Our Business

Greatbatch, Inc. is a leading designer and manufacturer of high quality, innovative products and systems to customers in the cardiac, neuromodulation, orthopedics and commercial markets. 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.

The Company operates its business in two reportable segments - Implantable Medical Components ("IMC") and Electrochem. The IMC segment includes sales of cardiac rhythm management ("CRM"), neuromodulation, therapy delivery and orthopedic products. The therapy delivery product line was added through the acquisitions of Enpath Medical, Inc. ("Enpath") and Quan Emerteq, LLC ("Quan") in the second quarter and fourth quarter of 2007, respectively. The orthopedic product line was added through the acquisition of P Medical Holding SA ("Precimed") and the DePuy Orthopedics Chaumont, France manufacturing facility (the "Chaumont Facility") in the first quarter of 2008. The Electrochem segment includes revenue from the Company's wholly-owned subsidiary Electrochem Solutions, Inc. ("Electrochem"). Electrochem designs and manufactures high performance batteries and battery packs for use in the energy, security, portable medical, environmental, mobile data and process markets. With the acquisitions of Engineered Assemblies Corporation ("EAC") and IntelliSensing, LLC ("Intellisensing") in the fourth quarter of 2007, the Electrochem business includes revenue from the design and manufacturing of rechargeable battery and wireless sensor systems.

Our IMC customers include leading Original Equipment Manufacturers ("OEM"), in alphabetical order here and throughout this report, such as Biotronik, Boston Scientific, DePuy Orthopedics, Johnson & Johnson, Medtronic, the Sorin Group, Smith & Nephew, St. Jude Medical and Zimmer Holdings, Inc. The nature and extent of our selling relationships with each IMC customer are different in terms of breadth of component products purchased, purchased product volumes, length of contractual commitment, ordering patterns, inventory management and selling prices. During 2007 and in the first quarter of 2008, we completed five acquisitions in the IMC market consistent with our strategic objective to diversify our customer base and market concentration. For the first nine months of 2008, Boston Scientific, DePuy Orthopedics, Medtronic and St. Jude Medical, collectively accounted for 55% of our total sales, compared to 67% for the comparable 2007 period. Additionally, for the first nine months of 2008 sales to the CRM market were below 50% of total sales compared to approximately 80% for the same period in 2007.

Our Electrochem customers are companies involved in the energy, security, portable medical, environmental, mobile data and process markets and include Conmed Linvatec, General Electric, Halliburton Company, PathFinder Energy Services, Thales, Weatherford International and Zoll Medical.

Financial Overview

Consolidated sales in the third quarter of 2008 were $136.2 million, including $48.7 million incremental revenue related to our acquisitions in 2007 and 2008, an increase of 72% over the prior year quarter. Excluding acquisitions, sales for the third quarter of 2008 increased by 12% over the prior year primarily due to higher sales of CRM products. Compared to the second quarter of 2008, sales decreased $5.4 million primarily due to lower orthopedic revenue resulting from holiday shutdowns at our European facilities.

Operating income increased to $15.7 million for the third quarter of 2008, compared to $10.3 million and $11.4 million for the third quarter of 2007 and second quarter of 2008, respectively. Operating income for the third quarter of 2008 included $3.6 million of acquisition related charges, consolidation costs and integration expenses compared to $0.1 million for the same period in 2007 and $2.9 million for the second quarter of 2008. Operating margin (operating income/sales) is lower due to the impact of our acquisitions in 2007 and 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 significant improvement in operating income over the last two quarters. While this expansion in operating margin is indicative of the type of improvements we are trying to achieve, we do not believe the current quarter's results can be assumed for a full year run-rate given the non-linear nature of our business. In particular, the timing of customer orders, inventory production and the implementation of our various operating initiatives can all significantly impact, both positively and negatively, our operating margins from quarter to quarter.

As of the end of the third quarter of 2008, cash and cash equivalents totaled $20.0 million. These funds along with the cash generated from operations ($47.7 million for the first nine months of 2008) and the availability 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. Since the beginning of the year, we have repaid $9 million of our debt.

We have been working diligently on completing the integration of our strategic acquisitions to improve the overall diversification of our business and leverage the core operational and product development strengths of our company. We believe this will significantly enhance our long term growth and profitability.
This diversification strategy has helped expand our opportunity within a variety of new markets, including the orthopedics and therapy delivery markets. As part of the acquisitions, we were able to add proprietary technologies and product lines to our portfolio as well as strategic manufacturing and product development capabilities. In addition, we expanded and diversified our global customer relationships.

Although the acquisitions helped diversify our customer base and reduce our concentration, it also created additional opportunities to sell a broader portfolio of products across multiple divisions within several key accounts. Instead of simply selling just to the cardiac rhythm management sector within one of our customers, we can now sell to their orthopedics business, neuromodulation, and therapy delivery sectors. We have taken great strides in diversifying Greatbatch and will continue to integrate these new businesses and look for ways to drive both near term and long term revenue gains.

Another key element of our strategy is focused on streamlining our operational efficiencies and optimizing our production. At Greatbatch, we have a history of successfully optimizing and consolidating operations. We have already identified and implemented several key initiatives to enhance the operating performance of these new businesses and move them closer to our operating model. As evidenced by the improvement in our operating margin from the second quarter of 2008, we have begun to realize several of the benefits. We have approached this initiative on several different fronts and expect our plans to take two years to implement.

Based on this and our current portfolio of research and development activities, we feel we are in a strong competitive position for future growth and profitability.

Product Development

Currently, we are developing a series of new products for customer applications in the CRM, neuromodulation, therapy delivery, orthopedics and commercial markets. Some of the key development initiatives include:

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

2. Continue development of MRI compatible product lines;

3. Integrate Biomimetic coating technology with therapy delivery devices;

4. Complete design of next generation steerable catheters;

5. Further minimally invasive surgical techniques for orthopedics industry;

6. Develop disposable instrumentation;

7. Provide wireless sensing solutions to commercial customers; and

8. Develop a charging platform for commercial secondary offering.

In May 2008, we announced the execution of a letter of intent in which the Sorin Group will leverage our MRI technology in their future CRM devices. At the same time we continue to explore and develop similar relationships with other customers in both the CRM and neuromodulation space. The MRI compatible leadwire system is just one aspect of our goal to continue to deliver innovative solutions for our customers that improve the functionality, safety, and efficiency of their products.

Approximately $13.8 million of the Enpath purchase price 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. These projects primarily represent the next generation of introducer and catheter products already being sold by Enpath which incorporate new enhancements and customer modifications. We expect to commercially launch various introducer products in 2008 and 2009 which will replace existing products. However, some of the 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 have been enjoined 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 more profitable projects. These delays in introducer and catheter projects are not expected to have a material impact on our results of operations.

Approximately $2.2 million of the Precimed 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. 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 expect to commercially launch these products in 2008 and 2009. Several of the orthopedic projects acquired have been delayed and one has been cancelled due to the timing of customer adoption, technical difficulties and feasibility assessments. These changes are not expected to have a material impact on our results of operations.

Cost Savings and Consolidation Efforts

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

In the fourth quarter of 2005, we announced our intent to close both the Columbia, MD facility ("Columbia Facility") and the Fremont, CA Advanced Research Laboratory ("ARL"). We also announced that the manufacturing operations at the Columbia Facility would be moved into the Tijuana Facility and that the research, development and engineering and product development functions at the Columbia Facility and at ARL would relocate to the Technology Center in Clarence, NY. The ARL move and closure 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.

The total cost for these consolidations was $18.8 million and include the following:

· Severance and retention - $7.4 million;

· Production inefficiencies and revalidation - $1.6 million;

· Accelerated depreciation and asset write-offs - $1.1 million;

· Personnel - $5.9 million; and

· Other - $2.8 million.

All categories of costs are considered to be cash expenditures, except accelerated depreciation and asset write-offs. The expenses for the 2005 facility shutdowns and consolidations are included in the IMC business segment.

2007 & 2008 facility shutdowns and consolidations - In the first quarter of 2007, we announced that we will close our current Electrochem manufacturing facility in Canton, MA and construct a new 80,000 square foot replacement facility in Raynham, MA. This initiative is not cost savings driven but capacity driven for the commercial group.

In the second quarter of 2007, we announced that we will consolidate our corporate offices in Clarence, NY into our existing Research and Development center in Clarence, NY after an expansion of that facility was complete. This expansion and relocation was completed in the third quarter of 2008.

As a result of our acquisitions in 2007 and 2008, during the second quarter of 2008, we began reorganizing and consolidating various general and administrative and research and development functions throughout the organization in order to optimize those resources.

During the third quarter of 2008, we ceased manufacturing at our facility in Suzhou, China, which was acquired from EAC, and closed our manufacturing facility in Orchard Park, NY, which was acquired from Intellisensing,
LLC. Additionally, we initiated the consolidation of one Switzerland manufacturing location, which we acquired from Precimed. The operations at these facilities will be relocated to existing facilities which have excess capacity.

The above initiatives are expected to be completed over the next three to nine months. The total cost for these facility shutdowns and consolidations is expected to be approximately $5.5 million to $6.9 million of which $3.5 million has been incurred through September 26, 2008. The major categories of costs include the following:

· Severance and retention - $1.5 million - $1.9 million;

· Production inefficiencies and revalidation - $1.6 million - $2.0 million;

· Accelerated depreciation and asset write-offs - $1.6 million - $2.0 million;

· Personnel - $0.3 million - $0.4 million; and

· Other - $0.5 million - $0.6 million.

All categories of costs are considered to be cash expenditures, except accelerated depreciation and asset write-offs. For the nine months ended September 26, 2008 expenses of $1.1 million related to the Electrochem facility expansion, Suzhou, China shutdown and Orchard Park facility consolidation which are included in the Electrochem business segment. For the nine months ended September 26, 2008 costs related to the relocation of our corporate offices and reorganizing and consolidating various general and administrative and research and development functions of $1.4 million were included in the IMC business segment. The costs incurred in 2007 relate to the facility expansion in Raynham, MA and are included in the Electrochem business segment. As of September 26, 2008 and December 28, 2007, $0.2 million and $0.5 million of accrued consolidation expenses relate to the IMC business segment, respectively. The remaining $0.4 million of restructuring charges were not allocated as they primarily related to corporate functions.

Subsequent Event - In October 2008, management of the Company approved a plan for the closure of its Teterboro, New Jersey (Electrochem manufacturing), Blaine, Minnesota (Therapy Delivery manufacturing) and Exton, Pennsylvania (Orthopedics corporate office) facilities. The operations at these facilities will be moved to other existing facilities with excess capacity. The total cost for these facility consolidations is estimated to be between $5.7 million and $7.0 million and will be incurred over the next twelve to fifteen months. The major categories of costs include the following:

a. Severance and retention - $2.1 million to $2.5 million;

b. Production inefficiencies and revalidation - $0.3 million to $0.5 million;

c. Accelerated depreciation and asset write-offs - $1.5 million to $1.7 million;

d. Personnel - $1.2 million to $1.4 million; and

e. Other - $0.6 million to $0.9 million.

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
third quarter of 2008 and 2007 ended on September 26, and September 28,
respectively. The commentary that follows should be read in conjunction with our
consolidated financial statements and Management's Discussion and Analysis of
Financial Condition and Results of Operations contained in our Form 10-K for the
fiscal year ended December 28, 2007.

                                 Three months ended                                                    Nine months ended
                          September 26,       September 28,          $             %           September 26,       September 28,          $             %
In thousands, except
per share data                2008                2007            Change         Change            2008                2007            Change        Change
IMC
   CRM/Neuromodulation   $        64,859     $        56,956         7,903             14 %   $       187,848     $       188,159          (311 )           0 %
   Therapy Delivery               14,521              10,047         4,474             45 %            46,824              11,632        35,192            NA
   Orthopedic                     37,940                   -        37,940             NA             106,700                   -       106,700            NA
Total IMC                        117,320              67,003        50,317             75 %           341,372             199,791       141,581            71 %
Electrochem                       18,922              12,006         6,916             58 %            58,672              34,540        24,132            70 %
Total sales                      136,242              79,009        57,233             72 %           400,044             234,331       165,713            71 %
Cost of sales -
excluding
amortization of
intangible
assets                            92,779              48,647        44,132             91 %           285,856             141,697       144,159           102 %
Cost of sales -
amortization
of intangible assets               1,710               1,222           488             40 %             5,141               3,164         1,977            62 %
Total Cost of Sales               94,489              49,869        44,620             89 %           290,997             144,861       146,136           101 %
Cost of sales as a %
of sales                            69.4 %              63.1 %                        6.3 %              72.7 %              61.8 %                      10.9 %

Selling, general, and
administrative
expenses (SG&A)                   15,681              11,362         4,319             38 %            52,685              32,130        20,555            64 %
SG&A as a % of sales                11.5 %              14.4 %                       -2.9 %              13.2 %              13.7 %                      -0.5 %

Research, development
and engineering costs,
net (RD&E)                         6,793               8,423        (1,630 )          -19 %            23,722              21,856         1,866             9 %
RD&E as a % of sales                 5.0 %              10.7 %                       -5.7 %               5.9 %               9.3 %                      -3.4 %

Other operating
expense, net                       3,565                (985 )       4,550             NA               9,714              20,889       (11,175 )         -53 %
Operating income                  15,714              10,340         5,374             52 %            22,926              14,595         8,331            57 %
Operating margin                    11.5 %              13.1 %                       -1.6 %               5.7 %               6.2 %                      -0.5 %

Interest expense                   3,268               2,112         1,156             55 %             9,908               5,345         4,563            85 %
Interest income                     (142 )            (1,586 )       1,444            -91 %              (663 )            (6,028 )       5,365           -89 %
Other (income)
expense, net                        (234 )                70          (304 )           NA              (1,597 )            (8,318 )       6,721           -81 %
Provision for income
taxes                              5,193               4,744           449              9 %             5,218              11,326        (6,108 )         -54 %
Effective tax rate                  40.5 %              48.7 %                       -8.2 %              34.2 %              48.0 %                     -13.8 %

Net income               $         7,629     $         5,000     $   2,629             53 %   $        10,060     $        12,270     $  (2,210 )         -18 %
Net margin                           5.6 %               6.3 %                       -0.7 %               2.5 %               5.2 %                      -2.7 %
Diluted earnings per
share                    $          0.33     $          0.22     $    0.11             50 %   $          0.44     $          0.54     $   (0.10 )         -19 %

IMC. The nature and extent of our selling relationship with each OEM customer is different in terms of 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 and can significantly change from quarter to quarter. 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. Also, changing customer order patterns due to market share shifts or accelerated device replacements may also impact our sales results as customer inventory levels may have to be rebalanced to match demand.

Third quarter sales for the IMC business segment were $117.3 million, a 75% increase over the prior year quarter and a 3% decrease over the second quarter of 2008.

The CRM and neuromodulation product line reported revenues of $64.9 million for the third quarter of 2008, a 14% increase compared to third quarter 2007 and consistent with the sequential quarter. In comparison to the prior year, the third quarter benefited from the increased adoption of our Q Series high rate ICD batteries as well as higher feedthrough and assembly revenue. These benefits were partially offset by lower demand for coated components, due to a customer recall near the end of 2007 unrelated to Greatbatch products, lower ICD battery sales and lower capacitor sales.

2008 third quarter revenues for the Therapy Delivery product line were $14.5 million, compared to $10.0 million for the comparable 2007 quarter and $15.8 million for the second quarter 2008. This increase over the prior year is primarily due to the Quan acquisition in November 2007 which added $5.5 million to revenue. The decrease from the sequential quarter was a result of lower demand for our catheter products.

The Orthopedic product line reported $37.9 million in sales for the quarter compared to $41.0 million in the second quarter of 2008. This quarter's results include the seasonal impact of holiday manufacturing facility shut downs at our European locations.

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

Third quarter sales for Electrochem were $18.9 million compared to $12.0 million in the third quarter 2007 and $20.1 million in the second quarter of 2008. The increase in sales compared with the prior year is a result of the acquisition of EAC in November 2007 which added $6.2 million to revenue, as well as strong demand from the oil and gas market. The decrease from the sequential quarter was primarily due to the timing of orders from our customers.

Cost of sales

Changes from the prior year to cost of sales as a percentage of sales were primarily due to the following:

. . .