Integer Holdings Corp (ITGR) 2006 Q4 法說會逐字稿

Welcome, everyone, to the fourth quarter Greatbatch Incorporated earnings 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 involves a number of risks and uncertainties. These uncertainties and risks 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 or implied. The company assumes no obligation to update its forward-looking information included in this 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, Tony Borowicz. Please proceed.

Thank you and welcome to the fourth quarter and year-end Greatbatch earnings conference call. On the call today are Tom Hook, our President and Chief Executive Officer, and Tom Mazza, Senior Vice President and Chief Financial Officer.

In terms of today's agenda, Tom Hook will review our 2006 accomplishments. Next, Tom Mazza will cover our fourth quarter results and discuss financial guidance for 2007. We'll turn the call back over to Tom Hook to conclude the prepared remarks, and end with a discussion on our major 2007 initiatives. As we have done in the past, we are including slide visuals along with this conference call and hopefully you will find those useful. With that let me turn the call over to Tom Hook who is going to start with some special introductions, as I understand.

Yes. Thank you, Tony. Good afternoon to everybody joining us on the call and happy birthday to my son Nicholas.

Let me start out by providing a year in review for our 2006 accomplishments. We achieved top-line growth of 12%. If you adjust 2005 results for the favorable benefit of approximately $12 million in ICD market, we achieved organic sales growth of approximately 18%. This growth was accomplished during a period in which the underlying CRM market which represents over 80% of our total sales was essentially flat.

Let me address the specific areas that were the drivers for a solid growth performance.

Looking first at our medical business, we achieved the year-over-year growth of 9%. As you are well aware the ICD market exhibited negative growth throughout much of 2006, ending the year flat compared to prior year. The best proxy for the underlying high power market growth is our ICD battery product line which declined by 1% commensurate with the market and market share shifts amongst our customers. The decline in sales was primarily due to the lower volume with U.S.-based customers. Partially offsetting this decline were strong European customer sales. This growth represents increased adoption of our high rate battery technology.

Medical capacitor business also experienced decline in sales. Capacitor sales declined by $4 million, or 19%, attributable to the actions taken by a single customer in late 2005. We adjust our baseline business for this action sales to all three of our existing customers increased significantly over the prior year. Capacitor product line represents a very significant growth opportunity and we continue to invest in advancing our technology to best position our product in the marketplace.

Continuing the -- continuing with the medical business, assembly products, feed-throughs, coated electrodes and machine components were the primary growth drivers. The assembly business was a new opportunity that was essentially launched Q4 of 2005. Growth in feed-throughs, coated product and machine components represents market share penetration with both our domestic and international customers. We believe these products will continue to represent a near term growth opportunity for the company as we continue to penetrate the market and bring new technology to our customer.

Overall I'm extremely pleased with the performance in our medical segment. Again, 2006 was a difficult period in the ICD device market and we will -- we were still able to demonstrate solid growth performance. We continue to advance both our relationships with our customers and our product technology which will benefit us going forward.

Turning to our commercial business, 2006 represented a truly banner year. Sales grew by a robust 32% through a combination of increased market penetration, new product introductions and greater value add pack assembly. The oil and gas market continued to drive the majority of our growth. In addition, our presence in the emerging telematics market has provided incremental sales opportunities. We look to continue to broaden our market reach to drive future growth opportunities.

Given the degree of success achieved in 2006 we will be initiating a facility and equipment expansion in 2007. This investment and new facility will enable to us maintain and grow the existing commercial business while capturing new growth opportunities. The expected completion of this $28 million expansion project is early 2008. We have sufficient capacity currently in place to meet our planned growth objectives throughout 2007.

Having reviewed 2006 in detail let me review our accomplishments to our stated strategic imperative. Significant progress has made on our top three strategic goals, which were obtaining critical mass; two, expanding our existing market share with our current customers; and three, diversifying our customer concentration. More specifically, sales for 2006 were $271 million, and projected to be approximately $300 million for 2007, which speaks to our market positioning. Second, sales for the top five medical customers increased by 12% year-over-year as reported. Excluding the field action benefit in 2005, sales to these customers were up 20% over last year. This increase, despite the lack of growth in the industry, speaks for our expanding market position. Third, record commercial sales increased international business, pursuing neurostimulation development programs and various other device company partnerships have contributed to the goal of diversifying customer concentration.

In addition to our top line strategic imperatives, our fourth strategic imperative is to continue to improve our operating margin. In 2006 our operating margin, adjusted for move related and stock option expenses, increased to 16.2% from 14.7% of sales in the prior year. Long term, the goal is to achieve operating margins of 20%. In 2006 we implemented a company-wide realignment plan aimed at improving our efficiency and maintaining our technology leadership. A plan was implemented to eliminate 40 positions generating net cost reductions of $2 to $4 million. With the exception of a few transitional positions the job eliminations are complete. The plan is to reinvest a portion of the gross savings in technology, sales, and key corporate positions, and will occur throughout 2007. One key corporate position that was recently added it was hiring of Tim McEvoy, as Vice President and General Counsel. In addition to his legal expertise, Tim will provide an active role in the business development process.

Our fifth 2000 strategic imperative to is to improve our margins by fully utilizing the capacity of the Tijuana facility. We are on track to meet our internal consolidation goals by closing the Columbia and Carson City facilities. We continue to successfully meet our milestones for the closure of the Columbia facility and on track to complete the move for mid 2007. With the exception of one product for a single customer we have completed the transfer of our Carson City facility, having met all of our quality, customer service, and cost goals. We continue to hold open the Carson city facility pending a customer's regulatory approval. Costs of the operating Carson city facility has been greatly reduced. However, we continue to manage the added cost of keeping this facility open. We are working closely with our customer regarding the timing and financial impact of delayed plant shutdown and expect this issue to be resolved in the very near future.

In summary, the strong 2006 results have come on the heels of an equally strong 2005. We have experienced significant growth over the past two years, sales have increased from $200 million to $271 million since 2004, a compound annual growth rate of 16%. During the same time pretax income has increased 27% adjusted for the move and stock option expense. Together these accomplishments resulted in an increase in cash and short term investments from $92 million at the end of 2004 to $143 million at the end of 2006. This increase of $51 million was generated during a period of heavy investment in which we spent over $40 million including a new medical power facility in New York, and a medical component facility in Tijuana, Mexico. [inaudible] positive cash flow generation for our company and the quality of our reported earnings.

I will now turn over the call to Tom to review our financial results.

Thanks, Tom, and good afternoon.

For the fourth quarter we reported sales of $63 million, an increase of 7% over the fourth quarter of 2005. For the full year, sales were $271 million, an increase of 12% over last year. Full year sales were within our previously announced range of $270 to $280 million. Typically, we see customers prudently managing inventory levels in the fourth quarter and this year was no exception.

Moving on to gross profit; we reported a gross margin of 35.5%. Gross margin declined by 1.5% -- percentage points from Q3 due to the lower production volume in the fourth quarter resulting in unfavorable manufacturing volume variances. This effect was temporary in nature and as volume increases in 2007, this volume variance will improve.

Turning to SG&A expense, costs increased by $1.3 million from Q3 due to CEO transition expenses and increased incentive compensation. Shifting to to RD&E, expenses of $6.2 million were in line with spending reported in previous quarters. In 2007 net RD&E expenses are expected to be approximately 9% to 10% of sales reflecting the increase in technology investments.

Tax rate was 18.4% which was lower than expected due to the reinstatement of the federal R&D tax credit. The lower tax rate contributed about a penny per share in earnings for the quarter. Diluted earnings per share for the quarter on a GAAP basis were $0.06. On an adjusted basis for selected charges and share based compensation, EPS were $0.28 per share, an increase of 115% over the adjusted EPS of $0.13 in 2005.

Let me now turn to a discussion of our 2007 financial guidance.

We expect both medical and commercial sales to increase by approximately 10% next year, resulting in a sales range of $295 to $305 million. We have assumed an underlying medical market growth rate of 5% for next year. Forecasted increase of 10%, or nearly twice the growth rate of the underlying market, reflects our confidence that we will increase our market share with our existing customer base and penetrate new customer opportunities. We expect our adjusted EPS will increase by approximately 12%, inclusive of share-based compensation of $0.12 to $0.15 per share and exclusive of move-related costs of $0.10 to $0.13 per share. Also note that our EPS guidance includes the continued excess capacity costs due to the delayed closing of the Carson City facility pending customer regulatory approval. These excess capacity costs are included in cost of sales.

In terms of the consolidation impact we are reiterating our expected savings of $10 million from these initiatives. From a timing perspective, savings in 2006 are estimated at $2.5 million. An additional $2 million is expected in 2007 with the balance of savings expected in 2008 when the consolidations have been completed.

We are providing directional guidance on the following items. As stated earlier, we expect RD&E spending to be approximately 9% to 10% of sales, SG&A will be reduced by approximately 3% from the 2006 levels. The savings from the realignment plan will partially offset any planned new hires or inflationary increases. The tax rate will be 35% or less, with capital spending in the range of $35 to $45 million; $20 million + of the increase pertains to the commercial expansion project. A plan is to begin construction on the new facility beginning in mid-2007 with completion expected in 2008.

Let me now turn the call back over to Tom to provide a summary remarks.

Thanks, Tom.

As we look ahead to 2007, our major focus will continue to be directed toward the following areas. Number one, completion of the plant consolidation initiatives at Carson City and Columbia and to exit 2007 with a cumulative savings run rate of $10 million per year. Second, initiate the commercial plan expansion project. Third, streamline, optimize and expand current product offerings, operations in the business processes. Fourth, introduce next-generation implantable batteries, capacitors, and coatings. Fifth, expand our rechargeable battery portfolio in both the medical and commercial markets. Sixth, further penetrate the neural stimulation market. Seventh, develop components that enable MRI-safe implant. Eight, maintain an active business development pipeline and evaluate potentially compelling new business opportunities.

In conclusion, we have an ambitious strategic agenda for 2007. I believe the leadership team is in place that will enable the company to achieve these objectives and I look forward of keeping you apprised of our progress.

Let me turn the call over to the moderator to facilitate some questions.

Thank you for that presentation.

[OPERATOR INSTRUCTIONS]

Your first question will come from the Alex Arrow representing Lazard Capital Markets. Please proceed.

Thank you very much. Tom, you mentioned the $10 million a year cumulative savings for the consolidation of the facilities. What is the baseline rate that that $10 million is compared against? Is that as of the beginning of '06 or the beginning of when this consolidation started? When is that? And the new facility you're describing, can you tell us what the implications on that are for improving operating margin, if that's not already in the $10 million a year?

I think I will kind of let Tom Mazza give you the baseline for the first part of the question, and then I'll jump in on the second piece.

Basically, Alex, we're talking about from probably the end of '05 run rate.

Okay. So as of December 31st --

We basically have -- as we gave the timing of the savings we basically think we had about $2.5 million coming in '06. We expect $2 million in '07, and the balance to come in in '08 when all the facilities are fully moved.

Okay. So the biggest bump in '08. And then the new facility you're describing building, is that -- that's part of the $6 million you're getting in '08 or is that additional that will make it even more savings in '09?

The new facility we're constructing is part of the commercial power business. It's completely separate project, it's part of the product lines that pertain to the nonmedical business, oil and gas, oceanographic and seismic, and that business is based in the Boston, MA area. It's a separate battery facility than the medical piece.

It's -- Alex, it's really due to capacity constraint in '08 and afterwards. So we're really really -- capacity more than margin improvement.

Let's move on to that nonmedical business -- oil and gas and telematics are what you have listed in the press release as the drivers, although in the past you have said that oil and gas is really the pigs, while pipeline inspection is not the material, not the main driver. Does that mean that telematics is becoming the most important part that's driving the big growth in ECP?

Just for clarification, our description of oil and gas is fairly broad. It's everything from down hole applications in drilling all the way through the pipeline inspection gauge market, or pigging, as it's commonly referred to. A lot of our gains in the oil and gas market in the '05 and '06 period did come in the down hole segment. There has been some favorable legislation and pipeline inspection that as of recent it is being more widely adopted, also a favorable effect later into '06. But really it's the down hole segment within the oil and gas market that has been one of the principal drivers over the last 24 months.

Would you describe telematics as a principal driver at this point or not?

I think telematics is an emerging driver. It wasn't even a revenue stream for us in the 2005 first half. We made some significant sales and marketing and product development efforts in these areas. We have won multiple customers. We have started to ship commercial quantities, and leaving 2006, it has been significant driver of growth and it will be a significant driver of growth in 2007.

Okay. On your feed-throughs, since that was a real standout -- is that vulnerable to customer integration like capacitors or should we not be thinking of feed-through as vulnerable in that way?

When you say -- just for clarification, I think you mean high energy capacitors, because the filtering technology itself is a capacitor itself. It's a very different type of capacitor to filter out EMI interference.

I was referring to the ICD capacitors that you had in your guidance, down 34% year-over-year.

Right. It it would be very tough for me to comment on vertical integration plans for customers but we feel we have a very good and healthy intellectual property position in EMI filtering technology. We sell broadly to the industry today both current generations of EMI filtering and, as you probably know, we talked before as stricter regulations for broader frequency ranges and power levels have been regulated and required moving forward, we have advanced our filtering technology from an intellectual property position, and also from a product development position to secure continuing business from customers. So we're very confident in our competitive position and we have grown that segment of the business both in terms of new customers as well as expanding product sales to current customers. So I would not say we're ever immune from vertical integration but I think we're making the required investments to stay on the front of the technology curve to meet customer and market requirements faster than our competitors.

Okay. If I can squeeze in one last question. In the past you have described part of your growth as further penetration into your existing ICD customer market with coatings, lead coatings, and I think in particular, you attributed that to customer penetration. So even without growth ICD's, you've still got some room for that. Has that run its course or are you mostly already penetrated with lead coatings into the existing ICD customers, or is there still a lot more room for growth in that?

I do believe there is a lot of growth opportunity for Greatbatch with our current customers. We don't have positions with all our products, with all our customer OEM markets, the CRM or neurostim. The more we focus on the basics of quality, reliability, design and integration, working with our customers and providing very good customer service, we will earn the opportunities to have more revenue streams with them. So we view it as a back to the basics strategy to earn our way into more revenue streams for performance, and showing the OEMs in particular that we have good technology to do it cost effectively and win that business either from their vertical channel inside their company or from other third-party competitors.

Can you estimate what percentage penetration you are for lead coatings?

Less than 50% of the market.

Okay, great. All right, thank you.

Your next question will come from the line of Bob Hopkins, representing Lehman Brothers. Please proceed.

Thank you and good afternoon.

Hey, Bob.

Couple quick questions.

First, just to start out with the quarter, you came in at that time low end of your guidance, or fairly close to the low end of your guidance. Tom, I think you referred to inventory issues. I was wondering if you could be a little more specific in where you felt that and why you think you came in at the low end of the range.

I'll be more than happy. Tom Mazza made the comment but I'm more than happy to provide a little color on it.

I think that the -- certainly the flatness within the CRM markets has definitely affects us, and as customers look at their prospects for the year and negotiate through what they're going to forecast for the supply chain, those effects certainly showed up for us a little bit in the fourth quarter. It is a little bit granular. We look at it literally by product line and by part number.

Obviously, it is tough to get into a lot of that detail on the call here since we don't break down into part numbers in terms of describing what's happened, but we can definitely see that there's been some inventory decisions to selectively alter inventory levels from what had been historically forecast. We think that definitely came and affected us in the fourth quarter, but we're just going to reference it generally. As we say the business tends to be lumpy quarter to quarter. We're trying to look at things over the -- you know, a rolling quarter basis over the course of four quarters. So we think there's some end of year adjustments made.

Obviously there's some optimism that the market is going to come back in 2007, you know, for transparency we're saying -- we're planning on 5%, but we're seeing estimates both from customers, as well as third-party sources, anywhere from 2% to 10% plus.

For the whole -- is that for the whole cardiac rhythm management market or just for ICDs?

Actually, we're doing that just as a market as a whole at 5%. Then within that, predicting probably that ICDs would be hopefully a little sweeter and the pacemakers would just be, you know, a little bit under that. Right around 5.

Exactly.

And then in your press release, you say that the guidance that you're giving includes some of the excess capacity costs associated with Carson City filter feed-through facility. Can you quantify that?

We're not going to break it out and quantify it, Bob. We have just said that we guided this is a one-time expense. We're coming to the final pieces of the shutdown, so we're going to shoulder the burden inside the P&L of that and not call it out as a pro forma adjustment any longer. We're close -- tantalizingly close to the completion of negotiating out how that's going to work. It's been a little bit certainly challenging for both us and our customer to get the last pieces done, and we have committed to them and to all customers we'll never completely shut down a facility until everybody is 100% satisfied that the security of supply and the supply chain is properly delivering them the product that they desire. So it's extended, it's been a miss for us since 2006, but we're going to shoulder any additional expenses in 2007. And we hope to see them drop off for us early in the year.

Okay. But you won't call out the exact number?

We're not going to break it out any longer. We're not going to call it out.

Okay. But would it work to your advantage if it truly is one-time and ending, but, anyway I'll leave it there.

On the commercial side, you're forecasting 10% growth in '07. Given the growth we saw in '06, that seems conservative, or is it that the lowering cost of the price of oil, is that having an impact on overall exploration? Just a little more color there would be great, because it seems like a pretty conservative estimate.

I think -- you know, we certainly had aggressive plans for commercial power the last couple of years. They far surpassed the growth that we expected them to achieve. We still think there's plenty of market for us. We have a lot of capacity expansion projects that we need to perform on this year to be able to meet demand. I think that we're de-coupled from the price of oil in that we sell mostly to oil services companies, not the actual companies that, you know, drill out the oil and sell it on the open market. So the number of tools in the drilling and pigging industries and how much they're being utilized is more of a factor since the number of assets out there in the industry, the Halliburtons, the Schlumbergers, the Baker Hughes have a tendency to be very constant year-over-year, they're not subject to the price of oil going up or down. Sometimes it's even counterintuitive that when the price of oil is up the industry wants to get the oil out of the ground. They don't want to necessarily do a lot of logging and measuring and drilling and pipeline inspection. They want product to be going through the pipes. So there's a bit of an asynchronous effect in the market as well. That market, historically, has been rather flat-growth, 3% to 5%, and it's been de-coupled from the price of oil. Despite it being 3% to 5%, we've made heavy investments in sales and marketing and also in product engineering and product development. We have won new business, and we have expanded our market share, and now we're just challenged because we're really starting to reach the limit of the 30,000 square foot manufacturing facility we have. We just have to build a bigger facility with more capability to keep the revenue expansion going. I think we originally planned this as a 2008 project, and it's just hitting our doorstep to do it a year early because of how much growth we've had over the last 24 months.

Okay. Great. Thanks so much.

thank you.

Your next question will come from the line of Jim Nelson representing Piper Jaffray. Please proceed.

Hi, guys. Just to focus a little more on the excess capacity share, because I know you don't want to quantify them, but was there anything else other than Carson city that was contributing to excess capacity in 2007?

Clearly the Tijuana facility is not totally being utilized, and we will not get rid of that excess capacity there until the Columbia and Carson City facilities have both been transferred.

So there is as soon as those facilities are finally shut down, they will be a significant increase.

That's correct. The Tijuana facility is currently for the excess space, we're willing to give that number out, that's about $1 million plus.

For the year? For '07?

For '07.

I'm assuming that's front half loaded.

No, because remember, the cost of sales is really three months behind, so we're actually producing the inventory for Columbia up until, you know, we're assuming that's going to be by mid-year, so it's pretty much back end loaded.

Back end loaded. Okay. And given all that, maybe I missed it, did you actually give gross margin guidance for '07?

No.

Only the operating line.

Would you care to?

No.

Okay. And the commercial power facility, will that -- is it safe to assume that's additional capacity and won't replace the current capacity, so there won't be other plant shutdown expenses --

Our intention is on the commercial power facility to build a new facility to meet the needs of that business over the foreseeable future of the strategic plan, five-plus years. Our intention is to build it, start it up, move into it, and shut down and sell the old facility. We're looking at our options right now for facilities, building a new one at the same site with the land that we own, and also looking at other sites and existing buildings in the greater Boston area.

So you will probably have the cost of running two plants for some period until you figure out exactly how to combine them and [inaudible] period of time.

I think you have to understand, as it is the nonmedical business, the regulations involved and the customer qualifications involved are lot more straightforward. There's definitely an overlap period that is more of our own managing of the project. We have to obviously break ground, build the building and get it up before we can run it. I'd estimate that three to six months of side by side operation over the course of the entire project, but for any one product line a matter of weeks before they transition from one facility to the next facility. A lot less involved in terms of the regulatory approval process than has been evident with the medical moves for the CRM market, Carson City and Columbia in particular.

Now on the revenue guidance -- the 10% growth for medical over and above the 5% market, what are the key products you're assuming necessary to drive that?

I still think that we have opportunities in all the product lines. We haven't really broken out guidance in terms of individual product lines. We're seeing 10% in general, so we think, you know, we'll have opportunities in each of the product lines to expand our sales. I would say that, you know, each of the opportunities with each customer and each product line carries its own risk, which is why we're not going to break it out. Some things we're planning on may not precipitate, the and other ones, if we risk-adjust it, it may come through.

And are new customers part of that guidance?

New customers are in -- from a neural stimulation perspective, are definitely looked at within this terms of sales opportunities as well. I think we're -- where the most of the efforts either on the neurostim side is winning product development wins to be qualified at the component level in with neuro stimulator product line.

Okay. And finally, what in the assumption is relative to the guidance concerning the Guidant battery contract? We can start looking to see some [inaudible] on that, and haven't. What are you assuming about that?

We're not going to provide guidance to a particular customer on particular product lines. We haven't done it historically and we don't plan on doing it going forward. We're working obviously very closely with them and every customer on the relationship contracts and shipments on a daily basis.

Okay. Thank you.

Have a good day.

Your next question will come from the line of Glenn Reicin representing Morgan Stanley. Please proceed.

Good evening, folks. Just curious for sales growth for 2007.

You can look at it one way and say that because of the inventory issues in the fourth quarter we'll have a bounce back in the first and each of the four quarters throughout the year will be very similar, or you can say that you're banking on a market recovery more back half driven and it will be a very back half driven year. What's your best guess at this point?

I think you've said it very well, Glenn. It's that the back half is when we're looking more at market recovery. And clearly, obviously, there has to be some prep for getting market recovery to take advantage of it coming back. There is obviously, you know, a lot of safety stock in the system that helps buffer that recovery come back, so we're not certainly in a -- we're in a prudent inventory position, which is where I think we like to stay with all the customers and the product line. I think we're insulated, kind of a shock absorber effect that exists in it, but definitely more market growth second half is kind of our thinking, and we just aggregated it in terms of 5% for the year.

So you do not think that order rates will bounce back in Q1 because of the inventory adjustments that took place in Q4?

I think we'll get some bounce in order rates, but, you know, it's very hard to predict, because it's kind of two effects here, you know, one is the market, the other one is the kind of the lumpiness. We tend to get orders in very large dollar amounts, you know, some close to $1 million range. So is when we see things happening with inventory it only takes a couple of orders to really have a large effect on us at times. So, you know, we expect certainly with the ordering rate to be healthy throughout the year as they normally are somewhat balanced, but we expect really to see the end market numbers, the device sales numbers to be healthier in the second half of the year that we kind of run the tempo of the business to. And we kind of see the device sales in the fourth quarter just extending on into Q1 and Q2. There is a disconnect between the supply chains at the OEM and the actual number of devices sold. There's a fair amount of variables in between that. The market we supply to and the end device market.

And you have always talked about the 90-day visibility. I assume that you are using what you're seeing as a basis for that guidance.

I think that's a very good statement, is we obviously have a much harder 90-day view of the market and we factor that in very heavily in terms of what we're seeing for the year.

Okay.

We risk-adjust the back portions of the year. The risk-adjust on each of the probabilities the customers and the product line accordingly from there.

Just a couple of housekeeping questions with respect to -- this is a follow-up to Thomas questions about the facility building on the commercial side. Are you going to hold it as construction in progress and not depreciate anything until the facility is functional, or is it a pay as you go kind of process?

It will be held until it's functional.

Construction in progress, the same way we've done it in the past.

And then I was under the impression na the the restructuring charges were going in at the end of the year. I was surprised that you've said it's only two-thirds of the way through. The question is, is that a change, and how much of that is cash?

Columbia is always scheduled for mid 2007, and turned new accounting literature we can't accrue all the severance and retention costs all up-front. It has to be accrued pro rata over the period of time. So we still have about -- we have about $4 million worth of costs scheduled for 2007 and the other operating expense and it's probably two-thirds of that.

In the other line, you're saying.

Yes, in the other operating expense line.

Glen this is Tony. I think what we said is that we're two-thirds of the way through which means really that 2007 is year three. So we are tracking according to plan.

Then, you know, my pet peeve is the asset write-offs. What are they and how big are they in 2007?

There nor significant asset write-offs budgeted in 2007.

We provided guidance last year for some asset write-offs in '06. We had none appreciable in the fourth quarter of '06. And we have none forecasted in the guidance for 07.

You had a penny or something in the fourth quarter. It wasn't material.

Then I noticed the inventory levels were up quite a bit. What I'm asking bout really is the actual cash and cash returns of the business. But I did see an inventory build, pretty significant one, and I'm wondering what that was about.

With moving a lot of the facilities it's necessary for us to build inventory stock, and also, the assembly business down in Tijuana has significant amount of inventory for it.

Just a couple things. We finished our rounding out of safety stock for the year in the fourth quarter which is an important contractual requirement we have, and then additionally we have move-related safety stocks in addition to that, that we have to build up to be able to qualify for the sign-offs of the final facility shut down. We do those over very long periods of time so that we don't have to work a lot of overtime in the process.

I promise I won't hold this against you if you answer this question incorrectly. But what is your inventory goal for 2007, that you oh -- do you actually plan on reducing the absolute amount of inventory that you have?

Yes, it is on our outlook for '07, is to look at reducing inventory levels.

Okay. Final question, which is question, I think you'll be -- that Tom will like to answer. Can you give us an update on the new product launches, QHR and the like?

I'm happy to say that QHR is now beg sold to customers and is actually being implanted by one customer in particular as we speak, so it has seen its first implant. Delighted with -- we're on the verge of making some exciting announcements with regards to our Nano SVO battery technology here shortly as well as our medium rate Q technology for neural stimulator application. We have a very healthy basket of filtering products for filtered feed-throughs of both EMI and MRI filtering. We've had some tremendous technical breakthroughs. We're doing some very exciting product development programs for some key customers. We have done a very nice job in the commercial power product to expand into telematics with not just individual cells but big battery packs and power modules. We've done a lot of very interesting reengineering of some standard product lines in commercial power to streamline the designs and take out costs. We have launched the high energy version of the Capri capacitor that has done a great job of attracting a great teal of interest from the CRM companies. And we have been successful in launching the second-generation rechargeable battery for implantable medical applications for neurostim customers in particular seeing is multiple new product developments already in generation 3 is already proceeding down the path of qualification. So the very strong year in the R&D and product development groups, and although it doesn't show up in revenue for a few years because of a qualification process, we've used the last 24 months to do a great job at getting a lot of product development initiatives and all the product lines started across all the businesses and obviously it contributes to somewhat of our bullishness and why we think we can do better than the market growth rate.

When do you think they are material?

I think the commercial ones are material already. They are hitting the opportunities in telematics because there's less regulation there. I think QHR is transitioning in and replacing solar vanadium oxide sales already. That transition could take three to five years to go because of the length of time it takes for customers to qualify for product platforms to use it. Filtering technology has a tendency to be more rapidly adapted over the course of 12 to 18 months because it's a lot simpler to take one filter feature out and put a new design in. So I think it's a mixture. I think it's a bleed-in effect, anywhere from six months on the commercial products, all the way out to two to three years on the power products like batteries and capacitors. And various product lines are in different states of transition with them.

Got it. Thank you very much.

Your next question will come from the line of Glenn Novarro representing Banc of America Securities.

Couple questions. First, as it relates to your '07 sales guidance, on the battery side, do you assume that Boston Scientific starts to make batteries in-house and thus lose part of their business? That's question one. Second, on the capacitor side, you expect to get business from St. Jude, or does growth in capacitors come from continued penetration of your international account? And then lastly, as it relates to your sub assembly business are we going to assume that business in '07 all comes from Medtronic or is there going to be business coming from some of your international accounts? Thanks.

Three great questions.

I won't answer them specifically but I will say certainly our goals are to maintain a dominant position of technology-driven sales to our current customers and also expand them. We have highlighted before that we don't sell capacitors to certain OEMs. We have made big investments in the technology of the high energy capacitors, and we have also made big investments in expanding the customer relationships and sales initiatives to highlight our technology to those customers, one in particular that you mentioned. We're not planning or breaking out guidance to what we're planning on getting or not getting, but we think that we can maintain our position and a lot of the technologies and on aggregate, you know, what we're signaling by saying we can grow 10%, assuming the market is growing 5% is we will win more opportunities than we would be replacing, and some of the ones that you mention in terms of high energy capacitors, we have three customers currently, it is our plan to develop customer number four and five that we have been very active with, and we think that we have opportunities there to do that within the '07 and '08 period. And we're going to put proposals on the period like we have been to try to earn those opportunities.

The assembly piece, we have been broadly looking at assembly. It's not just within the medical business from the CRM customer. It's also from this the emerging customers in the neurostimulation market. We think there's opportunities to do integration of the components for a variety of customers and have been actively working. Some of those tend to be smaller quantities as we do for neurostim opportunities because we're not shipping in commercial quantities yet, but we have some good programs going on there. They are not contributing to the P&L in 2007, just because of the amount of work that has to be done to qualify them and be deemed acceptable.

One of the steps that we did in 2006 was to qualify that facility for ISO 13485 so that we would be able to have that in place so that it would be done and out of the way for future assembly customers. There's also an opportunity to do assembly outside of the medical markets as well, for other businesses as well, particularly the commercial business, as it moves on from just selling battery packs to power assembly modules, et cetera. We're looking at a pretty broad range of alternatives, mostly which are outside of the 2007 time frame in terms of revenue showing up in the P&L.

Just one follow up question it is a relates to the Medtronic subassembly business, are there opportunities to start capturing more of their premium products versus kind of the low end products that you're assembling for them? Maybe I should say higher end business products.

Well, I think maybe I can say that, if I understand your question, Glenn, I can say that the original intent of moving into the assembly business was to be able to offer all of our customers the ability to take advantage of not only our expertise in assembly that we have developed internally, but also to be able to buy and procure Greatbatch intellectual property, and the components that it's engineered into, and there is an opportunity for us clearly with the customer that you have mentioned to win business at the component level. And the way we are going to do that is clearly we are going to do an excellent job at customer service, quality and reliability and just the general performance with the customer that we have, and we are going to then use that good reputation to highlight our capability at the component level to enter other product lines that we think we have good technology to sell to them.

That's an ongoing effort. There's not a month goes by that we don't do work in that area to earn the performance grades that are good and also to earn the opportunity to do more work with them. And that won't change in 2007. It's the same approach.

That was just my way of trying to ask you does the sub assembly business today get you a capacitor contract in 2007?

It earns us the right to get a capacitor contract. It earns us the right to get really any component contract. But earning the right opens up the possibility to have a negotiation because we're performing well, but the technology and the proposal for that component has to stand on its own, which means they have to be worked individually with each customer for each product platform.

So we're active in that. We've got a very good job with the start-up of the Tijuana facility, so we've earned that right but we still have to work on securing, you know, the revenue streams for other product lines as we go forward.

So that's on our action list for '07 and '08, and it's certainly where we're talking about how we're going to outpace the market growth by winning opportunities like that to grow the company.

Great, thanks, Tom.

You're welcome.

Your next question comes from the line of Jason Mills representing First Albany Capital. Please proceed.

Hi, Tom. Thanks for taking my question.

So my first question centers around the top line as well. It's kind of a long drawn out question so hopefully you can bear with me and I can get this out as smoothly as possible. If we kind of look it at what's happened over the last three years, we all know about what Guidant has done vertically integrating the capacitor business. Not having yet vertically integrated the battery business, we can draw conclusions as to maybe how big the guidance battery business and draw some conclusions that their capacitor business was not bigger than that but smaller, and then look at the, I see the capacitor revenue having come down from $32 million to this year about $17.5 million or about $15 million.

So I guess the first part of that question is it looks like if we're doing the math correctly, there isn't much Guidant capacitor business left to lose, perhaps that's why you're talking about having some significant opportunities to grow that business in 2007 and beyond. And then in addition to that, sort of the second part of the question, we're looking at your performance in the top line in the fourth quarter relative to sort of the midpoint of your guidance, it's about a $4 million delta, if we're looking at the capacitor specifically it's down quarter to quarter about a million and a half or a million or so.

Would that, therefore, imply, can we imply that about $3 million was the result of the inventory issues that you experienced in the quarter and that when we're looking at 2007 guidance that we can kind of think about that $3 million coming back in addition to the 5% growth, and that's one of the ways you get your 10% guidance? And I guess those questions are separate and combined at the same time. But I'm trying to get a sense for how much business there's left to lose at Guidant on the capacitor side and really how much there is to make up on this fourth quarter issue.

Yeah. I did follow your forensics, and -- I think you make a lot of excellent points, I often say that I would love to win 100% of the opportunities with 100% of the customers 100% of the time. But I realize we'll have puts and takes where there's certain third parties, potential vertical integration in which there's product lines that we may not win, but we're not going to give up pushing the technology forward to show the differentiation.

So I do think that certainly we have lost some capacitor business with the customer that you mentioned. There is no way we're giving up on any of the capacitor business with any customer. We think there's broad applicability for wet tantalum capacitors throughout the industry due to their inherent technical advantages. We're at the beginning of the technology of developing that.

We have done a very good job of going from reliance on single customer to three customers. Each of those customers has gradually qualified new programs over the course of 2006. Each of them is planning new products to qualify for 2007. We're bullish that we're going to, you know, overcome the bump we took in the capacitor business from the '04 and '05 time frame. And like I said, from a baseline perspective, when we look beyond those deals we lost, and we look forward, we're on the upwards trajectory.

So we think that the technology is speaking for itself but it's not generation one technology we're relying on, it's also the generation 2 technology that customers are qualifying right now. We are doing a very good job and we work very close well customers and we want to understand why we didn't win the business what do we need to do to get better. It's usually a mixture of the proposal, the quality, the cost, the time to engineer, the time to qualify. So we measure performance on a wide number of ranges. So we definitely think we can recover the capacitor revenue over '07 and '08. We moved this product line from plant in an old facility to the brand-new Albany, New York, facility where we have medical battery manufacturing. We have made a big investment in process capability so we feel that we have a very good manufacturing team, an excellent engineering team, and a very good R&D team behind this product line, and it plans prominently in our growth initiatives.

In terms of Q4, in terms of how we look at the capacitors and how we look at the overall midpoint of guidance and where we ended up with inventory and what's the specific product line, we'll always shy away from kind of breaking down forensically how it dices and slices out. Does it shift a little bit quarter to quarter. I think clearly there's a broad market effect here in terms of at the beginning of the year we're providing guidance for the whole year and tuning it in as the year goes on. There definitely was some inventory effects in Q4 that we had not seen when we were tuning our guidance. We're doing a very good job of risk adjusting each of the possibilities, giving transparency on the market growth rate of 5% in coming up with a 10% number.

We are including all the factors in there from inventory recovery, market growth, product mix shift, product line shift, new customer qualification. I'd say there's upwards of 20 variables we factored into the overall guidance picture and it's very hard to separate out and we would be reluctant to separate out any one effect on inventory or specific product line, because there's too many factors and too many risk adjustments that's done that way to come up with the aggregated number.

And that's very helpful. So just sort of taking that thought forward then, when you're thinking about those 20 or 25 variables that go into your guidance, I assume you're risk adjusting those variables to try to harness a guidance range you feel like you can this year being an important year for you, you're getting beyond your restructuring and have talked in the past about top-line growth being perhaps the most important thing now that you have established an infrastructure that you can leverage. So, you know, with all that being said, do you feel like you have set a guidance range that factors in sort of conservatively market rates as well as where the inventory reductions could come in as two of the 20 variables without knowing them all that I'll point out?

I think it's fair.

Definitely those are variables in the equation. We, without a doubt, risk adjust each of the potential variables and look at them in detail by customer by product line to come up with that guidance. I think, you know, it's important, you know, to understand when we do that that there's also a very important aspect that as leadership and management that has to be understood here is when we give guidance at 10% and we are stating the market is going to grow 5%, if the market grows 2%, it doesn't mean our target is 7%, it means our target is 10%, we're going to find the business to grow the company to the 10% level. So while there is a lot of macro variables, one of the significant ones is leadership and management of the business to deliver the 10% that we're committing to. So we can get 5% from the market, we think we're doing a pragmatic job of estimating where the overall market would be, but if it's not there, we're still going to put the pressure on the leadership and management team to come up with a 10% growth to drive the initiatives forward.

Right. And basically what I'm driving at the bottom line is it's not brain surgery to make the comment that investors don't necessarily like to see a miss on the top line but it seems to me, and obviously everyone has their own opinion, that that's primarily because of maybe thinking it's a precursor of things to come, but you've offset that a bit by giving a guidance range that sort of sets the consensus expectation for '07, at least entering the quarter at the midpoint.

It seems to me like perhaps that top line miss you're trying to with the guidance forecast that it is a lumpy business and we are pretty bullish about '07. What I'm trying to get at, I'm trying to understand, trying to make a decision whether or not you are being conservative and still getting to that guidance or you're having to be a little bit aggressive get to that guidance, understanding that you want to forecast what happened in December is not a precursor of things to come.

I think it it the's a fair question, and I think it's important to say is, when we give guidance, we risk adjust every variable we look at for pragmatism. We don't feel that we give wide guidance because the business is lumpy and because there is a lot of variables that we don't control. When we looked at the $270, $280 million guidance range, we view steering the business to get to that point as the right thing to do. That represents, you know organic sales growth in the 12% range, which is markedly above what the market could produce. So we did a very good job of growing better than the market. So we really don't view it as a miss per se, and we will always as we look at guidance risk adjust all the variables to be pragmatic with what we're going to give as our guidance ranges across the board. And then it is management's responsibility to perform to those levels and obviously we try to overperform to those levels because we want to deliver more than just what we're targeting.

Perfect. Thanks. Very helpful. Couple of housekeeping and I'll get back in queue. With respect to the CEO transition cost that you didn't pro forma out, any way you could give us a sense, quantify what that may have been in the quarter?

No, we said the combination of that and the incentive were about 1.3 combined.

$1.3 million is what we had highlighted.

We won't go into any more than that.

And then the bottom line guidance that you updated in November, you came in obviously a little bit above that but obviously the tax rate was lower. Just remind me at that point in time did you contemplate the tax credit in that guidance?

No. It only accounted -- if you look at how small the earnings were it only accounted for about $0.01 per share for the difference in the quarter.

We feel we were a couple cents high, about a penny of it was tax.

Your next question will come from the line of [Kay McKay] representing Unterberg Tobin.

Tom, you mentioned Nano SVO. Can we assume that you have customers or potential customers who are currently evaluating fully qualified cells that have been made to their specifications?

Great question.

Obviously hate to give the pat answer we don't talk about specific customers and specific product lines but I will say just in general there's been multiple customers that have evaluated but the trademark NanoSVO product line it is definitely, as you know, we relocated that business we acquired, Nanogram Device, what we called the Advanced Research Laboratory in Fremont, CA, it's been relocated to the new Holmes research development center in western New York. We have already implemented the equipment. We sampled customers, we have been in qualification regimes. You will be seeing some informational press releases on this in the very near future.

We are quite excited about it. It's way beyond concept in products development faces. It's squarely in the qualification loop. We think it it's a salable product. We're entering the stages of what we would deem as completing customer qualification, which is just perceived no commercial sales of that product. We've kept it under the covers for quite sometime, following the acquisition. We've had a lot of internal developments and enhancements that the medical powers group has done to the process as well as the product and it just has tremendous performance but we're really excited with coming up to the launch of it.

In talking about its performance and perhaps its price, can you give us a sense for why somebody who has an ICD device is going to want to select NanoSVO over QHR at this point?

Yeah, hat a couple of fundamental advantages. It's different than the Q high-rate battery. The NanoSVO material is a more stable material. It delivers more consistent and reliable discharge performance over the entire life of the battery, more predictable, more easily modeled to design the power system around. It also has better power out put in addition to that, a higher running voltage for any particular load. So it has many different variables that would appeal to a device designer, there's somewhat techy, but important considerations when designing any type of product. We think the NanoSVO is not only applicable to ICDs but also the pacemaker product lines as we launch our Q medium rate series product for neurostim and the Brady product as well. So it's a fundamental material technology that we are launching through ICD batteries. First it has a lot of fundamental technical advantages that probably only a device designer would love.

From a manufacturing perspective, you've invested the equipment to manufacture the Quasar products because of the tolerances on the layers that you're sandwiching. How does manufacturing of the Nano fit in with the new facility?

We made the investment for Q as you said that is correct, we have the facility set up with the automation equipment to do that. We haven't fully brought it on stream yet. But we will be doing that for the Q-products in '07. Same thing stands true for NanoSVO. The battery assembly equipment is more or less the same as what we already have in place, but the processing equipment to actually make the solar vanadium oxide, or SVO is different. That equipment has been procured. We are starting it up. And that is already within our capital plan guidance for '06 and some of it spills over as a carry-over into '07 but that's already in our numbers in our guidance.

Okay. Then just on a different topic, but related to your products, the filter feed-throughs and your desire to have Medtronic buy your product there, you mentioned earlier how you're trying to impress them with your service, and you also had, as a development initiative, a -- I guess what I would refer to as an integrated filter feed-through. Having that product completed would that be enough to get you over the hump in combination with your service order? Or at the end of the day, is this just a political situation that you're never going to be able to overcome?

It's a great question, only the customer of the particular device, particular product could answer that question. We ask them that question all the time. We get very valuable feedback and we take it for action.

I think there are always very complicated situations, and I think one of the complications always is, is when you do things on the outside or a third party, you have to trust that the behaviors and the service, the quality and reliability and the competence is there. So what we view as we have to show consistently good performance in those product lines to earn the right to do it. There's not just a set of four or two or three or variables that we have to do. And sometimes we have to let time pass by to show a consistency of performance in a particular product line for a particular customer, and sometimes it requires a new platform to come along so that it's cost effective to do a design in at that point.

So we're all about being prepared to earn the opportunity and then wait for the timing of the opportunity to come. Clearly we have been very patient with some customers, but it just means that we redouble our efforts to make sure we are doing a good job to earn the right to get in there. So we'll never give up on any product line with any customer. We think that there's opportunities for everything, and that's how we're pursuing the business.

One final question if I may. As for as acquisitions, is that something that you're actively looking at, or with all your other initiatives that's more on hold at this point?

No, I think our plan always has been a three-year consolidation plan in which we would start looking in the second half of the consolidation plan at active business development project, so in 2006 we looked at one deal in particular that we abandoned. We have continued to be very active in the deal funnel, both in the commercial and medical market, and our intentions are to continue to do that in 2007, and it's a prominent piece of our strategy going forward now that the consolidation initiatives are coming to completion.

Okay, thanks.

Thank you very much.

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

Thank you. Those were all very great questions. Sorry, I think there were a few of you in the queue we couldn't get to but I'm sure you'll follow up.

As a reminder you can get the audio portion on our website as well as the slide visuals. Again, thanks for the questions, and we'll talk to you later.

Thank you for your participation in today's conference. That does conclude the conference. You may now disconnect.