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Greatbatch, Inc. (NYSE:GB)

Q3 2007 Earnings Call

November 6, 2007 8:30 am ET

Executives

Tony Borowicz - Treasurer and Director of IR

Thomas Hook - President and CEO

Tom Mazza - SVP and CFO

Analysts

Bob Hopkins - Lehman Brothers

Alex Arrow - Lazard Capital Markets

Jason Mills - Canaccord Adams

Tim Nelson - Piper Jaffray

Jeff Englander - Standard & Poor's

Operator

Welcome, everyone, to the third quarter of Greatbatch, IncorporatedEarnings Call. Before we begin, I would like to read the Safe Harbor Statement.This presentation and our press release contain forward-looking statementswithin the meaning of the Private Securities Litigation Reform Act of 1995, andinvolve a number of risk and uncertainties.

These risks and uncertainties are described in the company'sannual report and form 10-K. The statements are based upon GreatbatchIncorporated's current expectations and actual results could differ materiallyfrom those stated or implied. The company assumes no obligations to updateforward-looking information included in this conference call to reflect changedassumptions, the occurrence of unanticipated events or changes in futureoperating results, financial conditions or prospects.

I would now like to turn the call over to today's host,Treasurer and Director of Investor Relations, Mr. Tony Borowicz.

Tony Borowicz

Thank you, Lauren. And welcome to the third quarterGreatbatch earnings conference call. On the call today are Thomas Hook,President and Chief Executive Officer and Tom Mazza, Senior Vice President andChief Financial Officer.

In terms of today's agenda, Tom Hook will start with areview of the strategic rationale for each of the acquisitions made today andprovide our preliminary thoughts regarding our 2008 sales outlook. He will thenturn the call over to Tom Mazza to review our Q3 results and comment on our2007 guidance. We also thought it would be useful to provide a review of ourcapital structure to help you in modeling net interest expense for 2008.

Tom, will conclude with some commentary on the new FASBlegislation, which could change the method of accounting for interest expensefor the convertible notes that can be settled in cash. As we have done in thepast, we are including slide visuals to go along with this presentation andwhich you can access on our website. With that let me turn the call over to TomHook.

Thomas Hook

Thank you, Tony. As everyone is aware we have spent the lastthree years optimizing the operations of the company. We relocated 85% of ouroperations, in which we consolidated eight facilities with two of them inprogress, built two new world class manufacturing facilities and commencedconstruction on a new commercial power building. We have accomplished thiswhile simultaneously growing sales and our medical and commercial businesses atrates faster than our underlying markets.

Over this three year period our sales have increased by 15%compounded annually. Our strategic initiatives have been focused on creating aleverageable platform that can support further growth. We remain steadfast inour mission of being a leader in the comprehensive design and manufacture ofcustom component technologies for the commercial power and implantable medicalmarkets.

Our intent is to grow through innovation, targetedinvestments and strategic acquisitions to broaden our technology and marketbase. Earlier this year, we put in place over $400 million of financialcapacity to facilitate this growth. We commenced execution on our growthstrategy with the schedule completion of five acquisitions in the current year.These acquisitions are very synergistic with our model of being a leadingsupplier of innovative specialty niche products, supported with strongintellectual property. Each of these acquisitions has served to compliment ourexisting business model and add to our current capabilities.

Let me provide a brief review of how these acquisitionsstead our strategic direction. In April of this year we purchased BIOMEC, in Cleveland, Ohio.BIOMEC provides us with enhanced design service capability and extends ourcustomer reach from device concept to commercial manufacturing.

In addition, BIOMEC provides the establishment of importantclinical relationships and increase our neurostimulation market presence with aminority ownership in Intellect Medical.

In June 2007, we acquired Enpath Medical in Minneapolis, Minnesota.This acquisition provides a number of strategic benefits. First, it broadensour reach into the vascular market. Second, it expands our current productofferings to the existing Greatbatch customer base. Third, it complements ourcurrent CRM business and provides a platform to build on in the vascularneurostimulation markets. And fourth, it leverages the proprietary productportfolio, which covers neurostimulation, catheter and Venous Introducers technologies.

We've negotiated a series of three additional acquisitionsover the past week. First, we acquired IntelliSensing based in Buffalo, New York,which designs and manufacturers battery-powered wireless sensing solution.

These sensors are used in applications such as oil drillingand provide essential temperature and pressure measurements. This acquisitioncomplements our current oil and gas product offering and enables us to betterserve our customers through a more comprehensive solution. We believe, in thefuture, we will be able to leverage our newly acquired wireless sensorcapabilities in the medical market as well.

Next, we acquired Quan Emerteq based in Minneapolis, Minnesota.Quan Emerteq adds to our critical mass in the vascular market. In additionapproximately 50% of their sales come from CRM and neurostimulation products,which further strengthen our position and the current customers in thesemarkets.

In addition to the synergy with our base CRMneurostimulation and vascular markets, Quan Emerteq also provides for entryinto the high growth peripheral, coronary and neurovascular market space. Theaddition of Quan Emerteq's vascular products complements Enpath portfolio to createvalue for our customers and provides for diversification to Greatbatch'sbusiness base.

The combination of Quan Emerteq and Enpath portfolios willcreate the bases for our therapy delivery product line. Yesterday we announcedour fifth acquisition the asset purchase of EAC, based in Teterboro, New Jersey.EAC designs and manufactures rechargeable battery pack solutions for customersin the External Medical, Communication, Automatic Data Collection andEnvironmental and Safety markets. This acquisition is synergestic with ourstrategy of increased product offerings to our existing commercial customers.The addition of EAC enhances our primary cell product portfolio to includerechargeable batteries and design solutions. EAC complements the markets we currentlyserve, such as the military market and allows for expansion into the growing ExternalMedical market.

On a pro-forma basis, the addition of these acquisitionswill bring our 2007 annual revenue to approximately $360 million. For 2008, ourpreliminary sales outlook is as follows. We expect our CRM and neuro sales toincrease by approximately 5%. We expect our therapeutic delivery sales, whichconsist of Enpath and Quan Emerteq, to increase by 12% plus. We expect ourcommercial sales, including EAC and IntelliSensing to grow at approximately 7%.

In summary, we are anticipating our 2008 sales to beapproaching $400 million. It is an exciting time for Greatbatch and we lookforward to communicating our progress on the integration of these companies andthe value these acquisitions will create. With that, I will now turn the callover to Tom Mazza, who will review our results for the quarter.

Tom Mazza

Thanks, Tom. I will provide a brief overview of thisquarter's results. I will then talk briefly about our capital structure andfinally provide a comment relative to our 2007 guidance. In terms of our thirdquarter results, we reported sales of $79 million, an increase of 14% over lastyear. Sales totaling approximately $10 million from Enpath were included inthis quarter's results. Excluding these sales, second quarter's results wereconsistent with last year. As anticipated, sales for the quarter, in particularfeed-through sales, were impacted by inventory adjustments from CRM customers.

Our gross margin was consistent with last year's margin at37%. However, our cost of sales for the quarter includes $1.1 million ofinventory step-up amortization relative to the Enpath acquisition.

Excluding this amortization, our gross margin percentageimproved to 38%. As at the end of the quarter, there was no inventory step-upamortization remaining relative to the Enpath acquisition.

Operating income adjusted for the ongoing move-relatedexpenses, and also for the purchase accounting cost which was $9.4 million, adecrease of 9% over the same period last year.

Higher RD&E cost and higher SG&A cost offset theimproved gross profit generated. These costs increased primarily as a result ofincluding Enpath operations in the 2007 results.

As Tom Hook mentioned, I would like to remind everyone thatearly in 2007, we started putting into place the financing package to enablethe acquisitions we have been executing over the past several months. Ourfinancing activities included refinancing of $118 million of convertible debtand issuing new convertible debt of $80 million.

As a result of completed convertible offering in March 2007,we are left with a total of $250 million in convertible notes, $52 million inthe old convertible notes with an effective maturity date of June, 2010, and a$198 million in new convertible notes with an effective maturity of June, 2013.

Nearly, all of our annual interest expense of $8.4 millionrelates to the $250 million in convertible notes. As of the end of September,subsequent to spending $110 million for the Enpath and BIOMEC acquisitions,cash and short-term investments totaled over $115 million.

In the near-term, we anticipate spending approximately $75million for the following, $55 million Quan Emerteq acquisition, $12 million onEAC, and $4 million IntelliSensing, plus related expenses for each of these projects,which should leave us a cash balance of approximately $40 million.

The second piece to our financing package was establishmentof a new credit facility, which increased our revolving line of credit to $235million with an [according] feature that could take it to $335 million. Atpresent, none of this credit line is currently drawn.

We expect our cash flow from operations continue to bestrong, our operating cash flows combined with our financing package shouldallow for successful implementation of our aggressive growth strategy.

As many of you are aware, many of you have been reading thatthe FASB board has issued a Position Paper for comment, which could change themethod of accounting for interest expense for convertible notes that can becash settled. If adopted as proposed, the amount of interest expense recognizedfor book purposes relative to $198 million in new notes could be substantiallyincreased. This could require interest expense we recognized on a market rateinstead of the current 2.25% actually payable on the notes. It should be notedthat the two economics in cash flows would not be altered as a result of thischange in accounting.

Since we are in the process of attaining purchase priceaccounting valuations for the acquisitions announcement subsequent to quarterend, our guidance has not been updated to reflect the impact on our 2007results. Excluding the impacts of acquisitions we are reiterating our revenueguidance of $305 million to $315 million and our adjusted earnings per shareguidance of $1.37 to $1.41.

At this point, I would like to turn the call over tomoderator to facilitate questions and answers.

Question-and-AnswerSession

Operator

(Operator Instructions). And your first question comes fromthe line of Bob Hopkins with Lehman Brothers.

Bob Hopkins - LehmanBrothers

Thanks and good morning.

Thomas Hook

Good morning.

Bob Hopkins - LehmanBrothers

A couple of things Tom, first, how is it that all thesedeals are happening in such a close proximity to one another? It [states] methat typically M&A doesn't happen that way. Were these all keyed up and youguys just came to a decision that you wanted to do them all at once and thereforewere able to execute them in close proximity? Could you just give us a littlebit more of a history there?

Thomas Hook

Well, if roll the hands of time back to the beginning of theyear, we very consciously, and in conjunction with the management team and theBoard of Directors, rolled the strategic plan to grow the company following ourconsolidation initiatives we've been running for the past three years. And withthat we embarked on a targeted investment and acquisition strategy, bothmedically and commercially, to identify candidates for targeted acquisition.And we proceeded down the path to complete those in a timely manner.

We have made sure, from a scheduling standpoint, that we areaggressive to the schedule. We did not purposely try to target specific dates,but we had a mindset of wanting to be targeted and aggressive in closing, andhave been very open with the aggressiveness of the process with the Board ofDirectors, who garnered their support. And some of the timing of the deals hereover the past couple of weeks is -- they are not linked or consciously linkedin any way, but the timing worked out to be that they were coincidental overthe same week to week and a half.

Bob Hopkins - LehmanBrothers

Okay. And then as you guys were talking about 2008 guidance,it strikes me that you were talking about things in a little bit of a differentway than you have in the past. Are you guys going to be providing guidance alittle differently than you have previously, because you are talking about CRM& Neuro and therapy delivery and commercial. Are you still going to bewilling to breakdown the components of CRM as you have in the past?

Thomas Hook

I think what we're going to do is now that we've broughtsome more product lines on both commercially and medically, and I'll reiteratethat we continue to have an active interest in targeted investments andacquisitions in these segments. We're going to continue to be adding productlines in there.

And so we are going to shift to report in our principallines of business around CRM and neurostimulation, what we're calling therapydelivery now and also historically what we called commercial power. Or onto thecommercial banner which is somewhat broader than we have originally describedin terms of electrochemical cells, which will include primary and rechargeablebatteries in a lot broader range of end-market applications. But that's howwe're going to, as we move forward provide color on the segments.

Bob Hopkins - LehmanBrothers

So you won't be disclosing pacer batteries, ICD batteries,capacitor sales, things like that?

Thomas Hook

That's correct.

Bob Hopkins - LehmanBrothers

And then Tom, one thing you said earlier this year is thatyou expected Greatbatch to be exiting 2007 at a 20% operating margin. Withthese deals and the necessary investments required to build out R&D ofthese deals, how far has that pushed back or pushed out into the future nowthat 20%, is it a year, is it two years, can you give us some sense there?

Thomas Hook

Clearly in the base business that we have, the consolidationinitiatives will continue to pay, following the shutdown of the Columbia plant and thefinal relocation down to the Greatbatch Mexico facility. But you are correct,it's with the acquisition of the product lines and the expense that we aretaking on and also some strategic moves that we planned on implementing that wehave not highlighted yet in the press releases that we have made. We will haveto provide more of a walk from a go-forward standpoint.

You are correct that our long-term goals have not changed,we are reiterating these. We want to grow revenue faster than the market. Weare targeting 20% operating income and 15% ROIC though, but there will beobviously a difference between the base business, profitability and the productline acquisitions that we bring on. And we are not prepared to provide thatbreakout yet, but we will provide it, going forward, to give the timing of howwe see the strategy unfolding.

Bob Hopkins - LehmanBrothers

And then last question for me is, as we think about nextyear, because there are so many moving parts and I do appreciate the top linethoughts. But if we're thinking about '08 from an operating margin perspective,if we were thinking about something in the mid-teens, is that in the ballparkof what you guys are thinking about, or something below that?

Thomas Hook

It's probably premature to comment. I felt comfortableenough providing as we did last year, some general top-line view. We are stillin the process of -- we have not closed these transactions yet, we still havework to be done, and we are in the end of year process from the base business.So, it won't be until really the beginning of the year when we'll comment onour earnings guidance for 2008 and give more color to that. But we understandthat with all the moving parts that there is a desire to have that information,but we're not ready for it yet.

Bob Hopkins - LehmanBrothers

Okay. Thanks, guys.

Operator

And your next question comes from the line of Alex Arrowwith Lazard Capital Markets.

Alex Arrow - LazardCapital Markets

Thank you. On the Columbiaplant closure, do you have any more visibility on exact date that you're goingto shut the doors there, I mean the first quarter '08 is, I think, the lastthing you said?

Thomas Hook

Yes. I think on previous calls I've said that one of thechallenges of shutting down the plants 100% is that with regards to customers,we have to make sure each customer product is transferred completely.

And what results is that Columbiareally is already partially shutdown, so rather than a drop stop date, it tendsto be phased out over time and the vast majority of manufacturing has alreadybeen moved to Greatbatch, Mexico.

But there are what I would call, afew product lines that are straggling in the timeline that do extend into firstquarter of 2008, and it's really solely governed by when our customers can gaintheir regulatory approvals for us to stop manufacturing in Columbia.

And right now, where we stand aswe see three products that had moved into that window really kind of end of thelast few weeks of the year, first few weeks of next year, but largely itdepends on the regulatory review windows for the actual and there is testingresults that are reviewed for us to actually, so to speak, turn the lights off.

So we're optimistic really in thefirst quarter, but we'll support our customers until all the risks have been retiredand they are fully satisfied with their approvals to do the shut down.

Alex Arrow - LazardCapital Markets

Okay, so for our purposes for modeling the benefit of theoperating margins. Have we already begun to see some of that in your thirdquarter or is that really starting now in the fourth quarter with the partialshut down benefiting now or?

Tom Mazza

It's probably safe to say, you have seen an effect of abouthalf of the benefit, that we described back when we started the projects andthe remainder of the benefit is still yet to come.

Alex Arrow - LazardCapital Markets

And when you start to see that the other half of the benefitalready was in play during this third quarter you just had?

Thomas Hook

That's right, Alex.

Alex Arrow - LazardCapital Markets

Okay.

Thomas Hook

We think it's about half through similar to what wementioned last quarter. That's our expectations for '07 and '08 we wouldhopefully once we exit the building in the first quarter. We would achieve thebalance of the benefit.

Alex Arrow - LazardCapital Markets

And then the final or maybe the crowning piece of your plantchanging program over the last two years, I think of what you are doing withthe Electrochem division in mid '08. Can you give us the same kind of guidanceon that that you just did on this Columbiaplant and what are you doing with that facility and also now that you have got[telesensors] and anyone else is adding to the ECP what effect did that have onthat commitment?

Thomas Hook

The facilities we are building in the suburb of Boston and Raynham is inprogress. We actually, have already broken ground and they are putting in thefoundation and really the footers for the building. On the net it has gone verywell, the team has done a magnificent job getting that project started and theweather has cooperated. So, we are ahead of schedule. Our plan is to have theRaynham facility up and operational on this time next year or slightly earlier.Some of it is weather dependent, but we will continue to run the Canton, Massachusettsfacility, our current facility, until the Raynham facility is up andoperational. At that time, we'll move whatever final pieces of equipment arerequired to the new facility and we will exit and sell the existing Canton facility and thennot operate in that building any longer.

Alex Arrow - LazardCapital Markets

Okay, so the real benefit of operating margins from thathappens today. You close the Cantonfacility which then sounds like it won't be until early '09, if you have gotsome overlap there as you typically do, right?

Thomas Hook

That is correct and the other half of your question Alexthat related to the acquisitions, our first priority is to see the closure ofthe acquisition that we are still have in the commercial side, pending which isEAC, which we would plan sometime more by the end of month. And in the processof doing that, they have operations in Teterboro,New Jersey as well as in China. We will have the ability forus to drive more volume in those facilities, right now with Canton, we tend to be fairly constrained. Andit's a challenge, obviously, until we get into the new facility to be able totake advantage of opportunities in the market to sell. And with the addition ofEAC and rechargeable battery technology and the design work that they do, itopens up a new market opportunity for us to press volume through thosefacilities and capitalize on a very large market opportunity in commercialpower.

So we are excited about the opportunity to work with the EACmanagement team and although IntelliSensing is a smaller company, we areequally as excited with the IntelliSensing team to get into the wirelesssensing area and to grow our product line that's really at the beginning of avery large opportunity and it brings us closer to the end customers in themarketplace. For not only the batteries but also for the device that's used inthe market.

Alex Arrow - LazardCapital Markets

If we're modeling about the same benefit to operatingmargins from closing Canton as we are fromclosing Columbiais that about right or is it more robust?

Thomas Hook

I would say its bit more fair say to we've been calling outthe one-time expenses with regards to the move, so that there's visibility onwhat that cost is. But largely there is not a cost savings for the move to thenew facility in commercial power.

It's more a capacity expansion to allow us to grow thebusiness, which obviously in turn we hope drives the operating income from thetop line rather than from a cost savings standpoint. There is automation andproductivity efforts going on in the plant, which we also think will benefitbut they weren't the primary move for the new facility.

Alex Arrow - LazardCapital Markets

But they will result in lower cost of goods sold wouldn'tthey, if you're automating them?

Thomas Hook

It will drive the ability for us to enhance profits anddrive volume as well. You are correct.

Tom Mazza

It's more of a -- this is Tom, Alex. It's more of a longerrun play though. Clearly when we move the certain operations to Tier 1. Therewas a labor arbitrage that we benefited from immediately that was the primarydriver of the cost savings. On Cantonit's really going to be getting to fully utilize the automation into thatfacility. We basically were constrained in our own facility on how much wecould actually capacity -- we could actually get through the facility.

Alex Arrow - LazardCapital Markets

Okay. Thanks. That helped a lot. If I could ask anotherquestion, your Quan acquisition, you said 50% of it is in neurostim. Can youcomment on your ability to get the neurostim battery business that St. Judehas, and if you have already either gotten that or can you comment on whetheryou are planning to?

Thomas Hook

Let me clarify, 50% of Quan Emerteq's revenues are vascular,the other 50% are in CRM and neurostimulation combined, is terms of obviouslyspecific customers, we won't comment on. But in general, we have rechargeablebattery programs that we have been highly successful in the medical powerbusiness with neurostimulation customers. Quan Emerteq will only enhance ourability to provide those products to customers in that market segment. AndEAC's acquisition brings us the rechargeable battery product for both externalmedical, as well as the other commercial power market.

So, the two acquisitions have done a nice job of enhancingour position in those markets, and certainly by having Quan Emerteq's expertisein neurostimulation, it is a nice leverage point for continued success in therechargeable battery side of the equation for our medical power segment, whichwe have done a very nice job on the last year and half of winning some keyaccounts, even though that they'll go nameless at this point.

Alex Arrow - LazardCapital Markets

At this point, you mean you will name them at some point?

Thomas Hook

It's highly unlikely, unless as you know that there is arequirement that we would have to issue a disclosure for a major contract. But,as a matter of course, we are going to maintain our confidentiality withcurrent customers, as that has been of primary importance with every single oneof our customers, and I expect that to continue in to the future as well.

Alex Arrow - LazardCapital Markets

Okay. All right. Thank you.

Operator

And your next question comes from the line of Jason Mills withCanaccord Adams.

Jason Mills -Canaccord Adams

Hi guys, good morning.

Thomas Hook

Good morning.

Jason Mills -Canaccord Adams

I just wanted to ask a few questions, stemming off of someof Bob's questions. Most of the acquisitions you have announced this year, youtalked about at least lately the acquisitions being earnings neutral in 2007and 2008, so couple of questions. First, on the top-line, could you break itdown a little bit in more detail for us and help us understand what yourorganic number, organic growth rate would be or organic guidance would be,excluding all the acquisitions, maybe including Enpath if you want, because Ithink most of us have that stimulated into our model.

And the second question would be from Bob's question aboutgoing to 20% operating margins, at least in my model I didn't have been doingthat at least until 2009, 2010, so I don't know how we get to that level. Butwe do have this sort of in the upper teens in 2008. And given that you'vetalked about these acquisitions being earnings neutral, could you commentperhaps as to a sort of a range of operating margins we could expect, just onthe base business, assuming again that what you said is true about theacquisitions been earnings neutral in 2008.

Thomas Hook

Sure. Jason if you look in the presentation on page 11,that's about the extent of the information on outlook that we feel comfortableproviding at this point. CRM and neurostimulation areeffectively the base business that we've been in for Implantable MedicalComponents for some time and we're calling that outlook for sales next yeararound 5%.

Therapy delivery is effectively the Enpath and Quan Emerteqcombination. We've provided kind of the 12% plus target from an initialstandpoint of how we're looking at 2008.

Commercial, which is the base commercial business, plus thetwo acquisitions we highlighted on the call here, IntelliSensing, which is thesmall sub $1 million revenue company that we announced week or so ago. ThenEAC, which we said in the press release, is kind of $20 million to $23 millionin size. And we're guiding that that segment is going to be about 7%.

We are just not really in a position with the moving partshere at this stage and bringing on these product lines to provide a detailedguidance for 2008. We are going to wait till the first quarter conference callto do that. And we will give a little bit more color and visibility to our[walked] operating income strategically and then also where we'll be from aprofitability standpoint as we bake, but largely described correctly as abreakeven deal on these from an economic standpoint going forward.

But, clearly, the combination of all these deals is going toprovide us some opportunities for continued expansion in the revenues, andpotentially some opportunities for consolidation, although that's not theprimary purpose. But it is also allows to us to cross-leverage between thebusinesses more effectively. We, at this point, aren't going to describe whatthose are, but we will provide more color for them starting at the beginning ofthe year. And we'll also provide really a formal guidance for 2008 as wenormally would in the end of year conference call we do in the Februarytimeframe.

Jason Mills -Canaccord Adams

Yeah, I could certainly appreciate. You guys have manymoving parts, and as Bob mentioned they've all come together. And you mentionedcoincidentally here in a short period of time, so I can certainly appreciate. Iwould certainly know how they experienced personally stimulating acquisitionslet alone this many at one time. And I am sure you can appreciate at the sametime that your equity is being valued on 2008 numbers and we have to come upwith some sort of rational view into 2008 and most of us have that I think for2008 sort of before the [third] acquisition pay started, maybe included Enpath,and you have given some good guidance following Enpath.

So, I guess I am pushing you a little Tom, in understandingthe sort of the difficulty that you have. You can appreciate where we are andperhaps we could talk about it, sort of all things been equal. In anotherwords, Tom mentioned the potential step-up in interest expense so there is alot of moving parts there, which really are out of your control at this point.

But sort of all things been equal excluding that and perhapsassuming the earnings neutrality of the other acquisitions, it looks likeconsensus is somewhere in the let's call $1.60 to $1.75 range or sort ofoperating margins in the 16% to 18% range on what before expecting for a revenuebase sort of before these acquisitions. I suppose you may wanted to referagain, but I just started giving another shot, because there is a need for usto get our clients a better viewpoint or a better sort of rational thinkingabout 2008?

Thomas Hook

Sure, I think when you look at the base business that we'vehad and have been providing guidance since the beginning of the year [glidepath], although slightly affected by the delay in the shutdown of Columbia, is largely onplan. We've done a nice job of moving and doing the revenue growth at the sametime and producing results as predicted.

When you look at the acquisitions that we've done, the fivepieces that has been brought in thus far this year, we've driven with thoseacquisitions some incremental research development and engineering expense,because we want to capitalize on opportunities more aggressively. And we'vealso largely put those acquisitions into the company grouped Enpath and QuanEmerteq, obviously Quan Emerteq is not closed yet so that is still pending, andlargely we have to put together that business unit which is going to take someinvestment, and we have to obviously have EAC, IntelliSensing dovetail intowhat our existing commercial power business.

So there is some incremental expense there but not a greatdeal. And what will result is after some of that investment if there is goingto be any major products announced, we would certainly highlight those. Butlargely, we would be importing those product lines and running them as is andtrying to drive top line growth.

So beyond getting down into the deal synergies andinitiatives, it's not having closed these deals yet, it's we are at a littlebit of an awkward point and we have to move and get these closed and it'spremature to provide really anything below the revenue line in terms of coloruntil we kind of get to the juncture in which we can have the closing datepassed.

With our more detailed plans together with the existingmanagement teams that come over and then provide inputs that are backed withstrategy and plan between the two management teams on how to move forward. So Iunderstand the frustration and the challenge in situation that you're in.

But I think if you look at just the base business being onthe path that we've been executing on and these product lines that we verystrategically targeted and put into the business, although we are driving alittle bit of extra expense and we are not doing a dude deals in any of theseand it won't be a drag kind of earnings and it will largely give you ballpark,the answer that you are looking for.

Jason Mills -Canaccord Adams

Okay. So just sort of thank you for that. So just sort oftail that together, we had a little bit of incremental expense here in thethird quarter from the Enpath being fully integrated, perhaps the operatingmargins this quarter somewhat suppressed versus sort of normal levels from thatthan we have the facility closure now in the first quarter that should help,and then perhaps a bit of more organic growth, if you will, next year than wesaw this year. So, we should see, net-net operating margins expand and you willprovide more clarity into what type of expansion we should see, including allthe acquisitions on the fourth quarter call. Is that a fair assessment?

Thomas Hook

I think that's a very fair way to assess it, and I think youare looking at it correctly and I think that you are spot on with the macro,the micro obviously is where we can have a lot of, I can't have a lot ofdiscussion.

Tom Mazza

Jason, one thing we can say, I think, which people areunderestimating to a certain extent, maybe the level of the RD&E spend, Imean we've mentioned this a couple of times that we are increasing our RD&Espend, and clearly that was not fully, we have not hired all the people weneeded to hire in 2007 to make that come through. So that, we expect the runrate for RD&E expense to go up in the fourth quarter and after that.

Jason Mills -Canaccord Adams

That's helpful. By the same token, you have also talkedabout bringing the SG&A down, is that also on track?

Thomas Hook

Yes.

Tom Mazza

Yes. That's correct.

Jason Mills -Canaccord Adams

Okay. Thanks, guys.

Thomas Hook

You are welcome.

Operator

And your next question comes from the line of Tim Nelsonwith Piper Jaffray.

Tim Nelson - PiperJaffray

Hi. Maybe can you elaborate a little bit, when you did theEnpath deal, you talked about significant RD&E increase and marketingincrease to leverage those opportunities. How does the Quan Emerteq deal playinto that? Were you considering the Quan Emerteq deal, when you talked aboutthose increased expenses, or is Quan Emerteq on top of that?

Thomas Hook

Well, I think where we were at the Quan Emerteq is -- in running the business we never really, what I would say,plan or bank on a deal occurring. We've identified gaps in areas that we needcapability and we look at ways to fill those gaps through investments,acquisitions, as well as internal innovation.

And following the Enpath transaction, wehave squarely looked at internally funding research and development to innovateand get the technologies that we need to be more competitive in the Enpathproduct lines, and that in turn, obviously is what we're doing to win dealswith customers and to drive revenues.

The addition of Quan Emerteq will help fill some of those gaps quicker, but alsobecause of their technology base opens us up to do more work for our currentcustomer and Quan Emerteq's customers faster.

So we still plan although the detailshave not been ironed out, we still plan to do research and developmentexpansion at both Enpath and Quan Emerteq to fuelthat growth from the revenue side.

And obviously because of the nature ofprojects, we are acquiring development, testing and regulatory approval.Sometimes there can be a year to two-year separation from design or conceptthrough revenue generation.

But we think being aggressive on thatside is the correct way to look at the market and for us that leads withinnovative technologies that we can bring in property when we work with ourcustomers for product development. So they can be successful and us at the sametime.

So we see that with Enpath and QuanEmerteq together, and working together, we'll be able toleverage those opportunities more effectively. First and foremost, we have tocomplete the Quan Emerteq transaction, so that we canstart to enjoy the benefits of what those combined opportunities are.

Tim Nelson - PiperJaffray

Okay, Enpath itself when are you going tobe able to highlight some of the growth barriers there more fully for instancethe arterial vascular assays and some of the other projects. When are theygoing to coming forth in to the company?

ThomasHook

As the various projects reach fruition, clearlyEnpath, very strong in the venous introducer market. As, we have been fortunateenough to acquire Enpath, there is a very keen interest in the arterialvascular introducer market and all segments, for that there has been a lot ofgreat work that's been done by the Enpath teams to make progress in thosemarkets.

Although, we have not highlighted on anyareas that we are prepared to talk about from a strategic standpoint that is anabsolute central point of the Enpath strategy and now a central point of thetherapy delivery business strategy, that we will plan prominently in terms ofcommunication as we win those opportunities going forward and we highlight thegrowth opportunities.

So, I don't have an exact date that Iwould say that we are willing to commit to that we describe it, but definitelythey are within the strategy. We have been working the challenges and are veryconfident in our ability to perform and gain entry into those markets. Andthat's some of what's driving some of the internal research and development spendingis in order to more effectively go after that opportunity at Enpath.

Tim Nelson - PiperJaffray

And then a final question on the closingschedule of all these deals. Do you think there will be charges out in the Q1 '08,or do you think you'll be able to take care of them all in Q4?

TomMazza

We are working on the valuations now, wethink we can get the lion share done in Q4, but obviously I doubt they'll beall closed out by the end of the year. I think we'll still have some through upsinto the first quarter.

Tim Nelson - PiperJaffray

Okay, great. I will get back in queue thanks.

Operator

And your next question is a follow-upfrom the line of Alex Arrow with Lazard Capital Market.

AlexArrow - Lazard Capital Market

Thanks, the accounting change that youdescribed that could impact your guidance. You described it is cash settlementaccounting. I didn't quite understand how much of a magnitude that would make. Imean, if it's difference in cash settlement, and when you are booking revenues,should we take the amount of your receivables and estimate that that's going tobe the magnitude of the change when we are looking at. How that's actuallygoing to play out?

TomMazza

No, I’m sorry Alex. Now this has nothingto do with revenue recognition, it is only interest expense related and this hasnot been fully adopted yet, it's still out for comments by the FASB board. Whatwe're doing is highlighting it. We have our convertible $198 million of our$250 million convertible notes, and have net cash settlement provisions, whichmake it more debt like than equity like. Those types of securities, they referto as type C securities, are being looked at by the FASB board to cause peopleto go rather than the 200 quarter percentages, which we're currently paying onthem to consider what the market rate of interest would be. So potentially itbasically makes no changes in cash flows, no changes of things, but couldpotentially double the amount of interest expense on those particular items.

AlexArrow - Lazard Capital Market

On $198 million of principle items.

TomMazza

On a $198 million, correct. But, like Isaid, it absolutely makes no difference in the cash flows, it's anon-cash item and really the two economics are unchanged and this is not beenadopted yet. So, it's definitely going to be '08 before we see anything onthis.

Alex Arrow - Lazard Capital Market

And you are saying the 2.25% assumed interest rate and that$198 million could go up to or perhaps double that, perhaps 4.5?

Tom Mazza

Yeah, potentially double that. It's 2.25% plus thediscounts. So, it could potentially go to 6% to 8% potentially rather then the3%, 3.5% we currently have been experiencing.

Alex Arrow - Lazard Capital Market

Okay, all right. Thank you.

Tom Mazza

Once again it's a non-cash item.

Alex Arrow - Lazard Capital Market

All right. So, the total magnitude then, would only be about3% on $200 million or about $6 million of impact?

Tom Mazza

Potentially more, yeah, it's probably more. The definitionof how it gets calculated, I'm really hasn't to do it. It could be 3% to 5%more interest expense.

Alex Arrow - Lazard Capital Market

And this sort of affects every company that has…?

Tom Mazza

Every company that's got these, it's all the same. There is100s of them out there.

Alex Arrow - Lazard Capital Market

Okay. Thank you.

Operator

(Operator Instructions). And your next question comes fromthe line of Jeff Englander with Standard & Poor's.

Jeff Englander -Standard & Poor's

Good morning. Just a quick question, without talking aboutspecific customers, can you give any color on any fallout in the market ingeneral from the Sprint recall?

Thomas Hook

I couldn’t quite understand the question, Jeff, you arecutting in and out when you asked it?

Jeff Englander -Standard & Poor's

Let me try again. Without talking about specific customers,can you give any color on any fallout in the market in general from the SprintFidelis recall?

Thomas Hook

I think I would say that obviously any news such as thisprovides an overall chilling effect to the macro market. Certainly, from astandpoint of individual companies and individual product line there can besome short-term shifting. We don't have the visibility really to the degree, interms of the individual product lines to highlight any changes. But, I wouldsay just the macro effect is, any bad news tends to be a drag on our ability toget some lift from the market growth rate.

And I think that's a trend that has kind of hit us movinginto 2007. It's obviously been a drag all year with some of the recall movesthat's been out there before the year started and during the year. And largely,what we are doing is a very strong job at maintaining linkage with ourcustomers' production system, so that we are in tight coordination, up or down,to be as efficient as possible in working to support them with whateverhappens. That's our job and that's pretty much how we will continue to grow thecompany, despite kind of the tough market news which we all feel.

Jeff Englander -Standard & Poor's

Have you seen any increased pace, or increased activity onthe regulatory front, in terms of activities and either tracking components orleads or product development all the way through? There has been some talkabout additional regulatory measures to take earlier action on recalls of thiskind?

Thomas Hook

I think it's safe to say that a lot of our product lines, wedo not do regulatory filings on. We coordinate with our key customers toprovide information for them to do that. We do a very thorough job andhistorically have done an extremely thorough job at testing and providinginformation in very standardized time proven protocols, and with theacquisitions of Enpath in particular. And in BIOMEC, we have new regulation tothe company, because those product lines are regulated. I see for us that whilewe definitely are increasing our standards because of the nature of the work weare doing, we still have a very strong commitment to quality and reliability,and we do an extensive amount of testing.

I would say regulatory hurdles have been very large for usover the past two to three years because with the number of facility moves thatwe've been doing, we've been keying those moves to final customer regulatoryapprovals.

So it does feel like we're subjected to more regulation, butthe plant moves are really driving that. I couldn't really comment to say thatfrom our experience, in our product lines, we see that that regulatory is beingdriven more harshly because of the market recalls per se. I just don't havevisibility to that, ours are move-related in the acquisitions of product lineswe historically have not had.

Jeff Englander -Standard & Poor's

Great. Thanks very much.

Operator

And your next question comes from the line of Tim Nelsonwith Piper Jaffray.

Tim Nelson - PiperJaffray

Yeah. This is a follow-up to that question. Relative to allof the uncertainty in the CRM marketplace, relative to market shares and whatnot, and your own reconfiguration of your manufacturing facilities, do you havethe capacity to respond to short-term needs from any one customer that mighthave a quick increase in demand?

Thomas Hook

That's an excellent question and was a principal reasonbehind relocating our manufacturing facilities at the higher stabilityfacilities, just to get exactly at what you're talking about, Tim. We havespent a lot of time making sure we have the bandwidth, so to speak, toefficiently expand production based on what the customers' needs are, and havedone a great job in all of our operations to use lean manufacturingtechnologies as well as Six Sigma quality system to drive the same quality andreliability we've always had. But also worth the responsiveness of leanmanufacturing, and largely because of the success of the business units to dothese moves, get into new facilities, we have already been able to leveragesome nice short-term revenue opportunities that historically would have been alot more challenging, if maybe not possible at all. So, I think that's anessential point, of having the consolidation done as we can enjoy those nowgoing forward.

Tim Nelson - PiperJaffray

Great. That's all I had.

Thomas Hook

Thank you, Tim.

Operator

And that does conclude today's question-and-answer session.I would like to turn the call back over to Tony Borowicz for any closingremarks.

Tony Borowicz

Great. Thank you. Again I would like to remind everybodythat both the audio portion of this call and the slide visuals will be archivedon our website at www.Greatbatch.com for 90 days. As always I am here to help,so I appreciate the phone calls and help with the clarity of theseacquisitions. Thanks everyone.

Thomas Hook

Thank you.

Operator

And thank you for your participation. That does concludetoday's conference.

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