognize liabilities for anticipated tax audit
issues in the U.S. and other tax jurisdictions
based on our estimate of whether, and the extent
to which, additional income taxes will be due. If
we ultimately determine that payment of these
amounts is unnecessary, we reverse the liability
and recognize a tax benefit during the period in
which we determine that the liability is no longer
necessary. We record an additional charge in our
provision for income taxes in the period in which
we determine that the recorded tax liability under
the criteria established by Financial Accounting
Standard No. 5 "Accounting for Contingencies" is
less than we expect the ultimate assessment to
be.
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</TABLE>
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<PAGE>
Our Financial Results
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
The commentary that follows should be read in conjunction with our consolidated
financial statements and related notes. We utilize a fifty-two, fifty-three week
fiscal year ending on the Friday nearest December 31st. For clarity of
presentation, the Company describes all periods as if the year-end is December
31st.
<TABLE>
<CAPTION>
Results of Operations Year ended December 31, 2005 - 2004 2004 - 2003
In thousands, except per share data 2005 2004(1)(3) 2003(3) $ Change % Change $ Change % Change
----------------------------------- ---------------------- ---------------------
<S> <C> <C> <C> <C> <C> <C> <C>
IMC
ICD batteries $ 45,803 $ 35,742 $ 41,494 $ 10,061 28% $ (5,752) -14%
Pacemaker and other batteries 21,708 19,434 24,578 2,274 12% (5,144) -21%
ICD capacitors 20,709 21,981 31,668 (1,272) -6% (9,687) -31%
Feedthroughs 59,210 47,387 48,257 11,823 25% (870) -2%
Enclosures 23,866 21,709 24,742 2,157 10% (3,033) -12%
Other 36,618 26,402 19,482 10,216 39% 6,920 36%
----------------------------------- ---------------------- ---------------------
Total IMC 207,914 172,655 190,221 35,259 20% (17,566) -9%
ECP 33,183 27,464 26,144 5,719 21% 1,320 5%
----------------------------------- ---------------------- ---------------------
Total sales 241,097 200,119 216,365 40,978 20% (16,246) -8%
Cost of sales - excluding amortization of
intangible assets 151,543 119,397 126,537 32,146 27% (7,140) -6%
Amortization of intangible assets - cost
of sales 3,841 4,002 3,217 (161) -4% 785 24%
----------------------------------- ---------------------- ---------------------
Gross profit (2) 85,713 76,720 86,611 8,993 12% (9,891) -11%
Gross margin 35.6% 38.3% 40.0% -2.7% -1.7%
Selling, general, and administrative
expenses ("SG&A") 31,528 26,719 30,384 4,809 18% (3,665) -12%
SG&A as a % of sales 13.1% 13.4% 14.0% -0.3% -0.6%
Research, development and engineering costs,
net ("RD&E") 18,725 18,476 16,991 249 1% 1,485 9%
RD&E as a % of sales 7.8% 9.2% 7.9% -1.4% 1.3%
Other operating expense 18,574 4,585 1,036 13,989 305% 3,549 343%
----------------------------------- ---------------------- ---------------------
Operating income 16,886 26,940 38,200 (10,054) -37% (11,260) -29%
Operating margin 7.0% 13.5% 17.7% -6.5% -4.2%
Interest expense 4,613 4,535 4,101 78 2% 434 11%
Interest income (3,113) (1,235) (702) (1,878) 152% (533) 76%
Other (income) expense, net (78) (92) 1,485 14 -15% (1,577) -106%
Provision for income taxes 5,357 9,514 10,028 (4,157) -44% (514) -5%
Effective tax rate 34.6% 40.1% 30.1% -5.5% 10.0%
----------------------------------- ---------------------- ---------------------
Net income $ 10,107 $ 14,218 $ 23,288 $ (4,111) -29% $ (9,070) -39%
=================================== ====================== =====================
Net margin 4.2% 7.1% 10.8% -2.9% -3.7%
Diluted earnings per share $ 0.46 $ 0.66 $ 1.05 $ (0.20) -30% $ (0.39) -37%
</TABLE>
(1) As restated, see Note 2 to the accompanying consolidated financial
statements.
(2) Gross profit, which equals total sales minus cost of sales including
amortization of intangibles, has been revised from prior year.
(3) Amounts presented for sales have been expanded to better coincide with our
significant product lines.
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<PAGE>
FISCAL 2005 COMPARED WITH FISCAL 2004
Sales
IMC. The nature and extent of our selling relationship with each CRM customer is
different in terms of component products purchased, selling prices, product
volumes, ordering patterns and inventory management. We have pricing
arrangements with our customers that at times do not specify minimum order
quantities. Our visibility to customer ordering patterns is over a relatively
short period of time. Our customers may have inventory management programs and
alternate supply arrangements of which we are unaware. Additionally, the
relative market share among the CRM device manufacturers changes periodically.
Consequently, these and other factors can significantly impact our sales in any
given period.
The 2005 results received the benefit of market place customer field actions
surrounding ICD products. However, it is extremely difficult to identify how
much benefit we received during the year. We do not have specific information on
the nature of the orders and can only assume that some percentage of the
increase relates to the ICD marketplace customer field actions.
Our customers may initiate field actions with respect to market-released
products. These actions may include product recalls or communications with a
significant number of physicians about a product or labeling issue. The scope of
such actions can range from very minor issues affecting a small number of units
to more significant actions, including a recall. There are a number of factors,
both short-term and long-term related to these field actions that may impact our
results. In the short-term, if product has to be replaced, or customer inventory
levels have to be restored, this will result in increased component demand.
Also, changing customer order patterns due to market share shifts or accelerated
device replacements may also have a positive impact on our sales results in the
near-term. These same factors may have longer-term implications as well.
Customer inventory levels may ultimately have to be rebalanced to match demand.
Moving beyond the field actions, the increase in demand is not isolated to any
one customer. We saw strength across all of our products and our entire customer
base. We believe that the market continues to exhibit strong underlying growth
fundamentals (as evidenced by the increased number of CRM device implants) and
that we are well positioned to participate in this market growth.
The increase in IMC sales of 20% for 2005 was primarily due to increased demand
for ICD batteries, filtered feedthroughs, coated components and medical
enclosures offset by an average 2% reduction in selling prices.
ECP. Similar to IMC customers, we have pricing arrangements with our customers
that many times do not specify minimum quantities. Our visibility to customer
ordering patterns is over a relatively short period of time.
The ECP sales increase of 21% for 2005 was driven by the following factors:
First and foremost, we have expanded our commercial sales force. We are
aggressively pursuing new business opportunities and have been successful on
many of these fronts.
Second, we have significantly reduced our manufacturing lead times at our
Canton, Massachusetts facility, which has allowed us to be more responsive to
our customers' needs. We will continue to expand on these efforts from various
lean manufacturing initiatives that are
35
<PAGE>
underway in our Canton facility and throughout the Company. Reduced lead times
have allowed us to win customer orders that would normally have gone to other
suppliers.
The third factor that has contributed to our positive commercial results has
been favorable market dynamics. The oil and gas exploration market remains
robust due to the increased demand for products used in pipeline inspections,
pressure monitoring and measurement while drilling applications. In addition, we
have seen an increase in demand for power sources used in wave monitoring and
seismic recording, due to increased Tsunami related concerns, mainly in the
international markets.
2006 Sales Outlook
We expect 2006 net sales to increase 2% to 10%. We expect IMC sales to increase
by 1% to 10%. This projection takes into consideration the effect of the
marketplace field actions that occurred in 2005 and resulted in incremental
medical sales of $10.0 million to $15.0 million. IMC's primary markets are CRM
and neurostimulation. The CRM market is comprised of two sub-markets - ICD and
pacemaker. In 2006, the ICD market is expected to grow between 15% - 20% and the
pacemaker market growth is expected to be 0% to 4%. The neurostimulation market
is expected to grow by 18% to 20%. Growth in these markets is based on expanding
patient base indicated for device therapy, broader medical reimbursement
coverage, favorable clinical trials and expanding indications for treatment of
various medical conditions.
We expect ECP sales to increase by 6% to 12%. ECP's primary markets are oil and
gas, as well as oceanographic. In 2006, these markets are expected to grow by 6%
and 11%, respectively. Growth in these markets will be driven by the price of
oil, increased requirements for pipeline inspections, and increased monitoring
of wave and ocean bottom research.
Cost of Sales
The 2005 impact on cost of sales as a percentage of sales was primarily due to
the following factors:
Year ended
December 31,
2005
Production efficiencies primarily associated with higher volumes (a) -3.4%
Excess capacity at wet tantalum capacitor and Tijuana facilities (b) 2.2%
Lower IMC selling prices (c) 1.5%
Profit sharing accruals and incentive compensation (d) 0.3%
Warranty (e) 1.0%
Other 1.1%
----
Total percentage point impact on cost of sales as a
percentage of sales 2.7%
====
a. This decrease in cost of sales is primarily due to the fact that as
production volumes increase, fixed costs such as plant overhead and
depreciation do not increase at the same rate.
b. During 2005, two facilities were not being utilized to their full capacity.
The capacitor facility was initially established to handle higher levels of
production quantities. The capacitor facility is expected to be fully
consolidated into the Alden facility by the end of the first quarter 2006.
This should eliminate the costs associated with the original capacitor
36
<PAGE>
facility. The Tijuana facility is new for 2005 and as a result its floor
space and infrastructure are considered under utilized at this time. The
production of feedthroughs (currently being performed in Carson City and
Columbia) is in the process of being relocated to the Tijuana facility. See
the "cost savings and consolidation" section for additional information.
c. Sales prices for Implantable Medical Components are subject to pricing
agreements with customers. Many times these agreements allow for changes in
price due to customer specific levels of demand.
d. Based on several metrics, this year's profit sharing and incentive
calculations were higher than in 2004.
e. We incurred incremental warranty costs in 2005 to settle customer claims
related to the IMC segment.
We expect cost of sales as a percentage of sales to decrease over the next
several years as the result of the consolidation efforts and the elimination of
excess capacity. Excess capacity for the Tijuana Facility is not expected to be
eliminated until mid 2007 when the last announced consolidation effort is
anticipated to be completed (see the "cost savings and consolidation" section
for additional information).
SG&A expenses
The increase in SG&A expenses for 2005 is primarily due to the following factors
(in millions):
Year ended
December 31,
2005
Higher incentive compensation $ 3.4
Increase in sales and marketing workforce 1.0
Depreciation related to ERP system partially installed in 2004 1.5
Costs associated with Sarbanes-Oxley compliance (0.5)
Other, including costs associated with the new Tijuana Facility (0.6)
-----------
Net increase in SG&A $ 4.8
===========
SG&A expenses are expected to increase in 2006 by approximately $3.7 to $4.3
million due to the implementation of SFAS No. 123 (revised 2004), Share-Based
Payment ("SFAS No. 123(R)"). This incremental cost is expected to be partially
offset by savings in other areas. However, the increase in sales and marketing
is expected to continue into the future.
37
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RD&E expenses
Net research, development and engineering costs are as follows (in millions):
Year ended December 31,
2005 2004
Research and development costs $ 17.1 $ 15.8
----------- ----------
Engineering costs 5.5 6.7
Less cost reimbursements (3.9) (4.0)
----------- ----------
Engineering costs, net 1.6 2.7
----------- ----------
Total research and development and engineering
costs, net $ 18.7 $ 18.5
=========== ==========
Gross RD&E spending was slightly higher in 2005 compared to 2004. Expenses
increased during 2005 by $2.1 million for increased staffing in RD&E to support
increased research initiatives for IMC. These expenses were offset by the QHR
battery product line moving from the development stage into production ($1.3
million). The gross costs in each year were offset by repayments for development
efforts for projects where the company is reimbursed for ach