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Greatbatch, Inc.’s (GB - Analyst Report) first-quarter 2013 adjusted earnings per share (excluding one-time expenses) of 44 cents beat the Zacks Consensus Estimate by a penny. It also exceeded the year-ago adjusted earnings of 37 cents by an impressive 19%, led by improved gross margins and continued focus on R&D expenses.

The company’s net income (as reported) increased 26.7% year over year to $5.7 million (or 23 cents per share) in the quarter. The results reflect a marked turnaround from the net loss of $5.6 million reported in the fourth quarter of 2012.

Revenues

However, revenues dropped 7% year over year to $148.3 million in the first quarter, which is also down 6.8% sequentially. Revenues missed the Zacks Consensus Estimate of $164 million by 9.6% and was below the company’s expectations. Management claims that the disposition of certain non-core orthopedic product lines amounting to $4.2 million, led to the year-over-year decline.

However, adjusting for this sale, on an organic basis, revenues decreased 4% in the quarter. This was mainly due to the prevailing softness in the underlying cardiac and neuromodulation market along with shifts in customer market share and inventory build up in the fourth quarter. The inventory build in the fourth quarter of 2012 resulted in lower orders in the first quarter of 2013.

Segment Review

In the reported quarter, revenues from the core Implantable Medical segment (75% of total sales) dropped 5% to $111.4 million. Within Implantable Medical, CRM/Neuromodulation sales declined 5% year over year to $71.2 million, reflecting sustained softness in the underlying market. However, the company expects the business to grow in the long term on the back of new products and enhanced sales and marketing efforts.

Revenues from Vascular Access dipped 9% to $10.6 million due to adjustments in customer inventory. Sales are expected to normalize from the second quarter of 2013, partially offset by product recall.

Orthopedic sales fell 5% year over year to $29.6 million due to sale of certain non-core orthopedic products which lowered sales by $4.2 million. On an organic constant currency basis, orthopedic sales jumped 11% because of market share gain in implants and new cases and tray product launches. This was partially offset by the transfer of operations from Switzerland to other facilities. Management claims that consolidation is complete and should benefit the company in the next 2 quarters.

Revenues from Greatbatch’s smaller Electrochem segment declined 11% to $36.9 million due to tough year-over-year comparables in the energy, military and other markets. The Micro Power product line has been integrated into Greatbatch as Portable Medical offerings. Portable medical sales grew only 1% in the quarter, despite favorable market dynamics. Management claims that product launches and customer inventory builds in the previous quarter reduced order intake rates in the first quarter and the segment will pick up pace going forward. Sales from Energy and Other product lines declined 17% and 27% to $12.3 million and $5.7 million, respectively.

Margins

Gross margin surged 340 basis points in the first quarter to 32.9% of total sales on the back of improved production volumes and cost savings realized from consolidation of Swiss facilities. Selling, general and administrative expenses, as a percentage of sales, increased to 13.6% from 11.9% in the prior-year quarter led by the company’s efforts to optimize synergies from acquisitions as well as facility consolidation.

Net research, development and engineering costs (RD&E), as a percentage of sales, inched down to 7.5% from 8.7% a year ago as the company is leveraging its RD&E expenses. Adjusted operating margin improved to 13.0% from 9.8% a year ago, on the back of improved gross margin and improved operational efficiency.

Balance Sheet and Cash Flows

Greatbatch ended first quarter 2013 with cash and cash equivalents of $10.1 million, up 6.3% year over year. The company reported operating cash flow of $7.6 million in the quarter versus $0.4 million in the year-ago quarter. Long-term debt in the quarter was $233.0 million, down 2.3% year over year.

Guidance

Moving ahead, Greatbatch expects revenues for 2013 towards the lower end of $660–$680 million due to the disposition of non-core orthopedic assets worth $15 million. On an organic basis, total sales are expected to be up by 5%–8%.

The company continues to expect adjusted earnings per share in the range of $1.90 to $2.00 (up 7%-13% year over year) for 2013. Moreover, Greatbatch foresees adjusted operating margin of 12.0%–12.5% for the year.

The current Zacks Consensus Estimates for revenue and earnings per share for full year 2013 are $649 million and $1.97, respectively.

Our Take

Greatbatch is a leading producer and supplier of batteries, capacitors and components used in implantable medical devices. The company’s top customers include Medtronic (MDT - Analyst Report) and St. Jude Medical (STJ - Analyst Report) among others.

Consolidation of the Swiss facility is now complete, which is encouraging. This in turn is helping to leverage operational efficiency as well as the bottom line. However, a soft CRM market and pricing pressure remain headwinds for the company.

In an effort to boost its top line, Greatbatch is focusing on R&D investments to improve its legacy business. The company’s pipeline is healthy with a number of products currently in development that are expected to support growth in the long run. The company has forged strategic long-term agreements with its OEM clients to secure healthy revenue growth.

Greatbatch, Inc. currently retains a Zacks Rank #3 (Hold). While we remain on the sidelines for Greatbatch, semi-discretes company Cree, Inc. (CREE - Snapshot Report) with a Zacks Rank #2 (Buy) warrants a look.

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