Integer Holdings Corp - Quarter Report: 2011 September (Form 10-Q)

 

 

U.S. SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2011

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 checkmark 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 þ 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 November 8, 2011 was: 23,426,241 shares.

 

 

Greatbatch, Inc.
Table of Contents for Form 10-Q

For the Quarterly Period Ended September 30, 2011

		Page No.
PART I — FINANCIAL INFORMATION
ITEM 1. Financial Statements
Condensed Consolidated Balance Sheets — Unaudited			3
Condensed Consolidated Statements of Operations and Comprehensive Income (Loss) — 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			40
ITEM 4. Controls and Procedures			41
PART II — OTHER INFORMATION
ITEM 1. Legal Proceedings			42
ITEM 1A. Risk Factors			42
ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds			42
ITEM 3. Defaults Upon Senior Securities			42
ITEM 4. (Removed and Reserved)			42
ITEM 5. Other Information			42
ITEM 6. Exhibits			42
SIGNATURES			42
EXHIBIT INDEX			43
Exhibit 31.1
Exhibit 31.2
Exhibit 32
EX-101 INSTANCE DOCUMENT
EX-101 SCHEMA DOCUMENT
EX-101 CALCULATION LINKBASE DOCUMENT
EX-101 LABELS LINKBASE DOCUMENT
EX-101 PRESENTATION LINKBASE DOCUMENT
EX-101 DEFINITION LINKBASE DOCUMENT

PART I — FINANCIAL INFORMATION

ITEM 1.		FINANCIAL STATEMENTS

GREATBATCH, INC.

		As of
		September 30,				December 31,
		2011				2010
ASSETS
Current assets:
Cash and cash equivalents		$	41,627			$	22,883
Accounts receivable, net of allowance for doubtful accounts of $2.3 million in 2011 and $1.8 million in 2010			82,829				70,947
Inventories			115,293				101,440
Refundable income taxes			—				2,763
Deferred income taxes			7,856				7,398
Prepaid expenses and other current assets			5,426				6,078
Total current assets			253,031				211,509
Property, plant and equipment, net			144,307				146,380
Amortizing intangible assets, net			74,413				75,114
Trademarks and tradenames			20,288				20,288
Goodwill			308,557				307,451
Deferred income taxes			2,126				2,427
Other assets			9,113				13,807
Total assets		$	811,835			$	776,976
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable		$	30,507			$	27,989
Income taxes payable			1,213				—
Deferred income taxes			618				514
Accrued expenses			41,438				32,084
Total current liabilities			73,776				60,587
Long-term debt			198,305				220,629
Deferred income taxes			67,504				64,290
Other long-term liabilities			8,325				4,641
Total liabilities			347,910				350,147
Stockholders’ equity:
Preferred stock, $0.001 par value, authorized 100,000,000 shares; no shares issued or outstanding in 2011 or 2010			—				—
Common stock, $0.001 par value, authorized 100,000,000 shares; 23,423,052 shares issued and 23,378,368 shares outstanding in 2011 23,319,492 shares issued and 23,256,897 shares outstanding in 2010			23				23
Additional paid-in capital			305,106				298,405
Treasury stock, at cost, 44,684 shares in 2011 and 62,595 shares in 2010			(1,048	)			(1,469	)
Retained earnings			146,883				119,400
Accumulated other comprehensive income			12,961				10,470
Total stockholders’ equity			463,925				426,829
Total liabilities and stockholders’ equity		$	811,835			$	776,976

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

GREATBATCH, INC.

		Three Months Ended								Nine Months Ended
		September 30,				October 1,				September 30,				October 1,
		2011				2010				2011				2010
Sales		$	131,718			$	127,490			$	427,076			$	400,314
Cost of sales			89,811				85,496				291,395				271,197
Gross profit			41,907				41,994				135,681				129,117
Operating expenses:
Selling, general and administrative expenses			17,760				17,098				53,980				49,220
Research, development and engineering costs, net			11,072				11,402				32,710				33,603
Other operating (income) expense, net			187				325				(166	)			1,812
Total operating expenses			29,019				28,825				86,524				84,635
Operating income			12,888				13,169				49,157				44,482
Interest expense			4,125				4,577				12,802				14,864
Interest income			(1	)			(4	)			(9	)			(9	)
Gain on cost method investments, net			—				—				(4,232	)			—
Other (income) expense, net			(475	)			306				766				822
Income before provision for income taxes			9,239				8,290				39,830				28,805
Provision for income taxes			2,250				2,326				12,347				9,506
Net income		$	6,989			$	5,964			$	27,483			$	19,299
Earnings per share:
Basic		$	0.30			$	0.26			$	1.18			$	0.84
Diluted		$	0.30			$	0.25			$	1.16			$	0.82
Weighted average shares outstanding:
Basic			23,297				23,078				23,241				23,060
Diluted			23,611				23,406				23,663				23,788
Comprehensive income (loss):
Net income		$	6,989			$	5,964			$	27,483			$	19,299
Foreign currency translation gain (loss)			(8,416	)			9,253				2,887				4,599
Net change in cash flow hedges, net of tax			(777	)			281				(396	)			861
Comprehensive income (loss)		$	(2,204	)		$	15,498			$	29,974			$	24,759

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

GREATBATCH, INC.

		Nine Months Ended
		September 30,				October 1,
		2011				2010
Cash flows from operating activities:
Net income		$	27,483			$	19,299
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization			35,568				34,873
Stock-based compensation			8,803				5,186
Gain on cost method investments, net			(4,232	)			—
Other non-cash (gains) losses			(1,180	)			1,182
Deferred income taxes			3,274				(235	)
Changes in operating assets and liabilities:
Accounts receivable			(10,429	)			1,863
Inventories			(13,594	)			3,302
Prepaid expenses and other assets			316				2,110
Accounts payable			2,212				(3,327	)
Accrued expenses			6,376				1,368
Income taxes payable			3,872				6,391
Net cash provided by operating activities			58,469				72,012
Cash flows from investing activities:
Acquisition of property, plant and equipment			(18,223	)			(10,231	)
Proceeds from sale of cost method investments, net			10,315				—
Other investing activities			(1,910	)			885
Net cash used in investing activities			(9,818	)			(9,346	)
Cash flows from financing activities:
Principal payments of long-term debt			(30,000	)			(57,450	)
Issuance of common stock			2,253				659
Payment of debt issuance costs			(2,114	)			—
Other financing activities			(1,104	)			(967	)
Net cash used in financing activities			(30,965	)			(57,758	)
Effect of foreign currency exchange rates on cash and cash equivalents			1,058				224
Net increase in cash and cash equivalents			18,744				5,132
Cash and cash equivalents, beginning of period			22,883				37,864
Cash and cash equivalents, end of period		$	41,627			$	42,996

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				Equity
At December 31, 2010			23,319			$	23			$	298,405				(63	)		$	(1,469	)		$	119,400			$	10,470			$	426,829
Stock-based compensation			—				—				5,062				—				—				—				—				5,062
Net shares issued under stock incentive plans			104				—				1,758				18				421				—				—				2,179
Income tax liability from stock options, restricted stock and restricted stock units			—				—				(119	)			—				—				—				—				(119	)
Net income			—				—				—				—				—				27,483				—				27,483
Total other comprehensive income			—				—				—				—				—				—				2,491				2,491
At September 30, 2011			23,423			$	23			$	305,106				(45	)		$	(1,048	)		$	146,883			$	12,961			$	463,925

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 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 31, 2010 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 31, 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 third quarter of 2011 and 2010 each contained 13 weeks and ended on September 30, and October 1, respectively.

2. SUPPLEMENTAL CASH FLOW INFORMATION

		Nine Months Ended
		September 30,				October 1,
		2011				2010
Noncash investing and financing activities (in thousands):
Unrealized (loss) gain on cash flow hedges, net		$	(396	)		$	861
Net change in property, plant and equipment purchases included in accounts payable			(1,066	)			1,794
Cash paid during the period for:
Interest		$	3,700			$	5,553
Income taxes			5,207				3,506

GREATBATCH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — Unaudited

3. INVENTORIES

Inventories are comprised of the following (in thousands):

		As of
		September 30,				December 31,
		2011				2010
Raw materials		$	51,878			$	45,974
Work-in-process			36,774				34,659
Finished goods			26,641				20,807
Total		$	115,293			$	101,440

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 September 30, 2011
Purchased technology and patents		$	89,273			$	(52,979	)		$	1,745			$	38,039
Customer lists			46,818				(13,172	)			2,327				35,973
Other			3,519				(3,179	)			61				401
Total amortizing intangible assets		$	139,610			$	(69,330	)		$	4,133			$	74,413
At December 31, 2010
Purchased technology and patents		$	83,023			$	(48,187	)		$	1,212			$	36,048
Customer lists			46,818				(10,577	)			2,119				38,360
Other			3,519				(2,862	)			49				706
Total amortizing intangible assets		$	133,360			$	(61,626	)		$	3,380			$	75,114

Aggregate amortization expense for the third quarter of 2011 and 2010 was $2.7 million and $2.4 million, respectively. Aggregate amortization expense for the nine months ended September 30, 2011 and October 1, 2010 was $7.7 million and $7.2 million, respectively. As of September 30, 2011, annual amortization expense is estimated to be $2.6 million for the remainder of 2011, $10.3 million for 2012, $9.5 million for 2013, $8.8 million for 2014 and $7.7 million for 2015. During 2011, the Company purchased technology and patents totaling $6.4 million, which is being amortized over a weighted average period of approximately 11 years. In connection with these purchases, the Company recorded a $3.0 million contingent liability, which will only be paid if certain sales targets for products that utilize that technology are achieved. This contingent liability is currently classified in Other Long-Term Liabilities.

GREATBATCH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — Unaudited

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

		Greatbatch
		Medical				Electrochem				Total
At December 31, 2010		$	297,508			$	9,943			$	307,451
Foreign currency translation			1,106				—				1,106
At September 30, 2011		$	298,614			$	9,943			$	308,557

5. DEBT

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

		September 30,				December 31,
		2011				2010
Revolving line of credit		$	20,000			$	50,000
2.25% convertible subordinated notes, due 2013			197,782				197,782
Unamortized discount			(19,477	)			(27,153	)
Total long-term debt		$	198,305			$	220,629

Revolving Line of Credit — On June 24, 2011, the Company amended and extended its revolving credit facility (the “2011 Credit Facility”). The 2011 Credit Facility provides a $400 million secured revolving credit facility, which can be increased to $600 million upon the Company’s request and approval by a majority of the lenders. The 2011 Credit Facility also contains a $15 million letter of credit subfacility and a $15 million swingline subfacility. The 2011 Credit Facility has a maturity date of June 24, 2016; provided, however, if CSN II (defined below) is not repaid in full, modified or refinanced before March 1, 2013, the maturity date of the 2011 Credit Facility will be March 1, 2013.

The 2011 Credit Facility is secured by the Company’s non-realty assets including cash, accounts receivable and inventories. Interest rates under the 2011 Credit Facility are, at the Company’s option either at: (i) the higher of (a) the prime rate and (b) the federal funds rate plus 0.5%, 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 divided by a number equal to 1.0 minus the maximum aggregate Federal Reserve System “Euro-currency Liabilities” reserve requirement 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 higher of (a) the prime rate and (b) the federal funds rate plus 0.5%, 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 2011 Credit Facility contains limitations on the incurrence of indebtedness, liens and licensing of intellectual property, investments and certain payments. The 2011 Credit Facility permits the Company to: 1) engage in permitted acquisitions in the aggregate not to exceed $250 million; 2) make other investments not to exceed $60 million in the aggregate; 3) make stock repurchases not to exceed $60 million in the aggregate; and 4) retire up to $198 million of Greatbatch, Inc.’s CSN II. 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 in clauses (1) through (4) above. Additionally, these limitations can be waived upon the Company’s request and approval of a majority of the lenders. As of September 30, 2011, the Company had available to it the full amount of the above limits.

GREATBATCH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — Unaudited

The 2011 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 4.5 to 1.0 through December 30, 2011, and not greater than 4.0 to 1.0 from December 31, 2011, and thereafter. The calculation of adjusted EBITDA and total leverage ratios 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 30, 2011, the Company was in compliance with all covenants.

The 2011 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 2011 Credit Facility immediately due and payable.

The weighted average interest rate on borrowings under the 2011 Credit Facility as of September 30, 2011, was 1.97%. As of September 30, 2011, the Company had $380 million of borrowing capacity available under the 2011 Credit Facility. This borrowing capacity 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.

Interest Rate Swaps — In 2008, the Company entered into three receive floating-pay fixed interest rate swaps indexed to the six-month LIBOR rate, in order to hedge against potential changes in cash flows on the Company’s outstanding debt, which was also indexed to the six-month LIBOR rate. As of September 30, 2011, none of these interest rate swaps remain outstanding. The receive variable leg of the interest rate swaps and the variable rate paid on the debt had the same rate of interest, excluding the credit spread, and reset and paid interest on the same dates. No portion of the change in fair value of the interest rate swaps during the 2011 or 2010 periods was considered ineffective. The amount recorded as Interest Expense related to the interest rate swaps for the third quarter of 2011 and 2010 was zero and $0.3 million, respectively, and $0.4 million and $1.5 million, respectively, for the nine months ended September 30, 2011 and October 1, 2010.

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.

CSN II 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. The fair value of CSN II as of September 30, 2011 was approximately $193 million and is based on recent sales prices.

GREATBATCH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — Unaudited

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 September 30, 2011, the carrying amount of the discount related to the CSN II conversion option value was $16.5 million. As of September 30, 2011, the if-converted value of the CSN II notes does not exceed their principal amount as the Company’s closing stock price of $20.01 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								Nine Months Ended
		September 30,				October 1,				September 30,				October 1,
		2011				2010				2011				2010
Contractual interest		$	1,113			$	1,113			$	3,338			$	3,338
Discount amortization			2,602				2,434				7,676				7,182

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 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 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 agreement, whereby the conversion ratio on the notes may be increased by up to 7.0 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.

GREATBATCH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — Unaudited

CSN II 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. 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 December 31, 2010		$	2,005
Financing costs deferred			2,164
Write-off during the period			(51	)
Amortization during the period			(703	)
At September 30, 2011		$	3,415

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

At December 31, 2010		$	4,647
Net periodic pension cost			885
Benefit payments			(805	)
Foreign currency translation			104
At September 30, 2011		$	4,831

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

		Three Months Ended								Nine Months Ended
		September 30,				October 1,				September 30,				October 1,
		2011				2010				2011				2010
Service cost		$	290			$	245			$	825			$	714
Interest cost			124				107				355				313
Amortization of net loss and prior service cost			21				5				60				16
Expected return on plan assets			(126	)			(109	)			(355	)			(317	)
Net pension cost		$	309			$	248			$	885			$	726

GREATBATCH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — Unaudited

7. STOCK-BASED COMPENSATION

Compensation costs related to share-based payments for the three months ended September 30, 2011 and October 1, 2010 totaled $1.8 million and $2.4 million, respectively. Of these amounts $1.5 million and $2.1 million, respectively, are included in Selling, General and Administrative Expenses. Compensation costs related to share-based payments for the nine months ended September 30, 2011 and October 1, 2010 totaled $5.1 million and $5.2 million, respectively. Of these amounts $4.2 million and $4.5 million, respectively, are included in Selling, General and Administrative Expenses. During the third quarter of 2010, the Company recorded $0.7 million of additional expense related to the accelerated vesting of equity awards issued to the Company’s former Senior Vice President — Orthopaedics, who passed away during the quarter.

Stock-based compensation expense included in the Condensed Consolidated Statement of Cash Flows includes costs recognized for the annual share contribution to the Company’s 401(k) plan of $1.2 million and $0.0 million for the three months ended September 30, 2011 and October 1, 2010, respectively. Stock-based compensation expense included in the Condensed Consolidated Statement of Cash Flows for the annual share contribution to the Company’s 401(k) plan for the nine months ended September 30, 2011 and October 1, 2010 totaled $3.7 million and $0.0 million, respectively.

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

		Nine Months Ended
		September 30,				October 1,
		2011				2010
Weighted average fair value		$	9.42			$	8.24
Risk-free interest rate			2.04	%			2.62	%
Expected volatility			40	%			40	%
Expected life (in years)			5				5
Expected dividend yield			0	%			0	%

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 December 31, 2010			1,463,556			$	23.46
Granted			292,959				24.15
Exercised			(78,028	)			21.41
Forfeited or expired			(101,901	)			22.55
Outstanding at September 30, 2011			1,576,586			$	23.75				6.3			$	0.4
Exercisable at September 30, 2011			1,055,286			$	23.51				5.2			$	0.4

GREATBATCH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — Unaudited

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 December 31, 2010			744,523			$	23.68
Exercised			(25,194	)			22.56
Forfeited or expired			(235,977	)			22.22
Outstanding at September 30, 2011			483,352			$	24.45				6.2			$	—
Exercisable at September 30, 2011			252,894			$	22.55				5.2			$	—

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

						Weighted
		Time-Vested				Average
		Activity				Fair Value
Nonvested at December 31, 2010			123,386			$	22.57
Granted			25,241				24.16
Vested			(7,993	)			21.98
Forfeited or expired			(2,713	)			23.23
Nonvested at September 30, 2011			137,921			$	22.88

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

		Performance-				Weighted
		Vested				Average
		Activity				Fair Value
Nonvested at December 31, 2010			283,797			$	15.10
Granted			279,415				18.21
Vested			(200	)			18.47
Forfeited or expired			(11,394	)			16.11
Nonvested at September 30, 2011			551,618			$	16.67

GREATBATCH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — Unaudited

8. OTHER OPERATING (INCOME) EXPENSE, NET

Other Operating (Income) Expense, Net is comprised of the following (in thousands):

		Three Months Ended								Nine Months Ended
		September 30,				October 1,				September 30,				October 1,
		2011				2010				2011				2010
Orthopaedic facility optimization(a)		$	164			$	59			$	425			$	59
2007 & 2008 facility shutdowns and consolidations(b)			—				165				—				1,021
Integration costs(c)			—				5				—				135
Asset dispositions and other(d)			23				96				(591	)			597
		$	187			$	325			$	(166	)		$	1,812

(a) Orthopaedic facility optimization. In the third quarter of 2010, the Company began updating its Indianapolis, IN facility to streamline operations, consolidate buildings, increase capacity, further expand capabilities and reduce dependence on outside suppliers. Ultimately these updates will further reduce lead times, improve quality and allow the Company to better meet the needs of its customers.

In the first quarter of 2011, the Company announced that it would construct an 80,000 square foot manufacturing facility in Allen County, IN and transfer the manufacturing operations currently being performed at its Columbia City, IN location into this new facility. The Company broke ground on this new facility in the second quarter of 2011 and is expected to be completed by mid-2012.

In October 2011, the Board of Directors approved a multi-faceted plan to further enhance, optimize and leverage the Company’s manufacturing infrastructure. This plan includes the next phase of the Company’s Orthopaedic facility optimization initiative and includes the opening of two Orthopaedic design centers, transferring production of certain Orthopaedic product lines to the Company’s lower cost manufacturing facilities and the consolidation of the Company’s Orthopaedic operations in Switzerland. These initiatives are expected to be completed over the next two to three years.

The total capital investment in connection with these initiatives is expected to be between $40 million and $45 million, of which approximately $8 million has been incurred to date. The total expense for these optimization projects is expected to be between $9 million and $11 million of which $0.7 million has been incurred to date. All expenses are cash expenditures, except accelerated depreciation and asset write-offs, and are recorded within the Greatbatch Medical segment. The remaining capital investment and expenses are expected to be incurred over the next two to three years.

GREATBATCH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — Unaudited

The change in accrued liabilities related to the orthopaedic facility optimization is as follows (in thousands):

						Production				Accelerated
		Severance				Inefficiencies,				Depreciation/
		and				Moving and				Asset Write-
		Retention				Revalidation				offs				Other				Total
At December 31, 2010		$	—			$	—			$	—			$	—			$	—
Restructuring charges			—				397				18				10				425
Write-offs			—				—				(18	)			—				(18	)
Cash payments			—				(397	)			—				(10	)			(407	)
At September 30, 2011		$	—			$	—			$	—			$	—			$	—

(b) 2007 & 2008 facility shutdowns and consolidations. From 2007 to 2010, the Company completed the following facility shutdowns and consolidation initiatives:

	•		Consolidated its Electrochem manufacturing facilities in Canton, MA, Teterboro, NJ and Suzhou, China, into a newly constructed facility in Raynham, MA;
	•		Consolidated its corporate offices in Clarence, NY into its technology center also in Clarence, NY;
	•		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;
	•		Consolidated its Orchard Park, NY (Electrochem manufacturing), Exton, PA (Orthopaedic corporate office) and Saignelegier, Switzerland (Orthopaedic manufacturing) facilities into existing facilities that had excess capacity; and
	•		Consolidated its manufacturing operations in Blaine, MN into its Plymouth, MN facility.

The total expenses incurred for these facility shutdowns and consolidations was $17.3 million and included the following:

	•		Severance and retention — $4.4 million;
	•		Production inefficiencies, moving and revalidation — $5.2 million;
	•		Accelerated depreciation and asset write-offs — $5.3 million;
	•		Personnel — $0.7 million; and
	•		Other — $1.7 million.

All categories of expenses were cash expenditures, except accelerated depreciation and asset write-offs. Costs incurred during 2010 primarily related to the Electrochem Solutions business segment.

(c) Integration costs. During 2010, the Company incurred costs related to the integration of companies acquired in 2007 and 2008. The integration initiatives include the implementation of the Oracle ERP system, training and compliance with Company policies, as well as the implementation of lean manufacturing and six sigma initiatives. These expenses were primarily for consultants, relocation and travel costs.

(d) Asset dispositions and other. During 2011 and 2010, the Company recorded (gains) write-downs in connection with various asset disposals, net of insurance proceeds received, if any.

GREATBATCH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — Unaudited

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 pre-tax income and the jurisdictions to which it relates, business acquisitions, settlements with taxing authorities and foreign currency fluctuations. The Company is currently under audit by the Internal Revenue Service for fiscal years 2010 and 2009 but is not expecting the audit to have a material impact on the effective tax rate when settled.

During the third quarter of 2011, the balance of unrecognized tax benefits decreased by $0.9 million, primarily as a result of the reversal of uncertain tax positions due to the expiration of the statute of limitations. Approximately $1.0 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 in the range of up to $0.8 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 and potential audit settlements.

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 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.

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 for the quarter is as follows (in thousands):

At July 1, 2011		$	2,173
Warranty claims paid			(436	)
Foreign currency effect			(22	)
At September 30, 2011		$	1,715

Operating Leases — The Company is a party to various operating lease agreements for buildings, equipment and software. Minimum future annual operating lease payments are $0.7 million for the remainder of 2011; $2.4 million in 2012; $2.1 million in 2013; $2.2 million in 2014; $1.8 million in 2015 and $4.7 million thereafter. The Company primarily leases buildings, which accounts for the majority of the future lease payments.

GREATBATCH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — Unaudited

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. As of September 30, 2011, the total contractual obligation related to such expenditures is approximately $27.2 million and will primarily be financed by existing cash and cash equivalents, cash generated from operations, or draws under the 2011 Credit Facility over the next twelve months. We also enter into blanket purchase orders with vendors that have preferred pricing and terms, as well as contracts with vendors for outsourced services. However, the obligations under these purchase orders and service contracts generally contain clauses allowing for cancellation without significant penalty.

Foreign Currency Contracts — In December 2009 and February 2010, the Company entered into forward contracts to purchase 6.6 million and 3.3 million, respectively, Mexican pesos per month through December 2010 at an exchange rate of 13.159 pesos and 13.1595 pesos per one U.S. dollar, respectively. 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 2010 and were accounted for as cash flow hedges.

In July 2010 and February 2011, the Company entered into forward contracts to purchase 6.6 million and 3.7 million, respectively, Mexican pesos per month through December 2011 at an exchange rate of 13.2231 pesos and 12.2761 pesos per one U.S. dollar, respectively. These contracts were 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 are being accounted for as cash flow hedges.

In September 2011, the Company entered into forward contracts to purchase 6.5 million and 4.9 million Mexican pesos per month beginning in January 2012 through December 2012 at an exchange rate of 13.0354 pesos and 14.0287 pesos per one U.S. dollar, respectively. These contracts were 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 2012 and are being accounted for as cash flow hedges.

As of September 30, 2011, these contracts had a negative fair value of $0.7 million, which is recorded within Accrued Expenses and Other Long-Term Liabilities in the Condensed Consolidated Balance Sheet. The amount recorded as a reduction of Cost of Sales during the nine months ended September 30, 2011 and October 1, 2010 related to these forward contracts was $0.5 million and $0.4 million, respectively. No portion of the change in fair value of the Company’s foreign currency contracts during the nine months ended September 30, 2011 or October 1, 2010 was considered ineffective.

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 deductible of $0.2 million per covered participant. The maximum aggregate loss (the sum of all claims under the $0.2 million deductible) is limited to $14.2 million with a maximum benefit of $1.0 million. As of September 30, 2011, the Company has $2.8 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.

GREATBATCH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — Unaudited

Workers’ Compensation Trust — The Company is a member of a group self-insurance trust that provides workers’ compensation benefits to employees of the Company in Western New York (the “Trust”). Based on actual experience, the Company could receive a refund or be assessed additional contributions for workers’ compensation claims. Under the Trust agreement, each participating organization has joint and several liability for Trust obligations if the assets of the Trust are not sufficient to cover those obligations. During the third quarter of 2011, the Company was notified by the Trust of its intentions to cease operations at the end of 2011 and was assessed $0.6 million as an estimate of its pro-rata share of future costs related to the Trust. As of September 30, 2011, this amount has been accrued and is recorded in Accrued Expenses in the Condensed Consolidated Balance Sheet. Beginning in 2012, the Company will utilize traditional insurance to provide workers’ compensation benefits.

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								Nine Months Ended
		September 30,				October 1,				September 30,				October 1,
		2011				2010				2011				2010
Numerator for basic EPS:
Net income		$	6,989			$	5,964			$	27,483			$	19,299
Effect of dilutive securities:
Interest expense on CSN I and related deferred financing fees, net of tax			—				—				—				241
Numerator for diluted EPS		$	6,989			$	5,964			$	27,483			$	19,540
Denominator for basic EPS:
Weighted average shares outstanding			23,297				23,078				23,241				23,060
Effect of dilutive securities:
Convertible subordinated notes			—				—				—				462
Stock options, restricted stock and restricted stock units			314				328				422				266
Denominator for diluted EPS			23,611				23,406				23,663				23,788
Basic EPS		$	0.30			$	0.26			$	1.18			$	0.84
Diluted EPS		$	0.30			$	0.25			$	1.16			$	0.82

GREATBATCH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — Unaudited

The diluted weighted average share calculations do not include the following securities, which are not dilutive to the EPS calculations or the performance criteria have not been met:

		Three Months Ended								Nine Months Ended
		September 30,				October 1,				September 30,				October 1,
		2011				2010				2011				2010
Time-vested stock options, restricted stock and restricted stock units			976,000				977,000				925,000				1,099,000
Performance-vested stock options and restricted stock units			672,000				844,000				678,000				883,000

12. ACCUMULATED OTHER COMPREHENSIVE INCOME

Accumulated Other Comprehensive Income 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 December 31, 2010		$	(2,014	)		$	(121	)		$	12,230			$	10,095			$	375			$	10,470
Unrealized loss on cash flow hedges			—				(523	)			—				(523	)			183				(340	)
Realized gain on cash flow hedges			—				(86	)			—				(86	)			30				(56	)
Foreign currency translation gain			—				—				2,887				2,887				—				2,887
At September 30, 2011		$	(2,014	)		$	(730	)		$	15,117			$	12,373			$	588			$	12,961

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 September 30, 2011 (in thousands):

Fair Value Measurements Using

Quoted

Prices in

Significant

Active Markets

Other

Significant

At

for Identical

Observable

Unobservable

September 30,

Assets

Inputs

Inputs

Description

2011

(Level 1)

(Level 2)

(Level 3)

Foreign currency contracts

Accrued Expenses

$

568

$

—

$

568

$

—

Other Long-Term Liabilities

162

—

162

—

GREATBATCH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — Unaudited

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.

Convertible subordinated notes — The fair value of the Company’s outstanding convertible subordinated notes described in Note 5 “Debt” was 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.

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 the Company’s cost method investments included in Other Assets was $5.7 million and $11.8 million as of September 30, 2011 and December 31, 2010, respectively. During the second quarter of 2011, the Company recorded a $0.3 million write-down of one of its cost method investments based upon a recent stock offering by that Company. On January 5, 2011, the Company sold its cost method investment in IntElect Medical, Inc. (“IntElect”) in conjunction with Boston Scientific’s acquisition of IntElect. This transaction resulted in a pre-tax gain of $4.5 million.

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 medical devices and components for the cardiac rhythm management (“CRM”), neuromodulation, vascular access and orthopaedic markets. Additionally, Greatbatch Medical offers value-added assembly and design engineering services for products that incorporate Greatbatch Medical components. As a result of the strategy put in place over three years ago, Greatbatch Medical now 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 Company’s QiG Group and leverages the component technology of Greatbatch Medical and Electrochem in the Company’s core markets: cardiovascular, neuromodulation and orthopaedic.

Electrochem designs, manufactures and distributes primary and rechargeable batteries, 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 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.

GREATBATCH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — Unaudited

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 30,				October 1,				September 30,				October 1,
		2011				2010				2011				2010
Sales:
Greatbatch Medical
CRM/Neuromodulation		$	70,731			$	69,376			$	226,492			$	225,139
Vascular Access			11,396				9,059				32,639				28,232
Orthopaedic			31,131				28,046				108,642				87,975
Total Greatbatch Medical			113,258				106,481				367,773				341,346
Electrochem			18,460				21,009				59,303				58,968
Total sales		$	131,718			$	127,490			$	427,076			$	400,314

		Three Months Ended								Nine Months Ended
		September 30,				October 1,				September 30,				October 1,
		2011				2010				2011				2010
Segment income from operations:
Greatbatch Medical		$	12,030			$	12,904			$	48,677			$	45,117
Electrochem			3,631				4,593				12,890				11,677
Total segment income from operations			15,661				17,497				61,567				56,794
Unallocated operating expenses			(2,773	)			(4,328	)			(12,410	)			(12,312	)
Operating income as reported			12,888				13,169				49,157				44,482
Unallocated other expense			(3,649	)			(4,879	)			(9,327	)			(15,677	)
Income before provision for income taxes		$	9,239			$	8,290			$	39,830			$	28,805

		Three Months Ended								Nine Months Ended
		September 30,				October 1,				September 30,				October 1,
		2011				2010				2011				2010
Sales by geographic area:
United States		$	61,502			$	61,025			$	187,795			$	186,414
Non-Domestic locations:
Puerto Rico			21,522				20,272				72,354				66,409
Belgium			11,958				12,759				48,555				43,471
United Kingdom & Ireland			14,466				12,801				42,585				37,850
Rest of world			22,270				20,633				75,787				66,170
Total sales		$	131,718			$	127,490			$	427,076			$	400,314

GREATBATCH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — Unaudited

Four customers accounted for a significant portion of the Company’s sales as follows:

		Three Months Ended								Nine Months Ended
		September 30,				October 1,				September 30,				October 1,
		2011				2010				2011				2010
Customer A			18	%			19	%			20	%			22	%
Customer B			20	%			19	%			18	%			18	%
Customer C			11	%			11	%			13	%			12	%
Customer D			9	%			9	%			8	%			8	%
			58	%			58	%			59	%			60	%

Long-lived tangible assets by geographic area are as follows (in thousands):

		As of
		September 30,				December 31,
		2011				2010
United States		$	110,311			$	126,519
Rest of world			33,996				36,095
Total		$	144,307			$	162,614

15. 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 September 2011, the FASB issued Accounting Standards Update (“ASU”) No. 2011-08 “Intangibles—Goodwill and Other (Topic 350): Testing Goodwill for Impairment.” This ASU modifies the impairment test for goodwill intangibles. Under the revised guidance, entities performing their annual goodwill impairment test have the option of performing a qualitative assessment before calculating the fair value of the reporting unit (i.e., step 1 of the goodwill impairment test). If entities determine, on the basis of this qualitative assessment, that the fair value of the reporting unit is more likely than not (i.e., a likelihood of more than 50 percent) less than the carrying amount, the two-step goodwill impairment test would be required. ASU No. 2011-08 is effective for the Company beginning in fiscal year 2012. Early adoption is permitted. The Company is currently assessing whether or not to adopt ASU No. 2011-08 for its 2011 annual goodwill impairment test. 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 a company is required to perform the two-step goodwill impairment test.

GREATBATCH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — Unaudited

In June 2011, the FASB issued ASU No. 2011-05, “Comprehensive Income (Topic 220): Presentation of Comprehensive Income.” This ASU provides companies two choices for presenting net income and comprehensive income: in a single continuous statement, or in two separate, but consecutive, statements. Presenting comprehensive income in the statement of equity is no longer an option. ASU No. 2011-05 is effective for the Company beginning in fiscal year 2012 and is not expected to have a material impact on the Company’s Condensed Consolidated Financial Statements as it only changes the disclosures surrounding comprehensive income and as the Company already presents net income and comprehensive income in a single continuous statement.

In May 2011, the FASB issued ASU No. 2011-04, “Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs.” ASU No. 2011-04 establishes a global standard for applying fair value measurement. In addition to a few updates to the measurement guidance, ASU No. 2011-04 includes enhanced disclosure requirements. The most significant change for companies reporting under U.S. GAAP is an expansion of the disclosures required for “Level 3” measurements; that is, measurements based on unobservable inputs, such as a company’s own data. This update is effective for the Company beginning in fiscal year 2012. The Company is currently assessing the impact of ASU No. 2011-04 on its Condensed Consolidated Financial Statements.

ITEM 2.		MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Our Business

We operate our business in two reportable segments — Greatbatch Medical and Electrochem Solutions (“Electrochem”). Greatbatch Medical designs and manufactures medical devices and components for the cardiac rhythm management (“CRM”), neuromodulation, vascular access and orthopaedic markets. Greatbatch Medical’s component products include: 1) batteries, capacitors, filtered and unfiltered feedthroughs, engineered components and enclosures used in implantable medical devices (“IMDs”); 2) introducers, catheters, steerable sheaths and implantable stimulation leads; and 3) instruments and delivery systems used in reconstructive, trauma and spine surgeries as well as hip, knee and shoulder implants. Additionally, Greatbatch Medical offers value-added assembly and design engineering services for medical systems and devices within the markets in which it operates. As a result of the strategy put in place over three years ago, Greatbatch Medical now offers its customers complete medical devices including design, development, manufacturing, regulatory submission and supporting worldwide distribution. This medical device strategy is being facilitated through our QiG Group (“QiG”) and leverages the component technology of Greatbatch Medical and Electrochem in our core markets: cardiovascular, neuromodulation and orthopaedic.

Electrochem provides technology solutions for critical industrial applications, including customized battery power and wireless sensing systems. Originating from the lithium cell invented for the implantable pacemaker by our Company’s founder, Wilson Greatbatch, Electrochem’s technology and superior quality and reliability is utilized in markets worldwide.

Our Customers

Greatbatch Medical customers include leading original equipment manufacturers (“OEMs”), in alphabetical order here and throughout this report, such as Biotronik, Boston Scientific, Johnson & Johnson, Medtronic, Smith & Nephew, Sorin Group, St. Jude Medical, Stryker and Zimmer. The nature and extent of our selling relationships with each OEM varies in terms of breadth of products purchased, purchased product volumes, length of contractual commitment, ordering patterns, inventory management and selling prices. During the nine months ended September 30, 2011, Boston Scientific, Johnson & Johnson, Medtronic and St. Jude Medical collectively accounted for 59% of our total sales.

Our Electrochem customers operate in the energy, security, portable medical and environmental monitoring markets and include 3M, General Electric, Halliburton, Honeywell, Weatherford and Zoll Medical. During 2011, Electrochem entered into long-term supply agreements with several of its larger OEM customers, thus securing a significant portion of their revenue. Additionally, these contracts are significant because they are with customers in markets that historically have not committed to long-term supply agreements, and provide a good example of how Electrochem is deepening its relationship with customers and is a testament to their commitment to quality and reliability.

Financial Overview

Third quarter 2011 sales grew 3% (2% constant currency) over the prior year period to $131.7 million, reflecting 26% vascular access growth and 11% (4% constant currency) orthopaedic growth. Third quarter 2011 sales included the impact of foreign currency exchange rate fluctuations, which benefitted orthopaedic sales by approximately $2 million compared to the prior year. During the quarter, CRM and neuromodulation revenue increased 2% over the prior year period despite the contraction in the underlying market. As expected, Electrochem revenue declined 12% in comparison to the prior year due to a one-time inventory build by an energy customer in 2010 that resulted in a record revenue quarter for that segment. For the first nine months of 2011, total sales increased 7%, or 5% on a constant currency basis, to $427.1 million. This strong constant currency growth was driven by our vascular access (16%) and orthopaedic (14%) product lines.

We prepare our financial statements in accordance with accounting principles generally accepted in the United States of America (“GAAP”). Additionally, we consistently report and discuss in our quarterly earnings releases and investor presentations adjusted operating income and margin, adjusted net income and adjusted earnings per diluted share. These adjusted amounts consist of GAAP amounts excluding the following adjustments to the extent they occur during the period: (i) facility consolidation, manufacturing transfer and system integration charges, (ii) asset write-down and disposition charges, (iii) severance charges in connection with corporate realignments or a reduction in force, (iv) the impact of non-cash charges to interest expense due to the accounting change governing convertible debt, (v) unusual or infrequently occurring items, (vi) medical device design verification testing (“DVT”) expenses incurred in connection with developing our neuromodulation platform, (vii) gain/loss on the sale of investments and (viii) the income tax (benefit) related to these adjustments. We believe that reporting these amounts provides important supplemental information to our investors and creditors seeking to understand the financial and business trends relating to our financial condition and results of operations. Additionally, certain performance-based compensation incentives provided to our executives are determined utilizing adjusted amounts.

GAAP operating income for the third quarter of 2011 decreased 2% to $12.9 million, compared to $13.2 million for the 2010 third quarter. Adjusted operating income increased 2% to $14.7 million compared to $14.4 million for the comparable 2010 period. These amounts reflect the benefit of higher revenue during the quarter, as well as our various lean initiatives, which were offset by pressure on our gross margin caused by price reductions given to some of our larger OEM customers at the end of last year in conjunction with their signing long-term contracts, as well as a higher level of performance-based compensation in 2011. For the first nine months of 2011, GAAP operating income and adjusted operating income were $49.2 million and $51.9 million, respectively, representing increases of 11% and 10%, respectively, reflecting higher revenue and gross profit levels, which were partially offset by higher professional and consulting costs and performance-based compensation.

A reconciliation of GAAP operating income to adjusted amounts is as follows (in thousands):

		Three Months Ended								Nine Months Ended
		September 30,				October 1,				September 30,				October 1,
		2011				2010				2011				2010
Operating income as reported		$	12,888			$	13,169			$	49,157			$	44,482
Adjustments:
Executive death benefits (SG&A)			—				885				—				885
Medical device DVT expenses (RD&E)			1,639				—				2,863				—
Consolidation costs			164				224				425				1,080
Integration expenses			—				5				—				135
Asset dispositions and other			23				96				(591	)			597
Adjusted operating income		$	14,714			$	14,379			$	51,854			$	47,179
Adjusted operating margin			11.2	%			11.3	%			12.1	%			11.8	%