Integer
Annual Report 2013

Plain-text annual report

2013 Annual Report  To our shareholders: Over the past decade, Greatbatch and its investors have enjoyed strong revenue growth from a more diversified product portfolio. Sales have grown from $200 million to $664 million, representing a 14 percent compound annual growth rate. A company almost completely dependent on cardiac rhythm management offerings now sees worldwide demand from the orthopaedics, portable medical, vascular, neuromodulation and energy, environmental and military markets. Our performance and potential have been recognized by our customers, by our investors, and most importantly, by the millions of people whose lives we touch every day through our innovative and reliable products. That was clearly exhibited in the company’s 2013 results, illustrating not only our continuing momentum, but also the effective measures we’re deploying to create an even brighter future. Revenue growth was sound – a five percent organic constant currency increase from the year prior – while our Adjusted Operating Income rose 12 percent. Both were achieved in a manner consistent with our strategic approach. The strategic consolidation of our orthopaedics business was extremely successful, contributing to the year’s organic growth outcomes. Not only did we increase our operational excellence in the United States and abroad to achieve cost reductions and margin expansion, but we also augmented our quality and manufacturing standards in the process. In parallel, we placed an even greater emphasis on customer service levels, the value of which becomes even more crucial during times of transition. We took a series of steps to expand the reach and effectiveness of our sales and marketing teams as we continued to leverage our intellectual property to drive sustainable increases to our top line. This included translating our unique, in-demand technologies into long-term agreements with some of the worlds most recognized and respected medical device companies, deepening our relationships while paving the way for sustained organic growth. The past year saw substantial progress of core research and development projects and medical technologies – the underpinnings of our future. Our teams received 55 new patents, and filed another 108 patent applications. Today, we maintain nearly 1,500 patents available for incorporation into our own and others’ products – a formidable intellectual property position that continues to increase in value. 2013 was also a milestone year for the continued development and commercialization of our medical device initiatives. For the first time, Greatbatch submitted a Class III PMA to the U.S. Food and Drug Administration for our Sutureless Myopore Pacing Lead, followed by a successful 100-day meeting with the agency. In December, we filed a PMA for our Spinal Cord Stimulation (SCS) system to treat chronic intractable pain of the trunk and/or limbs – a sizable, under-penetrated market. Executing Our Strategy Continually evolving how a company brings its products to market in an effective and profitable manner is no easy task, especially with nearly 3,400 Associates located in 18 facilities across the globe. Over the past several months, our initiative to align our operations and sales & marketing teams that were formerly split between our Greatbatch Medical and Electrochem business units have already generated greater Associate and customer engagement, higher efficiency levels, and better market insights. We’re approaching the future as an organization wholly focused on growing our top line, bottom line and pipeline – and our progress is nothing but encouraging. So what does 2014 hold? We’ll continue to grow organically through long-term agreements with a blue chip customer base, using our unmatched insights to solve unmet needs in growing markets while ensuring our discrete technologies are designed into OEM products. As that growth occurs, we’ll leverage our sustained operational excellence in a cost effective, flexible and scalable manner to expand our margins. We’ll further advance our integrated medical device strategy, guiding the SCS program through the regulatory approval processes in the U.S. and Europe. Concurrently, we will leverage our medical device system capabilities and technologies as we continue to invest in new opportunities. My team and I will also consider inorganic opportunities for growth: investments focused on targeted acquisitions to enhance our top line, bottom line and pipeline. To fund this, we will continue our efforts to generate cash and utilize our existing debt structure. Our strong financial capacity to conduct business in this manner is a true advantage, allowing us to move decisively and quickly as we uncover possibilities. Leading from a Point of Strength For a company whose past is rooted in discovery, it’s only natural that our future will be fueled by strategic, accelerated and applied innovation in the fast-growing medical device world. We expect our 2014 performance to remain on a positive growth trajectory, with sales rising in the mid-single digits and adjusted operating margin and adjusted diluted earnings per share rising double our revenue growth rates. Our guidance is illustrative of a multi-year strategy based on unparalleled market knowledge, a relentless passion to evolve our business to capitalize on market trends, and the acquisition, development and retention of some of the brightest and hardest working minds in the world. The future of Greatbatch is and always has been inextricably linked to our Associates, our customers, and our shareholders working together to change business for the better while at the same time changing lives. I’ve been honored and privileged to play a role in shaping this extraordinary company, and energized about the year to come. Sincerely, Thomas J. Hook President & Chief Executive Officer UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 _____________________________________ FORM 10-K _____________________________________ ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For The Fiscal Year Ended January 3, 2014 Commission File Number 1-16137 _____________________________________ GREATBATCH, INC. (Exact name of Registrant as specified in its charter) _____________________________________ Delaware (State of Incorporation) 16-1531026 (I.R.S. Employer Identification No.) 2595 Dallas Parkway Suite 310 Frisco, Texas 75034 (Address of principal executive offices) (716) 759-5600 (Registrant’s telephone number, including area code) Securities Registered Pursuant to Section 12(b) of the Act: Title of Each Class: Common Stock, Par Value $0.001 Per Share Name of Each Exchange on Which Registered: New York Stock Exchange Securities Registered Pursuant to Section 12(g) of the Act: None Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes (cid:2) No (cid:3) Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes (cid:2) No (cid:3) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes (cid:3) No (cid:2) Indicate by checkmark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes (cid:3) No (cid:2) Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. (cid:2) Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. Large accelerated filer (cid:3)(cid:4) Non-accelerated filer (cid:2)(cid:4) Accelerated filer (cid:2)(cid:4) Smaller reporting company (cid:2)(cid:4) Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes (cid:2) No (cid:3) The aggregate market value of common stock held by non-affiliates as of June 28, 2013 (the last business day of the registrant’s most recently completed second fiscal quarter), based on the last sale price of $32.79, as reported on the New York Stock Exchange: $771.2 million. Solely for the purpose of this calculation, shares held by directors and officers and 10 percent shareholders of the registrant have been excluded. Such exclusion should not be deemed a determination by or an admission by the registrant that these individuals are, in fact, affiliates of the registrant. Shares of common stock outstanding as of March 4, 2014: 24,649,884 DOCUMENTS INCORPORATED BY REFERENCE Portions of the following document are specifically incorporated by reference into the indicated parts of this report: Document Proxy Statement for the 2014 Annual Meeting of Stockholders Part III, Item 10 “Directors, Executive Officers and Corporate Governance” Part Part III, Item 11 “Executive Compensation” Part III, Item 12 “Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters” Part III, Item 13 “Certain Relationships and Related Transactions, and Director Independence” Part III, Item 14 “Principal Accountant Fees and Services” ITEM NUMBER 1 Business 1A Risk Factors 1B Unresolved Staff Comments 2 Properties 3 Legal Proceedings 4 Mine Safety Disclosures TABLE OF CONTENTS PART I PART II 5 Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities 6 Selected Financial Data 7 Management’s Discussion and Analysis of Financial Condition and Results of Operations 7A Quantitative and Qualitative Disclosures About Market Risk 8 Financial Statements and Supplementary Data 9 Changes in and Disagreements With Accountants on Accounting and Financial Disclosure 9A Controls and Procedures 9B Other Information 10 Directors, Executive Officers and Corporate Governance 11 Executive Compensation PART III 12 Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters 13 Certain Relationships and Related Transactions, and Director Independence 14 Principal Accountant Fees and Services PART IV 15 Exhibits and Financial Statement Schedules Signatures PAGE NUMBER 3 15 22 22 23 23 23 25 26 49 50 95 95 96 96 96 96 96 96 97 98 - 2 - PART I ITEM 1. BUSINESS OVERVIEW Greatbatch, Inc. was founded in 1970 and is a Delaware corporation incorporated in 1997. When used in this report, the terms “Greatbatch,” “we,” “us,” “our” and the “Company” mean Greatbatch, Inc. and its subsidiaries. The Company conducted its initial public offering in 2000. In connection with the realignment of our operating structure in 2013 to optimize profitable growth, which included changing our management and reporting structure, we reevaluated our operating and reporting segments. Beginning in the fourth quarter of 2013, we have two reportable segments: Greatbatch Medical and QiG Group (“QiG”). As required, prior year amounts have been reclassified in order to conform them to the current year presentation. Greatbatch Medical designs and manufactures products where Greatbatch either owns the intellectual property or has unique manufacturing and assembly expertise. The financial results of Greatbatch Medical include the former Implantable Medical and Electrochem Solutions (“Electrochem”) segments, excluding QiG. These products include medical devices and components for the cardiac, neuromodulation, orthopaedics, portable medical, vascular and energy markets among others. The Greatbatch Medical segment also offers value- added assembly and design engineering services for medical devices that utilize its component products. QiG focuses on developing medical device systems for some of healthcare’s most pressing challenges and reflects Greatbatch’s strategic evolution of its product offerings in order to raise the growth and profitability profile of the Company. Through the research and development professionals in QiG, the Company is now investing in three areas - new medical device systems commercialization, collaborative programs with OEM customers, and strategic equity positions in start-up companies - to grow a diversified and distinctive portfolio. The medical device systems developed by QiG are manufactured by Greatbatch Medical. The Company's customers include large multi-national original equipment manufacturers (“OEMs”). Since Greatbatch, Inc. was incorporated, it has completed the following acquisitions either directly or indirectly through one of its subsidiaries: Acquisition Date July 1997 Wilson Greatbatch Ltd. Acquired Company Business at Time of Acquisition August 1998 Hittman Materials and Medical Components, Inc. August 2000 Battery Engineering, Inc. June 2001 Sierra-KD Components division of Maxwell Technologies, Inc. July 2002 Globe Tool and Manufacturing Company, Inc. March 2004 NanoGram Devices Corporation April 2007 BIOMEC, Inc. - 3 - Founded in 1970, designed and manufactured batteries for implantable medical and commercial applications. Founded in 1962, designed and manufactured ceramic and glass feedthroughs and specialized porous coatings for electrodes used in implantable medical devices (“IMDs”). Founded in 1983, designed and manufactured high-energy density batteries for industrial, commercial, military and medical applications. Founded in 1986, designed and manufactured ceramic electromagnetic filtering capacitors and integrated them with wire feedthroughs for use in IMDs as well as military, aerospace and commercial applications. Founded in 1954, designed and manufactured precision enclosures used in IMDs and commercial products used in the aerospace, electronics and automotive sectors. Founded in 1996, developed nanoscale materials for battery and medical device applications. Established in 1998, provided medical device design and component integration to early-stage and established customers. Acquisition Date Acquired Company Business at Time of Acquisition June 2007 Enpath Medical, Inc. October 2007 IntelliSensing LLC November 2007 Quan Emerteq LLC November 2007 Engineered Assemblies Corporation January 2008 P Medical Holding SA Founded in 1981, designed, developed, and manufactured venous introducers and dilators, implantable leadwires, steerable sheaths and steerable catheters. Founded in 2005, designed and manufactured battery-powered wireless sensing solutions for commercial applications. Founded in 1998, designed, developed, and manufactured catheters, stimulation leadwires, microcomponents and assemblies. Founded in 1984, designed and integrated custom battery solutions and electronics focused on rechargeable systems for industrial, commercial, military and portable medical applications. Founded in 1994, designed, manufactured and supplied delivery systems, instruments and implants for the orthopaedics industry. February 2008 DePuy Orthopaedics’ Chaumont, France manufacturing facility Manufactured hip and shoulder implants for DePuy Orthopaedics. December 2011 Micro Power Electronics, Inc. (“Micro Power”) February 2012 NeuroNexus Technologies, Inc. (“NeuroNexus”) Founded in 1990, designed custom battery packs, smart chargers and power supplies for industrial, military and portable medical applications. Founded in 2004, medical device design firm specializing in developing neural interface technology, components and systems. FINANCIAL STATEMENT YEAR END We utilize a fifty-two, fifty-three week fiscal year ending on the Friday nearest December 31st. Fiscal years 2013, 2012 and 2011 ended on January 3, 2014, December 28, 2012 and December 30, 2011, respectively. Fiscal year 2013 contained fifty- three weeks and fiscal years 2012 and 2011 contained fifty-two weeks. SEGMENT INFORMATION In connection with the realignment of our operating structure in 2013, which included changing our management and reporting structure, we reevaluated our operating and reporting segments. Beginning in the fourth quarter of 2013, we have two reportable segments: Greatbatch Medical and QiG. Segment information including sales from external customers, profit or loss, and assets by segment as well as sales from external customers and long-lived assets by geographic area are set forth at Note 19 “Business Segment, Geographic and Concentration Risk Information” of the Notes to Consolidated Financial Statements contained in Item 8 of this report. Greatbatch Medical Greatbatch Medical's products include medical devices and components for the cardiac, neuromodulation, orthopaedics, portable medical, vascular and energy markets among others. A brief description of these products and markets follows: Cardiac and neuromodulation – Products include batteries, capacitors, filtered and unfiltered feedthroughs, engineered components, implantable stimulation leads and enclosures used in IMDs. Additionally, we offer value-added assembly for these IMDs. An IMD is an instrument that is surgically inserted into the body to provide diagnosis and/or therapy. One sector of the IMD market is cardiac, which is comprised of devices such as implantable pacemakers, implantable cardioverter defibrillators (“ICD”), cardiac resynchronization therapy (“CRT”) devices, and cardiac resynchronization therapy with backup defibrillation devices (“CRT-D”). Another sector of the IMD market is neuromodulation, which is comprised of pacemaker-type devices that stimulate nerves for the treatment of various conditions. Beyond established therapies of pain control, incontinence and movement disorders (Parkinson’s disease and epilepsy), nerve stimulation for the treatment of other disabilities such as migraines, obesity and depression has shown promising results. - 4 - The following table sets forth the main categories of battery-powered IMDs and the principal illness or symptoms treated by each device: Market Size (in billions) $4.0 $3.7 Principal Illness or Symptom Abnormally slow heartbeat (Bradycardia) Rapid and irregular heartbeat (Tachycardia) Congestive heart failure Device Pacemakers ICDs CRT/CRT-Ds Neurostimulators Cochlear hearing devices $3.0 $2.6 $0.8 Chronic pain, movement disorders, epilepsy, obesity or depression Hearing loss IMD systems generally include an implantable pulse generator (“IPG”) and one or more stimulation leads. An IPG is a battery powered device that produces electrical pulses. The lead then carries this electrical pulse from the IPG to the heart, spinal cord or other location in the body. Our portfolio of proprietary technologies, products and capabilities has been built to provide our cardiac and neuromodulation customers with a single source for the vast majority of the components and subassemblies required to manufacture an IPG or lead, to include complete lead systems. Our investments in research and development has ® and QCapacitor generated proprietary products such as the QHR enabled our OEM partners to make improvements in their system offerings in terms of device reliability, size, longevity and power. Our XcellionTM line of Lithium-Ion rechargeable batteries leverages decades of implantable battery research, development and manufacturing expertise. This line of cells now includes the optional CoreGuardTM feature, which enables batteries to discharge to zero volts without performance degradation. ® primary battery and capacitor lines, which have ®, QMR We believe that the cardiac and neuromodulation markets continue to exhibit fundamentals that position this product line for growth. Factors that are impacting these markets are as follows: • Growing patient population – Implantable pacemakers and ICDs remain primary therapies for a number of critical clinical conditions, most of which are non-elective in nature. As the prevalence of many of these clinical conditions increase with age, underlying population demographics in developed countries will provide an engine for procedure growth. • Focus on emerging markets – OEM’s have increased their focus and investment to expand physicians' awareness of these life changing therapies, which we believe will result in increased utilization to improve quality of life for more patients globally. These growth initiatives will drive increased utilization of existing cardiac technologies and provide an avenue for new device and technology development as device manufacturers look to develop unique products for these markets. • Trends in device features – IMD evolution continues to favor the development of smaller, longer lasting devices with increased functionality and more physiologic shapes. Innovative battery, capacitor, enclosure, and filtering solutions such as those provided by Greatbatch Medical are critical to the realization of these market needs. • Growth within neuromodulation – Neuromodulation applications continue to grow at a faster pace than traditional markets, and are expected to continue to expand as new therapeutic applications are identified. There continues to be growth in clinical data supporting new applications and a growing focus and excitement from clinicians looking for treatment alternatives for challenging patient conditions. Additionally, core neuromodulation markets—like spinal cord stimulation— that rely significantly on patients for co-pays, are positioned to see stronger growth as global economic markets strengthen. Many cardiac OEM companies are also OEMs in the neuromodulation market, which positions us to capitalize on both drivers of market growth. • Disruptive Technologies - Two disruptive device technologies, sub-cutaneous ICDs and leadless pacemakers, gained significant visibility in 2013. Our portfolio of technologies and next generation development efforts are vital to the advancement of these new therapy platforms. Orthopaedics – Products include hip and shoulder joint reconstruction implants, bone plates and spinal devices, and instruments and delivery systems used in hip and knee replacement, trauma fixation, extremity and spine surgeries. Orthopaedic implants are used in reconstructive surgeries to replace or repair hips, knees and other joints, such as shoulders, ankles and elbows that have deteriorated as a result of disease or injury. Trauma implant systems are used primarily to reattach or stabilize damaged bone or tissue while the body heals. Spinal implant systems are used by orthopaedic surgeons and neurosurgeons in the treatment of degenerative diseases, deformities and injuries in various regions of the spine. Each implant system typically has an associated instrument set that is used in the surgical procedure to insert that specific implant system. Instruments included in a set vary by implant system. Usually, instrument sets are sterilized after each use and then reused, however, recent trends are moving towards single use instrumentation. Cases are used to store, transport and arrange implant systems and other medical devices and related surgical instruments. Orthopaedic trays are generally designed to allow for sterilization and re-use after an implant or other surgical procedure is performed. The majority of cases are tailored for - 5 - specific implant procedures so that the instruments, implants and other devices are arranged to match the order of use in the procedure and are securely held in clearly labeled, custom-formed pockets or brackets. Many of the factors affecting the orthopaedics market segment are similar to the cardiac and neuromodulation markets and include: • Aging population in developed markets - Conditions like osteoarthritis and spine degeneration are underlying drivers of a diverse spectrum of reconstructive therapies, and increase significantly with age. Continued growth in the 65+ population, along with an increased desire to remain active, will provide a driver for procedural growth. • Rates of obesity—Rates of obesity globally have continued to rise, and are expected to do so for the foreseeable future. Excess weight carriage exacerbates wear on joints and will drive the need for replacement and revision procedures. • New implant and surgical technology - The orthopaedic market continues to see a growing focus on minimally invasive procedures across a number of sectors including joint reconstruction and spinal fusion, potentially expanding the use of these therapeutic approaches. • Growth in emerging markets—Growing affluence in emerging markets has provided an opportunity for global growth of a number of orthopaedic procedures. Patient populations outside of developed markets continue to be underpenetrated, and investment from large device manufacturers in these markets will provide for procedural growth of established therapies. We estimate that the orthopaedics market represents a $3 billion market opportunity for Greatbatch Medical. Vascular – Products include introducers, steerable sheaths and catheters that deliver minimally invasive therapies for many end- user markets including coronary and neurovascular disease, peripheral vascular disease, interventional radiology, vascular access, atrial fibrillation, and interventional cardiology, as well as products for medical imaging and drug and pharmaceutical delivery. Most of these markets are expected to experience significant global procedural growth over the next few years. Introducers enable physicians to create a conduit through which they can insert infusion catheters, implantable ports, pacemaker leads and other therapeutic devices into a blood vessel. A catheter is a tube that can be inserted into a blood vessel to deliver a therapeutic device or allow drainage, injection of fluids, or access by surgical instruments. Our products seek to capitalize on the growth in the cardiac and vascular markets, especially since many of the large cardiac OEMs are also in the vascular markets. This gives us an opportunity to develop close strategic partnerships that can be leveraged across markets, an opportunity that will grow in significance as OEMs continue to consolidate their operating divisions. In addition to those factors that are driving the cardiac and neuromodulation markets, increased demand is also being driven by continued focus on minimally invasive procedures. Patients, healthcare providers, and payors are looking for minimally invasive technologies to treat disease, expanding the use of catheter based procedures and associated vascular therapies. We also continue to see strong growth in the vascular markets because of the increased prevalence and treatment of peripheral artery disease as well as new indications for tissue extraction or ablation. We believe that the vascular market represents a $1.3 billion market opportunity for Greatbatch Medical. Portable Medical, Energy, Military and Environmental - Greatbatch Medical also provides customized battery power and management systems, charging and docking stations, and power supplies. We design customized primary (non-rechargeable) and secondary (rechargeable) battery solutions which are used in the portable medical, energy, military and environmental markets. Our primary and secondary power solutions are used where failure is not an option. Greatbatch Medical's primary lithium power solutions, which include high, moderate and low rate non-rechargeable cell solutions, are utilized in extreme conditions and can withstand exceptionally high and low temperatures, sterilization, and high shock and vibration. Our product designs incorporate protective circuitry, glass-to-metal hermetic seals, fuses and diodes to help ensure safe, durable and reliable power as devices are subjected to these harsh conditions. Our primary batteries are often used in remote and demanding environments, including down hole drilling tools, military communication devices, oceanographic buoys and more. In addition to primary power solutions, Greatbatch Medical offers customized secondary or rechargeable battery packs, in a diverse range of chemistries for critical applications requiring rechargeable solutions. Rechargeable chemistries include lithium ion, lithium ion polymer, nickel metal hydride, nickel cadmium, lithium iron phosphate and sealed lead acid. Greatbatch Medical’s rechargeable battery packs include advanced electronics, smart charging and battery management systems and are used in critical and life-saving applications, including automated external defibrillators, ventilators, powered surgical instruments and portable oxygen concentrators, among others. The portable medical market trends continue to be favorable with an aging population and the shift from clinical to home settings for portable equipment to monitor and provide therapy. This market represents a strong opportunity despite cost pressure from healthcare reform. New product development in this market is vibrant as our customers continue to invest in the future to position for growth. We estimate that the portable medical market represents a $1.0 billion market opportunity for Greatbatch Medical. - 6 - The following table summarizes information about our Greatbatch Medical products: Description Lithium iodine (“Li Iodine”) Lithium silver vanadium oxide (“Li SVO”) Lithium carbon monoflouride (“Li CFx”) Lithium ion rechargeable (“Li Ion”) Lithium SVO/CFx (“QHR” & “QMR”) Principal Product Attributes High reliability and predictability; Long service life; Customized configuration; Light weight; High energy density, small size Storage for energy generated by a battery before delivery to the heart. Used in ICDs and CRT-Ds. Stores more energy per unit volume (energy density) than other existing technologies; Customized configuration Product Batteries Capacitors EMI filters Feedthroughs Coated electrodes Filters electromagnetic interference to limit undesirable response, malfunctioning or degradation in the performance of electronic equipment Allow electrical signals to be brought from inside hermetically sealed IMD to an electrode Deliver electric signal from the feedthrough to a body part undergoing stimulation Precision components Machined Molded and over molded products Enclosures and related components Titanium Stainless steel Value-added assemblies Combination of multiple components in a single package/unit Stimulation leads Cardiac, neuromodulation and hearing restoration stimulation leads Introducers Catheters Creates a conduit to insert infusion catheters, guidewires, implantable ports, pacemaker leads and other therapeutic devices into a blood vessel Delivers therapeutic devices to specific sites in the body Cases and trays Delivery systems for cleaning and sterilizing orthopaedic instruments and implants - 7 - High reliability attenuation of EMI RF over wide frequency ranges; Customized design Ceramic to metal seal is substantially more durable than traditional seals; Multifunctional High quality coated surface; Flexible in utilizing any combination of biocompatible coating surfaces; Customized offering of surfaces and tips High level of manufacturing precision; Broad manufacturing flexibility Precision manufacturing, flexibility in configurations and materials Leveraging products and capabilities to provide subassemblies and assemblies; Provides synergies in component technology and procurement systems Custom and unique configurations that increase therapy effectiveness, provide finished device design and manufacturing Variety of sizes and materials that facilitate problem-free access in a variety of clinical applications Enable safe and effective delivery of therapeutic and diagnostic devices, providing the right balance of steerability, trackability and crossability to reach the intended location High degree of customization; Short, predictable development and production timelines Product Implants Instruments Primary cells Description Orthopaedic implants for large joint, spine, extremity and trauma procedures Principal Product Attributes Precision manufacturing, leveraging capabilities and product processes including sterile packaging and coatings Reusable and single use orthopaedic instruments for large joint, spine, extremity and trauma procedures Designed to improve surgical techniques, reduce surgery time, and increase surgical precision Low-rate Moderate-rate High rate (spiral) Wide Range Primary and secondary battery packs Highly-customized pack solutions Optimized rate capability, shock and vibration resistant, high and low temperature tolerant, high energy density; Ability to operate in low and high temp applications Diverse portfolio of cells in various sizes, temperature ranges and rate capabilities, custom-engineered and designed, value-add charging and battery management systems for secondary packs A majority of the components and devices Greatbatch Medical sells incorporate proprietary technologies. These proprietary technologies provide an entry barrier for new competitors, and further limit existing competitors from duplicating our products. In addition to these proprietary technologies, our proprietary “know-how” in the manufacture of these products provides further barriers to competition. QiG GROUP QiG focuses on developing medical device systems for some of healthcare’s most pressing challenges and reflects Greatbatch’s strategic evolution of its product offerings in order to raise the growth and profitability profile of the Company. QiG encompasses 120 research and development professionals across the U.S. working on a portfolio of new and innovative product opportunities. QiG has established relationships with highly specialized physicians across the U.S. and Europe that help support the design of medical device systems with unique benefits to improve clinical outcomes. QiG provides differentiated medical devices to OEM customers by accelerating the velocity of innovation while delivering optimized supply chain and cost efficiencies. We are utilizing our market research to drive our intellectual property portfolio with a goal of improved return on investment. QiG utilizes a disciplined and diversified portfolio approach with three investment modes: new medical device systems commercialization, collaborative programs with OEM customers, and strategic equity positions in start-up companies. The development of certain new medical device systems are facilitated through the establishment of limited liability corporations (“LLC”). These LLCs do not own, but have the exclusive right to use the technology of Greatbatch Medical in certain, specifically designed fields of use and have an exclusive manufacturing agreement with Greatbatch Medical. QiG currently owns 89% - 100% of three LLCs. The minority interest of these LLCs was granted to key opinion leaders, clinicians and strategic partners at or near the time the LLC was established. Under the LLC agreement, QiG is liable for 100% of the expenses incurred by the LLC. However, no income is distributed to the minority holders of the LLC until QiG is reimbursed for all expenses paid. Once QiG has been fully reimbursed, all future net income is distributed based upon the respective LLCs ownership percentages. One of the LLCs established by QiG is for our spinal cord stimulator to treat chronic intractable pain of the trunk and/or limbs. This product was submitted for Food and Drug Administration (“FDA”) and CE Mark approval near the end of 2013. Another medical device system being developed by QiG is an implantable loop recorder for cardiac arrhythmia diagnostics. QiG is in the early stages of development of two additional medical device systems, which are targeting approved and emerging indications. Additionally, based upon the technology acquired from NeuroNexus, QiG is developing a platform of thin-film electrodes for neuromodulation leads, sub-systems and components. Current QiG revenue includes sales of neural interface technology, components and systems to the neuroscience and clinical markets. Future income of QiG is expected to come from various sources including investment gains from the sales of LLC ownership interests, technology licensing fees, royalty revenue, and/or the sales of medical device systems to OEM customers. RESEARCH AND DEVELOPMENT Our position as a leading developer and manufacturer of medical devices and components is largely the result of our long history of technological innovation. We invest substantial resources in research, development and engineering. Our scientists, engineers and technicians focus on improving existing products, expanding the use of our products and developing new products. In addition to our internal technology and product development efforts, we also engage outside research institutions for unique technology projects. In order to facilitate the development of new and improved medical devices, in 2008 we significantly increased our investments in research and development. Net investments in medical device systems (including - 8 - gross profit and SG&A), which are being facilitated through QiG, totaled $30.5 million, $32.6 million and $27.3 million for 2013, 2012 and 2011, respectively. Further information regarding our research and development activities can be found in the “Product Development” section of Item 7 of this report. PATENTS AND PROPRIETARY TECHNOLOGY We rely on a combination of patents, licenses, trade secrets and know-how to establish and protect our proprietary rights to our technologies and products. Often, several patents covering various aspects of the design protect a single product. We believe this provides broad protection of the inventions employed. As of January 3, 2014, we have 625 active U.S. patents and 344 active foreign patents. We also have 279 U.S. and 241 foreign pending patent applications at various stages of approval. During the past three years, we have been granted 189 new U.S. patents, 55 of which were granted in 2013. As a result of QiG’s development of complete medical device systems, the amount of intellectual property being generated by the Company has accelerated. Of the 1,489 patents and patents pending, approximately 537 of these relate to our medical device systems. We are also a party to several license agreements with third parties under which we have obtained, on varying terms, exclusive or non-exclusive rights to patents held by them. An example of these agreements is the license of basic technology used in our wet tantalum capacitors, filtered feedthroughs, biomimetic coatings, safety needles and MRI compatible lead systems. We have also granted rights to our patents to others under license agreements. It is our policy to require our management and technical employees, consultants and other parties having access to our confidential information to execute confidentiality agreements. These agreements prohibit disclosure of confidential information to third parties except in specified circumstances. In the case of employees and consultants, the agreements generally provide that all confidential information relating to our business is the exclusive property of Greatbatch. MANUFACTURING AND QUALITY CONTROL We leverage our strength as an innovative designer and manufacturer of finished devices and components to the medical device industry. Our manufacturing and engineering services include: design, testing, component production, and device assembly. We have integrated our proprietary technologies in our own products and those of our customers throughout the medical device industry. Our flexible, high productivity manufacturing capabilities span sites in Tijuana, Mexico, Beaverton, OR, Plymouth, MN, Minneapolis, MN, Ft. Wayne, IN, Indianapolis, IN, Alden, NY, Clarence, NY, Raynham, MA, and Chaumont, France. Due to the highly regulated nature of the products we produce, we have implemented strong quality systems which are harmonized across our enterprise. The quality systems at our sites are compliant with and certified to various recognized international standards, requirements, and directives. Each site quality system is certified under an applicable International Organization for Standardization (“ISO”) quality system standard, such as ISO 13485 or ISO 9001. This certification requires, among other things, an implemented quality system that applies (where applicable) to the design and manufacture of components, assemblies and finished medical devices, including component quality and supplier control. Maintenance of these certifications for each facility requires periodic re-examination from an independent notified body. Along with ISO 13485, the facilities producing finished medical devices are subject to extensive and rigorous regulation by numerous government bodies, including the FDA and comparable international regulatory agencies in order to ship product worldwide. For these facilities, we maintain FDA registration and compliance to all applicable domestic and international regulations. Compliance with applicable regulatory requirements is subject to continual review and is monitored through periodic inspections by FDA and other international regulatory bodies. SALES AND MARKETING We sell our products directly to our customers. In 2013, approximately 49% of our products were sold in the U.S. Sales outside the U.S. are primarily to customers whose corporate offices are located and headquartered in the U.S. Information regarding our sales by geographic area is set forth at Note 19 “Business Segment, Geographic and Concentration Risk Information” of the Notes to Consolidated Financial Statements contained in Item 8 of this report. Although the majority of our customers contract with us to develop custom components and assemblies to fit their product specifications, we also provide system and device solutions ready for market distribution by OEMs. As a result, we have established close working relationships between our internal program managers and our customers. We market our products and technologies at industry meetings and trade shows domestically and internationally. Internal account executives support all activity and involve engineers and technology professionals in the sales process to address customer requests appropriately. For system and device solutions, we partner with our customers’ research, marketing, and clinical groups to jointly develop technology platforms in alignment with their product roadmaps and therapy needs. - 9 - We leverage our account executives with support from engineering to design and sell product solutions into our targeted markets. Our account executives are trained to assist our customers in selecting appropriate chemistries and configurations. We market our products and services through well-defined selling strategies and marketing campaigns that are customized for each of the industries we target. Over the last several years we have significantly enhanced our sales and marketing capabilities. This has included moving account executives closer to our major customers, upgrading our sales force with new sales talent, enhancing our sales commission programs, and intensifying our market research. Additionally, we have placed additional emphasis on reaching long-term agreements with our OEM customers in order to secure our revenue base. At times, we have provided our customers with price concessions in exchange for entering into long-term agreements and certain volume commitments. We estimate that approximately 70 percent of our revenue is generated from long-term (three- to seven-year) agreements. Firm backlog orders at January 3, 2014 and December 28, 2012 were approximately $170 million and $160 million, respectively. The majority of the orders outstanding at January 3, 2014 are expected to be shipped within one year. CUSTOMERS Our Greatbatch Medical customers include large multi-national OEMs and their affiliated subsidiaries such as, in alphabetical order here and throughout this report, Biotronik, Boston Scientific, Halliburton Company, Johnson & Johnson, Medtronic, Philips Healthcare, Smith & Nephew, Sorin Group, St. Jude Medical, Stryker, and Zimmer. During 2013, 2012, and 2011, Johnson & Johnson, Medtronic and St. Jude Medical collectively accounted for 49%, 46% and 51% of our total sales, respectively. We have been successful in leveraging our diversified product line to further penetrate these customers and selling into more of their operating divisions, which cover the cardiac, neuromodulation, vascular and orthopaedic markets. QiG customers include numerous scientists, hospitals and universities throughout the world who perform research for the neuroscience and clinical markets. The nature and extent of our selling relationship with each OEM customer is different in terms of breadth of products purchased, selling prices, product volumes, ordering patterns and inventory management. For customers with long-term contracts, we have negotiated fixed pricing arrangements for pre-determined volume levels with pricing fixed at each level. In general, the higher the volume level, the lower the pricing. We have pricing arrangements with our customers that at times do not specify minimum order quantities. We recognize revenue when it is realized or realizable and earned. This occurs when persuasive evidence of an arrangement exists, delivery has occurred, the price is fixed or determinable, the buyer is obligated to pay us (i.e. payment is not contingent on a future event), the risk of loss is transferred, there is no obligation of future performance, collectability is reasonably assured and the amount of future returns can reasonably be estimated. Those criteria are met at the time of shipment when title passes. Our visibility to customer ordering patterns is over a relatively short period of time. Our customers may have inventory management programs, vertical integration plans and/or alternate supply arrangements which we are unaware of. 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, 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 new demand. SUPPLIERS AND RAW MATERIALS We purchase certain critical raw materials from a limited number of suppliers due to the technically challenging requirements of the supplied product and/or the lengthy process required to qualify these materials both internally and with our customers. We cannot quickly establish additional or replacement suppliers for these materials because of these rigid requirements. For these critical raw materials, we maintain minimum safety stock levels and contractually partner with suppliers to help ensure the continuity of supply. Historically, we have not experienced any significant interruptions or delays in obtaining critical raw materials. For non-critical raw material purchases, we utilize competitive pricing methods such as bulk purchases, precious metal pool buys, blanket orders, and long-term contracts to secure supply. We believe that there are alternative suppliers or substitute products available at competitive prices for all of these non-critical raw materials. As discussed more fully in Item 1A “Risk Factors,” our business depends on a continuous supply of raw materials from a limited number of suppliers. If an unforeseen interruption of supply were to occur, we may be unable to obtain substitute sources for these raw materials on a timely basis or on terms acceptable to us, which could harm our ability to manufacture our - 10 - products profitably or on time. Additionally, we may be unable to quickly establish additional or replacement suppliers for these materials as there are a limited number of worldwide suppliers. COMPETITION Our existing and potential competitors include leading IMD manufacturers such as Biotronik, Boston Scientific, Johnson & Johnson, Medtronic, Smith & Nephew, Sorin Group, St. Jude Medical, Stryker and Zimmer that currently have vertically integrated operations and may expand their vertical integration capability in the future. Competitors also include independent suppliers who typically specialize in one type of component. Our known non-vertically integrated competitors include the following: Product Line Medical batteries Capacitors Feedthroughs EMI filtering Enclosures Machined and molded components Competitors Eagle-Picher Quallion Critical Medical Components Alberox (subsidiary of The Morgan Crucible Co. PLC) AVX (subsidiary of Kyocera) Eurofarad Heraeus Hudson National Numerous Value added assembly Numerous Catheters Introducers Creganna Teleflex Vention medical Pressure Products Theragenics (Galt) Merit Medical Stimulation leads Oscor Orthopaedic trays, instruments and implants Primary Power Solutions Secondary Power Solutions Accelent Avalign Technologies IMDS Micropulse, Inc. Juno Orchid Sandvik Symmetry Paragon Tracer Technologies Engineered Power Saft Ultralife Totex Palladium ICC/Nexergy BMZ Ultralife Saft - 11 - GOVERNMENT REGULATION As described below, our business is subject to direct governmental regulation including the laws and regulations generally applicable to all businesses in the jurisdictions in which we operate. We are subject to federal, state and local environmental laws and regulations governing the emission, discharge, use, storage and disposal of hazardous materials and the remediation of contamination associated with the release of these materials at our facilities and at off-site disposal locations. Our manufacturing and research, development and engineering activities may involve the controlled use of small amounts of hazardous materials. Liabilities associated with hazardous material releases arise principally under the Federal Comprehensive Environmental Response, Compensation and Liability Act and analogous state laws that impose strict, joint and several liabilities on owners and operators of contaminated facilities and parties that arrange for the off-site disposal of hazardous materials. We are not aware of any material noncompliance with the environmental laws currently applicable to our business and we are not subject to any material claim for liability with respect to contamination at any of our facilities or any off-site location. We may, however, become subject to these environmental liabilities in the future as a result of our historic or current operations. Our products are subject to regulation by numerous government agencies, including the FDA and comparable foreign agencies. For some of our component technology, we have “master files” on record with the FDA. Master files may be used to provide proprietary and confidential detailed information about technology, facilities, processes, or articles used in the manufacturing, processing, packaging and storing of one or more medical device components. These master files may be used by device manufacturers to support their premarket approval application (“PMA”), investigational device exemption application (“IDE”) or premarket notification (“510(k)”). In the U.S., our introducer and delivery catheter products are considered Class II devices. The 510(k) process requires us to demonstrate that our new medical devices are substantially equivalent to a legally marketed medical device. In order to support a substantial equivalence claim, we must submit supporting data. In Europe, these devices are considered Class IIa and Class III, respectively, under European Medical Device Directives. These Directives require companies that wish to manufacture and distribute medical devices in European Union member countries to obtain a CE Marking for those products, which indicate that the products meet minimum standards of performance, essential requirements, safety conformity assessment and quality. The PMA process is a more rigorous process that is required to demonstrate that a new medical device is safe and effective. This is demonstrated by generating data regarding the design, manufacturing processes, materials, bench testing, and animal testing and typically requiring human clinical data. Some of our products that we are developing are Class III medical devices that require a PMA or, in the European Union, premarket approval through submission of a Design Dossier. As a manufacturer of medical devices and components that go into medical devices, we are also subject to periodic inspection by the FDA for compliance with the FDA’s Quality System Requirements and the applicable notified body in the European Union to ensure conformity to the Medical Device Directives and Active Implantable Medical Device Directives. We believe that our quality controls, development, testing, manufacturing, labeling, marketing and distribution of our medical devices conform to the requirements of all pertinent regulations. Our sales and marketing practices are subject to regulation by the U.S. Department of Health and Human Services pursuant to federal anti-kickback laws, and are also subject to similar state laws. We are also subject to various other environmental, transportation and labor laws as well as various other directives and regulations both in the U.S. and abroad. We believe that compliance with these laws will not have a material impact on our capital expenditures, earnings or competitive position. Given the scope and nature of these laws, however, they may have a material impact on our operational results in the future. The Patient Protection and Affordable Care Act and the Health Care and Education Affordability Reconciliation Act (collectively “Health Care Reform”) legislated broad-based changes to the U.S. healthcare system that could significantly impact our business operations and financial results, including higher or lower revenue, as well as higher employee medical costs and taxes. Health Care Reform imposes significant new taxes on medical device OEMs, which will result in a significant increase in the tax burden on our industry and which could have a material negative impact on our financial condition, results of operations and our cash flows. Other elements of Health Care Reform such as comparative effectiveness research, an independent payment advisory board, payment system reforms including shared savings pilots and other provisions could meaningfully change the way healthcare is developed and delivered, and may materially impact numerous aspects of our business, results of operations and financial condition. Many significant parts of Health Care Reform will be phased in over the next several years and require further guidance and clarification in the form of regulations. The new medical device tax, which was effective in 2013, increased our cost of sales by $0.5 million. On August 22, 2012, the U.S. Securities and Exchange Commission (“SEC”) issued a rule under Section 1502 of the Dodd- Frank Wall Street Reform and Consumer Protection Act requiring companies to publicly disclose their use of conflict minerals that originated in the Democratic Republic of the Congo (“DRC”) or an adjoining country. Under the rule, issuers are required to conduct a reasonable due diligence process to ascertain the source of conflict minerals, defined as tantalum, tin, gold or tungsten, that are necessary to the functionality or production of their manufactured or contracted to be manufactured - 12 - products. Companies are required to provide this disclosure on a new form to be filed with the SEC called Form SD. Companies are required to file Form SD by May 31, 2014 for the 2013 calendar period and annually by May 31 every year thereafter. We anticipate additional, new compliance costs to be incurred since we utilize all of the minerals specified in the rule. We are unable to quantify the cost of implementing this new regulation at this time. RECRUITING AND TRAINING We invest substantial resources in our recruiting efforts to focus on a quality workforce that will support our business objectives. Our goal is to provide our associates with growth opportunities by attempting to fill many of our open employment positions internally. We further meet our hiring needs through outside sources, as required. We have an active talent review process including a comprehensive development program in place for senior management in order to ensure we are able to implement our strategic plan. We provide training for our associates designed to educate them on safety, quality, business strategy, and our culture. Our safety training programs educate associates on basic industrial safety practices while emphasizing the importance of knowing emergency response procedures. Our training programs focus on the methodologies and technical competencies required to support current and future business needs with a strong focus on quality and continuous improvement. Supporting our commitment to learning, we offer our associates tuition reimbursement and encourage them to continue their education at accredited colleges and universities. We have established a number of programs designed to challenge and motivate our associates specifically encouraging continuous improvement, supervisory and leadership skills. We believe ongoing development is necessary to ensure our associates utilize best practices, and share a common understanding of work practices and performance expectations. EMPLOYEES The following table provides a breakdown of our employees: Manufacturing – U.S. General and administrative – U.S. Sales and marketing – U.S. Research, development and engineering – U.S. Chaumont, France facility Switzerland facility Tijuana, Mexico facility Total 1,746 147 72 253 247 5 915 3,385 We also employ a number of temporary employees to assist us with various projects and service functions and address peaks in staff requirements. Our employees at our Chaumont, France and Tijuana, Mexico facilities are represented by a union. Nearly all of the positions at our Chaumont, France and Tijuana, Mexico facilities are manufacturing related. We believe that we have a good relationship with our employees. EXECUTIVE OFFICERS OF THE COMPANY Information concerning our executive officers is presented below as of March 4, 2014. The officers’ terms of office run from year to year until the first meeting of the Board of Directors occurring immediately following our Annual Meeting of Stockholders, and until their successors are elected and qualified, except in the case of earlier death, retirement, resignation or removal. Mauricio Arellano, age 47, is Executive Vice President for Global Operations and has served in that office since June 2013. From December 2010 to June 2013, he was President of Greatbatch Medical. Mr. Arellano served as Senior Vice President and Business Leader of our Cardiac and Neurology Group from October 2008 until December 2010, Senior Vice President and Business Leader of our CRM and Neuromodulation Group from January 2008 to October 2008, Senior Vice President and Business Leader of our Medical Solutions Group from November 2006 to January 2008, and as Vice President of Greatbatch Mexico from January 2005 to November 2006. Mr. Arellano joined our Company in October 2003 as the Plant Manager of our former Carson City, NV facility. Prior to joining our Company, he served in a variety of human resources and operational roles with Tyco Healthcare - Especialidades Medicas Kenmex and with Sony de Tijuana Este. - 13 - George M. Cintra, age 52, is Senior Vice President & Chief Technology Officer, and has served in that role since June 2013. Mr. Cintra had previously served as Vice President of Research, Development & Engineering of our Electrochem Solutions business since joining Greatbatch in August 2010. Prior to joining Greatbatch, he was Section Head & Technical Manager, Research & Development with Procter & Gamble from January 2007 to July 2010. Mr. Cintra previously held positions with Gillette Co, Duracell, W.R. Grace and Alcoa. Michael Dinkins, age 59, is Executive Vice President & Chief Financial Officer, and has served in that office since joining our Company in May 2012. From 2008 until May 2012, he was Executive Vice President and Chief Financial Officer of USI Insurance Services, an insurance intermediary company. From 2005 until 2008, he was Executive Vice President and Chief Financial Officer of Hilb Rogal & Hobbs Co., an insurance and risk management services company. Prior to that, Mr. Dinkins held senior positions at Guidant Corporation, Access Worldwide Communications, Cadmus Communications Group and General Electric Company. Michelle Graham, age 47, is Senior Vice President for Human Resources, and has served in that office since joining our Company in December 2010. From 2005 until December 2010, she held a number of senior human resources positions at Bausch & Lomb, most recently as Vice President of Human Resources for its Global Vision Care division. Andrew P. Holman, age 46, is Executive Vice President, Global Sales & Marketing, and has served in that role since June 2013. He joined Greatbatch in April 2012 as Vice President of Sales and Marketing for Greatbatch Medical. From September 2009 to October 2011, Mr. Holman served as Executive Vice President, Sales & Marketing for DJO Global, Inc., and from October 2005 to June 2009, he served as President of the Americas for the Orthopaedics business unit of Smith & Nephew, Inc. Mr. Holman previously held various sales and marketing leadership positions at Johnson & Johnson, Inc., Boston Scientific Corporation and Xerox Corporation. Thomas J. Hook, age 51, has served as our President & Chief Executive Officer since August 2006. Prior to August 2006, he was our Chief Operating Officer, a position he assumed upon joining our Company in September 2004. From August 2002 until September 2004, Mr. Hook was employed by CTI Molecular Imaging where he had served as President, CTI Solutions Group. Timothy G. McEvoy, age 56, is Senior Vice President, General Counsel & Secretary, and has served in that office since joining our Company in February 2007. From 1992 until January 2007, he was employed in a variety of legal roles by Manufacturers and Traders Trust Company. AVAILABLE INFORMATION We make available free of charge through our Internet website our annual report on Form 10-K, quarterly reports on Form 10- Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 as soon as reasonably practicable after we electronically file those reports with, or furnish them to, the SEC. Our Internet address is www.greatbatch.com. The information contained on our website is not incorporated by reference in this annual report on Form 10-K and should not be considered a part of this report. These items may also be obtained free of charge by written request made to Christopher J. Thome, Assistant Corporate Controller – Reporting and Shared Services, Greatbatch, Inc., 10000 Wehrle Drive, Clarence, New York 14031. CAUTIONARY FACTORS THAT MAY AFFECT FUTURE RESULTS Some of the statements contained in this annual report on Form 10-K and other written and oral statements made from time to time by us and our representatives are not statements of historical or current fact. As such, they are “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. We have based these forward-looking statements on our current expectations, and these statements are subject to known and unknown risks, uncertainties and assumptions. Forward-looking statements include statements relating to: future sales, expenses and profitability; future development and expected growth of our business and industry; • • • our ability to execute our business model and our business strategy; • our ability to identify trends within our industries and to offer products and services that meet the changing needs of those markets; and • projected capital expenditures. You can identify forward-looking statements by terminology such as “may,” “will,” “should,” “could,” “expects,” “intends,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,” “potential” or “continue” or “variations” or the negative of these terms or other comparable terminology. These statements are only predictions. Actual events or results may differ materially from those stated or implied by these forward-looking statements. In evaluating these statements and our prospects, you should carefully consider the factors set forth below. All forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by these cautionary factors and to others contained throughout this report. We are under - 14 - no duty to update any of the forward-looking statements after the date of this report or to conform these statements to actual results. Although it is not possible to create a comprehensive list of all factors that may cause actual results to differ from the results expressed or implied by our forward-looking statements or that may affect our future results, some of these factors include the following: our dependence upon a limited number of customers; customer ordering patterns; product obsolescence; our inability to market current or future products; pricing pressure from our customers; our ability to timely and successfully implement cost reduction and plant consolidation initiatives; our reliance on third party suppliers for raw materials, products and subcomponents; fluctuating operating results; our inability to maintain high quality standards for our products; challenges to our intellectual property rights; product liability claims; our inability to successfully consummate and integrate acquisitions and to realize synergies and to operate these acquired businesses in accordance with expectations; our unsuccessful expansion into new markets; our failure to develop new products including medical device systems; our inability to obtain licenses to key technology; regulatory changes or consolidation in the healthcare industry; global economic factors including currency exchange rates and interest rates; the resolution of various legal actions brought against the Company; and other risks and uncertainties that arise from time to time and are described in Item 1A “Risk Factors” of this report. ITEM 1A. RISK FACTORS. Our business faces many risks. Any of the risks discussed below, or elsewhere in this report or in our other SEC filings, could have a material impact on our business, financial condition or results of operations. Risks Related To Our Business We depend heavily on a limited number of customers, and if we lose any of them or they reduce their business with us, we would lose a substantial portion of our revenues. In 2013, Johnson & Johnson, Medtronic and St. Jude Medical, collectively accounted for approximately 49% of our revenues. Our supply agreements with these customers may not be renewed. Furthermore, many of our supply agreements do not contain minimum purchase level requirements and therefore there is no guaranteed source of revenue that we can depend upon under these agreements. The loss of any large customer or a reduction of business with that customer for any reason would harm our business, financial condition and results of operations. If we do not respond to changes in technology, our products may become obsolete and we may experience a loss of customers and lower revenues. We sell our products to customers in several industries that experience rapid technological changes, new product introductions and evolving industry standards. Without the timely introduction of new products and enhancements, our products and services will likely become technologically obsolete over time and we may lose a significant number of our customers. In addition, other new products introduced by our customers may require fewer of our components. We dedicate a significant amount of resources to the development of our products and technologies and we would be harmed if we did not meet customer requirements and expectations. Our inability, for technological or other reasons, to successfully develop and introduce new and innovative products could result in a loss of customers and lower revenues. If we are unable to successfully market our current or future products, our business will be harmed and our revenues and operating results will be adversely affected. The markets for our products have been growing in recent years. If the markets for our products do not grow as forecasted by industry experts, our revenues could be less than expected. In addition, it is difficult to predict the rate at which the markets for our products will grow or at which new and increased competition will result in market saturation. Slower growth in the cardiac and neuromodulation, orthopaedic, portable medical, vascular or energy markets in particular would negatively impact our revenues. In addition, we face the risk that our products will lose widespread market acceptance. Our customers may not continue to utilize the products we offer and a market may not develop for our future products. We may at times determine that it is not technically or economically feasible for us to continue to manufacture certain products and we may not be successful in developing or marketing them. Additionally, new technologies that we develop may not be rapidly accepted because of industry-specific factors, including the need for regulatory clearance, entrenched patterns of clinical practice and uncertainty over third party reimbursement. If this occurs, our business will be harmed and our operating results will be negatively affected. - 15 - We are subject to pricing pressures from customers, which could harm our operating results. We have made price concessions to some of our larger customers in recent years and we expect customer pressure for price concessions will continue. Price concessions or reductions may cause our operating results to suffer. In addition, any delay or failure by a large customer to make payments due to us would harm our operating results and financial condition. We rely on third party suppliers for raw materials, key products and subcomponents and if we are unable to obtain these materials, products and subcomponents on a timely basis or on terms acceptable to us, our ability to manufacture products will suffer. Our business depends on a continuous supply of raw materials. The principal raw materials used in our business include lithium, iodine, gold, palladium, stainless steel, aluminum, cobalt chrome, tantalum, platinum, ruthenium, gallium trichloride, tantalum pellets, vanadium pentoxide, iridium, and titanium. The supply and price of these raw materials are susceptible to fluctuations due to transportation, government regulations, price controls, foreign civil unrest, economic climate or other unforeseen circumstances. Increasing global demand for these raw materials has caused prices of these materials to increase significantly. In addition, there are a limited number of worldwide suppliers of several raw materials needed to manufacture our products. We may not be able to continue to procure raw materials critical to our business or to procure them at acceptable price levels. In addition, we rely on third party manufacturers to supply many of our products and subcomponents. Manufacturing problems may occur with these and other outside sources, as a supplier may fail to develop and supply products and subcomponents to us on a timely basis, or may supply us with products and subcomponents that do not meet our quality, quantity and cost requirements. If any of these problems occur, we may be unable to obtain substitute sources for these products and subcomponents on a timely basis or on terms acceptable to us, which could harm our ability to manufacture our own products and components profitably or on time. In addition, to the extent the processes our suppliers use to manufacture products and subcomponents are proprietary, we may be unable to obtain comparable subcomponents from alternative suppliers. We may never realize the full value of our intangible assets, which represent a significant portion of our total assets. At January 3, 2014, we had $443.1 million of intangible assets, representing 50% of our total assets. These intangible assets consist primarily of goodwill, trademarks, tradenames, customer lists and patented technology arising from our acquisitions. Goodwill and other intangible assets with indefinite lives are not amortized, but are tested annually or upon the occurrence of certain events which indicate that the assets may be impaired. Definite lived intangible assets are amortized over their estimated useful lives and are tested for impairment upon the occurrence of certain events which indicate that the assets may be impaired. We may not receive the recorded value for our intangible assets if we sell or liquidate our business or assets. In addition, the significant amount of intangible assets increases the risk of a large charge to earnings in the event that the recoverability of these intangible assets is impaired. In the event of such a charge to earnings, the market price of our common stock could be affected. In addition, intangible assets with definite lives, which represent $76.1 million of our net intangible assets at January 3, 2014, will continue to be amortized. We incurred total amortization expenses relating to these intangible assets of $13.2 million in 2013. These expenses will reduce our future earnings or increase our future losses. Quality problems with our products could harm our reputation and erode our competitive advantage. Our products are held to high quality and performance standards. In the event our products fail to meet these standards, our reputation could be harmed, which could damage our competitive advantage, cause us to lose customers and result in lower revenues. Quality problems with our products could result in warranty claims and additional costs. We generally allow customers to return defective or damaged products for credit, replacement, or exchange. We generally warrant that our products will meet customer specifications and will be free from defects in materials and workmanship. Additionally, we carry a safety stock of inventory for our customers which may be impacted by warranty claims. We reserve for our exposure to warranty claims based upon recent historical experience and other specific information as it becomes available. However, these reserves may not be adequate to cover future warranty claims and additional warranty costs or inventory write- offs may be incurred which could harm our operating results. Regulatory issues resulting from product complaints, or recalls, or regulatory audits could harm our ability to produce and supply products or bring new products to market. Our products are designed, manufactured and distributed globally in compliance with all applicable regulations and standards. However, a product complaint, recall or negative regulatory audit may cause products to be removed from the market and harm our operating results or financial condition. In addition, during the period in which corrective action is being taken by us to remedy a complaint, recall or negative audit, regulators may not allow new products to be cleared for marketing and sale. - 16 - If we become subject to product liability claims, our operating results and financial condition could suffer. The manufacturing and sale of our products expose us to potential product liability claims and product recalls, including those that arise from failure to meet product specifications, misuse or malfunction, or design flaws, or use of our products with components or systems not manufactured or sold by us. Many of our products are components and function in interaction with our customers’ medical devices. For example, our batteries are produced to meet electrical performance, longevity and other specifications, but the actual performance of those products is dependent on how they are utilized as part of the customers’ devices over the lifetime of the products. Product performance and device interaction from time to time have been, and may in the future be different than expected for a number of reasons. Consequently, it is possible that customers may experience problems with their medical devices that could require device recall or other corrective action, where our batteries met the specification at delivery, and for reasons that are not related primarily or at all to any failure by our product to perform in accordance with specifications. It is possible that our customers (or end-users) may in the future assert that our products caused or contributed to device failure. Even if these assertions do not lead to product liability or contract claims, they could harm our reputation and our customer relationships. Provisions contained in our agreements with key customers attempting to limit our damages, including provisions to limit damages to liability for negligence, may not be enforceable in all instances or may otherwise fail to protect us from liability for damages. Product liability claims or product recalls, regardless of their ultimate outcome, could require us to spend significant time and money in litigation and require us to pay significant damages. The occurrence of product liability claims or product recalls could affect our operating results and financial condition. We carry product liability insurance with coverage that is limited in scope and amount. We may not be able to maintain this insurance at a reasonable cost or on reasonable terms, or at all. This insurance may not be adequate to protect us against a product liability claim that arises in the future. Our operating results may fluctuate, which may make it difficult to forecast our future performance and may result in volatility in our stock price. Our operating results have fluctuated in the past and are likely to fluctuate significantly from quarter to quarter due to a variety of factors, including the following: • • • • a substantial percentage of our costs are fixed in nature, which results in our operations being particularly sensitive to fluctuations in production volumes; changes in the mix of our revenue represented by our various products and customers could result in reductions in our profits if the mix of our revenue represented by lower margin products increases; timing of orders placed by our principal customers who account for a significant portion of our revenues; and increased costs of raw materials or supplies. If we are unable to protect our intellectual property and proprietary rights, our business could be affected. We rely on a combination of patents, licenses, trade secrets and know-how to establish and protect our rights to our technologies and products. As of January 3, 2014, we held 625 active U.S. patents and 344 active foreign patents. However, the steps we have taken and will take in the future to protect our rights may not be adequate to deter misappropriation of our intellectual property. In addition to seeking formal patent protection whenever possible, we attempt to protect our proprietary rights and trade secrets by entering into confidentiality and non-compete agreements with employees, consultants and third parties with which we do business. However, these agreements may be breached and if breached, there may be no adequate remedy available to us and we may be unable to prevent the unauthorized disclosure or use of our technical knowledge, practices and/or procedures. If our trade secrets become known, we may lose our competitive advantages. Additionally, as patents and other intellectual property protection expire we may lose our competitive advantage. If third parties infringe or misappropriate our patents or other proprietary rights, our business could be seriously harmed. We may be required to spend significant resources to monitor our intellectual property rights, or we may not be able to detect infringement of these rights and may lose our competitive advantages associated with our intellectual property rights before we do so. In addition, competitors may design around our technology or develop competing technologies that do not infringe on our proprietary rights. - 17 - We may be subject to intellectual property claims, which could be costly and time consuming and could divert our management from our business operations. In producing our products, third parties may claim that we are infringing on their intellectual property rights, and we may be found to have infringed those intellectual property rights. We may be unaware of intellectual property rights of others that may be used in our technology and products. In addition, third parties may claim that our patents have been improperly granted and may seek to invalidate our existing or future patents. If any claim for invalidation prevailed, third parties may manufacture and sell products that compete with our products and our revenues from any related license agreements would decrease accordingly. We also typically do not receive significant indemnification from parties that license technology to us against third party claims of intellectual property infringement. Any litigation or other challenges regarding our patents or other intellectual property could be costly and time consuming and could divert our management and key personnel from our business operations. The complexity of the technology involved in producing our products, and the uncertainty of intellectual property litigation increases these risks. Claims of intellectual property infringement may also require us to enter into costly royalty or license agreements. However, we may not be able to obtain royalty or license agreements on terms acceptable to us, or at all. We also may be made subject to significant damages or injunctions against development and sale of our products. We may not be able to attract, train and retain a sufficient number of qualified employees to maintain and grow our business. Our success will depend in large part upon our ability to attract, train, retain and motivate highly skilled employees. There is currently aggressive competition for employees who have experience in technology and engineering. We compete intensely with other companies to recruit and hire from this limited pool. The industries in which we compete for employees are characterized by high levels of employee attrition. Although we believe we offer competitive salaries and benefits, we may have to increase spending in order to attract, train and retain personnel. We are dependent upon our senior management team and key personnel and the loss of any of them could significantly harm us. Our future performance depends to a significant degree upon the continued contributions of our senior management team and key technical personnel. Our products are highly technical in nature. In general, only highly qualified and trained scientists have the necessary skills to develop our products. The loss or unavailability to us of any member of our senior management team or a key technical employee could significantly harm us. We face intense competition for these professionals from our competitors, customers and companies operating in our industry. To the extent that the services of members of our senior management team and key technical personnel would be unavailable to us for any reason, we would be required to hire other personnel to manage and operate our Company and to develop our products and technology. We may not be able to locate or employ such qualified personnel on acceptable terms. We may not realize the expected benefits from our cost savings and consolidation initiatives or those initiatives may have unintended consequences, which may harm our business or results of operations. We have incurred significant charges related to various cost savings and consolidation efforts. These initiatives were undertaken to improve our operational effectiveness, efficiencies and profitability. Additional information regarding these initiatives is discussed in the “Cost Savings and Consolidation Efforts” section of Item 7 to this report. Cost reduction efforts under these initiatives include various cost and efficiency improvement measures such as, headcount reductions, the relocation of certain resources as well as administrative and functional activities, the closure of certain facilities, the transfer of certain production lines, the sale of certain non-strategic assets and other efforts to streamline our business, among other actions. These measures could yield unintended consequences, such as distraction of our management and employees, business disruption, disputes with customers, attrition beyond our planned reduction in workforce and reduced employee productivity. If any of these unintended consequences were to occur, they could negatively affect our business, sales, financial condition and results of operations. In addition, headcount reductions and customer disputes may subject us to the risk of litigation, which could result in substantial cost. Moreover, our expense reduction programs result in charges and expenses that impact our operating results. We cannot guarantee that these measures, or other expense reduction measures we take in the future, will result in the expected cost savings. - 18 - We may make acquisitions that could subject us to a number of operational risks and we may not be successful in integrating companies we acquire into our existing operations. We have made and expect to make in the future acquisitions that complement our core competencies in technology and manufacturing to enable us to manufacture and sell additional products to our existing customers and to expand our business into related markets. Implementation of our acquisition strategy entails a number of risks, including: inaccurate assessments of potential liabilities associated with the acquired businesses; the existence of unknown or undisclosed liabilities associated with the acquired businesses; • • • diversion of our management’s attention from our core businesses; • potential loss of key employees or customers of the acquired businesses; • difficulties in integrating the operations and products of an acquired business or in realizing projected revenue growth, efficiencies and cost savings; and increases in indebtedness and limitation in our ability to access capital if needed. • Our acquisitions have increased the size and scope of our operations, and may place a strain on our managerial, operational and financial resources and systems. Any failure by us to manage this growth and successfully integrate these acquisitions could harm our business and our financial condition and results. If we are not successful in making acquisitions to expand and develop our business, our operating results may suffer. One facet of our growth strategy is to make acquisitions that complement our core competencies in technology and manufacturing to enable us to manufacture and sell additional products to our existing customers and to expand our business into related markets. Our continued growth may depend on our ability to identify and acquire companies that complement or enhance our business on acceptable terms. We may not be able to identify or complete future acquisitions. Some of the risks that we may encounter include expenses associated with and difficulties in identifying potential targets, the costs associated with unsuccessful acquisitions, and higher prices for acquired companies because of competition for attractive acquisition targets. Accidents at any of our facilities could delay production and affect our operations. Our business involves complex manufacturing processes and hazardous materials that can be dangerous to our employees. Although we employ safety procedures in the design and operation of our facilities, there is a risk that an accident or death could occur. Any accident, such as a chemical spill or fire, could result in significant manufacturing delays or claims for damages resulting from injuries, which would harm our operations and financial condition. The potential liability resulting from any such accident or death, to the extent not covered by insurance, could harm our financial condition or operating results. Any disruption of operations at any of our facilities, and in particular our larger facilities, could harm our business. We may face competition that could harm our business and we may be unable to compete successfully against new entrants and established companies with greater resources. Competition in connection with the manufacturing of our medical products may intensify in the future. One or more of our medical customers may undertake additional vertical integration initiatives and begin to manufacture some or all of their components that we currently supply them which could cause our operating results to suffer. The market for commercial power sources is competitive, fragmented and subject to rapid technological change. Many other commercial power source suppliers are larger and have greater financial, operational, personnel, sales, technical and marketing resources than us. These and other companies may develop products that are superior to ours, which could result in lower revenues and operating results. We intend to develop new products and expand into new markets, which may not be successful and could harm our operating results. We intend to expand into new markets and develop new and modified products based on our existing technologies and engineering capabilities, including the development of complete medical device systems. These efforts have required and will continue to require us to make substantial investments, including significant research, development and engineering expenditures and capital expenditures for new, expanded or improved manufacturing facilities. Additionally, many of the new products we are working on take longer and more resources to develop and commercialize, including obtaining regulatory approval. Specific risks in connection with expanding into new products and markets include: longer product development cycles, the inability to transfer our quality standards and technology into new products, the failure to receive or delay in receipt of regulatory approval for new products or modifications to existing products, and the failure of our customers to accept the new or modified products. - 19 - Our failure to obtain licenses from third parties for new technologies or the loss of these licenses could impair our ability to design and manufacture new products and reduce our revenues. We occasionally license technologies from third parties rather than depending exclusively on our own proprietary technology and developments. Our ability to license new technologies from third parties is and will continue to be critical to our ability to offer new and improved products. We may not be able to continue to identify new technologies developed by others and even if we are able to identify new technologies, we may not be able to negotiate licenses on favorable terms, or at all. Additionally, we could lose rights granted under licenses for reasons beyond our control. Our international sales and operations are subject to a variety of market and financial risks and costs that could affect our profitability and operating results. Our sales outside the U.S., which accounted for 51% of sales for 2013, and our operations in Mexico, Switzerland and France, are and will continue to be subject to a number of risks and potential costs, including: changes in foreign economic conditions and/or regulatory requirements; local product preferences and product requirements; longer-term receivables than are typical in the U.S.; • • • • difficulties in enforcing agreements through foreign legal systems; • • • work force instability; • political and economic instability; and • less protection of intellectual property in some countries outside of the U.S.; trade protection measures and import and export licensing requirements; complex tax and cash management issues. We earn revenue and incur expenses related to our foreign sales and operations that are denominated in a foreign currency. Historically, foreign currency fluctuations have not had a material effect on our consolidated financial statements. However, fluctuations in foreign currency exchange rates could have a significant negative impact on our profitability and operating results. The current economic environment and credit market uncertainty could interrupt our access to capital markets, borrowings, or financial transactions to hedge certain risks, which could adversely affect our financial condition. To date, we have been able to access debt and equity financing that has allowed us to make investments in growth opportunities and fund working capital requirements. In addition, we enter into financial transactions to hedge certain risks, including foreign exchange and interest rate risk. Our continued access to capital markets, the stability of our lenders and their willingness to support our needs, and the stability of the parties to our financial transactions that hedge risks are essential for us to meet our current and long-term obligations, fund operations, and fund our strategic initiatives. An interruption in our access to external financing or financial transactions to hedge risk could affect our business prospects and financial condition. The failure of our information technology systems to perform as anticipated could disrupt our business and affect our financial condition. The efficient operation of our business is dependent on our information technology (“IT”) systems. Accordingly, we rely upon the capacity, reliability and security of our IT hardware and software infrastructure and our ability to expand and update this infrastructure in response to our changing needs. Despite our implementation of security measures, our systems are vulnerable to damages from computer viruses, natural disasters, incursions by intruders or hackers, failures in hardware or software, power fluctuations, cyber terrorists and other similar disruptions. The failure of our IT systems to perform as anticipated for any reason or any significant breach of security could disrupt our business and result in numerous consequences, including reduced effectiveness and efficiency of operations, inappropriate disclosure of confidential information, increased overhead costs and loss of important information, which could have a material effect on our business and results of operations. In addition, we may be required to incur significant costs to protect against damage caused by these disruptions or security breaches in the future. Risks Related To Our Industries The healthcare industry is highly regulated and subject to various political, economic and regulatory changes that could increase our compliance costs and force us to modify how we develop and price our products. The healthcare industry is highly regulated and is influenced by changing political, economic and regulatory factors. Several of our product lines are subject to international, federal, state and local health and safety, packaging and product content regulations. In addition, medical devices are subject to regulation by the FDA and similar governmental agencies. These regulations cover a wide variety of product activities from design and development to labeling, manufacturing, promotion, sales and distribution. Compliance with these regulations may be time consuming, burdensome and expensive and could negatively affect our ability to sell products. This may result in higher than anticipated costs or lower than anticipated revenues. - 20 - Furthermore, healthcare industry regulations are complex, change frequently and have tended to become more stringent over time. Federal and state legislatures have periodically considered programs to reform or amend the U.S. healthcare system at both the federal and state levels. In addition, these regulations may contain proposals to increase governmental involvement in healthcare, lower reimbursement rates or otherwise change the environment in which healthcare industry participants operate. We may be required to incur significant expenses to comply with these regulations or remedy past violations of these regulations. Our failure to comply with applicable government regulations could also result in cessation of portions or all of our operations, impositions of fines and restrictions on our ability to carry on or expand our operations. In addition, because many of our products are sold into regulated industries, we must comply with additional regulations in marketing our products. In response to perceived increases in healthcare costs in recent years, there have been and continue to be proposals by the Obama administration, members of Congress, state governments, regulators and third-party payors to control these costs and, more generally, to reform the U.S. healthcare system. Health Care Reform imposes significant new taxes on medical device manufacturers, which will result in a significant increase in the tax burden on our industry and which could have a material negative impact on our financial condition, results of operations and our cash flows. Other elements of Health Care Reform such as comparative effectiveness research, an independent payment advisory board, payment system reforms including shared savings pilots and other provisions could meaningfully change the way healthcare is developed and delivered, and may materially impact numerous aspects of our business, results of operations and financial condition. The new medical device tax, which was effective in 2013, increased our cost of sales by $0.5 million. Many significant parts of Health Care Reform will be phased in over time and require further guidance and clarification in the form of regulations. As a result, many of the impacts of Health Care Reform will not be known until those regulations are enacted, which we expect to occur over the next several years. Our business is subject to environmental regulations that could be costly to comply with. Federal, state and local regulations impose various environmental controls on the manufacturing, transportation, storage, use and disposal of batteries and hazardous chemicals and other materials used in, and hazardous waste produced by the manufacturing of our products. Conditions relating to our historical operations may require expenditures for clean-up in the future and changes in environmental laws and regulations may impose costly compliance requirements on us or otherwise subject us to future liabilities. Additional or modified regulations relating to the manufacture, transportation, storage, use and disposal of materials used to manufacture our products or restricting disposal or transportation of batteries may be imposed that may result in higher costs or lower operating results. In addition, we cannot predict the effect that additional or modified environmental regulations may have on us or our customers. Consolidation in the healthcare industry could result in greater competition and reduce our revenues and harm our business. Many healthcare industry companies are consolidating to create new companies with greater market power. As the healthcare industry consolidates, competition to provide products and services to industry participants will become more intense. These industry participants may try to use their market power to negotiate price concessions or reductions for our products. If we are forced to reduce our prices, our revenues would decrease and our operating results would suffer. Our business is indirectly subject to healthcare industry cost containment measures that could result in reduced sales of our products. Several of our customers rely on third party payors, such as government programs and private health insurance plans, to reimburse some or all of the cost of the procedures in which our products are used. The continuing efforts of government, insurance companies and other payors of healthcare costs to contain or reduce those costs could lead to patients being unable to obtain approval for payment from these third party payors. If that occurred, sales of medical devices may decline significantly and our customers may reduce or eliminate purchases of our products. The cost containment measures that healthcare payors are instituting, both in the U.S. and internationally, could reduce our revenues and harm our operating results. Our energy market revenues are dependent on conditions in the oil and natural gas industry, which historically have been volatile. Sales of our energy market products depend upon the condition of the oil and gas industry. In the past, oil and natural gas prices have been volatile and the oil and gas exploration and production industry has been cyclical, and it is likely that oil and natural gas prices will continue to fluctuate in the future. The current and anticipated prices of oil and natural gas influence the oil and gas exploration and production business and are affected by a variety of political and economic factors, including worldwide demand for oil and natural gas, worldwide and domestic supplies of oil and natural gas, the ability of the Organization of Petroleum Exporting Countries (“OPEC”) to set and maintain production levels and pricing, the level of production of non- OPEC countries, the price and availability of alternative fuels, political stability in oil producing regions and the policies of the various governments regarding exploration and development of their oil and natural gas reserves. A change in the oil and gas - 21 - exploration and production industry or a reduction in the exploration and production expenditures of oil and gas companies could cause our energy market revenues to decline. ITEM 1B. UNRESOLVED STAFF COMMENTS None. ITEM 2. PROPERTIES The following table sets forth information about our principal facilities as of January 3, 2014: Location Alden, NY Ann Arbor, MI Beaverton, OR Blaine, MN Chaumont, France Clarence, NY Clarence, NY Clarence, NY Cleveland, OH Fort Wayne, IN Frisco, TX Indianapolis, IN Minneapolis, MN Orvin, Switzerland Plymouth, MN Raynham, MA Tijuana, Mexico Own/Lease Own Sq. Ft. 125,000 9,970 62,200 32,400 59,200 117,800 20,800 18,600 16,900 81,000 9,200 82,600 72,000 40,400 122,800 81,000 190,800 Lease Lease Own Own Own Own Lease Lease Own Lease Own Own Own Lease Own Lease Principal Use Medical battery and capacitor manufacturing Office and lab space for design engineering team Commercial battery manufacturing Medical device engineering Manufacturing of orthopaedic implants Corporate offices and RD&E Machining and assembly of components Machining and assembly of components Office and lab space for design engineering team Manufacturing of orthopaedic instruments Global headquarters – principal executive office Manufacturing of orthopaedic cases and trays Enclosure manufacturing and engineering European corporate offices Introducers, catheters and leads manufacturing Commercial battery manufacturing and RD&E Feedthrough, catheters and orthopaedic instrument manufacturing and value-added assembly Warsaw, IN 3,000 Lease Orthopaedic rapid prototyping design center In 2012, the Company completed construction of an orthopaedic manufacturing facility in Fort Wayne, IN and transferred manufacturing operations being performed at its Columbia City, IN location into this new facility. During 2012, the Company also transferred most major functions previously performed at its facilities in Orvin and Corgemont, Switzerland into its Fort Wayne, IN and Tijuana, Mexico facilities. Additionally, during 2012, the Company relocated its global headquarters to Frisco, TX. In the first quarter of 2013, the Company’s Corgemont, Switzerland facility lease was assumed by a third party in connection with its purchase of certain non-core orthopaedic product lines. These initiatives were completed in 2013. During 2013, we began a project to expand its Chaumont, France facility in order to enhance our capabilities and fulfill larger volume customer supply agreements. This initiative is expected to be completed over the next three years. Near the end of 2011, the Company initiated plans to upgrade and expand its manufacturing infrastructure in order to support its medical device strategy. This includes the transfer of certain product lines to create additional capacity for the manufacture of medical devices, expansion of its Plymouth, MN and Tijuana, Mexico facilities, as well as the purchase of equipment to enable the production of medical devices. These initiatives are expected to be completed over the next year. Total capital investment under these initiatives is expected to be between $15 million to $20 million of which approximately $12.4 million has been expended to date. - 22 - ITEM 3. LEGAL PROCEEDINGS On December 21, 2012, the Company and several other unaffiliated parties were named as defendants in a personal injury and wrongful death action filed in the 113th Judicial District Court of Harris County, Texas. The complaint seeks damages alleging marketing and product defects and failure to warn, negligence and gross negligence relating to a product we manufactured and sold to a customer, one of the other named defendants. Our customer, in turn, incorporated our product into its own product which it sold to its customer, another named defendant. This matter is currently scheduled for trial in the second half of 2014. We are indemnified by our customer against any loss in this matter, including costs of defense, which obligation is supported by our customer's product liability insurance coverage. We also have our own product liability insurance coverage. The Company has meritorious defenses and is vigorously defending the matter. We are party to various legal actions arising in the normal course of business. A description of pending legal actions against the Company is set forth at Note 15 “Commitments and Contingencies” of the Notes to Consolidated Financial Statements contained in Item 8 of this report. We do not believe that the ultimate resolution of any pending legal actions will have a material effect on our consolidated results of operations, financial position or cash flows. However, litigation is subject to inherent uncertainties and there can be no assurance that any pending legal action, which we currently believe to be immaterial, does not become material in the future. ITEM 4. MINE SAFETY DISCLOSURES Not applicable. PART II ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES. The Company’s common stock trades on the New York Stock Exchange (“NYSE”) under the symbol “GB.” The following table sets forth information on the prices of our common stock as reported by the NYSE: 2012 First Quarter Second Quarter Third Quarter Fourth Quarter 2013 First Quarter Second Quarter Third Quarter Fourth Quarter High Low Close $ $ 27.22 $ 24.82 25.64 25.33 30.64 $ 34.41 38.36 45.02 21.35 $ 20.29 22.05 21.08 22.70 $ 27.03 32.70 33.24 24.52 22.71 24.33 22.89 29.87 32.79 33.69 43.80 As of March 4, 2014, there were approximately 118 record holders of the Company’s common stock. The Company stock account included in our 401(k) plan is considered one record holder for the purposes of this calculation. There is approximately 2,219 active and former employees’ holding Company stock in the 401(k) plan. We have not paid cash dividends and currently intend to retain any earnings to further develop and grow our business. - 23 - PERFORMANCE GRAPH The following graph compares, for the five year period ended January 3, 2014, the cumulative total stockholder return for Greatbatch, Inc., the S&P SmallCap 600 Index, and the Hemscott Peer Group Index. The Hemscott Peer Group Index includes approximately 115 comparable companies included in the Hemscott Industry Group 520 Medical Instruments & Supplies and 521 Medical Appliances & Equipment. The graph assumes that $100 was invested on January 2, 2009 and assumes reinvestment of dividends. The stock price performance shown on the following graph is not necessarily indicative of future price performance: $300 $250 $200 $150 $100 $50 $0 1/2/09 1/1/10 12/31/10 12/30/11 12/28/12 1/3/14 Greatbatch, Inc. S&P Smallcap 600 Hemscott Peer Group Index - 24 - ITEM 6. SELECTED FINANCIAL DATA The following table provides selected financial data for the periods indicated. You should read this data along with Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and Item 8, “Financial Statements and Supplementary Data” appearing elsewhere in this report. The consolidated statement of operations data and the consolidated balance sheet data for the fiscal years indicated have been derived from our consolidated financial statements and related notes (in thousands, except per share amounts): Statement of Operations Data: Sales Net income (loss) Earnings (loss) per share Basic Diluted Balance Sheet Data: Working capital Total assets Long-term obligations Years Ended Jan. 3 2014 (1) Dec. 28 2012 (1)(2) Dec. 30, 2011 (1)(2) Dec. 31, 2010 (1)(3) Jan. 1, 2010 (1)(3) $ $ $ 663,945 $ 36,267 646,177 $ (4,799 ) 568,822 $ 33,122 533,425 $ 33,138 521,821 (9,001 ) 1.51 $ 1.43 (0.20 ) $ (0.20 ) 1.42 $ 1.40 1.44 $ 1.40 (0.39 ) (0.39 ) 190,731 $ 890,703 256,846 176,376 $ 889,875 317,258 170,907 $ 881,347 320,015 150,922 $ 776,976 289,560 119,926 830,543 317,575 (1) From 2009 to 2013, we recorded material charges in Other Operating Expenses, Net, primarily related to our cost savings and consolidation initiatives. Additional information is set forth in Note 13 “Other Operating Expenses, Net” of the Notes to Consolidated Financial Statements contained in Item 8 of this report. (2) On February 16, 2012, and on December 15, 2011, we acquired NeuroNexus Technologies, Inc., and Micro Power Electronics, Inc., respectively. This data includes the results of operations of these companies subsequent to their acquisition. Additional information is set forth in Note 2 “Acquisitions” of the Notes to Consolidated Financial Statements contained in Item 8 of this report. In 2011, the Company sold its cost method investment in IntElect Medical, Inc. This transaction resulted in a pre-tax gain of $4.5 million. (3) In 2009, we recorded a $34.5 million litigation charge and a $15.9 million write-down of trademarks and tradenames. In 2010, we settled the litigation which resulted in a $9.5 million gain. - 25 - ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS YOU SHOULD READ THE FOLLOWING DISCUSSION AND ANALYSIS OF OUR FINANCIAL CONDITION AND RESULTS OF OPERATIONS IN CONJUNCTION WITH OUR FINANCIAL STATEMENTS AND RELATED NOTES INCLUDED ELSEWHERE IN THIS REPORT. Our Business • Our business • Our acquisitions • Our customers • Use of non-GAAP financial information • Strategic and financial overview • 2014 financial guidance • Cost savings and consolidation efforts • Product development • Government regulation Our Critical Accounting Estimates • Valuation of goodwill and other identifiable intangible assets • Stock-based compensation • • Tangible long-lived assets • Provision for income taxes Inventories Our Financial Results • Fiscal 2013 compared with fiscal 2012 • Fiscal 2012 compared with fiscal 2011 • Liquidity and capital resources • Off-balance sheet arrangements • Litigation • Contractual obligations • • Inflation Impact of recently issued accounting standards Our Business In connection with the realignment of our operating structure in 2013 to optimize profitable growth, which included changing our management and reporting structure, we reevaluated our operating and reporting segments. Beginning in the fourth quarter of 2013, we have two reportable segments: Greatbatch Medical and QiG Group (“QiG”). As required, prior year amounts have been reclassified in order to conform them to the current year presentation. Greatbatch Medical designs and manufactures products where Greatbatch either owns the intellectual property or has unique manufacturing and assembly expertise. The financial results of Greatbatch Medical include the former Implantable Medical and Electrochem Solutions (“Electrochem”) segments, excluding QiG. These products include medical devices and components for the cardiac, neuromodulation, orthopaedics, portable medical, vascular and energy markets among others. The Greatbatch Medical segment also offers value- added assembly and design engineering services for medical devices that utilize its component products. QiG focuses on developing medical device systems for some of healthcare’s most pressing challenges and reflects Greatbatch’s strategic evolution of its product offerings in order to raise the growth and profitability profile of the Company. Through the research and development professionals in QiG, the Company is now investing in three areas - new medical device systems commercialization, collaborative programs with OEM customers, and strategic equity positions in start-up companies - to grow a diversified and distinctive portfolio. The medical device systems developed by QiG are manufactured by Greatbatch Medical. The Company's customers include large multi-national original equipment manufacturers (“OEMs”). - 26 - Our Acquisitions On December 15, 2011, we acquired all of the outstanding stock of Micro Power Electronics, Inc. (“Micro Power”) headquartered in Beaverton, OR. Micro Power is a leading supplier of custom battery solutions, serving the portable medical, military and handheld automatic identification and data collection markets. Micro Power’s commercial portfolio is highly complementary to the products and services offered by Greatbatch Medical. The results of Micro Power were included in our Greatbatch Medical segment from the date of acquisition. The aggregate purchase price of Micro Power was $71.8 million, which we funded with cash on hand and $45 million borrowed under our revolving credit facility. Total assets acquired from Micro Power were $88.2 million. Total liabilities assumed from Micro Power were $16.4 million. For 2012, Micro Power added approximately $82.4 million to our revenue. On February 16, 2012, we purchased all of the outstanding common stock of NeuroNexus Technologies, Inc. (“NeuroNexus”) headquartered in Ann Arbor, MI. NeuroNexus is an active implantable medical device design firm specializing in developing and commercializing neural interface technology, components and systems for neuroscience and clinical markets. NeuroNexus has an extensive intellectual property portfolio, core technologies and capabilities to support the development and manufacturing of innovative neural interface devices across a wide range of functions including neuromodulation, sensing, optical stimulation and targeted drug delivery applications. The results of NeuroNexus were included in our QiG segment from the date of acquisition. The aggregate purchase price of NeuroNexus was $13.2 million, which we funded with cash on hand and $10 million borrowed under our revolving credit facility. Total assets acquired from NeuroNexus were $14.6 million. Total liabilities assumed from NeuroNexus were $1.4 million. For 2012, NeuroNexus added approximately $2.5 million to our revenue. Going forward, we will continue to pursue acquisitions to enhance our top and bottom line growth trajectory, with a focus on innovative solutions. Our strategic criteria for these acquisitions is that they should be complementary to our existing business model, drive expansion in core markets, allow us to enter adjacent growth markets, are focused on proprietary technology, can be tightly integrated into our operating base, and will enhance our return on invested capital performance. Our Customers Our products are designed to provide reliable, long-lasting solutions that meet the evolving requirements and needs of our customers. The nature and extent of our selling relationships with each customer are different in terms of breadth of products purchased, purchased product volumes, length of contractual commitment, ordering patterns, inventory management and selling prices. Our Greatbatch Medical customers include large multi-national OEMs, such as Biotronik, Boston Scientific, Halliburton Company, Johnson & Johnson, Medtronic, Philips Healthcare, Smith & Nephew, Sorin Group, St. Jude Medical, Stryker, and Zimmer. During 2013, Johnson & Johnson, Medtronic and St. Jude Medical collectively accounted for 49% of our total sales. QiG customers include numerous scientists, hospitals and universities throughout the world who perform research for the neuroscience and clinical markets. Use of Non-GAAP Financial Information We prepare our consolidated financial statements in accordance with generally accepted accounting principles in the United States of America (“GAAP”). Additionally, we consistently report and discuss in our quarterly earnings releases and investor presentations adjusted operating income and margin, adjusted net income, adjusted earnings per diluted share, and organic constant currency growth rates. These adjusted amounts, other than organic constant currency growth rates, consist of GAAP amounts excluding the following adjustments to the extent occurring during the period: (i) acquisition-related charges, (ii) facility consolidation, optimization, manufacturing transfer and system integration charges, (iii) asset write-down and disposition charges, (iv) severance charges in connection with corporate realignments or a reduction in force (v) litigation charges and gains, (vi) the impact of certain non-cash charges to interest expense, (vii) unusual or infrequently occurring items, (viii) certain R&D expenditures (such as medical device DVT expenses in connection with developing our neuromodulation platform), (ix) gain/loss on the sale of investments, (x) the income tax (benefit) related to these adjustments and (xi) certain tax charges related to the consolidation of our Swiss Orthopaedic facility. Adjusted earnings per diluted share were calculated by dividing adjusted net income by diluted weighted average shares outstanding. To calculate organic constant currency growth rates that exclude the impact of changes in foreign currency exchange rates, as well as the impact of any acquisitions or divestitures of product lines on sales growth rates, we convert current period sales from local currency to U.S. dollars using the previous periods foreign currency exchange rates and exclude the amount of sales acquired/divested during the period from the current/previous period amounts, respectively. We believe that the presentation of adjusted operating income and margin, adjusted net income, adjusted diluted earnings per share, and organic constant currency growth rates provides important supplemental information to management and investors seeking to understand the financial and business trends relating to our financial condition and results of operations. - 27 - Strategic and Financial Overview Our current strategy is centered around four strategic imperatives: 1) Organic Growth; 2) Margin Expansion; 3) Medical Device Systems; and 4) Targeted Acquisitions. This strategy was clearly exhibited in our 2013 results, illustrating not only our continuing momentum, but also the effective measures we are deploying to create an even brighter future. 2013 results include an additional week of operations in comparison to 2012 and 2011 as we utilize a fifty-two, fifty-three week fiscal year, which ends on the Friday nearest December 31st. Although this additional week of operations may have impacted certain financial statement line items, management believes that when combined with the additional holiday and weather related shutdowns, this additional week did not materially impact our net operating results. Organic Growth - Over the last several years we have significantly enhanced our sales and marketing capabilities. This has included moving account executives closer to our major customers, upgrading our sales force with new sales talent, enhancing our sales commission programs, and intensifying our market research. These initiatives contributed to our record sales for 2013 of $663.9 million, which represented a 3% increase over 2012 sales of $646.2 million despite the divestiture of $15 million of certain non-core orthopaedic product lines during the first quarter of 2013. After adjusting for the impact of these divestitures, as well as the $2 million positive impact of foreign currency exchange rates, sales increased 5% in 2013 due to strong organic constant currency growth from our cardiac/neuromodulation (6%) and orthopaedic (20%) product lines due to market share gains, customer product launches, the additional week of sales and the release of backlog stemming from our Swiss consolidation in 2012. Partially offsetting these increases were declines in our vascular and portable medical product lines due to the previously communicated voluntary recall of two vascular medical devices in 2012 and our increased pricing discipline, which resulted in the loss of low-margin portable medical business. Sales growth for 2012 of 14% included the benefit from our acquisitions of $84.8 million, as well as the negative impact of foreign currency exchange rate fluctuations of $6 million. On an organic constant currency basis, which excludes the impact of foreign currency exchange rates and acquired sales, sales for 2012 were consistent with 2011 as organic growth was offset by lower orthopaedic sales due to price concessions provided to customers and operational issues at our Swiss orthopaedic facilities, which were aggressively addressed in 2012. For 2014, we expect revenue to organically grow 3-6%, which is in line with our long-term organic growth goal objectives. Margin Expansion - We have a longstanding history of operational excellence, which is one of our core competencies. This, when combined with our organic sales growth, is expected to continue to drive both gross and operating margin expansion. This core competency was evident in our 2013 results as gross profit as a percentage of sales (“Gross Margin”) increased 180 basis points to 33.0%. This increase primarily resulted from the increased operational leverage gained from our higher sales volumes and productivity initiatives, as well as a favorable mix of higher margin products. Our Gross Margin for 2012 decreased 50 basis points in comparison to 2011 as increased operational leverage was offset by the operational issues at our Swiss orthopaedic facilities and a higher mix of lower margin products. Our increased sales volume, combined with the increase in Gross Margin for 2013 resulted in an increase to our gross profit of 9% and 12% for 2013 and 2012, respectively. Partially offsetting these increases in gross profit were increases in our selling, general and administrative expenses (“SG&A”) and research, development and engineering costs, net (“RD&E”). SG&A expenses increased 9% and 12% for 2013 and 2012, respectively. The 2013 increase in SG&A expense was primarily due to the additional investments in sales and marketing resources, higher performance-based compensation expense and the additional week of payroll expense in 2013 in comparison to 2012. The 2012 increase in SG&A expense was primarily due to our acquisitions which added $9.6 million to SG&A in comparison to 2011. RD&E expenses increased 3% and 15% for 2013 and 2012, respectively. The 2013 increase in RD&E was primarily due to lower customer cost reimbursements and the additional week of operations compared to the prior year. These increases were partially offset by the initiative launched in the second half of 2012 to more fully optimize our research and development efforts. This included the reallocation of research and development resources to higher priority projects, the postponement of some research and development projects, and the decision to pursue various alternatives to monetize our existing non-core intellectual property and entering into more co-development arrangements with our customers. The 2012 increase in RD&E expense was primarily due to our acquisitions, which added $2.6 million of expenses, as well as our additional investment in the development of complete medical device systems. Since 2007, we have invested substantial resources in integrating our acquisitions and streamlining our operations. As we move forward, investing in our operations will continue to be critical to the success of our strategic imperative to drive margin expansion. This strategy continued during 2013 and 2012 as we realigned our operating structure in order to optimize our profitable growth, continued to consolidate our orthopaedic footprint, expanded our manufacturing infrastructure to support the commercialization of our medical devices and upgraded our global ERP system in order to support our future growth. As a result of these initiatives, our other operating expense totaled $15.8 million, $42.3 million and $0.6 million for 2013, 2012 and 2011, respectively. The significant increase in other operating expenses, net for 2012 related to the consolidation of our Swiss orthopaedic facilities, which was completed in the first quarter of 2013. We continually evaluate our operating structure in order to maximize efficiencies and drive margin expansion. Future other operating expenses are expected to be lower than the 2013 levels, but could be impacted if new consolidation and optimization initiatives are undertaken. - 28 - GAAP operating income for 2013 was $61.3 million compared to $25.8 million for 2012 and $61.7 million for 2011. The significant decrease in 2012 was primarily due to the costs incurred in connection with our consolidation and productivity initiatives discussed above. Adjusted operating income, which excludes these items, was $82.9 million for 2013, compared to $73.9 million for 2012 and $67.6 million for 2011. Adjusted operating income as a percentage of sales (“Adjusted Operating Margin”) for 2013 was 12.5% compared to 11.4% for 2012 and 11.9% for 2011 and reflects the success the Company has had in leveraging its operating infrastructure and driving margin expansion. We expect these improvements to continue in 2014 as Adjusted Operating Margin is expected to be 13.0% - 13.3% of sales. A reconciliation of GAAP operating income (loss) to adjusted amounts is as follows (dollars in thousands): Total sales Greatbatch Medical Jan 3, 2014 Dec 28, 2012 $ 660,902 $ 643,722 $ QiG Unallocated Total Jan 3, 2014 3,043 $ Dec 28, 2012 2,455 $ Jan 3, 2014 — $ Dec 28, 2012 Jan 3, 2014 Dec 28, 2012 — $ 663,945 $ 646,177 Operating income (loss) as reported $ 111,805 $ 79,093 $ (30,484) $ (32,554) $ (19,982 ) $ (20,718) $ 61,339 $ 25,821 Adjustments: Inventory step-up amortization (COS) Medical device DVT expenses (RD&E) Consolidation and optimization costs Acquisition and integration (income) expenses Asset dispositions, severance and other — — 13,388 532 — 34,372 187 1,187 1,287 1,073 — 5,793 86 (690 ) 540 — 5,190 6 167 57 Adjusted operating income (loss) $ 126,567 $ 116,357 $ (24,755) $ (27,134) $ Adjusted operating margin 19.2 % 18.1 % N/A N/A — — 1,284 — — 4,670 — 5,793 14,758 532 5,190 39,048 1 (193) (18,890 ) $ N/A 6 708 (502 ) 1,460 1,838 1,534 (15,334) $ 82,922 $ 73,889 N/A 12.5 % 11.4 % Total sales Greatbatch Medical Dec 28, 2012 Dec 30, 2011 $ 643,722 $ 568,822 $ QiG Unallocated Total Dec 28, 2012 2,455 $ Dec 30, 2011 Dec 28, 2012 — $ — $ Dec 30, 2011 Dec 28, 2012 Dec 30, 2011 — $ 646,177 $ 568,822 Operating income (loss) as reported $ 79,093 $ 104,703 $ (32,554) $ (27,277 ) $ (20,718 ) $ (15,727) $ 25,821 $ 61,699 Adjustments: Inventory step-up amortization (COS) Medical device DVT expenses (RD&E) Consolidation and optimization costs Acquisition and integration expenses Asset dispositions, severance and other 532 — 34,372 1,287 1,073 177 — 361 — 168 — 5,190 6 167 57 Adjusted operating income (loss) $ 116,357 $ 105,409 $ (27,134) $ Adjusted operating margin 18.1 % 18.5 % N/A — 5,133 64 — — (22,080 ) $ NA — — 4,670 6 708 (15,334 ) $ N/A — — — — — 177 532 5,133 5,190 425 39,048 — 1,460 168 1,838 (15,727) $ 73,889 $ 67,602 N/A 11.4 % 11.9 % Medical Device Systems - In 2008, we began evolving our product offerings to include the development of complete medical device systems in order to raise the growth and profitability profile of the Company. This medical device systems strategy is being facilitated through QiG and leverages the component technology of Greatbatch Medical. More specifically, this strategy includes the development of a neuromodulation platform that can be used to support several devices most notably of which is our spinal cord stimulator to treat chronic intractable pain of the trunk and/or limbs, which we made a PMA filing and CE Mark submission near the end of 2013. In total, net medical device costs incurred by QiG were $30.5 million for 2013 compared to $32.6 million for 2012 and $27.3 million for 2011. QiG results for 2013 include $5.8 million of design verification testing (“DVT”) costs incurred in connection with our development of a neuromodulation platform compared to $5.2 million for 2012 and $5.1 million for 2011. - 29 - A reconciliation of GAAP net income (loss) and diluted earnings (loss) per share (“EPS”) to adjusted amounts is as follows (in thousands, except per share amounts): January 3, 2014 Year Ended December 28, 2012 December 30, 2011 Net Income (Loss) Impact Per Diluted Share Net Income (Loss) Impact Per Diluted Share Net Income (Loss) Impact Per Diluted Share $ 36,267 $ 1.43 $ (4,799 ) $ (0.20 ) $ 33,122 $ 1.40 — 3,765 10,602 (326 ) 997 — 0.15 0.42 (0.01) 0.04 346 3,374 28,934 949 1,186 0.01 0.14 1.21 0.04 0.05 115 3,336 276 — 109 — 0.14 0.01 — — 451 0.02 69 — (2,751 ) (0.12 ) 3,007 (1,600 ) — 53,163 $ 25,323 $ 0.12 (0.06) — 2.10 $ 6,234 — 6,190 42,483 $ 23,947 0.26 — 0.26 1.77 $ 5,515 — — 39,722 $ 23,636 0.23 — — 1.68 Net income (loss) as reported Adjustments: Inventory step-up amortization (COS)(a) Medical device DVT expenses (RD&E)(a) Consolidation and optimization costs(a) Acquisition and integration (income) expenses(a) Asset dispositions, severance and other(a) Loss (gain) on cost and equity method investments, net(a)(b) CSN conversion option discount and deferred fee acceleration amortization(a)(c) 2012 R&D tax credit(d) Swiss tax impact(e) Adjusted net income and diluted EPS(f) Adjusted diluted weighted average shares(g) (a) Net of tax amounts computed using a 35% U.S. and France statutory tax rates for the 2013, 2012 and 2011 periods and a 0%, 22.5% and 22.5% Switzerland tax rate for the 2013, 2012 and 2011 periods, respectively. (b) Pre-tax amount is a loss of $0.7 million, loss of $0.1 million and a gain of $4.2 million for 2013, 2012 and 2011, respectively. (c) Pre-tax amount is $4.6 million, $9.6 million and $8.5 million for 2013, 2012 and 2011, respectively. (d) Relates to the 2012 portion of the R&D tax credit which was reinstated in the first quarter of 2013 retroactive back to the beginning of 2012. As required, the impact of the R&D tax credit relating to 2012 was recognized in 2013. (e) Relates to the loss of our Swiss tax holiday due to our decision to transfer manufacturing out of Switzerland, as well as the establishment of a valuation allowance on our Swiss deferred tax assets as it is more likely than not that they will not be fully realized. (f) The per share data in this table has been rounded to the nearest $0.01 and therefore may not sum to the total. (g) Adjusted diluted weighted average shares for 2012 includes 363,000 shares of dilution related to outstanding stock incentive awards that were not dilutive for GAAP EPS purposes. GAAP net income (loss) and diluted EPS include the impact of costs incurred in connection with our consolidation and productivity initiatives discussed above, as well as certain tax charges/credits and certain non-cash charges to interest expense. Excluding these items, adjusted diluted EPS increased 19% in 2013 and 5% in 2012. We expect to achieve adjusted diluted EPS growth of 7-12% for 2014. Targeted Acquisitions - The results for 2013, 2012 and 2011 include the impact of our acquisition of Micro Power on December 15, 2011 and NeuroNexus on February 16, 2012. Going forward, we will continue to pursue acquisitions to enhance our top and bottom line growth trajectory, with a focus on innovative solutions. Our strategic criteria for these acquisitions is that they should be complementary to our existing business model, drive expansion in core markets, allow us to enter adjacent growth markets, are focused on proprietary technology, can be tightly integrated into our operating base, and will enhance our return on invested capital performance. We expect our 2014 performance to remain on a positive growth trajectory. Our guidance is illustrative of a multi-year strategy based on market knowledge, a relentless passion to evolve our business to capitalize on market trends, and the acquisition, development and retention of some of the brightest and hardest working minds in the world. - 30 - 2014 Financial Guidance For 2014, we have provided the following financial guidance: Sales GAAP Operating Income as a % of Sales Adjusted Operating Income as a % of Sales Capital Expenditures GAAP Effective Tax Rate GAAP Diluted EPS Adjusted Diluted EPS $685 - $705 million 11.0% - 11.5% 13.0% - 13.3% $25 - $35 million 34% - 35% $1.94 - $1.99 $2.25 - $2.35 Adjusted operating income for 2014 is expected to consist of GAAP operating income excluding items such as acquisition, consolidation, integration and asset disposition/write-down charges totaling approximately $12 million to $15 million. The after tax impact of these adjustments is estimated to be $7.5 million to $10 million or $0.31 to $0.35 per share. The current expected GAAP effective tax rate for 2014 does not include the benefit of the U.S. R&D tax credit, which expired at the end of 2013. If reinstated, our 2014 GAAP effective tax rate could be lowered to 32% to 33%. Cost Savings and Consolidation Efforts In 2013, 2012 and 2011, we recorded charges in Other Operating Expenses, Net related to cost savings and consolidation efforts. These initiatives were undertaken to improve our operational efficiencies and profitability. Additional information regarding the timing, cash flow impact and amount of future expenditures is set forth in Note 13 “Other Operating Expenses, Net” of the Notes to the Consolidated Financial Statements contained in Item 8 of this report, as well as the “Liquidity and Capital Resources” section of this Item. In 2013, we initiated a plan to realign our operating structure in order to optimize our continued focus on profitable growth. As part of this initiative, the sales and marketing and operations groups of our former Implantable Medical and Electrochem segments were combined into one sales and marketing and one operations group serving the entire Company. Total restructuring charges expected to be incurred in connection with this realignment are between $6.5 million to $7.0 million, of which $5.6 million have been incurred to date. Expenses related to this initiative will be recorded within the applicable segment and corporate cost centers to which the expenditures relate. When fully implemented, this plan is expected to result in annual savings of approximately $7.0 to $7.7 million. This initiative is expected to be completed over the next six months. Over the last three years, we have been implementing a multi-faceted plan to further enhance, optimize and leverage our orthopaedics operations. This plan included the construction of an orthopaedic manufacturing facility in Fort Wayne, IN, updating our Indianapolis, IN facility, the transfer of most major functions previously performed at our facilities in Orvin and Corgemont, Switzerland into our Fort Wayne, IN and Tijuana, Mexico facilities, and the expansion of our Chaumont, France facility in order to enhance our capabilities and fulfill larger customer supply agreements. The total capital investment expected for these initiatives is between $30 million and $35 million, of which $22 million has been expended to date. Total expense expected to be incurred for these initiatives is between $45 million and $50 million, of which $41.2 million has been incurred to date. Near the end of 2011, we initiated plans to optimize and expand our manufacturing infrastructure in order to support our medical device strategy. This included the transfer of certain product lines to lower cost facilities, expansion of two of our existing facilities, as well as the purchase of equipment to create additional capacity for the manufacture of medical devices and create additional cost savings. Total capital investment under these initiatives is expected to be between $15 million to $20 million, of which approximately $12.4 million has been expended to date. Total expenses expected to be incurred on these projects is between $2 million to $3 million, of which $1.8 million has been incurred to date. These orthopaedic and medical device initiatives are expected to be completed over the next three years and are expected to generate approximately $10 million to $15 million of annual cost savings and increase our capacity in order to support our growth and the manufacturing of complete medical devices. In 2011, we initiated plans to upgrade our existing global ERP system. This initiative is expected to be completed over the next three months. Total capital investment under this initiative is expected to be approximately $4 million to $4.5 million, of which approximately $3.9 million has been expended to date. Total expenses expected to be incurred on this initiative is between $6 million to $7 million, of which $5.8 million has been incurred to date. We continually evaluate our operating structure in order to maximize efficiencies and drive margin expansion. Future other operating expenses are expected to be lower than the 2013 levels, but could be impacted if new consolidation and optimization initiatives are undertaken. - 31 - Product Development Greatbatch Medical Our core business is well positioned because our OEM customers leverage our portfolio of intellectual property, and we continue to build a healthy pipeline of diverse medical technology opportunities. We continue to deepen our relationships with our OEM customers and continue to see an increased pace of product development opportunities. These product development opportunities, when combined with our increased sales and marketing resources, are expected to allow us to continue to grow faster than our underlying markets. Some of the product development opportunities Greatbatch Medical is pursuing are as follows: Product Line Cardiac/ Neuromodulation Orthopaedic Product Development Opportunities Developing next generation technology programs including Gen 2 QHR battery, next generation filtered feedthroughs, and high voltage capacitors. Developing single use instruments and a suite of reusable bone preparation instruments with an emphasis on increased efficacy and longer life. Portable Medical Developing wireless power solutions for the surgical tool marketplace. Vascular Developing a full line of arterial introducers, expanding our existing non-valved peelable introducer portfolio, and expanding our existing OptiSeal portfolio for the dialysis market. Energy/Other Developing wide range temperature battery packs. QiG Through QiG, we provide our Greatbatch Medical customers with complete medical device systems. This medical device strategy includes strategic equity investments and medical devices developed independently, as well as in conjunction with our OEM partners. While we do not intend to discuss each of these projects individually, we will discuss significant milestones as they occur. Our spinal cord stimulator to treat chronic intractable pain of the trunk and/or limbs, was designed to target unmet clinical needs with a focus on safety and product differentiation for all user groups. The FDA submission and Europe CE Mark submission for this device was made near the end of 2013. Collaboration continues with our investment bankers who are assisting us in identifying commercial partners. CardiomoniX is an implantable loop recorder for cardiac arrhythmia diagnostics that is being designed to address the unmet needs of remote patient monitoring and data quality. QiG is in the early stages of development of two additional medical device systems, which are targeting approved and emerging indications. Additionally, based upon the technology acquired from NeuroNexus, QiG is developing a platform of thin-film electrodes for neuromodulation leads, sub-systems and components. Government Regulation The Patient Protection and Affordable Care Act and the Health Care and Education Affordability Reconciliation Act (collectively “Health Care Reform”) legislated broad-based changes to the U.S. healthcare system that could significantly impact our business operations and financial results, including higher or lower revenue, as well as higher employee medical costs and taxes. Health Care Reform imposes significant new taxes on medical device OEMs, which will result in a significant increase in the tax burden on our industry and which could have a material negative impact on our financial condition, results of operations and our cash flows. Other elements of Health Care Reform such as comparative effectiveness research, an independent payment advisory board, payment system reforms including shared savings pilots and other provisions could meaningfully change the way healthcare is developed and delivered, and may materially impact numerous aspects of our business, results of operations and financial condition. Many significant parts of Health Care Reform will be phased in over the next several years and require further guidance and clarification in the form of regulations. The new medical device tax, which was effective in 2013, increased our cost of sales by $0.5 million. On August 22, 2012, the U.S. Securities and Exchange Commission (“SEC”) issued a rule under Section 1502 of the Dodd- Frank Wall Street Reform and Consumer Protection Act requiring companies to publicly disclose their use of conflict minerals that originated in the Democratic Republic of the Congo (“DRC”) or an adjoining country. Under the rule, issuers are required to conduct a reasonable due diligence process to ascertain the source of conflict minerals, defined as tantalum, tin, gold or tungsten, that are necessary to the functionality or production of their manufactured or contracted to be manufactured products. Companies are required to provide this disclosure on a new form to be filed with the SEC called Form SD. - 32 - Companies are required to file Form SD on May 31, 2014 for the 2013 calendar period and annually on May 31 every year thereafter. We anticipate additional, new compliance costs to be incurred since we utilize all of the minerals specified in the rule. We are unable to quantify the cost of implementing this new regulation at this time. Our Critical Accounting Estimates The preparation of our consolidated financial statements in accordance with GAAP requires us to make estimates and assumptions that affect reported amounts and related disclosures. The methods, estimates and judgments we use in applying our accounting policies have a significant impact on the results we report in our consolidated financial statements. Management considers an accounting estimate to be critical if (1) it requires assumptions to be made that were uncertain at the time the estimate was made; and (2) changes in the estimate or different estimates that could have been selected could have a material impact on our consolidated results of operations, financial position or cash flows. Our most critical accounting estimates are described below. We also have other policies that we consider key accounting policies, such as our policies for revenue recognition; however, these policies do not meet the definition of critical accounting estimates, because they do not generally require us to make estimates or judgments that are difficult or subjective. Valuation of goodwill and other identifiable intangible assets When we acquire a company, we allocate the purchase price to the tangible and intangible assets we acquire and liabilities we assume based on their fair value at the date of acquisition. Goodwill is recorded when the purchase price paid for an acquisition exceeds the estimated fair value of the net identified tangible and intangible assets acquired. In addition to goodwill, some of our intangible assets are considered non-amortizing intangible assets as they are expected to generate cash flows indefinitely. Goodwill and indefinite-lived intangibles are not amortized but are required to be assessed for impairment on an annual basis or more frequent if certain indicators are present. Definite-lived intangible assets are amortized over their estimated useful lives and are assessed for impairment if certain indicators are present. As discussed in Note 7 “Intangible Assets” of the Notes to Consolidated Financial Statements contained in Item 8 of this report, in connection with the realignment of the Company's operating structure in 2013, the Company reevaluated its operating and reporting segments. Beginning in the fourth quarter of 2013, the Company determined that it has two operating segments: Greatbatch Medical and QiG, and, as required, reassigned goodwill to each of these reporting units based upon their relative fair values. Fair values for the reporting units were determined using the assumptions and approach discussed below. Assumptions/Approach Used We base the fair value of identifiable tangible and intangible assets on detailed valuations that use information and assumptions provided by management. The fair values of intangible assets are determined using one of three valuation approaches: market, income or cost. The selection of a particular method depends on the reliability of available data and the nature of the asset. The market approach values the asset based on available market pricing for comparable assets. The income approach values the asset based on the present value of risk adjusted cash flows projected to be generated by that asset. The projected cash flows for each asset considers multiple factors from the perspective of a marketplace participant, including current revenue from existing customers, attrition trends, reasonable contract renewal assumptions, royalty rates and expected profit margins giving consideration to historical and expected margins. The cost approach values the asset by determining the current cost of replacing that asset with another of equivalent economic utility. The cost to replace the asset reflects the estimated reproduction or replacement cost, less an allowance for loss in value due to depreciation or obsolescence, with specific consideration given to economic obsolescence if indicated. We perform an annual review on the last day of each fiscal year, or more frequently if indicators of potential impairment exist, to determine if the recorded goodwill and other indefinite-lived intangible assets are impaired. We assess goodwill for impairment by comparing the fair value of our reporting units to their carrying value to determine if there is potential impairment. If the fair value of a reporting unit is less than its carrying value, an impairment loss is recorded to the extent that the implied fair value of the goodwill within the reporting unit is less than its carrying value. Fair values for reporting units are determined based on the income and market approaches. Indefinite-lived intangible assets are evaluated for impairment by using the income approach. Definite-lived intangible assets are reviewed at least quarterly to determine if any conditions exist or a change in circumstances has occurred that would indicate impairment or a change in their remaining useful life. We do not believe that the indefinite-lived intangible assets or goodwill allocated to our Greatbatch Medical or QiG segments are at risk of failing step one of future annual impairment tests unless operating conditions significantly deteriorate, given the significant amount that our estimated fair value for these assets was in excess of their respective book values as of January 3, 2014. Examples of a significant deterioration in operating conditions for Greatbatch Medical and QiG could include the following: Greatbatch Medical - the loss of one or more significant customers, technology obsolescence, product liability claims or significant manufacturing disruption, among others. QiG - regulatory non-approval of new medical device systems, - 33 - lack of market acceptance, discontinuation of significant development projects, technology obsolescence or failure of technology, among others. Effect of Variation of Key Assumptions Used The use of alternative valuation assumptions, including estimated cash flows and discount rates, and alternative estimated useful life assumptions could result in significant changes to our intangible asset fair value estimates. These changes in fair value estimates could impact the amount and timing of future intangible asset amortization expense and/or result in impairment losses. We make certain estimates and assumptions that affect the expected future cash flows of our reporting units for our goodwill impairment testing. These include discount rates, terminal values and projections of future revenues and expenses. Significant changes in these estimates and assumptions could create future impairment losses to our goodwill. The assumptions used in our 2013 impairment test incorporate the information disclosed in “2014 Financial Guidance” of this section as well as other forward-looking statements made in this Management's Discussion and Analysis of Financial Condition and Results of Operations section. For our indefinite-lived intangible assets, we make estimates of royalty rates, future revenues and discount rates. Significant changes in these estimates could create future impairments of these assets. Estimation of the useful lives of indefinite- and definite-lived intangible assets is based upon the estimated cash flows of the respective intangible asset and requires significant management judgment. Events could occur that would materially affect our estimates of the useful lives. Significant changes in these estimates and assumptions could change the amount of future amortization expense or could create future impairments of these intangible assets. The way the Company’s management allocates resources and evaluates its businesses determines the reporting unit level which goodwill is tested for impairment. Significant changes to these reporting units could create future impairments of goodwill. As of January 3, 2014, we have $443.1 million of intangible assets recorded on our consolidated balance sheet representing 50% of total assets. This includes $76.1 million of amortizing intangible assets, $20.3 million of indefinite-lived intangible assets and $346.7 million of goodwill. A 1% change in the amortization of our intangible assets would change 2013 net income by approximately $0.09 million, or approximately $0.003 per diluted share. Stock-based compensation We record compensation costs related to our stock-based awards which include stock options, restricted stock and restricted stock units. We measure stock-based compensation cost at the grant date based on the fair value of the award. Compensation cost for service-based awards is recognized ratably over the applicable vesting period. Compensation cost for performance awards based on Company financial metrics is reassessed each period and recognized based upon the probability that the performance targets will be achieved. Compensation cost for performance awards based on market metrics (such as total shareholder return) is expensed each period whether the performance metrics are achieved or not. The amount of stock- based compensation expense recognized during a period is based on the portion of the awards that are ultimately expected to vest, as well as market and nonmarket performance award considerations. The total expense recognized over the vesting period will only be for those awards that ultimately vest, as well as market and nonmarket performance award considerations. Assumptions/Approach Used We utilize the Black-Scholes Option Pricing Model to determine the fair value of stock options. We are required to make certain assumptions with respect to selected Black-Scholes model inputs, including expected volatility, expected life, expected dividend yield and the risk-free interest rate. Expected volatility is based on the historical volatility of our stock over the most recent period commensurate with the estimated expected life of the stock options. The expected life of stock options granted, which represents the period of time that the stock options are expected to be outstanding, is based, primarily, on historical data. The expected dividend yield is based on our history and expectation of dividend payouts. The risk-free interest rate is based on the U.S. Treasury yield curve in effect at the time of grant for a period commensurate with the estimated expected life. The fair value of time-based as well as nonmarket-based performance restricted stock and restricted stock unit awards is equal to the fair value of the Company’s stock on the date of grant. The fair value of market-based performance restricted stock unit awards is determined by utilizing a Monte Carlo simulation model, which projects the value of Greatbatch stock versus our peer group under numerous scenarios and determines the value of the award based upon the present value of these projected outcomes. - 34 - Compensation cost for nonmarket-based performance awards is reassessed each period and recognized based upon the probability that the performance targets will be achieved. That assessment is based upon actual and expected future performance. Stock-based compensation expense is recorded for those awards that are expected to vest, as well as market and nonmarket performance award considerations. Forfeiture estimates for determining appropriate stock-based compensation expense are estimated at the time of grant based on historical experience and demographic characteristics. Revisions are made to those estimates in subsequent periods if actual forfeitures differ from estimated forfeitures. Effect of Variation of Key Assumptions Used Option pricing models were developed for use in estimating the value of traded options that have no vesting restrictions and are fully transferable. Because our share-based payments have characteristics significantly different from those of freely traded options, and because changes in the subjective input assumptions can materially affect our estimates of fair values, existing valuation models may not provide reliable measures of the fair values of our share-based compensation. Consequently, there is a risk that our estimates of the fair values of our share-based compensation awards may bear little resemblance to the actual values realized upon the exercise, expiration or forfeiture of those share-based payments in the future. Stock options may expire worthless or otherwise result in zero intrinsic value as compared to the fair values originally estimated on the grant date and reported in our consolidated financial statements. Alternatively, value may be realized from these instruments that are significantly in excess of the fair values originally estimated on the grant date and reported in our consolidated financial statements. There are significant differences among valuation models. This may result in a lack of comparability with other companies that use different models, methods and assumptions. There is a high degree of subjectivity involved in selecting assumptions to be utilized to determine fair value and forfeiture assumptions. If factors change and result in different assumptions in future periods, the expense that we record for future grants may differ significantly from what we have recorded in the current period. Additionally, changes in performance of the Company and its stock price will affect the likelihood that performance-based targets are achieved and could materially impact the amount of stock-based compensation expense recognized. A 1% change in our stock-based compensation expense would change 2013 net income by approximately $0.06 million, or approximately $0.002 per diluted share. Inventories Inventories are stated at the lower of cost, determined using the first-in, first-out method, or market. Assumptions/Approach Used Inventory costing requires complex calculations that include assumptions for overhead absorption, scrap, sample calculations, manufacturing yield estimates and the determination of which costs may be capitalized. The valuation of inventory requires us to estimate obsolete or excess inventory, as well as inventory that is not of saleable quality. Effect of Variation of Key Assumptions Used Variations in methods or assumptions could have a material impact on our results. If our demand forecast for specific products is greater than actual demand and we fail to reduce manufacturing output accordingly, we could be required to record additional inventory write-downs or expense a greater amount of overhead costs, which would have a negative impact on our net income. As of January 3, 2014, we have $118.4 million of inventory recorded on our consolidated balance sheet representing 13% of total assets. A 1% write-down of our inventory would change 2013 net income by approximately $0.8 million, or approximately $0.03 per diluted share. - 35 - Tangible long-lived assets Property, plant and equipment and other tangible long-lived assets are carried at cost. The cost of property, plant and equipment is charged to depreciation expense over the estimated life of the operating assets primarily using straight-line rates. Tangible long-lived assets are subject to impairment assessment if certain indicators are present. Assumptions/Approach Used We assess the impairment of tangible long-lived assets when events or changes in circumstances indicate that the carrying value of the asset (asset group) may not be recoverable. Factors that we consider in deciding when to perform an impairment review include, but are not limited to: a significant decrease in the market price of the asset (asset group); a significant change in the extent or manner in which a long-lived asset (asset group) is being used or in its physical condition; a significant change in legal factors or in the business climate that could affect the value of a long-lived asset (asset group), including an action or assessment by a regulator; an accumulation of costs significantly in excess of the amount originally expected for the construction; a current-period operating or cash flow loss combined with a history of operating or cash flow losses or a projection or forecast that demonstrates continuing losses associated with the use of a long-lived asset (asset group); or a current expectation that, more likely than not, a long-lived asset (asset group) will be sold or otherwise disposed of significantly before the end of its previously estimated useful life. Recoverability potential is measured by comparing the carrying amount of the asset (asset group) to the related total future undiscounted cash flows. The projected cash flows for each asset (asset group) considers multiple factors, including current revenue from existing customers, proceeds from the sale of the asset (asset group), reasonable contract renewal assumptions, and expected profit margins giving consideration to historical and expected margins. If an asset’s (assets group’s) carrying value is not recoverable through related cash flows, the asset (asset group) is considered to be impaired. Impairment is measured by comparing the asset’s (asset group’s) carrying amount to its fair value. When it is determined that useful lives of assets are shorter than originally estimated, and there are sufficient cash flows to support the carrying value of the assets, we accelerate the rate of depreciation in order to fully depreciate the assets over their shorter useful lives. Effect of Variation of Key Assumptions Used Estimation of the cash flows and useful lives of tangible assets that are long-lived requires significant management judgment. Events could occur that would materially affect our estimates and assumptions. Unforeseen changes in operations or technology could substantially alter the assumptions regarding the ability to realize the return of our investment in long-lived assets or the useful lives. Also, as we make manufacturing process conversions and other facility consolidation decisions, we must make subjective judgments regarding the remaining cash flows and useful lives of our assets, primarily manufacturing equipment and buildings. Significant changes in these estimates and assumptions could change the amount of future depreciation expense or could create future impairments of these long-lived assets (asset groups). As of January 3, 2014 we have $145.8 million of tangible long-lived assets recorded on our consolidated balance sheet representing 16% of total assets. A 1% write-down in our tangible long-lived assets would change 2013 net income by approximately $0.9 million, or approximately $0.04 per diluted share. Provision for income taxes Our consolidated financial statements have been prepared using the asset and liability approach in accounting for income taxes, which requires the recognition of deferred income taxes for the expected future tax consequences of net operating losses, credits, and temporary differences between the financial statement carrying amounts and the tax bases of assets and liabilities. A valuation allowance is provided on deferred tax assets if it is determined that it is more likely than not that the asset will not be realized. Assumptions/Approach Used In recording the provision for income taxes, management must estimate the future tax rates applicable to the reversal of temporary differences based upon the timing of expected reversal. Also, estimates are made as to whether taxable operating income in future periods will be sufficient to fully recognize any gross deferred tax assets. If recovery is not likely, we must increase our provision for income taxes by recording a valuation allowance against the deferred tax assets that we estimate will not ultimately be recoverable. Alternatively, we may make estimates about the potential usage of deferred tax assets that decrease our valuation allowances. The calculation of our tax liabilities involves dealing with uncertainties in the application of complex tax regulations. Significant judgment is required in evaluating our tax positions and determining our provision for income taxes. During the ordinary course of business, there are many transactions and calculations for which the ultimate tax determination is uncertain. We establish reserves for uncertain tax positions when we believe that certain tax positions do not meet the more likely than not threshold. We adjust these reserves in light of changing facts and circumstances, such as the outcome of a tax audit or the lapse - 36 - of statutes of limitations. The provision for income taxes includes the impact of reserve provisions and changes to the reserves that are considered appropriate. Effect of Variation of Key Assumptions Used Changes could occur that would materially affect our estimates and assumptions regarding deferred taxes. Changes in current tax laws and tax rates could affect the valuation of deferred tax assets and liabilities, thereby changing the income tax provision. Also, significant declines in taxable income could materially impact the realizable value of deferred tax assets. At January 3, 2014, we had $34.1 million of gross deferred tax assets on our consolidated balance sheet and a valuation allowance of $11.7 million has been established for certain deferred tax assets as it is more likely than not that they will not be realized. A 1% change in the effective tax rate would impact the current year provision for income taxes by $0.5 million, and 2013 diluted earnings per share by $0.02 per diluted share. - 37 - Our Financial Results We utilize a fifty-two, fifty-three week fiscal year ending on the Friday nearest December 31st. Fiscal years 2013, 2012 and 2011 ended on January 3, 2014, December 28, 2012 and December 30, 2011, respectively. Fiscal year 2013 contained fifty- three weeks. Fiscal years 2012 and 2011 each contained fifty-two weeks. Year Ended 2013 vs. 2012 2012 vs. 2011 January 3, 2014 December 28, 2012 December 30, 2011 $ Change % Change $ Change % Change Dollars in thousands, except per share data Greatbatch Medical Sales Cardiac/ Neuromodulation Orthopaedics Portable Medical Vascular Energy Other Total Greatbatch Medical QiG Total sales Cost of sales Gross profit Gross profit as a % of sales Selling, general and administrative expenses (SG&A) SG&A as a % of sales Research, development and engineering costs, net (RD&E) RD&E as a % of sales Other operating expenses, net Operating income Operating margin Interest expense Interest income (Gain) loss on cost and equity method investments, net Other expense, net Provision for income taxes Effective tax rate Net income (loss) $ Net margin Diluted earnings (loss) per share $ $ $ 325,412 130,247 78,743 48,357 52,488 25,655 $ 306,669 122,061 81,659 51,980 54,066 27,287 $ 303,690 140,277 9,609 45,098 48,100 22,048 660,902 3,043 663,945 444,632 219,313 643,722 2,455 646,177 444,528 201,649 568,822 — 568,822 388,469 180,353 33.0 % 31.2 % 31.7 % 18,743 8,186 (2,916 ) (3,623 ) (1,578 ) (1,632 ) 17,180 588 17,768 104 17,664 6 % $ 7 % (4 )% (7 )% (3 )% (6 )% 3 % 24 % 3 % — % 9 % 2,979 (18,216 ) 72,050 6,882 5,966 5,239 74,900 2,455 77,355 56,059 21,296 1 % (13 )% N/A 15 % 12 % 24 % 13 % NA 14 % 14 % 12 % 88,107 80,992 13.3 % 12.5 % 72,548 12.8 % 7,115 9 % 8,444 12 % 54,077 52,490 45,513 1,587 3 % 6,977 15 % 8.1 % 8.1 % 8.0 % 15,790 61,339 42,346 25,821 593 61,699 9.2 % 4.0 % 10.8 % 11,261 — 18,055 (1 ) 16,928 (21 ) (26,556 ) 35,518 (63 )% 138 % 41,753 (35,878 ) (6,794 ) 1 (38 )% (100 )% NA (58 )% 7 % (95 )% NA 47 % 1,127 20 4,338 299 694 546 106 931 (4,232 ) 632 588 (385 ) NA (41 )% 12,571 25.7 % 36,267 $ 11,529 171.3 % (4,799 ) $ 5.5 % (0.7 )% 15,270 33,122 31.6 % $ 5.8 % 1,042 9 % (3,741 ) (24 )% 41,066 NA $ (37,921 ) (114 )% 1.43 $ (0.20 ) $ 1.40 $ 1.63 NA $ (1.60 ) (114 )% - 38 - Fiscal 2013 Compared with Fiscal 2012 Sales Changes to sales by major product lines were as follows (dollars in thousands): Sales: Greatbatch Medical Cardiac/Neuromodulation Orthopaedics Portable Medical Vascular Energy Other Total Greatbatch Medical QiG Total sales Greatbatch Medical Sales Highlights Year Ended 2013 vs. 2012 January 3, 2014 December 28, 2012 $ Change % Change $ 325,412 $ 130,247 78,743 48,357 52,488 25,655 660,902 3,043 $ 663,945 $ 306,669 $ 122,061 81,659 51,980 54,066 27,287 643,722 2,455 646,177 $ 18,743 8,186 (2,916 ) (3,623 ) (1,578 ) (1,632 ) 17,180 588 17,768 6 % 7 % (4 )% (7 )% (3 )% (6 )% 3 % 24 % 3 % Total 2013 sales for Greatbatch Medical increased 3% to $660.9 million. The most significant drivers of this increase were as follows: For 2013, our cardiac/neuromodulation sales increased 6% to $325.4 million which exceeded our expectations. During 2013, cardiac and neuromodulation sales benefited from stronger market performance and continued deepening relationships with our OEM partners. More specifically, we experienced strong growth in batteries, capacitors, leads, and assembly revenue. We continue to see an increased pace of product development opportunities from our cardiac customers. We believe that these opportunities, combined with our increased sales and marketing resources, will allow the Company to continue to grow this product line faster than the underlying market. Orthopaedic product line sales for 2013 increased 7% compared to the same period of 2012. During the first quarter of 2013, the Company divested certain non-core orthopaedic product lines, which reduced 2013 orthopaedic revenue by approximately $15 million in comparison to the prior year. Additionally, foreign currency exchange rate fluctuations benefited orthopaedic revenue by approximately $2 million in comparison to the prior year. On an organic constant currency basis, orthopaedic product line sales increased 20% in comparison to 2012. This organic constant currency improvement was across all orthopaedic products and was above market growth rates primarily due to our increased sales and marketing efforts, customer market share gains, customer product launches, as well as the release of backlog built up as a result of our Swiss orthopaedic facility consolidation near the end of 2012. During 2013 portable medical sales decreased $2.9 million or 4% compared to 2012. During the second half of 2013, this product line was impacted by our increased pricing discipline, which resulted in the loss of two lower margin portable medical programs accounting for approximately $9 million of revenues in 2013. We expect these factors to continue to impact the year over year comparisons for this product line for the next three quarters. We believe that we can return this product line back to historical growth once we are past this period of difficult comparisons. For 2013, our vascular product line sales decreased $3.6 million or 7% as a result of the previously communicated voluntary recall of two vascular medical devices in the fourth quarter of 2012. We began reshipping one of these products in the fourth quarter of 2013. QiG - QiG revenue includes sales of neural interface technology, components and systems to the neuroscience and clinical markets. The 24% revenue growth for 2013 in comparison to 2012 was primarily due to having a full year of sales from NeuroNexus, which was acquired in February 2012, as well as the higher growth characteristics of the neuroscience and clinical markets. - 39 - Gross Profit Changes to gross profit as a percentage of sales were primarily due to the following: Impact of Swiss consolidation(a) Performance-based compensation(b) Cost savings and production efficiencies(c) Other Total percentage point change to gross profit as a percentage of sales 2013-2012 % Point Change 0.4 % (0.5 )% 2.0 % (0.1 )% 1.8 % (a) Our Gross Margin benefited approximately $2.8 million from the consolidation of our Swiss orthopaedic facilities into other existing Greatbatch facilities in the first quarter of 2013. The 2012 gross profit percentage includes the negative impact of production inefficiencies at those facilities. (b) Amount represents higher performance-based compensation versus the prior year of approximately $3.4 million and is recorded based upon actual results achieved. Performance-based compensation is accrued based upon the level of performance achieved relative to targets set at the beginning of the year. (c) Our Gross Margin percentage benefited from production efficiencies gained at our manufacturing facilities as a result of our various lean and supply chain initiatives, as well as higher production volumes due to increased sales and inventory levels. Over the long-term, we expect to see Gross Margin improvements as we leverage our organic growth across our manufacturing footprint and due to the various productivity improvement initiatives that are being implemented (See “Cost Savings and Consolidation Efforts” section of this Item). Additionally, we expect our Gross Margin to improve as more system and device level products are introduced, which typically earn a higher margin. SG&A Expenses Changes to SG&A expenses were primarily due to the following (in thousands): Selling and marketing(a) Performance-based compensation(b) Swiss consolidation(c) Other(d) Net increase in SG&A 2013-2012 $ Change 3,848 2,680 (1,359) 1,946 7,115 $ $ (a) Amount represents the incremental SG&A expenses related to our decision near the end of 2012 to increase selling and marketing resources to drive core business growth and sustain a pipeline, in order to achieve our 5% or better organic revenue growth performance goal. (b) Amount represents the change in performance-based compensation versus the prior year period and is recorded based upon the actual results achieved. Performance-based compensation is accrued based upon the level of performance achieved relative to targets set at the beginning of the year. (c) Amount represents the estimated impact to SG&A costs as a result of the consolidation of our Swiss orthopaedic facilities into other existing Greatbatch facilities, which was completed in the first quarter of 2013. (d) Amount represents various cost increases in SG&A expenses that occurred during 2013 including an additional week of operations in comparison to 2012 as the Company utilizes a fifty-two, fifty-three week fiscal year, which ends on the Friday nearest December 31st. - 40 - RD&E Expenses, Net Net RD&E costs were as follows (in thousands): Research and development costs Engineering costs Less cost reimbursements Total RD&E, net Year Ended January 3, 2014 December 28, 2012 Change $ $ 17,953 $ 44,699 (8,575 ) 54,077 $ 24,071 $ 38,777 (10,358 ) 52,490 $ (6,118 ) 5,922 1,783 1,587 Net RD&E for 2013 increased $1.6 million to $54.1 million. This increase was attributable to a decrease of $1.8 million in customer cost reimbursements compared to the prior year due to the timing of achievement of milestones on various projects. During the second half of 2012, we began to implement an initiative to optimize our RD&E investment. This included the reallocation of RD&E resources to higher priority projects, the postponement of some RD&E projects, as well as the decision to pursue various alternatives to monetize some of our existing intellectual property that are outside our core business. Additionally, our Swiss orthopaedic facility consolidation contributed to a reduction in RD&E expenses of $3.1 million. The benefit that was realized in 2013 from these initiatives was offset by an increase in performance-based compensation ($1.4 million), a higher level of DVT costs ($0.6 million), as well as the additional week of payroll expense incurred during 2013. In total, net costs incurred by our QiG segment (including gross profit and SG&A), which is responsible for the development of our medical device systems, were $30.5 million for 2013 compared to $32.6 million for 2012. 2013 QiG results include $5.8 million of DVT costs incurred in connection with our development of a neuromodulation platform compared to $5.2 million for 2012. QiG’s medical device technology investment is primarily focused on successfully commercializing Algostim, which was submitted for PMA approval in December 2013. Other Operating Expenses, Net Other operating expenses, net were comprised of the following (in thousands): 2013 operating unit realignment(a) Orthopaedic facility optimization(a) Medical device facility optimization(a) ERP system upgrade(a) Acquisition and integration (income) costs(b) Asset dispositions, severance and other(c) Total other operating expenses, net Year Ended January 3, 2014 December 28, 2012 Change $ $ 5,625 $ 8,038 312 783 (502 ) 1,534 15,790 $ — $ 32,482 1,525 5,041 1,460 1,838 42,346 $ 5,625 (24,444 ) (1,213 ) (4,258 ) (1,962 ) (304 ) (26,556 ) (a) Refer to “Cost Savings and Consolidation Efforts” section of this Item and Note 13 “Other Operating Expenses, Net” of the Notes to Consolidated Financial Statements contained in Item 8 of this report for disclosures related to the timing and level of remaining expenditures for these initiatives. (b) During 2013 and 2012, we incurred costs (income) related to the integration of Micro Power and NeuroNexus. These expenses were primarily for retention bonuses, travel costs in connection with integration efforts, training, severance and the change in fair value of the contingent consideration recorded in connection with these acquisitions. (c) During 2013 and 2012, we recorded losses in connection with various asset disposals and/or write-downs. Additionally, during 2013, we recorded a $0.9 million write-off related to our wireless sensing product line and a $0.5 million write-off of NeuroNexus IPR&D. During 2012, we incurred $1.2 million of costs related to the relocation of our global headquarters to Frisco, Texas. We continually evaluate our operating structure in order to maximize efficiencies and drive margin expansion. Future other operating expenses are expected to be lower than the 2013 levels, but could be impacted if new consolidation and optimization initiatives are undertaken. - 41 - Interest Expense and Interest Income Interest expense for 2013 decreased $6.8 million over 2012 due to lower discount amortization as a result of the repayment of our convertible subordinated notes during the first quarter of 2013. Additionally, interest expense decreased due to lower outstanding debt balances, and lower interest rates paid on outstanding debt. During 2013, we made net repayments of $33.3 million on long-term debt. See Note 9 “Debt” of the Notes to Consolidated Financial Statements contained in Item 8 of this report. Interest income for 2013 was relatively consistent with 2012. (Gain) Loss on Cost and Equity Method Investments During 2013 and 2012, we incurred losses on our cost and equity method investments. These investments are in start-up research and development companies whose fair value is highly subjective in nature and subject to future fluctuations, which could be significant. Our recorded investment in cost and equity method investments was $12.3 million at January 3, 2014. Other Expense, Net Other expense, net primarily includes the impact of foreign currency exchange rate fluctuations on transactions denominated in foreign currencies. We generally do not expect foreign currency exchange rate fluctuations to have a material impact on our results of operations. Provision for Income Taxes The effective tax rate for the year ended January 3, 2014 was 25.7%, versus 171.3% for 2012. The stand-alone U.S. component of the effective tax rate for the year ended January 3, 2014 was 30.0% versus 33.1% for 2012. This decrease was primarily attributable to $6.2 million of tax charges recorded in 2012 relating to our Swiss Orthopaedic consolidation. These charges related to the loss of our Swiss tax holiday, due to our decision in 2012 to discontinue manufacturing in Switzerland and the valuation allowance established on our Swiss deferred tax assets, as it was more likely than not that they will not be fully realized. The reinstatement of the R&D tax credit in 2013, as well as higher income in lower tax rate jurisdictions also contributed to the more favorable tax rate in 2013. The provision for income taxes for 2013 differs from the U.S. statutory rate due to the following (dollars in thousands): Income before provision for income taxes Provision at statutory rate Federal tax credits(a) Foreign rate differential Uncertain tax positions State taxes, net of federal benefit Change in foreign tax rates(b) Valuation allowance Other Provision for income taxes/effective tax rate $ $ U.S. International Combined $ % $ % $ % 42,392 $ 6,446 $ 48,838 14,837 (3,651 ) — 831 1,147 — 176 (634 ) 35.0 % $ (8.6 ) — 2.0 2.7 — 0.4 (1.5 ) 2,256 — (348 ) — — (1,807 ) 10 (246 ) 35.0 % $ — (5.4 ) — — (28.0 ) 0.2 (3.8 ) 17,093 (3,651 ) (348 ) 831 1,147 (1,807 ) 186 (880 ) 35.0 % (7.5 ) (0.7 ) 1.7 2.3 (3.7 ) 0.4 (1.8 ) $ 12,706 30.0 % $ (135 ) (2.0 )% $ 12,571 25.7 % (a) Amounts relate to the retroactive reinstatement of the U.S. R&D tax credit. On January 2, 2013, the President signed into law the American Taxpayer Relief Act of 2012 (the “Act”), which included a retroactive extension of the section 41 R&D tax credit that had expired on December 31, 2011. Under the Act, the R&D credit is extended for two years retroactively from January 1, 2012 through December 31, 2013. As the Act was signed into law on January 2, 2013, the effects of the change in the tax law were recognized as a financial statement event in the financial statement period that includes the date of enactment. As such, we recorded a benefit for the R&D credits earned in 2012 and 2013 through the fiscal 2013 effective tax rate. (b) Amounts relate to the tax benefit recorded in 2013 relating to Mexican Tax Reform Package and a favorable Swiss tax ruling. On December 12, 2013, the 2014 Mexican Tax Reform Package took effect. This tax reform repealed the previous Mexican income tax law, including the flat tax regime and tax consolidation. The Mexican corporate income tax rate of 30% will be maintained. As such, for U.S. GAAP purposes, the deferred tax items, historically carried at the 17% flat tax rate, were adjusted to reflect a carrying value of 30%. Since our Mexican subsidiary was in an overall deferred tax asset position as of the enactment date the adjustment to 30% resulted in an overall deferred tax benefit which was recorded in 2013. In - 42 - addition, during 2013, our Swiss subsidiary filed for a tax ruling requesting a reduced income tax rate in Switzerland. We received an approved ruling in December 2013 effectively reducing the Swiss tax rate from 22.6% to approximately 9.3% depending on jurisdictional mix of revenues and expenditures. As such, the carrying value of the deferred taxes, which reflected a net deferred tax liability position as of the date of enactment, have been adjusted to reflect the rate reduction. The adjusted carrying value resulted in a reduction to the deferred tax liability and a corresponding deferred tax benefit. 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 exchange rate fluctuations. In addition, we continue to explore tax planning opportunities that may have a material impact on our effective tax rate. We believe it is reasonably possible that a reduction of up to $0.1 million of the balance of our 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, which would positively impact the effective tax rate in the period of reduction. Fiscal 2012 Compared with Fiscal 2011 Sales Changes to sales by major product lines were as follows (dollars in thousands): Sales: Greatbatch Medical Cardiac/Neuromodulation Orthopaedics Portable Medical Vascular Energy Other Total Greatbatch Medical QiG Total sales Greatbatch Medical Sales Highlights Year Ended 2012 vs. 2011 December 28, 2012 December 30, 2011 $ Change % Change $ $ 306,669 $ 122,061 81,659 51,980 54,066 27,287 643,722 2,455 646,177 $ 303,690 $ 140,277 9,609 45,098 48,100 22,048 568,822 — 568,822 $ 2,979 (18,216) 72,050 6,882 5,966 5,239 74,900 2,455 77,355 1 % (13)% N/A 15 % 12 % 24 % 13 % N/A 14 % Total 2012 sales for Greatbatch Medical increased 13% to $643.7 million. The most significant drivers of this increase were as follows: For 2012, our cardiac/neuromodulation sales increased 1% to $306.7 million. During 2012, cardiac and neuromodulation sales benefited from further adoption of our Q series batteries partially offset by the timing of customer inventory builds and product launches between 2011 and 2012. Orthopaedic product line sales for 2012 declined 13% compared to the same period of 2011. On an organic constant currency basis, orthopaedic sales declined 8% for 2012 as foreign currency exchange rate fluctuations decreased orthopaedic revenue by approximately $6 million. The remaining decline in 2012 orthopaedic sales was a result of price concessions provided to customers, as well as fewer customer product launches and development opportunities due to operational issues at our Swiss orthopaedic facilities, which were aggressively addressed in 2012. In addition to the consolidation of manufacturing, during 2012, we also streamlined our Swiss orthopaedic product line offerings. This included the sale of several non-core product lines to an independent third party near the end of the year, which closed in early 2013. The portable medical, energy and other 2012 sales increased $83.3 million to $163.0 million. These sales included $82.4 million of incremental revenue related to the acquisition of Micro Power in December 2011. On an organic basis, revenue from these product lines were consistent with the prior year. During 2012, the Micro Power acquisition benefited from successful product launches into the portable medical market. - 43 - For 2012, our vascular product line sales increased 15% to $52.0 million. This increase was primarily attributable to growth in the underlying market and market share gains. Additionally, vascular revenue for the year included $6.6 million from sales of medical devices that were developed under the Greatbatch name compared to $4.5 million for 2011, an increase of 47%. QiG - 2012 revenue includes sales from NeuroNexus Technologies, Inc., which was acquired in February 2012. Gross Profit Changes to gross profit as a percentage of sales were primarily due to the following: Impact of acquisitions(a) Excess capacity & Swiss production inefficiencies(b) Volume and productivity(c) Performance-based compensation(d) Selling price(e) Other Total percentage point change to gross profit as a percentage of sales 2012-2011 % Point Change (1.2 )% (1.6 )% 2.2 % 0.4 % (0.5 )% 0.2 % (0.5 )% (a) Our gross profit percentage was impacted by the acquisition of Micro Power in December 2011, which had a lower gross margin percentage due to its higher percentage of material costs in comparison to our legacy businesses. Additionally, during 2012 we recognized $0.5 million of inventory step-up amortization in connection with this acquisition. (b) Our gross profit percentage was negatively impacted during 2012 due to production inefficiencies at our Swiss orthopaedic facilities. Additionally, as a result of the addition of our Fort Wayne facility in the second quarter of 2012, we experienced excess capacity costs in comparison to 2011. In accordance with our inventory accounting policy, excess capacity costs are expensed in the period they occur. (c) Our gross profit percentage benefited from higher sales volumes, primarily cardiac and vascular, as well as production efficiencies gained at our manufacturing facilities as a result of our various lean and supply chain initiatives. (d) Amount represents the change in performance-based compensation versus the prior year and is recorded based upon the actual results achieved. Performance-based compensation is accrued based upon the level of performance achieved relative to targets set at the beginning of the year. (e) Our gross profit percentage has been negatively impacted in comparison to the prior year by price concessions given to our larger OEM customers in exchange for long-term contracts. SG&A Expenses Changes to SG&A expenses were primarily due to the following (in thousands): Impact of acquisitions(a) Professional and consulting expense(b) Medical device strategy communication(c) Other(d) Net increase in SG&A 2012-2011 $ Change 9,552 743 (501 ) (1,350 ) 8,444 $ $ (a) Amount represents the incremental SG&A expenses in 2012 related to the acquisition of Micro Power and NeuroNexus. (b) Amount represents the change in professional and consulting expense from 2011 and reflects a higher level of costs incurred in connection with our medical device strategy and our increased investment in sales and marketing to drive core business growth. (c) Amount represents the costs incurred during 2011 in connection with the communication of our medical device strategy to shareholders, customers and associates including costs incurred for our Investor Day held in the first quarter of 2011, which did not recur in 2012. - 44 - (d) Amount represents various decreases in SG&A expenses during 2012 and reflects the cost control initiatives being implemented by the Company including cost reductions in connection with our Swiss orthopaedic consolidations. RD&E Expenses, Net Net RD&E costs were as follows (in thousands): Research and development costs Engineering costs Less cost reimbursements Total RD&E, net Year Ended December 28, 2012 December 30, 2011 Change $ $ 24,071 $ 38,777 (10,358) 52,490 $ 19,014 $ 35,472 (8,973) 45,513 $ 5,057 3,305 (1,385) 6,977 Net RD&E for 2012 increased $7.0 million to $52.5 million. Approximately $2.6 million of this increase was a result of the operations from our recent acquisitions. Additionally, $3.2 million of this increase can be attributed to the RD&E investment in the development of complete medical devices, which totaled $24.8 million for 2012 compared to $21.6 million for 2011. In total, net medical device costs incurred by our QiG segment (including gross profit and SG&A) were $32.6 million for 2012 compared to $27.3 million for 2011. 2012 QiG results include $5.2 million of DVT costs incurred in connection with our development of a neuromodulation platform compared to $5.1 million for 2011. During the second half of 2012, we began to implement an initiative to optimize our RD&E investment. This included the reallocation of RD&E resources to higher priority projects, the postponement of some RD&E projects, as well as the decision to pursue various alternatives to monetize some of our existing intellectual property that are outside our core business. As a result of this initiative, RD&E for the second half of 2012 was $3.7 million lower than the first half of 2012. The increase in cost reimbursements in 2012 was a result of our NeuroNexus acquisition. These cost reimbursements can vary significantly from year to year due to the timing of the achievement of milestones on development projects. Other Operating Expenses, Net Other operating expenses, net were comprised of the following (in thousands): Orthopaedic facility optimization(a) Medical device facility optimization(a) ERP system upgrade(a) Acquisition and integration costs(b) Asset dispositions, severance and other(c) Total other operating expenses, net Year Ended December 28, 2012 December 30, 2011 Change $ $ 32,482 $ 1,525 5,041 1,460 1,838 42,346 $ 425 $ — — — 168 593 $ 32,057 1,525 5,041 1,460 1,670 41,753 (a) Refer to “Cost Savings and Consolidation Efforts” section of this Item and Note 13 “Other Operating Expenses, Net” of the Notes to Consolidated Financial Statements contained in Item 8 of this report for disclosures related to the timing and level of remaining expenditures for these initiatives. (b) During 2012, we incurred costs related to the integration of Micro Power and NeuroNexus. These expenses were primarily for retention bonuses, travel costs in connection with integration efforts, and severance. (c) During 2012 and 2011, we recorded write-downs in connection with various asset disposals, net of insurance proceeds received, if any. Additionally, during 2012, we incurred $1.2 million of costs related to the relocation of our global headquarters to Frisco, Texas. During 2011, we incurred $0.6 million of acquisition related costs in connection with our purchase of Micro Power. - 45 - Interest Expense and Interest Income Interest expense for 2012 increased $1.1 million over 2011 due to the increased discount amortization related to our convertible notes, which was being amortized utilizing the effective interest method. See Note 9 “Debt” of the Notes to Consolidated Financial Statements contained in Item 8 of this report. Interest income for 2012 was relatively consistent with 2011. (Gain) Loss on Cost and Equity Method Investments In 2011, we sold our cost method investment in IntElect Medical, Inc. (“IntElect”) in conjunction with Boston Scientific’s acquisition of IntElect. We obtained our ownership interest in IntElect through our acquisition of BIOMEC, Inc. in 2007 and two subsequent additional investments. This transaction resulted in a pre-tax gain of $4.5 million. During 2012 and 2011, we recognized impairment charges related to our cost and equity method investments of $0.1 million and $0.3 million, respectively. Other Expense, Net Other expense, net primarily includes the impact of foreign currency exchange rate fluctuations on transactions denominated in foreign currencies. Provision for Income Taxes The effective tax rate for 2012 was 171.3% versus 31.6% for 2011. The stand-alone U.S. component of the effective tax rate for the year ended December 28, 2012 was 33.1% versus 31.5% for 2011. The fluctuation between the overall rate between 2012 and 2011 is primarily attributable to approximately $6.2 million of tax charges (approximately 92% increase in our effective tax rate) recorded in connection with our Swiss orthopaedic restructuring. These charges relate to the loss of our Swiss tax holiday, due to our 2012 decision to transfer manufacturing out of Switzerland, as well as the establishment of a valuation allowance on a portion of our Swiss deferred tax assets as it is more likely than not that they will not be fully realized. Additionally, our 2012 effective tax rate reflects the impact of approximately $31.3 million of losses resulting from our Swiss restructuring, the benefit of which are recorded at the lower Swiss effective tax rate, thus giving rise to an approximate 57% increase in the overall effective tax rate of the Company. See Note 14 “Income Taxes” of the Notes to the Consolidated Financial Statements contained in Item 8 of this report for a reconciliation of the U.S. statutory rate to our effective tax rate. Liquidity and Capital Resources (Dollars in thousands) Cash and cash equivalents Working capital Current ratio At January 3, 2014 35,465 $ $ $ 190,731 $ 3.08 December 28, 2012 20,284 176,376 2.92 The increase in cash and cash equivalents from December 28, 2012 is due primarily to operating income earned during 2013. Excluding estimated tax payments made in 2013 of $28.8 million relating to the retirement of our convertible subordinated notes, we generated $85.5 million of cash flows from operations as compared to $64.8 million in 2012. These increases were partially offset by maintenance level property, plant and equipment purchases of $18.6 million, as well as net repayments made on our long-term debt of $33.3 million. This increase in cash, as well as our increased working capital levels in anticipation of higher sales and critical raw material purchases, were the primary drivers behind our current ratio increase. Of the $35.5 million of cash on hand as of January 3, 2014, $5.6 million is being held at our foreign subsidiaries and is considered permanently reinvested. Revolving Line of Credit – In September 2013, we amended and extended our credit facility (the “Credit Facility”), which consists of a $300 million revolving line of credit (the “Revolving Credit Facility”), a $200 million term loan (the “Term Loan”), a $15 million letter of credit subfacility, and a $15 million swingline subfacility. The Credit Facility can be increased by $200 million upon the Company's request and approval by the lenders. The Revolving Credit Facility has a maturity date of September 20, 2018, which may be extended to September 20, 2019 upon notice by us and subject to certain conditions. The principal of the Term Loan is payable in quarterly installments as specified in the Credit Facility until its maturity date of September 20, 2019 when the unpaid balance is due in full. The Credit Facility is supported by a consortium of fifteen banks with no bank controlling more than 18% of the facility. As of January 3, 2014, each bank supporting the Credit Facility has an S&P credit rating of at least BBB or better, which is considered investment grade. - 46 - The Credit Facility requires us to maintain a rolling four quarter ratio of adjusted EBITDA to interest expense of at least 3.0 to 1.0. For the twelve month period ended January 3, 2014, our ratio of adjusted EBITDA to interest expense, calculated in accordance with our credit agreement, was 22.4 to 1.00, well above the required limit. The Credit Facility also requires us to maintain a total leverage ratio of not greater than 4.5 to 1.0 and not greater than 4.25 to 1.0 after January 2, 2016. As of January 3, 2014, our total leverage ratio, calculated in accordance with our credit agreement, was 1.53 to 1.00, well below the required limit. The Credit Facility contains customary events of default. Upon the occurrence and during the continuance of an event of default, a majority of the lenders may declare the outstanding advances and all other obligations under the Credit Facility immediately due and payable. See Note 9 “Debt” of the Notes to Consolidated Financial Statements contained in Item 8 of this report. As of January 3, 2014, we had $300 million of borrowing capacity available under the Credit Facility. This amount may vary from period to period based upon our debt and EBITDA levels, which impacts the covenant calculations discussed above. We believe that our cash flow from operations and the Credit Facility provide adequate liquidity to meet our short- and long-term funding needs. Operating activities – Cash flows from operating activities for 2013 were $56.8 million compared to $64.8 million for 2012. During 2013, we made estimated tax payments related to the retirement of our convertible subordinated notes of $28.8 million. Refer to Note 9 “Debt” contained in Item 8 of this report for further discussion. Excluding these tax payments, cash flow from operations totaled $85.5 million. This increase in adjusted cash flow from operations as compared to 2012 is a result of a higher level of cash operating income partially offset by higher working capital levels in anticipation of higher sales and critical raw material purchases. During 2013, we reduced our receivable balances by $7.2 million and continue to remain focused on cash flow generation. Investing activities – Net cash used in investing activities for 2013 was $18.3 million compared to $59.8 million for 2012. This was net of $4.7 million of proceeds received from the sale of our Swiss orthopaedic product lines, which closed during the first quarter of 2013. The decrease in cash used in investing activities from 2012 primarily relates to a decline in capital expenditures of $22.5 million from 2012 due to the completion of various consolidation and optimization initiatives discussed in the “Cost Savings and Consolidation Efforts” section of this Item (primarily the construction of our Fort Wayne facility which was completed in 2012). Additionally, the Company made $17.2 million of cash payments in 2012 related to its acquisitions. Our current expectation is that capital spending for 2014 will be in the range of $25 million to $35 million, of which approximately half is discretionary in nature. We anticipate that cash on hand, cash flows from operations and availability under our Credit Facility will be sufficient to fund these capital expenditures. As part of our growth strategy, we have and will continue to consider targeted and opportunistic acquisitions. Financing activities – Net cash used in financing activities for 2013 was $23.4 million compared to $21.5 million for the prior year period. During 2013, we made $33.3 million of net long-term debt repayments as compared to $22.0 million in 2012 as cash flows from operations was significantly higher than our cash used in investing activities. These net repayments were partially offset by $12.8 million of cash received from the issuance of common stock under our stock-based compensation plans (i.e. exercise of stock options) versus $1.3 million in 2012 due to our higher stock price in 2013. Capital Structure – As of January 3, 2014, our capital structure consisted of $197.5 million of debt outstanding on our term loan and 24.4 million shares of common stock outstanding. Additionally, we had $35.5 million in cash and cash equivalents, which we believe is sufficient to meet our short-term operating cash needs. If necessary, we have available borrowing capacity under our Credit Facility and are authorized to issue 100 million shares of common stock and 100 million shares of preferred stock. We believe that if needed we can access public markets to raise additional capital. We believe that our capital structure provides adequate funding to meet our growth objectives. We continuously evaluate our capital structure as it relates to our anticipated long-term funding needs. Changes to our capital structure may occur as a result of this analysis, or changes in market conditions. Going forward, we expect excess cash flow from operations to be used to fund our remaining consolidation initiatives, potential acquisitions and to pay down outstanding debt. Off-Balance Sheet Arrangements We have no off-balance sheet arrangements within the meaning of Item 303(a)(4) of Regulation S-K. - 47 - Litigation We are party to various legal actions arising in the normal course of business. A description of pending legal actions against the Company is set forth at Note 15 “Commitments and Contingencies” of the Notes to Consolidated Financial Statements contained at Item 8 of this report. We do not believe that the ultimate resolution of any individual pending legal action will have a material effect on our consolidated results of operations, financial position or cash flows. However, litigation is subject to inherent uncertainties and there can be no assurance that any pending legal action, which we currently believe to be immaterial, does not become material in the future. Contractual Obligations The following table summarizes our contractual obligations at January 3, 2014: CONTRACTUAL OBLIGATIONS Debt obligations(a) Operating lease obligations(b) Purchase obligations(b) Foreign currency contracts(b) Defined benefit plan obligations(c) Total contractual obligations $ $ Total 221,466 $ 17,347 24,427 14,000 1,657 278,897 $ Payments due by period Less than 1 year 1-3 years 3-5 years 14,928 $ 5,268 17,118 14,000 381 51,695 $ 36,772 $ 8,688 4,109 — 127 49,696 $ 48,083 $ 2,455 3,140 — 239 53,917 $ More than 5 years 121,683 936 60 — 910 123,589 (a) Includes the annual interest expense on the $197.5 million outstanding on our Term Loan based upon the period end weighted average interest rate of 1.87%, which includes the impact of our interest rate swap agreement. Also includes $6.2 million of deferred federal and state taxes on our convertible subordinated notes that will be due between 2014 and 2018. See Note 9 “Debt” of the Notes to Consolidated Financial Statements contained in Item 8 of this report. (b) See Note 15 “Commitments and Contingencies” of the Notes to Consolidated Financial Statements contained in Item 8 of this report for additional information about our operating leases, purchase obligations and foreign currency contracts. (c) See Note 10 “Defined Benefit Plans” of the Notes to Consolidated Financial Statements contained in Item 8 of this report for additional information about our defined benefit plan obligations. Plan assets are expected to be sufficient to cover plan liabilities. This table does not reflect $1.9 million of unrecognized tax benefits as we are uncertain as to if or when such amounts may be settled. Refer to Note 14 “Income Taxes” of the Notes to Consolidated Financial Statements in Item 8 of this report for additional information about these unrecognized tax benefits. We self-fund the medical insurance coverage provided to our U.S. based employees. We limit our risk through the use of stop loss insurance. As of January 3, 2014, we had $1.6 million accrued related to our self-insurance obligations under our medical plan. This accrual is recorded in Accrued Expenses in the Consolidated Balance Sheet, and is primarily based upon claim history. For 2014, we have specific stop loss coverage per associate for claims in the year exceeding $225 thousand per associate with no annual maximum aggregate stop loss coverage. This table does not reflect any potential future payments for self-insured medical claims. We were a member of a group self-insurance trust that provided workers’ compensation benefits to our employees in Western New York (the “Trust”). During 2011, we were notified by the Trust of its intention to cease operations and were assessed $0.6 million as an estimate of our pro-rata share of future costs related to the Trust. This amount was accrued and paid in 2011. In 2013 and 2012 we utilized traditional insurance to provide workers’ compensation benefits to our employees. Based on actual experience, we could receive a refund or be assessed additional contributions for workers’ compensation claims as each participating organization has joint and several liability for Trust obligations if the assets of the Trust are not sufficient to cover those obligations. Inflation We utilize certain critical raw materials (including precious metals) in our products that we obtain from a limited number of suppliers due to the technically challenging requirements of the supplied product and/or the lengthy process required to qualify these materials with our customers. We cannot quickly establish additional or replacement suppliers for these materials because of these requirements. Our results may be negatively impacted by an increase in the price of these critical raw materials. This risk is partially mitigated as many of the supply agreements with our customers allow us to partially adjust prices for the impact - 48 - of any raw material price increases and the supply agreements with our vendors have final one-time buy clauses to meet a long- term need. Historically, raw material price increases have not materially impacted our results of operations. Impact of Recently Issued Accounting Standards In the normal course of business, we evaluate all new accounting pronouncements issued by the Financial Accounting Standards Board (“FASB”), SEC, Emerging Issues Task Force (“EITF”), American Institute of Certified Public Accountants (“AICPA”) or other authoritative accounting bodies to determine the potential impact they may have on our Consolidated Financial Statements. See Note 1 “Summary of Significant Accounting Policies” of the Notes to Consolidated Financial Statements contained in Item 8 of this report for additional information about these recently issued accounting standards and their potential impact on our financial condition or results of operations. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Foreign Currency – We have operations in France, Mexico and Switzerland, which expose the Company to foreign currency exchange rate fluctuations due to transactions denominated in Euros, Mexican pesos and Swiss francs, respectively. We continuously evaluate our foreign currency risk and will take action from time to time in order to best mitigate these risks, which includes the use of various derivative instruments such as forward currency exchange rate contracts. A hypothetical 10% change in the value of the U.S. dollar in relation to our most significant foreign currency exposures would have had an impact of approximately $8 million on our annual sales. This amount is not indicative of the hypothetical net earnings impact due to offsetting impacts on cost of sales and operating expenses in those currencies. We estimate that foreign currency exchange rate fluctuations during 2013 increased sales in comparison to 2012 by approximately $2 million. In 2013, we entered into a forward contracts to purchase 8.4 million and 7.0 million Mexican pesos per month beginning in January 2014 through December 2014 at an exchange rate of $0.0767 per peso and $0.0752 per peso, respectively. These contracts were entered into in order to hedge the risk of peso-denominated payments associated with a portion of the operations at our Tijuana, Mexico facility for 2014 and are being accounted for as cash flow hedges. As of January 3, 2014, these contracts had a negative fair value of $0.1 million, which is recorded within Accrued Expenses in the Consolidated Balance Sheet. The amount recorded as a reduction of Cost of Sales during 2013 related to these forward contracts was $1.2 million. No portion of the change in fair value of our foreign currency contracts during 2013 was considered ineffective. We translate all assets and liabilities of our foreign operations, where the U.S. dollar is not the functional currency, at the period-end exchange rate and translate sales and expenses at the average exchange rates in effect during the period. The net effect of these translation adjustments is recorded in the Consolidated Financial Statements as Comprehensive Income (Loss). The translation adjustment for 2013 was a $1.5 million gain. Translation adjustments are not adjusted for income taxes as they relate to permanent investments in our foreign subsidiaries. Net foreign currency transaction gains and losses included in Other Expense, Net amounted to a loss of $0.1 million for 2013. A hypothetical 10% change in the value of the U.S. dollar in relation to our most significant foreign currency net assets would have had an impact of approximately $8.4 million on our foreign net assets as of January 3, 2014. Interest Rates – Interest rates on our Credit Facility reset, at our option, based upon the prime rate or LIBOR rate, thus subjecting us to interest rate risk. To help offset this risk, from time to time, we enter into receive floating-pay fixed interest rate swaps indexed to the same applicable index rate as the debt it is hedging. In October 2012 we entered into a three-year $150 million interest rate swap, which amortizes $50 million per year beginning in 2014 and became effective during the first quarter of 2013. Under terms of the contract, we receive a floating interest rate indexed to the one-month LIBOR rate and pay a fixed interest rate of 0.573%. This swap was entered into in order to hedge against potential changes in cash flows on our outstanding variable-rate debt, which is also indexed to the one-month LIBOR rate. The receive variable leg of the interest rate swap and the variable rate paid on the debt is expected to have the same rate of interest, excluding the credit spread, and reset and pay interest on the same dates. This swap is accounted for as a cash flow hedge. As of January 3, 2014, we had $197.5 million outstanding on our Credit Facility, of which $150 million is currently being hedged. See Note 9 “Debt” of the Notes to the Consolidated Financial Statements in Item 8 of this report for additional information about our outstanding debt. A hypothetical one percentage point (100 basis points) change in the LIBOR rate on the $47.5 million of unhedged floating rate debt outstanding at January 3, 2014 would have an impact of approximately $0.5 million on our interest expense. - 49 - ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The following are set forth below: Management’s Report on Internal Control Over Financial Reporting Reports of Independent Registered Public Accounting Firm Consolidated Balance Sheets as of January 3, 2014 and December 28, 2012 Consolidated Statements of Operations and Comprehensive Income (Loss) for the years ended January 3, 2014, December 28, 2012 and December 30, 2011 Consolidated Statements of Cash Flows for the years ended January 3, 2014, December 28, 2012 and December 30, 2011 Consolidated Statements of Stockholders’ Equity for the years ended January 3, 2014, December 28, 2012 and December 30, 2011 Notes to Consolidated Financial Statements 51 52 54 55 56 57 58 - 50 - MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING The Company’s certifying officers are responsible for establishing and maintaining adequate internal control over financial reporting. The Company’s internal control over financial reporting is designed and maintained under the supervision of its certifying officers to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the Company’s consolidated financial statements for external reporting purposes in accordance with accounting principles generally accepted in the United States of America. As of January 3, 2014, management conducted an assessment of the effectiveness of the Company’s internal control over financial reporting based on the framework established in Internal Control – Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this assessment, management has determined that the Company’s internal control over financial reporting as of January 3, 2014 is effective. The effectiveness of internal control over financial reporting as of January 3, 2014 has been audited by Deloitte & Touche LLP, the Company’s independent registered public accounting firm. Dated: March 4, 2014 Thomas J. Hook President & Chief Executive Officer Michael Dinkins Executive Vice President & Chief Financial Officer - 51 - REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and Stockholders of Greatbatch, Inc. Frisco, Texas We have audited the internal control over financial reporting of Greatbatch, Inc. and subsidiary (the “Company”) as of January 3, 2014, based on criteria established in Internal Control - Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. A company's internal control over financial reporting is a process designed by, or under the supervision of, the company's principal executive and principal financial officers, or persons performing similar functions, and effected by the company's board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of January 3, 2014, based on the criteria established in Internal Control - Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission. We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements and financial statement schedule as of and for the year ended January 3, 2014 of the Company and our report dated March 4, 2014 expressed an unqualified opinion on those consolidated financial statements and financial statement schedule. Williamsville, New York March 4, 2014 - 52 - REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and Stockholders of Greatbatch, Inc. Frisco, Texas We have audited the accompanying consolidated balance sheets of Greatbatch, Inc. and subsidiary (the “Company”) as of January 3, 2014 and December 28, 2012, and the related consolidated statements of operations and comprehensive income (loss), cash flows, and stockholders' equity for each of the three years in the period ended January 3, 2014. Our audits also included the financial statement schedule listed in the Index at Item 15. These consolidated financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on the consolidated financial statements and financial statement schedule based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of the Company as of January 3, 2014 and December 28, 2012, and the results of their operations and their cash flows for each of the three years in the period ended January 3, 2014, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein. We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company's internal control over financial reporting as of January 3, 2014, based on the criteria established in Internal Control - Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 4, 2014 expressed an unqualified opinion on the Company's internal control over financial reporting. Williamsville, New York March 4, 2014 - 53 - GREATBATCH, INC. CONSOLIDATED BALANCE SHEETS (in thousands except share and per share data) ASSETS Current assets: Cash and cash equivalents Accounts receivable, net of allowance for doubtful accounts of $2.0 million in 2013 and $ $2.4 million in 2012 Inventories Refundable income taxes Deferred income taxes Prepaid expenses and other current assets Total current assets Property, plant and equipment, net Amortizing intangible assets, net Indefinite-lived intangible assets Goodwill Deferred income taxes Other assets Total assets LIABILITIES AND STOCKHOLDERS’ EQUITY Current liabilities: Accounts payable Income taxes payable Deferred income taxes Accrued expenses Total current liabilities Long-term debt Deferred income taxes Other long-term liabilities Total liabilities Commitments and contingencies (Note 15) Stockholders’ equity: Preferred stock, $0.001 par value, authorized 100,000,000 shares; no shares issued or outstanding in 2013 or 2012 Common stock, $0.001 par value, authorized 100,000,000 shares; 24,459,153 shares issued and 24,422,555 shares outstanding in 2013; 23,731,570 shares issued and 23,711,838 shares outstanding in 2012 Additional paid-in capital Treasury stock, at cost, 36,598 shares in 2013 and 19,732 shares in 2012 Retained earnings Accumulated other comprehensive income Total stockholders’ equity Total liabilities and stockholders’ equity $ $ $ At January 3, 2014 December 28, 2012 35,465 $ 20,284 113,679 118,358 2,306 6,008 6,717 282,533 145,773 76,122 20,288 346,656 2,933 16,398 890,703 $ 46,508 $ — 613 44,681 91,802 197,500 52,012 7,334 348,648 120,923 106,612 — 7,678 12,636 268,133 150,893 87,345 20,828 349,035 2,534 11,107 889,875 45,274 94 874 45,515 91,757 225,414 82,462 9,382 409,015 — — 24 344,915 (1,232 ) 183,990 14,358 542,055 890,703 $ 24 320,618 (452 ) 147,723 12,947 480,860 889,875 The accompanying notes are an integral part of these consolidated financial statements. - 54 - GREATBATCH, INC. CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS) (in thousands except per share data) Sales Cost of sales Gross profit Operating expenses: Selling, general and administrative expenses Research, development and engineering costs, net Other operating expenses, net Total operating expenses Operating income Interest expense Interest income Loss (gain) on cost and equity method investments, net Other expense, net Income before provision for income taxes Provision for income taxes Net income (loss) Earnings (loss) per share: Basic Diluted Weighted average shares outstanding: Basic Diluted Comprehensive Income (Loss) Net income (loss) Other comprehensive income (loss): Year Ended $ January 3, 2014 663,945 $ 444,632 219,313 December 28, 2012 646,177 $ 444,528 201,649 88,107 54,077 15,790 157,974 61,339 11,261 — 694 546 48,838 12,571 36,267 $ 80,992 52,490 42,346 175,828 25,821 18,055 (1 ) 106 931 6,730 11,529 (4,799 ) $ 1.51 $ 1.43 $ (0.20 ) $ (0.20 ) $ 23,991 25,323 23,584 23,584 $ $ $ December 30, 2011 568,822 388,469 180,353 72,548 45,513 593 118,654 61,699 16,928 (21 ) (4,232 ) 632 48,392 15,270 33,122 1.42 1.40 23,258 23,636 $ 36,267 $ (4,799 ) $ 33,122 Foreign currency translation gain (loss) Net change in cash flow hedges, net of tax Defined benefit plan liability adjustment, net of tax Other comprehensive income (loss) Comprehensive income (loss) $ 1,521 (382 ) 272 1,411 37,678 $ 1,905 428 1,685 4,018 (781 ) $ (704 ) (271 ) (566 ) (1,541 ) 31,581 The accompanying notes are an integral part of these consolidated financial statements. - 55 - GREATBATCH, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands) Cash flows from operating activities: Net income (loss) Adjustments to reconcile net income (loss) to net cash provided by operating activities: Depreciation and amortization Debt related amortization included in interest expense Stock-based compensation (Gain) loss on cost and equity method investments, net Other non-cash (gains) losses, net Deferred income taxes Changes in operating assets and liabilities, net of acquisitions: Accounts receivable Inventories Prepaid expenses and other assets Accounts payable Accrued expenses Income taxes payable Net cash provided by operating activities Cash flows from investing activities: Proceeds from sale of orthopaedic product lines Acquisition of property, plant and equipment Proceeds from sale of property, plant and equipment Proceeds from (purchase of) cost and equity method investments, net Acquisitions, net of cash acquired Other investing activities, net Net cash used in investing activities Cash flows from financing activities: Principal payments of long-term debt Proceeds from issuance of long-term debt Issuance of common stock Payment of debt issuance costs Other financing activities, net Net cash provided by (used in) financing activities Effect of foreign currency exchange rates on cash and cash equivalents Net increase (decrease) in cash and cash equivalents Cash and cash equivalents, beginning of year Cash and cash equivalents, end of year Year Ended January 3, 2014 December 28, 2012 December 30, 2011 $ 36,267 $ (4,799 ) $ 33,122 35,966 6,366 14,101 694 255 (29,856 ) 7,379 (11,508 ) (353 ) 1,307 (1,176 ) (2,687 ) 56,755 4,746 (18,558 ) 310 (3,732 ) — (1,050 ) (18,284 ) 46,368 12,557 10,904 106 10,788 5,733 (18,834 ) (7,481 ) 1,253 5,757 1,459 1,020 64,831 — (41,069 ) 396 (1,887 ) (17,224 ) (3 ) (59,787 ) (458,282 ) 425,000 12,807 (2,802 ) (81 ) (23,358 ) 68 15,181 20,284 35,465 $ $ (32,000 ) 10,000 1,263 — (717 ) (21,454 ) 186 (16,224 ) 36,508 20,284 $ 36,306 11,389 12,082 (4,232 ) (676 ) 8,776 (13,477 ) (2,139 ) (590 ) 4,236 3,678 1,446 89,921 — (22,489 ) 212 10,315 (66,493 ) (1,934 ) (80,389 ) (40,000 ) 45,000 2,401 (2,213 ) (1,500 ) 3,688 405 13,625 22,883 36,508 The accompanying notes are an integral part of these consolidated financial statements. - 56 - GREATBATCH, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (in thousands) At December 31, 2010 Stock-based compensation Net shares issued under stock incentive plans Income tax liability from stock options, restricted stock and restricted stock units Net income Total other comprehensive loss, net At December 30, 2011 Stock-based compensation Net shares issued under stock incentive plans Income tax liability from stock options, restricted stock and restricted stock units Shares contributed to 401(k) Plan Net loss Total other comprehensive income, net At December 28, 2012 Stock-based compensation Net shares issued (acquired) under stock incentive plans Income tax benefit from stock options, restricted stock and restricted stock units Shares contributed to 401(k) Plan Net income Total other comprehensive income, net At January 3, 2014 Common Stock Additional Paid-In Capital Treasury Stock Shares Amount Retained Earnings Accumulated Other Comprehensive Income (Loss) Total Stockholders’ Equity Shares Amount 23,319 $ — 23 $ 298,405 7,037 — (63 ) $ (1,469 ) $ 119,400 $ — — — 10,470 $ — 426,829 7,037 147 — 1,891 3 82 — — 1,973 — — — 23,466 — 103 — 163 — — 23,732 — — — — 23 — — — 1 — — 24 — (137 ) — — 307,196 9,019 663 (141 ) 3,881 — — 320,618 9,333 — — — (60 ) — 1 — 39 — — (20 ) — — — — (1,387 ) — — 33,122 — 152,522 — — — (1,541 ) 8,929 — (137 ) 33,122 (1,541 ) 467,283 9,019 24 — — 687 — 911 — — — (4,799 ) — (452 ) — — 147,723 — — — — 4,018 12,947 — (141 ) 4,793 (4,799 ) 4,018 480,860 9,333 636 — 12,245 (17 ) (780 ) — — 11,465 — 91 — — — — 242 2,477 — — — — — — — — — 36,267 — 24,459 $ — — 24 $ 344,915 — (37 ) $ (1,232 ) $ 183,990 $ — — — — — 242 2,477 36,267 1,411 14,358 $ 1,411 542,055 The accompanying notes are an integral part of these consolidated financial statements. - 57 - GREATBATCH, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Principles of Consolidation – The consolidated financial statements include the accounts of Greatbatch, Inc. and its wholly owned subsidiary Greatbatch Ltd. (collectively, the “Company” or “Greatbatch”). All intercompany balances and transactions have been eliminated in consolidation. Nature of Operations – In connection with the realignment of the Company's operating structure in 2013 to optimize profitable growth, which included changing the Company's management and reporting structure, the Company reevaluated its operating and reporting segments. Beginning in the fourth quarter of 2013, the Company determined that it has two reportable segments: Greatbatch Medical and QiG Group (“QiG”). As required, the Company reclassified certain prior year amounts to conform them to the current year presentation, including goodwill, segment operating income (loss), segment depreciation and amortization, segment assets and sales categorizations. See Note 13 “Other Operating Expenses, Net” and Note 19 “Business Segment, Geographic and Concentration Risk Information” for further discussion on these changes. Greatbatch Medical designs and manufactures products where Greatbatch either owns the intellectual property or has unique manufacturing and assembly expertise and includes the financial results of the former Implantable Medical and Electrochem Solutions (“Electrochem”) segments, excluding QiG. These products include medical devices and components for the cardiac, neuromodulation, orthopaedics, portable medical, vascular and energy markets among others. The Greatbatch Medical segment also offers value-added assembly and design engineering services for medical devices that utilize its component products. QiG focuses on developing medical device systems for some of healthcare’s most pressing challenges and reflects Greatbatch’s strategic evolution of its product offerings in order to raise the growth and profitability profile of the Company. Through the research and development professionals in QiG, the Company is now investing in three areas - new medical device systems commercialization, collaborative programs with OEM customers, and strategic equity positions in start-up companies - to grow a diversified and distinctive portfolio. These medical device systems developed by QiG are manufactured by Greatbatch Medical. The Company's customers include large multi-national original equipment manufacturers (“OEMs”). Fiscal Year End – The Company utilizes a fifty-two, fifty-three week fiscal year ending on the Friday nearest December 31st. Fiscal years 2013, 2012 and 2011 ended on January 3, 2014, December 28, 2012 and December 30, 2011, respectively. Fiscal year 2013 contained fifty-three weeks. Fiscal years 2012 and 2011 each contained fifty-two weeks. Fair Value Measurements – Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (i.e. the “exit price”) in an orderly transaction between market participants at the measurement date. Accounting Standards Codification (“ASC”) establishes a hierarchy for inputs used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that the most observable inputs be used when available. Observable inputs are inputs that market participants would use in pricing the asset or liability developed based on market data obtained from sources independent of the Company. Unobservable inputs are inputs that reflect the Company’s assumptions about the assumptions market participants would use in pricing the asset or liability developed based on the best information available in the circumstances. The hierarchy is broken down into three levels based on the reliability of inputs as follows: Level 1 — Valuation is based on quoted prices in active markets for identical assets or liabilities that the Company has the ability to access. Level 1 valuations do not entail a significant degree of judgment. Level 2 — Valuation is determined from quoted prices for similar assets or liabilities in active markets, quoted prices for identical instruments in markets that are not active or by model-based techniques in which all significant inputs are observable in the market. Level 3 — Valuation is based on unobservable inputs that are significant to the overall fair value measurement. The degree of judgment in determining fair value is greatest for Level 3 valuations. The availability of observable inputs can vary and is affected by a wide variety of factors, including, the type of asset/liability, whether the asset/liability is established in the marketplace, and other characteristics particular to the valuation. To the extent that a valuation is based on models or inputs that are less observable or unobservable in the market, the determination of fair value requires more judgment. In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, for disclosure purposes the level in the fair value hierarchy within which the fair value measurement in its entirety falls is determined based on the lowest level input that is significant to the fair value measurement in its entirety. - 58 - GREATBATCH, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Fair value is a market-based measure considered from the perspective of a market participant rather than an entity-specific measure. Therefore, even when market assumptions are not readily available, assumptions are required to reflect those that market participants would use in pricing the asset or liability at the measurement date. Note 18 “Fair Value Measurements” contains additional information on assets and liabilities recorded at fair value in the consolidated financial statements. Cash and Cash Equivalents – Cash and cash equivalents consist of cash and highly liquid, short-term investments with maturities at the time of purchase of three months or less. The carrying amount of cash and cash equivalents approximated their fair value as of January 3, 2014 and December 28, 2012 based upon the short-term nature of these instruments. Concentration of Credit Risk – Financial instruments that potentially subject the Company to concentration of credit risk consist principally of accounts receivable. A significant portion of the Company’s sales are to three customers, all in the medical device industry, and, as such, the Company is directly affected by the condition of those customers and that industry. However, the credit risk associated with trade receivables is partially mitigated due to the stability of those customers. The Company performs on-going credit evaluations of its customers. Note 19 “Business Segment, Geographic and Concentration Risk Information” contains information on sales and accounts receivable for these customers. The Company maintains cash deposits with major banks, which from time to time may exceed insured limits. The Company performs on-going credit evaluations of its banks. Allowance for Doubtful Accounts – The Company provides credit, in the normal course of business, to its customers in the form of trade receivables. Credit is extended based on evaluation of a customer’s financial condition and collateral is not required. The Company maintains an allowance for those customer receivables that it does not expect to collect. The Company accrues its estimated losses from uncollectable accounts receivable to the allowance based upon recent historical experience, the length of time the receivable has been outstanding and other specific information as it becomes available. Provisions to the allowance for doubtful accounts are charged to current operating expenses. Actual losses are charged against this allowance when incurred. The carrying amount of trade receivables approximated their fair value as of January 3, 2014 based upon the short-term nature of these assets. Inventories – Inventories are stated at the lower of cost, determined using the first-in first-out method, or market. Write- downs for excess, obsolete or expired inventory are based primarily on how long the inventory has been held as well as estimates of forecasted net sales of that product. A significant change in the timing or level of demand for products may result in recording additional write-downs for excess, obsolete or expired inventory in the future. Note 4 “Inventories” contains additional information on the Company’s inventory. Property, Plant and Equipment (“PP&E”) – PP&E is carried at cost less accumulated depreciation. Depreciation is computed by the straight-line method over the estimated useful lives of the assets, as follows: buildings and building improvements 7-40 years; machinery and equipment 3-8 years; office equipment 3-10 years; and leasehold improvements over the remaining lives of the improvements or the lease term, if less. The cost of repairs and maintenance are expensed as incurred; renewals and betterments are capitalized. Upon retirement or sale of an asset, its cost and related accumulated depreciation or amortization is removed from the accounts and any gain or loss is recorded in operating income or expense. Note 6 “Property, Plant and Equipment, Net” contains additional information on the Company’s PP&E. Business Combinations – The Company records its business combinations under the acquisition method of accounting. Under the acquisition method of accounting, the Company allocates the purchase price of each acquisition to the tangible and identifiable intangible assets acquired and liabilities assumed based on their respective fair values at the date of acquisition. The fair value of identifiable intangible assets is based upon detailed valuations that use various assumptions made by management. Any excess of the purchase price over the fair value of net tangible and identifiable intangible assets acquired is allocated to goodwill. All direct acquisition-related costs are expensed as incurred. In circumstances where an acquisition involves a contingent consideration arrangement, the Company recognizes a liability equal to the fair value of the contingent payments it expects to make as of the acquisition date. The Company re- measures this liability each reporting period and records changes in the fair value through Other Operating Expenses, Net. Increases or decreases in the fair value of the contingent consideration liability can result from changes in discount periods and rates, as well as changes in the timing, amount of, or the likelihood of achieving the applicable contingent consideration. See Note 18 “Fair Value Measurements” for additional information. Note 2 “Acquisitions” contains additional information on the Company’s acquisitions. Amortizing Intangible Assets – Amortizing intangible assets consists primarily of purchased technology, patents and customer lists. The Company amortizes its definite-lived intangible assets over their estimated useful lives utilizing an accelerated or straight-line method of amortization, which approximates the projected distribution of cash flows used to fair value those intangible assets at the time of acquisition. When the straight-line method of amortization is utilized, the estimated useful life of the intangible asset is shortened to assure that recognition of amortization expense corresponds with the distribution of expected cash flows. The amortization period for the Company’s amortizing intangible assets are - 59 - GREATBATCH, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS as follows: purchased technology and patents 5-15 years; customer lists 7-20 years and other intangible assets 1-10 years. Note 7 “Intangible Assets” contains additional information on the Company’s amortizing intangible assets. Impairment of Long-Lived Assets – The Company assesses the impairment of definite-lived long-lived assets or asset groups when events or changes in circumstances indicate that the carrying value may not be recoverable. Factors that are considered in deciding when to perform an impairment review include: a significant decrease in the market price of the asset or asset group; a significant change in the extent or manner in which a long-lived asset or asset group is being used or in its physical condition; a significant change in legal factors or in the business climate that could affect the value of a long-lived asset (asset group), including an action or assessment by a regulator; an accumulation of costs significantly in excess of the amount originally expected for the acquisition or construction; a current-period operating or cash flow loss combined with a history of operating or cash flow losses or a projection or forecast that demonstrates continuing losses associated with the use of a long-lived asset or asset group; or a current expectation that, more likely than not, a long-lived asset or asset group will be sold or otherwise disposed of significantly before the end of its previously estimated useful life. The term more likely than not refers to a level of likelihood that is more than 50 percent. Potential recoverability is measured by comparing the carrying amount of the asset or asset group to its related total future undiscounted cash flows. If the carrying value is not recoverable, the asset or asset group is considered to be impaired. Impairment is measured by comparing the asset or asset group’s carrying amount to its fair value. When it is determined that useful lives of assets are shorter than originally estimated, and no impairment is present, the rate of depreciation is accelerated in order to fully depreciate the assets over their new shorter useful lives. Goodwill and other indefinite lived intangible assets recorded are not amortized but are periodically tested for impairment. The Company assesses goodwill for impairment by comparing the fair value of its reporting units to their carrying amounts on the last day of each fiscal year, or more frequently if certain events occur as described above. If the fair value of a reporting unit is less than its carrying value, an impairment loss is recorded to the extent that the implied fair value of the goodwill within the reporting unit is less than its carrying value. Fair values for reporting units are determined based on discounted cash flows and market multiples. Other indefinite lived intangible assets are assessed for impairment on the last day of each fiscal year, or more frequently if certain events occur as described above, by comparing the fair value of the intangible asset to its carrying value. The fair value is determined by using the income approach. Note 7 “Intangible Assets” contains additional information on the Company’s long-lived intangible assets. Other Long-Term Assets – Other long-term assets includes deferred financing fees incurred in connection with the Company’s issuance of its convertible subordinated notes and credit facility. These fees are amortized to Interest Expense using the effective interest method over the period from the date of issuance to the put option date (if applicable) or the maturity date, whichever is earlier. The amortization of deferred fees is included in Debt Related Amortization Included in Interest Expense in the Consolidated Statements of Cash Flows. Note 9 “Debt” contains additional information on the Company’s deferred financing fees. Other long-term assets also include investments in equity securities of entities that are not publicly traded and which do not have readily determinable fair values. We account for investments in these entities under the cost or equity method depending on the type of ownership interest, as well as the Company’s ability to exercise influence over these entities. Equity method investments are initially recorded at cost, and are subsequently adjusted to reflect the Company’s share of earnings or losses of the investee. Cost method investments are recorded at cost. Each reporting period, management evaluates these cost and equity method investments to determine if there are any events or circumstances that are likely to have a significant effect on the fair value of the investment. Examples of such impairment indicators include, but are not limited to: a recent sale or offering of similar shares of the investment at a price below the Company’s cost basis; a significant deterioration in earnings performance; a significant change in the regulatory, economic or technological environment of the investee; or a significant doubt about an investee’s ability to continue as a going concern. If an impairment indicator is identified, management will estimate the fair value of the investment and compare it to its carrying value. The estimation of fair value considers all available financial information related to the investee, including, but not limited to, valuations based on recent third-party equity investments in the investee. If the fair value of the investment is less than its carrying value, the investment is impaired and a determination as to whether the impairment is other-than-temporary is made. Impairment is deemed to be other-than-temporary unless the Company has the ability and intent to hold the investment for a period sufficient for a market recovery up to the carrying value of the investment. Further, evidence must indicate that the carrying value of the investment is recoverable within a reasonable period. For other-than-temporary impairments, an impairment loss is recognized equal to the difference between the investment’s carrying value and its fair value. The Company has determined that these investments are not considered variable interest entities. The Company’s exposure related to these entities is limited to its recorded investment. These investments are in start-up research and development companies whose fair value is highly subjective in nature and subject to future fluctuations, which could be significant. - 60 - GREATBATCH, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Income Taxes – The consolidated financial statements of the Company have been prepared using the asset and liability approach in accounting for income taxes, which requires the recognition of deferred income taxes for the expected future tax consequences of net operating losses, credits, and temporary differences between the financial statement carrying amounts and the tax bases of assets and liabilities. A valuation allowance is provided on deferred tax assets if it is determined that it is more likely than not that the asset will not be realized. The Company accounts for uncertain tax positions using a more likely than not recognition threshold. The evaluation of uncertain tax positions is based on factors including, but not limited to, changes in tax law, the measurement of tax positions taken or expected to be taken in tax returns, the effective settlement of matters subject to audit, new audit activity and changes in facts or circumstances related to a tax position. These tax positions are evaluated on a quarterly basis. The Company recognizes interest expense related to uncertain tax positions as Provision for Income Taxes. Penalties, if incurred, are recognized as a component of Selling, General and Administrative Expenses (“SG&A”). The Company and its subsidiary file a consolidated U.S. federal income tax return. State tax returns are filed on a combined or separate basis depending on the applicable laws in the jurisdictions where tax returns are filed. The Company also files foreign tax returns on a separate company basis in the countries in which it operates. See Note 14 “Income Taxes” for additional information. Convertible Subordinated Notes (“CSN”) – For convertible debt instruments that may be settled in cash upon conversion, the Company accounts 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. Upon issuance, the Company determined the carrying amount of the liability component of CSN by measuring the fair value of a similar liability that does not have the associated conversion option. The carrying amount of the conversion option was then determined by deducting the fair value of the liability component from the initial proceeds received from the issuance of CSN. The carrying amount of the conversion option was recorded in Additional Paid-In Capital with an offset to Long-Term Debt and was amortized using the effective interest method over the period from the date of issuance to the maturity date. Deferred financing fees incurred in connection with the issuance of CSN, were allocated proportionally to the proceeds of the liability and equity components. The deferred financing fees allocated to the debt component were amortized using the effective interest method over the period from the date of issuance to the maturity date. The deferred financing fees allocated to the equity component were recorded as an offset to Additional Paid-In Capital. The amortization of discount and deferred fees related to the Company’s convertible debt instruments is included in Debt Related Amortization Included in Interest Expense in the Consolidated Statements of Cash Flows. See Note 9 “Debt” for additional information. Derivative Financial Instruments – The Company recognizes all derivative financial instruments in its consolidated financial statements at fair value. Changes in the fair value of derivative instruments are recorded in earnings unless hedge accounting criteria are met. The Company designates its interest rate swap (See Note 9 “Debt”) and foreign currency contracts (See Note 15 “Commitments and Contingencies”) entered into as cash flow hedges. The effective portion of the changes in fair value of these cash flow hedges is recorded each period, net of tax, in Accumulated Other Comprehensive Income until the related hedged transaction occurs. Any ineffective portion of the changes in fair value of these cash flow hedges is recorded in earnings. In the event the hedged cash flow for forecasted transactions does not occur, or it becomes probable that they will not occur, the Company would reclassify the amount of any gain or loss on the related cash flow hedge to income (expense) at that time. Cash flows related to these derivative financial instruments are included in cash flows from operating activities. Revenue Recognition – The Company recognizes revenue when it is realized or realizable and earned. This occurs when persuasive evidence of an arrangement exists, delivery has occurred, the price is fixed or determinable, the buyer is obligated to pay us (i.e., not contingent on a future event), the risk of loss is transferred, there is no obligation of future performance, collectability is reasonably assured and the amount of future returns can reasonably be estimated. With regards to the Company’s customers (including distributors), those criteria are met at the time of shipment when title passes. The Company includes shipping and handling fees billed to customers in Sales. Shipping and handling costs associated with inbound and outbound freight are recorded in Cost of Sales. In certain instances the Company obtains component parts for sub-assemblies from its customers that are included in the final product sold back to the same customer. These amounts are excluded from Sales and Cost of Sales recognized by the Company. The cost of these customer supplied component parts amounted to $45.3 million, $32.6 million and $27.9 million in 2013, 2012 and 2011, respectively. - 61 - GREATBATCH, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Product Warranties – The Company allows customers to return defective or damaged products for credit, replacement, or exchange. The Company warrants that its products will meet customer specifications and will be free from defects in materials and workmanship. The Company accrues its estimated exposure to warranty claims, through Cost of Sales, based upon recent historical experience and other specific information as it becomes available. Note 15 “Commitments and Contingencies” contains additional information on the Company’s product warranties. Research, Development and Engineering Costs, Net (“RD&E”) – RD&E costs are expensed as incurred. The primary costs are salary and benefits for personnel, material costs used in development projects and subcontracting costs. Cost reimbursements for engineering services from customers for whom the Company designs products are recorded as an offset to engineering costs upon achieving development milestones specified in the contracts. These reimbursements do not cover the complete cost of the development projects. Additionally, the technology developed under these cost reimbursement projects is owned by the Company and is utilized for future products developed for other customers. In-process research and development (“IPR&D”) represents research projects acquired in a business combination which are expected to generate cash flows but have not yet reached technological feasibility. The primary basis for determining the technological feasibility of these projects is whether or not regulatory approval has been obtained. The Company classifies IPR&D acquired in a business combination as an indefinite-lived intangible asset until the completion or abandonment of the associated projects. Upon completion, the Company would determine the useful life of the IPR&D and begin amortizing the assets to reflect their use over their remaining lives. Upon permanent abandonment, the remaining carrying amount of the associated IPR&D would be written-off. The Company tests the IPR&D acquired for impairment at least annually, and more frequently if events or changes in circumstances indicate that the assets may be impaired. The impairment test consists of a comparison of the fair value of the intangible assets with their carrying amount. If the carrying amount exceeds its fair value, the Company would record an impairment loss in an amount equal to the excess. Note 12 “Research, Development and Engineering Costs, Net” and Note 7 “Intangible Assets” contains additional information on the Company’s RD&E activities. Stock-Based Compensation – The Company records compensation costs related to stock-based awards granted to employees based upon their estimated fair value on the grant date. Compensation cost for service-based awards is recognized ratably over the applicable vesting period. Compensation cost for nonmarket-based performance awards is reassessed each period and recognized based upon the probability that the performance targets will be achieved. Compensation cost for market-based performance awards is expensed ratably over the applicable vesting period and is recognized each period whether the performance metrics are achieved or not. The Company utilizes the Black-Scholes option pricing model to estimate the fair value of stock options granted. For service-based and nonmarket-based performance restricted stock and restricted stock unit awards, the fair market value of the award is determined based upon the closing value of the Company’s stock price on the grant date. For market-based performance restricted stock unit awards, the fair market value of the award is determined utilizing a Monte Carlo simulation model, which projects the value of the Company’s stock under numerous scenarios and determines the value of the award based upon the present value of those projected outcomes. The amount of stock-based compensation expense recognized is based on the portion of the awards that are ultimately expected to vest. The Company estimates pre-vesting forfeitures at the time of grant by analyzing historical data and revises those estimates in subsequent periods if actual forfeitures differ from those estimates. The total expense recognized over the vesting period will only be for those awards that ultimately vest, excluding market and nonmarket performance award considerations. Note 11 “Stock-Based Compensation” contains additional information on the Company’s stock-based compensation. Foreign Currency Translation – The Company translates all assets and liabilities of its foreign subsidiaries, where the U.S. dollar is not the functional currency, at the period-end exchange rate and translates income and expenses at the average exchange rates in effect during the period. The net effect of this translation is recorded in the consolidated financial statements as Accumulated Other Comprehensive Income. Translation adjustments are not adjusted for income taxes as they relate to permanent investments in the Company’s foreign subsidiaries. Net foreign currency transaction gains and losses are included in Other Expense, Net and amounted to a loss of $0.1 million for 2013, a loss of $0.3 million for 2012 and a loss of $0.1 million for 2011. Defined Benefit Plans – The Company recognizes in its balance sheet as an asset or liability the overfunded or underfunded status of its defined benefit plans provided to its employees located in Mexico, Switzerland and France. This asset or liability is measured as the difference between the fair value of plan assets and the benefit obligation of those plans. For these plans, the benefit obligation is the projected benefit obligation, which is calculated based on actuarial computations of current and future benefits for employees. Actuarial gains or losses and prior service costs or credits that arise during the period, but are not included as components of net periodic benefit expense, are recognized as a component - 62 - GREATBATCH, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS of Accumulated Other Comprehensive Income. Defined benefit expenses are charged to Cost of Sales, SG&A and RD&E expenses as applicable. Note 10 “Defined Benefit Plans” contains additional information on these costs. Earnings (Loss) Per Share (“EPS”) – Basic EPS is calculated by dividing Net Income (Loss) by the weighted average number of shares outstanding during the period. Diluted EPS is calculated by adjusting the weighted average number of shares outstanding for potential common shares, which consist of stock options, unvested restricted stock and restricted stock units and, if applicable, contingently convertible instruments such as convertible debt. Note 16 “Earnings (Loss) Per Share” contains additional information on the computation of the Company’s EPS. Comprehensive Income (Loss) – The Company’s comprehensive income (loss) as reported in the Consolidated Statements of Operations and Comprehensive Income (Loss) includes net income (loss), foreign currency translation adjustments, the net change in cash flow hedges, and defined benefit plan liability adjustments. The Consolidated Statements of Operations and Comprehensive Income (Loss) and Note 17 “Accumulated Other Comprehensive Income” contains additional information on the computation of the Company’s comprehensive income (loss). Use of Estimates – The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and reported amounts of sales and expenses during the reporting period. Actual results could differ materially from those estimates. Recently Issued Accounting Pronouncements – In the normal course of business, management evaluates all new accounting pronouncements issued by the Financial Accounting Standards Board (“FASB”), Securities and Exchange Commission (“SEC”), Emerging Issues Task Force (“EITF”), American Institute of Certified Public Accountants (“AICPA”) or other authoritative accounting bodies to determine the potential impact they may have on the Company’s 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 Consolidated Financial Statements. In February 2013, the FASB issued Accounting Standards Update (“ASU”) 2013-02, “Comprehensive Income (Topic 220): Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income.” This ASU added new disclosure requirements regarding the effect of significant amounts reclassified from each component of accumulated other comprehensive income (“AOCI”) based on its source and the income statement line items affected by the reclassification. This ASU gave companies the flexibility to present the information either in the notes or parenthetically on the face of the financial statements provided that all of the required information is presented in a single location. This ASU was effective prospectively for annual and interim reporting periods beginning after December 15, 2012. This ASU was adopted during the first quarter of 2013 and did not have a material impact on the Company’s Consolidated Financial Statements as it only changed the disclosures surrounding AOCI. In July 2012, the FASB issued ASU No. 2012-02, “Intangibles-Goodwill and Other (Topic 350): Testing Indefinite-Lived Intangible Assets for Impairment.” This ASU simplified the guidance for testing the decline in the realizable value (impairment) of indefinite-lived intangible assets other than goodwill. The amendment allowed an organization the option to first assess qualitative factors to determine whether it is necessary to perform the quantitative impairment test. An organization electing to perform a qualitative assessment is no longer required to calculate the fair value of an indefinite- lived intangible asset unless the organization determines, based on a qualitative assessment, that it is “more likely than not” that the asset is impaired. The amendments in this ASU were effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012. This ASU did not have a material impact on the Company’s Consolidated Financial Statements as it only impacted the timing of when the Company was required to perform the two-step impairment test of its indefinite-lived intangible assets other than goodwill. In December 2011, the FASB issued ASU No. 2011-11 “Balance Sheet (Topic 210): Disclosures about Offsetting Assets and Liabilities.” This ASU requires companies to provide expanded disclosures about trading in financial instruments and related derivatives, and creates new disclosure requirements about the nature of an entity’s rights of offset and related arrangements associated with its financial instruments and derivative instruments. The disclosure requirements are effective for annual reporting periods beginning on or after January 1, 2013, and interim periods therein, with retrospective application required. This ASU did not have a material impact on the Company’s Consolidated Financial Statements as it only changes the disclosures surrounding the Company’s offsetting assets and liabilities. - 63 - GREATBATCH, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 2. ACQUISITIONS NeuroNexus Technologies, Inc. On February 16, 2012, the Company purchased all of the outstanding common stock of NeuroNexus Technologies, Inc. (“NeuroNexus”) headquartered in Ann Arbor, MI. NeuroNexus is an active implantable medical device design firm specializing in developing and commercializing neural interface technology, components and systems for neuroscience and clinical markets. NeuroNexus has an extensive intellectual property portfolio, core technologies and capabilities to support the development and manufacturing of neural interface devices across a wide range of applications including neuromodulation, sensing, optical stimulation and targeted drug delivery. This transaction was accounted for under the acquisition method of accounting. Accordingly, the operating results of NeuroNexus have been included in the Company's QiG segment from the date of acquisition. For 2012, NeuroNexus added approximately $2.5 million to the Company’s revenue and decreased the Company’s net loss by $0.2 million. The purchase price of NeuroNexus consisted of cash payments of $11.7 million and potential future payments of up to an additional $2 million. These future payments are contingent upon the achievement of certain financial and development- based milestones and had an estimated fair value of $1.5 million as of the acquisition date. The cost of the acquisition was allocated to the assets acquired and liabilities assumed from NeuroNexus based on their fair values as of the close of the acquisition, with the amount exceeding the fair value of the net assets acquired being recorded as goodwill. The valuation of the assets acquired and liabilities assumed from NeuroNexus was finalized during 2013 and did not result in a material adjustment to the original valuation of net assets acquired, including goodwill and therefore has not been reflected as a retrospective adjustment of the historical financial statements. The following table summarizes the allocation of the NeuroNexus purchase price to the assets acquired and liabilities assumed as of the acquisition date (in thousands): Assets acquired Current assets Property, plant and equipment Amortizing intangible assets Indefinite-lived intangible assets Goodwill Other assets Total assets acquired Liabilities assumed Current liabilities Deferred income taxes Total liabilities assumed $ $ 618 35 2,927 540 8,924 1,576 14,620 420 989 1,409 13,211 The fair values of the assets acquired were determined using one of three valuation approaches: market, income and cost. The selection of a particular method for a given asset depended on the reliability of available data and the nature of the asset, among other considerations. The market approach estimates the value for a subject asset based on available market pricing for comparable assets. The income approach estimates the value for a subject asset based on the present value of cash flows projected to be generated by the asset. The projected cash flows were discounted at a required rate of return that reflects the relative risk of the asset and the time value of money. The projected cash flows for each asset considered multiple factors from the perspective of a marketplace participant including revenue projections from existing customers, attrition trends, product life-cycle assumptions, marginal tax rates and expected profit margins giving consideration to historical and expected margins. The cost approach estimates the value for a subject asset based on the cost to replace the asset and reflects the estimated reproduction or replacement cost for the asset, less an allowance for loss in value due to depreciation or obsolescence, with specific consideration given to economic obsolescence if indicated. These fair value measurement approaches are based on significant unobservable inputs, including management estimates and assumptions. Current assets and liabilities - The fair value of current assets and liabilities was assumed to approximate their carrying value as of the acquisition date due to the short-term nature of these assets and liabilities. - 64 - GREATBATCH, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Intangible assets - The purchase price was allocated to identifiable intangible assets as follows (dollars in thousands): Amortizing Intangible Assets Technology and patents Customer lists Indefinite-lived Intangible Assets In-process research and development Fair Value Assigned Weighted Average Amortization Period (Years) Estimated Useful Life (Years) Weighted Average Discount Rate $ 1,058 1,869 2,927 540 6 7 7 N/A 10 15 13 12 14 % 13 % 13 % 26 % The weighted average amortization period is less than the estimated useful life due to the Company using an accelerated amortization method, which approximates the projected cash flows used to determine the fair value of those intangible assets. Technology and patents - Technology and patents consists of technical processes, patented and unpatented technology, manufacturing know-how, trade secrets and the understanding with respect to products or processes that have been developed by NeuroNexus and that will be leveraged in current and future products. The fair value of technology and patents acquired was determined utilizing the relief from royalty method, a form of the income approach, with royalty rates that ranged from 2% to 6%. The estimated useful life of the technology and patents is based upon management’s estimate of the product life cycle associated with technology and patents before they will be replaced by new technologies. Customer lists – Customer lists represent the estimated fair value of non-contractual customer relationships NeuroNexus has as of the acquisition date. The primary customers of NeuroNexus include numerous scientists and researchers from various geographic locations around the world. These relationships were valued separately from goodwill at the amount which an independent third party would be willing to pay for these relationships. The fair value of customer lists was determined using the multi-period excess-earnings method, a form of the income approach. The estimated useful life of the existing customer list was based upon historical customer attrition as well as management’s understanding of the industry and product life cycles. IPR&D – IPR&D represents research projects which are expected to generate cash flows but have not yet reached technological feasibility. The Company used the income approach to determine the fair value of the IPR&D acquired. In arriving at the value of the IPR&D, management considered, among other factors: the projects’ stage of completion; the complexity of the work to be completed as of the acquisition date; the projected costs to complete the projects; the contribution of other acquired assets; and the estimated useful life of the technology. The Company applied a market- participant risk-adjusted discount rate to arrive at a present value as of the date of acquisition. The value assigned to IPR&D related to the development of micro-electrodes for deep brain mapping and electrocorticography. For purposes of valuing the IPR&D, the Company estimated total costs to complete the projects to be approximately $1.5 million. Goodwill - The excess of the purchase price over the fair value of net tangible and intangible assets acquired and liabilities assumed was allocated to goodwill. Various factors contributed to the establishment of goodwill, including: the value of NeuroNexus’s highly trained assembled work force and management team; the incremental value that NeuroNexus’s technology will bring to the Company’s neuromodulation platform currently in development; and the expected revenue growth over time that is attributable to increased market penetration from future products and customers. The goodwill acquired in connection with the NeuroNexus acquisition was allocated to the QiG business segment and is not deductible for tax purposes. Micro Power Electronics, Inc. On December 15, 2011, the Company acquired all of the outstanding capital stock of Micro Power Electronics, Inc. (“Micro Power”) headquartered in Beaverton, OR. Micro Power is a leading supplier of custom battery solutions, serving the portable medical, military and handheld automatic identification and data collection markets. The aggregate purchase price consisted of the amount paid to Micro Power shareholders ($57.6 million), payments to Micro Power’s creditors at closing ($6.6 million) and certain Micro Power transaction-related expenses ($7.6 million). The Company financed this acquisition with cash on hand and borrowed $45 million under its revolving credit facility. As of December 30, 2011, the Company had accrued $5.7 million of Micro Power transaction-related expenses, which were paid during 2012. During - 65 - GREATBATCH, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 2012, the Company completed the valuation and made adjustments to the Micro Power opening balance sheet based upon the receipt of information that was needed in order to complete the valuation of certain assets and liabilities. As a result, the Company reduced the fair value recorded for the Micro Power amortizing intangible assets acquired by $0.4 million and increased the amount of goodwill recorded by $0.4 million. The impact of these adjustments, individually and in the aggregate, was not considered material and therefore has not been reflected as a retrospective adjustment of the historical financial statements. This transaction was accounted for under the acquisition method of accounting. Accordingly, the operating results of Micro Power have been included in the Company’s Greatbatch Medical segment from the date of acquisition. The cost of the acquisition was allocated to the assets acquired and liabilities assumed based on their fair values as of the close of the acquisition, with the amount exceeding the fair value of net assets acquired being recorded as goodwill. For 2011, the Micro Power acquisition added approximately $2.5 million to revenue and was neutral to net income. The following table summarizes the allocation of the Micro Power purchase price to the assets acquired and liabilities assumed as of the acquisition date (in thousands): Assets acquired Current assets Property, plant and equipment Amortizing intangible assets Goodwill Other assets Total assets acquired Liabilities assumed Current liabilities Long-term liabilities Total liabilities assumed $ $ 25,620 1,650 28,914 31,891 94 88,169 13,679 2,688 16,367 71,802 Current assets and liabilities - The fair value of current assets (excluding inventory) and current liabilities was assumed to approximate their carrying value as of the acquisition date due to the short-term nature of these assets and liabilities. The fair value of in-process and finished goods inventory acquired was estimated by applying a version of the market approach called the comparable sales method. This approach estimates the fair value of the assets by calculating the potential revenue generated from selling the inventory and subtracting from it the costs related to the completion and sale of that inventory and a reasonable profit allowance. Based upon this methodology, the Company recorded the inventory acquired at fair value resulting in an increase in inventory of $0.7 million. Intangible assets – The purchase price was allocated to specific intangible assets as follows (dollars in thousands): Amortizing Intangible Assets Technology and patents Customer lists Noncompete agreement Trademarks and tradenames Fair Value Assigned Weighted Average Amortization Period (Years) Estimated Useful Life (Years) Weighted Average Discount Rate $ $ 8,051 19,569 915 379 28,914 4 5 4 2 4 10 14 8 2 13 14 % 12 % 14 % 13 % 13 % The weighted average amortization period is less than the estimated useful life due to the Company using an accelerated amortization method, which approximates the projected cash flows used to determine the fair value of those intangible assets. Technology and patents - Technology and patents consists of technical processes, patented and unpatented technology, manufacturing know-how, trade secrets and the understanding with respect to products or processes that have been developed by Micro Power and that will be leveraged in current and future products. The fair value of technology and patents acquired was determined utilizing the relief from royalty method, a form of the income approach, with royalty - 66 - GREATBATCH, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS rates that ranged from 2% to 4%. The estimated useful life of the technology and patents was based upon management’s estimate of the product life cycle associated with technology and patents before they will be replaced by new technologies. Customer lists – Customer lists represent the estimated fair value of both the contractual and non-contractual customer relationships Micro Power has as of the acquisition date. These relationships were valued separately from goodwill at the amount which an independent third party would be willing to pay for these relationships. The fair value of customer lists was determined using the multi-period excess-earnings method, a form of the income approach. The estimated useful life of the existing customer list was based upon historical customer attrition as well as management’s understanding of the industry and product life cycles. Trademarks and tradenames – Trademarks and tradenames represent the estimated fair value of corporate and product names acquired from Micro Power. These tradenames were valued separately from goodwill at the amount which an independent third party would be willing to pay for use of these names. The fair value of the trademarks and tradenames was determined by utilizing the relief from royalty method, a form of the income approach, with a 0.5% royalty rate. Goodwill - The excess of the purchase price over the fair value of net tangible and intangible assets acquired was allocated to goodwill. Various factors contributed to the establishment of goodwill, including: the value of Micro Power’s highly trained assembled work force and management team; the expected revenue growth over time that is attributable to increased market penetration from future products and customers; and the incremental value to the Company’s business from expanding and diversifying its revenues. The goodwill acquired in connection with the Micro Power acquisition was allocated to the Greatbatch Medical business segment and is not deductible for tax purposes. Pro Forma Results (Unaudited) - The following unaudited pro forma information presents the consolidated results of operations of the Company, NeuroNexus, and Micro Power as if those acquisitions occurred as of the beginning of fiscal years 2011 (NeuroNexus) and 2010 (Micro Power) (in thousands, except per share amounts): Sales Net income (loss) Earnings (loss) per share: Basic Diluted Year Ended December 28, 2012 646,617 $ (4,973 ) December 30, 2011 636,502 32,306 (0.21 ) $ (0.21 ) $ 1.39 1.37 $ $ $ The unaudited pro forma information presents the combined operating results of Greatbatch, NeuroNexus, and Micro Power, with the results prior to the acquisition date adjusted to include the pro forma impact of the amortization of acquired intangible assets, the adjustment to interest expense reflecting the amount borrowed in connection with the acquisitions at Greatbatch’s interest rate, and the impact of income taxes on the pro forma adjustments utilizing the applicable statutory tax rate. The unaudited pro forma consolidated basic and diluted earnings (loss) per share calculations are based on the consolidated basic and diluted weighted average shares of Greatbatch. The unaudited pro forma results are presented for illustrative purposes only and do not reflect the realization of potential cost savings, and any related integration costs. Certain costs savings may result from the acquisition; however, there can be no assurance that these cost savings will be achieved. These pro forma results do not purport to be indicative of the results that would have been obtained, or to be a projection of results that may be obtained in the future. - 67 - GREATBATCH, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 3. SUPPLEMENTAL CASH FLOW INFORMATION (in thousands) Noncash investing and financing activities: Common stock contributed to 401(k) Plan Property, plant and equipment purchases included in accounts payable Cash paid during the year for: Interest Income taxes Acquisition of noncash assets Liabilities assumed 4. INVENTORIES Inventories are comprised of the following (in thousands): Raw materials Work-in-process Finished goods Total 5. ASSETS HELD FOR SALE January 3, 2014 Year Ended December 28, 2012 December 30, 2011 $ 2,477 $ 4,793 $ — 2,103 2,522 4,455 4,989 44,165 — — 6,230 4,909 14,396 1,244 6,148 5,259 87,766 16,483 At January 3, 2014 December 28, 2012 $ $ 67,939 $ 36,670 13,749 118,358 $ 58,204 30,022 18,386 106,612 Assets held for sale, which are included in Prepaid Expenses and Other Current Assets, is comprised of the following (in thousands): At Asset Inventory Technology Inventory PP&E Technology Disposal Group Business Segment January 3, 2014 December 28, 2012 Wireless sensing Wireless sensing Swiss orthopaedic product line Swiss orthopaedic product line Swiss orthopaedic product line Greatbatch Medical Greatbatch Medical Greatbatch Medical Greatbatch Medical Greatbatch Medical $ $ — $ — — — — — $ 288 655 2,552 1,471 476 5,442 During 2012, the Company transferred inventory and technology related to Greatbatch Medical's wireless sensing product line to held for sale. These assets were subsequently written off in 2013 to Other Operating Expenses, Net as a sales agreement could not be reached with interested buyers. In connection with the sale of certain non-core Swiss orthopaedic product lines to an independent third party in 2013, during 2012, the Company transferred certain inventory, PP&E and technology to held for sale. As the disposal group was considered a business, $2.8 million of goodwill was allocated to the disposal group during 2013 when the transaction closed. In connection with the transfer of these orthopaedic product lines to held for sale, the Company recognized a $3.6 million loss in Other Operating Expenses, Net in 2012 based upon the contractual sales price to the third party. As this disposal group did not have cash flows that were clearly distinguishable, both operationally and for financial reporting purposes, from the rest of the Company, they were not considered discontinued operations in accordance with ASC 205. - 68 - GREATBATCH, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS This transaction closed in the first quarter of 2013. During 2013, the Company received payments totaling $4.7 million in connection with this transaction and the third party assumed $2.4 million of severance liabilities. The purchase agreement provides the Company with an earn out payment based upon the amount of inventory consumed by the purchaser within one year after the close of the transaction. As a result of this earn out, we expect a gain of approximately $2.3 million will be recorded in the first quarter of 2014 in Other Operating Expenses, Net. See Note 13 “Other Operating Expenses, Net,” for additional information regarding this transaction. 6. PROPERTY, PLANT AND EQUIPMENT, NET Property, plant and equipment are comprised of the following (in thousands): Manufacturing machinery and equipment Buildings and building improvements Information technology hardware and software Leasehold improvements Furniture and fixtures Land and land improvements Construction work in process Other Accumulated depreciation Total At January 3, 2014 159,542 $ 87,359 28,010 31,522 13,889 13,016 7,886 633 341,857 (196,084 ) 145,773 $ $ $ December 28, 2012 150,344 87,357 29,823 20,520 13,414 12,499 15,441 676 330,074 (179,181 ) 150,893 Depreciation expense for property, plant and equipment was as follows (in thousands): Depreciation expense January 3, 2014 Year Ended December 28, 2012 December 30, 2011 $ 22,799 $ 31,575 $ 25,672 Construction work in process at January 3, 2014 primarily relates to routine purchases of machinery, equipment, and information technology assets to support normal recurring operations. Construction work in process at December 28, 2012 primarily relates to the transfer of the Company’s orthopaedic operations previously performed at its Orvin and Corgemont, Switzerland facilities to existing facilities located in Fort Wayne, IN and Tijuana, Mexico; the expansion of the Company’s manufacturing infrastructure in order to support its medical device strategy; and the relocation of the Company’s global headquarters to Frisco, Texas. These projects were completed during 2013. See Note 13 “Other Operating Expenses, Net” for a description of the Company’s significant capital investment projects. - 69 - GREATBATCH, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 7. INTANGIBLE ASSETS Amortizing intangible assets, net are comprised of the following (in thousands): At January 3, 2014 Purchased technology and patents Customer lists Other Total amortizing intangible assets At December 28, 2012 Purchased technology and patents Customer lists Other Total amortizing intangible assets Gross Carrying Amount Accumulated Amortization Foreign Currency Translation Net Carrying Amount $ $ $ $ 97,376 $ 68,257 4,434 170,067 $ 95,576 $ 68,257 4,434 168,267 $ (69,026 ) $ (24,671 ) (4,399 ) (98,096 ) $ (61,659 ) $ (18,929 ) (4,341 ) (84,929 ) $ 1,980 $ 1,367 804 4,151 $ 1,932 $ 1,270 805 4,007 $ 30,330 44,953 839 76,122 35,849 50,598 898 87,345 Aggregate intangible asset amortization expense is comprised of the following (in thousands): Cost of sales SG&A RD&E Total intangible asset amortization expense January 3, 2014 Year Ended December 28, 2012 December 30, 2011 $ $ 6,822 $ 5,800 545 13,167 $ 7,489 $ 6,227 545 14,261 $ 6,163 3,926 367 10,456 Estimated future intangible asset amortization expense based upon the current carrying value is as follows (in thousands): 2014 2015 2016 2017 2018 Thereafter Total estimated amortization expense Estimated Amortization Expense $ $ 13,695 12,644 10,350 9,227 6,938 23,268 76,122 During 2013, the Company made an asset purchase of technology totaling $1.8 million, which is being amortized over a weighted average period of approximately 7 years. In connection with this and other technology purchases in previous years, as of January 3, 2014 the Company has recorded $4.0 million of contingent liabilities, which will only be paid if certain performance targets are achieved. These contingent liabilities are classified in Other Long-Term Liabilities. - 70 - GREATBATCH, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The change in indefinite-lived assets during 2013 is as follows (in thousands): At December 28, 2012 Indefinite-lived assets written-off (Note 18) At January 3, 2014 Trademarks and Tradenames $ $ 20,288 $ — 20,288 $ IPR&D Total 540 $ (540) — $ 20,828 (540) 20,288 During 2013, the Company wrote off its IPR&D assets as these projects were discontinued prior to reaching technological feasibility. As discussed further in Note 13 “Other Operating Expenses, Net” and Note 19 “Business Segment, Geographic and Concentration Risk Information,” in connection with the realignment of the Company's operating structure in 2013, the Company reevaluated its operating and reporting segments. Beginning in the fourth quarter of 2013, the Company determined that it has two operating segments: Greatbatch Medical and QiG, and, as required, reassigned goodwill to each of these reporting units based upon their relative fair values and reclassified prior year amounts to conform them to the current year presentation. The change in goodwill during 2013 is as follows (in thousands): At December 28, 2012 Goodwill disposed (Note 5) Foreign currency translation At January 3, 2014 Greatbatch Medical $ $ 307,235 $ (2,771) 392 304,856 $ QiG Total 41,800 $ — — 41,800 $ 349,035 (2,771) 392 346,656 As of January 3, 2014, no accumulated impairment loss has been recognized for the goodwill allocated to the Company’s Greatbatch Medical or QiG segments. 8. ACCRUED EXPENSES Accrued expenses are comprised of the following (in thousands): Salaries and benefits Profit sharing and bonuses Warranty Swiss orthopaedic consolidation severance Other Total 9. DEBT Long-term debt is comprised of the following (in thousands): Revolving line of credit Variable rate term loan 2.25% convertible subordinated notes Unamortized discount Total long-term debt - 71 - At January 3, 2014 December 28, 2012 $ $ 16,311 $ 19,808 1,819 — 6,743 44,681 $ 12,704 12,488 2,626 9,567 8,130 45,515 At January 3, 2014 December 28, 2012 $ — $ 197,500 — — $ 197,500 $ 33,000 — 197,782 (5,368 ) 225,414 GREATBATCH, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Credit Facility – In September 2013, the Company amended and extended its credit facility (the “Credit Facility”). The new Credit Facility provides a $300 million revolving credit facility (the “Revolving Credit Facility”), a $200 million term loan (the “Term Loan”), a $15 million letter of credit subfacility, and a $15 million swingline subfacility. The Credit Facility can be increased by $200 million upon the Company’s request and approval by the lenders. The Revolving Credit Facility has a maturity date of September 20, 2018, which may be extended to September 20, 2019 upon notice by the Company and subject to certain conditions. The principal of the Term Loan is payable in quarterly installments as specified in the Credit Facility until its maturity date of September 20, 2019 when the unpaid balance is due in full. The Company has pledged its non-realty assets including cash, accounts receivable and inventories as collateral against the outstanding debt on the Credit Facility. Interest rates on the revolving and term loans under the Credit Facility are, at the Company’s option either at: (i) the prime rate plus the applicable margin, which ranges between 0.0% and 0.75%, based on the Company’s total leverage ratio or (ii) the applicable LIBOR rate plus the applicable margin, which ranges between 1.375% and 2.75%, based on the Company’s total leverage ratio. Loans under the swingline subfacility will bear interest at the prime rate plus the applicable margin, which ranges between 0.0% and 0.75%, 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 Credit Facility contains limitations on the incurrence of indebtedness, liens and licensing of intellectual property, investments and certain payments. The Credit Facility permits the Company to engage in the following activities up to an aggregate amount of $300 million: 1) engage in permitted acquisitions in the aggregate not to exceed $250 million; 2) make other investments in the aggregate not to exceed $100 million; 3) make stock repurchases and declare dividends not to exceed $150 million in the aggregate; and 4) make investments in foreign subsidiaries not to exceed $20 million in the aggregate. 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 above. Additionally, these limitations can be waived upon the Company’s request and approval of a majority of the lenders. As of January 3, 2014, the Company had available to it 100% of the above limits except for the aggregate limit and other investments limit which are now $298 million and $98 million, respectively. The 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 and a total leverage ratio not greater than 4.25 to 1.0 after January 2, 2016. The calculation of adjusted EBITDA and total leverage ratio 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 January 3, 2014, the Company was in compliance with all covenants under the Credit Facility. The Credit Facility contains customary events of default. Upon the occurrence and during the continuance of an event of default, a majority of the lenders may declare the outstanding advances and all other obligations under the Credit Facility immediately due and payable. As of January 3, 2014, the weighted average interest rate on borrowings under the Credit Facility, which does not take into account the impact of the Company’s interest rate swap, was 1.56%. As of January 3, 2014, the Company had $300 million of borrowing capacity available under the Credit Facility. This borrowing capacity may vary from period to period based upon the debt and EBITDA levels of the Company, which impacts the covenant calculations described above. Interest Rate Swap – From time to time, the Company enters into interest rate swap agreements in order to hedge against potential changes in cash flows on the outstanding borrowings on the Credit Facility. The variable rate received on the interest rate swaps and the variable rate paid on the debt have the same rate of interest, excluding the credit spread, and resets and pays interest on the same date. During 2012, the Company entered into a three-year $150 million interest rate swap, which amortizes $50 million per year. This swap was entered into in order to hedge against potential changes in cash flows on the outstanding Credit Facility borrowings, which are also indexed to the one-month LIBOR rate. This swap is being accounted for as a cash flow hedge. Information regarding the Company’s outstanding interest rate swap as of January 3, 2014 is as follows (dollars in thousands): Instrument Type of Hedge Notional Amount Start Date End Date Pay Fixed Rate Current Receive Floating Rate Fair Value January 3, 2014 Interest rate swap Cash flow $ 150,000 Feb-13 Feb-16 0.573 % 0.167 % $ (328 ) Balance Sheet Location Other Long- Term Liabilities - 72 - GREATBATCH, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The estimated fair value of the interest rate swap agreement represents the amount the Company expects to receive (pay) to terminate the contract. No portion of the change in fair value of the Company’s interest rate swap during 2013, 2012, or 2011 was considered ineffective. The amount recorded as Interest Expense during 2013, 2012, and 2011 related to the Company’s interest rate swaps was $0.5 million, $0.0 million and $0.4 million, respectively. Convertible Subordinated Notes – In March 2007, the Company issued $197.8 million of convertible subordinated notes (“CSN”) at a 5% discount. CSN accrued interest at 2.25% per annum. The effective interest rate of CSN, which took into consideration the amortization of the discount and deferred fees related to the issuance of these notes, was 8.5%. On February 20, 2013, the Company redeemed all outstanding CSN. The contractual interest and discount amortization for CSN were as follows (in thousands): Contractual interest Discount amortization January 3, 2014 Year Ended December 28, 2012 December 30, 2011 $ 634 $ 5,368 4,450 $ 11,464 4,450 10,320 The expected future minimum principal payments under the Credit Facility as of January 3, 2014 is as follows (in thousands): 2014 2015 2016 2017 2018 Thereafter Total $ $ 10,000 11,250 16,250 20,000 20,000 120,000 197,500 The Company has the ability and intent to use availability under the Revolving Credit Facility to fund principal payments on the Term Loan. Deferred Financing Fees - The change in deferred financing fees is as follows (in thousands): At December 30, 2011 Amortization during the period At December 28, 2012 Financing costs deferred Write-off during the period Amortization during the period At January 3, 2014 10. DEFINED BENEFIT PLANS $ $ 3,149 (1,093 ) 2,056 2,802 (156 ) (842 ) 3,860 Savings Plan – The Company sponsors a defined contribution 401(k) plan, which covers substantially all of its U.S. based employees. The plan provides for the deferral of employee compensation under Section 401(k) and a discretionary Company match. In 2013, 2012, and 2011, this match was 35% per dollar of participant deferral, up to 6% of the total compensation for each participant. Net costs related to this defined contribution plan were $2.0 million in 2013 and 2012, and $1.6 million in 2011. In addition to the above, under the terms of the 401(k) plan document there is an annual discretionary defined contribution of up to 4% of each employee’s eligible compensation based upon the achievement of certain performance targets. This amount is contributed to the 401(k) plan in the form of Company stock. Compensation cost recognized related to the defined contribution plan was $4.8 million, $1.9 million, $5.1 million in 2013, 2012, and 2011, respectively. As of January 3, 2014, the 401(k) Plan held 607,287 shares of Company stock. - 73 - GREATBATCH, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Education Assistance Program – The Company reimburses tuition, textbooks and laboratory fees for college or other job related programs for all of its U.S. based employees. The Company also reimburses college tuition for the dependent children of certain full-time U.S. based employees hired prior to 2012, which vests on a straight-line basis over ten years, up to the applicable local state university tuition rate. For certain employees and executives, the dependent children benefit is not limited. Minimum academic achievement is required in order to receive reimbursement under both programs. Aggregate expenses under the programs were $2.0 million, $2.2 million and $1.5 million in 2013, 2012 and 2011, respectively. Defined Benefit Plans – The Company is required to provide its employees located in Switzerland, Mexico, and France certain statutorily mandated defined benefits. Under these plans, benefits accrue to employees based upon years of service, position, age and compensation. The defined benefit pension plan provided to the Company’s employees located in Switzerland is a funded contributory plan while the plans that provide benefits to the Company’s employees located in Mexico and France are unfunded and noncontributory. The liability and corresponding expense related to these benefit plans is based on actuarial computations of current and future benefits for employees. During 2012, the Company transferred most major functions performed at its facilities in Switzerland into other existing facilities. As a result, the Company curtailed its defined benefit plan provided to employees at those Swiss facilities during 2012. In accordance with ASC 715, this gain was recognized in Other Operating Expenses, Net as the related employees were terminated. Since Swiss plan assets were sufficient to cover all plan liabilities, during 2012 the plan assets were transferred into cash. During 2013, the plan assets that remained after settlement payments were made were transferred to an AA- rated insurance carrier who bears the pension risk and longevity risk, and will be used to cover the pension liability for the remaining retirees of the Swiss plan, as well as the remaining employees at that location. Information relating to the funding position of the Company’s defined benefit plans as of the plans measurement date of January 3, 2014 and December 28, 2012 were as follows (in thousands): Change in projected benefit obligation: Projected benefit obligation at beginning of year Service cost Interest cost Prior service cost and plan amendments Plan participants’ contribution Actuarial (gain) loss Benefits paid Settlement/curtailment gain Foreign currency translation Projected benefit obligation at end of year Change in fair value of plan assets: Fair value of plan assets at beginning of year Employer contributions Plan participants’ contributions Actual gain (loss) on plan assets Benefits paid Settlements Foreign currency translation Fair value of plan assets at end of year Projected benefit obligation in excess of plan assets at end of year Defined benefit liability classified as other current liabilities Defined benefit liability classified as long-term liabilities Accumulated benefit obligation at end of year - 74 - Year Ended January 3, 2014 December 28, 2012 16,215 $ 236 138 (45) 134 (2) 434 (14,539) (149) 2,422 12,269 150 134 (26) 138 (11,780) (154) 731 17,053 1,115 409 — 976 958 229 (4,934) 409 16,215 11,484 1,050 976 644 229 (2,424) 310 12,269 1,691 $ 3,946 25 $ 23 1,666 $ 1,684 $ 3,923 14,606 $ $ $ $ $ GREATBATCH, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Amounts recognized in Accumulated Other Comprehensive Income are as follows (in thousands): Net loss occurring during the year Amortization of losses Prior service cost Amortization of prior service cost Foreign currency translation Pre-tax adjustment Taxes Net gain Year Ended January 3, 2014 December 28, 2012 25 $ (722) 150 33 224 (290) 18 (272) $ 740 (3,064) 342 (10) 294 (1,698) 13 (1,685) $ $ The amortization of amounts in Accumulated Other Comprehensive Income expected to be recognized as components of net periodic benefit expense during 2014 are as follows (in thousands): Amortization of net prior service cost Amortization of net loss $ 7 12 Net pension (income) cost is comprised of the following (in thousands): Service cost Interest cost Expected return on assets Recognized net actuarial (gain) loss Net pension (income) cost Year Ended January 3, 2014 December 28, 2012 $ $ 236 $ 138 — (1,929 ) (1,555 ) $ 1,115 409 (425 ) 222 1,321 The weighted-average rates used in the actuarial valuations were as follows: Discount rate Salary growth Expected rate of return on assets Projected Benefit Obligation Net Pension Cost January 3, 2014 December 28, 2012 2013 2012 2011 3.4 % 3.1 % 2.5 % 2.1 % 2.4 % — % 2.1 % 2.4 % — % 2.5 % 2.3 % 3.5 % 2.9 % 2.5 % 3.8 % The discount rate used is based on the yields of AA bonds with a duration matching the duration of the liabilities plus approximately 50 basis points to reflect the risk of investing in corporate bonds. The expected rate of return on plan assets reflects earnings expectations on existing plan assets. - 75 - GREATBATCH, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Plan assets were comprised of the following (in thousands): Fair Value Measurements Using Quoted Prices in Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) — $ — $ 731 $ 731 $ — — January 3, 2014 $ $ 731 $ 731 $ Fair Value Measurements Using Quoted Prices in Active Markets for Identical Assets (Level 1) December 28, 2012 Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) $ $ 12,269 $ 12,269 $ 12,269 $ 12,269 $ — $ — $ — — Insurance contract Total Cash Total The fair value of Level 1 plan assets are obtained by reference to the last quoted price of the identical security on the active market which it trades. The fair value of Level 2 plan assets are obtained from quoted market prices in inactive markets or valuation models with observable market data inputs to estimate fair value. These observable market data inputs include benchmark yields, reported trades, broker/dealer quotes, issuer spreads, benchmark securities, bids, offers and reference data. Estimated benefit payments over the next ten years are as follows (in thousands): 2014 2015 2016 2017 2018 2019-2023 $ 381 39 88 132 107 910 - 76 - GREATBATCH, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 11. STOCK-BASED COMPENSATION The components and classification of stock-based compensation expense were as follows (in thousands): Stock options Restricted stock and units 401(k) stock contribution Total stock-based compensation expense Cost of sales Selling, general and administrative expenses Research, development and engineering costs, net Other operating expenses, net (Note 13) Total stock-based compensation expense Year Ended January 3, 2014 December 28, 2012 December 30, 2011 $ $ $ $ 3,490 $ 5,843 4,768 14,101 $ 3,864 $ 7,907 1,194 1,136 14,101 $ 2,786 $ 6,233 1,885 10,904 $ 2,620 $ 7,684 600 — 10,904 $ 2,511 4,526 5,045 12,082 4,184 6,630 1,268 — 12,082 During 2013, the Company recorded within Other Operating Expenses, Net stock compensation modification expense related to the 2013 operating unit realignment, which is discussed in Note 13 “Other Operating Expenses, Net.” Summary of Plans The Company’s 1998 Stock Option Plan and Non-Employee Directors Stock Plan have been frozen to any new award issuances. Stock options remain outstanding under these plans. The Company’s 2005 Stock Incentive Plan (“2005 Plan”), as amended, authorizes the issuance of up to 2,450,000 shares of equity incentive awards including nonqualified and incentive stock options, restricted stock, restricted stock units, stock bonuses and stock appreciation rights subject to the terms of the 2005 Plan. The 2005 Plan limits the amount of restricted stock, restricted stock units and stock bonuses that may be awarded in the aggregate to 850,000 shares of the 2,450,000 shares authorized by the 2005 Plan. The Company’s 2009 Stock Incentive Plan (“2009 Plan”) authorizes the issuance of up to 1,350,000 shares of equity incentive awards including nonqualified and incentive stock options, restricted stock, restricted stock units, stock bonuses and stock appreciation rights subject to the terms of the 2009 Plan. The 2009 Plan limits the amount of restricted stock, restricted stock units and stock bonuses that may be awarded in the aggregate to 200,000 shares of the 1,350,000 shares authorized. The Company’s 2011 Stock Incentive Plan (“2011 Plan”) authorizes the issuance of up to 1,000,000 shares of equity incentive awards including nonqualified and incentive stock options, restricted stock, restricted stock units, stock bonuses and stock appreciation rights, subject to the terms of the 2011 Plan. The 2011 Plan does not limit the amount of restricted stock, restricted stock units or stock bonuses that may be awarded. As of January 3, 2014, there were 219,722, 517,356 and 187,098 shares available for future grants under the 2011 Plan, 2009 Plan and 2005 Plan, respectively. Due to plan sub-limits, of the shares available for grant, only 58,510 shares and 189,218 shares may be awarded under the 2009 Plan and the 2005 Plan, respectively, in the form of restricted stock, restricted stock units or stock bonuses. Stock Options Stock options granted generally vest over a three or four year period, expire 10 years from the date of grant, and are granted at exercise prices equal to or greater than the fair value of the Company’s common stock on the date of grant. Performance-based stock options only vest if certain performance metrics are achieved. The performance metrics generally cover a three-year performance period beginning in the year of grant and include the achievement of revenue, adjusted operating earnings and adjusted operating cash flow targets. In 2010, the Company began issuing all performance stock-based awards in the form of restricted stock units. The Company utilizes the Black-Scholes option pricing model to determine the fair value of stock options. Management is required to make certain assumptions with respect to selected model inputs. Expected volatility is based on the historical volatility of the Company’s stock over the most recent period commensurate with the estimated expected life - 77 - GREATBATCH, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS of the stock options. The expected life of stock options, which represents the period of time that the stock options are expected to be outstanding, is based on historical data. The expected dividend yield is based on the Company’s history and expectation of future dividend payouts. The risk-free interest rate is based on the U.S. Treasury yield curve in effect at the time of grant for a period commensurate with the estimated expected life. If factors change and result in different assumptions, the stock option expense that the Company records for future grants may differ significantly from what the Company recorded in the current period. Stock-based compensation expense is only recorded for those awards that are expected to vest. Pre-vesting forfeiture estimates for determining appropriate stock-based compensation expense are estimated at the time of grant based on historical experience. Revisions are made to those estimates in subsequent periods if actual forfeitures differ from estimated forfeitures. The weighted-average fair value and assumptions used are as follows: January 3, 2014 Year Ended December 28, 2012 December 30, 2011 $ 8.38 0.73 % 39 % 5.3 0 % 9 % $ 8.20 0.83 % 40 % 5.3 0 % 9 % 9.37 2.02 % 40 % 5.3 0 % 9 % Weighted Average Exercise Price Weighted Average Remaining Contractual Life (In Years) Aggregate Intrinsic Value (In Millions) 23.46 23.98 21.41 26.47 23.42 22.19 20.77 24.21 23.17 23.33 23.24 28.05 22.92 22.92 22.92 6.4 $ 6.3 $ 5.9 $ 33.7 33.3 28.0 Weighted average grant date fair value $ Risk-free interest rate Expected volatility Expected life (in years) Expected dividend yield Annual prevesting forfeiture rate The following table summarizes time-vested stock option activity: Outstanding at December 31, 2010 Granted Exercised Forfeited or expired Outstanding at December 30, 2011 Granted Exercised Forfeited or expired Outstanding at December 28, 2012 Granted Exercised Forfeited or expired Outstanding at January 3, 2014 Expected to vest at January 3, 2014 Exercisable at January 3, 2014 Number of Time-Vested Stock Options 1,463,556 $ 306,449 (84,237 ) (126,997 ) 1,558,771 395,978 (52,683 ) (126,219 ) 1,775,847 372,676 (443,428 ) (88,686 ) 1,616,409 $ 1,593,861 $ 1,342,675 $ - 78 - GREATBATCH, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 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 at December 31, 2010 Exercised Forfeited or expired Outstanding at December 30, 2011 Exercised Forfeited or expired Outstanding at December 28, 2012 Exercised Forfeited or expired Outstanding at January 3, 2014 Expected to vest at January 3, 2014 Exercisable at January 3, 2014 744,523 $ (26,478) (239,681) 478,364 (7,657) (185,782) 284,925 (107,664) — 177,261 $ 177,261 $ 177,261 $ 23.68 22.53 22.29 24.44 22.04 26.35 23.26 23.23 — 23.27 23.27 23.27 3.4 $ 3.4 $ 3.4 $ 3.6 3.6 3.6 Intrinsic value is calculated for in-the-money options (exercise price less than market price) outstanding and/or exercisable as the difference between the market price of the Company’s common shares as of January 3, 2014 ($43.80) and the weighted average exercise price of the underlying stock options, multiplied by the number of options outstanding and/or exercisable. As of January 3, 2014, $2.1 million of unrecognized compensation cost related to non-vested stock options is expected to be recognized over a weighted-average period of approximately 2 years. Shares are distributed from the Company’s authorized but unissued reserve upon the exercise of stock options or treasury stock if available. The Company does not intend to purchase treasury shares to fund the future exercises of stock options. Proceeds from the exercise of stock options are credited to common stock at par value and the excess is credited to additional paid-in capital. A portion of the options outstanding qualify as incentive stock options (“ISO”) for income tax purposes. As such, a tax benefit is not recorded at the time the compensation cost related to the stock options is recorded for book purposes due to the fact that an ISO does not ordinarily result in a tax benefit unless there is a disqualifying disposition. Stock option grants of non-qualified stock options result in the creation of a deferred tax asset, which is a temporary difference, until the time that the option is exercised. The following table provides certain information relating to the exercise of stock options (in thousands): Intrinsic value Cash received Tax benefit (expense) realized January 3, 2014 Year Ended December 28, 2012 December 30, 2011 $ 6,807 $ 12,807 727 148 $ 1,263 (132 ) 501 2,401 (146 ) - 79 - GREATBATCH, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Restricted Stock and Restricted Stock Units Time-vested restricted stock and restricted stock unit awards granted typically vest in equal annual installments over a three or four year period. The fair value of time-based as well as nonmarket-based performance restricted stock and restricted stock unit awards is equal to the fair value of the Company’s stock on the date of grant. The following table summarizes time-vested restricted stock and unit activity: Nonvested at December 31, 2010 Granted Vested Forfeited Nonvested at December 30, 2011 Granted Vested Forfeited Nonvested at December 28, 2012 Granted Vested Forfeited Nonvested at January 3, 2014 Time-Vested Activity Weighted Average Fair Value 123,386 $ 31,625 (80,825 ) (4,244 ) 69,942 92,265 (74,901 ) (7,037 ) 80,269 67,230 (74,062 ) (5,862 ) 67,575 $ 22.57 23.49 22.80 22.98 22.69 23.49 22.83 22.56 23.48 26.76 23.93 22.26 26.37 Performance-vested restricted stock granted prior to 2010 vests upon the achievement of certain annual diluted EPS targets by the Company, or the seventh anniversary date of the award. Performance-based restricted stock units granted only vest if certain market-based performance metrics are achieved. The amount of shares that ultimately vest range from 0 shares to 779,678 shares based upon the total shareholder return of the Company relative to the Company’s compensation peer group over a three year performance period beginning in the year of grant. The fair value of the restricted stock units was determined by utilizing a Monte Carlo simulation model, which projects the value of Greatbatch stock versus the peer group under numerous scenarios and determines the value of the award based upon the present value of these projected outcomes. The following table summarizes performance-vested restricted stock and stock unit activity related to the Company’s plans: Nonvested at December 31, 2010 Granted Vested Forfeited Nonvested at December 30, 2011 Granted Vested Forfeited Nonvested at December 28, 2012 Granted Vested Forfeited Nonvested at January 3, 2014 - 80 - Performance- Vested Activity Weighted Average Fair Value 283,797 $ 279,415 (6,600) (26,869) 529,743 332,918 (15,500) (64,715) 782,446 318,169 (49,139) (271,798) 779,678 $ 15.10 18.21 17.94 15.85 16.68 15.30 24.64 15.72 16.02 15.86 14.68 14.94 16.41 GREATBATCH, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The realized tax benefit (expense) from the vesting of restricted stock and restricted stock units was $(0.4) million, $(0.02) million and $0.008 million for 2013, 2012 and 2011, respectively. As of January 3, 2014, there was $10.5 million of total unrecognized compensation cost related to the restricted stock and restricted stock unit awards. That cost is expected to be recognized over a weighted-average period of approximately 2 years. The fair value of shares vested in 2013, 2012 and 2011 was $4.0 million, $1.5 million and $1.9 million, respectively. 12. RESEARCH, DEVELOPMENT AND ENGINEERING COSTS, NET Research, Development and Engineering Costs, Net are comprised of the following (in thousands): Research and development costs Engineering costs Less: cost reimbursements Total research, development and engineering costs, net January 3, 2014 Year Ended December 28, 2012 December 30, 2011 $ $ 17,953 $ 44,699 (8,575 ) 54,077 $ 24,071 $ 38,777 (10,358 ) 52,490 $ 19,014 35,472 (8,973 ) 45,513 13. OTHER OPERATING EXPENSES, NET Other Operating Expenses, Net is comprised of the following (in thousands): 2013 operating unit realignment Orthopaedic facility optimization Medical device facility optimization ERP system upgrade Acquisition and integration (income) costs Asset dispositions, severance and other Total other operating expenses, net Year Ended January 3, 2014 December 28, 2012 December 30, 2011 $ $ 5,625 $ 8,038 312 783 (502 ) 1,534 15,790 $ — $ 32,482 1,525 5,041 1,460 1,838 42,346 $ — 425 — — — 168 593 2013 operating unit realignment. In 2013, the Company initiated a plan to realign its operating structure in order to optimize its continued focus on profitable growth. As part of this initiative, the sales and marketing and operations groups of its former Implantable Medical and Electrochem reportable segments were combined into one sales and marketing and one operations group serving the entire Company. This initiative is expected to be completed over the next six months. Total restructuring charges expected to be incurred in connection with this realignment are between $6.5 million and $7.0 million, of which $5.6 million have been incurred to date. Expenses related to this initiative will be recorded within the applicable segment that the expenditures relate to and include the following: • Severance and retention: $5.0 million - $5.2 million; and • Other: $1.5 million - $1.8 million. Other costs primarily consist of relocation, recruitment and travel expenditures. The change in accrued liabilities related to the 2013 operating unit realignment is as follows (in thousands): At December 28, 2012 Restructuring charges Non-cash settlement (modification expense - Note 11) Cash payments At January 3, 2014 Severance and Retention Other Total $ $ — $ 4,153 (1,136 ) (2,552 ) 465 $ — $ 1,472 — (726 ) 746 $ — 5,625 (1,136 ) (3,278 ) 1,211 - 81 - GREATBATCH, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Orthopaedic facility optimization. In 2010, the Company began updating its Indianapolis, IN facility to streamline operations, consolidate two buildings, increase capacity, further expand capabilities and reduce dependence on outside suppliers. This initiative was completed in 2011. In 2011, the Company began construction on an orthopaedic manufacturing facility in Fort Wayne, IN and transferred manufacturing operations being performed at its Columbia City, IN location into this new facility. This initiative was completed in 2012. During 2012, the Company transferred most major functions previously performed at its facilities in Orvin and Corgemont, Switzerland into existing facilities in Fort Wayne, IN and Tijuana, Mexico. In connection with this consolidation, in 2012, the Company entered into an agreement to sell certain non-core Swiss orthopaedic product lines to an independent third party including inventory, PP&E and technology on hand related to these product lines. See Note 5 “Assets Held for Sale,” for additional information regarding this transaction. During 2013, the Company began a project to expand its Chaumont, France facility in order to enhance its capabilities and fulfill larger volume customer supply agreements. This initiative is expected to be completed over the next three years. The total capital investment expected to be incurred for these initiatives is between $30 million and $35 million, of which $22 million has been expended to date. Total expense expected to be incurred for these initiatives is between $45 million and $50 million, of which $41.2 million has been incurred to date. All expenses have been and will be recorded within the Greatbatch Medical segment and are expected to include the following: • Severance and retention: $11 million; • Accelerated depreciation and asset write-offs: $15 million; • Other: $19 million - $24 million. All expenses are cash expenditures, except accelerated depreciation and asset write-offs. The change in accrued liabilities related to the Orthopaedic facility optimizations is as follows (in thousands): At December 28, 2012 Restructuring charges Write-offs Liability assumed by third party (Note 5) Cash payments At January 3, 2014 Severance and Retention Accelerated Depreciation/ Asset Write-offs $ $ 9,567 $ 624 — (2,398 ) (7,793 ) — $ — $ 507 (507 ) — — — $ Other Total — $ 6,907 — — (6,050 ) 857 $ 9,567 8,038 (507 ) (2,398 ) (13,843 ) 857 Medical device facility optimization. Near the end of 2011, the Company initiated plans to upgrade and expand its manufacturing infrastructure in order to support its medical device strategy. This includes the transfer of certain product lines to create additional capacity for the manufacture of medical devices, expansion of two existing facilities, as well as the purchase of equipment to enable the production of medical devices. These initiatives are expected to be completed over the next year. Total capital investment under these initiatives is expected to be between $15 million to $20 million of which approximately $12.4 million has been expended to date. Total expenses expected to be incurred on these projects is between $2 million to $3 million of which $1.8 million has been incurred to date. All expenses have been and will be recorded within the Greatbatch Medical segment and are expected to include the following: • Production inefficiencies, moving and revalidation: $0.5 million—$1 million; • Personnel: $1 million—$1.5 million; and • Other: $1.0 million. - 82 - GREATBATCH, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The change in accrued liabilities related to the medical device facility optimization is as follows (in thousands): At December 28, 2012 Restructuring charges Cash payments At January 3, 2014 Production Inefficiencies, Moving and Revalidation $ $ — $ 19 (19 ) — $ Personnel Other Total — $ 2 (2 ) — $ — $ 291 (291 ) — $ — 312 (312 ) — ERP system upgrade. In 2011, the Company initiated plans to upgrade its existing global ERP system. This initiative is expected to be completed over the next three months. Total capital investment under this initiative is expected to be between $4 million to $4.5 million of which approximately $3.9 million has been expended to date. Total expenses expected to be incurred on this initiative is between $6 million to $7 million of which $5.8 million has been incurred to date. All expenses are cash expenditures, except accelerated depreciation and asset write-offs. Expenses related to this initiative are recorded within the corporate cost center and include the following: • Training and consulting costs: $4 million—$4.5 million; and • Accelerated depreciation and asset write-offs: $2 million – $2.5 million. The change in accrued liabilities related to the ERP system upgrade is as follows (in thousands): At December 28, 2012 Charges Write-offs Cash payments At January 3, 2014 Training & Consulting Costs Accelerated Depreciation/ Asset Write-offs Total $ $ 169 $ 436 — (605 ) — $ — $ 347 (347 ) — — $ 169 783 (347 ) (605 ) — Acquisition and integration (income) costs. During 2013 and 2012, the Company incurred costs (income) related to the integration of Micro Power and NeuroNexus, which were acquired in December 2011 and February 2012, respectively. These expenses were primarily for retention bonuses, travel cost in connection with integration efforts, training and severance and the change in fair value of the contingent consideration recorded in connection with these acquisitions. See Note 18 “Fair Value Measurements.” Asset dispositions, severance and other. During 2013, 2012 and 2011, the Company recorded losses in connection with various asset disposals and/or write-downs. Additionally, during 2013, Greatbatch Medical recorded a $0.9 million write- off related to its wireless sensing product line (Note 5) and QiG recorded a $0.5 million write-off of IPR&D (Note 7). During 2012, the Company incurred $1.2 million of costs related to the relocation of its global headquarters to Frisco, Texas. During 2011, the Company incurred $0.6 million of due diligence related costs in connection with its purchase of Micro Power. 14. INCOME TAXES The U.S. and international components of income before provision for income taxes were as follows (in thousands): U.S. International Total income before provision for income taxes January 3, 2014 Year Ended December 28, 2012 December 30, 2011 $ $ 42,392 $ 6,446 48,838 $ 36,057 $ (29,327 ) 6,730 $ 43,610 4,782 48,392 - 83 - GREATBATCH, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The provision for income taxes was comprised of the following (in thousands): Current: Federal State International Deferred: Federal State International Total provision for income taxes January 3, 2014 Year Ended December 28, 2012 December 30, 2011 $ $ 39,353 $ 1,604 1,470 42,427 (28,678 ) 427 (1,605 ) (29,856 ) 12,571 $ 4,747 $ 381 668 5,796 6,615 175 (1,057 ) 5,733 11,529 $ 5,150 (40 ) 1,384 6,494 8,028 599 149 8,776 15,270 The provision for income taxes differs from the U.S. statutory rate due to the following: Statutory rate Federal tax credits Foreign rate differential Uncertain tax positions State taxes, net of federal benefit Change in tax rate - loss of Swiss tax holiday Change in foreign tax rates Valuation allowance Other Effective tax rate January 3, 2014 Year Ended December 28, 2012 December 30, 2011 35.0 % (7.5 ) (0.7 ) 1.7 2.3 — (3.7 ) 0.4 (1.8 ) 25.7 % 35.0 % — 50.7 (10.1 ) 4.9 25.6 — 67.6 (2.4 ) 171.3 % 35.0 % (3.7 ) 0.3 (1.3 ) 0.3 — — 0.1 0.9 31.6 % - 84 - GREATBATCH, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Deferred tax assets (liabilities) consist of the following (in thousands): Tax credits Net operating loss carryforwards Inventories Accrued expenses Stock-based compensation Other Gross deferred tax assets Less valuation allowance Net deferred tax assets Property, plant and equipment Intangible assets Convertible subordinated notes Gross deferred tax liabilities Net deferred tax liability Presented as follows: Current deferred tax asset Current deferred tax liability Noncurrent deferred tax asset Noncurrent deferred tax liability Net deferred tax liability At January 3, 2014 December 28, 2012 $ $ $ $ 6,624 $ 9,161 4,202 4,303 9,194 573 34,057 (11,661 ) 22,396 (2,254 ) (57,648 ) (6,178 ) (66,080 ) (43,684 ) $ 6,008 $ (613 ) 2,933 (52,012 ) (43,684 ) $ 6,884 14,637 3,911 4,129 8,502 465 38,528 (12,768 ) 25,760 (2,648 ) (59,774 ) (36,462 ) (98,884 ) (73,124 ) 7,678 (874 ) 2,534 (82,462 ) (73,124 ) As a result of the repayment of CSN during 2013, the Company reclassified $30.3 million of Long-Term Deferred Income Taxes to Income Taxes Payable of which approximately $28.8 million was paid in 2013. As of January 3, 2014, the Company has the following carryforwards available: Jurisdiction U.S. International State U.S. and State Tax Attribute Net Operating Loss Net Operating Loss Net Operating Loss R&D Tax Credit $ Amount (in millions) Begin to Expire 3.8 (1) 56.2 (1) 34.4 (1) 1.4 (1) 5.4 2031 2014 Various Various State (1) The utilization of certain net operating losses and credits is subject to an annual limitation under Internal Revenue Investment Tax Credit Various Code Section 382. Certain federal tax credits reported on filed income tax returns included uncertain tax positions taken in prior years. Due to the application of the accounting for uncertain tax positions, the actual tax attributes are larger than the tax credits for which a deferred tax asset is recognized for financial statement purposes. In assessing the realizability of deferred tax assets, management considers, within each taxing jurisdiction, whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income and tax planning strategies in making this assessment. Based on the consideration of the weight of both positive and negative evidence, management has determined that a portion of the deferred tax assets as of January 3, 2014 and December 28, 2012 related to certain state investment tax credits and net operating losses will not be realized. - 85 - GREATBATCH, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The Company files annual income tax returns in the U.S., various state and local jurisdictions, and in various foreign jurisdictions. A number of years may elapse before an uncertain tax position, for which the Company has unrecognized tax benefits, is examined and finally settled. While it is often difficult to predict the final outcome or the timing of resolution of any particular uncertain tax position, the Company believes that its unrecognized tax benefits reflect the most probable outcome. The Company adjusts these unrecognized tax benefits, as well as the related interest, in light of changing facts and circumstances. The resolution of a matter could be recognized as an adjustment to the Provision for Income Taxes and the effective tax rate in the period of resolution. Below is a summary of changes to the unrecognized tax benefit (in thousands): January 3, 2014 Year Ended December 28, 2012 December 30, 2011 Balance, beginning of year Additions based upon tax positions related to the current year Additions recorded as part of business combinations Additions related to prior period tax positions Reductions relating to settlements with tax authorities Reductions as a result of a lapse of applicable statute of limitations Balance, end of year $ $ 970 $ 325 — 651 (88 ) — 1,858 $ 1,580 $ — — 210 (522 ) (298 ) 970 $ 2,756 300 260 — — (1,736 ) 1,580 The tax years that remain open and subject to tax audits varies depending on the tax jurisdiction. An audit of the consolidated federal 2009 and 2010 tax returns were completed during 2012. It is reasonably possible that a reduction of approximately $0.1 million of the balance of unrecognized tax benefits may occur within the next 12 months as a result of the lapse of the statute of limitations and potential audit settlements. As of January 3, 2014, approximately $1.7 million of unrecognized tax benefits would favorably impact the effective tax rate (net of federal impact on state issues), if recognized. The American Taxpayer Relief Act of 2012 (the “Act”) was signed into law on January 2, 2013. The Act retroactively restored several expired business tax provisions, including the Section 41 research and experimentation credit that had expired on December 31, 2011. Under the American Taxpayer Relief Act of 2012, the section 41 research tax credit is extended for two years retroactively from January 1, 2012 through December 31, 2013. As the Act was signed into law on January 2, 2013, Greatbatch recognized the benefit for the section 41 research tax credits earned in 2012 through the fiscal 2013 effective rate. In September 2013, the United States issued final regulations addressing the acquisition, production and improvement of tangible property and proposed regulations addressing the disposition of property. These regulations provide rules as to whether the cost of tangible units of property are capitalizable and recovered through allowances for depreciation or are more appropriately deducted for tax purposes in the year incurred. These regulations replace previously issued temporary regulations and are effective for tax years starting January 1, 2014, with optional adoption in 2013. To account for the 2014 adoption of these regulations, for the year ended January 3, 2014, the Company recorded an increase to current deferred tax liabilities, with an offsetting increase to non-current deferred tax assets of $0.2 million. 15. COMMITMENTS AND CONTINGENCIES Litigation – On December 21, 2012, the Company and several other unaffiliated parties were named as defendants in a personal injury and wrongful death action filed in the 113th Judicial District Court of Harris County, Texas. The complaint seeks damages alleging marketing and product defects and failure to warn, negligence and gross negligence relating to a product the Company manufactured and sold to a customer, one of the other named defendants. The Company's customer, in turn, incorporated the Greatbatch product into its own product which it sold to its customer, another named defendant. This matter is currently scheduled for trial in 2014. The Company is indemnified by its customer against any loss in this matter, including costs of defense, which obligation is supported by its customer's product liability insurance coverage in the amount of $5 million. The Company also has its own product liability insurance coverage, subject to a $10 million retention. The Company has meritorious defenses and is vigorously defending the matter. In the event of an adverse judgment, however, the Company could have liability to the extent of the amount of any award its customer is unable to satisfy. To date, the Company has not recorded a reserve in connection with this matter since any potential loss is not currently probable and the range of loss is not reasonably estimable at this time. - 86 - GREATBATCH, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The Company is a party to various other legal actions arising in the normal course of business. While the Company does not expect that the ultimate resolution of any of these pending actions will have a material effect on its consolidated results of operations, financial position, or cash flows, litigation is subject to inherent uncertainties. However, as litigation is subject to inherent uncertainties, there can be no assurance that any pending legal action, which the Company currently believes to be immaterial, does not become material in the future. License agreements – The Company is a party to various license agreements for technology that is utilized in certain of its products. The most significant of these agreements are the licenses for basic technology used in the production of wet tantalum capacitors, filtered feedthroughs and MRI compatible lead systems. Expenses related to license agreements were $3.5 million, $3.1 million and $2.8 million, for 2013, 2012 and 2011, respectively, and are included in Cost of Sales. 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 product warranty liability was comprised of the following (in thousands): Beginning balance Additions to warranty reserve Warranty claims paid Ending balance Year Ended January 3, 2014 December 28, 2012 $ $ 2,626 $ 1,624 (2,431 ) 1,819 $ 2,013 1,681 (1,068 ) 2,626 Operating Leases – The Company is a party to various operating lease agreements for buildings, machinery, equipment and software. The Company primarily leases buildings, which accounts for the majority of the future lease payments. Lease expense includes the effect of escalation clauses and leasehold improvement incentives which are accounted for ratably over the lease term. Operating lease expense was as follows (in thousands): Operating lease expense January 3, 2014 Year Ended December 28, 2012 December 30, 2011 $ 4,379 $ 4,024 $ 2,704 Minimum future estimated annual operating lease expenses are as follows (in thousands): 2014 $ 2015 2016 2017 2018 Thereafter Total estimated operating lease expense $ 5,268 4,646 4,042 1,452 1,003 936 17,347 Self-Insured Medical Plan – The Company self-funds the medical insurance coverage provided to its U.S. based employees. The Company has specific stop loss coverage per associate for claims incurred during the year exceeding $225 thousand per associate with no annual maximum aggregate stop loss coverage. As of January 3, 2014 and December 28, 2012, the Company had $1.6 million and $1.4 million accrued related to the self-insurance of its medical plan, respectively. This accrual is recorded in Accrued Expenses in the Consolidated Balance Sheet, and is primarily based upon claim history. 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. The Company’s purchase orders are normally based on its current manufacturing needs and are fulfilled by its vendors within short time horizons. The Company enters into blanket orders with vendors that have preferred pricing and terms, however these orders are normally cancelable by us without penalty. As of January 3, 2014, the total contractual obligation related to such expenditures is approximately $24.4 million and will primarily be financed by existing cash and cash equivalents, cash generated from operations, or the Credit Facility. The Company also enters into contracts for - 87 - GREATBATCH, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS outsourced services; however, the obligations under these contracts were not significant and the contracts generally contain clauses allowing for cancellation without significant penalty. Foreign Currency Contracts – The Company has entered into forward contracts to purchase Mexican pesos in order to hedge the risk of peso-denominated payments associated with the operations at its Tijuana, Mexico facility. The impact to the Company’s results of operations from these forward contracts was as follows (in thousands): Reduction in Cost of Sales Ineffective portion of change in fair value Year Ended January 3, 2014 December 28, 2012 December 30, 2011 $ (1,154 ) $ — (79 ) $ — (556 ) — Information regarding outstanding foreign currency contracts as of January 3, 2014 is as follows (dollars in thousands): Instrument Type of Hedge Aggregate Notional Amount Start Date End Date $/Peso Fair Value Balance Sheet Location FX Contract Cash flow 7,700 Jan-14 Dec-14 0.0767 $ (143 ) FX Contract Cash flow 6,300 Jan-14 Dec-14 0.0752 $ 3 (140 ) Accrued Expenses Accrued Expenses Workers’ Compensation Trust – The Company was a member of a group self-insurance trust that provided workers’ compensation benefits to employees of the Company in Western New York (the “Trust”). 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 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. This amount was accrued and paid in 2011. Based on actual experience, the Company could receive a refund or be assessed additional contributions for workers’ compensation claims. During 2012 and 2013, the Company utilized traditional insurance to provide workers’ compensation benefits. 16. EARNINGS (LOSS) PER SHARE The following table illustrates the calculation of Basic and Diluted EPS (in thousands, except per share amounts): Numerator for basic EPS: Net income (loss) Denominator for basic EPS: Weighted average shares outstanding Effect of dilutive securities: Stock options, restricted stock and restricted stock units Denominator for diluted EPS Basic EPS Diluted EPS January 3, 2014 Year Ended December 28, 2012 December 30, 2011 $ 36,267 $ (4,799 ) $ 33,122 23,991 23,584 23,258 1,332 25,323 1.51 $ 1.43 $ — 23,584 (0.20 ) $ (0.20 ) $ 378 23,636 1.42 1.40 $ $ 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: Time-vested stock options, restricted stock and restricted stock units Performance-vested stock options and restricted stock units - 88 - January 3, 2014 18,480 — Year Ended December 28, 2012 2,142,000 781,000 December 30, 2011 909,000 649,000 GREATBATCH, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS For all periods presented, no shares related to CSN were included in the diluted EPS calculations as the average share price of the Company’s common stock for those periods did not exceed CSN’s conversion price per share. 17. ACCUMULATED OTHER COMPREHENSIVE INCOME Accumulated Other Comprehensive Income is comprised of the following (in thousands): At December 28, 2012 Unrealized gain on cash flow hedges Realized gain on foreign currency hedges Realized loss on interest rate swap hedges Defined Benefit Plan Liability Cash Flow Hedges Foreign Currency Translation Adjustment Total Pre-Tax Amount Tax Net-of-Tax Amount $ (962 ) $ 120 $ 13,431 $ 12,589 $ 358 $ 12,947 — — — 58 (1,154 ) 508 — — — 58 (1,154 ) (20 ) 404 38 (750 ) 508 (178 ) 330 Net defined benefit plan liability adjustments Foreign currency translation gain At January 3, 2014 $ 290 — (672 ) $ — — (468 ) $ — 1,521 14,952 $ 290 1,521 13,812 $ (18 ) — 546 $ 272 1,521 14,358 The realized (gain) loss relating to the Company’s foreign currency and interest rate swap hedges were reclassified from Accumulated Other Comprehensive Income and included in Cost of Sales and Interest Expense, respectively, in the Consolidated Statements of Operations. See Note 10 “Defined Benefit Plans” for details on the change in defined benefit plan liability adjustments. 18. FAIR VALUE MEASUREMENTS Assets and Liabilities Measured at Fair Value on a Recurring Basis Fair value measurement standards apply to certain financial assets and liabilities that are measured at fair value on a recurring basis (each reporting period). For the Company, these financial assets and liabilities include its derivative instruments and accrued contingent consideration. The Company does not have any nonfinancial assets or liabilities that are measured at fair value on a recurring basis. 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 received 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. The fair value of the Company’s foreign currency contracts will be realized as Cost of Sales as the inventory, which the contracts are hedging the cash flows to produce, is sold, of which approximately $0.1 million is expected to be realized within the next twelve months. Interest rate swap - The fair value of the Company’s interest rate swap outstanding at January 3, 2014 was determined through the use of a cash flow model that utilizes observable market data inputs. These observable market data inputs include LIBOR, swap rates, and credit spread curves. In addition to the above, the Company received a fair value estimate from the interest rate swap counterparty to verify the reasonableness of the Company’s estimate. This fair value calculation was categorized in Level 2 of the fair value hierarchy. Accrued contingent consideration – The fair value of accrued contingent consideration recorded by the Company represents the estimated fair value of the contingent consideration the Company expects to pay to the former shareholders of NeuroNexus based upon the achievement of certain financial and development-based milestones. The fair value of the contingent consideration liability was estimated by discounting to present value, the probability weighted contingent payments expected to be made. The Company used risk-adjusted discount rates to derive the fair value of the expected obligations as of the acquisition date, which the Company believes are representative of market participant assumptions. The maximum amount of future contingent consideration (undiscounted) that the Company could be required to pay is $2.0 million. - 89 - GREATBATCH, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The Company’s accrued contingent consideration is categorized in Level 3 of the fair value hierarchy. Changes in accrued contingent consideration were as follows (in thousands): At December 30, 2011 Contingent consideration liability acquired Fair value adjustments At December 28, 2012 Fair value adjustments At January 3, 2014 $ $ — 1,500 30 1,530 (690 ) 840 The recurring Level 3 fair value measurements of the Company’s contingent consideration liability include the following significant unobservable inputs (dollars in thousands): Contingent Consideration Liability Financial milestones Fair Value at January 3, 2014 $ 200 Valuation Technique Discounted cash flow Development milestones $ 640 Discounted cash flow Unobservable Inputs Discount rate Projected year of payment Probability weighted payment amount Discount rate Projected year of payment Probability weighted payment amount 12 % 2014 $ 200 20 % 2016 $ 1,000 The following tables provide information regarding assets and liabilities recorded at fair value on a recurring basis (in thousands): Description Liabilities Foreign currency contracts (Note 15) Accrued contingent consideration Interest rate swap (Note 9) Description Assets Foreign currency contracts Liabilities Accrued contingent consideration Interest rate swap Fair Value Measurements Using Quoted Prices in Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) At January 3, 2014 $ 140 $ 840 328 — $ — — 140 $ — 328 — 840 — Fair Value Measurements Using Quoted Prices in Active Markets for Identical Assets (Level 1) At December 28, 2012 Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) $ $ 757 $ 1,530 $ 638 — $ — $ — 757 $ — $ 638 — 1,530 — - 90 - GREATBATCH, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis Fair value standards also apply to certain assets and liabilities that are measured at fair value on a nonrecurring basis. A summary of the valuation methodologies for assets and liabilities measured on a nonrecurring basis is as follows: Cost and equity method investments—The Company holds investments in equity and other securities that are accounted for as either cost or equity method investments, which are classified as Other Assets. The total carrying value of these investments is reviewed quarterly for changes in circumstance or the occurrence of events that suggest the Company’s investment may not be recoverable. The fair value of cost or equity method investments is not adjusted if there are no identified events or changes in circumstances that may have a material effect on the fair value of the investments. Gains and losses realized on cost and equity method investments are recorded in Other Expense, Net, unless separately stated. The aggregate recorded amount of cost and equity method investments at January 3, 2014 and December 28, 2012 was $12.3 million and $9.1 million, respectively. During 2013, 2012 and 2011, the Company recognized impairment charges related to its cost and equity method investments of $0.5 million, $0.1 million and $0.3 million, respectively. The fair value of these investments was determined by reference to recent sales data of similar shares to independent parties in an inactive market. This fair value calculation was categorized in Level 2 of the fair value hierarchy. 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 in 2011 and an additional $0.4 million during 2012. Cost and equity method investment impairment charges, gains and losses are included in Loss (Gain) on Cost and Equity Method Investments, Net in the Consolidated Statements of Operations. Long-lived assets – The Company reviews the carrying amount of its long-lived assets to be held and used for potential impairment whenever certain indicators are present as described in Note 1 “Summary of Significant Accounting Policies.” In connection with the sale of certain orthopaedic and wireless sensing product lines, during 2012, the Company transferred long-lived assets to held for sale. In connection with these transfers, the Company recognized impairment charges during 2013 and 2012. Refer to Note 5 “Assets Held for Sale” for further discussion. The fair value of these asset groups were determined based upon the sales price or offers for the long-lived assets and was categorized in Level 2 of the fair value hierarchy. During 2013, the Company wrote off its IPR&D assets as these projects were discontinued prior to reaching technological feasibility. See Note 7 “Intangible Assets.” The following table provides information regarding assets and liabilities recorded at fair value on a nonrecurring basis. There were no such assets or liabilities as of January 3, 2014 (in thousands): Fair Value Measurements Using Quoted Prices in Active Markets for Identical Assets (Level 1) At December 28, 2012 Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) $ 4,499 86 $ — — $ 4,499 86 — — Description Assets Assets Held for Sale—Swiss orthopaedic disposal group (Note 5) Cost method investment $ Fair Value of Other Financial Instruments Pension plan assets – The fair value of the Company’s pension plan assets disclosed in Note 10 “Defined Benefit Plans” are determined based upon quoted market prices in inactive markets or valuation models with observable market data inputs to estimate fair value. These observable market data inputs include benchmark yields, reported trades, broker/dealer quotes, issuer spreads, benchmark securities, bids, offers and reference data. The Company’s pension plan assets are categorized in Level 1 or Level 2 of the fair value hierarchy. - 91 - GREATBATCH, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 19. BUSINESS SEGMENT, GEOGRAPHIC AND CONCENTRATION RISK INFORMATION In connection with the realignment of the Company's operating structure in 2013 to optimize profitable growth, which included changing the Company's management and reporting structure, the Company reevaluated its operating and reporting segments. Beginning in the fourth quarter of 2013, the Company determined that it has two reportable segments: Greatbatch Medical and QiG. As required, the Company reclassified certain prior year amounts to conform them to the current year presentation, including goodwill, segment operating income (loss), segment depreciation and amortization, segment assets and sales categorizations. Greatbatch Medical designs and manufactures medical devices and components where Greatbatch either owns the intellectual property or has unique manufacturing and assembly expertise and includes the financial results of the former Implantable Medical and Electrochem segments, excluding QiG. Greatbatch Medical provides medical devices and components to the following markets: • Cardiac/Neuromodulation: Products include batteries, capacitors, filtered and unfiltered feed-throughs, engineered components, implantable stimulation leads, and enclosures used in implantable medical devices. • Orthopaedics: Products include hip and shoulder joint reconstruction implants, bone plates and spinal devices, and instruments and delivery systems used in hip and knee replacement, trauma fixation, and spinal surgeries. • Portable Medical: Products include life-saving and life-enhancing applications comprising automated external defibrillators, portable oxygen concentrators, ventilators, and powered surgical tools. • Vascular: Products include introducers, medical coatings, steerable sheaths, and catheters that deliver therapies for various markets such as coronary and neurovascular disease, peripheral vascular disease, interventional radiology, vascular access, atrial fibrillation, and interventional cardiology, plus products for medical imaging and pharmaceutical delivery. • Energy: Products include primary and rechargeable batteries and battery packs for demanding applications such as down hole drilling tools. Greatbatch Medical also offers value-added assembly and design engineering services for medical devices that utilize its component products. QiG focuses on developing medical device systems for some of healthcare’s most pressing challenges and reflects Greatbatch’s strategic evolution of its product offerings in order to raise the growth and profitability profile of the Company. QiG utilizes a disciplined and diversified portfolio approach with three investment modes: new medical device systems commercialization, collaborative programs with OEM customers, and strategic equity positions in start- up companies. The development of certain new medical device systems are facilitated through the establishment of limited liability corporations (“LLC”). These LLCs do not own, but have the exclusive right to use the technology of Greatbatch Medical in certain, specifically designed fields of use and have an exclusive manufacturing agreement with Greatbatch Medical. QiG currently owns 89% - 100% of three LLCs. The minority interest of these LLCs was granted to key opinion leaders, clinicians and strategic partners at or near the time the LLC was established. Under the LLC agreement, QiG is liable for 100% of the expenses incurred by the LLC. However, no income is distributed to the minority holders of the LLC until QiG is reimbursed for all expenses paid. Once QiG has been fully reimbursed, all future net income is distributed based upon the respective LLCs ownership percentages. One of the LLCs established by QiG is for the Company's spinal cord stimulator to treat chronic intractable pain of the trunk and/or limbs. This product was submitted for Food and Drug Administration (“FDA”) and CE Mark approval near the end of 2013. Another medical device system being developed by QiG is an implantable loop recorder for cardiac arrhythmia diagnostics. Current QiG revenue includes sales of neural interface technology, components and systems to the neuroscience and clinical markets. Future income of QiG is expected to come from various sources including investment gains from the sales of LLC ownership interests, technology licensing fees, royalty revenue, and/or the sales of medical device systems to OEM customers. Historical results reflecting the new business segments for previously reported periods are shown below. An analysis and reconciliation of the Company’s business segment, product line and geographic information to the respective information in the 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): - 92 - GREATBATCH, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Sales: Greatbatch Medical Cardiac/Neuromodulation Orthopaedics Portable Medical Vascular Energy Other Total Greatbatch Medical QiG Total sales Segment income (loss) from operations: Greatbatch Medical QiG Total segment income from operations Unallocated operating expenses Operating income as reported Unallocated other expense Income before provision for income taxes as reported Depreciation and Amortization: Greatbatch Medical QiG Total depreciation and amortization included in segment income from operations Unallocated depreciation and amortization Total depreciation and amortization Expenditures for tangible long-lived assets, excluding acquisitions: Greatbatch Medical QiG Total reportable segments Unallocated long-lived tangible assets Total expenditures - 93 - Year Ended January 3, 2014 December 28, 2012 December 30, 2011 $ $ 325,412 $ 130,247 78,743 48,357 52,488 25,655 660,902 3,043 663,945 $ 306,669 $ 122,061 81,659 51,980 54,066 27,287 643,722 2,455 646,177 $ 303,690 140,277 9,609 45,098 48,100 22,048 568,822 — 568,822 January 3, 2014 Year Ended December 28, 2012 December 30, 2011 111,805 $ (30,484 ) 81,321 (19,982 ) 61,339 (12,501 ) 48,838 $ 79,093 $ (32,554 ) 46,539 (20,718 ) 25,821 (19,091 ) 6,730 $ 104,703 (27,277 ) 77,426 (15,727 ) 61,699 (13,307 ) 48,392 January 3, 2014 Year Ended December 28, 2012 December 30, 2011 31,112 $ 1,539 32,651 9,681 42,332 $ 39,820 $ 630 40,450 18,475 58,925 $ 31,247 289 31,536 16,159 47,695 January 3, 2014 Year Ended December 28, 2012 December 30, 2011 13,242 $ 2,134 15,376 2,798 18,174 $ 33,249 $ 3,208 36,457 4,709 41,166 $ 22,692 889 23,581 741 24,322 $ $ $ $ $ $ GREATBATCH, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Identifiable assets: Greatbatch Medical QiG Total reportable segments Unallocated assets Total assets Sales by geographic area: United States Non-Domestic locations: Puerto Rico Belgium United Kingdom & Ireland Rest of world Total sales Long-lived tangible assets: United States Rest of world Total At January 3, 2014 December 28, 2012 December 30, 2011 $ $ 758,369 $ 56,245 814,614 76,089 890,703 $ 779,890 $ 57,750 837,640 52,235 889,875 $ 766,125 49,407 815,532 65,815 881,347 January 3, 2014 Year Ended December 28, 2012 December 30, 2011 $ 325,090 $ 330,537 $ 256,987 117,961 67,155 39,972 113,767 663,945 $ 105,731 58,043 43,938 107,928 646,177 $ 94,059 62,978 54,029 100,769 568,822 At January 3, 2014 December 28, 2012 December 30, 2011 116,484 $ 29,289 145,773 $ 123,104 $ 27,789 150,893 $ 113,693 32,113 145,806 $ $ $ A significant portion of the Company’s sales and accounts receivable were to three customers as follows: Customer A Customer B Customer C Sales Year Ended Accounts Receivable At January 3, 2014 December 28, 2012 December 30, 2011 January 3, 2014 December 28, 2012 20% 16% 13% 49% 19 % 16 % 11 % 46 % 19 % 19 % 13 % 51 % 8% 19% 8% 35% 7 % 21 % 6 % 34 % - 94 - GREATBATCH, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 20. QUARTERLY SALES AND EARNINGS DATA—UNAUDITED 2013 Sales Gross profit Net income EPS—basic EPS—diluted 2012 Sales Gross profit Net income (loss) EPS—basic EPS—diluted 4th Qtr. 3rd Qtr. 2nd Qtr. 1st Qtr. (in thousands, except per share data) $ $ 176,619 $ 57,385 9,781 0.40 0.38 159,186 $ 51,874 (5,556 ) (0.23 ) (0.23 ) 167,730 $ 55,877 11,071 0.46 0.44 161,340 $ 50,954 (7,561) (0.32) (0.32) 171,331 $ 57,302 9,752 0.41 0.39 166,548 $ 51,933 3,851 0.16 0.16 148,265 48,749 5,663 0.24 0.23 159,103 46,888 4,467 0.19 0.19 Net income in the third and fourth quarters of 2012 was impacted by charges incurred in connection with the consolidation of the Company’s Swiss orthopaedic facilities. See Note 13 “Other Operating Expenses, Net.” Fourth quarter results for 2013 includes an additional week of operations in comparison to the same period of 2012 as the Company utilizes a fifty-two, fifty-three week fiscal year, which ends on the Friday nearest December 31st. Although this additional week of operations may have impacted certain financial statement line items, management believes that, when combined with the additional holiday and weather related shutdowns, this additional week did not materially impact our net operating results. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. ITEM 9A. CONTROLS AND PROCEDURES Management’s Report on Internal Control Over Financial Reporting appears in Part II, Item 8, “Financial Statements and Supplementary Data” of this report and is incorporated into this Item 9A by reference. a. Evaluation of Disclosure Controls and Procedures. Our management, including the principal executive officer and principal financial officer, evaluated our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934) related to the recording, processing, summarization and reporting of information in our reports that we file with the Securities and Exchange Commission as of January 3, 2014. These disclosure controls and procedures have been designed to provide reasonable assurance that material information relating to us, including our subsidiaries, is made known to our management, including these officers, by our employees, and that this information is recorded, processed, summarized, evaluated and reported, as applicable, within the time periods specified in the Securities and Exchange Commission’s rules and forms. Based on their evaluation, as of January 3, 2014, our principal executive officer and principal financial officer have concluded that our disclosure controls and procedures are effective. b. Changes in Internal Control Over Financial Reporting. There have been no changes in the registrant’s internal control over financial reporting that occurred during our last fiscal quarter to which this Annual Report on Form 10-K relates that have materially affected, or are reasonably likely to materially affect, internal control over financial reporting. - 95 - ITEM 9B. OTHER INFORMATION None. PART III ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE Information regarding the Company’s directors appearing under the caption “Election of Directors” in the Company’s Proxy Statement for its 2014 Annual Meeting of Stockholders is incorporated herein by reference. Information regarding the Company’s executive officers is presented under the caption “Executive Officers of the Company” in Part I of this Annual Report on Form 10-K. The other information required by Item 10 is incorporated by reference from the Company’s Proxy Statement for its 2014 Annual Meeting of Stockholders. ITEM 11. EXECUTIVE COMPENSATION Information regarding executive compensation in the Company’s Proxy Statement for the 2014 Annual Meeting of Stockholders is incorporated herein by reference. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS Information regarding security ownership of certain beneficial owners and management and related stockholder matters, including the table titled “Equity Compensation Plan Information,” in the Company’s Proxy Statement for the 2014 Annual Meeting of Stockholders is incorporated herein by reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE Information regarding certain relationships and related transactions, and director independence in the Company’s Proxy Statement for the 2014 Annual Meeting of Stockholders is incorporated herein by reference. ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES Information regarding the fees paid to and services provided by Deloitte & Touche LLP, the Company’s independent registered public accounting firm, in the Company’s Proxy Statement for the 2014 Annual Meeting of Stockholders is incorporated herein by reference. - 96 - ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES (a) LIST OF DOCUMENTS FILED AS PART OF THIS REPORT PART IV 1. Financial statements and financial statement schedules filed as part of this Annual Report on Form 10-K. See Part II, Item 8. “Financial Statements and Supplementary Data.” 2. The following financial statement schedule is included in this report on Form 10-K (in thousands): Schedule II—Valuation and Qualifying Accounts Col. A Description January 3, 2014 Allowance for doubtful accounts Valuation allowance for deferred income tax assets December 28, 2012 Allowance for doubtful accounts Valuation allowance for deferred income tax assets December 30, 2011 Allowance for doubtful accounts Valuation allowance for deferred income tax assets Col. C—Additions Col. B Balance at Beginning of Period Charged to Costs & Expenses Charged to Other Accounts- Describe Col. D Deductions - Describe Col. E Balance at End of Period $ 2,372 $ (93 ) $ (15 ) (4) $ (263 ) (2) $ 2,001 $ 12,768 $ (1,263 ) (1) $ 32 (4) $ (1) 124 $ 11,661 $ $ $ $ 1,930 $ 484 $ 71 (3)(4) $ (113 ) (2) $ 2,372 7,775 $ 5,145 (1) $ 124 (4) $ (276 ) (5) $ 12,768 1,830 $ 288 $ 170 (3)(4) $ (358 ) (2) $ 1,930 6,482 $ 702 (1) $ 591 (3)(4) $ — $ 7,775 (1) Valuation allowance recorded in the provision for income taxes for certain net operating losses and tax credits. The net increase in allowance in 2013 primarily relates to net operating losses incurred by our Switzerland operations. (2) Accounts written off, net of collections on accounts receivable previously written off. (3) Balances recorded as a part of our 2012 acquisition of NeuroNexus Technologies, Inc. and 2011 acquisition of Micro Power Electronics, Inc. Includes foreign currency translation effect. (4) (5) Primarily relates to return to provision adjustments for prior years. Schedules not listed above have been omitted because the information required to be set forth therein is not applicable or is shown in the financial statements or notes thereto. (3) Exhibits required by Item 601 of Regulation S-K. The exhibits listed on the Exhibit Index of this Annual Report on Form 10-K have been previously filed, are filed herewith or are incorporated herein by reference to other filings. - 97 - Pursuant to the requirements of Sections 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. SIGNATURES Dated: March 4, 2014 By /s/ Thomas J. Hook Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the date indicated. Thomas J. Hook (Principal Executive Officer) President & Chief Executive Officer Signature Title Date March 4, 2014 President & Chief Executive Officer & Director (Principal Executive Officer) /s/ Thomas J. Hook Thomas J. Hook /s/ Michael Dinkins Michael Dinkins /s/ Thomas J. Mazza Thomas J. Mazza /s/ Bill R. Sanford Bill R. Sanford /s/ Pamela G. Bailey Pamela G. Bailey /s/ Anthony P. Bihl III Anthony P. Bihl III /s/ Joseph W. Dziedzic Joseph W. Dziedzic /s/ Rudy A. Mazzocchi Rudy A. Mazzocchi /s/ Kevin C. Melia Kevin C. Melia /s/ Dr. Joseph A. Miller, Jr. Dr. Joseph A. Miller, Jr. /s/ Peter H. Soderberg Peter H. Soderberg /s/ William B. Summers, Jr. William B. Summers, Jr. Executive Vice President & Chief Financial Officer (Principal Financial Officer) March 4, 2014 Vice President and Corporate Controller (Principal Accounting Officer) Chairman Director Director Director Director Director Director Director Director - 98 - March 4, 2014 March 4, 2014 March 4, 2014 March 4, 2014 March 4, 2014 March 4, 2014 March 4, 2014 March 4, 2014 March 4, 2014 March 4, 2014 EXHIBIT INDEX DESCRIPTION Amended and Restated Certificate of Incorporation, as amended (incorporated by reference to Exhibit 3.1 to our quarterly report on Form 10-Q for the period ended June 27, 2008). Amended and Restated Bylaws (incorporated by reference to Exhibit 3.2 to our annual report on Form 10-K for the period ended January 1, 2010). 1998 Stock Option Plan (including form of “standard” option agreement, form of “special” option agreement and form of “non-standard” option agreement) (incorporated by reference to Exhibit 10.2 to our Registration Statement on Form S-1 (File No. 333-37554)). Amendment to Greatbatch, Inc. 1998 Stock Option Plan Non-Employee Director Stock Incentive Plan (incorporated by reference to Exhibit A to our Definitive Proxy Statement on Schedule 14-A filed on April 22, 2002). Greatbatch, Inc. Executive Short Term Incentive Compensation Plan (incorporated by reference to Exhibit A to our Definitive Proxy Statement on Schedule 14-A filed on April 20, 2012). License Agreement dated August 8, 1996, between Greatbatch Ltd. and Evans Capacitor Company (incorporated by reference to Exhibit 10.23 to our Registration Statement on Form S-1 (File No. 333- 37554)). Amendment No. 2 dated December 6, 2002, between Greatbatch Technologies, Ltd. and Evans Capacitor Company (incorporated by reference to Exhibit 10.18 to our Annual Report on Form 10-K for the year ended January 3, 2003). Form of Change of Control Agreement between Greatbatch, Inc. and its executive officers (Thomas J. Hook, Mauricio Arellano, Michelle Graham and Timothy G. McEvoy) (incorporated by reference to Exhibit 10.1 to our quarterly report on Form 10-Q for the period ended July 1, 2011). Form of Change of Control Agreement between Greatbatch, Inc. and its executive officers (Michael Dinkins, Andrew P. Holman, and George M. Cintra) (incorporated by reference to Exhibit 10.8 to our Annual Report on Form 10-K for the year ended December 28, 2012). Second Amended and Restated Credit Agreement dated September 20, 2013 by and among Greatbatch Ltd., the lenders party thereto and Manufacturers and Traders Trust Company, as administrative agent, Bank of America, N.A., as syndication agent and RBS Citizens, N.A. and Wells Fargo Bank, National Association, as co-documentation agents (incorporated by reference to Exhibit 10.1 to our Current Report on Form 8-K filed on September 23, 2013). Employment Agreement dated August 5, 2013 between Greatbatch, Inc. and Thomas J. Hook (incorporated by reference to Exhibit 10.1 to our Current Report on Form 8-K filed on August 9, 2013). 2005 Stock Incentive Plan (incorporated by reference to Exhibit B to our Definitive Proxy Statement on Schedule 14-A filed on April 20, 2007). 2009 Stock Incentive Plan (incorporated by reference to Exhibit A to our Definitive Proxy Statement on Schedule 14-A filed on April 13, 2009). 2011 Stock Incentive Plan (as amended December 7, 2011) (incorporated by reference to Exhibit 10.12 to our Annual Report on Form 10-K for the year ended December 30, 2011). EXHIBIT NUMBER 3.1 3.2 10.1# 10.2*# 10.3# 10.4# 10.5 10.6+ 10.7# 10.8# 10.9 10.10# 10.11# 10.12# 10.13# 10.14*# Amendment to Greatbatch, Inc. 2011 Stock Incentive Plan, Greatbatch, Inc. 2009 Stock Incentive Plan, Greatbatch, Inc. 2005 Stock Incentive Plan - 99 - EXHIBIT NUMBER 10.15*# Form of Restricted Stock Award Letter DESCRIPTION 10.16*# Form of Performance-Based Restricted Stock Units Award Letter 10.17*# Form of Nonqualified Option Award Letter 10.18*# Form of Time-Based Restricted Stock Units Award Letter 12.1* 21.1* 23.1* 31.1* 31.2* 32.1** 101.INS 101.SCH 101.CAL 101.LAB 101.PRE 101.DEF Ratio of Earnings to Fixed Charges (Unaudited) Subsidiaries of Greatbatch, Inc. Consent of Independent Registered Public Accounting Firm Certification of Chief Executive Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act. Certification of Chief Financial Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act. Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. XBRL Instance Document XRBL Taxonomy Extension Schema Document XBRL Taxonomy Extension Calculation Linkbase Document XBRL Taxonomy Extension Labels Linkbase Document XBRL Taxonomy Extension Presentation Linkbase Document XBRL Taxonomy Extension Definition Linkbase Document Portions of those exhibits marked “+” have been omitted and filed separately with the Securities and Exchange Commission pursuant to a request for confidential treatment. * - Filed herewith. ** - Furnished herewith. # - Indicates exhibits that are management contracts or compensation plans or arrangements required to be filed pursuant to Item 14(c) of Form 10-K. - 100 - [This page intentionally left blank.] RATIO OF EARNINGS TO FIXED CHARGES (Unaudited) EXHIBIT 12.1 Earnings: Income (loss) before income taxes Fixed Charges: Interest expense Discounts & deferred financing fees Interest portion of rental expense Total earnings and fixed charges Fixed Charges: Interest expense Discounts & deferred financing fees Interest portion of rental expense Total fixed charges Ratio of earnings to fixed charges Jan. 3, 2014 Dec. 28, 2012 Year Ended Dec. 30, 2011 Dec. 31, 2010 Jan. 1, 2010 $ 48,838 $ 6,730 $ 48,392 $ 49,325 $ (18,177 ) 4,896 6,366 1,460 61,560 4,896 6,366 1,460 12,722 4.8 $ $ $ 5,498 12,557 1,056 25,841 5,498 12,557 1,056 19,111 1.4 $ $ $ 5,539 11,389 766 66,086 5,539 11,389 766 17,694 3.7 $ $ $ 7,839 10,680 848 68,692 7,839 10,680 848 19,367 3.5 $ $ $ 9,930 10,106 1,053 2,912 9,930 10,106 1,053 21,089 0.1 $ $ $ SUBSIDIARIES OF GREATBATCH, INC. EXHIBIT 21.1 Subsidiary Greatbatch Ltd. (direct subsidiary of Greatbatch, Inc.) Greatbatch LLC (direct subsidiary of Greatbatch Ltd.) Greatbatch Medical, S. de R.L. de C.V. (owned 99% by Greatbatch LLC & 1% by Greatbatch, Inc.) Electrochem Solutions, Inc. (direct subsidiary of Greatbatch Ltd.) Micro Power Electronics, Inc. (direct subsidiary of Electrochem Solutions, Inc.) Greatbatch-Globe Tool, Inc. (direct subsidiary of Greatbatch Ltd.) Precimed, Inc. (direct subsidiary of Greatbatch Ltd.) QiG Group, LLC (direct subsidiary of Greatbatch Ltd.) P Medical Holding SA (direct subsidiary of Greatbatch Ltd.) QiG Singapore Pte. Ltd. (direct subsidiary of P Medical Holding SA) Greatbatch Medical SA (direct subsidiary of P Medical Holding SA) Greatbatch Medical SAS (direct subsidiary of Greatbatch Medical SA) Greatbatch Medical Limited (direct subsidiary of Greatbatch Medical SA) NeuroNexus Technologies, Inc. (direct subsidiary of Greatbatch Ltd.) AlgoStim LLC (owned 88% by QiG Group, LLC) PelviStim LLC (owned 88.25% by QiG Group, LLC) Incorporated New York Delaware Mexico Massachusetts Delaware Minnesota Pennsylvania Delaware Switzerland Singapore Switzerland France United Kingdom Michigan Delaware Delaware EXHIBIT 23.1 CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM We consent to the incorporation by reference in Registration Statement Nos. 333-61476, 333-97209, 333-129002, 333-143519, 333-161159, 333-174559, and 333-184604 on Form S-8 of our reports dated March 4, 2014, relating to the consolidated financial statements and financial statement schedule of Greatbatch, Inc. and subsidiary (the “Company”), and the effectiveness of the Company’s internal control over financial reporting, appearing in this Annual Report on Form 10-K of Greatbatch, Inc. for the year ended January 3, 2014. Williamsville, New York March 4, 2014 CERTIFICATION EXHIBIT 31.1 I, Thomas J. Hook, certify that: 1. 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact I have reviewed this report on Form 10-K for the fiscal year ended January 3, 2014 of Greatbatch, Inc.; necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by the report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have: a. Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b. Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; c. Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures as of the end of the period covered by this report based on such evaluation; and d. Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting. 5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditor and the audit committee of registrant’s board of directors (or persons performing the equivalent functions): a. All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and b. Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting. Dated: March 4, 2014 Thomas J. Hook President and Chief Executive Officer (Principal Executive Officer) CERTIFICATION EXHIBIT 31.2 I, Michael Dinkins, certify that: 1. 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact I have reviewed this report on Form 10-K for the fiscal year ended January 3, 2014 of Greatbatch, Inc.; necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by the report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have: a. Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b. Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; c. Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures as of the end of the period covered by this report based on such evaluation; and d. Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting. 5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditor and the audit committee of registrant’s board of directors (or persons performing the equivalent functions): a. All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and b. Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting. Dated: March 4, 2014 Michael Dinkins Executive Vice President and Chief Financial Officer (Principal Financial Officer) EXHIBIT 32.1 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350 AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 Pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, each of the undersigned officers of Greatbatch, Inc. (the “Company”), does hereby certify, to such officer’s knowledge, that: The Annual Report on Form 10-K for the fiscal year ended January 3, 2014 (the “Form 10-K”) of the Company fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934 and the information contained in the Form 10-K fairly presents, in all material respects, the financial condition and results of operations of the Company. Dated: March 4, 2014 Dated: March 4, 2014 Thomas J. Hook President and Chief Executive Officer (Principal Executive Officer) Michael Dinkins Executive Vice President and Chief Financial Officer (Principal Financial Officer) [This page intentionally left blank.] Corporate Leadership Thomas J. Hook President & Chief Executive Officer Michael Dinkins Executive Vice President & Chief Financial Officer Mauricio Arellano Executive Vice President, Global Operations Andrew P. Holman Executive Vice President, Global Sales & Marketing George M. Cintra Senior Vice President & Chief Technology Officer Michelle Graham Senior Vice President, Human Resources Timothy G. McEvoy Senior Vice President, General Counsel & Secretary Board of Directors Pamela G. Bailey President and Chief Executive Officer, The Grocery Manufacturers Association Anthony P. Bihl III Chief Executive Officer, Bioventus, LLC Joseph W. Dziedzic Vice President and Chief Financial Officer, The Brink’s Company Thomas J. Hook President & Chief Executive Officer, Greatbatch, Inc. Kevin C. Melia Former Non-Executive Chairman, Vette Corporation Joseph A. Miller, Jr. Retired Executive Vice President and Chief Technology Officer, Corning, Inc. Bill R. Sanford, Chairman Founder and Chairman, Symark LLC Peter H. Soderberg Managing Partner, Worthy Ventures Resources, LLC William B. Summers, Jr. Retired Chairman and Chief Executive Officer, McDonald Investments, Inc. Global Headquarters Greatbatch, Inc. 2595 Dallas Parkway, Suite 310 Frisco, Texas 75034 Internet Address www.greatbatch.com Common Stock Listing New York Stock Exchange Trading Symbol: GB Investor Information Shareholders, securities analysts and investors seeking more information about the company can access information via the Internet or from the Investor Relations Department: Greatbatch, Inc. 2595 Dallas Parkway, Suite 310 Frisco, Texas 75034 Transfer Agent and Registrar Computershare Shareholder Services P.O. Box 30170 College Station TX 77842-3170 For Overnight mail: Computershare Shareholder Services 211 Quality Circle, Suite 210 College station TX 77845 www.computershare.com/investor Dedicated Toll Free Number: 1-877-832-7265 TDD Hearing Impaired: 800-231-5469 TDD Foreign Stockholders: 1-201-680-6610 Foreign Stockholders: 1-201-680-6578 Independent Registered Public Accounting Firm Deloitte & Touche LLP Williamsville, NY Greatbatch, Inc. 2595 Dallas Parkway Suite 310 Frisco, Texas 75034 (716) 759-5600 www.greatbatch.com 

Continue reading text version or see original annual report in PDF format above