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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended March 31, 2009
Commission File Number: 333-130470
Accellent Inc.
(Exact name of registrant as specified in its charter)
Maryland | 84-1507827 | |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification Number) |
100 Fordham Road Wilmington, Massachusetts | 01887 | |
(Address of registrant’s principal executive offices) | (Zip code) |
(978) 570-6900
Registrant’s Telephone Number, Including Area Code:
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 whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ¨ No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer | ¨ | Accelerated filer | ¨ | |||
Non-accelerated filer | x (Do not check if a smaller reporting company) | Smaller reporting company | ¨ |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
As of April 30, 2009, 1,000 shares of the Registrant’s common stock were outstanding. The registrant is a wholly owned subsidiary of Accellent Holdings Corp.
Table of Contents
PART I | FINANCIAL INFORMATION | 3 | ||||
ITEM 1. | Financial Statements | 3 | ||||
Unaudited Condensed Consolidated Balance Sheets | 3 | |||||
Unaudited Condensed Consolidated Statements of Operations | 4 | |||||
Unaudited Condensed Consolidated Statements of Cash Flows | 5 | |||||
Notes to Unaudited Condensed Consolidated Financial Statements | 6 | |||||
ITEM 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations | 18 | ||||
ITEM 3. | Quantitative and Qualitative Disclosures About Market Risk | 26 | ||||
ITEM 4T. | Controls and Procedures | 26 | ||||
PART II | OTHER INFORMATION | |||||
ITEM 1. | Legal Proceedings | 27 | ||||
ITEM 1A. | Risk Factors | 27 | ||||
ITEM 2. | Unregistered Sales of Equity Securities and Use of Proceeds | 27 | ||||
ITEM 3. | Defaults Upon Senior Securities | 27 | ||||
ITEM 4. | Submission of Matters to a Vote of Security Holders | 27 | ||||
ITEM 5. | Other Information | 27 | ||||
ITEM 6. | Exhibits | 28 | ||||
29 |
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ITEM 1. | FINANCIAL STATEMENTS |
Unaudited Condensed Consolidated Balance Sheets
As of March 31, 2009 and December 31, 2008
(in thousands, except share and per share data)
March 31, 2009 | December 31, 2008 | |||||||
Assets | ||||||||
Current assets: | ||||||||
Cash and cash equivalents | $ | 28,735 | $ | 14,525 | ||||
Accounts receivable, net of allowances of $1,320 and $1,154 as of March 31, 2009 and December 31, 2008, respectively | 52,648 | 50,724 | ||||||
Inventories | 58,994 | 64,204 | ||||||
Prepaid expenses and other current assets | 4,277 | 3,954 | ||||||
Total current assets | 144,654 | 133,407 | ||||||
Property and equipment, net | 124,214 | 127,460 | ||||||
Goodwill | 629,854 | 629,854 | ||||||
Other intangible assets, net | 190,770 | 194,505 | ||||||
Deferred financing costs and other assets | 16,876 | 17,505 | ||||||
Total assets | $ | 1,106,368 | $ | 1,102,731 | ||||
Liabilities and stockholder’s equity | ||||||||
Current liabilities: | ||||||||
Current portion of long-term debt | $ | 4,007 | $ | 4,007 | ||||
Accounts payable | 22,739 | 23,285 | ||||||
Accrued payroll and benefits | 14,389 | 11,575 | ||||||
Accrued interest | 12,434 | 5,065 | ||||||
Accrued expenses and other current liabilities | 17,485 | 17,497 | ||||||
Total current liabilities | 71,054 | 61,429 | ||||||
Long-term debt | 697,277 | 702,529 | ||||||
Other long-term liabilities | 35,778 | 36,600 | ||||||
Total liabilities | 804,109 | 800,558 | ||||||
Stockholder’s equity: | ||||||||
Common stock, par value $0.01 per share, 50,000,000 shares authorized and 1,000 shares issued and outstanding at March 31, 2009 and December 31, 2008 | — | — | ||||||
Additional paid-in capital | 633,996 | 633,914 | ||||||
Accumulated other comprehensive loss | (2,579 | ) | (1,974 | ) | ||||
Accumulated deficit | (329,158 | ) | (329,767 | ) | ||||
Total stockholder’s equity | 302,259 | 302,173 | ||||||
Total liabilities and stockholder’s equity | $ | 1,106,368 | $ | 1,102,731 | ||||
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
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Unaudited Condensed Consolidated Statements of Operations
For the three months ended March 31, 2009 and 2008
(in thousands)
Three Months Ended | ||||||||
March 31, 2009 | March 31, 2008 | |||||||
Net sales | $ | 126,349 | $ | 128,967 | ||||
Cost of sales (exclusive of amortization) | 91,465 | 94,817 | ||||||
Gross profit | 34,884 | 34,150 | ||||||
Selling, general and administrative expenses | 13,715 | 14,502 | ||||||
Research and development expenses | 679 | 751 | ||||||
Restructuring and other charges | 1,337 | 1,583 | ||||||
Amortization of intangible assets | 3,735 | 3,735 | ||||||
Income from operations | 15,418 | 13,579 | ||||||
Interest expense, net | (15,002 | ) | (17,047 | ) | ||||
Other income (expense) | 916 | (1,492 | ) | |||||
Income (loss) before income tax expense | 1,332 | (4,960 | ) | |||||
Income tax expense | 723 | 2,752 | ||||||
Net income (loss) | $ | 609 | $ | (7,712 | ) | |||
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
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Unaudited Condensed Consolidated Statements of Cash Flows
For the three months ended March 31, 2009 and 2008
(in thousands)
March 31, 2009 | March 31, 2008 | |||||||
Cash flows from operating activities: | ||||||||
Net income (loss) | $ | 609 | $ | (7,712 | ) | |||
Adjustments to reconcile net income (loss) to net cash provided by operating activities: | ||||||||
Depreciation and amortization | 9,103 | 8,660 | ||||||
Amortization of debt discounts and debt issuance costs | 1,049 | 1,049 | ||||||
Restructuring and other charges, net of payments | 587 | 920 | ||||||
Deferred income taxes | 398 | 790 | ||||||
Non-cash compensation expense | 118 | 719 | ||||||
Loss on derivative instruments | 185 | 878 | ||||||
Loss on disposal of property and equipment | 40 | 4 | ||||||
Changes in operating assets and liabilities: | ||||||||
Accounts receivable | (2,097 | ) | (11,995 | ) | ||||
Inventories | 4,998 | (1,597 | ) | |||||
Prepaid expenses and other current assets | (644 | ) | 750 | |||||
Accounts payable and accrued expenses | 9,528 | 15,167 | ||||||
Net cash provided by operating activities | 23,874 | 7,633 | ||||||
Cash flows from investing activities: | ||||||||
Purchase of property and equipment | (4,038 | ) | (2,877 | ) | ||||
Proceeds from sale of assets | 11 | 12 | ||||||
Net cash used in investing activities | (4,027 | ) | (2,865 | ) | ||||
Cash flows from financing activities: | ||||||||
Proceeds from borrowings on long-term debt | — | 16,000 | ||||||
Principal payments on long-term debt | (5,378 | ) | (17,058 | ) | ||||
Repurchase of parent company stock | — | (1,898 | ) | |||||
Net cash used in financing activities | (5,378 | ) | (2,956 | ) | ||||
Effect of exchange rate changes on cash and cash equivalents: | (259 | ) | 157 | |||||
Increase in cash and cash equivalents | 14,210 | 1,969 | ||||||
Cash and cash equivalents at beginning of period | 14,525 | 5,688 | ||||||
Cash and cash equivalents at end of period | $ | 28,735 | $ | 7,657 | ||||
Supplemental disclosure of cash flow information: | ||||||||
Cash paid for interest | $ | 6,534 | $ | 8,386 | ||||
Cash paid for income taxes | $ | 401 | $ | 274 | ||||
Property and equipment purchases included in accounts payable | $ | 976 | $ | 1,526 |
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
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Notes to Unaudited Condensed Consolidated Financial Statements
March 31, 2009
1. Summary of significant accounting policies
Basis of Presentation
The unaudited condensed consolidated financial statements include the accounts of Accellent Inc. and its subsidiaries (collectively, the “Company”). All intercompany transactions have been eliminated.
We have prepared the accompanying unaudited condensed consolidated financial statements pursuant to the rules and regulations of the Securities and Exchange Commission (SEC) regarding interim financial reporting. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. We have prepared the accompanying unaudited condensed consolidated financial statements on the same basis as the audited financial statements, and these financial statements include all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of the results of the interim periods presented. The operating results for the interim periods presented are not necessarily indicative of the results expected for the full fiscal year. These unaudited financial statements should be read in conjunction with the audited financial statements included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2008.
There have been no significant changes in our adoption of new accounting pronouncements or in our application of our significant accounting policies that were disclosed in our Annual Report on Form 10-K for the fiscal year ended December 31 2008, other than as discussed below.
Recent Accounting Pronouncements
In May 2008, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 162, “The Hierarchy of Generally Accepted Accounting Principles.” This statement identifies the sources of accounting principles and the framework for selecting the principles to be used in the preparation of financial statements of nongovernmental entities that are presented in conformity with generally accepted accounting principles in the United States. The adoption of SFAS No. 162 will not have a material impact on our consolidated financial statements.
In March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities” (“SFAS 161”). SFAS 161 enhances the disclosure requirements of SFAS No. 133 “Accounting for Derivative Instruments and Hedging Activities” by requiring disclosure of the fair values of derivative instruments and associated gains and losses and requires disclosure of derivative features that are subject to credit-risk. The adoption of SFAS 161 is required for interim periods beginning after November 15, 2008 which for the Company is the three months ended March 31, 2009. The adoption of SFAS No. 161 did not have a material impact on the accompanying unaudited condensed consolidated financial statements.
In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements — an amendment of Accounting Research Bulletin No. 51” (“ARB 51”). SFAS 160 amends ARB 51 to establish accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. The Company adopted SFAS 160 effective January 1, 2009. The Company does not have any noncontrolling interests within its consolidated subsidiaries.
In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements,” (“SFAS 157”). SFAS 157 defines fair value, establishes a framework for measuring fair value in accordance with GAAP, and expands the required disclosures about fair value measurements. In February 2008, the FASB issued FASB Staff Position No. SFAS 157-2, “Effective Date of FASB Statement No. 157” (“SFAS 157-2”), which provided a one year deferral of the effective date of SFAS 157 for non-financial assets and liabilities, except those that are recognized or disclosed in the financial statements at fair value at least annually. In accordance with this interpretation, the Company adopted the provisions of SFAS 157, effective January 1, 2008, with respect to its financial assets and liabilities that are measured at fair value on a recurring basis and adopted the provisions of SFAS 157-2 on January 1, 2009 with respect to non-financial assets and liabilities within the consolidated financial statements. The adoption of SFAS 157-2 on January 1, 2009 did not have a material effect on our consolidated results of operations, consolidated cash flows or consolidated financial position.
In December 2007, the FASB issued SFAS No. 141(R) (revised 2007), “Business Combinations” (“SFAS 141R”). SFAS 141R was revised to improve the relevance, representational faithfulness and comparability of the information that a reporting entity provides in its financial reports about a business combination and its effects. It establishes principles and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, liabilities assumed and any noncontrolling interest in the acquiree; recognizes and measures the goodwill acquired in the business combination or a gain from a bargain purchase; and determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination. SFAS 141(R) is applied prospectively, with one exception for income taxes, and is effective for business combinations made by the Company on or after January 1, 2009.
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2. Stock-based compensation
The Company maintains a 2005 Equity Plan for Key Employees of Accellent Holdings Corp. (the “2005 Equity Plan”), which provides for grants of incentive stock options, nonqualified stock options, restricted stock units and stock appreciation rights. Vesting is determined in the applicable stock option agreement and generally occurs either in equal installments over five years from the date of grant (“Time-Based”), or upon achievement of certain performance targets, over a five-year period (“Performance-Based”). Targets underlying the vesting of Performance Based shares are generally achieved upon the attainment of a specified level of Adjusted EBITDA, as defined in the Company’s Amended Credit Agreement (see Note 7), measured each calendar year. The vesting requirements for Performance Based shares permit a catch-up of vesting should the target not be achieved in a calendar year but achieved in a subsequent calendar year, over the five year vesting period. In addition, as a result of the acquisition of the Company in 2005, the Company exchanged fully vested stock options to acquire common shares of the Company for 4,901,107 fully vested stock options, or “Roll-Over” options, of Accellent Holdings Corp. which are recorded as a liability until such options are exercised, forfeited, expired or settled.
The table below summarizes the activity relating to the Roll-Over options during the three months ended March 31, 2009 and 2008:
2009 | 2008 | |||||||||||
Liability (in thousands) | Roll-Over Shares Outstanding | Liability (in thousands) | Roll-Over Shares Outstanding | |||||||||
Balance at January 1 | $ | 1,100 | 619,466 | $ | 6,506 | 2,624,673 | ||||||
Shares repurchased | — | — | (1,898 | ) | (1,029,763 | ) | ||||||
Shares exercised | — | — | (2,987 | ) | (746,706 | ) | ||||||
Shares forfeited | — | — | (144 | ) | (82,220 | ) | ||||||
Fair value adjustment to liability | 6 | — | 38 | — | ||||||||
Balance at March 31 | $ | 1,106 | 619,466 | $ | 1,515 | 765,984 | ||||||
Our stock-based compensation expense reflects the fair value of stock-based awards measured at the grant date that is recognized over the relevant service period and includes any adjustments to the fair value of our liability related to the Roll-Over options. We estimate the fair value of each stock-based award on the date of grant using the Black-Scholes option valuation model. The Black-Scholes option pricing model incorporates assumptions regarding stock price volatility, the expected life of options, a risk-free interest rate and dividend yield.
The following tables summarize the classification of stock-based compensation as reflected in our unaudited condensed consolidated statements of operations and the recorded stock compensation by type of award for the three months ended March 31, 2009 and 2008:
Classification of expense:
Three Months Ended | |||||||
March 31, 2009 | March 31, 2008 | ||||||
Cost of sales | $ | 4 | $ | (24 | ) | ||
Selling, general and administrative | 84 | 90 | |||||
Total | $ | 88 | $ | 66 | |||
Stock compensation expense by type of award:
Three Months Ended | |||||||
March 31, 2009 | March 31, 2008 | ||||||
Time based vesting awards | $ | 37 | $ | (49 | ) | ||
Performance based vesting awards | — | — | |||||
Restricted stock awards | 75 | 77 | |||||
Roll-over options | 6 | 38 | |||||
Total expense | $ | 118 | $ | 66 | |||
At March 31, 2009, the Company has determined that attainment of the 2009 targets necessary for Performance Based shares to vest is not likely to be achieved, Accordingly no expense related to performance shares was recorded during the three months ended March 31, 2009. The total unvested Performance Based shares and their aggregate fair value at March 31, 2009 are 3,394,023 and $2.8 million, respectively.
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3. Restructuring and other charges
Q1 2009 Reduction in Force
During the three months ended March 31, 2009, the Company eliminated 207 positions across both manufacturing and administrative functions as part of a company wide effort to reduce costs and streamline operations. All affected employees were offered individually determined severance arrangements. As a result of this action, the Company recorded $1.3 million in restructuring charges during the three months ended March 31, 2009.
Q1 2008 Reduction in Force
During the three months ended March 31, 2008, the Company eliminated 102 positions across both manufacturing and administrative functions as part of an effort to reduce costs. All affected employees were offered severance arrangements. As a result of this action, the Company recorded $1.6 million in restructuring charges during the three months ended March 31, 2008.
Summary of restructuring actions
The following table summarizes the recorded liabilities and activity related to restructuring activities for the three months ended March 31, 2009 (in thousands):
Employee costs | Other exit costs | Total | |||||||||
Balance at January 1, 2009 | $ | 400 | $ | 69 | $ | 469 | |||||
Restructuring charges incurred | 1,337 | — | 1,337 | ||||||||
Payments | (750 | ) | — | (750 | ) | ||||||
Balance at March 31, 2009 | $ | 987 | $ | 69 | $ | 1,056 | |||||
All restructuring actions have been completed and accrued restructuring costs at March 31, 2009 are expected to be paid in cash within twelve months and are therefore classified as current liabilities within accrued expenses and other current liabilities in the accompanying unaudited condensed consolidated balance sheet at March 31, 2009.
4. Income taxes
We provide for deferred income taxes resulting from temporary differences between financial and taxable income as well as current and deferred taxes attributable to the states and foreign jurisdictions in which we are required to pay income taxes. We record valuation allowances to reduce deferred tax assets to the amount that is more likely than not to be realized. We have not provided for U.S. income taxes on the undistributed earnings of non-U.S. subsidiaries, as these earnings have been permanently reinvested or would be offset by foreign tax credits.
Income tax expense for the three months ended March 31, 2009 was $0.7 and included $0.4 million of deferred income tax expense for differences in the book and tax treatment of goodwill and $0.3 million in foreign income taxes. Income tax expense for the three months ended March 31, 2008 was $2.8 million and included $0.8 million of deferred income taxes for differences in the book and tax treatment of goodwill, $1.8 million of foreign income taxes and $0.2 million of state income taxes.
The Company believes that it is more likely than not that the Company will not recognize the benefits of its domestic federal and state deferred tax assets. As a result, the Company continues to provide a full valuation allowance to those deferred tax assets. SFAS No.109, “Accounting for Income Taxes,” prevents the netting of deferred tax assets with deferred tax liabilities related to certain intangible assets when determining the need for a valuation allowance. The Company has $20.3 million and $19.9 million of deferred tax liabilities included in other long-term liabilities in the accompanying unaudited condensed consolidated balance sheets as of March 31, 2009 and December 31, 2008, respectively, relating to goodwill basis differences.
The Company is subject to income taxes in the U.S. Federal jurisdiction, and various state and foreign jurisdictions. Tax regulations within each jurisdiction are subject to the interpretation of the related tax law and regulations and require significant judgment to apply. With exception to one state jurisdiction, the Company is not currently under any examination by U.S. Federal, state and local, or non-U.S. tax authorities. The tax years ended December 31, 2004, 2005, 2006 and 2007 remain subject to examination by major tax jurisdictions. However, since the Company has net operating loss carryforwards which may be utilized in future years to offset taxable income, those years may also be subject to review by relevant taxing authorities if utilized, notwithstanding that the statute for assessment may have closed.
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5. Inventories
Inventories at March 31, 2009 and December 31, 2008 consisted of the following (in thousands):
March 31, 2009 | December 31, 2008 | |||||
Raw materials | $ | 15,721 | $ | 18,070 | ||
Work-in-process | 25,603 | 27,105 | ||||
Finished goods | 17,670 | 19,029 | ||||
Total | $ | 58,994 | $ | 64,204 | ||
6. Goodwill and intangible assets
Goodwill is the amount by which the cost of acquired net assets in a business combination exceeds the fair value of net identifiable assets on the date of acquisition. Intangible assets represent the value of the identifiable intangible assets determined in connection with business combinations.
The Company has elected October 31st as its annual impairment assessment date for goodwill and intangible assets and performs additional impairment tests if triggering events occur.
The Company reports all amortization expense related to intangible assets on a separate line in our unaudited condensed consolidated statement of operations. For the three months ended March 31, 2009 and 2008, the Company incurred intangible asset amortization expense related to cost of sales and selling, general and administrative expenses, respectively, as follows (in thousands):
Three Months Ended | ||||||
March 31, 2009 | March 31, 2008 | |||||
Cost of sales | $ | 497 | $ | 497 | ||
Selling, general and administrative | 3,238 | 3,238 | ||||
Total amortization | $ | 3,735 | $ | 3,735 | ||
7. Long-term debt
Long-term debt at March 31, 2009 and December 31, 2008 consisted of the following (in thousands):
March 31, 2009 | December 31, 2008 | |||||||
Amended Credit Agreement: | ||||||||
Term loan, interest at 3.51% and 4.70%, respectively | $ | 382,624 | $ | 388,000 | ||||
Revolving loan, interest at 2.77% and 2.71%, respectively | 16,000 | 16,000 | ||||||
Senior subordinated notes maturing December 1, 2013, interest at 10.5% | 305,000 | 305,000 | ||||||
Capital lease obligations | 16 | 18 | ||||||
Total debt | 703,640 | 709,018 | ||||||
Less—unamortized discount on senior subordinated notes | (2,356 | ) | (2,482 | ) | ||||
Less—current portion | (4,007 | ) | (4,007 | ) | ||||
Long-term debt, excluding current portion | $ | 697,277 | $ | 702,529 | ||||
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8. Derivative instruments
The Company maintains interest rate swap and collar agreements to mitigate exposures to changes in cash flows from movements in variable interest rates on its long-term debt.
The interest rate swap agreement was designated as a cash flow hedge effective November 30, 2006. Upon designation as a cash flow hedge, changes in the fair value of the interest rate swap which relate to the effective portion of the hedge are recorded in Accumulated other comprehensive loss and reclassified into earnings as the underlying hedged interest expense affects earnings. Changes in the fair value of the interest rate swap which relate to the ineffective portion of the interest rate swap are recorded in other income (expense). At March 31, 2009, the notional amount of our swap contract was $150.0 million, and will decrease to $125.0 million on February 27, 2010. The swap contract will expire on November 27, 2010. We will receive variable rate payments (equal to the three-month LIBOR rate) during the term of the swap contract and are obligated to pay fixed interest rate payments (4.85%) during the term of the contract. Every three months, coincident with the reset of the variable rate on the Company’s long-term debt, an amount is reclassified from Accumulated other comprehensive loss to earnings as a result of realized gains or losses from the quarterly contractual settlements on the cash flow hedging instrument. In addition should we determine the cash flow hedge does not meet our requirements for measuring effectiveness, we would reclassify the then current effective portion of the cash flow hedge into earnings over the remaining life of the cash flow hedge. For the next twelve months, the Company expects that approximately $2.1 million that is currently recorded in Accumulated other comprehensive loss will be reclassified into earnings.
In 2008 the interest rate swap agreement did not meet the Company’s method for assessing hedge effectiveness at September 30, 2008, as defined by management at the time the instrument was designated as a cash flow hedge on November 30, 2006. The Company’s policy requires the use of theHypothetical Derivative Method as defined by Statement of Financial Accounting Standards No. 133, “Accounting for Derivative Instruments and Hedging Activities” and further defined by Derivatives Implementation Group Issue No. G-7 (“DIG G-7”). As a result of this hedge ineffectiveness, the Company recognized in earnings the full change in fair value of the derivative instrument from the date the hedge was determined to be ineffective, July 1, 2008, through December 31, 2008. As a result of the ineffectiveness of the hedge in 2008, the Company is required to amortize to earnings over the remaining contractual term of the swap the unrealized losses accumulated during the period of historical effectiveness through June 30, 2008, when the hedge was last assessed as being effective. These accumulated losses amount to $4.1 million and were recorded in Accumulated other comprehensive loss. At both December 31, 2008 and March 31, 2009, the Company evaluated the effectiveness of the hedge and determined that, in accordance with the Company’s policy for measuring effectiveness of the hedge, hedge accounting was appropriate for the three months ended March 31, 2009. Accordingly, only the ineffective portion of the hedge, which was insignificant, and the amortization of the unrealized losses accumulated during the period of historical effectiveness through June 30, 2008, or approximately $0.5 million, was recorded in earnings during the three months ended March 31, 2009. This is included in other income (expense) in the accompanying unaudited condensed consolidated statements of operations. At March 31, 2009, the fair value of the interest rate swap was $6.9 million and is recorded within “Other long-term liabilities” in the accompanying unaudited condensed consolidated balance sheet.
The interest rate collar agreement has not been designated as a cash flow hedge. Therefore, changes in the fair value of the interest rate collar are recorded as other income (expense) as the instrument is marked to fair value at each reporting date. For the three months ended March 31, 2009, the Company recorded other income of $0.3 million relating to the change in fair value of the interest rate collar. The Company’s interest rate collar arrangement expired during the three months ended March 31, 2009.
The following table summarizes the balance sheet presentation of our derivative instruments:
Fair Values of Derivative Instruments | ||||||||||
March 31, 2009 | December 31, 2008 | |||||||||
Balance Location | Fair Value (in thousands) | Balance Location | Fair Value (in thousands) | |||||||
Interest rate contract designated as a hedging instrument under SFAS 133 | Other long-term liabilities | $ | 6,860 | Other long-term liabilities | $ | 7,689 | ||||
Interest rate contract not designated as a hedging instrument under SFAS 133 | — | $ | — | Other long-term liabilities | $ | 285 |
The following table summarizes the activity related to our derivative instrument designated as a cash flow hedge under SFAS 133:
Amount of gain/(loss) recognized in OCI (Effective portion) Three months ended March 31 | Amount of gain/(loss) reclassified from AOCI (Prior effective portion) Three months ended March 31 | Amount of gain/(loss) reclassified from AOCI (effective portion) Three months ended March 31, | Amount of gain/(loss) reclassified from AOCI (Ineffective portion) Three months ended March 31 | |||||||||||||||||||||||
2009 | 2008 | 2009 | 2008 | 2009 | 2008 | 2009 | 2008 | |||||||||||||||||||
Interest rate contract | $ | 830 | $ | (4,934 | ) | $ | (495 | ) | $ | — | 469 | (419 | ) | $ | 25 | $ | (31 | ) |
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The following table summarizes the activity related to our derivative instrument not designated as a hedge:
Location of gain/(loss) recognized in income on derivative | Amount of gain/(loss) recognized in income Three months ended March 31 | ||||||
2009 | 2008 | ||||||
Interest rate contract | Other income (expense) | 285 | (847 | ) |
All gains and losses recognized in our statement of operations related to derivative instruments are included within other income/(expense) and the cash settlement amounts resulting from the difference between our fixed rate on the swap and the variable rates on our term loan debt are included within interest expense, net.
9. Fair value of financial instruments
As discussed in Note 2, the Company uses the Black-Scholes option pricing model to value its liability for roll-over option awards. A roll-forward of the change in fair value of this level 3 financial instrument is also contained in Note 3. The Company’s interest rate swap and collar contracts are valued using an income approach which consists of a discounted cash flow model that takes into account the present value of future cash flows under the terms of the contracts using current market information as of the reporting date, such as prevailing interest rates. The following table provides a summary of the fair values of assets and liabilities recorded at fair value:
Fair Value Measurements at March 31, 2009 using | ||||||||||||
March 31, 2009 | Quoted prices in active markets for identical assets (Level 1) | Significant other observable inputs (Level 2) | Significant unobservable inputs (Level 3) | |||||||||
Liability for Roll-Over options | $ | 1,106 | $ | — | $ | — | $ | 1,106 | ||||
Liability for derivative instruments | $ | 6,860 | $ | — | $ | — | $ | 6,860 |
The change in fair value of our liability for derivative instruments for the three months ended March 31, 2009 is as follows (in thousands):
Fair value, January 1, 2009 | $ | 7,689 | ||
Total gains or losses (realized or unrealized): | ||||
Net loss included in earnings | 470 | |||
Net gain included in other comprehensive income | (1,299 | ) | ||
Fair value, March 31, 2009 | $ | 6,860 | ||
10. Comprehensive income (loss)
Comprehensive loss represents net income (loss) plus the results of any changes in stockholder’s equity related to currency translation and changes in the carrying value of the effective portion of interest rate hedging instruments. For the three months ended March 31, 2009 and 2008, the Company recorded comprehensive income (loss) as follows (in thousands):
Three Months Ended | ||||||||
March 31, 2009 | March 31, 2008 | |||||||
Net income (loss) | $ | 609 | $ | (6,661 | ) | |||
Effect of interest rate hedging instruments | 1,299 | (4,934 | ) | |||||
Cumulative translation adjustments | (1,905 | ) | 1,620 | |||||
Comprehensive income (loss) | $ | 3 | $ | (9,975 | ) | |||
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11. Related party transactions
The Company maintains a management services agreement with its principal equity owner, Kohlberg, Kravis, Roberts & Co., (“KKR”) pursuant to which KKR will provide certain structuring, consulting and management advisory services. During the three months ended March 31, 2009 and 2008, the Company incurred management fees and related expenses pursuant to this agreement of $0.3 million and $0.3 million, respectively. The Company has also historically utilized the services of Capstone Consulting LLC (“Capstone”), an entity affiliated with KKR. No fees were incurred with Capstone during the three months ended March 31, 2009. During the three months ended March 31, 2008, the Company incurred approximately $0.4 million of costs related to consulting services with Capstone. At March 31, 2009, the Company owed KKR and Capstone $0.3 million each for unpaid fees which are included in accrued expenses and other current liabilities on the accompanying unaudited condensed consolidated balance sheet.
The Company sells medical device equipment to Biomet, Inc., which is privately owned by a consortium of private equity sponsors, including KKR. Sales to Biomet, Inc. during the three months ended March 31, 2009 and 2008 totaled $0.4 million and $1.5 million, respectively. At March 31, 2009, accounts receivable from Biomet aggregated $0.3 million.
12. Environmental matters
The Pennsylvania Department of Environmental Protection (“DEP”) has filed a petition for review with the U.S. Court of Appeals for the District of Columbia Circuit challenging recent amendments to the U.S. Environmental Protection Agency (“EPA”) National Air Emissions Standards for hazardous air pollutants from halogenated solvent cleaning operations. These revised standards exempt three industry sectors (aerospace, narrow tube manufacturers and facilities that use continuous web-cleaning and halogenated solvent cleaning machines) from facility emission limits for TCE and other degreaser emissions. The EPA has agreed to reconsider the exemption. Our Collegeville facility meets current EPA control standards for TCE emissions and is exempt from the new lower TCE emission limit since we manufacture narrow tubes. Nevertheless, we have begun to implement a process that will reduce our TCE emissions generated by our Collegeville facility. However, this process will not reduce our TCE emissions to the levels required should a new standard become law.
At March 31, 2009, the Company had a long-term liability of $3.4 million primarily related environmental remeditation at its Collegeville site. The Company has prepared estimates of its potential liability based on available information. Changes in EPA standards, improvement in cleanup technology and discovery of additional information, however, could affect the estimated costs associated with these matters in the future.
13. Contingencies
We are subject to various legal proceedings and claims, either asserted or unasserted, which arise in the ordinary course of business. While the outcome of these claims cannot be predicted with certainty, management does not believe that the outcome of any of these other legal matters will have a material adverse effect on our consolidated financial position or results of operations.
14. Supplemental guarantor condensed consolidating financial statements
In connection with Accellent Inc.’s issuance of the its 10 1/2% Senior Subordinated Notes due 2013 (the “Notes”), all of its domestic subsidiaries (the “Subsidiary Guarantors”) guaranteed on a joint and several, full and unconditional basis, the repayment by Accellent Inc. of such Notes. Certain foreign subsidiaries of Accellent Inc. (the “Non-Guarantor Subsidiaries”) have not guaranteed such indebtedness.
The following tables present the unaudited consolidating statements of operations for the three months ended March 31, 2009 and 2008 of Accellent Inc. (“Parent”), the Subsidiary Guarantors and the Non-Guarantor Subsidiaries, the unaudited condensed consolidating balance sheets as of March 31, 2009 and December 31, 2008, and the unaudited condensed consolidating statements of cash flows for the three months ended March 31, 2009 and 2008.
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Unaudited Consolidating Statements of Operations —
Three months ended March 31, 2009 (in thousands):
Parent | Subsidiary Guarantors | Non- Guarantor Subsidiaries | Eliminations | Consolidated | ||||||||||||||||
Net sales | $ | — | $ | 119,838 | $ | 6,734 | $ | (223 | ) | $ | 126,349 | |||||||||
Cost of sales | — | 87,389 | 4,299 | (223 | ) | 91,465 | ||||||||||||||
Selling, general and administrative expenses | 30 | 13,008 | 677 | — | 13,715 | |||||||||||||||
Research and development expenses | — | 498 | 181 | — | 679 | |||||||||||||||
Restructuring charges | — | 1,337 | — | — | 1,337 | |||||||||||||||
Amortization of intangibles | 3,735 | — | — | — | 3,735 | |||||||||||||||
(Loss) income from operations | (3,765 | ) | 17,606 | 1,577 | — | 15,418 | ||||||||||||||
Interest (expense) income, net | (15000 | ) | (3 | ) | 1 | — | (15,002 | ) | ||||||||||||
Loss on derivative instruments | (185 | ) | — | — | — | (185 | ) | |||||||||||||
Other (expense) income | — | (26 | ) | 1,127 | — | 1,101 | ||||||||||||||
Equity in earnings of affiliates | 19,559 | 2,288 | — | (21,847 | ) | — | ||||||||||||||
Income tax (expense) | — | (306 | ) | (417 | ) | — | (723 | ) | ||||||||||||
Net income (loss) | $ | 609 | $ | 19,559 | $ | 2,288 | $ | (21,847 | ) | $ | 609 | |||||||||
Unaudited Consolidating Statements of Operations —
Three months ended March 31, 2008 (in thousands):
Parent | Subsidiary Guarantors | Non- Guarantor Subsidiaries | Eliminations | Consolidated | ||||||||||||||||
Net sales | $ | — | $ | 120,774 | $ | 8,337 | $ | (144 | ) | $ | 128,967 | |||||||||
Cost of sales | — | 89,944 | 5,017 | (144 | ) | 94,817 | ||||||||||||||
Selling, general and administrative expenses | 30 | 13,689 | 783 | — | 14,502 | |||||||||||||||
Research and development expenses | — | 543 | 208 | — | 751 | |||||||||||||||
Restructuring charges | — | 1,583 | — | — | 1,583 | |||||||||||||||
Amortization of intangibles | 3,735 | — | — | — | 3,735 | |||||||||||||||
(Loss) income from operations | (3,765 | ) | 15,015 | 2,329 | — | 13,579 | ||||||||||||||
Interest expense, net | (16,995 | ) | (56 | ) | 4 | — | (17,047 | ) | ||||||||||||
Loss on derivative instruments | (878 | ) | — | — | — | (878 | ) | |||||||||||||
Other expense | — | (119 | ) | (495 | ) | — | (614 | ) | ||||||||||||
Equity in earnings of affiliates | 13,926 | 1,203 | — | (15,129 | ) | — | ||||||||||||||
Income tax expense | — | (2,117 | ) | (635 | ) | — | (2,752 | ) | ||||||||||||
Net (loss) income | $ | (7,712 | ) | $ | 13,926 | $ | 1,203 | $ | (15,129 | ) | $ | (7,712 | ) | |||||||
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Unaudited Condensed Consolidating Balance Sheets
March 31, 2009 (in thousands):
Parent | Subsidiary Guarantors | Non- Guarantor Subsidiaries | Eliminations | Consolidated | ||||||||||||
Cash and cash equivalents | $ | — | $ | 26,597 | $ | 2,138 | $ | — | $ | 28,735 | ||||||
Receivables, net | — | 49,939 | 2,962 | (253 | ) | 52,648 | ||||||||||
Inventories | — | 56,242 | 2,752 | — | 58,994 | |||||||||||
Prepaid expenses and other | 85 | 4,092 | 100 | — | 4,277 | |||||||||||
Total current assets | 85 | 136,870 | 7,952 | (253 | ) | 144,654 | ||||||||||
Property, plant and equipment, net | — | 114,402 | 9,812 | — | 124,214 | |||||||||||
Intercompany receivable | — | 101,137 | 16,061 | (117,198 | ) | — | ||||||||||
Investment in subsidiaries | 295,437 | 27,787 | — | (323,224 | ) | — | ||||||||||
Goodwill | 629,854 | — | — | — | 629,854 | |||||||||||
Intangibles, net | 190,770 | — | — | — | 190,770 | |||||||||||
Deferred financing costs and other assets | 15,060 | 1,506 | 310 | — | 16,876 | |||||||||||
Total assets | $ | 1,131,206 | $ | 381,702 | $ | 34,135 | $ | (440,675 | ) | $ | 1,106,368 | |||||
Current portion of long-term debt | $ | 4,000 | $ | 7 | $ | — | $ | — | $ | 4,007 | ||||||
Accounts payable | — | 22,272 | 1,328 | (861 | ) | 22,739 | ||||||||||
Accrued liabilities | 12,431 | 28,714 | 3,163 | — | 44,308 | |||||||||||
Total current liabilities | 16,431 | 50,993 | 4,491 | (861 | ) | 71,054 | ||||||||||
Note payable and long-term debt | 803,827 | 10,040 | — | (116,590 | ) | 697,277 | ||||||||||
Other long-term liabilities | 8,689 | 25,232 | 1,857 | — | 35,778 | |||||||||||
Total liabilities | 828,947 | 86,265 | 6,348 | (117,451 | ) | 804,109 | ||||||||||
Equity | 302,259 | 295,437 | 27,787 | (323,224 | ) | 302,259 | ||||||||||
Total liabilities and equity | $ | 1,131,206 | $ | 381,702 | $ | 34,135 | $ | (440,675 | ) | $ | 1,106,368 | |||||
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Unaudited Condensed Consolidating Balance Sheets
December 31, 2008 (in thousands)
Parent | Subsidiary Guarantors | Non- Guarantor Subsidiaries | Eliminations | Consolidated | ||||||||||||
Cash and cash equivalents | $ | — | $ | 12,379 | $ | 2,146 | $ | — | $ | 14,525 | ||||||
Receivables, net | — | 48,313 | 2,621 | (210 | ) | 50,724 | ||||||||||
Inventories | — | 61,086 | 3,118 | — | 64,204 | |||||||||||
Prepaid expenses and other | 117 | 3,499 | 338 | — | 3,954 | |||||||||||
Total current assets | 117 | 125,277 | 8,223 | (210 | ) | 133,407 | ||||||||||
Property, plant and equipment, net | — | 117,201 | 10,259 | — | 127,460 | |||||||||||
Intercompany receivable | — | 89,476 | 15,278 | (104,754 | ) | — | ||||||||||
Investment in subsidiaries | 285,138 | 27,322 | — | (312,460 | ) | — | ||||||||||
Goodwill | 629,854 | — | — | — | 629,854 | |||||||||||
Intangibles, net | 194,505 | — | — | — | 194,505 | |||||||||||
Deferred financing costs and other assets | 16,225 | 1,159 | 121 | — | 17,505 | |||||||||||
Total assets | $ | 1,125,839 | $ | 360,435 | $ | 33,881 | $ | (417,424 | ) | $ | 1,102,731 | |||||
Current portion of long-term debt | $ | 4,000 | $ | 7 | $ | — | $ | — | $ | 4,007 | ||||||
Accounts payable | — | 21,869 | 1,603 | (187 | ) | 23,285 | ||||||||||
Accrued liabilities | 5,063 | 26,066 | 3,008 | — | 34,137 | |||||||||||
Total current liabilities | 9,063 | 47,942 | 4,611 | (187 | ) | 61,429 | ||||||||||
Note payable and long-term debt | 807,295 | 11 | — | (104,777 | ) | 702,529 | ||||||||||
Other long-term liabilities | 7,308 | 27,344 | 1,948 | — | 36,600 | |||||||||||
Total liabilities | 823,666 | 75,297 | 6,559 | (104,964 | ) | 800,558 | ||||||||||
Equity | 302,173 | 285,138 | 27,322 | (312,460 | ) | 302,173 | ||||||||||
Total liabilities and equity | $ | 1,125,839 | $ | 360,435 | $ | 33,881 | $ | (417,424 | ) | $ | 1,102,731 | |||||
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Unaudited Condensed Consolidating Statements of Cash Flows -
Three months ended March 31, 2009 (in thousands):
Parent | Subsidiary Guarantors | Non- Guarantor Subsidiaries | Eliminations | Consolidated | |||||||||||||||
Net cash (used in) provided by operating activities | $ | (7,076 | ) | $ | 29,311 | $ | 1,639 | $ | — | $ | 23,874 | ||||||||
Cash flows from investing activities: | |||||||||||||||||||
Purchase of property and equipment | — | (3,421 | ) | (617 | ) | — | (4,038 | ) | |||||||||||
Proceeds from sale of equipment | — | 11 | — | — | 11 | ||||||||||||||
Net cash used in investing activities | — | (3,410 | ) | (617 | ) | — | (4,027 | ) | |||||||||||
Cash flows from financing activities: | |||||||||||||||||||
Principal payments on long-term debt | (5,376 | ) | (2 | ) | — | — | (5,378 | ) | |||||||||||
Intercompany receipts (advances) | 12,452 | (11,669 | ) | (783 | ) | — | — | ||||||||||||
Cash flows provided by (used in) financing activities | 7,076 | (11,671 | ) | (783 | ) | — | (5,378 | ) | |||||||||||
Effect of exchange rate changes in cash | — | (12 | ) | (247 | ) | — | (259 | ) | |||||||||||
Net increase in cash and cash equivalents | — | 14,218 | (8 | ) | — | 14,210 | |||||||||||||
Cash and cash equivalents, beginning of period | — | 12,379 | 2,146 | — | 14,525 | ||||||||||||||
Cash and cash equivalents, end of period | $ | — | $ | 26,597 | $ | 2,138 | $ | — | $ | 28,735 | |||||||||
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Unaudited Consolidating Statements of Cash Flows—
Three months ended March 31, 2008 (in thousands):
Parent | Subsidiary Guarantors | Non- Guarantor Subsidiaries | Eliminations | Consolidated | |||||||||||||||
Net cash (used in) provided by operating activities | $ | (9,616 | ) | $ | 14,057 | $ | 3,192 | $ | — | $ | 7,633 | ||||||||
Cash flows from investing activities: | |||||||||||||||||||
Purchase of property and equipment | — | (2,652 | ) | (225 | ) | — | (2,877 | ) | |||||||||||
Proceeds from sale of equipment | — | 6 | 6 | — | 12 | ||||||||||||||
Net cash used in investing activities | — | (2,646 | ) | (219 | ) | — | (2,865 | ) | |||||||||||
Cash flows from financing activities: | |||||||||||||||||||
Proceeds from long-term debt | 16,000 | — | — | — | 16,000 | ||||||||||||||
Principal payments on long-term debt | (17,000 | ) | (58 | ) | — | — | (17,058 | ) | |||||||||||
Repurchase of parent company stock | (1,898 | ) | (1,898 | ) | |||||||||||||||
Intercompany receipts (advances) | 10,616 | (8,553 | ) | (2,063 | ) | — | — | ||||||||||||
Deferred financing fees | — | — | — | ||||||||||||||||
Cash flows provided by (used in) financing activities | 9,616 | (10,509 | ) | (2,063 | ) | — | (2,956 | ) | |||||||||||
Effect of exchange rate changes in cash | — | (8 | ) | 165 | — | 157 | |||||||||||||
Net increase in cash and cash equivalents | — | 849 | 1,075 | — | 1,969 | ||||||||||||||
Cash and cash equivalents, beginning of year | — | 3,976 | 1,712 | — | 5,688 | ||||||||||||||
Cash and cash equivalents, end of period | $ | — | $ | 4,870 | $ | 2,787 | $ | — | $ | 7,657 | |||||||||
15. Subsequent Events
In May 2009, the Board of Directors (the “Board”) approved the closure of the Company’s facility in Huntsville, Alabama. It is anticipated that all activities necessary to wind down operations will be completed by December 31, 2009. We anticipate that the operations of the Huntsville facility will be transferred to other Accellent facilities. At March 31, 2009, the carrying value of long-lived assets at the Huntsville facility totaled approximately $4.8 million, which consisted of machinery and equipment of approximately $3.6 million and land and building of approximately $1.2 million. The Company is in the process of evaluating the impaired amount, if any, of these long-lived assets and determining the amount of restructuring charges, if any, as a result of the planned closure.
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ITEM 2. | MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
Some of the information in this Quarterly Report on Form 10-Q includes “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. All statements other than statements of historical facts included in this Form 10-Q, including, without limitation, certain statements under “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” may constitute forward-looking statements. In some cases you can identify these “forward-looking statements” by words like “may,” “should,” “expects,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,” “potential” or “continue” or the negative of those words and other comparable words. 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 under the heading “Risk Factors” contained in our annual report on Form 10-K filed on March 31, 2009 with the Securities and Exchange Commission (File No. 333-130470) for the Company’s fiscal year ended December 31, 2008. The following discussion and analysis should be read in conjunction with the unaudited condensed consolidated financial statements and notes thereto included herein.
We undertake no obligation to update publicly or publicly revise any forward-looking statement, whether as a result of new information, future events or otherwise.
Unless the context otherwise requires, references in this Form 10-Q to “Accellent,” “we,” “our” and “us” refer to Accellent Inc. and its consolidated subsidiaries.
Overview
We believe that we are a leading provider of outsourced precision manufacturing services in our target markets within the medical device industry. We offer our customers design and engineering, precision component manufacturing, device assembly and supply chain management services. We have extensive resources focused on providing our customers with reliable, high quality, cost-efficient, integrated outsourced solutions. Based on discussions with our customers, we believe we often become the sole supplier of manufacturing and engineering services for the products we provide to our customers.
We primarily focus on leading companies in large and growing markets within the medical device industry including cardiology, drug delivery, endoscopy, neurology and orthopaedics. Our customers include many of the leading medical device companies including Abbott Laboratories, Boston Scientific, Johnson & Johnson, Medtronic, Smith & Nephew, St. Jude Medical, Stryker and Zimmer. While revenues are aggregated by us to the ultimate parent of a customer, we typically generate diversified revenue streams within these large customers across separate customer divisions and multiple products.
During the first three months of 2009, our 10 largest customers accounted for approximately 72% of revenues with three customers, Medtronic, Johnson & Johnson and Boston Scientific each accounting for greater than 10% of revenues. We expect net sales from our largest customers to continue to constitute a significant portion of our net sales in the future.
Results of Operations
The following table sets forth percentages derived from the consolidated statements of operations for the three months ended March 31, 2009 and 2008, presented as a percentage of net sales.
Three Months Ended | ||||||
March 31, 2009 | March 31, 2008 | |||||
STATEMENT OF OPERATIONS DATA: | ||||||
Net sales | 100.0 | % | 100 | % | ||
Cost of sales | 72.4 | 73.5 | ||||
Gross profit | 27.6 | 26.5 | ||||
Selling, general and administrative expenses | 10.8 | 11.3 | ||||
Research and development expenses | 0.5 | 0.6 | ||||
Restructuring charges | 1.1 | 1.2 | ||||
Amortization of intangibles | 3.0 | 2.9 | ||||
Income from operations | 12.2 | 10.5 | ||||
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Three Months Ended March 31, 2009 Compared to Three Months Ended March 31, 2008
Net Sales
Net sales for the three months ended March 31, 2009 were $126.3 million, a decrease of $2.7 million, or 2.1%, compared to net sales of $129.0 million for the three months ended March 31, 2008. The decrease in net sales is attributable to net price decreases totaling approximately $3.9 million, caused by passing through to our customers, decreases in precious metal prices which do not benefit gross profit. This decrease was offset by $1.2 million of increased demand for the Company’s products.
Gross Profit
Gross profit for the three months ended March 31, 2009 was $34.9 million compared to $34.2 million for the three months ended March 31, 2008. The $0.7 million increase in gross profit was a result of the increase in volume of net sales, excluding precious metals, during the three months ended March 31, 2009 compared to the three months ended March 31, 2008.
Selling, General and Administrative Expenses
Selling, general and administrative expenses, or SG&A, were $13.7 million for the three months ended March 31, 2009 compared to $14.5 million for the three months ended March 31, 2008. The $0.8 million decrease in SG&A expenses was primarily attributable to lower commission costs of approximately $0.7 million related to sales compensation resulting from changes in the manner in which we compensate our sales personnel, lower professional fees of approximately $0.2 million and lower travel and related expenses of approximately $0.2 million. These decreases were offset by executive severance costs totaling approximately $0.2 million and increased salary expenses of $0.1 million due to changes in our senior management team.
Research and Development Expenses
Research and development, or R&D, expenses for the three months ended March 31, 2009 were $0.7 million compared to $0.8 million for the three months ended March 31, 2008, primarily due to lower discretionary spending during the three months ended March 31, 2009 compared to the three months ended March 31, 2008.
Restructuring Charges
During the three months ended March 31, 2009, the Company eliminated 207 positions across both manufacturing and administrative functions as part of a company wide effort to reduce costs and streamline operations. As a result of this action, the Company recorded $1.3 million in restructuring charges during the three months ended March 31, 2009.
During the three months ended March 31, 2008, the Company eliminated 102 positions across both manufacturing and administrative functions as part of an effort to reduce costs. As a result of this action, the Company recorded $1.6 million in restructuring charges during the three months ended March 31, 2008.
Interest Expense, net
Interest expense, net, decreased $2.0 million to $15.0 million for the three months ended March 31, 2009, compared to $17.0 million for the three months ended March 31, 2008. The decrease was primarily the result of lower interest rates, and lower long term debt outstanding during the three months ended March 31, 2009 compared to the three months ended March 31, 2008.
Other Income (expense)
Included in other income (expense) are gains and losses on our derivative instruments and foreign currency translation gains and losses. We have entered into interest rate swap and collar agreements to reduce our exposure to variable interest rates on our outstanding term loan borrowings. During the three months ended March 31, 2009, we realized a $0.2 million loss on our derivative instruments compared to a $0.9 million loss during the three months ended March 31, 2008. In addition, we recorded a currency exchange gain of approximately $1.1 million during the three months ended March 31, 2009 compared to a currency exchange loss of $0.6 million during the three months ended March 31, 2008. This difference of $1.7 million is due to larger changes in foreign currency exchange rates during the three months ended March 31, 2009 compared to the three months ended March 31, 2008.
Income Tax Expense
Income tax expense for the three months ended March 31, 2009 was $0.7 and included $0.4 million of deferred income tax expense for differences in the book and tax treatment of goodwill and $0.3 million in foreign income taxes. Income tax expense for the three months ended March 31, 2008 was $2.8 million and included a $0.8 million deferred income tax charge for differences in the book and tax treatment of goodwill, $1.8 million of foreign income taxes and $0.2 million of state income taxes. The lower tax expense is primarily attributable to a legal entity re-organization completed in 2008.
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Liquidity and Capital Resources
Our principal source of liquidity is our cash flows from operations and borrowings under our senior secured credit facility, entered into in connection with the acquisition of the Company by KKR in 2005, which includes a $75.0 million revolving credit facility and a seven-year $400.0 million term facility (as amended, the “Amended Credit Agreement”). At March 31, 2009, we had $8.8 million of letters of credit outstanding and $16.0 million of outstanding loans under the revolving portion of our credit facility. In 2008, a member of the Company’s lending syndicate entered bankruptcy proceedings under the United States bankruptcy protection provisions. That member’s un-drawn revolving loan commitment at the time it entered bankruptcy proceedings totaled $6.3 million. As of March 31, 2009, the Company had not received notice regarding this member’s commitment, however, we believe that the un-drawn amount of this member’s commitment may not be available for future borrowing under the revolver. At March 31, 2009, we had $43.9 million available to borrow under the revolving portion of our senior secured credit facility.
Cash provided by operations was $23.9 million during the three months ended March 31, 2009, compared to $7.6 million during the three months ended March 31, 2008. The increase in cash provided by operating activities is primarily attributable to improvements in working capital utilization which increased cash provided by operating activities by approximately $10.9 million and $5.4 million of increased cash generated from operating profit.
Cash used in investing activities was $4.0 million during the three months ended March 31, 2009 compared to $2.9 million during the three months ended March 31, 2008. The increase in cash used in investing activities is due to higher purchases of property and equipment.
During the three months ended March 31, 2009, cash used in financing activities was $5.4 million compared to cash used in financing activities of $3.0 million during the three months ended March 31, 2008. The change in cash used in financing activities was primarily to due to higher repayments on our term loan during the three months ended March 31, 2009 compared to the three months ended March 31, 2008. The increased repayments reflect a required excess cash flow payment, as defined, made in March 2009.
Our senior secured credit facility contains restrictions on our ability to make capital expenditures. Based on current estimates, management believes that the amount of capital expenditures permitted to be made under the facility will be adequate to grow our business according to our business strategy and to maintain our continuing operations.
Our debt agreements, as amended, contain various covenants, including a maximum ratio of consolidated net debt to consolidated adjusted EBITDA (“Leverage Ratio”) and a minimum ratio of consolidated adjusted EBITDA to consolidated interest expense (“Coverage Ratio”). Both of these ratios are calculated at the end of each fiscal quarter based on our trailing twelve month financial results.
The Leverage Ratio may not exceed 8.0 to 1.0 for any four fiscal quarter period ending on or up to September 30, 2009, with such maximum permitted Leverage Ratio decreasing to 7.0 to 1.0, 6.0 to 1.0, and 5.0 to 1.0 for each quarter in the consecutive four quarter periods ending on September 30, 2010, September 30, 2011, and September 30, 2012, respectively, and to 4.5 to 1.0 for each fiscal quarter thereafter. The Interest Coverage Ratio may not be less than 1.35 to 1.00 for any four fiscal quarter period ending on or up to September 30, 2009, and increases to 1.55x, 1.75x and 2.00x for each quarter in the consecutive four quarter periods ending on September 30, 2010, September 30, 2011, September 30, 2012, respectively, and to 2.10x for each quarter thereafter. At March 31, 2009, the Company was in compliance with these covenants and we expect to remain in compliance based on current and expected future operating results.
Our ability to make payments on our indebtedness and to fund planned capital expenditures and necessary working capital will depend on our ability to generate cash in the future. This, to a certain extent, is subject to general economic, financial, competitive, legislative, regulatory and other factors that are beyond our control. Based on our current level of operations, we believe our cash flow from operations and available borrowings under our Amended Credit Agreement will be adequate to meet our liquidity requirements for the next 12 months. However, no assurance can be given that this will be the case.
Other Key Indicators of Financial Condition and Operating Performance
EBITDA and Adjusted EBITDA presented in this Form 10-Q are supplemental measures of our performance that are not required by, or presented in accordance with generally accepted accounting principles in the United States, or GAAP. EBITDA and Adjusted EBITDA are not measures of our financial performance under GAAP and should not be considered as alternatives to net income or any other performance measures derived in accordance with GAAP, or as an alternative to cash flow from operating activities as a measure of our liquidity.
EBITDA represents net income (loss) before net interest expense, income tax expense, depreciation and amortization. Adjusted EBITDA is defined as EBITDA further adjusted to give effect to unusual items, non-cash items and other adjustments, all of which are required in calculating covenant ratios and compliance under the indenture governing our 10 1/2% Senior Subordinated Notes due 2013 (the “Senior Subordinated notes”)and under our Amended Credit Agreement.
We believe that the inclusion of EBITDA and Adjusted EBITDA in this Form 10-Q is appropriate to provide additional
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information to investors and debt holders about the calculation of certain financial covenants in the indenture governing the senior subordinated notes and under our Amended Credit Agreement. Adjusted EBITDA is a material component of these covenants. For instance, the indenture governing the senior subordinated notes and our Amended Credit Agreement contain financial covenant ratios, specifically total leverage and interest coverage ratios that are calculated by reference to Adjusted EBITDA. Non-compliance with the financial ratio maintenance covenants contained in our Amended Credit Agreement could result in the requirement to immediately repay all amounts outstanding under such facility, while non-compliance with the debt incurrence ratios contained in the indenture governing the Senior Subordinated notes would prohibit us from being able to incur additional indebtedness other than pursuant to specified exceptions.
We also present EBITDA because we consider it an important supplemental measure of our performance and believe it is frequently used by securities analysts, investors and other interested parties in the evaluation of high yield issuers, many of which present EBITDA when reporting their results. Measures similar to EBITDA are also widely used by us and others in our industry to evaluate and price potential acquisition candidates. We believe EBITDA facilitates operating performance comparison from period to period and company to company by backing out potential differences caused by variations in capital structures (affecting relative interest expense), tax positions (such as the impact on periods or companies of changes in effective tax rates or net operating losses) and the age and book depreciation of facilities and equipment (affecting relative depreciation expense).
In calculating Adjusted EBITDA, as permitted by the terms of our indebtedness, we eliminate the impact of a number of items we do not consider indicative of our ongoing operations and for the other reasons noted above. For the reasons indicated herein, you are encouraged to evaluate each adjustment and whether you consider it appropriate. In addition, in evaluating Adjusted EBITDA, you should be aware that in the future we may incur expenses similar to the adjustments in the presentation of Adjusted EBITDA. Our presentation of Adjusted EBITDA should not be construed as an inference that our future results will be unaffected by unusual or non-recurring items.
EBITDA and Adjusted EBITDA have limitations as analytical tools, and you should not consider them in isolation, or as a substitute for analysis of our results as reported under GAAP. Some of these limitations are:
• | they do not reflect our cash expenditures for capital expenditure or contractual commitments; |
• | they do not reflect changes in, or cash requirements for, our working capital requirements; |
• | they do not reflect the significant interest expense, or the cash requirements necessary to service interest or principal payments on our indebtedness; |
• | although depreciation and amortization are non-cash charges, the assets being depreciated and amortized will often have to be replaced in the future, and EBITDA and Adjusted EBITDA do not reflect cash requirements for such replacements; |
• | Adjusted EBITDA does not reflect the impact of earnings or charges resulting from matters we consider not to be indicative of our ongoing operations, as discussed in our presentation of “Adjusted EBITDA” in this report; and |
• | other companies, including other companies in our industry, may calculate these measures differently than we do, limiting their usefulness as a comparative measure. |
Because of these limitations, EBITDA and Adjusted EBITDA should not be considered as measures of discretionary cash available to us to invest in the growth of our business or reduce our indebtedness. We compensate for these limitations by relying primarily on our GAAP results and using EBITDA and Adjusted EBITDA only as a supplemental measure. For more information, see our unaudited condensed consolidated financial statements and the notes to those statements included elsewhere in this report.
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The following table sets forth a reconciliation of EBITDA to Adjusted EBITDA for the periods indicated (in thousands):
Three Months Ended | ||||||||
March 31, 2009 | March 31, 2008 | |||||||
RECONCILIATION OF NET LOSS TO EBITDA: | ||||||||
Net income (loss) | $ | 609 | $ | (7,712 | ) | |||
Interest expense, net | 15,002 | 17,047 | ||||||
Provision for income taxes | 723 | 2,752 | ||||||
Depreciation and amortization | 9,103 | 8,660 | ||||||
EBITDA | $ | 25,437 | $ | 20,747 | ||||
Adjustments: | ||||||||
Restructuring and other charges | 1,337 | 1,583 | ||||||
Stock-based compensation - employees | 88 | 275 | ||||||
Stock-based compensation - non-employees | 30 | 444 | ||||||
Employee severance and relocation | 431 | 335 | ||||||
Chief executive recruiting costs | — | (26 | ) | |||||
Currency transaction (gain) / loss | (1,104 | ) | 611 | |||||
Loss on derivative instruments | 185 | 878 | ||||||
Loss on sale of property and equipment | 40 | 4 | ||||||
Management fees to stockholder | 289 | 289 | ||||||
Adjusted EBITDA | $ | 26,733 | $ | 25,140 | ||||
Off-Balance Sheet Arrangements
We do not have any “off-balance sheet arrangements” (as such term is defined in Item 303 of Regulation S-K) that are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.
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Contractual Obligations and Commitments
The following table sets forth our long-term contractual obligations as of March 31, 2009 (in thousands):
Total | Less than 1 year | 1-3 years | 3-5 years | More than 5 years | |||||||||||
Senior secured credit facility (1) | $ | 448,474 | $ | 17,980 | $ | 51,376 | $ | 379,118 | $ | — | |||||
Senior subordinated notes (1) | 456,763 | 32,470 | 65,028 | 359,265 | — | ||||||||||
Capital leases | 20 | 9 | 11 | — | — | ||||||||||
Operating leases | 42,999 | 6,359 | 11,744 | 9,408 | 15,488 | ||||||||||
Purchase obligations (2) | 35,255 | 35,255 | — | — | — | ||||||||||
Other long-term obligations (3) | 35,778 | — | 737 | 9,163 | 25,878 | ||||||||||
Total | $ | 1,019,289 | $ | 92,073 | $ | 128,896 | $ | 756,954 | $ | 41,366 | |||||
(1) Includes principal and interest payments. (2) Purchase obligations consist of commitments for material, supplies and machinery and equipment incidental to the ordinary conduct of business. (3) Other long-term obligations include share-based payment obligations of $1.8 million, environmental remediation obligations of $3.4 million, accrued compensation and pension benefits of $2.8 million, deferred income taxes of $20.3 million, accrued swap liability of $6.9 million and other obligations of $0.6 million. |
Critical Accounting Policies
Our unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial statements. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. We base our estimates on historical experience, current conditions and various other assumptions that are believed to be reasonable under the circumstances. Estimates and assumptions are reviewed on an ongoing basis and the effects of revisions are reflected in the unaudited consolidated financial statements in the period they are determined to be necessary. Actual results could differ materially from those estimates under different assumptions or conditions. We believe the following critical accounting policies impact our judgments and estimates used in the preparation of our consolidated financial statements.
Revenue Recognition. The amount of product revenue recognized in a given period is impacted by our judgments made in establishing our reserve for potential future product returns. We provide a reserve for our estimate of future returns against revenue in the period the revenue is recorded. Our estimate of future returns is based on such factors as historical return data and current economic condition of our customer base. The amount of revenue we recognize will be directly impacted by our estimates made to establish the reserve for potential future product returns. To date, the amount of estimated returns has not been material to total net revenues. Our provision for sales returns was $2.7 million and $2.4 million for the three months ended March 31, 2009 and 2008, respectively.
Allowance for Doubtful Accounts. We estimate the collectibility of our accounts receivable and the related amount of bad debts that may be incurred in the future. The allowance for doubtful accounts results from an analysis of specific customer accounts, historical experience, credit ratings and current economic trends. Based on this analysis, we provide allowances for specific accounts where collectibility is not reasonably assured. Our provision for bad debts was $0.1 million for the three months ended March 31, 2009. No bad debt expense was recorded in the three months ended March 31, 2008.
Provision for Inventory Valuation. Inventory purchases and commitments are based upon future demand forecasts. Excess and obsolete inventory are valued at their net realizable value, which may be zero. We periodically experience variances between the amount of inventory purchased and contractually committed to and our demand forecasts, resulting in excess and obsolete inventory valuation charges.
Valuation of Goodwill, Trade Names and Trademarks. Goodwill is the excess of the purchase price over the fair value of identifiable net assets acquired in business combinations. Goodwill and certain of our other intangible assets, specifically trade
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names and trademarks, have indefinite lives. Goodwill and other indefinite life intangible assets are subject to an annual impairment test, or more often if impairment indicators arise, using a fair-value-based approach. In assessing the fair value of goodwill and other indefinite life intangible assets, we make projections regarding future cash flow and other estimates. If these projections or other estimates change, we may be required to record an impairment charge. In 2008, the fair value of the reporting unit significantly exceeded its carrying value.
Valuation of Long-lived Assets. Long-lived assets are comprised of property, plant and equipment and intangible assets with finite lives. We assess the impairment of long-lived assets whenever events or changes in circumstances indicate that the carrying value may not be recoverable through projected undiscounted cash flows expected to be generated by the asset. When we determine that the carrying value of intangible assets and fixed assets may not be recoverable, we measure impairment by the amount by which the carrying value of the asset exceeds the related fair value. Estimated fair value is generally based on projections of future cash flows and other estimates.
Self Insurance Reserves. We accrue for costs to provide self-insured benefits under our workers’ compensation and employee health benefits programs. We determine the accrual for workers’ compensation losses based on estimated costs to resolve each claim. We accrue for self-insured health benefits based on historical claims experience. We maintain insurance coverage to prevent financial losses from catastrophic workers’ compensation or employee health benefit claims. Our financial position or results of operations could be materially impacted in a fiscal quarter due to a material increase in claims. Our accruals for self-insured workers’ compensation and employee health benefits at March 31, 2009 and December 31, 2008 were $4.8 million and $4.2 million, respectively.
Environmental Reserves. We accrue for environmental remediation costs when it is probable that a liability has been incurred and a reasonable estimate of the liability can be made. Our remediation cost estimates are based on the facts known at the current time including consultation with a third-party environmental specialist and external legal counsel. Changes in environmental laws, improvements in remediation technology and discovery of additional information concerning known or new environmental matters could affect our operating results.
Pension and Other Employee Benefits. Certain assumptions are used in the calculation of the actuarial valuation of our defined benefit pension plans. These assumptions include the weighted average discount rate, rates of increase in compensation levels and expected long-term rates of return on assets. If actual results are less favorable than those projected by management, additional expense may be required.
Share Based Payments. We adopted SFAS 123R on January 1, 2006 using the modified prospective transition method, which requires that we record stock compensation expense for all unvested and new awards as of the adoption date. Under the fair value provisions of SFAS 123R, stock-based compensation cost is measured at the grant date based on the fair value of the award and is recognized as expense over the requisite service period. Determining the fair value of stock-based awards at the grant date requires considerable judgment, including estimating the underlying value of the common stock, the expected term of stock options, expected volatility of the underlying stock, and the number of stock-based awards expected to be forfeited due to future terminations. In addition, for stock-based awards where vesting is dependent upon achieving certain operating performance goals, we estimate the likelihood of achieving the performance goals. Differences between actual results and these estimates could have a material impact on our financial results.
Income Taxes. We estimate our income taxes in each of the jurisdictions in which we operate. This process involves estimating our actual current tax exposure together with assessing temporary differences resulting from differing treatment of items, such as goodwill amortization, for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included within our consolidated balance sheet. We then assess the likelihood that our deferred tax assets will be recovered from future taxable income and, to the extent we believe that recovery is not likely, we establish a valuation allowance. To the extent we establish a valuation allowance or increase this allowance in a period, we increase or decrease our income tax provision in our consolidated statement of operations. If any of our estimates of our prior period taxable income or loss require change, material differences could impact the amount and timing of income tax benefits or payments for any period.
The Company provides liabilities for uncertain tax positions in accordance with the requirements of FASB Interpretation No. 48, or FIN 48, “Accounting for Uncertainty in Income Taxes.” FIN 48 requires that we evaluate positions taken or expected to be taken in our income tax filings in all jurisdictions where we are required to file, and provide a liability for any positions that do not meet a “more likely than not” threshold of being sustained if examined by tax authorities.
Hedge Accounting. We use derivative instruments, including interest rate swaps and collars to reduce our risk to variable interest rates on our Amended Credit Agreement. We have documented our swap agreement as a cash flow hedge in accordance with the requirements of SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities.” As a result, changes in the fair value of our swap agreement are recorded in accumulated other comprehensive income and reclassified into earnings as the underlying hedged item affects earnings. Our swap agreement qualifies for this hedge accounting treatment as long as the hedge meets certain effectiveness criteria. We determine the effectiveness of this hedge using the Hypothetical Derivative Method as described in the Derivative Implementation Group Issue No. G-7 (“DIG G-7”). DIG G-7 requires that we create a hypothetical derivative with terms that match our underlying debt agreement. To the extent that changes in the fair value of the
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hypothetical derivative mirror changes in the fair value of the swap agreement, the hedge will be considered effective. The fair values of the swap agreement and hypothetical derivative are based on a discounted cash flow model which contains a number of variables including estimated future interest rates, projected reset dates, and projected notional amounts. A material change in these assumptions, which we experienced in 2008, could cause our hedge to be considered ineffective. If our swap agreement is not treated as a hedge, we would be required to record the change in fair value of the swap agreement in our results of operations, which could have material adverse effect on our results of operations.
New Accounting Pronouncements
In May 2008, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 162, “The Hierarchy of Generally Accepted Accounting Principles.” This statement identifies the sources of accounting principles and the framework for selecting the principles to be used in the preparation of financial statements of nongovernmental entities that are presented in conformity with generally accepted accounting principles in the United States. The adoption of SFAS No. 162 will not have a material impact on our consolidated financial statements.
In March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities” (“SFAS 161”). SFAS 161 enhances the disclosure requirements of SFAS No. 133 “Accounting for Derivative Instruments and Hedging Activities” by requiring disclosure of the fair values of derivative instruments and associated gains and losses and requires disclosure of derivative features that are subject to credit-risk. The adoption of SFAS 161 is required for interim periods beginning after November 15, 2008, which for the Company is the three months ended March 31, 2009. The adoption of SFAS No. 161 did not have a material impact on the accompanying unaudited condensed consolidated financial statements.
In December 2007, the FASB issued SFAS 160, “Noncontrolling Interests in Consolidated Financial Statements — an amendment of Accounting Research Bulletin No. 51” (“ARB 51”). SFAS 160 amends ARB 51 to establish accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. The Company adopted SFAS 160 effective January 1, 2009. The Company does not have any noncontrolling interests within its consolidated subsidiaries.
In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements,” (“SFAS 157”). SFAS 157 defines fair value, establishes a framework for measuring fair value in accordance with GAAP, and expands the required disclosures about fair value measurements. In February 2008, the FASB issued FASB Staff Position No. SFAS 157-2, “Effective Date of FASB Statement No. 157” (“SFAS 157-2”), which provided a one year deferral of the effective date of SFAS 157 for non-financial assets and liabilities, except those that are recognized or disclosed in the financial statements at fair value at least annually. In accordance with this interpretation, the Company adopted the provisions of SFAS 157, effective January 1, 2008, with respect to its financial assets and liabilities that are measured at fair value on a recurring basis and adopted the provisions of SFAS 157-2 on January 1, 2009 with respect to non-financial assets and liabilities within the consolidated financial statements. The adoption of SFAS 157-2 on January 1, 2009 did not have a material effect on our consolidated results of operations, consolidated cash flows or consolidated financial position.
In December 2007, the FASB issued SFAS 141(R) (revised 2007), “Business Combinations” (“SFAS 141R”). SFAS 141R was revised to improve the relevance, representational faithfulness and comparability of the information that a reporting entity provides in its financial reports about a business combination and its effects. It establishes principles and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, liabilities assumed and any noncontrolling interest in the acquiree; recognizes and measures the goodwill acquired in the business combination or a gain from a bargain purchase; and determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination. SFAS 141(R) is applied prospectively, with one exception for income taxes, and is effective for business combinations made by the Company on or after January 1, 2009.
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ITEM 3. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK |
Market Risk
We are subject to market risk associated with change in interest rates and foreign currency exchange rates. We do not use derivative financial instruments for trading or speculative purposes.
Interest Rate Risk
We are subject to market risk associated with change in the London Interbank Offered Rate (“LIBOR”) and the Federal Funds Rate published by the Federal Reserve Bank of New York in connection with outstanding term loans under our senior secured credit facility for which we have an outstanding balance at March 31, 2009 of $382.6 million with an interest rate of 3.51%. We have entered into interest rate agreements to limit our exposure to variable interest rates. At March 31, 2009, the notional amount of our swap contract was $150.0 million, and will decrease to $125.0 million on February 27, 2010. The swap contract will expire on November 27, 2010. We will receive variable rate payments (equal to the three-month LIBOR rate) during the term of the swap contract and are obligated to pay fixed interest rate payments (4.85%) during the term of the contract. During the period when our interest rate swap is in place, a 1% change in interest rates would result in a change in interest expense of approximately $2.3 million per year. Upon the expiration of the swap agreement, a 1% change in interest rates would result in change in interest of approximately $3.8 million per year.
Foreign Currency Risk
We operate manufacturing facilities in foreign countries. Our principal currency exposures relate to the Euro, British pound and Mexican peso. We consider the currency risk to be low, as the majority of the transactions at these locations are denominated in the local currency.
ITEM 4T. | CONTROLS AND PROCEDURES |
The certifications of our principal executive officer and principal financial officer required in accordance with Rule 13a-14(a) under the Exchange Act and Section 302 of the Sarbanes-Oxley Act of 2002 are attached as exhibits to this Form 10-Q. The disclosures set forth in this Item 4T contain information concerning the evaluation of our disclosure controls and procedures, and changes in internal control over financial reporting, referred to in paragraph 4 of the certifications. Those certifications should be read in conjunction with this Item 4T for a more complete understanding of the matters covered by the certifications.
(a) Evaluation of Disclosure Controls and Procedures: Our management, with the participation of our principal executive officer and principal financial officer, has evaluated the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report. The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is properly recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure. Based on this evaluation, our chief executive officer and chief financial officer concluded that our disclosure controls and procedures were effective to provide a reasonable level of assurance that the information required to be disclosed in the reports filed or submitted by us under the Securities Exchange Act of 1934 was recorded, processed, summarized and reported within the requisite time periods.
(b) Changes in Internal Control over Financial Reporting.We are in the process of implementing the Oracle ERP system throughout the entire company. The implementation of Oracle during the first three months of 2009 modified our existing controls at one manufacturing location as they migrated to the Oracle ERP system.
There were no additional changes in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during our first fiscal quarter that materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
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ITEM 1. | Legal Proceedings. |
The Pennsylvania Department of Environmental Protection (“DEP”) has filed a petition for review with the U.S. Court of Appeals for the District of Columbia Circuit challenging recent amendments to the U.S. Environmental Protection Agency (“EPA”) National Air Emissions Standards for hazardous air pollutants from halogenated solvent cleaning operations. These revised standards exempt three industry sectors (aerospace, narrow tube manufacturers and facilities that use continuous web-cleaning and halogenated solvent cleaning machines) from facility emission limits for TCE and other degreaser emissions. The EPA has agreed to reconsider the exemption. Our Collegeville facility meets current EPA control standards for TCE emissions and is exempt from the new lower TCE emission limit since we manufacture narrow tubes. Nevertheless, we have begun to implement a process that will reduce our TCE emissions generated by our facility in Collegeville, PA. However, this process will not reduce our TCE emissions to the levels required should a new standard become law. If the narrow tube exemption were no longer available to us, we may not be able to reduce our Collegeville facility TCE emissions to the levels required by the new EPA standard, resulting in a reduction in our ability to manufacture narrow tubes, which could have a material adverse impact on our financial position and results of operations.
We are subject to various other legal proceedings and claims, either asserted or unasserted, which arise in the ordinary course of business. While the outcome of these other claims cannot be predicted with certainty, management does not believe that the outcome of any of these other legal matters will have a material adverse effect on our consolidated financial position or results of operations.
ITEM 1A. | RISK FACTORS |
For a discussion of our potential risks or uncertainties, please see Part I, Item 1A, of Accellent Inc.’s 2008 Annual Report on Form 10-K filed with the Securities and Exchange Commission. There have been no material changes to the risk factors disclosed in Part I, Item 1A, of Accellent Inc.’s 2008 Annual Report on Form 10-K.
ITEM 2. | UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS |
No unregistered equity securities of the registrant were sold and no repurchases of equity securities were made during the three months ended March 31, 2009.
ITEM 3. | DEFAULTS UPON SENIOR SECURITIES |
Not applicable.
ITEM 4. | SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS |
Not applicable.
ITEM 5. | OTHER INFORMATION |
Not applicable.
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ITEM 6. | EXHIBITS |
Exhibit Number | Description of Exhibits | |
31.1* | Rule 13a-14(a) Certification of Principal Executive Officer | |
31.2* | Rule 13a-14(a) Certification of Principal Financial Officer | |
32.1* | Section 1350 Certification of Principal Executive Officer | |
32.2* | Section 1350 Certification of Principal Financial Officer |
* | Filed herewith. |
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Pursuant to the requirements 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.
Accellent Inc. | ||||
May 15, 2009 | By: | /s/ Robert E. Kirby | ||
Robert E. Kirby | ||||
Chief Executive Officer (Principal Executive Officer) |
Accellent Inc. | ||||
May 15, 2009 | By: | /s/Jeremy A. Friedman | ||
Jeremy A. Friedman | ||||
Chief Financial Officer (Principal Financial Officer) |
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EXHIBIT INDEX
Exhibit Number | Description of Exhibits | |
31.1* | Rule 13a-14(a) Certification of Principal Executive Officer | |
31.2* | Rule 13a-14(a) Certification of Principal Financial Officer | |
32.1* | Section 1350 Certification of Principal Executive Officer | |
32.2* | Section 1350 Certification of Principal Financial Officer |
* | Filed herewith. |
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