Our Business
Greatbatch, Inc. is a leading developer and manufacturer of critical products used in medical devices for the cardiac rhythm management ("CRM"), neuromodulation, vascular, orthopaedic and interventional radiology markets. Additionally, Greatbatch, Inc. is a world leader in the design, manufacture and distribution of battery and wireless sensing technologies. When used in this report, the terms "we," "us," "our" and the "Company" mean Greatbatch, Inc. and its subsidiaries. We believe that our proprietary technology, close customer relationships, multiple product offerings, market leadership and dedication to quality provide us with competitive advantages and create a barrier to entry for potential market entrants.

We operate our business in two reportable segments - Greatbatch Medical and Electrochem Solutions ("Electrochem"). During 2009, we rebranded our Implantable Medical Component ("IMC") segment as Greatbatch Medical. The Greatbatch Medical segment designs and manufactures components and devices for the CRM, Neuromodulation, Vascular Access and Orthopaedic markets. These include batteries, capacitors, filtered feedthroughs, engineered components and enclosures used in Implantable Medical Devices ("IMDs") and more recently hip and knee replacement, trauma and spine as well as hip and shoulder implants and introducers, catheters, implantable stimulation leads and microcomponents. Additionally, the Greatbatch Medical business offers value-added assembly and design engineering services for products that incorporate Greatbatch Medical components.

Electrochem is a world leader in the design, manufacture and distribution of electrochemical cells, battery packs and wireless sensors for demanding applications in markets such as energy, security, portable medical, environmental monitoring and more.

Our Customers
Our Greatbatch Medical customers include leading Original Equipment Manufacturers ("OEM"), in alphabetical order here and throughout this report, such as Biotronik, Boston Scientific, DePuy, Johnson & Johnson, Medtronic, Smith & Nephew, the Sorin Group, St. Jude Medical, Stryker and Zimmer Holdings, Inc. The nature and extent of our selling relationships with each Greatbatch Medical customer are different in terms of breadth of products purchased, purchased product volumes, length of contractual commitment, ordering patterns, inventory management and selling prices. During the first six months of 2009, Boston Scientific, Johnson & Johnson, Medtronic and St. Jude Medical collectively accounted for 63% of our total sales.

Our Electrochem customers are primarily companies in markets such as energy, security, portable medical and environmental monitoring including General Electric, Halliburton Company, Scripps Institution of Oceanography, Thales, Weatherford International and Zoll Medical Corp.

Financial Overview
Consolidated sales for the first six months of 2009 were $274.5 million, an increase of 4% over the comparable 2008 period. This growth was driven by CRM and Neuromodulation revenue and the benefit of a full six months of Orthopaedic operations ($8 million) as compared to the 2008 period. Partially offsetting these increases were lower Electrochem revenue due to a slow-down in the energy markets and approximately $4 million of foreign currency impact on our Orthopaedic sales. Our revenue is significantly impacted each quarter due to the timing of various customer product launches, shifts in customer market share, customer inventory management initiatives as well as marketplace field actions.

Operating income increased to $27.3 million for the first six months of 2009 compared to $7.2 million for the comparable 2008 period. Operating income for the first six months of 2009 included $5.2 million of acquisition related charges, consolidation costs and integration expenses compared to $12.6 million for the same period in 2008. We have initiated various consolidation initiatives aimed at streamlining our operations and improving operating profitability. The progress made on these initiatives can be seen by the improvement in operating margin from 2008 to 2009.

As of the end of the second quarter of 2009, cash and cash equivalents totaled $19.0 million. These funds along with the cash generated from operations and the $114 million available under our line of credit are sufficient to meet our operating and investment activities for the foreseeable future, including the cash expenditures relating to our consolidation initiatives. During the first two quarters of 2009, we repaid $11 million of our long-term debt which was funded by cash flows from operations.

Our CEO's View

We continued to deliver solid financial results during the first half of 2009. This was a direct result of our balanced approach to diversifying our revenue base, continuously generating value through operating performance improvements, and delivering innovative new products to our customers. We continued to make important strides in reducing costs and implementing the Greatbatch operating model across all of our business lines, as evidenced by the progress we have made on the integration of our acquisitions and our ongoing consolidation of facilities around the globe. We remain focused on reaching our financial and operational goals for the year, but we are also keenly aware of the market conditions that continue to impact our business. While these market conditions are expected to be our biggest challenge in the second half of 2009, we believe our strong cash generation, financial discipline and effective cost structure will enable us to continue to increase shareholder value.

Product Development
Currently, we are developing a series of new products for customer applications in the CRM/Neuromodulation, Vascular Access, Orthopaedic and Electrochem markets. Some of the key development initiatives include:

1. To continue the evolution of our Q series high rate ICD batteries;

2. To continue development of MRI compatible components;

3. To continue development of higher energy/higher density capacitors;

4. To integrate Biomimetic coating technology with therapy delivery devices;

5. To complete design of next generation steerable catheters;

6. To further minimally invasive surgical techniques for the orthopaedics industry;

7. To develop disposable instrumentation;

8. To provide wireless sensing solutions to Electrochem customers; and

9. To develop a charging platform for Electrochem secondary offering.

Approximately $2.3 million of the BIOMEC, Inc. ("BIOMEC") acquisition purchase price in April 2007 was allocated to the estimated fair value of acquired in-process research and development ("IPR&D") projects that had not yet reached technological feasibility and had no alternative future use, thus were immediately expensed on the date of acquisition. The value assigned to IPR&D related to projects that incorporate BIOMEC's novel-polymer coating (biomimetic) technology that mimics the surface of endothelial cells of blood vessels. An agreement was reached in 2008 with an OEM partner to provide coating material and services for their catheter products. The 510(k) application was approved by the Food and Drug Administration ("FDA") and sales began in the second quarter of 2009. There have been no significant changes from our original estimates with regard to these projects.

Approximately $13.8 million of the Enpath Medical, Inc. ("Enpath") acquisition purchase price in June 2007 was allocated to the estimated fair value of acquired IPR&D projects that had not yet reached technological feasibility and had no alternative future use, thus were immediately expensed on the date of acquisition. These projects primarily represent the next generation of introducer and catheter products already being sold by Enpath which incorporate new enhancements and customer modifications. One introducer project was launched near the end of 2008. We expect to commercially launch the other introducer products under development in 2010 which will replace existing products. These introducer projects acquired have been delayed due to timing of customer adoption and transition and technical difficulties of some of the projects. Additionally, future sales from our ViaSealTM introducer project are uncertain due to litigation (See "Litigation"). The catheter IPR&D project, to which a portion of the Enpath purchase price was allocated, has been put on hold indefinitely in order to allocate resources to other projects. The lost revenue from the delays in these introducer and catheter projects are expected to be partially offset with revenue from other projects initiated after the acquisition of Enpath.

Approximately $2.2 million of the P Medical Holding SA ("Precimed") acquisition purchase price was allocated to the preliminary estimated fair value of acquired IPR&D projects that had not yet reached technological feasibility and had no alternative future use, thus were immediately expensed on the date of acquisition. The value assigned to IPR&D related to Reamer, Instrument Kit, Locking Plate and Cutting Guide projects. These projects primarily represent the next generation of products already being sold by Precimed which incorporate new enhancements and customer modifications. We commercially launched a portion of these products in 2008 and expect to launch others in 2009. Several of the other orthopaedic projects acquired have been delayed and two have been cancelled due to the timing of customer adoption, technical difficulties, inability to meet margin goals and feasibility assessments. These changes are not expected to have a material impact on operating income as these projects were expected to have lower margins associated with them.

Cost Savings and Consolidation Efforts
From 2005 to 2008, we recorded charges in other operating expenses related to our ongoing cost savings and consolidation efforts. Additional information is set forth in Note 10 - "Other Operating Expense" of the Notes to the Condensed Consolidated Financial Statements contained in this report.

2005 & 2006 facility shutdowns and consolidations - Beginning in the first quarter of 2005 and ending in the second quarter of 2006 we consolidated our medical capacitor manufacturing operations in Cheektowaga, NY, and our implantable medical battery manufacturing operations in Clarence, NY, into our advanced power source manufacturing facility in Alden, NY ("Alden Facility"). We also consolidated our capacitor research, development and engineering operations from our Cheektowaga, NY facility into our technology center in Clarence, NY.

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

In the fourth quarter of 2005, we announced our intent to close our Columbia, MD facility ("Columbia Facility") and Fremont, CA Advanced Research Laboratory ("ARL"). We also announced that the manufacturing operations at our Columbia Facility would be moved into our Tijuana Facility and that the research, development and engineering and product development functions at our Columbia Facility and at ARL would relocate to our 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, we completed a plan for consolidating our 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.

2007 & 2008 facility shutdowns and consolidations - In the first quarter of 2007, we announced that we would close our 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, we announced that we would consolidate our corporate offices in Clarence, NY into our 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, we reorganized and consolidated various general and administrative and research and development functions throughout the organization in order to optimize those resources with the businesses we acquired in 2007 and 2008.

In the second half of 2008, we ceased manufacturing at our facility in Suzhou, China (Electrochem), closed our leased manufacturing facility in Orchard Park, NY (Electrochem), and consolidated our 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, we approved a plan for the closure of our 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 first two quarters of 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.

Our Financial Results
We utilize 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 ended on July 3, and June 27, respectively. The commentary that follows should be read in conjunction with our Condensed Consolidated Financial Statements and related notes and with the Management's Discussion and Analysis of Financial Condition and Results of Operations contained in our Form 10-K for the fiscal year ended January 2, 2009.

During the first quarter of 2009, we were 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)." 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 the Condensed Consolidated Financial Statements contained in this report, 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. This FSP requires retrospective restatement for all prior periods presented in financial statements. Accordingly, the 2008 Condensed Consolidated Financial Statements presented in this report have been retroactively adjusted to reflect the accounting for FSP APB 14-1 as if it were in effect as of the date CSN II was originally issued. See Note 2 to the Condensed Consolidated Financial Statements.

                                            Three months ended                                     Six months ended
                                           July 3,      June 27,          $             %        July 3,      June 27,          $             %
In thousands, except per share data         2009          2008         Change       Change        2009          2008         Change       Change
Greatbatch Medical
   CRM/Neuromodulation                    $  78,026     $  70,720     $  7,306           10 %   $ 155,293     $ 135,884       19,409           14 %
   Vascular Access                            9,152         9,842         (690 )         -7 %      19,885        19,409          476            2 %
   Orthopaedic                               31,389        40,974       (9,585 )        -23 %      65,472        68,760       (3,288 )         -5 %
Total Greatbatch Medical                    118,567       121,536       (2,969 )         -2 %     240,650       224,053       16,597            7 %
Electrochem                                  16,158        20,112       (3,954 )        -20 %      33,893        39,749       (5,856 )        -15 %
Total sales                                 134,725       141,648       (6,923 )         -5 %     274,543       263,802       10,741            4 %
Cost of sales                                93,253       101,053       (7,800 )         -8 %     188,907       196,508       (7,601 )         -4 %
Gross profit                                 41,472        40,595          877            2 %      85,636        67,294       18,342           27 %
Gross profit as a % of sales                   30.8 %        28.7 %                     2.1 %        31.2 %        25.5 %                     5.7 %

Selling, general, and administrative
expenses (SG&A)                              17,885        18,657         (772 )         -4 %      36,572        37,004         (432 )         -1 %
SG&A as a % of sales                           13.3 %        13.2 %                     0.1 %        13.3 %        14.0 %                    -0.7 %

Research, development and engineering
costs, net (RD&E)                             8,694         7,705          989           13 %      16,569        16,929         (360 )         -2 %
RD&E as a % of sales                            6.5 %         5.4 %                     1.1 %         6.0 %         6.4 %                    -0.4 %

Other operating expense, net                  2,424         2,881         (457 )        -16 %       5,227         6,149         (922 )        -15 %
Operating income                             12,469        11,352        1,117           10 %      27,268         7,212       20,056          278 %
Operating margin                                9.3 %         8.0 %                     1.3 %         9.9 %         2.7 %                     7.2 %

Interest expense                              4,930         4,889           41            1 %       9,819         9,967         (148 )         -1 %
Interest income                                  (2 )        (125 )        123          -98 %         (27 )        (521 )        494          -95 %
Other (income) expense, net                    (604 )          94         (698 )         NA          (397 )      (1,363 )        966          -71 %
Provision (benefit) for income taxes          1,583         1,781         (198 )        -11 %       4,647        (1,139 )      5,786           NA
Effective tax rate                             19.4 %        27.4 %                    -8.0 %        26.0 %          NA                        NA

Net income                                $   6,562     $   4,713     $  1,849           39 %   $  13,226     $     268     $ 12,958           NA
Net margin                                      4.9 %         3.3 %                     1.6 %         4.8 %         0.1 %                     4.7 %
Diluted earnings per share                $    0.28     $    0.21     $   0.07          7.0 %   $    0.56     $    0.01     $   0.55           NA

  Sales

                                            Three months ended                        Six months ended
                                    July 3,      June 27,         %          July 3,      June 27,         %
Sales:                               2009          2008         Change        2009          2008         Change
Greatbatch Medical
   CRM/Neuromodulation             $  78,026     $  70,720         10%      $ 155,293     $ 135,884         14%
   Vascular Access                     9,152         9,842         -7%         19,885        19,409         2%
   Orthopaedic                        31,389        40,974        -23%         65,472        68,760         -5%
Total Greatbatch Medical             118,567       121,536         -2%        240,650       224,053         7%
Electrochem                           16,158        20,112        -20%         33,893        39,749        -15%
Total sales                        $ 134,725     $ 141,648         -5%      $ 274,543     $ 263,802         4%

Greatbatch Medical - The nature and extent of our selling relationship with each OEM customer is different in terms of component products purchased, selling prices, product volumes, ordering patterns and inventory management. We have pricing arrangements with our customers that at times do not specify minimum order quantities. Our visibility to customer ordering patterns is over a relatively short period of time. Our customers may have inventory management programs and alternate supply arrangements of which we are unaware. Additionally, the relative market share among the OEM manufacturers changes periodically. Consequently, these and other factors can significantly impact our sales in any given period.

Our customers may initiate field actions with respect to market-released products. These actions may include product recalls or communications with a significant number of physicians about a product or labeling issue. The scope of such actions can range from very minor issues affecting a small number of units to more significant actions. There are a number of factors, both short-term and long-term, related to these field actions that may impact our results. In the short-term, if a product has to be replaced, or customer inventory levels have to be restored, component demand will increase. Also, changing customer order patterns due to market share shifts or accelerated device replacements may also have a positive or negative impact on our sales results in the near-term. These same factors may have longer-term implications as well. Customer inventory levels may ultimately have to be rebalanced to match demand.

Greatbatch Medical sales decreased 2% for the second quarter of 2009 when compared to the same period of 2008 as CRM and Neuromodulation revenue growth of 10% was offset by decreases in Vascular Access and Orthopaedic revenues. Greatbatch Medical sales for the first six months of 2009 were $240.7 million, an increase of 7% over the comparable 2008 period. This growth was driven by CRM and Neuromodulation revenue and the benefit of a full six months of Orthopaedic operations ($8 million) as compared to the 2008 period. Partially offsetting these increases was $4 million of foreign currency impact on our Orthopaedic sales as well as other market conditions in the Orthopaedic market.

CRM and Neuromodulation product line revenue of $78.0 million for the quarter increased 10% over the prior year. The second quarter's results benefited from strong feedthrough, coated component and assembly revenue partially offset by lower capacitor sales. CRM revenue is significantly impacted each quarter due to the timing of various customer product launches, shifts in customer market share, customer inventory management initiatives as well as marketplace field actions. Additionally, CRM revenue is impacted by the overall market growth for implantable devices. The last several quarters of CRM revenue have benefited from the timing of various customer product launches and is expected to begin to return to more normalized growth levels for the remainder of 2009.

Second quarter revenues for our Vascular Access product line were $9.2 million, compared to the prior year quarter revenues of $9.8 million. This decrease was primarily due to lower catheter revenues. We remain optimistic about the potential of this product line as we continue to work with customers on new product development. However, many of the projects that we are working on today will not be seen in our results until 2010.

The Orthopaedic product line reported revenues of $31.4 million for the quarter compared to $41.0 million for second quarter 2008. Current quarter revenues include the negative impact of foreign currency exchange rate fluctuations of approximately $2 million as well as other market conditions, including a delay in product launches and elective surgeries. Additionally, second quarter 2008 revenue included the benefit from the release of approximately $3 million of excess backlog. We believe that year over year comparisons in orthopaedic revenues will continue to be challenging for the remainder of 2009. We continue to streamline and invest in our orthopaedic operations which we believe presents significant opportunities.

Electrochem - We have pricing arrangements with our customers that many times do not specify minimum quantities. Our visibility to customer ordering patterns is over a relatively short period of time.

Second quarter and first half 2009 sales for our Electrochem business segment were $16.2 million and $33.9 million, respectively, compared to $20.1 million and $39.7 million in the comparable 2008 periods, respectively. These decreases are consistent with the slow down in the energy and portable medical markets over the last two quarters, driven by lower oil prices and uncertainty in the healthcare industry. We continue to actively manage our business so that we will be better prepared to meet the needs of our customers once the markets recover.

2009 Sales Outlook - Our continuing outlook is for full year 2009 sales to be in the range of $550 million to $600 million. This revenue projection assumes that we will continue to grow faster than our underlying markets by leveraging our diversified revenue base and our strength in the development and manufacturing of custom technologies for our customers. This projection may be impacted by a . . .