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Executives

Tom Mazza - VP & Corporate Controller

Thomas J. Hook - President & CEO

Michael Dinkins - SVP & CFO

Analysts

Julia Kufman - RBC Capital Markets

Charles Croson - Sidoti & Company

Brooks West - Piper Jaffray

Bruce Jackson - Northland Capital Markets

Charles Haff - Craig-Hallum

Greatbatch, Inc. (GB) Q4 2012 Earnings Call February 25, 2013 5:00 PM ET

Operator

Good day ladies and gentlemen and welcome everyone to the Fourth Quarter 2012 Greatbatch, Incorporated Conference Call. Before we begin, I would like to read the Safe Harbor statement.

This presentation and our press release contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and involve a number of risks and uncertainties. These risks and uncertainties are described in the company's annual report on Form 10-K. The statements are based upon Greatbatch, Incorporated’s comfort, current expectations and actual results could differ materially from those stated or implied. The company assumes no obligation to update forward-looking information included in this conference call to reflect changed assumptions, the occurrence of unanticipated events or changes in the future operating results, financial conditions or prospects.

I would like to now turn the call over to today's host, Vice President and Corporate Controller, Mr. Tom Mazza. Please proceed sir.

Tom Mazza

Thank you. Hello everyone and thank you for joining us today for our 2012 fourth quarter earnings call. With us on the call today are, Thomas J. Hook, President and Chief Executive Officer, and Michael Dinkins, Senior Vice President and Chief Financial Officer.

In terms of today's agenda, Tom Hook will start off with a few brief comments regarding our fourth quarter results and will then provide an overview of our strategic focus going forward. After that Michael will review our financial results and 2013 guidance in more detail. We will then open up the call to Q&A. As we have done in the past, we are including slide visuals that go along with this presentation which you can access on our website at www.greatbatch.com.

With that let me now turn the call over to Tom Hook.

Thomas J. Hook

Thank you, Tom and welcome to all of you who are listening on our call today. We are pleased to be able to share with you our results for the fourth quarter which was a strong quarter for us. During the quarter, we were able to achieve a 36% increase in adjusted diluted earnings per share to $0.53. This increase was fueled by our revenue growth due to our acquisitions and reduced RD&E expenditures. Sales increased 12% over the prior year as a 2% organic constant currency decline was offset by additional revenue from our acquisitions of Micro Power in December of 2011 and Neuro Nexus in February 2012.

The first year performance of our Micro Power acquisition has met or exceeded our initial expectations on almost every financial measure, including revenue where the proforma organic growth is 38% and driving an accretion of our earnings per share. Michael will discuss our financial results in further detail later in the presentation, but you will notice the following improvements in our quarter-over-quarter performance.

A 110 basis point improvement in gross margin, reduced net RD&E expenses by 13% despite incremental spend related to the acquisitions, adjusted operating margin performance of 13.3%, which is up 220 basis points over the prior year.

As shown on slide six, there are two key things we want everyone on the call to understand about Greatbatch. First and most importantly, our core business is well positioned because OEM customers leverage our portfolio of intellectual property and have entered into long-term manufacturing agreements which secure our core business revenue stream.

Second, we are building a healthy pipeline of opportunities as we work with our OEM customers on projects. Additionally, we are enhancing our sales and marketing capabilities to take our existing portfolio of intellectual property and manufacturing excellence to new customers and new markets. Combined this with a stronger discipline to ensure we have adequate returns for all projects, we expect our bottomline performance will continue to improve.

As indicated in last quarter’s call, the top of the priority list is the completion of the consolidation of productivity initiatives and in particular the Swiss Orthopedic consolidation. These initiatives continue to impact GAAP financial performance and resulted in negative GAAP earnings for the quarter given the charges taken.

On slide seven, we have provided an update for you on the Swiss Orthopaedics consolidation. As of today, we have successfully completed new supplier certification for key customers and also reached a resolution on our lawsuit. We have successfully shipped product from our Mexico facility and now we are working on ramping up volume to meet customer demand. The Fort Wayne validation process is in progress and we are in good position to service our customers with some backlog that will clear up in second quarter. Our progress is consistent with the guidance we provided for 2013.

I would now like to devote the remainder of my prepared remarks to update you on the progress we are making towards achieving our strategic objectives. Our strategic focus is outlined on slide nine is as follows: To strengthen our core business. To sustain at least 5% core organic sales growth. To increase our earnings growth and to commercialize Algostim for additional upside. For the next few minutes I will spend some time on each of these key objectives.

First, strengthening our core business. A majority of components and devices Greatbatch sells incorporate our proprietary technologies. These proprietary technologies provide an entry barrier for our new competitors and prohibit existing competitors from duplicating our design. In addition to these technologies, our proprietary know-how in the manufacture of these products provides further barriers to competitions; both of these factors are drivers behind our continued success and entering into long term agreements with key OEM customers across all of our product lines.

As of the end of 2012, we have 541 active US patents and 367 active foreign patents. We also have 307 US and 286 foreign pending patent applications at various stages of approval. As a result of the QiG Group’s efforts to develop complete medical devices, the amount of intellectual property being generated by the company is accelerated. We currently have 159 pending patent applications and 57 patents have been granted to us relative to our medical devices. Our manufacturing history in intellectual property makes us a uniquely positioned company in our targeted markets. When combined with our enhanced sales and marketing resources, we can leverage this new profitable growth.

Our second objective is to sustain 5% core organic sales growth. During 2012, our 2% increase in cardiac and neuromodulation sales exceeded expectation, benefiting from further adoption of our proprietary component technologies and deepening customer relationships. Over the long-term, we anticipate of increased pace of product development opportunities from our cardiac customers, and in combination with our enhanced sales and marketing resources will allow the company to achieve this strategic objective and grow this product line faster than the underlying market.

For 2012 our vascular product line grew 15%. This was due to underlying market growth and share gains and included a 47% increase in sales of medical devices developed by Greatbatch to $6.6 million; still a significant increase despite being below our projections at the beginning of the year. These medical devices will be another key factor in achieving our organic growth objective.

During 2012, we took aggressive steps to turn our orthopedic business around which experienced an 8% constant currency sales decline. By the end of the year, production was moved in Switzerland to existing Greatbatch facilities in the US and Mexico and we expect to see the benefit throughout 2013. We now feel that the worst is behind us for this product line and expect to see organic growth resume in 2013.

Finally with regards to Electrochem, revenue continues to exceed our expectations and doubled during 2013 as a result of the acquisition of Micro Power in December of 2011. This acquisition significantly enhanced our position in the portable medical market which is benefiting from an ageing population and the shifting of patient care from clinical settings to the home.

These favorable market dynamics along with our pipeline of new products provide a significant lever to drive organic growth. We have a long standing history of operational excellence which is one of our core competencies. As we move forward investing in operations, we will continue to be critical of the success of our profitable growth.

Another important strategic objective is to drive earnings growth. Mike will review our 2012 results and reconfirm the 2013 guidance in a minute. I want to focus on the key enablers for upside performance.

Since 2006 we had completed 17 plant consolidations. Going forward, we will have some small carryover costs but essentially the major plant consolidations are behind us. As a result, we are projecting that the orthopedic fix along with manufacturing productivity and reduced R&D spend will be the key drivers behind our 7% to 13% 2013 adjusted EPS growth. All this while still funding an increased investment in our sales and marketing capabilities and an increase in our performance based compensation.

Finally, I want to spend a minute talking about our R&D spend so everyone understands what has happened and what we plan going forward. This quarter for the first time we expanded table A in the press release to show our operating results by segment and to break out our incremental medical device expenses.

We believe this will assist the reader of our financial statements in better understanding the performance of the company. In 2012, we spent $28 million for medical device R&D and an additional $5 million for design verification testing or DVT. The comparable numbers for 2011 were $22 million and $5 million.

A large portion of these expenses went towards the development of our neuromodulation platform and more specifically Algostim our evolutionary spinal cord stimulator. As previously announced, we have scheduled an Investor Day presentation March 18. At that time, we will provide significantly more information with regards to Algostim.

At this time, I'm pleased to report that we continue to make strong technical progress under development of this novel device and continue to retire critical milestones needed for program completion.

We have started to discuss with several world class medical device companies the opportunity to market and distribute Algostim through interventional pain physicians, neurosurgeons and orthopedic spine surgeons around the world.

We believe Algostim’s unique features and benefits will allow us to write commercial partner to capture significant market share in today's $1.3 billion spinal cord stimulation market which continues to see double-digit market growth.

Our strategy is to set up partnerships with key OEM customers beyond these three components to include medical device systems. I want to emphasize that the strategy is to extend our partnership with our partnership with our existing OEM customers and not compete with them.

Until this point, we have funded the medical device strategy including Algostim through our P&L. However, after we complete the Algostim commercialization, future medical device development would be funded through third-party development agreements to partially or completely offset the EPS impact. Not takeaway, we expect R&D spend in 2014 to decline.

In closing, I'm pleased with the progress we've made on our strategic objectives and remained confident that these initiatives will improve the long-term growth and profitability of the company. There is still a significant amount of work which remains to be completed for us to achieve our strategic objectives over the short and long term.

We look forward to updating you at our Investor Day meeting which will provide you an opportunity to understand more about our core business performance and appreciate Algostim technology and commercialization plans.

With that, let me know turn the call over to Michael Dinkins for a more detailed review of our third quarter financial results.

Michael Dinkins

Thanks, Tom, and good afternoon everyone. I am very pleased to be on the call today and view with you our results for 2012. I would like to provide some color commentary on our financial results to help everyone understand how we view our performance and confirm our guidance for 2013.

For more specific details regarding our financial results for the year, we refer you to our press release that we issued earlier today. With that, let’s get started.

As shown on slide 16, the key highlights for the year are as follows. Revenue up 14%, adjusted operating margin performance of 11.4%, down 50 basis points from the prior year, adjusted EPS up 5% and continuous strong adjusted cash flow performance of $80 million when adjusted for the Swiss consolidation effort in DVT. Actual cash flow is $65 million compared to $90 million last year. I'll also address our high effective tax rate in few minutes.

In 2012, our cardiac and neuromodulation sales increased 2% which exceeded our expectations. During 2012, cardiac and neuromodulation sales benefited from other adoption of our Q series batteries partially offset by the timing of customer inventory builds and product launches between 2011 and 2012.

We remain cautiously optimistic over the short-term prospects of this product line given the continued ongoing challenges surrounding some of our key cardiac customers. We believe that the impact of this factor is somewhat minute by the fact that we have business with all of the key cardiac OEMs and have significantly diversified our revenue base.

Additionally, we continue to see increased pace of product development opportunities from our customers. This combined with our increased focus on sales and marketing will allow us to grow this product line faster than the underlying market.

For 2012, our vascular product lines sales increased 15%. 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 by Greatbatch, an increase of 47% over 2011.

Orthopedic product line sales for 2012 declined 13%. On a constant currency basis, orthopedic sales declined 8% for 2012 as foreign currency exchange rate fluctuations decreased orthopedic revenue by approximately $6 million.

The remaining decline in 2012 orthopedic sales was a result of price concessions provided to customers as well as pure customer product launches and development opportunities due to the operational issues that are swift orthopedic facility that Tom discussed earlier.

In addition to the consolidation of manufacturing, during 2012 we also streamlined our Swiss orthopedic product line offerings; this included the sale of several non-core product lines at the end of the year which closed last month.

Our current estimate is that the sale of these products will reduce our 2013 orthopedic revenue by approximately $15 million in comparison with 2012.

For 2013, we expect our performance to improve as we progress through the year. As the first quarter 2013 will be impacted by the startup of think these recently transferred orthopedic production lines, the second half for the year is expected to improve as this orthopedic backlog is relieved.

2012 sales for Electrochem increased $83.3 million to a $163 million and included $82.4 million of incremental revenue related to our acquisition of Micro Power in December 2011. When on organic basis, Electrochem revenue was consistent with the prior year.

The first year performance of our Micro Power acquisition has met or exceeded our initial expectations in almost every financial measure including the revenue where the pro forma organic growth is 38%.

These acquisitions significantly enhanced our position in the portable medical market which is benefiting from the shift in the patient care from clinical settings to the home plus an aging population. These favorable market dynamics along with our pipeline and new products provides us with a significant lever to drive organic growth.

Electrochem’s technology, customer relationship and legacy of delivering highly reliable and innovative solutions has enabled us to win in this evolving market and continues to position us to capture market share. Electrochem continues to secure long term agreements in this space and our funnel of portable medical products from this acquisition continues to be full which is expected to drive revenue growth from this product line for the next several years.

On slide 18 we are providing a summary of our operating performance for 2012 compared to 2011. We have talked about these items throughout the year and during this call. This chart quantifies the main drivers for the year. I'll be happy to answer questions on the drivers during the Q&A portion of this call. I will make a few brief comments on 2013.

We are reaffirming our guidance for 2013. Based upon our results for 2012, and the first couple of months of 2013, we are confirming the sales guidance provided last month. We expect our performance to improve as we progress through 2013 as a new product introductions and the impact of targeted sales initiatives will benefit the second half of the year more than the first.

Additionally, our productivity projects will show favorable impact starting in the first quarter, but because of volume leveraging we will have a greater impact in the second half of the year and the same is true for our R&D spend wherein the first half of the year we will have a full impact of Algostim, but as we approach PMA submission the spend will decrease. We also expect a milestone achievement for engineering reimbursement to be slightly weighted to the second half.

One of the area, I want to spend a few minutes discussing with you is our effective tax rate. As you can see from today’s release our effective tax rate has been significantly impacted this year by our Swiss Orthopedic consolidation. Our GAAP effective tax rate for 2012 was 171% and it includes approximately $6 million of tax charges recorded in connection with our Swiss Orthopedic consolidation. These charges relate to the loss of our Swiss tax holiday. Due to our decision to discontinue manufacturing in Switzerland and the establishment of evaluation allowance on 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 includes a significant amount of losses from our Swiss operations which are deducted by the lower effective tax rate thus increasing the overall effective tax rates of the company.

Finally, our 2012 effective tax rate does not include the benefit of the US R&D tax credit which expired at the end of 2011. As you all are aware, the R&D tax credit was signed into law last month. However, as required by GAAP, the benefit of the R&D tax credits earned in 2012 will be recognized in the first quarter of fiscal 2013. R&D tax credits earned in 2013 will be recorded throughout fiscal 2013. We estimate that the benefit we laid it in the 2012 R&D tax credits will be approximately $1.5 million.

On an adjusted basis, which excludes the impact of these consolidation charges, our effective tax rate is more in line with US statutory rate of 35%. It is important to note that the impact of the loss of the Swiss tax holiday, valuation allowance in our Swiss deferred tax assets could be reversed at some point in the future when our operations in Swiss will turn profitable again. I should also point out that we currently have various tax planning initiatives in place that are aimed at reducing our effective tax rate over the long-term and is another strategic objective that our finance department is focused on.

In closing, I would like to reiterate some key points. We have a strong core business because of the intellectual property and long-term relationships from OEM customers. We are targeting sustainable 5% organic growth and higher earnings growth and we are working on commercializing Algostim as an upside.

With that, let me now turn the call back over to the moderator to take questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Julia Kufman with RBC Capital Markets. Please proceed.

Julia Kufman - RBC Capital Markets

Hi, this is Julia Kufman, calling in for Glen. So my first question is a weighting to the CRM market and sort of what's your outlook for 2013?

Thomas J. Hook

Well, this is Tom. I think when we look at CRM market, we’ll really review the same information that you see in terms of tracking OEM performance and the marketing analytics. So we do see the kind of a separation between price and volume, we see a continued contraction in the clinical CRM markets of our customers, and we do see it and project that it's going to stabilize as has been shown by some of the results that had been reported by the OEMs, we are monitoring it.

But given the adoption we had over the course of the years, the winning technology adoptions with OEMs in selling incremental technologies to them we’re a little bit more bullish than what the market looks like in terms of being able to get our technologies into the new designs of the OEMs and offset some of that market decline which is why we think we can out chase the market. So we don’t have a perfect visibility into 2013 and we expect still there would be some price decline in the clinical markets.

Our-long term agreements that we have in place with customers in the adoptions of the technologies they have will be able to hold our revenue stable to slightly growing because of those long term agreements and the adoption of new technologies combined. So we project that we will be able to drive the business in a low single-digit territory relative for the year.

Julia Kufman - RBC Capital Markets

Okay. Thank you. That’s helpful. And is there any update on Algostim FDA filing?

Thomas J. Hook

We will be updating that at our March 18th Investor Day Julia and we look forward to seeing you there.

Operator

The next question comes from the line of Charles Croson with Sidoti & Company. Please proceed.

Charles Croson - Sidoti & Company

I just have a few quick ones. Just actually a quick one, real quick, the neurostim, how much CRM is that now making?

Thomas J. Hook

Neurostimulation and combined with all kind of cardiac and neuromodulation product line neurostim components is a very small number, so you are looking at, you know I think we used before on the $10 million neighborhood, but we don't break it out specifically; but we are woefully under-penetrated in the neurostimulation components and it's been an area that Mauricio Arellano in Greatbatch Medical has focused considerable attention on, and you can see that in this quarter we are successful in doing well to pick up a key customer contract in this area and a lot of that is being leveraged off the technology which is we’re developing for our neuromodulation platforms, we have to leverage those in component forms with our OEM customers, so we project that neuromodulation and the component level be a driver for us as well that will help our growth rate in 2013 and beyond.

Charles Croson - Sidoti & Company

Okay, all right, that's helpful. And in terms of the increased spend in sales and marketing; can you touch up a little bit more on that, what initiatives you are really undertaking there?

Thomas J. Hook

You know for the eight years I have been in the company, we have talked extensively on our operating capability and our engineering capability and we’ve had a lot of moving parts in consolidating and integrating our manufacturing base, and acquisitions together; we’ve got a very good job of designing products for OEMs and also protecting those intellectual properties; well, what's not been in the core DNA of Greatbatch has been a concerted commercialization process as a company and both Mauricio Arellano in Greatbatch Medical and Susan Bratton in Electrochem have brought in sales leadership in those areas, so we can commercialize our technologies and our operating capabilities in a better fashion more effectively and efficiently with OEMs, not just our current OEM customers but to identify new customers and new applications for the technologies we have.

So we brought on a key individual Andrew Holman to run our sales and marketing initiatives in Greatbatch medical and we brought on a key individual for Micro Power, Greg Webster in Electrochem and he have been providing incremental investment there to bring on sales and marketing expertise to identify customer opportunities that were hidden from our view before and engage the customers that we currently have new customers to win products and its off to a very good start.

It's increasing our effectiveness and our partnership; it's deepening them with the OEMs and we are picking up some new applications to use our current technologies in and now that's been very effective for us and we plan on continuing to roll that out and its going to receive incremental investment in 2013 as it continues to build momentum and we expect that to be a driver for our 5% revenue growth as we go forward.

Operator

The next question comes from the line of Brooks West with Piper Jaffray. Please proceed.

Brooks West - Piper Jaffray

Let me start off with the orthopedic business, wanting to base that business, I know with the shutdown of the Swiss plant you lost I want to say it was $15 million to $25 million as you exited that business, but I'm guessing you also might have lost a little bit of business with the issues that you have over there, can you just kind of talk about the base business that you have now and how we should think about that kind of progressing over the next couple of years. Are you aggressively going after new customers, what just a little bit more flesh on the bones of that orthopedic business?

Thomas J. Hook

Certainly as I think when you look at 2012, the 8% constant currency decline you saw in our business was based on us struggling operationally to perform for customers and that's the lost business.

The $15 million plus of business we elected not to move which would end up being on the business that we sold off and left in Switzerland to another company to manage is what we literally will not be transferring into US operations.

What that equates to is in 2013 we are targeting 8% to 14% organic growth in orthopedics. So but those three buckets will kind of give you the answers that I think you are looking for Brooks.

Brooks West - Piper Jaffray

Okay, and then how much of that you know (indiscernible) that you talk about in with last year, how much of that is forever gone and how much of that is volume that your OEMs are willing to fairly immediately switch back to you?

Thomas J. Hook

I think I never think anything is forever gone except for the product lines we've agreed to sell off which is that $15 million plus of business that I'll just call it low volume business that would be more expensive to move than to sell.

That business we are not going to get back into those types of product lines. We feel that with the stronger operating base and obviously the challenge in making these investments, we feel we are in an operating base that's actually stronger in 2013 than last year. So we feel we can win back any business that moved away from us last year and even pickup incremental business which is why we're bullish on the organic growth for 2013.

Brooks West - Piper Jaffray

Okay and then maybe one just follow up on the sales and marketing expense. It sounds like that’s a couple of people on some programs. Mike, could you give us an actual number, incremental sales and marketing expense per model?

Michael Dinkins

We believe our sales and marketing expense for 2013 compared to ‘12 will probably be increase somewhere in the range of $3 million to $5 million.

Operator

Your next question comes from the line of Bruce Jackson with Northland Capital Markets. Please proceed.

Bruce Jackson - Northland Capital Markets

So, with the CRM in neuro, you've done a pretty good job. I am talking about why you think you are going to grow faster than the overall end user market. Can you do the same thing for us in orthopedics? What are some of the strategies you are employing to get faster than expected growth and then also could you speak to the success of your new marketing efforts in orthopedics that’s one area where you have been investing some money?

Thomas J. Hook

Certainly, Bruce. I think the highlight in orthopedic market is we don’t expect a lot of market growth. We are a very small player in the orthopedic market and that’s different than the cardiac rhythm management component market where we have substantial share within that market space. So the opportunity for growth in orthopedics at the delivery systems, instruments, and implants level is a very large opportunity. So we don’t have a ceiling that inhibits us in this area.

Additionally, in orthopedics, the deals tend to be of shorter gestation period than they are in cardiac rhythm management or takes years in cardiac rhythm management to develop technologies additional years to develop designs and sign development agreements of OEMs and then move on to manufacturing.

In orthopaedics we can do that cycle on a much shorter basis. So our initial sales and marketing investments have been in orthopaedics in 2012 and that brought us some struggling results because we are offsetting trying to win business at the same time or trying to move our Swiss facility over to the US.

However, I will say that in the areas where we did make investments in our product lines who are US based, we were able to do fairly well with getting engaged with our customers. But its imperative on us to 2013 to get beyond the Swiss consolidation dynamics that we struggled behind and we have seen the engagements that have been good with customers, the customers have worked with us even now it’s been challenging at times with the Swiss moves.

But they have given us incremental opportunities to win business and especially out of some of the locations that have received investment dollars like our Indianapolis and our Fort Wayne facilities and they have done well in 2012 to perform. And we expect that performance to continue, we expect our profitability to continue to improve as we drive volume into those facilities as well.

So you when you look at our engagement with the better operating basis where we can meet time, quality and our commitments to the customers, we feel will more confident that we can back up the contracts that we do sign and of course, in orthopaedics, when you perform you have the ability to continue to collect more business and its that foundation that the sales and marketing resources are driving off of.

We definitely see an increased funnel of activity. We are bidding on more opportunities and we are trying to leverage our operating capabilities that we already have running now to be able to deliver for the customers. So we remained confident for 2013 we are not bullish yet, we will definitely feel the pick up momentum during the course of the year sticking to just performing for customers and getting into new business opportunities with the sales team.

Bruce Jackson - Northland Capital Markets

Okay, that is very helpful. Then just two other questions on the income statement, you have said that the revenue this year was going to be probably strong in the second half of the year; do you expect to be up sequentially in Q1?

Michael Dinkins

We don't give guidance by each individual quarter except we try to give some indication but Q1 should be somewhere flat or maybe slightly down a little bit for all the reasons that we indicated but we believe our total year guidance by organic growth that we are still on track to be within that range.

So but it is the pattern that builds from the first quarter and second quarter, not only from the orthopedic business but also some of our other businesses our portable medical etcetera because we are seeing that's a new product introductions or more in the second half of the year than they are in the first half of the year.

Bruce Jackson - Northland Capital Markets

Okay, then last question on the research and development expense line, is that something where it’s going to continue its current rate for the first half of the year and then kind of like step down in the second half of the year?

Michael Dinkins

No, if you look at the rates that we have in the fourth quarter, we have the benefit of a [NRE] payment and the timing of that sold that, we went off of the $13 million and $14 million run rate down to $11 million that was one of the drivers for our fourth quarter. With the efforts that we have on Algostim etcetera even though we've reduced it from the run rate in the first half of 2012, we expect that that will come back up to the third quarter kind of run rate in first half of 2013.

Then in the second half as we near PMA submission and because of some other things that we are doing, it will come down a little bit in the second half. And there's also channel NREs that we assume to get for the milestones more in the second half of the year than the first half so we've done work and we want for the P&L and then we have reimbursed from it, from our clients, customers, in the second half. So first half back to the third quarter run rate and then second half come back down a little bit.

Operator

Your next question comes from the line of Charles Haff with Craig-Hallum. Please proceed

Charles Haff - Craig-Hallum

I had a question regarding an item you had in the press release about a $1.7 million additional customer cost reimbursements due to the timing of when milestones were achieved, can you explain that a little bit, is that a good guy or bad guy, I'm not quite…

Michael Dinkins

It’s a good guy. Our customers engage us to do research for their products and we run that engineering service and R&D expense through our P&L and then we periodically get reimbursed from the customers as we reach the milestones. So in the fourth quarter of 2012, we have the benefit above and beyond our normal run rate of our $1.7 million milestone.

Now the good thing about that and this is what Tom was talking about earlier. Those projects are the future new product introductions that our customers are going to introduce into the marketplace where they hope to either replace some existing products or win market share with that product. So as we are doing that type of work, that builds our pipeline for future sales and that's one of the reasons why we believe that in these markets we can slightly up upon the market performance because we are winning and being successful on working on these projects with our customers.

Charles Haff - Craig-Hallum

And then I was trying to understand the pro forma Electrochem numbers that you are giving. In the press release you said pro forma Electrochem in portable medical grew 38% and then I think you said in your comments Mike that Electrochem ex-Micro Power was flat. So I'm just trying to understand what your definition is of pro forma here?

Michael Dinkins

By pro forma we were trying to say that if we have owned Electrochem in 2011 and you just look at what their business was that they inherited and how we grew it, we grew that 38% but we didn't have the 2011 base. So then when you look at how it actually impacts our financials it all comes through as an acquisition dollars so we were given the acquisition dollars impact capability that it had for us by us owning it in 2012.

Charles Haff - Craig-Hallum

And then you mentioned in your prepared remarks that you resolved the lawsuit with Zimmer, how did that get resolved, was that the ortho products that were divested or was there some other resolution?

Thomas J. Hook

It was a direct interface with Zimmer to bridge a transition approach for the qualification as we went forward and it was on an agreement that got put in place after extensive negotiation over the holiday period with the executives of both companies cooperating in it. It just defines how the transition will go and you know, we did it cooperatively and that’s how we resolved it and all that it does sets out the approach and the timeline for an orderly transition, much is which is in our integration and consolidation plans anyways. So we just, we did not do a good of a job as we should have in communicating with our customers. We fell out of synchronization with them. We were able to recover it before the end of the year to get the lawsuit resolved and we're back in it at very positive track with them now.

Operator

And that concludes today’s question-and-answer session. I would now like to turn the call back over to Tom Mazza for any closing remarks. Please proceed.

Tom Mazza

Thank you. I would like to remind you that both the audio portion of this call and the slide visuals will be archived on our website at www.greatbatch.com and will be accessible for 30 days. Thanks everyone for joining us today.

Operator

Thank you for your participation. That concludes today’s conference. You may now disconnect. Have a great day.

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Source: Greatbatch Incorporated's CEO Discusses Q4 2012 Results - Earnings Call Transcript
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