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1. BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information (Accounting Standards Codification (“ASC”) 270, Interim Reporting) and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information necessary for a full presentation of financial position, results of operations, and cash flows in conformity with accounting principles generally accepted in the United States of America (“U.S. GAAP”). Operating results for interim periods are not necessarily indicative of results that may be expected for the fiscal year as a whole. In the opinion of management, the condensed consolidated financial statements reflect all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation of the results of Greatbatch, Inc. and its wholly-owned subsidiary, Greatbatch Ltd. (collectively “Greatbatch” or the “Company”), for the periods presented. The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, sales, expenses, and related disclosures at the date of the financial statements and during the reporting period. Actual results could differ materially from these estimates. The December 30, 2011 condensed consolidated balance sheet data was derived from audited consolidated financial statements but does not include all disclosures required by U.S. GAAP. For further information, refer to the consolidated financial statements and notes included in the Company's Annual Report on Form 10-K for the year ended December 30, 2011. The Company utilizes a fifty-two, fifty-three week fiscal year ending on the Friday nearest December 31st. The third quarter and year-to-date periods of 2012 and 2011 each contained 13 weeks and 39 weeks, respectively, and ended on September 28, and September 30, respectively.
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2. ACQUISITIONS
NeuroNexus Technologies, Inc.
On February 16, 2012, the Company purchased all of the outstanding common stock of NeuroNexus Technologies, Inc. (“NeuroNexus”) headquartered in Ann Arbor, MI. NeuroNexus is an active implantable medical device design firm specializing in developing and commercializing neural interface technology, components and systems for neuroscience and clinical markets. NeuroNexus has an extensive intellectual property portfolio, core technologies and capabilities to support the development and manufacturing of neural interface devices across a wide range of applications including neuromodulation, sensing, optical stimulation and targeted drug delivery.
This transaction was accounted for under the acquisition method of accounting. Accordingly, the operating results of NeuroNexus have been included in the Company's Implantable Medical segment from the date of acquisition. For the nine months ended September 28, 2012, NeuroNexus added approximately $1.7 million to the Company's revenue and decreased the Company's net income by $0.1 million. The purchase price of NeuroNexus consisted of cash payments of $11.7 million and potential future payments of up to an additional $2 million. These future payments are contingent upon the achievement of certain financial and development-based milestones and had an estimated fair value of $1.5 million as of the acquisition date.
The cost of the acquisition was preliminarily allocated to the assets acquired and liabilities assumed from NeuroNexus based on their fair values as of the close of the acquisition, with the amount exceeding the fair value of the net assets acquired being recorded as goodwill. The value assigned to certain assets and liabilities are preliminary and are subject to adjustment as additional information is obtained, including, but not limited to, the finalization of pre-acquisition tax positions. The valuation is expected to be finalized in 2012. When the valuation is finalized, any changes to the preliminary valuation of assets acquired or liabilities assumed may result in material adjustments to the fair value of the intangible assets acquired, as well as goodwill. The following table summarizes the preliminary allocation of the NeuroNexus purchase price to the assets acquired and liabilities assumed as of the acquisition date (in thousands):
Assets acquired | ||||||
Current assets | $ | 618 | ||||
Property, plant and equipment | 35 | |||||
Amortizing intangible assets | 2,927 | |||||
Indefinite-lived intangible assets | 540 | |||||
Goodwill | 8,875 | |||||
Other assets | 1,576 | |||||
Total assets acquired | 14,571 | |||||
Liabilities assumed | ||||||
Current liabilities | 420 | |||||
Deferred income taxes | 940 | |||||
Total liabilities assumed | 1,360 | |||||
Purchase price | $ | 13,211 |
The preliminary fair values of the assets acquired were determined using one of three valuation approaches: market, income and cost. The selection of a particular method for a given asset depended on the reliability of available data and the nature of the asset, among other considerations.
The market approach estimates the value for a subject asset based on available market pricing for comparable assets. The income approach estimates the value for a subject asset based on the present value of cash flows projected to be generated by the asset. The projected cash flows were discounted at a required rate of return that reflects the relative risk of the asset and the time value of money. The projected cash flows for each asset considered multiple factors from the perspective of a marketplace participant including revenue projections from existing customers, attrition trends, product life-cycle assumptions, marginal tax rates and expected profit margins giving consideration to historical and expected margins. The cost approach estimates the value for a subject asset based on the cost to replace the asset and reflects the estimated reproduction or replacement cost for the asset, less an allowance for loss in value due to depreciation or obsolescence, with specific consideration given to economic obsolescence if indicated. These fair value measurement approaches are based on significant unobservable inputs, including management estimates and assumptions.
Current assets and liabilities - The fair value of current assets and liabilities was assumed to approximate their carrying value as of the acquisition date due to the short-term nature of these assets and liabilities.
Intangible assets - The purchase price was allocated to intangible assets as follows (dollars in thousands):
Weighted | Weighted | Weighted | ||||||||
Fair | Average | Average | Average | |||||||
Value | Amortization | Useful | Discount | |||||||
Assigned | Period (Years) | Life (Years) | Rate | |||||||
Amortizing Intangible Assets | ||||||||||
Technology and patents | $ | 1,058 | 6 | 10 | 14% | |||||
Customer lists | 1,869 | 7 | 15 | 13% | ||||||
$ | 2,927 | 7 | 13 | 13% |
Weighted | Weighted | Weighted | ||||||||
Fair | Average | Average | Average | |||||||
Value | Amortization | Useful | Discount | |||||||
Assigned | Period (Years) | Life (Years) | Rate | |||||||
Indefinite-Lived Intangible Assets | ||||||||||
In-process research and development | $ | 540 | N/A | 12 | 26% |
The weighted average amortization period is less than the estimated useful life due to the Company using an accelerated amortization method, which approximates the projected cash flows used to determine the fair value of those intangible assets.
Technology and patents - Technology and patents consists of technical processes, patented and unpatented technology, manufacturing know-how, trade secrets and the understanding with respect to products or processes that have been developed by NeuroNexus and that will be leveraged in current and future products. The fair value of technology and patents acquired was determined utilizing the relief from royalty method, a form of the income approach, with royalty rates that ranged from 2% to 6%. The estimated useful life of the technology and patents is based upon management's estimate of the product life cycle associated with technology and patents before they will be replaced by new technologies.
Customer lists – Customer lists represent the estimated fair value of non-contractual customer relationships NeuroNexus has as of the acquisition date. The primary customers of NeuroNexus include numerous scientists and researchers from various geographic locations around the world. These relationships were valued separately from goodwill at the amount which an independent third party would be willing to pay for these relationships. The fair value of customer lists was determined using the multi-period excess-earnings method, a form of the income approach. The estimated useful life of the existing customer was based upon historical customer attrition as well as management's understanding of the industry and product life cycles.
In-process research and development (“IPR&D”) – IPR&D represents research projects which are expected to generate cash flows but have not yet reached technological feasibility. The primary basis for determining the technological feasibility of these projects is whether or not regulatory approval has been obtained. The Company classifies IPR&D acquired in a business combination as an indefinite-lived intangible asset until the completion or abandonment of the associated projects. Upon completion, the Company would determine the useful life of the IPR&D and begin amortizing the assets to reflect their use over their remaining lives. Upon permanent abandonment, the remaining carrying amount of the associated IPR&D would be written-off. The Company will test the IPR&D acquired for impairment at least annually, and more frequently if events or changes in circumstances indicate that the assets may be impaired. The impairment test consists of a comparison of the fair value of the intangible assets with their carrying amount. If the carrying amount exceeds its fair value, the Company would record an impairment loss in an amount equal to the excess. The Company used the income approach to determine the fair value of the IPR&D acquired. In arriving at the value of the IPR&D, management considered, among other factors: the projects' stage of completion; the complexity of the work to be completed as of the acquisition date; the projected costs to complete the projects; the contribution of other acquired assets; and the estimated useful life of the technology. The Company applied a market-participant risk-adjusted discount rate to arrive at a present value as of the date of acquisition.
The value assigned to IPR&D related to the development of micro-electrodes for deep brain mapping and electrocorticography, and is expected to be commercialized by 2014. For purposes of valuing the IPR&D, the Company estimated total costs to complete the projects to be approximately $1.5 million. If the projects are not successful or completed in a timely manner, the Company may not realize the financial benefits expected for these projects.
Goodwill - The excess of the purchase price over the fair value of net tangible and intangible assets acquired and liabilities assumed was allocated to goodwill. Various factors contributed to the establishment of goodwill, including: the value of NeuroNexus's highly trained assembled work force and management team; the incremental value that NeuroNexus's technology will bring to the Company's neuromodulation platform currently in development; and the expected revenue growth over time that is attributable to increased market penetration from future products and customers. The goodwill acquired in connection with the NeuroNexus acquisition was allocated to the Implantable Medical business segment and is not deductible for tax purposes.
Micro Power Electronics, Inc.
On December 15, 2011, the Company purchased all of the outstanding common and preferred stock of Micro Power Electronics, Inc. (“Micro Power”) headquartered in Beaverton, OR. Micro Power is a leading supplier of custom battery solutions, serving the portable medical, military and handheld automatic identification and data collection markets. The aggregate purchase price of Micro Power was $71.8 million, which was paid in cash. Total assets acquired from Micro Power were $88.2 million. Total liabilities assumed from Micro Power were $16.4 million.
This transaction was accounted for under the acquisition method of accounting. Accordingly, the operating results of Micro Power have been included in the Company's Electrochem Solutions (“Electrochem”) segment from the date of acquisition and the cost of the acquisition was preliminarily allocated to the assets acquired and liabilities assumed from Micro Power based on their fair values as of the close of the acquisition, with the amount exceeding the fair value of net assets acquired being recorded as goodwill. The value assigned to certain assets and liabilities are preliminary and are subject to adjustment as additional information is obtained, including, but not limited to, the finalization of pre-acquisition tax positions. The valuation will be finalized in 2012. During 2012, the Company has made adjustments to the Micro Power opening balance sheet valuation based upon the receipt of information that was needed in order to complete the valuation of certain assets and liabilities. As a result, the Company reduced the fair value recorded for the Micro Power amortizing intangible assets acquired by $0.4 million and increased the amount of goodwill recorded by $0.4 million. The impact of these adjustments, individually and in the aggregate, was not considered material and therefore has not been reflected as a retrospective adjustment of the historical financial statements.
Pro Forma Results (Unaudited)
The following unaudited pro forma information presents the consolidated results of operations of the Company, NeuroNexus and Micro Power as if those acquisitions occurred as of the beginning of fiscal years 2011 (NeuroNexus) and 2010 (Micro Power) (in thousands, except per share amounts):
Three Months Ended | Nine Months Ended | |||||||||||||
September 28, | September 30, | September 28, | September 30, | |||||||||||
2012 | 2011 | 2012 | 2011 | |||||||||||
Sales | $ | 161,340 | $ | 149,991 | $ | 487,431 | $ | 478,159 | ||||||
Net income (loss) | (7,561) | 7,227 | 583 | 26,719 | ||||||||||
Earnings per share: | ||||||||||||||
Basic | $ | (0.32) | $ | 0.31 | $ | 0.02 | $ | 1.15 | ||||||
Diluted | $ | (0.32) | $ | 0.31 | $ | 0.02 | $ | 1.13 |
The unaudited pro forma information presents the combined operating results of Greatbatch, NeuroNexus and Micro Power, with the results prior to the acquisition date adjusted to include the pro forma impact of the amortization of acquired intangible assets based on the purchase price allocations, the adjustment to interest expense reflecting the amount borrowed in connection with the acquisitions at Greatbatch's interest rate, and the impact of income taxes on the pro forma adjustments utilizing the applicable statutory tax rate. The unaudited pro forma consolidated basic and diluted earnings per share calculations are based on the consolidated basic and diluted weighted average shares of Greatbatch.
The unaudited pro forma results are presented for illustrative purposes only and do not reflect the realization of potential cost savings, and any related integration costs. Certain cost savings may result from the acquisition; however, there can be no assurance that these cost savings will be achieved. These pro forma results do not purport to be indicative of the results that would have been obtained, or to be a projection of results that may be obtained in the future.
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3. SUPPLEMENTAL CASH FLOW INFORMATION
Nine Months Ended | ||||||||
September 28, | September 30, | |||||||
(in thousands) | 2012 | 2011 | ||||||
Noncash investing and financing activities: | ||||||||
Common stock contributed to 401(k) Plan | $ | 4,793 | $ | 0 | ||||
Property, plant and equipment purchases included | ||||||||
in accounts payable | 4,611 | 1,575 | ||||||
Cash paid during the period for: | ||||||||
Interest | $ | 3,250 | $ | 3,700 | ||||
Income taxes | 2,923 | 5,207 | ||||||
Acquisition of noncash assets | $ | 14,396 | $ | - | ||||
Liabilities assumed | 1,244 | 0 |
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4. INVENTORIES
Inventories are comprised of the following (in thousands): | |||||||
As of | |||||||
September 28, | December 30, | ||||||
2012 | 2011 | ||||||
Raw materials | $ | 56,364 | $ | 49,773 | |||
Work-in-process | 36,902 | 36,603 | |||||
Finished goods | 17,897 | 23,537 | |||||
Total | $ | 111,163 | $ | 109,913 |
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5. INTANGIBLE ASSETS
Amortizing intangible assets are comprised of the following (in thousands): | |||||||||||||
At | September 28, 2012 | Gross Carrying Amount | Accumulated Amortization | Foreign Currency Translation | Net Carrying Amount | ||||||||
Technology and patents | $ | 96,862 | $ | (59,253) | $ | 815 | $ | 38,424 | |||||
Customer lists | 68,257 | (18,455) | 1,879 | 51,681 | |||||||||
Other | 4,434 | (4,169) | 695 | 960 | |||||||||
Total amortizing intangible assets | $ | 169,553 | $ | (81,877) | $ | 3,389 | $ | 91,065 | |||||
At | December 30, 2011 | ||||||||||||
Technology and patents | $ | 97,324 | $ | (54,054) | $ | 842 | $ | 44,112 | |||||
Customer lists | 66,388 | (14,009) | 1,807 | 54,186 | |||||||||
Other | 5,174 | (4,019) | 805 | 1,960 | |||||||||
Total amortizing intangible assets | $ | 168,886 | $ | (72,082) | $ | 3,454 | $ | 100,258 |
During the third quarter of 2012, the Company transferred $0.7 million of Electrochem's wireless sensing technology and patents to held-for-sale, which is classified within Prepaid Expenses and Other Current Assets in the Condensed Consolidated Balance Sheet.
Aggregate intangible asset amortization expense is comprised of the following (in thousands): | ||||||||||||
Three Months Ended | Nine Months Ended | |||||||||||
September 28, | September 30, | September 28, | September 30, | |||||||||
2012 | 2011 | 2012 | 2011 | |||||||||
Cost of sales | $ | 1,863 | $ | 1,446 | $ | 5,658 | $ | 4,595 | ||||
Selling, general and administrative expenses | 1,573 | 985 | 4,713 | 2,912 | ||||||||
Research, development and engineering costs, net | 136 | 231 | 409 | 231 | ||||||||
Total intangible asset amortization expense | $ | 3,572 | $ | 2,662 | $ | 10,780 | $ | 7,738 |
Estimated future intangible asset amortization expense based on the current carrying value is as follows (in thousands): | |||||
Estimated | |||||
Amortization | |||||
Expense | |||||
Remainder of | 2012 | $ | 3,474 | ||
2013 | 13,223 | ||||
2014 | 13,458 | ||||
2015 | 12,407 | ||||
2016 | 10,112 | ||||
Thereafter | 38,391 | ||||
Total estimated amortization expense | $ | 91,065 |
The change in indefinite-lived intangible assets is as follows (in thousands): | ||||||||||
Trademarks and Tradenames | IPR&D | Total | ||||||||
At | December 30, 2011 | $ | 20,288 | $ | 0 | $ | 20,288 | |||
Indefinite-lived assets acquired | 0 | 540 | 540 | |||||||
At | September 28, 2012 | $ | 20,288 | $ | 540 | $ | 20,828 | |||
The change in goodwill is as follows (in thousands): | ||||||||||
Implantable Medical | Electrochem | Total | ||||||||
At | December 30, 2011 | $ | 297,232 | $ | 41,421 | $ | 338,653 | |||
Goodwill acquired | 8,875 | 413 | 9,288 | |||||||
Foreign currency translation | (138) | 0 | (138) | |||||||
At | September 28, 2012 | $ | 305,969 | $ | 41,834 | $ | 347,803 |
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6. DEBT
Long-term debt is comprised of the following (in thousands): | |||||||
As of | |||||||
September 28, | December 30, | ||||||
2012 | 2011 | ||||||
Revolving line of credit | $ | 41,000 | $ | 55,000 | |||
2.25% convertible subordinated notes, due 2013 | 197,782 | 197,782 | |||||
Unamortized discount | (8,628) | (16,832) | |||||
Total long-term debt | $ | 230,154 | $ | 235,950 |
Revolving Line of Credit –The Company has a revolving credit facility (the “Credit Facility”), which provides a $400 million secured revolving credit facility, and can be increased by $200 million upon the Company's request and approval by a majority of the lenders. The Credit Facility also contains a $15 million letter of credit subfacility and a $15 million swingline subfacility. The Credit Facility has a maturity date of June 24, 2016; provided, however, if CSN (defined below) are not repaid in full, modified or refinanced before March 1, 2013, the maturity date of the Credit Facility is March 1, 2013.
The Credit Facility is secured by the Company's non-realty assets including cash, accounts receivable and inventories. Interest rates under the Credit Facility are, at the Company's option either at: (i) the prime rate plus the applicable margin, which ranges between 0.0% and 1.0%, based on the Company's total leverage ratio or (ii) the applicable LIBOR rate plus the applicable margin, which ranges between 1.5% and 3.0%, based on the Company's total leverage ratio. Loans under the swingline subfacility will bear interest at the prime rate plus the applicable margin, which ranges between 0.0% and 1.0%, based on the Company's total leverage ratio. The Company is also required to pay a commitment fee which, varies between 0.175% and 0.25% depending on the Company's total leverage ratio.
The Credit Facility contains limitations on the incurrence of indebtedness, liens and licensing of intellectual property, investments and certain payments. The Credit Facility permits the Company to engage in the following activities up to an aggregate amount of $250 million: 1) engage in permitted acquisitions in the aggregate not to exceed $250 million; 2) make other investments in the aggregate not to exceed $60 million; 3) make stock repurchases not to exceed $60 million in the aggregate; and 4) retire up to $198 million of CSN. At any time that the total leverage ratio of the Company for the two most recently ended fiscal quarters is less than 2.75 to 1.0, the Company may make an election to reset each of the amounts specified above. Additionally, these limitations can be waived upon the Company's request and approval of a majority of the lenders. As of September 28, 2012, the Company had available to it 100% of the above limits as the Company reset these limits in the second quarter of 2012, except for the aggregate limit and other investments limit which are now $248 million and $58 million, respectively.
The Credit Facility requires the Company to maintain a rolling four quarter ratio of adjusted EBITDA to interest expense of at least 3.0 to 1.0, and a total leverage ratio of not greater than 4.0 to 1.0. The calculation of adjusted EBITDA and total leverage ratio excludes non-cash charges, extraordinary, unusual, or non-recurring expenses or losses, non-cash stock-based compensation, and non-recurring expenses or charges incurred in connection with permitted acquisitions. As of September 28, 2012, the Company was in compliance with all covenants.
The Credit Facility contains customary events of default. Upon the occurrence and during the continuance of an event of default, a majority of the lenders may declare the outstanding advances and all other obligations under the Credit Facility immediately due and payable.
The weighted average interest rate on borrowings under the Credit Facility as of September 28, 2012, was 2.17%. As of September 28, 2012, the Company had $359 million of borrowing capacity available under the Credit Facility. This borrowing capacity may vary from period to period based upon the debt levels of the Company and the level of EBITDA, which impacts the covenant calculations described above.
Interest Rate Swap (Subsequent Event) In October 2012 the Company entered into a three-year $150 million interest rate swap, which amortizes $50 million per year. Under terms of the contract, the Company will receive a floating interest rate indexed to the one-month LIBOR rate and pay a fixed interest rate of 0.573%. The swap will be effective in February 2013. This swap was entered into in order to hedge against potential changes in cash flows on the anticipated outstanding debt on the Credit Facility from the repayment of CSN, which is also expected to be in February 2013 and indexed to the one-month LIBOR rate. The receive variable leg of the interest rate swap and the variable rate paid on the debt is expected to have the same rate of interest, excluding the credit spread, and reset and pay interest on the same dates. This swap will be accounted for as a cash flow hedge.
Convertible Subordinated Notes – In March 2007, the Company completed a private placement of $197.8 million of convertible subordinated notes (“CSN”) at a 5% discount. CSN bear interest at 2.25% per annum, payable semi-annually, and are due on June 15, 2013. The holders may convert CSN into shares of the Company's common stock at a conversion price of $34.70 per share, which is equivalent to a conversion ratio of 28.8219 shares per $1,000 of principal. The conversion price and the conversion ratio will adjust automatically upon certain changes to the Company's capitalization. The fair value of CSN as of September 28, 2012 was approximately $197 million and is based on recent sales prices.
The effective interest rate of CSN, which takes into consideration the amortization of the discount and deferred fees related to the issuance of these notes, is 8.5%. The discount on CSN is being amortized to the maturity date utilizing the effective interest method. As of September 28, 2012, the carrying amount of the discount related to the CSN conversion option value was $7.3 million. As of September 28, 2012, the if-converted value of the CSN does not exceed their principal amount as the Company's closing stock price of $24.33 per share did not exceed the conversion price of CSN.
The contractual interest and discount amortization for CSN were as follows (in thousands): | ||||||||||||
Three Months Ended | Nine Months Ended | |||||||||||
September 28, | September 30, | September 28, | September 30, | |||||||||
2012 | 2011 | 2012 | 2011 | |||||||||
Contractual interest | $ | 1,113 | $ | 1,113 | $ | 3,338 | $ | 3,338 | ||||
Discount amortization | 2,781 | 2,602 | 8,205 | 7,676 |
CSN are convertible at the option of the holders at such time as: (i) the closing price of the Company's common stock exceeds 150% of the conversion price of the notes for 20 out of 30 consecutive trading days; (ii) the trading price per $1,000 of principal is less than 98% of the product of the closing sale price of common stock for each day during any five consecutive trading day period and the conversion rate per $1,000 of principal; (iii) CSN have been called for redemption; (iv) the Company distributes to all holders of common stock rights or warrants entitling them to purchase additional shares of common stock at less than the average closing price of common stock for the ten trading days immediately preceding the announcement of the distribution; (v) the Company distributes to all holders of common stock any form of dividend which has a per share value exceeding 5% of the price of the common stock on the day prior to such date of distribution; (vi) the Company effects a consolidation, merger, share exchange or sale of assets pursuant to which its common stock is converted to cash or other property; (vii) the occurrence of the period beginning 60 days prior to but excluding June 15, 2013; and (viii) certain fundamental changes, as defined in the indenture governing the notes, occur or are approved by the Board of Directors.
Conversions in connection with corporate transactions that constitute a fundamental change require the Company to pay a premium make-whole amount, based upon a predetermined table as set forth in the indenture, whereby the conversion ratio on the notes may be increased by up to 6.3 shares per $1,000 of principal. The premium make-whole amount will be paid in shares of common stock upon any such conversion, subject to the net share settlement feature of the notes described below.
CSN contains a net share settlement feature that requires the Company to pay cash for each $1,000 of principal to be converted. Any amounts in excess of $1,000 will be settled in shares of the Company's common stock, or at the Company's option, cash. The Company has a one-time irrevocable election to pay the holders in shares of its common stock, which it currently does not plan to exercise.
CSN are redeemable by the Company at any time on or after June 20, 2012, or at the option of a holder upon the occurrence of certain fundamental changes, as defined in the indenture, affecting the Company. CSN are subordinated in right of payment to all of the Company's senior indebtedness and effectively subordinated to all debts and other liabilities of the Company's subsidiaries. The Company currently intends to use availability under the Credit Facility to repay CSN when they mature.
Deferred Financing Fees - The change in deferred financing fees is as follows (in thousands):
At | December 30, 2011 | $ | 3,149 | |
Amortization during the period | (802) | |||
At | September 28, 2012 | $ | 2,347 |
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7. DEFINED BENEFIT PLANS
The Company is required to provide its employees located in Switzerland, Mexico and France certain statutorily mandated defined benefits. Under these plans, benefits accrue to employees based upon years of service, position, age and compensation. The defined benefit plan provided to the Company's employees located in Switzerland is a funded contributory plan while the plans that provide benefits to the Company's employees located in Mexico and France are unfunded and noncontributory. The liability and corresponding expense related to these benefit plans is based on actuarial computations of current and future benefits for employees. As discussed in Note 9 “Other Operating (Income) Expense, Net,” in the third quarter of 2012, the Company finalized its plan to transfer most major functions currently performed at its facilities in Switzerland into other existing facilities. As a result of this decision, the Company curtailed its defined benefit plan provided to employees at those Swiss facilities during the third quarter of 2012. The Company has estimated that a net curtailment gain will be recognized as a result of this curtailment. In accordance with ASC 715, this gain will be recognized as the related employees are terminated. No curtailment gain was recognized in the third quarter of 2012. Additionally, as nearly all of the Swiss pension liability is expected to be paid off in the next year, the Company moved all Swiss pension plan investments into cash during the third quarter of 2012. Plan assets are expected to be sufficient to cover plan liabilities.
The change in net defined benefit plan liability is as follows (in thousands): | |||||
At | December 30, 2011 | $ | 5,569 | ||
Net defined benefit cost | 914 | ||||
Benefit payments | (786) | ||||
Foreign currency translation | (18) | ||||
At | September 28, 2012 | $ | 5,679 |
Net defined benefit cost is comprised of the following (in thousands): | ||||||||||||
Three Months Ended | Nine Months Ended | |||||||||||
September 28, | September 30, | September 28, | September 30, | |||||||||
2012 | 2011 | 2012 | 2011 | |||||||||
Service cost | $ | 272 | $ | 290 | $ | 835 | $ | 714 | ||||
Interest cost | 98 | 124 | 305 | 313 | ||||||||
Amortization of net loss | 30 | 21 | 92 | 16 | ||||||||
Expected return on plan assets | (103) | (126) | (318) | (317) | ||||||||
Net defined benefit cost | $ | 297 | $ | 309 | $ | 914 | $ | 726 | ||||
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8. STOCK-BASED COMPENSATION
The components and classification of stock-based compensation expense were as follows (in thousands): | ||||||||||||
Three Months Ended | Nine Months Ended | |||||||||||
September 28, | September 30, | September 28, | September 30, | |||||||||
2012 | 2011 | 2012 | 2011 | |||||||||
Stock options | $ | 671 | $ | 629 | $ | 2,038 | $ | 1,792 | ||||
Restricted stock and units | 1,523 | 1,186 | 4,559 | 3,270 | ||||||||
401(k) stock contribution | 1,280 | 1,193 | 2,410 | 3,741 | ||||||||
Total stock-based compensation expense | $ | 3,474 | $ | 3,008 | $ | 9,007 | $ | 8,803 | ||||
Cost of sales | $ | 1,119 | $ | 1,013 | $ | 2,486 | $ | 3,094 | ||||
Selling, general and administrative | 2,006 | 1,675 | 5,732 | 4,787 | ||||||||
Research, development and engineering | 349 | 320 | 789 | 922 | ||||||||
Total stock-based compensation expense | $ | 3,474 | $ | 3,008 | $ | 9,007 | $ | 8,803 |
The weighted average fair value and assumptions used to value options granted are as follows: | ||||||
Nine Months Ended | ||||||
September 28, | September 30, | |||||
2012 | 2011 | |||||
Weighted average fair value | $ | 8.20 | $ | 9.42 | ||
Risk-free interest rate | 0.83% | 2.04% | ||||
Expected volatility | 40% | 40% | ||||
Expected life (in years) | 5 | 5 | ||||
Expected dividend yield | 0% | 0% |
The following table summarizes time-vested stock option activity: | |||||||||||||||
Number of Time-Vested Stock Options | Weighted Average Exercise Price | Weighted Average Remaining Contractual Life (In Years) | Aggregate Intrinsic Value (In Millions) | ||||||||||||
Outstanding at | December 30, 2011 | 1,558,771 | $ | 23.42 | |||||||||||
Granted | 383,292 | 22.20 | |||||||||||||
Exercised | (44,993) | 20.86 | |||||||||||||
Forfeited or expired | (106,092) | 24.05 | |||||||||||||
Outstanding at | September 28, 2012 | 1,790,978 | $ | 23.19 | 6.2 | $ | 3.6 | ||||||||
Exercisable at | September 28, 2012 | 1,239,536 | $ | 23.38 | 5.1 | $ | 2.7 |
The following table summarizes performance-vested stock option activity: | |||||||||||||||
Number of Performance-Vested Stock Options | Weighted Average Exercise Price | Weighted Average Remaining Contractual Life (In Years) | Aggregate Intrinsic Value (In Millions) | ||||||||||||
Outstanding at | December 30, 2011 | 478,364 | $ | 24.44 | |||||||||||
Exercised | (5,353) | 22.11 | |||||||||||||
Forfeited or expired | (177,733) | 26.49 | |||||||||||||
Outstanding at | September 28, 2012 | 295,278 | $ | 23.25 | 4.6 | $ | 0.4 | ||||||||
Exercisable at | September 28, 2012 | 295,278 | $ | 23.25 | 4.6 | $ | 0.4 |
The following table summarizes time-vested restricted stock and unit activity: | |||||||||
Time-Vested Activity | Weighted Average Fair Value | ||||||||
Nonvested at | December 30, 2011 | 69,942 | $ | 22.69 | |||||
Granted | 87,803 | 23.48 | |||||||
Vested | (24,228) | 21.91 | |||||||
Forfeited | (5,586) | 22.30 | |||||||
Nonvested at | September 28, 2012 | 127,931 | $ | 23.40 |
The following table summarizes performance-vested restricted stock and unit activity: | |||||||||
Performance-Vested Activity | Weighted Average Fair Value | ||||||||
Nonvested at | December 30, 2011 | 529,743 | $ | 16.68 | |||||
Granted | 332,918 | 15.30 | |||||||
Vested | (7,500) | 24.62 | |||||||
Forfeited | (64,715) | 15.72 | |||||||
Nonvested at | September 28, 2012 | 790,446 | $ | 16.11 |
|
9. OTHER OPERATING (INCOME) EXPENSE, NET
Other Operating (Income) Expense, Net is comprised of the following (in thousands): | ||||||||||||
Three Months Ended | Nine Months Ended | |||||||||||
September 28, | September 30, | September 28, | September 30, | |||||||||
2012 | 2011 | 2012 | 2011 | |||||||||
Orthopaedic facility optimization(a) | $ | 12,452 | $ | 164 | $ | 14,774 | $ | 425 | ||||
Medical device facility optimization(b) | 388 | 0 | 1,282 | 0 | ||||||||
ERP system upgrade(c) | 1,938 | 0 | 4,745 | 0 | ||||||||
Integration costs(d) | 232 | 0 | 1,287 | 0 | ||||||||
Asset dispositions, severance and other(e) | 303 | 23 | 1,893 | (591) | ||||||||
$ | 15,313 | $ | 187 | $ | 23,981 | $ | (166) |
(a) Orthopaedic facility optimization. In 2010, the Company began updating its Indianapolis, IN facility to streamline operations, consolidate two buildings, increase capacity, further expand capabilities and reduce dependence on outside suppliers. This initiative was completed in 2011.
In 2011, the Company began construction on an orthopaedic manufacturing facility in Fort Wayne, IN, which was completed in the second quarter of 2012. In the third quarter of 2012, the Company completed the transfer of the manufacturing operations being performed at its Columbia City, IN orthopaedic facility into this new facility.
In the third quarter of 2012, the Company finalized plans to transfer most major functions currently performed at its facilities in Orvin and Corgemont, Switzerland into existing facilities in Fort Wayne, IN and Tijuana, Mexico by mid-2013.
The total capital investment expected for these initiatives is between $25 million and $35 million, of which $21 million has been expended to date. Total expense expected to be incurred for these initiatives is between $30 million and $36 million, of which $15.4 million has been incurred to date. All expenses will be recorded within the Implantable Medical segment and are expected to include the following; other costs include production inefficiencies, moving, revalidation, personnel, training and travel costs associated with these consolidation projects:
The change in accrued liabilities related to the orthopaedic facility optimization is as follows (in thousands): | |||||||||||||||||||
Severance and Retention | Accelerated Depreciation/Asset Write-offs | Other | Total | ||||||||||||||||
At | December 30, 2011 | $ | 0 | $ | 0 | $ | 0 | $ | 0 | ||||||||||
Restructuring charges | 4,525 | 5,246 | 5,003 | 14,774 | |||||||||||||||
Write-offs | 0 | (5,246) | 0 | (5,246) | |||||||||||||||
Cash payments | (83) | 0 | (5,003) | (5,086) | |||||||||||||||
At | September 28, 2012 | $ | 4,442 | $ | 0 | $ | 0 | $ | 4,442 |
(b) Medical device facility optimization. Near the end of 2011, the Company initiated plans to upgrade and expand its manufacturing infrastructure in order to support its medical device strategy. This will include the transfer of certain product lines to create additional capacity for the manufacture of medical devices, expansion of two existing facilities, as well as the purchase of equipment to enable the production of medical devices. These initiatives are expected to be completed over the next two to three years. Total capital investment under these initiatives is expected to be between $15 million to $20 million of which approximately $8.5 million has been expended to date. Total expenses expected to be incurred on these projects is between $2.5 million to $3.5 million, of which $1.3 million has been incurred to date. All expenses will be recorded within the Implantable Medical segment and are expected to include the following:
The change in accrued liabilities related to the medical device facility optimization is as follows (in thousands): | |||||||||||||||||||
Production Inefficiencies, Moving and Revalidation | Personnel | Other | Total | ||||||||||||||||
At | December 30, 2011 | $ | 0 | $ | 0 | $ | 0 | $ | 0 | ||||||||||
Restructuring charges | 549 | 531 | 202 | 1,282 | |||||||||||||||
Cash payments | (549) | (531) | (202) | (1,282) | |||||||||||||||
At | September 28, 2012 | $ | 0 | $ | 0 | $ | 0 | $ | 0 |
(c) ERP system upgrade. In 2011, the Company initiated plans to upgrade its existing global ERP system. This initiative is expected to be completed over the next two years. Total capital investment under this initiative is expected to be between $4 million to $5 million of which approximately $2.8 million has been expended to date. Total expenses expected to be incurred on this initiative is between $5 million to $7 million, of which $4.7 million has been incurred to date. Expenses related to this initiative will be recorded within the applicable segment and corporate cost centers that the expenditures relate to and include the following:
The change in accrued liabilities related to the ERP system upgrade is as follows (in thousands): | |||||||||||||
Training & Consulting Costs | Accelerated Depreciation/ Asset Write-offs | Total | |||||||||||
At | December 30, 2011 | $ | 0 | $ | 0 | $ | 0 | ||||||
Charges | 2,579 | 2,166 | 4,745 | ||||||||||
Write-offs | 0 | (2,166) | (2,166) | ||||||||||
Cash payments | (1,853) | 0 | (1,853) | ||||||||||
At | September 28, 2012 | $ | 726 | $ | 0 | $ | 726 |
(d) Integration costs. During 2012, the Company incurred costs related to the integration of Micro Power and NeuroNexus. These expenses were primarily for retention bonuses, travel costs in connection with integration efforts, training and severance, which will not be required or incurred after the integrations are completed.
(e) Asset dispositions, severance and other. During 2012 and 2011, the Company recorded (gains) write-downs in connection with various asset disposals, net of insurance proceeds received, if any. Additionally, during the second quarter of 2012, the Company incurred $1.2 million of costs related to the relocation of its global headquarters to Frisco, Texas.
|
10. INCOME TAXES
The income tax provision for interim periods is determined using an estimate of the annual effective tax rate, adjusted for discrete items, if any, that are taken into account in the relevant period. Each quarter, the estimate of the annual effective tax rate is updated, and if the estimated effective tax rate changes, a cumulative adjustment is made. There is a potential for volatility of the effective tax rate due to several factors, including changes in the mix of the pre-tax income and the jurisdictions to which it relates, changes in tax laws and foreign tax holidays, business reorganizations, settlements with taxing authorities and foreign currency fluctuations.
The effective tax rate for the first nine months of 2012 was 93.0% compared to 31.0% for the same period of 2011. This increase was primarily attributable to approximately $5.0 million of tax charges recorded in connection with the Swiss orthopaedic consolidation. These charges related to the loss of the Company's Swiss tax holiday, due to its third quarter 2012 decision to discontinue manufacturing in Switzerland, as well as the establishment of a valuation allowance on a portion of its Swiss deferred tax assets as it is more likely than not that they will not be fully realized. Additionally, the 2012 effective tax rate reflects the impact of losses resulting from the Swiss restructuring, the benefit of which are recorded at a lower Swiss effective tax rate, thus increasing the overall effective tax rate of the Company. The effective tax rate also does not include the benefit of the U.S. R&D tax credit, which expired at the end of 2011. The provision for income taxes for the third quarter of 2012 represents the amount necessary to bring the year-to-date effective tax rate to 93.0% and is based upon the Company's full year expected U.S. GAAP effective tax rate.
During the first nine months of 2012, the balance of unrecognized tax benefits decreased by $0.8 million as a result of the settlement of IRS audits for 2009 and 2010 and as a result of the lapse of certain statute of limitations. Approximately $0.7 million of the balance of unrecognized tax benefits would favorably impact the effective tax rate, net of federal benefit on state issues, if recognized.
|
11. COMMITMENTS AND CONTINGENCIES
Litigation – The Company is a party to various legal actions arising in the normal course of business. While the Company does not believe that the ultimate resolution of any such pending actions will have a material effect on its results of operations, financial position, or cash flows, litigation is subject to inherent uncertainties. If an unfavorable ruling were to occur, there exists the possibility of a material impact in the period in which the ruling occurs.
Product Warranties – The Company generally warrants that its products will meet customer specifications and will be free from defects in materials and workmanship. The change in aggregate product warranty liability is as follows (in thousands):
At | December 30, 2011 | $ | 2,013 | |
Additions to warranty reserve | 483 | |||
Warranty claims paid | (993) | |||
Foreign currency effect | 3 | |||
At | September 28, 2012 | $ | 1,506 |
Contractual Obligations – Contractual obligations are defined as agreements that are enforceable and legally binding on the Company and that specify all significant terms, including: fixed or minimum obligations; fixed or minimum price provisions; and the approximate timing of the transaction. The Company's contractual obligations are normally fulfilled within short time horizons. The Company also enters into blanket orders with vendors that have preferred pricing and terms, however these orders are normally cancelable by us without penalty. As of September 28, 2012, the total contractual obligations of the Company are approximately $29.7 million and will primarily be funded by existing cash and cash equivalents, cash flow from operations, or the Credit Facility. The Company also enters into contracts for outsourced services; however, the obligations under these contracts were not significant and the contracts generally contain clauses allowing for cancellation without significant penalty.
Operating Leases – The Company is a party to various operating lease agreements for buildings, equipment and software. Estimated future operating lease expense is as follows (in thousands):
Remainder of | 2012 | $ | 1,072 | |
2013 | 4,156 | |||
2014 | 4,155 | |||
2015 | 3,566 | |||
2016 | 3,092 | |||
Thereafter | 3,133 | |||
Total estimated operating lease expense | $ | 19,174 |
Foreign Currency Contracts - The Company enters into forward contracts to purchase Mexican pesos in order to hedge the risk of peso-denominated payments associated with the operations at its Tijuana, Mexico facility. The impact to the Company's results of operations from these forward contracts was as follows (in thousands):
Three Months Ended | Nine Months Ended | |||||||||||
September 28, | September 30, | September 28, | September 30, | |||||||||
2012 | 2011 | 2012 | 2011 | |||||||||
Increase (reduction) in Cost of Sales | $ | 11 | $ | (213) | $ | (8) | $ | (529) | ||||
Ineffective portion of change in fair value | 0 | 0 | 0 | 0 |
Instrument | Type of Hedge | Aggregate Notional Amount | Start Date | End Date | $/Peso | Fair Value | Balance Sheet Location | ||||||||
FX Contract | Cash flow | $ | 1,500 | Jan-12 | Dec-12 | 0.0767 | $ | 11 | Current Assets | ||||||
FX Contract | Cash flow | 1,050 | Jan-12 | Dec-12 | 0.0713 | 89 | Current Assets | ||||||||
FX Contract | Cash flow | 6,000 | Jan-13 | Dec-13 | 0.0727 | 235 | Current Assets/ Other Assets | ||||||||
FX Contract | Cash flow | 6,000 | Jan-13 | Dec-13 | 0.0693 | 548 | Current Assets/ Other Assets |
Self-Insured Medical Plan – The Company self-funds the medical insurance coverage provided to its U.S. based employees. The risk to the Company is being limited through the use of stop loss insurance, which has an annual maximum aggregate loss of $13.5 million with a maximum benefit of $1.0 million. As of September 28, 2012, the Company has $2.0 million accrued related to the self-insurance of its medical plan, which is recorded in Accrued Expenses in the Condensed Consolidated Balance Sheet, and is primarily based upon claim history.
|
13. ACCUMULATED OTHER COMPREHENSIVE INCOME
Accumulated Other Comprehensive Income is comprised of the following (in thousands): | ||||||||||||||||||
Defined Benefit Plan Liability | Cash Flow Hedges | Foreign Currency Translation Adjustment | Total Pre-Tax Amount | Tax | Net-of-Tax Amount | |||||||||||||
At | December 30, 2011 | $ | (2,660) | $ | (538) | $ | 11,526 | $ | 8,328 | $ | 601 | $ | 8,929 | |||||
Unrealized gain on cash flow hedges | - | 1,429 | - | 1,429 | (500) | 929 | ||||||||||||
Realized gain on cash flow hedges | - | (8) | - | (8) | 3 | (5) | ||||||||||||
Foreign currency translation loss | - | - | (522) | (522) | 0 | (522) | ||||||||||||
At | September 28, 2012 | $ | (2,660) | $ | 883 | $ | 11,004 | $ | 9,227 | $ | 104 | $ | 9,331 |
|
14. FAIR VALUE MEASUREMENTS
Assets and Liabilities Measured at Fair Value on a Recurring Basis
Fair value measurement standards apply to certain financial assets and liabilities that are measured at fair value on a recurring basis (each reporting period). For the Company, these financial assets and liabilities include its foreign currency contracts and accrued contingent consideration. The Company does not have any nonfinancial assets or liabilities that are measured at fair value on a recurring basis.
Foreign currency contracts - The fair value of foreign currency contracts are determined through the use of cash flow models that utilize observable market data inputs to estimate fair value. These observable market data inputs include foreign exchange rate and credit spread curves. In addition to the above, the Company receives fair value estimates from the foreign currency contract counterparty to verify the reasonableness of the Company's estimates. The Company's foreign currency contracts are categorized in Level 2 of the fair value hierarchy. The fair value of the Company's foreign currency contracts will be realized as Cost of Sales as the inventory, which the contracts are hedging the cash flows to produce, is sold, of which approximately $0.7 million is expected to be realized within the next twelve months.
Accrued contingent consideration – In circumstances where an acquisition involves a contingent consideration arrangement, the Company recognizes a liability equal to the fair value of the contingent payments it expects to make as of the acquisition date. The Company re-measures this liability each reporting period and records changes in the fair value through Other Operating (Income) Expense, Net. Increases or decreases in the fair value of the contingent consideration liability can result from changes in discount periods and rates, as well as changes in the timing, amount of, or the likelihood of achieving the applicable milestones.
The fair value of accrued contingent consideration recorded by the Company represents the estimated fair value of the contingent consideration the Company expects to pay to the former shareholders of NeuroNexus based upon the achievement of certain financial and development-based milestones. The fair value of the contingent consideration liability was estimated by discounting to present value, contingent payments expected to be made. The Company used risk-adjusted discount rates ranging from 12 to 20 percent to derive the fair value of the expected obligations as of the acquisition date, which the Company believes is appropriate and representative of market participant assumptions. The Company's accrued contingent consideration is categorized in Level 3 of the fair value hierarchy. Changes in accrued contingent consideration were as follows (in thousands):
At | December 30, 2011 | $ | 0 | |
Contingent consideration liability recorded | 1,500 | |||
Fair value adjustments | 110 | |||
At | September 28, 2012 | $ | 1,610 |
The recurring Level 3 fair value measurements of the Company's contingent consideration liability include the following significant unobservable inputs (dollars in thousands):
Fair | |||||||||
Contingent | Value at | ||||||||
Consideration | September 28, | Valuation | Unobservable | ||||||
Liability | 2012 | Technique | Inputs | ||||||
Financial milestones | $ | 855 | Discounted cash flow | Discount rate | 12% | ||||
Projected year | |||||||||
of payment | 2014 | ||||||||
Development milestones | 755 | Discounted cash flow | Discount rate | 20% | |||||
Projected year | |||||||||
of payment | 2014 |
The following table provides information regarding assets and liabilities recorded at fair value on a recurring basis in the Condensed Consolidated Balance Sheet (in thousands): | |||||||||||||
Fair Value Measurements Using | |||||||||||||
Quoted | |||||||||||||
Prices in | Significant | ||||||||||||
Active Markets | Other | Significant | |||||||||||
At | for Identical | Observable | Unobservable | ||||||||||
September 28, | Assets | Inputs | Inputs | ||||||||||
Description | 2012 | (Level 1) | (Level 2) | (Level 3) | |||||||||
Assets | |||||||||||||
Foreign currency contracts | $ | 883 | $ | 0 | $ | 883 | $ | 0 | |||||
Liabilities | |||||||||||||
Accrued contingent consideration | 1,610 | 0 | 0 | 1,610 |
Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis
Fair value standards also apply to certain nonfinancial assets and liabilities that are measured at fair value on a nonrecurring basis. A summary of the valuation methodologies for the Company's assets and liabilities measured on a nonrecurring basis is as follows:
Long-lived assets - The Company reviews the carrying amount of its long-lived assets to be held and used, other than goodwill and indefinite-lived intangible assets, for potential impairment whenever certain indicators are present such as; a significant decrease in the market price of the asset or asset group; a significant change in the extent or manner in which the long-lived asset or asset group is being used or in its physical condition; a significant change in legal factors or in the business climate that could affect the value of the long-lived asset or asset group, including an action or assessment by a regulator; an accumulation of costs significantly in excess of the amount originally expected for the acquisition or construction of the asset; a current-period operating or cash flow loss combined with a history of operating or cash flow losses or a projection or forecast that demonstrates continuing losses associated with the use of the long-lived asset or asset group; or a current expectation that, more likely than not the long-lived asset or asset group will be sold or otherwise disposed of significantly before the end of its previously estimated useful life. The term more likely than not refers to a level of likelihood that is more than 50 percent.
If an indicator is present, potential recoverability is measured by comparing the carrying amount of the long-lived asset or asset group to its related total future undiscounted cash flows. If the carrying value is not recoverable, the asset or asset group is considered to be impaired. Impairment is measured by comparing the asset or asset group's carrying amount to its fair value, which is determined by using independent appraisals or discounted cash flow models. The discounted cash flow model requires inputs to a present value cash flow calculation such as a risk-adjusted discount rate, terminal values, operating budgets, long-term strategic plans and remaining useful lives of the asset or asset group. If the carrying value of the long-lived asset or asset group exceeds the fair value, the carrying value is written down to the fair value in the period identified. During the first nine months of 2012, the Company recorded an impairment charge of $0.3 million relating to the write-off of a definite-lived intangible asset. The Company did not record any impairment charge related to its long-lived assets, other than goodwill and indefinite-lived intangible assets, during the first nine months of 2011.
Goodwill and indefinite-lived intangible assets – The Company assess the impairment of goodwill and other indefinite-lived intangible assets on the last day of each fiscal year, or more frequently if certain indicators are present as described above under long-lived assets. The Company assesses goodwill for impairment by comparing the fair value of its reporting units to their carrying amounts. If the fair value of a reporting unit is less than its carrying value, an impairment loss is recorded to the extent that the implied fair value of the goodwill within the reporting unit is less than its carrying value. Fair values for reporting units are determined based on discounted cash flow models and market multiples. The discounted cash flow model requires inputs to a present value cash flow calculation such as a risk-adjusted discount rate, terminal values, operating budgets, and long-term strategic plans. The fair value from the discounted cash flow model is then combined, based on certain weightings, with market multiples in order to determine the fair value of the reporting unit. These market multiples include revenue multiples and multiples of earnings before interest, taxes, depreciation and amortization.
Indefinite-lived intangible assets are assessed for impairment by comparing the fair value of the intangible asset to its carrying value. If the carrying value of the indefinite-lived intangible asset exceeds the fair value, the carrying value is written down to the fair value in the period identified. The fair value of indefinite-lived intangible assets is determined by using a discounted cash flow model. The discounted cash flow model requires inputs to a present value cash flow calculation such as a risk-adjusted discount rate, royalty rates, operating budgets, and long-term strategic plans.
Note 5 “Intangible Assets” contains additional information on the Company's intangible assets.
Cost and equity method investments - The Company holds investments in equity and other securities that are accounted for as either cost or equity method investments, which are classified as Other Assets. The total carrying value of these investments is reviewed quarterly for changes in circumstance or the occurrence of events that suggest the Company's investment may not be recoverable. The fair value of cost or equity method investments is not adjusted if there are no identified events or changes in circumstances that may have a material effect on the fair value of the investments. Gains and losses realized on cost and equity method investments are recorded in Other (Income) Expense, Net, unless separately stated. The aggregate recorded amount of cost and equity method investments at September 28, 2012 and December 30, 2011 was $9.3 million and $5.7 million, respectively.
The Company did not record any impairment charges related to its investments during the first nine months of 2012. During the second quarter of 2011, the Company recognized impairment charges related to its cost method investments of $0.3 million. The fair value of these investments was determined by reference to recent sales data of similar shares to independent parties in an inactive market. This fair value calculation was categorized in Level 2 of the fair value hierarchy. In the first quarter of 2011, the Company sold its cost method investment in IntElect Medical, Inc. (“IntElect”) in conjunction with Boston Scientific's acquisition of IntElect, which resulted in a pre-tax gain of $4.5 million in the first quarter of 2011 and an additional $0.4 million gain during the third quarter of 2012.
Fair Value of Other Financial Instruments
Convertible subordinated notes - The fair value of CSN disclosed in Note 6 “Debt” was determined based upon recent third-party transactions for CSN in an inactive market. CSN are valued for disclosure purposes utilizing Level 2 measurements of the fair value hierarchy.
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15. BUSINESS SEGMENT, GEOGRAPHIC AND CONCENTRATION RISK INFORMATION
The Company operates its business in two reportable segments – Implantable Medical and Electrochem. The Implantable Medical segment (formerly Greatbatch Medical) is comprised of our Greatbatch Medical and QiG Group brands and designs and manufactures medical devices and components for the cardiac rhythm management (“CRM”), neuromodulation, vascular access and orthopaedic markets. Additionally, the Implantable Medical segment offers value-added assembly and design engineering services. As a result of the strategy put in place over three years ago, the Implantable Medical segment offers its customers complete medical devices including design, development, manufacturing, regulatory submission and supporting worldwide distribution. This medical device strategy is being facilitated through the QiG Group and leverages the component technology of Greatbatch in the Company's core markets: cardiovascular, neuromodulation and orthopaedic. The devices designed and developed by the QiG Group are manufactured by Greatbatch Medical.
Electrochem is an industry leader in designing and manufacturing total power solutions for critical applications with market-leading OEMs, largely in the portable medical and energy space. Electrochem offers its customers consultation, design, development and testing for medical device applications, in high-value markets, including those that support the transition of delivery of health care from clinical to outpatient and home settings, as well as those that enhance the quality of life for an aging population. Examples of these devices include powered surgical tools, automated external defibrillators, portable ultrasound devices, portable oxygen concentrators, and ventilators, among others. Electrochem provides cell and battery pack configurations for rechargeable and non-rechargeable battery power systems, charging and docking stations, and power supplies, for devices where failure is not an option.
The Company defines segment income from operations as sales less cost of sales including amortization and expenses attributable to segment-specific selling, general, administrative, research, development, engineering and other operating activities. Segment income also includes a portion of non-segment specific selling, general, and administrative expenses based on allocations appropriate to the expense categories. The remaining unallocated operating and other expenses are primarily administrative corporate headquarters expenses and capital costs that are not allocated to reportable segments. Transactions between the two segments are not significant.
An analysis and reconciliation of the Company's business segment, product line and geographic information to the respective information in the Condensed Consolidated Financial Statements follows. Sales by geographic area are presented by allocating sales from external customers based on where the products are shipped to (in thousands):
Three Months Ended | Nine Months Ended | |||||||||||||
September 28, | September 30, | September 28, | September 30, | |||||||||||
Sales: | 2012 | 2011 | 2012 | 2011 | ||||||||||
Implantable Medical | ||||||||||||||
CRM/Neuromodulation | $ | 80,246 | $ | 70,731 | $ | 235,406 | $ | 226,492 | ||||||
Vascular Access | 13,674 | 11,396 | 37,791 | 32,639 | ||||||||||
Orthopaedic | 27,173 | 31,131 | 91,079 | 108,642 | ||||||||||
Total Implantable Medical | 121,093 | 113,258 | 364,276 | 367,773 | ||||||||||
Electrochem | ||||||||||||||
Portable Medical | 20,219 | 1,954 | 59,346 | 6,105 | ||||||||||
Energy/Environmental | 16,192 | 13,955 | 51,441 | 45,813 | ||||||||||
Other | 3,836 | 2,551 | 11,928 | 7,385 | ||||||||||
Total Electrochem | 40,247 | 18,460 | 122,715 | 59,303 | ||||||||||
Total sales | $ | 161,340 | $ | 131,718 | $ | 486,991 | $ | 427,076 |
Three Months Ended | Nine Months Ended | |||||||||||||
September 28, | September 30, | September 28, | September 30, | |||||||||||
2012 | 2011 | 2012 | 2011 | |||||||||||
Segment income from operations: | ||||||||||||||
Implantable Medical | $ | 2,744 | $ | 12,030 | $ | 24,252 | $ | 48,677 | ||||||
Electrochem | 5,350 | 3,631 | 16,020 | 12,890 | ||||||||||
Total segment income from operations | 8,094 | 15,661 | 40,272 | 61,567 | ||||||||||
Unallocated operating expenses | (5,967) | (2,773) | (15,856) | (12,410) | ||||||||||
Operating income as reported | 2,127 | 12,888 | 24,416 | 49,157 | ||||||||||
Unallocated other expense | (4,299) | (3,649) | (13,599) | (9,327) | ||||||||||
Income (loss) before provision for income taxes | $ | (2,172) | $ | 9,239 | $ | 10,817 | $ | 39,830 |
Three Months Ended | Nine Months Ended | |||||||||||||
September 28, | September 30, | September 28, | September 30, | |||||||||||
2012 | 2011 | 2012 | 2011 | |||||||||||
Sales by geographic area: | ||||||||||||||
United States | $ | 82,522 | $ | 61,502 | $ | 249,306 | $ | 187,795 | ||||||
Non-Domestic locations: | ||||||||||||||
Puerto Rico | 31,320 | 21,522 | 81,541 | 72,354 | ||||||||||
Belgium | 11,346 | 11,958 | 41,737 | 48,555 | ||||||||||
United Kingdom & Ireland | 9,837 | 14,466 | 34,525 | 42,585 | ||||||||||
Rest of world | 26,315 | 22,270 | 79,882 | 75,787 | ||||||||||
Total sales | $ | 161,340 | $ | 131,718 | $ | 486,991 | $ | 427,076 |
Four customers accounted for a significant portion of the Company’s sales as follows: | ||||||||||||||
Three Months Ended | Nine Months Ended | |||||||||||||
September 28, | September 30, | September 28, | September 30, | |||||||||||
2012 | 2011 | 2012 | 2011 | |||||||||||
Customer A | 19% | 18% | 19% | 20% | ||||||||||
Customer B | 18% | 20% | 15% | 18% | ||||||||||
Customer C | 10% | 11% | 10% | 13% | ||||||||||
Customer D | 5% | 9% | 6% | 8% | ||||||||||
Total | 52% | 58% | 50% | 59% |
Long-lived tangible assets by geographic area are as follows (in thousands): | ||||||
As of | ||||||
September 28, | December 30, | |||||
2012 | 2011 | |||||
United States | $ | 124,451 | $ | 113,693 | ||
Rest of world | 32,211 | 32,113 | ||||
Total | $ | 156,662 | $ | 145,806 |
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16. IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS
In the normal course of business, management evaluates all new accounting pronouncements issued by the Financial Accounting Standards Board (“FASB”), Securities and Exchange Commission, Emerging Issues Task Force, American Institute of Certified Public Accountants or other authoritative accounting bodies to determine the potential impact they may have on the Company's Condensed Consolidated Financial Statements. Based upon this review except as noted below, management does not expect any of the recently issued accounting pronouncements, which have not already been adopted, to have a material impact on the Company's Condensed Consolidated Financial Statements.
In July 2012, the FASB issued Accounting Standards Update (“ASU”) No. 2012-02, Intangibles—Goodwill and Other (Topic 350): Testing Indefinite-Lived Intangible Assets for Impairment. This ASU simplifies the guidance for testing the decline in the realizable value (impairment) of indefinite-lived intangible assets other than goodwill. This ASU allows an organization the option to first assess qualitative factors to determine whether it is necessary to perform the quantitative impairment test. An organization electing to perform a qualitative assessment is no longer required to calculate the fair value of an indefinite-lived intangible asset unless the organization determines, based on a qualitative assessment, that it is “more likely than not” that the asset is impaired. The amendments in this ASU are effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012. Early adoption is permitted. When adopted, this ASU will not have a material impact on the Company's Condensed Consolidated Financial Statements as it only impacts the timing of when the Company is required to perform the two-step impairment tests of its indefinite-lived intangible assets other than goodwill.
In December 2011, the FASB issued ASU No. 2011-11 “Balance Sheet (Topic 210): Disclosures about Offsetting Assets and Liabilities.” This ASU requires companies to provide information about trading in financial instruments and related derivatives in expanded disclosures, creates new disclosure requirements about the nature of an entity's rights of offset and related arrangements associated with its financial instruments and derivative instruments. The disclosure requirements are effective for annual reporting periods beginning on or after January 1, 2013, and interim periods therein, with retrospective application required. When adopted, this ASU will not have a material impact on the Company's Condensed Consolidated Financial Statements as it only changes the disclosures surrounding the Company's offsetting assets and liabilities.
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The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information (Accounting Standards Codification (“ASC”) 270, Interim Reporting) and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information necessary for a full presentation of financial position, results of operations, and cash flows in conformity with accounting principles generally accepted in the United States of America (“U.S. GAAP”). Operating results for interim periods are not necessarily indicative of results that may be expected for the fiscal year as a whole. In the opinion of management, the condensed consolidated financial statements reflect all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation of the results of Greatbatch, Inc. and its wholly-owned subsidiary, Greatbatch Ltd. (collectively “Greatbatch” or the “Company”), for the periods presented.
The December 30, 2011 condensed consolidated balance sheet data was derived from audited consolidated financial statements but does not include all disclosures required by U.S. GAAP. For further information, refer to the consolidated financial statements and notes included in the Company's Annual Report on Form 10-K for the year ended December 30, 2011.
The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, sales, expenses, and related disclosures at the date of the financial statements and during the reporting period. Actual results could differ materially from these estimates.
The Company utilizes a fifty-two, fifty-three week fiscal year ending on the Friday nearest December 31st. The third quarter and year-to-date periods of 2012 and 2011 each contained 13 weeks and 39 weeks, respectively, and ended on September 28, and September 30, respectively.
IPR&D represents research projects which are expected to generate cash flows but have not yet reached technological feasibility. The primary basis for determining the technological feasibility of these projects is whether or not regulatory approval has been obtained. The Company classifies IPR&D acquired in a business combination as an indefinite-lived intangible asset until the completion or abandonment of the associated projects. Upon completion, the Company would determine the useful life of the IPR&D and begin amortizing the assets to reflect their use over their remaining lives. Upon permanent abandonment, the remaining carrying amount of the associated IPR&D would be written-off. The Company will test the IPR&D acquired for impairment at least annually, and more frequently if events or changes in circumstances indicate that the assets may be impaired. The impairment test consists of a comparison of the fair value of the intangible assets with their carrying amount. If the carrying amount exceeds its fair value, the Company would record an impairment loss in an amount equal to the excess.
The income tax provision for interim periods is determined using an estimate of the annual effective tax rate, adjusted for discrete items, if any, that are taken into account in the relevant period. Each quarter, the estimate of the annual effective tax rate is updated, and if the estimated effective tax rate changes, a cumulative adjustment is made. There is a potential for volatility of the effective tax rate due to several factors, including changes in the mix of the pre-tax income and the jurisdictions to which it relates, changes in tax laws and foreign tax holidays, business reorganizations, settlements with taxing authorities and foreign currency fluctuations.
In circumstances where an acquisition involves a contingent consideration arrangement, the Company recognizes a liability equal to the fair value of the contingent payments it expects to make as of the acquisition date. The Company re-measures this liability each reporting period and records changes in the fair value through Other Operating (Income) Expense, Net. Increases or decreases in the fair value of the contingent consideration liability can result from changes in discount periods and rates, as well as changes in the timing, amount of, or the likelihood of achieving the applicable milestones.
The Company reviews the carrying amount of its long-lived assets to be held and used, other than goodwill and indefinite-lived intangible assets, for potential impairment whenever certain indicators are present such as; a significant decrease in the market price of the asset or asset group; a significant change in the extent or manner in which the long-lived asset or asset group is being used or in its physical condition; a significant change in legal factors or in the business climate that could affect the value of the long-lived asset or asset group, including an action or assessment by a regulator; an accumulation of costs significantly in excess of the amount originally expected for the acquisition or construction of the asset; a current-period operating or cash flow loss combined with a history of operating or cash flow losses or a projection or forecast that demonstrates continuing losses associated with the use of the long-lived asset or asset group; or a current expectation that, more likely than not the long-lived asset or asset group will be sold or otherwise disposed of significantly before the end of its previously estimated useful life. The term more likely than not refers to a level of likelihood that is more than 50 percent.
If an indicator is present, potential recoverability is measured by comparing the carrying amount of the long-lived asset or asset group to its related total future undiscounted cash flows. If the carrying value is not recoverable, the asset or asset group is considered to be impaired. Impairment is measured by comparing the asset or asset group's carrying amount to its fair value, which is determined by using independent appraisals or discounted cash flow models. The discounted cash flow model requires inputs to a present value cash flow calculation such as a risk-adjusted discount rate, terminal values, operating budgets, long-term strategic plans and remaining useful lives of the asset or asset group. If the carrying value of the long-lived asset or asset group exceeds the fair value, the carrying value is written down to the fair value in the period identified.
The Company assess the impairment of goodwill and other indefinite-lived intangible assets on the last day of each fiscal year, or more frequently if certain indicators are present as described above under long-lived assets. The Company assesses goodwill for impairment by comparing the fair value of its reporting units to their carrying amounts. If the fair value of a reporting unit is less than its carrying value, an impairment loss is recorded to the extent that the implied fair value of the goodwill within the reporting unit is less than its carrying value.
Indefinite-lived intangible assets are assessed for impairment by comparing the fair value of the intangible asset to its carrying value. If the carrying value of the indefinite-lived intangible asset exceeds the fair value, the carrying value is written down to the fair value in the period identified.
The Company holds investments in equity and other securities that are accounted for as either cost or equity method investments, which are classified as Other Assets. The total carrying value of these investments is reviewed quarterly for changes in circumstance or the occurrence of events that suggest the Company's investment may not be recoverable. The fair value of cost or equity method investments is not adjusted if there are no identified events or changes in circumstances that may have a material effect on the fair value of the investments.
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Assets acquired | ||||||
Current assets | $ | 618 | ||||
Property, plant and equipment | 35 | |||||
Amortizing intangible assets | 2,927 | |||||
Indefinite-lived intangible assets | 540 | |||||
Goodwill | 8,875 | |||||
Other assets | 1,576 | |||||
Total assets acquired | 14,571 | |||||
Liabilities assumed | ||||||
Current liabilities | 420 | |||||
Deferred income taxes | 940 | |||||
Total liabilities assumed | 1,360 | |||||
Purchase price | $ | 13,211 |
Weighted | Weighted | Weighted | ||||||||
Fair | Average | Average | Average | |||||||
Value | Amortization | Useful | Discount | |||||||
Assigned | Period (Years) | Life (Years) | Rate | |||||||
Amortizing Intangible Assets | ||||||||||
Technology and patents | $ | 1,058 | 6 | 10 | 14% | |||||
Customer lists | 1,869 | 7 | 15 | 13% | ||||||
$ | 2,927 | 7 | 13 | 13% |
Weighted | Weighted | Weighted | ||||||||
Fair | Average | Average | Average | |||||||
Value | Amortization | Useful | Discount | |||||||
Assigned | Period (Years) | Life (Years) | Rate | |||||||
Indefinite-Lived Intangible Assets | ||||||||||
In-process research and development | $ | 540 | N/A | 12 | 26% |
Three Months Ended | Nine Months Ended | |||||||||||||
September 28, | September 30, | September 28, | September 30, | |||||||||||
2012 | 2011 | 2012 | 2011 | |||||||||||
Sales | $ | 161,340 | $ | 149,991 | $ | 487,431 | $ | 478,159 | ||||||
Net income (loss) | (7,561) | 7,227 | 583 | 26,719 | ||||||||||
Earnings per share: | ||||||||||||||
Basic | $ | (0.32) | $ | 0.31 | $ | 0.02 | $ | 1.15 | ||||||
Diluted | $ | (0.32) | $ | 0.31 | $ | 0.02 | $ | 1.13 |
|
Nine Months Ended | ||||||||
September 28, | September 30, | |||||||
(in thousands) | 2012 | 2011 | ||||||
Noncash investing and financing activities: | ||||||||
Common stock contributed to 401(k) Plan | $ | 4,793 | $ | 0 | ||||
Property, plant and equipment purchases included | ||||||||
in accounts payable | 4,611 | 1,575 | ||||||
Cash paid during the period for: | ||||||||
Interest | $ | 3,250 | $ | 3,700 | ||||
Income taxes | 2,923 | 5,207 | ||||||
Acquisition of noncash assets | $ | 14,396 | $ | - | ||||
Liabilities assumed | 1,244 | 0 |
|
Inventories are comprised of the following (in thousands): | |||||||
As of | |||||||
September 28, | December 30, | ||||||
2012 | 2011 | ||||||
Raw materials | $ | 56,364 | $ | 49,773 | |||
Work-in-process | 36,902 | 36,603 | |||||
Finished goods | 17,897 | 23,537 | |||||
Total | $ | 111,163 | $ | 109,913 |
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Amortizing intangible assets are comprised of the following (in thousands): | |||||||||||||
At | September 28, 2012 | Gross Carrying Amount | Accumulated Amortization | Foreign Currency Translation | Net Carrying Amount | ||||||||
Technology and patents | $ | 96,862 | $ | (59,253) | $ | 815 | $ | 38,424 | |||||
Customer lists | 68,257 | (18,455) | 1,879 | 51,681 | |||||||||
Other | 4,434 | (4,169) | 695 | 960 | |||||||||
Total amortizing intangible assets | $ | 169,553 | $ | (81,877) | $ | 3,389 | $ | 91,065 | |||||
At | December 30, 2011 | ||||||||||||
Technology and patents | $ | 97,324 | $ | (54,054) | $ | 842 | $ | 44,112 | |||||
Customer lists | 66,388 | (14,009) | 1,807 | 54,186 | |||||||||
Other | 5,174 | (4,019) | 805 | 1,960 | |||||||||
Total amortizing intangible assets | $ | 168,886 | $ | (72,082) | $ | 3,454 | $ | 100,258 |
Aggregate intangible asset amortization expense is comprised of the following (in thousands): | ||||||||||||
Three Months Ended | Nine Months Ended | |||||||||||
September 28, | September 30, | September 28, | September 30, | |||||||||
2012 | 2011 | 2012 | 2011 | |||||||||
Cost of sales | $ | 1,863 | $ | 1,446 | $ | 5,658 | $ | 4,595 | ||||
Selling, general and administrative expenses | 1,573 | 985 | 4,713 | 2,912 | ||||||||
Research, development and engineering costs, net | 136 | 231 | 409 | 231 | ||||||||
Total intangible asset amortization expense | $ | 3,572 | $ | 2,662 | $ | 10,780 | $ | 7,738 |
Estimated future intangible asset amortization expense based on the current carrying value is as follows (in thousands): | |||||
Estimated | |||||
Amortization | |||||
Expense | |||||
Remainder of | 2012 | $ | 3,474 | ||
2013 | 13,223 | ||||
2014 | 13,458 | ||||
2015 | 12,407 | ||||
2016 | 10,112 | ||||
Thereafter | 38,391 | ||||
Total estimated amortization expense | $ | 91,065 |
The change in indefinite-lived intangible assets is as follows (in thousands): | ||||||||||
Trademarks and Tradenames | IPR&D | Total | ||||||||
At | December 30, 2011 | $ | 20,288 | $ | 0 | $ | 20,288 | |||
Indefinite-lived assets acquired | 0 | 540 | 540 | |||||||
At | September 28, 2012 | $ | 20,288 | $ | 540 | $ | 20,828 | |||
The change in goodwill is as follows (in thousands): | ||||||||||
Implantable Medical | Electrochem | Total | ||||||||
At | December 30, 2011 | $ | 297,232 | $ | 41,421 | $ | 338,653 | |||
Goodwill acquired | 8,875 | 413 | 9,288 | |||||||
Foreign currency translation | (138) | 0 | (138) | |||||||
At | September 28, 2012 | $ | 305,969 | $ | 41,834 | $ | 347,803 |
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Long-term debt is comprised of the following (in thousands): | |||||||
As of | |||||||
September 28, | December 30, | ||||||
2012 | 2011 | ||||||
Revolving line of credit | $ | 41,000 | $ | 55,000 | |||
2.25% convertible subordinated notes, due 2013 | 197,782 | 197,782 | |||||
Unamortized discount | (8,628) | (16,832) | |||||
Total long-term debt | $ | 230,154 | $ | 235,950 |
The contractual interest and discount amortization for CSN were as follows (in thousands): | ||||||||||||
Three Months Ended | Nine Months Ended | |||||||||||
September 28, | September 30, | September 28, | September 30, | |||||||||
2012 | 2011 | 2012 | 2011 | |||||||||
Contractual interest | $ | 1,113 | $ | 1,113 | $ | 3,338 | $ | 3,338 | ||||
Discount amortization | 2,781 | 2,602 | 8,205 | 7,676 |
At | December 30, 2011 | $ | 3,149 | |
Amortization during the period | (802) | |||
At | September 28, 2012 | $ | 2,347 |
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The change in net defined benefit plan liability is as follows (in thousands): | |||||
At | December 30, 2011 | $ | 5,569 | ||
Net defined benefit cost | 914 | ||||
Benefit payments | (786) | ||||
Foreign currency translation | (18) | ||||
At | September 28, 2012 | $ | 5,679 |
Net defined benefit cost is comprised of the following (in thousands): | ||||||||||||
Three Months Ended | Nine Months Ended | |||||||||||
September 28, | September 30, | September 28, | September 30, | |||||||||
2012 | 2011 | 2012 | 2011 | |||||||||
Service cost | $ | 272 | $ | 290 | $ | 835 | $ | 714 | ||||
Interest cost | 98 | 124 | 305 | 313 | ||||||||
Amortization of net loss | 30 | 21 | 92 | 16 | ||||||||
Expected return on plan assets | (103) | (126) | (318) | (317) | ||||||||
Net defined benefit cost | $ | 297 | $ | 309 | $ | 914 | $ | 726 | ||||
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The components and classification of stock-based compensation expense were as follows (in thousands): | ||||||||||||
Three Months Ended | Nine Months Ended | |||||||||||
September 28, | September 30, | September 28, | September 30, | |||||||||
2012 | 2011 | 2012 | 2011 | |||||||||
Stock options | $ | 671 | $ | 629 | $ | 2,038 | $ | 1,792 | ||||
Restricted stock and units | 1,523 | 1,186 | 4,559 | 3,270 | ||||||||
401(k) stock contribution | 1,280 | 1,193 | 2,410 | 3,741 | ||||||||
Total stock-based compensation expense | $ | 3,474 | $ | 3,008 | $ | 9,007 | $ | 8,803 | ||||
Cost of sales | $ | 1,119 | $ | 1,013 | $ | 2,486 | $ | 3,094 | ||||
Selling, general and administrative | 2,006 | 1,675 | 5,732 | 4,787 | ||||||||
Research, development and engineering | 349 | 320 | 789 | 922 | ||||||||
Total stock-based compensation expense | $ | 3,474 | $ | 3,008 | $ | 9,007 | $ | 8,803 |
The weighted average fair value and assumptions used to value options granted are as follows: | ||||||
Nine Months Ended | ||||||
September 28, | September 30, | |||||
2012 | 2011 | |||||
Weighted average fair value | $ | 8.20 | $ | 9.42 | ||
Risk-free interest rate | 0.83% | 2.04% | ||||
Expected volatility | 40% | 40% | ||||
Expected life (in years) | 5 | 5 | ||||
Expected dividend yield | 0% | 0% |
The following table summarizes time-vested stock option activity: | |||||||||||||||
Number of Time-Vested Stock Options | Weighted Average Exercise Price | Weighted Average Remaining Contractual Life (In Years) | Aggregate Intrinsic Value (In Millions) | ||||||||||||
Outstanding at | December 30, 2011 | 1,558,771 | $ | 23.42 | |||||||||||
Granted | 383,292 | 22.20 | |||||||||||||
Exercised | (44,993) | 20.86 | |||||||||||||
Forfeited or expired | (106,092) | 24.05 | |||||||||||||
Outstanding at | September 28, 2012 | 1,790,978 | $ | 23.19 | 6.2 | $ | 3.6 | ||||||||
Exercisable at | September 28, 2012 | 1,239,536 | $ | 23.38 | 5.1 | $ | 2.7 |
The following table summarizes performance-vested stock option activity: | |||||||||||||||
Number of Performance-Vested Stock Options | Weighted Average Exercise Price | Weighted Average Remaining Contractual Life (In Years) | Aggregate Intrinsic Value (In Millions) | ||||||||||||
Outstanding at | December 30, 2011 | 478,364 | $ | 24.44 | |||||||||||
Exercised | (5,353) | 22.11 | |||||||||||||
Forfeited or expired | (177,733) | 26.49 | |||||||||||||
Outstanding at | September 28, 2012 | 295,278 | $ | 23.25 | 4.6 | $ | 0.4 | ||||||||
Exercisable at | September 28, 2012 | 295,278 | $ | 23.25 | 4.6 | $ | 0.4 |
The following table summarizes time-vested restricted stock and unit activity: | |||||||||
Time-Vested Activity | Weighted Average Fair Value | ||||||||
Nonvested at | December 30, 2011 | 69,942 | $ | 22.69 | |||||
Granted | 87,803 | 23.48 | |||||||
Vested | (24,228) | 21.91 | |||||||
Forfeited | (5,586) | 22.30 | |||||||
Nonvested at | September 28, 2012 | 127,931 | $ | 23.40 |
The following table summarizes performance-vested restricted stock and unit activity: | |||||||||
Performance-Vested Activity | Weighted Average Fair Value | ||||||||
Nonvested at | December 30, 2011 | 529,743 | $ | 16.68 | |||||
Granted | 332,918 | 15.30 | |||||||
Vested | (7,500) | 24.62 | |||||||
Forfeited | (64,715) | 15.72 | |||||||
Nonvested at | September 28, 2012 | 790,446 | $ | 16.11 |
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Other Operating (Income) Expense, Net is comprised of the following (in thousands): | ||||||||||||
Three Months Ended | Nine Months Ended | |||||||||||
September 28, | September 30, | September 28, | September 30, | |||||||||
2012 | 2011 | 2012 | 2011 | |||||||||
Orthopaedic facility optimization(a) | $ | 12,452 | $ | 164 | $ | 14,774 | $ | 425 | ||||
Medical device facility optimization(b) | 388 | 0 | 1,282 | 0 | ||||||||
ERP system upgrade(c) | 1,938 | 0 | 4,745 | 0 | ||||||||
Integration costs(d) | 232 | 0 | 1,287 | 0 | ||||||||
Asset dispositions, severance and other(e) | 303 | 23 | 1,893 | (591) | ||||||||
$ | 15,313 | $ | 187 | $ | 23,981 | $ | (166) |
The change in accrued liabilities related to the orthopaedic facility optimization is as follows (in thousands): | |||||||||||||||||||
Severance and Retention | Accelerated Depreciation/Asset Write-offs | Other | Total | ||||||||||||||||
At | December 30, 2011 | $ | 0 | $ | 0 | $ | 0 | $ | 0 | ||||||||||
Restructuring charges | 4,525 | 5,246 | 5,003 | 14,774 | |||||||||||||||
Write-offs | 0 | (5,246) | 0 | (5,246) | |||||||||||||||
Cash payments | (83) | 0 | (5,003) | (5,086) | |||||||||||||||
At | September 28, 2012 | $ | 4,442 | $ | 0 | $ | 0 | $ | 4,442 |
The change in accrued liabilities related to the medical device facility optimization is as follows (in thousands): | |||||||||||||||||||
Production Inefficiencies, Moving and Revalidation | Personnel | Other | Total | ||||||||||||||||
At | December 30, 2011 | $ | 0 | $ | 0 | $ | 0 | $ | 0 | ||||||||||
Restructuring charges | 549 | 531 | 202 | 1,282 | |||||||||||||||
Cash payments | (549) | (531) | (202) | (1,282) | |||||||||||||||
At | September 28, 2012 | $ | 0 | $ | 0 | $ | 0 | $ | 0 |
The change in accrued liabilities related to the ERP system upgrade is as follows (in thousands): | |||||||||||||
Training & Consulting Costs | Accelerated Depreciation/ Asset Write-offs | Total | |||||||||||
At | December 30, 2011 | $ | 0 | $ | 0 | $ | 0 | ||||||
Charges | 2,579 | 2,166 | 4,745 | ||||||||||
Write-offs | 0 | (2,166) | (2,166) | ||||||||||
Cash payments | (1,853) | 0 | (1,853) | ||||||||||
At | September 28, 2012 | $ | 726 | $ | 0 | $ | 726 |
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At | December 30, 2011 | $ | 2,013 | |
Additions to warranty reserve | 483 | |||
Warranty claims paid | (993) | |||
Foreign currency effect | 3 | |||
At | September 28, 2012 | $ | 1,506 |
Remainder of | 2012 | $ | 1,072 | |
2013 | 4,156 | |||
2014 | 4,155 | |||
2015 | 3,566 | |||
2016 | 3,092 | |||
Thereafter | 3,133 | |||
Total estimated operating lease expense | $ | 19,174 |
Three Months Ended | Nine Months Ended | |||||||||||
September 28, | September 30, | September 28, | September 30, | |||||||||
2012 | 2011 | 2012 | 2011 | |||||||||
Increase (reduction) in Cost of Sales | $ | 11 | $ | (213) | $ | (8) | $ | (529) | ||||
Ineffective portion of change in fair value | 0 | 0 | 0 | 0 |
Instrument | Type of Hedge | Aggregate Notional Amount | Start Date | End Date | $/Peso | Fair Value | Balance Sheet Location | ||||||||
FX Contract | Cash flow | $ | 1,500 | Jan-12 | Dec-12 | 0.0767 | $ | 11 | Current Assets | ||||||
FX Contract | Cash flow | 1,050 | Jan-12 | Dec-12 | 0.0713 | 89 | Current Assets | ||||||||
FX Contract | Cash flow | 6,000 | Jan-13 | Dec-13 | 0.0727 | 235 | Current Assets/ Other Assets | ||||||||
FX Contract | Cash flow | 6,000 | Jan-13 | Dec-13 | 0.0693 | 548 | Current Assets/ Other Assets |
|
Accumulated Other Comprehensive Income is comprised of the following (in thousands): | ||||||||||||||||||
Defined Benefit Plan Liability | Cash Flow Hedges | Foreign Currency Translation Adjustment | Total Pre-Tax Amount | Tax | Net-of-Tax Amount | |||||||||||||
At | December 30, 2011 | $ | (2,660) | $ | (538) | $ | 11,526 | $ | 8,328 | $ | 601 | $ | 8,929 | |||||
Unrealized gain on cash flow hedges | - | 1,429 | - | 1,429 | (500) | 929 | ||||||||||||
Realized gain on cash flow hedges | - | (8) | - | (8) | 3 | (5) | ||||||||||||
Foreign currency translation loss | - | - | (522) | (522) | 0 | (522) | ||||||||||||
At | September 28, 2012 | $ | (2,660) | $ | 883 | $ | 11,004 | $ | 9,227 | $ | 104 | $ | 9,331 |
|
At | December 30, 2011 | $ | 0 | |
Contingent consideration liability recorded | 1,500 | |||
Fair value adjustments | 110 | |||
At | September 28, 2012 | $ | 1,610 |
Fair | |||||||||
Contingent | Value at | ||||||||
Consideration | September 28, | Valuation | Unobservable | ||||||
Liability | 2012 | Technique | Inputs | ||||||
Financial milestones | $ | 855 | Discounted cash flow | Discount rate | 12% | ||||
Projected year | |||||||||
of payment | 2014 | ||||||||
Development milestones | 755 | Discounted cash flow | Discount rate | 20% | |||||
Projected year | |||||||||
of payment | 2014 |
The following table provides information regarding assets and liabilities recorded at fair value on a recurring basis in the Condensed Consolidated Balance Sheet (in thousands): | |||||||||||||
Fair Value Measurements Using | |||||||||||||
Quoted | |||||||||||||
Prices in | Significant | ||||||||||||
Active Markets | Other | Significant | |||||||||||
At | for Identical | Observable | Unobservable | ||||||||||
September 28, | Assets | Inputs | Inputs | ||||||||||
Description | 2012 | (Level 1) | (Level 2) | (Level 3) | |||||||||
Assets | |||||||||||||
Foreign currency contracts | $ | 883 | $ | 0 | $ | 883 | $ | 0 | |||||
Liabilities | |||||||||||||
Accrued contingent consideration | 1,610 | 0 | 0 | 1,610 |
|
Long-lived tangible assets by geographic area are as follows (in thousands): | ||||||
As of | ||||||
September 28, | December 30, | |||||
2012 | 2011 | |||||
United States | $ | 124,451 | $ | 113,693 | ||
Rest of world | 32,211 | 32,113 | ||||
Total | $ | 156,662 | $ | 145,806 |
Three Months Ended | Nine Months Ended | |||||||||||||
September 28, | September 30, | September 28, | September 30, | |||||||||||
2012 | 2011 | 2012 | 2011 | |||||||||||
Sales by geographic area: | ||||||||||||||
United States | $ | 82,522 | $ | 61,502 | $ | 249,306 | $ | 187,795 | ||||||
Non-Domestic locations: | ||||||||||||||
Puerto Rico | 31,320 | 21,522 | 81,541 | 72,354 | ||||||||||
Belgium | 11,346 | 11,958 | 41,737 | 48,555 | ||||||||||
United Kingdom & Ireland | 9,837 | 14,466 | 34,525 | 42,585 | ||||||||||
Rest of world | 26,315 | 22,270 | 79,882 | 75,787 | ||||||||||
Total sales | $ | 161,340 | $ | 131,718 | $ | 486,991 | $ | 427,076 |
Three Months Ended | Nine Months Ended | |||||||||||||
September 28, | September 30, | September 28, | September 30, | |||||||||||
Sales: | 2012 | 2011 | 2012 | 2011 | ||||||||||
Implantable Medical | ||||||||||||||
CRM/Neuromodulation | $ | 80,246 | $ | 70,731 | $ | 235,406 | $ | 226,492 | ||||||
Vascular Access | 13,674 | 11,396 | 37,791 | 32,639 | ||||||||||
Orthopaedic | 27,173 | 31,131 | 91,079 | 108,642 | ||||||||||
Total Implantable Medical | 121,093 | 113,258 | 364,276 | 367,773 | ||||||||||
Electrochem | ||||||||||||||
Portable Medical | 20,219 | 1,954 | 59,346 | 6,105 | ||||||||||
Energy/Environmental | 16,192 | 13,955 | 51,441 | 45,813 | ||||||||||
Other | 3,836 | 2,551 | 11,928 | 7,385 | ||||||||||
Total Electrochem | 40,247 | 18,460 | 122,715 | 59,303 | ||||||||||
Total sales | $ | 161,340 | $ | 131,718 | $ | 486,991 | $ | 427,076 |
Three Months Ended | Nine Months Ended | |||||||||||||
September 28, | September 30, | September 28, | September 30, | |||||||||||
2012 | 2011 | 2012 | 2011 | |||||||||||
Segment income from operations: | ||||||||||||||
Implantable Medical | $ | 2,744 | $ | 12,030 | $ | 24,252 | $ | 48,677 | ||||||
Electrochem | 5,350 | 3,631 | 16,020 | 12,890 | ||||||||||
Total segment income from operations | 8,094 | 15,661 | 40,272 | 61,567 | ||||||||||
Unallocated operating expenses | (5,967) | (2,773) | (15,856) | (12,410) | ||||||||||
Operating income as reported | 2,127 | 12,888 | 24,416 | 49,157 | ||||||||||
Unallocated other expense | (4,299) | (3,649) | (13,599) | (9,327) | ||||||||||
Income (loss) before provision for income taxes | $ | (2,172) | $ | 9,239 | $ | 10,817 | $ | 39,830 |
Four customers accounted for a significant portion of the Company’s sales as follows: | ||||||||||||||
Three Months Ended | Nine Months Ended | |||||||||||||
September 28, | September 30, | September 28, | September 30, | |||||||||||
2012 | 2011 | 2012 | 2011 | |||||||||||
Customer A | 19% | 18% | 19% | 20% | ||||||||||
Customer B | 18% | 20% | 15% | 18% | ||||||||||
Customer C | 10% | 11% | 10% | 13% | ||||||||||
Customer D | 5% | 9% | 6% | 8% | ||||||||||
Total | 52% | 58% | 50% | 59% |
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