Integer Holdings Corp (ITGR) 2008 Q2 法說會逐字稿

Welcome, everyone, to the second quarter Greatbatch, Inc. 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 risks and uncertainties are described in the Company's annual report and Form 10-K. The statements are based upon Greatbatch Inc. prior expectations and actual results could differ materially from those stated or implied. The Company assumes no obligations to update 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 now like to turn the call over to today's host, Corporate Controller, Marco Benedetti. Please proceed, sir.

Thank you. On the call today are Thomas J. Hook, President and Chief Executive Officer, and Thomas J. Mazza, Senior Vice President and Chief Financial Officer. In term of today's agenda, Tom Hook will start by providing a few comments regarding our accomplishments for the quarter, and then provide an update relative to our major strategic initiative and MRI technologies. After that, Tom Mazza will provide a financial overview and further comments on our second quarter financial results, after which we will then open up the floor to Q&A. As we have done in the past, we are including slide visuals that will go along with this presentation, which you can access on our website. Let me now turn the call over to, our President and Chief Executive Officer, Tom Hook.

Thanks, Marco. And I'd like to thank all of you for joining our second quarter 2008 earnings call. As you'll note from this morning's release, we are pleased with the financial results for this quarter. Furthermore we are excited by the execution and progress we continue to make toward our long-term strategic initiatives, which include increasing the diversification of our sales mix, driving new product development and innovation to enhance sales growth, and improving the operational efficiency throughout the organization. We reported a record quarter with sales of $141.6 million which represents an 81% increase over the second quarter of 2007 and a 16% sequential improvement over the first quarter of 2008. The benefits of our recent acquisitions were reflected in the diversification of our sales mix as well as improved profitability as our adjusted operating income grew to $14.2 million during the quarter, which is a substantial increase over the first quarter of 2008, Tom Mazza will provide additional detail on the financial results later in the call.

Over the past year, we have worked diligently to find and complete strategic acquisitions that will improve the overall diversification of our business. These acquisitions offer significant opportunities to leverage the core operational and product development strengths of the Company to significantly enhance our long-term growth and profitability. This diversification strategy has helped expand our opportunity within a variety of new markets including Orthopedics and Therapy Delivery. As part of the acquisition, we're able to add proprietary technologies and product lines through our portfolio as well as strategic manufacturing and product development capabilities. In addition, we expanded and diversified our global customer relationships. Although the acquisition's clearly diversified our customer base and reduced our concentration with a few key accounts, it also created additional opportunities to sell a broader portfolio of products across multiple divisions within these key accounts.

Instead of simply selling to just (inaudible) with the management business with one of our key customers, we now can sell to the Orthopedics, Neuromodulation or Therapy Delivery businesses combined. We've taken great strides in diversifying Greatbatch and we will continue to integrate these new businesses and look for ways to drive both near-term and long-term revenue gains.

A key element of our strategy is focused on streamlining our operations and optimizing our production. At Greatbatch we have a history of successfully optimizing and consolidating our operations. We have already identified and implemented several key initiatives to enhance the operating performance of these new businesses and move them closer to our operating model. As evidenced by the substantial improvement in our adjusted operating margin this quarter over the first quarter of 2008, we have begun to realize several of the benefits immediately. We have approached this initiative on several different fronts and I want to provide an overview of our plan for the next 24 months.

First let's review some of the initiatives and accomplishments in both the medical and commercial facilities. As of last month, the Columbia Manufacturing Facility has been closed. We have completed the expansion of a new research and development center in Western New York near Buffalo, thereby eliminating the need for a leased facility. In addition, we are in the process of finalizing the construction of a commercial manufacturing plant in Raynham, Massachusetts, the opening ceremony is scheduled for later this month. This will enable a significant capacity increase over the Canton, Massachusetts facility. During the quarter, we announced that we will discontinue manufacturing operations in Suzhou, China, in the third quarter of 2008. And that our operations in Orchard Park, New York, will be consolidated into existing Western New York facilities. Given the significant increase in our size, we are working aggressively to rationalize our supplier base and to take a more strategic approach with these relationships, essentially allowing us to contract more effectively and increase our buying power.

Additionally, we have begun integrating across the Company into a common ERP platform with three of the acquired companies already completed and Quan Emerteq and Enpath Medical scheduled for completion in the third quarter of 2008. This will allow us to continue to centralize our back office, finance and IT functions. Just looking at the companies that we have acquired, we've seen enormous amount of capabilities and opportunity that can be realized. At the high level, we believe we can align our R&D spending with the right growth market opportunities, generate additional sales volume from cross selling and other initiatives, implement Lean manufacturing initiatives and supply chain improvements that would generate immediate gains and provide groundwork for future improvement as well as leverage opportunities to in-source key component parts.

We currently spend approximately 8% of our sales revenue on an annual basis in research, development and engineering, so we're very focused on technology and innovation. This investment in R&D will enable us to maintain our leadership position in core markets, drive new market growth opportunities and potentially provide additional cost savings across our growing portfolio. We will reinvest some of that money at an appropriate level, not only to drive profitability, but obviously to drive future product developments as well. One recent example of our success is our investment in MRI compatible technologies. This suite of products consists of three parts: First, nonmagnetic component materials designed to mitigate diagnostic image artifacts. Part two is an advanced EMI proximal tip filtering to shield implantable pulse generators from strain, interference and noise in an MRI environment. And the third part that we'll highlight today,is our eM-able technology which addresses patient safety for anyone with an active implantable medical device that must undergo an MRI procedure.

Our new product is designed to eliminate the potential for lead-wire tip heating and minimizes the potential negative impact on the performance for certain implantable medical devices. We are currently completing the development of our eM-able Brady pacing lead-wire, which incorporates this technology and realizes significant product synergies resulting from our acquisitions of Enpath Medical and Quad Emerteq in late 2007. Initial rounds of testing of functional prototypes have proven our technology is effective in blocking MRI specific frequencies harmful to patients with implantable medical devices. With 35 million MRI procedures performed in the United States on a yearly basis, and with 50% to 70% of active implantable medical device patients requiring an MRI in their lifetime, you can see there's a definite market and a need for this type of technology.

In May of 2008 we announced the execution of a letter of intent in which the Sorin Group will leverage our eM-able technology for their future Cardiac Rhythm Management Devices. At the same time we continue to explore and develop similar relationships with other customers in both the CRM and Neuromodulation space. And we are excited to share the positive results attained during our last rounds of testing. The lead-wire system is just one aspect of our goal to continue to deliver innovative solutions to our customers and improve the functionality, safety and efficiency of our products.

Based on our current portfolio and research development activities, we feel we're in a strong competitive position for future growth and profitability. The acquired markets are growing faster than our historic Cardiac Rhythm Management market and remain confident that our diversification strategy was the right move to make. We are hopeful that the CRM business can deliver future growth opportunities given continued underlying product demand and our ability to deliver innovative new product solutions.

We are moving aggressively to ensure we consolidate our operating footprint to drive profitability and take advantage of increased market growth across all of our product lines. We're evaluating and looking for cross selling opportunities amongst our customer base and continue to leverage our technology as we work toward selling more customized components and lead systems in the future. In the meantime, we remain dedicated to executing on our long-term plan, streamlining our operations, and integrating and developing our new product lines. I'll now turn the call over to Tom Mazza for a review of the financial results.

Thanks, Tom and good afternoon. Sales for the second quarter were in line with our expectations and reflected the contributions of our recent acquisitions. We reported approximately $142 million in revenue. Of this record amount, acquisitions contributed over $64 million. Excluding acquisitions, sales for the second quarter of 2008 increased by 1% over the prior year, which is primarily due to a higher Electrochem sales offset by slightly lower sales of CRM products.

Second quarter sales for the Implantable Medical Components business segment were $121.5 million, an 80% increase over the prior year quarter and a 19% increase over the first quarter of 2008. IMC results for the second quarter of 2008 include revenue of $56.8 million from our recent acquisitions. The Cardiac Rhythm Management and Neuromodulation Product Lines reported revenues of $64.8 million, a 2% decrease compared to the second quarter of 2007, however, a sequential increase of 11% from the first quarter. The second quarter benefited from the increased adoption of our Q series high rate ICD batteries as well as higher feedthrough and assembly revenue. However, these benefits were mitigated by lower demand for coded components due to a customer recall unrelated to Greatbatch products and lower capacitor sales. You will recall that the second quarter of 2007 includes an increased level of capacitor sales due to a customer supply issue in the first half of 2007.

Second quarter revenues for the Therapy Delivery Product line were $15.8 million compared to the prior quarter revenues of $16.5 million. This 4% decrease was primarily due to lower sales of introducers and leads. The Orthopedic Product Line reported $41 million in sales for the quarter, compared to $27.8 million in the first quarter of 2008. This quarter results include the full impact of Chaumont manufacturing facility which was acquired in February of 2008. The sequential increase also reflects our efforts to clear the bottlenecks that existed within the Orthopedics manufacturing operations, which were delaying deliveries to our customers and negatively impacting our sales and operating profitability.

Switching to our commercial business. Second quarter sales for the Electrochem business segment were $20.1 million compared to $10.9 million in the second quarter of 2007 and $19.6 million in the first quarter of 2008. The increase in sales as a result of the acquisition of EAC in October 2007, and increased demand in the oil and gas market. As intended our acquisition strategy has enabled us to successfully diversify our revenue mix from a combined concentration of approximately 85% in CRM to below 50%. Given the slow growth level currently being experienced by the CRM market, our revenue growth and diversification has validated our strategic seat of investments in the vascular, commercial and orthopedics markets.

Turning now to expenses. Our selling, general and administrative expenses increased $7.9 million over the prior year, including $6.1 million related to acquisitions completed in 2007 and 2008, and approximately $3 million in incremental legal expenses related to a lawsuit from the former Enpath Medical. Research, development and engineering costs for the second quarter were $7.7 million, in line with expectations and lower as a percentage of sales versus the prior year. R&D costs also decreased as the Company recognized the function as part of its overall plan to streamline operations during the second quarter of 2008. Other operating expenses incurred in the second quarter of 2008 were $2.9 million and were primarily included costs in connection with various consolidation initiatives and the integration of the newly acquired businesses. We anticipate that these costs will continue and potentially increase over the next 24 months as we move aggressively to integrate our newly acquired businesses and consolidate resources to improve the overall operating performance of the Company.

Adjusted operating income was $14.2 million, a sequential increase of 156% from the previous quarter and consistent with the prior year. Adjusted operating margins for the second quarter 2008 were 10%, up from 4.5% for the first quarter of 2008 but down from 18.1% in the prior year period. Recent improvements in both operating income and operating margins were driven by operations streamlining efforts and increased sales. As a result of the acquired in-process research and development write-off not being deductible for tax purpose, and the exploration of the research and development tax credit, the effective tax rate for 2008 is expected to be approximately 37%. Ultimately, our adjusted operating income translates to an adjusted earnings per diluted share of $0.30 in the quarter compared to $0.42 per diluted share in the second quarter of 2007 and $0.16 per share in the first quarter of 2008. These results exclude the impact of acquisition-related charges and facility consolidation, manufacturing transfer and system integration expenses.

More importantly, the progress made on our strategic initiatives and our results for the second quarter give us confidence that we are in line with our original range of expectations for the full year. We are continuing to guide in the $490 million to $530 million for revenues, and on an adjusted EPS we are continuing to guide in the range of $1.20 to $1.50. For CapEx, we are projecting a range of $50 million to $55 million. We remain extremely confident in our ability to execute on our operating efficiencies and sales growth initiatives. While many of these initiatives are long-term in nature and will be completed over the next two to three years, we feel we can continue to improve on our operating profitability from the current levels by a couple hundred basis points a year over the next three years. We remain excited about-- by the prospects that we see for Greatbatch in both the near and long-term, and we look forward to driving growth and profitability for the Company and our shareholders going forward. Let me now turn the call back over to the moderator to take questions.

Thank you, sir. (OPERATOR INSTRUCTIONS) And your first question comes from the line of Jason Mills with Canaccord Adams, please proceed.

Hi, Tom and Tom, thanks for taking the question. Can you hear me okay?

Yes, we can.

Great. Tom, your Orthopedics business was quite good in the quarter. Clearly J&J reported out of their DePuy unit pretty strong second quarter results with I believe the shoulder and hip products, but wanted to get a sense for whether we should expect this level of sales, this run rate on a go-forward basis or were there any one-time order -- as you mentioned that you were back ordered obviously and you got out from under that. Is $41 million a good sales run rate or are there any one-time sort of backfill there that we should back out to get to what we should expect on the run rate going-forward?

Well, I assume you mean Tom Hook, and Jason-- but what I would say is just, you've got to be sensitive to a few things. We highlighted after the acquisitions that we're going to focus on relieving some of the backlog that had built up in the Chaumont plant and we're going to work very hard to streamline operations there, in which we've done a very nice job of making ground there. It certainly isn't implemented 100%, but we've made ground. We have to be sensitive too that the France location will have a shutdown in the summer months in Q3. So sometimes there's a little bit of push before then, a little catchup following it, in terms of the year, but obviously we're learning more about that operation, we're confident we have the ability to run it smoothly. I don't think it's dramatically above where we expect it. And although obviously from quarter-to-quarter, it will be a little bit lumpy and we had a very strong second quarter. We think it's consistent with what our plans were over the calendar year, and it's coming in strong, which is good news.

I'm not sure I could really give you much more color than that, or would feel comfortable. Because I'm not sure we have the ability yet to really be very predictive about that business. We're just confident that Orthopedics is growing healthy. DePuy's got very good products on that they're bringing into the market, the [Cry] and the Delta in particular. We feel confident that we're just going to do a very good job on the operating side of delivering for them, and not let the backlog challenge their sales growth. And we're just going to focus on really pushing things through the plant for them efficiently and effectively.

Thanks for that color, Tom. I have a little bit of a cold. I did -- I don't know what it sounded like, but that's what meant to say. Sorry about that.

So moving on from Orthopedics to CRM, the-- a couple of your customers have already recorded their calendar second quarter. It isn't great relative to where we saw growth rates obviously in the 2004 and 2005 time frame. But we have started to see some improvement yet in the second quarter. Although you had a difficult comp in capacitors, you were down year-over-year, and I appreciate that you don't break out your trends by customer, but perhaps you could give us some color with respect to, I guess I'll just mention it, [Alvin] there in Boston Scientific, which has bantered about moving some of their battery business in-house in the ensuing quarters. And I don't know if that had any impact or not. But one of your biggest customers at this point, St. Jude, certainly had a good quarter. So I'm trying to-- I'm trying to understand exactly where that business is relative to where the market is telling us growth is at the present time.

Certainly, I'll trying to give you a maybe a macro overlay that would be helpful. I've seen a lot of encouraging signs globally in customers that the international markets are still healthy, domestic markets seem to be recovering. Pacing seems to be particularly strong, and we've done a very good job of focusing on each of our key customers at delivering the products they need and also new product technologies. So again, as we won't win 100% of the time on all projects, so there's definitely competitive threats out there that have been challenging for us. I think comparables from us are particularly challenging this quarter for the-- one of the things you pointed out, is we had a one-time pickup that we called out in the first half of 2007 to sell capacitors on a one-time basis that we didn't repeat.

Right.

It's also important as you remember, is that we have a very large amount of revenue that's tied up in coded components that has been suspended this year until we re-- get-- kickoff that product line with the customer that's kind of going through the FDA loop right now on the product line to get it requalified. So, there's kind of two effects, both of which tended to be large. They're a little bit more challenging for us, and I think it makes kind of -- it look, our output in CRM looks flat. But if you adjust for that, actually I think it's consistent, it looks healthy that the market's coming back somewhat, maybe a little bit more on the pacing side than on the fibrillation side. But we see good activity with all customers, and we see our product development funnel fairly full as well with opportunities.

So we're encouraged that we think the broader portfolio from adding in the acquisitions opens up more opportunities than before, both with the (inaudible) management and Neuromodulation. So I continue to see those as very good markets, and we've been very successful at partnering with some of the European customers as well at bringing in new levels of product technology. So overall, I think we've been quite satisfied that the positive signs of the market are coming back, and although we probably-- the numbers we're reporting, aren't really representative of that I think it really clouded by those two special circumstances.

Right.

That -- that I think our-- it'll mislead you when you look at it.

Okay. That's really helpful color, because that's a little bit hard to tease out of what you report. So just one final and I'll get back in queue. Tom, on the P&L, you mentioned the press release, you expect 37% effective tax rate for the year. That would imply given what you reported to get to $0.16 in the first quarter and then what you reported here in the second quarter, for the back half of the year, you'll be booking a tax of 50% each quarter. Is that correct or perhaps you could help me in understanding that? And then secondly, you obviously did not pro forma out the $2.9 million litigation expense, which I wouldn't guess would recur, but perhaps you could correct me if I'm wrong there. And if that did not recur, you're running at about $16 million SG&A, which I'm wondering, is a good level to sort of model going-forward on that line? Thanks, guys, good quarter.

Thank you. Yes, Jason, I think you're spot on. We'll allow the analysts to figure out whether or not they want to give us credit for the $2.9 million. We don't expect it-- to certainly to increase it to continue at that level in future quarters, we will -- there will be some residual legal expense, but certainly not at the $2.9 million dollar level. We expect our overall tax rate for the full year to be at 37%. That includes the IP R&D write-off. On an adjusted basis, we're actually, we should be on an adjusted basis, be approximately 34%, when you take out the in-process R&D.

Okay so 34% is what you're $1.20 to $1.50 guidance is predicated on, and that guidance also leaves in the $2.9 million litigation, am I right on those two points?

Yes, you are.

Okay, thanks, guys.

Your next question comes from the line of Tim Lee with Piper Jaffray, please proceed.

Good afternoon, thanks for taking the question. I wanted to follow-up on the Orthopedic Product sales, and I appreciate there's quarter-to-quarter variability. But I mean is there any backlog left at this point that we could see just continued [bowls] in the third quarter are we-- or just any color on that front?

Yes, and -- I'll just tell you, the answer is yes. We still have ground to cover to continue to relieve that. And you have to remember that also, obviously because the product launches that are going on from our key customer out of Chaumont are being received by the market very well and they're being very successful. Combined with the fact that we have a little bit of a summer shutdown there, which is typical in France. Operationally, we're going to continue to have backlog and what we got the operating focus and some of the Greatbatch expertise working with the management team out there to continue to relieve that. So I expect that business to be strong for the second half of the year as well, given that we're going to continue to bleed off the backlog and keep up with the demand that's being driven by the market for those products that our customer. And we just have some of our best operating talent in that plant focused on that right now exactly because of that. So it-- we expect it to be good for the second half.

Thank you. And just in terms of the P&L impact of the Orthopedic business, I mean should we think about that product category less than the corporate gross margin? So as that does well --I mean could it put-- does it put pressure on the gross margin line?

I mean, I'll just say that from a gross margin performance standpoint, it's below what we find is going to be acceptable in the long run, so we know we have to make stride for operating improvements, not only to drive return to us, but also value to the customers so they drive more volume. So the initiative, the operating initiatives are squarely oriented within the Orthopedics business for some of the Greatbatch, historical Greatbatch manufacturing expertise to work in concert with the management teams and the acquired Orthopedics businesses to work together to improve overall margin performance, and also performance for the customers. So as the two things combine, because when we do that right, we definitely will end up growing as our customers grow, and then we'll do it more profitably and reward both ourselves and shareholders as well as the customers to continue to drive more business.

So we're not where we need to be in the initiatives, there's multiple initiatives underneath that, all the way through the supplier base into manufacturing, et cetera, that are focused specifically on improving it to be able to drive the long-term profitability that we expect in the Company. And we're not there yet in Orthopedics.

And then just one last accounting one, if I may. I mean can you just kind of walk us through how the upcoming change in the convertible bond accounting is going to impact your reported earnings numbers?

Yes, we haven't final-- it's a great question, Tim. We haven't finalized a calculation on that yet. We are discussing-- we are looking at it. It potentially is going to add to the interest expense and the range of interest expense is really how the calculation will run, I wouldn't want to guess whether really the range is at this time. But certainly it would show up as additional interest expense prior to -- in the normal line for it.

Okay.

So -- but that range hasn't been determined yet, and we would call it out. And we'll call it out and certainly give details. And then probably-- once the literature and how the valuation is to be calculated is finalized, and we pursue all of our other options regarding that as well, as far as our call options and other things, we would then determine what the expense is and then call it out on the next call.

Okay. Thank you very much.

Okay.

Your next question comes from the line of Keay Nakae with Collins Stewart. Please proceed.

Yes, good afternoon, my first question pertains to your medical battery sales. Tom, year-over-year, were they up?

I think is in general, medical batteries, obviously is part of the management Neuromodulation, and I think what we're going to be focused on doing as we go forward is, less on individual product line details and revenue report outs and more on the segments that underlie them. And it's a little bit of a shift from a reporting standpoint for Greatbatch. And I think that way it's a little bit easier for us to talk about the macro businesses and less about the individual product lines and specific projects that a lot of times we answer questions on. So we're going to kind of make a little bit of a shift there and not give as much color on those things, because we tend to get individual questions on them rather than on the global perspective, which is where we would have liked to start having more of the focus on.

All right. Moving on to Enpath and Quan, was there-- the sequential decline there, is there anything notable?

Well, I think the -- one of the things we have to be sensitive to is it that the litigation has been a large distraction to some of the product development activities in terms of product launches, which obviously because that's washing through the courts right now, that is really hurt our ability to commercialize some new products. We're behind-- while we're ahead on Orthopedics like we talked about, we're behind in some of the Therapy Delivery stuff, in terms of our plans. So we're obviously porting over and trying to use some more engineering -- incremental engineering focus to get some of the new product development programs back on track from a timing perspective. But you're right, as we're behind what our plans are, and we're focused on pulling that back in to be stronger for the second half of the year, because we've gotten off to a slow start.

Okay. When we think about your adjusted EPS guidance, as we move into the back half of the year, what's the low hanging fruit in the back half of the year that either drives gross margin improvement or reduced operating expense as a percentage of sale to hit your adjusted EPS guidance?

Well I think there's several things, the-- in second quarter we were doing many initiatives on overhead rationalization, R&D rationalization, we only had a partial quarter effect of those, we'll get full second half effect of those. Clearly we're exiting the old headquarters building and that expense goes away, we'll be shutting down Orchard Park in Suzhou in the third quarter, which will feed into the second half improvements, because our costing that rolls up both through production, SG&A and those areas will be eliminated. There's other projects at-- there's other projects that we're going to end up announcing. Some of the projects that finally like Columbia, Maryland, finally closed down in the second quarter, so we'll obviously no longer see from this point forward any expenses associated with that. So I think there's a variety of things that have already been done that we get full second half year effects.

There's projects that we have announced and it's started. And they're rolling out in this third quarter, that we'll get a percentage of effect in the second half. And there's also new products that we kind of obtusely referred to here as other consolidations and overhead reductions, that we haven't announced or started yet, that we will in this quarter, the third quarter, and those will roll out over the balance of the year and also contribute to the profitability. And that's-- all of that I would say is more on the consolidation and rationalization front. I still think there's a lot of opportunity as CRM continues to come back, and we continue to be able to meet demand on the Orthopedics market in particular, and get Therapy Delivery Product introductions back on track that we'll also be able to take advantage of those growth drivers. And since I have a lot of confidence in that, it's why we've maintained the $1.20 to $1.50 EPS guidance since the beginning of the year and our revenue guidance consistent with that.

So even though we had a kind of weak start to the first quarter, we still see the opportunities as very rich. We're behind in a few areas, we're ahead in a few areas, we have a lot of work to do, it's not a slam dunk. Clearly, we had a strong second quarter, we covered a lot of one-time legal expense arguably, which we'll have a lot less of in second half. So I've still got good confidence we're going to come in the range as we said we would, and hopefully that laundry list, so to speak, of pieces there gives you a little bit more confidence that we really do have enough fruit low hanging and at the higher branches that we can get to between now and the end of the year to deliver it.

Okay thanks for that answer. With respect to Orchard Park and the China location facility that you're shutting down, can you give us an idea of what the annual expense savings there is?

Yes, I mean, I want to be a little bit careful on the individual locations in that there's some -- there's obviously employee sensitivities and other things at play here, and those transitions are kind of in progress. But I think it's a reasonable question that as these things are done in the third quarter, we'll give you a little bit of flavor on what that is in hard numbers on kind of an aggregated basis so you can kind of see where the savings are coming from. But I'm a little uncomfortable breaking it down in kind of specific detail.

Okay one final question for you, in the commercial battery business, give us a sense of what the margins for EAC look like relative to your prior core business there, are they higher, lower, or about the same?

I'd say dramatically less, that business is much more materials heavy than labor, it's very, very complimentary to the existing business we have. And we have a lot of great opportunities to drive improvements there, we picked up some exceptional technical people in an acquisition. They have some very innovative products and opportunities. And I think the sales opportunity funnel is very rich on that side, and what we need to do is we need to integrate that into one commercial business mindset under the Electrochem banner or brand name that we use in that business. We've centralized the management team, we've been centralizing sales marketing and engineering. And as an integrated group, are going after the opportunities that the EAC business has brought us very aggressively. And I expect that historic margins of that business to continue to grow up as we operationally execute better.

And combined with that, obviously, we have the IntelliSensing acquisition that was in Orchard Park, New York, that is de minimis sales revenue, but it's a great new product that's really at the verge of creating some prototyping and customer sampling. And we expect that to be a nice product line that could also be sold along with the EAC type product in the marketplace. The good thing about that, is we've already got a jump in the commercial area, we're already into a single management team construct and pushing sales opportunities. And now that we've got the new facility and the new investments there, we have the appetite to consolidate into those, and we also have the ability to meet demand as we continue to grow sales and we just didn't have that in Canton. So we're on a really good front-- we're on solid footing on the commercial market but a lot of work to do.

Okay, thank you very much.

Thanks.

Your next question comes from the line of Jeff Englander with Standard & Poor's. Please proceed.

Good morning, guys, or good afternoon, rather. Just a kind of a follow-up to Keay's, but a slightly different take. Can you give some sense of what your expectations are in terms of the ability to kind of drive the improvement process without a lot of bumps in the road? You did a very nice job this quarter, certainly above my expectations, in terms of rectifying some of the things you saw in the first quarter. You talked about some of the low hanging fruit and some of the operational people you put in place. It sounds like you've been very aggressive in terms of some of the changes you've made. And I'm just wondering, how-- what degree of confidence you can give us that this is going to have some linearity to it?

I think as much as I would like that-- there's a lot of individual projects going on right now, they do have discrete numbers associated with them. I think it would be a misnomer to say that we're going to be able to get a linear behavior, that's going to be smooth. But that's not to suggest that it's not predictable. We have very detailed managerial plans, that time out the individual projects so that we do have predictability in the financial results. We try to stage the projects to be able to be able to take and look at the overall work load and managerial load and be able to handle the appropriate number at the appropriate time. But the savings, because there's different opportunities and different projects for savings, and the quarter points, sometimes depending on the timing of the projects, can spill shipments and revenues to different sides of the quarters, it's hard to get a real smooth linear relationship in terms of things like earnings growth.

So as best we can, on the big projects, when we start those big projects, I'll watch through the best we possibly can to talk to the magnitude of them, so that there's some color on why things are not going to be linear. I don't -- I only expect one, maybe two of those programs, most of them I think will be smaller scope programs that we'll do that are more individual facility shutdowns, we'll talk to them on a completed basis. And I don't think they're going to create a lot of major jumps in terms of numbers. So I think the progress, because we're a larger Company now, there's more programs, we have more locations and there's more initiatives running, it'll be smoother than history. But we'll still on the big projects need to break out a little bit of color on those so that there's some understanding as to why a shift would have taken place. And we just don't have any of those right now to talk to.

Thank you, that's very helpful. Also, and I apologize if I missed it cause I had to hop off the call for a few moments, can you talk about any Orthopedics as to how many, maybe in a quarter sense, how long you expect the backlog to continue through?

My hope would be that there's two sources I think of pressure here, one is the successful product launches of our customers that drive the backlog, as well as what I would call historic backlog. It's-- it is there and we're working very hard to relieve that backlog on after acquiring the manufacturing facility to be a very good supplier for our customer. So relief of the historic backlog has been envisioned we wanted to be able to relieve that over the course of the year. Obviously, the successful product launches has exacerbated that situation, so I still think we'll bleed off the backlog, the historic backlog over the course of the year. And I think we'll be able to maintain pace with the market growth in the second half of the year. So I expect that as we exit 2008, we are going to have that managed successfully with our customer. And we are making the investments both in the managerial team as well as the facility to make sure we can do that.

So I don't expect it to result in blowout numbers in 2008, we're trying to do this over a nine month period of time. We've made great progress in the first three months, and then we got six months left to go. And then we'll be more of at a predictable synchronized rate with what the sales demand is going to be, which obviously right now is quite healthy. But I kind of view that as a-- as an effect that we're going to manage over 2008. And then I want to be more on a clean basis, working on new product developments with our key customers out of that facility for 2009. And that's essential to have it done in 2008 because of that.

Great, thanks very much. I appreciate the help.

You're welcome.

Thanks, Jeff.

(OPERATOR INSTRUCTIONS) And your next question comes from the line of Stanman with Man Investments. Please proceed.

Good quarter, gentlemen. I have several questions. One, when I look at your current gross margin and your operating margins, it seems to me that we always talked about getting to 20% operating margin and you were almost there. If we move margins to normal 40, and the way you're moving on SG&A and R&D, it seems to me we can expect moving toward a 20% operating margin in the near future. Do you kind of agree with my modeling?

Definitely. Stan, this is Tom Mazza. We basically have put out there that we think we can do 2% a year for the next three years, so it's going to add another 6% on the operating margin line. Can we do better than that? I mean, that's the goal post we've put out there for now. And clearly over the longer timeframe, if we get additional volume and stuff, potentially we could even do better than that.

All right, but can I just add something. The model you put out last year before the acquisitions moved you to about a 13% top margin for 2008, and if my numbers are correct, in order to get $1.50, you needed to be close to 12%. So 12% and 6% make 18%. And I'm talking about a maybe a four-year frame, and I really would like to hear Tom answer the question, Tom Hook.

Yes, I'd be happy to. As I -- in November when we talked obviously, there was two kind of base assumptions there, what the mix of the business was going to be post acquisition and what the person's accounting was post running those numbers and adjustments and digesting that down through the financials. So I -- obviously, we know what we started out the first half of the year at is-- I kind of view that as first half year is the starting point. I see we have the programs and initiatives to sequentially improve that by a couple hundred basis points a year. We obviously have two to three years of hard work to do. I would say that we are not -- we don't want to be optimistic with regards to growth in the underlying markets, because we think that can -- we're going to try to plan ahead for growth. We should be planning ahead for capacity, we should plan conservatively for growth, which is what we've done. So we don't want to rely on a lot of growth to come to us to be able to get these gross margin and operating margin profitability. We just have to do the hard work in the manufacturing environment to perform that. And that's what the couple hundred basis points is predicated on.

It's not just driven by a big bowl of sales over the course of the three years, it's driven by hard operating cost reductions and consolidations that drive technology adoption as well as elimination waste and manufacturing. We've already got a start on those things, and we already shut multiple facilities down, so we're already showing-- it isn't like I want to just wait to the second half here to show progress. But you're absolutely right, is that there's a way for us to get back to our historical margins on the gross margin basis as well as get back towards the operating margin target of 20%, which we'll continue to say is a long-term goal. And I will say, if you obviously were a big believer in us and following us to that point, following the first round of consolidations, we obviously have diversified and become a broader Company, but we have the operating talent and skills, we have a very talented operating team to deliver this on this round of consolidations.

So the mix of new businesses can give us the potential in time of a 40% gross margin which has been sort of traditional, even with this mix, moving forward, possibly.

Yes, I mean I think, I think less in terms of gross margin than I do operating margin, because the flavor of businesses is different in each segment in terms of what we make. But I would agree with your statement that in the long run we can become a 20% operating income business and we can make these new markets that we've entered. We can use our operational expertise in concert with the technical and business expertise in the acquired companies and work together to obtain the 20% operating income number. And that is the long-term objective. And I say it long-term, but I do mean to suppress that in earnest with the consolidations over the next three years.

Okay. And second question on Ortho, your competitor in outsourcing in Ortho has been growing over 20% a year, double-digit, let's say double-digit. I know that you're-- the business that you bought, Precimed, is a European based Ortho business, I believe. Do you see that type of growth rate for that particular business Ortho -- your Orthopedics.

Yes, I think what we did is we tried to break out a little bit of color in terms of where we thought the underlying growth was going to come from in Orthopedics, we said 10%, 12%. I think couple of things we're conscious of here is, we obviously like to do designs of technology in which we are able to do the research, develop those technologies and sell them out into customers. It tends to be a little bit different model than when we're actively functioning like a pure outsource or a contract manufacturer. So the flavor of the business in Orthopedics has two different elements within Greatbatch. The areas where we want to do more research and more innovation on, we expect those to feed a higher margin products because we're making investments in those areas.

I would say yes, there's certainly other competitors in this market space that may have higher unit sales and higher sales in terms of growth because they're more well established, they're in broader geographies. And I just think that's why, because we think we're very good at this, this is an attractive place for Greatbatch to be. We're not going to win 100% of the time, but we think there's plenty of opportunity out there for us to grow this aggressively at double-digits for multiple years, because we're going to put the operating and engineering sophistication behind becoming very good. And there's more than enough room for another competitor in this marketplace that knows how to do it well. But we'll never win the majority of the business, we'll earn our fair share and I want to be profitable in that fair share. So I'm -- we want good double-digit growth rate, but we want quality growth rate that comes with good margins that returns to the shareholders.

Okay, my last question. On MRI, you indicate that it's a -- you have a proprietary-- you've got an intellectual property position on the MRI technology. You indicate that you've got a Sorin relationship -- development relationship. Do you have any feel at all for commercialization of the initial product utilizing your MRI technology and CRM and the type product?

I think we have a feel for it, but we will only commercialize through our key OEM partners. So we view it much like we would an individual component, a capacitor or feed through. We view it as, it's a subsystem that we're able to do because of these acquisitions, like Quan Emerteq and Enpath, we can take the lead-wire expertise, combined with our filtering expertise, and offer a more system solution. It speeds product development and allows us to partner more closely with OEMs. So we will only work through them at commercializing it. We've had very good discussions so far, it is very early in the game. It's only been the last couple months that we actually we've done the system's testing to show them results.

We have a lot of work to do with them in terms of integrating it into their product plans. And I think while we're doing that, we're working with them to get a flavor of what that end market opportunity is. So we're kind of highlighting it as a wonderful technology. We have not yet determined clinically, and can't do that without our key customers helping with us and working together to say what the real value is. And from a clinical setting over the long run in the overall market.

Do you see a U.S. manufacturer tieing in with you at this point, other than Sorin?

I think we will be able to enter active discussions with every CRM and Neuromodulation customer. We think it's a very broad technology and we think that it's got opportunities everywhere. We're working on understanding where we need to be from a cost and performance standpoint. In other words, what filtering's important, what filtering's not important, what's the cost of manufacturer, obviously we have to make sure we have a durable risk free design. So I think all those things we're actively working on now, and I do expect us to make progress with customers in the U.S. markets as well, both in a variety of not just in the CRM market, but also in the Neuromodulation space, which is arguably even more important.

Okay. Thank you, good job, gentlemen.

Thank you, Stan.

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

Thanks. I would like to remind you that the both the audio portion of this call and the slide visuals will be archived on our website at greatbatch.com and will be accessible for 90 days. Thanks, everyone, for joining us.

Thank you for your participation, that does conclude today's conference, you may now disconnect. Have a great day.