Integer Holdings Corp (ITGR) 2005 Q4 法說會逐字稿

Welcome everyone to the fourth quarter Greatbatch Incorporated conference call. Before we begin, I would like to read the Safe Harbor statement.

This presentation and our press release contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and involve 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 upon Greatbatch Incorporated's current expectations and actual results could differ materially from those stated and implied. The Company assumes no obligation to update forward-looking information included in this conference call to reflect changed assumptions, the occurrence of unanticipated events or change in future operating results, financial conditions or prospects.

I would now like to turn the call over to today's host, Treasurer and Director of Investor Relations, Mr. Tony Borowicz. You may go ahead, sir.

Thank you, [Japhian]. Nice job, you read that with a lot of passion there. Again, thanks everyone and welcome to the fourth quarter and year-end Greatbatch earnings conference call.

On the call today are Ed Voboril, our Chairman and CEO; Tom Hook, our President and COO; and Tom Mazza, Senior Vice President and CFO. In terms of the format for today's call, Ed will start by reviewing our 2005 key accomplishments. Next, Tom Hook will follow with an update on some of our key milestones for '06. And Tom Mazza will conclude with a detailed review of our fourth quarter results and provide our outlook as far as 2006 guidance. At that point, I will open up the call to customary Q&A.

Let me encourage everyone to take a look at the slides that accompany this presentation that can be accessed at our website. There's a lot of detailed numbers that can be more easily understood by looking at that slide presentation.

With that, let me turn the call over to Ed.

All right. Thank you, Tony. Well, good morning, everyone. Welcome to our fourth quarter and year-end conference call. I am pleased to report that we achieved sales of $59 million in the fourth quarter of 2005, an increase of 27% over the comparable period last year. For the full year, we achieved record total sales of $241 million, an increase of 20% over the $200 million recorded in 2004.

Now let me start by providing an overview of the many significant accomplishments for 2005. First of all, 2005 was a very challenging and rewarding year. We responded to increased customer demand while at the same time carrying out our facility consolidation plan, which we accomplished with minimal disruption to the business. Our 2005 record sales results were favorably impacted by approximately 10 to $15 million from the effects of marketplace field actions. Notwithstanding this impact, we achieved strong organic growth for the year.

Turning to our product categories, we achieved record annual sales in medical of $208 million, an increase of 20% from 2004. The growth was broad-based with sales to our top three customers increasing by 21% year-over-year. Looking at customer concentration, at the end of 2005, our top three customers accounted for about 70% of our sales. Guidance represented 35% of total sales. Guidant represented 35% of total sales, St. Jude Medical represented 23% of sales and Medtronic increased from 10% of our sales in 2004 to 12% of our sales in 2005.

We also achieved record sales in our Commercial Battery business, with sales increasing by 21% to $33 million compared to $27 million last year. We have expanded our sales and marketing efforts which resulted in increased market penetration in oil and gas, military, and oceanographic market segments.

Moving on to plant consolidations, our goal has been to implement a new manufacturing footprint that will enable us to become even more cost effective. I am very pleased to report that we are executing these moves according to plan. We completed the construction and successful startup of both our new Alden, New York medical power facility and our assembly facility in Tijuana, Mexico. We completed the move of the medical battery production into Alden and have essentially completed the move of the existing capacitor facility into the Alden location as well. These moves were conducted during a period of increased volume with no disruption to customer shipments.

In Tijuana, our clean rooms and other production areas were ready to accept transfer of customer assembly activities as scheduled. We started up the assembly process and commenced shipping from Tijuana in March of 2005. Regarding the move of filtered feedthrough manufacturing from Carson City to Tijuana, we actually began shipping feedthroughs manufactured from Tijuana in December, which is ahead of schedule. We are in the process of validating all of our operations there and expect to be fully operational with all filtered feedthrough production in Tijuana by mid-2006.

We also made significant progress on planning for the move of the Columbia facility to Tijuana. We have started facility modifications in Tijuana and have hired the insertion team that we will place in Columbia to handle the transition. Furthermore, we recently completed the move of the R&D facility from Fremont, California to the Technology Development Center in Clarence, New York and are also in the process of consolidating research and development activities from Columbia, Maryland to Clarence, New York.

Related to those moves, we sold the facility in Carson City as well as the vacant sales and marketing facility in Western New York for over $5 million. Once these moves are complete, which we believe will happen in the first half of 2007, we will have reduced the number of locations from seven to four, and expect to generate savings in excess of $10 million on an annual basis.

At this point, I'd like to turn the call over to Tom Hook, to outline some priorities for 2006.

Thank you, Ed. First, I would like to remind everybody of our long-term strategy. Our strategy is to build on four fundamental principles. First, maintaining technology leadership by providing a fresh pipeline of next generation core products. Second, optimize our operating capabilities by establishing best-in-class manufacturing capabilities, including an efficient manufacturing footprint. Third, delivering customer focused growth by designing solutions and applications early in the end product lifecycle for our customers and fourth, pursuing business development opportunities which will broaden the Greatbatch customer base.

Now, given this strategy and the significant investments we have already outlined, our key milestones for 2006 are as follows. First, we are going to continue the evolution of the Q series High Rate ICD Batteries. Second, we are going to complete the development of the high-voltage capacitor technology. Third, we are going to continue the development of the medium rate battery technologies for neurostimulation and also advanced pacemaker applications.

Fourth, augmenting our existing rechargeable battery with new rechargeable battery technology offerings, specifically for use in neurostimulation applications. Fifth, we are going to be developing rechargeable battery packs for use in commercial applications. Sixth, we are going to be introducing new inductor slab filtering technology for our feedthrough product lines and also some advanced molded header technologies. And finally, number seven, we are going to continue to actively look at executing on acquisitions that will diversify the customer base and also provide new product platforms.

Now, let me turn the call over to Tom Mazza, to review the fourth quarter results and provide our financial outlook for 2006.

Thank you, Tom. As mentioned previously by Ed, sales for the fourth quarter were 58.9 million, an increase of 27% from the fourth quarter in 2004. We estimate that the marketplace field actions had minimal impact in the quarter. Gross profit decreased by 200 basis points from last year to 33.1%, primarily due to increased warranty expense and lower selling prices experienced in the quarter. This decrease was partially offset by favorable fixed manufacturing overhead absorption due to the higher production volume in the fourth quarter of 2005 compared to last year.

SG&A expenses of 7.4 million increased by 15% from last year. Approximately 50% of this increase is due to the incremental expenses of the Tijuana facility with the balance of the increase due to the higher incentive compensation expenses. Net RD&E expenses of 5.5 million increased by 48% from last year. This increase was due to the recognition of certain milestone billings in 2004, which served to reduce the net spending. Looking at gross spending before milestone billings, RD&E expenses increased by 11%, which is more indicative of our commitment to technology development.

The effective tax rate in the quarter increased due to the change in the estimate of the benefit associated with foreign sales. As a result of this change, the annual effective rate was adjusted to 34.6%. This increase had the effect of reducing earnings per share in the fourth quarter by $0.03. On a GAAP basis, net income was essentially breakeven for the quarter. Our fourth quarter GAAP earnings per share included special charges of 4.4 million pretax or $0.13 per share.

These special charges consisted of 2.7 million related to the Alden and Tijuana moves, the 1.1 million pertaining to the consolidation of the Fremont and Columbia facilities that we announced in November and 6 million -- 0.6 million for asset dispositions and other charges. For the full year, we incurred special charges of 18.6 million, pretax, or $0.56 per share pertaining to the various plant moves, severance and asset dispositions.

For the full year, earnings per share on a GAAP basis were $0.46, which was in the middle of our range of our previously issued guidance of $0.39 to $0.49 per share. Adjusting for the special charges we discussed earlier, we earned $1.02 per share.

For the full year, earrings per -- turning to the balance sheet, we ended the year with cash, equivalents and short-term investments of 112 million, which is an increase of approximately 20 million over year-end 2004. Accounts receivable days outstanding at December were 45 days, up one day from last year. Inventory turns remained essentially flat, while spending on capital projects of 28 million was $11 million lower than last year.

Let me now turn to the discussion of our financial outlook for 2006. First of all, let me discuss the impact of the new accounting rules requiring companies to expense stock-based compensation as well as the onetime moving and asset disposition charges anticipated for 2006. We expect that stock-based compensation on a pretax basis will total approximately 5 to $6 million, which will reduce earnings per share by $0.15 to $0.18 per share. For modeling purposes, we expect 0.5 to 0.6 million to be reflected in cost of goods sold, 0.8 to 1.2 million to be in RD&E, and approximately 3.75 million to 4.2 million to be in SG&A.

In regards to the moving and asset dispositions, we expect to incur 10 to $12.5 million in pretax charges in 2006 or between $0.30 and $0.38 per share. These charges consist of pretax costs of the closure of the Carson City facility of $2 million, 5.5 million to 6 million for the consolidation of the Columbia and Fremont facilities, and 2.5 million to 4.5 million in other asset disposition costs.

In terms of our financial targets for 2006, we expect sales to be in the range of 245 to 265 million, an increase of 2 to 10%. This forecast takes into consideration the effect of the recall bubble of 10 to $15 million we experienced in 2005. In terms of product lines, we expect the medical sales will be in the range of 210 to 228 million and commercial sales will be in the range of 35 to 37 million. We expect to increase RD&E spending to approximately 10% of sales, excluding the impact of the FAS 123(R) charges previously discussed.

This takes into consideration the technology investments outlined earlier. We expect our effective tax rate to be in the range of 34%, comparable to the 2005 annual effective tax rate. We also anticipate our capital spending to be in the range of 22 to 27 million, of which approximately 5 to 7 million represents spending connected with our Tijuana facility build out and equipment.

In terms of earnings per share, we expect GAAP earnings per share inclusive of stock-based compensation and moving and other charges will be in the range of $0.40 to $0.60 per share. Excluding stock-based compensation of $0.15 to $0.18 per share and the moving and other costs of $0.30 to $0.38 per share, earnings per shares are expected to be in the range of $0.95 to $1.15. Preparing this EPS guidance, we have assumed that the average weighted shares outstanding for the full year will be approximately 22 million.

That concludes our prepared remarks. I will turn it back over to the moderator at this time.

[OPERATOR INSTRUCTIONS]

And at this time you have a question from Bob Hopkins from Lehman Brothers. You may proceed, sir.

Yes. Good morning.

Good morning, Bob.

A couple of questions. First, I dialed in about two minutes late, and I am not sure if you covered this in the beginning of the prepared remarks. But can you give us a little bit more information on the recall and the warranty expense and kind of give us some confidence or instill some confidence that this won't be something that has an impact in 2006?

Okay. Well, we certainly wouldn't categorize it as recall expense, but I will let Tom Hook speak to the warranty provision.

Certainly, Bob, in the fourth quarter, obviously Greatbatch has a very expanded quality system and a focus on quality, especially with 2005 and the dynamics in the marketplace. We reiterate our commitment to quality, and we had what we thought was a potential production problem that we quarantined in our quality system, a series of production of product that were suspect. And unfortunately, we had to do destructive analysis to determine if the product had an issue or not.

We did not discover any product in the process of doing that destructive analysis and obviously, had to take the financial hit for the cost of the product and also the related expenses involved in doing that analysis as a charge in the fourth quarter. But it reaffirmed our confidence in our quality system and our process control. It was a very difficult management decision for the management team here to make because of the nature of the testing that had to be done had to consume the product in testing and occupy a large amount of resources to do that.

So, bottom line, there was never any problem actually discovered and no faulty product shipped to customers, is that fair?

That's a fair statement.

Okay. Secondly, could you give us a sense where Guidant's percentage of revenues was exiting 2005? I mean was it -- if you don't want to give details, just directionally higher or lower than the overall average for the year?

Bob, well, first of all, I think, as you know, we don't really put much stock in, in looking at any one quarter's analysis, but basically the percentage of sales from Guidant hasn't changed all that much from 2004 to 2005. I think in 2004 it was about 36% and in 2005, it's about 35%.

Then no major change towards the end of the year?

Well, you know, I honestly haven't looked at it in the fourth quarter, but there is no reason to believe that directionally we see anything that is significantly different.

Are you saying on a run rate basis, Bob?

Basically, yes.

Yes. I mean, I think, we're consistent with what the broader market indices are in terms of the broader market.

Yes.

But our business is healthy across the board.

Yes.

And that includes them.

Yes.

Okay. And then, last question, and we'll save some for offline. Tom, on the commercial battery side, in 2006, in terms of the way you're thinking about that business, obviously, the price of oil has come down a little bit. Do you think that can be a double-digit grower in 2006?

Absolutely.

Yes.

Yes.

It's going to continue to be a very strong business for us, Bob.

Okay. Thanks a lot, guys. I appreciate it.

And your next question comes from Glenn Novarro from Banc of America. Please proceed.

Hi. It's [Eric Lewis] sitting in for Glenn. In terms of the gross margins for the Q4, what was the actual impact from lower selling prices and impact from the warranty expenses?

We really don't want to break that out, Glenn, but the lion's share of the different from the yearly run rate is probably due to the warranty expense.

So selling prices didn't have a major impact at all?

1 or 2%.

1 to 2%. Okay. And in terms of your forecasts for 2006, what are the assumptions that you guys have for ICD growth and pacemaker growth?

Well, first of all, I want to remind everybody that when we look at growth, we're thinking about -- we view it in terms of unit growth. On a unit growth basis, we still see ICD unit growth in the market as certainly in the high-teens for '06 and certainly in the 20% range, going forward, almost as far as the eye can see.

Now, there can be, in terms of dollar-based growth rates, certainly the effect of discounting or selling prices or anything else that our customers deal with in the marketplace isn't reflected in our view, because we've basically measure things in unit volume growth.

Okay. And the last question is regarding new business opportunities for '06.

Yes.

Can you guys talk about the timing of these opportunities and what, if any, are already built into your sales forecast?

What kind of new business opportunities are you talking about?

You know, you listed a number of them, you know, QHR, ICD battery, when you might sign a new customer and also --

To some extent, when we look at new product introductions, our timing is dependent on how long it takes our customers to get approval on new devices with PMAs.

We have -- our qualification protocols are pretty much on schedule. But I don't see there is any significant uptick. There is no step function. It's blended in amongst many customers with many product programs. And there will be puts and takes depending on new products, clinical trial successes, and so forth at the customer level.

Yes. Eric, this is Tom Hook. We don't really break out by product or by customer where the individual changeovers of technology are. They occur on a broad basis and a month to month basis by product line. So some obviously are additive and some are substitutive. But the trend on all technology programs is they're all being adopted broadly and the changeover is very favorable for us as a company.

Okay. Thanks, guys.

And your next question comes from Tim Nelson from Piper Jaffray. You may proceed.

Hey, guys.

Hi, Tim.

Hi, Tim.

Hello.

How are you doing? A little bit more on gross margin. How should we think about gross margin in '06 in your guidance, as you continue to achieve those efficiencies you've talked about?

Okay.

You know, how's that trend for the year, excluding, of course, we're not going to have -- hopefully, you don't have the warranty impacts?

Tim, you'll recall, in my earlier remarks, I said, we were anticipating in '07 to see approximately a $10 million annualized across-the-board savings. We will start to realize some of that in '06.

Pretty much, our product plans are and our consolidation plans are on schedule. It depends a little bit on product mix. So there is a ramp. But I honestly don't have the details on how that ramp would build. But we are very much on track to realize the benefits of consolidation, going forward.

Yes. Tim, this is Tom Hook. And Tim, you know, pretty much, we know we are going to be seeing gross margin leverage based on the moves we're doing, but we really don't break that out and quantify it externally.

And the 10 million in savings for '07 is probably toward the back half of that year, I would assume, after all of these consolidations are done?

We build leverage from the beginning of the year, and we increase leverage towards the end of the year.

Absolutely.

And the same would probably go to '06. On the revenue line a little bit, could you talk -- you mentioned your expectations for ICD growth, but what about pacer and other growth, which I know includes neurostimulators?

Yes.

What would you assume there?

Tim, the problem is or the question is what do you call a pacer these days?

Right.

But we certainly are going to start seeing good growth rates in our medium-rate battery line, as people convert what typically had been thought of as pacing business to medium rate. And although it's a little early yet, we really believe that the neuromodulation marketplace is going to be a very strong market for us.

Again, this depends somewhat on product approvals, as companies launch new neurostimulator products, but we are seeing strong activity on new design programs across the board on many, many neurostimulation devices. Whether a lot of that will hit in '06 is still a question, but it will be a major driver in terms of growth, going forward, in the future.

Okay.

Yes.

In terms of the commercialization of the QHR battery, is that planned for '06, and how significant is it?

Tom, go ahead and take that.

Yes. Tim, we've -- we are qualified in several customers. And yes, they are buying commercial product in 2006 for specific products that they have. So we expect to see sales there.

And I just, on the prior question, thought I'd make sure, the way we view the market in the pacer side of the business is effectively fairly stable and flat globally. And -- but obviously, the technology, as Ed was referring to, in the pacer side of the business opens up more opportunities for all our product lines in there. So it's really not flat in the Greatbatch world, even though the unit volume is flat in the market.

Got you. And then, finally, your R&D projections for '06. Did that include the impact of any R&D sharing cost-sharing agreements?

Yes, it does.

Yes, it does. This includes basically coverage we get from our customers for technology developments.

Yes. The numbers we're quoting, Tim, are related basically to the net RD&E, which is after any cost-sharing arrangements that we have.

Great. Thanks. That's all I have.

And the next question comes from Glenn Reicin from Morgan Stanley. You may proceed.

Glenn Reicin, Morgan Stanley. Yes. Good morning, guys.

Hi, Glenn.

Hi, Glenn.

A couple of things, small details. So when you say the bubble contributed $10 million to $50 million in sales in 2005, do you account in that number a Guidant device that is essentially given away for free. I know Guidant had to -- in the case of Guidant, they had to first replenish inventory, and then they continued to sell products for free or give away products for free that are replacements that they are not obviously -- that are not charged for because of the warranties.

And obviously they're buying product from you, and they have to give away these devices. So what's actually in that calculation 10 to 15 million? Is it just the replenishment number or does it include those devices, too?

Well, you know, Glenn just in general, we have no ability to break out that demand.. It's our estimate based on more or less looking at what data we have, the trends, also some of the impacts of some of the decisions that were made by individual customers in breaking out our estimate of the $10 million to $15 million. But for the -- since we don't have visibility to the end-market, we can't really a battery sale is a battery sale. . We can't tell whether it's going into a replacement device or a regular device that's being sold in the ordinary course of business.

So how did you calculate it?

We calculated it based on the difference in the run rates that we were experiencing for the periods of time. But you know, Glenn, I think Tom has answered your question. It does include all sales -- any sales to Guidant.

Okay. So you say you took monthly sales from before July, is that the number and then you compared it --?

Exactly.

-- with after July.

It's an estimate, Glenn..

With an estimate. Okay. No, I understand, it's a wide estimate too. Okay, secondly and this a little bit more detailed here. I'm having problems coming up with $0.13 pro forma for the fourth quarter? And what the issue is you're telling us the tax rate is 34.6 for the year and your net income for the year is 22.3. I'm coming up with $0.11 with a tax rate of close to 57% pro forma for the fourth quarter. And that gets me $1.02 for the year, which is exactly in line with what you said it is. So what am I -- I don't know quite where I'm wrong here.

Yes. I don't -- Glenn, this is Tony. The earnings per share on a GAAP basis in the quarter was as we said essentially flat at zero. And if you look at the net operating expense of 4.367 million, tax affect that at 34.6% which is annually for the year, that's the $0.13.

So using the normalized --?

Yes. Using the normalized, not the 40% rate.

Okay. I guess but -- I guess that's one way of looking at it. We're coming up with 5.6 million pretax. And maybe this is the wrong way of looking at it, 5.6 million pretax. And then if you back out the tax rate to get you 34.6 per year, that's 3.2 million of income taxes in the fourth quarter or 2.4 million net income?

We'll have to work through it offline.

Okay. I'm pretty sure this is correct but -- okay. The third issue that I want to ask you about is acquisitions. Is this -- you said this is a key objective for 2006. I'm not quite sure if that was a key objective for 2005. So is that a new objective and if so what are you looking at?

No, I don't think it's necessarily a new objective, Glenn, I think we are clearly more well-positioned. We've got well over $100 million worth of cash in the bank. We believe our stock is still a very good currency. I think we would be very disappointed if we didn't reach agreement on at least one acquisition within the next 12 months.

Okay. So you know one of my sticking issues with the Company has been the write-down of assets to improve return on invested capital, which essentially was acknowledgement that you overpaid for previous acquisitions. So what I'd like to know is what criteria are you using for acquisitions going forward?

Well, first of all, I guess I would qualitatively disagree with you in terms of your assessment of what we have been doing there. But I think what we are looking for in the future acquisitions is first of all very close to a similar model that we've used with all the businesses that we have acquired, which is they're a leader in their category, both from a technology and a market share standpoint. They are very good companies in their own right.

And from a strategy standpoint, I think we are certainly trying to put more emphasis on, finding something that will reduce the risk of concentration that we have. Not by moving very far afield from what we've been doing. But we still consider the fact that 70% of our sales are tied up in three customers, albeit very good customers, that risk concentration is still with us, and we would like to do something about reducing that risk. And of course we're looking for things are not dilutive.

So EPS is the main determinant of the financial --?

Well, we look at a broad base of financial metrics, currently future returns, and growth rate. We are looking for businesses that can contribute to significant ongoing growth for the company in attractive markets.

Glenn, the top two are certainly accretion dilution and cash flows. And strong cash flows.

Okay. I am just surprised, you didn't say return on invested capital after everything we've been through in the last three years.

I mean strong cash flow supports ROIC as well, right.

So what's the hurdle there?

Eventually our goal is 15%, as we've stated previously.

Return on invested capital, the 15?

Okay.

Okay.

Okay. Our cost of capital is around 13%, a little under 13, and we're shooting for 15.

Okay. Final question and I'll get back in line. What's your best estimate for '05 as to the volumes of capacitors that you are supplying relative to the total capacitors required by Guidant? In other words, is Guidant -- and how does that compare with '04? Are they -- I thought in '04, they were producing as much as 70% to 80% of their own capacitors. I'd love to know what you think that estimate was back in '04 and how that compares with '05?

This is Tom Hook. Glenn I will try to answer the question. Certainly the opportunity there on the capacitor side is for us to sell more broadly the [inaudible] technology into the customer base. I won't really talk specifically about any one specific customer's adoption, but we have room to grow with everybody in terms of getting them over to that technology.

Okay. Thank you.

And your next question is coming from Keau Nakae from Unterberg. You may proceed.

Hi, this is [Jim Morris] for Keau. I have couple of questions. I am looking for a breakdown of your Tijuana facility, just more detail. And I'm wondering what were sub-assembly sales for this quarter and '05 and projections for '06?

We normally don't break it out by individual product lines for that, but clearly '06 will be substantially more value-added sales than '06 than '05, 2005.

Can you give us some ballpark in terms of percentage maybe for Globe sales in Mexico or enclosures?

For enclosure sale. Yes. We don't -- all of the Globe products are manufactured in Minneapolis.

They're still all in Minneapolis.

Yes. I mean now they are used -- they are then used in assemblies that we put together in Tijuana, but the manufacturing of the enclosures themselves still and will take place in Minneapolis.

Okay.

And your next question comes from Alex Arrow from Lazard Capital Markets. You may proceed sir.

Thank you. Good morning. I would like to start on your rechargeable batteries. You made that a focus of your remarks and specially for neuro, which leads to the question about the potential for the ANSI business given that St. Jude is such a good customer and then that in that Picher, I think Picher is still in bankruptcy. Can you tell us; is an ANSI order in your 2006 revenue guidance?

First of al,l just on neurostimulation in general. The market is a mix of primary and rechargeable batteries, that's most important. And we -- certainly, there has been favorable effects in the marketplace with a bankruptcy at a competitor of ours. But we have active projects with a variety of customers, and although we haven't outright disclosed who we've been working with, we are pretty much working with the leaders out there right now.

Some of those are primary battery projects and some of those are a rechargeable battery product as well. So we are well represented and making clearly big investments on a rechargeable side to take advantage of the technology we already had developed internally, that there is a lot of interest in. But there is still very healthy primary battery market on the neurostimulation side. It is important to recognize that both exist.

Okay. So without any of these specific customers by name, can you say the revenue guidance you gave for '06, does that assumes some new rechargeable neuro business?

It does, but again as the customers individually are qualifying their product, it ramps with what their product life cycles are. So there is some in '06, but it's commensurate and symmetrical with what their adoption rates are.

And just to underscore what Tom said Alex. Although we know there is interest, and we are responding to interest on rechargeables, there is very strong interest on QMR battery technology across the board for neurostimulation application.

Okay. Thanks. And you also said, you've mentioned rechargeables for non-medical application. Does that represent new business in your oil and gas pipeline opportunity? Are those currently already using rechargeables or is hat totally new?

Our commercial battery business is almost exclusively a primary battery business, but as we are expanding our applications base outside of the oil and gas industry, we are looking at applications in the rechargeable battery space as well and have found that there is a receptive market out there for that technology. Again, as a very niche supplier of technology in commercial markets, we make highly specialized batteries for harsh environments, high pressure, high temperature. I would envision taking our rechargeable battery effort on the commercial side and focusing on the same niche market focus that has made us successful.

Specifically with the Oil and Gas Pipeline Safety Inspection Act of 2002, is that inspection of long gas pipeline something that rechargeable battery technology would be good for? And how much, can you give us an update on how penetrated you are in that market?

We are very penetrated in what's called the long run pipeline inspection market. And it's almost exclusively a primary battery market. Rechargeable battery technology cannot really hold up to the environmental rigors of the temperature and pressure regimes that are needed for pipeline inspection. So right now that's a primary battery market and we have very significant market share based on our type of technology that we use there.

Very significant is more than 50%?

I wouldn't want to characterize, but I'd say it's high double digits.

Okay. And so you are saying that the rechargeable is not going to expand your business in the long run inspection, but it will in other parts of oil and gas safety, or is that just in non-oil and gas safety applications?

It's non-oil and gas applications that the big opportunity in rechargeable is. There could be some opportunities in oil and gas, but again because of harsh environmental condition there -- there is not high temperature, high pressure rechargeable battery technology readily available today.

In things like what, space and deep sea and stuff like that?

Certainly, obviously, temperature is the most problematic issue.

Is this a material part of '06 or should we not be focusing on it?

It's not -- rechargeable batteries for commercial are not a material portion for '06. It's a technological development for us in the company, and we are trying to broaden beyond just the primary battery focus.

In oil and gas inspection, is there still more business in the nation as a whole or is the nation pretty much compliant with all of its pipelines being inspected as much as they should be?

The Pipeline Inspection Act certainly has broadened the market opportunity. We're not big participants in terms of product into the short run market, so we have been planning on making offerings there and pursuing applications in that area to expand our sales opportunities and have been doing that.

It seems like it would be more challenging to get new business by growing your market share versus your competitors, but probably much easier to get it if people simply becoming more compliant with the Oil and Pipeline Safety Act, and gas pipeline, they weren't be inspected before at all are now going to be inspected. I mean, is that the right way to look at it, or easy growth still to had by --?

I think it's both axis. First of fall, there is market share opportunities because the technology we provide has some big advantages in terms of performance, which we have to sell. But then also because of the additional pipeline inspection demand that's being regulated, is also a favorable trend we can take advantage of as well.

Alex, I've just -- this is Ed again. I'll just say one thing. As in the case with implantable medical batteries, the first company that anyone thinks of is Greatbatch. Our brand name for high reliability commercial batteries, Electrochem has a similar position in the industry. When anyone thinks about a higher reliability specialty batteries, Electrochem is the first brand that you think of. So as we expand our penetration to different market segments, that strong brand equity is going to help us as it has in medical.

Okay. Thank you. And then last question, you give the Guidant and Medtronic percent of your total revenue in '04 and '05. Would you be willing to do that with St. Jude as well?

Yes, we did. I think -- what was it, 23%, Tom.

Yes. 23%.

23%.

In '05 and from what in '04?

I don't think it changed very much.

24 to 23.

24 to 23.

Okay. Thank you very much.

Okay.

And your next question comes from Jason Mills from First Albany. You may proceed.

Hi guys. Thanks for taking my question.

Sure.

I wanted to go back to gross margins specifically, you know, asking in another way. Could you, sort of, give us the sense for what gross margins were on a normalized basis excluding the excess capacity potentially in the quarter. I know you don't want to give us the warranty expense specifically, but excess capacity has been a drag as well. What was it excluding that?

Jason, This is Ed. I realize you guys are always want to drill down on one quarter. And I want to set the tone here. We, in the last roughly four to six quarters, have undertaken a tremendous initiative, both the startup advanced manufacturing technology new facilities to do a significant consolidation activity all on the fly and at the same time increase -- and response to increasing demand without a hitch.

You will begin to see in '06, as I said earlier, in response to Tim's question, you will begin to see starting in the early part of '06 and beyond, a steady improvement in gross margin in response to the significant investments that we have made over the last year and a half and will continue to make in '06. You won't see the full impact until '07. But everything is on track. It is all coming together, exactly as we have planned it, and we said it would.

Every now and then, we're going to see a hiccup. That's the business. But we are absolutely on track with everything we have put in place to be the low-cost manufacturer in the component areas of interest, and we will be there.

Thanks for that, I appreciate that. Ed, I don't know that it addressed my question, and with all due respect you're being presumptive that I'm actually drilling down on that on a negative basis. I actually, I can see where you're going, and so I'd like to be able to model it better and it's the only reason I ask. And one of the things that we do in our model is we do not back out excess capacity expenses you've had to get to a different EPS number, but we look at it because it's not going to be something that exists in perpetuity.

Yes, how we're doing, this is Tom Mazza again. Yes, I mean for purpose of modeling purposes, approximately $6 million to $7 million was excess capacity in 2005. And clearly, in 2006, it's going to be reduced. It's not going to go to zero because we still have the Tijuana facility, as Ed said and we'll see gradual improvement. But approximately in those 2005 year numbers it was about $6 million to $7 million worth of excess capacity.

Yes, Jason the easiest way to get at your question is, kind of, our normalized run rate exiting '05 is about 37%.

It's very helpful. Thank you very much and that goes to your comments, Ed that you're expecting to see sequential improvements going forward vis-à-vis these investments?

Absolutely.

Yes. And by the way Jason, I apologize if I was getting on my soapbox to much.

No. No I said that you can --

I'm a believer here.

I mean, I think it's helpful for the people to whether they the company or not to see the passion. So it's good to hear. Just a couple of other housekeeping items, then I'll get back in queue, most of the stuff has been asked. Why the tax rate, going to a normalized basis, 34% to 35%? A lot of companies are working on strategies almost as an operational initiative to lower that tax rate. I understand what your guidance is. Is there a chance for that to be -- to see some upside there? Where can we see that in two, three years?

Obviously, we are looking at that. But as our volume gets higher, the amount of credits we get for R&D and other initiatives get reduced. So proportionally, as our -- our sales volume get higher and our earnings get higher, the benefit of those credits is lost in future periods, it's reduced in future periods. But we believe -- we are working hard to improve on it, and we are undertaking initiatives. And we're keeping it under the federal rate right now. And we will work to get it even lower.

The same thing I do in my household. And if we go to the revenue model, you have very good feedthrough growth on a year-over-year basis, down sequentially though the lowest level of the year. Anything there we should read into or -- and how should we sort of look at that next year?

Well, we continue to be the technology leader and the market leader, and that will be continued to be a significant growth area for us in the future, both on the top line and the bottom line.

Okay. So you have relatively speaking some easier comps in the first half of the year to that business in the second half? Would that be fair and -- but net net for the year growing about in line with market growth?

Yes

On a unit perspective?

Definitely.

Okay. And then lastly, on the shares outstanding, you mentioned 22 million for the entire year. Does that include the convertible dilution there? I think you had mentioned, Tony, that when you are earning over $0.25 a share, which you could do at some point in the back half of the year that you're going to have to include 4.5 million shares there?

That's, this is Tom. It does not include the contingent converts because of an annual basis, we will be below the $0.75, which is the --

Okay. So the annual trumps the quarterly, so we should just model it at 22?

That's what we are doing.

Okay. Thanks, guys.

And your next question comes from Eli Kammerman from Cathay Financial. You may proceed.

Yes, it's Eli.. I have a question on the growth rate for feedthroughs in the fourth quarter. It's very different than the growth rate for ICD components. Why is that difference so large?

Well, I'll let Tom maybe get you a little bit more detail. But again, Eli, if you look at the annualized rates and you look at where we are at, we continue to be both the technology and the market share leader. We are experiencing good growth across the board, and we also have got some important new product introductions, what we call in [vectors lab] coming up. So we don't see any issues with -- that's going to continue to be one of our strongest businesses and one of our best growers.

So would it be unfair to expect the rate for that component to be roughly equivalent to your larger lines of business like ICD components?

Eli, the best way to understand it is as more customers are broadly adopting more standard EMI filtering technologies, the growth rate on that is going to continue to increase. Those technologies aren't always broadly utilized. So the feedthrough line item is a combination of both future technology as well as the EMI filter on it as well. And as we grow both our success in feedthroughs and in the EMI filtering technology, we have basically two items into that revenue line item.

Okay. Thank you. And then regarding the unusual costs for manufacturing consolidation, is there a certain fiscal quarter that you have in mind now where those costs will cease?

Yes. Yes, basically all those costs will cease around the second half of '07, which is what we thought in accordance with our previous guidance. You're talking about the consolidation of the Columbia facility, the Advanced Research Laboratory? Those -- we expect those moves to be completed in the second half of 2007.

But, Eli, be careful, as certain projects that we have undertaken have completed and that special charges have already ceased. The last project we've announced was the relocation of Columbia, Maryland facility to Tijuana and the consolidation of our R&D facilities into Clarence, New York. Those are the last projects that will have spending on them. As we've discussed and that is what Tom Mazza is referring to, and on those projects in the second half of 2007?

Okay. And then finally in the neurostim area, are you expecting to see any kind of a jump in demand upon FDA approval of certain devices and what clinical indications might those devices be for?

Yes, we do expect to see a jump in demand by specific application, which is obviously by customer as well. Our products that we are qualifying are specific product technologies, specific catalog numbers, so to speak, that the demand of them are directly based on regulatory approval, reimbursements, macroeconomic indicators. So we obviously stay in close communication with each of our customers. And as they receive approvals and their business ramps, we normally proceed that by a quarter or two to build inventory and help them build the supply chain.

But to help us get a fix on the market opportunity there, can you just give us some inkling of which particular clinical areas you are talking about? Is it something small like stroke physical rehab or a something large like epilepsy?

We don't really break it out. We're involved in a very broad basis of them. So whether it's a small or broad opportunity, we usually benefit in some product areas, if not all.

Again, just to add, just to underscore, we have at least one and in most cases, one or more components in almost every neurostimulation device we sold in the marketplace and any approval chain. So like Tom said, it's -- there is a lot of pieces on the chessboard, and as things move, we will benefit. But it's hard to predict which is going to move first.

Okay. Thanks very much.

And you have a follow-up question from Glenn Reicin from Morgan Stanley. You may proceed, sir.

Hi, yes. Just a couple more follow-ups. You mentioned there that revenues have shifted away from closures to subassembly. Can you give us a sense of how big the subassembly business was in 2005?

No, Glenn, I think we mentioned before we won't -- we're not going to give the level of detail on that. But clearly our value-added manufacturing down in Tijuana also includes some of the closures made at Globe. I think we quoted a number of about 1.6 million in the fourth quarter for that.

Right. But doesn't give us a sense of how big that subassembly business is?

And Glenn, we can't disclose that. Of course, you know that's really related primarily to one customer now. And we just don't disclose anything that might shed light on the customer's operation.

Okay. On the revenue guidance you gave us, care to shed any light on the progression for 2006 on a quarterly basis?

You know we don't guide for the quarter. But it's, clearly, lower to higher long-term.

Okay. If you look at the year-over-year, it sounds like you got one more big quarter in Q1, and then you start getting into tougher comparisons from the, you know, from last year's recall activity and then you see a rebound in) Q4, is that a good way of looking at it?

Comparing the quarter, it probably as. But I'm just talking about on straight growth base --

On a year basis.

On a year basis we expect the first to be lower than the fourth.

Growth rate or -- I'm sorry.

No. As far as sales, as far as revenue.

The first to be lower than the fourth. Okay. That doesn't -- okay. But I mean, order of magnitude, are we talking couple of million or are we talking about 5 million to 10 million?

We're not going to guide the quarters, Glenn.

Okay. And then beyond next year the 34% tax rate, do we keep it at 34% or is there downward pressure over time?

That's probably our best estimate at this point in time, it's a safe bet at 34.

So it's a static number, even though products are going to Mexico.

Yes. Mexico is cost-efficient, not necessarily tax-efficient.

Okay. Thank you.

And your next question comes from Jeff Frelick from Susquehanna Financial Group. You may proceed.

Good morning, guys. Jeff Frelick in for Mark Landy. Tom, in the press you've given us the CFx cells, can you give us again for this quarter?

A little less than 1 million.

Less than 1 million. Okay. And then just one more question. As you look to the kind of neuromodulation business, we see a lot of younger companies out there, maybe still a handful of these private companies. Do you see much as a business opportunity for you to advise on the design and manufacturing of neurostimulators because these small companies go to one of the -- existing incumbents. So what do you see as far as the business opportunity?

Yes. This is Ed Voboril. Again I think that we see, and there are a lot of studies starting to be published on that. But the neuromodulation or neurostimulation market is going to be a huge market. It's going to develop into a market that probably is going to be significantly larger than CRM over time just because the number of patients that are now amenable to device therapies are multiples of what has been approved for CRM type therapy reimbursement.

We are pretty much involved across the board from small companies to large companies, and we classically get involved at a very early stage. And especially now that we have the capability for assembly in Tijuana, the smaller companies have the option of having us add significantly more value than just being a component supplier, which will continue to be part of our strategy to use the assets that we've got in Tijuana to make ourselves an even stronger competitor in the marketplace. But, we -- I mean these are investments. We work with the small companies. Sometimes they don't make it, but we can't afford to miss out on someone that might turn in to be the next Cyberonics or the Medtronic. So we are involved across the board in most of our component technologies and --

So, Ed, can monetize it outside of selling components?

I'm sorry?

Do you think you can monetize the business outside of selling components?

Well, we certainly are heading in that direction.

Okay. Thanks guys.

And that does conclude today's question and answer session. I would like to turn the call back over to Tony Borowicz for any closing remarks.

Thanks Japhian. Let me just turn the call quickly back to Ed to summarize our thoughts.

Thanks Tony. We benefited from really good growth in '05. It's a platform to continuing growth and improved profitability in '06 and beyond. As I mentioned earlier, all of our initiatives in terms of our consolidation, the start-ups of our advancing manufacturing facilities are absolutely on track. Our new product program is on track.

We continue to have outstanding relationships across the board with all of our customers, both large and small. And as we've seen in '05, our commercial battery business, which has always been probably an under-appreciated, a little gold star in our crown, has become even a better grower and will become an even more important contributor to profitability in the long term. So net upshot is -- we're coming out of '05 into '06 with a very positive outlook and a very solid platform for future growth.

Thanks Ed and that does conclude our call for today. Thanks for joining us.

Thank you for your participation. This does conclude today's conference. Have a wonderful day.