Unassociated Document

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 Quarter ended July 3, 2009

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 x  No ¨
 
Indicate by checkmark whether the registrant has submitted electronically and posted on its corporate Web site, 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 ¨  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 ¨
  
Accelerated filer                  x
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 x
 
The number of shares outstanding of the Company’s common stock, $0.001 par value per share, as of August 10, 2009 was: 23,183,871 shares.

 
 
 

GREATBATCH, INC.
TABLE OF CONTENTS FOR FORM 10-Q
AS OF AND FOR THE THREE AND SIX MONTHS ENDED JULY 3, 2009

 
Page
COVER PAGE
1
   
TABLE OF CONTENTS
2
   
PART I - FINANCIAL INFORMATION (unaudited)
  
   
ITEM 1.
Condensed Consolidated Financial Statements
  
     
 
Condensed Consolidated Balance Sheets
3
     
 
Condensed Consolidated Statements of Operations and Comprehensive Income
4
     
 
Condensed Consolidated Statements of Cash Flows
5
     
 
Condensed Consolidated Statements of Stockholders’ Equity
6
     
 
Notes to Condensed Consolidated Financial Statements
7
     
ITEM 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
27
     
ITEM 3.
Quantitative and Qualitative Disclosures About Market Risk
42
     
ITEM 4.
Controls and Procedures
43
   
PART II - OTHER INFORMATION
  
   
ITEM 1.
Legal Proceedings
44
     
ITEM 1A.
Risk Factors
44
     
ITEM 2.
Unregistered Sales of Equity Securities and Use of Proceeds
44
     
ITEM 3.
Defaults Upon Senior Securities
44
     
ITEM 4.
Submission of Matters to a Vote of Security Holders
45
     
ITEM 5.
Other Information
45
     
ITEM 6.
Exhibits
45
   
SIGNATURES
46
   
EXHIBIT INDEX
46

 
- 2 -
 

PART I - FINANCIAL INFORMATION
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

GREATBATCH, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS - Unaudited
(in thousands except share and per share data)
   
As of
  
   
July 3,
    
January 2,
  
   
2009
    
2009 (1)
  
ASSETS
            
Current assets:
            
Cash and cash equivalents
   $ 19,003     $ 22,063  
Accounts receivable, net of allowance for doubtful accounts of $2.5 million in 2009 and $1.6 million in 2008
     86,533       86,364  
Inventories, net of reserve
     116,400       112,304  
Deferred income taxes
     2,928       8,086  
Prepaid expenses and other current assets
     11,299       6,754  
Total current assets
     236,163       235,571  
Property, plant and equipment, net
     159,410       166,668  
Amortizing intangible assets, net
     85,740       90,259  
Trademarks and tradenames
     36,122       36,130  
Goodwill
     302,137       302,221  
Deferred income taxes
     2,316       1,942  
Other assets
     15,967       15,242  
Total assets
   $ 837,855     $ 848,033  
LIABILITIES AND STOCKHOLDERS’ EQUITY
                
Current liabilities:
                
Current portion of long-term debt
   $ 30,450     $ -  
Accounts payable
     36,595       48,727  
Income taxes payable
     501       4,128  
Accrued expenses and other current liabilities
     34,096       40,497  
Total current liabilities
     101,642       93,352  
Long-term debt
     277,379       314,384  
Deferred income taxes
     56,049       57,905  
Other long-term liabilities
     7,858       7,601  
Total liabilities
     442,928       473,242  
Stockholders' equity:
                
Preferred stock, $0.001 par value, authorized 100,000,000 shares; no shares issued or outstanding in 2009 or 2008
     -       -  
Common stock, $0.001 par value, authorized 100,000,000 shares; 23,183,838 shares issued and outstanding in 2009 and 22,970,916 shares issued and 22,943,176 shares outstanding in 2008
     23       23  
Additional paid-in capital
     289,438       283,322  
Treasury stock, at cost, no shares in 2009 and 27,740 shares in 2008
     -       (741 )
Retained earnings
     108,489       95,263  
Accumulated other comprehensive loss
     (3,023 )     (3,076 )
Total stockholders’ equity
     394,927       374,791  
Total liabilities and stockholders' equity
   $ 837,855     $ 848,033  

(1) Retroactively adjusted - See Note 2.

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

 
- 3 -
 

GREATBATCH, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE INCOME - Unaudited
(in thousands except per share data)
 
   
Three months ended
    
Six months ended
  
   
July 3,
    
June 27,
    
July 3,
    
June 27,
  
   
2009
    
2008 (1)
    
2009
    
2008 (1)
  
                         
Sales
   $ 134,725     $ 141,648     $ 274,543     $ 263,802  
Cost of sales
     93,253       101,053       188,907       196,508  
Gross profit
     41,472       40,595       85,636       67,294  
Operating expenses:
                                
Selling, general and administrative expenses
     17,885       18,657       36,572       37,004  
Research, development and engineering costs, net
     8,694       7,705       16,569       16,929  
Acquired in-process research and development
     -       -       -       2,240  
Other operating expense, net
     2,424       2,881       5,227       3,909  
Total operating expenses
     29,003       29,243       58,368       60,082  
Operating income
     12,469       11,352       27,268       7,212  
Interest expense
     4,930       4,889       9,819       9,967  
Interest income
     (2 )     (125 )     (27 )     (521 )
Other (income) expense, net
     (604 )     94       (397 )     (1,363 )
Income (loss) before provision (benefit) for income taxes
     8,145       6,494       17,873       (871 )
Provision (benefit) for income taxes
     1,583       1,781       4,647       (1,139 )
Net income
   $ 6,562     $ 4,713     $ 13,226     $ 268  
                                 
Earnings per share:
                                
Basic
   $ 0.29     $ 0.21     $ 0.58     $ 0.01  
Diluted
   $ 0.28     $ 0.21     $ 0.56     $ 0.01  
                                 
Weighted average shares outstanding:
                                
Basic
     22,960       22,536       22,887       22,461  
Diluted
     23,855       22,639       23,900       22,570  
                                 
Comprehensive income:
                                
Net income
   $ 6,562     $ 4,713     $ 13,226     $ 268  
Foreign currency translation gain (loss)
     3,934       (1,929 )     17       5,280  
Unrealized gain (loss) on cash flow hedges, net of tax
     (230 )     786       36       325  
Unrealized gain (loss) on short-term investments available for sale, net of tax
     -       (15 )     -       20  
Comprehensive income
   $ 10,266     $ 3,555     $ 13,279     $ 5,893  

(1) Retroactively adjusted - See Note 2.

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

 
- 4 -
 
 
GREATBATCH, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS - Unaudited
(in thousands)

   
Six months ended
  
   
July 3,
    
June 27,
  
   
2009
    
2008 (1)
  
Cash flows from operating activities:
            
Net income
   $ 13,226     $ 268  
Adjustments to reconcile net income to net cash provided by operating activities:
                
Depreciation and amortization
     23,473       28,895  
Stock-based compensation
     4,918       5,453  
Acquired in-process research and development
     -       2,240  
Other non-cash (gains) losses
     49       (41 )
Deferred income taxes
     2,943       (607 )
Changes in operating assets and liabilities:
                
Accounts receivable
     74       (16,018 )
Inventories
     (4,151 )     (914 )
Prepaid expenses and other current assets
     (163 )     141  
Accounts payable
     (11,494 )     11,160  
Accrued expenses and other current liabilities
     (3,490 )     (423 )
Income taxes payable
     (3,649 )     (2,791 )
Net cash provided by operating activities
     21,736       27,363  
                 
Cash flows from investing activities:
                
Purchase of short-term investments
     -       (2,010 )
Proceeds from maturity/disposition of short-term investments
     -       7,469  
Acquisition of property, plant and equipment
     (10,874 )     (20,048 )
Purchase of cost method investments
     (1,050 )     (2,500 )
Acquisitions, net of cash acquired
     -       (105,197 )
Other investing activities
     (589 )     210  
Net cash used in investing activities
     (12,513 )     (122,076 )
                 
Cash flows from financing activities:
                
Principal payments of long-term debt
     (23,000 )     (34,690 )
Proceeds from issuance of long-term debt
     12,000       117,000  
Debt issuance costs
     -       (15 )
Issuance of common stock
     49       151  
Excess tax benefits from stock-based awards
     5       17  
Repurchase of treasury stock
     (741 )     (793 )
Net cash provided by (used in) financing activities
     (11,687 )     81,670  
                 
Effect of foreign currency exchange rates on cash and cash equivalents
     (596 )     (419 )
Net decrease in cash and cash equivalents
     (3,060 )     (13,462 )
Cash and cash equivalents, beginning of year
     22,063       33,473  
Cash and cash equivalents, end of period
   $ 19,003     $ 20,011  

(1) Retroactively adjusted - See Note 2.

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

 
- 5 -
 
 
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
    
Loss
    
Equity
  
                                                 
Balance, January 2, 2009 (1)
     22,971     $ 23     $ 283,322       (28 )   $ (741 )   $ 95,263     $ (3,076 )   $ 374,791  
Stock-based compensation
     -       -       2,791       -       -       -       -       2,791  
Net shares issued under stock incentive plans
     18       -       -       -       -       -       -       -  
Income tax benefit from stock options and restricted stock
     -       -       51       -       -       -       -       51  
Shares contributed to 401(k) Plan
     195       -       3,274       28       741       -       -       4,015  
Net income
     -       -       -       -       -       13,226       -       13,226  
Total other comprehensive income
     -       -       -       -       -       -       53       53  
Balance, July 3, 2009
     23,184     $ 23     $ 289,438       -     $ -     $ 108,489     $ (3,023 )   $ 394,927  

(1) Retroactively adjusted - See Note 2.

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

 
- 6 -
 

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 Principles Board Opinion (“APB”) No. 28, Interim Financial Reporting) and with the instructions to Form 10-Q and Article 10 of Regulation S-X.  Accordingly, they do not include all of the information necessary for a fair presentation of financial position, results of operations, and cash flows in conformity with accounting principles generally accepted in the United States of America.  Operating results for interim periods are not necessarily indicative of results that may be expected for the fiscal year as a whole.  In the opinion of management, the condensed consolidated financial statements reflect all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation of the results of Greatbatch, Inc. and its wholly-owned subsidiary Greatbatch Ltd. (collectively “Greatbatch” or the “Company”) for the periods presented.  The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, sales, expenses, and related disclosures at the date of the financial statements and during the reporting period.  Actual results could differ from these estimates.  The January 2, 2009 condensed consolidated balance sheet data, as retroactively adjusted (see note 2), was derived from audited consolidated financial statements but does not include all disclosures required by accounting principles generally accepted in the United States of America.  For further information, refer to the consolidated financial statements and notes included in the Company’s Annual Report on Form 10-K for the year ended January 2, 2009.  The Company utilizes a fifty-two, fifty-three week fiscal year ending on the Friday nearest December 31st.  For 52-week years, each quarter contains 13 weeks.  The second quarter of 2009 and 2008 each contained 13 weeks and ended on July 3, and June 27, respectively.  The Company has evaluated subsequent events through August 11, 2009, the date of issuance of our condensed consolidated financial statements.  The Company has revised its Condensed Consolidated Statements of Operations to include a presentation of Gross Profit and to combine intangible amortization expense related to cost of sales with Cost of Sales, which was previously broken out separately.

2.
APPLICATION OF NEW ACCOUNTING POLICY

Beginning in 2009, the Company was required to adopt Financial Accounting Standards Board (“FASB”) Staff Position (“FSP”) APB 14-1, “Accounting for Convertible Debt Instruments that May be Settled in Cash Upon Conversion (Including Partial Cash Settlement)” as it was determined that Emerging Issues Task Force Issue 07-5, “Determining Whether an Instrument (or Embedded Feature) is Indexed to an Entity’s Own Stock” did not impact the Company’s determination that its convertible subordinated notes are indexed to its own stock.  Thus, the conversion feature of the subordinated notes remains eligible for the paragraph 11(a) scope exception of Statement of Financial Accounting Standards (“SFAS”) No. 133, “Accounting for Derivative Instruments and Hedging Activities” and is not required to be accounted for as a derivative instrument. This FSP requires retrospective restatement for all prior periods presented in financial statements.

This FSP requires issuers of convertible debt instruments that may be settled in cash upon conversion, such as the Company’s CSN II as described in Note 6, to separately account for the liability and equity components of those instruments in a manner that will reflect the entity’s nonconvertible debt borrowing rate when interest cost is recognized in subsequent periods.  As a result, the Company first determined the carrying amount of the liability component of CSN II by measuring the fair value of a similar liability that does not have the associated conversion option as of the date CSN II was issued (March 2007).  The carrying amount of the conversion option was then determined by deducting the fair value of the liability component from the initial proceeds received from the issuance of CSN II.  The carrying amount of the conversion option was retroactively recorded as Additional Paid-In Capital with an offset to Long-Term Debt.

 
- 7 -
 

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

The carrying amount of the conversion option is being amortized to Interest Expense using the effective interest rate method over the expected life of a similar liability without a conversion option. Deferred financing fees incurred in connection with the issuance of CSN II, previously recorded as Other Assets, were allocated to the liability and equity components in proportion to the allocation of proceeds between the liability and equity components. The deferred financing fees allocated to the debt component are being amortized to Interest Expense over the expected life of CSN II.  The deferred financing fees allocated to the equity component were recorded as an offset to Stockholders’ Equity. The 2008 Condensed Consolidated Financial Statements presented in this quarterly report have been retroactively adjusted to reflect the adoption of FSP APB 14-1 as if it were in effect on the date CSN II were originally issued. The following table provides the impact of FSP APB 14-1 on the 2008 Condensed Consolidated Financial Statements:

   
As Previously
    
FSP APB 14-1
    
Adjusted
  
(in thousands except per share amounts)
  
Reported
    
Adjustment
    
Amounts
  
Condensed Consolidated Balance Sheet
                  
(As of January 2, 2009)
                  
ASSETS
                  
Other assets
   $ 16,140     $ (898 )   $ 15,242  
Total assets
     848,931       (898 )     848,033  
                         
LIABILITIES
                        
Long-term debt
   $ 352,920     $ (38,536 )   $ 314,384  
Deferred income taxes - noncurrent
     44,306       13,599       57,905  
Total liabilities
     498,179       (24,937 )     473,242  
                         
STOCKHOLDERS' EQUITY
                        
Additional paid-in capital
   $ 251,772     $ 31,550     $ 283,322  
Retained earnings
     102,774       (7,511 )     95,263  
Total stockholders' equity
     350,752       24,039       374,791  
Total liabilities and stockholders' equity
     848,931       (898 )     848,033  
                         
Condensed Consolidated Statement of Operations
                        
(Three months ended June 27, 2008)
                        
Interest expense
   $ 3,209     $ 1,680     $ 4,889  
Income before provision for income taxes
     8,174       (1,680 )     6,494  
Provision for income taxes
     2,369       (588 )     1,781  
Net income
     5,805       (1,092 )     4,713  
                         
Earnings per share:
                        
Basic
   $ 0.26     $ (0.05 )     0.21  
Diluted
     0.25       (0.04 )     0.21  
(Six months ended June 27, 2008)
                        
Interest expense
   $ 6,640     $ 3,327     $ 9,967  
Income (loss) before provision (benefit) for income taxes
     2,456       (3,327 )     (871 )
Provision (benefit) for income taxes
     25       (1,164 )     (1,139 )
Net income
     2,431       (2,163 )     268  
                         
Earnings per share:
                        
Basic
   $ 0.11     $ (0.10 )   $ 0.01  
Diluted
     0.11       (0.10 )     0.01  

 
- 8 -
 

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

   
As Previously
    
FSP APB 14-1
    
Adjusted
  
(in thousands except per share amounts)
  
Reported
    
Adjustment
    
Amounts
  
Condensed Consolidated Statement of Cash Flows
                  
(Six months ended June 27, 2008)
                  
Net income
   $ 2,431     $ (2,163 )   $ 268  
Depreciation and amortization
     25,568       3,327       28,895  
Deferred income taxes
     557       (1,164 )     (607 )
Net cash provided by operating activities
     27,363       -       27,363  

3.
SUPPLEMENTAL CASH FLOW INFORMATION
   
Six months ended
  
   
July 3,
    
June 27,
  
   
2009
    
2008
  
Noncash investing and financing activities (in thousands):
            
Unrealized gain on cash flow hedges, net
   $ 36     $ 325  
Common stock contributed to 401(k) Plan
     4,015       3,472  
Property, plant and equipment purchases included in accounts payable
     2,214       7,014  
Deferred financing fees and acquisition costs included in accrued expenses and other current liabilities
     -       371  
Shares issued in connection with a business acquisition
     -       1,473  
 
               
Cash paid during the period for:
                
Interest
   $ 4,665     $ 4,575  
Income taxes
     4,602       2,221  
Acquisition of noncash assets and liabilities:
                
Assets acquired
   $ 850     $ 163,040  
Liabilities assumed
     -       56,407  

4.
INVENTORIES, NET

Inventories are comprised of the following (in thousands):

   
July 3,
    
January 2,
  
   
2009
    
2009
  
             
Raw materials
   $ 60,408     $ 58,352  
Work-in-process
     27,267       28,851  
Finished goods
     28,725       25,101  
Total
   $ 116,400     $ 112,304  

The above inventory amounts are shown net of a reserve for obsolescence of $12.3 million and $10.6 million as of July 3, 2009 and January 2, 2009, respectively.

 
- 9 -
 

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

5.
INTANGIBLE ASSETS

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

   
Gross
carrying
amount
    
Accumulated
amortization
    
Foreign
currency
translation
    
Net carrying
amount
  
July 3, 2009
              
Purchased technology and patents
   $ 82,673     $ (39,318 )   $ (47 )   $ 43,308  
Customer lists
     46,818       (5,650 )     (66 )     41,102  
Other
     3,519       (2,185 )     (4 )     1,330  
Total amortizing intangible assets
   $ 133,010     $ (47,153 )   $ (117 )   $ 85,740  
                                 
January 2, 2009
                  
Purchased technology and patents
   $ 81,639     $ (35,881 )   $ 184     $ 45,942  
Customer lists
     46,547       (4,056 )     271       42,762  
Other
     3,508       (1,964 )     11       1,555  
Total amortizing intangible assets
   $ 131,694     $ (41,901 )   $ 466     $ 90,259  

 
Aggregate amortization expense for the second quarter of 2009 and 2008 was $2.6 million and $2.7 million, respectively.  Aggregate amortization expense for the six months ended July 3, 2009 and June 27, 2008 was $5.3 million and $5.4 million, respectively.  As of July 3, 2009, annual amortization expense is estimated to be $4.9 million for the remainder of 2009, $9.5 million for 2010, $9.4 million for 2011, $9.3 million for 2012, $8.5 million for 2013 and $7.8 million for 2014.

 
The change in trademarks and trade names during 2009 is as follows (in thousands):

Balance at January 2, 2009
   $ 36,130  
Foreign currency translation
     (8 )
Balance at July 3, 2009
   $ 36,122  

 
The change in goodwill during 2009 is as follows (in thousands):

   
Greatbatch
Medical
    
Electrochem
    
Total
  
Balance at January 2, 2009
   $ 292,278     $ 9,943     $ 302,221  
Foreign currency translation
     (84 )     -       (84 )
Balance at July 3, 2009
   $ 292,194     $ 9,943     $ 302,137  

 
- 10 -
 

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

6.
DEBT

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

   
July 3,
    
January 2,
  
   
2009
    
2009
  
             
Revolving line of credit
   $ 121,000     $ 132,000  
2.25% convertible subordinated notes I, due 2013
     30,450       30,450  
2.25% convertible subordinated notes II, due 2013
     197,782       197,782  
Unamortized discount
     (41,403 )     (45,848 )
Total debt
     307,829       314,384  
Less: current portion of long-term debt
     (30,450 )     -  
Total long-term debt
   $ 277,379     $ 314,384  

Revolving Line of Credit - The Company has a senior credit facility (the “Credit Facility”) consisting of a $235 million revolving credit facility, which can be increased to $335 million upon the Company’s request.  The Credit Facility also contains a $15 million letter of credit subfacility and a $15 million swingline subfacility.  The Credit Facility is secured by the Company’s non-realty assets including cash, accounts receivable and inventories, and has an expiration date of May 22, 2012 with a one-time option to extend to April 1, 2013 if no default has occurred.  Interest rates under the Credit Facility are, at the Company’s option, based upon the current prime rate or the LIBOR rate plus a margin that varies with the Company’s leverage ratio.  If interest is paid based upon the prime rate, the applicable margin is between minus 1.25% and 0.00%.  If interest is paid based upon the LIBOR rate, the applicable margin is between 1.00% and 2.00%.  The Company is required to pay a commitment fee between 0.125% and 0.250% per annum on the unused portion of the Credit Facility based on the Company’s leverage ratio.

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

The Credit Facility also requires the Company to maintain a ratio of adjusted EBITDA, as defined in the credit agreement, to interest expense of at least 3.00 to 1.00, and a total leverage ratio, as defined in the credit agreement, of not greater than 5.00 to 1.00 from May 22, 2007 through September 29, 2009 and not greater than 4.50 to 1.00 from September 30, 2009 and thereafter.  As of July 3, 2009, the Company was in compliance with all required covenants.

The Credit Facility contains customary events of default.  Upon the occurrence and during the continuance of an event of default, a majority of the lenders may declare the outstanding advances and all other obligations under the Credit Facility immediately due and payable.

 
- 11 -
 

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

The weighted average interest rate on borrowings under the Company’s revolving line of credit as of July 3, 2009, which does not include the impact of the interest rate swaps described below, was 2.6%.  Interest rates reset based upon the six-month ($111 million) and two-month ($10 million) LIBOR rate.  As of July 3, 2009, the Company had $114 million available under its revolving line of credit.

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

                         
Current
    
Fair
    
                   
Pay
    
receive
    
value
  
Balance
   
Type of
  
Notional
  
Start
  
End
  
fixed
    
floating
    
July 3,
  
Sheet
Instrument
  
hedge
  
amount
  
date
  
date
  
rate
    
rate
    
2009
  
Location
       
(In thousands)
                      
(In thousands)
    
Interest rate swap
  
Cash flow
   $ 80,000  
3/5/2008
  
7/7/2010
     3.09 %     1.75 %   $ (1,560 )
Oth Liabilities
Interest rate swap
  
Cash flow
     18,000  
12/18/2008
  
12/18/2010
     2.00 %     1.16 %     (171 )
Oth Liabilities
Interest rate swap
  
Cash flow
     50,000  
7/7/2010
  
7/7/2011
     2.16 %  
6M LIBOR
       (35 )
Oth Liabilities
        $ 148,000             2.64 %           $ (1,766 )  

The estimated fair value of the interest rate swap agreements represents the amount the Company expects to receive (pay) to terminate the contracts and is recorded as Other Assets or Other Long-Term Liabilities in the Condensed Consolidated Balance Sheets.  No portion of the change in fair value of the interest rate swaps during the first six months of 2009 was considered ineffective.  The amount recorded as additional interest expense during the first six months of 2009 related to the interest rate swaps was $0.5 million.

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 is included in the terms of CSN I.  In connection with the Exchange, the Company issued an additional $80 million aggregate principal amount of CSN II at a price of $950 per $1,000 of principal.  In December 2008, the Company entered into privately negotiated agreements under which it repurchased $21.8 million in aggregate principal amount of its outstanding CSN I at $845.38 per $1,000 of principal.  The primary purpose of this transaction was to retire the notes, which contained a put option exercisable on June 15, 2010, at a discount.

 
- 12 -
 

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

The following is a summary of the significant terms of CSN I and CSN II:

CSN I - The notes bear interest at 2.25% per annum, payable semi-annually, and are due on June 15, 2013.  Holders may convert the notes into shares of the Company’s common stock at a conversion price of $40.29 per share, which is equivalent to a conversion ratio of 24.8219 shares per $1,000 of principal, subject to adjustment, before the close of business on June 15, 2013 only under the following circumstances: (1) during any fiscal quarter commencing after July 4, 2003, if the closing sale price of the Company’s common stock exceeds 120% of the $40.29 conversion price for at least 20 trading days in the 30 consecutive trading day period ending on the last trading day of the preceding fiscal quarter; (2) subject to certain exceptions, during the five business days after any five consecutive trading day period in which the trading price per $1,000 of principal for each day of such period was less than 98% of the product of the closing sale price of the Company’s common stock and the number of shares issuable upon conversion of $1,000 of principal; (3) if the notes have been called for redemption; or (4) upon the occurrence of certain corporate events. The fair value of the CSN I notes based on recent sales prices as of July 3, 2009 was approximately $29 million.

Beginning June 20, 2010, the Company may redeem any of the notes at a redemption price of 100% of their principal amount, plus accrued interest.  Note holders may require the Company to repurchase their notes on June 15, 2010 or at any time prior to their maturity following a fundamental change, as defined in the indenture agreement, at a repurchase price of 100% of their principal amount, plus accrued interest.  As a result of this provision, beginning in the second quarter of 2009 the remaining balance of CSN I, along with the associated deferred tax liability and deferred fees, were classified as short-term in the Condensed Consolidated Balance Sheet and will be repaid with availability under the Company’s revolving line of credit or cash flow from operations. 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.

Beginning with the six-month interest period commencing June 15, 2010, the Company will pay additional contingent interest during any six-month interest period if the trading price of the notes for each of the five trading days immediately preceding the first day of the interest period equals or exceeds 120% of the principal amount of the notes.

CSN II - The notes bear interest at 2.25% per annum, payable semi-annually, and are due on June 15, 2013.  The holders may convert the notes into shares of the Company’s common stock at a conversion price of $34.70 per share, which is equivalent to a conversion ratio of 28.8219 shares per $1,000 of principal.  The conversion price and the conversion ratio will adjust automatically upon certain changes to the Company’s capitalization.  CSN II notes were issued at a price of $950 per $1,000 of principal.  The fair value of the CSN II notes based on recent sales prices as of July 3, 2009 was approximately $162 million.

The effective interest rate of CSN II notes, which takes into consideration the amortization of the original discount, deferred fees related to the issuance of these notes and FSP APB 14-1 discount (See Note 2) is 8.5%.  The discount on CSN II is being amortized to the maturity date of the convertible notes utilizing the effective interest method.  As of July 3, 2009, the carrying amount of the discount related to the FSP APB 14-1 equity component was $34.9 million.  As of July 3, 2009, the if-converted value of CSN II notes does not exceed its principal amount as the Company’s closing stock price of $22.00 did not exceed the conversion price.

 
- 13 -
 
 
GREATBATCH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – Unaudited

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

   
Three months ended
    
Six months ended
  
   
July 3,
    
June 27,
    
July 3,
    
June 27,
  
   
2009
    
2008
    
2009
    
2008
  
Contractual interest
   $ 1,113     $ 1,113     $ 2,225     $ 2,225  
Discount amortization
     2,240       2,097       4,444       4,161  
 
The notes are convertible at the option of the holders at such time as: (i) the closing price of the Company’s common stock exceeds 150% of the conversion price of the notes for 20 out of 30 consecutive trading days; (ii) the trading price per $1,000 of principal is less than 98% of the product of the closing sale price of common stock for each day during any five consecutive trading day period and the conversion rate per $1,000 of principal; (iii) the notes have been called for redemption; (iv) the Company distributes to all holders of common stock rights or warrants entitling them to purchase additional shares of common stock at less than the average closing price of common stock for the ten trading days immediately preceding the announcement of the distribution; (v) the Company distributes to all holders of common stock any form of dividend which has a per share value exceeding 5% of the price of the common stock on the day prior to such date of distribution; (vi) the Company affects a consolidation, merger, share exchange or sale of assets pursuant to which its common stock is converted to cash or other property; (vii) the period beginning 60 days prior to but excluding June 15, 2013; and (viii) certain fundamental changes, as defined in the indenture agreement, occur or are approved by the Board of Directors.

Conversions in connection with corporate transactions that constitute a fundamental change require the Company to pay a premium make-whole amount, based upon a predetermined table as set forth in the indenture agreement, whereby the conversion ratio on the notes may be increased by up to 8.2 shares per $1,000 of principal.  The premium make-whole amount will be paid in shares of common stock upon any such conversion, subject to the net share settlement feature of the notes described below.

CSN II contains a net share settlement feature that requires the Company to pay cash for each $1,000 of principal to be converted.  Any amounts in excess of $1,000 will be settled in shares of the Company’s common stock, or at the Company’s option, cash.  The Company has a one-time irrevocable election to pay the holders in shares of its common stock, which it currently does not plan to exercise.

The notes are redeemable by the Company at any time on or after June 20, 2012, or at the option of a holder upon the occurrence of certain fundamental changes, as defined in the agreement, affecting the Company.  The notes are subordinated in right of payment to all of our senior indebtedness and effectively subordinated to all debts and other liabilities of the Company’s subsidiaries.

Deferred Financing Fees - The following is a reconciliation of deferred financing fees for the first six months of 2009 (in thousands):

Previously reported balance at January 2, 2009
   $ 4,994  
FSP APB 14-1 adjustment
     (898 )
Retroactively adjusted amounts
     4,096  
Amortization during the period
     (532 )
Balance at July 3, 2009
   $ 3,564  

 
- 14 -
 

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

7.
PENSION PLANS

The Company offers certain non-U.S. employees defined benefits under defined benefit pension plans.  Under these plans, benefits accrue to employees based upon years of service, position, age and compensation.  The liability and corresponding expense related to these pension plans is based on actuarial computations of current and future benefits for employees.  Pension expense is charged to current operating expenses.

 
The change in the net pension liability for the first six months of 2009 is as follows (in thousands):

Balance at January 2, 2009
   $ 5,985  
Net periodic pension cost
     532  
Benefit payments
     (363 )
Foreign currency translation
     (6 )
Balance at July 3, 2009
   $ 6,148  

The fair value of pension plan assets, which is not included in the Condensed Consolidated Balance Sheets, as of July 3, 2009 and January 2, 2009 was $7.8 million and $7.5 million, respectively.  In order to reduce the underfunded status of one of its defined benefit pension plans, the Company made a $1.4 million cash contribution to that plan in July 2009.

Net pension cost is comprised of the following (in thousands):
 
   
Three months ended
    
Six months ended
  
   
July 3,
2009
    
June 27,
2008
    
July 3,
2009
    
June 27,
2008
  
Service cost
   $ 218     $ 205     $ 428     $ 372  
Interest cost
     99       146       195       264  
Amortization of net loss
     32       -       62       -  
Expected return on plan assets
     (78 )     (112 )     (153 )     (220 )
Net pension cost
   $ 271     $ 239     $ 532     $ 416  

8.
FAIR VALUE MEASUREMENTS

The following table provides information regarding financial assets and liabilities measured at fair value in the Company’s Condensed Consolidated Balance Sheet as of July 3, 2009 (in thousands):

         
Fair value measurements using
  
         
Quoted
              
         
prices in
              
         
active
    
Significant
        
         
markets
    
other
    
Significant
  
   
At
    
for
    
observable
    
unobservable
  
   
July 3,
    
identical
    
inputs
    
inputs
  
Description
  
2009
    
assets
    
(Level 2)
    
(Level 3)
  
Assets
                        
Foreign currency contracts
   $ 428     $ -     $ 428     $ -  
                                 
Liabilities
                                
Interest rate swaps
   $ 1,766     $ -     $ 1,766     $ -  
 
 
- 15 -
 

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

Interest rate swaps - The fair value of interest rate swaps are obtained from cash flow models that utilize observable market data inputs to estimate fair value.  These observable market data inputs include LIBOR and swap rates, and credit spread curves.  In addition to the above, the Company receives fair value estimates from the interest rate swap counterparty to verify the reasonableness of the Company’s estimates.  The Company’s interest rate swaps are categorized in Level 2 of the fair value hierarchy.

Foreign currency contracts - The fair value of foreign currency contracts are obtained from 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.  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 convertible subordinated notes disclosed in Note 6 – “Debt” were determined based upon recent third-party transactions for the Company’s notes in an inactive market.  The Company’s convertible subordinated notes are categorized in Level 2 of the fair value hierarchy.

Pension plan assets - The fair value of the Company’s pension plan assets disclosed in Note 7 - “Pension Plans” are obtained from an independent pricing service that utilizes multidimensional relational models with observable market data inputs to estimate fair value. These observable market data inputs include benchmark yields, reported trades, broker/dealer quotes, issuer spreads, benchmark securities, bids, offers and reference data.  The Company’s pension plan assets are categorized in Level 2 of the fair value hierarchy.

9.
STOCK-BASED COMPENSATION

At the Company’s 2009 Annual Meeting of Stockholders held on May 15, 2009, the stockholders of the Company approved the 2009 Stock Incentive Plan (“2009 Plan”). The 2009 Plan authorizes the issuance of up to 1,350,000 shares of equity incentive awards including nonqualified and incentive stock options, restricted stock, restricted stock units, stock bonuses and stock appreciation rights subject to the terms of the 2009 Plan. The 2009 Plan limits the amount of restricted stock, restricted stock units and stock bonuses that may be awarded in the aggregate to 150,000 shares of the 1,350,000 shares authorized.

Compensation costs related to share-based payments for the three and six months ended July 3, 2009 totaled $1.0 million and $2.8 million, respectively, and $1.4 million and $3.3 million for the three and six months ended June 27, 2008, respectively. Stock-based compensation expense included in the Condensed Consolidated Statements of Cash Flows includes costs recognized for the annual share contribution to the Company’s 401(k) Plan as well as for share-based payments. The following table summarizes the Company’s time-vested and performance-vested stock option activity:
 
   
Number of
time-vested
    
Weighted
average
exercise
    
Weighted
average
remaining
contractual
life
    
Aggregate
Intrinsic value
  
   
stock options
    
price
    
(in years)
    
(in millions)
  
Outstanding at January 2, 2009
     1,498,294     $ 24.28              
     Granted
     240,170       26.53              
     Exercised
     (3,193 )     16.93              
     Forfeited or expired
     (323,432 )     27.84              
                             
Outstanding at July 3, 2009
     1,411,839     $ 23.85       7.2     $ 1.6  
Exercisable at July 3, 2009
     818,107     $ 23.79       6.1     $ 1.2  
 
 
- 16 -
 
 
GREATBATCH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – Unaudited
 
   
Number of
performance-vested
    
Weighted
average
exercise
    
Weighted
average
remaining
contractual
life
    
Aggregate
intrinsic value
  
   
stock options
    
price
    
(in years)
    
(in millions)
  
Outstanding at January 2, 2009
     798,564     $ 23.62              
     Granted
     310,407       26.53              
     Forfeited or expired
     (78,224 )     23.77              
                             
Outstanding at July 3, 2009
     1,030,747     $ 24.49       8.6     $ 0.0  
Exercisable at July 3, 2009
     89,019     $ 23.60       5.9     $ 0.0  
 
The weighted-average fair value and assumptions used to value options granted are as follows:

   
Six months ended
  
   
July 3,
    
June 27,
  
   
2009
    
2008
  
Weighted-average fair value
   $ 8.63     $ 7.93  
Risk-free interest rate
     2.02 %     2.92 %
Expected volatility
     39 %     40 %
Expected life (in years)
     5.6       5.2  
Expected dividend yield
     0 %     0 %

The following table summarizes the Company’s restricted stock and restricted stock unit activity:

         
Weighted average
  
   
Activity
    
fair value
  
             
Nonvested at January 2, 2009
     207,765     $ 22.86  
  Shares granted
     98,858       26.23  
  Shares forfeited
     (10,259 )     23.66  
                 
Nonvested at July 3, 2009 (1)
     296,364     $ 23.96  

(1)   Includes 24,000 performance-vested restricted stock shares with a weighted average grant date fair value of $22.59 per share.
 
10.
OTHER OPERATING EXPENSE

The following were recorded in other operating expense, net in the Company’s Condensed Consolidated Statements of Operations and Comprehensive Income (in thousands):

   
Three months ended
    
Six months ended
  
   
July 3,
    
June 27,
    
July 3,
    
June 27,
  
   
2009
    
2008
    
2009
    
2008
  
                         
(a) 2005 & 2006 facility shutdowns and consolidations
   $ -     $ 113     $ -     $ 337  
(b) 2007 & 2008 facility shutdowns and consolidations
     1,578       909       3,477       1,629  
(c) Integration costs
     717       1,914       1,580       2,068  
     Asset dispositions and other
     129       (55 )     170       (125 )
    $ 2,424     $ 2,881     $ 5,227     $ 3,909  
 
 
- 17 -
 
 
GREATBATCH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – Unaudited
 
(a)  2005 & 2006 facility shutdowns and consolidations. Beginning in the first quarter of 2005 and ending in the second quarter of 2006 the Company consolidated its medical capacitor manufacturing operations in Cheektowaga, NY, and its implantable medical battery manufacturing operations in Clarence, NY, into its advanced power source manufacturing facility in Alden, NY (“Alden Facility”).  The Company also consolidated its capacitor research, development and engineering operations from its Cheektowaga, NY facility into its technology center in Clarence, NY.

In the first quarter of 2005, the Company announced its intent to close its Carson City, NV facility and consolidate the work performed at that facility into its Tijuana, Mexico facility.  That consolidation project was completed in the third quarter of 2007.

In the fourth quarter of 2005, the Company announced its intent to close its Columbia, MD facility (“Columbia Facility”) and Fremont, CA Advanced Research Laboratory (“ARL”).  The Company also announced that the manufacturing operations at its Columbia Facility would be moved into its Tijuana Facility and that the research, development and engineering and product development functions at its Columbia Facility and at ARL would relocate to its technology center in Clarence, NY.  The ARL portion of this consolidation project was completed in the fourth quarter of 2006.  The Columbia Facility portion of this consolidation project was completed in the third quarter of 2008.

During the fourth quarter of 2006, the Company completed a plan for consolidating its corporate and business unit organization structure.  A significant portion of the annual savings from this initiative was reinvested into research and development activities and business growth opportunities.

The total cost of these projects was $24.7 million, which was incurred from 2005 to 2008, and included the following:

 
a.
Severance and retention - $7.4 million;
 
b.
Production inefficiencies, moving and revalidation - $4.6 million;
 
c.
Accelerated depreciation and asset write-offs - $1.1 million;
 
d.
Personnel - $8.4 million; and
 
e.
Other - $3.2 million.

All categories of costs were considered to be cash expenditures, except accelerated depreciation and asset write-offs.  All costs incurred during 2008 were included in the Greatbatch Medical business segment.  Accrued liabilities related to the 2005 & 2006 facility shutdowns and consolidations are comprised of the following (in thousands):
 
   
Severance
And
retention
    
Production
inefficiencies,
moving and
revalidation
    
Personnel
    
Other
    
Total
  
Balance, December 28, 2007
   $ 2,150     $ -     $ -     $ -     $ 2,150  
Restructuring charges
     159       42       184       278       663  
Cash payments
     (2,234 )     (42 )     (184 )     (278 )     (2,738 )
Balance, January 2, 2009
   $ 75     $ -     $ -     $ -     $ 75  
                                         
Cash payments
     (53 )     -       -       -       (53 )
Balance, July 3, 2009
   $ 22     $ -     $ -     $ -     $ 22  
 
 
- 18 -
 
 
GREATBATCH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – Unaudited
 
(b) 2007 & 2008 facility shutdowns and consolidations. In the first quarter of 2007, the Company announced that it would close its Electrochem manufacturing facility in Canton, MA and construct a new 81,000 square foot replacement facility in Raynham, MA.  This initiative was not cost savings driven but capacity driven and was completed in the first quarter of 2009.

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

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

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

In the fourth quarter of 2008, management of the Company approved a plan for the closure of its Teterboro, New Jersey (Electrochem manufacturing), Blaine, Minnesota (Vascular Access manufacturing) and Exton, Pennsylvania (Orthopaedics corporate office) facilities.  The Blaine, Minnesota and Exton, Pennsylvania consolidations were completed in the second quarter of 2009. The Teterboro, New Jersey initiative is expected to be completed over the next six months.

The total cost for the 2007 & 2008 facility shutdowns and consolidations is expected to be approximately $14.2 million to $17.5 million, of which $12.4 million has been incurred through July 3, 2009.  The major categories of costs include the following:

 
a.
Severance and retention - $4.5 million to $5.5 million;
 
b.
Production inefficiencies, moving and revalidation - $3.0 million to $4.0 million;
 
c.
Accelerated depreciation and asset write-offs - $3.5 million to $4.0 million;
 
d.
Personnel - $1.2 million to $1.5 million; and
 
e.
Other - $2.0 million to $2.5 million.
 
All categories of costs are considered to be cash expenditures, except accelerated depreciation and asset write-offs.  For the six months ended July 3, 2009, costs relating to these initiatives of $1.4 million and $2.1 million were included in the Greatbatch Medical and Electrochem business segments, respectively.  Costs incurred during the first six months of 2008 of $1.1 million and $0.5 million were included in the Greatbatch Medical and Electrochem business segments, respectively.

As a result of these consolidation initiatives, during the second quarter of 2009 two facilities with a carrying value of $4.3 million were transferred to held for sale in accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets.  As the current fair value of these facilities was determined to be above their carrying value, no impairment charge was recorded.  These facilities are expected to be sold within the next year.  As of July 3, 2009, the balance of assets held for sale was $5.5 million and is included in Other Current Assets in the Condensed Consolidated Balance Sheet.
 
- 19 -
 
 
GREATBATCH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (con’t) – Unaudited
 
Accrued liabilities related to the 2007 & 2008 facility shutdowns and consolidations are comprised of the following (in thousands):
 
   
Severance
and
retention
    
Production
inefficiencies
and
revalidation
    
Accelerated
depreciation/
asset write-
offs
    
Personnel
    
Other
    
Total
  
Balance, December 28, 2007
   $ 570     $ -     $ -     $ -     $ -     $ 570  
Restructuring charges
     2,661       2,074       2,978       82       552       8,347  
Write-offs
     -       -       (2,978 )     -       -       (2,978 )
Cash payments
     (2,637 )     (2,074 )     -       (82 )     (552 )     (5,345 )
Balance, January 2, 2009
   $ 594     $ -     $ -     $ -     $ -     $ 594  
                                                 
Restructuring charges
     1,468       588       324       372       725       3,477  
Write-offs
     -       -       (324 )     -       -       (324 )
Cash payments
     (454 )     (588 )     -       (372 )     (725 )     (2,139 )
Balance, July 3, 2009
   $ 1,608     $ -     $ -     $ -     $ -     $ 1,608  

(c) Integration costs. During the first six months of 2009 and 2008, the Company incurred costs related to the integration of the 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.  The expenses are primarily for consultants, relocation and travel costs that will not be required after the integrations are completed.

11.
INCOME TAXES

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

The effective tax rate for the second quarter of 2009 was 19.4%.  This is lower than the 35% U.S. federal statutory rate primarily as a result of the favorable impact of the resolution of tax audits during the quarter, which are treated as discrete items.  Currently we expect the effective tax rate (including discrete items) to be approximately 29% for 2009.
 
During the second quarter of 2009, the balance of unrecognized tax benefits decreased approximately $0.9 million to $4.0 million.  This is a result of the favorable impact of the resolution of tax audits during the quarter.  Approximately $2.5 million of the balance of unrecognized tax benefits would favorably impact the effective tax rate (net of federal benefit on state issues), if recognized.  It is reasonably possible that a reduction in the range of $0.8 million to $1.2 million of the balance of unrecognized tax benefits may occur within the next twelve months as a result of potential settlements with taxing authorities and the lapse of applicable statutes of limitation.

On May 4, 2009, President Obama’s administration outlined a proposal to modify certain aspects of the rules governing the U.S. taxation of certain non-U.S. subsidiaries. Many details of the proposal remain unknown and any legislation enacting such modifications would require Congressional approval; however, changes to these rules could impact our effective tax rate.

 
- 20 -
 

GREATBATCH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (con’t) – Unaudited

12.
COMMITMENTS AND CONTINGENCIES
 
Litigation – The Company is a party to various legal actions arising in the normal course of business.  While the Company does not believe, except as indicated below, that the ultimate resolution of any such pending actions will have a material adverse effect on its results of operations, financial position or cash flows, litigation is subject to inherent uncertainties.  If an unfavorable ruling were to occur, there exists the possibility of a material adverse impact in the period in which the ruling occurs.

As previously reported, on June 12, 2006, Enpath Medical, Inc. (“Enpath”), a subsidiary of the Company that has since been merged into Greatbatch Ltd., was named as defendant in a patent infringement action filed by Pressure Products Medical Supplies, Inc. (“Pressure Products”) in which Pressure Products alleged that Enpath’s FlowGuard™ valved introducer, which has been on the market for more than four years, and Enpath’s ViaSeal™ prototype introducer, which has not been sold, infringes claims in Pressure Products patents.  After trial, a jury found that Enpath infringed the Pressure Products patents, but not willfully, and awarded damages in the amount of $1.1 million.  The Company has appealed the judgment to the U.S. Court of Appeals for the Federal Circuit, and oral arguments were heard before that tribunal on April 21, 2009.  As a result of a post-trial motion and pending the appeal, the Company is permitted to continue to sell FlowGuard™ provided that it pays into an escrow fund a royalty of between $1.50 and $2.25 for each sale of a FlowGuard™ valved introducer.  The amount accrued as escrow during the second quarter of 2009 was $0.2 million and $1.2 million in total as of July 3, 2009.

During 2002, a former non-medical customer commenced an action alleging that Greatbatch had used proprietary information of the customer to develop certain products.  Management believes the Company has meritorious defenses and is vigorously defending the matter.  The matter is scheduled for trial during the third quarter of 2009.  The estimated potential risk of loss is up to $2.5 million.

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

The change in aggregate product warranty liability for the quarter ended July 3, 2009 is as follows (in thousands):

Beginning balance at April 3, 2009
   $ 1,420  
Additions to warranty reserve
     519  
Warranty claims paid
     (480 )
Ending balance at July 3, 2009
   $ 1,459  

 
- 21 -
 

GREATBATCH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (con’t) – 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.  Our purchase orders are normally based on our current manufacturing needs and are fulfilled by our vendors within short time horizons.  We enter into blanket orders with vendors that have preferred pricing and terms, however these orders are normally cancelable by us without penalty.  As of July 3, 2009, the total contractual obligation related to such expenditures is approximately $15.0 million and will be financed by existing cash and cash equivalents or cash generated from operations over the next twelve months.  We also enter into contracts for outsourced services; however, the obligations under these contracts were not significant and the contracts generally contain clauses allowing for cancellation without significant penalty.

Operating Leases - The Company is a party to various operating lease agreements for buildings, equipment and software.  Minimum future annual operating lease payments are $1.3 million for the remainder of 2009; $2.1 million in 2010; $1.9 million in 2011; $1.8 million in 2012; $1.7 million in 2013 and $3.0 million thereafter.  The Company primarily leases buildings, which accounts for the majority of the future lease payments.

Foreign Currency Contracts  - In December 2007, the Company entered into a forward contract to purchase 80,000,000 CHF, at an exchange rate of 1.1389 CHF per one U.S. dollar, in order to partially fund the purchase price of P Medical Holdings SA (“Precimed”), which was payable in Swiss Francs.  In January 2008, the Company entered into an additional forward contract to purchase 20,000,000 CHF at an exchange rate of 1.1156 per one U.S. dollar.  The Company entered into a similar foreign exchange contract in January 2008 in order to fund the purchase price of the DePuy Orthopaedics’ Chaumont, France facility (the “Chaumont Facility”), which was payable in Euros.  The net result of the above contracts, which were settled upon the funding of the respective acquisitions, was a gain of $2.4 million, $1.6 million of which was recorded in the first quarter of 2008 and $0.8 million in the fourth quarter of 2007 as Other Income, Net.

In February 2009, the Company entered into a forward contract to purchase 10 million Mexican pesos per month from March 2009 to December 2009 at an exchange rate of 14.85 pesos per one U.S. dollar.  This contract was entered into in order to hedge the risk of peso-denominated payments associated with the operations at the Company’s Tijuana, Mexico facility.  This contract was accounted for as a cash flow hedge and had a fair value of $0.4 million as of July 3, 2009, which is recorded within Other Assets in the Condensed Consolidated Balance Sheets.  No portion of the change in fair value of the foreign currency contracts during the first three months of 2009 was considered ineffective.  The amount recorded as a reduction of Cost of Sales during the first six months of 2009 related to the forward contract was $0.2 million.

 
- 22 -
 

GREATBATCH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (con’t) – Unaudited

13.
EARNINGS PER SHARE

The following table reflects the calculation of basic and diluted earnings per share (in thousands, except per share amounts):
   
Three months ended
    
Six months ended
  
   
July 3,
    
June 27,
    
July 3,
    
June 27,
  
   
2009
    
2008
    
2009
    
2008
  
Numerator for basic earnings per share: