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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
|X| Annual Report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 for the fiscal year ended JUNE 30, 2002
OR
|_| Transition Report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the transition period from ________ to ________
Commission file number 000-49702
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MEDSOURCE TECHNOLOGIES, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 52-2094496
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
110 CHESHIRE LANE, SUITE 100
MINNEAPOLIS, MINNESOTA 55305
(Address of principal executive offices) (Zip Code)
(952) 807-1234
(Registrant's telephone number, including area code)
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SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED
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Common stock, par Nasdaq National Market
value $0.01 per share
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 |X| No: |_|
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K 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: |X|
State the aggregate market value of the voting stock held by non-affiliates
of the registrant. The aggregate market value shall be computed by reference to
the price at which the stock was sold, or the average bid and asked prices of
such stock, as of a specified date within 60 days prior to the date of filing:
$159,465,513 approximately, based on the closing sales price on the Nasdaq
National Market on September 5, 2002. Shares of common stock held by each
executive officer, director, holders of greater than 10% of the outstanding
common stock of the registrant and persons or entities known to the registrant
to be affiliates of the foregoing have been excluded in that such persons may be
deemed to be affiliates. This assumption regarding affiliate status is not
necessarily a conclusive determination for other purposes.
Indicate the number of shares outstanding of the registrant's common stock
as of September 5, 2002: 26,930,703 shares.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's proxy statement relating to the registrant's
2002 annual meeting of stockholders are incorporated by reference into Part III
of this Form 10-K.
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1
TABLE OF CONTENTS
PART I
Item 1. Business..............................................................3
Item 2. Properties...........................................................24
Item 3. Legal Proceedings....................................................24
Item 4. Submission of Matters to a Vote of Security Holders..................24
PART II
Item 5. Market for Registrant's Common Stock and Related Stockholder
Matters............................................................25
Item 6. Selected Financial Data.............................................27
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations..........................................28
Item 7A. Quantitative and Qualitative Disclosures about Market Risk..........40
Item 8. Financial Statements and Supplementary Data.........................41
Item 9. Changes in and Disagreements With Accountants on Accounting and
Financial Disclosure..............................................68
PART III
Item 10. Directors and Executive Officers of the Registrant..................68
Item 11. Executive Compensation..............................................68
Item 12. Security Ownership of Certain Beneficial Owners and Management......68
Item 13. Certain Relationships and Related Transactions......................68
Item 14. Controls and Procedures.............................................68
PART IV
Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K.....68
Signatures...................................................................75
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Unless the context otherwise requires, all references to "we," "us," "our,"
"MedSource" or the "Company" include MedSource Technologies, Inc. and our
subsidiaries.
FORWARD-LOOKING STATEMENTS
The following discussion contains "forward-looking statements" within the
meaning of Section 27A of the Securities Act of 1933 and Section 21E of the
Securities Exchange Act of 1934, as amended. In many cases, you can identify
forward-looking statements by terminology such as may," "will," "should,"
"expect," "plan," "anticipate," "believe," "estimate, ""predict," "intend,"
"potential" or "continue" or the negative of these terms or other comparable
terminology. These forward-looking statements involve risks and uncertainties.
Our actual results could differ materially from those indicated in these
statements as a result of certain factors, as more fully discussed below and
under the heading "risk factors" contained elsewhere in this Annual Report on
Form 10-K. Readers should not place undue reliance on any such forward-looking
statements, which are made pursuant to the Private Securities Litigation Reform
Act of 1995 and, as such, speak only as of the date made. We do not assume any
obligation to update the forward-looking statements after the date hereof.
PART I
ITEM 1. BUSINESS
We are an engineering and manufacturing services provider to the medical
device industry. Our customers include many of the largest medical device
companies in the world, such as Johnson & Johnson affiliates, Medtronic, and
Boston Scientific as well as other large and emerging medical device companies.
We provide engineering services, precision metal and plastic component
manufacturing, including milling, lathe turning, wire forming, stamping, plastic
tubing and injection molding, and product assembly services. In addition, we
provide supply chain management services, including the sourcing of components
that we do not manufacture internally, such as electronic circuitry, from third
party suppliers for the devices we assemble for our customers. Through these
products and services, we offer our customers a single source solution for their
device development and manufacturing needs, accelerated product development time
and reduced costs, allowing them to focus on their core competencies such as
research and sales and marketing. Examples of the medical devices and components
we manufacture for our customers include minimally invasive surgical
instruments, components for pacemakers and defibrillators, interventional
catheters and guidewires, and orthopedic implants such as hips and knees.
We began operations during March 1999 through the acquisition of seven
companies with complementary capabilities and subsequently broadened our
capabilities by completing five additional acquisitions through June 30, 2000.
Since our launch, we have focused our efforts on integrating and growing our
business and have made significant investments in our product design and
development capabilities, sales and marketing teams, operations, quality systems
information technology infrastructure to support that growth. As of June 30,
2002, we had multiple manufacturing facilities located in various states as well
as one located in Mexico with an aggregate of approximately 565,000 square feet
and approximately 1,450 employees.
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OUR PRODUCTS AND SERVICES
We offer our customers a broad range of products and services for their
medical engineering and manufacturing needs, including:
o ENGINEERING SERVICES. Our product design, design for
manufacturability, development and prototyping capabilities allow us
to participate throughout the entire product development process to
help reduce our customers' costs, accelerate product development times
and secure ongoing manufacturing relationships. Equipping our
facilities with rapid prototyping technologies and using these
technologies across multiple disciplines (e.g., machining and plastic
molding) is an important element of our product development services.
In providing these services, our internal application engineering
group and internal product design engineers provide our customers with
expertise in desired disciplines (e.g., electro-mechanical design).
o COMPONENT MANUFACTURING. Precision metal and plastics manufacturing
are core elements of our manufacturing capabilities. Our metal
manufacturing capabilities include milling, lathe turning, drilling,
grinding, polishing, lapping, laser cutting, sintering, wire forming,
stamping and precision metal injection manufacturing with materials as
diverse as stainless steel, titanium, and shape memory alloys. Trends
in the medical industry towards minimally-invasive surgical techniques
have made our micro-machining capabilities increasingly important.
These micro-machining capabilities include computer numerically
controlled, or CNC, multi-axis and Swiss-machining, as well as
electric discharge machining, or EDM. Our plastics manufacturing
capabilities include precision tubing (dip coating and extrusion),
molding (injection, insert and thermoforming) and machining, with a
wide range of engineering polymer materials.
o PRODUCT ASSEMBLY AND SUPPLY CHAIN MANAGEMENT SERVICES. Our product
assembly and supply chain management capabilities allow us to provide
customers with completed medical devices and subassemblies. Our
assembly capabilities include mechanical, electromechanical and
instrumentation assembly, as well as functional testing, inspection,
complex integration (with advanced materials), kitting and packaging.
We utilize our supply chain management services to source components
and services, either from internal operations or from third party
suppliers, to facilitate our customers need for streamlined inbound
logistics, as well as to provide vendor managed inventory services to
facilitate outbound logistics management for our customers. Our
assembly and supply chain management capabilities enable us to extend
our vertically integrated manufacturing business and further
distinguish us from suppliers with more limited capabilities.
We provide our products and services to each of the following primary
target markets:
o SURGICAL INSTRUMENTATION - devices and components for both the
minimally invasive and general surgery markets. Surgical devices are
typically produced from metal or plastic components and, in the case
of powered products, electronic components. We manufacture a variety
of surgical device and component products for our customers for wound
closure, endo-laparoscopy, electosurgery, arthoscopy, cardiac surgery,
ophthalmology, and urogynecology applications.
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o ELECTRO-MEDICAL IMPLANTS - devices and components for cardiac rhythm
management, or CRM, including pacemakers and defibrillators,
neurostimulation, hearing assist, cardiac assist and implantable drug
delivery markets. These products are high precision and are typically
produced from metal and plastic materials and electronic components.
We manufacture a variety of components and provide our customers with
laser welding services.
o INTERVENTIONAL - devices and components for the cardiology, radiology,
neuroradiology, vascular access and electrophysiology markets.
Interventional products are typically produced from a combination of
metal and plastic materials. We manufacture a variety of
interventional products for our customers, including precision
catheters, PTCA guidewires, electrophysiology catheters and distal
protection devices.
o ORTHOPEDICS - implants and instruments, for the reconstructive, spinal
implant and trauma markets. Orthopedic products are typically produced
from metal, plastic and ceramic materials. We manufacture a variety of
orthopedic implants for our customers, such as hips, knees, plates,
rods, screws and instruments for the placement of these implants.
OUR CUSTOMER SOLUTION
Our medical engineering and manufacturing capabilities enable our customers
to concentrate their internal resources on developing innovative technologies
and broadening their product offerings. The key components of our customer
solution are:
o PROVIDE A SINGLE SOURCE SOLUTION. By providing a broad range
of design, engineering, development, process technology,
manufacturing and assembly and supply chain management
capabilities, we offer our customers the ability to outsource
all or part of the production of a device to a single
provider. We have won several significant projects under which
we design, manufacture and package finished devices for
leading global medical device companies. In addition, we work
closely with smaller, emerging medical device companies as
their engineering and manufacturing partner.
o ACCELERATE PRODUCT DEVELOPMENT CYCLE TIME. Our experience in
design engineering and rapid prototyping positions us as a
valuable resource early in the new product development process
and enables critical processes to occur simultaneously, which
reduces the overall time-to-market. We employ over 130
engineers of whom approximately 40 are devoted to new product
introductions. Our engineers provide technical expertise to
transform our customers' concepts into finished devices that
can be efficiently manufactured on a commercial scale.
o PROVIDE QUALITY PRODUCTS AND PRACTICES. Quality is of the
highest importance to our customers due to the serious and
costly consequences of product failure. We operate our
facilities under a single integrated quality system. Each of
these facilities has been certified by independent
certification bodies to comply with the ISO 9001 quality
management standard and ISO 13485 medical device-specific
standard. We register each of our facilities with the FDA as a
contract manufacturing facility within one year of
acquisition, which establishes good manufacturing practice
requirements for product design, manufacture, management,
packaging, labeling, distribution and installation.
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o REDUCE COSTS FOR CUSTOMERS. We reduce our customers' total costs
associated with manufacturing by:
- designing for manufacturability;
- providing purchasing power on raw materials and machinery; and
- delivering manufacturing processes that lower costs through
increased efficiencies and continuous improvement efforts.
In addition, by offering a single source solution encompassing design,
engineering, manufacturing and other services such as assembly, sterilization
and packaging, we are able to lower the total cost of the products that we
deliver to our customers by designing optimal manufacturing processes and
reducing coordination costs, redundant engineering and overhead related to
quality and purchasing.
OUR STRATEGY
Our objective is to be the leading medical engineering and manufacturing
services provider to established, as well as emerging, medical device companies.
We expect to grow by focusing our sales and marketing teams on cross-selling our
design and engineering, manufacturing, assembly and supply chain management
services to both existing customers and new customers.
The key elements of our business strategy include:
o CONTINUE TO GROW WITHIN CORE MARKETS. We are focused on continued
growth within our four core markets: surgical instrumentation,
electro-medical implants, interventional products, and orthopedic
implants and instruments. We believe that these markets present a
promising growth opportunity, and we will continue to use a
market-focused sales strategy to further penetrate these markets. Our
existing customer relationships provide a foundation for future
growth, and we also look for opportunities to expand our scope of
services in these markets to provide an enhanced offering.
o STRENGTHEN OUR CUSTOMER RELATIONSHIPS BY COLLABORATING IN THE DESIGN
AND ENGINEERING OF NEW PRODUCTS. Working closely with customers in the
design and engineering of new products provides significant
opportunity to anticipate customers' needs and secure ongoing
manufacturing relationships. Increasingly, our customers provide only
functional or system performance specifications and request that we
provide much of the design and engineering specifications associated
with new products or product modifications. Our ability to provide
product design and development services enables us to secure long term
manufacturing relationships for finished devices, sub-assemblies and
components.
o DRIVE ADDITIONAL COMPONENT MANUFACTURING BUSINESS BY CONTINUING TO
EXPAND OUR DEVICE ASSEMBLY SERVICES. As we increase our assembly
business, we have the opportunity to also increase our manufacturing
of components because the assembler, or sub-assembler, of a device
typically controls the source of the components used in that device.
Our manufacturing capabilities position us well to produce many of the
components for the products we assemble.
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o FOCUS ON MANUFACTURING EXCELLENCE AND LEADING PROCESS TECHNOLOGIES. We
are committed to maintaining and improving our manufacturing processes
and services, which we believe has made us an efficient and high
quality medical engineering and manufacturing services provider. Our
manufacturing capabilities are supported by advanced manufacturing
process technologies and a strong culture of continuous improvement.
We are implementing a manufacturing strategy founded on the principles
of employee excellence, technology deployment, quality-driven
operations, an integrated low-cost manufacturing network, lean
manufacturing and customer satisfaction.
o PURSUE PRODUCT LINE TRANSFERS AND ACQUISITIONS OF CUSTOMERS'
MANUFACTURING ASSETS. We believe that the transfer of the
manufacturing responsibility for product lines and our acquisition of
customer manufacturing facilities will provide a vehicle for
substantial growth, as well as a mechanism to develop closer
relationships with leading medical device companies. These
transactions allow our customers to reduce capital employed and focus
resources on their core competencies, including research and sales and
marketing. During October 2001, we acquired a manufacturing assembly
facility for a product line from one of our major customers, a leading
medical device company. As part of this transaction, we signed a
multi-year supply agreement with this customer. We believe that
product line transfers and asset acquisitions of this kind are
becoming increasingly attractive to our customers.
o SELECTIVELY ACQUIRE NEW COMPANIES. We plan to make select acquisitions
of complementary medical engineering and manufacturing services
providers that bring desired capabilities, customers or geographic
coverage and either strengthen our position in our target markets or
provide us with a significant presence in a new market. We have an
experienced business development team focusing on acquisitions and
integrating these acquisitions into our operations. Since our
formation through the acquisition of seven companies in March 1999, we
have completed five additional acquisitions. We believe that our
ability to identify, close and integrate acquisitions is a competitive
advantage.
o OFFER FINANCIAL STABILITY. We believe the medical engineering and
manufacturing services industry includes over 4,000 companies, many of
which have annual revenues of less than $3.5 million in medical device
products. We believe our customers prefer working with large and well
capitalized medical engineering and manufacturing service providers
such as MedSource, who can ensure a stable supply of products and
services. Additionally, we have the financial capacity to allow us to
respond rapidly to our customers' requirements, such as higher
production volumes.
We intend to continue to build our brand name and deploy our sales and
marketing team, as well as to use our information technology infrastructure, to
further implement our strategy. In addition, we believe that our scale and
resources provide our customers with security and reliability.
SALES AND MARKETING
Our sales organization uses a team approach that integrates approximately
50 account managers, application engineering managers, customer support managers
and project managers. This team approach is designed to allow us to serve our
customers while providing a single point of contact through each phase of a
project. We believe this customer team approach distinguishes us by enabling us
to handle complex projects involving outsourcing of completed medical devices
from design to delivery.
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We have a group of applications engineering managers who are trained in our
various manufacturing technologies and processes. These managers assist our
customers' engineering groups and our sales professionals by specifying the best
manufacturing technology for a particular device or component. These managers
are supported by our process experts in each of the facilities who provide
functional expertise in each of the various manufacturing processes.
Our market development team provides strategic marketing support to our
sales and operations organizations. Market development helps to optimize the
allocation of our sales and application engineering resources across our four
key target markets and aligns their efforts with our manufacturing capabilities
and capacity. In addition, this team plays an important role in tailoring our
broad product and service offerings, including key account and market
strategies, pricing strategies, capability bundling strategies, marketing
campaigns and establishing strategic alliances with business partners in each of
our target markets.
We invest significant resources to develop the MedSource brand name by
participating in a number of medical related tradeshows, including medical
design and manufacturing shows in the United States and Europe and by
advertising our capabilities in a number of medical device and equipment
industry magazines and trade publications.
CUSTOMERS
We serve leading medical device companies as well as many other private and
public emerging medical device companies. During fiscal 2002, we had sales to
over 200 medical device companies, and our customers include eight of the
largest ten medical device companies (by revenues), including Johnson & Johnson
affiliates, Medtronic, and Boston Scientific. Johnson & Johnson affiliates and
Medtronic each accounted for more than 10% of our revenues during our year ended
June 30, 2002.
We work with our customers on a product by product basis and often work
with many different divisions of our largest customers. To date, most of our new
sales have been made to existing customers that, we believe, have typically
ordered new products from us based upon their previous satisfactory experiences.
The products that we manufacture are made to order based on the customer's
specifications and may be designed using our design and engineering services.
Our customers retain ownership of and the rights to their product's design while
we generally retain the rights to any of our proprietary manufacturing
processes.
INFORMATION TECHNOLOGY
We believe that our use of information technology will be a competitive
advantage. We are installing the Oracle 11i enterprise resource planning, or
ERP, system in all of our facilities. We successfully completed the
implementation at two sites and are in the process of installing the Oracle 11i
software and business processes at additional sites. We also installed the
Oracle integrated financial reporting system at all locations and generally
convert newly acquired facilities to this system within six months to one year.
In addition, we have standardized our computer aided design, or CAD, and
computer aided manufacturing, or CAM, software at our facilities.
We expect these systems to provide several key benefits to us, our
customers and our suppliers. The systems enable the sharing of customer,
supplier and engineering data across our company. We believe that this will
enable us to better understand and predict customer demand, take advantage of
economies of scale, provide greater flexibility to move product design between
sites and improve the accuracy of capturing and estimating our manufacturing and
engineering costs. In addition, the systems provide greater visibility into
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the operations of the enterprise through integrated financial and management
reporting capabilities. This system also benefits our suppliers by giving them
more accurate and timely information about our requirements. Overall, these
systems will provide the infrastructure that will enable us to provide
additional value to our customers through improved supply chain management
capability, reduced costs and accelerated product development.
MANUFACTURING
We combine advanced manufacturing technology, such as CAD/CAM, with
manufacturing techniques such as just-in-time manufacturing, total quality
management, or TQM, and the "MedSource business excellence program," which we
are implementing during fiscal 2003. Just-in-time manufacturing is a production
technique that minimizes work-in-process inventory and manufacturing cycle time
while enabling delivery of products to customers in the quantities and time
frame required. TQM is a management philosophy that seeks to impart high levels
of quality in every operation by setting quality objectives for every operation,
tracking performance against those objectives, identifying work flow and policy
changes required to achieve higher quality levels and committing executive
management to support changes required to deliver higher quality. The MedSource
business excellence program is a multi-year continuous improvement effort based
on the principles of Six Sigma and lean manufacturing.
To serve our market as a comprehensive manufacturing solution for medical
device companies, we address customers' requirements from a "quote-to-order,"
"order-to-fill" and an after sales service perspective. We have identified the
key processes within this structure and are currently implementing standard
operating procedures to create a seamless process within our organization
structure and with our customers. This approach to customer service is vital in
maintaining and developing customer relationships and differentiating us from
our competitors.
We intend to continue to offer our customers advanced manufacturing process
technologies, which currently include computer integrated manufacturing, CNC
machines, laser cutting, injection molding, stamping, dip coating, extruding and
our patented precision metal injection manufacturing. Our flexible manufacturing
capability allows us to efficiently produce both high-volume products and
low-volume products. Our investment in new equipment will position us to
continue to provide efficient and flexible medical engineering and manufacturing
services to medical device companies.
We operate a multi-facility manufacturing network strategically located
throughout the United States and in Mexico. During June 2001, we completed a
review of our manufacturing operations and support functions. Based on our
evaluation of the unique and common characteristics of our various facilities,
we determined that we could achieve over-all cost savings by closing three of
the facilities, thus improving capacity utilization and efficiency of the
remaining facilities. Criteria in our evaluation included current capacity
utilization, uniqueness of manufacturing capabilities, current operating costs,
difficulty and cost associated with relocation and recertification of key
equipment, and customer supply requirements. We sold our facilities in
Pittsfield and East Longmeadow, Massachusetts during our fiscal year ended June
30, 2002. In addition, we initiated the shutdown of our facility in Danbury,
Connecticut during our fiscal year ended June 30, 2002, which we expect to be
closed by February 2003. In conjunction with our plant rationalization, we
initiated the expansion of our manufacturing facilities located in Corry,
Pennsylvania, Brooklyn Park, Minnesota, Laconia, New Hampshire, and Navojoa,
Mexico to accommodate the transfer of selected products and product lines for
specific medical companies.
Overall, we have not experienced any significant capacity constraints
within our manufacturing network. We expect that we have adequate capacity to
meet future growth requirements.
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QUALITY
We believe that product quality is a critical success factor in the medical
engineering and manufacturing services market. We strive for continuous
improvement of our processes and have adopted a number of quality improvement
and measurement techniques to monitor our performance.
We operate our facilities under a single integrated quality system and
comply with the ISO 9001 quality management standard and the ISO 13485 medical
device-specific quality management standard, and they are certified to such
standards by independent certification bodies. The ISO 9001 standard specifies
quality system requirements for product design and production. ISO 13485
establishes additional, more specific requirements for medical devices in
particular. Newly acquired facilities are promptly brought into conformity with
our integrated quality system, generally within six months to one year. We
believe our quality system also complies with FDA quality system regulations
with respect to all of our products, services and internal processes. With our
integrated company-wide quality system in place, customers are able to audit
select MedSource facilities knowing that every facility that has been integrated
into the system is subject to the same quality system and process controls, as
applicable to the facility's particular operations. This system can provide
significant time and cost savings for customers, as well as reduced risk of
non-conforming products resulting in customer dissatisfaction, product recall or
patient adverse events. The FDA quality system regulation establishes good
manufacturing practice requirements for product design, manufacture, management,
packaging, labeling, distribution and installation. We register each of our
facilities with the FDA as a contract manufacturing facility within one year of
acquisition.
SUPPLY ARRANGEMENTS
We have established relationships with many of our materials providers.
However, most of the raw materials that are used in our products are subject to
fluctuations in market price. In particular, the prices of stainless steel,
titanium and platinum have historically fluctuated, and the prices that we pay
for these materials, and, in some cases, their availability, are dependent upon
general market conditions. In the short term, we generally cannot pass these
cost increases on to our customers.
Our current internal manufacturing and engineering capabilities do not
include all elements that are required to satisfy all of our customers'
requirements. When we do not possess the appropriate manufacturing or
engineering capabilities internally, such as electronic circuitry manufacturing,
we subcontract with third party providers for the necessary components or
services. As we provide our customers with a fully integrated supply chain
solution, we will continue to rely on third party suppliers, subcontractors and
other outside sources for components or services that we cannot provide through
our internal resources.
To date we have not experienced any difficulty obtaining necessary raw
materials or subcontractor services.
INTELLECTUAL PROPERTY
The products that we manufacture are made to order based on the customer's
specifications and may be designed using our design and engineering services.
Our customers retain ownership of and the rights to their product's design while
we generally retain the rights to any of our proprietary manufacturing
processes. We generally rely on know-how to manufacture products to our
customers' specifications.
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We use a combination of patents, licenses and trade secrets to establish
and protect the proprietary rights to our technologies and products used in
connection with precision metal injection manufacturing processes, guidewire
technology, plastic tubing manufacturing processes and surgical instrumentation
manufacturing processes.
We own an aggregate of two United States and one foreign patents in
connection with our precision metal injection manufacturing processes. We also
have five foreign pending patent applications at various stages of approval. The
United States patents relating to our precision metal injection manufacturing
processes expire in 2015, and our foreign patent expires in 2016. In addition,
we are a party to several license agreements with third parties pursuant to
which we have obtained, on varying terms, non-exclusive rights to patents held
by third parties in connection with precision metal injection manufacturing
technology.
We own an aggregate of nine United States patents that we use in connection
with the manufacture of our guidewire products. We also have one United States
and six foreign pending patent applications at various stages of approval. The
United States patents relating to our guidewire products expire between 2010 and
2015.
We own an aggregate of seven other United States patents that we use in
connection with other manufacturing processes. We also have one United States
pending patent application. The United States patents relating to these other
manufacturing processes expire between 2014 and 2019.
We do not believe that the expiration of any of our patents or the
termination of any of our licenses would have a material effect on our business.
It is our policy to require all employees, consultants and other parties 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
MedSource.
We have an agreement with one of our former employees that provides him
with an exclusive license to our precision metal injection technology for use
only outside the medical industry. This license is royalty-free. In addition, we
must obtain the former employee's consent if we desire to sublicense or exploit
this technology for non-medical applications.
COMPETITION
We compete with different companies depending on the type of product or
service offered or the geographic area served. Our management believes that the
primary basis of competition in our targeted markets is existing customer
relationships, as well as reputation, quality, delivery, responsiveness, breadth
of capabilities and price.
We have as customers many of the leading medical device companies in our
four target markets. In addition, we believe that our integrated quality system
and manufacturing network allow us to compete favorably in terms of breadth of
product and service offerings, quality, responsiveness and price. We are not
aware of a single competitor that operates in all of our target markets or
offers the same range of products and services that we offer. To remain
competitive, we must continue to provide a single source solution, accelerate
product development time, provide quality products and practices, reduce costs
for our customers and offer financial stability.
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Our existing or potential competitors include the internal operations of
medical device companies themselves and other medical engineering and
manufacturing services providers. Other medical engineering and manufacturing
services providers currently compete in some but not all of the same target
markets that we do. We believe that the medical engineering and manufacturing
services industry is highly fragmented with over 4,000 companies that have
limited manufacturing capabilities and limited sales and marketing expertise.
Many of these 4,000 companies have less than $3.5 million in annual revenues
from medical device companies.
GOVERNMENT REGULATION
We are a medical engineering and manufacturing services provider. Some of
the products and components of products that we manufacture may be considered
finished medical devices, and the manufacturing processes used in the production
of finished medical devices are subject to FDA inspection and assessment, and
must comply with the FDA quality system regulation. The FDA quality system
regulation establishes good manufacturing practice requirements for product
design, manufacture, management, packaging, labeling, distribution, and
installation for medical devices. Additional FDA regulations impose requirements
for record keeping, reporting, facility and product registration, product safety
and effectiveness, and product tracking. Failure to comply with these regulatory
requirements may result in civil and criminal enforcement actions, including
financial penalties, seizures, injunctions and other measures. Our products must
also comply with state and foreign requirements. Also, in order to comply with
regulatory requirements, our customers may wish to audit our operations to
evaluate our quality systems. Accordingly, we routinely permit audits by our
customers.
In addition, the FDA and state and foreign governmental agencies regulate
many of our customers' products as medical devices. FDA approval is required for
those products prior to commercialization in the United States, and approval of
regulatory authorities in other countries may also be required prior to
commercialization in those jurisdictions. Moreover, in the event that we build
or acquire additional facilities outside the United States, we will be subject
to the medical device manufacturing regulations of those countries. Some other
countries may rely upon compliance with United States regulations or upon ISO
certification as sufficient to satisfy certain of their own regulatory
requirements for a product or the manufacturing process for a product.
Other than as described in the prior two paragraphs, our business is not
subject to direct governmental regulation other than the laws and regulations
generally applicable to businesses in the jurisdictions in which we operate,
including those 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 activities involve the controlled use of, and some of our products
contain, small amounts of hazardous materials. Liabilities associated with
hazardous material releases arise principally under the Clean Water Act, the
Clean Air Act, the Resource Conservation and Recovery Act and the Comprehensive
Environmental Response, Compensation and Liability Act and analogous state laws
which impose strict, joint and several liability 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 company
facility or any off-site location. We cannot assure you, however, that we will
not be subject to such environmental liabilities in the future as a result of
historic or current operations.
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RISK FACTORS
You should carefully consider the following risk factors together with all
of the other information contained in this Annual Report on Form 10-K before
making an investment decision with respect to our common stock. Any of the
following risks, as well as other risks and uncertainties described in this
Annual Report on Form 10-K, could harm our business, financial condition and
results of operations and could adversely affect the value of our common stock.
RISKS RELATED TO OUR BUSINESS
ADVERSE TRENDS OR BUSINESS CONDITIONS AFFECTING THE MEDICAL DEVICE INDUSTRY OR
OUR CUSTOMERS COULD HARM OUR OPERATING RESULTS.
Our business depends on trends in the medical device industry, which is
subject to rapid technological changes, short product life-cycles, frequent new
product introductions and evolving industry standards, as well as economic
cycles. Conditions or technological innovations adversely affecting any of our
major customers, the medical device industry in general or the surgical
instrumentation, electro-medical implant, interventional and orthopedic markets
we target in particular, could adversely affect our operating results. For
example, the discovery and market acceptance of non-device treatments for
specific medical conditions could make the medical devices used to treat these
conditions obsolete. In addition, the products and services that we provide to
our customers generally are specific to a particular medical device being
developed or marketed by them. If a customer's medical device does not gain or
maintain market acceptance because of competing medical devices or treatments,
changing market conditions, unfavorable regulatory actions or other reasons, our
revenues from that customer and our results of operations would be adversely
affected.
BECAUSE A SIGNIFICANT PORTION OF OUR REVENUE COMES FROM A FEW LARGE CUSTOMERS,
ANY DECREASE IN SALES TO THESE CUSTOMERS COULD HARM OUR OPERATING RESULTS.
The medical device industry is concentrated, with relatively few companies
accounting for a large percentage of sales in the surgical instrumentation,
electro-medical implant, interventional and orthopedic markets that we target.
Accordingly, our revenue and profitability are highly dependent on our
relationships with a limited number of large medical device companies. In fiscal
2002, our top four customers accounted for approximately 52% of our revenues,
with one customer accounting for 25% of our revenues and another accounting for
12% of our revenues. In fiscal 2001, our top four customers accounted for
approximately 41% of our revenues, with one customer accounting for 18% of our
revenues and another accounting for 12% of our revenues. In fiscal 2000, our top
four customers accounted for approximately 42% of our revenues, with one
customer accounting for 16% of our revenues and another accounting for 14% of
our revenues. We provide products and services to several different divisions of
our top customers. We are likely to continue to experience a high degree of
customer concentration, particularly if there is further consolidation within
the medical device industry. We cannot assure you that there will not be a loss
or reduction in business from one or more of our major customers. In addition,
we cannot assure you that revenues from customers that have accounted for
significant revenues in the past, either individually or as a group, will reach
or exceed historical levels in any future period. The loss or a significant
reduction of business from any of our major customers would adversely affect our
results of operations.
OUR GROWTH MAY BE SLOW IF THE TREND TOWARD OUTSOURCING BY MEDICAL DEVICE
COMPANIES DOES NOT CONTINUE OR IF OUR CUSTOMERS DECIDE TO MANUFACTURE INTERNALLY
PRODUCTS THAT WE CURRENTLY PROVIDE.
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To date, we have benefited from the growing trend of medical device
companies to outsource all or a portion of their engineering, product
development, manufacturing and assembly requirements. Although we expect medical
device companies to increase their outsourcing of these requirements in the
future, we cannot be certain that this trend will continue or that, if it
continues, we will benefit from it. Even if the outsourcing trend in the
industry continues, one or more of our principal customers could decide to
decrease its reliance on or use of outsourcing, which would reduce our customer
base.
Also, as part of our growth strategy, we are seeking to accept full supply
chain management and manufacturing responsibility for selected product lines
from our customers and, in some cases, to acquire the related manufacturing
assets from these customers. While we believe that product line transfers and
asset acquisitions of this kind are becoming increasingly attractive to our
customers, we have only consummated one of these transactions to date. We cannot
be sure that opportunities of this nature will be available, especially if the
trend toward outsourcing does not continue.
WE HAVE FEW CONTRACTS WITH OUR CUSTOMERS THAT ENSURE US FUTURE BUSINESS, AND
CANCELLATIONS, REDUCTIONS OR DELAYS IN CUSTOMER ORDERS COULD HARM OUR OPERATING
RESULTS.
Generally, we work with our customers on a project-by-project or purchase
order-by-purchase order basis, without any long term revenue, volume or other
commitments to ensure us future business. Customer orders typically may be
cancelled and volume levels may be changed or delayed at any time. We cannot
assure you that we can replace delayed, cancelled or reduced projects with new
business in a timely manner. Also, we may not fully recover our costs in
connection with cancelled, delayed or reduced projects.
OUR QUARTERLY OPERATING RESULTS FLUCTUATE SIGNIFICANTLY, AND IF WE FAIL TO MEET
THE EXPECTATIONS OF SECURITIES ANALYSTS OR INVESTORS, OUR STOCK PRICE MAY
DECREASE.
Our operating results have fluctuated in the past from quarter to quarter
and are likely to fluctuate significantly in the future due to a variety of
factors, including:
o the timing of actual customer orders and the accuracy of our
customers' forecasts of future production requirements;
o the introduction and market acceptance of our customers' new products
and changes in demand for our customers' existing products;
o changes in the relative portion of our revenue represented by our
various products, services and customers, including the relative mix
of our business across our target markets;
o changes in competitive or economic conditions generally or in our
customers' markets;
o changes in availability or costs of raw materials or supplies; and
o demand for our products and services, which, during our limited
operating history, has been higher than average during the last
quarter of our fiscal year and lower than average during the first
quarter of our fiscal year.
For all these reasons, our quarterly results are difficult to predict and
should not be relied upon as an indication of future performance. Fluctuations
in our quarterly results could result in our failing to meet the
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expectations of the investment community, which could adversely affect the
market price of our common stock even if those fluctuations are unrelated to our
long term operating performance or prospects.
RISKS RELATING TO ACQUISITIONS, INCLUDING FAILURE TO SUCCESSFULLY MANAGE OUR
GROWTH AND INTEGRATE ACQUIRED BUSINESSES, MAY ADVERSELY AFFECT OUR FINANCIAL
PERFORMANCE.
We were formed in March 1999 through the acquisition of seven separate
businesses. In January 2000, we acquired the business of Tenax Corporation; in
February 2000, we acquired Apex Engineering; in May 2000, we acquired Thermat
Precision Technology, Inc.; in December 2000, we acquired ACT Medical, Inc.; and
in January 2002, we acquired HV Technologies. As a result, we are experiencing
rapid growth that could strain our managerial and other resources.
We also plan to seek to make select acquisitions of complementary medical
engineering and manufacturing services providers that bring desired
capabilities, customers or geographic coverage and either strengthen our
position in our target markets or provide us with a significant presence in a
new market. The risks we may encounter in pursuing these acquisitions include
expenses associated with, and difficulties in identifying, potential targets,
costs associated with acquisitions we ultimately are unable to complete and
higher prices for acquired companies due to competition for attractive targets.
Completing acquisitions also may result in dilution to our existing stockholders
and may require us to seek additional capital, if available, including by
increasing our indebtedness.
Once acquired, the successful integration and operation of a business
requires communication and cooperation among key managers, the transition of
customer relationships, the management of ongoing projects of acquired companies
and the management of new projects across previously independent facilities.
Acquisitions also involve a number of other risks, including:
o the diversion of management attention;
o difficulties in integrating the operations and products of an acquired
business or in realizing projected operational results, synergies and
cost savings;
o inaccurate assessments of undisclosed liabilities; and
o potential loss of key customers or employees of the acquired
businesses.
Customer satisfaction or performance problems with an acquired company
could also harm our reputation as a whole, and any acquired business could
significantly underperform relative to our expectations. Because five of our
acquisitions were completed in the past 36 months, we are currently facing all
of these challenges and our ability to meet them over the long term has not been
established. For all these reasons, our pursuit of an overall acquisition
strategy or any individual completed, pending or future acquisition may
adversely affect the realization of our strategic goals.
In addition, while we anticipate cost savings, operating efficiencies and
other synergies as a result of our acquisitions, the consolidation of functions
and the integration of departments, systems and procedures present significant
management challenges. We cannot assure you that we will:
o successfully accomplish those actions as rapidly as anticipated;
o achieve the cost savings and efficiencies that we expect from our
acquisitions;
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o successfully manage the integration of new locations or acquired
operations;
o fully use new capacity; or
o enhance our business as a result of any past or future acquisition,
including those mentioned above.
The acquisition of new operations can also introduce new types of risks to
our business. For example, new acquisitions may require greater effort to
address United States Food and Drug Administration, or FDA, regulation or
similar foreign regulation.
WE MAY FACE PRODUCT LIABILITY CLAIMS THAT COULD RESULT IN COSTLY LITIGATION AND
DIVERT THE ATTENTION OF OUR MANAGEMENT.
We may be exposed to product liability claims and product recalls,
including those which may arise from misuse or malfunction of, or design flaws
in, our customers' products, whether or not such problems directly relate to the
products and services we have provided. Generally, we do not at this time have
agreements in place with our customers governing liability for product liability
and recalls. Even where we have agreements with customers that contain
provisions attempting to limit our damages, these provisions may not be
enforceable or may otherwise fail to protect us from liability. Product
liability claims or product recalls, regardless of their ultimate outcome, could
require us to spend significant time and money in litigation or require us to
pay significant damages. The occurrence of product liability claims or product
recalls could cause our results of operations to be adversely affected.
We carry $20.0 million of product liability insurance coverage, which is
limited in scope. Our management believes that our insurance coverage is
adequate given the risks we face. We cannot assure you that we will be able to
maintain this insurance or to do so at reasonable cost and on reasonable terms.
We also cannot assure you that this insurance will be adequate to protect us
against a product liability claim that may arise in the future.
IF WE EXPERIENCE DECREASING PRICES FOR OUR PRODUCTS AND SERVICES AND WE ARE
UNABLE TO REDUCE OUR EXPENSES, OUR RESULTS OF OPERATIONS WILL SUFFER.
We may experience decreasing prices for the products and services we offer
due to:
o pricing pressure experienced by our customers from managed care
organizations and other third-party payors;
o increased market power of our customers as the medical device industry
consolidates; and
o increased competition among medical engineering and manufacturing
services providers.
If the prices for our products and services decrease for whatever reason
and we are unable to reduce our expenses, our results of operations will be
adversely affected.
IF OUR MANUFACTURING PROCESSES, PRODUCTS AND SERVICES FAIL TO MEET THE HIGHEST
QUALITY STANDARDS, OUR REPUTATION COULD BE DAMAGED AND OUR RESULTS OF OPERATIONS
COULD BE HARMED.
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Quality is extremely important to us and our customers due to the serious
and costly consequences of product failure. Our success depends in part on our
ability to manufacture to exact design specifications precision engineered
plastic and metal components, subassemblies and finished devices from multiple
materials. If our products and services fail to meet the highest quality
standards or fail to adapt to evolution in those standards, our reputation could
be harmed and our competitive position could be damaged. In addition, our
quality systems and certifications are critical to the marketing success of our
products and services. If we fail to maintain our quality systems or
certifications, our reputation could be damaged and our results of operations
could be adversely affected.
COMPETITION FROM OUR CUSTOMERS' INTERNAL OPERATIONS AS WELL AS FROM OTHER
MEDICAL ENGINEERING AND MANUFACTURING SERVICE PROVIDERS COULD RESULT IN DOWNWARD
PRESSURE ON PRICES, FEWER NEW BUSINESS OPPORTUNITIES AND LOSS OF MARKET SHARE.
Our current and prospective customers often evaluate our product and
service offerings against the merits of internal design and engineering,
manufacturing, assembly and supply chain management. In this sense, we often
compete for business with the internal resources of our customers, many of whom
are leading medical device companies with long-standing internal design and
engineering, manufacturing and supply chain management capabilities. Our success
therefore depends heavily upon our ability to demonstrate and deliver cost
savings and accelerated time to market for our customers as compared to use of
internal resources, without loss of quality, confidentiality or reliability.
In addition, we believe the medical engineering and manufacturing services
industry is very competitive and fragmented with over 4,000 companies, many of
which are specialized. To the extent that medical device companies seek to
outsource more of the design, prototyping and manufacturing of their products,
we will face increasing competitive pressures to broaden our capabilities and
grow our business in order to maintain our competitive position, and we may
encounter competition from other companies with design, technological and
manufacturing capabilities similar or superior to ours.
IF WE FAIL TO COMPLY WITH THE COVENANTS UNDER OUR SENIOR CREDIT FACILITY OR
OTHER INDEBTEDNESS, ARE UNABLE TO PAY INTEREST AND PRINCIPAL WHEN DUE OR
EXPERIENCE INCREASED INTEREST COSTS, OUR OPERATING RESULTS AND FINANCIAL
CONDITION COULD BE HARMED.
Failure to comply with the covenants under our senior credit facility or
with respect to any future indebtedness may result in an event of default. If an
event of default occurs and is not cured or waived, substantially all of our
indebtedness could become immediately due and payable. The ability to pay
interest and principal on our debt obligations will depend on our future
operating performance, which will be affected by prevailing economic conditions
and financial, business and other factors, many of which are beyond our control.
There can be no assurance that our operations will generate earnings in any
future period sufficient to cover the fixed charges. In addition, we may
experience variable financial results as a consequence of floating interest rate
debt. As interest rates fluctuate, we may experience increases in interest
expense, which may materially affect financial results.
IF WE CANNOT OBTAIN THE ADDITIONAL CAPITAL REQUIRED TO FUND OUR OPERATIONS AND
FINANCE ACQUISITIONS ON FAVORABLE TERMS OR AT ALL, WE MAY HAVE TO DELAY OR
ABANDON OUR GROWTH STRATEGY.
Our growth strategy will require additional capital for, among other
purposes, completing acquisitions of companies and customers' product lines and
manufacturing assets, integrating acquired companies and assets, acquiring new
equipment and maintaining the condition of existing equipment. If cash
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generated internally is insufficient to fund capital requirements, if funds are
not available under our senior credit facility, or if we desire to make
acquisitions, we will require additional debt or equity financing. Adequate
financing may not be available or, if available, may not be available on terms
satisfactory to us. If we raise additional capital by issuing equity or
convertible debt securities, the issuances may dilute the share ownership of the
existing investors. In addition, we may grant future investors rights that are
superior to those of our existing investors. If we fail to obtain sufficient
additional capital in the future, we could be forced to curtail our growth
strategy by reducing or delaying capital expenditures and acquisitions, selling
assets or restructuring or refinancing our indebtedness.
OUR GROWTH MAY BE LIMITED AND OUR COMPETITIVE POSITION MAY BE HARMED IF WE ARE
UNABLE TO IDENTIFY AND CONSUMMATE FUTURE ACQUISITIONS.
Our continued growth may depend on our ability to identify and acquire on
acceptable terms companies that complement or enhance our business. 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 incomplete acquisitions and higher
prices for acquired companies because of competition for attractive acquisition
targets. If we fail to acquire additional capabilities, we may be unable to
compete with other companies in our industry that are able to provide more
complete outsourcing capabilities and services to medical device companies,
which could adversely affect our results of operations.
A SUBSTANTIAL AMOUNT OF OUR ASSETS REPRESENTS GOODWILL, AND OUR NET INCOME WILL
BE REDUCED IF OUR GOODWILL BECOMES IMPAIRED.
As of June 30, 2002, goodwill represented approximately $113 million, or
46%, of our total assets. Goodwill is generated in our acquisitions when the
cost of an acquisition exceeds the fair value of the net tangible and
identifiable intangible assets we acquire. We historically had recorded goodwill
on our balance sheet and amortized it, generally on a straight-line basis over
twenty years. We adopted Statement of Financial Accounting Standard, or SFAS,
No. 142, Goodwill and Other Intangible Assets, effective July 1, 2001. Goodwill
is no longer amortized under generally accepted accounting principles as a
result of SFAS No. 142. Instead, goodwill is subject to an impairment analysis
at least annually based on the fair value of the reporting unit. We could be
required to recognize reductions in our net income caused by the write-down of
goodwill, if impaired, that if significant could materially and adversely affect
our results of operations. For example, in June 2001 we recorded an impairment
charge of $3.6 million related to residual goodwill allocated to the three
businesses targeted for restructuring. The residual goodwill was impaired by the
planned closure of the facilities related to those businesses.
WE DEPEND ON OUTSIDE SUPPLIERS AND SUBCONTRACTORS, AND OUR PRODUCTION AND
REPUTATION COULD BE HARMED IF THEY ARE UNABLE TO MEET OUR VOLUME AND QUALITY
REQUIREMENTS AND ALTERNATIVE SOURCES ARE NOT AVAILABLE.
Our current capabilities do not include all elements that are required to
satisfy all of our customers' requirements. As we increasingly position
ourselves to provide our customers with a single source solution, we may rely
increasingly on third party suppliers, subcontractors and other outside sources
for components or services. Manufacturing problems may occur with these third
parties. A supplier may fail to develop and supply products and components to us
on a timely basis, or may supply us with products and components that do not
meet our quality, quantity or cost requirements. If any of these problems occur,
we may be unable to obtain substitute sources of these products and components
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
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addition, if the processes that our suppliers use to manufacture products and
components are proprietary, we may be unable to obtain comparable components
from alternative suppliers.
IF WE ARE UNABLE TO MAINTAIN OUR EXPERTISE IN MANUFACTURING PROCESSES OR IF OUR
CUSTOMERS DEMAND CAPABILITIES THAT WE CANNOT PROVIDE, WE WILL BE UNABLE TO
COMPETE SUCCESSFULLY.
We use highly engineered, proprietary processes and sophisticated machining
equipment to meet the specifications of our customers. Without the timely
incorporation of new processes and enhancements, particularly relating to
quality standards and cost-effective production, our manufacturing capabilities
would likely become outdated, which would cause us to lose customers. In
addition, new or revised technologies could render our existing process
technology less competitive or obsolete or could reduce demand for our products
and services. It is also possible that finished medical device products
introduced by our customers may require fewer of our components or may require
components that we lack the capabilities to manufacture or assemble. In
addition, we cannot assure you that any investment that we make in new
technologies will result in commercially viable processes for our business.
Although we anticipate that our manufacturing and marketing expertise will
enable us to successfully develop and market our capabilities, any failure by us
to anticipate or respond in a cost-effective and timely manner to technological
developments or changes in industry standards or customer requirements, or any
significant delays in capability development or introduction could adversely
affect our results of operations.
THERE ARE OPERATIONAL AND FINANCIAL RISKS ASSOCIATED WITH OUR NEW FACILITY IN
MEXICO THAT COULD HARM OUR OPERATING RESULTS.
We operate a manufacturing facility in Navojoa, Mexico and are in the
process of significantly expanding that facility. Our operations at this
facility currently comprise a small portion of our business; however, we expect
that these operations will increase as we expand our device assembly service
offering. Our operations in Mexico may expose us to risks and uncertainties that
are different from those we experience in the United States, including
political, social and economic instability, difficulties in staffing and
managing international operations and controlling manufacturing quality, product
or material transportation delays or disruption, trade restrictions, currency
fluctuation and changes in tariffs, regulatory restrictions and import and
export license requirements. In addition, we will be subject to currency
fluctuations with respect to our labor and facilities costs in Mexico. If any of
these risks materializes, our business may be harmed.
OUR COST OF PRODUCTS SOLD MAY BE HARMED BY FLUCTUATIONS IN THE AVAILABILITY AND
PRICE OF RAW MATERIALS.
Raw materials needed for our business are susceptible to fluctuations in
price and availability due to transportation costs, government regulations,
price controls, changes in economic climate or other unforeseen circumstances.
In particular, stainless steel, titanium and platinum are used in some of our
products and are in limited supply and subject to fluctuations in price. Our
cost of products sold may be adversely impacted by decreases in the availability
and increases in the market prices of the raw materials used in our
manufacturing processes. There can be no assurance that price increases in raw
materials can be passed on to our customers through increases in product prices.
Even when we are able to pass along all or a portion of our raw material price
increases, there is typically a lag time between the actual cost increase of raw
materials and the corresponding increase in the price of our products.
WE AND OUR CUSTOMERS ARE SUBJECT TO GOVERNMENTAL HEALTH, SAFETY AND CONSUMER
PRODUCT REGULATIONS THAT ARE BURDENSOME AND CARRY SIGNIFICANT PENALTIES FOR
NONCOMPLIANCE.
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We and our customers are subject to federal, state and local health and
safety and consumer product regulation, including regulation by the FDA, and to
similar regulatory requirements in other countries. These regulations govern a
wide variety of activities from product safety and effectiveness to design and
development to labeling, manufacturing, promotion, sales and distribution. We
believe that we are in compliance with the requirements of FDA, of state and
local authorities and, as applicable, of equivalent foreign authorities. In the
event that we build or acquire additional facilities outside the United States,
we will be subject to medical device manufacturing regulation in those
jurisdictions as well. Also, our customers' products are subject to regulation,
including manufacturing standards, of other countries in which they sell their
products. As a result, we also may be obliged to comply with these manufacturing
standards.
To maintain manufacturing approvals, we are generally required, among other
things, to register certain of our manufacturing facilities with the FDA and
with certain state and foreign agencies, maintain extensive records and submit
to periodic inspections by the FDA and certain state and foreign agencies. We
may be required to incur significant expenses and to spend significant amounts
of time to comply with these regulations or to remedy violations of these
regulations. These efforts could be burdensome. In addition, any failure by us
to comply with applicable government regulations could result in cessation of
portions or all of our operations, imposition of fines and restrictions on our
ability to carry on or expand our operations. Compliance by our customers with
governmental regulations and their remedying of violations of these regulations
also may be time consuming, burdensome and expensive and could negatively affect
our customers' abilities to sell their products, which in turn could adversely
affect our ability to sell our products and services.
The regulations to which we are subject are complex, change frequently and
have tended to become more stringent over time. In addition, future laws and
regulations may increase governmental involvement in healthcare and lead to
increased compliance costs.
OUR FACILITIES ARE SUBJECT TO ENVIRONMENTAL REGULATION THAT EXPOSES US TO
POTENTIAL FINANCIAL LIABILITY.
Federal, state and local laws impose various environmental controls on the
management, handling, generation, manufacturing, transportation, storage, use
and disposal of hazardous chemicals and other materials used or generated in our
manufacturing activities. If we fail to comply with any present or future
environmental laws, we could be subject to future liabilities or the suspension
of production. We cannot assure you that our operations will not require
expenditures for clean-up in the future. Although we do not anticipate that
these remediation efforts will be material, we cannot assure you that the costs
associated with these efforts will not have an adverse effect on our business,
financial condition or results of operations. Changes in environmental laws may
impose costly compliance requirements on us or otherwise subject us to future
liabilities and additional laws relating to the management, handling,
generation, manufacture, transportation, storage, use and disposal of materials
used in or generated by the manufacture of our products may be imposed. In
addition, we cannot predict the effect that these potential requirements may
have on us or our customers.
ACCIDENTS AT OUR FACILITIES COULD DELAY PRODUCTION, ADVERSELY AFFECT OUR
OPERATIONS AND EXPOSE US TO FINANCIAL LIABILITY.
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 and we have not
experienced any serious accidents or deaths, there is a risk that an accident or
death could occur in one of our facilities. Any accident could result in
significant manufacturing delays or claims for damages resulting from injuries,
which would harm our operations and financial condition. The potential
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liability resulting from any such accident or death could cause our business to
suffer. Any disruption of operations at any of our facilities could harm our
business.
IF WE LOSE OUR KEY PERSONNEL, OUR ABILITY TO OPERATE OUR COMPANY AND OUR RESULTS
OF OPERATIONS MAY SUFFER.
Our future success depends in part on our ability to attract and retain key
executive, engineering, marketing and sales personnel. Our key personnel include
Mr. Effress and our other executive officers and the loss of certain key
personnel could have a material adverse effect on us. We face intense
competition for these professionals from our competitors, our customers and
other 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
cannot assure you that we would be able to locate or employ such qualified
personnel on acceptable terms.
IF WE ARE UNABLE TO ATTRACT ADDITIONAL QUALIFIED PERSONNEL, OUR GROWTH STRATEGY
COULD BE ADVERSELY AFFECTED.
Our success will depend in large part upon our ability to attract, train,
retain and motivate highly skilled employees and management. There is currently
aggressive competition for employees who have experience in the engineering and
technology used in our products and services. We compete intensely with other
companies to recruit and hire from this 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 retain personnel.
OUR BUSINESS IS INDIRECTLY SUBJECT TO HEALTHCARE INDUSTRY COST CONTAINMENT
MEASURES THAT COULD RESULT IN REDUCED SALES OF MEDICAL DEVICES CONTAINING OUR
COMPONENTS.
Our customers and the healthcare providers to whom our customers supply
medical devices may rely on third party payors, including government programs
and private health insurance plans, to reimburse some or all of the cost of the
procedures in which medical devices that incorporate components manufactured or
assembled by us 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 finished medical devices that
include our components may decline significantly, and our customers may reduce
or eliminate purchases of our components.
WE AND OUR CUSTOMERS MAY BE SUBJECT TO INFRINGEMENT CLAIMS BY THIRD PARTIES THAT
COULD SUBJECT US TO FINANCIAL LIABILITY OR LIMIT OUR PRODUCT AND SERVICE
OFFERINGS, AND OUR COMPETITIVE POSITION COULD BE HARMED IF WE ARE UNABLE TO
PROTECT OUR INTELLECTUAL PROPERTY.
Litigation to enforce and defend patent and other intellectual property
rights is common in the medical device industry. Although we do not believe that
any of our products, services or processes infringe the intellectual property
rights of third parties, we may be accused of infringing the rights of others.
Our customers' products also may be the subject of third-party infringement
claims, which could seek damages from both the customer and from us. With most
of our customers, we do not have formal agreements governing allocation of
liability for such claims. Even where we do not have liability to third parties,
an infringement claim against one of our customers could result in reduced
demand for our products and services
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or increased pricing pressure. Any infringement claim, significant charge or
injunction against our products or those of our customers could harm our
business.
We rely on a combination of patent, trade secret and trademark laws,
confidentiality procedures and contractual provisions to protect our
intellectual property, which relates principally to proprietary manufacturing
processes. We cannot be sure that the steps we take to protect our proprietary
rights will adequately deter unauthorized disclosure or misappropriation of our
intellectual property, technical knowledge, practice or procedures. We may be
required to spend significant resources to monitor and defend our intellectual
property rights, we may be unable to detect or defend against infringement of
these rights and we may lose any competitive advantage associated with these
rights.
RISKS RELATED TO THE SECURITIES MARKETS AND OWNERSHIP OF OUR COMMON STOCK
OUR STOCK PRICE COULD BE EXTREMELY VOLATILE AND, AS A RESULT, YOU MAY NOT BE
ABLE TO RESELL YOUR SHARES AT OR ABOVE THE PRICE YOU PAID FOR THEM.
Among the factors that could affect our stock price are:
o industry trends and the business success of our customers;
o loss of a key customer;
o fluctuations in our results of operations;
o our failure to meet the expectations of the investment community and
changes in investment community recommendations or estimates of our
future results of operations;
o strategic moves by our competitors, such as product announcements or
acquisitions;
o regulatory developments;
o litigation;
o general market conditions; and
o other domestic and international macroeconomic factors unrelated to
our performance.
The stock market has recently experienced extreme volatility that has often
been unrelated to the operating performance of particular companies. These broad
market fluctuations may adversely affect the market price of our common stock.
In the past, following periods of volatility in the market price of a
company's securities, securities class action litigation has often been
instituted. If a securities class action suit is filed against us, we would
incur substantial legal fees and our management's attention and resources would
be diverted from operating our business in order to respond to the litigation.
OUR PRINCIPAL STOCKHOLDERS AND MANAGEMENT OWN A SIGNIFICANT PERCENTAGE OF OUR
COMPANY AND WILL BE ABLE TO EXERCISE SIGNIFICANT INFLUENCE OVER OUR COMPANY AND
THEIR INTERESTS MAY DIFFER FROM THOSE OF OTHER STOCKHOLDERS.
-22-
As of September 5, 2002, our executive officers and directors and principal
stockholders and their affiliated entities controlled approximately 39% of our
outstanding common stock. Accordingly, these stockholders, if they act together,
will likely be able to control the composition of our board of directors and
many other matters requiring stockholder approval and will continue to have
significant influence over our affairs. They may exercise this influence,
including by voting at a meeting of the stockholders or by written consent, in a
manner that advances their best interests and not necessarily those of other
stockholders. This concentration of ownership also could have the effect of
delaying or preventing a change in our control or otherwise discouraging a
potential acquirer from attempting to obtain control of us.
PROVISIONS IN OUR CHARTER DOCUMENTS AND DELAWARE LAW MAY DETER TAKEOVER EFFORTS
THAT YOU FEEL WOULD BE BENEFICIAL TO STOCKHOLDER VALUE.
Our certificate of incorporation and bylaws and Delaware law contain
provisions which could make it difficult for a third party to acquire us without
the consent of our board of directors. These provisions include a classified
board of directors and limitations on actions by our stockholders. In addition,
our board of directors has the right to issue preferred stock without
stockholder approval that could be used to dilute a potential hostile acquiror.
Delaware law also imposes restrictions on mergers and other business
combinations between us and any holder of 15% or more of our outstanding common
stock. While we believe these provisions provide for an opportunity to receive a
higher bid by requiring potential acquirers to negotiate with our board of
directors, these provisions apply even if the offer may be considered beneficial
by some stockholders, and a takeover bid otherwise favored by a majority of our
stockholders might be rejected by our board of directors.
-23-
ITEM 2. PROPERTIES
As of June 30, 2002, our principal operations were conducted at the
following locations:
APPROX. LEASED/
LOCATION SQUARE FEET OWNED
- -------- ----------- -----
Brimfield, Massachusetts......................... 30,000 Owned
Brooklyn Park, Minnesota......................... 69,000 Leased
Corry, Pennsylvania.............................. 65,000 Leased
Danbury, Connecticut(a).......................... 89,000 Leased
Englewood, Colorado.............................. 36,000 Leased
Laconia, New Hampshire........................... 31,000 Leased
Minneapolis, Minnesota(b)........................ 7,000 Leased
Navojoa, Mexico.................................. 35,000 Leased
Newton, Massachusetts............................ 60,000 Leased
Norwell, Massachusetts........................... 37,000 Leased
Orchard Park, New York........................... 41,000 Leased
Redwood City, California(c)...................... 28,000 Leased
Santa Clara, California.......................... 10,000 Leased
Trenton, Georgia................................. 27,000 Leased
--------------
Total.......................................... 565,000
==============
- -----------
(a) This facility will be closed by February 2003.
(b) Corporate offices.
(c) This facility will be closed by December 2003.
We believe these facilities and the manufacturing and assembly capacity
they provide are adequate for our current and foreseeable purposes and that
additional space and capacity will be available when needed.
ITEM 3. LEGAL PROCEEDINGS
From time to time, we are involved in legal proceedings in the ordinary
course of our business. We are not currently involved in any pending legal
proceedings that we believe could have a material adverse effect on our
financial position or results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
-24-
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED SECURITY
HOLDER MATTERS
PRICE RANGE OF COMMON STOCK
Our common stock has traded on the Nasdaq National Market under the symbol
"MEDT" since our initial public offering on March 27, 2002. The following table
sets forth, for the periods indicated, the high and low sales prices per share
of our common stock as reported on the Nasdaq National Market:
FISCAL YEAR 2002 HIGH LOW
- ---------------- ---- ---
Third quarter (beginning March 27, 2002)..... $13.00 $12.96
Fourth quarter............................... $15.11 $9.91
On September 5, 2002, there were approximately 130 holders of record of our
common stock. This does not include the number of persons whose stock is in
nominee or "street name" accounts through brokers. The last reported sale price
of our common stock on the Nasdaq National Market on that date was $8.91 per
share.
DIVIDEND POLICY
We anticipate that we will retain future earnings, if any, to finance the
continued development and expansion of our business. In addition, our senior
credit facility restricts our payment of dividends. Any future determination
with respect to the payment of dividends will be dependent upon, among other
things, our earnings, capital requirements, the terms of our then existing
indebtedness, applicable requirements of Delaware corporate law, general
economic conditions and other factors considered relevant by our board of
directors.
RECENT SALES OF UNREGISTERED SECURITIES
During April and May 2002, we sold an aggregate of 28,804 shares of our
common stock to former employees upon exercise of stock options. We received
aggregate gross proceeds of $0.1 million upon exercise of these options. We
issued these securities in reliance on the exemption from registration provided
by Rule 701 under the Securities Act of 1933.
During April and May 2002, we issued an aggregate of 43,302 shares of our
common stock upon exercise of warrants issued to five of the investors who had
purchased our Series E preferred stock. The exercise price of the warrants was
$0.01 per share, and all of the investors used a "cashless" exercise provision
that enabled them to surrender the right to receive upon exercise of the
warrants a number of shares of common stock with a value equal to the aggregate
exercise price of the warrants and, as a result, surrendered the right to
receive an aggregate of 25 shares. We issued these securities in reliance on the
exemption from registration provided by Section 4(2) of the Securities Act of
1933.
INITIAL PUBLIC OFFERING AND USE OF PROCEEDS FROM SALES OF REGISTERED SECURITIES
Our registration statement on Form S-1 (Registration No. 333-76842), which
related to the initial public offering of our common stock, was declared
effective by the Securities and Exchange Commission on
-25-
March 26, 2002 (we filed an additional registration statement on Form S-1
(Registration No. 333-84978) under Rule 462(b) under the Securities Act of 1933
on March 27, 2002).
We paid $21.5 million of the net proceeds to affiliates of Whitney & Co.,
which owns more than 10% of our common stock, of which $4.3 million represented
accrued dividends on our Series B preferred stock, which converted into our
common stock at the time of the offering, $16.0 million represented the
redemption (with premium) of our $15.0 million senior subordinated promissory
note and $1.2 million represented accrued and unpaid fees due under, and amounts
due to, termination of a service agreement.
We paid $2.7 million to Kidd & Company, LLC, a company controlled by
William J. Kidd, a director, as accrued and unpaid fees due under, and amounts
due to, termination of a service agreement.
We also applied additional net proceeds as follows: $66.3 million to pay
off existing senior debt, $5.4 million to pay off the remainder of senior
subordinated promissory note with premium, $6.1 million to redeem our Series E
preferred stock, $4.1 million to redeem our Series F preferred stock, $1.9
million to terminate interest rate hedges on previous senior debt, $2.0 million
in related IPO expenses and $0.5 million additional accrued dividends on our
Series B preferred stock.
-26-
ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth selected statement of operations data for
our fiscal years ended June 30, 2002, June 30, 2001 and July 1, 2000 and for the
period from March 31, 1999 (inception) through July 3, 1999 and balance sheet
data as of the end of each such fiscal year.
PERIOD FROM
FISCAL YEAR ENDED MARCH 31, 1999
----------------- (INCEPTION)
JUNE 30, JUNE 30, JULY 1, THROUGH JULY
2002 2001 2000 3, 1999
---- ---- ---- -------
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
STATEMENT OF OPERATIONS DATA:
Revenues.......................................... $ 158,899 $128,462 $89,352 $21,968
Costs and expenses:
Cost of products sold........................... 117,089 94,386 59,811 13,437
Selling, general and administrative expense..... 29,876 26,199 21,167 4,458
Amortization of goodwill and other intangibles.. 340 5,640 4,255 4,135
Organization and start-up costs................. -- -- -- 4,981
Restructuring charges........................... -- 11,464 -- --
------------ ----------- ----------- ----------------
Total costs and expenses...................... 147,305 137,689 85,233 27,011
------------ ----------- ----------- ----------------
Operating income (loss)........................... 11,594 (9,227) 4,119 (5,043)
Interest expense, net............................. (7,671) (10,213) (10,682) (2,658)
Other (expense) income............................ (4,782) 53 (7) (289)
------------ ----------- ----------- ----------------
Loss before income taxes.......................... (859) (19,387) (6,570) (7,990)
Income tax benefit (expense)...................... 118 (70) 535 2,975
------------ ----------- ----------- ----------------
Loss before extraordinary loss.................... (741) (19,457) (6,035) (5,015)
Extraordinary loss on debt extinguishment......... (6,857) -- -- --
------------ ----------- ----------- ----------------
Net loss.......................................... (7,598) (19,457) (6,035) (5,015)
Preferred stock dividends and accretion of
discount on preferred stock.................... (31,168) (9,688) (8,345) (2,078)
------------ ----------- ----------- ----------------
Net loss attributed to common stockholders........ $(38,766) $(29,145) $(14,380) $(7,093)
============ =========== =========== ================
Net loss per share attributed to common
stockholders before extraordinary loss......... $(2.88) $(5.55) $(3.10) $(1.60)
Extraordinary loss per share...................... $(0.62) -- -- --
Net loss per share attributed to common
stockholders................................... $ (3.50) $(5.55) $(3.10) $(1.60)
============ =========== =========== ================
Weighted average number of shares of common stock
outstanding (basic and diluted)................ 11,086,103 5,252,749 4,633,571 4,448,000
============ =========== =========== ================
BALANCE SHEET DATA (AT END OF PERIOD):
Cash and cash equivalents......................... $38,268 $20,289 $2,210 $1,808
Current assets.................................... 85,204 58,242 28,282 18,109
Property and equipment, net....................... 42,045 38,873 34,956 21,550
Total assets...................................... 247,829 203,965 151,101 126,792
Total debt........................................ 41,906 89,544 98,653 81,224
Mandatorily redeemable preferred stock............ 1,974 98,867 22,293 16,250
Total stockholders equity (deficit)............... 186,320 (13,261) 15,072 21,248
-27-
We began operations on March 30, 1999 through the acquisition of seven
unaffiliated businesses, to whom we refer as our "predecessor companies." The
following tables set forth certain historical financial data of six of the
individual predecessor companies.
W.N. RUSHWOOD, INC.
KELCO INDUSTRIES, INC. D/B/A HAYDEN PRECISION INDUSTRIES
---------------------- ---------------------------------
ELEVEN THREE
YEAR MONTHS MONTHS
ENDED ENDED YEAR ENDED DECEMBER 31, ENDED
APRIL 30, MARCH 30, ----------------------- MARCH 30,
1998 1999 1997 1998 1999
---- ---- ---- ---- ----
STATEMENT OF OPERATIONS DATA (IN THOUSANDS):
Net sales.................................... $23,192 $22,877 $6,003 $9,777 $2,227
Gross profit................................. 9,742 9,951 1,583 2,787 448
Operating expenses........................... 2,830 2,784 949 1,072 195
-------- -------- -------- --------- --------
Operating income (loss)...................... 6,912 7,167 634 1,715 253
Other income (expense)....................... 99 76 (201) (241) (100)
--------- -------- --------- ---------- ---------
Income before taxes.......................... 7,011 7,243 433 1,474 153
Income taxes................................. - - - - -
Net income (loss)............................ $ 7,011 $ 7,243 $ 433 $ 1,474 $ 153
======== ======== ======== ========== ========
BALANCE SHEET DATA (IN THOUSANDS)
(AT END OF PERIOD)
Total assets................................. $13,484 $18,962 $3,410 $7,066 $7,206
Long-term debt............................... - - 1,804 3,174 3,744
Shareholders' equity......................... 11,229 16,215 739 1,685 1,753
THE MICROSPRING COMPANY, INC. NATIONAL WIRE AND STAMPING, INC.
----------------------------- --------------------------------
THREE THREE
MONTHS MONTHS
YEAR ENDED DECEMBER 31, ENDED YEAR ENDED DECEMBER 31, ENDED
----------------------- MARCH 30, ----------------------- MARCH 30,
1997 1998 1999 1997 1998 1999
---- ---- ---- ---- ---- ----
STATEMENT OF OPERATIONS DATA (IN THOUSANDS):
Net sales............................. $11,782 $10,176 $1,792 $9,513 $8,619 $1,636
Gross profit.......................... 3,321 2,896 394 3,730 3,618 669
Operating expenses.................... 3,420 3,343 1,314 3,112 3,057 800
--------- --------- --------- --------- -------- --------
Operating income (loss)............... (99) (447) (920) 618 561 (131)
Other income (expense)................ 7 (32) 1 65 126 125
-------- ---------- --------- --------- ------- ---------
Income before taxes................... (92) (479) (919) 683 687 (6)
Income taxes.......................... 31 7 3 275 264 45
-------- --------- --------- -------- -------- ---------
Net income (loss)..................... $ (123) $ (486) $ (922) $ 408 $ 423 $ (51)
======== ========= ========= ======== ======== =========
BALANCE SHEET DATA (IN THOUSANDS)
(AT END OF PERIOD)
Total assets.......................... $6,185 $3,984 $3,895 $3,894 $4,373 $3,250
Long-term debt........................ 250 250 -- 117 107 --
Stockholders' equity.................. 3,377 2,990 3,076 2,290 2,757 2,664
PORTLYN CORPORATION TEXCEL, INC.
------------------- ------------
THREE THREE
MONTHS MONTHS
YEAR ENDED DECEMBER 31, ENDED YEAR ENDED DECEMBER 31, ENDED
----------------------- MARCH 30, ----------------------- MARCH 30,
1997 1998 1999 1997 1998 1999
---- ---- ---- ---- ---- ----
STATEMENT OF OPERATIONS DATA (IN THOUSANDS):
Net sales............................. $6,955 $5,773 $1,180 $4,310 $6,184 $2,045
Gross profit.......................... 3,391 2,573 473 1,677 2,295 941
Operating expenses.................... 3,259 2,572 522 900 952 270
--------- ---------- ------- ------- ----- -------
Operating income (loss)............... 132 1 (49) 777 1,343 671
Other income (expense)................ (76) (74) (14) (62) (68) (11)
--------- ---------- -------- --------- ------- ----------
Income before taxes................... 56 (73) (63) 715 1,275 660
Income taxes.......................... -- -- -- 307 15 14
----- ---------- -------- --------- ------ --------
Net income (loss)..................... $ 56 $ (73) $ (63) $ 408 $ 1,260 $ 646
===== ======== ======== ========= ========== ========
BALANCE SHEET DATA (IN THOUSANDS)
(AT END OF PERIOD)
Total assets.......................... $2,710 $1,886 $1,818 $2,324 $3,278 $3,363
Long-term debt........................ 113 82 75 504 451 770
Stockholders' equity.................. 651 578 514 749 2,009 1,265
-28-
The following selected unaudited pro forma condensed combined statement of
operations for the year ended June 30, 2002 is presented as if costs relating to
the repayment of our former debt, costs relating to terminated service
agreements and costs relating to preferred stock had not been incurred, and the
following selected unaudited pro forma condensed combined statement of
operations for the year ended June 30, 2001 is presented as if costs relating to
ourrestructuring, costs relating to terminated service agreements and costs
relating to preferred stock had not been incurred. All of the following selected
unaudited pro forma condensed combined financial information should be read in
conjunction with the historical financial statements of MedSource and the notes
thereto appearing elsewhere in this Annual Report on Form 10-K.
The following selected unaudited pro forma condensed combined financial
information is not indicative of our future results.
YEAR ENDED JUNE 30, 2002 YEAR ENDED JUNE 30, 2001
------------------------ ------------------------
HISTORICAL ADJUSTMENTS PRO FORMA HISTORICAL ADJUSTMENTS PRO FORMA
---------- ----------- --------- ---------- ----------- ---------
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
Revenues......................................... $ 158,899 $ -- $ 158,899 $ 128,462 $ -- $128,462
Costs and expenses:
Cost of products sold.......................... 117,089 -- 117,089 94,386 -- 94,386
Selling, general and administrative expenses... 29,876 (1,474) (a) 28,402 26,199 (1,656)(a) 24,543
Amortization of goodwill and intangibles....... 340 -- 340 5,640 -- 5,640
Restructuring charges.......................... -- -- -- 11,464 (11,464)(d) --
----------- ----------- ----------- ------------- ------------ ---------
Total costs and expenses....................... 147,305 (1,474) 145,831 137,689 (13,120) 124,569
----------- ----------- ----------- ------------- ------------ ---------
Operating income (loss)........................... 11,594 1,474 13,068 (9,227) 13,120 3,893
Interest expense, net............................. (7,671) -- (7,671) (10,213) -- (10,213)
Other (expense) income............................ (4,782) 4,853(a)(c) 71 53 -- 53
----------- ----------- ----------- ------------- ------------ ---------
Loss before income taxes.......................... (859) 6,327 5,468 (19,387) 13,120 (6,267)
Income tax benefit (expense)...................... 118 -- 118 (70) -- (70)
----------- ----------- ----------- ------------- ------------ ---------
Loss before extraordinary loss.................... (741) 6,327 5,586 (19,457) 13,120 (6,337)
Extraordinary loss on debt extinguishment......... (6,857) 6,857 (c) -- -- -- --
----------- ----------- ----------- ------------- ------------ ---------
Net loss.......................................... (7,598) 13,184 5,586 (19,457) (6,337)
Preferred stock dividends and accretion of
discount on preferred stock.................... (31,168) 31,168 (b) -- (9,688) 9,688 (b) --
Net loss attributed to common stockholders........ $ (38,766) $44,352 $ 5,586 $ (29,145) $ 22,808 (6,337)
=========== =========== =========== ============ ============ =========
Net loss per share attributed to common
stockholders before extraordinary loss......... $ (2.88) $ -- $ 0.28(e) $ (5.55) $ -- $ (1.21)(e)
Extraordinary loss per share...................... $ (0.62) $ -- $ -- $ -- $ -- $ --
Net loss per share attributed to common
stockholders................................... $ (3.50) $ -- $ 0.28(e) $ (5.55) $ -- $ (1.21)(e)
=========== =========== =========== ============ ============ =========
Weighted average number of shares of common stock
outstanding.................................... 11,086,103(f) -- 19,840,124(g) 5,252,749(f) -- 5,252,749(f)
=========== =========== =========== ============ ============ ===========
- --------------------------
(a) Represents costs of management agreements we entered into with Kidd &
Company and Whitney & Company that were terminated in conjunction with
ourinitial public offering.
(b) Represents charges on preferred stock that was converted to common in
conjunction with our initial public offering.
(c) Represents charges associated with the repayment of our former debt.
(d) Represents a one-time restructuring charge we recorded in June of 2001.
(e) Represents pro forma net loss attributed to common stockholders divided by
pro forma weighted average number of shares of common stock outstanding.
(f) Represents number of shares of common stock outstanding (basic).
(g) Represents number of shares of common stock outstanding (diluted).
-29-
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
OVERVIEW
We provide product development and design services, precision metal and
plastic part manufacturing, product assembly services and supply chain
management. We provide our products and services to each of the following
primary target markets:
o Surgical Instrumentation devices and components;
o Electro-medical implant devices and components;
o Interventional devices and components; and
o Orthopedic implants and instruments.
COMPANY HISTORY
During 1998, our co-founders, Richard J. Effress and William J. Kidd,
established MedSource to identify business opportunities in the medical
engineering and manufacturing services industry. During March 1999, with
additional equity capital from Whitney & Co., we acquired seven unaffiliated
businesses to begin our operations. The original seven acquisitions were Kelco
Industries, W.N. Rushwood d/b/a Hayden Precision Industries, National Wire and
Stamping, The MicroSpring Company, Portlyn, Texcel and Brimfield Precision. Our
first fiscal period, which ended July 3,1999, consisted of only three months of
consolidated results, which included material one-time expenses for business
combination and formation.
Since our initial acquisitions, we had acquired five additional businesses
through June 30, 2002. We acquired Tenax in January 2000, Apex Engineering in
February 2000 and Thermat Precision in May 2000. The acquisition of Tenax
provided injection molding capability, the acquisition of Thermat added
injection molding and precision metal injection manufacturing capabilities to
our operations, enabling us to manufacture low cost precision stainless steel
components, and the acquisition of Apex Engineering provided mold design and
plastic injection molding and mold making capabilities. We acquired ACT Medical
in December 2000. The acquisition of ACT Medical enhanced our product design and
development engineering expertise and provided a low cost assembly operation in
Mexico. We acquired HV Technologies, or HVT, in January 2002. The acquisition of
HVT, a specialized manufacturer of polyimide and composite micro-tubing used in
interventional and minimally invasive catheters, delivery systems and
instruments, enabled us to expand our offering of proprietary manufacturing
capabilities to our customers in the interventional device market. All of our
acquisitions were accounted for using the purchase method of accounting.
During June 2001, we completed a review of our manufacturing operations and
support functions. Based on our evaluation of the unique and common
characteristics of our various facilities, we determined that we could achieve
over-all cost savings by closing three of the facilities, thus improving
capacity utilization and efficiency of the remaining facilities. We sold our
facilities in Pittsfield and East Longmeadow, Massachusetts during our fiscal
year ended June 30, 2002. We also initiated the shutdown of our facility in
Danbury, Connecticut during our fiscal year ended June 30, 2002 and expect it to
be closed by February 2003.
-30-
RESULTS OF OPERATIONS
REVENUES
We recognize product revenue at the time products are shipped. Product
shipments are supported by purchase orders from customers that indicate the
price for each product. For services, we recognize revenues primarily on a time
and materials basis. Service revenues are supported by customer orders or
contracts that indicate the price for the services being rendered. For fiscal
2002, service revenues were less than 10% of total revenues. Revenues for
product shipments and services rendered must also have reasonable assurance of
collectibility from the customer. Reserves for returns and allowances are
recorded against revenues based on management's estimates and historical
experience.
We target the sale of our products and services to medical device companies
in four target markets. As we have continued to focus on these markets, our
sales to nonmedical customers as a percentage of our total revenues have been
decreasing over time. Sales to nonmedical customers were approximately 4% of our
total revenues for the year ended June 30, 2002. We expect sales to nonmedical
customers as a percentage of our total revenues to continue to decrease in the
future.
Historically, most of our revenues were derived from the manufacture of
components used in medical devices. However, in order to accelerate revenue
growth and better serve our customers, we aggressively pursued opportunities for
the assembly of completed devices. To support this effort, we have completed a
number of acquisitions to expand our product offerings and enhance our supply
chain services. Over time, we anticipate that revenues from the assembly of
completed devices will likely continue to grow as a percentage of our total
revenues. Nevertheless, we will continue to aggressively pursue component sales
opportunities.
Our top four customers accounted for 52% of our revenues for the year ended
June 30, 2002, with one customer accounting for 25% of our revenues and another
accounting for 12% of our revenues. For the year ended June 30, 2001, our top
four customers accounted for 41% of our revenues, with one customer accounting
for 18% of our revenues and another accounting for 12% of our revenues. We
expect revenues from our largest customers to continue to constitute a
significant portion of our total revenues.
We primarily derive our revenues from serving leading medical device
companies. These customers are typically large companies with substantial market
share in one or more of our four target markets, and we believe that expanding
our relationships with these customers represents our most important revenue
opportunity. As a result, we devote significant sales efforts to securing
additional business from the business units and product lines of the leading
medical device companies that we currently serve, as well as developing business
with other business units and product lines of these customers. As we
increasingly focus on serving customers and expand our offerings to them by
developing or acquiring additional engineering and manufacturing capabilities,
we expect the percentage of revenues we derive from these customers to increase
over time, as compared with revenues from non-medical device companies. We also
intend to continue to selectively pursue promising opportunities with emerging
medical device companies.
As discussed above, we have acquired five businesses since we began
operations during March 1999. A substantial portion of our revenue growth to
date has been attributable to the addition of these acquired companies'
revenues. In the periods following these acquisitions, we have grown our
revenues by offering our existing customers access to our newly acquired
engineering and manufacturing capabilities, as well as by offering the customers
of the acquired businesses access to our existing capabilities. We generally
have retained the medical device customers of the companies that we have
acquired, but have selectively
-31-
discontinued business with customers of the acquired businesses that did not fit
our strategic focus of serving leading and select emerging medical device
companies in our four target markets or related medical fields. We expect to
continue to make select acquisitions of complementary medical engineering and
manufacturing services providers that bring desired capabilities, customers and
/ or geographic coverage that either strengthens our position in our target
markets or provide us with a significant presence in a new market.
We generally do not have long-term volume commitments from our customers,
and they may cancel their orders or change or delay volume levels at any time.
COST AND EXPENSES
Cost of products sold includes expenses for raw materials, purchased
components, outside services, supervisory, engineering and direct production
manpower including benefits, production supplies, depreciation and other related
expenses to support product manufacturing. We purchase most of the raw materials
that are used in our products at prevailing market prices and, as a result, are
subject to fluctuations in the market price of those raw materials. In
particular, the prices of stainless steel, titanium and platinum have
historically fluctuated, and the prices that we pay for these materials, and, in
some cases, their availability, are dependent upon general market conditions.
Gross margins as a percentage of revenues for the years ended June 30, 2002
and 2001 were 26.3% and 26.5%, respectively. Our margins are driven by sales mix
between devices and components as well as the respective product mixes within
our various product categories. Historically, our component business produced
strong gross margins. When we were initially formed during March 1999, we were
predominately a components supplier. However, in order to expand the scope of
our services and accelerate revenue growth, we aggressively pursued
opportunities for the assembly of completed devices, which generally have higher
material content and a lower value added content, resulting in slightly lower
gross margins but with lower capital investment.
Selling, general and administrative expense includes support of our
facilities for production and shipments to the customer as well as strategic
investments in our sales and marketing, operations and quality teams, and our
corporate support staff.
We have accounted for all of our acquisitions by using the purchase method
of accounting. Through our year ended June 30, 2001, we amortized goodwill and
other intangibles attributable to our acquisitions and incurred associated
amortization expense of $5.6 million in fiscal 2001 and $4.3 million in fiscal
2000. Effective July 1, 2001, in connection with our adoption of SFAS No. 142,"
Goodwill and Other Intangibles," we no longer amortize goodwill. Instead, we
will periodically test goodwill and intangibles for impairment and record an
expense if those assets become impaired, as further discussed under "--Recent
Accounting Pronouncements."
COMPARISON OF FISCAL YEARS ENDED JUNE 30, 2002 AND JUNE 30, 2001
Revenues for our fiscal year ended June 30, 2002 totaled $158.9 million
compared to $128.5 million for the fiscal year ended June 30, 2001, an increase
of 24%. Approximately 15% of this increase was due to the acquisitions of HVT
and ACT Medical, with the other 9% due to internal growth. Internal growth was
15% excluding the planned decline in non-medical shipments. Our internal, or
organic, growth was primarily driven by strength in our surgical instrumentation
market, mainly products for cardiac surgery and endo-laparoscopic
instrumentation, as well arthroscopic and electro-surgical components, along
with solid growth in our orthopedics market, primarily spinal components and
instruments and device products, as well as strength in our electro-medical
implant, or EMI, segment, primarily components for
-32-
pacemakers and defibrillators. A small portion of our internal growth also
resulted from new surgical instrumentation and interventional business that we
secured by offering our existing customers additional manufacturing capabilities
that we acquired.
Cost of products sold for the fiscal year ended June 30, 2002 totaled
$117.1 million compared to $94.4 million for the fiscal year ended June 30,
2001. The increase in cost of products sold resulted principally from the
increased revenues over the prior fiscal year.
Gross margins for the fiscal year ended June 30, 2002 were 26.3% compared
to 26.5% for the year ended June 30, 2001. Our margins are driven by the sales
mix between devices and components as well as the respective product mixes
within our various product categories.
Selling, general and administrative expense was $29.9 million, or 18.8% of
revenues, for the fiscal year ended June 30, 2002 and $26.2 million, or 20.4% of
revenues, for the fiscal year ended June 30, 2001. The $3.6 million increase was
due to the selling, general and administrative expense attributable to the
business of HVT, which we acquired during January 2002, and the business of ACT
Medical, which we acquired during December 2000.
Net interest expense was $7.7 million for the fiscal year ended June 30,
2002 compared to $10.2 million for the fiscal year ended June 30, 2001. This
decrease was due primarily to the lower amounts outstanding under our senior
credit facility during the fourth quarter of our fiscal year ended June 30,
2002.
Other expense for the year totaled $4.8 million compared to other income of
$0.1 million for the prior year. The increase is a result of two non-recurring
charges, $1.9 million of interest rate swap breakage fees associated with the
repayment of debt and $2.9 million for service agreements terminated in
conjunction with our initial public offering.
During our fiscal year ended June 30, 2002, we also incurred an
extraordinary loss on debt extinguishment of $6.9 million as a result of the
repayment of our subordinated debt and the debt under our old senior credit
facility. The loss consisted of a write off of $5.5 million in unamortized
financing costs and discount and a $1.4 million prepayment fee.
We incurred charges related to the accrual of dividends and accretion of
discount on preferred stock of $31.2 million for our fiscal year ended June 30,
2002, compared to $9.7 million for our fiscal year ended June 30, 2001. The
increase was mainly due to one time charges in connection with the conversion of
these shares into common stock in conjunction with our initial public offering.
Net loss attributed to common stockholders totaled $38.8 million, or $3.50
per share, while net loss attributed to common stockholders for fiscal 2001 was
$29.1 million, or $5.55 per share.
Pro forma net income for the year ended June 30, 2002, which excluded
non-recurring charges of $31.2 million for preferred stock charges, $4.4 million
for terminated service agreements, and $8.8 million for charges relating to
repayment of debt, was $5.6 million or $0.28 per share fully diluted compared
with a pro forma loss of $6.3 million or $1.21 per share for the same period a
year ago. Pro forma net loss for the year ended June 30, 2001 excluded $11.5
million of restructuring charges, $9.7 million for preferred stock charges, and
$1.7 million for terminated service agreements.
COMPARISON OF FISCAL YEARS ENDED JUNE 30, 2001 AND JULY 1, 2000
Revenues for our fiscal year ended June 30, 2001 totaled $128.5 million
compared to $89.4 million for the fiscal year ended July 1, 2000, an increase of
44%. Approximately two-thirds of this increase was due to acquisitions during
fiscal year 2001 and 2000, with the other third due to internal growth. Our
internal growth was primarily driven by increased shipments of pacemaker and
implantable defibrillator components, ophthalmological devices, arthroscopic
devices, electrosurgical instruments and devices and endoscopic accessories from
several of our established customers. A small portion of our internal growth
also resulted from new surgical instrumentation business that we secured by
offering our existing customers additional
-33-
manufacturing capabilities, such as injection molding, tool making and precision
metal injection manufacturing, that we acquired in acquisitions. Although sales
to nonmedical customers as a percentage of total revenues decreased during the
period, sales were helped to a lesser extent by increased shipments to an
established nonmedical customer in the telecommunications industry, as well as
shipments of various products to new customers. A small portion of the increase
in our revenues due to the acquisitions resulted from new surgical
instrumentation business that we secured by offering former customers of the
acquired companies access to the broad range of capabilities that we had in
place prior to the acquisitions.
Cost of products sold for the fiscal year ended June 30, 2001 totaled $94.4
million compared to $59.8 million for the fiscal year ended July 1, 2000. The
increase in cost of products sold resulted principally from the increased
revenues over the prior fiscal year.
Gross margins for fiscal year ended June 30, 2001 were 26.5% compared to
33.1% for the year ended July 1, 2000. The decrease in gross margin during
fiscal year 2001 compared to fiscal year 2000 reflected the full year impact of
businesses acquired during fiscal 2000 and 2001, all with lower margins than the
base businesses.
Selling, general and administrative expense was $26.2 million, or 20.4% of
revenues, for the fiscal year ended June 30, 2001 and $21.2 million, or 23.7% of
revenues, for the fiscal year ended July 1, 2000. Of the $5.0 million increase
in selling, general and administrative expense, $2.2 million was attributable to
the acquisition of ACT Medical in December 2000, while annualized operating
expenses for the businesses acquired during fiscal 2000 accounted for $1.1
million of the increase. The balance of the increase occurred largely as a
result of our investment in our sales and marketing infrastructure to support
future growth.
During June 2001, we completed a strategic review of our manufacturing
operations and support functions and recorded a restructuring charge of $11.5
million. Since their acquisition, certain of our manufacturing facilities have
operated with excess capacity. Based on our evaluation of the unique and common
characteristics of our various facilities, we determined that we could achieve
over-all cost savings by closing three of the facilities, thus improving
capacity utilization and efficiency of the remaining facilities. Criteria in our
evaluation included current capacity utilization, uniqueness of manufacturing
capabilities, current operating costs, difficulty and cost associated with
relocation and recertification of key equipment, and customer supply
requirements. During our fiscal year ended June 30, 2002 we sold our facilities
in Pittsfield and East Longmeadow, Massachusetts and initiated the closing of
our facility in Danbury, Connecticut, which we expect to be completed by
February 2003. Because we expected that we would not retain all of the customers
served by these three facilities, we wrote off a portion of the customer base
intangible asset ($0.6 million) as well as the entire remaining acquired
workforce intangible for each facility ($0.5 million). In addition, because we
believed the residual goodwill recorded at each acquisition was significantly
related to the local operations, we concluded that goodwill was impaired by the
closure of the facilities and wrote off the related goodwill ($2.6 million).
Other recorded charges related to the restructuring include employee termination
benefits expected to be paid based on our announced termination benefits policy
($2.6 million), costs of plant and equipment not expected to be recovered ($1.9
million), and other exit costs ($2.2 million), including costs related to lease
termination, facilities restoration, equipment dismantlement and disposal, legal
costs and other costs. Costs related to the realignment of leadership positions
in the corporate support organization also were accrued as of June 30, 2001
($1.2 million). Based on actual expenses incurred during fiscal 2001, we expect
to save $3 million to $4 million annually after completing the restructuring of
our plants.
-34-
Net interest expense was $10.2 million for the fiscal year ended June 30,
2001 compared to $10.7 million for the fiscal year ended July 1, 2000. This
decrease was due to the lower amounts outstanding under our existing senior
credit facility.
We incurred charges related to the accrual of dividends and accretion of
discount on preferred stock of $9.7 million for our fiscal year ended June 30,
2001, compared to $8.3 million for our fiscal year ended July 1, 2000. The
increase was due to the increase in the amount of preferred stock outstanding
during fiscal year 2001.
LIQUIDITY AND CAPITAL RESOURCES
Our principal sources of liquidity are cash provided by operations and
borrowings under our senior credit facility, which includes a $25 million unused
revolving credit facility. Prior to our initial public offering, our principal
uses of cash were to finance acquisitions, meet debt service requirements and
finance capital expenditures. We expect that these uses will continue in the
future.
OPERATING ACTIVITIES
Net cash used by operating activities totaled $7.8 million for the year
ended June 30, 2002 compared to net cash provided by operating activities of
$1.3 million for the prior year. The decrease in cash provided by operating
activities over the prior year period is primarily the result of a $6.6 million
decrease in payables and accrued expenses, mainly the result of the payment of
accrued expenses related to restructuring and a decrease in accrued bonuses in
fiscal 2002, and a $6.9 million increase in inventories, mainly due to
anticipated product transfers in conjunction with the previously announced plant
consolidations as well as anticipated product launches. These amounts were
offset by a lower net loss for the current period.
Management believes that current cash balances and cash generated from
operations, combined with available borrowings under our senior credit facility,
will be adequate to fund requirements for working capital, capital expenditures,
and future expansion through fiscal 2003.
INVESTING ACTIVITIES
Cash used in investing activities was $14.7 million for the year ended June
30, 2002, compared to $11.6 million for the year ended June 30, 2001. This
increase was due to an increase in cash paid for acquisitions of $6.0 million
over the prior year period, as a result of the acquisition of HVT in January
2002. Cash paid for capital expenditures was down $2.9 million when compared to
the prior year period. We expect capital expenditures in fiscal 2003 to be
approximately $12.5 million. Subsequent to June 30, 2002, we spent $18.0 million
in cash in connection with our acquisition of Cycam.
FINANCING ACTIVITIES
Cash provided by financing activities was $40.4 million for the year ended
June 30, 2002 compared to $28.5 million provided by financing activities for the
year ended June 30, 2001. The increase was primarily due to proceeds from our
IPO during March 2002, as well as approximately $2.0 million as a result of the
sale of our Series E preferred stock, offset by debt repayments. Subsequent to
June 30, 2002, we borrowed $8.0 million that was available under the acquisition
line under our senior credit facility to pay a portion of the cash paid in our
acquisition of Cycam.
-35-
COMMITMENTS
As of June 30, 2002, we had the following future contractual cash
commitments:
PAYMENTS DUE BY PERIOD
TOTAL 1 YEAR 2-3 YEARS 4-5 YEARS AFTER 5 YEARS
----- ------ --------- --------- -------------
(DOLLARS IN MILLIONS)
Long-term debt............................ $40,000 $5,500 $15,000 $19,500 $--
Capital lease obligations................. 1,906 439 822 645 --
Operating leases.......................... 13,668 2,443 3,798 2,556 4,871
Unconditional purchase obligations........ -- -- -- -- --
Other contractual obligations(b).......... 1,935 -- -- -- 1,935
----------- ----------- ---------- ---------- -------------
Total future contractual cash obligations $57,509 $8,382 $19,620 $22,701 $6,806
=========== =========== ========== ========== =============
- ----------
(a) All long term debt is described below under the caption "-- Senior Credit
Facility."
(b) Due on Series E preferred stock that was outstanding on June 30, 2002.
As of June 30, 2002, we had the following future commercial commitments
that may result in future cash outflows:
PAYMENTS DUE BY PERIOD
TOTAL 1 YEAR 2-3 YEARS 4-5 YEARS AFTER 5 YEARS
----- ------ --------- --------- -------------
(DOLLARS IN MILLIONS)
Lines of credit(a)........................ $-- $-- $-- $-- $--
Letters of credit(b)...................... 1,300 1,300 -- -- --
Guarantees................................ -- -- -- -- --
----------- ----------- ---------- --------- -------------
Total future contractual commitments.... $1,300 $1,300 $-- $-- $--
=========== =========== ========== ========= =============
(a) Our line of credit is described below under the caption "-- Senior Credit
Facility."
(b) Letters of credit under capital leases, commitment expires over the life of
the leases.
SENIOR CREDIT FACILITY
Concurrent with receipt of funds from our initial public offering, on April
2, 2002, we repaid the entire $66.3 million outstanding under our former senior
credit facility and the entire $21.4 million outstanding (including a $1.4
million pre-payment fee) under our former senior subordinated notes. We also
entered into a new senior credit facility that provides us with a $25.0 million
revolving credit facility, a $40.0 million term loan and an acquisition line
term loan of up to $20.0 million. We borrowed $8.0 million under the acquisition
line term loan to finance our acquisition of Cycam during August 2002 and no
longer have any availability under the acquisition line given its expiration at
the end of September 2002. All loans under our new senior credit facility will
mature on April 12, 2007.
During the twelve months ending March 31, 2003, we will be required to make
payment under the term loan of $4.0 million payable in three installments.
During the years ending March 31, 2004, 2005, 2006 and 2007, we will make
payments of $6.0 million, $8.0 million, $10.0 million and $12.0 million,
respectively, payable in quarterly installments. During the year ending March
31, 2003 we will also be required to make an annual payment of 15% of the $8.0
million that we borrowed under the acquisition line. In addition under our
acquisition line, future annual payments of 20%, 30% and 35% of the original
principal borrowed payable in quarterly installment during the years ending
March 31, 2004, 2005, 2006 and 2007, respectively, are required. We paid costs
and fees of $2.1 million to enter into the new senior credit facility.
-36-
At our option, interest rates applicable to loans under our new senior
credit facility will be either:
o The greater of the bank's prime rate plus a margin, which depends upon
our leverage ratio, ranging from zero to 125 basis points, or the
federal funds rate plus 50 basis points plus the same margin; or
o LIBOR plus a margin, which depends upon our leverage ratio, ranging
from 175 to 300 basis points.
We have entered into an interest rate cap agreement to protect against
interest rate fluctuations with respect to 50% of the term loans outstanding
under our new senior credit facility. This agreement, executed with a
highly-rated financial counter-party, provides for the counter-party to make
payments to us in the event that a reference floating rate index exceeds an
agreed-upon fixed rate.
The senior credit facility contains affirmative and negative covenants and
limitations, including, but not limited to, required minimum coverage of our
obligations to pay interest and incur fixed charges, restrictions on our ability
to pay dividends, make other payments and enter into sale transactions,
limitations on liens, limitations on our ability to incur additional
indebtedness and agreements that we use excess cash on hand and proceeds from
future equity issuances to pay down our senior credit facility. In addition to
the requirements that we obtain the consent of the lenders under our senior
credit facility to borrow under the $20.0 million acquisition line, we also need
their consent to make any other acquisition in which we pay more than $10.0
million (including more than $5.0 million in cash, deferred payments and the
assumption of debt) or pay more than $20.0 million (including more than $10.0
million in cash, deferred payments and the assumption of debt) for all of the
acquisitions that we complete during any fiscal year.
The senior credit facility is secured by all of our assets and contains
various events of default, including, but not limited to, defaults upon the
occurrence of a change of control of MedSource and defaults for non-payment of
principal interest or fees, breaches of warranties or covenants, bankruptcy or
insolvency, ERISA violations and cross-defaults to other indebtedness.
As of September 5, 2002 we had an outstanding balance of approximately
$48.0 million under our new senior credit facility.
ISSUANCES OF PREFERRED STOCK FOR CASH
In December 2001, we received an aggregate of $5.5 million from the
issuance of our Series E preferred stock, and we received an additional $0.5
million in January 2002. In connection with these issuances, we also issued
warrants to purchase an aggregate of 200,000 shares of our common stock at $0.01
per share. The proceeds from the Series E preferred stock were used to help
finance the acquisition of HVT. During April 2002 we redeemed 4,065 shares of
the 6,000 outstanding shares. The remaining 1,935 shares were redeemed during
August 2002.
-37-
QUARTERLY RESULTS
The following tables set forth selected unaudited quarterly consolidated
financial information for the eight quarters ended June 30, 2002. This unaudited
quarterly consolidated information, in the opinion of management, includes all
adjustments necessary for a fair presentation of such information in accordance
with generally accepted accounting principles. These quarterly results are not
necessarily indicative of future results, growth rates or quarter-to-quarter
comparisons.
We have completed five acquisitions since July 1, 2000, but the quarterly
consolidated financial information set forth below is presented on an actual
historical basis, not on a pro forma basis for any of those acquisitions. The
increase in revenues over the periods presented resulted from both acquisitions
and growth in our base business. In addition, during our limited operating
history, excluding the impact of acquisitions, we have experienced higher than
average revenues during the last quarter of our fiscal year and lower than
average revenues during the first quarter of our fiscal year, but we cannot
predict whether this will continue.
QUARTER ENDED
SEPTEMBER 30, DECEMBER 30, MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 30, MARCH 30, JUNE 30,
2000 2000 2001 2001 2001 2001 2002 2002
---- ---- ---- ---- ---- ---- ---- ----
(IN MILLIONS)
STATEMENT OF OPERATIONS DATA:
Revenues............. $27.6 $27.9 $34.8 $38.2 $33.9 $38.3 $42.2 $44.6
Cost and expenses:...
Cost of products sold 20.8 20.7 26.1 26.8 26.1 28.5 31.5 31.0
Selling, general and
administrative
expense........... 5.6 6.1 7.3 7.2 6.4 7.7 8.2 7.6
Amortization of
goodwill and other
intangibles(a).... 1.2 1.2 1.7 1.5 0.1 0.1 0.1 0.1
Restructuring charge(b) - - - 11.5 - - - -
------- ------- ------- ------- ------- ------- ------- -------
Operating Income (loss) - (0.1) (0.3) (8.8) 1.3 2.0 2.4 5.9
Interest expense, net (2.9) (2.5) (2.3) (2.5) (2.5) (2.4) (2.3) (0.4)
Other expense........ (0.2) (0.2) 0.3 0.1 - - (2.9) (1.9)
Income tax benefit
(expense)......... - - - (0.1) - - - 0.1
Extraordinary loss... - - - - - - - (6.9)
------- ------- ------- ------- ------- ------- ------- --------
Net loss $ (3.1) $ (2.8) $ (2.3) $(11.3) $ (1.2) $ (0.4) $ (2.8) $ (3.2)
======== ======== ======== ======= ======== ======== ======== =======
- --------------
(a) Effective at the beginning of our 2002 fiscal year, we adopted the
provisions of SFAS No. 141, Business Combinations, and No. 142, Goodwill
and Other Intangible Assets, and, accordingly, we reclassified certain
identifiable intangibles to goodwill and will no longer amortize goodwill
and intangible assets that are deemed to have indefinite lives under SFAS
142.
(b) In June 2001, we completed a strategic review of our manufacturing
operations and support functions. Based on this review and with board
approval, we began actions to eliminate redundant facilities. These actions
resulted in pre-tax charges of $11.5 million. The charges include employee
termination benefits of $3.8 million, other exit costs of $2.2 million,
impairment of goodwill and other intangibles of $3.6 million and impairment
of property, plant, and equipment of $1.9 million.
-38-
CRITICAL ACCOUNTING POLICIES
Certain of our accounting policies require the application of significant
judgment by management in selecting the appropriate assumptions for calculating
financial estimates. By their nature, these judgments are subject to an inherent
degree of uncertainty. These judgments are based on our historical experience,
terms of existing contracts, our observance of trends in the industry,
information provided by our customers, and information available from other
outside sources, as appropriate. Actual results may differ from these judgments
under different assumptions or conditions. Our accounting policies that require
management to apply significant judgment include:
o ALLOWANCES FOR DOUBTFUL ACCOUNTS. We specifically analyze our accounts
receivable, historical bad debts, customer concentrations, customer
credit-worthiness, and current economic trends, when evaluating the
adequacy of our allowance for doubtful accounts. Our accounts
receivable balance was $24.0 million and $21.5 million, net of
allowance for doubtful accounts, at June 30, 2002 and 2001,
respectively.
o EXCESS AND OBSOLETE INVENTORIES. We value our inventory at the lower
of the actual cost to purchase and/or manufacture the inventory and
its market value. We regularly review inventory quantities on hand and
record a provision for excess and obsolete inventory based primarily
on our estimated forecast of product demand and production
requirements for the next six to nine months. A significant increase
in the demand for our products could result in a decrease in the
amount of excess inventory on hand while a significant decrease in
demand could result in an increase in the amount of excess inventory
quantities on hand. Also, our estimates of future product demand may
prove to be inaccurate, in which case we may have understated or
overstated the provision required for excess and obsolete inventory.
In the future, if our inventory is determined to be overvalued, we
would be required to recognize additional cost of goods sold at the
time of such determination. Likewise, if our inventory is determined
to be undervalued, we may have over-reported our costs of goods sold
in previous periods and would be required to recognize additional
gross profit at the time of sale. Therefore, although we make every
effort to ensure the accuracy of our forecasts of future product
demand, any significant unanticipated changes in demand or
technological developments could have a significant impact on the
value of our inventory and our reported operating results. At June 30,
2002 and 2001, our inventory balance was $20.5 million and $13.4
million net of reserves, respectively.
o IMPAIRMENT OF GOODWILL AND OTHER INTANGIBLES. As discussed below under
"-- Recent Accounting Pronouncements," we adopted SFAS 142, Goodwill
and Other Intangible Assets, and are required to subject our goodwill
to an annual impairment test. Our decisions regarding our long-lived
assets are based on our business judgment of when assets have become
impaired. Any impairment would require a charge to our operating
income. The annual impairment analysis was performed at the beginning
of our fourth quarter. No impairment charge was necessary.
-39-
RECENT ACCOUNTING PRONOUNCEMENTS
In October 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment of Disposal of Long-Lived Assets," which replaces SFAS No. 121,
"Accounting for the Impairment of Long-Lived Assets and Long -Lived Assets to Be
Disposed Of." Though SFAS No. 144 retains the basic guidance of SFAS No. 121,
regarding when and how to measure an impairment loss, it provides additional
implementation guidelines. The Company will adopt this statement in the first
quarter of fiscal 2003 and does not believe its adoption will have a material
impact on the Company's financial statements.
In April 2002, the FASB issued SFAS No. 145, which rescinds FAS No. 4,
"Reporting Gains and Losses from Extinguishment of Debt." We will adopt this
statement in the first quarter of fiscal 2003 and will reclassify the
extraordinary loss on debt extinguishment that was recognized in fiscal 2002.
The reclassification will have no impact on our net loss, cash flows or
financial position.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk represents the risk of changes in value of a financial
instrument, derivative or non-derivative, caused by fluctuations in interest
rates, foreign exchange rates or equity prices. Changes in these factors could
cause fluctuations in earnings and cash flows.
INTEREST RATE RISK
For fixed rate debt, changes in interest rates generally affect the fair
market value of the debt instrument, but not earnings or cash flows. We do not
have any obligations under any fixed rate debt.
For variable rate debt, changes in interest rates generally do not impact
the fair market value of the debt instrument, but do affect future earnings and
cash flows. We had $40 million of variable rate debt outstanding under our
senior credit facility at June 30, 2002. To reduce our exposure to interest rate
risk, we entered into an agreement to hedge our exposure to interest rate risk
under our new senior credit facility. The effect of a 10% increase in interest
rates would have resulted in an immaterial increase in interest expense during
our year ended June 30, 2002.
FOREIGN CURRENCY RISK
Most of our sales and purchases are denominated in United States dollars
and as a result, we have relatively little exposure to foreign currency exchange
risk with respect to our sales. Accordingly, we do not use forward exchange
contracts to hedge exposures denominated in foreign currencies or any other
derivative financial instrument for trading or speculative purposes.
-40-
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
TABLE OF CONTENTS
Report of independent auditors...............................................42
Consolidated balance sheets..................................................43
Consolidated statements of operations........................................44
Consolidated statement of changes in mandatory redeemable convertible
stock and stockholders' equity (deficit)..................................45
Consolidated statements of cash flows........................................47
Notes to consolidated financial statements...................................48
-41-
REPORT OF INDEPENDENT AUDITORS
The Board of Directors
MedSource Technologies, Inc.
We have audited the accompanying consolidated balance sheets of MedSource
Technologies, Inc. and subsidiaries as of June 30, 2002 and 2001 and the related
consolidated statements of operations, changes in mandatory redeemable
convertible stock and stockholders' equity (deficit), and cash flows for the
years ended June 30, 2002 and 2001, and July 1, 2000. These financial statements
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the 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, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
MedSource Technologies, Inc. and subsidiaries at June 30, 2002 and 2001, and the
consolidated results of their operations and their cash flows for the years
ended June 30, 2002 and 2001, and July 1, 2000, in conformity with accounting
principles generally accepted in the United States.
As discussed in Notes 2 and 6 to the consolidated financial statements, the
Company adopted Statement of Financial Accounting Standards No. 142, Goodwill
and Other Intangibles Assets, in fiscal 2002.
/s/ Ernst & Young LLP
Minneapolis, Minnesota
July 23, 2002
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MEDSOURCE TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
JUNE 30, JUNE 30,
2002 2001
ASSETS
Current assets:
Cash and cash equivalents $ 38,268 $ 20,289
Accounts receivable, net of allowance of $646 in 2002 and $596 in
2001 24,031 21,504
Inventories 20,503 13,350
Prepaid expenses and other current assets 2,402 3,099
----------- ------------
Total current assets 85,204 58,242
Property, plant, and equipment, net 42,045 38,873
Goodwill, net 113,113 62,210
Other identifiable intangible assets, net 4,092 39,035
Deferred financing costs 1,971 3,386
Interest escrow fund -- 1,849
Other assets 1,404 370
----------- ------------
Total assets $ 247,829 $ 203,965
=========== ============
LIABILITIES, MANDATORY REDEEMABLE CONVERTIBLE STOCK, AND STOCKHOLDERS'
EQUITY (DEFICIT)
Current liabilities:
Accounts payable $ 7,924 $ 8,691
Accrued compensation and benefits 5,352 6,341
Other accrued expenses 3,491 5,784
Reserve for restructuring 2,381 5,928
Current portion of long-term debt 5,939 7,215
----------- ------------
Total current liabilities 25,087 33,959
Long-term debt, less unamortized discount and current portion 35,967 82,329
Other long-term liabilities 455 2,071
Mandatory redeemable convertible stock:
6% Series B preferred stock, par value $0.01 per share:
Authorized shares--none at 2002 and 400,000 at 2001
Issued and outstanding shares--none at 2002 and 332,728 at 2001 -- 26,289
6% Series C preferred stock, par value $0.01 per share:
Authorized shares-- none at 2002 and 52,029 at 2001
Issued and outstanding shares-- none at 2002 and 40,300 at 2001 -- 39,190
6% Series D preferred stock, par value $0.01 per share:
Authorized shares-- none at 2002 and 43,000 at 2001
Issued and outstanding shares-- none at 2002 and 35,165 at 2001 2 -- 33,388
Stockholders' equity (deficit):
Preferred stock, par value $0.01 per share:
Authorized shares--1,000,000 -- --
Series A convertible preferred stock, par value $0.01 per share:
Authorized shares---none-at 2002 and 100,000 at 2001
Issued and outstanding shares-- none at 2002 and 38,370 2001 -- --
6% Series E preferred stock, par value $0.01 per share:
Authorized shares--6,000
Issued and outstanding shares--1,935 at 2002 and none at 2001 1,974 --
Series Z convertible preferred stock, par value $0.01 per share:
Authorized shares-- none at 2002 and 65,000 at 2001
Issued and outstanding shares-- none at 2002 and 65,000 2001 -- 1
Common stock, par value $0.01 per share:
Authorized shares--70,000,000 at 2002 and 40,000,000 at 2001
Issued and outstanding shares--26,918,533 at 2002 and 5,255,758
at 2001 269 52
Additional paid-in capital 268,455 33,875
Treasury stock, 97,576 shares at 2002 (1,282) --
Accumulated other comprehensive loss -- (1,560)
Accumulated deficit (83,025) (45,415)
Unearned compensation (71) (214)
----------- ------------
Total stockholders' equity (deficit) 186,320 (13,261)
----------- ------------
Total liabilities, mandatory redeemable convertible stock, and
stockholders' equity (deficit) $ 247,829 $ 203,965
=========== ============
See accompanying notes.
-43-
MEDSOURCE TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
FISCAL YEAR ENDED
JUNE 30, JUNE 30, JULY 1,
2002 2001 2000
--------------- -------------- -------------
Revenues $ 158,899 $ 128,462 $ 89,352
Cost and expenses:
Cost of products sold 117,089 94,386 59,811
Selling, general, and administrative expense 29,876 26,199 21,167
Amortization of goodwill and other intangibles 340 5,640 4,255
Restructuring charge -- 11,464 --
--------------- -------------- -------------
147,305 137,689 85,233
--------------- -------------- -------------
Operating income (loss) 11,594 (9,227) 4,119
Interest expense, net (7,671) (10,213) (10,682)
Other (expense) income (4,782) 53 (7)
--------------- -------------- -------------
Loss before income taxes and extraordinary loss (859) (19,387) (6,570)
Income tax benefit (expense) 118 (70) 535
--------------- -------------- -------------
Loss before extraordinary loss (741) (19,457) (6,035)
Extraordinary loss on debt extinguishment (6,857) -- --
--------------- -------------- -------------
Net loss (7,598) (19,457) (6,035)
Preferred stock dividends and accretion of discount on preferred
stock (31,168) (9,688) (8,345)
--------------- -------------- -------------
Net loss attributed to common stockholders $ (38,766) $ (29,145) $ (14,380)
=============== ============== =============
Net loss per share attributed to common stockholders before
extraordinary loss--basic and diluted $ (2.88) $ (5.55) $ (3.10)
=============== ============== =============
Extraordinary loss - basic and diluted $ (0.62) $ -- $ --
=============== ============== =============
Net loss per share attributed to common stockholders after
extraordinary loss--basic and diluted $ (3.50) $ (5.55) $ (3.10)
=============== ============== =============
Weighted average common shares outstanding--basic and diluted 11,086,103 5,252,749 4,633,571
=============== ============== =============
See accompanying notes.
-44-
MEDSOURCE TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN MANDATORY REDEEMABLE
CONVERTIBLE STOCK AND STOCKHOLDERS' EQUITY (DEFICIT)
(IN THOUSANDS)
MANDATORY REDEEMABLE CONVERTIBLE STOCK
--------------------------------------------------
SERIES B SERIES C SERIES D SERIES F
PREFERRED PREFERRED PREFERRED PREFERRED
STOCK STOCK STOCK STOCK
--------- --------- --------- ---------
Balance at July 3, 1999 16,250 -- -- --
Stock issued for acquired businesses -- -- -- --
Accretion of discounts on mandatory redeemable convertible preferred stock 4,522 -- -- --
Accrued dividends on mandatory redeemable convertible preferred stock 1,521 -- -- --
Net loss and comprehensive net loss for the year -- -- -- --
---------- ----------- ---------- ------------
Balance at July 1, 2000 22,293 -- -- --
Cumulative effect change due to implementation of SFAS No. 133 -- -- -- --
Change in fair value of interest rate swaps -- -- -- --
Net loss for the year -- -- -- --
Comprehensive loss for the year -- -- -- --
Sale and issuance of Series C preferred stock, net of costs of $3,061 -- 37,239 -- --
Issuance of Series D preferred stock and options for acquired business -- -- 31,575 --
Issuance of stock pursuant to option exercises -- -- 374 --
Accretion of discounts on mandatory redeemable convertible preferred stock 2,379 275 391 --
Accrued dividends on mandatory redeemable convertible preferred stock 1,617 1,676 1,048 --
Amortization of unearned compensation -- -- -- --
---------- ----------- ---------- ------------
Balance at June 30, 2001 26,289 39,190 33,388 --
Change in fair value of interest rate swaps -- -- -- --
Net loss for the period -- -- -- --
Comprehensive loss for the period -- -- -- --
Issuance of stock pursuant to option exercises -- -- 48 --
Sale of Series E preferred stock and common stock purchase warrants -- -- -- --
Accretion of discounts on mandatory redeemable convertible preferred stock 177 310 598 --
Accrued dividends on mandatory redeemable convertible preferred stock 1,276 2,415 1,571 --
Amortization of unearned compensation -- -- -- --
Issuance of preferred and common stock for acquired business -- -- -- 3,636
Conversion of Series Z to common stock -- -- -- --
Conversion of Series A to common stock -- -- -- --
Conversion of Series B to common stock (22,980) -- -- --
Conversion of Series D to common stock -- -- (35,605) --
Conversion of Series C to common stock -- (41,915) -- --
Payment of Series B dividend (4,762) -- -- --
Sale of common stock, net of issuance costs -- -- -- --
Amortization of discount on redeemable preferred stock -- -- -- 364
Amortization of dividend on redeemable preferred stock -- -- -- 63
Return on Series C preferred stock -- -- -- --
Termination of interest rate swap -- -- -- --
Redemption of Series F preferred stock -- -- -- (4,063)
Redemption of Series E preferred stock -- -- -- --
Shares received from sale of business -- -- -- --
---------- ----------- ---------- ------------
Balance at June 30, 2002 $ -- $ -- $ -- $ --
========== =========== ========== ============
See accompanying notes.
-45-
STOCKHOLDERS' EQUITY (DEFICIT)
- ------------------------------------------------------------------------------------------------------------------------------------
SERIES A SERIES E ACCUMULATED TOTAL
CONVERTIBLE CONVERTIBLE SERIES Z NUMBER OF ADDITIONAL OTHER STOCKHOLDER
PREFERRED PREFERRED PREFERRED COMMON COMMON PAID-IN TREASURY COMPREHENSIVE ACCUMULATED UNEARNED EQUITY
STOCK STOCK STOCK SHARES STOCK CAPITAL STOCK LOSS DEFICIT COMPENSATION (DEFICIT)
- ----------- ----------- --------- --------- ------- ----------- -------- ------------- ------------ ------------ -----------
$ -- $ -- $ 1 4,448 $ 44 $ 27,697 $ -- $ -- $ (6,494) $ -- $ 21,248
- ----------- ----------- ---------- --------- ------- ----------- ---------- ------------- ------------- ------------ -----------
-- -- -- 787 8 5,894 -- -- -- -- 5,902
-- -- -- -- -- -- -- -- (4,522) -- (4,522)
-- -- -- -- -- -- -- -- (1,521) -- (1,521)
-- -- -- -- -- -- -- -- (6,035) -- (6,035)
- ----------- ----------- ---------- --------- ------- ----------- ---------- ------------- ------------- ------------ -----------
-- -- 1 5,235 52 33,591 -- -- (18,572) -- 15,072
-- -- -- -- -- -- -- 1,097 -- -- 1,097
-- -- -- -- -- -- -- (2,657) -- -- (2,657)
-- -- -- -- -- -- -- -- (19,457) -- (19,457)
-----------
-- -- -- -- -- -- -- -- -- -- (22,114)
-- -- -- -- -- -- -- -- -- -- --
-- -- -- -- -- -- -- -- -- (286) (286)
-- -- -- 21 -- 284 -- -- -- -- 284
-- -- -- -- -- -- -- -- (3,045) -- (3,045)
-- -- -- -- -- -- -- -- (4,341) -- (4,341)
-- -- -- -- -- -- -- -- -- 72 72
- ----------- ----------- ---------- --------- ------- ----------- ---------- ------------- ------------- ------------ -----------
-- -- 1 5,256 52 33,875 -- (1,560) (45,415) (214) (13,261)
-- -- -- -- -- -- -- (374) -- -- (374)
-- -- -- -- -- -- -- -- (7,598) -- (7,598)
-----------
-- -- -- -- -- -- -- -- -- -- (7,972)
-- -- -- -- -- 19 -- -- -- -- 19
-- 4,168 -- -- -- 1,832 -- -- -- -- 6,000
-- -- -- -- -- -- -- -- (1,085) -- (1,085)
-- -- -- -- -- -- -- -- (5,262) -- (5,262)
-- -- -- -- -- -- -- -- -- 143 143
-- -- -- 824 8 9,883 -- -- -- -- 9,891
-- -- (1) 650 7 (6) -- -- -- -- --
-- -- -- 1,919 19 (19) -- -- -- -- --
-- -- -- 3,327 33 22,947 -- -- -- -- 22,980
-- -- -- 1,770 18 35,587 -- -- -- -- 35,605
-- -- -- 3,906 39 41,876 -- -- -- -- 41,915
-- -- -- -- -- -- -- -- -- -- --
-- -- -- 9,266 93 101,174 -- -- -- -- 101,267
-- 1,832 -- -- -- -- -- -- (2,196) -- (364)
-- 119 -- -- -- -- -- -- (182) -- (63)
-- -- -- -- -- 21,287 -- -- (21,287) -- --
-- -- -- -- -- -- -- 1,934 -- -- 1,934
-- -- -- -- -- -- -- -- -- -- --
-- (4,145) -- -- -- -- -- -- -- -- (4,145)
-- -- -- -- -- -- (1,282) -- -- -- (1,282)
- ----------- ----------- ---------- --------- ------- ----------- ---------- ------------- ------------- ------------ -----------
$ -- $ 1,974 $ -- 26,918 $ 269 $ 268,455 $ (1,282) $ -- $ (83,025) $ (71) $ 186,320
=========== ========== ========== ========= ======= =========== ========= ============ ============= ============ ===========
See accompanying notes.
-46-
MEDSOURCE TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
FISCAL YEAR ENDED
-------------------------------------------------
JUNE 30, JUNE 30, JULY 1,
2002 2001 2000
-------------- ---------- ------------
OPERATING ACTIVITIES
Net loss $ (7,598) $ (19,457) $ (6,035)
Adjustments to reconcile net loss to net cash (used
in) provided by operating activities:
Depreciation 7,791 6,555 4,500
Amortization of goodwill and other intangibles 340 5,640 4,255
Amortization of deferred financing costs and
discount on long-term debt 6,157 1,122 1,295
Amortization of unearned compensation 143 72 --
Restructuring charges -- 11,464 --
Deferred taxes -- -- (685)
Gain on sale of equipment -- (29) --
Changes in operating assets and liabilities, net
of effect of businesses acquired:
Accounts and notes receivable (1,682) (4,296) (3,168)
Inventories (6,889) (1,775) (1,915)
Prepaid expenses and other current assets 768 (836) 65
Interest escrow fund 1,849 2,500 2,500
Accounts payable, accrued compensation and
benefits, accrued expenses, and other (6,570) 476 5,493
Other (1,120) (183) (15)
-------------- ---------- ------------
Net cash (used in) provided by operating activities (7,755) 1,253 6,290
INVESTING ACTIVITIES
Acquisition of businesses, net of cash acquired (6,312) (378) (15,458)
Other additions to plant and equipment, net (8,598) (11,491) (6,786)
Proceeds from sale of equipment 245 242 --
-------------- ---------- ------------
Net cash used in investing activities (14,665) (11,627) (22,244)
FINANCING ACTIVITIES
Proceeds from issuance of long-term debt, net of
financing costs, and interest escrow fund 37,939 105 19,506
Payments of long-term debt (91,890) (5,549) (3,150)
Proceeds from sale of Series C and D preferred
stock, net of costs 37,897 --
Proceeds from sale of Series E preferred stock and
common stock, net of costs 107,286 -- --
Payments of Series B dividends (4,762) -- --
Redemption of Series E and F preferred stock (8,208) -- --
Net payments on lines of credit -- (4,000) --
Other 37 -- --
-------------- ---------- ------------
Net cash provided by financing activities 40,399 28,453 16,356
-------------- ---------- ------------
Increase in cash and cash equivalents 17,979 18,079 402
Cash and cash equivalents at beginning of period 20,289 2,210 1,808
-------------- ---------- ------------
Cash and cash equivalents at end of period $ 38,268 $ 20,289 $ 2,210
============== ========== ============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid for interest $ 7,018 $ 9,319 $ 9,616
============== ========== ============
Cash paid for income taxes $ 108 $ 150 $ 179
============== ========== ============
Preferred and common stock issued for acquisitions $ 13,527 $ 31,289 $ 5,902
============== ========== ============
See accompanying notes.
-47-
MEDSOURCE TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION AND DESCRIPTION OF BUSINESS
MedSource Technologies, Inc. (the Company) was formed as a Delaware
corporation on April 14, 1998. For the period from April 14, 1998 through March
30, 1999 (inception of operations), the Company had no employees or other
operations.
The Company and its subsidiaries operate in one business segment and
provide product development and design services, precision metal and plastic
part manufacturing, product assembly services and supply chain management
primarily for the medical device industry. The Company's operations and customer
base are located primarily in North America.
2. SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the Company
and its wholly owned subsidiaries. All significant intercompany balances and
transactions have been eliminated.
STOCK SPLIT
In January 2000, the Company's common stock was split 10-for-1 and all
share and per share references to common stock have been adjusted to give effect
to the split.
FISCAL YEAR END
The Company's fiscal year historically ended on the Saturday closest to
June 30. Effective July 1, 2001, the Company's fiscal year end was changed to
June 30.
CASH EQUIVALENTS
Cash equivalents include money market mutual funds and other highly liquid
investments purchased with maturities of three months or less. The cash
equivalents are carried at cost, which approximates market.
INVENTORIES
Inventories are stated at the lower of cost, using the FIFO (first-in,
first-out) method, or market.
PROPERTY, PLANT, AND EQUIPMENT
Property, plant, and equipment are recorded at cost. Depreciation is
computed using the straight-line method over the estimated useful lives of the
assets. Amortization of capital leases and leasehold improvements is provided on
a straight-line basis over the lives of the related assets or the life of the
lease, whichever is shorter, and is included with depreciation expense.
-48-
MEDSOURCE TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
GOODWILL AND OTHER INTANGIBLE ASSETS
Goodwill represents the cost in excess of the fair value of the tangible
and identifiable intangible assets of the businesses acquired and, prior to July
1, 2001, was being amortized on a straight-line basis over 20 years based on the
operating histories and market niches of these businesses. Effective July 1,
2001, the Company adopted Statement of Financial Accounting Standards No. 142,
Goodwill and Other Intangible Assets. Under FAS No. 142, goodwill must be tested
for impairment annually, or more often if an event occurs or circumstances
change that would more likely than not reduce the fair value of a reporting unit
below its carrying amount, using a two-step approach. Step one is to compare the
fair value of a reporting unit with its carrying amount, including goodwill. If
the carrying amount of a reporting unit exceeds its fair value, the second step
of the goodwill impairment test will be performed to measure the amount of
impairment loss, if any. Step two compares the implied fair value of reporting
unit goodwill with the carrying amount of that goodwill. The implied fair value
of goodwill shall be determined in the same manner as the amount of goodwill
recognized in a business combination is determined. If the carrying amount of
reporting unit goodwill exceeds the implied fair value of that goodwill, an
impairment loss shall be recognized in an amount equal to that excess. The
Company has one operating segment consisting of multiple manufacturing
facilities with similar economic characteristics producing goods for a similar
set of customers (i.e., the medical device industry). Thus the Company has
concluded that it currently has one reporting unit for purposes of the goodwill
impairment test. The Company intends to use the fair value of its common stock
in combination with, as necessary, the present value of its estimated future
cash flows or other market valuation techniques to measure the fair value of the
reporting unit. The annual impairment was performed as of the beginning of the
Company's fourth quarter, noting no required impairment charge.
The identifiable intangible assets consist mainly of patents, amortized
over the life of the patents and covenants not to compete, amortized over the
life of the agreements.
See Note 6--Goodwill and Other Intangible Assets for effects of adoption of
Statements of Financial Accounting Standards 141 and 142 in fiscal year 2002.
IMPAIRMENT OF LONG-LIVED ASSETS
The Company evaluates long-lived assets for impairment whenever events or
changes in circumstances indicate that the carrying amount of an asset may not
be recoverable. If the estimated future cash flows (undiscounted and without
interest charges) from the use of an asset are less than the carrying amount, a
write-down would be recorded to reduce the related asset to the amount of
discounted estimated future cash flows, for assets in use, or to estimated fair
value for assets held for sale.
In conjunction with the restructuring charges recorded in fiscal 2001 (see
Note 13--Restructuring Charges), the Company recognized impairment to goodwill
and other intangibles of $3.6 million and impairment to property, plant, and
equipment of $3.3 million.
DEFERRED FINANCING COSTS
Costs incurred in connection with arranging the Company's long-term debt
agreements are capitalized and amortized over the life of the related debt issue
using the effective interest method. Accumulated amortization was $0.1 million
at June 30, 2002, $1.9 million at June 30, 2001, and $1.1 million at July 1,
2000. In conjunction with the repayment of the senior subordinated debt (See
Note 10 - Long-Term Debt) the Company wrote off $5.5 million of unamortized
deferred financing costs during fiscal 2002. On
-49-
MEDSOURCE TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
March 31, 2002 the Company entered into a new $85 million senior credit facility
and capitalized costs of $2.1 million associated with the new agreement.
DEFERRED INCOME TAXES
Deferred income taxes are determined using the liability method, which
gives consideration to the future tax consequences associated with differences
between the financial accounting and tax basis of assets and liabilities. This
method also gives immediate effect to changes in income tax laws.
MANDATORY REDEEMABLE SECURITIES
Mandatory redeemable preferred stock is recorded at fair value at date of
issuance, net of related costs. Fair value of the preferred stock at date of
issuance is based on the net proceeds received. The fair value of the Series B
preferred stock was further reduced by the intrinsic value of the related
contingent additional consideration.
Any discount to the face amount of the mandatory redeemable preferred stock
or additional reduction representing issuance costs is amortized over the period
from the date of issuance to the mandatory redemption date.
PREFERRED STOCK DIVIDENDS
The Company accrues dividends on redeemable preferred stock.
REVENUE RECOGNITION
The Company recognizes revenue at the time products are shipped or services
are rendered. Product shipments are supported by purchase orders from customers
that indicate the price for each product. In the case of services, we recognize
revenues primarily on a time and materials basis. Service revenues are supported
by customer orders or contracts that indicate the price for the services being
rendered. For fiscal 2002, 2001, and 2000 service revenues were less than 10% of
total revenues. Revenues for product shipments and services rendered must also
have reasonable assurance of collectibility from the customer. Reserves for
returns and allowances are recorded against revenues based on management's
estimates and historical experience.
SHIPPING AND HANDLING COSTS
The Company includes shipping and handling costs in the cost of products
sold.
STOCK-BASED COMPENSATION
The Company has elected to follow Accounting Principles Board Opinion No.
25, Accounting for Stock Issued to Employees, in the primary financial
statements and to provide the supplemental disclosures required by Statement of
Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation
(SFAS No. 123) (see Note 10--Mandatory Redeemable Convertible Stock and
Stockholders' Equity).
-50-
MEDSOURCE TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
CONCENTRATION OF CREDIT RISKS
Financial instruments that potentially subject the Company to
concentrations of credit risk consist primarily of cash equivalents and accounts
receivable. The Company performs ongoing credit evaluations of its customers,
does not generally require collateral or other security, and maintains an
allowance for potential credit losses.
SIGNIFICANT CUSTOMERS
Customers that accounted for more than 10% of consolidated revenues are as
follows:
YEAR ENDED
JUNE 30, JUNE 30, JULY 1,
2002 2001 2000
---- ---- ----
Customer A....................... 25 % 18 % 14 %
Customer B....................... 12 12 16
At June 30, 2002 and 2001 receivables from these customers represented 17%
and 13% respectively, of total accounts receivable.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The Company's financial instruments consist primarily of cash equivalents,
accounts receivable, accounts payable, and debt instruments. The carrying
amounts of financial instruments other than the debt instruments are
representative of their fair values due to their short maturities. The Company's
principal long-term debt agreements bear interest at market rates; thus,
management believes their carrying amounts approximate fair value. Management
believes the carrying amount of the remaining loans is not materially different
from estimated fair value.
NET LOSS PER COMMON SHARE
Net loss per common share attributed to common stockholders is based on the
net loss for the period adjusted for dividend requirements on all preferred
stocks and accretion during the period of discounts on mandatory redeemable
preferred stock. The resulting net loss attributed to common stockholders is
divided by the weighted average number of shares of common stock outstanding
during the period to arrive at the basic net loss per share attributed to common
stockholders. For all periods presented, the impact of the inclusion of
potentially dilutive securities related to the assumed exercise or conversion of
options and convertible securities was anti-dilutive.
HEDGING ACTIVITIES
The Company adopted Financial Accounting Standards Board Statement of
Financial Accounting Standards No. 133, Accounting for Derivative Instruments
and Hedging Activities (SFAS No. 133), in its fiscal year beginning July 2,
2000. The statement requires the Company to recognize all derivatives on the
balance sheet at fair value. Derivatives that are not hedges must be adjusted to
fair value through earnings. If the derivative is a hedge, depending on the
nature of the hedge, changes in the fair value of derivatives will either be
offset against the change in fair value of the hedged assets, liabilities, or
firm commitments through earnings or recognized in other comprehensive income
until the hedged item is recognized in earnings.
-51-
MEDSOURCE TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
The ineffective portion of a derivative's change in fair value will be
immediately recognized in earnings. (See Note 7--Long-Term Debt.)
RECLASSIFICATION
Certain prior year amounts have been reclassified to conform with the
current year presentation.
USE OF ESTIMATES
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States 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 consolidated financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.
3. ACQUISITIONS
During fiscal year ended June 30, 2002, the Company completed the
acquisition of HV Technologies, Inc. (HV Technologies), a company located in
Trenton, Georgia that manufactures polyimide and composite micro-tubing used in
interventional and minimally invasive catheters, delivery systems and
instruments. The total purchase price was approximately $19.1 million, including
cash of $5.6 million, 4,000 shares of Series F stock valued at $3.6 million, and
824,255 shares of common stock valued at $9.9 million. The results of HVT are
included in the Company's consolidated Statement of Operations from the date of
acquisition and were not material.
To help provide financing for the acquisition, the Company issued 6,000
shares of its 6% Series E preferred stock (the Series E preferred stock) and
warrants to purchase an aggregate of 200,000 shares of its common stock.
Although the Company had agreed that the total number of shares issuable upon
exercise of the warrants would increase on each of the first five anniversaries
of the date of issuance of the Series E Preferred Stock by an aggregate of
45,000 shares per year for each year that the Series E preferred stock remains
outstanding, the Company had redeemed 4,065 shares of Series E preferred stock
as of June 30, 2002 and, as a result, the warrants would be exercisable for an
aggregate of 337,062 shares of common stock if the remaining 1,935 shares of
Series E preferred stock were to remain outstanding for five or more years if
the Series E preferred stock had remained outstanding for five or more years,
the warrants would be exercisable for an aggregate of up to 425,000 shares). The
Company recorded a discount of $1.8 million to the carrying value of the Series
E preferred stock equal to the consideration allocated to the warrants.
The Series E preferred stock and the Series F preferred stock accrue
dividends at $60 per year during the first year from issuance, payable at the
discretion of the Board of Directors, and at the rate of $160 per year on a
retroactive basis after the first anniversary of issuance. The Company redeemed
the Series F preferred stock and 4,065 shares of the Series E preferred stock in
April 2002, at a price equal to $1,000 per share plus accrued and unpaid
dividends.
In connection with the Company's issuance of Series E preferred stock, the
Company obtained the consent of the holders of its $20.0 million of Senior
Subordinated Promissory Notes (Notes) to complete the acquisition of HV
Technologies and changed some of the covenants to which the Company was subject
under an agreement between the Company and those holders. At the same time, the
Company agreed to increase by
-52-
MEDSOURCE TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
$1.0 million the amount payable by the Company upon redemption of the Notes. As
of April 2, 2002 the Company repaid all of the Notes, including the prepayment
fees.
The Company preliminarily allocated the purchase price as follows: $3.2
million for fair value of tangible assets acquired, net of liabilities assumed,
and deferred taxes and $15.9 million for goodwill.
During fiscal year ended June 30, 2001, the Company completed the
acquisition of ACT Medical, Inc., a Massachusetts company with additional
facilities in Santa Clara, California and a contract for production and assembly
services in Navojoa, Mexico. The acquisition was completed by the issuance of
33,423 shares of 6% Series D cumulative convertible redeemable preferred stock,
rollover of options for an additional 6,920 shares of Series D preferred stock,
and cash payments of $1.0 million to stockholders electing to receive cash
instead of stock. The rollover of options represented replacement of outstanding
options to purchase the common stock of ACT Medical that had been issued under a
plan sponsored by ACT Medical with options to purchase the Series D preferred
stock of the Company. The fair value of the options to purchase the Series D
preferred stock of the Company of $3.4 million was included in the purchase
price, and the intrinsic value related to the unvested options was recorded as
unearned compensation. The acquisition was recorded using the purchase method of
accounting, and the operating results are included in the Company's consolidated
statements of operations since the date of acquisition (December 30, 2000). The
total purchase price was allocated as follows (in thousands):
Fair value of tangible assets acquired, net of liabilities
assumed, and deferred taxes................................... $ 1,649
Identifiable intangible assets, net of deferred taxes............ 3,648
Goodwill......................................................... 28,440
----------
$ 33,737
==========
The following unaudited pro forma summary presents the consolidated results
of operations as if the acquisition had occurred at the beginning of the fiscal
period (in thousands, except per share):
YEAR ENDED
-------------------------
JUNE 30, JULY 1,
2001 2000
----------- ----------
Net revenues......................................... $ 141,248 $ 116,298
Loss before taxes.................................... (20,750) (5,395)
Net loss............................................. (20,820) (5,408)
Net loss attributed to common stockholders........... (31,825) (16,385)
----------- ----------
Net loss per share attributed to common stockholders. $ (6.06) $ (3.54)
=========== =========
During fiscal year ended July 1, 2000, the Company completed the following
acquisitions:
SHARES OF FAIR VALUE LOCATION OF
COMPANY CASH COMMON STOCK OF SHARES OPERATIONS
- ------- ------------- ------------ ---------- -----------
(IN THOUSANDS (IN THOUSANDS
Tenax........................................... $ 7,700 50,000 $ 375 Connecticut
Apex Engineering, Inc........................... 1,954 236,950 1,777 Massachusetts
Thermat Precision Technology, Inc............... 4,045 500,000 3,750 Pennsylvania
------------- -------------
$ 13,699 $ 5,902
============= =============
-53-
MEDSOURCE TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
The cash amounts reflected above include payments to the former owners and
the payoff of certain debt at acquisition. Costs incurred with the acquisitions
totaled approximately $1.8 million.
The total purchase consideration does not reflect contingent consideration
related to earn-out arrangements included in the Apex Engineering, Inc. (Apex)
Purchase Agreement. The Apex Purchase Agreement provides for a post-closing
adjustment whereby additional contingent consideration would be payable to Apex
(as defined in the Apex Purchase Agreement). The Company has determined that
there is no additional earn-out consideration to be paid.
A summary of the combined purchase price allocations for the acquisitions
in fiscal 2000 is as follows (in thousands):
Fair value of tangible assets acquired, net of liabilities
assumed and deferred taxes.................................... $ 13,724
Identified intangible assets, net of deferred taxes............. 1,222
Goodwill........................................................ 6,484
------------
$ 21,430
============
During fiscal 2001, the Company finalized its purchase price allocations
related to the acquisitions made in 2000. In conjunction with the final
allocations, approximately $4.5 million was reclassified from goodwill to
identifiable intangibles.
4. INVENTORIES
Inventories consist of the following (in thousands):
JUNE 30, JUNE 30,
2002 2001
---------- ----------
Raw materials...................................... $ 10,638 $ 6,287
Work in progress................................... 6,529 5,051
Finished goods..................................... 3,336 2,012
---------- ----------
Total.............................................. $ 20,503 $ 13,350
========== ==========
-54-
MEDSOURCE TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
5. PROPERTY, PLANT, AND EQUIPMENT
Property, plant, and equipment consists of the following (in thousands):
ESTIMATED
USEFUL LIVES JUNE 30, JUNE 30,
(YEARS) 2002 2001
------------ ---------- ----------
Land.................................. $ 169 $ 198
Buildings and improvements............ 1 to 20 46 1,987
Leasehold improvements................ 2 to 20 6,320 3,173
Machinery and equipment............... 3 to 15 39,796 35,530
Furniture and fixtures................ 1 to 7 6,136 4,011
Automobiles........................... 2 to 3 82 86
Software.............................. 3 to 8 626 602
Construction in progress.............. 6,410 5,176
---------- ----------
Total................................. 59,585 50,763
Less accumulated depreciation and
amortization........................ (17,540) (11,890)
---------- ----------
Net property, plant, and equipment.... $ 42,045 $ 38,873
========== ==========
As of June 30, 2002 capital leases of $1.9 million were included in machinery
and equipment.
6. GOODWILL AND OTHER IDENTIFIABLE INTANGIBLE ASSETS
In June 2001, the Financial Accounting Standards Board issued Statements of
Financial Accounting Standards No. 141, Business Combinations, and No. 142,
Goodwill and Other Intangible Assets, effective for fiscal years beginning after
December 15, 2001 with early adoption permitted for companies with fiscal years
beginning after March 15, 2001. Under the new rules, goodwill and intangible
assets deemed to have indefinite lives will no longer be amortized but will be
subject to annual impairment tests in accordance with the statements. Other
intangible assets will continue to be amortized over their useful lives.
The Company adopted the new rules on accounting for goodwill and other
intangible assets beginning in the first quarter of fiscal 2002. Amounts
previously recorded as separately identifiable intangibles for acquired work
force and customer base have been subsumed to goodwill in accordance with FAS
141, increasing goodwill by $34.6 million as of the date of adoption. Effective
with the July 1, 2002 adoption of FAS 142, goodwill is no longer amortized but
is instead subject to an annual impairment test. The transitional test conducted
in connection with the adoption of FAS 142 and the annual impairment test,
performed as of the beginning of the Company's fourth quarter resulted in no
impairment being required.
Goodwill and other identifiable intangible assets resulting from
acquisitions of businesses and the formation of the Company consist of the
following (in thousands):
-55-
MEDSOURCE TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
JUNE 30, JUNE 30,
2002 2001
------------ ----------
Goodwill........................................ $ 125,783 $ 67,268
Less accumulated amortization................... (12,670) (5,058)
------------ ----------
$ 113,113 $ 62,210
============ ==========
Other identifiable intangibles:
Customer base............................. $ - $ 39,155
Acquired workforce........................ - 3,437
Patents and intellectual properties....... 4,383 4,383
Covenants not to compete.................. 476 476
------------ ----------
4,859 47,451
Less accumulated amortization................... (767) (8,416)
------------ ----------
$ 4,092 $ 39,035
============ ==========
The increase in goodwill and decrease in customer base and acquired
workforce at June 30, 2002, results from the adjustment to subsume those
intangibles into goodwill in accordance with FAS 142.
With the adoption of FAS 142, the Company ceased amortization of goodwill
as of July 1, 2001. The following table presents the results of the Company for
all periods presented on a comparable basis (in thousands, except per share
data):
FISCAL YEAR ENDED
--------------------------------------------------
JUNE 30, JUNE 30, JULY 1,
2002 2001 2000
--------------- --------------- ---------------
Net loss attributed to common
stockholders, as reported............... $ (38,766) $ (29,145) $ (14,380)
Add back goodwill, workforce, and customer
base amortization (net of tax).......... -- 5,268 4,211
--------------- --------------- ---------------
Adjusted net loss attributed to common
stockholders............................ $ (38,766) $ (23,877) $ (10,169)
=============== =============== ===============
Basic and diluted net loss per share:
Net loss attributed to common
stockholders, as reported......... $ (3.50) $ (5.55) $ (3.10)
Goodwill, workforce, and customer
base amortization (net of tax).... -- 1.00 0.91
--------------- --------------- ---------------
Adjusted net loss attributed to common
stockholders............................ $ (3.50) $ (4.55) $ (2.19)
=============== =============== ===============
The estimated amortization expense for the intangible assets for each of
the five fiscal years subsequent to June 30, 2002 is approximately $0.4 million
per year.
-56-
MEDSOURCE TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
7. LONG-TERM DEBT
Long-term debt consists of the following (in thousands):
JUNE 30, JUNE 30,
2002 2001
------------- -------------
Notes Payable.............................................. $ 40,000 $ -
A Term Loan................................................ - 19,000
B Term Loan................................................ - 39,200
Senior Subordinated Notes.................................. - 20,000
Acquisition Loans.......................................... - 13,413
Other...................................................... 1,906 612
------------- -------------
41,906 92,225
Less:
Unamortized discount on Senior Subordinated Notes....... - (2,681)
Current portion......................................... (5,939) (7,215)
------------- -------------
$ 35,967 $ 82,329
============= =============
CREDIT AGREEMENT
Concurrent with receipt of funds from the Company's initial public offering
(IPO) on April 2, 2002, the Company repaid the entire $66.3 million outstanding
under its former senior credit facility and the entire $21.4 million outstanding
(including a $1.4 million pre-payment fee) under its former Senior Subordinated
Notes. The Company also entered into a new senior credit facility that provides
it with a $25.0 million revolving credit facility, a $40.0 million term loan and
a $20.0 million acquisition line term loan. The acquisition line term loan is
available to finance an acquisition by the end of September 2002 that is
approved by the Company's lenders. All loans under the new senior credit
facility will mature on April 12, 2007. As a result of repaying our former
senior subordinated debt the Company recognized extraordinary losses of $6.9
million, consisting of a $5.5 million write-off of unamortized financing costs
and discount and a $1.4 million prepayment fee. The Company also recognized a
non-recurring charge of $1.9 million for terminating the interest rate swap
agreements.
During the twelve months ending March 31, 2003, the Company will be
required to make an aggregate annual payment of principal under the term loan of
$4.0 million payable in three installments. During the years ending March 31,
2004, 2005, 2006 and 2007, the Company will make aggregate annual payments of
$6.0 million, $8.0 million, $10.0 million and $12.0 million, respectively,
payable in quarterly installments. During the year ending March 31, 2003, the
Company will also be required to make an annual payment of 15% of any original
principal that it may borrow under our acquisition line. In addition under the
Company's acquisition line, future annual payments of 20%, 30% and 35% of any
original principal borrowed payable in quarterly installment during the years
ending March 31, 2004, 2005, 2006 and 2007, respectively, are required. The
Company paid costs and fees of $2.1 million to enter into the new senior credit
facility.
-57-
MEDSOURCE TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
At the Company's option, interest rates applicable to loans under its new
senior credit facility will be either:
o The greater of the bank's prime rate plus a margin, which depends upon
the Company's leverage ratio, ranging from zero to 125 basis points,
or the federal funds rate plus 50 basis points plus the same margin;
or
o LIBOR plus a margin, which depends upon our leverage ratio, ranging
from 175 to 300 basis points.
The Company has entered into an interest rate cap agreement to protect
against interest rate fluctuations with respect to 50% of the term loans
outstanding under its new senior credit facility. This agreement, executed with
a highly-rated financial counter-party, requires the counter-party to make
payments to be made to the Company in the event that a reference floating rate
index exceeds an agreed upon fixed rate. The impact of the agreement on the
financial statements was not significant at June 30, 2002.
The senior credit facility contains affirmative and negative covenants and
limitations, including, but not limited to, required minimum coverage of the
Company's obligations to pay interest and incur fixed charges, restrictions on
its ability to pay dividends, make other payments and enter into sale
transactions, limitations on liens, limitations on its ability to incur
additional indebtedness and agreements that the Company use excess cash on hand
and proceeds from future equity issuances to pay down its senior credit
facility. In addition to the requirements that it obtain the consent of the
lenders under its senior credit facility to borrow under the $20.0 million
acquisition line, the Company also needs their consent to make any other
acquisition in which it pays more than $10.0 million (including more than $5.0
million in cash, deferred payments and the assumption of debt) or to pay more
than $20.0 million (including more than $10.0 million in cash, deferred payments
and the assumption of debt) for all of the acquisitions that the Company
completes during any fiscal year.
The senior credit facility is secured by all of the Company's assets and
contains various events of default, including, but not limited to, defaults upon
the occurrence of a change of control of the Company and defaults for
non-payment of principal interest or fees, breaches of warranties or covenants,
bankruptcy or insolvency, ERISA violations and cross-defaults to other
indebtedness.
Maturities of long-term debt outstanding at June 30, 2002, are summarized
by fiscal year as follows (in thousands):
2003................................................ $ 5,939
2004................................................ 6,957
2005................................................ 8,865
2006................................................ 10,876
2007................................................ 9,269
Thereafter.......................................... -
-------------
$ 41,906
=============
-58-
MEDSOURCE TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
8. RELATED-PARTY TRANSACTIONS
CLOSING FEES AND MANAGEMENT FEES
The Company had entered into management services agreements (MSAs) with
entities associated with certain of the Company's directors and stockholders
whereby the Company paid fees plus reimbursement of out-of-pocket expenses for
management services rendered. Fees incurred for the years ended June 30, 2002,
June 30, 2001 and July 1, 2000 totaled $1.5 million, $1.7 million, and $1.5
respectively. In addition, pursuant to the MSAs, the Company paid fees based on
a percentage of the aggregate consideration of each future business acquisition,
plus reimbursement of out-of-pocket expenses. Such fees and expenses totaled
$0.3 million, $0.6 million, and $0.5 million relating to the acquisitions made
in the years ended June 30, 2002, June 30, 2001, and July 1, 2000 ,
respectively. As of April 2002 all MSA's were terminated.
REAL ESTATE LEASES
Certain of the Company's subsidiaries lease their facilities from related
parties. Total rent expense under these for the years ended June 30, 2002, June
30, 2001 and July 1, 2000 was approximately $0.6 million, $0.7 million, and $1.1
million, respectively. Future minimum lease commitments at June 30, 2002 in
connection with these related-party leases are approximately $0.6 million per
year with a total future commitment of $4.9 million.
9. INCOME TAXES
The income tax benefit (expense) consists of the following (in thousands):
YEAR ENDED
------------------------------------
JUNE 30, JUNE 30, JULY 1,
2002 2001 2000
--------- -------- ----------
Current:
Federal............................ $ 208 $ -- $ --
State.............................. (90) (70) (150)
--------- -------- ----------
118 (70) (150)
Deferred:
Federal............................ -- -- 599
State.............................. -- -- 86
--------- -------- ----------
-- -- 685
--------- -------- ----------
$ 118 $ (70) $ (535)
========= ======== ==========
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components of
deferred tax assets and liabilities are as follows (in thousands):
-59-
JUNE 30, JUNE 30, JULY 1,
2002 2001 2000
------------ ---------- ----------
Deferred tax assets:
Organization costs........................................................$ 889 $ 1,798 $ 2,337
Nondeductible reserves and current liabilities............................ 900 1,335 621
Restructuring reserve..................................................... 1,330 3,704 --
Net operating loss carryforwards.......................................... 16,838 8,708 4,145
Valuation reserve......................................................... (12,805) (6,147) (1,853)
------------ ---------- ----------
Total deferred tax assets........................................... 7,132 9,398 5,250
Deferred tax liabilities:
Identified intangible assets.............................................. (1,450) (6,187) (3,275)
Property, plant, and equipment............................................ (1,666) (1,530) (433)
Goodwill.................................................................. (4,013) (1,662) (1,542)
Other..................................................................... (3) (19) --
------------ ---------- ----------
Total deferred tax liabilities...................................... (7,132) (9,398) (5,250)
------------ ---------- ----------
Net deferred tax liabilities....................................................$ -- $ -- $ --
============ ========== ===========
The Company has U.S. net operating loss carryforwards of approximately
$42.0 million which expire at different times beginning in 2019 and extending
through 2022.
A reconciliation between the income tax benefit computed at the federal
statutory rate and the recorded income tax benefit (expense) is as follows (in
thousands):
JUNE 30, JUNE 30, JULY 1,
2002 2001 2000
----------- ----------- ----------
Income tax benefit computed at the federal statutory rate....... $ 2,698 $ 6,785 $ 2,300
State income taxes, net of federal benefit...................... 315 899 178
Restructuring reserve, portion not deductible for tax purposes.. -- (882) --
Amortization of goodwill, not deductible for tax purposes....... -- (401) (153)
Valuation reserve............................................... (3,108) (6,462) (1,853)
Other........................................................... 213 (9) 63
----------- ----------- ----------
Income tax benefit (expense).................................... $ 118 $ (70) $ 535
=========== =========== ==========
10. MANDATORY REDEEMABLE CONVERTIBLE STOCK AND STOCKHOLDERS' EQUITY
MANDATORY REDEEMABLE CONVERTIBLE STOCK
Series B
On March 30, 1999, the Company sold 300,000 shares of 6% Series B
Cumulative Convertible Redeemable Preferred Stock (the Series B preferred
stock), $0.01 par value per share, for cash in a private placement. On May 14,
1999, the Company sold an additional 32,728 shares for cash in a private
placement.
-60-
MEDSOURCE TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
All Series B preferred stock were converted in connection with the Company's IPO
on March 27, 2002. As a result of the conversion, the Company paid $4.8 million
in accrued dividends.
Series C
On October 24, 2000, the Company sold 40,000 shares of 6% Series C
Cumulative Convertible Redeemable Preferred Stock (the Series C preferred
stock), $0.01 par value per share, for cash in a private placement. On April 18,
2001, the Company sold an additional 300 shares for cash in a private placement.
In addition to the shares purchased at a price of $1,000 per share, each
purchaser also received an option to purchase an additional .2857 shares at a
price of $1,000 per share for each share acquired. The option was exercisable
prior to or coincident with the earlier to occur of (i) a qualified public
offering (as defined) and (ii) October 24, 2001. The options were not exercised
and expired on October 24, 2001. All Series C preferred stock were converted in
connection with the Company's IPO on March 27, 2002.
In connection with the Company's initial public offering, our Series C
preferred stock converted into a number of shares of our common stock based upon
the initial public offering price of our common stock. The Company's net loss
for the fiscal year ending June 30, 2002 therefore reflects a deemed preferred
stock dividend of approximately $21.3 million for the value of the additional
shares of our common stock issued to the holders of our Series C preferred stock
upon conversion and to reflect the beneficial conversion feature.
Series D
In conjunction with the acquisition of ACT Medical, Inc. (see Note 3), the
Company issued 33,423 shares of 6% Series D Cumulative Convertible Redeemable
Preferred Stock (the Series D preferred stock), $0.01 par value per share, and
rolled over options for an additional 6,920 shares of Series D preferred stock.
All Series D preferred stock were converted in connection with the Company's IPO
on March 27, 2002.
OTHER PREFERRED AND COMMON STOCK
Series A
On March 30, 1999, the Company issued 37,440 shares of Series A Preferred
Stock (the Series A preferred stock), $.01 par value per share, in connection
with the acquisition of businesses (see Note 3--Acquisitions). In addition, the
Company also issued 600 shares of Series A preferred stock to key employees of
an acquired company in conjunction with the acquisition. The fair value of these
shares totaled approximately $201,000 and was included in the Company's
organization and start-up costs in the period ended July 3, 1999. Subsequent to
March 30, 1999, the Company sold an additional 330 shares of Series A preferred
stock to key employees for cash at fair value as determined at March 30, 1999.
All Series A preferred stock were converted in connection with the Company's IPO
on March 27, 2002.
Series Z
On March 30, 1999, the Company sold 65,000 shares of Series Z Convertible
Nominal Value Redeemable Preferred Stock (the Series Z preferred stock), $0.01
par value per share, for cash in a private placement (see Note 7--Long-Term
Debt). The Series Z preferred stock had no dividend rights and was senior only
to the common stock with respect to rights on liquidation. The Series Z
preferred stock was convertible at the option of the holder into common stock at
any time. The initial conversion rate was one
-61-
MEDSOURCE TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
share of Series Z preferred stock for 10 shares of common stock, subject to
anti-dilution provisions. All Series Z preferred stock were converted in
connection with the Company's IPO on March 27, 2002.
Series E
On January 4, 2002, the Company issued 6,000 shares of its 6% Series E
Preferred Stock (the Series E preferred stock), $.01 par value per share, for
cash in a private placement (see Note 3--Acquisitions). The Series E preferred
stock accrues dividends at $60 per year during the first year from issuance,
payable at the discretion of the Board of Directors, and at the rate of $160 per
year on a retroactive basis after the first anniversary of issuance. During
April 2002, there were 4,065 of the Series E preferred stock redeemed for $1,000
per share plus accumulated dividends. As of June 30, 2002 there were 1,935
shares of Series E preferred stock issued and outstanding.
Common Stock
On April 14, 1998, the Company was incorporated with the sale of 100 shares
of common stock at $1 per share. In February 1999, an additional 65 shares were
sold to individuals at $1,000 per share. On March 30, 1999, in conjunction with
the acquisitions and the commencement of business operations, the stock was
split 2,209-for-1 (adjusting the pre-split shares to 363,594 shares) and an
additional 38,706 shares were sold for cash to existing stockholders. The amount
paid for the common stock was based on fair value. Also on March 30, 1999,
42,500 shares of common stock were issued in connection with the acquisition of
a business (see Note 3--Acquisitions). In January 2000, the Company's common
stock was split 10-for-1 and all share references to common stock have been
adjusted to give effect to the split. The adjusted post-split outstanding common
shares was 4,448,000.
On March 27, 2002, the Company commenced its initial public offering
("IPO") in which it initially sold 8,340,000 shares of common stock at a price
of $12.00 per share. The net proceeds of the IPO, which the Company received on
April 2, 2002, after deducting underwriting discounts, were approximately $93.1
million. The Company used these proceeds to pay down senior debt in the amount
of $66.3 million, extinguish senior subordinated debt in the amount of $21.4
million (including a $1.4 million pre-payment fee), redeem Series E preferred
stock in the amount of $4.1 million (including dividends), redeem Series F
preferred stock in the amount of $4.1 million (including dividends), pay accrued
and unpaid dividends on Series B preferred stock in the amount of $4.8 million
and to pay fees under service agreements with Kidd & Co. and Whitney Mezzanine
Management Company. The Company also incurred approximately $2.0 million in
other expenses related to the IPO. Additionally, in April 2002, the Company's
underwriters exercised their option to purchase an additional 1,251,000 shares
of common stock at $12.00 per share, with 926,000 shares sold by the Company and
325,000 shares sold by two stockholders. This resulted in additional net
proceeds, which the Company received on April 17, 2002, of $10.3 million after
deducting underwriting discounts.
Upon consummation of the IPO all shares of the Company's Series A, Series
B, Series C, Series D and Series Z preferred stock converted to common stock.
The conversion amounts were as follows:
-62-
MEDSOURCE TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Series A............................................1,918,500
Series B............................................3,327,279
Series C............................................3,934,870
Series D............................................1,769,549
Series Z..............................................650,000
Series C Warrant........................................2,916
ACCUMULATED UNPAID DIVIDENDS
Dividends accumulated and unpaid on the Series E preferred stock through
June 30, 2002 were $27,000. No dividends may be paid on the common stock until
accumulated unpaid dividends are paid on the preferred stock. The accumulated
and unpaid dividends of the Series E preferred stock are accrued and have been
added to the carrying value of the stock with an offsetting charge to
accumulated deficit. Dividends are only required to be paid on the Series E
preferred stock upon a liquidation or redemption.
STOCK OPTIONS
The Company has reserved 4,430,000 shares of its common stock for issuance
to directors, officers, employees, and consultants under the 1999 Stock Plan
(the Plan). The table below shows the activity in the Plan:
WEIGHTED AVERAGE
OPTIONS SHARES INITIAL
OUTSTANDING RESERVED EXERCISE PRICE
------------- ------------ ----------------
Balance at July 3, 1999............................... 945,720 804,280
Reserved........................................ 840,459 (804,459) 14.57
Granted......................................... (345,109) 345,109 12.07
------------- ------------
Balance at July 1, 2000............................... 1,441,070 308,930
Reserved........................................ -- 1,680,000
Granted......................................... 1,555,660 (1,555,660) 17.13
Exercised....................................... (20,308) -- 13.99
Canceled........................................ (401,038) 401,038 14.40
------------- ------------
Balance at June 30, 2001.............................. 2,575,384 834,308 15.54
Reserved........................................ -- 1,000,000
Granted......................................... 739,624 (739,624)) 16.96
Exercised....................................... (400) -- 12.00
Canceled........................................ (461,996) 461,996 17.58
------------- ------------
Balance at June 30, 2002.............................. 2,852,612 1,556,680 $ 15.58
============= ============
The options outstanding at June 30, 2002 include 567,607 options with an
initial exercise price of $11.62-$13.20 per share, 341,535 options with an
initial exercise price of $14.00-$15.40 per share, 657,857 options with an
exercise price of $15.94-$16.25 per share, 1,081,113 options with an exercise
price of $17.00-$18.63 per share, and 204,500 options with an exercise price of
$20.00 per share. Options granted through June 30, 2002 are exercisable for 10
years from date of grant and vest 25% each year. The initial exercise price of
the options applies to the options vesting at the first anniversary date. The
exercise price remains fixed for all options except for options granted prior to
the year ended July 30, 2001, excluding
-63-
MEDSOURCE TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
grants at $16.24 in the fiscal year ended July 1, 2000 which are fixed, when
vesting at the second, third, and fourth anniversary dates have exercise prices
equal to 110%, 121%, and 133.1%, respectively, of the initial exercise price of
the options. There were 592,784 options outstanding with an initial exercise
price between $12.00-$16.00 per share and 504,040 options outstanding with an
initial exercise price between $16.24 and $20.00 per share that were fully
vested and exercisable at June 30, 2002. The weighted average grant date fair
values of options to purchase common stock granted in fiscal years 2002 and 2001
were $16.96 and $17.13, respectively.
As permitted under SFAS No. 123, the Company has not recognized
compensation expense for the theoretical value of its options at the grant date.
In determining the fair value of options granted, the Company used the minimum
value option-pricing model with the following weighted average assumptions:
risk-free interest rate of 5.5%; dividend yield of zero; and an expected option
life of four years. Had compensation cost for the Company's stock option plan
been based on the fair value of options at the grant date amortized over the
vesting period, the Company's pro forma net loss attributed to common
stockholders and net loss per share attributed to common stockholders would have
been:
2002 2001 2000
---- ---- ----
Pro forma net loss attributed to common stockholders.................. $ (39,788) $ (29,627) $ (14,384)
Pro forma net loss per share attributed to common stockholders........ $ (3.59) $ (5.64) $ (3.10)
The Company also has 210,700 options outstanding that were assumed in
connection with the ACT Medical acquisition (see Note 3 - Acquisitions).
-64-
MEDSOURCE TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
RESERVED SHARES OF COMMON STOCK
The Company has reserved the following shares of common stock as of June
30, 2002:
1999 Stock Plan.............................................. 4,409,292
Series E Warrants............................................ 200,000
Series D Options............................................. 210,700
-----------------
Total.................................................... 4,819,992
=================
11. EMPLOYEE BENEFITS
401(K) PLANS
Certain of the Company's subsidiaries offer their qualified employees the
opportunity to participate in defined contribution retirement plans qualifying
under the provisions of Section 401(k) of the Internal Revenue Code. During the
year ended July 1, 2000, the Company implemented a company-wide plan and, during
the current year, all plans were consolidated into it.
Expenses recorded by the Company with respect to 401(k) plans for the years
ended June 30, 2002, June 30, 2001 and July 1, 2000 were $1.6 million, $0.6
million, and $0.9 million respectively.
12. LEASES
The Company has operating leases relating principally to its buildings.
Total rent expense for the for the years ended June 30, 2002, June 30, 2001, and
July 1, 2000 (including amounts to related parties--see Note 8--Related-Party
Transactions) was approximately $2.5 million, $3.5 million and $2.0 million,
respectively. Future minimum lease commitments at June 30, 2002, for leases with
initial or remaining terms of more than one year, including amounts due to
related parties, are summarized by fiscal year as follows (in thousands):
2003.............................................. $ 2,443
2004.............................................. 2,044
2005.............................................. 1,754
2006.............................................. 1,381
2007.............................................. 1,175
Thereafter........................................ 4,871
---------------
$ 13,668
===============
13. RESTRUCTURING CHARGE
In June 2001, the Company completed a strategic review of its manufacturing
operations and support functions. Based on this review and with approval of the
Board of Directors, management began actions to eliminate redundant facilities
and recorded a restructuring charge of $11.5 million.
Information relating to the restructuring charges is as follows (in
millions):
-65-
MEDSOURCE TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
INCURRED BALANCE
THROUGH AT
INITIAL JUNE 30, JUNE 30,
ACCRUAL RECLASS 2002 2002
----------- -------------- ------------ ------------
Impairment of goodwill and other intangibles.............. $ 3.6 $ -- $ 3.6 $ --
Impairment of property, plant and equipment............... 1.9 1.4 3.3 --
Employee termination benefits............................. 3.8 (0.8) 1.1 1.9
Other direct costs........................................ 2.2 (0.6) 1.1 0.5
----------- -------------- ------------ ------------
$ 11.5 $ -- $ 9.1 $ 2.4
=========== ============== ============ ============
Certain of the Company's manufacturing facilities operate with excess
capacity. Based on the evaluation of the unique and common characteristics of
the various facilities, management determined that it could achieve overall cost
savings by closing three of the facilities, thus improving capacity utilization
and efficiency of the remaining facilities. Criteria in this evaluation
included: current capacity utilization; uniqueness of manufacturing
capabilities; current operating costs; difficulty and cost associated with
relocation and revalidation of key processes and equipment; and customer supply
requirements. Facilities at Danbury, Connecticut, Pittsfield, Massachusetts, and
East Longmeadow, Massachusetts were identified to be closed or sold with
production absorbed into existing facilities in Pennsylvania, Minnesota, New
Hampshire, and Mexico. During fiscal 2002 the Company sold the Pittsfield and
East Long Meadows facilities. The Company expects that the Danbury facility will
be closed by February 2003.
Because management expected that it would not retain all of the customers
served by these three facilities, a portion of the customer base intangible
asset ($0.5 million) was written off as well as the entire remaining acquired
workforce intangible for each facility ($0.5 million). In addition, because
management believes the residual goodwill recorded at each acquisition was
significantly related to the local operations, it concluded that goodwill was
impaired by the closure of the facilities and wrote off the related goodwill
($2.6 million). Other recorded charges related to the restructuring include
employee termination benefits expected to be paid based on the Company's
announced termination benefits policy ($1.8 million), costs of plant and
equipment not expected to be recovered ($3.3 million), and other exit costs
($1.6 million), including costs related to lease terminations, facilities
restoration, equipment dismantlement and disposal, legal costs, and other costs.
Costs related to realignment of leadership positions in the corporate support
organization also were accrued at June 30, 2002 ($1.2 million). A reclass in the
allocation of the reserve as shown in the table above was a result of selling
the Pittsfield and East Longmeadow facilities as opposed to closing them.
Employee termination benefits consist of payments to employees based on the
Company's severance policy of two weeks pay for each year of credited service
with a minimum of six weeks payment and outplacement consultation services. The
$1.8 million accrual for employee termination benefits was based on
approximately 225 individuals estimated to be affected, actual credited service,
and actual compensation. The $1.2 million accrual for corporate management
severance benefits included salary continuation, outplacement consultation
services and legal cost for seven individuals employed by the Company's
corporate headquarters operations whose positions were eliminated as a result of
the Company-wide restructuring. The charge for other direct costs which
aggregated $1.6 million was comprised of estimated costs for (1) lease
terminations, real estate taxes and property insurance of $0.5 million, (2)
plant shut down costs and restoration of facilities to pre-lease conditions of
$0.5 million, (3) dismantlement and disposal of obsolete equipment of $0.3
million, (4) legal costs of $0.2 million and (5) other related shut down costs
of $0.1 million.
The expected payment of all accrued costs as of June 30, 2002 is as
follows:
-66-
MEDSOURCE TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
QUARTERS ENDING
SEPTEMBER 29, DECEMBER 29, MARCH 30,
2002 2002 2003 TOTAL
---- ---- ---- -----
Employee termination benefits.............. $ 0.8 $ 0.7 $ 0.4 $ 1.9
Other direct cost.......................... 0.2 0.2 0.1 0.5
------------ ----------- ---------- -----------
Total...................................... $ 1.0 $ 0.9 $ 0.5 $ 2.4
============ =========== ========== ===========
-67-
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
The information called for by Part III (Items 10, 11, 12 and 13) of Form
10-K is incorporated herein by reference to such information, which will be
contained in our definitive proxy statement relating to our 2002 annual meeting
of stockholders, to be filed pursuant to Regulation 14A under the Securities
Exchange Act of 1934, as amended, within 120 days after the end of the fiscal
year covered by this Form 10-K.
ITEM 14. CONTROLS AND PROCEDURES
Item 14 has been omitted pursuant to the transition provisions of Exchange
Act Release No. 34-46427.
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT, SCHEDULES, AND REPORTS ON FORM 8-K
1. Financial statements:
All financial statements are filed in Part II of this report under Item 8
- -- "Financial Statements and Supplementary Data."
2. Financial statement schedules:
Schedule II -- Valuation and Qualifying Accounts for the three fiscal years
ended June 30, 2002.
All other schedules are omitted as the required information is inapplicable
or the information is presented in our consolidated financial statements and
notes thereto in Item 8 above.
-68-
SCHEDULE II
MEDSOURCE TECHNOLOGIES, INC. AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS
Balance Charged Balance
at to Costs Charged to at End
Beginning and Other of
of Period Expense Accounts Deductions Period
----------- ----------- ------------ ----------- ---------
Year ended June 30, 2002:
Deduct from asset accounts:
Allowance for doubtful accounts...... $596 $530 -- $(480) (1) $646
Year ended June 30, 2001:
Deduct from asset accounts:
Allowance for doubtful accounts...... $427 $101 $295 (2) $(227) (1) $596
Year ended July 1, 2000:
Deduct from asset accounts:
Allowance for doubtful accounts...... $249 $75 $116 (2) $(13) (1) $427
- -------------
(1) Deductions were for write-offs against the allowance.
(2) Represents allowances from acquired companies.
-69-
3. Exhibits:
The following exhibits are filed herewith or are incorporated by reference
to exhibits previously filed with the SEC. We will furnish copies of the
exhibits for a reasonable fee (covering the expense of furnishing copies) upon
request:
EXHIBIT
NUMBER DESCRIPTION
------ -----------
2.1 Asset Purchase Agreement dated December 18, 1998 among the
registrant, Brimfield Acquisition Corp., Brimfield Precision, Inc.
and Image Guided Technologies, Inc. (incorporated by reference to
Exhibit 2.1 filed as part of the registrant's registration
statement on Form S-1, Registration No. 333-76842)
2.2 Asset Contribution and Exchange Agreement dated January 25, 1999
among the registrant, Kelco Acquisition LLC, Kelco Industries,
Inc., Paul D. Kelly, individually and as trustee of the Paul D.
Kelly 1997 Annuity Trust, and Wayne A. Kelly (incorporated by
reference to Exhibit 2.2 filed as part of the registrant's
registration statement on Form S-1, Registration No. 333-76842)
2.3 Stock Contribution and Exchange Agreement dated March 11, 1999
among the registrant, MedSource Technologies, LLC, Laurence S.
Derose, as Special Trustee of the Laurence S. Derose Trust,
Barbara M. Derose, as Trustee of the BMD Irrevocable Trust of
1998, Jeffrey L. Derose, as Trustee of the Jeffrey L. Derose
Irrevocable Trust and Kevin L. Derose, as Trustee of the Kevin L.
Derose Irrevocable Trust (incorporated by reference to Exhibit 2.3
filed as part of the registrant's registration statement on Form
S-1, Registration No. 333-76842)
2.4 Asset Contribution and Exchange Agreement dated March 22, 1999
among the registrant, Hayden Acquisition LLC, W.N. Rushwood, Inc.,
d/b/a/ Hayden Precision Industries, William H. Heywood, William B.
Heywood, Nancy A. Heywood, individually and as trustee of the
Trust for the benefit of Michele Lynn Dunbar, and Michele Lynn
Dunbar, as trustee of the Trust for the benefit of Michele Lynn
Dunbar (incorporated by reference to Exhibit 2.4 filed as part of
the registrant's registration statement on Form S-1, Registration
No. 333-76842)
2.5 Stock Contribution and Exchange Agreement dated March 22, 1999
among the registrant, MedSource Technologies, LLC, Peter J.
Neidecker, Peter J. Neidecker Limited Partnership, Peter C.
Neidecker Irrevocable Trust, Sally N. Morris and Sylvia N. Coors
(incorporated by reference to Exhibit 2.5 filed as part of the
registrant's registration statement on Form S-1, Registration No.
333-76842)
2.6 Asset Contribution and Exchange Agreement dated March 24, 1999
among the registrant, Portlyn Acquisition LLC, Portlyn
Corporation, David E. Porter, Ronald V. Porter, Ronald V. Porter
Amended and Restated Revocable Trust d/t/d 9/7/95, Porter Family
1997 Irrevocable Trust d/t/d 7/8/97 and Shirley J. Porter Amended
and Restated Revocable Trust d/t/d 9/7/95 (incorporated by
reference to Exhibit 2.6 filed as part of the registrant's
registration statement on Form S-1, Registration No. 333-76842)
2.7 Asset Contribution and Exchange Agreement dated as of March 24,
1999 among the registrant, The MicroSpring Company, LLC, The
MicroSpring Co., Inc., George Fowle, William S. Hodgson, Paul J.
Dobson, James F. Marten, David G. Lubrano, Katherine Griswold,
Mary Dashiell, Julie Parsons, Donald E. Milley, Louisa J. Dekkers,
Joseph Keller, Robert F. Coughlin, Benjamin B. Brock, Patricia A.
Van Blarcom, William T. McDonough, Kevin K. Gee, Carmine Sammarco
and In Sup Choi, M.D. (incorporated by reference to Exhibit 2.7
filed as part of the registrant's registration statement on Form
S-1, Registration No. 333-76842)
-70-
EXHIBIT
NUMBER DESCRIPTION
------ -----------
2.8 Asset Purchase Agreement dated as of January 11, 2000 by and among
the registrant, Bespak Inc., Tenax Corporation and Tenax, LLC
(incorporated by reference to Exhibit 2.8 filed as part of the
registrant's registration statement on Form S-1, Registration No.
333-76842)
2.9 Agreement and Plan of Merger dated January 31, 2000 among the
registrant, A.P.X. Acquisition Corp., Apex Engineering, Inc.,
Donald R. Rochelo and Donna L. Rochelo (incorporated by reference
to Exhibit 2.9 filed as part of the registrant's registration
statement on Form S-1, Registration No. 333-76842)
2.10 Agreement and Plan of Merger dated May 15, 2000 among the
registrant, Thermat Acquisition Corp., Thermat Precision
Technology, Inc., Thomas J. Roche and Karl Frank Hens
(incorporated by reference to Exhibit 2.10 filed as part of the
registrant's registration statement on Form S-1, Registration No.
333-76842)
2.11 Agreement and Plan of Merger dated as of December 8, 2000 among
the registrant, ACT Acquisition Corp., ACT Medical, Inc., The
Tolkoff Family Limited Partnership and M. Joshua Tolkoff
(incorporated by reference to Exhibit 2.11 filed as part of the
registrant's registration statement on Form S-1, Registration No.
333-76842)
2.12 Agreement and Plan of Merger dated December 31, 2001 among the
registrant, MedSource Trenton, Inc., HV Technologies, Inc. and
Rudolph E. Carlson (incorporated by reference to Exhibit 2.12
filed as part of the registrant's registration statement on Form
S-1, Registration No. 333-76842)
3.1 Form of registrant's restated certificate of incorporation
(incorporated by reference to Exhibit 3.1 filed as part of the
registrant's registration statement on Form S-1, Registration No.
333-76842)
3.2 Form of registrant's amended and restated bylaws (incorporated by
reference to Exhibit 3.2 filed as part of the registrant's
registration statement on Form S-1, Registration No. 333-76842)
4.1 Specimen certificate representing the registrant's common stock
(incorporated by reference to Exhibit 4.1 filed as part of the
registrant's registration statement on Form S-1, Registration No.
333-76842)
4.2 Credit Agreement among the registrant, MedSource Technologies,
LLC, the domestic subsidiaries of the registrant from time to time
party thereto, the lenders party thereto, First Union National
Bank, as administrative agent, and First Union Securities, Inc.,
as lead arranger (incorporated by reference to Exhibit 4.2 filed
as part of the registrant's registration statement on Form S-1,
Registration No. 333-76842)
10.1 Registration Rights Agreement dated as of March 30, 1999 among the
registrant, William J. Kidd, Carla G. Kidd, Edward R. Mandell, as
Trustee under the Catherine M. Kidd Trust, Edward R. Mandell, as
Trustee under the Cara E. Kidd Trust, Edward R. Mandell, as
Trustee under the Thomas C. Kidd Trust, Clarice E. Webb, John P.
Neafsey, Richard J. Effress, Andrew D. Lipman, Adam D. Lehrhoff,
John C. Hertig, William Altieri, J.H. Whitney Mezzanine Fund,
L.P., Whitney Strategic Partners, III, L.P., J.H. Whitney III,
L.P. and German American Capital Corporation (incorporated by
reference to Exhibit 10.1 filed as part of the registrant's
registration statement on Form S-1, Registration No. 333-76842)
10.2 Registration Rights Agreement dated as of March 30, 1999 among the
registrant, William J. Kidd, Carla G. Kidd, Edward R. Mandell, as
Trustee under the Catherine M. Kidd Trust, Edward R. Mandell, as
Trustee under the Cara E. Kidd Trust, Edward R. Mandell, as
Trustee under the Thomas C. Kidd Trust, Clarice E. Webb, John P.
Neafsey, Richard J. Effress, Andrew D. Lipman, Adam D. Lehrhoff,
John C. Hertig, William Altieri, Portlyn Corporation, Kelco
Industries, Inc., The MicroSpring Company, Inc., Laurence S.
Derose Trust, BMD Irrevocable Trust of 1998, Jeffrey L. Derose
Irrevocable Trust, Kevin L. Derose Irrevocable Trust, W.N.
Rushwood, Inc. d/b/a Hayden Precision Industries, Peter J.
Neidecker, Peter J. Neidecker Limited Partnership, Peter C.
Neidecker Irrevocable Trust, Sally N. Morris and Sylvia N. Coors
(incorporated by reference to Exhibit 10.2 filed as part of the
registrant's registration statement on Form S-1, Registration No.
333-76842)
-71-
EXHIBIT
NUMBER DESCRIPTION
------ -----------
10.3 Registration Rights Agreement dated as of May 14, 1999 between the
registrant and IndoSuez MST Partners (incorporated by reference to
Exhibit 10.3 filed as part of the registrant's registration
statement on Form S-1, Registration No. 333-76842)
10.4 Registration Rights Agreement dated as of May 15, 2000 among the
registrant, Karl F. Hens and Thomas J. Roche (incorporated by
reference to Exhibit 10.4 filed as part of the registrant's
registration statement on Form S-1, Registration No. 333-76842)
10.5 Registration Rights Agreement dated as of January 31, 2000 among
the registrant, Donald R. Rochelo and Donna L. Rochelo
(incorporated by reference to Exhibit 10.5 filed as part of the
registrant's registration statement on Form S-1, Registration No.
333-76842)
10.6 Registration Rights Agreement dated as of October 25, 2000 among
the registrant, The 1818 Fund III, L.P., William J. Kidd, Carla G.
Kidd, Edward R. Mandell, as trustee under the William J. Kidd
Grantor Trust, Richard J. Effress, Andrew D. Lipman, John W.
Galiardo and Manire Limited Partnership (incorporated by reference
to Exhibit 10.6 filed as part of the registrant's registration
statement on Form S-1, Registration No. 333-76842)
10.7 Registration Rights Agreement dated as of December 29, 2000 among
the registrant and each of the former stockholders of ACT Medical,
Inc. (incorporated by reference to Exhibit 10.7 filed as part of
the registrant's registration statement on Form S-1, Registration
No. 333-76842)
10.8 Registration Rights Agreement dated as of February 27, 2001
between the registrant and Thomas Weisel Partners LLC
(incorporated by reference to Exhibit 10.8 filed as part of the
registrant's registration statement on Form S-1, Registration No.
333-76842)
10.9 Registration Rights Agreement dated as of January 2, 2002 among
the registrant and each of the investors in its Series E Preferred
Stock (incorporated by reference to Exhibit 10.9 filed as part of
the registrant's registration statement on Form S-1, Registration
No. 333-76842)
10.10 Registration Rights Agreement dated as of January 2 2002 among the
registrant and each of the former stockholders of HV Technologies,
Inc. (incorporated by reference to Exhibit 10.10 filed as part of
the registrant's registration statement on Form S-1, Registration
No. 333-76842)
*10.11 1999 Stock Plan of the registrant (as amended and restated through
December 14, 2001) (incorporated by reference to Exhibit 10.11
filed as part of the registrant's registration statement on Form
S-1, Registration No. 333-76842)
*10.12 Omnibus Stock Plan of ACT Medical, Inc. (as amended and restated
through April 4, 2000) (incorporated by reference to Exhibit 10.12
filed as part of the registrant's registration statement on Form
S-1, Registration No. 333-76842)
*10.13 2001 Employee Stock Purchase Plan of the registrant (incorporated
by reference to Exhibit 10.13 filed as part of the registrant's
registration statement on Form S-1, Registration No. 333-76842)
*10.14 Employment agreement dated as of August 8, 2000 between the
registrant and Richard J. Effress (incorporated by reference to
Exhibit 10.14 filed as part of the registrant's registration
statement on Form S-1, Registration No. 333-76842)
*10.15 Employment agreement dated as of April 1, 1999 between the
registrant and James Drill (incorporated by reference to Exhibit
10.15 filed as part of the registrant's registration statement on
Form S-1, Registration No. 333-76842)
*10.16 Employment agreement between the registrant and William Ellerkamp
(incorporated by reference to Exhibit 10.16 filed as part of the
registrant's registration statement on Form S-1, Registration No.
333-76842)
*10.17 Employment agreement dated as of April 1, 1999 between the
registrant and Ralph Polumbo (incorporated by reference to Exhibit
10.17 filed as part of the registrant's registration statement on
Form S-1, Registration No. 333-76842)
*10.18 Employment agreement between the registrant and William Ellerkamp
(incorporated by reference to Exhibit 10.18 filed as part of the
registrant's registration statement on Form S-1, Registration No.
333-76842)
*10.19 Employment agreement dated as of April 1, 1999 between the
registrant and Ralph Polumbo (incorporated by reference to Exhibit
10.19 filed as part of the registrant's registration statement on
Form S-1, Registration No. 333-76842)
-72-
EXHIBIT
NUMBER DESCRIPTION
------ -----------
*10.20 Employment agreement between the registrant and Joseph J.
Caffarelli (incorporated by reference to Exhibit 10.20 filed as
part of the registrant's registration statement on Form S-1,
Registration No. 333-76842)
*10.21 Employment agreement between the registrant and Rick McWhorter
(incorporated by reference to Exhibit 10.21 filed as part of the
registrant's registration statement on Form S-1, Registration No.
333-76842)
*10.22 Employment Severance and Termination Agreements, each dated as of
March 2002 between the registrant and Richard J. Effress
(incorporated by reference to Exhibit 10.22 filed as part of the
registrant's registration statement on Form S-1, Registration No.
333-76842)
*10.23 Employment Severance and Termination Agreements, each dated as of
March 2002 between the registrant and Joseph J. Caffarelli
(incorporated by reference to Exhibit 10.23 filed as part of the
registrant's registration statement on Form S-1, Registration No.
333-76842)
*10.24 Employment Severance and Termination Agreements, each dated as of
March 2002 between the registrant and Dan Croteau (incorporated by
reference to Exhibit 10.24 filed as part of the registrant's
registration statement on Form S-1, Registration No. 333-76842)
*10.25 Employment Severance and Termination Agreements, each dated as of
March 2002 between the registrant and Jim Drill (incorporated by
reference to Exhibit 10.25 filed as part of the registrant's
registration statement on Form S-1, Registration No. 333-76842)
*10.26 Employment Severance and Termination Agreements, each dated as of
March 2002 between the registrant and Douglas Woodruff
(incorporated by reference to Exhibit 10.26 filed as part of the
registrant's registration statement on Form S-1, Registration No.
333-76842)
*10.27 Employment Severance and Termination Agreements, each dated as of
March 2002 between the registrant and Rick McWhorter (incorporated
by reference to Exhibit 10.27 filed as part of the registrant's
registration statement on Form S-1, Registration No. 333-76842)
*10.28 Employment Severance and Termination Agreements, each dated as of
March 2002 between the registrant and Ralph Polumbo (incorporated
by reference to Exhibit 10.28 filed as part of the registrant's
registration statement on Form S-1, Registration No. 333-76842)
*10.29 Employment Severance and Termination Agreements, each dated as of
March 2002 between the registrant and Rich Snider (incorporated by
reference to Exhibit 10.29 filed as part of the registrant's
registration statement on Form S-1, Registration No. 333-76842)
10.30 Business Conduct Policy and form of acknowledgement for the
registrant's employees (incorporated by reference to Exhibit 10.30
filed as part of the registrant's registration statement on Form
S-1, Registration No. 333-76842)
10.31 Form of Confidentiality Agreement for the registrant's employees
(incorporated by reference to Exhibit 10.31 filed as part of the
registrant's registration statement on Form S-1, Registration No.
333-76842)
10.32 Form of Disclosure Policy and acknowledgement for the registrant's
employees (incorporated by reference to Exhibit 10.32 filed as
part of the registrant's registration statement on Form S-1,
Registration No. 333-76842)
10.33 Lease dated March 30, 1999 between Paul D. Kelly and Kelco
Acquisition LLC in respect of the premises located at 6320 Zane
Avenue North, Brooklyn Park, Minnesota (incorporated by reference
to Exhibit 10.34 filed as part of the registrant's registration
statement on Form S-1, Registration No. 333-76842)
*10.34 The registrant's Management Bonus Plan description (incorporated
by reference to Exhibit 10.40 filed as part of the registrant's
registration statement on Form S-1, Registration No. 333-76842)
-73-
EXHIBIT
NUMBER DESCRIPTION
------ -----------
10.35 Share Transfer Agreement dated as of March 30, 1999 among the
registrant, J.H. Whitney III, L.P., Whitney Strategic Partners
III, L.P. and the stockholders of the registrant named therein,
and amendment thereto dated June 2000 (incorporated by reference
to Exhibit 10.41 filed as part of the registrant's registration
statement on Form S-1, Registration No. 333-76842)
10.36 Share Escrow Agreement dated as of March 30, 1999 among the
registrant, J.H. Whitney III, L.P., Whitney Strategic Partners
III, L.P. and the stockholders of the registrant named therein
(incorporated by reference to Exhibit 10.42 filed as part of the
registrant's registration statement on Form S-1, Registration No.
333-76842)
21.1 List of Subsidiaries (incorporated by reference to Exhibit 21.1
filed as part of the registrant's registration statement on Form
S-1, Registration No. 333-76842)
23.1 Consent of Ernst & Young LLP
99.1 Certificate of Chief Executive Officer
99.2 Certificate of Chief Financial Officer
- --------
* Management contract, compensation plan or arrangement.
(b) Reports on Form 8-K
None.
-74-
SIGNATURES
Pursuant to the requirements of Section 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 on September 17, 2002.
MEDSOURCE TECHNOLOGIES, INC.
By: /s/ Richard J. Effress
-------------------------------
Name: Richard J. Effress
Title: Chairman and CEO
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 dates indicated.
SIGNATURES TITLE DATE
---------- ----- ----
/s/ Richard J. Effress Chairman of the Board of Directors and Chief September 17, 2002
- ------------------------------- Executive Officer (Principal Executive
Richard J. Effress Officer)
/s/ Joesph J. Caffarelli Senior Vice President and Chief Financial September 17, 2002
- ------------------------------ Officer (Principal Financial Officer and
Joseph J. Caffarelli Principal Accounting Officer)
/s/ Joseph Ciffolillo Director September 17, 2002
- ------------------------------
Joseph Ciffolillo
/s/ John Galiardo Director September 17, 2002
- ------------------------------
John Galiardo
/s/ Wayne Kelly Director September 17, 2002
- ------------------------------
Wayne Kelly
/s/ William J. Kidd Director September 17, 2002
- ------------------------------
William J. Kidd
/s/ T. Michael Long Director September 17, 2002
- ------------------------------
T. Michael Long
/s/ Ross Manire Director September 17, 2002
- ------------------------------
Ross Manire
/s/ Carl Sloane Director September 17, 2002
- ------------------------------
Carl Sloane
-75-
CERTIFICATION BY PRINCIPAL EXECUTIVE OFFICER
I, Richard J. Effress, certify that:
1. I have reviewed this annual report on Form 10-K of MedSource
Technologies, Inc.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact
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 this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual 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 annual report;
[Items 4, 5 and 6 omitted pursuant to the transition provisions of Release
No. 34-46427.]
Date: September 17, 2002
/s/ Richard J. Effress
------------------------------------
Richard J. Effress
Chairman of the Board and Chief
Executive Officer
CERTIFICATION BY PRINCIPAL FINANCIAL OFFICER
I, Joseph J. Caffarelli, certify that:
1. I have reviewed this annual report on Form 10-K of MedSource
Technologies, Inc.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact
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 this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual 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 annual report;
[Items 4, 5 and 6 omitted pursuant to the transition provisions of Release
No. 34-46427.]
Date: September 17, 2002
/s/ Joseph J. Caffarelli
------------------------------------
Joseph J. Caffarelli
Senior Vice President -- Finance
and Chief Financial Officer