Integer Holdings Corp (ITGR) 2003 Q1 法說會逐字稿

Welcome, everyone, to the first-quarter Wilson Greatbatch Technologies conference call. Before we begin, I would like to read the safe harbor statement.

The presentation and our press release contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, and involves a number of risks and uncertainties. These risks and uncertainties are described in the company's annual report and Form 10-K.

The statements are based on Wilson Greatbatch Technologies' current expectations and actual results could differ materially from those stated or implied. The company assumes no obligations to update forward-looking information included in the conference call to reflect changed assumptions, the occurrence of unanticipated events or changes in future operating results, financial conditions, or prospects.

I would like to now turn the call over to today's host, treasurer and director of investor relations, Anthony Borowicz.

Thank you, and welcome to the first-quarter Wilson Greatbatch earnings conference call. This call is being web cast and, for the first time, we are providing slide visuals with the call which we hope you'll find useful.

In case you are listening only, these slides will be accessible on our web site at www.Greatbatch.com, if you want to review these later.

With me on the call today are Ed Voboril, our chairman, president, and CEO, and Larry Reinhold, our executive vice president and chief financial officer.

In terms of the format for today's call, Ed will provide an overview of the results and key initiatives, and Larry will provide details on the financial results, and then we'll open up the lines for your questions. With that introduction, I now would like to turn the call over to Ed Voboril.

Thanks, Tony. Let's just look at an agenda slide first, and again, for those of you who don't have this up on a screen, I'll just speak briefly to our agenda.

First of all, we're going to talk about financial results. We had a very strong quarter, both on the top line and the bottom line. Sales up 51 percent compared to the first quarter of the prior year, and earnings per share up 75 percent on a GAAP basis.

Sales highlights will be discussed. We'll look at the results by major product area, and discuss how our significant participation in cardiac rhythm management is driving results to the levels that we're reporting in the first quarter.

Then we'll talk a little bit about some of our ongoing initiatives in terms of operational improvements, six sigma, (inaudible) manufacturing and so forth, give a little progress report on our consolidation of the non-medical battery production facility in Canton, Massachusetts, and discuss a little bit about some of the key developments in terms of customer initiatives, some of our capital spending plans, and so forth, and then Larry Reinhold will cover in somewhat more detail the financials.

Just going to the next chart, summarizing by major product category, as I mentioned, of course, sales growth up by 51 percent compared to the prior year. Revenues for the first quarter of '03 of approximately $55 million compared to $36.3 million in the first quarter of '02.

I would remind everyone that the first-quarter results from '02 do not record any sales revenues from Globe, an acquisition that was completed in July of '02, but in total, obviously, speaking to the tremendous momentum we're seeing from CRM.

The most notable example of that is in our defibrillator battery sales. Sales of ICD batteries of $10.8 million compared to $6.5 million in the first quarter of the prior year, an increase of 65 percent.

Pacemaker battery revenues, lithium iodine battery revenues, also strengthening by about $500,000. First-quarter '03 revenues of $6 million compared to $5.5 million in the prior year, a growth of 9 percent.

Capacitors also showing strong growth, again in conjunction with the very robust CRM market segment growth. Capacitor sales for the first quarter of $7.2 million compared to $5.8 million in the first quarter of '02.

We, as I mentioned earlier in the year at some of the conferences we attended, are on track to add additional customers by the end of this year. Components growth, very strong, even figuring in the fact that Globe was not included in the first quarter of last year.

Component, medical component sales doubling from the prior year, recording sales of $23.3 million compared to $11.5 million, and if we factored Globe out, sales would still have been up by 32 percent organically compared to the prior year.

Commercial battery business, again, going into a growth mode, with revenues of $6.8 million compared to $6 million in the prior year, lifting oil prices starting to regenerate some growth in the oil field services business, but obviously with the continuing unsettled situation in the Middle East, we are cautiously optimistic but certainly are still taking a wait-and-see attitude in terms of what the performance of commercial batteries will be for the full year.

Now, taking a little different cut at our sales mix, on the next chart, if we look at sales devoted to the cardiac rhythm management segment of the medical technology marketplace, sales increasing from 79 percent of our total revenues in the first quarter of last year to 83 percent of our total revenues for '03, and again showing organic growth of 37 percent if we factor out revenues that would have been included for globe tool, which of course are in first quarter of '03 and not in the first quarter of '02.

Other medical technology sales showing growth, but because of the robust growth in CRM becoming a smaller percentage of the total, and again, the similar situation even though our commercial battery business is growing it's not growing as fast as CRM and as a result, as a consequence, the commercial battery sales have declined as a percentage of total sales, now about 12 percent of the total revenues.

Talking about some of our ongoing initiatives, we invested in the first quarter of the year. That investment showed up as cost of goods sold, and we certainly would expect to see the benefits of that lean manufacturing implementation ongoing, most notably at places like Globe and in some of our battery production facilities.

That will start to benefit us with improved gross margins in the second half. The commercial consolidation of our battery production facilities for non-medical batteries in Massachusetts on schedule for completion in the second quarter.

Again, additional costs recorded in the first quarter of this year in support of that consolidation. Just, just beginning the investment in terms of fitting out our new battery facility that will support the new battery technology that we're introducing for implantable batteries, and as I mentioned earlier, lean initiatives at Globe will begin to bear fruit certainly in '04.

Globe showing very robust growth again in conjunction with the growth that we're seeing in cardiac rhythm management, and continuing to see the margin improvements at Sierra. I believe we mentioned in the press release that our sales of filtered feed-throughs are up by 60 percent compared to the same period last year.

Turning to some of our other recent developments, as we mentioned in a recent press release, we've extended our battery purchasing agreement with Guidant through the end of '06. We are on track to add the additional capacitor customers we've been talking about. And we continue to enhance performance in capacitors to make the bar even higher for competitive technologies.

On the acquisition front, we continue to evaluate opportunities. Certainly we're looking at opportunities that would broaden our technology base. We typically look at companies that are market leaders in the field of interest, and we, of course, would like to expand our customer base, if possible, and we're fairly confident that we'll be able to announce something certainly within the next 12 months.

Probably at this time I should also note that we were advised that CSFB has liquidated the last of their position in Wilson Greatbatch. Of course the predecessor company, Donaldson Lufkin Genret, was our partner in the buyout of the company from the Greatbatch family in '97, and it has certainly been a productive and enjoyable working relationship and we wish them well for the future.

Now, I guess at this point in time, I'll turn the call over to Larry Reinhold who will discuss more of the details of our financial performance.

Larry.

Thank you, Ed. I'm going to discuss first-first quarter 2003 selected financial highlights of the Q1 versus Q1 of last year. As previously mentioned, our sales were up 51 percent, as reported under GAAP, which again is our primary measure of reporting operating performance.

If we pro forma Globe in, as if it had been acquired in the first day of '01, excuse me, of '02, which is about $5.3 million of revenues, the organic growth in our top line was about 32 percent. And we provide this pro forma measurement because we believe it is a meaningful presentation of sort of same-store growth.

Turning to gross profit, our overall gross profit increased from $16.0 to $22.8 million in the current quarter. Our consolidated gross margins declined from 43.9 percent to 41.6 percent, and I will explain the margin impact of various investments that we made during the quarter and of our product mix on the overall composite gross margin in a moment.

Turning to SG&A expenses, those increased by 36 percent, from $5.7 million to $7.7 million in the current quarter, but declined as a percentage of sales revenue from 15.6 percent to 14.0 percent, reflecting a partial leveraging of our fixed costs over significantly higher sales volumes.

Our RD&E expense increased 25 percent from $3.7 million to $4.6 million in the current quarter. This was a decline from 10.1 percent to 8.3 percent of sales revenue due primarily to inclusion of Globe revenues in the current quarter that were not in the picture last year. And as we've mentioned before, Globe has a very low level of RD&E, so there's not a corresponding increase.

On operating income we saw increased leverage from the higher sales volume, and our operating profit margin increased to 17.8 percent from 15.9 percent last year.

On an earnings per share basis, we reported 28 cents per share, which is up 75 percent over the prior year, despite the aforementioned project-related costs that we incurred during the quarter.

In short, we delivered earnings growth at a higher rate than our sales growth.

Turning to the gross margin percentage for the quarter. As I mentioned a moment ago, our gross margin was 43.9 percent versus 41.6 percent a year ago. This overall composite lower gross margin was attributable to several factors. First was the addition of Globe into our product mix. As we've disclosed previously, Globe, the Globe products are the lowest gross margin products in our portfolio currently, and the inclusion of the Globe revenues this quarter accounted for a 2.1 percent or margin point decline in our overall gross margin.

Second, we mentioned the consolidation of our commercial battery manufacturing in our Massachusetts facility. Those efforts commenced in Q4, were going strong in Q1, and are on track to be mostly finished by the end of Q2.

The inefficiencies associated with the commercial consolidation accounted for 0.9 margin point decrease in the current quarter. And third, the lean manufacturing costs that we've initiated during the quarter comprised a 1.1 margin point deadline during Q1.

Offsetting these three margin decline factors was an improvement in our Sierra gross margins. If you'll recall a year ago that we were impacted during the first half of '02 by various manufacturing issues out at our Sierra facility in Nevada.

In the latter half of '02 those issues were resolved, and we saw during the current quarter a 2.2 margin point increase in our consolidated margin as a result of improved margins out at Sierra.

So we're proceeding as planned in terms of gross margin improvement and we anticipate delivering on our expectations for the second half of the year.

Turning to the next slide, as we've mentioned we've invested heavily in the quarter in lean manufacturing efforts, consolidation of facilities,. From an information technology perspective, we have invested significantly in the early stages of ERP selection.

We anticipate an implementation efforts will occur, commence in the second half of the year. We've added a number of senior-level operational people into the company, and we've invested, started investing in a new battery manufacturing facility.

All of those investments have been funded with internal cash flow. Since we acquired Globe on July 9th of last year, we've steadily paid down our debt, which hit $93.2 million as of the closing of the Globe acquisition, and we closed Q1 of '03 at $77.3 million.

That is a pay-down of approximately $16 million in debt over the last 9 months. And we have prepaid about 85 percent of our 2003 scheduled debt requirements. And our existing outstanding debt right now of $77 million is at about 3.3 percent coupon rate.

One other item of note with respect to inventory turns, from under three times a year in Q1 of '02 to close to four times in Q1 of '03 as a result of numerous initiatives and higher sales volume.

This concludes our prepared remarks. I now would like to turn the call back to our moderator to facilitate Q&A.

Thank you, sir. Ladies and Gentlemen, this is your question-and-answer session. If you have a question or a comment, please key star 1 on your touch-tone telephone. If you wish to withdraw your question, please key star 2.

Questions are taken in the order they are received. Once again, that's star 1 for questions. Sir, please stand by for your first question.

Sir, your first question comes from Keay Nakae of Wedbush Morgan. Please go ahead.

Yes. Nice quarter, Gentlemen.

Thanks, Keay.

Thank you.

With respect to the gross margin in Q2 as you wrap up the consolidation of the two battery facilities, should we look for a similar type of impact in Q2?

Let me turn that one over to Larry.

Yeah. I think that, yeah, I would expect that Q2, excuse me, the commercial business in Q2, probably a similar level. We expect to be, it's not completely substantially completed with this process by the end of Q2. And the heaviest, action, if you will, is occurring in Q1 and currently.

Okay. And then with respect to the impact from the lean manufacturing initiatives, should we expect that to be fairly constant for the balance of the year, or will that start to tail off here shortly?

You mean in terms of ongoing investment?

Yeah. I mean, obviously you're doing some work at globe that I'm sure is incorporated in that.

Yeah.

And elsewhere. But ...

Keay, the implementation of lean is ongoing throughout the business. It will continue for the next several quarters, but will start picking up toward the end of the second quarter and certainly in the second half we'll start picking up the benefits. So it, I would say in the second half, it should be a net positive.

Okay. And then if we look at gross margin for the year, then, can you give us an idea of what you're shooting for?

Well, I think we've been pretty consistent in saying that if you look at it on a year-over-year basis, we want to add at least one gross margin point per year and we're sticking to that.

Okay. Thank you. I'll get back in queue.

Thank you, sir. Your next question comes from Tom Gunderson of Piper Jaffray. Please go ahead.

Hi. Good afternoon.

Hi, Gundy.

Hi. Say, I just want to make sure I got the math right but if not for the sales mix of Globe and the investment in TQM and the consolidation, we'd be at a 45.7 percent gross margin, is that right? Give or take?

I'd have to, I didn't add those numbers up that way myself, but again, Globe was 2.1, the commercial consolidation was .9, and lean was 1.1, so that's, that adds up to 4.1.

Okay. And then I just want to make sure those are all additive.

Yeah, those are additive. The Sierra, well, those are negative, if you will, to the quarter.

Right.

But the one that goes the other way is the improved margins at Sierra.

Correct.

And that's 2.2 points.

Correct. And then maybe on the fun part of the quarter, gee, nice numbers on ICDs and CRM. Did you notice any catch-up that maybe some of your customers are doing as they scramble to keep up with the heavy demand out there for ICDs or CRTD business, and/or are you sensing them trying to add to any of their safety margin as they try and stay ahead of this game?

Well, Tom, I don't think there's any question that people have been ramping up, and I think I had said earlier this year, a couple months ago, maybe it was at your conference, that perhaps we've been a little bit more conservative than our customers in terms of looking at the growth in the ICD market segment.

Obviously, with the numbers that they're reporting, they're reporting very robust sales increases, and I think, you know, if you hear what's happening out there, a lot of people are saying, well, if Med-to-patient reimbursement happens at Medicare, we'll, you know, at CMS we'll continue to see very significant increases, and if CMS waffles and Medicare doesn't get approved this year, reimbursement is skipped for this year, it may take some wind out of the sails. But I guess we'll have to wait and see.

But Ed, you're not seeing any meaningful change in the inventories that they're keeping on board relative to their sales?

I guess just, you know, in very general terms, I guess the answer so that question is yes, Tom.

Okay. And then last question. Just because we're being forced ask this question. Could you just review real quickly what you believe might be some of your IP barriers to entry on batteries?

Well, I guess I should mention that even though our SVO patent has expired, there are many, many other patents related to how batteries are designed and manufactured compatible cardiac defibrillators, we have many patents, design patents and related, on CFX.

And, of course, most recently, on April 22nd, our first basic patents related to the new convey Quasar technology was issued by the Patent Office. So we're very satisfied with our intellectual property position regarding the kind of batteries that we build.

Okay. Thanks. I'll get back in queue.

Thank you, sir. Your next question comes from Bob Hopkins of Lehman Brothers. Please go ahead.

Thanks, and good afternoon. A couple quick questions. First, on the pacer side, could you talk about whether or not this is the first quarter that we're seeing Biotronic come back on-line on the pacer side?

Well, I don't think we, hi, Bob, by the way.

Hi, Ed.

We, I don't think we're prepared to break out results or indicate what's happening with individual customers, but you'll recall that about a year ago, we said that there were some ordering patterns in Europe that had changed and now I think it's safe to say that those ordering patterns have changed back into a more normal mode, and we're seeing growth resume overall, strengthened by what we're seeing in Europe.

Okay. Thank you. That's very fair. Question number two is sort of on the new business development side, and I was wondering if you could give us an update on how the third capacitor customer is coming on-line, if you didn't do that already because I missed a few minutes at the beginning of the call.

No, I, we're kind of going through the normal paces of bringing a customer on stream, working on designs and sending out, you know, the early prototypes and so forth. But it's kind of just moving along.

Okay. And then just give us a quick update on, you know, how you guys view the opportunity, the potential opportunity, to bring the fourth and fifth customers or the fourth and fifth of the major CRM players on-line at some point?

Well, I guess we continue to be as optimistic as we have been earlier in the year. I still believe that, again, it doesn't, this isn't, you know, a step function. We don't get all of everybody's business right away. But I think, again, given the fact that we continue to improve in significant ways the performance of our technology on a year-over-year basis, I think the technical argument for doing this becomes even more compelling.

Okay. And then one last question on components. The growth in the quarter on components was terrific. I'm wondering, can you make a comment? Do you know what percentage of that component business comes from ICD-related sales versus pacer-related sales?

To be honest with you, Bob, I really don't. I don't have that breakout. I don't, Larry, do you have that breakout?

Bob, that is difficult to get very precisely, as you can appreciate.

Sure.

You know, some of the components that we make are, it's not entirely, it's not always obvious, if you will, what the end-device is going to be, and so for us to break that, we don't break it out that way. We've basically gone, if you will, as far as we feel comfortable going in the disclosure that we provided earlier about CRM now comprising 83 percent of our revenues.

I think what it would be fair to say, though, Bob, is that the growth rates for filtering, filtered feed-throughs are closer for Brady and Tachy than the battery sales are. In other words, it's not, you know, you saw we had 65 percent in ICD batteries, and 90 percent on pacer batteries.

The growth rates for those types of applications for filtered feed-throughs are closer in terms of the rates.

: Okay. I guess the question, I mean, is it a fair assumption that, you know, obviously at least a portion of those sales are going to pacemaker-related sales.

And therefore, some of this growth has to be coming from, you know, deeper customer penetration as a result of the new feed feed-throughs?

h, absolutely, absolutely. No question about it.

Okay.

Absolutely.

Okay. That's all I have. Thanks and great numbers. Thanks.

Thank you, Bob.

Thank you, sir. Our next question comes from Glenn Reicin of Morgan Stanley. Please go ahead.

Good afternoon, folks.

Hi, Glenn.

Hi, Glenn.

A bunch of questions, like usual. I am surprised that when you talked about positive factors influencing your gross margin, you did not mention capacitors, so what's happening with profitability of the capacitor, sorry, of the capacitor business, yeah?

Yeah. Glenn, profits and gross margins in the capacitor business have increased, but in terms of breaking down the most significant drivers at the consolidated level it didn't make the top four, but they have increased.

Okay. And you don't want to give us some sort of magnitude?

Not today.

Either on, you know, percentage improvements or anything like that?

Oh, I'm sorry, somebody's high-fiving me something. It's at least mid-single-digit improvements in margin, Glenn.

Okay. Did you guys bet that I was going to ask that question?

What's that?

Did you guys have a bet that I was going to ask that question?

No, but we have other bets.

Okay, anything else to add on that one?

No. I think that covers it.

Okay. With respect to the rest of the P&L, I was sort of surprised, I'm not complaining, but I was surprised that SG&A and R&D spending was able to keep up with the sales growth, so you've always talked about that business as a percentage of sales, but I always thought that that was not realistic, that was more of a fixed cost, you know, kind of part of the P&L.

Can you talk to that and give us some idea about the absolute spending levels on SG&A and R&D for the next couple of quarters?

Well, Glenn, I'm not sure I, the SG&A increased, but declined as a percent of revenues.

Correct.

So we did get some leverage. We're not, as we've talked, you know, our business is not as leverageable yet as it will be next year, but we did get leverage on SG&A.

I guess what I'm asking is: Do you expect SG&A to continue to be in the $7.5 to $8 million range or does it revert back to a sort of like a $7 to $7.5 million range in the coming quarters?

At least in the coming quarters of this year I do not expect it to decline in any quarter the remainder of this year. We have significant, we've discussed, we have significant sort of infrastructure investments that we're making.

Okay. So I'm surprised that you had not mentioned anything about guidance, either in the second quarter or for the year. Any changes in your thoughts there given the strong first quarter?

Yeah. I would say we did have a bet on that one.

Yeah, I'm sure.

Glenn, you know, obviously we can do the math probably not as well as you guys can, but we can at least do the arithmetic, and clearly this quarter exceeded our internal expectations, and if this were to, if a quarter were a year we clearly would have been conservative on our guidance.

Right now we're certainly cautiously optimistic about the full year, and comfortable with our guidance range. We're not prepared right now, after only one quarter, to sort of adjust our guidance. We think we'll be looking very carefully at that at the end of Q2, if results stay as robust as they were this quarter.

Any guidance? It could be very broad guidance, in Q2 with respect to sales?

Not today. I mean, we're comfortable with our guidance and, you know, business looks strong.

Okay. Two other quick questions. I don't know if I'm missing this on the press release. I didn't see anything below the operating income line. Can you give us the details in terms of the other expense, tax rate, that type of thing, and shares outstanding?

Oh, you mean we have those things?

I did not see it on the press release.

No. They're there, Glenn. We can reissue the press release. The, if you stopped at $9.7 million of operating income?

Yeah.

Okay. There's $931,000 interest, $8.8 million of EBIT, $2.8 million tax provision for 6.037 of net.

Okay. And then shares?

21 three five four.

Okay. And then I promise this is my last question. I think we sort of hinted to this before. I'd love to get your perspective about what you think inventory levels are at from your customers for both ICDs and pacers. If you look at your growth this quarter, it does look to have exceeded the unit growth of the actual customers you sell into for ICDs, so is this replenishment or are they buying ahead? Whatever you can speculate and give us, you know, some help looking at this market.

It's a tough question for us to answer just based on one quarter, Glenn. I think there is a ramp going on, and like I said, I think the bellwether, obviously, was what was going to happen with CMS decision regarding reimbursement for Med to patients and I said earlier I think our customers are being more bullish, have been more bullish than we have been in terms of the outlook for market growth. That is probably still the case, but certainly I think during the second quarter, a lot of those questions will be answered.

But it sounds at this point that they have their arms around their own production and they have enough capacity to meet demand right now?

Well, again, that's a tough question for me to answer in detail but I, let's put it this way: I don't think we're, I don't think we're holding anybody back in terms of our ability to deliver everything they need.

Right. Okay. I'll get back in line. Thank you.

Thank you, sir. Our next question is from Sanjiv Arora of UBS. Please go ahead.

Nice quarter. Just a couple questions. One to follow on with Glenn's line of thinking. If you look at the ordering patterns at your customers, historically how have they differed if you compare, for example, Guidant versus Medtronic versus St. Jude? What do they historically hold for inventory purchasing?

Well, first of all, if we had that information, we'd probably would not disclose it to you, Sanjiv, but to be honest with you I think there have been so many changes over the past couple of years with our customers in terms of going to combine systems, implementing lean, reducing lead times, Guidant moves a lot of their production to Ireland, it's tough to take a snapshot at any one point in time and say that's representative.

I think in general, our customers are trying to shorten their lead times and reduce their inventories, so they're depending on us to be able to deliver more just-in-time and that means we have to be even more responsive to what they ask us to do.

Okay. Next question. With regards to the R&D expenditures, if you look at the pipeline of products or technologies that you are working on, can you give us a little vision in terms of where your expectations are leading?

Well, I think, again, in the past few months when we've done presentations, we've mentioned that we've got major new product initiatives in every part of the business. In feed-throughs we're working on integrated filtered feed-through.

We've got our new implantable battery technology that's going to be ramping up into production over the next couple of years. We are working on even higher energy density capacitors. The list goes on.

So, I mean, the fact that we added Globe, which doesn't carry a R&D budget, kind of diluted the percentage as a percentage of sales, but on an apples-to-apples basis we're probably pretty much in a steady-as-she-goes in terms of the spending levels on R&D as a percentage of sales.

And is, go ahead.

It was a $900,000 increase in Q over Q, in absolute dollars.

Okay. And as these new products, for example, the next-generation feed-through, as that gets incorporated into the product families at the OEM level, is it the next generation product that it goes into, or can it often be incorporated into a currently-released product?

Well, most people usually don't retrofit on an existing platform, and quite frankly, the pacer changes are still so rapid out there that there's almost always a platform on an annual or even a semi-annual basis for us to put a new component into.

Okay. Great. Thank you.

Thank you, sir. Our next question is from Mark Landy of Leerink Swann. Please go ahead.

Good evening, guys.

Hi, Mark.

Hi, Mark.

That was an awesome quarter.

Thank you.

In terms of pacemakers, should we think of pacemaker levels for the remainder of this year at the current level, or should we see those maybe train toward the historical trend?

Yeah, I think historical, yeah, Mark, I think historical. We still believe that the, let me answer that in two ways. First of all, we think that the Brady market is still kind of in the mid-single digits, but it's getting increasingly difficult to use the old categories, as I'm sure you can appreciate because of some of the cardiac resynchronization devices, cannibalizing some of the, what we have thought of as the Brady market.

But I, yeah, I would say middle-single digits, 5 percent is probably more likely for the full year.

Is that just kind of leading into my next question? In terms of CRT, do you guys view those as pacemaker sales or do they fall into another category?

Well, this is where it gets blurry and we're, especially as our CFX battery volume starts to ramp up, we may have to think about re-categorizing. And we don't , we haven't decided on that yet, but we may wind up slicing the apple a different way.

Okay. You mentioned CFX. Can you give us a idea where their sales were this quarter?

Again, pretty much steady-as-she-goes. We haven't seen the big surge yet. You know, we're just getting designed into some medium-rate devices that probably won't show up in the marketplace for another couple of years. Everybody knows that we're in cyberonics, which has been pretty steady, but then obviously if we've seen an up-tick there with new applications and so forth, that could drive the growth in the near term, as well.

Have you seen an uptake from your Australian customer relative to some of the issues that their competitor is going through?

Well, actually, we, on the emerging, the emerging technology folks aren't a real big, I mean, they don't move the needle for us yet on, you know, certainly compared to CRM. They just don't move the needle for us.

But that line gets into CFX, right? The cochlea plants?

The implantable hearing devices are primarily rechargeable battery technology.

Okay. And then lastly, you were talking about lead times coming down. Historically, I think we've thought of lead times in from the six- to nine-month period. Should we still think of them like that or should we think of them coming down maybe three to six months.

Well, I was talking more of production lead times, and we're moving from, you know, from months to weeks to now in some cases days.

Okay. Then, you know, just to go along Glenn's thesis, assuming you still are supplying major components to some of the new devices that are hitting the CRT space and the CRTD space, the next two quarters should be pretty good for you guys, as two of your larger customers ramp-out new products over the next nine months?

Well, I certainly hope you're right about that, Mark.

Okay. Well, thank you very much, guys. I'll get back in line.

Okay. Thank you.

Thank you, sir. Our next question is from Alex Arrow of Lazard. Please go ahead.

Thank you. Congratulations on a great quarter.

Thank you.

Just a couple of questions. On your non-medical part of your business, I'm trying to understand the statement about the oil drilling season. It seems like the demand for oil would be relatively constant and predictable, even if the situation in the Middle East is not predictable.

Can you give us just a bit of a description on why the, what you were getting at when you said the instability in the Middle East would impact the demand for the oil-drilling type of batteries you produce?

Well, I think oil prices have come down from their recent highs, and that always makes our oil field services customers pull in their horns a little bit. So even though we benefited from higher oil prices in the, I'll say the third and fourth quarter of last year and the early first quarter of this year, we're seeing that cool off a little bit.

But recons are still up, and I would think that's, you know, that's what's been driving our demand, and then of course you might recall that, I didn't mention this in the comments, but one of our customers is the British ministry of defense, and of course I think the conclusion of hostilities in Iraq may have a little bit of a tempering effect in terms of, against what may be some additional growth in oil.

Okay. Thanks. And then one follow-up. The capacitor business, you said that the filtered feed-throughs was, you know, perhaps the best part of that business. I know that, you know, that your press release say the full thing grew at 24 percent but the number you gave for filtered feed-throughs was much higher. Can you tell us what ...

Well, those are different capacitor technologies, Alex. The capacitors for filtered feed-throughs are solid-state capacitors. The capacitors used for implantable defibrillators for delivering therapy are a hybrid wet tantalum. Now, on the filtering capacitors, we've got both the growth of the marketplace, CRM, because again the bulk of the sales are to CRM, but then we've got the adoption rate as new devices become filtered for the first time as people convert over, as old products are phased out, when they phase new products in they add filtering for the first time.

So that 60 percent growth rate is a combined factor of the strong growth in CRM plus the growth driven by the adoption rate of the conversion to filtering for the first time.

Okay. So the figure that says capacitors in the press release is wet tantalum capacitors?

Yes, yes, that's right.

And then the 60 percent capacitor growth, what category does that one show up in?

That's in medical components. That's filtered feed-throughs are made by CRF business out in Reno, Nevada.

Okay.

It is generically a capacitor technology, but it's a much different type of capacitor technology than those used for delivering therapy in implantable cardiac defibrillators.

Great. Okay. Thank you.

Thank you, sir. Our next question is again from Glenn Reicin of Morgan Stanley. Please go ahead.

Hey, folks. Just a couple of follow-up questions here.

Sure, Glenn.

You mentioned that without Globe, year-over-year growth would have been 32 percent. And if I do back-of-the-envelope calculations, that implies $6.9 million for Globe, but I think you mentioned it was $5.3 million. What is the number for Globe?

It's $5.3 last year, Globe, Glenn, I'm sorry. It's $5.3 million in Q1 of last year.

Oh, you're saying if you would have pro forma for it last year?

Yeah. It's adding in as of 1/1.

So what is the number this year then?

Unidentified We don't break Globe out separately.

So you're just saying, okay.

If you add $5.3 to the base, hopefully that number will come out.

Yeah, that we can figure out here. And then if we listen to what you're saying on gross and you're still committed to a hundred basis point improvement in gross margins for the year, you're talking a back half of the gross margins being in the 44 percent, 45 percent range. Does that sound right?

It could happen. A lot of it is dependent upon, you know, mix plays a major role in it, as you can appreciate.

Yeah, sure.

And the rapidity, if you will, of the benefits of our lean initiatives will really drive that.

Okay. Now, one thing I don't understand. Where do you draw the line between a capitalized expense and an actual expense when you put through these different initiatives?

Well ...

Because I would have thought that when you talked about starting up new facilities, when you're talking about even parts of six sigma, a lot of that should be capitalized as opposed to directly expensed?

Yeah, you know we, most, there are certain things that are certainly required to be capitalized, Glenn, but we've been probably reasonably conservative in the things that are just period costing.

We're certainly capitalized, you know, things like new facilities and modifications to facilities and the like, but if you will, consulting kinds of things with respect to, you know, people who were assisting us in relaying out and redesigning of factory space were, we're period-costing that, not capitalizing that.

So it, you know, there is a line to be drawn, and we try to draw that on a fairly conservative basis.

It certainly sounds that way. And then traditionally where we tend to get bit surprised is sort of these incremental programs that sort of come in out of the blue, and I'm wondering, has any incremental spending over and above what we're seeing in the first quarter come to mind?

I know you did hire a new CIO. He's going to spend some of your money, as well. You know, sort of what's happening in terms of projects that you're contemplating right now that could bring spending to another level?

Yeah. You know, I think the major, if you will the things that are really are more than noise level, the major initiatives that will surround the new facility and information technology, and of that most notably will be an ERP solution. Those continue to be the big-ticket investment items that we will really start spending on in the second half of '03.

So we have not seen the ERP improvements yet?

No.

Okay.

Not at, no. No.

And any way of giving us a size of that investment?

Not yet. Glenn, I would expect that, you know, we're going through a, on both pieces of it, you know, in terms of the design of the facility, as well as, you know, we're in the vendor selection process right now with respect to the ERP, and I hope that by the time we're done with Q2, we'll be in a position to provide some sort of, we'll be able to band the figure, the ballpark figure for those two things.

But right now it's probably a quarter premature.

Okay. Thank you very much.

Thank you, sir. Our next question is from Bob Hopkins from Lehman Brothers. Please go ahead.

Thanks very much. Just two quick follow-ups. One, again, if I missed it in the prepared remarks, I apologize, but could you comment on the outlook for M&E, M&A activity that you guys, you know, might be looking at over the next 12 to 24 months?

Yeah.

Obviously, M&A is something you guys have done in the past. Just wanted to get an update there and then I have one more.

Yeah. We're looking at things, Bob. Again, I can't get too specific, but typically, again, we're looking for companies that are market leaders in their segment, things that aren't too far afield from what we've done in the past, and obviously where we might help make a difference in terms of improving their bottom line.

Should we expect something this year?

I think there's a, given that we're sitting here in April yet, yeah, I think there's a good chance something might happen this year.

Okay. And in terms of the magnitude of the size, obviously without getting into specifics, are we contemplating anything that's a little bit bigger than the things we've seen over the last few years or more in line with what we've seen?

I think we probably shouldn't comment on that one, Bob.

Fair enough. One other question on the CFX side. Just trying to get a sense for what that opportunity might look like. Do you guys think that CFX might actually start to replace basic lithium iodine pacemaker batteries or just --

Absolutely. No question about it.

You do.

Absolutely.

So this just isn't something for, say, pacemakers with by bi-ventricular capabilities. You think ...

No. New pacemakers, you're talking about all this communication technology, higher-speed telemetry and so forth. Lithium iodine cannot handle that on a rate capability basis.

Okay. Could you talk maybe about, I mean, is there a significant ASP differential between a CFX battery and a pacemaker battery?

Yeah, reasonably significant. I mean, as the volumes ramp up on CFX, it will get closer in price, but, yes, there is a premium on CFX. No question about it.

Okay. But you think it's, we're still a good year away from having the CFX revenue line branch out much beyond cyberonics?

Yeah. It will be more than a year before we see reasonable growth.

Okay. That's all I had. Thanks.

Okay, Bob.

Thank you, sir. Our next question is again from Mark Landy of Leerink Swann. Please go ahead.

Gentlemen, Glenn and I probably will hitting on the same points but if I take up and do the math backwards, is it fair to say that Globe had a similar increase that we saw in the pacemaker batteries, that it appears that if my math is correct that it had a substantial increase from last year?

Hey, Mark, Globe, while we don't break Globe out, its operating performance since we acquired it has exceeded our expectations that we, you know, the model, if you will, that we based our purchase decision on.

All right. And then if we think of the old Greatbatch, in terms of Hickman versus Sierra, would it be fair to say that Sierra had larger sales than Hickman?

Yes. Significantly.

Thank you very much.

Thank you, sir. Our next question comes from Keay Nakae of Wedbush Morgan. Please go ahead.

Larry, just to get back to this capitalized expense versus operating expense, when you do proceed with the ERP purchase, I assume the front-end purchase costs will be capitalized, and then as the vendor that you choose chooses subsequently tries to bleed you dry with consulting fees with the implementation, based on what you said previously, will that be an operating expense?

No. Let me, I used to be very conversant with all these rules, but I think I'm still close enough. The, you know, with any of these ERP implementations, certainly the license fees, as well as the basic implementation charges that, and we're not going to say they're going to bleed us with, you know, you brought it up.

Those are capitalized. The basic model is early, in any of these big ticket things, early on you expense various design and feasibility things, and then you make a decision what you're going to buy and how you're going to implement it, and then you, once you're done, you kind of get into a maintenance mode and you start expensing again.

So there's a big slug, if you will, a window that you capitalize, you know, the license and implementation costs. The other aspect that can be significant in that period would be things like a lot of re-engineering of business processes frequently goes along with ERPs and sort of that re-engineering effort, the accounting rules require you to expense that as well so you kind of have to split out the consultants' efforts between those related to implementation of a system, which you capitalize, and those related to, you know, maybe changing processes which you expense. And that's my accounting 101, or not 101, but my ERP accounting expertise.

Okay. Thanks.

Okay.

Thank you, sir. And that does conclude today's question-and-answer session. I'd now like to turn the call back over for any closing remarks.

Okay. Thank you. Just in summary I'd like to say, of course, we had a great quarter. We saw growth across all of our major product lines. We're committed to meeting all of our customers' requirements while at the same time we're implementing some of these lean initiatives and continuing with six sigma that we believe will deliver the improvements of the gross margin line that we're committed to.

We will continue to look at some acquisition targets but basically we're investing to support the business, to benefit from the significant growth that we see across CRM, and at the same time doing so in a way that we continue to meet our own expectations. Thank you all for attending our call.

Thank you, ladies and gentlemen. That does conclude your conference call. Have a nice day.