Integer Holdings Corp (ITGR) 2010 Q3 法說會逐字稿

Welcome, everyone, to the third quarter 2010 Greatbatch, Inc. conference call.

Before we begin, I would like to read the Safe Harbor Statement.

This presentation and our press release contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and involve a number of risks and uncertainties. These risks and uncertainties are described in the Company's Annual Report on Form 10-K. The statements are based on Greatbatch, Inc.'s current expectations, and actual results could differ materially from those stated or implied. The Company assumes no obligation to update forward-looking information included in this conference call to reflect changed assumptions, the occurrence of unanticipated events or changes in the 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.

Hello, everyone, and thank you for joining us today for our third quarter earnings call. With us on the call 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 third quarter results, and then he will update you on our key strategic initiatives. After that, Tom Mazza will provide further comments on our financial results. We will then open up the call to Q&A. As we have done in the past, we are including slide visuals that go along with this presentation, which you can access on our website at www.greatbatch.com.

Let me now turn the call over to our President and CEO, Tom Hook.

Thank you, Marco, and welcome to all of you who are listening on our call today. We are pleased to be able to share with you our results for the third quarter of 2010.

As you can see from the highlights starting on Slide 5, we had another solid quarter. Given the challenging market dynamics we are currently facing, we are pleased with our third quarter financial results. Similar to our peers and customers in the industry, during the third quarter we began to feel the impact of the slowdown in the cardiac rhythm management market, which caused several of our larger customers to begin reducing their inventory levels. More broadly speaking, growth rates for all of our medical markets are below what was originally anticipated at the beginning of the year due to uncertainty surrounding the healthcare market, reduced procedure volumes and continuous pricing pressures. However, as a result of our diversification strategy that we embarked on three years ago, we were able to increase our revenue over the prior year.

Sales for the quarter increased 5%, to $127.5 million, as the impact from the downturn in the cardiac rhythm management market and pricing pressure from our customers was more than offset by the continued recovery in our Vascular, Orthopaedic and Electrochem product lines. In particular, we saw significant improvements in our Orthopaedic and Electrochem revenue, which grew 21% and 33%, respectively. Of note, the $21 million of Electrochem revenues during the quarter was a record for that business.

Taking all of this into consideration, we are pleased that we are still able to reaffirm our 2010 sales guidance in the $532 million to $551 million range, albeit at the lower end of that range. As we move into 2011, we expect that these difficult market conditions will persist but are working to offset the impact of the contracting cardiac rhythm management market with the launch of new system and device projects, particularly within our Vascular product line.

Similar to sales, our operating results were also solid during the quarter, as our adjusted operating income increased 5%, to $14.4 million, or 11.3% of sales. This improvement reflects the benefit of the higher revenue level during the quarter as well as our various cost-control measures that we have implemented over the past year. These factors helped drive the 70-basis-point improvement in our gross margin during the quarter and also helped contain our SG&A costs.

During the quarter we also continued to pursue our long-term strategic objective of delivering system and device-level projects to our customers, which is reflected in the higher research, development and engineering costs. For the quarter, these costs increased $1.7 million over the prior year, bringing gross research, development and engineering costs to 10.2% of our sales.

The net result of all this was that we achieved GAAP EPS of $0.25 per share as well as adjusted EPS of $0.34 per share for the quarter, which represents a 6% increase over the prior year.

Tom Mazza will provide additional detail on our financial results later in this call.

As is customary, I would now like to spend a few minutes updating you on the progress we are making in our strategic initiatives.

With regards to our first long-term strategic initiative, diversification, this quarter provides another good example of the benefits of this strategy. Despite the slowdown in the underlying cardiac rhythm management market this quarter, we were able to report moderate growth, driven by recoveries in the Vascular, Orthopaedic and Electrochem markets. To illustrate how far we've come, only two years ago we had no sales from our Vascular and Orthopaedic product lines, and our Electrochem business was almost entirely dependent on the energy markets. Today our diversified revenue base extends across multiple product lines, customers and industries and provides us a more stable foundation from which to grow over the long term.

Driving operating performance is out second strategic initiative and is also a critical part of our long-term plan to create shareholder value. The consolidation and cost control initiatives we completed over the last several years are driving improved operating performance and a more scalable business model that will enable us to capture more profitability when higher volumes return. Additionally, our improved operating performance allows us to maintain a higher level of research and development investment, which is critical to driving our future growth and bolstering our product pipeline.

Despite having completed all of our publicly announced consolidation initiatives, we assess our business on a continuous basis in order to find ways to improve our operational efficiency. One area of focus in particular is our Orthopaedics product line. Over the last two years we have taken significant strides to implement our operating model in this business, and it has begun to pay dividends. We remain committed to this product line and continue to invest in it in order to further drive improvements and growth, which I will talk about in further detail in just a few minutes.

Our last key strategic initiative is to drive growth through delivering innovative solutions. During this economic downturn, when companies are cutting back on research and development investment, we are increasing our focus in this area. Our investment in R&D, particularly related to systems and device-level projects, is critical to the long-term growth and profitability of our company.

We continue to make significant progress towards the completion of these key initiatives and expect to make additional announcements in the near future. We remain confident that this investment in R&D will enable us to maintain our leadership position in our core markets and drive further growth in margin improvements over the long term.

With that, I would now like to spend a few minutes providing you with an update on the progress we are making on our strategic initiative specific to our Orthopaedics business, beginning on Slide 7.

As most of you are aware, during the quarter Susan Campbell, Senior Vice President of Orthopaedics, passed away after an unexpected illness. Susan was an integral part of Greatbatch ever since joining the Company in 2003, and her contributions have been pivotal to our success. In her absence, I have assumed her responsibilities as head of the Company's Orthopaedics group for the short term until a suitable replacement or alternative solution can be found. I would like to take this opportunity to reiterate that we remain committed to the strategy that Susan and her leadership team developed over the past two years, and I am confident that their vision for our Orthopaedics group will be realized.

One of the first things we did after entering the Orthopaedics business was to put a management team in place that would be able to [implement] the Greatbatch operating model. This included hiring industry experts from outside the Company as well as tapping into the bench strength at Greatbatch who excel at operational excellence and lean manufacturing. This team has spent a considerable amount of time talking to customers and analyzing our operations. From these efforts they have developed a long-term plan, which we have been implementing over the past 12 months.

Over the past month I've become intimately familiar with this plan and the management team in place. I would like to reiterate for own investors, employees and customers that may be listening to that now more than ever I have the utmost confidence that we are positioned for success. We have the right team, the right capabilities and right resources in place to be successful in this business.

One of the first initiatives the Orthopaedics team embarked on was to streamline and simplify our product development and business process. We quickly realized that to be successful in this business we need to be quicker, more innovative, have higher quality and be more cost-effective than the competition. And I'm delighted to say that over the last two years we have become one of the industry leaders in this regard.

Some examples of this would be our better than 95% on-time delivery and significantly reduced lead times for our entire range of products. Not only do we streamline our processes, we have also worked with several of our larger customers and vendors to optimize our extended value streams. Ultimately this benefits our customers by allowing them to optimize their supply chain and provides them access to our innovative products at a cost-effective price. To put it simply, we are easier to do business with. This is a value proposition that many of our competitors cannot offer, and, given the high-mix, low-volume nature of the Orthopaedics business, our operational expertise and financial wherewithal gives us a significant competitive advantage.

In addition to the above, we also continue to make investments in our facilities. As you can see from Slide 8, we have begun updating our Indianapolis, Indiana facility to streamline operations, consolidate two buildings into one, free up space to further expand our capabilities and reduce our dependence on outside suppliers. Ultimately, these updates will further reduce lead times, increase capacity and improve quality. I am pleased to report that this project is on schedule, more importantly is being carried out with no interruption to our customers or our on-time delivery.

In addition to the Indianapolis facility, we have also made investments in our Chaumont, France facility. As you may recall, that's this facility that we purchased in 2008 and primarily produced hip and shoulder implants for one customer. Through these additional investments we are now able to produce spine implants and now manufacture implants for multiple new customers. We intend to continue to invest in the facility and expand our implant business to higher growth products and new customers in order to drive future sales.

Another example of investments we have made is our rapid prototyping center in Warsaw, Indiana. This facility is located next to some of our key customers and is open for engineers to visit and discuss projects and solution with our highly qualified team of experts that reside there. This development center has two prototyping machines that allow the prompt delivery and evaluation of parts to validate ideas and accelerate the development cycle for our customers. To date, this facility has been well received by our consumers, and we intend to open additional regional development centers in the near future.

This desire to shorten the development cycle for our customers has also lead us to invest in a pilot line at our Columbia City, Indiana facility. This pilot line has the same capabilities as our full production line and is dedicated to the manufacture of low-volume runs to provide clinical use-ready instruments, tools and implants in less than two weeks without disrupting our main production runs. Basically, we are shortening the development lead time for our customers, which helps secure future production business for us. We expect this pilot line to be fully operational by the end of the year.

We have added to our capabilities in order to become a full-service provider to our customers. This not only includes investing in our facilities, machinery and equipment, but also the hiring of additional engineers and industry experts, as well. To date, we have hired over 25 additional engineers to this business, primarily to focus on development, R&D and regulatory compliance. With the FDA controls and suppliers becoming more sophisticated, our goal is to help our customers by knowing the requirements, anticipating demand for data and having it ready at the appropriate points. We also believe that we can assist our customers by helping them with regulatory advice and submissions.

These are just a few examples of our accomplishments to date related to our orthopedics business. Going forward, we intend to continue our aggressive investment to further expand our capabilities, further reduce lead times and provide innovative and higher quality products as well as become the preferred provider of innovative, turnkey solutions to the orthopedics industry, with a full surgical procedure focus.

While we expect to continue to face challenging industry headwinds in the near term, we remain confident that the investments we are making today will yield dividends for our business in the long term, as we have only tapped 6% of the potential $2 billion market for orthopedics. As stated before, I am convinced that we have the right team and the right strategy in place to make this happen.

In closing, we are proud of the progress we continue to make on all our strategic initiatives. By staying connected, committed and focused on all aspects of our business, we expect to continue driving value for our shareholders. We are certain that our dedication to improving the business and closely following our strategic priorities has positioned us well for success in 2010 and beyond.

With that, I'll now turn the call over to Tom Mazza for a more detailed review of the second 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 in comparison to the prior year. However, when relevant I will also be discussing sequential variances from the second quarter of 2010.

As shown on Slide 14, consolidated sales in the third quarter of 2010 grew to $127.5 million from $121.5 million in the comparable 2009 period. This 5% increase was primarily due to improvements in our Vascular, Orthopaedics and Electrochem markets. In comparison to the sequential 2010 second quarter, sales decreased 9% due to the anticipated seasonal shutdown in our Orthopaedics facilities as well as a slowdown in the CRM markets.

CRM and neuromodulation sales for the third quarter 2010 declined 6% compared to the prior year period. This decrease was primarily due to the slowdown in the underlying CRM markets, which caused customers to reduce inventory levels. Additionally, CRM results were impacted by continuing pricing pressure as well as the timing of orders between the second and third quarter of 2010. We estimate that the impact of the timing of these orders increased second quarter sales and reduced third quarter sales by approximately $2 million.

As indicated in the past, our visibility to customer ordering patterns is over a relatively short period of time. Our customers may have inventory management programs and alternative supply arrangements that we are unaware of. Additionally, the relative market share among the OEM manufacturers changes periodically. Consequently, these and other factors can significantly impact our sales in any given quarter.

Third quarter 2010 sales for the Vascular product line increased 8%, to $9.1 million, compared to prior year sales of $8.4 million. This increase was primarily due to higher introducer sales as customer inventory reduction programs which began in 2009 are now complete. We expect ordering patterns to return to a more normalized rate.

Orthopaedic product line sales of $28 million for the third quarter 2010 were 21% above the $23.2 million for the comparable 2009 period. This increase was across all of our products as we continue to see a recovery in the orthopedics market and our investments and expended capabilities have begun to deliver new business. We delivered this strong performance in spite of a weaker euro exchange rate which reduced third quarter Orthopaedic sales by approximately $1 million compared to the prior year. This foreign currency impact began to ease towards the end of the third quarter and is not expected to materially impact revenue in the fourth quarter, assuming, of course, that exchange rates remain at their current levels. In comparison to the 2010 second quarter, sales decreased 8%, primarily due to seasonal facility shutdowns in our European operations.

Third quarter 2010 sales for the Electrochem business segment were a record $21 million, compared to $15.8 million in the third quarter 2009. The increase from the prior year primarily related to the continued recovery in the energy and portable medical markets and a significant customer restocking inventory. We estimate that the impact of this customer restocking was to increase sales in the second and third quarters of 2010 by approximately $3 million in each quarter. We do not expect this restocking to occur in the fourth quarter and have already begun to see a reduced level of orders.

Turning now to expenses, gross profit as a percentage of sales for the 2010 third quarter was 32.9%, compared to 32.2% in the 2009 third quarter. This 70-basis-point improvement was primarily a result of the higher sales volume during the quarter as well as our various cost-cutting initiatives. Additionally, our gross profit benefitted from a better mix of sales of higher margin products but continues to be negatively impacted by pricing pressure from our customers. We expect that our gross profit margin will continue around the current level for the remainder of the year.

Selling, general and administrative expenses were $17.1 million for the third quarter of 2010. As disclosed in our earnings release, SG&A costs for the current quarter included $900,000 in death benefits provided to the family of the Company's former Senior Vice President of Orthopaedics. Excluding these costs, SG&A as a percentage of revenue for the quarter was 12.7%, compared to 13% for the comparable 2009 period, reflecting the implementation of various cost-control measures.

As expected, net research, development and engineering costs for the 2010 third quarter of $11.4 million were above the 2009 period of $9.7 million. As Tom discussed earlier, these higher costs reflect our strategy to further invest resources in long-term growth opportunities, including systems and device-level projects. During the quarter, customer cost reimbursements were consistent with the prior year period. These cost reimbursements can vary significantly from period to period due to customer resources and the timing of the achievement of milestones on development projects.

GAAP operating income for the third quarter of 2010 was $13.2 million, compared to a loss of $23.9 million for the third quarter of 2009. Prior year results include $34.5 million litigation charge related to a jury verdict against our Electrochem subsidiary. Adjusted operating income was $14.4 million, or 11.3% of sales, in the third quarter of 2010, compared to $13.6 million, or 11.2% of sales, for the comparable 2009 period.

The 2010 third quarter GAAP and adjusted effective tax rates were 28.1% and 30%, respectively, compared to 27.9% and 30.2%, respectively, for the same period of 2009. The 2010 rates include the benefit of higher income from lower foreign tax rate jurisdictions, which was offset by the absence of the research and development credit that expired at the end of 2009. Pending legislation would retroactively reinstate the R&D credit to the beginning of 2010. We estimate that if this legislation were enacted in the fourth quarter, as currently proposed, it would positively impact the full-year effective tax rate by approximately 350 basis points.

GAAP diluted EPS for the third quarter of 2010 was $0.25 per share, compared to a loss of $0.90 per share for the third quarter of 2009. Adjusted diluted EPS was $0.34 per share for the third quarter of 2010 and $0.32 per share for the comparable 2009 period.

Cash flows from operations for the third quarter of 2010 were $28 million and were used to fund the repayment of approximately $27 million of our outstanding line of credit. For the year, we have generated $72 million of cash flow from operations, which funded the repayment of $57 million of long-term debt. We continue to take steps to strengthen our balance sheet in order to support future internal growth. As such, we currently expect the cash flow from operations for the remainder of 2010 will continue to be used to support capital expenditures and to further pay down debt.

Moving on to our 2010 guidance, as you can see from Slide 16, we are reaffirming our expectation that 2010 sales will be within the range of $532 million to $551 million set at the beginning of the year. However, based upon our results for the first three quarters of the year, and taking into account the slower than expected CRM market growth, we now believe that our sales will be at the lower end of the range. This guidance assumes that our CRM, (inaudible) and neuromodulation revenue growth will be flat in comparison to the prior year and that our 2010 Electrochem revenue growth will be slightly above the 0% to 5% range provided at the beginning of the year.

Consistent with our 2010 sales expectations, we now believe that our adjusted operating profit as a percentage of sales for the year will be at the lower end of the 12% to 13.5% range previously provided.

Overall, the fundamentals of our business remain strong. We remain focused on our strategic objectives and remain on track to achieve our long-term goals. We have worked hard to implement our strategic plan and are now beginning to see some of its benefits. We continue to streamline our operations in order to help offset the impact of slower growth in our end markets and customer pricing pressure.

As a result of our strategic initiatives over the last several years we have significant capacity within our existing facilities to accommodate future growth. Ultimately this will help drive incremental margin expansion once the industry environment improves and we are able to further leverage our resources.

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

(Operator instructions.)

And your first question comes from the line of Stan Mann, from Mann Family Investments. Please proceed.

Afternoon, gentlemen. I have several questions, one on your debt paydown. As I recall, the majority of your debt that's left is convertibles, converts, and basically can you explain what your paydown plan would be? Have you got a call on the converts, or etc., etc.? That's the first question.

Stan, this is Tom Mazza. Let me answer that. We still have -- as of the end of October we still have a line of credit that we're currently utilizing to the tune of about $71 million, and so our paydown would be on that amount of money.

Next, and what would you do after that?

Well, I think right now, Stan, we're evaluating, given the current financing markets and our strategic plans as a company, which we're just completing with the Board of Directors on the next sets of plans for systems devices for the Company, and then we're going to make a decision on capitalization, but at present we're happy with paying, using 2011, continuing to pay down the credit line to completion, and then looking out, obviously, at the -- both the credit line and the converts start reaching maturity in 2012. so then we'll have to start making decisions on our next steps for capitalization, and we'll be planning that out next year on how we want to go forward and renew or other ideas that we have. But we haven't made a financial decision on it yet, so mostly just focused on paying down the credit line right now.

Okay. I know you can't talk about names of customers, but in your major markets, for instance Orthopaedics, CRM, do you have more than one customer?

In Orthopaedics and CRM we have a major customer in Orthopaedics because we bought their manufacturing facility, and we disclosed that. It was Johnson & Johnson for the implants. In the balance of the Orthopaedics business, which is trays and instruments, we have multiple large customers, so it's very diverse. In cardiac rhythm management we sell to the five cardiac rhythm management players, and they're all significant in terms of our sales revenue. So we sell different products to each one and have different supply agreements with each one, and many of those are disclosed and EDGARized in terms of what the relationships are. And they're very longstanding and they have a -- well, they periodically come up for renewable, sometimes every three, five or seven years. We routinely, as one reaches maturity, we renew it and then reengage with the customer to extend it to -- under a new agreement.

Are you finding any of the major producers in, say, ortho, are any of the other producers looking to sell their facility to get lower costs and more efficiency, like the J&J deal? Is that anything on the table like that?

I've seen other deals like ours a few years ago in which that also took place, but of recent I have not seen a lot of movement in the M&A markets regarding that. So potentially there are still opportunities out there, but I think everybody's been waiting for the recovery in the orthopedics market to kind of stabilize and come back again. We're not really looked forward towards any specific acquisitions as a company. We're happy with the product lines and technologies we have, and we['re working on integrating them and doing more for our customers, and not really focused on M&A growth.

My last question refers to your R&D spending level. It just seems, as I've said before in calls, it seems like we're spending a lot of money in a market where really we're just producing something efficiently. I guess you really haven't gone into any detail about any major developments or submission for your investment -- investor base to kind of get confidence that the money -- it's a lot of spending compared to your other functions, SG&A, etc. And can you kind of give us a little more color or detail on how you see the payback, and in what areas?

I certainly will, and thanks again, Stan, for always questioning on this, because it does allow me a chance to talk a little bit more open ended on it. I agree with you. With the support of the Board of Directors and the management team here we have planned out and have been executing on a ramp in R&D spending. We've been maintaining our spending on our core component technologies as we engage with our current customers, and we've been, as we would with any product line, continue to mature the technologies along that customers are demanding for their devices that are of higher levels of performance, and particularly technical performance.

We've always maintained quality and reliability extraordinarily high and really held ourselves out as a gold standard in manufacturing and quality on the component side. But the incremental spin in research and development has been almost exclusively been focused on systems and device projects that strategically we've decided that we're going to leverage our core component capability. We're going to work with specific customers or sets of customers on device- and system-level projects that they have.

And then we're going to work towards commercialization of those technologies where we do the development and we're delivering those regulatory approved devices to the customers. And that has been a multiyear strategy. There's multiple projects that are running right now, the first of which was OptiSeal. There are additional filings, regulatory filings that are occurring before the end of this year, and then there's additional regulatory filings on some of those projects at the beginning of next year.

So, in response to your question with regards to needing confidence and information, we've decided at the beginning of the next year, we're -- in 2011 in the first quarter conference call we're going to start to provide more color on the overall strategy and additionally the individual projects that we have. And then we will also, along with those projects, disclose who we're working with as we make the regulatory filings for them. And that communication will roll out over the course of all of 2011 as these projects are reaching the regulatory submissions.

And, of course, it's taken us years to develop the underlying technologies and also these devices and systems, and the first sets of projects coming out are the Vascular projects themselves. And we're going to be talking about those in great detail and potentially even having expanded investor sessions where we'll be able to have site visits where we can explain more particularly details regarding the systems and devices.

We've recruited a lot of people into the Company that have a long range of experience in these areas. We're highly confident with our timelines. We've remained on our spending and budgeted plans, and we've been running to the timelines that we've originally planned. And, while we have certainly have projected a more robust components business at the beginning of the year, that's flattened out. It's kind of highlighted a lot of the R&D spending, but really that spending is on plan.

It's just the weakness in the underlying component markets that have kind of shed a brighter light on it, because the components business has struggled to be able to achieve growth with some of these tough market conditions. And I think if the market had grown for what we originally thought it would be, then we would've had better push through productivity and better profitability under those higher revenue streams, and I think we would've been able to show that we kept the R&D spending fairly reasonable.

So I think it's just we're in a period of really pressing on efficiencies but not sacrificing the funding of those programs, because that's where we think is the key growth driver for revenue in the Company and profitability for the Company as we get those approvals out 2011 and 2012. It's really pivotal we push those through the regulatory windows and partnering with the OEM customers for that.

But we really haven't heard -- a major market like CRM, I mean, we've talked about MRI-compatible CRM devices, and really nothing's been released that I'm aware of from GB in the last couple of years. And it would be good if you would in January or at some point tell us, share with us where we are in the payback on these projects, specifically.

Yes, and I think you're right. We've spent heavily on them. A few of them we have, like introducers and lead wires, we have shared some information, because we've signed agreements with key customers on those. We'll continue as we have comfort, because a lot of these projects are competitively sensitive, as we -- and they're also sensitive with the customers we're launching them with. We'll end up disclosing what the projects are and providing that financial analysis on what we invested and also what we expect the payback.

And because we're not only manufacturing the devices, we're also manufacturing every single underlying component technology of those devices, it pulls a lot of parts business for us through the overall strategy, which, obviously, because we have already completed the consolidations in these various businesses we have the ability to leverage that new capacity that we've installed when we make those system and device sales.

And, again, we're not going to the end markets with these products. We're partnering and selling through our OEM partners, so that when it's -- there are sometimes devices under the Greatbatch Medical brand, but they're also devices that go to market as our customer's brand, like they typically would, and we're cooperatively working on them, just like we would any other component product that we have.

All right. I accept that. But, again, we need some specifics. Over $40 million spent, you've got to get a return on investment in a reasonable period of time. But thank you.

Thanks, Stan.

(Operator instructions.)

And your next question comes from the line of Tim Lee, from Piper Jaffray. Please proceed.

Hi, Tom, it's actually Cynthia in for Tim. So, I just wanted to touch on CRM, because I know the underlying markets have slowed and so you're seeing your customers kind of draw down inventory. Can you help me better understand ordering patterns for the CRM market, and specifically just how long should we expect the impact of inventory drawdowns to impact CRM and neuro sales? Would two to three quarters be a fair assumption, just similar to what we saw in Ortho a year ago?

Yes, Cynthia, the way I like to look at it is, as you know, similar to Ortho, when kind of the projections change on the growth rate of the market from the principal players there's kind of two effects. One would be that their take rate going forward is reduced, and then additionally there's an additional incremental decline while they readjust their inventory levels. And obviously the take rate tends to persist, obviously, for perpetuity until there's a market shift change, but the inventory level does usually take two to three quarters to stretch out. It varies a little bit by product line.

But I would say, as you can imagine, that typically customers focus on their higher dollar items to adjust for inventory first, and then it stretches out. We don't always get POs from customers. We work on poll systems, lean manufacturing (inaudible), so they make adjustments to those literally by part number. And the operating groups do tend to take several quarters to make that change-out over. So for that inventory adjustment you're making a good assumption to look at two to three quarters for the impact.

Okay. And kind of just another follow-up question on CRM, I know you had a partnership announced, an agreement with St. Jude, to develop their MRI-compatible components for their pacemakers. Can you disclose anything about the timing and when we could see maybe a benefit?

Certainly. I'll be specific here. There's multiple layers of technology that are required to make any active implantable medical device MRI conditional. One of the components that's required is filtering capability that's MRI compatible that's actually on the pulse generator itself that eliminates interference. So what we've done with the new development agreement with St. Jude is we've signed an agreement in which we're going to take the lead at developing technologies that apply to that and work cooperatively with them at incorporating those into their designs.

So, overall, we're working on the underlying component technology there, and St. Jude has to make the decisions on how they would incorporate that in their broader strategy of MRI-conditional devices. And, obviously, for confidentiality reasons, we wouldn't comment kind of beyond what's in the supply agreement, but St. Jude may be willing to provide more color as to their product plans. But we're focused on giving them the underlying technology that enables their strategy.

Okay. And, just switching gears to operating margins, they came in a little bit lower than our expectations and what you've done in the first half of the year. And I think it's fair to say that that's due more to a step up in R&D investment less so than not getting the expected efficiencies of SG&A. But given the increased R&D investments, I mean, is this fair assumption, about 100 basis points improving year over year going forward for just operating margins?

I think that's what we've always tried to target in terms of it we have a zero, flattish growth environment is to target the 100-basis-point improvement range to drive productivity, and then obviously making decisions in SG&A and R&D to allow us just to keep the business balanced. And I think you're exactly on, Cynthia, is is that we planned for a little bit more growth that we have received. Cardiac rhythm management is, in particular, weak. We did not -- we elected not to turn off the strategic project spending in research and development, which allowed -- really basically brought that line item in heavier, and it definitely put pressure on the operating margins.

I think as we look forward in 2011 and we start to see the initial commercialization of some of these products, we start to begin having some level of ability to offset that R&D spending. And we obviously have started to adjust our plans to wait for some of these projects to reach fruition before starting new device and system projects in 2011 so we can keep the growth rate of research and development linked up with the size revenue we have as an operating company. And until we get that back on a stronger growth trajectory we'll keep playing it a little bit more conservative.

But we're not going to cancel the current projects. And that should allow us to continue to, even under a lot of pressure in terms of the overall markets being flat, we still should be able to produce a lot of productivity in our manufacturing environment, including the business in Orthopaedics that we're working on now, and we would want to target that 100-basis-point improvement and put the programs behind it to achieve it.

And besides the Vascular project in 2011, what other divisions do we see new products and new projects coming out of in 2011?

In 2011 we focused most of our projects two and a half years ago on the Vascular area, but there's multiple projects, there's five or six projects that we focused on that we will talk to. There's other system and device products that we have. But I think it's probably safe to say that those are more 2012 and beyond projects.

But I will highlight that, while the Vascular projects will start to produce some tangible results in 2011, we'll talk about not only the Vascular projects next year but some of those non-Vascular system and device products that we have running. And while they won't materially provide any revenue for 2011, some of those non-Vascular products we'll message, too, so that people understand the technologies and the business cases behind them as they come to fruition in 2012 and beyond. So we will be providing information next year on those, as well.

Okay, great. Thank you.

You're welcome.

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. 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 call.