Integer Holdings Corp (ITGR) 2010 Q4 法說會逐字稿

Welcome everyone to the fourth quarter 2010 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 Greatbatch Incorporated 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 future operating results, financial conditions, or prospects. I would 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 year end 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 fourth quarter results and strategic accomplishments for the year. After that, Tom Mazza will provide further comments on our financial results and guidance for 2011. 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.

Before we begin today, I would like to remind everyone that we will be hosting an investor day for members of the institutional investment community on March 24, 2011, where management from across all of our businesses will provide an in-depth look into the Company's innovation strategy, which has opened new pathways for future growth. The event will take place, beginning at 8.30 AM at the Millennium Broadway hotel in New York city and will be simultaneously webcast. We would like to point out that this location has changed from the previously announced venue. Please refer to our website for further details. With that, 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 fourth quarter, which marked the completion of another solid year for Greatbatch. Our fourth quarter revenue of $133.1 million increased 6% over the prior year, and was led by a 29% vascular access growth and 22% orthopaedic growth.

Given the challenging dynamics we are currently facing in the cardiac rhythm management market, the diversification strategy that we embarked on three years ago certainly appears justified. I'm particularly pleased that we are able to overcome these head winds and still achieve results within our guidance range for the year. As with move into 2011, we expect that these difficult market conditions will persist, but will be partially mitigated by the initial benefits of our systems and device strategy, particularly within our vascular access product line.

Similar to sales, our operating results were also solid during the quarter, as our adjusted operating income increased 8% to $17.8 million or 13.3% of sales. Versus $60.4 million or 13.1% of sales last year. This improvement reflects the benefit of the higher revenue during the quarter, as well as our various cost cutting measures. These initiatives also contributed to the 30 basis point improvement in our gross margin and drove reductions in SG&A costs, which decreased 15% in comparison with the prior year quarter.

As expected during the quarter, we continued to invest in our long-term strategic objective of delivering system and device products to our customers, which is reflected in the higher research, development and engineering costs. For the quarter, these costs increased $4.1 million over the prior year, bringing the net research, development and engineering cost to 8.5% of sales. Versus 5.8% in the prior year. For the year, adjusted operating income was 12.2% of sales, which was also within our original guidance provided at the beginning of the year.

The net result of all this was that we achieved adjusted earnings per diluted share of $0.46 per share for the quarter, which represents a 15% increase over the prior year. More importantly, we generated $21 million of cash flow from operations during the quarter, which was used to repay the same amount of debt. I should point out that this cash flow number excludes the $16.3 million of after tax impact of the settlement of our Electrochem litigation during the quarter. This brings total cash generated from operations to $93 million for the year, and debt repaid to $78 million. Tom Mazza will provide additional detail on your financial results later in the call.

I would now like to spend a few minutes reviewing with you some of our more significant accomplishments for 2010 and the progress we made on our strategic initiatives. In my opinion, 2010 was a year of solid execution. Throughout the year, we stayed focused on our three key strategic initiatives, growing and diversifying our revenue base, driving operational excellence, and delivering innovative solutions.

With regards to our first long-term strategic initiative of growing and diversifying our revenue base, this year provided a good example of the benefits of this strategy. Despite a 1% decline in our cardiac rhythm management revenue, which still comprises 57% of our overall business, we were able to report steady revenue growth. As a direct result of our diversification strategy, today we have a revenue base that extends across multiple product lines, customers and industries and provides us with a more stable foundation from which to grow over the longer term.

Over the past year, we also took steps to further solidify our relationship with three of our largest customers. Boston Scientific, Medtronic and St Jude Medical, by renewing and extending our long-term supply agreements with them. These agreements are important on multiple levels, first and foremost they secure a significant portion of our revenue base through various dates up to 2017. Additionally, these agreements demonstrate the close working relationship that we have with our customers, and are a testament to our quality and reliability, as we are a key supplier for several critical components for their devices. Finally, these are agreements further reflect the diversification strategy as we are able to add new product lines to these agreements, which are a direct result of our broader portfolio of products.

We are committed to working with our customers to enable them to bring solutions to market. We do this by providing innovative and dependable products in a cost effective manner, which is enabled by our operational excellence and intellectual capital. These agreements illustrate our ability to deliver on that commitment and are clearly a win/win situation for both Greatbatch and our customers.

Additionally, with regards to diversifying our revenue base, during 2010, we continued to make significant investments in our orthopaedic business by expanding our capabilities, reducing lead times and improving on time delivery. We continue to make progress in this market, and are gaining a reputation for our quality, operational excellence and innovation. In 2011, we will continue to make investments in our orthopaedic business, which will include our recently announced $17 million investment, in an 80,000 square foot facility that is state of the art and will be located in Allen County, Indiana. This is the third project Greatbatch Medical has deployed as part of our overall strategy to partner with orthopaedic device makers.

In 2010 we also announced Phase I of our state of the art orthopaedic design center in Warsaw, Indiana providing customers with rapid prototyping capabilities. Additionally, we are in the process of completing a $6 million investment in our Indianapolis, Indiana manufacturing facility. Additionally, during 2010, we also made investments in our Chaumont, France orthopaedic facility. Through all of these investments, we are now able to produce spine implants and manufacture reconstructive implants for our 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.

Driving operating performance is our second strategic initiative and is also a critical part of our long-term plan to create shareholder value. Despite the fact that nearly all of our consolidation initiatives were completed at the beginning of the year, in fiscal 2010, we still achieved substantial productivity improvements across our operations. These improvements contributed to the 8% reduction in SG&A expenses during the year, as well as 60 basis point improvement in gross margin. What is most impressive about this improvement is that it came despite increased pricing pressure from our customers.

The consolidation and cost control initiatives completed over the last five years are driving improved operating performance in a more scalable business model. We have a significant amount of manufacturing capacity at our existing facilities to support the launch of our systems and device projects, which began delivering new revenues in 2011. Additionally, our improved operating performance is driving strong cash generation, which allowed for us to fund increased level of research and development investment and to pay down debt. We have now repaid over half of the debt used to fund our acquisitions in 2007 and 2008. And have sufficient capital to fund our future investment and growth plans.

Finally, I'm extremely happy to report that near the end of 2010, we consolidated our Greatbatch Medical business under the leadership of Mauricio Arellano. We also promoted Mauricio to President of that group. The consolidation of Greatbatch Medical will allow us to further leverage our infrastructure as part of our overall strategy to drive growth through innovation, reliability, operational excellence and customer satisfaction. Given Mauricio's exemplary track record and dedication to exceptional customer service over the last seven years, I have the utmost confidence that he and his team will be successful in leading the largest business segment of our Company.

Our last key strategic initiative is to drive growth through delivering innovative solutions. In connection with this initiative, over the last three years, we have significantly increased the level of our research and development investment. The outcome of this investment is that we are now able to provide our OEM customers with full system and device solutions. This includes development and regulatory submission, as well as supporting worldwide manufacturing and distribution. During 2010, we began to see returns on our increased investment with the receipt of our first 5-10-K regulatory clearance under the Greatbatch Medical brand related to our OptiSeal Introducer. Sales of OptiSeal began in the end 2010 and future expectations for sales of OptiSeal, as well as other device level vascular access products, are included in our guidance for 2011.

As the second example, of how we are benefiting from the investments we made in connection with our innovation strategy, with the announcement last month of the sale of our minority investment at Intellect Medical, in conjunction with Boston Scientific' s acquisition of Intellect in January 2011. As previously disclosed, we received $10.5 million in cash proceeds, and expect to recognize a pre-tax gain of approximately $4.5 million in the first quarter of 2011 in connection with this transaction. Investments in start up technology companies such as Intellect that operate in our core medical markets of cardiac rhythm management, neuromodulation, vascular access and orthopaedics is another example of how we are investing in innovation.

Finally, in addition to the products just discussed, in 2010, we made significant progress toward our goal of delivering longer term system and device solutions to our customers. These products are expected to drive incremental growth and margin expansion for our Company and ultimately, provide a return for our shareholders. Due to the complex nature of these projects, a one hour earnings call is not a sufficient amount of time to properly detail them. The strategy behind them and how they will benefit our shareholders. Instead we look forward to providing further and in depth details on the strategy, including our how our QIG group is supporting this initiative, our accomplishments to date and our plans for the future at our investor day on March 24, 2011.

Before turning the call over to Tom Mazza, I would like to take the opportunity to acknowledge and thank our associates around the world who have chosen to dedicate themselves to driving Greatbatch forward on all our strategic initiatives. Thank you for all your hard work and commitment.

This is an exciting time for our Company. I believe everyone at Greatbatch shares my sense of optimism and confidence in the enormous opportunities embodied in our strategy. We expect innovation to be the growth engine for the Company for the years ahead and look forward up to updating you at our progress at our investor day next month. With that, I'll now turn the call over to Tom Mazza for a more detailed review of our fourth quarter financial results.

Thanks, Tom. Good afternoon. For the call today I'm pleased to review with you our results for the fourth quarter and full year ending December 31, 2010, beginning on slide 9. Consolidated sales for the fourth quarter 2010, of $133.1 million grew 6% over the prior year quarter and 4% over the sequential third quarter. For the year sales were $533.4 million or 2% above the prior year as recoveries in our vascular access, orthopaedics and Electrochem markets offset the slow down in CRM. Fourth quarter and full year results include the impact of foreign currency exchange rates which reduced sales by approximately $1 million and $2 million respectively in comparison to the prior year periods.

Looking at our individual product lines, CRM and neuromodulation sales for the fourth quarter 2010 increased 3%, compared to the prior year. This increase was primarily due to higher sales of medical batteries, as customers continue to adopt our Q series batteries, which enable new device features and reduced device size. For the year, CRM and neuromodulation sales were down slightly due to continued pressure from our OEM customers on pricing, dual sourcing and vertical integration initiatives. We expect these pressures on CRM revenue to continue to impact sales in 2011.

Fourth quarter 2010 sales for the vascular access product line increased 29% to $9.8 million. This increase was primarily due to higher introducer sales as customer inventory reduction programs, which impacted sales from the second quarter of 2009 to the second quarter of 2010 are now complete. For the year, vascular access sales increased 6% primarily due to higher introducer and catheter sales. We currently expect vascular access revenue growth to accelerate in 2011 as we launch several new systems products.

Orthopaedics product line, sales of $30.8 million for the fourth quarter 2010, were 22% above the comparable 2009 period. This increase was across all of our orthopaedic product lines as this market continued to recover from the slow down in 2009 and as our investments and expanded capabilities have begun to deliver new business. Fourth quarter 2010 orthopaedic sales includes the negative impact of the weaker Euro exchange rate which reduced sales by approximately $1 million compared to the prior year. For the year orthopaedic sales increased 4% at the market continued to recover throughout the course of the year and includes approximately $2 million of negative foreign currency exchange rate impact.

As expected, Electrochem sales for the fourth quarter of 2010 were 17% below the prior year and 32% below the sequential third quarter as some of our largest oil and gas customers purchased the majority of their inventory requirements during the second and third quarters of 2010. For the year Electrochem revenues were up 10% due to the recovery in the energy and portable medical markets in the downturn in 2009. Going forward, we expect Electrochem revenue to return to a more normalized run rate beginning in the first quarter of 2011.

Turning now to expenses. Gross profit as a percentage of sales for the 2010 fourth quarter was 33.4%, an increase from 33.1% in the 2009 fourth quarter. For the year, gross margin as a percentage of sales was 32.5%, compared to 31.9% for 2009. These improvements were primarily the result of continuous productivity gains, as well as a better mix of sales and higher margin products that was partially offset by continued pricing pressures. For 2011, we expect that our gross profit margin will continue to improve as our higher margin systems and device projects ramp up and as our volume improves.

Selling, general and administrative expenses for the fourth quarter and full year 2010 declined $2.6 million and $5.8 million respectively, compared to the same periods of 2009. Excluding the $900,000 in death benefits provided to the family of our former Senior Vice President of Orthopaedics in the third quarter of 2010, SG&A expenses for the year decreased $6.7 million, or 9% in comparison to 2009. The primary driver behind this decrease was the various cost reduction initiatives implemented during the year.

As expected, net research, development and engineering costs for the 2010 fourth quarter of $11.4 million were above the comparable 2009 period of $7.3 million. For the year, net RD&E as a percentage of sales was 8.4%, compared to 6.4% for 2009. These higher levels of RD&E reflect our strategy to further invest resources in long-term growth opportunities, including systems and device projects. Additionally, the 2009 fourth quarter included a higher amount of customer cost reimbursements, which vary significantly from period to period, due to the timing of the achievement of milestones on development projects.

GAAP operating income for the fourth quarter and full year 2010 was $24.5 million and $69 million respectively, compared to a loss of $2.3 million and income of $1 million for the respective periods of 2009. In 2009, the Company incurred a $50.9 million trade name write down charge in the fourth quarter, as well as a $34.5 million litigation charge related to the Company's Electrochem subsidiary in the third quarter. The fourth quarter of 2010 includes a $9.5 million gain related to the settlement of this litigation.

Adjusted operating income, which excludes the fact of these as well as certain other items, was $17.8 million or 13.3% of sales in the fourth quarter 2010, compared to $16.4 million or 13.1% of sales for the comparable 2009 period. For the year, adjusted operating income as a percentage of sales was 12.2, which was within our guidance range we provided at the beginning of the year and above the 12% for 2009. I would like to refer you to the appendix of today's presentation for a reconciliation of the adjusted amounts to GAAP.

During the fourth quarter of 2010, research and development tax credit was extended for both 2010 and 2011. Retroactive to the beginning of 2010. As a result, the fourth quarter 2010 GAAP and adjusted effective tax rates include the benefit of approximately $1 million, representing the cumulative catch up adjustment for the credit related to the first three quarters of 2010. The 2009 GAAP and adjusted effective tax rates benefits include the favorable impact of the resolution of tax audits and the lapse of statutes of limitations on certain tax items.

GAAP diluted EPS for the fourth quarter and full year 2010 was $0.59 and $1.40 respectively, compared to losses of $0.07 and $0.39 respectively for the comparable 2009 periods. Adjusted diluted EPS for the fourth quarter and full year were $0.46 and $1.51 respectively, compared to $0.40 and $1.52 for the comparable 2009 periods.

Cash flow from operations for the fourth quarter of 2010 were $4.9 million and were unfavorably impacted by the $16.3 million after tax impact of the Electrochem litigation settlement. Excluding this settlement, cash generated from the operations for the fourth quarter was $21.1 million and $93.1 million for the year. During the quarter we paid $21 million of outstanding debt. With total debt repaid for the year to $78 million.

Moving on to 2011 guidance, as you can see from slide 11, our current expectation is that 2011 sales will be approximately $540 million to $560 million. This guidance assumes that our CRM and neuromodulation revenue will be flat for the year and our vascular access revenue will grow between 10% and 20%, bolstered by the launch of several new systems and device projects. We are assuming that our orthopaedics and Electrochem revenue will continue their moderate growth rates, that is growth of 2% to 10% for the orthopaedics group and 2% to 5% for Electrochem.

Adjusted operating income for 2011 is projected to be between 12% and 13% of sales and is expected to consist of GAAP operating income less non-recurring unusual or infrequently occurring items such as consolidation and integration charges, certain R&D expenditures, asset disposition and write down charges, totaling approximately $8 million to $11 million.

The net result of the above guidance is that we currently expect 2011 adjusted, diluted earnings per share to be in the range of $1.55 to $1.65 per share. Adjusted diluted EPS is GAAP diluted EPS, excluding the after tax impact of the amounts just described. Plus $8.5 million, $5.5 million net of tax for the non-cash convertible debt interest expense and approximately $4.5 million on pre-tax basis, $9.5 million after tax related to the gain on the previously disclosed sale of the Company's investment in Intellect Medical. This guidance also assumes that our effective tax rate would be approximately 35% and assumes approximately $24 million average diluted shares outstanding.

We will provide further details regarding our 2011 guidance at our upcoming investor day next month, where we will also provide more insight to our innovation strategy and how the investments we made over the last three years will positively impact the long-term growth potential of our Company.

Our financial performance in 2010 includes the benefit of the investments and operations in infrastructure we made over the last five years. These investments have also provided us with significant --sufficient manufacturing capacity for our systems and device level products, which we will begin to ramp up in 2011 and is expected to drive future revenue growth in margin expansion. With that, let me turn the call back over to the moderator to take questions.

(Operator Instructions) Your first question comes from the line of Jason Mills with Canaccord. Please proceed.

Thank you very much. Hi, Tom and Tom. Thanks for taking the questions.

How are you doing, Jason?

Good. Thanks guys. First a housekeeping item for Tom, sorry if I missed it, but did you give guidance for interest expense during the year for 2011?

No, I did not.But it should be similar to 2010. (multiple speakers)

Right.

(multiple speakers) On additional cash flows.

The run rate dropped in the fourth quarter. I wondered if we should use that as a run rate or more in the $2.5 million to $3 million range?

Yes, use the fourth quarter run rate.

Thanks. Thinking more long-term, Tom, would love your thoughts on a couple of different areas. First, more specifics if you can, on some of the systems level projects you have going on. You spoke of some that you're -- in your prepared remarks on the vascular side. But perhaps some that you have mentioned in the past briefly on the -- in the CRM and Electrochem businesses respectively. And then my last question is with respect to your long-term operating margin targets. In the past, you've given some guidance as to how you see the business projected over a two or three-year period of time, wondering if you are willing to do that again on this call?

Certainly, Jason. Well I can say long -- over the longer run, we remain committed to the discrete product franchise that we've built over 40 years, both in Greatbatch Medical and Electrochem. And as we've said, as the idea behind the systems and device strategy is to add product lines in addition to those discrete product offerings, and continue selling them out to the OEM customers that we are currently doing business with. And some of the agreements that we are signing incorporate both those discrete product or component sales, as well as the new systems and devices as we get them approved. So, they're very much in cooperation with the OEMs. You are correct that, initially, the vascular access products were the ones that have cleared the FDA regulatory processes first. We also have other cardiovascular projects, including cardiac rhythm management, that are in process of completing designs, customer evaluations, and regulatory approvals, both within the US as well as in Europe, for the CE mark. The systems and device strategy is not just medical, there is also strategies going on in Electrochem, in similar veins with Electrochem customers. They have projects started there as well. And what we're going to do is when we have the investor day in March, is we're going to go down by each of our core areas, cardiovascular, break that out into the projects we are doing, and we are also going to break out some of the work that's being done on the neuromodulation side. And although we won't be providing a lot of details on orthopaedics, because that's a future endeavor, we'll be providing some commentary on what our longer range plans are for, there. The important thing to note is that we have a chance to do more comprehensive work for customers, based on customer demand and customer requests. And it is a unique opportunity for us to highlight it next month in a half day session on the investor day.

I think what that means to your second part of your question on longer operating margins, is consistent with what we've said before is that we feel that we have been able to steadily improve from an operating base and post good productivity with what limited revenue growth we've had. And we think that with limited revenue growth, we still can get about a 100 basis points of productivity a year, that we have 5% to 7% revenue growth, we feel we can get several hundred basis points of productivity improvement per year. Now, we have been take that productivity growth and we have been funding an increase in research development expenditures to fund the systems and device initiative. But I can tell you that the systems and device initiative are what's going to return the higher rates of margins, both at the gross margin line and the operating income line, that allows us in the longer run to approach that 20% operating income target that we are oriented at. And just right now, in 2010 in particular, was a period of time in which we had very heavy research and development spending. And no project revenues from any of these systems and device projects. And now that 2011 has finally hit, we finally have revenues starting in these areas in systems and devices that deliver us higher margins. But not only that, next month we'll be able to actually describe what those projects are, so then they can be modeled appropriately as we go out and look at what the size of the opportunities are, how fast we can grow it, and what the milestones dates are for approval on the various projects. So, there will be a lot more information that is shared in March relative to that. And then you can get a better sense of how we want to walk our operating margins up by launching systems and device projects with OEM customers, and how we keep driving that forward.

Okay, that's helpful. We'll look forward to that. Seems like there is going to be a lot of information there.Last question for me, last two questions for me, I guess, is if you could just go over the announcement yesterday of the extension in the agreement with Boston Scientific and how important that is. And any additional details that you could provide on that front. And then, also interested to know what your longer term tax strategy is. It's -- your tax rate is not abnormal, but certainly companies in the med tech space that are profitable, like you are, that have been able to bring that tax rate down over time. Just curious whether or not that is a focus area for you long-term or if this is a level you expect the Company to be running at from a tax standpoint for a longer period of time? And thanks a lot for taking all the questions.

Thanks Jason. I'll certainly say the five year extension of the Boston Scientific agreement an exceptional accomplishment by Mauricio Arellano and his team. Clearly those are very complex agreements to negotiate and discuss with customers. The agreement does incorporate an extension of not only the historical product lines we have sold to them, or discrete products, it also incorporates system levels products as well as purchases that we will make from Boston Scientific of certain product lines. So, it is a complex agreement, it took a significant time to negotiate, and any time that we have the ability to partner that deeply with one of our top customers, it's a tremendous accomplishment. So, we are very proud of it, and it's really the -- obviously the ending milestone to cementing that relationship for the next five years, and provide us and Boston Scientific the ability to work together closely and have predictability in the business so we can drive improvements for them and ourselves. From the tax strategy standpoint, is I would like the tax rate to go down and I'm just as interested in understanding how Tom Mazza is going to answer that in terms of getting it down.

Jason, clearly it's a focus area of ours. Over the past couple of years I think we have been able to keep it below the US statutory rate, a couple of points at least per year on it. Clearly that's going to be a target. We kind of use the 35% as our benchmark as a starting point. We are able to cover all the state taxes with that. But particularly, it will depend upon future growth in our orthopaedic area, which has a significant amount of operations overseas, to try to get it down any further would be below that 32 number for us on our side.

Okay guys, thanks, that's helpful.

Your next question comes from the line of Cynthia Yee with Piper Jaffray. Please proceed.Cynthia, your line is open.

Hi, sorry. Thanks for taking the question. I just had a follow-up question on ortho. The guidance range is pretty big, 2% to 10%, and I'm just curious what you guys are seeing in terms of demand from your end customers, and if that has led to the wide guidance range?

I think it is a combination of factors, Cynthia, is that there definitely is some uncertainty within the orthopaedic customer base in terms of what true global market demand is. In addition, what their supply chain statuses are that kind of ebb and flow based on end market demand. So the bottom end of our range really reflects us, really the conservativeness we like to plan around for a market that is in this recovery phase. However, at the same time, because we are operationalizing a lot of investments in this area, our Warsaw design center, our Indianapolis, Indiana manufacturing facility investments, as well as our Chaumont, France investments. We think as we complete those projects and launch them, and can get projects started, even with a pessimistic sentiment in the orthopaedic market, through project execution we could drive up to 10% growth in that market segment. So, that 10% is largely reflective on us finishing the projects and launching them in 2011, which would then end up giving us more material revenues in the second half of the year when these projects are done. Even though we've started the projects in Allen County near Fort Wayne on our manufacturing operation there, that we announced last month, it won't be completed until next year, so we'll get no benefit out of that facility in 2011. But the Chaumont investments, the Warsaw design center and the Indianapolis investments all should be paying off. And I think if we get those to pay off, we should be at the higher end of that orthopaedic guidance range, based on those project executions. Of course, if we get a more healthy rebound in the orthopaedic markets or more pull from customers, that would also be a very favorable factor that we have not considered in giving the guidance because we don't want to plan on a good guy coming through from the market end of the business. Hopefully that's helpful.

And how would the shift in mix in terms of higher ortho revenues and flat CRM, neuro revenues impact margins? Because from what I recall, CRM and neuro are probably 500 basis points higher on a gross margin basis than ortho line?

In general, you are correct, is a higher push from orthopaedics. The margin is not as sweet. But it is important to point out a lot of investments we are make in the facilities are specifically to improve efficiencies and productivity to mitigate that problem. So, as we are launching these projects, we are launching them as efficiency improvement projects, as well as product launch projects so that we are not perpetuating the negative mix, we are fixing the negative mix as we're growing with better capability.

Okay, and then one last question. My perennial one. The MRI compatible components for Sorin, when do we expect that to be reflected in the numbers?

It's, it's always been scheduled for a 2012 submission with Sorin in terms of our overall project goals. We've done an excellent job at completing the engineering, the miniaturization, and the prototyping of the product. And next month at the investor day, we are going to provide some color on the key milestones of that project that we are going towards commercialization. We're really pleased with how that technology has come along. And as you know, we have taken kind of an innovation direction on the MRI program to be a true filtering of the MRI fields. We're not trying to place heavy restrictions in the use of an MRI with an implanted medical device. So, we are trying to allow some level of immunity from the patient to the fields. And our research work, basically, is centered around trying to prove that we can do that in the three buckets of technology I've mentioned before, on the distal and proximal tip filtering and the non-magnetic materials. And so we'll be providing, more or less, a project milestone when we do the investor day event next month, to answer the underlying details of your question.

Okay great. Thank you. I'll jump back in the queue. Thanks.

(Operator instructions) Next question comes from the line of Stan Mann with Mann Family Investors. Please proceed.

Very, very good job operationally. I've got several questions. On your operating ability, just spectacular and proven, I can see the investments in the Chaumont plant or whatever $17 million, and these plant expansions. What I cannot understand is where we're going to get a return for $45 million R&D spending. I know you are putting it through until March. Why don't you run us through on OptiSeal? I guess I'm puzzled as to the approach to marketing and how the project actually worked. You have a customer, one customer, more than one customer? So, can you give us a little color just on OptiSeal? And run us through your thinking on getting $45 million that we are throwing in there, getting some of it back? I just can't see it.

Sure. Well, first of all I'll give you a global overview of the $45 million, is, that's all research, development and engineering. So, it's split between the continuation and evolution of our current product lines and current designs with our customers. And then there is also what I would call green projects that are de novo projects like OptiSeal that we start from ground zero and we invest a few million dollars in their development. Obviously we have -- it takes several years to develop these products and get them through regulatory hurdles, and to use OptiSeal as an example. I won't go into the precise investment profile in terms of the amount of money.

Are we all -- is this shared with a customer, or multiple customers?

Yes, I'll go through it. So we've developed OptiSeal as a valve introducer, vascular introducer for cardiac rhythm management lead wire placement. So we have developed that product, and it's branded Greatbatch Medical. We've, in turn, taken that product and sent it to receive 510(k) clearance through the FDA.

Okay.

We have identified that market as a $20 million market opportunity, and that our plans over the next two years is to capture about half of the market.

Which is?

Which is about $10 million worth of sales. $20 million market. We think within the next 18 months, we can get the $10 million of revenue on that, on an annual basis. So, capture half the market.

For one customer?

So, we have gone out to all the cardiac rhythm management customers and one customer we already have an agreement with, to be bringing that product to market with them. They -- and we already have an assigned agreement. They're -- ended up evaluating the product and selected us, and we have additionally started to sell that product to other, what I'll call third party organizations, that are lower volume or they are distributors or users of the product that we already have sales to. In addition, we'll go to every major OEM that would use that product, and we have active discussions with them and several of them, we also have active negotiations around supply agreement for them. So, the more successful -- we definitely feel we can get to the 50% market share. If we are more successful with the remaining customers, we can get even higher than the 50% market share.I think if you remember several investor calls ago when we talked about the systems and device initiatives, we're looking at the net present value, ROIC, the amount of investment and risk we put in. And the multiple projects that we have going right now. We'll be talking about multiple projects next month on investor day in each of these spaces, we'll highlight basically how we are investing money and what the pay backs would end up looking like, from a hypothetical standpoint. But they are higher than our pay back from the discrete product area investments that we have made historically.

Okay, so if I was in the hospital and I got a St Jude inducer, and would it have Greatbatch's name on it?

That's correct. I mean it -- depending on -- I don't want to go into who we have got a distribution agreement with yet. But it is yes, it would have a Greatbatch Medical name on it. And it would be sold as part of the OEMs overall kit of product with say a pacemaker sale. It would come with a Greatbatch Medical vascular introducer, and that is in partnership with our OEM customers, done that way.

Okay. If you went to another one, Boston Sci, not the real case, would that be labeled or product would be different for OptiSeal?

No, it is exactly the same.

Okay. And it is not sold individually, it is sold as part of a kit?

It's sold individually and it's cleared at the FDA individually as a separate device. But it is part of an overall kit or system that they would sell for a procedure like implanting a pacemaker. But most importantly is, the systems and device initiative is agnostic to this branding. We are happy to do the device designs and brand them with our customer's name or our name, whatever their preference or desire is. If there is a product that is [nichey] enough, in other words the market opportunity is small enough, there is limited utility to branding it with multiple names when it is the same product, so the Greatbatch Medical name is fine. As there is more distinctiveness to a medical device or product, each OEM will make the decision to have it customized to its specific design, and we are happy to put their brand name on it when we do that. We still do the design, we still do the manufacturing, we still do the regulatory approvals for it. We made the strategic decision to kind of do that ourselves and fund it ourselves, rather than have that funded under non-recurring engineering, or exclusivity agreements that kind of restrict our ability to commercialize the technology more broadly.

The smaller players then cannot cut price? They don't operate on margins like St Jude or the big producers, so is there a conflict in why distribution affecting the large customers that you have, that you are starting?

Well, I think different -- vascular access is a widely used technology, that goes even beyond cardiac rhythm management, even though that is a principal application of it. So, when we sell a product, obviously it is a product that is being included in an overall kit with an OEM that is selling a pacemaker, defibrillator, et cetera. Other distributors that buy these may end up using them in other applications that is in their sales kit or product portfolio, they are selling out to individual hospitals or hospital networks. We don't always get a complete breakdown of what those applications are for, although the volumes are usually limited to lower numbers than what the OEMs would purchase overall.

Okay, but the market that you see, for $10 million is just in the CRM area?

Well, okay. So, the market, as a whole, in just cardiac rhythm management valve introducers, we have identified as a $20 million overall market. We feel our opportunity in the next year and a half is to capture half of that market share. So, that is $10 million of revenue for us.

Okay.

I would say that just in general, the pay back period of these investments, these products take two to three years for us to complete. But when we are successful in launching them, the pay back is within one to two year period of time, which is dramatically quicker than what we see in our discrete products area where it typically takes four to five years to commercialize the technology, and then three to four years in order to achieve a pay back because of that long and lengthy time line.

So, we, the investor, should see an increase in top line and bottom line 2012 and beyond?

That's correct. Right now, you are, in the guidance we are giving, seeing the effect of the R&D spending, but we haven't explained the opportunity in terms of revenue growth projects in the longer term. Which, they start in 2011, that is in the guidance for revenue already. But it's really 2012, 2013, where we get more of these, what I'll call [nichier] products through, and they start materially impacting the revenue line.

Do you have an idea looking down the road what your goal is, top line growth?

We think we can grow 5% faster than what the markets are, is what our target has been. And we think we can grow our profitability faster than our revenue growth.

Well you've always done a great job on profitability. That is not my issue. You think you can jam -- get that top line moving on a consistent basis after 2011, 2012, 2013 with this?

That's the underlying nature of the systems and device strategy is precisely that, Stan, is because the markets were not allowing us the opportunities to grow revenue. We couldn't leverage our operating performance. So, by driving innovations ourselves to do more for our current customers, we can drive revenue and leverage our operating performance better in the process, to our benefit and the OEMs benefit to drive value for them.

You are going to put some numbers out at the March meeting?

That is the concept is for us to basically give you more granularity, so you understand where those R&D dollars are going, what projects they are going to, what the time line of the projects are, and what the size and the opportunity on those projects are.

Let me give you some simpler. The debt that's left seems to be all converted, is that correct? You had $197 million?

Stan, there is $50 million worth of revolver left and the balance of it is the converts.

Okay, and the converts though, come due in 2013?

2013 and the revolving line of credit is 2013 as well.

It is? So, your plan on use of this growing amount of cash, can you talk to that a little bit? Your cash flow is improving.

Yes, initially, it's to pay down debt and then obviously we have continued spend on the R&D line, as Tom's been talking about. But it's to pay off the revolving line of credit first, and then go for the converts after that.

Okay. Last question. D&A and 123R for 2011?

I'm sorry, depreciation and amortization? Probably about $46 million.

What about the 123R?

Are you talking about the non-cash interest, you are talking about?

No, 123R is for --

About $10 million.

About $10 million? Is there any other non-cash on to that? You said something about the --

Well, that number's included -- that $10 million, we have approximately $8 million worth of non-cash interest expense, but that's included in the D&A line item.

Oh it is, okay. Thank you. Good job on operations, gentlemen.

Thank you, Stan.

Thank you.

And that concludes today's question and answer session. I would 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 participation. That concludes today's conference call.