Edgar Filing: GREATBATCH, INC.

GB-2014.10.03-10Q

Table of Contents

UNITED STATES

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 October 3, 2014

Commission File Number 1-16137

_____________________________________

GREATBATCH, INC.

(Exact name of Registrant as specified in its charter)

_____________________________________



Delaware		16-1531026
(State of Incorporation)		(I.R.S. Employer Identification No.)

2595 Dallas Parkway

Suite 310

Frisco, Texas 75034

(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 ý No ¨

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 ý No ¨

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	ý	Accelerated filer	¨

Non-accelerated filer	¨	Smaller reporting company	¨

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

The number of shares outstanding of the Company’s common stock, $0.001 par value per share, as of November 12, 2014 was: 24,995,025 shares.

Table of Contents

Greatbatch, Inc.

Table of Contents for Form 10-Q

As of and for the Quarterly Period Ended October 3, 2014



		Page No.
	PART I—FINANCIAL INFORMATION

ITEM 1.	Financial Statements	3

	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	29

ITEM 3.	Quantitative and Qualitative Disclosures About Market Risk	41

ITEM 4.	Controls and Procedures	42

	PART II—OTHER INFORMATION

ITEM 1.	Legal Proceedings	43

ITEM 1A.	Risk Factors	43

ITEM 2.	Unregistered Sales of Equity Securities and Use of Proceeds	43

ITEM 3.	Defaults Upon Senior Securities	43

ITEM 4.	Mine Safety Disclosures	43

ITEM 5.	Other Information	43

ITEM 6.	Exhibits	43

SIGNATURES		44

EXHIBIT INDEX		45

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PART I—FINANCIAL INFORMATION


ITEM 1.	FINANCIAL STATEMENTS

GREATBATCH, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS—Unaudited

(in thousands except share and per share data)



	As of
	October 3, 2014			January 3, 2014
Assets
Current assets:
Cash and cash equivalents	$	61,582		$	35,465
Accounts receivable, net of allowance for doubtful accounts of $1.6 million in 2014 and $2.0 million in 2013	121,615			113,679
Inventories	128,727			118,358
Refundable income taxes	—			2,306
Deferred income taxes	5,890			6,008
Prepaid expenses and other current assets	9,121			6,717
Total current assets	326,935			282,533
Property, plant and equipment, net	142,336			145,773
Amortizing intangible assets, net	68,763			76,122
Indefinite-lived intangible assets	20,288			20,288
Goodwill	354,583			346,656
Deferred income taxes	2,933			2,933
Other assets	15,449			16,398
Total assets	$	931,287		$	890,703
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable	$	44,989		$	46,508
Income taxes payable	2,559			—
Deferred income taxes	613			613
Accrued expenses	41,798			44,681
Total current liabilities	89,959			91,802
Long-term debt	190,000			197,500
Deferred income taxes	50,593			52,012
Other long-term liabilities	3,673			7,334
Total liabilities	334,225			348,648
Stockholders’ equity:
Preferred stock, $0.001 par value, authorized 100,000,000 shares; no shares issued or outstanding in 2014 or 2013	—			—
Common stock, $0.001 par value, authorized 100,000,000 shares; 24,958,994 shares issued and 24,942,689 shares outstanding in 2014; 24,459,153 shares issued and 24,422,555 shares outstanding in 2013	25			24
Additional paid-in capital	360,435			344,915
Treasury stock, at cost, 16,305 shares in 2014 and 36,598 shares in 2013	(720		)	(1,232		)
Retained earnings	225,272			183,990
Accumulated other comprehensive income	12,050			14,358
Total stockholders’ equity	597,062			542,055
Total liabilities and stockholders’ equity	$	931,287		$	890,703

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

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GREATBATCH, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

AND COMPREHENSIVE INCOME — Unaudited

(in thousands except per share data)



	Three Months Ended						Nine Months Ended
	October 3, 2014			September 27, 2013			October 3, 2014			September 27, 2013
Sales	$	171,699		$	167,730		$	518,061		$	487,326
Cost of sales	113,581			111,853			343,877			325,398
Gross profit	58,118			55,877			174,184			161,928
Operating expenses:
Selling, general and administrative expenses	22,121			21,569			65,753			63,909
Research, development and engineering costs, net	13,638			13,806			39,962			38,983
Other operating expenses, net	6,176			3,500			10,223			10,560
Total operating expenses	41,935			38,875			115,938			113,452
Operating income	16,183			17,002			58,246			48,476
Interest expense	1,051			1,515			3,208			9,948
Other (income) expense, net	(3,768		)	(57		)	(4,055		)	907
Income before provision for income taxes	18,900			15,544			59,093			37,621
Provision for income taxes	4,888			4,473			17,811			11,135
Net income	$	14,012		$	11,071		$	41,282		$	26,486
Earnings per share:
Basic	$	0.56		$	0.46		$	1.67		$	1.11
Diluted	$	0.54		$	0.44		$	1.60		$	1.06
Weighted average shares outstanding:
Basic	24,899			24,047			24,784			23,904
Diluted	25,923			25,188			25,850			25,017
Comprehensive Income
Net income	$	14,012		$	11,071		$	41,282		$	26,486
Other comprehensive income (loss):
Foreign currency translation gain (loss)	(3,211		)	3,579			(2,422		)	1,147
Net change in cash flow hedges, net of tax	(49		)	(403		)	114			(365		)
Defined benefit plan liability adjustment, net of tax	—			—			—			597
Other comprehensive income (loss)	(3,260		)	3,176			(2,308		)	1,379
Comprehensive income	$	10,752		$	14,247		$	38,974		$	27,865

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

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GREATBATCH, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS—Unaudited

(in thousands)



	Nine Months Ended
	October 3, 2014			September 27, 2013
Cash flows from operating activities:
Net income	$	41,282		$	26,486
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization	27,943			26,658
Debt related amortization included in interest expense	580			6,171
Stock-based compensation	10,531			11,413
Other (gains) losses	(7,191		)	184
Deferred income taxes	(3,000		)	(31,197		)
Changes in operating assets and liabilities, net of acquisitions:
Accounts receivable	(8,460		)	(9,901		)
Inventories	(7,111		)	(15,999		)
Prepaid expenses and other current assets	(23		)	1,010
Accounts payable	(1,311		)	(7,220		)
Accrued expenses	(3,627		)	(1,732		)
Income taxes payable	5,070			10,202
Net cash provided by operating activities	54,683			16,075
Cash flows from investing activities:
Acquisition of property, plant and equipment	(16,029		)	(14,953		)
Proceeds from sale of orthopaedic product lines (Note 9)	2,655			3,228
(Purchase of) proceeds from sale of cost and equity method investments	4,306			(1,928		)
Acquisitions, net of cash acquired (Note 2)	(15,801		)	—
Other investing activities	—			(194		)
Net cash used in investing activities	(24,869		)	(13,847		)
Cash flows from financing activities:
Principal payments of long-term debt	(7,500		)	(445,782		)
Proceeds from issuance of long-term debt	—			425,000
Issuance of common stock	5,705			6,213
Payment of debt issuance costs	—			(2,697		)
Other financing activities	(1,059		)	(327		)
Net cash used in financing activities	(2,854		)	(17,593		)
Effect of foreign currency exchange rates on cash and cash equivalents	(843		)	54
Net increase (decrease) in cash and cash equivalents	26,117			(15,311		)
Cash and cash equivalents, beginning of period	35,465			20,284
Cash and cash equivalents, end of period	$	61,582		$	4,973

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

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GREATBATCH, INC.

CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY — Unaudited

(in thousands)



													Accumulated
				Additional		Treasury							Other			Total
	Common Stock			Paid-In		Stock					Retained		Comprehensive			Stockholders’
	Shares	Amount		Capital		Shares		Amount			Earnings		Income (Loss)			Equity
At January 3, 2014	24,459	$	24	$	344,915	(37	)	$	(1,232	)	$	183,990	$	14,358		$	542,055
Stock-based compensation	—	—		6,800		—		—			—		—			6,800
Net shares issued under stock incentive plans	500	1		8,594		(74	)	(3,703		)	—		—			4,892
Shares contributed to 401(k) Plan	—	—		126		95		4,215			—		—			4,341
Net income	—	—		—		—		—			41,282		—			41,282
Total other comprehensive loss	—	—		—		—		—			—		(2,308		)	(2,308		)
At October 3, 2014	24,959	$	25	$	360,435	(16	)	$	(720	)	$	225,272	$	12,050		$	597,062

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

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GREATBATCH, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – Unaudited


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 (“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 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 January 3, 2014 condensed consolidated balance sheet data was derived from audited consolidated financial statements but does not include all disclosures required by 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 January 3, 2014. The Company utilizes a fifty-two, fifty-three week fiscal year ending on the Friday nearest December 31st. The third quarter and year-to-date periods of 2014 and 2013 each contained 13 weeks and 39 weeks, respectively, and ended on October 3, and September 27, respectively.


2.	ACQUISITION

On August 12, 2014 the Company purchased all of the outstanding common stock of Centro de Construcción de Cardioestimuladores del Uruguay (“CCC”), headquartered in Montevideo, Uruguay. CCC is an active implantable neuromodulation medical device systems developer and manufacturer that produces a range of medical devices including implantable pulse generators, programmer systems, battery chargers, patient wands and leads. This acquisition allows the Company to more broadly partner with medical device companies, complements the Company’s core discrete technology offerings and enhances the Company’s medical device innovation efforts.

This transaction was accounted for under the acquisition method of accounting. Accordingly, the operating results of CCC have been included in the Company’s QiG segment from the date of acquisition. For the three and nine months ended October 3, 2014, CCC added approximately $1.6 million to the Company’s revenue and increased the Company’s net income by $0.4 million. The aggregate purchase price of $19.6 million was funded with cash on hand.

The cost of the acquisition was preliminarily allocated to the assets acquired and liabilities assumed from CCC based on their fair values as of the closing date of the acquisition, with the amount exceeding the fair value of the net assets acquired being recorded as goodwill. The value assigned to certain assets and liabilities are preliminary and are subject to adjustment as additional information is obtained, including, but not limited to, the finalization of: the intangible asset valuation; net assets acquired; the working capital adjustment as defined in the purchase agreement; and pre-acquisition tax positions. The valuation is expected to be finalized in 2015. When the valuation is finalized, any changes to the preliminary valuation of assets acquired or liabilities assumed may result in material adjustments to the fair value of the intangible assets acquired, as well as goodwill.

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GREATBATCH, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – Unaudited

The following table summarizes the preliminary allocation of the CCC purchase price to the assets acquired and liabilities assumed as of the acquisition date (in thousands):



Assets acquired
Current assets	$	9,519
Property, plant and equipment	1,106
Amortizing intangible assets	6,100
Goodwill	8,321
Total assets acquired	25,046
Liabilities assumed
Current liabilities	3,874
Deferred income taxes	1,590
Total liabilities assumed	5,464
Net assets acquired	$	19,582

The preliminary fair values of the assets acquired were determined using one of three valuation approaches: market, income or cost. The selection of a particular method for a given asset depended on the reliability of available data and the nature of the asset, among other considerations.

The market approach estimates the value for a subject asset based on available market pricing for comparable assets. The income approach estimates the value for a subject asset based on the present value of cash flows projected to be generated by the asset. The projected cash flows were discounted at a required rate of return that reflects the relative risk of the asset and the time value of money. The projected cash flows for each asset considered multiple factors from the perspective of a marketplace participant including revenue projections from existing customers, attrition trends, technology life-cycle assumptions, marginal tax rates and expected profit margins giving consideration to historical and expected margins. The cost approach estimates the value for a subject asset based on the cost to replace the asset and reflects the estimated reproduction or replacement cost for the asset, less an allowance for loss in value due to depreciation or obsolescence, with specific consideration given to economic obsolescence if indicated. These fair value measurement approaches are based on significant unobservable inputs, including management estimates and assumptions.

Current assets and liabilities - The fair value of current assets and liabilities, excluding inventory, was assumed to approximate their carrying value as of the acquisition date due to the short-term nature of these assets and liabilities.

The fair value of in-process and finished goods inventory acquired was estimated by applying a version of the market approach called the comparable sales method. This approach estimates the fair value of the assets by calculating the potential revenue generated from selling the inventory and subtracting from it the costs related to the completion and sale of that inventory and a reasonable profit allowance. Based upon this methodology, the Company recorded the inventory acquired at fair value resulting in an increase in inventory of $0.3 million.

Intangible assets - The purchase price was allocated to intangible assets as follows (dollars in thousands):



Amortizing Intangible Assets	Fair Value Assigned		Weighted Average Amortization Period (Years)	Weighted Average Discount Rate

Technology	$	1,400	10	18%
Customer lists	4,600		10	18%
Trademarks and tradenames	100		2	18%
	6,100

Technology - Technology consists of technical processes, unpatented technology, manufacturing know-how, trade secrets and the understanding with respect to products or processes that have been developed by CCC and that will be

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GREATBATCH, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – Unaudited

leveraged in current and future products. The fair value of technology acquired was determined utilizing the relief from royalty method, a form of the income approach, with a royalty rate of 3%. The weighted average amortization period of the technology is based upon management’s estimate of the product life cycle associated with technology and patents before they will be replaced by new technologies.

Customer lists - Customer lists represent the estimated fair value of non-contractual customer relationships CCC has as of the acquisition date. The primary customers of CCC include medical device companies in various geographic locations around the world. These relationships were valued separately from goodwill at the amount that an independent third party would be willing to pay for these relationships. The fair value of customer lists was determined using the multi-period excess-earnings method, a form of the income approach. The weighted average amortization period of the existing customer base was based upon the historical customer annual attrition rate of 15%, as well as management’s understanding of the industry and product life cycles.

Trademarks and tradenames – Trademarks and tradenames represent the estimated fair value of corporate and product names acquired from CCC. These tradenames were valued separately from goodwill at the amount that an independent third party would be willing to pay for use of these names. The fair value of the trademarks and tradenames was determined by utilizing the relief from royalty method, a form of the income approach, with a 0.5% royalty rate.

Goodwill - The excess of the purchase price over the fair value of net tangible and intangible assets acquired and liabilities assumed was allocated to goodwill. Various factors contributed to the establishment of goodwill, including: the value of CCC's highly trained assembled work force and management team; the incremental value that CCC’s technology will bring to QiG's medical devices; and the expected revenue growth over time that is attributable to increased market penetration from future products and customers for Greatbatch Medical. The goodwill acquired in connection with the CCC acquisition was allocated to the QiG business segment and is not deductible for tax purposes.

Pro Forma Results (Unaudited)

The following unaudited pro forma information presents the consolidated results of operations of the Company and CCC as if that acquisition occurred as of the beginning of fiscal year 2013 (in thousands, except per share amounts):



	Three Months Ended				Nine Months Ended
	October 3, 2014		September 27, 2013		October 3, 2014		September 27, 2013

Sales	$	173,413	$	171,158	$	526,631	$	497,610
Net income	14,219		11,407		42,165		27,495
Earnings per share:
Basic	$	0.57	$	0.47	1.70		1.15
Diluted	$	0.55	$	0.45	1.63		1.10

The results prior to the acquisition date have been adjusted to include the pro forma impact of the amortization of acquired intangible assets based on the purchase price allocations and the impact of income taxes on the pro forma adjustments utilizing the applicable statutory tax rate. The unaudited pro forma consolidated basic and diluted earnings per share calculations are based on the consolidated basic and diluted weighted average shares of Greatbatch.

The unaudited pro forma results are presented for illustrative purposes only and do not reflect the realization of potential cost savings or any related integration costs. Certain cost savings may result from the acquisition; however, there can be no assurance that these cost savings will be achieved. These pro forma results do not purport to be indicative of the results that would have been obtained in the periods presented, or to be indicative of results that may be obtained in the future.

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GREATBATCH, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – Unaudited


3.	SUPPLEMENTAL CASH FLOW INFORMATION



	Nine Months Ended
(in thousands)	October 3, 2014		September 27, 2013
Noncash investing and financing activities:
Common stock contributed to 401(k) Plan	$	4,341	$	2,477
Property, plant and equipment purchases included in accounts payable	2,618		711
Cash paid during the period for:
Interest	$	2,736	$	4,388
Income taxes	11,791		31,755
Acquisition of noncash assets	$	21,282	$	—
Liabilities assumed	5,464		—


4.	INVENTORIES

Inventories are comprised of the following (in thousands):



	As of
	October 3, 2014		January 3, 2014
Raw materials	$	74,718	$	67,939
Work-in-process	39,604		36,670
Finished goods	14,405		13,749
Total	$	128,727	$	118,358


5.	INTANGIBLE ASSETS

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



	Gross Carrying Amount		Accumulated Amortization			Foreign Currency Translation		Net Carrying Amount
At October 3, 2014
Technology and patents	$	95,776	$	(74,287	)	$	1,966	$	23,455
Customer lists	72,857		(29,705		)	1,374		44,526
Other	4,534		(4,555		)	803		782
Total amortizing intangible assets	$	173,167	$	(108,547	)	$	4,143	$	68,763
At January 3, 2014
Technology and patents	$	97,376	$	(69,026	)	$	1,980	$	30,330
Customer lists	68,257		(24,671		)	1,367		44,953
Other	4,434		(4,399		)	804		839
Total amortizing intangible assets	$	170,067	$	(98,096	)	$	4,151	$	76,122

Aggregate intangible asset amortization expense is comprised of the following (in thousands):



	Three Months Ended				Nine Months Ended
	October 3, 2014		September 27, 2013		October 3, 2014		September 27, 2013
Cost of sales	$	1,567	$	1,668	$	4,696	$	5,207
Selling, general and administrative expenses	1,756		1,446		5,190		4,343
Research, development and engineering costs, net	164		137		565		409
Total intangible asset amortization expense	$	3,487	$	3,251	$	10,451	$	9,959

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GREATBATCH, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – Unaudited

Estimated future intangible asset amortization expense based on the current carrying value is as follows (in thousands):



	Estimated Amortization Expense
Remainder of 2014	$	3,426
2015	12,988
2016	10,676
2017	9,520
2018	7,232
Thereafter	24,921
Total estimated amortization expense	$	68,763

As of January 3, 2014, the Company had recorded within Other Long-Term Liabilities $4 million of contingent liabilities incurred in connection with technology purchases made in previous years. During the third quarter of 2014, the Company reversed $3 million of these contingent liabilities as a result of certain performance targets not being achieved, which reduced the technology asset recorded at the time of the asset acquisition.

Indefinite-lived intangible assets are comprised of the following (in thousands):



	Trademarks and Tradenames
At January 3, 2014	$	20,288
At October 3, 2014	$	20,288

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



	Greatbatch Medical			QiG		Total
At January 3, 2014	$	304,856		$	41,800	$	346,656
Goodwill acquired	—			8,321		8,321
Foreign currency translation	(394		)	—		(394		)
At October 3, 2014	$	304,462		$	50,121	$	354,583


6.	DEBT

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



	As of
	October 3, 2014		January 3, 2014
Revolving line of credit	$	—	$	—
Variable rate term loan	190,000		197,500
Total long-term debt	$	190,000	$	197,500

Credit Facility – In September 2013, the Company amended and extended its credit facility (the “Credit Facility”). The new Credit Facility provides a $300 million revolving credit facility (the “Revolving Credit Facility”), a $200 million term loan (the “Term Loan”), a $15 million letter of credit subfacility, and a $15 million swingline subfacility. The Revolving Credit Facility can be increased by $200 million upon the Company’s request and approval by the lenders. The Revolving Credit Facility has a maturity date of September 20, 2018, which may be extended to September 20, 2019 upon notice by the Company and subject to certain conditions. The principal of the Term Loan is payable in quarterly installments as specified in the Credit Facility until its maturity date of September 20, 2019, when the unpaid balance is due in full.

The Credit Facility is secured by the Company’s non-realty assets including cash, accounts receivable and inventories. Interest rates on the Revolving Credit Facility and Term Loan are, at the Company’s option either at: (i) the prime rate plus the applicable margin, which ranges between 0.0% and 0.75%, based on the Company’s total leverage ratio or (ii) the LIBOR rate plus the applicable margin, which ranges between 1.375% and 2.75%, based on the Company’s

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GREATBATCH, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – Unaudited

total leverage ratio. Loans under the swingline subfacility will bear interest at the prime rate plus the applicable margin, which ranges between 0.0% and 0.75%, based on the Company’s total leverage ratio. The Company is also required to pay a commitment fee, which varies between 0.175% and 0.25% depending on the Company’s total leverage ratio.

The Credit Facility contains limitations on the incurrence of indebtedness, liens and licensing of intellectual property, investments and certain payments. The Credit Facility permits the Company to engage in the following activities up to an aggregate amount of $300 million: 1) permitted acquisitions in the aggregate not to exceed $250 million; 2) other investments in the aggregate not to exceed $100 million; 3) stock repurchases and dividends not to exceed $150 million in the aggregate; and 4) investments in foreign subsidiaries not to exceed $20 million in the aggregate. At any time that the total leverage ratio of the Company for the two most recently ended fiscal quarters is less than 2.75 to 1.0, the Company may make an election to reset each of the amounts specified above. Additionally, these limitations can be waived upon the Company’s request and approval of a majority of the lenders. As of October 3, 2014, the Company had available to it 100% of the above limits except for the aggregate limit and acquisitions limit which are now $280 million and $230 million, respectively.

The Credit Facility requires the Company to maintain a rolling four quarter ratio of adjusted EBITDA to interest expense of at least 3.0 to 1.0, and a total leverage ratio of not greater than 4.5 to 1.0 decreasing to not greater than 4.25 to 1.0 after January 2, 2016. The calculation of adjusted EBITDA and total leverage ratio excludes non-cash charges, extraordinary, unusual, or non-recurring expenses or losses, non-cash stock-based compensation, and non-recurring expenses or charges incurred in connection with permitted acquisitions. As of October 3, 2014, the Company was in compliance with all covenants under the Credit Facility.

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.

As of October 3, 2014, the weighted average interest rate on borrowings under the Credit Facility, which does not take into account the impact of the Company’s interest rate swap, was 1.56%. As of October 3, 2014, the Company had $300 million of borrowing capacity available under the Revolving Credit Facility. This borrowing capacity may vary from period to period based upon the debt and EBITDA levels of the Company, which impacts the covenant calculations described above.

Interest Rate Swap – From time to time, the Company enters into interest rate swap agreements in order to hedge against potential changes in cash flows on the outstanding borrowings on the Credit Facility. The variable rate received on the interest rate swaps and the variable rate paid on the debt have the same rate of interest, excluding the credit spread, and resets and pays interest on the same date. During 2012, the Company entered into a three-year $150 million interest rate swap, which amortizes $50 million per year. This swap was entered into in order to hedge against potential changes in cash flows on the outstanding Credit Facility borrowings, which are also indexed to the one-month LIBOR rate. This swap is being accounted for as a cash flow hedge. Information regarding the Company’s outstanding interest rate swap as of October 3, 2014 is as follows (dollars in thousands):

Instrument

Type of

Hedge

Notional

Amount

Start

Date

End

Date

Pay

Fixed

Rate

Current

Receive

Floating

Rate

Fair Value October 3, 2014

Balance

Sheet Location

Interest rate swap

Cash flow

100,000

Feb-13

Feb-16

0.573

0.154

(191

)

Other Long-Term Liabilities

The estimated fair value of the interest rate swap agreement represents the amount the Company expects to receive (pay) to terminate the contract. No portion of the change in fair value of the Company’s interest rate swap during the nine months ended October 3, 2014 and September 27, 2013 was considered ineffective. The amount recorded as Interest Expense during the nine months ended October 3, 2014 and September 27, 2013 related to the Company’s interest rate swap was $0.3 million.

Subsequent Event - On November 3, 2014, the Company entered into an additional interest rate swap in order to hedge against potential changes in cash flows on the outstanding borrowings under the Credit Facility. The first $45 million of notional amount of the swap is effective February 20, 2015 and the second $45 million of notional amount is effective February 22, 2016. The notional amount of the swap amortizes $10 million per year beginning on February 21, 2017 with the remaining settled on the termination date of the swap agreement on September 20, 2019.

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GREATBATCH, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – Unaudited

Under the terms of the swap agreement the Company will pay a fixed interest rate of 1.921% and receive a floating interest rate equal to the one-month LIBOR rate. The variable rate received on the interest rate swaps and the variable rate paid on the Credit Facility will have the same rate of interest, excluding the credit spread, and will reset and pay interest on the same date. The swap will be accounted for as a cash flow hedge.

The expected future minimum principal payments under the Term Loan as of October 3, 2014 are as follows (in thousands):



Remainder of 2014	$	2,500
2015	11,250
2016	16,250
2017	20,000
2018	20,000
Thereafter	120,000
Total	$	190,000

The Company has the ability and intent to use availability under the Revolving Credit Facility to fund principal payments on the Term Loan. As such, the entire balance of the Term Loan is classified as a non-current liability in the condensed consolidated balance sheets.

Convertible Subordinated Notes – In March 2007, the Company issued $197.8 million of convertible subordinated notes (“CSN”) at a 5% discount. CSN accrued interest at 2.25% per annum. The effective interest rate of CSN, which took into consideration the amortization of the discount and deferred fees related to the issuance of these notes, was 8.5%. On February 20, 2013, the Company redeemed all outstanding CSN.

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



	Three Months ended				Nine Months Ended
	October 3, 2014		September 27, 2013		October 3, 2014		September 27, 2013
Contractual interest	$	—	$	—	$	—	$	634
Discount amortization	—		—		—		5,368

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



At January 3, 2014	$	3,860
Amortization during the period	(580		)
At October 3, 2014	$	3,280


7.	DEFINED BENEFIT PLANS

The Company is required to provide its employees located in Switzerland, Mexico and France certain statutorily mandated defined benefits. Under these plans, benefits accrue to employees based upon years of service, position, age and compensation. The defined benefit plan provided to employees located in Switzerland is a funded contributory plan while the plans that provide benefits to employees located in Mexico and France are unfunded and noncontributory. The liability and corresponding expense related to these benefit plans is based on actuarial computations of current and future benefits for employees.

During 2012, the Company transferred most major functions performed at its facilities in Switzerland into other existing facilities. As a result, the Company curtailed its defined benefit plan provided to employees at those Swiss facilities and recognized a curtailment gain during 2013. In accordance with ASC 715, this gain was recognized in Other Operating Expenses, Net as the related employees were terminated. Refer to Note 9 "Other Operating Expenses, Net" for further information.

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GREATBATCH, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – Unaudited

The change in net defined benefit plan liability is as follows (in thousands):



At January 3, 2014	$	1,691
Net defined benefit cost	229
Benefit payments	(96		)
Foreign currency translation	(153		)
At October 3, 2014	$	1,671

Net defined benefit cost (income) is comprised of the following (in thousands):



	Three Months Ended				Nine Months Ended
	October 3, 2014		September 27, 2013		October 3, 2014		September 27, 2013
Service cost	$	51	$	76	$	155	$	227
Interest cost	18		41		57		144
Curtailment gain (Other Operating Expenses, Net)	—		—		—		(1,150		)
Amortization of net loss	6		—		17		—
Net defined benefit (income) cost	$	75	$	117	$	229	$	(779	)


8.	STOCK-BASED COMPENSATION

The components and classification of stock-based compensation expense were as follows (in thousands):



	Three Months Ended				Nine Months Ended
	October 3, 2014		September 27, 2013		October 3, 2014		September 27, 2013
Stock options	$	595	$	1,374	$	1,811	$	2,784
Restricted stock and units	1,850		2,013		5,008		4,958
401(k) Plan stock contribution	1,357		679		3,712		3,671
Total stock-based compensation expense	$	3,802	$	4,066	$	10,531	$	11,413

Cost of sales	$	1,129	$	1,117	$	3,187	$	3,246
Selling, general and administrative expenses	1,951		1,598		5,872		6,052
Research, development and engineering costs, net	429		215		1,179		979
Modification expense – Other Operating Expenses, Net (Note 9)	293		1,136		293		1,136
Total stock-based compensation expense	$	3,802	$	4,066	$	10,531	$	11,413

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



	Nine Months Ended
	October 3, 2014			September 27, 2013
Weighted average fair value	$	16.43		$	8.38
Risk-free interest rate	1.73		%	0.73		%
Expected volatility	39		%	39		%
Expected life (in years)	5			5
Expected dividend yield	—		%	—		%

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GREATBATCH, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – Unaudited

The following table summarizes time-vested stock option activity:



	Number of Time-Vested Stock Options		Weighted Average Exercise Price		Weighted Average Remaining Contractual Life (In Years)	Aggregate Intrinsic Value (In Millions)
Outstanding at January 3, 2014	1,616,409		$	22.92
Granted	183,571		43.84
Exercised	(191,501	)	22.94
Forfeited or expired	(33,279	)	27.82
Outstanding at October 3, 2014	1,575,200		25.26		6.3	$	28.9
Exercisable at October 3, 2014	1,159,129		23.09		5.5	$	23.7

The following table summarizes performance-vested stock option activity:



	Number of Performance- Vested Stock Options		Weighted Average Exercise Price		Weighted Average Remaining Contractual Life (In Years)	Aggregate Intrinsic Value (In Millions)
Outstanding at January 3, 2014	177,261		$	23.27
Exercised	(56,243	)	23.34
Outstanding at October 3, 2014	121,018		23.25		3.2	$	2.5
Exercisable at October 3, 2014	121,018		23.25		3.2	$	2.5

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



	Time-Vested Activity		Weighted Average Fair Value
Nonvested at January 3, 2014	67,575		$	26.37
Granted	63,817		44.78
Vested	(14,118	)	43.80
Forfeited	(7,073	)	33.79
Nonvested at October 3, 2014	110,201		34.32

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



	Performance- Vested Activity		Weighted Average Fair Value
Nonvested at January 3, 2014	779,678		$	16.41
Granted	186,825		31.33
Vested	(221,470	)	18.51
Forfeited	(28,870	)	18.42
Nonvested at October 3, 2014	716,163		19.57

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GREATBATCH, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – Unaudited


9.	OTHER OPERATING EXPENSES, NET

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



	Three Months Ended						Nine Months Ended
	October 3, 2014			September 27, 2013			October 3, 2014			September 27, 2013
2014 investments in capacity and capabilities	$	2,787		$	—		$	5,005		$	—
2013 operating unit realignment	(31		)	2,214			1,004			3,066
Orthopaedic facility optimization costs	996			1,420			1,032			6,723
Medical device facility optimization	—			52			11			282
ERP system upgrade (income) costs	—			(121		)	(82		)	264
Acquisition and integration (income) costs	133			(522		)	(248		)	(340		)
Asset dispositions, severance and other	2,291			457			3,501			565
	$	6,176		$	3,500		$	10,223		$	10,560

2014 investments in capacity and capabilities. In 2014, the Company announced several initiatives to invest in capacity and capabilities and to better align its resources to meet its customers' needs and drive organic growth and profitability. These included the following:


•	Functions currently performed at the Company’s facility in Plymouth, MN to manufacture catheters and introducers will transfer into the Company’s existing facility in Tijuana, Mexico by the first half of 2016.


•	Functions currently performed at the Company’s facilities in Beaverton, OR and Raynham, MA to manufacture products for the portable medical market will transfer to a new facility in Tijuana, Mexico by the end of 2015. Products currently manufactured at the Beaverton facility, which do not serve the portable medical market, are planned to transfer to the Company’s Raynham facility.

•

Establishing a R&D hub in the Minneapolis/St. Paul, MN area for the Company's Global R&D QiG - Medical Device Systems team, which will serve as the technical center of expertise for active implantable medical device development, implantable leads design, system level design verification testing, and continuation engineering. As part of this initiative, the design engineering responsibilities currently performed at our Cleveland, OH facility will be transferred to the new R&D hub by the end of 2014.


•	Establishing a commercial operations hub at the Company's global headquarters in Frisco, Texas. This initiative will build upon the investment the Company has made in its global sales and marketing function and is expected to be completed during the first half of 2015.

The total capital investment expected for these initiatives is between $25.0 million and $27.0 million, of which $1.4 million has been expended to date. Total restructuring charges expected to be incurred in connection with this realignment are between $29.0 million and $34.0 million, of which $5.0 million has been incurred to date. Expenses related to this initiative are recorded within the applicable segment and corporate cost centers that the expenditures relate to and include the following:

•Severance and retention: $7.0 million - $9.0 million;

•Accelerated depreciation and asset write-offs: $2.0 million - $3.0 million; and

•Other: $20.0 million - $22.0 million

Other costs primarily consist of costs to relocate certain equipment and other personnel, duplicate personnel costs, disposal and travel expenditures. All expenses are cash expenditures, except accelerated depreciation and asset write-offs.

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GREATBATCH, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – Unaudited

The change in accrued liabilities related to the 2014 investments in capacity and capabilities is as follows (in thousands):



	Severance and Retention			Accelerated Depreciation/Asset Write-offs			Other			Total
At January 3, 2014	$	—		$	—		$	—		$	—
Restructuring charges	1,445			33			3,527			5,005
Write-offs	—			(33		)	—			(33		)
Cash payments	(434		)	—			(2,838		)	(3,272		)
At October 3, 2014	$	1,011		$	—		$	689		$	1,700

2013 operating unit realignment. In June 2013, the Company initiated a plan to realign its operating structure in order to optimize its continued focus on profitable growth. As part of this initiative, the sales and marketing and operations groups of its former Implantable Medical and Electrochem Solutions (“Electrochem”) reportable segments were combined into one sales and marketing group and one operations group each serving the entire Company. This initiative is expected to be completed by the end of 2014. Total restructuring charges expected to be incurred in connection with this realignment are between $6.6 million and $7.0 million, of which $6.6 million has been incurred to date. Expenses related to this initiative are recorded within the applicable segment and corporate cost centers that the expenditures relate to and include the following:


•	Severance and retention: $5.0 million – $5.2 million; and


•	Other: $1.6 million – $1.8 million.

Other costs primarily consist of relocation and travel expenditures.

The change in accrued liabilities related to the 2013 operating unit realignment is as follows (in thousands):



	Severance and Retention			Other			Total
At January 3, 2014	$	465		$	746		$	1,211
Restructuring charges	849			155			1,004
Cash payments	(1,314		)	(901		)	(2,215		)
At October 3, 2014	$	—		$	—		$	—

Orthopaedic facility optimization costs. In 2010, the Company began updating its Indianapolis, IN facility to streamline operations, consolidate two buildings, increase capacity, further expand capabilities and reduce dependence on outside suppliers. This initiative was completed in 2011.

In 2011, the Company began construction on an orthopaedic manufacturing facility in Fort Wayne, IN and transferred manufacturing operations being performed at its Columbia City, IN location into this new facility. This initiative was completed in 2012.

During 2012, the Company transferred manufacturing and development operations performed at its facilities in Orvin and Corgemont, Switzerland into existing facilities in Fort Wayne, IN and Tijuana, Mexico. In connection with this consolidation, in 2012, the Company entered into an agreement to sell assets related to certain non-core Swiss orthopaedic product lines to an independent third party including inventory, machinery, equipment, customer lists and technology related to these product lines. This transaction closed during the first quarter of 2013. The Company received payments totaling $4.7 million in 2013 in connection with this transaction and the third party assumed $2.4 million of severance liabilities. During the first half of 2014, the Company recognized a gain and received an additional contingent payment of $2.7 million from the third party in connection with the achievement of certain milestones defined in the sales agreement. In addition, during the first quarter of 2013, the Company recognized a pension curtailment gain in connection with this consolidation. Refer to Note 7 “Defined Benefit Plans” for further information. These gains were recognized in Other Operating Expenses, Net in the Condensed Consolidated Statements of Operations.

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GREATBATCH, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – Unaudited

During 2013, the Company initiated a project to expand its Chaumont, France facility in order to enhance its capabilities and fulfill larger volume customer supply agreements. This initiative is expected to be completed over the next three years.

The total capital investment expected for these initiatives is between $30 million and $35 million, of which $23.7 million has been expended to date. Total expense expected to be incurred for these initiatives is between $43 million and $48 million, of which $42.0 million has been incurred to date. All expenses are recorded within the Greatbatch Medical segment and are expected to include the following:


•	Severance and retention: approximately $11 million;


•	Accelerated depreciation and asset write-offs: approximately $13 million; and


•	Other: $19 million – $24 million.

Other costs include production inefficiencies, moving, revalidation, personnel, training and travel costs associated with these consolidation projects.

All expenses are cash expenditures, except accelerated depreciation and asset write-offs. The change in accrued liabilities related to the orthopaedic facility optimization is as follows (in thousands):



	Severance and Retention		Accelerated Depreciation/Asset Write-offs			Other			Total
At January 3, 2014	$	—	$	—		$	857		$	857
Restructuring charges (income)	—		(2,655		)	3,687			1,032
Cash (payments) receipts	—		2,655			(4,004		)	(1,349		)
At October 3, 2014	$	—	$	—		$	540		$	540

Medical device facility optimization. Near the end of 2011, the Company initiated plans to upgrade and expand its manufacturing infrastructure in order to support its medical device strategy. This includes the transfer of certain product lines to create additional capacity for the manufacture of medical devices, expansion of two existing facilities, as well as the purchase of equipment to enable the production of medical devices. These initiatives are expected to be completed over the next three months. Total capital investment under these initiatives is expected to be between $12.5 million and $13 million, of which approximately $12.5 million has been expended to date. Total expenses expected to be incurred on these projects is between $1.8 million and $2.0 million, of which $1.8 million has been incurred to date. All expenses are recorded within the Greatbatch Medical segment and are expected to include the following:


•	Production inefficiencies, moving and revalidation: $0.7 million;


•	Personnel: $0.6 million; and


•	Other: approximately $0.5 million - $0.7 million.

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



	Production Inefficiencies, Moving and Revalidation		Personnel			Other			Total
At January 3, 2014	$	—	$	—		$	—		$	—
Restructuring charges	—		1			10			11
Cash payments	—		(1		)	(10		)	(11		)
At October 3, 2014	$	—	$	—		$	—		$	—

ERP system upgrade (income) costs. In 2011, the Company initiated plans to upgrade its existing global ERP system. This initiative was completed during the first half of 2014. Total capital investment expended under this initiative was $4.0 million. Total expenses incurred on this initiative were $5.8 million. Expenses related to this initiative were recorded within the applicable segment and corporate cost centers that the expenditures related to and included the following:


•	Training and consulting costs: $3.3 million; and


•	Accelerated depreciation and asset write-offs: $2.5 million.

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GREATBATCH, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – Unaudited

The change in accrued liabilities related to the ERP system upgrade is as follows (in thousands):



	Training & Consulting Costs			Accelerated Depreciation/Asset Write-offs		Total
At January 3, 2014	$	—		$	—	$	—
Restructuring income	(82		)	—		(82		)
Cash receipts	82			—		82
At October 3, 2014	$	—		$	—	$	—

Acquisition and integration (income) costs. During 2014 and 2013, the Company incurred cost (income) related to the integration of Micro Power Electronics, Inc., NeuroNexus Technologies, Inc., and CCC, which were acquired in December 2011, February 2012, and August 2014, respectively. These expenses were primarily for retention bonuses, travel costs in connection with integration efforts, training, severance, and the change in fair value of the contingent consideration recorded in connection with these acquisitions. Refer to Note 14 “Fair Value Measurements” for discussion on changes in fair value of the contingent consideration, which resulted in net gains being recognized in Other Operating Expenses, Net in the Condensed Consolidated Statements of Operations.

Asset dispositions, severance and other. During 2014 and 2013, the Company recorded charges in connection with various asset disposals and write downs. During the third quarter of 2014, the Company also incurred $0.8 million of expense related to the separation of the Company's Senior Vice President, Human Resources. Additionally, during the first three quarters of 2014, the Company recorded charges in connection with its business reorganization to align its contract manufacturing operations, which is expected to produce tax savings over the long-term. Costs incurred primarily relate to consulting and IT development, and are expected to be completed by the end of 2014.


10.	INCOME TAXES

The income tax provision for interim periods is determined using an estimate of the annual effective tax rate, adjusted for discrete items, if any, that are taken into account in the relevant period. Each quarter, the estimate of the annual effective tax rate is updated, and if the estimated effective tax rate changes, a cumulative adjustment is made. There is a potential for volatility of the effective tax rate due to several factors, including changes in the mix of the pre-tax income and the jurisdictions to which it relates, changes in tax laws and foreign tax holidays, business reorganizations, settlements with taxing authorities and foreign currency fluctuations.

As of October 3, 2014, the balance of unrecognized tax benefits is approximately $1.6 million. It is reasonably possible that a reduction of up to $0.6 million of the balance of unrecognized tax benefits may occur within the next twelve months as a result of potential audit settlements. Approximately $1.5 million of the balance of unrecognized tax benefits would favorably impact the effective tax rate, net of federal benefit on state issues, if recognized.


11.	COMMITMENTS AND CONTINGENCIES

Litigation – On December 21, 2012, the Company and several other unaffiliated parties were named as defendants in a personal injury and wrongful death action filed in the 113th Judicial District Court of Harris County, Texas. The complaint seeks damages alleging marketing and product defects and failure to warn, negligence and gross negligence relating to a product the Company manufactured and sold to a customer, one of the other named defendants. The Company's customer, in turn, incorporated the Greatbatch product into its own product which it sold to its customer, another named defendant. This matter is currently scheduled for trial during the first quarter of 2015.

The Company is indemnified by its customer against any loss in this matter, including costs of defense, which obligation is supported by the customer's product liability insurance coverage in the amount of $5 million. The Company also has its own product liability insurance coverage, subject to a $10 million retention. The Company has meritorious defenses and is vigorously defending the matter. In the event of an adverse judgment, however, the Company could have liability to the extent of the amount of any award its customer is unable to satisfy. To date, the Company has not recorded a reserve in connection with this matter since any potential loss is not currently probable and the range of loss is not reasonably estimable at this time.

The Company is a party to various other legal actions arising in the normal course of business. While the Company does not expect that the ultimate resolution of any of these pending actions will have a material effect on its consolidated results of operations, financial position, or cash flows, litigation is subject to inherent uncertainties and

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GREATBATCH, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – Unaudited

there can be no assurance that any pending legal action, which the Company currently believes to be immaterial, does not become material in the future.

Product Warranties– The Company generally warrants that its products will meet customer specifications and will be free from defects in materials and workmanship. The change in aggregate product warranty liability is as follows (in thousands):



At January 3, 2014	$	1,819
Increase to warranty reserve	680
Warranty claims paid	(1,934		)
At October 3, 2014	$	565

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. The Company’s purchase orders are normally based on its current manufacturing needs and are fulfilled by its vendors within short time horizons. The Company also enters into blanket orders with vendors that have preferred pricing and terms, however these orders are normally cancelable without penalty. As of October 3, 2014, the total contractual obligation related to such expenditures is approximately $31.7 million and will primarily be funded by existing cash and cash equivalents, cash flow from operations, or borrowings under the Credit Facility. The Company also enters into contracts for outsourced services; however, the obligations under these contracts were not significant and the contracts generally contain clauses allowing for cancellation without significant penalty.

Workers’ Compensation Trust - The Company was a member of a group self-insurance trust that provided workers’ compensation benefits to its Western New York employees (the “Trust”). 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 2011, the Company was notified by the Trust of its intention to cease operations at the end of 2011, and was assessed a pro-rata share of future costs related to the Trust. Based on actual experience, the Company could receive a refund or be assessed additional contributions for workers’ compensation claims insured by the Trust. Since 2011, the Company has utilized a traditional insurance provider for workers’ compensation coverage.

Operating Leases – The Company is a party to various operating lease agreements for buildings, equipment and software. Estimated future operating lease expense is as follows (in thousands):



Remainder of 2014	$	1,285
2015	5,635
2016	5,036
2017	2,548
2018	2,099
Thereafter	6,352
Total estimated operating lease expense	$	22,955

Foreign Currency Contracts – The Company enters into forward contracts to purchase Mexican pesos in order to hedge the risk of peso-denominated payments associated with the operations at its Tijuana, Mexico facility. The impact to the Company’s results of operations from these forward contracts was as follows (in thousands):



	Three Months Ended						Nine Months Ended
	October 3, 2014			September 27, 2013			October 3, 2014			September 27, 2013
Reduction in cost of sales	$	(48	)	$	(346	)	$	(204	)	$	(908	)
Ineffective portion of change in fair value	—			—			—			—

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GREATBATCH, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – Unaudited



Instrument	Type of Hedge	Aggregate Notional Amount		Start Date	End Date	$/Peso	Fair Value			Balance Sheet Location
FX Contract	Cash flow	$	1,927	Jan-14	Dec-14	0.0767	$	(72	)	Accrued expenses
FX Contract	Cash flow	$	1,580	Jan-14	Dec-14	0.0752	$	(30	)	Accrued expenses

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 specific stop loss coverage per associate for claims in the year exceeding $225 thousand per associate with no annual maximum aggregate stop loss coverage. As of October 3, 2014, the Company had $1.8 million accrued related to the self-insurance portion of its medical plan, which is recorded in Accrued Expenses in the Condensed Consolidated Balance Sheet, and is primarily based upon claim history.


12.	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
	October 3, 2014		September 27, 2013		October 3, 2014		September 27, 2013
Numerator for basic and diluted EPS:
Net income	$	14,012	$	11,071	$	41,282	$	26,486
Denominator for basic EPS:
Weighted average shares outstanding	24,899		24,047		24,784		23,904
Effect of dilutive securities:
Stock options, restricted stock and restricted stock units	1,024		1,141		1,066		1,113
Denominator for diluted EPS	25,923		25,188		25,850		25,017
Basic EPS	$	0.56	$	0.46	$	1.67	$	1.11
Diluted EPS	$	0.54	$	0.44	$	1.60	$	1.06

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
	October 3, 2014	September 27, 2013	October 3, 2014	September 27, 2013
Time-vested stock options, restricted stock and restricted stock units	163,000	43,000	177,000	59,000
Performance-vested restricted stock units	4,400	27,000	3,600	26,000

For the 2013 periods, no shares related to CSN were included in the diluted EPS calculations as the average share price of the Company’s common stock for that period did not exceed CSN’s conversion price per share.

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GREATBATCH, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – Unaudited


13.	ACCUMULATED OTHER COMPREHENSIVE INCOME

Accumulated Other Comprehensive Income is comprised of the following (in thousands):



	Defined Benefit Plan Liability			Cash Flow Hedges			Foreign Currency Translation Adjustment			Total Pre-Tax Amount			Tax			Net-of-Tax Amount
At July 4, 2014	$	(672	)	$	(218	)	$	15,741		$	14,851		$	459		$	15,310
Unrealized loss on cash flow hedges	—			(133		)	—			(133		)	46			(87		)
Realized gain on foreign currency hedges	—			(48		)	—			(48		)	17			(31		)
Realized loss on interest rate swap hedges	—			106			—			106			(37		)	69
Foreign currency translation loss	—			—			(3,211		)	(3,211		)	—			(3,211		)
At October 3, 2014	$	(672	)	$	(293	)	$	12,530		$	11,565		$	485		$	12,050



	Defined Benefit Plan Liability			Cash Flow Hedges			Foreign Currency Translation Adjustment			Total Pre-Tax Amount			Tax			Net-of-Tax Amount
At January 3, 2014	$	(672	)	$	(468	)	$	14,952		$	13,812		$	546		$	14,358
Unrealized gain on cash flow hedges	—			35			—			35			(12		)	23
Realized gain on foreign currency hedges	—			(204		)	—			(204		)	71			(133		)
Realized loss on interest rate swap hedges	—			344			—			344			(120		)	224
Foreign currency translation loss	—			—			(2,422		)	(2,422		)	—			(2,422		)
At October 3, 2014	$	(672	)	$	(293	)	$	12,530		$	11,565		$	485		$	12,050



	Defined Benefit Plan Liability			Cash Flow Hedges			Foreign Currency Translation Adjustment		Total Pre-Tax Amount			Tax			Net-of-Tax Amount
At June 28, 2013	$	(365	)	$	178		$	10,999	$	10,812		$	338		$	11,150
Unrealized loss on cash flow hedges	—			(419		)	—		(419		)	147			(272		)
Realized gain on foreign currency hedges	—			(346		)	—		(346		)	121			(225		)
Realized loss on interest rate swap hedges	—			145			—		145			(51		)	94
Foreign currency translation gain	—			—			3,579		3,579			—			3,579
At September 27, 2013	$	(365	)	$	(442	)	$	14,578	$	13,771		$	555		$	14,326



	Defined Benefit Plan Liability			Cash Flow Hedges			Foreign Currency Translation Adjustment		Total Pre-Tax Amount			Tax			Net-of-Tax Amount
At December 28, 2012	$	(962	)	$	120		$	13,431	$	12,589		$	358		$	12,947
Unrealized gain on cash flow hedges	—			2			—		2			(1		)	1
Realized gain on foreign currency hedges	—			(908		)	—		(908		)	318			(590		)
Realized loss on interest rate swap hedges	—			344			—		344			(120		)	224
Net defined benefit plan gain (Note 7)	597			—			—		597			—			597
Foreign currency translation gain	—			—			1,147		1,147			—			1,147
At September 27, 2013	$	(365	)	$	(442	)	$	14,578	$	13,771		$	555		$	14,326

The realized (gains) losses relating to the Company’s foreign currency and interest rate swap hedges were recognized in Cost of Sales and Interest Expense, respectively, in the Condensed Consolidated Statements of Operations.

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GREATBATCH, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – Unaudited

The net defined benefit plan reclassifications from Accumulated Other Comprehensive Income are as follows (in thousands):



	Nine Months Ended
	September 27, 2013
Net gain occurring during the period	$	(171	)
Amortization of losses	(581		)
Prior service cost	155
Pre-tax adjustment	(597		)
Taxes	—
Net gain	$	(597	)


14.	FAIR VALUE MEASUREMENTS

Assets and Liabilities Measured at Fair Value on a Recurring Basis

Fair value measurement standards apply to certain financial assets and liabilities that are measured at fair value on a recurring basis (each reporting period). For the Company, these financial assets and liabilities include its derivative instruments and accrued contingent consideration. The Company does not have any nonfinancial assets or liabilities that are measured at fair value on a recurring basis.

Foreign currency contracts – The fair value of foreign currency contracts are determined through the use of cash flow models that utilize observable market data inputs to estimate fair value. These observable market data inputs include foreign exchange rate and credit spread curves. In addition, the Company received fair value estimates from the foreign currency contract counterparty to verify the reasonableness of the Company’s estimates. The Company’s foreign currency contracts are categorized in Level 2 of the fair value hierarchy. The fair value of the Company’s foreign currency contracts will be realized as Cost of Sales as the inventory, which the contracts are hedging the cash flows to produce, is sold, of which approximately $0.1 million is expected to be realized within the next three months as an increase to Cost of Sales.

Interest rate swap – The fair value of the Company’s interest rate swap outstanding at October 3, 2014 was determined through the use of a cash flow model that utilizes observable market data inputs. These observable market data inputs include LIBOR, swap rates, and credit spread curves. In addition, the Company received a fair value estimate from the interest rate swap counterparty to verify the reasonableness of the Company’s estimate. This fair value calculation was categorized in Level 2 of the fair value hierarchy. The fair value of the Company’s interest rate swap will be realized as Interest Expense as interest on the Credit Facility is accrued.

Accrued contingent consideration – In circumstances where a business combination involves a contingent consideration arrangement, the Company recognizes a liability equal to the fair value of the contingent payments it expects to make as of the acquisition date. The Company re-measures this liability each reporting period and records changes in the fair value through Other Operating Expenses, Net. Increases or decreases in the fair value of the contingent consideration liability can result from changes in discount periods and rates, as well as changes in the timing, amount, or the likelihood of achieving the applicable milestones.

The fair value of accrued contingent consideration recorded by the Company represents the estimated fair value of the contingent consideration the Company expects to pay to the former shareholders of NeuroNexus Technologies, Inc. acquired in 2012 based upon the achievement of certain financial and development-based milestones. The fair value of the contingent consideration liability was estimated by discounting to present value, the probability weighted contingent payments expected to be made utilizing a risk adjusted discount rate. During the first quarter of 2014, the financial milestone expired unachieved and as a result, was determined to have a fair value of zero. The maximum amount of future contingent consideration (undiscounted) that the Company could be required to pay for the development milestone is $1.0 million. The Company’s accrued contingent consideration is categorized in Level 3 of the fair value hierarchy. Changes in accrued contingent consideration were as follows (in thousands):



At January 3, 2014	$	840
Fair value adjustments	(750		)
At October 3, 2014	$	90

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GREATBATCH, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – Unaudited

The recurring Level 3 fair value measurements of the Company’s contingent consideration liability include the following significant unobservable inputs (dollars in thousands):



Contingent Consideration Liability	Fair Value at October 3, 2014		Valuation Technique	Unobservable Inputs
Development milestone	$	90	Discounted cash flow	Discount rate	20		%
				Projected year of payment	2015
				Probability weighted payment amount	$	100

The following table provides information regarding assets and liabilities recorded at fair value on a recurring basis in the Condensed Consolidated Balance Sheet (in thousands):



	Fair Value Measurements Using
	At October 3,		Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
Description	2014		(Level 1)		(Level 2)		(Level 3)
Liabilities
Foreign currency contracts (Note 11)	$	102	$	—	$	102	$	—
Interest rate swap (Note 6)	191		—		191		—
Accrued contingent consideration (Note 14)	90		—		—		90

Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis

Fair value standards also apply to certain nonfinancial assets and liabilities that are measured at fair value on a nonrecurring basis. The carrying amounts of cash, accounts receivable, accounts payable and accrued expenses approximate fair value because of the short-term nature of these items. As of October 3, 2014, the fair value of the Company’s variable rate Long-Term Debt approximates its carrying value and is categorized in Level 2 of the fair value hierarchy. A summary of the valuation methodologies for the Company’s assets and liabilities measured on a nonrecurring basis is as follows:

Long-lived assets – The Company reviews the carrying amount of its long-lived assets to be held and used, other than goodwill and indefinite-lived intangible assets, for potential impairment whenever certain indicators are present such as: a significant decrease in the market price of the asset or asset group; a significant change in the extent or manner in which the long-lived asset or asset group is being used or in its physical condition; a significant change in legal factors or in the business climate that could affect the value of the long-lived asset or asset group, including an action or assessment by a regulator; an accumulation of costs significantly in excess of the amount originally expected for the acquisition or construction of the asset; a current-period operating or cash flow loss combined with a history of operating or cash flow losses or a projection or forecast that demonstrates continuing losses associated with the use of the long-lived asset or asset group; or a current expectation that it is more likely than not the long-lived asset or asset group will be sold or otherwise disposed of significantly before the end of its previously estimated useful life. The term more likely than not refers to a level of likelihood that is more than 50 percent.

If an indicator is present, potential recoverability is measured by comparing the carrying amount of the long-lived asset or asset group to its related total future undiscounted cash flows. If the carrying value is not recoverable, the asset or asset group is considered to be impaired. Impairment is measured by comparing the asset or asset group’s carrying amount to its fair value, which is determined by using independent appraisals or discounted cash flow models. The discounted cash flow model requires inputs such as a risk-adjusted discount rate, terminal values, cash flow projections, and remaining useful lives of the asset or asset group. If the carrying value of the long-lived asset or asset group exceeds the fair value, the carrying value is written down to the fair value in the period identified. During the second quarter of 2014, the Company transferred $2.1 million of assets relating to the Company's Orvin, Switzerland property to held for sale. The Company did not record any impairment charges related to any of its long-lived assets during the first nine months of 2014 and 2013.

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GREATBATCH, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – Unaudited

Goodwill and indefinite-lived intangible assets – The Company assesses the impairment of goodwill and other indefinite-lived intangible assets on the last day of each fiscal year, or more frequently if certain indicators are present as described above under long-lived assets. The Company assesses goodwill for impairment by comparing the fair value of its reporting units to their carrying amounts. If the fair value of a reporting unit is less than its carrying value, an impairment loss is recorded to the extent that the implied fair value of the goodwill within the reporting unit is less than its carrying value. Fair values for reporting units are determined based on discounted cash flow models and market multiples. The discounted cash flow model requires inputs such as a risk-adjusted discount rate, terminal values, probability of success factor, and cash flow projections. The fair value from the discounted cash flow model is then combined, based on certain weightings, with market multiples in order to determine the fair value of the reporting unit. These market multiples include revenue multiples and multiples of earnings before interest, taxes, depreciation and amortization.

Indefinite-lived intangible assets are assessed for impairment by comparing the fair value of the intangible asset to its carrying value. If the carrying v