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Greatbatch Beats EPS, Sales Lag

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Greatbatch, Inc.’s fourth-quarter 2012 adjusted earnings per share of 53 cents beat the Zacks Consensus Estimate of 50 cents and significantly exceeded the year-ago adjusted earnings of 39 cents (up 36% year over year). Earnings growth was led by gross margin expansion along with controlled RD&E spending.
Adjusted earnings exclude one-time items such as medical device design verification testing (“DVT”) costs associated with the development of a neuromodulation platform along with consolidation and optimization expenses, and integration charges. It also excluded the loss of the Swiss tax holiday due to the discontinuation of manufacturing in Switzerland.
The company reported net loss of $5.6 million (or a loss of 23 cents) compared with net income of $5.6 million in the year-ago quarter. Operational hazards at Greatbatch’s Swiss Orthopedic facilities resulted in the reported net loss. According to management, results are likely to improve from the first quarter of 2013. 
For 2012, adjusted earnings of $1.77 a share (up 5% year-over-year) also exceeded the Zacks Consensus Estimate by a penny. 
Revenues grew 12% year over year to $159.2 million in the fourth quarter but missed the Zacks Consensus Estimate of $163 million. Accretion from recent acquisitions of about $20.3 million and growth in the vascular business offset an organic constant currency decline of 2% due to lower Cardiac and Neuromodulation sales. 
For the full year, sales climbed 14% year over year to $646.2 million, also behind the Zacks Consensus Estimate of $650 million. Above market growth in the cardiac and vascular businesses were dampened by operational issues in the Orthopedic franchise.
Segment Review
In the reported quarter, revenues from the core Implantable Medical segment (75% of total sales) dropped 2% year over year to $118.9 million.
Within Implantable Medical, CRM/Neuromodulation sales decreased 5% year over year to $73.7 million due to sustained market headwinds, strong shipments in the prior quarter as well as tough year-over-year comparables. Increased focus on sales and marketing coupled with product development is expected to boost CRM sales. However, management is cautious of the short-term headwinds from key Original Equipment Manufacturer (“OEM”) customers.
Revenues from Vascular Access jumped 14% to $14.2 million on the back of market share gains and solid demand in the underlying market.
However, Orthopedic sales dipped 2% year over year (flat in constant currency) to $30.9 million. Healthy implant sales were offset by soft instrument sales due to the transition of the Swiss facility. Currency fluctuations negatively impacted orthopedic sales by $0.6 million in the quarter. On a positive note, Orthopedic sales increased 14% sequentially because of the seasonal shut-downs at the company’s European facilities.
Revenues from Greatbatch’s smaller Electrochem segment nearly doubled on a year- over-year basis to $40.3 million on the back of acquisitions and new products. On a pro forma basis, revenues from Portable Medical products soared 38% in 2012. Further, revenues from the Energy/Environmental segment grew 19% to $15.6 million.
The segment is benefiting from a shift in focus from clinical settings to cater to the home and aging population by developing lightweight and portable devices, which is in high demand in the Portable Medical market. Management believes that the company’s advanced portable medical offerings will bolster future revenue growth. 
Gross margin increased 110 basis points year over year to 32.6%, benefiting from increased sales volume and a favorable shift in mix to higher margin products. Selling, general and administrative expenses, as a percentage of sales, inched up to 13.2% from 13.1% in the prior-year quarter led by expenses associated with the acquisitions.
Net research, development and engineering costs (RD&E), as a percentage of sales, inched down to 7.0% from 9.0% a year ago as the company is leveraging its RD&E expenses. RD&E expenses include contributions to the company’s acquisitions as well as investments for the development of complete medical devices (including DVT costs for the neuromodulation platform). Adjusted operating margin increased to 13.3% from 11.1% a year ago, led by sales growth and improved operating activities.
Balance Sheet and Cash Flows
Greatbatch ended fourth quarter 2012 with cash and cash equivalents of $20.3 million, down 44.4% year over year. The company reported operating cash flow of $25 million in the quarter versus $31 million in the year-ago quarter. This allowed the company to repay an additional long-term debt of $8 million. Long-term debt in the quarter was $225.2 million, down 4.5%.
Moving ahead, Greatbatch expects revenues for 2013 in the band of $660–$680 million, up 2%–5% year over year. On an organic basis, total sales is expected to be up by 5%–8%.
The company expects revenues from CRM & Neuromodulation to be flat to up 2% in 2013. Vascular access sales are forecast to climb 7%–13% while Orthopedic revenues are expected to be flat to down 5%. Organic sales growth expectation from the Orthopedic division is 8%–14% due to the disposition of non-core offerings worth $15 million in 2012.
Revenues from the Portable Medical segment is expected to grow roughly 15%–20% in 2013 and Energy and Other product lines is anticipated to be up 6%.
Greatbatch expects 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 $677 million and $1.92, 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 - Free Report) and St. Jude Medical among others. 
The company has successfully integrated both Micro Power and Neuro Nexus in its business and completed the consolidation of its facilities. These achievements should propel growth going forward.
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 is also focusing on sales and marketing to improve its legacy business and has leveraged its RD&E expenses by discontinuing certain non-core projects. Additionally, the company has also forged strategic long-term agreements with its OEM clients to secure healthy revenue growth.
However, issues in the Orthopedic business, a soft CRM market and pricing pressure remain headwinds for the company. It is aggressively investing in production and consolidation initiatives to drive bottom-line growth.
Greatbatch, Inc. currently retains a Zacks Rank #3 (Hold). While we remain on the sidelines for Greatbatch, semi-discretes company Cree, Inc. (CREE - Free Report) with a Zacks Rank #2 (Buy) warrants a look.

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