10-Q 1 a4763128.txt WILSON GREATBATCH 10-Q 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 October 1, 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 November 5, 2004 was: 21,393,819 shares. WILSON GREATBATCH TECHNOLOGIES, INC. TABLE OF CONTENTS FOR FORM 10-Q QUARTER ENDED SEPTEMBER 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 16 Results of Operations ITEM 3. Quantitative and Qualitative Disclosures About Market Risk 24 ITEM 4. Controls and Procedures 24 PART II - OTHER INFORMATION ITEM 1. Legal Proceedings 25 ITEM 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities 25 ITEM 3. Defaults Upon Senior Securities 25 ITEM 4. Submission of Matters to a Vote of Security Holders 25 ITEM 5. Other Information 25 ITEM 6. Exhibits and Reports on Form 8-K 25 SIGNATURES 26 EXHIBIT INDEX 27
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PART I - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS WILSON GREATBATCH TECHNOLOGIES, INC. CONDENSED CONSOLIDATED BALANCE SHEET - Unaudited (IN THOUSANDS) ------------------------------------------------------------------------------------------------------ ASSETS September 30, December 31, 2004 2003 Current assets: Cash and cash equivalents $77,801 $119,486 Short-term investments 6,064 11,559 Accounts receivable, net 28,777 23,726 Inventories 33,348 28,598 Prepaid expenses and other current assets 1,328 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 154,656 194,364 Property, plant, and equipment, net 83,146 63,735 Intangible assets, net 65,061 51,441 Goodwill 156,759 119,521 Deferred income taxes 2,896 2,896 Other assets 5,009 6,286 -------- -------- Total assets $467,527 $438,243 ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable 3,077 4,091 Accrued expenses and other current liabilities 18,147 18,968 Current portion of long-term debt 809 850 -------- -------- Total current liabilities 22,033 23,909 Long-term debt, net of current portion 1,138 928 Convertible subordinated notes 170,000 170,000 Deferred income taxes 20,026 7,251 Other long-term liabilities - 815 -------- -------- Total liabilities 213,197 202,903 -------- -------- Stockholders' equity: Preferred stock - - Common stock 21 21 Additional paid-in capital 211,812 207,969 Deferred stock-based compensation (615) (1,185) Treasury stock, at cost - (179) Retained earnings 43,112 28,714 -------- -------- Total stockholders' equity 254,330 235,340 -------- -------- Total liabilities and stockholders' equity $467,527 $438,243 ======== ======== The accompanying notes are an integral part of these condensed consolidated financial statements
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WILSON GREATBATCH TECHNOLOGIES, INC. CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS - Unaudited (IN THOUSANDS EXCEPT PER SHARE AMOUNTS) ----------------------------------------------------------------------------------------------------- Three Months Ended Nine Months Ended September 30, September 30, 2004 2003 2004 2003 Sales $45,177 $56,335 $153,644 $166,994 Cost of sales 27,775 32,375 89,249 97,004 ------- ------- -------- -------- Gross profit 17,402 23,960 64,395 69,990 Selling, general and administrative expenses 6,913 7,290 20,227 23,127 Research, development and engineering costs, net 4,156 3,953 14,725 13,148 Amortization of intangible assets 1,074 796 2,925 2,424 Other operating expense, net 346 125 3,524 272 Operating income 4,913 11,796 22,994 31,019 Interest expense 1,144 1,154 3,448 2,952 Interest income (244) (253) (802) (384) Early extinguishment of debt - - - 1,603 Other income, net (75) (25) (75) (113) ------- ------- -------- -------- Income before provision for income taxes 4,088 10,920 20,423 26,961 Provision for income taxes 1,042 3,144 6,025 8,196 ------- ------- -------- -------- Net income $3,046 $7,776 $14,398 $18,765 ======= ======= ======== ======== Earnings per share: Basic $0.14 $0.37 $0.67 $0.89 Diluted $0.14 $0.36 $0.67 $0.87 Weighted average shares outstanding: Basic 21,387 21,168 21,345 21,132 Diluted 21,495 21,623 21,517 21,507 The accompanying notes are an integral part of these condensed consolidated financial statements
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WILSON GREATBATCH TECHNOLOGIES, INC. CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS - Unaudited (IN THOUSANDS) ----------------------------------------------------------------------------------------------------- Nine Months Ended September 30, 2004 2003 Cash flows from operating activities: Net income $14,398 $18,765 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 10,861 10,305 Stock-based compensation 2,061 1,966 Early extinguishment of debt - 1,487 Deferred income taxes 4,780 (468) Loss on disposal of assets 551 411 Changes in operating assets and liabilities: Accounts receivable (5,051) (7,687) Inventories (4,750) 3,681 Prepaid expenses and other current assets 2,310 2,623 Accounts payable (1,131) (1,355) Accrued expenses and other current liabilities 49 6,596 Income taxes (159) 5,764 ------------- ------------- Net cash provided by operating activities 23,919 42,088 ------------- ------------- Cash flows from investing activities: Sale (purchase) of short-term investments 5,495 (9,447) Acquisition of property, plant and equipment (26,046) (7,724) Proceeds from sale of assets 69 2,458 Decrease in other assets 37 107 Acquisition of subsidiary, net (45,604) - ------------- ------------- Net cash used in investing activities (66,049) (14,606) ------------- ------------- Cash flows from financing activities: Proceeds from issuance of long-term debt - 170,000 Principal payments of long-term debt (924) (85,240) Payment of debt issue costs - (4,535) Issuance of common stock 1,190 441 Issuance of treasury stock 179 - ------------- ------------- Net cash provided by financing activities 445 80,666 ------------- ------------- Net (decrease) increase in cash and cash equivalents (41,685) 108,148 Cash and cash equivalents, beginning of year 119,486 4,608 ------------- ------------- Cash and cash equivalents, end of period $77,801 $112,756 ============= ============= 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 (IN THOUSANDS EXCEPT PER SHARE AMOUNTS) -------------------------------------------------------------------------------- 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 third quarter of 2004 and 2003 each contained 13 weeks. The nine months ended September 30, 2004 and 2003 each contained 39 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:
Acquisition date March 16, 2004 Purchase price: --------------- Cash paid $45,000 Transaction costs 604 ---------------- Total purchase price $45,604 ================ Purchase price allocation: -------------------------- Assets: Property and equipment $717 Other assets 168 Intangible assets (amortizing over 13 years) 16,500 Goodwill 35,082 Liabilities: Accounts payable 117 Other current liabilities 971 Deferred income taxes 5,775 ---------------- Total purchase price $45,604 ================
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.
Three months ended Nine months ended September 30, September 30, In thousands except per share amounts: 2004 2003 2004 2003 Sales $45,177 $56,335 $153,644 $166,994 Net income $3,046 $6,690 $13,305 $15,843 Net income per diluted share: $0.14 $0.31 $0.62 $0.74
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. 7 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.
Three Months Ended Nine Months Ended September 30, September 30, 2004 2003 2004 2003 Risk-free interest rate 3.48% 2.61% 3.65% 2.68% 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:
Three Months Ended Nine Months Ended September 30, September 30, 2004 2003 2004 2003 Net income as reported $3,046 $7,776 $14,398 $18,765 Stock-based employee compensation cost included in net income as reported, net of related tax effects $396 $606 $1,484 $1,368 Stock-based employee compensation cost determined using the fair value based method, net of related tax effects $1,082 $1,134 $2,747 $2,576 Pro forma net income $2,360 $7,248 $13,135 $17,557 Earnings per share: Basic - as reported $0.14 $0.37 $0.67 $0.89 Basic - pro forma $0.11 $0.34 $0.62 $0.83 Diluted - as reported $0.14 $0.36 $0.67 $0.87 Diluted - pro forma $0.11 $0.34 $0.61 $0.82
8 4. SUPPLEMENTAL CASH FLOW INFORMATION
Nine Months Ended September 30, 2004 2003 Noncash investing and financing activities: Acquisition of property utilizing capital leases $1,089 $1,585 Common stock contributed to ESOP $2,723 $3,668
5. SHORT-TERM INVESTMENTS Short-term investments at September 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:
As of September 30, 2004 Cost Gross Gross Unrealized Unrealized Estimated Gains Losses Fair Value Municipal Bonds $6,064 $- $(6) $6,058 ------- - --- ------- Short-term investments $6,064 $- $(6) $6,058 ======= = === ======= The municipal bonds have maturity dates ranging from July 2004 to January 2005. As of December 31, 2003 Cost Gross Gross Unrealized Unrealized Estimated Gains Losses Fair Value Municipal Bonds $11,559 $- $(1) $11,558 ------- - --- ------- Short-term investments $11,559 $- $(1) $11,558 ======= = === =======
6. INVENTORIES Inventories comprised the following:
September 30, December 31, 2004 2003 Raw materials $12,199 $11,688 Work-in-process 12,518 10,421 Finished goods 8,631 6,489 ------- ------- Total $33,348 $28,598 ======= =======
9 7. INTANGIBLE ASSETS Intangible assets comprised the following:
As of September 30, 2004 Gross Carrying Accumulated Net Carrying Amount Amortization Amount Amortizing intangible assets: Patented technology $21,462 $(9,737) $11,725 Unpatented technology 30,886 (5,969) 24,917 Other 1,340 (1,174) 166 ------- -------- ------- 53,688 (16,880) 36,808 Non-amortizing intangible assets: Trademark and names 31,420 (3,167) 28,253 ------- -------- ------- Total intangible assets $85,108 $(20,047) $65,061 ======= ======== =======
Aggregate amortization expense for the third quarter 2004 and 2003 was $1,086 and $800, respectively. Aggregate amortization expense for the nine months ended September 30, 2004 and 2003 was $2,948 and $2,438, respectively. Estimated amortization expense for the remainder of 2004 and for the years subsequent to 2004 are as follows: Remainder of 2004 $1,074 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:
Three Months Ended Nine months September 30, September 30, 2004 2003 2004 2003 ---- ---- ---- ---- Earnings per share - basic -------------------------- Earnings available to common shareholders $3,046 $7,776 $14,398 $18,765 Weighted average shares outstanding 21,387 21,168 21,345 21,132 Earnings per share - basic $0.14 $0.37 $0.67 $0.89 Earnings per share - diluted ---------------------------- Earnings available to common shareholders $3,046 $7,776 $14,398 $18,765 Weighted average shares outstanding 21,387 21,168 21,345 21,132 Dilutive impact of options outstanding & unvested restricted stock 108 455 172 375 ------ ------ ------ ------ Weighted average shares and potential dilutive shares outstanding 21,495 21,623 21,517 21,507 Earnings per share - diluted $0.14 $0.36 $0.67 $0.87
Net income per diluted share for the three and nine months ended September 30, 2004 and 2003 exclude the effect of 4,219 shares related to the contingent convertible notes, as the effect is anti-dilutive. 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 September 30, 2004, is as follows:
Beginning balance at June 30, 2004 $337 Additions to warranty reserve 81 Warranty claims paid (66) ------------ Ending balance at September 30, 2004 $352 ============
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 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 is estimated to be $338 for the first year, $566 for the second year, with 3% annual increases thereafter for years three through ten. Workers' Compensation Trust - In Western New York, the Company is a member of a group self-insurance trust that provides workers' compensation benefits to eligible employees of the Company and other group member employers. For locations outside of Western New York, the Company utilizes traditional insurance relationships to provide workers' compensation benefits. Under the terms of the Trust, the Company makes annual contributions to the Trust based on reported salaries paid to the employees using a rate based formula. Based on actual experience, the Company could receive a refund or be assessed additional contributions. For financial statement purposes, no amounts have been recorded for any refund or additional assessment since the Trust has not informed the Company of any such adjustments. Under the trust agreement, each participating organization has joint and several liability for trust obligations if the assets of the trust are not sufficient to cover its obligation. The Company does not believe that it has any current obligations under the joint and several liability. 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; principal markets for these products are for oil and gas exploration, oceanographic equipment, and aerospace. 12 In second quarter of 2003, the Company was completely reorganized. This reorganization consisted of position additions, eliminations and reassignments along with new operational performance measures to align compensation with new roles. Fundamental to this was the need to more fully allocate various costs to the new business units and functional areas. 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. 13 An analysis and reconciliation of the Company's business segment information to the respective information in the condensed consolidated financial statements is as follows:
Three Months Ended Nine Months Ended September 30, September 30, Sales: 2004 2003 2004 2003 IMC ICD batteries $7,687 $10,603 $27,226 $32,641 Pacemaker and other batteries 4,116 6,121 15,166 19,518 ICD Capacitors 4,103 7,869 18,750 22,866 Feedthroughs 9,533 14,086 35,521 37,441 Enclosures 5,631 6,235 16,170 19,453 Other 6,676 4,693 19,390 14,737 ------- ------- -------- -------- Total IMC 37,746 49,607 132,223 146,656 EPS 7,431 6,728 21,421 20,338 ------- ------- -------- -------- Total sales $45,177 $56,335 $153,644 $166,994 ======= ======= ======== ======== Segment income from operations: IMC $5,272 $13,296 $24,490 $35,768 EPS 2,267 1,423 6,170 2,922 ------- ------- -------- -------- Total segment income from operations 7,539 14,719 30,660 38,690 Unallocated operating expenses (2,626) (2,923) (7,666) (7,671) ------- ------- -------- -------- Operating income as reported 4,913 11,796 22,994 31,019 Unallocated other income and expense (825) (876) (2,571) (4,058) ------- ------- -------- -------- Income before income taxes as reported $4,088 $10,920 $20,423 $26,961 ======= ======= ======== ========
The changes in the carrying amount of goodwill are as follows:
IMC EPS Total Balance at January 1, 2004 $116,955 $2,566 $119,521 Goodwill recorded during the year 37,238 - 37,238 -------- ------ -------- Balance at September 30, 2004 $154,193 $2,566 $156,759 ======== ====== ========
The Company assesses goodwill for impairment under the provisions of SFAS No. 142 Goodwill and Other Intangible Assets. SFAS No. 142 requires the Company to assess goodwill for impairment by comparing the fair value of the reporting units to their carrying amounts on an annual basis, or more frequently if certain events occur or circumstances change, to determine if there is potential impairment. The Company will be performing its annual goodwill impairment test at January 1, 2005. 14 12. OTHER OPERATING EXPENSE During second quarter 2004, there were two charges included in other operating expense in the Company's Condensed Consolidated Statement of Operations. Patent acquisition. The Company recorded a $2,000 pre-tax charge associated with the acquisition of certain patents during the quarter. The acquired patents cover how wet tantalum 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. The Company had a prior legal opinion that in effect said the patents were not valid, therefore the Company believes it is appropriate to record the $2,000 acquisition cost in accordance with its economic substance as a period expense. 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 $800 during the second quarter. The severance charges during the second quarter 2004 were $600 and $100 for IMC and EPS, respectively. The remaining $100 relates to corporate employees and is included in year to date unallocated operating expenses. The remaining accrued severance of $190 as of September 30, 2004, is expected to be paid within the next three months. The unpaid balance is $120, $40 and $30 for IMC, EPS, and unallocated corporate, respectively. 13. IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS On September 30, 2004 the Emerging Issues Task Force (EITF) of the Financial Accounting Standards Board reached a final 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 consensus, EITF Issue 04-8, The Effect of Contingently Convertible Debt on Diluted Earnings per Share, is effective for the Company for reporting periods ending after December 15, 2004. The Financial Accounting Standards Board ("FASB") ratified this consensus in October 2004. The provisions of EITF Issue 04-8 will be applied on a retroactive basis and will require restatement of prior period diluted earnings per share. The Company believes that the EITF as written could result in additional dilution to its diluted earnings per share of up to 4,129 shares. The Company will adopt EITF 04-08 as of December 31, 2004 and will restate the computation of diluted earnings per share for prior periods. When the Company adopts this consensus in the fourth quarter of 2004, it anticipates it will restate its diluted earnings per share for the 2nd, 3rd and 4th quarters of 2003, the full year 2003, and the 1st and 2nd quarters of 2004. For the 3rd quarter of 2004 and for the anticipated results of the 4th quarter and full year 2004, the impact would be anti-dilutive and therefore will not be adjusted. 15 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. The principal markets for these products are 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 third quarter of 2004 and 2003 each contained 13 weeks. The nine months ended September 30, 2004 and 2003 each contained 39 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 and subsequent to the third quarter 2004, there were several developments affecting our business: - We executed a supply agreement with Medtronic, Inc. to provide sub-assembly for many of its Cardiac Rhythm Management ("CRM") and Neurostimulation devices. - We are on schedule to complete construction of our new advanced battery manufacturing plant in Alden, New York and the assembly plant in Tijuana, Mexico in the first quarter of 2005. - We have successfully implemented the ERP business platform at three locations and remain on schedule to implement the final location in the fourth quarter of 2004. - We extended the current supply agreement with St. Jude Medical, Inc. through 2008. - We amended the current supply agreement with Guidant Corporation to include QHR cell pricing, our next generation medical battery technology. - We experienced a 20% decline in sales during the third quarter primarily due to lower sales volume to one major CRM customer. 16
Results of Operation and Financial Condition Three months ended Nine months ended September 30, $ % September 30, $ % In thousands, except per share data 2004 2003 Change Change 2004 2003 Change Change ------------------------------------------------------------------------------------------------------------------------ IMC ICD batteries $7,687 $10,603 (2,916) -28% $27,226 $32,641 $(5,415) -17% Pacemaker and other batteries 4,116 6,121 (2,005) -33% 15,166 19,518 (4,352) -22% ICD Capacitors 4,103 7,869 (3,766) -48% 18,750 22,866 (4,116) -18% Feedthroughs 9,533 14,086 (4,553) -32% 35,521 37,441 (1,920) -5% Enclosures 5,631 6,235 (604) -10% 16,170 19,453 (3,283) -17% Other 6,676 4,693 1,983 42% 19,390 14,737 4,653 32% ------------------------------------------------------------------- Total IMC 37,746 49,607 (11,861) -24% 132,223 146,656 (14,433) -10% EPS 7,431 6,728 703 10% 21,421 20,338 1,083 5% ------------------------------------------------------------------- Total sales 45,177 56,335 (11,158) -20% 153,644 166,994 (13,350) -8% Cost of sales 27,775 32,375 (4,600) -14% 89,249 97,004 (7,755) -8% ------------------------------------------------------------------- Gross profit 17,402 23,960 (6,558) -27% 64,395 69,990 (5,595) -8% Gross margin 38.5% 42.5% 41.9% 41.9% Selling, general, and administrative expenses (SG&A) 6,913 7,290 (377) -5% 20,227 23,127 (2,900) -13% SG&A as a % of sales 15.3% 12.9% 13.2% 13.8% Research, development and engineering costs, net (RD&E) 4,156 3,953 203 5% 14,725 13,148 1,577 12% RD&E as a % of sales 9.2% 7.0% 9.6% 7.9% Intangible amortization 1,074 796 278 35% 2,925 2,424 501 21% Other operating expense 346 125 221 177% 3,524 272 3,252 1196% ------------------------------------------------------------------- Operating income 4,913 11,796 (6,883) -58% 22,994 31,019 (8,025) -26% Operating margin 10.9% 20.9% 15.0% 18.6% Interest expense 1,144 1,154 (10) -1% 3,448 2,952 496 17% Interest income (244) (253) 9 -4% (802) (384) (418) 109% Early extinguishment of debt - - - - 1,603 (1,603) -100% Other expense (income), net (75) (25) (50) 200% (75) (113) 38 -34% Provision for income taxes 1,042 3,144 (2,102) -67% 6,025 8,196 (2,171) -26% Effective tax rate 25.5% 28.8% 29.5% 30.4% ------------------------------------------------------------------- Net income $3,046 $7,776 $(4,730) -61% $14,398 $18,765 $(4,367) -23% =================================================================== Net margin 6.7% 13.8% 9.4% 11.2% Diluted earnings per share $0.14 $0.36 $(0.22) -61% $0.67 $0.87 $(0.20) -23%
17 Sales IMC. Our medical technology sales comprise various component products that are sold to medical device manufacturers. Many of the medical technology products that we sell are utilized by customers in cardiac rhythm management ("CRM") devices. 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 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. A volume decrease of 21% combined with a 3% price decrease were the primary drivers for the sales decline for IMC in the third quarter. As a percentage of the total IMC sales decline for the quarter, 84% was primarily due to lower sales volume to one major CRM customer. This particular decline is not expected to reverse in the immediate future. Due to a variety of factors, we anticipate that our customers will continue to demand technologically advanced products at competitive prices. The average selling prices of our current IMC products are expected to decrease over the next several years. A volume decrease of 8% combined with a 2% price decrease were the primary drivers for the sales decline for IMC on a year to date basis. On a year-to-date basis, the IMC sales volume decline was primarily due to lower sales to one major CRM customer. EPS. The increase in EPS sales for the quarter and the year to date was primarily the result of demand for batteries by customers in the oil and gas industry. Price changes did not significantly impact sales in the third quarter or year to date. Gross profit For the quarter ended September 2004, approximately 280 basis points of the 400 basis point decrease in overall gross margin were related to the price decreases in the IMC product lines. Price changes in the EPS segment were not a significant factor in the overall gross margin analysis. The remaining decrease in the gross margin was primarily related to the unfavorable impact of spreading fixed manufacturing costs over lower production volumes in the IMC segment. For the year-to-date comparison, price decreases of IMC products had a negative impact of approximately 220 basis points on the overall gross margin. Price in the EPS segment was not a significant factor in the overall gross margin analysis. This decrease was offset by improved plant performance, in particular in the area of scrap reduction. 18 SG&A expenses The lower SG&A expense for the third quarter and year to date is primarily due to the continued effect of cost controls put in place during the second quarter of 2004 including lower incentive compensation. RD&E expenses Expenses for the third quarter and year to date increased compared to last year in absolute dollars, and as a percent of sales due to the inclusion of seven 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 Technologies Advanced Research Laboratory is fully integrated. The additional expense is estimated at between $1.0 million and $3.0 million. Amortization expense Amortization expense for the third 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. Other operating expense Other operating expense for the third quarter included $0.4 million for start-up expenses related to the new Tijuana facility and $0.2 million for dispositions of property, plant and equipment. These increases were offset by a $0.2 million reduction for other miscellaneous items. Year to date operating expense has three primary components. First is the $2.0 million acquisition of certain patents incurred in the second quarter. Also, the second quarter implementation of a 7% workforce reduction resulted in a severance charge of $0.8 million. Lastly, we have incurred $0.7 million in expense for dispositions of property, plant and equipment. Interest expense and interest income Interest expense for the third quarter is consistent with the prior year. Year to date interest 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 is consistent with the prior year. Year to date interest income 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 The effective tax rate for the third quarter declined from the prior year due to various state planning initiatives realized in the current quarter. For the year to date, our effective tax rate declined from the prior year primarily as a result of increased research and development credits, as well as the benefits of federal and state tax planning strategies. We anticipate the fourth quarter effective tax rate to be 29.5%. 19 The American Jobs Creation Act of 2004 (P.L. 108-357) ("the Act") signed into law on October 22, 2004 repeals the Extraterritorial Income Exclusion ("ETI") after the World Trade Organization ruled it to be an illegal export subsidy. The Act addresses the illegal subsidy issue and creates new tax breaks for a broad spectrum of taxpayers. The repeal of the ETI will impact transactions after December 31, 2004. We have not completed a full assessment on how this law change will impact the Company. Liquidity and Capital Resources Our principal source of short-term liquidity is our working capital of $132.6 million at September 30, 2004 combined with our unused $20 million credit line with our lending syndicate. At September 30, 2004 our current ratio was 7.0:1, a decrease from 7.6:1 at June 30, 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 sound. Year to date operating cash flow declined from 2003 levels due in large measure to the increase in inventories compared to 2003. Inventory levels have increased to meet the safety stock requirements of our customers. The other key factor contributing to the decline in operating cash flow is the reduction in accrued expenses and other current liabilities in 2004 compared to 2003. This reflects the payment of accrued 2003 bonuses during the first quarter of 2004 that were significantly higher than the 2002 bonuses paid during 2003. The Company regularly engages in discussions relating to potential acquisitions and may announce an acquisition transaction at any time. At September 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 $83.0 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. Capital spending of $26.0 million in the first nine 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 $7.7 million in the nine months ended September 30, 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 $20.0 million to $25.0 million. 20 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 On September 30, 2004 the Emerging Issues Task Force (EITF) of the Financial Accounting Standards Board reached a final 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 consensus, EITF Issue 04-8, The Effect of Contingently Convertible Debt on Diluted Earnings per Share, is effective for us for reporting periods ending after December 15, 2004. The Financial Accounting Standards Board ("FASB") ratified this consensus in October 2004. The provisions of EITF Issue 04-8 will be applied on a retroactive basis and will require restatement of prior period diluted earnings per share. We believe that the EITF as written could result in additional dilution to our diluted earnings per share of up to 4,129,000 shares. We will adopt EITF 04-08 as of December 31, 2004 and will restate the computation of diluted earnings per share for prior periods. When we adopt this consensus in the fourth quarter of 2004, we anticipate we will restate our diluted earnings per share for the 2nd, 3rd and 4th quarters of 2003, the full year 2003, and the 1st and 2nd quarters of 2004. For the 3rd quarter of 2004 and for the anticipated results of the 4th quarter and full year 2004, the impact would be anti-dilutive and therefore will not be adjusted. 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 nine months ended September 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. 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 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 is estimated to be $338 for the first year, $566 for the second year, with 3% annual increases thereafter for years three through ten. 21 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. 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 22 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. 23 ITEM 3. Quantitative and Qualitative Disclosures About Market Risk. Under our existing line of credit any borrowings bear interest at fluctuating market rates. At September 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 designed to enhance our internal controls. By the end of 2004, all facilities are expected to be operational on the global ERP system. The Company is currently undergoing a comprehensive effort to comply with Section 404 of the Sarbanes-Oxley Act of 2002. Compliance is required for our fiscal year-end December 31, 2004. This effort includes documenting and testing of internal controls. During the course of these activities, the Company has identified certain internal control issues which management believes should be improved. The Company's review continues, but to date the Company has not identified any material weaknesses in its internal control as defined by the Public Company Accounting Oversight Board. The Company is nonetheless making improvements to its internal controls over financial reporting as a result of its review efforts. These planned improvements include additional information technology controls, further formalization of policies and procedures, improved segregation of duties and additional monitoring controls. 24 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. None. ITEM 5. Other Information. None. ITEM 6. Exhibits. See the Exhibit Index for a list of those exhibits filed herewith. 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: November 10, 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+ Supply Agreement, dated August 2, 2004, by and between Wilson Greatbatch Technologies, Inc. and Medtronic Puerto Rico Operations Co. 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. Portions of the exhibit marked "+" have been omitted and filed separately with the Securities and Exchange Commission pursuant to a request for confidential treatment. 27