Business Overview

Headquartered in Arden Hills, Minnesota, IntriCon Corporation (together with its subsidiaries referred to as the "Company", "we", "us" or "our") is an international firm engaged in designing, developing, engineering and manufacturing body-worn devices and electronic products. Currently, the Company has two operating segments: its body worn device segment and electronics products segment. The Company serves the body-worn device market by designing, developing, engineering and manufacturing micro-miniature injection-molded plastics, microelectronics, micro-mechanical assemblies and complete assemblies, primarily for bio-telemetry devices, medical equipment, hearing instruments, electronics, professional audio and telecommunications devices and computers. In addition to its operations in Minnesota, the Company has facilities in California, Maine, Singapore, and Germany.

Currently, the Company has two operating segments: its body worn device segment and electronics products segment. Prior to 2008, the Company's body-worn device and electronics products segments were combined in the Company's precision miniature medical and electronics products segment. The Company determined these segments no longer meet the criteria for aggregation. The nature of the products and services has been deemed separately identifiable, as the Company has further developed technologies and products included in the body-worn device segment. Furthermore, as the underlying products and technology have changed, the economic characteristics of each business segment are not expected to be similar. Our electronics products segment margin is subject to more variability due to material pricing and we believe our future revenue growth and margin will be different for each segment as a result of the proprietary technology included in our body-worn device products.

Body-Worn Device Segment

Medical

In the medical market, the Company is focused on sales of multiple biotelemetry devices from life-critical diagnostic monitoring devices to drug-delivery systems. Using our nanoDSP™ and ultra-low power ("ULP") nanoLink™ technology, the Company manufactures microelectronics, micro-mechanical assemblies, high-precision injection-molded plastic components and complete bio-telemetry devices for emerging and leading medical device manufacturers. Targeted customers include medical product manufacturers of portable and lightweight battery powered devices, as well as a variety of sensors designed to connect a patient to an electronic device.

The medical industry is faced with pressures to reduce the costs of healthcare. IntriCon currently serves this market by offering medical manufacturers the capabilities to design, develop and manufacture components for medical devices that are easier to use, measure with greater accuracy and provide more functions while reducing the costs to manufacture these devices. IntriCon manufactures and supplies bubble sensors and flow restrictors that monitor and control the flow of fluid in an intravenous infusion system. IntriCon also manufactures a family of safety needle products for an original equipment manufacturer ("OEM") customer that utilizes IntriCon's insert and straight molding capabilities. These products are assembled using full automation including built-in quality checks within the production lines. Other examples include sensors used to detect pathologies in specific organs of the body and monitoring devices to detect cardiac, respiratory functions, and blood glucose levels. The early and accurate detection of pathologies allows for increased likelihood for successful treatment of chronic diseases and cancers. Accurate monitoring of multiple functions of the body, such as heart rate, breathing and blood glucose levels, aids in generating more accurate diagnosis and treatments for patients.

In addition, there has been an industry-wide trend toward further miniaturization and ambulatory operation enabled by wireless connectivity, which is also referred to as bio-telemetry. Through the further development of our ULP BodyNet™ family, a series of wirelessly enabled products including our new wireless nanoLink™ family, we believe the bio-telemetry offers a significant future opportunity. Increasingly, the medical industry is looking for wireless, low-power capabilities in their devices. We believe our strategic partnership with AME will allow us to develop new bio-telemetry devices that better connect patients and care givers, providing critical information and feedback. Current examples of IntriCon biotelemetry products used by medical device manufacturers include components found in wireless glucose sensor pumps that introduce drugs into the bloodstream.

Hearing Health

IntriCon manufactures hybrid amplifiers and integrated circuit components ("hybrid amplifiers"), along with faceplates for in-the-ear and in-the-canal hearing instruments. IntriCon is a leading manufacturer and supplier of microminiature electromechanical components to hearing instrument manufacturers. These components consist of volume controls, microphones, receivers, trimmer potentiometers and switches. Components are offered in a variety of sizes, colors and capacities in order to accommodate a hearing manufacturer's individualized specifications.

Hearing instruments, which fit behind or in a person's ear to amplify and process sound for a hearing impaired person, generally are composed of four basic parts and several supplemental components for control or fitting purposes. The four basic parts are microphones, amplifier circuits, miniature receivers/speakers and batteries, all of which IntriCon manufactures, with the exception of the battery. IntriCon's hybrid amplifiers are a type of amplifier circuit. Supplemental components include volume controls, trimmer potentiometers, which shape sound frequencies to respond to the particular nature of a person's hearing loss, and switches used to turn the instrument on and off and to go from telephone to normal speech modes. Faceplates and an ear shell, molded to fit the user's ear, often serve as housing for hearing instruments. IntriCon manufactures its components on a short lead-time basis in order to supply "just-in-time" delivery to its customers and, consequently, order backlog amounts are not meaningful.

Using our ULP BodyNet™ family technology, specifically nanoDSP™ and our new wireless nanoLink™ product family, IntriCon is building a new generation of affordable, high-quality hearing aids and similar amplifier devices under contracts for OEM's. Digital signal processing ("DSP") devices have better clarity, attractive pricing points and an improved ability to filter out background noise. During 2008, we introduced Ethos, our new high-performance adaptive DSP hearing instrument amplifier. In our view, Ethos' advanced capabilities are ideally suited for the hearing health market. We believe the introduction of Ethos solidifies our position as a leader of high-performance adaptive DSP hearing instrument amplifiers. Furthermore, we believe our strategic alliance with Dynamic Hearing will allow us to develop new body-worn applications and further expand both our hearing health and professional audio product portfolio.

Overall, we believe the hearing health market holds significant opportunities for the Company. In the United States, Europe and Japan, the 65-year-old-plus age demographic is the fastest growing segment of the population, and many of those individuals could, at some point, benefit from a hearing device that uses IntriCon's proprietary technology.

While it harbors great potential, the hearing health market is experiencing slowness due to macroeconomic conditions. In general, the U.S. market does not provide insurance reimbursement for hearing aid purchases. People can defer their hearing aid purchase. We believe the softness in the market will continue into 2009. Reimbursement trends in Europe are more favorable, with insurers and the governments covering more devices.

Professional Audio Communications

IntriCon entered the high-quality audio communication device market in 2001, and now has a line of miniature, professional audio headset products used by customers focusing on homeland security and emergency response needs. The line includes several communication devices that are extremely portable and perform well in noisy or hazardous environments. These products are well suited for applications in the fire, law enforcement, safety, aviation and military markets. In addition, the Company has a line of miniature ear- and head-worn devices used by performers and support staff in the music and stage performance markets. Our May 2007 acquisition of Tibbett's Industries provided the Company access to homeland security agencies in this market. We believe performance in difficult listening environments and wireless operations will continue to improve as these products increasingly include our proprietary nanoDSP™, wireless nanoLink™ and ULP nanoLink™ technology.

Electronics Products Segment

Our electronic products segment business is conducted by RTI Electronics, Inc. ("RTIE"), a wholly owned subsidiary of the Company. RTIE manufactures and sells thermistors and thermistor assemblies, which are solid state devices that produce precise changes in electrical resistance as a function of any change in absolute body temperature. RTIE sells through its Surge-Gard™ product line, an inrush current limiting device used primarily in computer power supplies. The balance of sales represents various industrial, commercial and military sales for other thermistor, film capacitor and magnetic products to domestic and international markets.

Forward-Looking and Cautionary Statements

Certain statements included in this Quarterly Report on Form 10-Q or documents the Company files with the Securities and Exchange Commission, which are not historical facts, or that include forward-looking terminology such as "may", "will", "believe", "expect", "should", "optimistic" or "continue" or the negative thereof or other variations thereof, are forward-looking statements (as such term is defined in Section 21E of the Securities Exchange Act of 1934 and
Section 27A of the Securities Act of 1933, and the regulations thereunder), which are intended to be covered by the safe harbors created thereby. These statements may include, but are not limited to statements in "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Notes to the Company's Condensed Consolidated Financial Statements" such as net operating loss carryforwards, the ability to meet cash requirements for operating needs, the ability to meet liquidity needs, assumptions used to calculate future level of funding of employee benefit plans, the adequacy of insurance coverage, the impact of new accounting pronouncements and litigation.

Forward-looking statements also include, without limitation, statements as to the Company's expected future results of operations and growth, the Company's ability to meet working capital requirements, the Company's business strategy, the expected increases in operating efficiencies, anticipated trends in the Company's precision miniature medical and electronic products markets, estimates of goodwill impairments and amortization expense of other intangible assets, the effects of changes in accounting pronouncements, the effects of litigation and the amount of insurance coverage, and statements as to trends or the Company's or management's beliefs, expectations and opinions.

Forward-looking statements are subject to risks and uncertainties and may be affected by various factors that may cause actual results to differ materially from those in the forward-looking statements. In addition to the factors discussed in this Quarterly Report on Form 10-Q, certain risks, uncertainties and other factors can cause actual results and developments to be materially different from those expressed or implied by such forward-looking statements, including, without limitation, the following:

† the ability to successfully implement the Company's business and growth strategy;
† risks arising in connection with the insolvency of our former subsidiary, Selas SAS, and potential liabilities and actions arising in connection therewith;
† the volume and timing of orders received by the Company;
† changes in estimated future cash flows;
† ability to collect on our accounts receivable;
† foreign currency movements in markets the Company services;
† changes in the global economy and financial markets;
† weakening demand for the Company's products due to general economic conditions;
† changes in the mix of products sold;
† ability to meet demand;
† changes in customer requirements;
† timing and extent of research and development expenses;
† acceptance of the Company's products;
† competitive pricing pressures;
† pending and potential future litigation;
† cost and availability of electronic components and commodities for the Company's products;
† ability to create and market products in a timely manner and develop products that are inexpensive to manufacture;
† ability to repay debt when it comes due;
† the loss of one or more of our major customers;
† ability to identify and integrate acquisitions;
† effects of legislation;
† effects of foreign operations;
† foreign currency risks;
† ability to recruit and retain engineering and technical personnel;
† the costs and risks associated with research and development investments;
† our ability and the ability of our customers to protect intellectual property; and
† loss of members of our senior management team.

For a description of these and other risks, see "Risk Factors" in Part I, Item 1A: Risk Factors in the Company's Annual Report on Form 10-K for the year ended December 31, 2008 or in other filings the Company makes from time to time with the Securities and Exchange Commission. The Company does not undertake to update any forward-looking statement that may be made from time to time by or on behalf of the Company.

Results of Operations

Sales, net

Consolidated net sales for the three months ended March 31, were as follows (in
thousands):



                                                                Change
                                      2009       2008     Dollars    Percent

              Body-Worn Devices     $ 11,844   $ 14,606   ($ 2,762 )   (18.9% )

              Electronic Products   $  1,486   $  1,985   ($   499 )   (25.1% )

Our net sales are comprised of four main markets: hearing health, medical, professional audio device and electronics. Sales, net broken down by market for the three months ended March 31, 2009 was as follows: medical 40%, hearing health 33%, professional audio communications 16% and electronics 11%. Sales, net for the three months ended March 31, 2009 were down 20 percent over the same prior year period, as a result of the fluctuations described below.

For the three months ended March 31, 2009, we experienced an increase of 8 percent in net sales in the medical equipment market as a direct result of increased sales to existing OEM customers. Management believes there is an industry-wide trend toward further miniaturization and ambulatory operation enabled by wireless connectivity, referred to as bio-telemetry, which resulted in further growth in our medical business. We have experienced solid growth in our most advanced biotelemetry device, a continuous wireless glucose monitor, which we manufacture for a major medical OEM. We are also working with our strategic partner, AME, on proprietary biotelemetry technologies that will enable us to develop new devices that connect patients and care givers, providing critical information and feedback.

Net sales in our hearing health business for the three months ended March 31, 2009 decreased 32 percent from the same period in 2008, primarily due to lower demand from our customers in this market as people delayed hearing aid purchases, compounded by the fact that the first quarter of our fiscal year is typically the weakest. We believe the softness in the market will continue through the first half of 2009, with customers cautiously beginning to replenish inventory levels and reengaging projects during the second half of the year. Despite the anticipated short-term softness, we believe our longer term prospects in our hearing health business remain strong as we continue to develop advanced technologies, such as our nanoDSP™, which will enhance the performance of hearing devices. In addition, we believe the market indicators in the hearing health industry, including the aging world population, suggest long-term industry growth.

Net sales to the professional audio device sector declined 34 percent for the three month period ended March 31, 2009 compared to the same period in 2008, impacted by various customers in this market cautiously working through their inventories and delaying projects due to current economic uncertainties and lower demand for their products. In spite of this decline, we believe our extensive portfolio of communication devices that are portable and perform well in noisy or hazardous environments will provide for future long-term growth in this market. These products are well suited for applications in fire, law enforcement, safety, aviation and military markets.

Electronics net sales for the three months ended March 31, 2009 decreased 25 percent from 2008 primarily due to lower demand from our customers in this market. Management has made efforts to reduce this segment cost structure.

Gross margin

Gross margin for the three months ended March 31, was as follows (in thousands):


                                  2009                    2008                  Change
                                      Percent                 Percent
                          Dollars     of Sales    Dollars     of Sales    Dollars    Percent

    Body-Worn Devices     $  2,176         18.4 % $  3,489         23.9 % ($ 1,313 )   (37.6% )

    Electronic Products   $    200         13.5 % $    356         17.9 % ($   156 )   (43.8% )

Gross margin as a percentage of sales decreased for the three months ended March 31, 2009 compared to the prior year period for both operating segments. The declines in gross margin primarily resulted from the lower revenue levels described above combined with lower-margin product mix, partially offset by the increased margin from our higher medical sales. We have various activities underway to increase efficiency and improve our gross margin, such as introducing Six Sigma lean manufacturing methods across various medical and hearing health product lines, conservatively managing our business and reducing expenses, and increasing the percentage of IntriCon proprietary content in the devices we manufacture.

Selling, general and administrative expenses

Selling, general and administrative expenses ("SG&A") for the three months ended March 31 were as follows (in thousands):

                                        2009                       2008                     Change
                                             Percent                    Percent
                                           of Segment                 of Segment
                               Dollars        Sales       Dollars        Sales        Dollars     Percent

Body-Worn Devices:
Selling                        $    619            5.2 %  $    817            5.6 %  ($    198 )     (24.2 %)
General and Administrative        1,378           11.6       1,423            9.7          (55 )      (3.9 %)
Research and Development            881            7.4         788            5.4           93        11.8 %
Electronics Products:
Selling                        $    161           10.8 %  $    179            9.0 %  ($     18 )     (10.1 %)
General and Administrative          203           13.7         229           11.5          (26 )     (11.4 %)
Research and Development              -              -           -              -            -           -

The decreased body-worn device selling expenses for the three months ended March 31, 2009 as compared to the prior year period were driven by decreases in royalties and commissions as a result of lower revenues, lower salary and benefit expenses from lower headcount levels and decreased bad debt expense. The decrease in body-worn device general and administrative expenses were driven by cost control measures taken by the Company in conjunction with the revenue decreases including lower salary and benefit expenses from reduced headcount levels, partially offset by increases in professional and legal fees compared to the prior year. The increased body-worn device research and development expenses as compared to the prior year were due to our continued emphasis on investing in research and development projects to develop new products and technology to further enhance our product portfolio, including expenses recognized from our partnership with Dynamic Hearing.

Electronics products SG&A expenses decreased for the three months ended March 31, 2009 as compared to the prior year as a result of management's efforts to reduce this segment cost structure in the face of declining revenues.

Net interest expense

Net interest expense for the three months ended March 31, 2009 was $125,000 compared to $188,000 for the same period in 2008. The decrease in net interest expense was due primarily to lower interest rates in effect on lower principal levels of outstanding debt in 2009.

Equity in earnings of partnerships

The equity in earnings of partnerships for the three months ended March 31, 2009 was ($87,000) compared to $22,000 for the same period in 2008.

The Company recorded a $37,000 decrease in the carrying amount of the HIMPP investment, reflecting amortization of the patents, other intangibles and the Company's portion of the partnership's operating results for both the three months ended March 31, 2009 and 2008, respectively.

The Company recorded a $50,000 decrease and a $59,000 increase in the carrying amount of IntriCon Tibbetts Corporation's investment in joint venture, reflecting the Company's portion of the joint venture's operating results for the three months ended March 31, 2009 and 2008, respectively.

Other income (expense), net

Other income (expense), net for the three months ended March 31, 2009, was $54,000 compared to other income (expense), net of ($5,000) for the same period in 2008. The change in other income (expense), net primarily related to the changes in foreign currency exchange rates.

Income taxes

Income tax benefit for the three months ended March 31, 2009, was ($34,000) compared to expense of $87,000 and for the same period in 2008. The benefit recognized in 2009 was primarily due operating losses incurred on both domestic and foreign operations.

Liquidity and Capital Resources

As of March 31, 2009, we had approximately $0.3 million of cash on hand. Sources of our cash for the three months ended March 31, 2009 have been from our operations, as described below.

The Company's cash flows from operating, investing and financing activities, as reflected in the statement of cash flows, are summarized as follows (in thousands):

                                                           Three months Ended
                                                        March 31,     March 31,
                                                           2009          2008
     Cash provided (used) by:
     Operating activities                               $      435    $   (1,334 )
     Investing activities                                     (159 )        (381 )
     Financing activities                                     (277 )       1,692
     Effect of exchange rate changes on cash                    (5 )          35
     Increase (decrease) in cash and cash equivalents   $       (6 )  $       12

The most significant items that contributed to the $0.4 million of cash provided by operating activities were changes in operating assets and liabilities of $0.7 million, depreciation of $0.6 million and net loss of $(1.0) million. The change in operating assets and liabilities was primarily due to decreases in accounts receivable, partially offset by decreases in accrued expenses. The change in accounts receivable is due to lower revenue and the timing of sales and customer payments. The change in accrued expenses is primarily due to less accrued expense for salary and benefits.

Net cash used by investing of activities consisted of purchases of property, plant and equipment of $0.4 million, partially offset by $0.2 million of cash received from notes receivable.

Net cash used by financing activities of $0.3 million was comprised primarily of net payments of debt of $0.2 million.

The Company had the following bank arrangements (in thousands):

                                                        March 31,     December 31,
                                                          2009            2008

  Total borrowing capacity under existing facilities   $    12,268   $       13,243

  Facility Borrowings:
  Domestic revolving credit facility                         3,000            3,000
  Domestic term loan                                         2,616            2,756
  Foreign overdraft and letter of credit facility              588              605
  Domestic capital equipment leases                          1,279            1,330
  Total borrowings and commitments                           7,482            7,691
  Remaining availability under existing facilities     $     4,786   $        5,552

The Company and its subsidiaries, IntriCon, Inc., RTI Electronics, Inc. and IntriCon Tibbetts Corporation, referred to as the borrowers, entered into a credit facility with LaSalle Bank, National Association (now Bank of America), referred to as the lender, on May 22, 2007. The credit facility provides for:

† a $10,000,000 revolving credit facility, with a $200,000 subfacility for letters of credit. Under the revolving credit facility, the availability of funds depends on a borrowing base composed of stated percentages of our eligible trade receivables and eligible inventory, less a reserve.

† a $4,500,000 term loan, which was used to fund the Tibbetts acquisition.

Loans under the credit facility are secured by a security interest in substantially all of the assets of the borrowers including a pledge of the stock of the subsidiaries. All of the borrowers are jointly and severally liable for all borrowings under the new credit facility.

Loans under the credit facility bear interest, at the option of the Company, at:

. . .