INTEGER HOLDINGS CORP, 10-Q filed on 11/8/2011
Quarterly Report
Document and Entity Information
9 Months Ended
Sep. 30, 2011
Nov. 8, 2011
Document and Entity Information [Abstract]
 
 
Entity Registrant Name
GREATBATCH, INC. 
 
Entity Central Index Key
0001114483 
 
Document Type
10-Q 
 
Document Period End Date
Sep. 30, 2011 
 
Amendment Flag
FALSE 
 
Document Fiscal Year Focus
2011 
 
Document Fiscal Period Focus
Q3 
 
Current Fiscal Year End Date
--12-30 
 
Entity Filer Category
Accelerated Filer 
 
Entity Common Stock, Shares Outstanding
 
23,426,241 
Condensed Consolidated Balance Sheets (Unaudited) (USD $)
In Thousands
Sep. 30, 2011
Dec. 31, 2010
Current assets:
 
 
Cash and cash equivalents
$ 41,627 
$ 22,883 
Accounts receivable, net of allowance for doubtful accounts
82,829 
70,947 
Inventories
115,293 
101,440 
Refundable income taxes
2,763 
Deferred income taxes
7,856 
7,398 
Prepaid expenses and other current assets
5,426 
6,078 
Total current assets
253,031 
211,509 
Property, plant and equipment, net
144,307 
146,380 
Amortizing intangible assets, net
74,413 
75,114 
Trademarks and tradenames
20,288 
20,288 
Goodwill
308,557 
307,451 
Deferred income taxes
2,126 
2,427 
Other assets
9,113 
13,807 
Total assets
811,835 
776,976 
Current liabilities:
 
 
Accounts payable
30,507 
27,989 
Income taxes payable
1,213 
Deferred income taxes
618 
514 
Accrued liabilities
41,438 
32,084 
Total current liabilities
73,776 
60,587 
Long-term debt
198,305 
220,629 
Deferred income taxes
67,504 
64,290 
Other long-term liabilities
8,325 
4,641 
Total liabilities
347,910 
350,147 
Stockholders' equity:
 
 
Preferred stock
Common stock
23 
23 
Additional paid-in capital
305,106 
298,405 
Treasury stock, at cost
(1,048)
(1,469)
Retained earnings
146,883 
119,400 
Accumulated other comprehensive income (loss)
12,961 
10,470 
Total stockholders' equity
463,925 
426,829 
Total liabilities and stockholders' equity
$ 811,835 
$ 776,976 
Condensed Consolidated Balance Sheets (Unaudited) (Parenthetical) (USD $)
In Thousands, except Share data
Sep. 30, 2011
Dec. 31, 2010
Current assets:
 
 
Allowance for doubtful accounts
$ 2,300,000 
$ 1,800,000 
Stockholders' equity:
 
 
Preferred stock, par value
$ 0.001 
$ 0.001 
Preferred stock, shares authorized
100,000,000 
100,000,000 
Preferred stock, shares issued
Preferred stock, shares outstanding
Common stock, par value
$ 0.001 
$ 0.001 
Common stock, shares authorized
100,000,000 
100,000,000 
Common stock, shares issued
23,423,052 
23,319,492 
Common stock, shares outstanding
23,378,368 
23,256,897 
Treasury stock, shares
44,684 
62,595 
Condensed Consolidated Statements of Operations and Comprehensive Income (Unaudited) (USD $)
In Thousands, except Per Share data
3 Months Ended
Sep. 30, 2011
3 Months Ended
Oct. 1, 2010
9 Months Ended
Sep. 30, 2011
9 Months Ended
Oct. 1, 2010
Condensed Consolidated Statements of Operations and Comprehensive Income [Abstract]
 
 
 
 
Sales
$ 131,718 
$ 127,490 
$ 427,076 
$ 400,314 
Cost of sales
89,811 
85,496 
291,395 
271,197 
Gross profit
41,907 
41,994 
135,681 
129,117 
Operating expenses:
 
 
 
 
Selling, general and administrative expenses
17,760 
17,098 
53,980 
49,220 
Research, development and engineering costs, net
11,072 
11,402 
32,710 
33,603 
Other operating (income) expense, net
187 
325 
(166)
1,812 
Total operating expenses
29,019 
28,825 
86,524 
84,635 
Operating income
12,888 
13,169 
49,157 
44,482 
Interest expense
4,125 
4,577 
12,802 
14,864 
Interest income
(1)
(4)
(9)
(9)
(Gain) loss on cost method investments, net
(4,232)
Other (income) expense
(475)
306 
766 
822 
Income before provision for income taxes
9,239 
8,290 
39,830 
28,805 
Provision for income taxes
2,250 
2,326 
12,347 
9,506 
Net income
6,989 
5,964 
27,483 
19,299 
Earnings per share:
 
 
 
 
Basic
$ 0.30 
$ 0.26 
$ 1.18 
$ 0.84 
Diluted
$ 0.30 
$ 0.25 
$ 1.16 
$ 0.82 
Weighted average shares outstanding:
 
 
 
 
Basic
23,297 
23,078 
23,241 
23,060 
Diluted
23,611 
23,406 
23,663 
23,788 
Comprehensive income:
 
 
 
 
Net income
6,989 
5,964 
27,483 
19,299 
Foreign currency translation gain (loss)
(8,416)
9,253 
2,887 
4,599 
Net change in cash flow hedges, net of tax
(777)
281 
(396)
861 
Comprehensive income (loss)
$ (2,204)
$ 15,498 
$ 29,974 
$ 24,759 
Condensed Consolidated Statements of Cash Flows (Unaudited) (USD $)
In Thousands
9 Months Ended
Sep. 30, 2011
9 Months Ended
Oct. 1, 2010
Cash flows from operating activities:
 
 
Net income
$ 27,483 
$ 19,299 
Adjustments to reconcile net income to net cash provided by operating activities:
 
 
Depreciation and amortization
35,568 
34,873 
Stock-based compensation
8,803 
5,186 
(Gain) loss on cost method investments, net
(4,232)
Other non-cash (gains) losses
(1,180)
1,182 
Deferred income taxes
3,274 
(235)
Changes in operating assets and liabilities:
 
 
Accounts receivable
(10,429)
1,863 
Inventories
(13,594)
3,302 
Prepaid expenses and other assets
316 
2,110 
Accounts payable
2,212 
(3,327)
Accrued expenses
6,376 
1,368 
Income taxes payable
3,872 
6,391 
Net cash provided by (used in) operating activities
58,469 
72,012 
Cash flows from investing activities:
 
 
Acquisition of property, plant and equipment
(18,223)
(10,231)
Proceeds from sale of cost method investments, net
10,315 
Other investing activities
1,910 
(885)
Net cash provided by (used in) investing activities
(9,818)
(9,346)
Cash flows from financing activities:
 
 
Principal payments of long-term debt
(30,000)
(57,450)
Issuance of common stock
2,253 
659 
Payment of debt issuance costs
(2,114)
Other financing activities
(1,104)
(967)
Net cash provided by (used in) financing activities
(30,965)
(57,758)
Effect of foreign currency exchange rates on cash and cash equivalents
1,058 
224 
Net increase (decrease) in cash and cash equivalents
18,744 
5,132 
Cash and cash equivalents, beginning of period
22,883 
37,864 
Cash and cash equivalents, end of period
$ 41,627 
$ 42,996 
Condensed Consolidated Statement of Stockholders' Equity (Unaudited) (USD $)
In Thousands
Total
Common Stock
Additional Paid-In Capital
Treasury Stock
Retained Earnings
Accumulated Other Comprehensive Income (Loss)
Balance at Dec. 31, 2010
$ 426,829 
$ 23 
$ 298,405 
$ (1,469)
$ 119,400 
$ 10,470 
Balance, shares at Dec. 31, 2010
 
23,319 
 
(63)
 
 
Stock-based compensation
5,062 
 
5,062 
 
 
 
Net shares issued under stock incentive plans, shares
 
104 
 
18 
 
 
Net shares issued under stock incentive plans
2,179 
 
1,758 
421 
 
 
Income tax liability from stock options, restricted stock and restricted stock units
(119)
 
(119)
 
 
 
Net income
27,483 
 
 
 
27,483 
 
Total other comprehensive income (loss)
2,491 
 
 
 
 
2,491 
Balance at Sep. 30, 2011
$ 463,925 
$ 23 
$ 305,106 
$ (1,048)
$ 146,883 
$ 12,961 
Balance, shares at Sep. 30, 2011
 
23,423 
 
(45)
 
 
Basis of Presentation
BASIS OF PRESENTATION

1. BASIS OF PRESENTATION

 

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information (Accounting Standards Codification (“ASC”) 270, Interim Reporting) and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information necessary for a full presentation of financial position, results of operations, and cash flows in conformity with accounting principles generally accepted in the United States of America (“U.S. GAAP”). Operating results for interim periods are not necessarily indicative of results that may be expected for the fiscal year as a whole. In the opinion of management, the condensed consolidated financial statements reflect all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation of the results of Greatbatch, Inc. and its wholly-owned subsidiary, Greatbatch Ltd. (collectively “Greatbatch” or the “Company”), for the periods presented. The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, sales, expenses, and related disclosures at the date of the financial statements and during the reporting period. Actual results could differ materially from these estimates. The December 31, 2010 condensed consolidated balance sheet data was derived from audited consolidated financial statements but does not include all disclosures required by U.S. GAAP. For further information, refer to the consolidated financial statements and notes included in the Company's Annual Report on Form 10-K for the year ended December 31, 2010. The Company utilizes a fifty-two, fifty-three week fiscal year ending on the Friday nearest December 31st. For 52-week years, each quarter contains 13 weeks. The third quarter of 2011 and 2010 each contained 13 weeks and ended on September 30, and October 1, respectively.

 

Supplemental Cash Flow Information
SUPPLEMENTAL CASH FLOW INFORMATION

2. SUPPLEMENTAL CASH FLOW INFORMATION

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

3. INVENTORIES

 Inventories are comprised of the following (in thousands):
       
  As of
  September 30, December 31,
  2011 2010
 Raw materials$ 51,878 $ 45,974
 Work-in-process  36,774   34,659
 Finished goods  26,641   20,807
 Total$ 115,293 $ 101,440
Intangible Assets
INTANGIBLE ASSETS

4. INTANGIBLE ASSETS

 Amortizing intangible assets are comprised of the following (in thousands):
              
 AtSeptember 30, 2011 Gross Carrying Amount  Accumulated Amortization  Foreign Currency Translation  Net Carrying Amount
 Purchased technology and patents$ 89,273 $ (52,979) $ 1,745 $ 38,039
 Customer lists  46,818   (13,172)   2,327   35,973
 Other  3,519   (3,179)   61   401
 Total amortizing intangible assets$ 139,610 $ (69,330) $ 4,133 $ 74,413
              
 AtDecember 31, 2010           
 Purchased technology and patents$ 83,023 $ (48,187) $ 1,212 $ 36,048
 Customer lists  46,818   (10,577)   2,119   38,360
 Other  3,519   (2,862)   49   706
 Total amortizing intangible assets$ 133,360 $ (61,626) $ 3,380 $ 75,114

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

 The change in goodwill is as follows (in thousands):
           
    Greatbatch Medical  Electrochem  Total
 AtDecember 31, 2010$ 297,508 $ 9,943 $ 307,451
 Foreign currency translation  1,106  0   1,106
 AtSeptember 30, 2011$ 298,614 $ 9,943 $ 308,557
Debt
DEBT

5. DEBT

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

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

 

The 2011 Credit Facility is secured by the Company's non-realty assets including cash, accounts receivable and inventories. Interest rates under the 2011 Credit Facility are, at the Company's option either at: (i) the higher of (a) the prime rate and (b) the federal funds rate plus 0.5%, plus the applicable margin, which ranges between 0.0% and 1.0%, based on the Company's total leverage ratio or (ii) the applicable LIBOR rate divided by a number equal to 1.0 minus the maximum aggregate Federal Reserve System “Euro-currency Liabilities” reserve requirement plus the applicable margin, which ranges between 1.5% and 3.0%, based on the Company's total leverage ratio. Loans under the swingline subfacility will bear interest at the higher of (a) the prime rate and (b) the federal funds rate plus 0.5%, plus the applicable margin, which ranges between 0.0% and 1.0%, based on the Company's total leverage ratio. The Company is also required to pay a commitment fee which, varies between 0.175% and 0.25% depending on the Company's total leverage ratio.

 

The 2011 Credit Facility contains limitations on the incurrence of indebtedness, liens and licensing of intellectual property, investments and certain payments. The 2011 Credit Facility permits the Company to: 1) engage in permitted acquisitions in the aggregate not to exceed $250 million; 2) make other investments not to exceed $60 million in the aggregate; 3) make stock repurchases not to exceed $60 million in the aggregate; and 4) retire up to $198 million of Greatbatch, Inc.'s CSN II. At any time that the total leverage ratio of the Company for the two most recently ended fiscal quarters is less than 2.75 to 1.0, the Company may make an election to reset each of the amounts specified in clauses (1) through (4) above. Additionally, these limitations can be waived upon the Company's request and approval of a majority of the lenders. As of September 30, 2011, the Company had available to it the full amount of the above limits.

The 2011 Credit Facility requires the Company to maintain a rolling four quarter ratio of adjusted EBITDA to interest expense of at least 3.0 to 1.0, and a total leverage ratio of not greater than 4.5 to 1.0 through December 30, 2011, and not greater than 4.0 to 1.0 from December 31, 2011, and thereafter. The calculation of adjusted EBITDA and total leverage ratios excludes non-cash charges, extraordinary, unusual, or non-recurring expenses or losses, non-cash stock-based compensation, and non-recurring expenses or charges incurred in connection with permitted acquisitions. As of September 30, 2011, the Company was in compliance with all covenants.

 

The 2011 Credit Facility contains customary events of default. Upon the occurrence and during the continuance of an event of default, a majority of the lenders may declare the outstanding advances and all other obligations under the 2011 Credit Facility immediately due and payable.

 

The weighted average interest rate on borrowings under the 2011 Credit Facility as of September 30, 2011, was 1.97%. As of September 30, 2011, the Company had $380 million of borrowing capacity available under the 2011 Credit Facility. This borrowing capacity may vary from period to period based upon the debt levels of the Company as well as the level of EBITDA, which impacts the covenant calculations described above.

 

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

 

Convertible Subordinated Notes – In May 2003, the Company completed a private placement of $170 million of 2.25% convertible subordinated notes, due June 15, 2013 (“CSN I”). In March 2007, the Company entered into separate, privately negotiated agreements to exchange $117.8 million of CSN I for an equivalent principal amount of a new series of 2.25% convertible subordinated notes due 2013 (“CSN II”) (collectively the “Exchange”) at a 5% discount. The primary purpose of the Exchange was to eliminate the June 15, 2010 call and put option that was included in the terms of CSN I. In connection with the Exchange, the Company issued an additional $80 million aggregate principal amount of CSN II.

 

CSN II bear interest at 2.25% per annum, payable semi-annually, and are due on June 15, 2013. The holders may convert the notes into shares of the Company's common stock at a conversion price of $34.70 per share, which is equivalent to a conversion ratio of 28.8219 shares per $1,000 of principal. The conversion price and the conversion ratio will adjust automatically upon certain changes to the Company's capitalization. The fair value of CSN II as of September 30, 2011 was approximately $193 million and is based on recent sales prices.

 

The effective interest rate of CSN II, which takes into consideration the amortization of the discount and deferred fees related to the issuance of these notes, is 8.5%. The discount on CSN II is being amortized to the maturity date of the convertible notes utilizing the effective interest method. As of September 30, 2011, the carrying amount of the discount related to the CSN II conversion option value was $16.5 million. As of September 30, 2011, the if-converted value of the CSN II notes does not exceed their principal amount as the Company's closing stock price of $20.01 per share did not exceed the conversion price of $34.70 per share.

 The contractual interest and discount amortization for CSN II were as follows (in thousands):
             
  Three Months Ended Nine Months Ended
  September 30,  October 1, September 30, October 1,
  2011 2010 2011 2010
 Contractual interest$ 1,113 $ 1,113 $ 3,338 $ 3,338
 Discount amortization  2,602   2,434   7,676   7,182

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

 

Conversions in connection with corporate transactions that constitute a fundamental change require the Company to pay a premium make-whole amount, based upon a predetermined table as set forth in the indenture agreement, whereby the conversion ratio on the notes may be increased by up to 7.0 shares per $1,000 of principal. The premium make-whole amount will be paid in shares of common stock upon any such conversion, subject to the net share settlement feature of the notes described below.

 

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

 

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

 

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

 

 AtDecember 31, 2010$2,005
 Financing costs deferred 2,164
 Write-off during the period (51)
 Amortization during the period (703)
 AtSeptember 30, 2011$3,415
Pension Plans
PENSION PLANS

6. PENSION PLANS

 

The Company is required to provide its employees located in Switzerland and France certain defined pension benefits. These benefits accrue to employees based upon years of service, position, age and compensation. The defined benefit pension plan that provides benefits to the Company's employees located in Switzerland is a funded contributory plan while the pension plan that provides benefits to the Company's employees located in France is unfunded and noncontributory.

 The change in net pension liability is as follows (in thousands):
     
 AtDecember 31, 2010$4,647
 Net periodic pension cost 885
 Benefit payments (805)
 Foreign currency translation 104
 AtSeptember 30, 2011$4,831

 Net pension cost is comprised of the following (in thousands):      
             
  Three Months Ended Nine Months Ended
  September 30, October 1, September 30, October 1,
  2011 2010 2011 2010
 Service cost$ 290 $ 245 $ 825 $ 714
 Interest cost  124   107   355   313
 Amortization of net loss and prior service cost  21   5   60   16
 Expected return on plan assets  (126)   (109)   (355)   (317)
 Net pension cost$ 309 $ 248 $ 885 $ 726
             
Stock-Based Compensation
STOCK-BASED COMPENSATION

7. STOCK-BASED COMPENSATION

 

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

 

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

 

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

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

 The following table summarizes time-vested stock option activity:
      Number of Time-Vested Stock Options  Weighted Average Exercise Price  Weighted Average Remaining Contractual Life (In Years)  Aggregate Intrinsic Value (In Millions)
 Outstanding atDecember 31, 2010  1,463,556 $ 23.46      
  Granted  292,959   24.15      
  Exercised  (78,028)   21.41      
  Forfeited or expired  (101,901)   22.55      
 Outstanding atSeptember 30, 2011  1,576,586 $ 23.75   6.3 $ 0.4
 Exercisable atSeptember 30, 2011  1,055,286 $ 23.51   5.2 $ 0.4

 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 atDecember 31, 2010  744,523 $ 23.68      
  Exercised (25,194)   22.56      
  Forfeited or expired  (235,977)   22.22      
 Outstanding atSeptember 30, 2011  483,352 $ 24.45  6.2 $0.0
 Exercisable atSeptember 30, 2011  252,894 $ 22.55  5.2 $0.0

 The following table summarizes time-vested restricted stock and unit activity:
      Time-Vested Activity  Weighted Average Fair Value
 Nonvested atDecember 31, 2010  123,386 $ 22.57
  Granted  25,241   24.16
  Vested  (7,993)   21.98
  Forfeited or expired  (2,713)   23.23
 Nonvested atSeptember 30, 2011  137,921 $ 22.88

 The following table summarizes performance-vested restricted stock and unit activity:
      Performance-Vested Activity  Weighted Average Fair Value
 Nonvested atDecember 31, 2010  283,797 $ 15.10
  Granted  279,415   18.21
  Vested  (200)   18.47
  Forfeited or expired  (11,394)   16.11
 Nonvested atSeptember 30, 2011  551,618 $ 16.67
Other Operating Expenses, Net
OTHER OPERATING EXPENSES, NET

8. OTHER OPERATING (INCOME) EXPENSE, NET

 Other Operating (Income) Expense, Net is comprised of the following (in thousands):
             
  Three Months Ended Nine Months Ended
  September 30, October 1, September 30, October 1,
  2011 2010 2011 2010
 Orthopaedic facility optimization(a)$ 164 $ 59 $ 425 $ 59
 2007 & 2008 facility shutdowns and consolidations(b)  -   165   -   1,021
 Integration costs(c)  -   5   -   135
 Asset dispositions and other(d) 23   96  (591)   597
  $ 187 $ 325 $ (166) $ 1,812

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

       

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

 

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

 

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

 The change in accrued liabilities related to the orthopaedic facility optimization is as follows (in thousands):
                 
    Severance and Retention  Production Inefficiencies, Moving and Revalidation  Accelerated Depreciation/Asset Write-offs  Other  Total
 AtDecember 31, 2010$ - $ - $ - $ - $ -
 Restructuring charges  -   397   18   10   425
 Write-offs  -   -   (18)   -   (18)
 Cash payments  -   (397)   -   (10)   (407)
 AtSeptember 30, 2011$0 $0 $0 $0 $0

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

 

  • Consolidated its Electrochem manufacturing facilities in Canton, MA, Teterboro, NJ and Suzhou, China, into a newly constructed facility in Raynham, MA;

  • Consolidated its corporate offices in Clarence, NY into its technology center also in Clarence, NY;
  • Reorganized and consolidated various general and administrative and research and development functions throughout the organization in order to optimize those resources with the businesses it acquired in 2007 and 2008;
  • Consolidated its Orchard Park, NY (Electrochem manufacturing), Exton, PA (Orthopaedic corporate office) and Saignelegier, Switzerland (Orthopaedic manufacturing) facilities into existing facilities that had excess capacity; and
  • Consolidated its manufacturing operations in Blaine, MN into its Plymouth, MN facility.

 

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

 

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

 

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

 

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

 

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

Income Taxes
INCOME TAXES

9. INCOME TAXES

 

The income tax provision for interim periods is determined using an estimate of the annual effective tax rate, adjusted for discrete items, if any, that are taken into account in the relevant period. Each quarter, the estimate of the annual effective tax rate is updated, and if the estimated effective tax rate changes, a cumulative adjustment is made. There is a potential for volatility of the effective tax rate due to several factors, including changes in the mix of pre-tax income and the jurisdictions to which it relates, business acquisitions, settlements with taxing authorities and foreign currency fluctuations. The Company is currently under audit by the Internal Revenue Service for fiscal years 2010 and 2009 but is not expecting the audit to have a material impact on the effective tax rate when settled.

 

During the third quarter of 2011, the balance of unrecognized tax benefits decreased by $0.9 million, primarily as a result of the reversal of uncertain tax positions due to the expiration of the statute of limitations. Approximately $1.0 million of the balance of unrecognized tax benefits would favorably impact the effective tax rate (net of federal benefit on state issues), if recognized. It is reasonably possible that a reduction in the range of up to $0.8 million of the balance of unrecognized tax benefits may occur within the next twelve months as a result of the expiration of applicable statutes of limitation and potential audit settlements.

Commitments And Contingencies
COMMITMENTS AND CONTINGENCIES

10. COMMITMENTS AND CONTINGENCIES

 

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

 

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

 

 AtJuly 1, 2011$2,173 
 Warranty claims paid (436) 
 Foreign currency effect (22) 
 AtSeptember 30, 2011$1,715 

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

 

Purchase Commitments – Contractual obligations for purchase of goods or services are defined as agreements that are enforceable and legally binding on the Company and that specify all significant terms, including: fixed or minimum quantities to be purchased; fixed, minimum or variable price provisions; and the approximate timing of the transaction. As of September 30, 2011, the total contractual obligation related to such expenditures is approximately $27.2 million and will primarily be financed by existing cash and cash equivalents, cash generated from operations, or draws under the 2011 Credit Facility over the next twelve months. We also enter into blanket purchase orders with vendors that have preferred pricing and terms, as well as contracts with vendors for outsourced services. However, the obligations under these purchase orders and service contracts generally contain clauses allowing for cancellation without significant penalty.

 

Foreign Currency Contracts In December 2009 and February 2010, the Company entered into forward contracts to purchase 6.6 million and 3.3 million, respectively, Mexican pesos per month through December 2010 at an exchange rate of 13.159 pesos and 13.1595 pesos per one U.S. dollar, respectively. These contracts were entered into in order to hedge the risk of peso-denominated payments associated with the operations at the Company's Tijuana, Mexico facility for 2010 and were accounted for as cash flow hedges.

 

In July 2010 and February 2011, the Company entered into forward contracts to purchase 6.6 million and 3.7 million, respectively, Mexican pesos per month through December 2011 at an exchange rate of 13.2231 pesos and 12.2761 pesos per one U.S. dollar, respectively. These contracts were entered into in order to hedge the risk of peso-denominated payments associated with a portion of the operations at the Company's Tijuana, Mexico facility for 2011 and are being accounted for as cash flow hedges.

 

In September 2011, the Company entered into forward contracts to purchase 6.5 million and 4.9 million Mexican pesos per month beginning in January 2012 through December 2012 at an exchange rate of 13.0354 pesos and 14.0287 pesos per one U.S. dollar, respectively. These contracts were entered into in order to hedge the risk of peso-denominated payments associated with a portion of the operations at the Company's Tijuana, Mexico facility for 2012 and are being accounted for as cash flow hedges.

 

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

 

Self-Insured Medical Plan The Company self-funds the medical insurance coverage provided to its U.S. based employees. The risk to the Company is being limited through the use of stop loss insurance, which has an annual deductible of $0.2 million per covered participant. The maximum aggregate loss (the sum of all claims under the $0.2 million deductible) is limited to $14.2 million with a maximum benefit of $1.0 million. As of September 30, 2011, the Company has $2.8 million accrued related to the self-insurance of its medical plan, which is recorded in Accrued Expenses in the Condensed Consolidated Balance Sheet, and is primarily based upon claim history.

 

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

Earnings Per Share (Eps)
EARNINGS PER SHARE (EPS)

11. EARNINGS PER SHARE (“EPS”)

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

 The diluted weighted average share calculations do not include the following securities, which are not dilutive to the EPS calculations or the performance criteria have not been met:
           
    Three Months Ended Nine Months Ended
    September 30, October 1, September 30, October 1,
    2011 2010 2011 2010
 Time-vested stock options, restricted stock        
  and restricted stock units976,000  977,000 925,000 1,099,000
 Performance-vested stock options and        
  restricted stock units672,000  844,000 678,000 883,000
Comprehensive Income
COMPREHENSIVE INCOME

12. ACCUMULATED OTHER COMPREHENSIVE INCOME

 

 Accumulated Other Comprehensive Income is comprised of the following (in thousands):
   Defined Benefit Pension Plan Liability  Cash Flow Hedges  Foreign Currency Translation Adjustment  Total Pre-Tax Amount  Tax  Net-of-Tax Amount
AtDecember 31, 2010$ (2,014) $ (121) $ 12,230 $ 10,095 $ 375 $ 10,470
Unrealized loss on cash flow hedges  -   (523)   -   (523)   183   (340)
Realized gain on cash flow hedges  -   (86)   -   (86)   30   (56)
Foreign currency translation gain  -   -   2,887   2,887   -   2,887
AtSeptember 30, 2011$ (2,014) $ (730) $ 15,117 $ 12,373 $ 588 $ 12,961
Fair Value Measurements
FAIR VALUE MEASUREMENTS

13. FAIR VALUE MEASUREMENTS

 

The following table provides information regarding assets and liabilities recorded at fair value in the Company's Condensed Consolidated Balance Sheet as of September 30, 2011 (in thousands):

 

   Fair Value Measurements Using
       Quoted      
       Prices in  Significant   
       Active Markets  Other  Significant
   At  for Identical  Observable  Unobservable
   September 30,  Assets  Inputs  Inputs
Description 2011  (Level 1)  (Level 2)  (Level 3)
Foreign currency contracts            
 Accrued Expenses $ 568 $0 $ 568 $0
 Other Long-Term Liabilities   162  0   162  0

Foreign currency contracts - The fair value of foreign currency contracts are determined through the use of cash flow models that utilize observable market data inputs to estimate fair value. These observable market data inputs include foreign exchange rate and credit spread curves. In addition to the above, the Company receives fair value estimates from the foreign currency contract counterparty to verify the reasonableness of the Company's estimates. The Company's foreign currency contracts are categorized in Level 2 of the fair value hierarchy.

 

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

 

Cost method investments - The Company holds certain cost method investments that are measured at fair value on a non-recurring basis in periods subsequent to initial recognition. The fair value of a cost method investment is only estimated if there are identified events or changes in circumstances that indicate impairment may be present. The aggregate carrying amount of the Company's cost method investments included in Other Assets was $5.7 million and $11.8 million as of September 30, 2011 and December 31, 2010, respectively. During the second quarter of 2011, the Company recorded a $0.3 million write-down of one of its cost method investments based upon a recent stock offering by that Company. On January 5, 2011, the Company sold its cost method investment in IntElect Medical, Inc. (“IntElect”) in conjunction with Boston Scientific's acquisition of IntElect. This transaction resulted in a pre-tax gain of $4.5 million.

 

Business Segment, Geographic and Concentration Risk Information
BUSINESS SEGMENT, GEOGRAPHIC AND CONCENTRATION RISK INFORMATION

14. BUSINESS SEGMENT, GEOGRAPHIC AND CONCENTRATION RISK INFORMATION

 

The Company operates its business in two reportable segments – Greatbatch Medical and Electrochem Solutions (“Electrochem”). The Greatbatch Medical segment designs and manufactures medical devices and components for the cardiac rhythm management (“CRM”), neuromodulation, vascular access and orthopaedic markets. Additionally, Greatbatch Medical offers value-added assembly and design engineering services for products that incorporate Greatbatch Medical components. As a result of the strategy put in place over three years ago, Greatbatch Medical now offers its customers complete medical devices including design, development, manufacturing, regulatory submission and supporting worldwide distribution. This medical device strategy is being facilitated through the Company's QiG Group and leverages the component technology of Greatbatch Medical and Electrochem in the Company's core markets: cardiovascular, neuromodulation and orthopaedic.

 

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

 

The Company defines segment income from operations as sales less cost of sales including amortization and expenses attributable to segment-specific selling, general and administrative, research, development and engineering expenses, and other operating expenses. Segment income also includes a portion of non-segment specific selling, general and administrative expenses based on allocations appropriate to the expense categories. The remaining unallocated operating and other expenses are primarily administrative corporate headquarters expenses and capital costs that are not allocated to reportable segments. Transactions between the two segments are not significant.

 

An analysis and reconciliation of the Company's business segment, product line and geographic information to the respective information in the Condensed Consolidated Financial Statements follows. Sales by geographic area are presented by allocating sales from external customers based on where the products are shipped to (in thousands):

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

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

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

               
 Four customers accounted for a significant portion of the Company’s sales as follows:
               
    Three Months Ended Nine Months Ended
    September 30, October 1, September 30, October 1,
  2011 2010 2011 2010
 Customer A 18%  19%  20%  22%
 Customer B 20%  19%  18%  18%
 Customer C 11%  11%  13%  12%
 Customer D 9%  9%  8%  8%
     58%  58%  59%  60%

 Long-lived tangible assets by geographic area are as follows (in thousands):
  As of
  September 30, December 31,
  2011 2010
 United States$ 110,311 $ 126,519
 Rest of world  33,996   36,095
 Total$ 144,307 $ 162,614
Impact of Recently Issued Accounting Standards
IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS

15. IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS

 

In the normal course of business, management evaluates all new accounting pronouncements issued by the Financial Accounting Standards Board (“FASB”), Securities and Exchange Commission, Emerging Issues Task Force, American Institute of Certified Public Accountants or other authoritative accounting bodies to determine the potential impact they may have on the Company's Condensed Consolidated Financial Statements. Based upon this review except as noted below, management does not expect any of the recently issued accounting pronouncements, which have not already been adopted, to have a material impact on the Company's Condensed Consolidated Financial Statements.

 

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

 

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

 

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