10-Q 1 a4699670.txt WILSON GREATBATCH TECHNOLOGIES U.S. SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Quarter ended July 2, 2004 Commission File Number 1-16137 WILSON GREATBATCH TECHNOLOGIES, INC. (Exact name of Registrant as specified in its charter) Delaware (State of incorporation) 16-1531026 (I.R.S. employer identification no.) 9645 Wehrle Drive Clarence, New York 14031 (Address of principal executive offices) (716) 759-5600 (Registrant's telephone number, including area code) Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [ X ] No [ ] Indicate by check mark whether the Registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes [ X ] No [ ] The number of shares outstanding of the Company's common stock, $.001 par value per share, as of August 6, 2004 was: 21,381,859 shares WILSON GREATBATCH TECHNOLOGIES, INC. TABLE OF CONTENTS FOR FORM 10-Q QUARTER ENDED JUNE 30, 2004
Page ---- COVER PAGE 1 ---------- TABLE OF CONTENTS 2 PART I - FINANCIAL INFORMATION (unaudited) ITEM 1. Financial Statements Condensed Consolidated Balance Sheet 3 Condensed Consolidated Statement of Operations 4 Condensed Consolidated Statement of Cash Flows 5 Notes to Condensed Consolidated Financial Statements 6 ITEM 2. Management's Discussion and Analysis of Financial Condition and 15 Results of Operations ITEM 3. Quantitative and Qualitative Disclosures About Market Risk 23 ITEM 4. Controls and Procedures 23 PART II - OTHER INFORMATION ITEM 1. Legal Proceedings 24 ITEM 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities 24 ITEM 3. Defaults Upon Senior Securities 24 ITEM 4. Submission of Matters to a Vote of Security Holders 24 ITEM 5. Other Information 24 ITEM 6. Exhibits and Reports on Form 8-K 25 SIGNATURES 26 EXHIBIT INDEX 27
-2- WILSON GREATBATCH TECHNOLOGIES, INC. CONDENSED CONSOLIDATED BALANCE SHEET - Unaudited (IN THOUSANDS) -------------------------------------------------------------------------------- ASSETS JUNE 30, DECEMBER 31, 2004 2003 --------- ----------- Current assets: Cash and cash equivalents $ 79,851 $ 119,486 Short-term investments 3,070 11,559 Accounts receivable, net 29,354 23,726 Inventories 32,989 28,598 Prepaid expenses and other current assets 2,474 3,591 Refundable income taxes 575 583 Deferred income taxes 3,163 3,163 Asset available for sale 3,600 3,658 --------- --------- Total current assets 155,076 194,364 Property, plant, and equipment, net 74,994 63,735 Intangible assets, net 66,079 51,441 Goodwill 156,825 119,521 Deferred income taxes 2,896 2,896 Other assets 6,000 6,286 --------- --------- Total assets $ 461,870 $ 438,243 ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable $ 5,641 $ 4,091 Accrued expenses and other current liabilities 13,491 18,968 Current portion of long-term debt 1,182 850 --------- --------- Total current liabilities 20,314 23,909 Long-term debt, net of current portion 939 928 Convertible subordinated notes 170,000 170,000 Deferred income taxes 18,786 7,251 Other long-term liabilities 815 815 --------- --------- Total liabilities 210,854 202,903 --------- --------- Stockholders' equity: Preferred stock -- -- Common stock 21 21 Additional paid-in capital 211,778 207,969 Deferred stock-based compensation (849) (1,185) Treasury stock, at cost -- (179) Retained earnings 40,066 28,714 --------- --------- Total stockholders' equity 251,016 235,340 --------- --------- Total liabilities and stockholders' equity $ 461,870 $ 438,243 ========= ========= The accompanying notes are an integral part of these condensed consolidated financial statements -3- WILSON GREATBATCH TECHNOLOGIES, INC. CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS - Unaudited (IN THOUSANDS EXCEPT PER SHARE AMOUNTS) --------------------------------------------------------------------------------
THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, ------------------------ -------------------------- 2004 2003 2004 2003 -------- -------- --------- --------- Sales $ 52,942 $ 55,802 $ 108,467 $ 110,659 Cost of sales 29,124 32,585 61,474 64,629 -------- -------- --------- --------- Gross profit 23,818 23,217 46,993 46,030 Selling, general and administrative expenses 6,389 8,146 13,314 15,837 Research, development and engineering costs, net 5,688 4,635 10,569 9,195 Amortization of intangible assets 1,076 813 1,851 1,628 Other operating expense, net 2,957 77 3,178 147 -------- -------- --------- --------- Operating income 7,708 9,546 18,081 19,223 Interest expense 1,144 867 2,304 1,798 Interest income (245) (122) (558) (131) Early extinguishment of debt -- 1,603 -- 1,603 Other income, net (2) (30) -- (88) -------- -------- --------- --------- Income before provision for income taxes 6,811 7,228 16,335 16,041 Provision for income taxes 2,078 2,276 4,983 5,052 -------- -------- --------- --------- Net income $ 4,733 $ 4,952 $ 11,352 $ 10,989 ======== ======== ========= ========= Earnings per share: Basic $ 0.22 $ 0.23 $ 0.53 $ 0.52 Diluted $ 0.22 $ 0.23 $ 0.53 $ 0.51 Weighted average shares outstanding: Basic 21,366 21,159 21,323 21,114 Diluted 21,496 21,535 21,562 21,416
The accompanying notes are an integral part of these condensed consolidated financial statements -4- WILSON GREATBATCH TECHNOLOGIES, INC. CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS - Unaudited (IN THOUSANDS) --------------------------------------------------------------------------------
SIX MONTHS ENDED JUNE 30, 2004 2003 --------- --------- Cash flows from operating activities: Net income $ 11,352 $ 10,989 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 7,253 6,817 Stock-based compensation 1,511 1,095 Early extinguishment of debt -- 1,487 Deferred income taxes 3,540 (468) Loss on disposal of assets 115 425 Changes in operating assets and liabilities: Accounts receivable (5,628) (7,415) Inventories (4,391) 1,772 Prepaid expenses and other current assets 1,164 2,490 Accounts payable 1,433 (1,730) Accrued expenses and other current liabilities (2,915) 3,808 Income taxes (1,502) 504 --------- --------- Net cash provided by operating activities 11,932 19,774 --------- --------- Cash flows from investing activities: Sale (purchase) of short-term investments 8,489 (2,991) Acquisition of property, plant and equipment (15,183) (5,116) Proceeds from sale of assets 64 2,302 Decrease in other assets 37 107 Acquisition of subsidiary, net (45,604) -- --------- --------- Net cash used in investing activities (52,197) (5,698) --------- --------- Cash flows from financing activities: Proceeds from issuance of long-term debt -- 170,000 Principal payments of long-term debt (663) (85,000) Payment of debt issue costs -- (4,540) Issuance of common stock 1,114 330 Issuance of treasury stock 179 -- --------- --------- Net cash provided by financing activities 630 80,790 --------- --------- Net (decrease) increase in cash and cash equivalents (39,635) 94,866 Cash and cash equivalents, beginning of year 119,486 4,608 --------- --------- Cash and cash equivalents, end of period $ 79,851 $ 99,474 ========= =========
The accompanying notes are an integral part of these condensed consolidated financial statements -5- WILSON GREATBATCH TECHNOLOGIES, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Unaudited -------------------------------------------------------------------------------- 1. BASIS OF PRESENTATION The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information necessary for a fair presentation of financial position, results of operations, and cash flows in conformity with generally accepted accounting principles. Operating results for interim periods are not necessarily indicative of results that may be expected for the fiscal year as a whole. In the opinion of management, the condensed consolidated financial statements reflect all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation of the results of Wilson Greatbatch Technologies, Inc. (the "Company") for the periods presented. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, sales, expenses, and related disclosures at the date of the financial statements and during the reporting period. Actual results could differ from these estimates. For further information, refer to the consolidated financial statements and notes thereto included in the Company's Annual Report on Form 10-K for the year ended January 2, 2004. Certain reclassifications were made to the prior years' financial statements to conform with the current year presentation. None of the reclassifications affected net income or stockholders' equity. The Company utilizes a fifty-two, fifty-three week fiscal year ending on the Friday nearest December 31st. For 52-week years, each quarter contains 13 weeks. For clarity of presentation, the Company describes all periods as if each quarter end is March 31st, June 30th and September 30th and as if the year-end is December 31st. The second quarter of 2004 and 2003 each contained 13 weeks. The six months ended June 30, 2004 and 2003 each contained 26 weeks. 2. ACQUISITION During March 2004, the Company completed the following acquisition: o NanoGram Devices Corporation (NDC), a materials research and development company focused on developing nanoscale materials for implantable medical devices. NDC was acquired to further broaden our materials science expertise. NDC utilizes nanomaterials synthesis technology in the development of battery and medical device applications. -6- The acquisition was accounted for using the purchase method of accounting and accordingly, the results of the operations of NDC have been included in the consolidated financial statements from the date of acquisition. Acquisition information (in thousands): Acquisition date March 16, 2004 -------------- Purchase price: Cash paid $ 45,000 Transaction costs 604 -------- Total purchase price $ 45,604 ======== Purchase price allocation: Property and equipment $ 717 Other assets/(liabilities) (6,695) Intangible assets (amortizing over 13 years) 16,500 Goodwill 35,082 -------- Total purchase price $ 45,604 ======== The above preliminary purchase price allocation has not been finalized, and any required adjustments will be recorded as necessary. The following pro forma information presents the Company's consolidated results of operations for 2004 and 2003 as if the acquisition had been consummated at January 1, 2003. The pro forma consolidated results of operations include certain pro forma adjustments, including the amortization of intangible assets and interest on a term loan. SIX MONTHS ENDED JUNE 30, ------------------------ In thousands except per share amounts: 2004 2003 --------- --------- Sales $108,467 $110,659 Net income $ 10,276 $ 9,009 Net income per diluted share: $ 0.48 $ 0.42 The pro forma results are not necessarily indicative of those that would have actually occurred had the acquisition taken place at the beginning of the periods presented. 3. STOCK-BASED COMPENSATION The Company accounts for stock-based compensation in accordance with Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation ("SFAS No. 123"). As permitted in that standard, the Company has chosen to account for stock-based compensation using the intrinsic value method prescribed in Accounting Principles Board No. 25, Accounting for Stock Issued to Employees, and related interpretations. The Company has determined the pro forma information as if the Company had accounted for stock options granted under the fair value method of SFAS No. 123. The Black-Scholes option-pricing model was used with the following weighted average assumptions. These pro forma calculations assume the common stock is freely tradable for all periods presented and, as such, the impact is not necessarily indicative of the effects on reported net income of future years. -7- THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, ----------------- ----------------- 2004 2003 2004 2003 ----- ----- ----- ----- Risk-free interest rate 3.93% 2.60% 3.80% 2.45% Expected volatility 50% 55% 50% 55% Expected life (in years) 5 5 5 5 Expected dividend yield 0% 0% 0% 0% The Company's net income and earnings per share as if the fair value based method had been applied to all outstanding and unvested awards in each year is as follows (in thousands except per share data):
THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, --------------------------- --------------------------- 2004 2003 2004 2003 ----------- ---------- ---------- ---------- Net income as reported $ 4,733 $ 4,952 $ 11,352 $ 10,989 Stock-based employee compensation cost included in net income as reported, net of related tax effects $ 438 $ 406 $ 1,050 $ 750 Stock-based employee compensation cost determined using the fair value based method, net of related tax effects $ 968 $ 676 $ 2,104 $ 1,438 Pro forma net income $ 4,203 $ 4,682 $ 10,298 $ 10,301 Earnings per share: Basic - as reported $ 0.22 $ 0.23 $ 0.53 $ 0.52 Basic - pro forma $ 0.20 $ 0.22 $ 0.48 $ 0.49 Diluted - as reported $ 0.22 $ 0.23 $ 0.53 $ 0.51 Diluted - pro forma $ 0.20 $ 0.22 $ 0.48 $ 0.48
-8- 4. SUPPLEMENTAL CASH FLOW INFORMATION
SIX MONTHS ENDED JUNE 30, --------------------- 2004 2003 ------- ------- Noncash investing and financing activities (in thousands): Acquisition of property utilizing capital leases $ 1,007 $ 1,445 Common stock contributed to ESOP 2,723 3,668
5. SHORT-TERM INVESTMENTS Short-term investments at June 30, 2004 consist of investments acquired with maturities that exceed three months and are less than one year at the time of acquisition. Held-to-maturity securities comprised the following (in thousands): AS OF JUNE 30, 2004 ----------------------------------------- GROSS GROSS ESTIMATED UNREALIZED UNREALIZED FAIR COST GAINS LOSSES VALUE ------ -------- ------- ------- Municipal Bonds $3,070 $ -- $ (2) $3,068 ------ -------- ------- ------- Short-term investments $3,070 $ -- $ (2) $3,068 ====== ======== ======= ======= The municipal bonds have maturity dates ranging from July 2004 to January 2005. AS OF JUNE 30, 2004 ----------------------------------------- GROSS GROSS ESTIMATED UNREALIZED UNREALIZED FAIR COST GAINS LOSSES VALUE ------ -------- ------- ------- Municipal Bonds $11,559 $-- $(1) $11,558 ------ -------- ------- ------- Short-term investments $11,559 $-- $(1) $11,558 ====== ======== ======= ======= 6. INVENTORIES Inventories comprised the following (in thousands): JUNE 30, DECEMBER 31, 2004 2003 -------- ------------ Raw materials $ 11,250 $ 11,688 Work-in-process 12,006 10,421 Finished goods 9,733 6,489 -------- --------- Total $ 32,989 $ 28,598 ======== ========= -9- 7. INTANGIBLE ASSETS Intangible assets comprised the following (in thousands): GROSS NET CARRYING ACCUMULATED CARRYING AMOUNT AMORTIZATION AMOUNT -------- -------------- -------- Amortizing intangible assets: Patented technology $ 21,462 $ (9,337) $12,125 Unpatented technology 30,886 (5,413) 25,473 Other 1,340 (1,044) 296 53,688 (15,794) 37,894 Unamortizing intangible assets: Trademark and names 31,420 (3,235) 28,185 Total intangible assets $ 85,108 $(19,029) $66,079 Aggregate amortization expense for the second quarter 2004 and 2003 was $1,081 and $813 respectively. Aggregate amortization expense for the six months ended June 30, 2004 and 2003 was $1,862 and $1,632 respectively. Estimated amortization expense for the remainder of 2004 and for the years subsequent to 2004 are as follows: Remainder of 2004 $ 2,161 2005 3,841 2006 3,812 2007 3,794 2008 3,794 2009 3,248 -10- 8. EARNINGS PER SHARE The following table reflects the calculation of basic and diluted earnings per share (in thousands, except per share amounts):
THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, --------------------- ---------------------- 2004 2003 2004 2003 ------- ------- ------- --------- Earnings per share - basic Earnings available to common shareholders $ 4,733 $ 4,952 $11,352 $10,989 Weighted average shares outstanding 21,366 21,159 21,323 21,114 Earnings per share - basic $ 0.22 $ 0.23 $ 0.53 $ 0.52 Earnings per share - diluted Earnings available to common shareholders $ 4,733 $ 4,952 $11,352 $10,989 Weighted average shares outstanding 21,366 21,159 21,323 21,114 Dilutive impact of options outstanding & unvested restricted stock 130 376 239 302 ------- ------- ------- ------- Weighted average shares and potential dilutive shares outstanding 21,496 21,535 21,562 21,416 Earnings per share - diluted $ 0.22 $ 0.23 $ 0.53 $ 0.51
Contingent convertible notes outstanding at June 30, 2004 were excluded from the computation of diluted earnings for the three and six months ended June 30, 2004 because the conditions required to convert the notes were not met. The notes were not convertible for the three and six month periods ended June 30, 2003, as conversion is only possible for any fiscal quarter commencing after July 4, 2003. See Note 13 for discussion of recent accounting standards impacting contingent convertible securities. 9. COMPREHENSIVE INCOME For all periods presented, the Company's only component of comprehensive income is its net income. 10. COMMITMENTS AND CONTINGENCIES The Company is a party to various legal actions arising in the normal course of business. The Company does not believe that the ultimate resolution of any such pending activities will have a material adverse effect on its consolidated results of operations, financial position, or cash flows. -11- Product Warranties - The change in aggregate product warranty liability for the quarter ended June 30, 2004, is as follows (in thousands): Beginning balance at March 31, 2004 $ 313 Additions to warranty reserve 96 Warranty claims paid (72) ----- Ending balance at June 30, 2004 $337 ===== Lease Agreements - In second quarter 2004, the Company entered into an operating lease agreement for a 144,000 square foot manufacturing facility in Tijuana, Mexico. The lease has an initial term of ten years with two renewal options for an additional 5 years each. This facility is currently under construction and will initially house the Company's new value-added assembly operations. Lease payments will not commence until construction of the facility is substantially completed per the terms of the agreement. When payments commence, the annual lease expense (in thousands) is estimated to be $338 for the first year, $566 for the second year, with 3% annual increases thereafter for years three through ten. 11. BUSINESS SEGMENT INFORMATION The Company operates its business in two reportable segments: Implantable Medical Components ("IMC") and Electrochem Power Solutions ("EPS"). The IMC segment designs and manufactures critical components used in implantable medical devices. The principal components are batteries, capacitors, filtered feedthroughs, enclosures and precision components. The principal medical devices are pacemakers, defibrillators and neurostimulators. The EPS segment designs and manufactures high performance batteries and battery packs including oil and gas exploration, oceanographic equipment, and aerospace. During 2003, the Company's IMC segment included multiple business units that were aggregated because they share similar economic characteristics and similarities in the areas of products, production processes, types of customers, methods of distribution and regulatory environment. The reportable segments were separately managed, and their performance was evaluated based on numerous factors, including income from operations. Effective January 1, 2004, the Company completed an internal reorganization consolidating three business units into one business unit which comprises the IMC segment. The Company defines segment income from operations as gross profit less costs and expenses attributable to segment specific selling, general and administrative, research, development and engineering expenses, intangible amortization and other operating expenses. Segment income also includes a portion of non-segment specific selling, general and administrative, and research, development and engineering expenses based on allocations appropriate to the expense categories. The remaining unallocated operating expenses along with other income and expense are not allocated to reportable segments. Transactions between the two segments are not significant. The accounting policies of the segments are the same as those described and referenced in Note 1. -12- An analysis and reconciliation of the Company's business segment information to the respective information in the condensed consolidated financial statements is as follows (in thousands):
THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, ------------------------- -------------------------- SALES: 2004 2003 2004 2003 --------- -------- --------- --------- IMC ICD batteries $ 10,119 $ 11,278 $ 19,539 $ 22,038 Pacemaker and other batteries 5,361 7,022 11,050 13,442 ICD Capacitors 6,239 7,849 14,647 14,997 Feedthroughs 12,261 12,108 26,016 23,281 Enclosures 5,142 6,310 10,539 13,244 Other 7,077 4,454 12,686 10,048 -------- -------- --------- --------- Total IMC 46,199 49,021 94,477 97,050 EPS 6,743 6,781 13,990 13,609 -------- -------- --------- --------- Total sales $ 52,942 $ 55,802 $ 108,467 $ 110,659 ======== ======== ========= ========= Segment income from operations: IMC 8,396 11,450 19,218 22,471 EPS 1,608 911 3,903 1,499 -------- -------- --------- --------- Total segment income from operations 10,004 12,361 23,121 23,970 Unallocated operating expenses (2,296) (2,815) (5,040) (4,747) -------- -------- --------- --------- Operating income as reported 7,708 9,546 18,081 19,223 Unallocated other income and expense (897) (2,318) (1,746) (3,182) -------- -------- --------- --------- Income before income taxes as reported 6,811 7,228 16,335 16,041 ======== ======== ========= =========
The changes in the carrying amount of goodwill are as follows (amounts in thousands):
IMC EPS TOTAL -------- ------ -------- Balance at January 1, 2004 $116,955 $2,566 $119,521 Goodwill recorded during the year 37,304 -- 37,304 -------- ------ -------- Balance at June 30, 2004 $154,259 $2,566 $156,825 ======== ====== ========
12. OTHER OPERATING EXPENSE During second quarter 2004, there were two non-recurring charges included in other operating expense in the Company's Condensed Consolidated Statement of Operations. -13- Patent acquisition. The Company recorded a $2.0 million pre-tax charge associated with the acquisition of certain patents during the quarter. The acquired patents cover how capacitors are used in an Impantable Cardioverter Defibrillator ("ICD"). Although the Company believed that the patents could have been successfully challenged in court proceedings prior to the acquisition, a decision was made to acquire the patents and remove this as a potential obstacle for existing customers to more fully adopt wet tantalum technology and for potential customers to initially adopt the technology. Severance charges. In response to a reduction in forecasted sales for the year, the Company implemented a 7% workforce reduction during June, which resulted in a severance charge of $0.8 million during the quarter. The severance charges were $0.6 million and $0.1 million for IMC and EPS, respectively. The remaining $0.1 million relates to corporate employees and is included in unallocated operating expenses. The remaining accrued severance of $0.5 as of June 30, 2004, is expected to be paid within the next six months. The unpaid balance is $0.3 million, $0.1 million, and $0.1 million for IMC, EPS, and unallocated corporate, respectively. 13. IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS At its meeting on July 1, 2004, the Emerging Issues Task Force (EITF) of the Financial Accounting Standards Board reached a tentative consensus that the dilutive effect of contingent convertible debt instruments must be included in diluted earnings per share regardless of whether the triggering contingency has been satisfied. This tentative consensus, EITF Issue 04-8, The Effect of Contingently Convertible Debt on Diluted Earnings per Share, would be effective for the Company for reporting periods ending after December 15, 2004. The provisions of EITF Issue 04-8 would be applied on a retroactive basis and would require restatement of prior period earnings per share. The consensus is tentative to allow time for public comment, which ends on September 3, 2004. The Company believes that the EITF as written could result in additional dilution to its diluted earnings per share. Until a final consensus is reached, the Company cannot estimate the effect that this change would have on its diluted earnings per share. -14- ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Introduction We are a leading developer and manufacturer of critical components used in implantable medical devices ("IMDs") through our Implantable Medical Components ("IMC") business. The principal components are batteries, capacitors, filtered feedthroughs, enclosures and precision components. The principal medical devices are pacemakers, defibrillators and neurostimulators. We also leverage our core competencies in technology and manufacturing through our Electrochem Power Solutions ("EPS") 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. We utilize a fifty-two, fifty-three week fiscal year ending on the Friday nearest December 31st. For 52-week years, each quarter contains 13 weeks. For clarity of presentation, we describe all periods as if each quarter end is March 31st, June 30th and September 30th and as if the year-end is December 31st. The second quarter of 2004 and 2003 each contained 13 weeks. The six months ended June 30, 2004 and 2003 each contained 26 weeks. The commentary that follows should be read in conjunction with our consolidated financial statements and related notes and with the Management's Discussion and Analysis of Financial Condition and Results of Operations contained in our Form 10-K for the fiscal year ended January 2, 2004. Overview During the second quarter 2004, there were several developments affecting our business: o We received notifications that a major customer will reduce its anticipated orders for the balance of 2004. o In response to the reduced sales forecasts, we implemented a 7% workforce reduction during June, which resulted in a severance charge of $0.8 million during the quarter and the elimination of approximately $8.0 million from our ongoing annual cost structure. o Subsequent to the second quarter, we signed a long-term agreement with a major diversified Cardiac Rhythm Management ("CRM") device manufacturer to provide value-added sub assembly of most of their implantable medical devices for CRM and other applications. It is currently anticipated that sales will commence in the second quarter of 2005. o Construction on the new advanced battery manufacturing facility in Alden, NY continued on schedule. -15- o Integration of the first quarter 2004 NDC acquisition is proceeding as planned. The first Nano-Silver Vanadium Oxide ("SVO") cells were successfully manufactured in June and are currently going through our quality control testing processes. o During the quarter we acquired certain patents that cover how capacitors are used in an Impantable Cardioverter Defibrillator ("ICD"). Although we believe the patents could have been successfully challenged in court proceedings prior to the acquisition, a decision was made to acquire the patents and remove this as a potential obstacle for existing customers to more fully adopt wet tantalum technology and for potential customers to initially adopt the technology. We recorded a $2.0 million pre-tax charge associated with these patents. o We began construction on a new manufacturing facility in Tijuana, Mexico. This facility will initially house our new value-added assembly operations. We anticipate incurring approximately $3.0 million in start-up expenses in 2004 pertaining to the construction of this facility. o We signed a development contract for a new wet tantalum capacitor customer during the quarter. This capacitor will provide a new therapeutic approach to CRM. -16- RESULTS OF OPERATION AND FINANCIAL CONDITION
THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, $ % JUNE 30, $ % --------------------- ------------------------- IN THOUSANDS, EXCEPT PER SHARE DATA 2004 2003 CHANGE CHANGE 2004 2003 CHANGE CHANGE ----------------------------------------------------------------------------------------------------------------------------------- IMC ICD batteries $ 10,119 $ 11,278 $(1,159) -10% $ 19,539 $ 22,038 $(2,499) -11% Pacemaker and other batteries 5,361 7,022 (1,661) -24% 11,050 13,442 (2,392) -18% ICD Capacitors 6,239 7,849 (1,610) -21% 14,647 14,997 (350) -2% Feedthroughs 12,261 12,108 153 1% 26,016 23,281 2,735 12% Enclosures 5,142 6,310 (1,168) -19% 10,539 13,244 (2,705) -20% Other 7,077 4,454 2,623 59% 12,686 10,048 2,638 26% ---------------------------------------------------------------------------------------------- Total IMC 46,199 49,021 (2,822) -6% 94,477 97,050 (2,573) -3% EPS 6,743 6,781 (38) -1% 13,990 13,609 381 3% ---------------------------------------------------------------------------------------------- Total sales 52,942 55,802 (2,860) -5% 108,467 110,659 (2,192) -2% Cost of sales 29,124 32,585 (3,461) -11% 61,474 64,629 (3,155) -5% ---------------------------------------------------------------------------------------------- Gross profit 23,818 23,217 601 3% 46,993 46,030 963 2% Gross margin 45.0% 41.6% 43.3% 41.6% Selling, general, and administrative expenses (SG&A) 6,389 8,146 (1,757) -22% 13,314 15,837 (2,523) -16% SG&A as a % of sales 12.1% 14.6% 12.3% 14.3% Research, development and engineering costs, net (RD&E) 5,688 4,635 1,053 23% 10,569 9,195 1,374 15% RD&E as a % of sales 10.7% 8.3% 9.7% 8.3% Intangible amortization 1,076 813 263 32% 1,851 1,628 223 14% Other operating expense 2,957 77 2,880 3740% 3,178 147 3,031 2062% ---------------------------------------------------------------------------------------------- Operating income 7,708 9,546 (1,838) -19% 18,081 19,223 (1,142) -6% Operating margin 14.6% 17.1% 16.7% 17.4% Interest expense 1,144 867 277 32% 2,304 1,798 506 28% Interest income (245) (122) (123) 101% (558) (131) (427) 326% Early extinguishment of debt -- 1,603 (1,603) -100% -- 1,603 (1,603) -100% Other expense (income), net (2) (30) 28 -93% -- (88) 88 -100% Provision for income taxes 2,078 2,276 (198) -9% 4,983 5,052 (69) -1% Effective tax rate 30.5% 31.5% 30.5% 31.5% --------------------------------------------------------------------------------------------- Net income $ 4,733 $ 4,952 $ (219) -4% $ 11,352 $ 10,989 $ 363 3% ============================================================================================= Net margin 8.9% 8.9% 10.5% 9.9% Diluted earnings per share $ 0.22 $ 0.23 $ (0.01) -4% $ 0.53 $ 0.51 $ 0.02 4%
-17- SALES IMC. The IMC sales decline for the quarter was due to lower sales to one major CRM customer. Sales increased to all of the remaining major CRM customers. An overall volume decrease of 7% combined with a 2% price decrease were the drivers for the sales decline for IMC in the second quarter, partially offset by a 3% favorable product mix impact due to increased sales of feedthroughs and other products including coated components. The sales volume decline was primarily in the batteries and capacitors product lines. The IMC sales decline year to date was also due to lower sales volumes to one major CRM customer. Sales increased to the remaining major CRM customers. On a year to date basis, we have experienced a 1% overall sales decrease due to lower prices. EPS. The slight sales decline for EPS was the result of product mix. For the year to date, sales have increased due to higher demand for batteries. This volume increase has been offset by a product mix that is favoring products with lower selling prices per unit. GROSS PROFIT IMC gross margin for the second quarter and year to date increased due to production improvements related to the implementation of Six Sigma and lean manufacturing initiatives (including reductions in scrap levels), and a favorable product mix. The increase in EPS gross margin for the second quarter and year to date is primarily due to cost reductions resulting from the consolidation of the EPS plants that was completed in 2003. SG&A EXPENSES Expenses for the second quarter and on a year to date basis declined compared to the prior year primarily due to lower incentive compensation accruals and the elimination of certain general management positions resulting from an internal reorganization from four business units to two. RD&E EXPENSES Expenses for the second quarter and year to date increased compared to last year in absolute dollars, and as a percent of sales due to the inclusion of four months of development costs from NDC. We expect the expense level for RD&E to increase for the balance of 2004 as the new Greatbatch Advanced Research Laboratory is fully integrated. The additional expense is estimated at between $4.0 million and $5.0 million. AMORTIZATION EXPENSE Amortization expense for the second quarter and year to date is higher than the prior year due to the incremental intangible asset amortization resulting from the NDC acquisition. The acquisition has added $0.4 million per quarter to our amortization expense. -18- OTHER OPERATING EXPENSE The increase for the second quarter and the year to date has two primary components. First is the $2.0 million acquisition of certain patents that cover how capacitors are used in an ICD. Although we believe the patents could have been successfully challenged in court proceedings, we decided to acquire the patents and remove this as a potential obstacle for existing customers to more fully adopt wet tantalum technology and for potential customers to initially adopt the technology. Also during the second quarter as a response to the reduced sales forecasts, we implemented a 7% workforce reduction, which resulted in a severance charge of $0.8 million. INTEREST EXPENSE AND INTEREST INCOME Interest expense for the second quarter and year-to-date increased over the prior year as the interest-bearing debt increased by $90.0 million in May of 2003 as the result of the issuance of the convertible subordinated notes. Interest income for the quarter and year to date increased over the prior year as the issuance of the convertible subordinated notes provided additional funds that are being invested on a short-term basis. PROVISION FOR INCOME TAXES Our effective tax rate declined primarily as a result of increased research and development credits, as well as the benefits of federal and state tax planning strategies. LIQUIDITY AND CAPITAL RESOURCES Our principal source of short-term liquidity is our working capital of $134.8 million at June 30, 2004 combined with our unused $20 million credit line with our lending syndicate. At June 30, 2004 our current ratio was 7.6:1, an increase from 7.4:1 at March 31, 2004. While these ratios are down from 8.1:1 at December 31, 2003, we do not consider this decline to be significant as $45.5 million of cash was utilized during the first quarter of 2004 to fund the acquisition of NDC and our liquidity continues to be strong. The Company regularly engages in discussions relating to potential acquisitions and may announce an acquisition transaction at any time. At June 30, 2004, our capital structure consisted primarily of $170.0 million of convertible subordinated notes and our 21.4 million shares of common stock outstanding. We have in excess of $82.0 million in cash, cash equivalents and short-term investments and are in a position to facilitate future acquisitions if necessary. We are also authorized to issue 100 million shares of common stock and 100 million shares of preferred stock. The market value of our outstanding common stock since our IPO has exceeded our book value and the average daily trading volume of our common stock has also increased; accordingly, we believe that if needed we can access public markets to sell additional common or preferred stock assuming conditions are appropriate. -19- Capital spending of $15.0 million in the first six months of 2004 is significantly higher than historical expenditure levels. The majority of the current year spending was for the build-out of our new medical battery plant and the continuation of the ERP implementation. In comparison, we spent $5.1 million in the first quarter of 2003, which was primarily for maintenance capital expenditures. In 2003, we significantly enhanced our balance sheet through improved cash flow from operations and through the convertible note financing we completed in May. This improved capital structure allows us to support our internal growth and provides liquidity for corporate development initiatives. We anticipate that for the remainder of 2004 we will continue to incur additional capital costs related to the advanced battery manufacturing plant, the Mexican manufacturing facility and the ERP implementation. We estimate that capital spending for the balance of 2004 will be in the range of $32.0 million to $37.0 million. OFF-BALANCE SHEET ARRANGEMENTS We have no off-balance sheet arrangements within the meaning of Item 303(a)(4) of Regulation S-K. INFLATION We do not believe that inflation has had a significant effect on our operations. IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS At its meeting on July 1, 2004, the Emerging Issues Task Force (EITF) reached a tentative consensus that the dilutive effect of contingent convertible debt instruments must be included in diluted earnings per share regardless of whether the triggering contingency has been satisfied. This tentative consensus, EITF Issue 04-8, The Effect of Contingently Convertible Debt on Diluted Earnings per Share, would be effective for our reporting periods ending after December 15, 2004. The provisions of EITF Issue 04-8 would be applied on a retroactive basis and would require restatement of prior period earnings per share. The consensus is tentative to allow time for public comment, which ends on September 3, 2004. We believe that the EITF as written could result in additional dilution to our diluted earnings per share. Until a final consensus is reached, we cannot estimate the effect that this change would have on our diluted earnings per share. APPLICATION OF CRITICAL ACCOUNTING ESTIMATES Our unaudited consolidated financial statements are based on the selection of accounting policies and the application of significant accounting estimates, some of which require management to make significant assumptions. We believe that some of the more critical estimates and related assumptions that affect our financial condition and results of operations are in the areas of inventories, goodwill and other indefinite lived intangible assets, long-lived assets and income taxes. During the six months ended June 30, 2004, we did not change or adopt new accounting policies that had a material effect on our consolidated financial condition and results of operations. -20- CONTRACTUAL OBLIGATIONS In the second quarter of 2004, we entered into an operating lease agreement for a 144,000 square foot manufacturing facility in Tijuana, Mexico. The lease has an initial term of ten years with two renewal options for an additional 5 years each. This facility is currently under construction and will initially house the Company's new value-added assembly operations. Lease payments will not commence until construction of the facility is substantially completed per the terms of the agreement. When payments commence, the annual lease expense (in thousands) is estimated to be $338 for the first year, $566 for the second year, with 3% annual increases thereafter for years three through ten. FORWARD-LOOKING STATEMENTS Some of the statements contained in this Quarterly Report on Form 10-Q and other written and oral statements made from time to time by us and our representatives, are not statements of historical or current fact. As such, they are "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. We have based these forward-looking statements on our current expectations, which are subject to known and unknown risks, uncertainties and assumptions. They include statements relating to: o future sales, expenses and profitability; o the future development and expected growth of our business and the implantable medical device industry; o our ability to successfully execute our business model and our business strategy; o our ability to identify trends within the for implantable medical devices, medical components, and commercial power sources industries and to offer products and services that meet the changing needs of those markets; o projected capital expenditures; and o trends in government regulation. You can identify forward-looking statements by terminology such as "may," "will," "should," "could," "expects," "intends," "plans," "anticipates," "believes," "estimates," "predicts," "potential" or "continue" or the negative of these terms or other comparable terminology. These statements are only predictions. Actual events or results may differ materially from those suggested by these forward-looking statements. In evaluating these statements and our prospects generally, you should carefully consider the factors set forth below. All forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by these cautionary factors and to others contained throughout this report. We are under no duty to update any of the forward-looking statements after the date of this report or to conform these statements to actual results. -21- Although it is not possible to create a comprehensive list of all factors that may cause actual results to differ from the results expressed or implied by our forward-looking statements or that may affect our future results, some of these factors include the following: dependence upon a limited number of customers, product obsolescence, inability to market current or future products, pricing pressure from customers, reliance on third party suppliers for raw materials, products and subcomponents, fluctuating operating results, inability to maintain high quality standards for our products, challenges to our intellectual property rights, product liability claims, inability to successfully consummate and integrate acquisitions, unsuccessful expansion into new markets, competition, inability to obtain licenses to key technology, regulatory changes or consolidation in the healthcare industry, and other risks and uncertainties that arise from time to time as described in the Company's Annual Report on Form 10-K and other periodic filings with the Securities and Exchange Commission. -22- ITEM 3. Quantitative and Qualitative Disclosures About Market Risk. Under our existing line of credit any borrowings bear interest at fluctuating market rates. At June 30, 2004, we did not have any borrowings outstanding under our line of credit and thus no interest rate sensitive financial instruments. ITEM 4. Controls and Procedures. a) Evaluation of Disclosure Controls and Procedures. We carried out an evaluation, under the supervision and with the participation of the Company's management including our Chief Executive Officer and our Chief Financial Officer, of the effectiveness of the design and operation of our "disclosure controls and procedures" (as defined in the Securities Exchange Act of 1934 Rules 13a-15(e)). Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, as of the end of the period covered by this report, our disclosure controls and procedures were effective to ensure that information required to be disclosed by us in the reports we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified by the SEC's rules and forms. b) Changes in Internal Control Over Financial Reporting. As previously disclosed, the Company is in the process of implementing a global ERP system. During the second quarter ended June 30, 2004, we began the implementation of the following ERP initiatives that are designed to enhance our internal controls: o The Oracle ERP system will (1) reduce the number of platforms used to record, summarize and report the o results of operations and financial position; (2) integrate various databases into consolidated files; and (3) reduce the number of manual processes employed by the Company; o The Company is designing and implementing new policies and procedures related to general ledger, accounts payable, accounts receivable, inventory and production, cash management and treasury, payroll and sales o order entry, including communicating them to our staff who are undergoing training on these new policies and procedures; and The Company is imposing mitigating and redundant controls where changes to certain processes are underway o and not completed. Such policies and procedures and redundant and mitigating controls, in management's opinion, represent an improvement in our internal control environment. By the end of 2004, all facilities are expected to be operational on the global ERP system. The Company is taking the necessary steps to monitor and maintain the appropriate internal controls during this period of change. -23- PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS. None. ITEM 2. CHANGES IN SECURITIES, USE OF PROCEEDS, AND ISSUER PURCHASES OF EQUITY SECURITIES. None. ITEM 3. DEFAULTS UPON SENIOR SECURITIES. None. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. At the Company's Annual Meeting of stockholders held on May 25, 2004, the stockholders approved the following: (a) A proposal to elect eight directors of the Company to serve until the next annual meeting of stockholders or until their successors are duly elected and qualified, as follows: Director Votes For Votes Withheld -------- --------- -------------- Edward F. Voboril 17,954,252 850,533 Pamela G. Bailey 18,192,296 602,489 Joseph A. Miller 18,094,420 700,365 Bill R. Sanford 15,584,670 3,210,115 Peter H. Soderberg 16,908,582 1,886,203 Thomas S. Summer 16,809,170 1,985,615 William B. Summers 16,905,845 1,888,940 John P. Wareham 16,907,137 1,887,648 There were no broker non-votes. ITEM 5. OTHER INFORMATION. None. -24- ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K. (a) Exhibits See the Exhibit Index for a list of those exhibits filed herewith. (b) Reports on Form 8-K On April 29, 2004, the Company filed a Current Report on Form 8-K containing information pursuant to Item 11 ("Temporary Suspension of Trading Under Registrant's Employee Benefit Plans") to provide a notice to Directors and Executive Officers of WGT regarding a blackout period related to the Wilson Greatbatch Technologies, Inc. Equity Plus Plan - 401(k) Retirement Plan. On May 6, 2004, the Company filed a Current Report on Form 8-K containing information pursuant to Item 5 ("Other Events") in order to provide additional information to Institutional Shareholder Services regarding tax fees that WGT reported in its proxy statement for its 2004 Annual Meeting of Shareholders. On May 11, 2004, the Company furnished a Current Report on Form 8-K containing information pursuant to Item 12 ("Results of Operations and Financial Condition") relating to the announcement of earnings for the fiscal quarter ended April 2, 2004. On May 14, 2004, the Company filed a Current Report on Form 8-K containing information pursuant to Item 5 ("Other Events") relating to the announcement of the Company's revision of previously forecasted sales guidance for 2004. -25- SIGNATURES Pursuant to the requirements of Sections 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. Dated: August 11, 2004 WILSON GREATBATCH TECHNOLOGIES, INC. By /s/ Edward F. Voboril ---------------------------------- Edward F. Voboril Chairman of the Board, President and Chief Executive Officer (Principal Executive Officer) By /s/ Lawrence P. Reinhold ---------------------------------- Lawrence P. Reinhold Executive Vice President and Chief Financial Officer (Principal Financial Officer) By /s/ Thomas J. Mazza ---------------------------------- Thomas J. Mazza Vice President and Controller (Principal Accounting Officer) -26- EXHIBIT INDEX Exhibit No. Description ------ ----------- 3.1 Amended and Restated Certificate of Incorporation (incorporated by reference to Exhibit 3.1 to our registration statement on Form S-1 (File No. 333-37554) filed on May 22, 2000). 3.2 Amended and Restated Bylaws (incorporated by reference to Exhibit 3.2 to our quarterly report on Form 10-Q ended March 29, 2002). 10.1 Lease Agreement, dated April 22, 2004, by and between Wilson Greatbatch Technologies, Inc. as tenant and ProLogis Tijuana Mexico Investment LLC, as landlord, for space at the Tijuana Industrial Center II located in Tijuana, Baja California, Mexico. 31.1 Certification of Chief Executive Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act. 31.2 Certification of Chief Financial Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act. 32.1 Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. -27-