Integer Holdings Corp (ITGR) 2002 Q1 法說會逐字稿

Good afternoon. My name is Kathy, and I will be your conference facilitator today. At this time, I would like to welcome everyone to the Wilson Greatbatch Technologies, Inc. conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question-and-answer period. If you would like to ask a question during this time, simply press star then the number 1 on your telephone key pad. If you would like to withdraw your question, press the pound key. Thank you, Mr. Norman. You may begin your conference.

Thank you, Kathy. I'm Ernest Norman, the Director of Investor Relations, and I would like to welcome you to our call today. I would briefly like to read our Safe Harbor statement first, however. Before we begin, we'd like to remind you that this presentation contains forward-looking statements within the Securities Litigation Reform Act of 1995, and involves uncertainties and risks. These risks and uncertainties are described in the companies annual report form 10-K and other periodic filings with the Securities and Exchange Commission. Our statements made today are based upon Wilson Greatbatch Technologies' current expectations, and actual results could differ materially from those that are stated or implied. Wilson Greatbatch Technologies assumes no obligations to update forward-looking information included in this conference call to reflect changed assumptions, the inoccurrence of unanticipated events or changes in the future operating results, financial conditions or prospects. With that said, I'd like to introduce our call participants today. First would be Edward Voboril, who is our Chairman, President, and the CEO, and Frank Forkull, who is our Controller. Ed, would you begin, please?

Thanks, Ernie. Good afternoon, and thank you all for joining us for our first-quarter earnings conference call. If you've had a chance to review our news release, you know that despite a difficult market for commercial products, Wilson Greatbatch Technologies produced record first-quarter revenue and net income for the period ended March 29th, 2002. Consolidating revenues increased by 23% for the quarter. Our quarterly sales of $36.3 million were a first quarter record. We reported $3.3 million in net income in earnings per share of 16 cents per diluted share for the first quarter. Last year's first quarter results included a $75,000 net loss due to a charge of $3 million net of tax for the early extinguishment of debt. First quarter 2001 also included $448,000 in revenues and pretax income from royalties that were payable from Medtronic on patents that have subsequently expired. Demand for our medical technology products improved strongly, with quarterly sales increasing by 34% over last year's first quarter. The wider use of cardiac further management devices, bolstered by recent studies such as [INAUDIBLE], continues to drive growth in our medical technology segment. In that regard, I am pleased to announce that we have signed a contract with a new customer who will design our wet tantalum capacitors into their products. This will yield incremental sales in 2002, with significant additional product sales starting in 2004. It is our belief that our capacitor technology can enable significant sized reduction and improved electrical performance including a meaningful contribution toward reduction of charge time. We continue in active discussions with all manufacturers of implantable cardiac defibrillators regarding adoption of our wet tantalum capacitor technology. We see other long-term opportunities coming from further advances in medical treatments using implantable medical devices for applications in neuro physiology, drug infusion, and [INAUDIBLE], and especially congestive heart failure. The Greatbatch-Sierra acquisition in June of 2001 broadened our product line by adding electromagnetic interference filtering technology, EMI. We believe EMI protection will likely be required for all implantable medical devices. Some manufacturing difficulties with the new product line impacted both revenues and margins at Greatbatch-Sierra in the first quarter. We believe that those issues will be resolved in the second quarter, and that we will see substantial Greatbatch-Sierra growth in the second half of the year. First quarter revenues of our commercial power sources decreased by 14% compared to the prior year. The first quarter of 2001 was exceptionally strong, as pent-up demand in the oil and gas exploration market turned into orders. The dynamics of the global petroleum marketplace have produced a 2002 decline in commercial revenues. However, with strengthening of oil and gas prices, we expect to see improvements in these markets in the latter half of the year so that overall in 2002, commercial revenues are projected to be flat or slightly down for the year. Commercial power sources remain an important part of our business and mix, providing over 70% of consolidated revenues in the first quarter. Wilson Greatbatch is implementing the tools and disciplines of Six Sigma to take our organization to a new level of process capability and customer satisfaction. Six Sigma's a diciplined process using data and statistical tools to reduce variability, eliminate waste, create more capable processes, reduce costs, increase profitability and improve customer satisfaction. We are convinced that -- based on our pilot projects, that Six Sigma methodology will help add minimally one point of gross margin per year. More importantly, adding the strength of Six Sigma to our already strong quality foundation will ensure that WGT is the first source customers think of when they have a need. I will provide some additional comments on 2002 after Frank Forkull, our Controller, gives a detailed financial review and analysis of our 2002 first quarter results. Frank?

Thanks, Ed. Sales growth was strong in the first quarter across all of our medical product lines. Of the $30.3 million in first quarter medical technology sales, medical batteries contributed $13 million, or 43% of the total segment. Battery revenues were up 16% over last year's first quarter, as sales of defibrillator batteries climbed to $6.5 million from $4.9 million a year ago. At $5.7 million, capacitor sales are up 65% over the 2001 first quarter, and reflects strong market acceptance of our wet tantalum capacitors that were introduced in 1999. With the announced signing of another capacitor customer, in conjunction with the achievement of operating efficiency gains, we are on track with our growth expectations for our capacitor business. The components group completes our medical segment, with first quarter sales of $11.5 million, up 47% over 2001. Sales by our Greatbatch-Sierra acquisition have been included in the components group since its June 18th, 2001, acquisition date, and were a major contributor this segment's first quarter revenue increase. Turning to our commercial business, revenues of $6 million were down 14% in the first quarter of 2002, compared to last year. As Ed indicated, sales for the first quarter of 2001 were exceptionally high, as we benefited from pent-up demand in the oil and gas sector. Looking at our consolidated business results, our gross margin percentage decreased to 44% in the first quarter, down 3 percentage points from the 47% in the 2001 first quarter. One point of margin was consumed in this year's first quarter by a restructuring charge taken at Greatbatch-Sierra, as several nonmedical product lines were discontinued. Over one full point of margin decrease is attributable to the first quarter of 2001, including over $440,000 in royalty revenue which was essentially 100% gross margin. There is no similar amount in 2002. In addition, we continue to focus on efficiency and yield improvements at Greatbatch-Sierra, Where operating results are not yet at desired levels. Selling, general and administrative costs were $5.7 million for the 2002 first quarter, an increase of 50% over $3.8 million for the 2001 first quarter. SG&A as a percentage of sales increased from 13% in the 2001 first quarter to 16% for the current quarter. The investment in our Six Sigma initiative, expenses related to legal support of our patent activities and the addition of Greatbatch-Sierra and our new emerging technologies unit are the primary drivers of the SG&A increase. Research, development and engineering spending increased to $3.7 million in the first quarter, up 15% from $3.2 million in last year's quarter. As a percentage of sales, 2002's first quarter research and development is at our targeted 10% of sales. Going forward, this target of R&D expense as a percentage of sales reflects our commitment to maintain our leadership position as a developer of enabling technologies for our customers in the implantable medical device industry. Intangible amortization in the first quarter totalled $886,000, as compared to $1.6 million last year. This 54% decrease reflects the adoption of Statement of Financial Accounting Standard number 142 on January 1st, 2002. This new standard requires that all amortization of goodwill, and other intangible assets with indefinite lives, cease in fiscal 2002. We have determined that in addition to goodwill and assembled workforce, our trademark and names, intangible assets, have indefinite lives as defined in FAS-142, and must no longer be amortized. The cessation of amortization on goodwill, assembled workforce and trademark and names in the first quarter of 2002, reduced our amortization expense by $1 million from what would have been recorded if FAS-142 had not been adopted. This lower level of amortization added three cents to net income per diluted share in the first quarter of 2002. If FAS-142 had been in effect during the first quarter of 2001, net income for that period would have been two cents per diluted share. This new accounting standard also requires that all intangible assets be tested for impairment annually. Our review in the first quarter of 2002 indicates that there is no impairment of our intangible assets. Interest costs were $747,000 in the first quarter, compared to $712,000 in the 2001 first quarter. At our current leverage and libor levels, the weighted average interest rate on our long-term debt is approximately 3.2%. We are estimating an effective tax rate of 33% for 2002. This is lower than 2001's first quarter rate of 37%, primarily due to increase uses of research and development credits. Turning to the balance sheet, total assets are $283 million, equal to the year-end balance and up 54% compared to March 30th, 2001. Cash balances were drawn down in the first quarter, as $4.7 million was invested in purchases of property, plant, and equipment. We expect the level of capital expenditures to remain above historical norms over the next three quarters, as we continue to fund the construction of our new R&D facilities, and invest in the process equipment associated with new product technology. Required inventory increases also consumed cash during the first quarter. This area will receive our focused effort during the next few quarters, with the goal of reducing inventory levels where possible while still maintaining appropriate levels of critical raw materials and contractual safety stocks. That concludes the financial report, and I'll turn our presentation back to Ed for his closing remarks.

Thanks, Frank. As Frank mentioned, we have been working on our new R&D center. It's on schedule, both on time and within budget, and we anticipate opening that in late May of 2002. During the fourth quarter, we created an exciting new business unit, Emerging Technologies, to focus on [INAUDIBLE] applications for our new implantable battery and drug pump technologies. Emerging Technologies is making good progress, and we anticipate beginning shipment of some substantial quantities of drug pumps over the next 12 months, based on agreements that should be finalized in the near future. 2002 continues to be a year of significant investment in our company for continuing long-term growth and development. In 2001, we committed a significant amount of our resources to provide a base for future growth and development. These investments will continue and expand -- and produce significant returns, both near and long term, including the previously mentioned research and development facility, our investment in new defibrillator battery technology, our quality initiatives on Six Sigma, and the emerging technology activities previously mentioned. It's also my pleasure today to introduce Anthony Borowitz. Tony is enjoying his first day of employment with Wilson Greatbatch Technologies as our Treasurer. Tony is expected to be an outstanding addition to our already strong financial staff. Tony was previously Chief Financial Officer of Graphic Controls, a Buffalo-based company acquired by Tyco a couple of years back, and he has been a Vice President of Finance for one of Tyco's units up until just recently. We continue to make progress in our search for a new CFO, with several strong candidates under consideration, and an announcement of our choice can be expected in the near future. We continue to estimate that our revenues for 2002 will be approximately $155 million, with estimated earnings per share of 75 to 80 cents a share. We expect those results to reflect a stronger second half in 2002, after a somewhat softer first half. This concludes our prepared remarks, and at this time, I'll ask the moderator to open the call for questions.

At this time, I would like to remind everyone in order to ask a question, please press star then the number 1 on your telephone key pad. We'll pause for just a moment to compile the Q&A roster. [PAUSE] Your first question comes from Archie Smith of U.S. Bancorp Piper Jaffrey.

Hi, Arch.

Hey, Ed. How you doing?

Great.

I have three or four quick questions. The first of which is that your capacitor business continues to track very strong, and that's just tracking your single customer?

Yeah.

Thus far?

Yes.

Are you -- are you in a position to disclose who your second capacitor customer is?

No, we're not, Arch. You know that our customers typically consider that to be proprietary information, and we would not disclose that without their prior consent.

Are they domestically based or they an international customer?

You know -- you know, Archie, all of our customers do business worldwide. [LAUGHTER]

My words were very carefully chosen, though. I'll assume that's a "No comment".

You got it.

Okay. In your comments, you said business with that customer would pick up in '02 and become material in '04?

Yes.

So that's -- but you discreetly left '03 out. What would your expectations be for '03?

Well, Archie, as I'm sure you can imagine, when our capacitor technology gets designed into a new product, it's typically part of a new platform. So to some extent, it depends on the customers' time line for the development schedules. So we said '04. I mean, we could see the ramp starting to build earlier, but it's -- it's going to depend on, you know, their design time line and approvals and so forth.

Okay. Another couple of quick questions, and I'll get back in line. You talk about a weak first half, but on my numbers, you had a very nice increase in the first quarter. Is your expectation that revenue for Q2 will be up sequentially, flat sequentially or down sequentially?

Well, we're not going to give any guidance on second quarter, Archie, but we think that, again, the first half will be a little weaker than the second half.

In total?

Yeah.

If were you to look at the two quarters in this portion.

Yeah.

Okay. Is Q2 today tracking fairly well?

We're not disappointed. You know, as you know, from month to month, we have ups and downs as people move stuff around. But we think our business is very solid right now.

And to the extent they're soft, the only place I see it is in the commercial business.

Well, like we said, we think first half, you know, the oil markets were a little jittery. But as prices have picked up now, on the oil and gas market, we think that's perhaps going to stimulate some additional strength in the second half.

And last question, you've obviously historically been active on the acquisition front. Is there anything you can tell us about your acquisition program now, in terms of the likelihood of announcements in the relatively near future?

Well, you'll recall, Archie, at your conference we said we'd be disappointed if we didn't sue something within the next 12 months. And I guess a little time has gone on, so I should modify that and I'd say we'd be disappointed if we didn't complete something within this fiscal year.

Great. Thanks for your help. I will get back in -- actually, one last question. What are your capacitor gross margins running?

Well, as you know, Archie, our target, we keep telling ourselves that we need to be a 50% gross margin company. And while it bounces around, I can tell you we're probably at least halfway there.

Great. Thanks again. I'll get back in the queue.

Your next question comes from Glenn Reesen of Morgan Stanley.

Hi, Glenn.

Hi, folks. A couple of questions as well. I noticed on the P&L that SG&A was very high. You did talk about some sort of restructuring charge that hurt the gross profit margin, but I guess I was expecting Sierra to influence SG&A more than gross margin. What is happening there? Can you give us some guidance?

It's just a bunch of little stuff that's added up, Glenn, and, you know, we're going to see this trend down into the low teens again. We have a little hump in the first quarter, but it's certainly above our target.

Okay.

And we're managing it down into the low teens.

And absolute spending, it would come down as well?

Well, to be honest with you, a little bit depends on -- you know, we have recruiting -- in the category of little things that add up, recruiting expenses for the CFO and so forth, I think in absolute terms for the second quarter, to be honest with you, I'm -- I'm not into the detail enough right now on that number to tell you, -- but other than saying that for the year, we expect it to be down into the lower teens.

Okay.

Glenn, this is Frank, certainly the Six Sigma, which we've talked a lot about, as you can imagine, to launch that, the initial training and the costs associated with getting everyone geared up, certainly drives the absolute dollar amount on that. And while there is an ongoing effort that would be associated with that, the training after we get everybody first tooled up, then that does start to trend down.

Yeah, that was all first-half expenses.

But Sierra is under control from a cost perspective right now?

I believe so, Glenn.

Okay. On that same note, can you give us an idea of what the gross -- gross contribution was from Sierra, and what you think the net contribution on the revenue side was for Sierra? Do you understand the distinction?

Yeah, we were -- the gross and the net.

In other words, Hitman was a -- was a customer, right? So the net would be net of -- just the net contribution to the corporation from this acquisition.

For that very reason, Glenn, is why we, you know, stuck pretty much with just a posting of the total components group. It's not only Hitman, but even the machining services group has intercompany sales. so to carve any one of them out in terms of sales from the overall components group gets to be very difficult, because there's a lot of intercompany sales back and forth. So I think it's most helpful, most informative if we stay with the total components group as we are.

Although you must have some idea what Sierra has contributed.

I'll just tell you that we're -- we -- when we acquired Sierra, we told you that it was running at about, you know, we anticipated it be approximately a $20 million a year run rate company. And we're a little under that rate in the first quarter for the aforementioned problems we mentioned, but we expect a much stronger second half as we again see some further product introductions of devices that incorporate filtered.

So is $4 million to $4.5 million a good guess for a contribution?

Sure.

You just making me feel better?

No. Of course not.

Okay. You mentioned the Six Sigma as having a contribution to your gross profit in the outer years?

Yeah.

Is that the start of 2004 or 2003?

I think it will start in 2003, Glenn.

Okay. And then finally, on the tax rate. You said you benefited from R&D tax credits this year. Does it go back up next year?

No, I would expect that the R&D tax credit that we're going to start bennifiting from this year should be occurring for quite a few years out in the future, as we get the baseline of the information developed for that credit program. So I think that's going to be with us providing benefits for years to come.

Okay. So I know next year is a ways away, okay? But if I look at the business for next year, you have CHF, you have a lower tax rate, you have benefits from Six Sigma. You have easy comparisons created by Sierra. You have any commentary on expectations for '03 at this point?

Well, when we looked at what you guys were projecting for 2003, we were very comfortable with the analysts' estimates.

And that was obviously before we knew about the tax rate, and before we knew about the hundred basis point on gross margins, right? [LAUGHTER]

Don't get too [bulliant] too quick.

Okay, I won't. I'll get back in line, too. Thank you.

Your next question comes from Kurt Krueger of Banc of America Securities.

Hey, Kurt.

Hi guys, how are you? I wanted to just see if you could quickly provide an update on the search for both the COO and CFO, and also just to perhaps ask, you know, what is -- what was the -- what was Rich doing, and are you noticing any, you know, deficiencies in that you don't have him anymore? Are we potentially missing out on some things that he was contributing on? And will that alter the, you know, the business plan at all going forward?

Well first of all, as far as the searches go, we're much further along with the CFO search. But obviously, I think with Tony's addition, we've -- between Tony and Frank, we've got a very strong leadership team in the financial function. But we're -- we're quite far along with the interview process, and like I said in my remarks, we expect to be making an announcement within the relatively near future. The COO isn't quite nearly as far along, although we're seeing a lot of really interesting candidates emerge. I guess I mentioned, actually, I think during my presentation or during my question and answer at your conference, Kurt, that we have -- we have an outstanding leadership team at Wilson Greatbatch that is certainly fully capable of leading this business. And I -- I mean, I don't see anything dropping through the cracks, quite frankly. So we're doing just fine.

Yeah, I didn't mean to put you to challenge you too much. Just if there were any particular -- kind of like, particular new product offerings, new product efforts, or, you know, any little even narrow, you know, function that he was providing that maybe is not --

Well, I can tell you one thing, I'm traveling more.

Okay. That's fair. I think Nathan might have some questions, too, but one of the things I'd like to ask is if you could help us understand how the CHF market is likely to impact your numbers? Do I understand that a million within the batteries was potentially CHF-related? And --

No, not -- not -- no, I mean, right now, the closest product to approval that would influence us directly on CHF would probably be the guidance contact CD, which has our batteries and other componentry, but doesn't have our caps.

Sure.

Then, I think, of course, we have all of the other categories that are also CHF-related, like LVAD's and the [INAUDIBLE], which are probably a longer term play, but do create meaningful revenue in the short term, [INAUDIBLE] clinical and prototyping, and so forth.

And so some portion of the batteries is already going to contact CD [INAUDIBLE] the guidance selling overseas as well as --

Oh, yeah, sure. Sure. It's our battery. Mm-hmm.

Okay. And that's not the CFS --

Yeah, but we haven't seen the big updraft yet.

Likely to see it in the next, you know, quarter three, quarter four?

Well, we don't -- to be honest with you, I guess we're being conservative. We haven't projected a heck of a lot of uplift in this year, but I think we'll start to see some in '03.

Mm-hmm. Okay. Nathan, do you want to --

If I could ask quickly on the gross margin, as much as we expect to see a percentage point in growth in Six Sigma, Until -- without a hit from Sierra on the gross margin line, you know, what do we expect going forward for this year in terms of gross margin? Should we see some improvement, or are we looking at 44%, or around there, for the rest of the year?

Frank, why don't you take that one?

yeah. I think we can start to plan some increase. Capacitors, as Ed said, is starting to make headway, getting to targets. The same can be said for Sierra. So while mix can certainly play a factor in that, you know, I would hope that we would see a start to trend up a little bit, even this year, from the 44%. I should also say that while the real Six Sigma effects will, you know, be in the future, we're already starting to work with some of the key projects there, and would like to see, you know, a return on that investment to some degree as soon as the second half of this year.

Okay. Thanks a lot.

And if I I could just ask another one, following up on the operating margin line. You did fall short of our expectation, I guess one of that was an extraordinary item. But do you feel like you can return to more of a 17.5 or so average for the next three quarters, which would seem to be required to get you to the range of 75 cents to 80 cents? Is that a fair question?

Yeah, I -- I think -- I think if we achieve what we've been talking about, just said on the margin side, as well as the comments on SG&A, yeah, think that's within reason.

Okay. Great. And then just -- maybe this has been asked, sorry, I've been in and out of the phone call here, traveling. But the -- the defib would appears to be a reaccelerating in the defib market. Are you -- is that impacting your numbers, or is it likely to impact them going forward here?

Oh, sure, Kurt. You know, we -- we -- we see our growth rate being driven very significantly by what we -- what we believe to be a very robust market for ICD's.

Mm-hmm. So, in particular, I guess the capacity line, you well over our expectations there, $1.2 million over our thoughts.

Yeah.

So that -- that overage could continue as we go through this?

Well, I don't know if we'll see -- I wouldn't -- we keep telling you folks don't multiply by four, because I think we have the effect of product launches and so forth. But, you know, the capacitor business will be very solid for the year, and in general, we believe a strong ICD market will have a positive effect across the board. I mean, all of the -- almost all of the ICD products now using filtered see-throughs, we make other componentry in the components group, capacitors and batteries, so ICD market growth has a very salutary effect on the business in general.

Okay. One quick follow-up question, if I can, and this might be difficult to do right on the fly, on the spot. But you reported about top line growth of 22% all in. Some portion of that was because of Sierra. But if you could take that out, you had some remaining organic growth. What portion of that do you think was just tracking with growth of your customers' outbound growth, if you will, or was there implied some portion of that which is a deepening of your participation into those customers?

You know, Kurt, that's -- it is a tough question to ask, kind of like on a one-layer of the onion, because it is -- you know, it's product mix, it's customer mix. It's inventory adjustments. It is a -- it's a tough -- I think that in general we're just seeing a very strong market in the product categories that we have components going into.

Yep. Yeah, I think that's what we all, you know, assume, but I guess we'd like to be -- we believe anyway there's an ever-sweeping, you know, ever-improving trend where folks were outsourcing more, and I don't mow if that was manifested in the first quarter, or if you can monitor that, because it's virtually impossible to monitor.

Yeah, I wouldn't say that played a bigger role in the first quarter necessarily.

Okay. Okay. Thanks, guys.

Thank you.

Thank you.

Your next question comes from Kay Nikkai of Woodbush Morgans.

Yes, can you tell us what you have tucked into the other category under medical batteries? I can't imagine that's the monofloride stuff, all of that million dollars.

Well, there is -- there is some monofluoride in there. But also rolling up in that bucket is lithium-ion cells, which are batteries currently as part of the Emerging Technologies group. So those two items combined is the million dollars.

Okay. And can you give some additional color on the production issue related to the EMI filters?

I'll give you two kind of general -- we had a -- we had a design-related issue where we had to make a design change from manufacturability. And then there was a process that we used in all our products that turned out not to be appropriate for the new product in question, so we also had to make a process change. And both of those will wash through in the early part of the second quarter, and we think we'll be where we need to be in terms of yield and efficiencies and so forth by the end of the second quarter in Sierra.

So should we expect that second quarter results, because of those issues, should look similar to Q1?

Again, we're not giving any specific guidance on second quarter. But, like I said, I think we see -- we see an improving situation at Sierra And I think certainly by the second half, that will start to be meaningfully evident in the numbers.

And then, just, if you can, can you give us some some additional color on the departure of Richard Mott? I mean, it happened very abruptly and --

No -- no, I can't.

Okay. All right. That's fine for now. Thanks.

Okay, Kay.

Your next question comes from Mark Landy of [INAUDIBLE] Swan.

Good evening, guys.

Hi, Mark.

Just maybe if I walk down the revenue models a little bit. Pacemaker sales, have you got big expectations for [INAUDIBLE], or is there something else there for -- that you think might help going out as we head out into '02?

Well, first of all, let's just say, we still see the Brady market as kind of a high single-digit market in terms of the baseline growth. And as you know, that we're -- you know, one of our key customers for Brady is St. Jude, and you also, I think, know that they reported some fairly solid results for the first quarter. So I think, assuming st. Jude continues to perform well and that we see a continuation of the high single-digit growth rate, I think we'll, you know, we'll have some reasonable performance in Brady for the year. But again, the big driver is ICD.

Yeah, we'll get to that. I'm just trying to understand, because you know, in terms of -- St. Jude had a fairly large number, but on a year-over-year basis, it appears to me that pacemaker sales were down. Your competitor had a number up. So either ISP's are coming down or something did --

No, let me remind you of something, which we mentioned during the last quarter call. We had -- two of our European customers merged. And this is about the third or fourth time this has happened to us in the recent past, and we're seeing the historical trend here whereas they rationalize their product line. There typically is about a year's worth of inventory from the salesman'S car to component back to the pacemaker product line.

Right.

So what we see, as they sell off old product, we see a dip in demand as they burn that off. And then they usually, within six to nine months or so, will re-establish their historic ordering patterns. And that's exactly what's happening to us in Europe right now. So I think most of what you see as a weakness in the first quarter is attributable to the European situation.

Then, we should start seeing meaningful appreciation then, again, as you say, second half?

Second half, yes.

A number of people have suggested that while they might dramatic increase of the ICD market they could start canniballizing pacemaker implants. Do you think that will be large enough to affect your pacemaker sales?

I don't think in the very short term. But, I mean, there's a lot -- if you look out three years, there's a lot of talk about common platforms and so forth. So it's not very clear yet what the long-term trend will be there. I think there's a good argument for ICD backup in congestive heart failure devices. But I think it's still a little early to tell. I mean -- and of course, we see product road maps that we can't talk about, but I think it's not clear exactly how this whole thing will shake out over the next three to four years.

Okay. I don't know if you guys [INAUDIBLE] a number, and I will try to get it out of you. CSX sales, are there a couple hundred, or just a hundred odd thousand?

A few hundred thousand.

Yeah, okay. Then, you might have mentioned this on the call, and forgive me for reasking it, but the new customer, in terms of the sales, are these going to come in as royalties, so meaningfully affect the gross margin, or were they coming, you know, the revenues under ICD, or under capacitor sales?

You mean the new capacitor customer?

Yes.

Oh, they'd be product sales.

Product sales. Any idea what the margin is kind of is below the average, below the average? Corporate margin right now?

Well, I'll repeat what I said before, that our target -- we believe our target for an engineered product is approximately 50% gross margin, and we're -- in our capacitor business more than halfway there now in terms of getting the margin where we want it to be.

And last question, the shared account should stay stable through the year?

The shared account?

Yes. Fully diluted shares outstanding.

Yeah, I believe so.

I think it might go up a little bit as options and things are exercised, but nothing dramatic.

All righty, guys. Thanks very much.

You're welcome.

Thank you.

Your next question comes from Steven Greer of Sigma Capital.

Oh, hi. Good quarter. Can you help me understand the latest trends in the ordering pattern for the capacitors? If I am to remember correctly, it's approximately about a three-month lead time. Are you seeing that speed up or shorten at all?

Well, it depends on a lot of things. It depends on timing of the product launches, inventory levels. It's hard -- Steve, I -- I -- I know you're not going to like this answer, but it's very difficult to ascribe to any one quarter something that can be, you know, extrapolated by a simple multiplication. And I'm not trying to trivialize your question, but it's -- I think, you know, like I said, we're gonna have a solid -- solid year for capacitors. It's primarily going to be based on the -- you know, the one customer for 2002. And it may bounce around from quarter to quarter, as that customer manages the inventory levels prior to introduction dates.

Okay. Thanks.

Your next question comes from Bob Yetted of Philhouse Capital.

I just wanted to clarify one thing, in terms of the goodwill amortization. You said you take in 2001 first quarter on a pro forma basis, that would have saved about two cents per share?

Yeah, net income would have been two cents per share.

Higher, because of that elimination?

That's correct.

Okay, fine. The rest of my questions were answered. Thank you very much.

Okay. You're welcome.

Your next question comes from Matthew Butten of Arduous Partners.

Hi, Matt.

Hi, guys. Quick question on guidance. Essentially keeping top line and EPS the same, it seems like you've lowered the operating income. And I just wanted to know if you could make take us through the changing guide and allocate, you know, how much of that was due to gross margin, by how much SG&A, or R&D. Just take us through the -- below the top line, just to get us to the same places as we were before, without the lower tax rate?

Well, let me try to answer. I think we -- the three areas that we've spoken about in margin -- in the gross margin area, the softening, as we talked about restructuring provision a little bit less royalty income this year, which is essentially none. So we lost two points of margin with those two items. And talked about the Sierra effect in the first quarter, so that would speak to the relative return at the margin line.

And we're not, I mean, we're not going to be making up this -- what we had for the restructuring provision at Sierra. I mean, that's -- that's burned.

The next piece, of course, would be the SG&A. which, again, we've talked about in terms of, you know, being aggressive in the patent front and having Six Sigma expenses and also, you know, putting in an administrative and marketing infrastructure not only for Sierra, which is additive over last year, but also for the Emerging Technologies group. We have those fully in place. So that again, relative to sales, would have hurt on the operating line. And lastly, research and development, which, if we can stick to our target of investing 10% as sales go up, you know, that number in terms of absolute dollars, is going to climb as well.

Okay. And one other follow-up. The '01 full-year -- to make an apples-to-apples earning, would it be four cents for the first half and then six cents for the second half or 10 cents for a full year earnings if you wanted to look at putting '01 on the same base, '02, how should we think of that --

You mean with the FAS-142 effect, the amortization change.

yeah, versus the 13 cents --

Yeah. '01, on an after-tax basis, the effect would have been about 10 to 11 cents. Full year.

Okay. Thank you very much.

You're welcome.

You have a follow-up question from Glenn Reesen of Morgan Stanley.

I'm going to push you a little bit on sort of the remainder of the year here.

Sure.

With respect to the other battery sales, is that -- that million dollars, is that expected to continue, or is it going back down to a couple hundred thousand in the next couple quarters per quarter?

No, I think -- I think we're going to see some additional both CSX volume and rechargeables. I think -- earlier, I had mentioned that we're going to see some significant -- we think we're going to see some significant drug pump sales over the next 12 months.

Mm-hmm.

And some of that is going to be in the second half. And you can almost correlate there's probably a CFX battery that goes out with every pump, because the CFX is the -- has been the battery of choice for the, you know, for the drug bumps.

So what's your best guess for the year now on that other category? $3 million or so?

Well, you caught me cold, because I don't have a best guess for it. Right now.

Hmm.

I think, Glenn, you know, if it -- if we see it starting to grow a little bit, and, you know, we're at a million for the quarter, so some slight growth on that, if things progress as Ed was saying on the lithium-ion, it should get you within the ballpark.

Glenn, I'm hedging a little bit because again, there is a correlation with this comment I made earlier on the call about the drug pump. We don't have -- we don't have the agreements signed yet for these programs -- there are two programs that would involve both the pump and, of course, the battery. And so, the timing is a little uncertain right now.

So what was the million dollars?

It was rechargeable batteries and CFX.

I guess what I'm trying to get after, is this a recurable sale without new contracts? Or is this, like, a one-time stocking --.

It's not a one-time. I mean, the number's gonna bounce around a little bit. But it is a recognition that our lithium-ion rechargeable battery is designed into a number of LVAD's. And as they move through prototype and start getting into clinicals, you'll see that ramp build. And then CFX, both on drug pump and now with some initial units where people are designing them into other devices, we'll start to see that build as well.

Okay. I want to try this on a couple other businesses. I'm going to try and put some words in your mouth, and you're going to tell me if it makes sense or not. The pacemaker business, it sounds like we have another quarter of similar kind of run rates to what we're seeing, and then significant increases in the third and fourth quarter. Is that a good way of looking at it?

I don't know. [OVERLAPPING VOICES, INAUDIBLE]

Significant, yeah, that's -- that's the word I'm looking at. You know, as we said, moreover with the -- you know, you can't annualize times four. And then the overall growth rate and pacer in any event, you know, isn't as significant as when we're talking about the defib market. So the significant is the only word in there that I would be concerned about.

Right. Okay. And then with ICD's. you also had this huge 2000 in one, and the ICD batteries are actually looking for pretty flattish kind of growth this year. You did come in significantly better than I thought in the first quarter. So the question is, does the run rate of around 6.5 stay with us, or does it go back down to sort of 5, you know, $5 to 6 million kind of run rate per quarter?

I think from everything we can see, and again, I know you're tired of hearing this, but subject to the fact that the quarters can bounce around, but, you know, I don't know that it's going to vary too much from what we seen in the first quarter, at least it might -- nothing to indicate that it needs to.

Yeah, I mean, we -- we think the ICD market is very strong, and we will benefit from it accordingly.

Okay. And then, you had mentioned the capacitor business. That sounds like it is definitely going to bounce around, depending on the product introductions and --

It is.

-- the acceptance?

Yes, it is.

Okay. And that would be -- vitality is what we're really looking at at this point going forward?

Yeah.

Okay. So these were mainly stocking orders for the most part?

And, again I --

I mean, it sounds like it will be down sequentially for the next two quarters until we get some sales around vitality?

It's gonna bounce around. And I -- again, we -- again, we -- on a quarter-to-quarter basis, we're effected by customers making decisions on what they want to do about inventory levels. Sometimes they take them up. Sometimes they take them down.

Right. I was just wondering, in this case, whether they could take them down the next two quarters until there's some self-run vitality?

That's a tough call to make right now, Glenn.

Okay. I'll try to be conservative.

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At this time, there are no further questions.

Thanks, everyone.

Thank you.

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