Integer Holdings Corp (ITGR) 2009 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 the Company's annual report on Form 10-K. The statements are based upon Greatbatch, Inc.'s current expectations and actual results could differ materially from those stated or implied. The Company assumes no obligations to update forward-looking information included in the conference call to reflect changed assumptions, the occurrence of unanticipated events, or changes in future operating results, financial conditions, or prospects.

I would now like to turn the call over to today's host, Corporate Controller and Treasurer, 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 terms of today's agenda, Tom Hook will start by providing a few brief comments regarding our second quarter results and then he will update you on our major strategic initiatives. After that Tom Mazza will provide further comments on our second quarter. We will then open up the floor to Q&A. As we have done in the past, we're including slide visuals which go along with our presentation, which can you access on our website.

Now let me turn the all over to our President and Chief Executive Officer, Tom Hook.

Thank you, Marco. I would like to thank everyone for joining our earnings call today. We're pleased to share with you our results for the second quarter 2009. I am proud of our success and feel we have made many accomplishments in the first half of the year. Despite the ever-increasing pressure of today's operating environment, we continue to make solid progress towards both our short-term operational and financial goals, as well as our long-term strategic objectives. During the quarter, revenue decreased 5% over the prior year period. However, adjusted operating income increased 5% to $14.9 million or 11.1% of sales. Similarly, operating income calculated in accordance with GAAP, increased 10% to $12.5 million or 9.3% of sales. We continue to be pleased with our operating margin performance, which benefits from streamlined operations as well as improved manufacturing and administrative efficiencies. We remain committed to ongoing improvements on our operating performance through continued facility consolidation and integration, optimization of our production efficiency, and product development activities focused on high value-added products. Tom Mazza will provide additional detail on our second quarter financial results later in the call.

While we remain focused on achieving our financial and operational goals for the year, we are also keenly aware of the market issues that continue to impact their business. The pressure on Electrochem is mainly driven by decreases in energy and portable medical expenditures due to lower oil prices and uncertainty in the healthcare industry. Additionally, we are seeing some impact on our orthopedics product line as the current economic climate has had a negative effect on the number of new product launches and elective surgeries being performed by our customers. This effect, combined with some inventory runoff over the last six months, has resulted in lower volumes, which has had a direct impact on our operating performance. However, we remain confident in the underlying long-term trends for the orthopedic and Electrochem markets and our ability to expand our customer relationships and streamline our operations. We believe this will provide us with a competitive advantage once the markets begin to recover.

In these uncertain economic times we believe that remaining dedicated to our strategy of diversification, streamlining our operations, and driving growth through innovation will not only help Greatbatch emerge from this recessions as a stronger Company, but also better positioned to meet the unique, customized demands of our customers.. Diversification is one of our key long-term strategic initiatives. It has created multiple opportunities and will help drive our revenue growth. At the same time it reduces our concentration risk and brings us stability during the various economic and customer cycles. We have made great strides in diversifying Greatbatch and will continue to integrate our businesses and look for cross-selling opportunities within our blue-chip customer base that will drive both near-term and long-term revenue growth. Driving operating performances is also a critical part of our long-term plan to drive shareholder value. During the quarter, we made progress with a number of ongoing consolidation initiatives, and we move the newly acquired businesses to the Greatbatch operating model.

More specifically, we completed the transition of our Blaine, Minnesota, manufacturing facility into our Plymouth, Minnesota operations ahead of schedule and under budget in April. We continue to transfer operations from our Electrochem facility in [Teteroboro], New Jersey, into our [Rainem], Massachussetts, facility, which remains on-track with our original plans. We successfully closed our [Exton], Pennsylvania, administrative offices in April and finally, we completed the Oracle ERP system implementation at our seventh acquired facility in July. These initiatives, as well as the consolidations completed last year, will continue to drive operating margins in line with our expectations throughout the remainder of this year and help us reach our financial and operating goals. Looking ahead, we still see numerous opportunities that we plan to tap into. At a high level, we believe we can generate additional sales volume from cross-selling opportunities, creating additional synergies through further consolidations, additional synergies through the implementation of lean manufacturing initiatives and supply chain improvement. And also by continuing to move the Company to a common ERP platform, which will further allow us to centralize our back office, finance and IT functions, and also laying the ground work for future growth.

Our last key strategic initiative is to drive growth through developing new technologies and innovation. During the quarter we spent approximately 8% of our sales revenue on Research & Development. We expect this percentage to increase for the remainder of the year as we continue to invest resources in the development of new technologies and solutions for our customers. The continued investment in R&D will enable us to maintain our leadership position in our core markets and drive further margin improvements once our consolidation initiatives are complete. Ultimately we believe this investment will facilitate a more diverse product portfolio and multiple future growth platforms. Based on our current portfolio and R&D activities, we feel we are at a strong competitive position for future growth and profitability.

Finally, I would like to reiterate what we discussed last quarter with regards to the successful launch of our new Greatbatch family of companies. We feel these companies and the identity system we now have in place will be successful in driving brand awareness, preference, and loyalty. The new Greatbatch family of companies is strategically aligned to deliver unprecedented performance, reliability, and critical technologies to allow our customers the opportunity to bring their solutions to market. Greatbatch is now unified under a global brand based on reputation of excellence and reliability, and we look forward to benefiting from this strategic move in the future. While we do see some challenges in the second half of 2009, we believe our strong cash generation, portfolio of intellectual property, our financial discipline and effective cost structure, will enable us to continue to increase shareholder value and successfully drive Greatbatch through the economic downturn.

With that, I will now turn the call over to Tom Mazza for a review of our second quarter financial results.

Thanks, Tom. And good afternoon. Sales for the second quarter were $134.7 million, compared to $141.6 million in the 2008 period. The Cardiac Rhythm Management and Neuromodulation product line reported revenues of $78 million for the second quarter, A 10% increase over the prior year quarter. Results from the period benefited from strong feed through, coded component, and assembly revenue partially offset by lower capacity sales. CRM revenue is significantly impacted each quarter due to the timing of various customer product launches, shifts in customer market share, and customer inventory management initiatives. The last several quarters of CRM revenue have benefited from the timing of various customer product launches and is expected to begin to return to more normalized growth levels for the remainder of 2009.

Second quarter revenues for our Vascular Access product line were $9.2 million compared to the prior year quarter revenues of $9.8 million. This decrease was primarily due to lower capital revenues. We remain optimistic about the potential for this product line as we continue to work with customers on new product development. However, many of these products that we are working on today will not be seen in our results until 2010. The Orthopedic product line reported revenues of $31.4 million for the quarter, compared to $41 million for the second quarter 2008. Current quarter revenues include the negative impact of foreign currency translation fluctuations of approximately $2 million as well as other market conditions. Additionally, second quarter 2008 revenue included the benefit from the lease of approximately $3 million of excess backlog. We believe that year-over-year comparisons in Orthopedic revenues will continue to be challenging for the remainder of 2009. We continue to streamline and invest in your Orthopedic operations, which we believe presents significant future opportunities.

Second quarter sales of our Electrochem business segment were $16.2 million compared to $20.1 million in the second quarter 2008. This decrease is consistent with the slowdown in the energy and portable medical markets over the last two quarters, which are driven by lower oil prices and uncertainty in the health care industry. We continue to actively manage our business so that we will be better prepared to meet the needs of our customers once the markets recover. Our gross profit margin was 30.8% compared to 28.7% for the second quarter of 2008. This improvement was driven by a shifting mix towards higher margin products as well as the impact of consolidation mix shifts completed over the past year. Our selling, general and administrative expenses for the second quarter of 2009 decreased by $800,000 compared to the same period of 2008. This decrease was primarily due to lower legal expenses of $2.2 million, partially offset by increased corporate development initiatives in IT, human resources and sales and marketing.

Net research, development and engineering cost for the second quarter were $8.7 million, which has expected were $1 million higher versus the second quarter of 2008. Due to the strategic decision in 2009 to further invest resources in the development of new technologies, in order to provide solutions to our customers and ultimately drive long-term growth. Other operating expenses incurred in the second quarter of 2009 were $2.4 million, primarily including cost incurred in connection with our various consolidation issues and the integrations of our acquired businesses. We anticipate that these costs will remain at the current levels for the second half of 2009 as we continue to integrate and consolidate resources across our entire infrastructure. GAAP operating income for the second quarter 2009 increased to $12.5 million compared to $11.4 million in the second quarter of 2008. Similarly, adjusted operating income was $14.9 million in the second quarter of 2009, compared to $14.2 million for the second quarter of 2008. More meaningful was the expansion in operating margin to 9.3% on GAAP basis and 11.1%on an adjust the basis. This expansion in operating margin is indicative of the type of improvements we are trying to achieve through our various consolidation initiatives and streamlining operations.

Effective tax rate for the second quarter 2009 was 19.4%, compared to 27.4% for the same period in 2008. The 2009 second quarter effective tax rate includes the impact of favorable resolution of tax audits in the second-quarter of 2009. Effective tax rate for 2009 -- for the full-year 2009 is expected to be approximately 29%, because of the impact on these certain discrete items. Both our GAAP and non-GAAP earnings per diluted share increased 33% over prior year quarter. More specifically, earnings per share per diluted share on GAAP basis were $0.28 per share, compared to $0.21 per share in the second quarter of 2008. Adjusted earnings per diluted share were $0.40, an increase from $0.30 per share in the second quarter of 2008. Progress that we have made on our strategic initiatives and our results for the first six months keep us on track to reach our guidance for the year. As we believe the current year results will fall within the range provided at the beginning of the year, our guidance remains unchanged at $550 million to $600 million for revenues and between 11% to 13% for adjusted operating margin. Which includes GAAP operating income less non-recurring costs associated with plant consolidation and integration of acquisitions of approximately $10 million to $13 million. GAAP operating income is expected to be between 8.5% and 10.5%.

Although we're confident of our guidance, we continually monitor our business due to the current state of the markets. The factors that we see potentially impacting this guidance include continuing softening in the orthopedic and commercial energy markets, potential delays in elective surgeries, foreign currency volatility, changes to insurance reimbursement policies and potential customer inventory adjustments. We are in solid financial position with strong cash flow from operations, access to over $100 million under our line of credit and long-term financing in place. During the current quarter, we generated approximately $22 million of cash flow from operations, which enabled us to pay off $10 million or 8% of the outstanding balance on our line of credit. We have worked hard to implement an efficient operating model while making the necessary investments in short growth across our various product lines. Additionally, our cash-flow generation has provided us with sufficient capital to execute on all of our strategic priorities while also paying down our debt. At the current time we are utilizing any free cash flow generated from your business to continue to pay down our debt. Despite limited visibility in our industry, we remain confident in your ability to reach estimated revenue and operating performance throughout 2009, while continuing to invest in new technologies to support our long-term growth initiatives and emerge from the economic downturn as a stronger Company.

Let me now turn the call back over to the moderator to take questions.

(Operator Instructions). Your first question comes from the line of Mr. Tim Lee from Piper Jaffray. Please proceed.

Good afternoon and thanks for taking the question. First on the Orthopaedic side, you mentioned the FX impact and destocking impact and benefits of the numbers you saw last year. When you take out all those, I guess I'm getting about 12% decline on year-over-year basis. Is that the right way to think about it? And of that how much was tied to the slowdown in the industry versus the destocking efforts by your customers?

Well, I think if we just -- obviously, we have a split business here in both implants as well as the instruments and trays is clearly launches are very driven by instruments and trays in particular and with the number of launches down, that has a direct impact there. Clearly, the implants are more linked to the overall procedural volume and the growth there is tempered mightily, and then we obviously are linked very closely to one particular customer and tied to them. So as they have adjusted inventory levels in their system, it has a direct impact on us, since it's a very tight supply chain that has a direct impact on us. The two halves kind of have different algorithms that function with it.

In terms of your customer streamlining their inventory levels, has that level finalized or should we see more of that impact here in the third quarter?

I think the way we like to think of it is that when someone is going to rationalize that inventory in a system, they take a look over multiple quarters and make an adjustment for that and they kind of spread the wealth, so to speak, and move in that direction over a period of time. So we expect to see it, just like we saw last year with the backlog being off over the year, we expect some of the inventory shifts not to be instantaneous in this quarter, but to be spread across the year and normalized near the end of the year and not be in effect in 2010.

And just one more, if I may. I know you guys have stayed away from given quarter-to-quarter revenue guidance, but relative to your thinking the sales number this quarter came in a little light, but internally was this a good quarter for you? Was this a quarter that work needs to be done? How would you characterize the overall topline results here for this quarter?

Tim, great question. As you know, I'm rarely satisfied and given the environment, we're pleased with what we have done on an overall financial performance basis, in particular how we have been able to enhance the profitability and invest more in R&D. But I'm not satisfied with the top-line revenue performance. We have got a lot of headwinds in your face, that you pointed out in Orthopaedics and Electrochem. We have done a good job in Cardiac Rhythm Management and Neurology. We weren't able to make up for all the headwinds and we lost some ground on the topline, but our operations were and to push through some nice gains on profitability, and we have to do a better job in the second half of the year at getting the top-line back to the growth trajectory that we would like to see, which would clearly enhance profitability even more.

Very helpful. Thank you very much.

Your next question comes from the line of Mr. Glenn Novarro with RBC Capital Markets. Please proceed.

Thanks. Good afternoon, guys. Two questions. One, in your handout on the website you mention that your guidance assumes market growth rate of 5%. Tom, I'm wondering if you could just break out those assumptions a little bit further between CRM, Orthopaedic and Electrochem in terms of market growth rate. The second question I have is related to the revenue guidance. Given where you are through the first half of the year, you think that it's better to be at the lower end of the revenue guidance given the challenges in the back-end of the year? Thanks.

I assume you meant Tom Hook.

Yes, sorry.

Obviously we avoided trying to provide quarterly guidance and we're comfortable with the 2009 guidance on sale and operating margin that we provided. We understand where we stand at the halfway point literally is halfway to the low-end of guidance. So we have a lot of work to do in the second half of the year, but we're confident that we'll finish in the ranges where have designated. Obviously the market growth rate of 5% is kind of a consolidated market growth rate. We're see something healthy trends in Cardiac Rhythm Management, Neurology for our customers both in the US and outside of the U.S. I think Orthopaedics clearly is slowing down, but definitely it's in that mid/single-digit range. I think clearly the Electrochem business is where the most dramatic changes have occurred. Obviously this is a smaller section of our overall business,being 10% to 15% of our revenues, but drilling activity, (inaudible) and a lot of the oil service companies in particular is down. Obviously the Electrochem business is not only oil and gas-related. A lot of it is portable medical, et cetera, but we definitely see that in negative growth territory that we averaged in. So with all the data we have seen, we think that the market will grow close to 5% neighborhood on a consolidated base as we define of markets. I think it's a very good assumption still and I think right now when you look at our growth opportunities, we can add growth on top of what the market should be giving us and that is what we're planning for.

Okay. Just one follow-up; because I think most of us on the call have a good feel for the CRM and the Ortho markets, so just to recap. For Electrochem, you don't want to give specifics, but those markets are going to be negative, and then when you add up ortho, CRM and Neuromodulation, those markets you are predicting 5% or better? Is that accurate?

That is for the second half, Glenn.

That is a fair statement the way you have stated it.

Okay. You don't want to comment at all on the full year guidance, where the stree should be?

The range.

Okay.

Again, we feel comfortable with where it's at for the year. And obviously, every quarter we analyze whether we want to make an adjustment or not. We're very comfortable with what we have out there, and we don't plan on changing it.

Okay. Thank you.

Thanks, Glenn.

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

Yes, thank you. Tom, can you help us understand which specific component areas you expect to continue to be able to gain revenue growth faster than the targets that you are serving?

I think that could be a tricky question, because I believe -- I will start off with the most challenging market first, which is Electrochem. And even though the market is declining, we can stay ahead of the decline by winning customer orders. I will say that during my five years with the Company, our product development activity is as high as it has ever been in terms of projects for customers. That, to me, is always a leading indicator, that the revenue is going to come. The macro market impacts in the slowdown of orthopaedics, kind of lower growth rates over the past multiple years in Cardiac Rhythm and Neurology are the headwinds that we fight, but in terms of opportunities I still is see across the board on the product lines from Cardiac Rhythm Management is full of growth opportunity. Because we're such a small player in Orthopaedics and Vascular, the opportunity set there is much larger, because we have a lot more ceiling room to go up against. So a lot more opportunities to bid upon.

I think the additional thing that we have done is as we have done more of the acquisitions and we have been able to merge several technologies together to do more comprehensive design work for our customers, it results in a more complicated sale that has a longer gestation period, but results in a better product mix for us. That is an opportunity. We have never been able to do that type of work with customers before and now we can take more of those integrated projects on and obviously have to push those through the customer approval loops and their FDA approval hoops to result in revenue for us, but we still think strategically all the leading indicators is that we can grow in all of those product categories right now. While some have longer gestation periods than others, we still see plenty of head room, fundamentally, in all of the markets to grow.

Help us understand the timing of when your product solutions can start to have an impact? It sounds like we're not really going to see that in the second half of that year, but maybe 2010 is more reasonable. Can you narrow that down for us?

I certainly can. I think the opportunity set for us in the nearest term really results from two things. One would be the projects in Orthopaedics tend to be on quicker loops than in Cardiac and Neurology, which tends to be on longer qualification windows. However, in Cardiac and Neurology side because we have been investing in that for years and we have really gotten a head start or jump relative to the orthopaedics business, we have already seen some of the fruits of our labor coming out in the Cardiac Rhythm Neurology Management number here we are presenting this quarter. We have been enjoying some of that growth, and I think we're positioned with what R&D investments we have made to continue to be able to capitalize on the technology wins that we have and maintain a good pace of product wins with customers, and we will continue to grow in those areas. I think Orthopaedics we can recover quickly from the headwinds that we have here, even if we still have some challenging market conditions relative to overall market growth. I still think we can, as we're professionalizing our operations and partnering closely with customers, we can pick up meaningful amounts of business over the course of the next 12 months.

How much we can pull of that into 2009 is going to be limited based on lead times, but certainly in 2010, there is more opportunities for us in Orthopaedics. I think in Vascular we have been operating under the cloud somewhat of having issues with launching our ViaPeel product lines because of the lawsuit that we had with pressure products. So that put us behind on a timing base, but given that that appeal decision we're waiting on and we have done some work on new product lines that work around the problem. We're in a better position to be able to capitalize in the vascular access markets in 2010 as well. So although that has been a down year and it's not what we planned on doing, we have good prospects there. I'm also a big believer on the Electrochem side that as the national healthcare issues are clarified, the portable medical will get back on track to more where it has historically been, and also the oil and gas industry when the global economy stabilizes, drilling activity will pick up again and we expect some recovery of that and we're just maintaining close linkage to the oil services companies and their capital deployment plans and their drill schedules to be able to support them. We see that coming back slowly in 2009 into 2010 and a lot of the inventory hits and stoppages that we have seen in the first and second quarter, that will normalize out and we'll start to recover the revenue streams there as things return more to normal. So I hope that is a little extra color that helps you on each of the product lines from a trajectory standpoint.

That was very helpful and maybe drill down on a couple of specific product lines that you have talked about in the past. In Cardiac Neuro, which would be your high voltage cap and your MRI-compatible. Where are you with those products?

High voltage cap actually has a couple of iterations. The high energy capacitor and the high voltage capacitor both of those -- high energy in particular is in customer wonderful cation loops right now. In customer programs the high voltage is still in product development. A year and a half to two years ago we split that program into two pieces based on customer input. So half of that program is being qualified and the other half of that program is still in the product development stage. On the MRI lead wire initiatives, we have been very active in terms of doing the productization of those technologies. So we have platforms. We're linking very closely with our OEM partners. We have one agreement in place that has been announced with a European customer, and we have multiple negotiations that are ongoing. We have done a very good job of protecting our technology from an intellectual property standpoint and we have done a very good job at engineering and miniaturizing the ultimate solution, but it will come to market with our OEM partners. There is a lot of interest here.

We're still not ready to be predicting revenue in the next 12 months, but I would say on a product development and a project engineering standpoint with specific customers, we're at our band width in terms of activity and really could not do it any quicker, given the work that has to be done. So I'm very pleased with that project. The project team has done an exceptional job on this one. I think on our original track and schedule with our key OEM customers, we plan on continuing to progress that one towards the market. A lot of complications on that in terms of technology deliverables and operational deliverables, but so far we have been progressing very nicely on it, and I look forward to highlighting that in future as we generate more results with our OEM partners.

So for the (inaudible) maybe a 2011 product launch in Europe?

I think that is a fair statement. Clearly we rely on our partners to really commercialize the individual technologies that we produce, to do the work that is required to get them finally qualified, to sell in the end markets. That is consistent what their plans are. We would certainly feel more comfortable if you asked them directly, but that is our understanding.

Very good. Thanks for the color, Tom.

Your next question comes from the line of Jason Mills with Canaccord Adams. Please proceed.

Hi Tom and Tom. Thanks tor taking my question. Want to start with Keay left off on system level product initiatives. You talked about them a little bit in the past. It seems the number of initiatives in the pipeline pale in comparison to the ones you talked about to date, Tom. So perhaps you can give us a little more color and also help us understand in your mind how this potentially could augment the Company's profile with customers and perhaps even change the slope of the Company's growth trajectory, understanding it's longer term.

It certainly is an excellent question, and I would be happy to provide some more color in general. In each of the product line categories we have, we have multiple technologies that we can use together. So if it's Electrochem rather than making a sensor and battery we can make sensing systems that are networked together. Vascular business we could make, rather than [sheaths], we can make steerable catheter kits. We can just do a higher-level product design and assembly for our customers. Before a year ago we never had the ability to do that integrated design and contract that way with our customers. We can only effectively sell the discrete products themselves and they were left to do the product integration, assembly, packaging, sterilization, and tests. On a project-by-project basis as each OEM customer is willing to define their needs, we're able to offer something other that that a la carte solution for discrete components. We could offer subsystem more integrated system solutions from a design and manufacturing perspective.

So we can now do and have been successful at doing some projects around the vascular product lines, in particular, and some cardiac rhythm management like lead wires. Rather than making components is doing a more integrated qualification. We only do that right now with regards to specific programs with specific customers. So we have seen those in lead wires. We have seen those in our steerable sheath as they relate to oblation. We have seen those in vascular introduction kits, and we have seen those even in the Electrochem in applications in wireless sensing. Those products tend to be a lot more complicated because we're asked to do a bigger load of the overall design work and we have to validate those for the customers and then in turn, cooperate with them in terms of how their commercialization efforts move with their marketing teams. So the gestation period for these products is longer than our typical discrete component product line, gestation period, which results in effectively an increase in R&D expense, which we're seeing on the P&L this quarter and we'll continue to see, but you are right. It It does produce a revenue opportunity for us.

We're -- not only do we get the discrete component revenue when we sell those, but we also get the value of the integrated system or subsystem that we sell to. And we don't have revenue of that category today as a Company. So in the future, as we highlight these moving into commercialization as a corporation, that we worked on very hard on over the last year to 18 months to win these projects, contract with customers and show the benefits of those, we'll be able to highlight more and give more color on both in terms of financial guidance and project-specifics, where we have won those, which ones are reaching commercialization and which ones -- obviously which ones the customers have FDA approval? Let them highlight and they can highlight our involvement in the project. So there is more good news to come on that front, but for the second half of this year and into the beginning of 2010, we have a hot of work to do on the project engineering side to push these through the project qualification systems and frankly move on to the next set of projects that the teams have to roll off into to win the next batch.

That's very interesting. Let me go a little further there. You mentioned R&D spending is showing up as it relates to these projects. Revenue associated with systems-level sale to your customers has not -- will not show up for a little while. Is that a correct assessment insofar as your current guidance for operating margins this year inclusive of that R&D spending includes expenses associated with these projects, and therefore, while we won't see the revenue, we're going to see the cost. And the second part of that question is, roughly speaking, while you haven't given 2010 guidance and certainly not 2011 guidance , I'm wondering within what time frame you think is realistic to start to see some of these systems level revenue projects hit the P&L? And the third part of the question is within the systems level sale, what does Greatbatch bring to bear that is proprietary and how sticky is that, once you get that business on a system level, how sticky is that business? Is it more or less sticky than a discrete level component

Okay. I'm just going to handle those a little bit at a time. You are correct in assuming that. You are seeing the cost of the seeds, but not any of the juice coming out. You are seeing the impact on the P&L, the R&D expense on those projects. We have yet to show that we can produce that revenue. We have to prove that by getting the customer qualifications down and have them commercialize to generate revenue on those products for us. You are correct that the guidance does not include those system level impacts for 2009 and really on a 2010 or 2011 basis it would only evolve into the P&L. Clearly right now we have $550 million to $600 million of discrete-component sales that dominate our revenue stream. As we move into systems, we will slowly see those P&L numbers change for the addition of a system level sale, but it will be evolution and not a revolution on that growth. We'll, of course, incorporate that into the overall guidance for 2010 and 2011 for overall revenue.

Our (inaudible) in the Company is to design and manufacture discrete components and subsystems expressly customized for OEM use. That is our whole business model. In that, we embody our intellectual properties that we protect and a long-term supply agreement with our customers. So whether it's a discrete component or subsystem, we have a mutually cooperative relationship that is, for lack of a better word, that you used sticky, that allows us to understand how we cooperate and who does what in part of the relationship. So I don't see a change in terms of how we do a discrete component customized design for a customer or we do a system. The systems tend to involve the design of multiple discrete components, but they are still under an agreement with a customer in terms of the development and also for manufacturer. It provides them predictability. It provides us a level of security, and it has a common understanding on cooperativeness.

You could impugn in that, because there are multiple technologies in a system that it may be stickier, but I think each of technologies have to stand on the merit of themselves to be valuable for a customer. That is up to us and our pressure to do that on a value-added base for them. And we have been successful at winning those with customers, and we have continued to focus on them and that is going to drive some nice business for us and it will become an ever increasing percentage, probably starting in 2011. It will start to build from there. We won't abate our growth in the discrete component area, but we'll complement that growth with system level sales that will also contribute to the revenue growth.

That is very helpful. Last question, back to your guidance. It seems like you have much more control, perhaps even more visibility because you have more control on your expense infrastructure. So insofar as you can't predict what is going to happen in Orthopaedics and Electrochem in the second half of the year. It seems like folks are generally more comfortable given where you were at in the first half of the year to be towards the lower end of the revenue range. Just guessing from the questions here and looking at where people are already in consensus. I'm wondering though, does that necessarily mean that the lower end of revenue would equate to the lower end of operating margin guidance, or do you have more visibility and control over the operating margin line on your expenses and the speed with which you are consolidating plans and driving efficiencies?

Well, you are right. I think it definitely is fair to say that we have fewer levers on the revenue line item than we do on the operating income line is internally, we control the consolidations and the integrations and the pace. We also control the rate of our increase in Research & Development spending. We control our expense take out from back office perspectives, and we clearly, obviously, have a flow down of profitability from the top line sales. So we do have more levels of control on an operating margin perspective as we explained before. As you know, Jason, is that we don't like too kickoff R&D spending until we have visibility on the productivity coming out of the P&L. So we're very judicious at our increases in R&D spend. We like to make sure we have this covered from an operating perspective to afford those investments.

And we put a great deal of pressure on the businesses, especially in the manufacturing facilities to perform -- to produce that productivity, to meet our contractual obligations with customers, and then also to create incremental profitability and increase profit margin and we take a slice of that to increase our Research & Development expenditures. We are loathe to increase Research & Development expenditures before we can see the plan for delivering that profitability. So we do have more control levers. It's not infinitely controllable, because when we start R&D projects we don't turn them off. We maintain them running. The nature of the project is once you start one you have to see it through to completion with the customer. We can't be controlling expenditures. We tend not to start new ones until we're in a configuration where they are affordable.

Got it. Thank you very much.

Your next question comes from the line of [Stan Manney] with [Manney Family Investments]. Please proceed. Mr. Manney, your line is open. You have a follow-up question from Tim Lee with Piper Jaffray. Please proceed.

Thanks for taking the follow-up. Just one quick one, in terms of some of the summer seasonality, particularly in Europe, I think last year you talked about the (inaudible) facility being shut down for August. Will we see a similar phenomenon this year?

That is correct. That is correct.

Should we see that in the other line items as well? Should we see a similar seasonality in CRM or vascular?

I this it's very much a European effect. You are correct, it's an Orthopaedics line item for us, typical with what other European operators would see. Clearly we're shipping some things out of inventory, so it's not just four weeks off, but you are right. It is an effect and we expect to see that seasonality every year.

Great. Thank you.

(Operator Instructions) That concludes today's question and answer session. I would like to turn the call back over to Mr. Marco Benedetti for any closing remarks.

Thanks. I would like to remind you that both the audio portion of this call and slide visuals will be archived on our website at www.greatbatch.com and will be accessible for 30 days. Thanks everyone for joining us.

Thank you for your participation. That concludes today's conference call.