Integer Holdings Corp (ITGR) 2009 Q4 法說會逐字稿

Welcome, everyone, to the fourth quarter 2009 Greatbatch Incorporated conference call. Before we begin, I would like to read the Safe Harbor Statement. This presentation and our press release contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and involves a number of risks and uncertainties. These risks and uncertainties are described in the Company's annual report on Form 10-K.

The statements are based upon Greatbach Incorporated current expectations and actual results could differ materially from those stated or implied. The Company assumes no obligation to update forward-looking statements. Information included in this conference to reflect change assumptions 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 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 fourth quarter and full year results and then he will update you on our major strategic initiatives. After that, Tom Mazza will provide further comments on our financial results. 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

Thank you, Marco. I'd like to thank everyone for joining our earnings call today. We are pleased to be able to share with you our results for the fourth quarter and full year. I'm proud of our strategic accomplishments in 2009. And the fourth quarter concluded what I consider a successful year for Greatbatch.

This year provides additional evidence of our execution and progress towards achieving both our short-term operational goals and our long-term strategic objectives. With that said, I was not satisfied with the level of our revenue we achieved in 2009. Despite the turbulent global economy and uncertain health care environment, markets we operate in provide us opportunities and we need to take advantage of them. As a fellow shareholder, I can reassure you that we have taken and will continue to take measures and actions that enable us to capitalize on these opportunities. Now let's look at our financial results.

As you can see from the highlights listed on slide five, this was a solid quarter. Revenues of $125.8 million were below 2008 but encouragingly were 4% above the third quarter. For the year, our sales were $522 million, which is in line with our recent guidance. Cardiac Rythym Management and Neuromodulation revenue continued to be stable during the quarter and our orthopedic and Electrochem product lines showed modest improvements from their third quarter lows.

While we expect these difficult market conditions to continue to impact all of our product lines in the near term, we remain confident that the steps we are taking to deepen our customer relationships will position us to benefit when the broader economy and health care industry improves. During the quarter, management continued to make the difficult cost cutting decisions to help offset the impact of lower revenue levels and higher R&D investment on profitability. These steps, along with the progress we have made in our consolidation integration initiatives helped improve our adjusted operating income to $16.4 million or 13.1% of sales for the quarter. Which is slightly above the 13.0% in last year's fourth quarter and well above the 11.2% in the sequential quarter.

For the year, our adjusted operating income margin was 12%, which was in line with our guidance set at the beginning of the year. While I consider this a significant accomplishment given the difficult operating environment, we remain committed to ongoing improvements in our operating performance through continued facility consolidation and integration. Optimizing our production efficiencies and product development activities focused on high value added products. Tom Mazza will provide additional details on our financial results later in the call. I think now, more than ever, is a time in which we need to focus on our long-term strategic objectives as they will be an integral part of driving our business through this economic downturn and setting the stage for a strong recovery.

In these uncertain economic times, we feel that remaining dedicated to our strategy of growth and diversification, driving operational efficiencies and delivering innovative solutions will not only help Greatbatch emerge from this recession as a stronger company, but also better positioned to meet the unique customized demands of our customers. Growth and diversification is one of our key long-term strategic initiatives. It has and will continue to create new opportunities while simultaneously reducing our concentration risk. We believe this will provide greater stability as we move forward and better serve us during the various economic and customer cycles.

We are confident the long-term benefit of this strategy far outweighs the near-term impact benefit we have seen in recent quarters. One example of the progress we have made in this initiative is the 7.5% increase in 2009 sales we experienced with our four largest OEM customers. This was a direct result of taking advantage of cross selling opportunities and deepening those relationships across product lines and markets. During 2009, we also made progress in diversifying our revenue which included further leveraging our capabilities at our Shomault facility to keep knee implants and significant progress was made toward providing full system solutions to our vascular customers which I will further discuss later in the call. We are proud of the strides we have taken to diversify Greatbatch, but realize that we need to do a better job of taking advantage of the long-term growth opportunities within the key markets we operate in. Driving operating performance is our second strategic initiative and is also a critical part of the long-term plan to drive shareholder value.

During 2009, we made significant progress with our consolidation and integration initiatives as we move to our newly acquired businesses to the Greatbatch operating model. More specifically, during the fourth quarter we completed the transfer of operations from our acquired facility in Peterboro, New Jersey into our Rayna, Massachusetts facility. This brings the total number of facilities consolidated in 2009 to five and will be a key to driving further operating margin improvements.

What's more impressive it is that all these consolidation products were completed on time and with minimal destruction to our customers or operations. We now have completed all facility consolidation projects, except for those within our orthopedics product line which we are continuing to annualize. During the fourth quarter, we also completed an additional Oracle ERP system implementation which brings the total to four in 2009. Again, all these implementations went very smoothly with minimal business interruption. We have now integrated all of our North American operations into a single ERP platform and consolidated finance IT and human resources functions into one shared services group located at our corporate headquarters. This completion of our Switzerland ERP platform conversion is expected to be in the early 2011 timeframe.

Finally, during 2009 we spent a considerable amount of time talking to customers and improving our orthopedic product line. The result of this was a significant improvement in our score card metrics for this business such as on time delivery, RFQ lead times and production lead times. Just to name a few. We believe that improving operations is critical to our future success in this business and will give us a significant competitive advantage. We intend to aggressively invest in our orthopedic business over the next three years in order to further drive improvements in growth and remain committed to this business and its future growth prospects. These integrations are just a few examples that demonstrate our operational excellence and why we consider one of our core competencies in key strategic competitive advantages. These initiatives will continue to derive improved operating margins and to help us to achieve financial and operating goals. Looking ahead, we still see additional opportunities we plan to tap into.

Our last key strategic initiative is to drive growth through delivering innovative solutions. During this economic downturn, when other companies were cutting back on R&D investments we are increasing our focus in this area. During 2009, we spent approximately 8.5% of our sales revenue on research and development compared to 7.5% last year. This continued investment in R&D will enable us to maintain our leadership position in our core markets and drive further margin improvements once the markets recover.

I would now like to spend a few minutes discussing this strategy and a little further detail which begins on slide seven. Up until this point, we have placed most of the focus on the first two facets of our strategy. However, we are now in a better position to begin talking in more detail about the third facet of our strategy, which is driving growth through innovation. The first steps began in 2007 and included filling technology gaps and acquiring the capabilities we needed to support our innovation strategy. This included acquiring technology related MRI compatibility, lead wire manufacturing, rechargeable batteries and wireless sensing.

Additionally, we acquired device design and engineering capabilities in order to become a full service provider for our customers and as this was a natural extension of our current capabilities. Next as we rebranded our medical segment and restructured our Company to support our strategic objectives. This included a creation of an independent group which we call QIG in order to facilitate the introduction of new and improved technologies in the medical device market for OEM customers. This also included spending a significant amount of time and effort with our customers in order to learn more about their technology road maps and determining how Greatbatch's technology and capabilities could enable those customers to bring solutions to market.

Finally, over the past year we have invested a significant amount of time and resources into upgrading our quality and regulatory systems across the Company. The outcome of all this is that we are now in a position to provide our OEM customers with full system solutions. This includes providing turn key products which include development, regulatory submissions, manufacturing and worldwide distribution. These systems are Neesh product solutions that are not a core product of our OEM customers, but which fit perfectly into our expertise and capabilities. The strategy also includes partnering with our OEM customers including sharing technology and resources in order to bring these solutions to market. The benefits to our OEM customers, is that it will shorten their lead time to market for these Neesh products by accelerating the velocity of innovation, optimizing their supply chain and ultimately provide them with cost efficiencies.

To date, this strategy and the Greatbatch brand has been very positively reviewed and received by our customers. I want to emphasize that we will compliment our customers products and technology. We have no intentions of ever selling directly to the end market such as hospitals and clinicians. This is not one of our core competencies. We excel at operational excellence, technology, innovation and quality systems. And that is what we will provide to our customers in one integrated solution.

I would like to also clarify that we will continue to invest in our core component product lines and technologies. These products are the engine that got us to where we are today and will continue to be a primary focus for us going forward. Without these core component technologies, our system strategy simply will not work.

A good example of this strategy, is our announcement just last week of the opening of our orthopedic design center in Warsaw, Indiana, which will significantly advance our product development capabilities. The new facility will be equipped with rapid prototyping instruments and staffed with an industry leading team of orthopedic development experts. The addition of these capabilities will expand both our service offering and our ability to effectively partner with our customers in developing, delivering effective solutions quickly.

The current focus of our systems project is in the same core markets that we serve today. Cardiology, neurostimulation and orthopedics. We will provide further insights into these projects as they come to fruition. The revenue growth projections we provided today include the benefits of some of these system level initiatives of the however we are anticipating that most of the benefits will not come until the 2011 through 2014 timeframe. Before ending my portion of the call today, I'd like to recognize the talent and dedication of our 3,000 Greatbatch employees. It is through this group of people that we've been able to further our strategic objectives in 2009 and establish the quality and brand recognition that accompanies our products today. Thank you for all of your hard work and dedication. With that, I'll now turn the call over to Tom Mazza for review of our fourth quarter financial results.

Thanks Tom and good afternoon. For the call today, I would like to provide you a quick overview of our results for the quarter and the full year comparison to the prior year amounts. However, when relevant, we will also discuss sequential variances from the third quarter of 2009.

As you can see on slide 10, sales for the fourth quarter were $125.8 million compared to $146.6 million in the comparable 2008 period and $121.5 million for the third quarter of 2009. For the year revenue totaled $521.8 million compared to $546.6 million in 2008. We should point out that fourth quarter 2008 results include the benefit of an additional week of operations due to the Company's fiscal year ending on the closest Friday to December 31st. This additional week added approximately $10 million to 2008 sales. Excluding this additional week of operation, 2009 annual revenue was 3% below the 2008 period as CRM neuromodulation revenue growth was offset by decreases in other product lines.

Compared to the third quarter of 2009 revenue increased 4% due to moderate CRM neuromodulation growth, seasonally higher orthopedic sales and a pickup in Electrochem's energy markets. Excluding the additional week of operations included in the 2008 period, 2009 fourth quarter CRM neuromodulation revenue remained consistent with the prior year fourth quarter as higher assembly revenue was offset by lower battery sales.

For the year, CRM and neuromodulation revenue increased 7% as the Company continued to deepen relationships with its customers by providing exceptional innovation and quality technologies. We should point out that CRM neuromodulation revenue can vary significantly from quarter to quarter based upon the timing of customer product launches, customer outsourcing decision, changes in customer market share mix and customer inventory adjustments.

Fourth quarter 2009 revenues for the Vascular Access product line were $7.6 million compared to prior year revenues of $11.2 million and sequential quarter revenue up $8.4 million. For the year, Vascular Access revenue was $35.8 million versus $39.4 million in 2008. These decreases were primarily due to lower introducer sales as a result of customer inventory stocking that took place during the first quarter of 2009.

Sales were also lower in comparison to the prior year due to one less week of operations. We remain optimistic about the potential of this product line as we continue to work with customers on developing system levels projects. However, many of the projects that we are working on today will not generate revenue until the second half of 2010 and beyond.

In addition to having one less week of operations the 29% decline in orthopedic revenues of $25.2 million for the fourth quarter 2009 was due to reduced spending on elective procedures and increased emphasis on inventory management programs from our customers as a result of the uncertain economic and regulatory environment. Fourth quarter revenue was 9% above the $22.--$23.2 million in the third quarter 2009, primarily due to seasonal fluctuations.

During this industry downturn, we continue to streamline and invest in our orthopedic operations which we believe present significant opportunities. We anticipate that these difficult market conditions will persist through the first half of 2010.

Fourth quarter 2009 sales for the Electrochem business segment were 17.1 million, and 15.8 million in the sequential quarter. The decrease from the prior year primarily related to the slow down in the energy and portable medical market which caused customers to reduce inventory levels and push back products. These continues began to ease in the fourth quarter of 2009, but still remain a challenge and are expected to continue into the first half of 2010.

We continue to actively manage our business so that we will be better prepared to meet the needs of our customers once the market recovers. Turning now to expenses, gross profit as a percentage of revenue for the fourth quarter 2009 improved to 33.1% compared to 31.9% for the 2008 period. This improvement is attributable to the consolidation integration initiatives completed over the past year.

Additionally, we continue to take difficult cost cutting measures to help mitigate the impact of the lower revenue levels on operating income. This included adjusting 2009 related performance based compensation. Which benefited cost of sales by approximately $2.5 million versus the fourth quarter 2008. Selling, general and administrative expenses of $17.9 for the fourth quarter were $2 million. Lower than the same period of 2008, as normal business growth was more than offset by savings on our various consolidation and cost cutting initiatives. Including reduced 2009 performance based compensation of approximately $1.5 million for the quarter compared to 2008.

Net research development and engineering costs for the 2009 fourth quarter of $7.3 million were consistent with the 2008 fourth quarter as our higher level of R&D investment was offset by an increase in customer reimbursements. The timing of customer reimbursements is dependent on the achievement of milestones on development projects and can vary significantly from quarter to quarter. Excluding these reimbursements, RDE was 9% of sales or $1 million higher than the fourth quarter of 2008. This was due to our strategic decision in 2009 to further invest resources in the development of new technologies in order to provide solutions for our customers and ultimately create long-term growth opportunities which is expected to continue in 2010.

The GAAP operating loss for the fourth quarter of 2009 was $2.3 million. Compared to income of $12 million in the fourth quarter of 2008. And a loss of $23.9 million in the third quarter 2009. GAAP operating results for the current quarter, include a $16 million non-cash trade name write down related to our decision to discontinue use of our non-Greatbatch trade names due to the successful rebranding campaign of our medical segment in 2009. For the year, GAAP operating income was $1 million compared to $34.9 million in 2008. GAAP operating results for the third quarter 2009 include a $34.5 million litigation accrual related to the previously disclosed Electrochem litigation which did not change in the fourth quarter. Adjusted operating income was $16.4 million or 13.1% of sales in the fourth quarter of 2009.

Compared to $19.1 million or 13% of sales for the comparable 2008 period and $13.6 million or 11.2% of sales in the third quarter 2009. For the year, adjusted operating income was $62.6 million or 12% of sales compared to $58.1 million or 10.6% of sales for 2008. This increase was primarily due to our consolidation, integration and cost cutting initiatives which helped further leverage our operations. Please refer to the appendix of today's presentation for a reconciliation of the adjusted amounts to GAAP. The 2009 GAAP and adjusted tax rate included the favorable impact of the resolution of tax audits and the lapse of statutes of limitation on certain tax items. The fourth quarter 2008 GAAP and adjusted tax rates include the benefit of the enactment of the research and development tax credit in October, 2008.

For 2010, we expect the GAAP effective tax rate to approximate the 35% statutory rate due to the expiration of the R&D tax credit at the end of 2009. GAAP delighted UPS UPS for the fourth quarter 2009 were a $0.07 per share loss compared to $0.31 per share for the fourth quarter 2008 and a loss of $0.90 per share for the third quarter 2009. GAAP diluted earnings per share for 2009 were a loss of $0.39 per share compared to income of $0.62 per share in the fiscal year 2008.

Adjusted earnings per share decreased to $0.40 per share in the quarter from $0.50 per share in the fourth quarter 2008. But increased in comparison to the $0.32 per share for the third quarter of 2009. For the year, adjusted earnings per share increased to $1.52 per share from $1.40 per share for 2008. Driving operating performance is a critical part of our long-term plan to drive shareholder value.

During 2009, we completed a number of strategic initiatives designed to improve operational efficiencies. The benefit of these initiatives can be seen in our strong cash flow generation. Cash flows from operations for the fourth quarter of 2009 were approximately $22 million and were used to support capital expenditures and to pay down our line of credit by $9 million or 8% of the outstanding balance.

For the year, cash flows from operations increased 26% to $72 million and overall we repaid $34 million or 26% of our line of credit. Moving on to our outlook on slide 13, as you can see, for 2010 we are providing a range of annual revenue growth rates by our various product line. This information is provided to allow our investors to better understand how we review -- how we view the various markets that we operate in.

Additionally, we are providing our expectations for adjusted operating income which is projected to be between 12% and 13.5% of sales for 2010. This expectation includes the continued ramp up in R&D as just discussed. It is important to note that the above percentages are annual growth rates.

Although we are confident in our annual guidance, we recognize that the volatile economic and health care environments continue to create uncertainty around these estimates. With that said, we are anticipating the operating income will start off lower in the first quarter and prove throughout 2010 as the economy and health care environment improve as the first and as the first quarter typically includes a higher level of expenses. I should also point out, that for 2010, we will no longer exclude the additional interest expense related to the change in accounting for convertible debt adopted in 2009 in the presentation of our adjusted financial results. As our year-over-year comparisons will now be consistent.

For 2010 this change in accounting, which was adopted in 2009, is expected to be approximately $8 million of interest expense and decrease adjusted earnings per share by approximately $0.21 per share. Overall, we remain focused on our long-term strategic objective of growing revenue faster than our markets. Through diversifying our revenue base, leading innovation and providing our customers with technology solutions that they need to be successful.

We have worked hard to implement an efficient operating model while making the necessary investments to insure growth across our various product lines. Despite a difficult operating environment, our strong financial position, resiliency of our core markets as well as the benefits of more diversified revenue stream make us confident in our ability to deliver more profitable results once the markets recover. Let me now turn the call back over to the moderator to take questions.

Ladies and gentlemen, if you wish to ask a question please press star one on your touchtone phone. If your question has been answered or you would like to withdraw your question, please press star two. Questions will be taken in the order received. Please press star one to begin. Your first question comes from the line of Tim Lee from Piper Jaffray, please proceed.

Hi, Tom. It's actually Cynthia in for Tim. I just had a couple questions. In terms of the segment sales guidance, you provided a range, but in hard dollars is that, should we look at it as $530 million to $550 or so million, to 6% on a four year basis?

I think your math is close to ours.

Okay. And I guess there wasn't really that much different in terms of the way we were thinking the quarter was going to turn out except for Vascular Access. And it looks like you said there was some stocking and inventory that was being drawn down. Should we, how should we look at that segment, should we expect to see continued draw downs of inventory or when should we see that working through?

No, I think our growth rates for the year on the vascular side, we've given you the growth rates for the vascular side, and I think most of it should be, the stocking issues should be over by now for 2009.

And then I guess similarly for orthopedics, it looks like in the quarter you still had an inventory impact from your customer. Should we see that working through in the next two quarters or potentially sooner?

As we mentioned Cynthia, I mean the first -- we're seeing both on the Electrochem side and on the ortho side the first two quarters being difficult, continue to be difficult. But the growth rates we have given for the year out there we think are achievable. We think last quarter was probably the low point for the ortho side and most of the inventory issues should be worked off. Certainly by our major implant customer.

Okay. And I guess one last question, then I'll let others get a chance. I know in the past, you guys were targeting around 200 year-over-year improvement in adjusted operating margin and it looks like you're backing off a little bit off those goals. I was just wondering is that just from the slower sales growth?

Cynthia, this is Tom Hook. Is -- from a goal standpoint it's still our objective to deliver 200 basis points of improvement. I think the challenge ends up being is we still want to increase our research and development funding, so we're taking some of that productivity improvement to R&D expense and some of it to the operating income line. But given the underlying markets are going to just be challenged for growth, we're planning the year more conservatively based on that. And on a delivery basis, we want to be able to -- against that, you know, 5% growth organic growth range deliver the 100 basis points, but then also be able to afford to make some additional rampup in R&D at the same time. So that gives you a little more color on it.

No, that's very helpful. What needs to happen in order to achieve the higher end of your adjusted operating margin goal?

Basically reach, you know, over 5% growth rate.

I think if you think of the kind of mid-single digit, you know, as being able to deliver a, you know, productivity objective of 100 basis points, anything above that then we start to achieve to the higher end of the operating income range. And obviously we can exceed that, because the markets pick up and because our performance improves, in particular, with say the system launch with OEM customers, then we can, we can outpace that.

Okay. And R&D on a reported basis, I know it's hard to calibrate just because you have the milestones and the reimbursements, but on a reported basis, how should we look at that as a percent of sale?

Probably around seven.

7%, okay.

And you're right, it can get tough, because as we start entering in the systems realm the nonrecurring engineering reimbursements for those will be a little different than on the component side and we'll have to provide more information on that as those projects reach the revenue line.

And you are working on an MRI compatible battery for one of the CRM manufacturers and I was just wondering should we -- when should we expect to see revenues, when should we expect to see that product come to market, is that still mid-11?

Yeah, there's actually three types of MRI compatible technologies. One of them they're nonmagnetic materials that can be used in batteries. The second one is filtered feed throughs . Then the third one is what we call the enable band stop filter for lead wire themselves. So all three of those are products that are going through qualification and you're correct, some of those component technologies actually are in qualification with customers as we speak. And they're more 2011 revenue streams and beyond based on, you know, working with customers and then obtaining the regulatory approvals for the use of those products. But they're not 2010 revenue line

Okay, that's very helpful, thank you.

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

Hi, this is Jim Morris Mayo for Jason. Just to follow up on that last question, just to be clear. I know both St. Jude and Medtronic announced, you know, MRI compatible products in the last, you know, the last quarter, so you guy's technology is not in either of those yet?

Jim, we just don't comment on where our technology specifically goes. That's really up to the OEM customers on the level of detail that they would like to provide. Obviously all the OEM's are active customers and we're engaged with them also on the MRI technology front on the three that I had mentioned. But we never really provide any specific commentary of the underlying technologies that individuals customers can use. It's just too competitively sensitive for them. So they would have to answer that question, because we're under confidentiality provisions in our agreements that prevent us from making any comments on it, unfortunately.

Okay. Next question, on the system level initiatives, thanks for giving us an update on that. I know you talked a little bit about vascular, some of the vascular systems hitting in Q2010, are there going to be any other systems level product in any other product categories this year?

Not for 2010. Where those, not on the revenue line item I should say, certainly from an R&D expense we're working cooperatively with customers on a number of projects. But the vascular ones which we started in 2007 have reached the regulatory windows. Several of those actually are now in the regulatory approval process at the FDA and other countries around the world. And as they, you know, they, they're approved or cleared they'll move off into the customers doing the initial polls and stocking and then launching those products into the market. So those vascular ones will hit the revenue line item in 2010. Really starting the first product line will really start next quarter. And then it will start to build throughout 2010 and then other product lines which we'll highlight later in the year will start coming in in 2011 and beyond.

Okay. So in terms of material revenue 2011 and after that?

Correct.

Okay. Well, thanks a lot.

(Operator Instructions). Your next question comes from the line of Stan Mann from Mann Family Investments. Please proceed.

Hi, gentlemen. Got two or three questions. One, the only R&D project you've talked about is the MRI compatible device. Can you talk a little more about your other, I mean that's a pretty large amount of money you're putting in, on any other project areas at all on development within your confidentiality agreements.

Is -- you know, one, I'll give you a highlight of another one that we talked to as our, we make vascular introducers in the market and we obviously since acquiring Enpath have been working with OEM's to launch new innovations in this area which we have patented and the patents certainly have been, are public information. So as we've been commercializing those and that new series of vascular introducers, those technologies actually are in the FDA 5-10 clearance process right now and we're waiting approval on those. Some are valved introducers and some are non-valved introducers. They target the cardic rhythm management, neurostimulation, and also the general Vascular Access market for things like dialysis. In some of those segments, we really don't have effective product offerings in particular for cardiac rhythm management and neurostimulation as well. So those upon, those achieving clearance we're going to be in a position to negotiate and partner with the OEM customers which are actively engaged in right now pending those approvals. And those are-- that's another example of a system. The next sets of systems that are vascular related will pertain to Steerable Sheaths. Any why we're not really at the point of making our final regulatory submissions, we already have development and supply contracts with key OEM's. And in the next quarter we will actually be able to provide a little more color with regards to these projects, because they will actually have been submitted or near submission to the FDA and will be essentially in the same waiting loop for the five 10K clearance for them. And then, you know, the customer that we're working with and ourselves will be making an announcement relative to that technology. But it's in Steerable Sheaths' realm. From there we will move on to other systems that some of them are sensor related and other technologies, but you're right Stan, as we've been -- we were trying to wait to talk about these things until they're at the regulatory approval windows so that we don't get ahead of ourselves.

Do you have any measurement parameters that you apply to these R&D's? I mean you're investing an awful lot of money in R&D. And you have not really talked about market size or how you justify this size investment and the outcomes. Can you give us a little frame on how do you look at, I mean on your consolidation projects, your payout's clear, but on this type, on R&D it always worries me that, you know, you're throwing a lot of money in and we don't see or we don't know how to measure what's going to come out.? What kind of parameters are you applying? I mean the sheath is the market, you know, ten times the size of the investment or the return.

I think Stan the way I can look at it from a macro perspective and I will take away from your question and work with Tom Mazza to understand if we can provide more color on this and provide meaningful information to you.

You understand our concern though.

Sure we do. I think the best way to look at it is today we're not entering new new markets. The technologies that we're bringing to market embody the component technologies that we already sell today to OEM customers. The systems and device strategy is merely working with the existing OEM's. And rather than making just the part integrating those parts, which would the overwhelming majority be designed and manufactured by Greatbatch and we would integrate them into sub-assemblies and full systems for them under development contracts and also under supply contracts. So it's maturing along the product line revenues we have today to include a more integrated and comprehensive solution. The underlying markets really are the same ones we serve in today with our current customers. So there's a richer set of -- the regulatory windows for the systems are longer, because we're shouldering more of the project load. And hence we're having to do more of the development burden of that. But the actual economic drivers of those markets are largely the ones we've existed in for a long period of time.

Okay. But that doesn't answer the question. I mean you could spend a million dollars on a product that you're working on that's going to generate a million dollars of revenue and take 20 years to pay out. So there's got to be some measurement to prevent overload on insignificant project development. I mean a customer can ask you for a lot of things, it's just passing the cost down. How do you -- how are you looking at the payout and generation of profits for these products, the investment?

We would look at it as we would any product, whether it's an individual component or whether it's a system. We would look for the time investment of the cash flows, the return on that investment, the present value of the investment discounting against it, time value of money as well as it's technical risks for development. Obviously, because we partner with the OEM customers in pursuing these they provide partial funding for these, you know, basically what amounts to be a co-investment so we're insured they will be commercialized. There's certainly risks in the regulatory window, but every project is not going to have the same set of time frame considerations. But we boil those down project by project and we overlay the expenditures so we understand what we can afford and what's too rich and which projects have to wait because of the timeframe or magnitude of investment is too long. And like I said before, we have been very careful with starting R&D projects until we're sure from a productivity standpoint the Company can afford to do them. So we have been very careful at making sure that we're going after the highest return on our R&D dollar and we're very disciplined in that area. But it isn't, you know, while most of these systems take, you know, the three plus year time frame to reach regulatory approval. They're still all long-term investments. But we have to obviously have the components and system combined. Because systems is a new initiative for us, we are obviously having to ramp up that R&D spending now, but we still don't have system revenue. We have done that over the past two years, and, you know, obviously next quarter's when we first start to see some of that systems revenue come in which is exciting for us. And then by project, that will start to build up over the coming years and it will start to, you know, show the return on the R&D investment we did in the second half of 2008 and most of 2009, into 2010.

But you're going to examine the investment, I mean it's a lot of money we're throwing in, right?

Absolutely.

Okay. On our goals, we had always talked about a 15% operating margin goal. Is that still in your vision?

Yes

And still reasonable?

Yes. Okay.

And the second part of it, when will we be clean in the statement to that we don't have all these adjustments and trying and figure out the real profitability is?

I think as every year over the last five years that I've been here, as we finished a consolidation projects those adjustments have decreased. I think, you know, right now I think we're looking at in 2010 is about $4 million to $6 million of adjustments, which is far less than we have had historically. And, you know, my expectation is that we will be the GAAP financials will be cleaner because most of these consolidation projects have bled off. We don't plan on doing more acquisitions and we're settling down as a Company without a lot of moving parts and really the, we have the setup for the Oracle implementation in Switzerland which will happen early next year, and we also have some orthopedics consolidation integration stuff that will flow through on adjustment basis.

So 11 should be reasonably simpler and clearer?

Yeah, it will get cleaner next year as well. So I think we're down now to a very low amount. I think the challenge always is do we not disclose that. I've been in favor of disclosing it so people, even though that's $4 million to $6 million, they can understand what the effect on a one time basis is so they can model correctly.

Yeah, yeah. My number shows you only paid down $7 million of debt in the fourth quarter when I compared third to fourth. Am I missing anything? And why did you not pay down more? You build up cash level, since you just stated we're going to work on paying down debt basically, not acquiring. Yes, we're keeping it perfect because part of it is we have a short term due on the converts in the first six months. And then A short term on the converts meaning?

On the converts. We also --

What do you mean short term on the converts for all of us?

If you see, if you see the convertible debt there's $30 million that's payable, that's putable in June of 2010. Which is shown as a short-term liability.

I see, I see.

Okay. So part of that is for that. But it's also the timing when we got the money as opposed to what other swaps and stuff we have out there on the interest rates that we're trying to cover. So it's a treasury management tool.

Okay. Are we able to buyback any longer data converts at a discount? I don't think I've ever asked that question.

We're not permitted under our credit agreement to do that currently.

Oh, currently, until you get down to a lower level of debt relative to EBITDA, etcetra.

No, it's not -- it has nothing to do with the covenant calculation. It's just a restriction from buying back subordinated debt under the credit line

Oh, okay. So we shouldn't look forward to any discount buying in this environment of converts.

No.

My last question. Is it seems to me ortho sales have kind of come down considerably more than the market itself. And my question is have we lost any customers or business in that area that really is part of this 20% decline?

I think, you know, I think the operating environment in the United States and Europe are dramatically different Stan. I think really with our US based customers and our significant implant customer we have been in synchronization with them. But the inventory, you know, rationalization really hit us hard. In Europe, we kind of have a couple effects. One is the up and down nature, what's happening with, you know, foreign currency translation on revenue. Then the second one ends of being is that the year of operating environment in orthopedics is a lot tougher than in the United States. So you combine that with the fact that we do a lot of instruments and trays.

Instrument cases you mean?

That's right, instrument cases and instruments. That is very launch driven technology at OEM.

Right, right, right.

Even though the implant business is kind of synchronize the with the market, with the offset being inventory, but there's not a lot of trays and instrument launches right now. That's start to recover, in that we will need 2010 stability in that area, kind of took it on the chin in 2009.

Do we have any plans to diversify that product line near term so that we're less case related or new product launch related?

What we plan on doing, Stan, is squarely moving it to the Greatbatch operating model, which is we have brought in a team of people that are experts in design engineering and prototyping

Right

And we plan on innovating and partnering with the OEM's to deliver them products they want at a cost level that they find is extremely competitive. And from a technology perspective is differentiatable so we get the business, we partner with them to commercialize it

Is practically all of business in Europe in that ortho product line?

No, we have several locations in Indiana to do instruments.

Warsaw.

One is in the Warsaw area, one is in Indianapolis itself. But we also do have the implant business in France and we have more instruments designed and manufacturing capability in Switzerland.

Okay, but you see that business, it's not a major loss of customer, that's what I was trying to get at

No, it's the market driven slow down in inventory adjustment. The overwhelming majority of the hit.

Okay, Marco, I'm sure others on the call would like to know if the tax credit does hit in 2010, what's the positive effect on your model?

It's probably be about 1% differential, Stan.

One percent on what?

From 35 to 34

Oh, on tax rate

On tax rate

Okay, thank you very much.

Okay.

Your next question comes from the line of Gregory Macosko from Lloyd Abbett. Please proceed.

Yes, thank you. Can you hear me?

Yes .

Okay. Good. Just with regard to some of the sales, you mentioned that you had four large customers that grew 7.2%, was that for all of '09?

Correct.

About 7.5% for all of 2009.

Yeah. And were those, I assume, those were existing customers and primarily NCRM?

Three NCRM and one in ortho.

One in ortho. And I want to say, when we say CRM it's really CRM in neuromodulation and in orthopedics.

Okay All right. Good.

And some of that is obviously is just we're -- the rebranding initiatives and we've used the favorable reputation in the Greatbatch operating model, the win business in other segments of our major customers and it's worked well.

So you are convinced that, you know, the rebranding etc. really makes a lot of sense, obviously it's part of the acquisitions , etcetra that you took the write-off, but you're comfortable that that will pay

I think it Greg is it paid off and worked a lot better than even we thought it would, which is why we felt that centralizing around that Greatbatch brand based on that success was the right thing to do early in the launch, because, you know, we've been at the launch over the last nine months and it's really been well received by customers. It's backed up with not just the brand names, we've actually moved a lot of operating people around into these various companies to put a Greatbatch experience, professionalism, capability in there, and moving them to the operating model is really the performance along with the brand that's making the difference. So, we're very confident it's been the right thing to do, and, you know, we'll take the report card from the customers and my report card is revenue. So, that's where l I think we need to focus and that's coming through the way it should.

I think I heard throughout sort of your comments here today that sort of this year will be second half loaded in terms of the revenue line?

Yeah, that's a fair --

That's a good way to look at it. I just think it's going to be, it's going to be kind of a slower start. And then, I don't -- I'm not worried about another global economic meltdown in 2010, so I think we'll be able to focus more on capitalizing on the projects we have, hitting their milestones and building momentum in revenue towards the second half of the year, and it'll set up more momentum for us in 2011 as well.

Is any of that still inventory related at this point? Do you still feel like there's orthopedic customers that have got to burn down, Electrochem customers, they have to burn off inventory, or is it a question that's done and now it's flat and waiting for things to turn around?

I would say from a broad market basis on Electrochem that I think on the inventory side, I don't think that's going to be a major effect. Cardiac Rhythm management, neurostimulation, I think we're okay. I don't think there's any major ups or downs, but there could be some adjustment I think in orthopedics, I think some customers are normalized. I think other customers may still have one to two quarters of adjustments. But, you know, obviously as it applies to us, you know, some of those customers will have a little bit of adjustment. But across all of Greatbatch, I think the inventory issue is largely behind us. And now we're going to talk about just typical quarter to quarter adjustments by customers that we would see virtually any year. So I think we're back down to normal behavior and it's not going to be a big factor in 2010.

And then with regard to the ERP implementation, are you stepping out any of that in terms of the charges you're talking about? I guess you're talking about charges of $4 million to $6 million in '10, this year.

Correct.

Is any ERP cost involved in that?

Yes, yes. A small, not a small portion, but probably a million to a million and a half of that is ERP implementation in Europe.

Okay. And the idea is, is that this will be all in place by the end of this year and in '11, there will be no more spending and it will start to pay off?

Most of the implementation will be done this year. We believe we probably will switch it over actually push the switch in the first or second quarter of 2011. But the spending, the lion share of the spending will be done in 2010.

Just for clarity, Greg, it's one location, the Swiss location that we haven't gone to Oracle yet. What Tom's referring to that's our last location to convert over to Oracle, working on it in 2010 and spending that million and a half this year. There will be a limited amount of spend in 2011 as we turn that switch and that's effectively the last of the ERP integrations across the entire Company. So that's whatever 20 some implementations since we have been here. So it's the completion of a massive effort over six years when we do it. And we're being very careful, because we don't, we have done all of these perfectly with very little interruption. We don't -- Swiss is going to be -- facilities is going to be a little bit more complicated in terms of its transition because of language and other things, so we're going to take a little extra time to make sure we're not going to do it not at year end, but at the beginning of '11 after we kind of complete the year. And we feel we're going to prepare for it well this year and be in a position to go live early next year.

The other thing Greg, this is Tom Mazza, if I can just add one more word to that. We have a policy herof not implementing anything in the fourth quarter for socks control reasons. So that is why -- rather than doing it kind of September, October time frame, we're choosing to do it in the first or second quarter of 2011.

So there were no -- there were no charges in the fourth quarter?

We don't go live in the fourth quarter. We basically still get all the preparations done, we just don't flip the switch.

Oh, for next fourth quarter.

Correct, for next fourth quarter.

Okay. I'm sorry, right. But it was sort of ongoing in the quarter we just completed in terms of the charges?

That's correct.

Correct.

Okay. All right. Thank you very much.

Thank you .

Thank you Greg.

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

Thank you everyone. I would like to remind you that 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 30 days. Thanks, everyone, for joining us.

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