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Greatbatch, Inc.’s (GB - Analyst Report) third-quarter 2013 adjusted earnings per share of 57 cents comfortably beat the Zacks Consensus Estimate of 54 cents. Earnings also exceeded the year-ago adjusted earnings by an impressive 24%, driven by solid organic revenue growth, improved gross margins and lower medical device spending, along with benefits from effective tax rate. Reported net income in the quarter was $11.1 million or 44 cents per share, rebounding from a loss of $7.6 million or 32 cents in the year-ago quarter.

Revenues grew 4% year over year to $167.7 million in the third quarter, marginally surpassing the Zacks Consensus Estimate of $167 million. On a constant currency organic basis, revenues increased 5% in the quarter.

Gross margin improved 170 basis points (bps) in the third quarter to 33.3% from 31.6% in the prior-year quarter. The improvement came on the back of higher production volumes and a favorable product mix.

Selling, general and administrative expenses rose 6.4% to $21.6 million in the quarter, led by the company’s sales and marketing initiatives and higher performance-based compensation, partially offset by synergies realized from the consolidation of the Swiss facility.

Net research, development and engineering costs (RD&E) rose 4% to $13.8 million in the quarter. Adjusted operating margin escalated 150 bps to 13.1% on the back of improved gross margin and lower consolidation and optimization costs.

Segment Review

In the reported quarter, revenues from the core Implantable Medical segment (77% of total sales) increased 7% to $129.3 million. Within the segment, Cardiac/Neuromodulation revenues climbed 8% year over year to $87.0 million. Improvement in the underlying market and strategic relationships with Original Equipment Manufacturer (OEM) partners drove the sales growth.

Revenues from the segment’s Orthopedic business grew 11% to $30.1 million in the third quarter. On an organic constant currency basis, orthopedic sales jumped 22% due to market share gains in implants, and cases and tray offerings. However, revenues from the Vascular product line fell 10% to $12.3 million, owing to a product recall.

On a disappointing note, revenues from Greatbatch’s smaller Electrochem segment dipped 5% to $38.4 million. This is mainly on account of soft portable medical sales, which declined 4% to $19.3 million in the quarter.

Environmental and military product sales were also weak owing to the company’s increased pricing discipline and reduced government funding on certain military and environmental projects. However, revenues from Energy business improved 4% to $13.6 million, reflecting normalization of customer ordering patterns. Other product lines revenues plunged 22% to $5.4 million in the quarter.

Balance Sheet and Cash Flows

Greatbatch ended third-quarter 2013 with cash and cash equivalents of roughly $5.0 million, significantly down from $20.3 at the end of 2012. Long-term debt was $210.0 million compared with $225.4 million at the end of 2012.

Cash flow from operating activities increased to $24.7 million in the third quarter of 2013 compared with $16.0 million generated in the third quarter of 2012, due to higher operating income. Year-to-date cash flow totaled $60 million.

Guidance

Moving ahead, Greatbatch reiterated its revenue outlook for 2013 toward the lower end of $660–$680 million. On an organic basis, total sales are expected to be up by 5% to 8%, after adjusting for the disposition of non-core orthopedic assets worth $15 million. The Zacks Consensus Estimate for 2013 is pegged at $663 million.

Moreover, management expects its adjusted earnings per share to be closer to the middle to higher end of its guided range of $2.05–$2.15 based on the company’s strong performance in the first nine months of 2013. The current Zacks Consensus Estimate of $2.09 for 2013 lies within the guided range.

Moreover, GB continues to expect adjusted operating margin of 13% for the year. Adjusted tax rate is forecasted at 31% and share count should be approximately 25 million.

Our Take

We remain impressed by GB’s double-digit bottom line growth on the back of strategic restructuring efforts along accretive investments in sales and marketing. We believe that the company’s realignment plan will help it to focus on investing in its core business as well as develop innovative products by combining the resources of the integrated unit.

We are also encouraged by Greatbatch’s effort to transform into a medical devices company. Almost 80% of its revenues are generated from medical devices companies. The company’s pipeline is healthy with a number of products currently in development that are expected to support growth in the long run. Greatbatch has a Zacks Rank #3 (Hold).

GB has forged strategic long-term agreements with its OEM clients to secure healthy revenue growth. Its top customers include leading players such as Medtronic (MDT - Analyst Report), Boston Scientific (BSX - Analyst Report) and St. Jude Medical (STJ - Analyst Report). Among these stocks, BSX has a Zacks Rank #2 (Buy), while both MDT and STJ carry a Zacks Rank #3 (Hold).

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