Integer Holdings Corp - Quarter Report: 2010 July (Form 10-Q)

 

 

U.S. SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

Commission File Number 1-16137

GREATBATCH, INC.

(Exact name of Registrant as specified in its charter)

Delaware
(State of incorporation)

16-1531026
(I.R.S. employer identification no.)

10000 Wehrle Drive
Clarence, New York
14031
(Address of principal executive offices)

(716) 759-5600
(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o		Accelerated filer þ		Non-accelerated filer o		Smaller reporting company o

Indicate by check mark whether the registrant is a shell company (as defined in Exchange Act Rule 12b-2). Yes o No þ

The number of shares outstanding of the Company’s common stock, $0.001 par value per share, as of August 10, 2010 was: 23,249,387 shares.

 

 

Greatbatch, Inc.
Table of Contents for Form 10-Q
As of and for the Six Months Ended July 2, 2010

		Page #
PART I — FINANCIAL INFORMATION
ITEM 1. Condensed Consolidated Financial Statements
Condensed Consolidated Balance Sheets — Unaudited			3
Condensed Consolidated Statements of Operations and Comprehensive Income — Unaudited			4
Condensed Consolidated Statements of Cash Flows — Unaudited			5
Condensed Consolidated Statement of Stockholders’ Equity — Unaudited			6
Notes to Condensed Consolidated Financial Statements — Unaudited			7
ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			25
ITEM 3. Quantitative and Qualitative Disclosures About Market Risk			39
ITEM 4. Controls and Procedures			40
PART II — OTHER INFORMATION
ITEM 1. Legal Proceedings			41
ITEM 1A. Risk Factors			41
ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds			41
ITEM 3. Defaults Upon Senior Securities			41
ITEM 4. (Removed and Reserved)			41
ITEM 5. Other Information			41
ITEM 6. Exhibits			41
SIGNATURES			42
EXHIBIT INDEX			42
Exhibit 31.1
Exhibit 31.2
Exhibit 32

PART I — FINANCIAL INFORMATION

ITEM 1.		CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

GREATBATCH, INC.

		As of
		July 2,				January 1,
		2010				2010
ASSETS
Current assets:
Cash and cash equivalents		$	45,657			$	37,864
Accounts receivable, net of allowance for doubtful accounts of $1.8 million in 2010 and $2.5 million in 2009			87,480				81,488
Inventories			101,133				106,609
Deferred income taxes			20,335				13,896
Prepaid expenses and other current assets			9,151				13,313
Total current assets			263,756				253,170
Property, plant and equipment, net			143,614				153,601
Amortizing intangible assets, net			76,977				82,076
Trademarks and tradenames			20,288				20,288
Goodwill			302,381				303,926
Deferred income taxes			1,568				2,458
Other assets			14,529				15,024
Total assets		$	823,113			$	830,543
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Current portion of long-term debt		$	—			$	30,450
Accounts payable			32,591				34,395
Income taxes payable			2,409				403
Accrued expenses and other current liabilities			65,878				67,996
Total current liabilities			100,878				133,244
Long-term debt			263,721				258,972
Deferred income taxes			61,740				54,043
Other long-term liabilities			4,424				4,560
Total liabilities			430,763				450,819
Stockholders’ equity:
Preferred stock, $0.001 par value, authorized 100,000,000 shares; no shares issued or outstanding in 2010 or 2009			—				—
Common stock, $0.001 par value, authorized 100,000,000 shares; 23,248,487 shares issued and 23,240,479 shares outstanding in 2010 23,190,105 shares issued and 23,157,097 shares outstanding in 2009			23				23
Additional paid-in capital			294,810				291,926
Treasury stock, at cost, 8,008 shares in 2010 and 33,008 shares in 2009			(154	)			(635	)
Retained earnings			99,597				86,262
Accumulated other comprehensive income (loss)			(1,926	)			2,148
Total stockholders’ equity			392,350				379,724
Total liabilities and stockholders’ equity		$	823,113			$	830,543

The accompanying notes are an integral part of these condensed consolidated financial statements.

GREATBATCH, INC.

		Three Months Ended								Six Months Ended
		July 2,				July 3,				July 2,				July 3,
		2010				2009				2010				2009
Sales		$	140,795			$	134,725			$	272,824			$	274,543
Cost of sales			95,336				93,253				185,701				188,907
Gross profit			45,459				41,472				87,123				85,636
Operating expenses:
Selling, general and administrative expenses			16,470				17,885				32,122				36,572
Research, development and engineering costs, net			11,177				8,694				22,201				16,569
Other operating expenses, net			495				2,424				1,487				5,227
Total operating expenses			28,142				29,003				55,810				58,368
Operating income			17,317				12,469				31,313				27,268
Interest expense			5,139				4,930				10,287				9,819
Interest income			(3	)			(2	)			(5	)			(27	)
Other (income) expense, net			200				(604	)			516				(397	)
Income before provision for income taxes			11,981				8,145				20,515				17,873
Provision for income taxes			4,193				1,583				7,180				4,647
Net income		$	7,788			$	6,562			$	13,335			$	13,226
Earnings per share:
Basic		$	0.34			$	0.29			$	0.58			$	0.58
Diluted		$	0.33			$	0.28			$	0.57			$	0.56
Weighted average shares outstanding:
Basic			23,058				22,960				23,051				22,887
Diluted			23,926				23,855				23,946				23,900
Comprehensive income:
Net income		$	7,788			$	6,562			$	13,335			$	13,226
Foreign currency translation gain (loss)			(1,460	)			3,934				(4,654	)			17
Unrealized gain (loss) on cash flow hedges, net			107				(230	)			580				36
Comprehensive income		$	6,435			$	10,266			$	9,261			$	13,279

The accompanying notes are an integral part of these condensed consolidated financial statements.

GREATBATCH, INC.

		Six Months Ended
		July 2,				July 3,
		2010				2009
Cash flows from operating activities:
Net income		$	13,335			$	13,226
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization			23,446				23,473
Stock-based compensation			2,765				4,918
Other non-cash losses			1,221				49
Deferred income taxes			1,770				2,943
Changes in operating assets and liabilities:
Accounts receivable			(6,649	)			74
Inventories			4,809				(4,151	)
Prepaid expenses and other current assets			2,137				(163	)
Accounts payable			(595	)			(11,494	)
Accrued expenses and other current liabilities			(199	)			(3,490	)
Income taxes payable			2,185				(3,649	)
Net cash provided by operating activities			44,225				21,736
Cash flows from investing activities:
Acquisition of property, plant and equipment			(6,416	)			(10,874	)
Purchase of cost method investments			—				(1,050	)
Other investing activities			821				(589	)
Net cash used in investing activities			(5,595	)			(12,513	)
Cash flows from financing activities:
Principal payments of long-term debt			(30,450	)			(23,000	)
Proceeds from issuance of long-term debt			—				12,000
Issuance of common stock			640				49
Other financing activities			(671	)			(736	)
Net cash used in financing activities			(30,481	)			(11,687	)
Effect of foreign currency exchange rates on cash and cash equivalents			(356	)			(596	)
Net increase (decrease) in cash and cash equivalents			7,793				(3,060	)
Cash and cash equivalents, beginning of period			37,864				22,063
Cash and cash equivalents, end of period		$	45,657			$	19,003

The accompanying notes are an integral part of these condensed consolidated financial statements.

GREATBATCH, INC.

																										Accumulated
										Additional				Treasury												Other				Total
		Common Stock								Paid-In				Stock								Retained				Comprehensive				Stockholders’
		Shares				Amount				Capital				Shares				Amount				Earnings				Income (Loss)				Equity
At January 1, 2010			23,190			$	23			$	291,926				(33	)		$	(635	)		$	86,262			$	2,148			$	379,724
Stock-based compensation			—				—				2,765				—				—				—				—				2,765
Net shares issued under stock incentive plans			58				—				159				25				481				—				—				640
Income tax liability from stock options and restricted stock			—				—				(40	)			—				—				—				—				(40	)
Net income			—				—				—				—				—				13,335				—				13,335
Total other comprehensive loss			—				—				—				—				—				—				(4,074	)			(4,074	)
At July 2, 2010			23,248			$	23			$	294,810				(8	)		$	(154	)		$	99,597			$	(1,926	)		$	392,350

The accompanying notes are an integral part of these condensed consolidated financial statements.

GREATBATCH, INC.

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 fair presentation of financial position, results of operations, and cash flows in conformity with accounting principles generally accepted in the United States of America. 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 accounting principles generally accepted in the United States of America 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 January 1, 2010 condensed consolidated balance sheet data was derived from audited consolidated financial statements but does not include all disclosures required by accounting principles generally accepted in the United States of America. 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 January 1, 2010. The Company utilizes a fifty-two, fifty-three week fiscal year ending on the Friday nearest December 31st. For 52-week years, each quarter contains 13 weeks. The second quarter of 2010 and 2009 each contained 13 weeks and ended on July 2, and July 3, respectively.

2.

SUPPLEMENTAL CASH FLOW INFORMATION

		Six Months Ended
		July 2,				July 3,
		2010				2009
Noncash investing and financing activities (in thousands):
Unrealized gain on cash flow hedges, net		$	580			$	36
Common stock contributed to 401(k) Plan			—				4,015
Property, plant and equipment purchases included in accounts payable			514				2,214
Cash paid during the period for:
Interest		$	4,571			$	4,665
Income taxes			3,331				4,602
Acquisition of noncash assets		$	350			$	850

GREATBATCH, INC.

3.

INVENTORIES

Inventories are comprised of the following (in thousands):

		As of
		July 2,				January 1,
		2010				2010
Raw materials		$	47,674			$	54,002
Work-in-process			30,071				28,329
Finished goods			23,388				24,278
Total		$	101,133			$	106,609

4.

INTANGIBLE ASSETS

Amortizing intangible assets are comprised of the following (in thousands):

		Gross								Foreign				Net
		Carrying				Accumulated				Currency				Carrying
		Amount				Amortization				Translation				Amount
At July 2, 2010
Purchased technology and patents		$	83,023			$	(45,207	)		$	111			$	37,927
Customer lists			46,818				(8,906	)			248				38,160
Other			3,519				(2,633	)			4				890
Total amortizing intangible assets		$	133,360			$	(56,746	)		$	363			$	76,977
At January 1, 2010
Purchased technology and patents		$	82,673			$	(42,289	)		$	399			$	40,783
Customer lists			46,818				(7,264	)			612				40,166
Other			3,519				(2,410	)			18				1,127
Total amortizing intangible assets		$	133,010			$	(51,963	)		$	1,029			$	82,076

Aggregate amortization expense for the second quarter of 2010 and 2009 was $2.4 million and $2.6 million, respectively. Aggregate amortization expense for the six months ended July 2, 2010 and July 3, 2009 was $4.8 million and $5.3 million, respectively. As of July 2, 2010, annual amortization expense is estimated to be $4.8 million for the remainder of 2010, $9.6 million for 2011, $9.4 million for 2012, $8.7 million for 2013 and $7.9 million for 2014.

The change in goodwill is as follows (in thousands):

		Greatbatch
		Medical				Electrochem				Total
At January 1, 2010		$	293,983			$	9,943				303,926
Foreign currency translation			(1,545	)			—				(1,545	)
At July 2, 2010		$	292,438			$	9,943			$	302,381

GREATBATCH, INC.

5.

DEBT

Long-term debt is comprised of the following (in thousands):

		July 2,				January 1,
		2010				2010
Revolving line of credit		$	98,000			$	98,000
2.25% convertible subordinated notes I			—				30,450
2.25% convertible subordinated notes II, due 2013			197,782				197,782
Unamortized discount			(32,061	)			(36,810	)
Total debt			263,721				289,422
Less: current portion of long-term debt			—				(30,450	)
Total long-term debt		$	263,721			$	258,972

Revolving Line of Credit — The Company has a senior credit facility (the “Credit Facility”) consisting of a $235 million revolving credit facility, which can be increased to $335 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. In connection with the Electrochem Litigation described in Note 10 “Commitments and Contingencies,” the Company was required to bond the amount of the judgment and statutory interest in order to appeal. The Company satisfied this requirement by posting a bond, which required collateralization. The Company received approval from the lenders supporting the Credit Facility to increase the letter of credit subfacility by up to $35 million for use only in connection with bonding the appeal of the Electrochem Litigation, of which $23 million was being utilized as of July 2, 2010.

The Credit Facility is secured by the Company’s non-realty assets including cash, accounts receivable and inventories, and has an expiration date of May 22, 2012 with a one-time option to extend to April 1, 2013 at the Company’s option if no default has occurred. Interest rates under the Credit Facility are, at the Company’s option, based upon the current prime or LIBOR rate plus a margin that varies with the Company’s leverage ratio, as defined in the credit agreement for the Credit Facility. If interest is paid based upon the prime rate, the applicable margin is between minus 1.25% and 0.00%. If interest is paid based upon the LIBOR rate, the applicable margin is between 1.00% and 2.00%. The Company is required to pay a fee on its outstanding letter of credit equal to a margin between 1.125% and 2.125%, depending on the Company’s leverage ratio, as defined in the credit agreement. The Company is also required to pay a commitment fee between 0.125% and 0.250% per annum on the unused portion of the Credit Facility based on the Company’s leverage ratio, as defined in the credit agreement.

The Credit Facility contains limitations on the incurrence of indebtedness, liens and licensing of intellectual property, investments and certain payments. Except to the extent paid by the issuance of common stock of Greatbatch or paid out of cash on hand, the Credit Facility limits the amount paid for acquisitions in total to $100 million. The restrictions on payments, among other things, limit repurchase of Greatbatch stock to $60 million and limit the ability of the Company to make cash payments upon conversion of its convertible subordinated notes II. These limitations can be waived upon the Company’s request and approval of a simple majority of the lenders.

GREATBATCH, INC.

The Credit Facility requires the Company to maintain a ratio of adjusted EBITDA, as defined in the credit agreement, to interest expense of at least 3.00 to 1.00, and a total leverage ratio, as defined in the credit agreement, of not greater than 4.50 to 1.00. The calculation of adjusted EBITDA and leverage ratio exclude non-cash charges, as well as charges in connection with the Electrochem Litigation up to $35 million. As of July 2, 2010, 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 Company’s revolving line of credit as of July 2, 2010, which does not include the impact of the interest rate swaps described below, was 1.49% and resets based upon the six-month LIBOR rate. As of July 2, 2010, the Company had $114 million of borrowing capacity available under the Credit Facility. This amount may vary from period to period based upon the debt levels of the Company as well as the level of EBITDA which impacts the covenant calculations described above. The interest rate on the $23 million letter of credit outstanding as of July 2, 2010 was 1.125%.

Interest Rate Swaps — The Company has entered into three receive floating, pay fixed interest rate swaps indexed to the six-month LIBOR rate. The objective of these swaps is to hedge against potential changes in cash flows on the Company’s outstanding revolving line of credit, which is also indexed to the six-month LIBOR rate. No credit risk was hedged. The receive variable leg of the swap and the variable rate paid on the revolving line of credit bear the same rate of interest, excluding the credit spread, and reset and pay interest on the same dates. The Company intends to continue electing the six-month LIBOR as the benchmark interest rate on the debt being hedged. If the Company repays the debt, it intends to replace the hedged item with similarly indexed cash flows.

Information regarding the Company’s outstanding interest rate swaps is as follows (dollars in thousands):

Current

Fair

Pay

Receive

Value

Balance

Type of

Notional

Start

End

Fixed

Floating

July 2,

Sheet

Instrument

Hedge

Amount

Date

Date

Rate

Rate

2010

Location

Int. rate swap

Cash flow

$

80,000

3/5/2008

7/7/2010

3.09

%

0.43

%

$

(30

)

Other Current Liabilities

Int. rate swap

Cash flow

18,000

12/18/2008

12/18/2010

2.00

%

0.75

%

(105

)

Other Current Liabilities

Int. rate swap

Cash flow

50,000

7/7/2010

7/7/2011

2.16

%

6M LIBOR

(654

)

Other Long-Term Liabilities

$

(789

)

The estimated fair value of the interest rate swap agreements represents the amount the Company would have to pay to terminate the contracts. No portion of the change in fair value of the interest rate swaps during the 2010 or 2009 periods was considered ineffective. The amount recorded as additional Interest Expense related to the interest rate swaps for the second quarter of 2010 and 2009 was $0.6 million and $0.3 million, respectively, and $1.2 million and $0.5 million, respectively, for the six months ended July 2, 2010 and July 3, 2009.

GREATBATCH, INC.

Convertible Subordinated Notes — In May 2003, the Company completed a private placement of $170 million of 2.25% convertible subordinated notes, due June 15, 2013 (“CSN I”). In March 2007, the Company entered into separate, privately negotiated agreements to exchange $117.8 million of CSN I for an equivalent principal amount of a new series of 2.25% convertible subordinated notes due 2013 (“CSN II”) (collectively the “Exchange”) at a 5% discount. The primary purpose of the Exchange was to eliminate the June 15, 2010 call and put option that was included in the terms of CSN I. In connection with the Exchange, the Company issued an additional $80 million aggregate principal amount of CSN II at a price of $950 per $1,000 of principal. In December 2008, the Company entered into privately negotiated agreements under which it repurchased $21.8 million in aggregate principal amount of its outstanding CSN I at $845.38 per $1,000 of principal. The primary purpose of this transaction was to retire the notes, which contained a put option exercisable on June 15, 2010, at a discount. During the second quarter of 2010 the holders of the remaining $30.5 million of CSN I notes exercised their put option. These notes were repaid with cash on hand.

CSN II notes bear interest at 2.25% per annum, payable semi-annually, and are due on June 15, 2013. The holders may convert the notes 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. CSN II notes were issued at a price of $950 per $1,000 of principal. The fair value of CSN II as of July 2, 2010 was approximately $177 million and is based on recent sales prices.

The effective interest rate of CSN II, 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 II is being amortized to the maturity date of the convertible notes utilizing the effective interest method. As of July 2, 2010, the carrying amount of the discount related to the CSN II conversion option value was $27.1 million. As of July 2, 2010, the if-converted value of the CSN II notes does not exceed their principal amount as the Company’s closing stock price of $22.00 per share did not exceed the conversion price of $34.70 per share.

The contractual interest and discount amortization for CSN II were as follows (in thousands):

		Three Months Ended								Six Months Ended
		July 2,				July 3,				July 2,				July 3,
		2010				2009				2010				2009
Contractual interest		$	1,113			$	1,113			$	2,225			$	2,225
Discount amortization			2,394				2,240				4,748				4,444

GREATBATCH, INC.

The notes 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) the notes 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 affects a consolidation, merger, share exchange or sale of assets pursuant to which its common stock is converted to cash or other property; (vii) the period beginning 60 days prior to but excluding June 15, 2013; and (viii) certain fundamental changes, as defined in the indenture agreement, 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 agreement, whereby the conversion ratio on the notes may be increased by up to 7.4 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 II 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.

The notes 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 agreement, affecting the Company. The notes are subordinated in right of payment to all of our senior indebtedness and effectively subordinated to all debts and other liabilities of the Company’s subsidiaries.

Deferred Financing Fees — The change in deferred financing fees is as follows (in thousands):

At January 1, 2010		$	3,028
Amortization during the period			(539	)
At July 2, 2010		$	2,489

6.

PENSION PLANS

The Company is required to provide its employees located in Switzerland and France certain defined pension benefits. These benefits accrue to employees based upon years of service, position, age and compensation. The defined benefit pension plan that provides benefits to the Company’s employees located in Switzerland is a funded contributory plan while the pension plan that provides benefits to the Company’s employees located in France is unfunded and noncontributory. The liability and corresponding expense related to these pension plans is based on actuarial computations of current and future benefits for employees. Pension expense is charged to current operating expenses.

GREATBATCH, INC.

The change in net pension liability is as follows (in thousands):

At January 1, 2010		$	3,974
Net periodic pension cost			478
Benefit payments			(460	)
Foreign currency translation			(190	)
At July 2, 2010		$	3,802

Net pension cost is comprised of the following (in thousands):

		Three Months Ended								Six Months Ended
		July 2,				July 3,				July 2,				July 3,
		2010				2009				2010				2009
Service cost		$	229			$	218			$	469			$	428
Interest cost			100				99				206				195
Amortization of net loss			6				32				11				62
Expected return on plan assets			(102	)			(78	)			(208	)			(153	)
Net pension cost		$	233			$	271			$	478			$	532

7.

STOCK-BASED COMPENSATION

Compensation costs related to share-based payments for the three months ended July 2, 2010 and July 3, 2009 totaled $1.7 million and $1.0 million, respectively. Compensation costs related to share-based payments for the six months ended July 2, 2010 and July 3, 2009 totaled $2.8 million and $2.8 million, respectively. Stock-based compensation expense included in the Condensed Consolidated Statement of Cash Flows includes, when incurred, costs recognized for the annual share contribution to the Company’s 401(k) Plan as well as for share-based payments.

The weighted average fair value and assumptions used to value options granted are as follows:

		Six Months Ended
		July 2,				July 3,
		2010				2009
Weighted average fair value		$	8.24			$	8.63
Risk-free interest rate			2.62	%			2.02	%
Expected volatility			40	%			39	%
Expected life (in years)			5				6
Expected dividend yield			0	%			0	%

GREATBATCH, INC.

The following table summarizes time-vested stock option activity:

										Weighted
										Average
		Number of				Weighted				Remaining				Aggregate
		Time-Vested				Average				Contractual				Intrinsic
		Stock				Exercise				Life				Value
		Options				Price				(In Years)				(In Millions)
Outstanding at January 1, 2010			1,362,123			$	23.94
Granted			239,253				20.57
Exercised			(33,296	)			19.22
Forfeited or expired			(71,291	)			24.77
Outstanding at July 2, 2010			1,496,789			$	23.48				6.8			$	1.6
Exercisable at July 2, 2010			952,487			$	24.12				5.8			$	1.1

The following table summarizes performance-vested stock option activity:

										Weighted
										Average
		Number of				Weighted				Remaining				Aggregate
		Performance-				Average				Contractual				Intrinsic
		Vested Stock				Exercise				Life				Value
		Options				Price				(In Years)				(In Millions)
Outstanding at January 1, 2010			1,001,984			$	24.48
Forfeited or expired			(219,848	)			27.30
Outstanding at July 2, 2010			782,136			$	23.69				7.7			$	0.0
Exercisable at July 2, 2010			206,255			$	22.86				5.7			$	0.0

The performance-based restricted stock units granted in 2010 only vest if certain performance metrics are achieved. The amount of shares that ultimately vest range from 0 shares to 280,419 shares based upon the total shareholder return of the Company relative to the Company’s compensation peer group, as disclosed in the Company’s definitive proxy statement filed on April 20, 2010, over a three year performance period beginning in the year of grant.

GREATBATCH, INC.

The following table summarizes time-vested restricted stock and unit activity:

						Weighted
		Time-Vested				Average
		Activity				Fair Value
Nonvested at January 1, 2010			160,998			$	24.28
Granted			102,379				20.70
Forfeited or expired			(10,188	)			25.02
Nonvested at July 2, 2010			253,189			$	22.82

The following table summarizes performance-vested restricted stock and unit activity:

		Performance-				Weighted
		Vested				Average
		Activity				Fair Value
Nonvested at January 1, 2010			24,000			$	22.59
Granted			280,419				14.46
Forfeited or expired			(200	)			18.47
Nonvested at July 2, 2010			304,219			$	15.10

8.

OTHER OPERATING EXPENSES, NET

Other operating expenses, net is comprised of the following (in thousands):

		Three Months Ended								Six Months Ended
		July 2,				July 3,				July 2,				July 3,
		2010				2009				2010				2009
2007 & 2008 facility shutdowns and consolidations(a)		$	536			$	1,578			$	856			$	3,477
Integration costs(b)			8				717				130				1,580
Asset dispositions and other(c)			(49	)			129				501				170
		$	495			$	2,424			$	1,487			$	5,227

In the second quarter of 2007, the Company announced that it would consolidate its corporate offices in Clarence, NY into its existing research and development center also in Clarence, NY after an expansion of that facility was complete. This expansion and relocation was completed in the third quarter of 2008.

During the second and third quarters of 2008, the Company reorganized and consolidated various general and administrative and research and development functions throughout the organization in order to optimize those resources with the businesses it acquired in 2007 and 2008.

GREATBATCH, INC.

In the second half of 2008, the Company ceased manufacturing at its facility in Suzhou, China (Electrochem), closed its leased manufacturing facility in Orchard Park, NY (Electrochem), and consolidated its Saignelegier, Switzerland manufacturing facility (orthopaedics). The operations of these facilities were relocated to existing facilities that had excess capacity.

In the fourth quarter of 2008, management approved a plan for the consolidation of its Teterboro, NJ (Electrochem manufacturing), Blaine, Minnesota (vascular manufacturing) and Exton, Pennsylvania (orthopaedics corporate office) facilities into existing facilities that had excess capacity. The Blaine, MN and Exton, PA consolidations were completed in the second quarter of 2009. The Teterboro, NJ initiative was substantially completed in the fourth quarter of 2009.

The total cost incurred for these facility shutdowns and consolidations was $16.8 million and included the following:

a.

Severance and retention — $4.4 million;

b.

Production inefficiencies, moving and revalidation — $5.2 million;

c.

Accelerated depreciation and asset write-offs — $4.8 million;

d.

Personnel — $0.7 million; and

e.

Other — $1.7 million.

All categories of costs are considered to be cash expenditures, except accelerated depreciation and asset write-offs. Costs incurred during 2010 relating to these initiatives primarily related to the Electrochem business segment. For the six months ended July 3, 2009, costs relating to these initiatives of $1.4 million and $2.1 million were included in the Greatbatch Medical and Electrochem business segments, respectively.

As a result of these consolidation initiatives, one Greatbatch Medical facility and one Electrochem facility are classified as held for sale as of July 2, 2010. These facilities are recorded at the lower of their carrying amount or estimated fair value less costs to sell. The fair value of these facilities is primarily determined by reference to recent sales data for comparable facilities taking into consideration recent offers, if any, received from prospective buyers of the facility, which is categorized as Level 2 in the fair value hierarchy. These facilities are expected to be sold within the next year and have a carrying value of $3.6 million as of July 2, 2010 and are included in Other Current Assets in the Condensed Consolidated Balance Sheet. During the second quarter of 2010, the Company recognized a $0.6 million write down related to its Electrochem facility, as the estimated fair value less costs to sell was below the recorded book value. During the first quarter of 2010, the Company sold its Saignelegier, Switzerland facility for $1.1 million, which was previously classified as held for sale. No gain or loss was recognized during the period related to this facility.

GREATBATCH, INC.

The change in accrued liabilities related to the 2007 & 2008 facility shutdowns and consolidations is as follows (in thousands):

						Production				Accelerated
		Severance				Inefficiencies,				Depreciation/
		and				Moving and				Asset Write-
		Retention				Revalidation				offs				Personnel				Other				Total
At January 2, 2009		$	594			$	—			$	—			$	—			$	—			$	594
Restructuring charges			1,796				2,948				671				534				1,120				7,069
Write-offs			—				—				(671	)			—				—				(671	)
Cash payments			(1,466	)			(2,948	)			—				(534	)			(1,120	)			(6,068	)
At January 1, 2010		$	924			$	—			$	—			$	—			$	—			$	924
Restructuring charges			—				153				570				68				65				856
Write-offs			—				—				(570	)			—				—				(570	)
Cash payments			(924	)			(153	)			—				(68	)			(65	)			(1,210	)
At July 2, 2010		$	—			$	—			$	—			$	—			$	—			$	—

9.

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, business acquisitions, settlements with taxing authorities and foreign currency fluctuations.

As discussed in Note 5 “Debt,” $30.5 million of CSN I were put back to the Company during the second quarter of 2010. This transaction resulted in discharge of indebtedness (“COD”) income for tax purposes. Under the American Recovery and Reinvestment Tax Act of 2009, an election can be made to defer such COD income and begin recognizing over a 5 year period, beginning in 2014. At this time, it is the Company’s intent to make this election, which is made with the filing of the 2010 tax return. As such, the tax liability associated with the COD income (approximately $6 million) has been classified as non-current Deferred Income Taxes.

GREATBATCH, INC.

During the quarter ended July 2, 2010, there has been no change in the balance of unrecognized tax benefits. Approximately $1.9 million of the balance of unrecognized tax benefits would favorably impact the effective tax rate (net of federal benefit on state issues), if recognized. It is reasonably possible that a reduction of approximately $0.7 million of the balance of unrecognized tax benefits may occur within the next twelve months as a result of the expiration of applicable statutes of limitation.

10.

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, except as indicated below, that the ultimate resolution of any such pending actions will have a material adverse 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 adverse impact in the period in which the ruling occurs.

As previously reported, the Company is appealing the September 2009 jury verdict in the Input/Output Marine Systems action against the Company (“Electrochem Litigation”). During the third quarter of 2009, the Company accrued $34.5 million in connection with this litigation. During the appeal process, interest on the judgment will accrue based upon the Louisiana statutory rate, which is currently 3.75% per annum. The amount of interest that has accrued on this judgment through July 2, 2010 is $0.4 million.

The litigation previously reported in the Company’s Annual Report on Form 10-K for the year ended on January 1, 2010 commenced against the Company by its insurance carrier that had been paying the cost of defense in the Electrochem Litigation has been settled. Under the terms of the settlement agreement, the insurer has no further obligation to defend the Company, but the Company has no obligation to reimburse the insurer for defense costs expended prior to the jury verdict.

With regard to the previously reported patent infringement action filed by Pressure Products Medical Supplies, Inc. (“Pressure Products”), in August 2010 the parties reached an agreement to settle the litigation.  In exchange for a cash payment by the Company, Pressure Products will grant a covenant not to sue on the Company’s FlowGuard^TM and OptiSeal^TM introducer products and dismiss its claims against the Company.  No further material litigation charges are anticipated with regards to this litigation as a result of this settlement. As part of the settlement, the litigation commenced by the Company against Pressure Products also will be dismissed. 

Product Warranties — The Company generally warrants that its products will meet customer specifications and will be free from defects in materials and workmanship. The Company accrues its estimated exposure to warranty claims based upon recent historical experience and other specific information as it becomes available.

GREATBATCH, INC.

The change in aggregate product warranty liability for the quarter is as follows (in thousands):

Beginning balance at April 2, 2010		$	1,692
Additions to warranty reserve			340
Warranty claims paid			(436	)
Ending balance at July 2, 2010		$	1,596

Purchase Commitments — Contractual obligations for purchase of goods or services are defined as agreements that are enforceable and legally binding on the Company and that specify all significant terms, including: fixed or minimum quantities to be purchased; fixed, minimum or variable price provisions; and the approximate timing of the transaction. Our purchase orders are normally based on our current manufacturing needs and are fulfilled by our vendors within short time horizons. We enter into blanket orders with vendors that have preferred pricing and terms, however these orders are normally cancelable by us without penalty. As of July 2, 2010, the total contractual obligation related to such expenditures is approximately $10.4 million and will be financed by existing cash and cash equivalents or cash generated from operations over the next twelve months. We also enter 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. Minimum future annual operating lease payments are $1.5 million for the remainder of 2010; $2.0 million in 2011; $1.9 million in 2012; $1.8 million in 2013; $1.9 million in 2014 and $6.4 million thereafter. The Company primarily leases buildings, which accounts for the majority of the future lease payments.

Foreign Currency Contracts — In February 2009, the Company entered into forward contracts to purchase 10 million Mexican pesos per month from March 2009 to December 2009 at an exchange rate of 14.85 pesos per one U.S. dollar. These contracts were entered into in order to hedge the risk of peso-denominated payments associated with the operations at the Company’s Tijuana, Mexico facility for 2009. These contracts were accounted for as cash flow hedges. The amount recorded as a reduction of Cost of Sales during the six months ended July 3, 2009 related to these forward contracts was $0.2 million.

In December 2009, the Company entered into forward contracts to purchase 6.6 million Mexican pesos per month from January 2010 to December 2010 at an exchange rate of 13.159 pesos per one U.S. dollar. In February 2010, the Company entered into forward contracts to purchase an additional 3.3 million Mexican pesos per month from February 2010 to December 2010 at an exchange rate of 13.1595 pesos per one U.S. dollar. These contracts were entered into in order to hedge a portion of the risk of peso-denominated payments associated with the operations at the Company’s Tijuana, Mexico facility for 2010 and are being accounted for as cash flow hedges. As of July 2, 2010, these contracts had a negative fair value of $0.02 million, which is recorded within Accrued Expenses and Other Current Liabilities in the Condensed Consolidated Balance Sheet. The amount recorded as a reduction of Cost of Sales during the six months ended July 2, 2010 related to these forward contracts was $0.3 million. No portion of the change in fair value of the Company’s foreign currency contracts during the six months ended July 2, 2010 or July 3, 2009 was considered ineffective.

GREATBATCH, INC.

Subsequent Event — In July 2010, the Company entered into a forward contract to purchase 6.6 million Mexican pesos per month from January 2011 to December 2011 at an exchange rate of 13.2231 pesos per one U.S. dollar. This contract was entered into in order to hedge the risk of peso-denominated payments associated with a portion of the operations at the Company’s Tijuana, Mexico facility for 2011 and will be accounted for as a cash flow hedge.

Self-Insured Medical Plan — In an attempt to help offset the cost of rising health care expenses, in 2010, the Company began self-funding the medical insurance coverage for all of its U.S. based employees. The risk to the Company is being limited through the use of stop loss insurance which has annual deductibles in the amount of $0.2 million per covered participant and $9.9 million in the aggregate. The maximum benefit for aggregate losses is $1.0 million and $4.8 million for specific losses. As of July 2, 2010, the Company has $2.2 million accrued related to the self-insurance of its medical plan, which is recorded as Accrued Expenses and Other Current Liabilities in the Condensed Consolidated Balance Sheet, and is based upon prior years claim history.

11.

EARNINGS PER SHARE (“EPS”)

The following table illustrates the calculation of basic and diluted EPS (in thousands, except per share amounts):

		Three Months Ended								Six Months Ended
		July 2,				July 3,				July 2,				July 3,
		2010				2009				2010				2009
Numerator for basic EPS:
Net income		$	7,788			$	6,562			$	13,335			$	13,226
Effect of dilutive securities:
Interest expense on convertible notes and related deferred financing fees, net of tax			111				130				241				260
Numerator for diluted EPS		$	7,899			$	6,692			$	13,576			$	13,486
Denominator for basic EPS:
Weighted average shares outstanding			23,058				22,960				23,051				22,887
Effect of dilutive securities:
Convertible subordinated notes			630				756				693				756
Stock options and unvested restricted stock			238				139				202				257
Denominator for diluted EPS			23,926				23,855				23,946				23,900
Basic EPS		$	0.34			$	0.29			$	0.58			$	0.58
Diluted EPS		$	0.33			$	0.28			$	0.57			$	0.56

GREATBATCH, INC.

The diluted weighted average share calculations do not include the following securities, which are not dilutive to the EPS calculations:

		Three Months Ended								Six Months Ended
		July 2,				July 3,				July 2,				July 3,
		2010				2009				2010				2009
Time-vested stock options, restricted stock and restricted stock units			1,118,000				1,289,000				1,372,000				1,314,000
Performance-vested stock options and restricted stock units			942,000				942,000				956,000				942,000

12.

COMPREHENSIVE INCOME

The Company’s comprehensive income as reported in the Condensed Consolidated Statements of Operations and Comprehensive Income includes net income, foreign currency translation gains (losses) and unrealized gains (losses) on cash flow hedges.

The Company translates all assets and liabilities of its foreign subsidiaries, where the U.S. dollar is not the functional currency, at the period-end exchange rate and translates income and expenses at the average exchange rates in effect during the period. The net effect of these translation adjustments is recorded in the condensed consolidated financial statements as comprehensive income (loss). Translation adjustments are not adjusted for income taxes as they relate to permanent investments in the Company’s foreign subsidiaries.

The Company has designated its interest rate swaps and foreign currency contracts (See Notes 5 “Debt” and 10 “Commitments and Contingencies”) as cash flow hedges. Accordingly, the effective portion of any change in the fair value of these instruments is recorded in comprehensive income (loss), net of tax, and reclassified into earnings (Interest Expense — Swaps, Cost of Sales — FX Contracts) in the same period or periods during which the hedged transaction affects earnings. Gains and losses on the derivative representing hedge ineffectiveness are recognized in current earnings.

Accumulated other comprehensive income (loss) is comprised of the following (in thousands):

		Defined
		Benefit								Foreign
		Pension				Cash				Currency				Total								Net-of-
		Plan				Flow				Translation				Pre-Tax								Tax
		Liability				Hedges				Adjustment				Amount				Tax				Amount
At January 1, 2010		$	(1,455	)		$	(1,701	)		$	4,334			$	1,178			$	970			$	2,148
Unrealized loss on cash flow hedges			—				(130	)			—				(130	)			46				(84	)
Realized loss on cash flow hedges			—				1,021				—				1,021				(357	)			664
Foreign currency translation loss			—				—				(4,654	)			(4,654	)			—				(4,654	)
At July 2, 2010		$	(1,455	)		$	(810	)		$	(320	)		$	(2,585	)		$	659			$	(1,926	)

GREATBATCH, INC.

13.

FAIR VALUE MEASUREMENTS

The following table provides information regarding assets and liabilities recorded at fair value in the Company’s Condensed Consolidated Balance Sheet as of July 2, 2010 (in thousands):

		Fair Value Measurements Using
						Quoted
						Prices in				Significant
						Active Markets				Other				Significant
		At				for Identical				Observable				Unobservable
		July 2,				Assets				Inputs				Inputs
Description		2010				(Level 1)				(Level 2)				(Level 3)
Assets
Asset held for sale		$	1,500			$	—			$	1,500			$	—
Liabilities
Foreign currency contracts		$	21			$	—			$	21			$	—
Interest rate swaps			789				—				789				—

Asset held for sale — Assets held for sale are recorded at the lower of their carrying amount or estimated fair value less cost to sell. For the property written-down in the second quarter of 2010, the fair value was primarily determined by reference to recent offers received from prospective buyers of the facility. The Company’s assets held for sale that are recorded at fair value are categorized in Level 2 of the fair value hierarchy.

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.

Interest rate swaps — The fair value of interest rate swaps 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 LIBOR and swap rates, and credit spread curves. In addition to the above, the Company receives fair value estimates from the interest rate swap counterparty to verify the reasonableness of the Company’s estimates. The Company’s interest rate swaps are categorized in Level 2 of the fair value hierarchy.

Convertible subordinated notes — The fair value of the Company’s convertible subordinated notes disclosed in Note 5 “Debt” were determined based upon recent third-party transactions for the Company’s notes in an inactive market. The Company’s convertible subordinated notes are valued for disclosure purposes utilizing Level 2 measurements of the fair value hierarchy.

GREATBATCH, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — Unaudited

Cost method investments — The Company holds certain cost method investments that are measured at fair value on a non-recurring basis in periods subsequent to initial recognition. The fair value of a cost method investment is only estimated if there are identified events or changes in circumstances that indicate impairment may be present. The aggregate carrying amount of our cost method investments included in Other Assets was $11.9 million as of July 2, 2010 and January 1, 2010.

14.

BUSINESS SEGMENT, GEOGRAPHIC AND CONCENTRATION RISK INFORMATION

The Company operates its business in two reportable segments — Greatbatch Medical and Electrochem Solutions (“Electrochem”). The Greatbatch Medical segment designs and manufactures components and devices for the CRM, neuromodulation, vascular and orthopaedics markets. Additionally, the Greatbatch Medical business offers value-added assembly and design engineering services for products that incorporate Greatbatch Medical components.

Electrochem designs, manufactures and distributes electrochemical cells, battery packs and wireless sensors for demanding applications in markets such as energy, security, portable medical, environmental monitoring and more.

The Company defines segment income from operations as sales less cost of sales including amortization and expenses attributable to segment-specific selling, general and administrative, research, development and engineering expenses, and other operating expenses. 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 expenses are primarily corporate headquarters and administrative function expenses. The unallocated operating expenses along with other expense 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								Six Months Ended
		July 2,				July 3,				July 2,				July 3,
		2010				2009				2010				2009
Sales:
Greatbatch Medical
CRM/Neuromodulation		$	78,838			$	78,026			$	155,763			$	155,293
Vascular			11,007				9,152				19,173				19,885
Orthopaedics			30,488				31,389				59,929				65,472
Total Greatbatch Medical			120,333				118,567				234,865				240,650
Electrochem			20,462				16,158				37,959				33,893
Total sales		$	140,795			$	134,725			$	272,824			$	274,543

GREATBATCH, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — Unaudited

		Three Months Ended								Six Months Ended
		July 2,				July 3,				July 2,				July 3,
		2010				2009				2010				2009
Segment income (loss) from operations:
Greatbatch Medical		$	18,183			$	15,736			$	32,213			$	32,374
Electrochem			3,331				(335	)			7,084				1,060
Total segment income from operations			21,514				15,401				39,297				33,434
Unallocated operating expenses			(4,197	)			(2,932	)			(7,984	)			(6,166	)
Operating income as reported			17,317				12,469				31,313				27,268
Unallocated other expense			(5,336	)			(4,324	)			(10,798	)			(9,395	)
Income before provision for income taxes		$	11,981			$	8,145			$	20,515			$	17,873