Greatbatch announces results for fourth quarter and full-year ended 2014

Greatbatch, Inc. (NYSE:GB), today announced results for its fourth quarter and full-year ended January 3, 2014 highlighted by 5% constant currency organic revenue growth for the full year 2013; 12% year over year improvement in adjusted operating income; and 19% improvement in adjusted diluted EPS over 2012.

CEO Comments

"We are pleased with our 2013 performance having finished the year in line with our revenue and EPS expectations, which delivered 5% organic constant currency revenue growth, a 12% increase in adjusted operating income and $2.10 adjusted diluted EPS," stated Thomas J. Hook, president and CEO. "Along with achieving our financial targets for 2013, we also made significant progress and achieved numerous milestones on our long-term strategic imperatives. This included our PMA filing for our spinal cord stimulation system to treat chronic intractable pain of the trunk and/or limbs. We subsequently filed for CE Mark approval in January of this year. Our intellectual property portfolio continues to expand with one third of the portfolio representing medical device patents. Through our new functional organization, we were able to improve and expand our sales and marketing efforts and deliver productivity improvements. We are renewed in our belief that our RD&E and sales and marketing investments, coupled with our operating discipline, position Greatbatch to meet its long term objectives of maintaining 5% organic constant currency growth and double digit adjusted diluted EPS growth."

CFO Comments

"We ended the year with record revenues, excellent cash flows and delivered $2.10 adjusted diluted EPS. With 13% organic constant currency growth in the fourth quarter we achieved our targeted 5% organic constant currency revenue growth in 2013. Operating cash flow, when adjusted for tax payments related to the retirement of our convertible debt, totaled $86 million," commented Michael Dinkins, executive vice president and chief financial officer. "Leveraging the Company's revenue growth, adjusted operating income margin improved 110 basis points for the year although fourth quarter adjusted operating income was down 8% versus the same period in 2012 driven by several contributing factors including the planned increase in sales and marketing, higher medical device spending, expenses associated with filing intellectual property, and the timing of customer reimbursements for engineering projects."

Mr. Dinkins continued, "We are confirming our 2014 guidance of 3% to 6% organic constant currency revenue growth and 7% to 12% adjusted diluted EPS improvement."

Fourth Quarter and Full Year Results

In connection with the realignment of the Company's operating structure in 2013 to optimize profitable growth, which included changing our management and reporting structure, the Company reevaluated its operating and reporting segments. Beginning in the fourth quarter of 2013, the Company determined that it has two operating segments. Greatbatch Medical designs and manufactures products where Greatbatch either owns the intellectual property or has unique manufacturing and assembly expertise and includes the financial results of the former Implantable Medical and Electrochem segments, excluding our QiG Group ("QiG"). QiG focuses on developing medical device systems for some of health care's most pressing challenges. Through the research and development professionals in QiG, the Company is now investing in three areas - new medical device systems commercialization, collaborative programs with OEM customers, and strategic equity positions in start-up companies - to grow a diversified and distinctive portfolio. The medical device systems developed by QiG are manufactured by Greatbatch Medical. We have reclassified certain prior year amounts to conform them to the new segment presentation.

Fourth quarter and full year results for 2013 include an additional week of operations in comparison to the same periods of 2012 as the Company utilizes a fifty-two, fifty-three week fiscal year, which ends on the Friday nearest December 31st. Although this additional week of operations may have impacted certain financial statement line items, management believes that when combined with the additional holiday and weather related shutdowns, this additional week did not materially impact our net operating results.

Fourth quarter 2013 sales increased 11% to $176.6 million. After adjusting sales by $3.1 million for the divestiture of certain non-core orthopaedic product lines during the first quarter of 2013 and approximately $1 million for the positive impact of foreign currency exchange rate fluctuations in comparison to the prior year, sales increased $19.5 million or 13% organically. This growth was primarily due to strong organic constant currency growth from our cardiac/neuromodulation (17%) and orthopaedic (33%) product lines due to market share gains resulting from our increased sales and marketing investment, customer product launches and the release of backlog stemming from our Swiss consolidation and has not been adjusted for the additional week of sales. This growth was partially offset by an 18% decline in portable medical sales due to the tough comparable versus the fourth quarter of 2012 as well as our pricing discipline, which resulted in the loss of some low-margin business. For the year, sales increased 5% on an organic constant currency basis to a record $663.9 million, and, similar to our fourth quarter results, this increase was driven by above market growth from our cardiac/neuromodulation (6%) and orthopaedic (20%) product lines. This 5% increase is consistent with our long-term organic constant currency growth target.

Gross profit increased 11% to $57.4 million in the fourth quarter of 2013, compared to $51.9 million for the comparable 2012 period due to our higher sales volumes. In comparison to the prior year quarter, gross profit as a percentage of sales remained consistent at 32.5%. For the year, gross profit increased 9% to $219.3 million over 2012 and was driven by increased operational leverage due to our higher sales volumes and productivity initiatives, as well as a favorable sales mix of higher margin products. As a result, our gross profit as a percentage of sales for 2013 increased 180 basis points to 33.0% from 31.2% for 2012.

Selling, general and administrative ("SG&A") expenses increased $3.3 million to $24.2 million for the fourth quarter of 2013 compared to $20.9 million for the same period of 2012. This increase is attributable to the additional investments in sales and marketing resources to drive core business growth, higher intellectual property filing fees, as well as the additional week of payroll expense in 2013. For the year, SG&A expenses increased 9% to $88.1 million, primarily due to the additional investments made in sales and marketing and increased performance-based compensation of $2.7 million. These increases were partially offset by the synergies realized from our Swiss orthopaedic facility consolidation of approximately $1.4 million.

Net research, development and engineering ("RD&E") costs for the 2013 fourth quarter of $15.1 million increased $3.9 million over the fourth quarter of 2012. This increase was primarily attributable to a decrease in customer cost reimbursements compared to the prior year of $2.5 million, due to the timing of achievement of milestones on various projects. The remainder of this increase was due to a higher level of performance-based compensation as well as the additional week of payroll expense. These increases were partially offset by our Swiss orthopaedic facility consolidation which reduced RD&E expenses by $0.6 million in comparison to the prior year quarter. For the year, RD&E expenses increased $1.6 million as the fourth quarter increase and additional performance-based compensation for the year were partially offset by our initiative to refocus medical device RD&E investment, which began in the third quarter of 2012, and included the discontinuation of certain non-core RD&E projects.

In total, net medical device costs incurred by our QiG segment were $8.8 million and $30.5 million for the quarter and year ended January 3, 2014, respectively, compared to $6.9 million and $32.6 million for the respective 2012 periods. Current quarter and full-year 2013 QiG results include $1.3 million and $5.8 million, respectively, of design verification testing ("DVT") costs incurred in connection with the Company's development of a neuromodulation platform compared to $1.4 million and $5.2 million, respectively, for the comparable 2012 periods. QiG's medical device technology investment is primarily focused on successfully commercializing Algostim and being selective in opportunities that leverage the strengths of Greatbatch Medical and drive sustainable growth.

GAAP operating income for the fourth quarter and full-year 2013 was $12.9 million and $61.3 million, respectively, compared to $1.4 million and $25.8 million, respectively, for the comparable 2012 periods. These increases were primarily due to gross profit improvements and lower consolidation and optimization costs, partially offset by higher SG&A and RD&E expenses. Adjusted operating income, which excludes other operating and DVT expenses, for the fourth quarter and full-year 2013 was $19.4 million and $82.9 million, respectively, compared to $21.1 million and $73.9 million, respectively, for the comparable 2012 periods. As a result of our increased operational leverage as well as our various consolidation and productivity initiatives implemented over the past year, our adjusted operating income as a percentage of sales for 2013 increased 110 basis points over the prior year to 12.5%. Refer to Table A at the end of this release for a reconciliation of GAAP operating income to adjusted operating income and the "Use of Non-GAAP Financial Information" section below.

The 2013 full-year GAAP effective tax rate was 25.7% compared to 171.3% for the same period of 2012. This decrease was primarily attributable to $6.2 million of tax charges recorded in 2012 relating to our Swiss Orthopaedic consolidation. These charges related to the loss of our Swiss tax holiday, due to our decision in 2012 to discontinue manufacturing in Switzerland and the valuation allowance established on our Swiss deferred tax assets, as it was more likely than not that they will not be fully realized. The reinstatement of the R&D tax credit in 2013, as well as higher income in lower tax rate jurisdictions also contributed to the more favorable tax rate in 2013.

GAAP diluted EPS for the fourth quarter and full-year 2013 were $0.38 and $1.43, respectively, compared to a loss of $0.23 and $0.20 for the respective 2012 periods. Adjusted diluted EPS for the fourth quarter and full-year 2013 were $0.55 and $2.10, respectively, compared to $0.53 and $1.77 for the corresponding 2012 periods. These represent increases of 4% and 19%, respectively, and are well above our long-term adjusted diluted EPS growth target of 10%. Refer to Table B at the end of this release for a reconciliation of GAAP net income (loss) to adjusted net income and the "Use of Non-GAAP Financial Information" section below.

Cash flow from operating activities for the fourth quarter and full-year of 2013 were $40.7 million and $56.8 million, respectively, compared to $25.3 million and $64.8 million, respectively, for the comparable 2012 periods. The quarter over quarter increase was primarily due to a higher level of cash operating income. During the fourth quarter and year-to-date periods of 2013, the Company made estimated tax payments related to the retirement of its convertible subordinated notes in 2013 of $8.2 million and $28.8 million. Excluding these tax payments, cash flow from operations totaled $48.9 million and $85.5 million for the fourth quarter and full-year of 2013, respectively. This excess cash flow from operations was used to repay $12.5 million of long-term debt during the fourth quarter of 2013 and brought total net long-term debt repayments to $33.3 million for 2013.

Product Line Sales Highlights

Cardiac/neuromodulation sales for the fourth quarter and full-year 2013 increased 17% and 6%, respectively, over the prior year periods. This growth was driven by stronger market performance and continued deepening relationships with our OEM partners. More specifically, we experienced strong growth in batteries, capacitors, leads, and assembly revenue. We continue to see an increased pace of product development opportunities from our cardiac customers. We believe that these opportunities, combined with our increased sales and marketing resources, will allow the Company to continue to grow this product line faster than the underlying market.

Orthopaedic sales of $38.2 million and $130.2 million for the fourth quarter and year-to-date periods of 2013 increased 23% and 7%, respectively, in comparison to the fourth quarter and full-year of 2012. During the first quarter of 2013, the Company divested certain non-core orthopaedic product lines, which reduced fourth quarter revenue by $3 million and full-year 2013 orthopaedic revenue by approximately $15 million, in comparison to the prior year periods. Additionally, foreign currency exchange rate fluctuations benefited current quarter and full-year orthopaedic revenue by approximately $1 million and $2 million, respectively, in comparison to the prior year. On a constant currency organic basis, orthopaedic product line sales increased 33% and 20% in comparison to the prior year fourth quarter and full-year, respectively. These organic constant currency improvements were across all orthopaedic products and were above market growth rates primarily due to our increased sales and marketing efforts, customer market share gains, customer product launches, as well as the release of backlog built up as a result of our Swiss orthopaedic facility consolidation near the end of 2012.

Full-year 2013 vascular sales decreased $3.6 million in comparison to the prior year reflecting the previously communicated voluntary recall of two vascular medical devices in the fourth quarter of 2012.

Fourth quarter and full-year 2013 portable medical sales decreased $3.9 million and $2.9 million, respectively, compared to their respective 2012 periods. During the second half of 2013, this product line was impacted by our increased pricing discipline which resulted in the loss of some low-margin business. We expect these factors to continue to impact the year over year comparisons for this product line for the next three quarters. We believe that we can return this product line back to historical growth once we are past this period of difficult comparisons.

Fourth quarter other Greatbatch Medical revenue, which includes sales to our military and environmental customers, increased $2.1 million in comparison to the prior year fourth quarter but declined $1.6 million when comparing the year-to-date periods. These variances were primarily due to the timing of customer orders.

QiG revenue includes sales of neural interface technology, components and systems to the neuroscience and clinical markets. The 24% revenue growth for 2013 in comparison to 2012 was primarily due to having a full year of sales from NeuroNexus Technologies, Inc., which was acquired in February 2012, as well as the higher growth characteristics of the neuroscience and clinical markets.

Adjusted operating income for 2014 is expected to consist of GAAP operating income excluding items such as acquisition, consolidation, integration and asset disposition/write-down charges totaling approximately $12 million to $15 million. The after tax impact of these adjustments is estimated to be $7.5 million to $10 million or $0.31 to $0.35 per share. The current expected GAAP effective tax rate for 2014 does not include the benefit of the U.S. R&D tax credit, which expired at the end of 2013. If reinstated, our 2014 GAAP effective tax rate could be lowered to 32% to 33%.

Conference Call

The Company will host a conference call on Tuesday, February 25, 2014 at 8:30 a.m. E.T. to discuss these results. The scheduled conference call will be webcast live and is accessible through the Company's website at www.greatbatch.com or by dialing 800-299-9086 and the participant passcode is 81394130. An audio replay will also be available beginning from 12:30 p.m. E.T. on February 25, 2014 until March 4, 2014. To access the replay, dial 888-286-8010 and enter the pass code 25822735.