Greatbatch, Inc. (GB), headquartered in Clarence, NY, is a leading producer and supplier of batteries, capacitors, and components used in implantable medical devices through its Implantable Medical Components (IMC) business. The company also produces batteries for commercial and industrial applications such as oil and gas exploration, oceanographic equipment, seismic surveying equipment, and others. The National Aeronautics and Space Administration (NASA) use Greatbatch batteries in various aspects of its aerospace programs.
Greatbatch currently has two operating segments. The Implantable Medical Components (IMC) division designs and manufactures batteries for devices in the cardiac rhythm management (CRM) industry, including implantable cardioverter defibrillators (ICDs), pacemakers, cardiac resynchronization therapy (CRT) and other medical devices, as well as capacitors for ICDs, filtered feedthroughs, engineered components and enclosures used in implantable medical devices (IMDs). An IMD is an instrument (like a pacemaker or defibrillator) that is surgically inserted into the body to provide diagnosis or therapy. The Electrochem Commercial Power (ECP) division designs and manufactures high performance batteries for use in oil and gas exploration, oceanographic equipment, seismic surveying equipment and aerospace. Of the $271 million in 2006 revenue, implantable medical components accounted for 84% and Electrochem Power Solutions 16%.
Greatbatch has focused on new technologies to drive additional growth, principally from current customers, like the QHR (high-rate) and QMR (medium-rate) batteries that combine better longevity and shorter charge time with less late power fall-off . In the case of new customer-demanded higher voltage capacitors GB has indicated they believe they will have high voltage capacitors available for customer evaluation in later 2007, another delay from earlier expected Q406 evaluation. This suggests potential commercialization and meaningful revenue contribution in 2008. A next-generation two-capacitor system project has been delayed as the company focused on the current high voltage project. The technologically-advanced two-capacitor project should be available in late 2009, a significant delay from earlier expectations. Nonetheless, the project could help GB garner greater market share. A new nano SVO battery for ICDs and pacemakers, providing greater, more predictable and consistent power output, is also under development. In February 2007, the company announced it had received customer qualification for the new nano battery.
The company hopes to expand QMR (medium rate) battery use beyond CRM customers and looks to attract new fast growing markets like neurostimulation. The company expects good growth rates in QMR batteries as some customers continue to convert pacer business to medium rate. While early, the company believes the neuromodulation marketplace will be a growth driver. GB is seeing new design programs on many neurostimulation devices, including rechargeable lithium ion battery designs. Although neurostim applications only represent about 5% of revenues at present, management believes these devices will be a major driver in terms of growth longer term. Advanced Neuromodulation Systems (ANSI), a pain neurostimulation company, was acquired by St. Jude Medical in November 2005. While St. Jude Medical is a current GB customer, ANSI is not. Greatbatch stands a chance of gaining some switched business.
In June 2007, the company completed its tender offer acquisition of Enpath Medical, Inc. Management believes that the acquisition supports its long-term objective of customer and market diversification by broadening market opportunities into the vascular segment with the core introducer product line as well as adding several major new customers from Enpath Medical such as CR Bard, Angiodynamics, ev3 and Tyco. Enpath's main product lines include venous vessel introducers and valved introducers that create a conduit to insert infusion catheters, implantable ports and pacemaker leads into a blood vessel advanced delivery catheters and implantable stimulation leads, adaptors and delivery systems for the cardiac and neuro markets. Enpath is expected to generate roughly $20-$21 million in incremental 2H 2007 revenue with an expected low-to-mid teens growth outlook. However, the company expects no EPS accretion in 2007 from the deal.
The company has been acquiring complementary businesses like the Enpath acquisition. The Biomec acquisition made during Q207 provides design capabilities in the emerging neurostimulation market. To further expand its product offerings and to move beyond a CRM/Neuro original equipment manufacturer, the company, during the fourth quarter of 2007, acquired the assets of: Quan Emerteq, a provider of delivery systems in the cardiology, peripheral and neurovascular market space fro $55 million EAC, a provider of custom battery solutions focused on rechargeable batteries for the commercial and external medical markets fro $12.4 million and Intellisensing, a manufacturer of battery-powered wireless sensing solutions for the oil & gas and other industrial markets fro $3.9 million. Management has indicated that EAC, with $20-$23 million in 2007 sales, and Quan, with $20-$24 million in 2007 revenues, should be neutral to 2007 and 2008 earnings, but accretive thereafter.
Greatbatch management increased its diversification with the acquisition of P Medical Holding SA (Precimed) in January 2008, as well as the rights and obligations of Precimed's own pending acquisition expected to close early in 2008. Precimed is a leading supplier to the orthopedic industry and is located in Orvin, Switzerland & Exton, PA, with manufacturing operations throughout Switzerland & Indiana and sales offices in Japan, Asia & the United Kingdom. Its products, including instrumentation for hip & knee replacement, trauma and spine, are sold worldwide. Greatbatch acquired Precimed for approximately CHF 123,000,000 (at current exchange roughly U.S $111 million) in cash with an additional earnings-based contingent cash payment of up to CHF 12,000,000 (at current exchange roughly U.S. $11 million) in 2009. The transaction will position Greatbatch as one of the top three suppliers to orthopedic OEMs. We believe the acquisition will provide significant market presence along with geographic and customer diversification for the company, while also expanding relationships with existing Greatbatch customers. With the acquisition, GB's 2008 orthopedic revenues are expected to be $100-$120 million in 2008. The transaction is expected to be neutral to 2008 EPS but accretive beyond. Post-acquisitions, management indicated the preliminary 2008 revenue growth outlook to be $500-$550 million. Greatbatch's new segment 2008 outlook is below:
% Of GB Revenues
2008 Sales Growth %
CRM & Neuro
While customers like BSX/Guidant and St. Jude Medical have grown the CRM market substantially, Greatbatch has lost a large amount of business from its major customer BSX/Guidant. The relationship has historically been somewhat contentious as Guidant increased internal development. The Guidant recall field action in 2005, and the acquisition of Guidant by Boston Scientific, increases the risk of lower or lost business. We believe Boston Scientific intends Guidant to become more fully integrated. However, BSX/Guidant's capability to launch new internally-developed battery ICDs has been delayed given FDA issues. If BSX can resolve its FDA difficulties, it is possible the new ICDs will be launched by early 2008. GB management believes $25 million in BSX battery business could be lost. However, GB did announce in July 2007 an amended and extended (through the end of 2010) agreement with BSX that incorporates supplying BSX with batteries, capacitors and enclosures. The agreement enables BSX to retain dual source flexibility but does provide for better pricing with higher volume commitment. In February 2007, the company announced a new agreement with St. Jude, through 2013, giving GB exclusive supplier status of battery technology and filtered feedthroughs. However, while the contract protects GB market share with St. Jude and extends visibility, the contract also provides for annual price reductions that could affect margins. Pricing has been eroding for the last few years.
Greatbatch executed a sub-assembly manufacturing contract with Medtronic for their implantable CRM devices. Revenues from this contract, to be fulfilled out of the Tijuana, Mexico plant, began late in the first quarter 2005. This work is low margin and overall company gross margins are likely to shrink. However, the company believes it can win higher margin Medtronic business. Expense related to the capacity ramp in the new facility has, and will continue to, pressure margins. The Other Medical revenue line that includes this sub-assembly business grew 53% to $56 million in 2006 and increased 17% in first quarter 2007. Now annualized, the Other Medical revenue fell 4% in Q207, but did increase 12% in the third quarter.
The company has consolidated battery/capacitor manufacturing to a new, more automated plant in Alden, NY. The battery consolidation is complete and the company has essentially completed the capacitor consolidation. The latest announced facility consolidation closes the Columbia, MD feedthroughs and coatings plant and the Fremont, CA advanced research facility. The Columbia facility is being consolidated into Tijuana and the consolidation, as of Q307, is behind the original completion goal of mid-2007 due to technological issues. Management believes the Columbia consolidation will be complete by year end 2007. Management believes the consolidation plan (7 locations down to 4 locations) will generate annual savings of more than $10 million beginning in the second half of 2007. In Q207, the company announced a new 80,000 square foot commercial power facility will begin construction, with completion expected in mid-2008, in Canton Massachusetts next to the older facility. The company believes it can take advantage of commercial opportunities with the expanded capacity.
In November 2006, the company announced consolidation and downsizing activity on the heels of the manufacturing consolidation. The company is consolidating its corporate and business unit organization structure to generate additional annualized savings and enable future technology & business investments. The downsizing eliminates approximately 40 corporate and business unit positions. Management estimates annual gross savings of $8.0 to $10.0 million and net annual savings of $2.0 to $4.0 million upon plan completion. Of the annual savings, the company intends to invest approximately $6.0 million in critical areas including Research, Development & Product Engineering.
While the ongoing consolidations will reduce excess capacity in Tijuana and improve margins once completed in 2007, we are suspicious of the nature accorded to many of the on-going consolidation charges and expenses, especially since they will benefit margins and EPS in the out-years. While we believe the investments in new facilities and streamlining of the cost structure are good strategic moves, we question the continual "one-time" nature of the consolidation plan. The company generated approximately $16.9 million in pre-tax relocation/consolidation, severance and asset disposition costs in 2006, or about $0.44 impact to EPS. Due to continuing consolidation (the Columbia Maryland facility closing is expected at the end of 2007) expected in 2007, the company anticipates an additional $0.14-$0.16 per share (up from $0.10-$0.13) in relocation/consolidation, asset disposition charges and excess capacity charges for the delayed Columbia closing.
In March 2007, the company raised an additional $80 million through a privately negotiated exchange offering of $118 million of its outstanding $170 million 2.25% Convertible Subordinated Debentures due 2013 for new 2.25% Convertible Subordinated Debentures due 2013. The new debentures have an initial conversion price of $34.70 (vs. the old debentures conversion price of $40.29), and a net share settlement feature allowing the company to pay the $1,000 in principal with cash with the difference in shares or cash. The additional $80 million in new debentures will increase interest income of the company due to the low borrowing rate, although we believe the new financing signaled the company would be looking for acquisitions. We note the BIOMEC deal that closed in April 2007 and the Enpath deal that closed in June 2007). As well, with the exchange of $118 million of its outstanding converts to the new converts with a net share settlement feature, the company will be able to eliminate about 2.9 million shares from its current diluted share count. If the remaining $52 million of the old convert gets exchanged, an additional 1.2 million shares will be removed from the share count. In the third quarter, management indicated that, the Financial Accounting Standards Board (FASB) has issued an accounting position paper that could eventually change the method of accounting for interest expense for cash settlement convertible notes. The accounting change, if adopted, would require interest expense to be recognized at a market rate compared to the $198 million of convertible notes' current low 2.25% rate.
Summary: GB has a stronger outlook if neurostimulation batteries, especially the newer rechargeable variety, become a reality in later 2007. The facility closings and consolidation, brought on by past years' under-investment, is a necessity given the need for advanced technology solutions and gives the company cost savings, although low-margin sub-assembly work mitigates some of those savings. While we see some risk in revenue, given weakness in core CRM markets, or if the company is unsuccessful in gaining neurostimulation contracts or falls behind in development, the company appears headed in the right direction. The recent flurry of acquisition activity broadens the customer base and the product portfolio in higher growth segments, and attempts to move GB beyond an original equipment manufacturer with an increase in operating margin. Nonetheless, we believe the outlook presents some substantial risk, particularly in acquisition integration and believe the company is fairly valued at current levels.